Talking Tax – Issue 183
By Frank Hinoporos and Rachel Law
A revisit of the Myer Emporium principle and Greig’s silver lining in the face of large losses - Greig v The FCT [2020] FCAFC 25
In Greig v FCT [2020] FCAFC 25, the Full Federal Court of Australia (FCAFC) overturned the Federal Court’s decision to disallow Mr Greig (Taxpayer) from claiming deductions for over $11 million in losses that occurred throughout his share trading activities and over $500,000 in associated legal costs.
The FCAFC agreed with the Taxpayer that the loss incurred in respect of the shares was of a revenue nature and therefore deductible under section 8-1 of the Income Tax Assessment Act 1997. This was on the basis that the Taxpayer purchased the shares with the intention of making a profit from their sale and that the transaction amounted to a ‘business operation or commercial transaction’.
From 2007 to 2014, the Taxpayer engaged in a significant number of share transactions. The majority of these related to a company called Nexus Energy Limited (Nexus), in which, the Taxpayer purchased $11,851,762 worth of shares over 64 separate occasions between 28 March 2012 and 9 May 2014. The shares decreased in value and eventually Nexus was put into voluntary administration and the Taxpayer had to transfer his shares for nil consideration.
The Taxpayer maintained that these acquisitions occurred as part of a scheme he called his ‘Target Profit Strategy’ where he would identify underperforming shares, hold them for a short term and then sell them to realise a profit.
To characterise the losses as deductible, the Taxpayer had to show that the test set out in the Myer Emporium case was satisfied, namely that the he had incurred his losses from a ‘business operation or commercial transaction’ entered into for the purpose of making a profit.
It was accepted here and in the first instance that the shares were obtained for a profit making purpose, which was the Taxpayer’s ‘Target Profit Strategy’. In determining whether the share transactions as a whole amounted to a ‘business operation or commercial transaction’ the FCAFC applied the test expressed in Parson’s Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (The Law Book Company Limited, 1985), namely that the transaction must be the sort of thing a business person or person in trade does.
The FCAFC found that the actions of the Taxpayer were similar to those that would be undertaken by a business person due to the following factors:
- the Taxpayer’s actions in engaging professional help;
- the size and volume of the transactions;
- the Taxpayer was using his own business knowledge obtained from working in the mining, energy and resources sector to identify undervalued stocks; and
- the Taxpayer was taking steps to defend the value of the asset by acquiring more shares to defeat a takeover bid and fighting a proposed deed of company arrangement in court.
For these reasons, the requirements in both limbs of the Myer Emporium principle were satisfied and the deduction for the losses incurred in relation to the ‘Target Profit Strategy’ was allowed.
This decision was not unanimous with Derrington J dissenting. Derrington J believed the commercial or business nature of the operation or transaction must have existed at the time the transaction was entered into. He did not accept the reliance on post-acquisition conduct to lend the transaction the required commercial nature.
Derrington J was critical of the Taxpayer’s lack of clarity as to when the scheme was intended to start, stating at [150] the reason for this may be:
'because Mr Greig was not aware that he was engaging in such a strategy until after he had consulted his accountants following the sustaining of significant losses in the 2015 income tax year.'
It was not all good news for the Taxpayer. The FCAFC noted the distinction between the tax treatment of the Nexus shares and the other shares that were obtained by the taxpayer from 2007 to 2014 seemed artificial. It is possible that any revised assessment will treat all gains and losses from the Taxpayer’s trading activities over the period as being on a revenue account.
While this case largely turned on its facts, the discussion by the FCAFC is a useful reminder of the types of activities that may lead a transaction to be treated on revenue rather than capital account, including the actions of the taxpayer that can lead to dealings being characterised as a business or commercial transaction.
$867 million in deductions denied to energy powerhouse - Origin Energy Limited v FCT (No 2) [2020] FCA 409
In Origin Energy Limited v FCT (No 2) [2020] FCA 409, the Federal Court (Court) dismissed an appeal by Origin Energy Limited (Origin) to categorise upfront capacity charges totalling approximately $867 million as deductible.
Background
Origin Energy Electricity Limited (OEEL), a member of Origin’s tax consolidated group, entered into two agreements with Eraring Energy (Eraring), an energy producer owned by the NSW Government. One agreement, amongst other things, allowed OEEL to sell the energy produced by Eraring at the Eraring Power Station. The other agreement was in relation to the Shoalhaven Scheme, which involves pumping water to a reservoir to be stored until it is needed to generate electricity. In exchange for this, OEEL placed approximately $867 million on interest bearing deposit with the NSW Treasury who would then pay a yearly capacity charge to Eraring on OEEL’s behalf.
Positions
OEEL claimed that the capacity charges were deductible either as an expense under s 8-1 of the Income Tax Assessment Act 1997 (ITAA97) or, if they were capital in nature, as ‘black hole’ expenditure over five years under s 40-880 ITAA97.
The Federal Commissioner of Taxation (FCT) argued that the expenditure resulted in an extension of OEEL’s profit making structure and was therefore capital in nature. The FCT also argued that the exceptions to the ‘black hole’ expenditure deduction provision applied.
Decision
In finding for the FCT, the Court’s key considerations were:
- OEEL acquired Eraring’s trading business, not just the right to energy produced by them;
- the agreement gave OEEL substantial control over the amount of electricity produced;
- OEEL was involved in the management and operation of the power stations;
- the contractual arrangements resulted in OEEL taking on business risk and opportunities which is a characteristic of acquiring a new, or extending an existing, business structure. These risks included:
- OEEL taking the obligation to supply the fuel for the plant;
- OEEL bearing the cost of capital improvements it requested; and
- the fees and costs under the agreement were structured in a way that some of the risks of electricity generation and generation failure were shared between Eraring end OEEL.
- although the capacity charges reoccurred annually, OEEL paid them up front which lessened any inferences that would usually be drawn from a period payment arrangement; and
- the term of the agreements were for a significant period of time (22 and 28 years) which was also the expected remaining life of the power stations.
The Court also found that the capacity charge payments were not deductible under the ‘black hole’ provisions. The payments fell within the exceptions set out in the legislation for choses in action and expenditure that could be captured in assessing a relevant capital gain or loss (s40-880(5)(d)&(f)).
No luck for BHP in the High Court - BHP Limited v FCT [2020] HCA
In BHP Billiton Limited v FCT [2020] HCA 5, the High Court of Australia (HCA) dismissed the appeal by BHP against the Full Court’s previous decision in FCT v BHP Billiton Limited [2019] FCAFC which examined the meaning of ‘sufficiently influenced’ in section 318 of the Income Tax Assessment Act 1936 (Cth).
For an article previously prepared that looks at the decision of the Full Federal Court click here.
BHP contended in their appeal that ‘sufficiently influenced’ required ‘effective control’ of the other entity which is in turn subservient to it. However, the HCA has affirmed that the focus of section 318(6)(b) is on ‘influence’ and not ‘control’ and the section states:
‘a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts).’
As mentioned previously, although the decision was made in the context of a specific dual-listed company arrangement, there may be broader implications for stapled groups which share the same features.
For assistance in interpreting how this decision might apply to you, contact Frank Hinoporos and Rachel Law.
This article was written with the assistance of Bradley White, Graduate Lawyer.
Contact
Frank Hinoporos
Partner & Head of Tax
Frank Hinoporos the Hall & Wilcox Tax team. He advises on direct taxes, international structuring and taxation disputes.
Rachel Law
Senior Associate
Taxation lawyer Rachel Law, specialises in direct taxes and tax disputes. She is experienced in domestic and international laws.
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