Federal Court rejects yet another ATO anti-avoidance decision

The Federal Court has ruled in favour of Mylan Australia, rejecting the Commissioner of Taxation’s claim the taxpayer’s acquisition activities had triggered anti-avoidance rules.

Justice Button’s reasoning largely coincided with the Full Federal Court’s recent findings in Minerva Financial Group Pty Ltd v Commissioner of Taxation.

Most notably, the Court agreed that a taxpayer’s decision to employ a certain scheme partly to obtain a tax benefit will not necessarily trigger the anti-avoidance rules.

In 2007, the US-based Mylan Inc acquired five subsidiary companies of Merck Generics Group, a Dutch science and technology group. Alphapharm, an Australian generics business, was among those acquired.

Based on tax advice, Mylan incorporated a new Australian subsidiary to facilitate the acquisition of Alphapharm. The subsidiary, MAPL, was formed under an Australian holding company.

MAPL then used a mixture of equity and related part debt to fund the acquisition, within the applicable thin capitalisation ‘safe harbour.’

The debt, which accounted for three-quarters of the acquisition funding, was obtained in the form of an AUD-denominated loan from a Mylan subsidiary based in Luxembourg. It was obtained at a fixed interest rate of 10.15 per cent.

The ATO’s amended assessments rejected approximately AUD$589 million worth of interest deductions, claimed in the decade or so following the acquisition agreement.

It did so on the basis that the acquisition funding ‘schemes’ were entered into for the dominant purpose of obtaining a tax benefit, thereby triggering Part IVA anti-avoidance rules.

In making this case, the Commissioner outlined two schemes.

The first related to the taxpayer’s decision to incorporate the Australian holding companies, to amend the acquisition agreement to have the Australian subsidiary carry out the acquisition, and to issue the Luxembourg loan.

Had the acquisition, instead, been entirely funded by a Mylan group company with no debt pushdown into Australia, the taxpayer would not have obtained the same tax benefit, it claimed.

The second scheme targeted by the Commissioner related to the narrower decision to issue the Luxembourg loan at a relatively high fixed interest rate and principal, thereby maximising deductions.

While the Court agreed it “appeared” the taxpayer had obtained a tax benefit by application of the schemes, it did not agree this was the dominant purpose of entering into them.

Funding the acquisition with 100 per cent equity would have made less commercial sense than going beyond the simple tax benefit.

In reaching this conclusion, the Court agreed that intercompany debt was believed to be more flexible than equity and, therefore, made good commercial sense.

Further, Justice Catherine Button said the Commissioner failed to make the case that the 10.15 per cent interest rate attached to the loan was necessarily set so high simply to maximise deductions.

Following the Minerva decision, Justice Button undertook an objective assessment by application of the eight factors listed under s 177D(b) of the Income Tax Assessment Act 1936 (Cth) in ruling for the taxpayer.

Interestingly, however, the Court did admit the taxpayer’s failure to refinance the loan when an opportunity presented itself complicated their case.

“It was common ground … that interest rates declined significantly following the collapse of Lehman Brothers in September 2008 which marked the beginning of the GFC,” said Justice Button, agreeing this afforded ample opportunity to seek refinancing.

On this point, the taxpayer submitted three claims.

Firstly, that a failure to renegotiate interest rates is a “matter of commercial judgment” unrelated to Part IVA; secondly, that the entity lacked a unilateral power to refinance; and, thirdly, that a failure to do something has no relevance to a Part IVA “matter.”

“None of those arguments hold water,” said Justice Button, claiming a “commercial judgment” is not “insulated” from the provisions and that a dominant purpose analysis can include reference to alternative courses of action.

On the second point, Justice Button said that, while the taxpayer did not have a unilateral refinancing power, it in no way lacked a right to seek refinancing.

The Court agreed the failure to seek refinancing did suggest the taxpayer did not regard interest expenses as something to “be minimised wherever possible.”

“However, it must be recalled that, as the Full Court said in Minerva … obtaining a tax benefit is not enough, and nor is desiring the tax benefit,” said Justice Button.

“In addition, to the extent that the failure to refinance indicates that the deductions for interest expenses were welcome, this matter cannot be considered in isolation from other factors.