On 20 March 2024, the Federal Court found for the taxpayer in Mylan Australia Holding Pty Ltd v Commissioner of Taxation (No 2) [2024] FCA 253 (Mylan). The Court decided that the general anti-avoidance rules (Part IVA) did not apply to an intra-group financing structure which involved a “debt pushdown” (being the allocation of group debt to the Australian target subsidiary), undertaken as part of a global acquisition.
The Full Federal Court’s recent decision in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28 (Minerva) was a significant win for the taxpayer concerning the scope and limitations attaching to Part IVA. The Federal Court’s decision in Mylan reinforces a number of principles observed in Minerva, with some of the key takeaways from the decision including:
- Part IVA does not pose a “but for” test. That is, a dominant purpose cannot be drawn merely because, as a matter of objective fact, it is to be concluded that “but for” the relevant tax benefit, another course of action would have been adopted. Quoting the Full Federal Court’s decision in Minerva at [413]-[414], Button J reiterated that for the purposes of the dominant purpose enquiry, it is not enough merely to point to the fact that less tax has been paid under the form of the transaction that was ultimately selected and executed;
- structuring a transaction to conform with a limit imposed by Australian tax law (such as the thin capitalisation rules), should not necessarily be viewed as indicative of a taxpayer having the requisite dominant purpose. This is particularly the case where commercial considerations (such as the benefits associated with intra-group lending), operate in favour of conforming with the relevant limit;
- where the events in question took place some time ago (16 years ago in the case of Mylan), the absence of lay witness evidence speaking to the purpose for which aspects of the relevant scheme were entered into should not be given significant weight with respect to the dominant purpose enquiry;
- although Mylan’s failure to refinance the relevant borrowing (until September 2014) to take advantage of interest rates falling from the end of 2008 was viewed as supporting the existence of the requisite purpose, this factor alone was not considered sufficient to establish dominant purpose. The Court emphasised that when examining the “manner” in which a scheme was entered into or carried out, this exercise may include considering steps that could have been, but ultimately were not, taken by a taxpayer;
- the flexibility which often attends intra-group financing arrangements was not seen as indicative of the requisite dominant purpose. The commercial rationale underpinning the flexibility of the relevant terms of the intra-group borrowing was viewed by the Court as a critical factor in this respect; and
- although the taxpayer bears the onus of proof in Part IVC appeals, this does not absolve the Commissioner from engaging with the facts and conducting a proceeding in a manner consistent with the overarching purpose of resolving disputes as quickly, inexpensively, and efficiently as possible.
Facts
On 12 May 2007, Mylan Inc (Mylan) agreed to acquire the global generics business of Merck KgaA (Merck), including all of its Australian operations. In order to undertake the transaction, it was decided that two newly incorporated subsidiaries would be established, being Mylan Australia Holding Pty Ltd (MAHPL) and it subsidiary, Mylan Australia Pty Ltd (MAPL) (both Australian tax residents). These entities formed an Australian tax consolidated group, of which MAHPL was the head company.
On 2 October 2007, MAPL acquired all of the shares in Alphapharm Pty Ltd (Alphapharm), being the relevant target entity within the Merck group. The acquisition was partly funded by debt in the form of a promissory note (PN A2), which was provided to MAPL by a related entity, Mylan Luxembourg 1 S.a.r.l. (Lux 1) (a Luxembourg tax resident). This “intra-group debt pushdown” (i.e., the creation of intercompany debt at the MAPL level) resulted in the Mylan Australian tax consolidated group (of which MAHPL was the head company), adopting a gearing ratio of 75% consistent with Australia’s thin capitalisation safe harbour limit at the time. The interest rate on PN A2 was originally floating, but was later fixed at 10.15% p.a., with retrospective effect from 2 October 2007.
The Share Purchase Agreement (SPA) originally signed by Mylan and Merck on 12 May 2007 included provisions which allowed Mylan to put forward a finalised transaction structure. Pursuant to those provisions in the SPA, the following changes were ultimately made to the original transaction structure:
- Alphapharm was made the relevant target entity and MAPL the purchaser (instead of Alphapharm being acquired indirectly as part of the acquisition); and
- a debt percentage to fund the acquisition of Alphapharm was selected which tracked the Australian thin capitalisation limits.
The court’s decision
In finding for the taxpayer, the Federal Court held that Part IVA did not apply to the loan arrangement in question. The counterfactual put forward by the Commissioner was found to be unsatisfactory, with the Court formulating its own counterfactual based on the matters raised before it (the Preferred Counterfactual). Some of the key features of the Preferred Counterfactual included:
- MAPL would have borrowed the equivalent of AUD 785,329,802.60 (the original amount of PN A2), on 7 year terms directly from external financiers under the Senior Credit Agreement (SCA) (being the loan agreement which governed the external borrowing taken out by Mylan, which was ultimately pushed down to the MAPL level). This borrowing would be at a floating rate consistent with the rates specified in the SCA;
- MAPL would otherwise have been equity funded to the extent necessary to fund the initial purchase of Alphapharm and to stay within the thin capitalisation limits safe harbour ratio;
- interest on the borrowing would not have been capitalised; and
- MAPL would have been required to pay down the principal on a schedule consistent with that specified in the SCA.
By entering into the scheme, the court concluded that it “appeared” MAHPL had obtained a tax benefit, being the difference between the deductions it had in fact claimed for interest expenses incurred by MAPL, and the deductions that MAHPL would have (or might reasonably be expected to have) claimed, had it proceeded according to the Preferred Counterfactual.
Although Mylan did not succeed on the issue of whether it had obtained a tax benefit, the court ultimately concluded that Part IVA did not apply to the loan arrangement in question. This conclusion was primarily based on the court’s view that MAHPL had successfully established that, assessed objectively, it had not entered into the relevant arrangement for the dominant purpose of obtaining such tax benefit.
In her Honour’s reasons, Button J provided a comprehensive summary of the legal authorities underlying the ‘dominant purpose’ enquiry from [404], before going on to deal with the eight factors listed in section 177D(b).
The manner in which the scheme was entered into or carried out
The majority of the Court’s analysis in relation to the dominant purpose enquiry related to the first of the eight factors listed in section 177D(b), being the manner in which the scheme was entered into or carried out. With the exception of MAPL’s failure to refinance the relevant loan prior to September 2014 in order to take advantage of falling interest rates, none of the matters listed below were considered to support an adverse conclusion in relation to the dominant purpose of the taxpayer:
- the incorporation of MAPL and MAHPL, and the choice to form a consolidated group with MAHPL as the head company — Button J remarked that the incorporation of a local holding company structure was an entirely unremarkable step taken in the context of a large multinational corporate acquisition which involved acquiring an Australian operating subsidiary;
- the structuring of the transaction and changes to the SPA — subject to matters of method and quantum, the “pushdown” of the debt to the MAPL level was not considered indicative of the requisite dominant purpose. The Court noted that there existed a clear commercial rationale in financing subsidiaries via intercompany loans;
- the quantum of debt incurred by MAPL for the purposes of its acquisition of Alphapharm, and the corresponding debt to equity ratio which tracked the thin capitalisation limits in place within Australia at the time (i.e., 75%) — the Court noted that the setting of MAPL’s debt level in line with Australia’s thin capitalisation limits was supported by a significant body of expert evidence concerning the benefits of intra-group debt. In light of this, the tracking of Australia’s thin capitalisation limit was not seen as indicative of Mylan having the dominant purpose of enabling MAHPL to obtain a tax benefit. The Commissioner’s attempts to rely on a lack of contemporaneous evidence in respect of MAPL’s debt servicing capacity was held to be misdirected in this regard, with Button J observing that the parent company of a group with global treasury functions should not be expected to continually analyse the debt servicing capacity of a holding company subsidiary;
- the decision to fix the interest rate of PN A2, and the timing of this decision — the Court held that there was no evidence to suggest that the fixed rate of 10.15% was set to maximise borrowing costs (and therefore deductions in Australia). Rather, the evidence established that the fixed interest rate was set to achieve equivalence with external funding;
- the flexible terms of the borrowing — the Commissioner relied on evidence which suggested that the original impetus for the inclusion of a term in the MAPL borrowing which provided for the prepayment of principal without penalty was to ensure sufficient flexibility to stay within the thin capitalisation limits. For the reasons outlined above, a desire to stay within the thin capitalisation limits was not seen as inidicative of the requisite dominant purpose; and
- the availability of alternative means of repatriating cash from Australia — noting the clear advantages in using intercompany debt to capitalise a subsidiary (principally in terms of flexibility), the Court did not regard the availability of alternative means of repatriating cash as supporting an adverse conclusion on dominant purpose.
Form and substance of the scheme
The Commissioner submitted that the form of the scheme diverged from its substance in two principal respects. The first was that the substance of the scheme involved only one economic borrowing, whereas the form of the scheme involved amendments being made to the SPA to introduce the separate transfer of the shares in Alphapharm, as well as the duplication of debt in Australia, all while keeping the headline price the same. The second related to a lack of economic risk borne by MAPL.
The Court did not consider that the first or second points above exposed a divergence between substance and form. In relation to the first point, it was held that the substance and form of the transaction both involved debt being distributed internally while maintaining a streamlined external debt profile. In relation to the second point, the Court emphasised that a promissory note constitutes a real economic obligation.
The time at which the scheme was entered into and the length of the period during which the scheme was carried out
The only matter raised by the Commissioner in relation to this consideration was the time at which the interest rate on PN A2 was varied and fixed at 10.15%. The Court held that no evidence had been adduced which supported a conclusion that Mylan had acted to fix the interest rate only in October 2008, by which time market interest rates had begun to decline. This factor was therefore considered neutral.
The result in relation to the operation of ITAA36 that, but for Part IVA, would be achieved by the scheme
The Court again emphasised that the bare fact that a taxpayer pays less tax than it otherwise would have due to adopting a particular form of a transaction does not, of itself, warrant any inference of the requisite dominant purpose. The obtaining of tax deductions for interest expenses was recognised as an ordinary incident of the financing structure which had been adopted by Mylan. This, in and of itself, did not bespeak of the requisite dominant purpose.
Changes to the financial position of the relevant taxpayer or any other person connected with the relevant taxpayer, that has resulted, will result, or may reasonably be expected to result, from the scheme, and any other consequences of the scheme for those persons
The fifth, sixth and seventh factors in section 177D(b) were considered together by the Court. In relation to these factors, the Commissioner contended that the scheme effectively involved a double deduction (the first deduction being for the interest incurred on the external debt, with the second being taken in Australia on the internal debt (i.e. PN A2). The Court dismissed this contention, accepting MAHPL’s submission that the “second” (internal) deduction was ultimately offset by an anticipated second income stream which was anticipated to be assessable income in the US (i.e. as a result of interest paid by MAPL on PN A2 making its way up the corporate chain).
The nature of any connection between the relevant taxpayer and any person whose financial position is affected as a result of the scheme
Finally, while it was recognised by the Court that the related status of the relevant Mylan entities explained the shape of the relevant schemes (i.e. why MAPL was funded by intercompany promissory notes, as well as the flexible terms of PN A2), this was not seen as pointing to the requisite dominant purpose. In this respect, the tax deductions claimed by MAHPL were recognised as being ultimately driven by the quantum of, and interest rate on, MAPL’s debt.
