Focus: When are tax issues capable of settlement by arbitration?
11 December 2009
In brief: It is not unusual for one party to agree to indemnify another party for tax liabilities arising from particular projects or transactions. Partner Andrea Martignoni (view CV), Special Counsel Nicola Nygh (view CV) and Lawyer Mark Hare look at a recent case in the Supreme Court of Victoria that indicated that a dispute arising under such an indemnity may be capable of settlement by arbitration.
How does it affect you?
In AED Oil Limited v Puffin FPSO Limited (No 2)  VSC 534, the Supreme Court of Victoria has indicated its approach to determining applications for a stay of court proceedings under the International Arbitration Act 1974 (Cth) (the IAA) and, in the alternative, under the Commercial Arbitration Act 1984 (Vic) (the CAA). Two points may be of particular interest to parties to arbitration agreements:
- disputes concerned with the quantum of a party's tax liability may not, in certain circumstances, be 'capable of settlement by arbitration'. However, where the dispute is essentially contractual, even if it involves an assessment of an underlying tax liability, it may still be arbitrable. Any determination of an underlying tax liability by the arbitrator will not be binding on the Commissioner of Taxation; and
- in the context of an application for a stay of proceedings under the IAA, the filing of a defence does not, of itself, constitute a waiver of the right to arbitrate or amount to an election to submit to jurisdiction such as to render the arbitration agreement 'inoperative'.
A party to an arbitration agreement may apply to the court under section 7 of the IAA to stay court proceedings involving the determination of a matter within the scope of an arbitration agreement if certain conditions are met. Two such conditions are that:
- the subject matter of the dispute is 'capable of settlement by arbitration'; and
- that the arbitration agreement is 'not inoperative'.
AED Services (incorporated in Singapore) and Puffin (incorporated in Malta) were parties to a charter contract for an oil exploration project. An Australian company, AED Oil is the ultimate holding company of AED Services and guaranteed its obligations under the charter contract.
Under the charter contract, AED Services also indemnified Puffin for its tax liabilities arising from the exploration project. In return, Puffin was obliged to comply with Australian taxation law and to minimise its tax liabilities.
A dispute arose between AED Oil/AED Services and Puffin concerning the correct approach to the depreciation of Puffin's assets and, accordingly, the amount of tax payable. As a result of the dispute, Puffin refused to sign and authorise the lodgment of tax returns prepared by AED Services on the basis that the draft returns were not, in Puffin's view, 'true and correct'.
In the principal proceedings brought against Puffin, AED Services sought, and was granted, an injunction restraining Puffin from exercising its powers under a charge in favour of Puffin to secure the obligations of AED Oil as guarantor of performance by AED Services under the charter contract. In addition, AED Services claimed that:
- Puffin was in breach of the charter contract by refusing to sign and authorise the lodgment of tax returns prepared by AED Services; and
- the amounts demanded by Puffin did not fall within the definition of a 'tax claim' in the charter contract and, accordingly, AED Services was not liable to indemnify Puffin for those amounts.
In response to the principal proceeding and by its amended defence and counterclaim, Puffin alleged that:
- AED Services had unreasonably withheld its consent to Puffin registering with the ATO for GST purposes, lodging business activity statements, paying GST owed by it and filing an income tax return; and
- AED Services was liable to indemnify Puffin for its tax liabilities.
AED Services and AED Oil applied to the court for a stay of the counterclaims, relying on an arbitration clause in the contract. The application was brought under s7 of the IAA and, in the alternative, pursuant to the court's discretion to grant a stay under s53 of the CAA.
Puffin argued that, relevantly:
- the court should refuse the application for a stay on the basis that, inter alia, a dispute about its statutory obligation to register for GST, file income tax returns and ultimately pay GST and income tax is not a 'matter that is capable of settlement by arbitration'; and
- the counterclaims fell within clause 33.10 of the charter contract, which expressly permitted a party to seek urgent interlocutory or declaratory relief from the court where, in that party's reasonable opinion, that action is necessary to protect its rights.
In determining the application, Justice Judd held that the counterclaims were sufficiently urgent to be captured by clause 33.10 of the charter contract and, accordingly, the entire dispute should be determined by the court and the application dismissed. In obiter, Justice Judd made the following additional observations about the stay application:
- although a determination by the tax commissioner may bear upon the contractual issues and the reasonableness of the positions taken by the parties, the dispute was essentially contractual and was therefore 'capable of settlement by arbitration';
- in filing defences to the counterclaims, AED Oil and AED Services had not waived the right to arbitrate so as to render the arbitration agreement 'inoperative';
- if it were not for clause 33.10, the court would have been required to grant a stay under the IAA and would have done so subject to appropriate conditions; and
- if called upon to exercise the discretion under s53 of the CAA to grant a stay, his Honour would not do so on the basis that the counterclaims were intimately connected with the primary claim by AED Oil for injunctions and declarations.
In addition, Justice Judd observed that it would be highly undesirable to fragment the proceedings so that the counterclaims would be decided by an arbitrator while the primary claim remained for the court to decide.
This decision reflects the current trend of Australian courts to interpret the grounds on which they may refuse to grant a stay of court proceedings under the IAA narrowly. We expect that this approach will continue and will be encouraged if the Bill to amend the IAA, currently before Federal Parliament, is passed. This Bill expressly refers to the objectives of facilitating the use of international commercial arbitration agreements and giving effect to Australia's obligations under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958.
- Andrea MartignoniPartner,
Ph: +61 2 9230 4485
- Nicola NyghSpecial Counsel,
Ph: +61 2 9230 4616
- Louise JenkinsPartner,
Ph: +61 3 9613 8785
- Stephen McComishPartner,
Ph: +61 8 9488 3767
- Tracey HarripPartner,
Ph: +61 7 3334 3215