Case note

Where the Australian rules started, and why they were rebuilt

Federal Commissioner of Taxation v Commonwealth Aluminium Corporation Ltd (1980) 143 CLR 646; [1980] HCA 28

The first Australian provision aimed at profits leaving the country asked who controlled the business, not whether the dealing was on commercial terms. The High Court held that a foreign parent's unexercised capacity to control was not control, and a bauxite on-sale at a discount through a Hong Kong intermediary went untaxed. The case is the clearest demonstration of why that approach was abandoned.

Court

High Court of Australia

Bench

Barwick CJ, Stephen, Mason, Murphy and Wilson JJ

Decided

12 August 1980

On appeal from

Full Court of the Federal Court of Australia (1979) 38 FLR 19

Outcome

Appeals dismissed with costs, four to one, Murphy J dissenting

The facts

Commonwealth Aluminium Corporation Ltd was an Australian company mining and selling bauxite at Weipa in Queensland. Its shares were wholly owned by Comalco Ltd, itself an Australian company. Comalco in turn was owned in equal halves by an American corporation and by an Australian company that sat under a chain ending in two United Kingdom companies. So there were non-residents at the top of the chain, and Australian companies at every level in between: [7], [8].

In none of the tax years did the foreign companies give directions to the taxpayer or interfere in the management of its business, and the Commissioner largely conceded as much: [11] (Barwick CJ), [9] (joint judgment). Their capacity to control, acting together, was not in doubt. Whether they had used it was.

The one exception was the arrangement that made this a tax case. A sales company was incorporated in Hong Kong, owned as to 52 per cent by Comalco and as to 48 per cent by the two Japanese companies that were buying the bauxite. Under long-term contracts the taxpayer sold bauxite to that company at a discount and the sales company on-sold to the Japanese buyers at current prices. Murphy J gives the figures: bought at 33 shillings a ton, sold at 40. The bauxite never went to Hong Kong, travelling direct to the buyers, and the sales company did, in his Honour's words, relatively little except for book entries. Its profit was paid out as dividends to its three shareholders: [24] (joint judgment), [8] (Murphy J).

The Chairman of the Board of Review found that he could detect no business need for interposing a company between the taxpayer and its Japanese customers, that the decision to supply at 33 shillings operated to the detriment of the taxpayer and to the advantage of its parent, and that the taxpayer accordingly got less for its bauxite than might be expected: set out at [8] (Murphy J). The finding of a pricing problem was therefore not in dispute.

What was in dispute

The Commissioner abandoned the two shareholding gateways in the section and relied only on the first, that the business was "controlled principally by non-residents": [7]. Everything turned on what "controlled" meant.

The Commissioner's case was that, given the shareholdings, it should be inferred that the foreign companies in fact controlled the taxpayer, and he pointed to the Hong Kong arrangement as evidence that they did: [14], [24]. The taxpayer's case was that it had controlled its own business throughout, and that a capacity to control which was never exercised was not enough: [15].

What the Court decided

The appeals were dismissed with costs. Murphy J dissented. On the central question the Court held that "controlled" means control in fact, and not the capacity to control.

Moreover, the word "controlled", when used passively, in its ordinary meaning refers to de facto control rather than to capacity to control, a concept which is reflected in pars. (b) and (c).

Stephen, Mason and Wilson JJ at 659, joint judgment [13].

Two supporting propositions carried that conclusion. "Controlled principally" means controlled chiefly or in the main: [11]. And shareholders do not ordinarily exercise control in fact over a company's business at all: their participation is generally limited to receiving accounts and electing directors, while the important decisions are invariably taken by the board: [14]. Cases about control of a company, or a controlling interest, were therefore of little assistance, because they turn on the different idea of capacity: [16].

Applied to the facts, the inference the Commissioner asked for could not be drawn. The taxpayer had indeed acted on directions in relation to the Hong Kong arrangement, but those directions came from Comalco, which is an Australian company: [25]. For the later years a majority of the directors in office were Australian residents: [27]. For the earliest year the Court declined to treat silence by overseas directors as participation in board decisions without evidence that they had been informed in detail and had at times participated overtly: [28].

Barwick CJ reached the same result by a different route, holding that control of a general meeting must be distinguished from control of the business, and that the only control in fact was by the taxpayer itself: [16], [24].

Murphy J, dissenting, would have allowed the appeals. His judgment is the one a modern reader finds most familiar. He set out the mechanics of shifting profits to a low-tax jurisdiction through an intermediary, called the counting of resident against non-resident directors superficial and often an absurd formalism, and treated the existence of the arrangement as itself a strong indication of foreign control: [6], [7]. He also emphasised that the taxpayer bore the onus and had not discharged it: [13].

Why the decision matters

The case is usually mentioned as the beginning of Australian transfer pricing, and that is right only in the sense that s 136 occupied the place Division 13 later took. It is important to be precise about what the section did and did not do, because the difference explains everything that followed. Section 136 asked a question about corporate control and, if the answer was yes, allowed the Commissioner to tax a proportion of gross receipts. It did not ask whether the price was one independent parties would have agreed, and it gave no power to substitute an arm's length price for the one the parties used.

So the pricing problem the Board of Review had found was never reached. The Court accepted that the taxpayer had sold at a discount for no business reason of its own and to its parent's advantage, and the assessments still failed, because the gateway was about who ran the business rather than about the terms on which it dealt. A provision that can be defeated by inserting Australian companies into the middle of an ownership chain is not a transfer pricing provision.

That is the contrast the High Court itself drew when it came to the replacement regime in W R Carpenter Holdings Pty Ltd v Federal Commissioner of Taxation (2008) 237 CLR 198 at [21], where Division 13 as remade was described as fixing not upon questions of corporate control or ownership but upon an absence of arm's length dealings. The modern provisions ask about the dealing. This case is why.

Two smaller propositions from the judgment have outlived the section and are still cited: that "principally" means chiefly or in the main, and the division of function between the general meeting and the board.

Where it stands

The decision stands. Nothing in the citator material read for this note reverses, overrules or doubts it, and it was restated as correct by the High Court in W R Carpenter Holdings Pty Ltd v Federal Commissioner of Taxation (2008) 237 CLR 198 at [21]. It was still being applied as at September 2024 for the meaning of "principally" and for the division of power between directors and the general meeting.

The provision it construed is gone. Section 136 was replaced by the remade Division 13, which was in turn replaced by Subdivision 815-A and then by Subdivision 815-B of the Income Tax Assessment Act 1997 (Cth). Nothing in this decision construes any of them, and it should not be cited for any proposition about the current law.

One caution about how the case is summarised. The Commissioner lost, and lost four to one. An account that places it on a list of milestones in Australian transfer pricing enforcement, without saying so, leaves the opposite impression.

A case note by Boettcher Law. It is general information about Australian law and a summary of a published decision, and it is not legal advice on any particular arrangement. Page references are to the Commonwealth Law Reports and paragraph references to the judgments as reported.