The General Anti-Avoidance Provisions - First Case to Apply Part IVA to Foreign tax Credits: E-Alert [...]

Citigroup Pty Limited v Commissioner of Taxation

Introduction

The reach and scope of the general anti-avoidance provisions in Part IVA is often underestimated. The Commissioner has a good track record in Part IVA litigation – see Peabody, Spotless and Hart, and the latest decision continues that trend.

Peter Poulos and Stephen Jones represented the Commissioner of Taxation in proceedings in the Federal Court of Australia concerning, for the first time, whether the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA)are availableto deny foreign tax credits.

Facts

The Judge noted that the transactions which gave rise to the foreign tax credits claimed by Citigroup Pty Limited (CPL) were complex, with the implication that they were designed to give rise to a tax benefit which might fall within Part IVA. Foreign tax credits arose in the following circumstances: CPL and its wholly owned subsidiary Overseas Investments Pty Limited (OIPL) formed special purpose partnerships in Hong Kong in the years of income ended 30 June 2004 and 2005 for the purpose of buying 5-year bonds with detachable interest coupons. The special purpose partnership immediately on-sold the detachable interest coupons to another special purpose partnership set up as part of the arrangement on the same day as the bond was purchased. The bond purchasing partnership comprised CPL's Hong Kong customer and another Citigroup entity. CPL's customer obtained a tax deduction for the purchase price of the coupons. In the 2004 year, the purchase price for the coupons was AUD60,495,296 and for the 2005 year it was AUD61,199,317. The special purpose Hong Kong purchasing partnerships were liable to pay tax in Hong Kong on the gross proceeds on the sale of the coupons, which resulted in Hong Kong tax payable of HKD68,558,742 (equivalent to AUD11,561,399) for the 2003/4 Hong Kong year with a similar amount payable in respect of the subsequent year.

Importantly, His Honour, Edmonds J, found that although the bond purchasing partnerships made net profits of approximately AUD6 million before tax in Hong Kong, after payment of tax those entities made net losses.

In Australia, CPL returned as assessable income, amounts equal to the pre-tax profit derived by the Hong Kong partnership in the income year in which the bonds were purchased. As a consequence, CPL had a liability to pay tax for approximately $1.8 million on the foreign income from the disposal of the bond coupons in each of the respective years but claimed foreign tax credits equal to the Hong Kong tax paid. CPL was also liable to include in its assessable income approximately $60 million over the 5 year life of the bond pursuant to Division 16E of the ITAA. However, CPL had an allowable deduction over the same period which completely offset the Division 16E income.

CPL had sufficient other foreign sourced income in each of the respective years to fully absorb the foreign tax credits claimed by it.

CPL claimed that it did not know whether it would have sufficient foreign income to fully absorb the foreign tax credits in the year in which they where incurred.  However, Edmonds J, having regard to all of the evidence in the matter, did not accept that CPL had little or no expectation of having any foreign source income, other than from the Hong Kong bond transactions, at the time those transactions were entered into. 

The Decision

Part IVA

Edmonds J considered each of the 8 matters set out in section 177D(b) of the ITAA and concluded, based on the evidence that the dominant purpose of CPL in entering into the scheme as defined by the Commissioner was to obtain the tax benefit, that is the foreign tax credits in Australia with the result that the assessments raised by the Commissioner disallowing CPL's foreign tax credits were upheld.

General Interest Charge

CPL also sought declarations that, in the event that the assessments giving effect to the Commissioner's Part IVA determinations were upheld, that CPL would not be liable to pay the general interest charge in respect of the over-claimed foreign tax credits because, relevantly there was "no tax" which CPL was liable to pay which remained unpaid after the "due date for payment of tax". His Honour agreed with this proposition and held that section 204(3) of the ITAA did not apply to impose the general interest charge on the over-claimed foreign tax credits.

Implications

The foreign tax credits in this case were crucial to the overall commercial outcome of the arrangement entered into. Without the FTC, the transaction did not make sense and this has echoes of the Hart decision.

The Commissioner has indicated that he will be giving close scrutiny to cross border financial transactions such as asymmetric swaps, and has taken the view that transactions which, absent some tax benefit, make no commercial sense, will be vulnerable to attack under Part IVA.   

If you have any queries about any of the matters in the update please click here to contact a member of the Tax Controversy team.