At first glance, the Federal Court decision in Messenger Press Proprietary Limited v FCT looks like 'old news' (forgive the pun). The events, which involved the News Corporation group, happened in the late 1980s and early 1990s under tax rules that have now been superseded twice – by the Div.775 forex rules in 2003 and more recently by the Div.230 TOFA rules in 2010. Nevertheless, the case contains important lessons about the former foreign exchange rules in Division 3B of the Income Tax Assessment Act 1936 which will have an impact on forex matters still in dispute.
Forex has always been difficult for Courts, taxpayers and the ATO, and the confusion continues in the case. If nothing else, this case validates the decision to codify the treatment of foreign exchange in the much-maligned Div.775 forex rules. Flawed as they are, this case is convincing evidence that something needed to be done.
1 Facts and issues
The precise issue in the case was whether the taxpayer was entitled to deduct in 2001 and 2002 currency exchange losses totalling approximately AUD 2bn, arising from the decline in the Australian dollar against the US dollar between 1991 and 2001-02.
Given the passage of time, establishing the facts proved especially difficult. In the first third of the judgment, Perram J tries to reconstruct what occurred and in the next third he tries to analyse the legal consequences that follow from the facts as found. It is only then that the tax issues could be explored. In several instances, the Court's holding on an issue is critically affected by the findings of fact.
Reduced to its essence, the dispute is relatively simple. In June 1991, the taxpayer consolidated and refinanced a number of debts denominated in various currencies, borrowing USD 2.8bn from a subsidiary. It repaid that consolidated debt in two tranches, partly in 2001 and the balance in 2002. The taxpayer claimed the repayments triggered forex losses of AUD 629m in 2001 and AUD 1.4bn in 2002.
And yet the parties fought over many facts and transactions which pre-dated the loan. This was apparently driven by a particular view asserted by the ATO about the need to establish antecedent transactions so that the one giving rise to the forex loss could be sustained.
2 Some observations of the judgment
The complexity of the facts and the reasoning precludes a comprehensive analysis of the case in the space available. What follows are disparate observations on some of the curious and novel aspects of the decision.
2.1 Foreign currency or AUD?
Under Div 3B, a forex loss could only arise from transactions undertaken in foreign currency. Div 3B did not apply to a transaction effected in AUD, even if the amount of AUD was calculated as the equivalent of an amount of (say) USD. Descriptions in the taxpayer's accounts were often ambivalent. For example, one transaction was recorded as occurring at 'US$2,270,000,000 or its Australian Dollar equivalent' [para 22]. Was this recording:
- a transaction which occurred in AUD, the amount of AUD being derived from a
- figure expressed in USD; or
- a transaction which occurred in USD, which should be translated into a stated amount of AUD for the purposes of the taxpayer's records?
This issue manifested itself in respect of one advance and share issue. The taxpayer argued that it had impliedly borrowed USD 168m as a result of an advance to the taxpayer's subsidiary to pay for a share issue being made to the taxpayer. The Court concluded that the lender advanced by some means funds equal to USD 168.5m, but it was not clear from the evidence how the advance was made or in what currency. The Court later inferred that this advance should be regarded as having been made in AUD because it satisfied the taxpayer's obligation to the subsidiary which was denominated in AUD and there was no antecedent obligation to lend an amount to the taxpayer in a foreign currency. This gave rise to an obligation on the taxpayer to repay in AUD. This finding of fact eliminated any forex aspect.
2.2 Transactions in foreign currency v. rights and obligations in foreign currency
In several places the judge takes the position that the proper legal analysis of the transaction should focus not on the denomination of the cash flows, but rather on the currency of the underlying rights and obligations. This complicates the analysis significantly.
The best example is the first loan analysed by the Court. The parties set up a multi-currency loan under which the lender agreed to make loans amounting to AUD 3bn available in AUD, GBP and USD. The funds were actually advanced by the lender in a single cheque, drawn on an Australian bank, denominated in AUD.
The ATO argued that the taxpayer had borrowed in AUD because that was the currency of the cheque. The judge, however, took the view that this was a multicurrency loan even though the funds had been advanced exclusively in AUD.
2.3 The idea of an 'exchange'
The early part of the judgment examines the question whether the realisation of a foreign currency position had occurred.
The judge took the view that, under Div 3B, a forex loss is incurred when there is an 'exchange' of currency, or a liability expressed in one currency for cash or a liability expressed in another.
The language of 'exchange' in this context can be traced back to the High Court decision in Energy Resources of Australia (ERA) which held that the refinancing of a USD loan with another USD loan did not trigger a foreign exchange gain or loss. Even if that reasoning made sense in ERA, it fails to elucidate in this context.
Evidence of the problems that using this terminology leads to can be seen in the analysis of a separate and more straightforward loan and share acquisition. The Court found a relevant 'exchange' of obligations:
the effect of the settlement was to discharge [the taxpayer's] Australian dollar liability to [the subsidiary to pay for the shares] by replacing it with a US dollar liability to [the lender]. In other words: an exchange of liabilities denominated in different currencies.
This is a curious description to apply to borrowing money and then buying an asset – that the liability to pay the seller for the asset had been 'exchanged' for a liability owed to the lender to repay the loan. Describing this as 'an exchange of liabilities' is not enlightening.
2.4 Transacting in cash v. negotiable instruments
Foreign exchange transactions may involve cash flows – an amount of AUD is exchanged for USD to repay a debt denominated in USD. Do the same rules apply if there is no physical flow of funds, but rather an exchange of liabilities – for example, if the USD debt is 'repaid' by the issue of a promissory note denominated in AUD?
The ATO argued that Division 3B did not extend to transactions effected by negotiable instruments, only transactions involving flows of cash. The judge disagreed with this conclusion, and ruled that the exchange of a liability in one currency for a liability in another was within the scope of the rules.
The judge paid particular attention to why the High Court decision in ERA did not require a different conclusion. ERA, he said, analysed what happens when there is no exchange at all, whether of money or liabilities and said nothing to support the ATO's argument that only an exchange of cash would suffice.
2.5 'Lending' by the transfer of negotiable instruments
A point of commercial law arose because many of the transactions in the case were effected by transfers of promissory notes or other negotiable instruments. These transfers were not accounted for as sales of assets as the Commissioner asserted was appropriate. Apparently, the taxpayer treated the transactions as loans of the face value of the instruments and in the currency of the instrument.
Interestingly, the judge took the view that the transactions were loans, but not necessarily of the face value of the instrument or in the currency of the instruments.
The Court inferred that there must have been an underlying loan agreement evidenced by the issue by the taxpayer of its own promissory note. The transfer of the promissory notes to the taxpayer was simply the means by which value was provided to the taxpayer.
2.6 Dual conversions
A particular argument raised by the ATO involved the assertion that Div 3B only applied if currency had been converted twice – out of AUD into a foreign currency, and then from the foreign currency back to AUD. This argument, which appears to be based on a particular reading of ERA, probably explains why so much of the judgment is occupied by examining events which occurred prior to the June 1991 loan.
The judge side-stepped the issue, saying that in his view there generally had been two exchanges, but he also said that he doubted whether the text of Div 3B supported this position. This conclusion is important, although obiter. The judge was prepared to accept that a deductible loss could occur without currency having been first converted out of AUD and then back into AUD. He gives as an example:
it is not difficult to imagine circumstances in which a single conversion may generate losses. A US dollar loan used by a taxpayer to acquire a capital asset in the United States but serviced from a supply of Australian dollars converted at the time of each repayment to US dollars will generate losses if there is an adverse shift in the exchange rate. In this context an increased expense is a loss.
Again, the judge examined ERA and concluded that it did not require a different conclusion.
2.7 'Under' an eligible contract
The ATO also argued that the losses in question were not deductible because they did not arise 'under' an eligible contract, again relying on a passage in ERA.
The ATO's argument was that a forex loss only arises 'under' a contract if the terms of the contract permit or require that a currency conversion occur.
Perram J disagreed that ERA required this view and concluded that:
it is sufficient for the purposes of Division 3B for a loss to result from the repayment, as here, of a foreign currency loan when there has been a decline in the value of the Australian dollar. In such cases the loss arises under the loan agreement.
The result of the case was that the assessment was held to be excessive. Given that the dispute was about the decision to reject the taxpayer's objection to an assessment, one would have thought the matter could be resolved by an order that the ATO allow the objection. However, the judge threw into doubt so many other matters he required the parties to come back to court with a draft of the appropriate orders.
Given the amount of money involved, it seems unlikely that this will be the end of this case. However, much of the result turns on the particular findings of facts made by the judge. Ordinarily, findings of fact are rarely over-turned on appeal, but when so many of the facts have been inferred, or are conclusions of law, perhaps that difficulty will prove less daunting to the ATO.
Moreover, there are enough questions of law – both in regard to the commercial effect of the transactions that occurred and the interpretation of Div 3B – that an appeal on those questions alone seems inevitable.
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