Skip to content.

Home

Allens

Focus: Tax focus on Finance - December 2005

In this issue: We look at a number of recent developments that are relevant to the taxation of financing transactions; in particular, the ATO's view on the extension of section 128F to 'debt interests'; the Full Federal Court decision in the Macquarie Finance case; proposed amendments to the NSW Duties Act that include two anti-avoidance measures in relation to mortgage duty; deemed ownership under Divisions 40 and 240 of the Income Tax Assessment Act in the context of hire purchase transactions; and a recent UK VAT Tribunal decision that should be of interest to the securitisation industry.

ATO's view on extension of section 128F to 'debt interests'

In brief: Senior Associate Thomas McAuliffe discusses the Australian Tax Office's position on the extension of section 128F to 'debt interests'.

Where an Australian borrower pays interest, or amounts in the nature of interest such as discount on a security, to persons outside Australia, the borrower is required to deduct Australian interest withholding tax (IWT) from the interest payment at the rate of 10 per cent of the amount of that payment. The terms of such borrowings will generally include a gross-up clause that imposes an obligation on the Australian borrower to pay additional amounts to the offshore lender to compensate it for any amounts withheld from interest payments on account of Australian withholding taxes. The effect of such clauses is to increase the cost to the Australian borrower of servicing the debt. This competitive disadvantage is often eliminated for Australian borrowers by their relying on section 128F of the Income Tax Assessment Act 1936 (Cth). That section provides an exemption from IWT for interest paid on debt raised in accordance with a public offer test.

The s128F exemption from IWT has historically only applied to interest paid in respect of 'debentures'. However, earlier this year, s128F was amended to extend the exemption to returns paid on 'debt interests' (ie financing arrangements that are treated as debt for Australian tax purposes, the simplest example being redeemable preference shares with terms that make them economically equivalent to debt). Although the concept of a 'debt interest' is a wide one, it remains necessary that the financing arrangement in question be capable of being issued in a manner that satisfies the public offer test requirements in s128F.

Where the financing arrangement is not in the form of a debenture, such that reliance must be placed on it being a 'debt interest' in order to access the exemption from IWT, the rules contained in Division 974 of the Income Tax Assessment Act 1997 (Cth) that govern the time at which a 'debt interest' is issued, and the Commissioner's ability to determine that what would otherwise be a single scheme is to be treated as two or more separate schemes, raise questions about the time at which debt interests are issued. The time of issuance is critical to the s128F exemption, because a debt interest must be issued as a result of it being offered for issue in accordance with the public offer test.

At the 8 August 2005 meeting of the Finance and Investment subcommittee of the National Tax Liaison Group, the Australian Taxation Office (ATO) was asked to:

  • elaborate on whether the new reference to 'debt interests' permits the s128F exemption to be claimed in respect of the return paid on any financing arrangement that satisfies the definition of a 'debt interest'; and
  • confirm that there is no particular temporal requirement in s128F that the debt interest be issued within a limited time after the relevant public offer is made, such that a 'revolving' or 'come and go' facility may qualify for the exemption from IWT.

The preliminary view expressed by the ATO at that meeting in response to these issues is that the exemption from IWT under s128F (or s128FA for debt raisings by certain unit trusts) is not necessarily available in respect of interest paid on all types of debt interests. The ATO believes that the contexts in which s128F and s128FA appear are indicative of those provisions only applying to debt interests that are tradeable type instruments. Furthermore, the ATO believes that the views expressed in the many Taxation Determinations dealing with the practical application of the public offer test have been given in the context of an environment for tradeable instruments.

Whether or not the preliminary views expressed by the ATO at this meeting are warranted by the wording of the relevant provisions is debatable. It also should be recognised that the National Tax Liaison Group is a consultative forum dealing with complex technical and policy issues between the tax, accounting and legal professions and the ATO. Therefore, views expressed by participants of those meetings, including those by ATO officers, are put forward as part of the consultative process and cannot be regarded as binding, settled positions of the ATO. However, at this stage, the ATO's comments that it does not accept that all debt interests are capable of satisfying the requirements of s128F are the only publicly available guidance on the ATO's views on this matter.

Ultimately, satisfaction of the requirements of s128F will depend on the facts of each particular case. Where the ATO's preliminary views on this matter give rise to concerns in relation to a proposed arrangement, it remains open to seek a private binding ruling on the availability of the exemption from IWT for that arrangement. However, where time constraints do not allow for a private ruling to be obtained (which may take several months), it may be prudent to document the financing in the form of a debenture rather than rely on the characterisation of the financing arrangement as a 'debt interest' in order to secure the exemption from IWT.

Return to top

Macquarie Finance v FCT

In brief: A recent Full Federal Court decision creates uncertainty about important general principles of deductibility, particularly as they apply to structured products and funding transactions. Lawyer Rory O'Brien explains.

In Macquarie Finance v FCT [2005] FCAFC 205, the majority of the Full Federal Court bench did not apply High Court authority that states in determining deductibility, one can only have reference to the benefit obtained by the taxpayer, and not by any other person. Instead, in holding that the interest paid by Macquarie Finance on perpetual notes was not deductible, the majority had regard to the benefit obtained by the corporate group of which the taxpayer was a member. The strong dissenting judgment of Justice Hely should be noted, but the decision creates uncertainty about important general principles of deductibility, particularly as they apply to structured products and funding transactions. Macquarie Finance was also the latest case to consider the potential application of Part IVA  of the Income Tax Assessment Act 1936.

Summary of facts

The case dealt with the deductibility of interest paid on a component part of stapled securities that Macquarie had sold to the public. The stapled security consisted of a preference share issued by Macquarie Bank Limited (MBL) stapled to a perpetual note issued by Macquarie Finance Limited (MFL). In order to ensure that the stapled securities could be counted as Tier 1 capital for the purposes of APRA's prudential standard on capital adequacy for banks, the product was designed broadly as follows:

  • Where Macquarie was not insolvent, the stapled security holders would own:
    • interests in notes issued by MFL worth about $400 million (practically calculated by reference to yield rather than face amount); and
    • a preference share issued by MBL worth nothing, as there would be no immediate prospect of any dividend or capital return.
  • If Macquarie became insolvent, the stapled security holders would own:
    • interests in notes worth nothing, as all amounts payable on the notes would be payable to MBL and
    • a preference share with paid-up capital of $400 million.

It is noted that MBL formally had the right to direct that the interest payable on the notes be paid to it at any time, even where Macquarie was not insolvent but, practically speaking, it was probably unlikely that this right would be exercised unless the product was being wound up because of the flow-on consequences.

However, looking at the transaction just from the perspective of MFL, it had raised $400 million from the issue of perpetual notes, which it had on-lent at a profit. The same amount of interest would be payable on the notes no matter what happened. If Macquarie became insolvent, this would only affect the identity of the recipient of the interest, not the quantum.

South Australian Battery Makers

Justice Hely's minority judgement in Macquarie Finance depends on FCT v South Australian Battery Makers (1978) 140 CLR 645, and it is submitted that it is the decisive authority in this case.

The key facts of the case are as follows:

  • The taxpayer sought to claim a deduction for amounts paid to rent land.
  • A member of the same wholly owned group held an option to purchase the land.
  • The rental payments were calculated by reference to the capital cost of the land, plus a notional interest component.
  • Each rental payment made by the taxpayer reduced the exercise price of the option by the capital component of the rental payment.

The majority of the High Court found that the rent was deductible because the taxpayer did not acquire a capital asset, merely the right to occupy the land for the period to which the rent related, which was a revenue benefit.

The High Court found that it was irrelevant that, looking at the transaction as a whole, the point of the 'rent' payments was to obtain a capital benefit for a member of the same wholly owned group. In determining whether or not an outgoing is deductible, reference can only be had to the benefit obtained by the taxpayer as a result of the payment and not to any benefit obtained by anyone else.

It is submitted that the facts in South Australian Battery Makers were no less contrived (although probably less complicated) than the facts in Macquarie Finance.

Later cases have demonstrated that, in determining what benefit was actually obtained by the taxpayer, the inquiry looks to substantive benefits rather than merely formal legal rights. Thus, the test for deductibility is a curious mixture of form and substance. One must look beyond strict legal rights to the substantive advantage obtained, but this can only be done from the perspective of the taxpayer.

It is noted that the Full Federal Court said in FCT v Email [1999] FCA 1177:

We are conscious of the fact that in Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 at 655 Gibbs ACJ, as his Honour then was, pointed out that the advantage, to which the phrase "the character of the advantage sought" refers, is an advantage to the taxpayer, and that an incidental advantage which some other person, such as even a subsidiary or holding company of the taxpayer derives, but which is not shared by the taxpayer will not be enough to give the outgoing a character of capital. This comment may need to be treated with some caution having regard to the criticism levied of it by Brennan J in Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183 at 190. It may well, if taken too far, unduly prefer form to substance and ignore too the requirement that the task has to be undertaken in a practical and business like way.

However, it should also be noted that South Australian Battery Makers is a decision of the High Court, whereas Email and Magna Alloys are decisions of the Federal Court.

Decision on deductibility

Justices French and Gyles found that the interest expense on the perpetual note incurred by MFL was not deductible because its purpose was to facilitate capital raising by MBL. As such, it was not incurred for the purposes of producing assessable income for MFL, and was capital in nature.

It is respectfully submitted that South Australian Battery Makers prevents regard being had to the benefit obtained by MBL in characterising the nature of the expense incurred by MFL, and that Justice Hely was correct to apply that case to find that the interest was deductible.

It is interesting to note that Justice French cites South Australian Battery Makers but does not, with respect, appear to appreciate the force of the argument based on that case. Conversely, Justice Gyles does appear to appreciate the force of the argument but, in deciding not to accept it, does not cite the case.

It could be said that Justice Gyles shows a strong reluctance to analyse the question otherwise than in a 'practical and business like way'. This might arguably be a good policy outcome, but it is submitted that any decision to overrule South Australian Battery Makers should be made by the High Court. For this reason, it would be desirable for the High Court to grant special leave on the deductibility point. The High Court registry advises that special leave to appeal has been sought.

Relevance of decision on deductibility

It is noted that the stapled securities were designed before the new debt/equity rules were introduced in 2001, and would not be designed in the same way today. Further:

  • Section 25-85(2)(b) (enacted as part of the new debt/equity rules) provides that the return on a debt interest is not prevented from being deductible just because 'the return secures a permanent or enduring benefit for the entity or a connected entity of the entity'. Therefore, the fact that a debt interest is connected with a capital raising of a connected entity would not necessarily preclude deductions for interest incurred on the debt interest, although it is likely that the stapled security would be an equity interest under the debt/equity rules.
  • The consolidations regime means that only a single taxpayer will be recognised in respect of many corporate groups, which reduces the scope for Macquarie Finance to apply.

However, as a general principle, Macquarie Finance is potentially relevant wherever one taxpayer incurs an expense that relates to a capital transaction of a related taxpayer. Section 25-85(2)(b) and the consolidations regime far from cover this field.

There are also several other interesting points that space constraints do not permit this article to discuss, the most obvious being the relevance of Macquarie Finance to pre-debt/equity non-stapled income securities.

Decision on Part IVA

In respect of Part IVA, Justice Hely concluded that the dominant purpose was a commercial one, whereas Justice Gyles concluded that the dominant purpose to obtain a tax benefit. Justice French's views are so short and hypothetical, it is difficult to see them as having much precedent value (as he himself acknowledged might be the case). As there is no clear decision, it is submitted that Macquarie Finance has little precedent value on Part IVA.

Return to top

Proposed amendments to the Duties Act 1997 (NSW)

In brief: Special Counsel Anthony Johnston and Senior Associate Kah Wah Yoong examine new legislation that will amend the NSW Duties Act.

The State Revenue Legislation Further Amendment Bill 2005 (the Bill) contains a number of proposed amendments to the Duties Act 1997 (NSW) (the Act).

Three of the amendments are considered below, including two anti-avoidance measures in relation to mortgage duty which, once enacted, will take effect from 15 November 2005, the date the Bill was first introduced into the Legislative Assembly.

Land rich duty – wholesale unit trust schemes

If a private unit trust scheme is land rich, there are advantages in registering it as a 'wholesale unit trust scheme' because the taxable acquisition threshold is higher. That is, a person must acquire an interest of 50 per cent or more in a land rich wholesale unit trust scheme (rather than 20 per cent) before a 'relevant acquisition' is made for the purposes of the land rich provisions.

The Bill seeks to widen the circumstances in which a unit trust scheme is eligible to be registered as a wholesale unit trust scheme.
In order to be registered as a wholesale unit trust scheme, the Commissioner must be satisfied that at least 80 per cent of the units in the scheme are held by 'qualifying investors' and that:

  • each qualifying investor holds less than 50 per cent of the units in the scheme; or
  • if a qualifying investor holds units in more than one capacity, it holds less than 50 per cent of the units in the scheme in each capacity.

Under the current rules, a foreign investment vehicle would not, in most cases, be eligible to be a qualifying investor.

However, under the amendments proposed by the Bill, a person who holds units in a unit trust scheme will be a qualifying investor for the purposes of registration of the scheme as a wholesale unit trust scheme if the Chief Commissioner is satisfied that the person holds those units in a capacity which corresponds, under the law of an external Territory or foreign country, to one of the capacities specified for qualifying investors.

A corporation or unit trust that is wholly owned by such a person will also be a qualifying investor.

The proposed amendments will, if enacted, result in a significant broadening of the meaning of 'qualifying investor'. For example, although the Chief Commissioner will need to reach a level of satisfaction in relation to the matter, it could be expected that the trustee of a widely held foreign pension fund would be a qualifying investor. As a consequence of the proposed amendments, it should be easier for unit trust schemes to fulfil the criteria required to enable them to be registered as wholesale unit trust schemes.

Mortgage duty – stamping before an advance

A mortgage that affects property partly located in NSW (ie a multi-jurisdictional mortgage or mortgage package) is stamped concessionally. That is, only a proportion of the NSW duty normally payable is charged. It is the same proportion that the value of the NSW property affected by the mortgage bears to the value of the whole of the property located in Australia that is affected by the mortgage.

Generally, a mortgage only becomes liable to ad valorem duty once it begins to secure an advance. However, under s218 of the Act, a mortgage may be stamped before an advance has been made, in which case the liability date in respect of the mortgage is taken to be the date of stamping.

Under the proposed amendments, while it will still be possible to have a multi-jurisdictional mortgage stamped before it begins to secure an advance, the mortgage will, in such circumstances, only be capable of being stamped for an amount of an advance that does not exceed the value of the property affected by the mortgage.

According to the Explanatory Notes to the Bill, the purpose of the amendment is to prevent:

... an avoidance practice by which the proportion of New South Wales property secured by a mortgage is artificially reduced by omitting New South Wales property from the mortgage until after the date on which liability to duty is assessed.

As noted above, this measure is intended to have effect from 15 November 2005, the date the Bill was introduced into the Legislative Assembly.

Mortgage duty – mortgages securing debenture issues

Section 226 of the Act contains an exemption from duty for certain mortgages to the extent they secure the repayment of money received or to be received by a corporation in respect of debentures.

In 2003, the Office of State Revenue become aware that such arrangements were being commonly used in financing transactions and that minimal duty was being paid since the relevant debentures were subscribed for outside of NSW. As a result, s226 was amended so that it only applied to mortgages executed before 24 June 2003 and to advances in respect of debentures subscribed for before that date.
Despite the 2003 amendments, advances in respect of debentures subscribed for before 24 June 2003 continued to be made and, where these advances were secured by a mortgage executed before 24 June 2003, no liability to duty arose.

Further amendments in the Bill operate to make ad valorem duty payable in respect of any advances made under such arrangements after the date on which the Bill was introduced into the Legislative Assembly (ie 15 November 2005), even if such advances are in respect of debentures subscribed for before 24 June 2003.

According to the Explanatory Notes to the Bill, the purpose of the proposed amendments is to

prevent a practice under which old debenture issues are reused to facilitate the avoidance of mortgage duty.

Given these amendments, it would be prudent to consider the possible stamp duty implications before making further advances under existing debenture facilities in secured financing arrangements.

Return to top

Deemed ownership under Division 240 and Division 40: the practical approach

In brief: Draft Taxation Ruling TR 2005/D12 expresses the Commissioner of Taxation's views on the way in which the deemed ownership provisions in Division 240 of the Income Tax Assessment Act 1997 are intended to interact with the capital allowance provisions in Division 40 of that Act. Senior Associate Judith Taylor explains.

Overview

Division 240 applies to treat certain hire purchase agreements, for tax purposes, like a sale of goods by a notional seller to a notional buyer, combined with a loan from the notional seller to the notional buyer to finance the acquisition of the goods. Where Division 240 applies to a relevant hire purchase agreement, the notional buyer is taken to own the goods (subject to satisfying the requirements in s240-115, discussed below) until either the arrangement ends or the notional buyer becomes the notional seller under a later arrangement to which Division 240 applies.

Division 40 provides for deductions for the decline in value of depreciating assets that taxpayers hold. In defining holders for this purpose, Division 40 uses the concepts of legal owner, equitable owner and economic owner.

It is not clear from the legislation how the deemed ownership rule in Division 240 is intended to apply in the context of the definition of holder in Division 40. If the two Divisions were taken to be exclusive codes in respect of their particular subject matter, it is conceivable that, in certain circumstances, because of the different language used in the two Divisions, taxpayers that are deemed to be the owners of hired goods under Division 240 may not be the relevant holders of the goods under Division 40 and, therefore, may not be entitled to claim deductions for the depreciation of those goods. This result would be contrary to the stated objective of Division 240, which is to recharacterise hire purchase agreements, for tax purposes, such that they are treated as vendor financings of the acquisition of hired goods.

Upon encountering such issues in considering certain private ruling applications of which we are aware, and after considerable deliberation, the Commissioner has sought to clarify how the Commissioner intends to interpret Division 240 and Division 40 in TR 2005/D12. The ruling is currently in draft form and may be subject to change before being issued in final form.

History of provisions

Division 240 and Division 40 were both enacted on 30 June 2001. However, Division 240 originated earlier than Division 40. Division 240 was foreshadowed in the 1997-98 Budget, with details announced by the Treasurer on 27 February 1998. After initially being introduced in a Bill that lapsed, Division 240 was finally enacted on 30 June 2001, with application to hire purchase agreements entered into after 27 February 1998. In contrast, Division 40 was first announced by the Treasurer on 21 September 1999 and broadly applies, subject to certain transitional rules, to arrangements entered into after 30 June 2001.

For the period from 27 February 1998 to 30 June 2001, Division 240 operated in conjunction with the former rules for the depreciation of plant in Division 42. In contrast to Division 40, the provisions of former Division 42 were based on the common law concept of owner, which is consistent with the language used in Division 240. However, from the date of the contemporaneous enactment of Divisions 240 and 40, the operation of the deemed ownership provisions in Division 240 ceased to flow seamlessly into the tax depreciation provisions. In TR 2005/D12, the Commissioner refers to this as 'superficial imperfections in the mechanics' of the interaction of the two Divisions.

Hire purchase agreements

A hire purchase agreement is defined in subsection 995-1(1) as:

(a) a contract for the hire of goods where:

(i) the hirer has the right, obligation or contingent obligation to buy the goods; and

Note: An example of a contingent obligation is a put option.

(ii) the charge that is or may be made for the hire, together with any other amount payable under the contract (including an amount to buy the goods or to exercise an option to do so), exceeds the price of the goods; and

(iii) title in the goods does not pass to the hirer until the option referred to in subparagraph (a)(i) is exercised; or

(b) an agreement for the purchase of goods by instalments where title in the goods does not pass until the final instalment is paid.

Under Division 240, the notional buyer under a hire purchase agreement is taken to own the hired goods, subject to satisfying the requirements in s240-115. Section 240-115 provides that the notional buyer is only deemed to own the goods if:

  1. the notional buyer would have been the owner or the quasi-owner of the goods if the arrangement had been a sale of the goods; and
  2. it is reasonably likely that the right, obligation or contingent obligation to acquire the goods will be exercised by, or in respect of, the notional buyer.

Section 240-15 provides that Division 240 applies for the purposes of the income tax legislation generally, other than for the capital gains and withholding tax provisions. There is no specific exclusion of the application of Division 240 for the purpose of the depreciation provisions in Division 40. Therefore, the tax treatment of hirers under hire purchase agreements must be intended to be ascertained by reference to both Division 240 and Division 40.

Division 40 provides for deductions for the decline in value of depreciating assets that taxpayers hold. Section 40-40 defines when taxpayers are holders of depreciating assets.

Item 10 is the default provision that is intended to apply if no other, more specific, Item applies. Item 10 provides that the holder of a depreciating asset is 'the owner, or the legal owner if there is both a legal and equitable owner'.

Item 6 is the provision that is designed to deal with, among other arrangements, hire purchase agreements. It applies where:

A * depreciating asset that an entity (the former holder) would, apart from this item, hold under this table (including by another application of this item) where a second entity (also the economic owner):

(a) possesses the asset, or has a right as against the former holder to possess the asset immediately; and

(b) has a right as against the former holder the exercise of which would make the economic owner the holder under any item of this table;
and it is reasonable to expect that the economic owner will become its holder by exercising the right, or that the asset will be disposed of at the direction and for the benefit of the economic owner.

The holder, under item 6, is the economic owner, not the former holder.

TR 2005/D12

In TR 2005/D12, the Commissioner has concluded that a notional buyer under Division 240 can be taken to be a holder of goods under either item 6 or item 10 of s40-40 because the requirements to hold under s40-40 and to own under Division 240 were intended, by the drafters, to achieve the same result.

Both Division 240 and Item 6 of s40-40 seek to align the tax treatment of hire purchase agreements and similar arrangements with the perceived economic effects of such arrangements. However, there are some notable differences between the relevant provisions that have been specifically addressed in TR 2005/D12.

Reasonableness test: Both sets of provisions use a reasonableness-based test to ascertain whether a hirer would be entitled to the benefits of the provisions: in Division 240 the test is reasonably likely, whereas the Division 40 test is reasonable to expect. Relevant case-law (some of which is referred to in the draft ruling) and ordinary dictionary meanings would appear to indicate that reasonable to expect requires some further degree of certainty than reasonably likely, but it is not practically possible to quantify the difference.

The Commissioner has pragmatically concluded that these phrases should have the same meaning when interpreting Division 240 and s40-40. It is concluded that the effect of this is that, in the vast majority of cases, whether a hirer is a holder of goods under item 6 of s40-40 or item 10, via the operation of Division 240, will be academic. This should be somewhat of a relief to those who have been faced with interpreting and comparing the two 'reasonableness' tests.

Rights and obligations: Division 240 refers to rights and obligations and therefore encompasses both put and call options. Division 40 refers only to rights that can be exercised by the holders of such rights. Also, item 6 of s40-40 contemplates the disposal of relevant hired assets at the direction and for the benefit of a hirer/lessee, which are circumstances that are not specifically contemplated by Division 240.

It is acknowledged in TR 2005/D12 that these points are 'real' differences between the provisions but it is surmised by the Commissioner that both the existence of a put option in favour of a notional seller and the right of a hirer to dispose of assets to other parties are commercially rare circumstances.

In any event, it is concluded that, for most hire purchase arrangements, item 6 of s40-40 must be satisfied in order for the hirer of goods to be entitled to claim depreciation deductions in respect of the hired goods but, in the rare circumstances where item 6 would not apply to allow depreciation deductions to a Division 240 notional buyer, it will be the practice of the Commissioner to allow depreciation deductions to hirers of goods who are deemed to be owners under Division 240 as holders under item 10 of s40-40.

Return to top

UK decision of interest to the securitisation industry

In brief: Although there are doubts whether a recent UK VAT Tribunal decision will apply in Australia, the decision should be of interest to the securitisation industry. Lawyer Melanie Baker reports.

The UK's VAT Tribunal concluded in Capital One Bank (Europe) plc v Commissioners for Her Majesty's Revenue and Customs (2005), VAT Decision 19238 that an assignment of receivables as part of a securitisation arrangement was not a supply for VAT purposes, but was rather the provision of security for a loan. Although there are significant doubts as to whether Capital One Bank would apply in Australia, the decision should be of interest to the securitisation industry given the Tribunal's characterisation of the arrangement as a borrowing for VAT purposes based on its 'economic whole'.

Facts

Capital One Bank (Europe) plc (COBE) was a UK company that operated a credit card business. COBE had a low credit rating and, therefore, it sought to securitise its credit card receivables so it could obtain cheaper funds at an interest rate appropriate to a borrower with a better rating.

The securitisation structure adopted by COBE involved the following steps:

  • A bare trust was established, which had a newly incorporated Jersey-based company as its trustee. The trust had four beneficiaries, three of which were borrowers, or 'investor beneficiaries', and the fourth was COBE, in its capacity as the 'transferor beneficiary'. The investor beneficiaries were also Jersey-based companies and had the same directors as the trustee.
  • COBE sold its existing receivables on designated customers' credit card accounts to the trust and agreed to assign future receivables as they came into existence. When COBE transferred its credit card receivables to the trust by way of equitable assignment, the value of its interest in the trust increased. The investor beneficiaries had only nominal interests at that time.
  • An investor beneficiary would then issue loan notes to raise funds. The funds raised were then paid to the trust, which, in turn, paid them to COBE. As a result, COBE's interest in the trust diminished and the investor beneficiary's interest increased.
  • The  investor beneficiary's beneficial interest in the assigned receivables was security to support its obligations on the notes it had issued.
  • As and when payments were made on the receivables, ie the credit card users repaid the principal and interest owing on their card accounts (collections), the arrangement required that the amount of those collections remaining after deducting the return to noteholders and administration charges be used to acquire new receivables from COBE to maintain the pool of receivables.

COBE treated its assignments of the receivables as supplies that were outside the scope of the UK VAT, but that nonetheless gave rise to a right to input tax recovery on the basis that they were supplies made to a person belonging outside the European Union. In addition to the fact that this structure was designed to permit input tax deductions relating to an out of scope supply, the structure was also thought to be advantageous because COBE was partially exempt for VAT purposes and recovered its input tax on the basis of an agreed special method. Therefore, if COBE could include the value of the supplies made to the receivables trust as part of the calculation required by the agreed special method, COBE would increase the proportion of input tax it could recover generally.

Questions at issue

Six issues in total were dealt with by the Tribunal in Capital One Bank. However, by far the most significant question was whether the assignment of the receivables by COBE to the trust was a supply for VAT purposes. The remaining five issues were only relevant if the assignment was in fact such a supply. However, the Tribunal was asked to provide answers to all the questions in issue 'in case the matter should go further'.

Was the assignment a supply for VAT purposes?

Although the VAT Tribunal accepted that the assignment of a chose in action can in principle constitute a supply, they found that the equitable assignment of receivables by COBE to the Jersey-based trust under the arrangement described above was not a supply for VAT purposes.

Economic purpose of borrowing

The Tribunal distinguished the cases relied on by COBE to support the proposition that it is impermissible to take an overall, purposive view of a series of transactions in determining the VAT consequences on the basis that those cases did not deal with 'a set or series of transactions designed, together, to achieve an objective'. Accordingly, the Tribunal analysed the assignment of the receivables in the context of the various interdependent transactions occurring as part of the overall securitisation arrangement.

The Tribunal also commented that analysis of a transaction for contractual and VAT purposes may differ. It therefore went behind the strict contractual analysis of the securitisation arrangement to consider its economic purpose. In doing so, the Tribunal described the arrangement as an 'elaborate contractual edifice', the purpose of which was to 'enable COBE to secure funds and to do so at a cost lower than it would have been required to pay had it borrowed directly from the investors'.

Receivables as security for the borrowing

The Tribunal identified three features of this securitisation arrangement that supported its characterisation of the assignment as merely being by way of securitisation and not sale.

  • In the Tribunal's opinion, the Jersey-based entities, such as the trustee and investor beneficiaries, shared the same economic purpose as COBE because COBE was in a position to influence their decisions. In accordance with having an economic purpose of borrowing funds, the trustee and investor beneficiaries never treated the receivables as anything other than security for loan notes.
  • The terms of the assignment were such that COBE did not wholly alienate the receivables in a way that the trustee could do with them as they wished. Instead, the trustee was under an obligation to use existing receivables that became collections to acquire new receivables.
  • COBE did not divest itself of all interest in the receivables. Instead, they were held in a bare trust in which COBE retained more than a nominal interest.
COBE transferred the receivables to itself

The Tribunal went on to state that, even if they were not permitted to take a holistic view of the securitisation transaction and were confined to looking at each part of the transaction separately, they still would have found that the assignment was not a supply for VAT purposes. Broadly, the Tribunal took the view that the assignment of the receivables by COBE to the trust before COBE was paid did not, in effect, cause any change in the beneficial ownership of the receivables as COBE was effectively the only beneficiary (the investor beneficiaries having nominal interests only before any loan notes were issued). This mean that, at that stage, 'COBE had placed receivables in a trust for its own benefit, on terms which enabled it to retrieve them immediately'. The Tribunal regarded this as being tantamount to COBE transferring the receivables to itself.

Subsequent payments made to COBE after the issue of loan notes by an investor beneficiary related to COBE's interest in the trust diminishing. The payments related to the reduction in COBE's interest and were not in exchange for the receivables it had assigned to the trust.

Discussion

There is significant doubt about the correctness of some aspects of the VAT Tribunal's decision in Capital One Bank. We understand that it is likely to be appealed.

Irrespective of the outcome of any appeal against the Tribunal's decision, it nonetheless seems unlikely that the VAT Tribunal's analysis would be adopted in Australia. A number of aspects of the decision appear to turn on the specific fact pattern under consideration. Also, and more significantly, there are sufficient differences in the principles governing Australian legal interpretation and in the provisions in the A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act).

One difference between Australia and the UK is that the contractual position is likely to be more important in Australia when determining the GST consequences of a transaction. The principles governing legal interpretation in Australia are not the same as those governing legal interpretation under European Community law. This would appear to militate against the Australian courts examining securitisation arrangements as an economic whole for GST purposes. Therefore, it seems unlikely that securitisation structures of the type used in Australia would be treated as giving rise to borrowings by assignors of receivables. In the event that they were, it would be interesting to consider what consequences that characterisation would have for some 'borrowers' in light of section 11-15(5) of the GST Act.

An important aspect of the Capital One Bank case is the fact that the assignment was to a bare trust for the assignor. In Australia, that is unlikely to be considered to constitute a supply. Section 184-1(1) of the GST Act includes a 'trust' within the 'entity' definition.

Nevertheless, in this context we do not believe that the trust concept extends to a bare trust. On that basis, a transfer of property to a bare trust would not result in a supply to another entity. An entity cannot make a supply to itself. 

Return to top

For further information, please contact:

Return to top

Share with

What are these?

 

 

Recent Tax publications