FEDERAL COURT OF AUSTRALIA Visy Industries USA Pty Ltd v Commissioner of Taxation [2011] FCA 1065 Citation: Visy Industries USA Pty Ltd v Commissioner of Taxation [2011] FCA 1065 Parties: VISY INDUSTRIES USA PTY LTD (ACN 005 449 445) v COMMISSIONER OF TAXATION File numbers: VID 1151 of 2010 VID 1152 of 2010 Judge: GORDON J Date of judgment: 14 September 2011 Catchwords: INCOME TAX – allowable deduction – Income Tax Assessment Act 1997 (Cth) s 8-1 – forward exchange contract – internal hedge – indemnity fee – isolated transaction – commercial transaction – adventure in the nature of trade – profit-making purpose – wager – incurred in gaining or producing assessable income – loss or outgoing of capital or in the nature of capital Legislation: Income Tax Assessment Act 1936 (Cth) Income Tax Assessment Act 1997 (Cth) Cases cited: American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1979] AC 676 Argy v Blunts & Lane Cove Real Estate Pty Ltd (1990) 26 FCR 112 Babka v Federal Commissioner of Taxation (1989) 89 ATC 4963 BHP Billiton Finance Ltd v Federal Commissioner of Taxation (2009) 72 ATR 746 BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386 Brajkovich v Federal Commissioner of Taxation (1989) 89 ALR 408 Brookton Co-operative Society Ltd v Federal Commissioner of Taxation (1981) 147 CLR 441 Cecil Bros Pty Ltd v Federal Commissioner of Taxation (1964) 111 CLR 430 Commissioner of Taxation of the Commonwealth of Australia v Citylink Melbourne Limited (2006) 228 CLR 1 Commissioner of Taxation v Cooling (1990) 22 FCR 42 Commissioner of Taxation v Lau (1984) 6 FCR 202 Commissioner of Taxation v Raymor (NSW) Pty Ltd (1990) 24 FCR 90 Commissioner of Taxation v Roberts and Smith (1992) 37 FCR 246 Cooper (Inspector of Taxes) v Stubbs [1925] 2 KB 753 Comptroller-General of Customs v AMI Toyota Ltd [1989] VR 231 David Securities Pty Limited v Commonwealth Bank of Australia [1990] FCA 186 Development Finance Corporation of New Zealand Ltd v Bielby [1991] 1 NZLR 587 Drambo Pty Limited v Westpac Banking Corporation Limited (1996) 96 ATC 4737 Esso Australia Resources Pty Ltd v Commissioner of Taxation [2011] FCA 565 Federal Commissioner of Taxation v Anstis (2010) 241 CLR 443 Federal Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd (2011) 192 FCR 325 Federal Commissioner of Taxation v BHP Billiton Finance Limited (2010) 182 FCR 526 Federal Commissioner of Taxation v Day (2008) 236 CLR 163 Federal Commissioner of Taxation v Day (2007) 164 FCR 250 Federal Commissioner of Taxation v Haass (1999) 91 FCR 132 Federal Commissioner of Taxation v Midland Railway Co of Western Australia Ltd (1952) 85 CLR 306 Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 Federal Commissioner of Taxation v Payne (2001) 202 CLR 93 Federal Commissioner of Taxation v South Australian Battery Makers (1978) 140 CLR 645 Federal Commissioner of Taxation v Whitford's Beach Pty Ltd (1982) 150 CLR 355 Ferneyhough v Westpac Banking Corporation (unreported, Federal Court of Australia, 18 November 1991) Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 Graham v Green (Inspector of Taxes) [1925] 2 KB 37 Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 IEL Finance Ltd v Commissioner of Taxation (2010) 272 ALR 640 Kidston Goldmines Ltd v Commissioner of Taxation (1991) 30 FCR 77 Jones v Federal Commissioner of Taxation (1932) 2 ATD 16 Lamesa Holding BV v Commissioner of Taxation [1999] FCA 612 LNC (Wholesale) Pty Ltd v Collector of Customs (1988) 77 ALR 347 Lubidineuse v Bevanere Pty Ltd (1984) 3 FCR 1 Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213 National Australia Bank Ltd v Commissioner of Taxation (1997) 80 FCR 352 National Australia Bank Ltd v Meeke [2007] WASC 11 Paramedical Services Pty Ltd v Ambulance Service of New South Wales (2005) 217 ALR 502 Robb Evans of Robb Evans & Associates v European Bank Ltd [2009] NSWCA 67 Ronpibon Tin NL & Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 Spassked Pty Ltd v Commissioner of Taxation (2003) 136 FCR 441 Specialised Printing Equipment v de Vries [2003] NSWSC 1168 Spriggs v Federal Commissioner of Taxation (2009) 239 CLR 1 Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 Tweddle v Commissioner of Taxation (1942) 180 CLR 1 Westfield Ltd v Federal Commissioner of Taxation (1991) 28 FCR 333 Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 Guy, A.F, Foreign Exchange Risk Management (1985) Australian Mining and Petroleum Law Association Yearbook 178-195 TR 2005/15: Income tax: tax consequences of financial contracts for differences (Commissioner of Taxation, 31 August 2005) Date of hearing: 10, 11 and 12 August 2011 Date of last submissions: 24 August 2011 Place: Melbourne Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 132 Counsel for the Applicant: Mr SHP Steward SC with Ms LA Hespe and Mr SA Linden Solicitor for the Applicant: Deloitte Lawyers Pty Ltd Counsel for the Respondent: Ms H Symon SC with Ms M Baker Solicitor for the Respondent: Australian Government Solicitor IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 1151 of 2010 BETWEEN: VISY INDUSTRIES USA PTY LTD (ACN 005 449 445) Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: GORDON J DATE OF ORDER: 14 SEPTEMBER 2011 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 21 September 2011, the parties bring in orders to give effect to these reasons for decision. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011. IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 1152 of 2010 BETWEEN: VISY INDUSTRIES USA PTY LTD (ACN 005 449 445) Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: GORDON J DATE OF ORDER: 14 SEPTEMBER 2011 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 21 September 2011, the parties bring in orders to give effect to these reasons for decision. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011. IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 1151 of 2010 VID 1152 of 2010 BETWEEN: VISY INDUSTRIES USA PTY LTD (ACN 005 449 445) Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: GORDON J DATE: 14 SEPTEMBER 2011 PLACE: MELBOURNE REASONS FOR JUDGMENT A. INTRODUCTION 1 Under a Forward Exchange Contract made in April 1997, the applicant, Visy Industries USA Pty Ltd (formerly known as Pratt Trading Pty Ltd) (Visy USA), was obliged to deliver to Pratt Finance Pty Ltd (Pratt Finance) on dates in 2015, 2016 and 2017 specified United States Dollars (USD) in exchange for Australian Dollars (AUD) at a specified exchange rate of 0.775 (the Forward Exchange Contract). 2 On 28 April 1999, Visy USA and Pratt Investments Inc (Pratt Investments) entered into a Forward Agreement (the Forward Agreement). In consideration of Pratt Investments entering into the Forward Agreement and undertaking to indemnify Visy USA against its potential loss under the Forward Exchange Contract, Visy USA was required to pay a one-off non-refundable amount of USD17,801,325 upon execution of the Forward Agreement (the Indemnity Fee). On 18 June 1999, Visy USA paid the Indemnity Fee which at the then prevailing exchange rate equated to AUD27,053,685. As the AUD had increased in value against the USD since 28 April 1999, Visy USA recorded a realised foreign exchange gain of AUD396,315 as a result of the payment. 3 The issue is whether the Indemnity Fee is an allowable deduction for Visy USA in the 1999 income year under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act). Visy USA submitted that it is deductible because it incurred the fee in gaining or producing its assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Further, Visy USA submitted that it was not a loss or outgoing of capital or of a capital nature. The respondent, the Commissioner, submitted that the Indemnity Fee was not deductible because it was not a commercial transaction or an adventure in the nature of trade and further or alternatively, it was not made with a view to profit and, if that submission was rejected, that it was a loss or outgoing of capital or of a capital nature. 4 For the reasons that follow, I consider that the Indemnity Fee was deductible under s 8-1 of the 1997 Act. Visy USA incurred the fee in gaining or producing its assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Further, the Indemnity Fee was not a loss or outgoing of capital or of a capital nature. As will become apparent, I have rejected the Commissioner's contention that the Forward Exchange Contract is not a commercial transaction or was not an adventure in the nature of trade. 5 These reasons for decision summarise the facts giving rise to the dispute, then address the relevant legislative provisions and applicable legal principles and, then, analyse whether the Indemnity Fee is deductible under s 8-1 of the 1997 Act. B. FACTS 6 The Pratt group of companies carries on a diverse range of businesses, including waste collection, paper and cardboard box manufacture, primary packaging and property and share investments (the Pratt Group). The Pratt Group has been controlled by the Pratt family since 1948. 7 In the late 1980s, the Pratt Group significantly expanded both in Australia and internationally. A complex group and business structure developed. Between 1989 and 1993, the Pratt Group restructured itself into business groups. Three business divisions were created – the Australian Manufacturing Group (AMG), the Overseas Manufacturing Group (OMG) and the Family Finance and Investment Group. Each division had its own management team. Each division was separately accountable for its operating and financial performance. 8 The AMG included the entities conducting paper packaging and recycling businesses in Australia. The parent company of the AMG was Visy Industries Australia Pty Ltd (Visy Industries Australia). All of the AMG's borrowings were raised through Pratt Finance, which acted as the internal finance company for the AMG. The OMG included the entities conducting paper, packaging and recycling businesses and investment activities in the United States (the US). The Australian holding company of the OMG was Visy USA. Finance Committee – consideration of refinancing and hedging options 9 A finance committee of the Pratt Group was responsible for making recommendations to the Pratt family about the financing structure and debt arrangements for the three business divisions. The Pratt Group Finance Committee (the Finance Committee) comprised senior executives and financial officers including Vincent O'Halloran, the Group Finance Director of Pratt Holdings Pty Ltd, John Nixon-Smith, the Chief Financial Officer of the AMG, Gary Byrd, the Chief Executive Officer of Pratt Industries (USA) Inc, Michael Naphtali, the former General Manager of the Pratt Group and Family Advisory Board member and three Pratt family members – Alex Waislitz, Anthony Pratt and Raphael Geminder. Mr O'Halloran, Mr Byrd and Mr Geminder were called to give evidence. 10 In early 1997, Pratt Finance was looking to refinance its debt then constituted by a Bilateral Finance Facility (BIFF) with a panel of local and overseas banks. The BIFF was due to mature in 2022. The quantum of the debt in early 1997 was approximately AUD563 million. 11 In March 1997, the Finance Committee began to consider alternative refinancing options including the need for, and viability of, hedging. The Finance Committee recognised that, in contrast to the position in the US, there were severe limitations to the Australian debt market. The demand for private bonds as well as the long term private bond debt market in Australia was virtually non-existent. 12 The Finance Committee considered how the Pratt Group might be able to use the group's US assets to mitigate the hedging cost and to capture for the AMG any gain if the value of the AUD increased against the USD. As external hedges were expensive, both external and internal hedges were considered. 13 On 12 March 1997, Joel Cohen, who worked for Mr Nixon-Smith, prepared a memorandum for Arthur Anderson, the auditors of the AMG. Mr Cohen's memorandum recorded that the AMG was considering a foreign currency loan proposal and that he had been asked to provide a summary of the profit and loss impacts associated with the transaction. Mr Cohen addressed three forms of hedging – fully hedged loan, unhedged loan and use of a USD loan to form a natural hedge against the US assets. Notwithstanding that Mr Cohen's description of each form of hedging was less than clear, his analysis of the last method identified that the Pratt Group's US investment was held outside of the AMG, and suggested, as an alternative, that the AMG enter into an internal hedge. 14 After seeking and receiving advice from Credit Suisse First Boston, the Finance Committee decided that it would recommend to the board of Pratt Finance that it seek to repay the existing local BIFF by borrowing USD400 million through the issue of senior unsecured notes (also referred to as bonds). 15 On 19 March 1997, the board of Pratt Finance resolved that Pratt Finance participate in placement of senior unsecured notes (the Bonds) to institutional investors resident in the US, repayable in 15 to 18 years (the Proposed Bond Issue). At that time, the tranches were still to be determined. The cost of those funds were described as follows: Bond Issue Based on average loan life, indicative all-up rates are: 15 years 16 years 17 years 18 years 9.11% 9.16% 9.21% 9.26% Above includes all-up hedge /cross currency /swaps. Costs of using existing interest hedge /swaps will add 20 basis points to the costs. The ability to use the Visy US assets as a natural hedge is under review. This will be subject to accounting standards. Consideration will be given to locking in interest rates once approval is given to proceed with the issue. Further advice and guidance is being sought from Credit Suisse First Boston … 16 The Finance Committee agreed upon the following actions being taken: • Hedge proposed $200 million working capital facility. • … • Maintain a range of exchange cover for the US$400 million to maximise Australian dollar proceeds. • … • Endeavour to negotiate 30 business days' grace for tangible net with covenant. • … • Determine whether or not U.S. assets can be a natural hedge and thus reduce cost of funding. … As is apparent, the Proposed Bond Issue, hedging, and in particular, the use of US assets to reduce the cost of funding, were interrelated. In relation to the various hedging scenarios (unhedged / fully hedged using cross-currency swap / use of an internal foreign exchange contract to partially hedge the US liability), detailed consideration was given to the accounting treatment of those scenarios in relation to the Proposed Bond Issue. 17 The Proposed Bond Issue required several actions from Pratt Finance. First, Pratt Finance was required to obtain a credit rating. Fitch Investors Services LP rated the Bonds as BBB+, which was investment grade. 18 Secondly, as most institutional investors could only participate in a debt issue denominated in USD, it was necessary for Pratt Finance to consider how it would swap the USD it raised back into AUD to repay the AUD denominated debt in the BIFF. 19 Thirdly, because the Proposed Bond Issue would be repayable in USD, and Pratt Finance and Visy Industries Australia reported debt in AUD, it was necessary for the Finance Committee to consider options for hedging against movements in the USD-AUD exchange rate. If the US debt was not hedged, a substantial devaluation in the AUD against the USD could affect the AMG's compliance with the covenants in the loan documentation for the Proposed Bond Issue that obliged the AMG to not exceed minimum debt levels and to preserve a minimum net worth. 20 Given the size of the Proposed Bond Issue denominated in USD, the Finance Committee engaged Coopers & Lybrand to consider the potential choices open to Pratt Finance to hedge its USD liability. Mr O'Halloran described the transaction as "the likes of which [they had] never entered into before". 21 In April 1997, Coopers & Lybrand provided a report. The scope of Coopers & Lybrand's review: … was to provide independent specialist risk advice on the following: • hedging issues arising from the US $400m private placement • identification and re-affirmation of key hedging choices for the placement • high level evaluation of each of the hedging choices, with key advantages and disadvantages for each • other issues / recommendations related to the placement 22 The report considered the issues from the viewpoint of Pratt Finance, not Visy USA. The report stated that Coopers & Lybrand had identified issues through discussions with senior management and had reviewed information provided by management in relation to Visy Industries and the debt placement. Significantly, the report also recorded that Coopers & Lybrand were required to advise Visy Industries "generally about needs to be considered when implementing a hedge" and that Coopers & Lybrand did not advise Visy Industries "whether the terms of any particular hedge [were] appropriate to meet [its] needs". The report identified a number of "hedging methods" and the advantages and disadvantages of each method. Mr O'Halloran was cross-examined about the report. He accepted that the report identified disadvantages in using cross-currency swaps as follows: Whilst the swap is relatively low cost, the cost of the hedge may still be significant. The all in cost of funds (including swap costs to AUD fixed) is approximately 9.35%. The all in cost of funds excluding the swaps is approximately 8.14%. Therefore, based on the full US$400m, the cost of the hedge is approximately US$4.8 per annum. Mr O'Halloran accepted that the net cost of the cross-currency swaps was approximately 1.2%. 23 Not all hedging methods identified by Coopers & Lybrand were available to the Pratt Group. For example, one method described utilising the US operations to hedge the debt for the entire life of the debt. Mr O'Halloran's evidence was that method was not available to the Pratt Group because there were no unencumbered US assets. 24 Taking into account the Coopers & Lybrand report, the Finance Committee adopted Mr O'Halloran's recommendations and recommended to the directors of Pratt Finance and Visy USA that they adopt a combination of external and internal hedging methods. 25 Specifically, the Finance Committee recommended that Pratt Finance enter into principal and interest currency cross-currency swaps with Australian financial institutions for the first half of the Proposed Bond Issue (USD200 million) which had the earlier maturity dates of 2012-2015 and Pratt Finance enter into a foreign exchange hedge with Visy USA for the principal repayment due under the other half of the Bonds. The foreign exchange risk on the balance of the interest payments was to be managed through the USD revenues of the AMG, which were growing as the AMG grew. 26 At the time, the Finance Committee considered (albeit mistakenly) that the cross-currency swaps with Australian financial institutions could not be used to hedge the second half of the Bonds. The Finance Committee were mistakenly of the view that the Australian market did not provide hedges for Bonds with such extensive maturity dates and that Australian banks required a right to break the hedge every five or six years. As a result, Pratt Finance carried a refinance risk. 27 Because of uncertainties about the USD revenues of the AMG, Mr O'Halloran thought it prudent to put shorter dated swap maturities in place for USD165 million to cover the principal and interest payments due on the Bonds for the first three to five years. Given the long term nature of the Proposed Bond Issue, Mr O'Halloran considered that there may be an opportunity later to hedge the US debt at a higher exchange rate, particularly given the then upward trend in the value of the AUD as against the USD, and that the short term hedges would provide flexibility to reset the hedge at their expiry. Therefore, Mr O'Halloran recommended to the Finance Committee, and then to Mr Richard Pratt, that the principal portion of the debt for three to five years be hedged by both the short dated external maturities / cross-currency swaps and a long dated forward exchange contract between Visy USA and Pratt Finance. 28 On 14 April 1997, Mr O'Halloran sent a memorandum to Messrs Pratt, Waislitz and Naphtali in relation to the Proposed Bond Issue. In the memorandum, Mr O'Halloran outlined the assumptions and perceptions which drove the Proposed Bond Issue and the profound impact of those assumptions on the Pratt Group's business over the next 15 years. Mr O'Halloran reported that it was not possible to fully hedge the capital value of the debt for the full term without providing for reviews (or what are commonly described as Break Points) at five yearly intervals. 29 Under the heading "Internal Hedge", Mr O'Halloran stated that the concept needed to be "fully grasped". As Mr O'Halloran said in cross-examination, the internal hedge was a unique transaction. He described it in the memorandum as follows: It will involve Pratt Holdings (or say [Visy USA], the owner of all our US companies) effectively providing a guarantee to the bond holders for any shortfall in the US $ required to repay the debt. This guarantee must be put in place to avoid non compliance with the minimum net worth test should the A$ fall against the US$. Again the arms length test is likely to come into play. The guarantee that is put into place must be good. At the moment our equity into the USA is unencumbered (albeit our US operations are highly geared). We may need to be able to borrow against this equity to make good the guarantee. We will only be able to borrow against that equity if the net market value/ net tangible assets of the USA operations is sufficient. Over a period of time we have tried to ensure that Pratt Holdings and each of the two main businesses (AMG and USA) have remained independent of each other. An internal hedge will go against this principle. At this point we must determine whether we are going to manage the company with a global perspective or continue to manage the finance function of the two countries independent of each other. In terms of the internal hedge, the current proposal as I understand it is as follows Borrow US$400m First three years hedge total liability externally After three years hedge externally US$300m., balance internally After five years hedge externally US$150m., balance internally 30 In early to mid April 1997, the Finance Committee agreed that the Proposed Bond Issue would be USD400 million and would be hedged. The hedging strategy which was proposed was as follows: 1. USD200 million would be hedged for the full duration of the Proposed Bond Issue; and 2. for three to five years, the remaining USD200 million foreign exchange risk would be covered by the US asset base with USD200 million hedged for three years and, at year three, USD100 million would revert to the natural hedge and, at year five, the remaining USD100 million would revert to the natural hedge. This specific hedging proposal was not ultimately adopted. 31 The Finance Committee also recommended that Pratt Finance enter into an internal hedge with Visy USA which at the time, directly and indirectly, owned all the issued share capital of the US resident Pratt holding company, Pratt Holdings USA Inc (Pratt Holdings USA). Pratt Holdings USA was not the borrowing entity within the US group. The exchange rate for the internal hedge was to be the same as that negotiated with the external financial institutions; that is, 0.775. Under the arrangement, Visy USA would agree to deliver USD to Pratt Finance at maturity dates between 2015 and 2017 in exchange for AUD at the rate of 0.775. It became known as the Forward Exchange Contract. Mr O'Halloran's evidence was that advice was not sought about the pricing of the Forward Exchange Contract and its terms because: We knew that the particular transaction was unique in its own fashion, and we used our own judgment in terms of what the rate ought to be on that contract. We were keen to ensure that the contract did offer Pratt Trading the opportunity to actually do something with the contract, or through to maturity, simply see it out. 32 Messrs O'Halloran and Byrd were members of the Finance Committee. Both gave evidence that they considered the risks and opportunities the proposed hedge held for Visy USA. Mr O'Halloran's unchallenged evidence was that: In so far as the opportunities were concerned, I expected that the volatility in the AUD/USD exchange rate would continue and that over the term of the contract, the AUD would experience both increases and decreases in value. I also regarded it as highly probable that at some point over the 20 year swap period, the value of the AUD as against the USD would climb above USD 0.775. [Visy USA] stood to make a gain if the value of the AUD increased against the USD. I expected that because Pratt Finance held a credit rating, financial commitments made by it would have significant commercial value and potential for gain. Because Pratt Finance held a credit rating of BBB+ (and was therefore investment grade), I considered that it would be commercially possible for [Visy USA] to realise any gain by either selling the swap at the time when the AUD had increased above USD 0.775 or by entering into some form of derivative transaction. Because of Pratt Finance's credit rating, I considered the forward exchange contract to be like a marketable security in respect of which [Visy USA] would be able to realise any increase in its value even prior to its maturity. This was an issue which was discussed at finance committee meetings held at the time to consider the Coopers & Lybrand report. I also considered the risks to [Visy USA] should the AUD depreciate against the USD. [Visy USA] directly and indirectly owned all the shares in [Pratt Holdings USA]. This meant that [Visy USA] had a 100% indirect interest in the US operating assets. Because the AMG (of which Pratt Finance was part) and OMG (of which [Visy USA] was part) operated as standalone entities, I considered that it was important that the OMG executives and directors of [Visy USA] be aware of the obligations being placed on [Visy USA]. However, I expected that any depreciation in the value of the AUD against the USD (which could give rise to liability for [Visy USA] under the forward exchange contract) would be matched by an increase in the AUD value of the earnings and cashflows from the US operations and that accordingly, the risks to [Visy USA] were relatively low provided the base value market value of the US business remained stable. As a result, I did not expect [Visy USA] to incur any additional costs merely as a result of having exposure under the contract. Instead, I considered that because of the duration of the forward exchange contract, [Visy USA] was more likely to be able to profit from it at some point over its term with minimal cost and risk. 33 Mr O'Halloran stated in cross-examination that because the AUD "had traded up well and truly above 77 cents at various times in the previous 20 year period", he had "good cause" to think that entry into the Forward Exchange Contract was "a reasonable position" for Visy USA to be in and that "the likely movement in the exchange rate up would give [Visy USA] the profit opportunity to capitalise on the position it was in." 34 Mr Byrd's evidence was to similar effect. In cross-examination he stated that: … the long dated maturity was particularly advantageous because it gave us many years of opportunities when the Aussie dollar would be in the money as opposed to out of the money. So I – I looked at that as being prudent because of the long dated maturity; not imprudent because of the long dated maturity. Could get as many opportunities in which to either re-hedge or take advantage of when the Aussie dollar is strong. Mr Byrd could not recall discussing the possibility of profit with anybody else. His explanation was that it was a "no-brainer in terms of there's a profit opportunity as well as a loss opportunity in any financial … unit hedge transaction that you enter into, whether it's … two banks or a private company". 35 Mr Geminder's evidence was also to similar effect. In cross-examination he stated that: It was hoped in fact that [Visy USA] would ultimately make a profit on the instrument that it put in place … I never anticipated that we would lose money on that contract. My anticipation was that we would make money on that contract. 36 The precise form a derivative transaction might have taken in the future was not considered at the time. Mr Geminder explained in cross-examination that: We didn't actually sit down and think about when the – when we were in a profitable position, how are we going to crystallise that profit. But – why would we do that? You know, crystallising a profit in a synthetic hedge, or a hedge like that is not that complicated … There's lots of ways that you can crystallise a profit; there are lots of mechanics and lots of tools … lots of ways to make a mark-up to realise a profit. (Emphasis added.) 37 So, for example, Mr Geminder's evidence was that it would have been open to seek to re-hedge either internally or externally, thus achieving both a profit and a hedge. He described the market as "very vibrant and active". 38 Similarly, when asked in cross-examination whether there were other methods that Visy USA could have used to lock in a profit, Mr O'Halloran responded that: I've mentioned the concepts of derivatives; I've mentioned the assignment of all of the obligations. Whether there are other opportunities that could avail themself over a period of time with a range of products that appear in a marketplace, I was aware of that. I had been involved in finance for quite some period of time and seen considerable change in different products that avail themselves; we could have levered off the value of the benefit. Pratt Finance had the underlying obligation – was actually BBB rated credit at the time, which is … great credit for a private company … And whilst it had that credit profile, that instrument that was created and the obligations created under it, in my view, had the ability of being levered and a benefit taken from it. 39 Mr O'Halloran rejected the proposition that the alternatives that were in contemplation all necessarily involved a termination or cancellation of the Forward Exchange Contract and noted that the Forward Agreement that was entered into between Visy USA and Pratt Investments (see [66]-[70] below) did not involve a termination of the Forward Exchange Contract. I accept that as a result of the different "mechanics" and "tools", it was open to Visy USA to crystallise a profit without affecting the hedge arrangement; cancellation of the Forward Exchange Contract was just one option. 40 Visy USA did not seek a fee or immediate payment from Pratt Finance for entry into the Forward Exchange Contract because the exchange rate of 0.775 which it used represented what was described as a "reasonable amount". As Mr O'Halloran explained: I felt that the exchange rate that was in the forward agreement at the time reflected the risk that [Visy USA] was entering into the contract. [Visy USA] was not a bank. The nearest comparable amount that we had was the amount in the cross-currency swaps. We had no indication of how much of the fees embedded in the cross-currency swap actually related to principal and how much related to the interest flux. So the nearest comparably comparable we had was what was actually in the cross-currency swap. We didn't know what was allocated to principal and what was allocated to interest flux. We considered the position of [Visy USA] we considered its asset base. We considered what it might be able to do with the contract, and we considered that it had some 18-year period in which to make a profit. 41 That there was no express cost to Pratt Finance is not surprising. Mr Carroll explained that in a forward exchange agreement such costs are generally built into the exchange rate. 42 It was expected that any loss arising to Visy USA if the AUD was to devalue against the USD would be offset by the gain in value of Visy USA's USD denominated assets. If, on the other hand, the value of the AUD increased against the USD, Visy USA would be able to profit from the hedge. Overall, because of the duration of the Forward Exchange Contract, it was considered that Visy USA would be likely to profit from the Forward Exchange Contract at some point over its term with minimal cost and risk. Implementation of Finance Committee Recommendations 43 On 21 April 1997, the directors of Pratt Finance and Visy USA resolved that their respective companies would enter into the Forward Exchange Contract. 44 The minutes of meeting of Pratt Finance recorded that: … [Pratt Finance intends] to participate and act as the issuer in a private placement of US$400 million of Senior Unsecured Notes to institutional investors resident within the United States of America ("Note Issue"). … as a consequence of the Note Issue, [Pratt Finance] would face certain foreign exchange exposures commencing in the years 2000 and 2002 and that [Pratt Finance] would be required to manage and limit these exposures. IT WAS RESOLVED that [Pratt Finance] would enter into inter-company foreign exchange hedge contracts with [Visy USA] to manage certain foreign exchange exposures arising in connection with the Note Issue. 45 The minutes of meeting of Visy USA recorded that: … [Pratt Finance intends] to participate and act as the issuer in a private placement of US$400 million of Senior Unsecured Notes to institutional investors resident within the United States of America ("Note Issue"). … [Visy USA] wished to hedge its US dollar asset base by using an internal foreign exchange hedge with [Pratt Finance] and [Pratt Finance] also wished to enter into such hedges as a consequence of the Note Issue. IT WAS RESOLVED that [Visy USA] would enter into inter-company foreign exchange hedge contracts with [Pratt Finance] given the common interest and benefits to both companies. 46 The terms of the Forward Exchange Contract were as follows: 1. Visy USA agreed to sell to Pratt Finance five amounts of USD, being amounts which matched Pratt Finance's USD liability under half of the Bonds. 2. In exchange, Pratt Finance agreed to deliver to Visy USA equivalent amounts of AUD at the agreed exchange rate of 0.775. 3. The time for delivery of the amounts was fixed by reference to the maturity dates under each tranche of the second half of the issued Bonds as follows: Commence Date Maturity Date Amount (USD) 23.05.1997 23.05.2015 9 million 23.05.1997 23.05.2016 26 million 23.05.1997 23.05.2016 50 million 23.05.1997 23.05.2017 15 million 23.05.1997 23.05.2017 100 million Total 200 million 4. Pratt Finance could request early delivery, which if agreed to by Visy USA, would be at the exchange rate determined by Visy USA. 5. If Pratt Finance repudiated the contract or failed to take delivery of or pay the USD amounts at maturity (or any other date which the parties had agreed), Visy USA would be entitled to compensation from Pratt Finance equal to the difference between the USD amounts calculated at the then prevailing exchange rate and the rate of 0.775. 6. Pratt Finance could not assign or otherwise transfer all or any part of its entitlements under the Forward Exchange Contract. Visy USA could. 47 On 20 May 1997, Pratt Finance entered into a Note Purchase Agreement (the Notes Agreement) with a syndicate of 18 US financial institutions (primarily life insurance companies). Under the Notes Agreement, the Bonds were issued in six tranches with maturity dates ranging from 2012 to 2017 as follows: Notes Series Interest Aggregate Due Principal Amount (USD) A 7.96% pa 88 million 2012 B 8.00% pa 30 million 2013 C 8.04% pa 53 million 2014 D 8.08% pa 38 million 2015 E 8.12% pa 76 million 2016 F 8.16% pa 115 million 2017 (the Bond Issue). 48 Under the terms of the Bond Issue: 1. the AMG was required to limit its level of future indebtedness; 2. the AMG had prescribed minimum financial performance standards, including minimum "Consolidated Net Worth": cl 10.2, The "Consolidated Net Worth" was to be determined in accordance with Generally Accepted Accounting Principles: cl 24.5 and Sch B (B-3); 3. the obligations of Pratt Finance were unconditionally guaranteed by the AMG companies: cl 12. As noted earlier, the private placement was denominated in USD because most US institutional investors could only participate in a debt denominated in USD. 49 On 21 May 1997, the directors of Pratt Finance ratified the Notes Agreement. 50 In late May 1997, Pratt Finance entered into the following cross-currency swaps with different financial institutions. No single bank was prepared to be the counterparty: Effective Date Bank Amount (USD) Maturity Date Break Points 23.05.97 Westpac 25 million 23.05.2000 23.05.97 Citibank 40 million 23.05.2000 23.05.97 ANZ 50 million 23.05.2002 23.05.97 Citibank 50 million 23.05.2002 23.05.97 ANZ 13 million 23.05.2012 23.05.07 23.05.97 Societe Generale Australia Limited 75 million 23.05.2012 23.05.07 23.05.97 Citibank 30 million 23.05.2013 22.04.03 and 21.04.09 23.05.97 Citibank 20 million 23.05.2014 22.04.03 and 21.04.09 23.05.97 ANZ 33 million 23.05.2014 23.05.07 23.05.97 ANZ 29 million 23.05.2015 23.05.02, 23.05.07 and 23.05.12 Total 365 million 51 Under the cross-currency swaps, Pratt Finance exchanged USD it received under the Bond Issue for AUD at the prevailing rate of 0.775 and, at maturity, Pratt Finance agreed to pay AUD to purchase USD at that same exchange rate. These cross-currency swaps initially hedged USD365 million of Pratt Finance's principal and interest obligations under the Bonds. As is apparent (see [47] and [50] above), there was some mismatch between the maturity date of the swaps as against the Bonds. So, for example, two short term swaps matured in 2000 and 2002 and none of the cross-currency swaps was for a term beyond 2015. Events after May 1997 52 Daily and monthly reports on the value of the AUD as against the USD were provided to the Finance Committee. Mr O'Halloran also met regularly with foreign exchange advisers from Societe Generale to obtain advice on anticipated future trends in the movement of the value of the AUD / USD exchange rate. 53 From mid May 1997, as a result of the Asian economic crisis, the value of the AUD fell sharply against the USD. 54 In June or July 1997, the shorter term swaps of USD165 million maturing in 2000 and 2002 were closed out in respect of principal but not interest. Pratt Finance realised a gain of AUD5 million which it returned as assessable income. Once the earlier maturing swaps were closed out, the total amount of USD principal liabilities hedged was reduced to USD400 million. 55 By the end of October 1997, as the Asian economic crisis deepened, the AUD had fallen below USD0.70. 56 As a result of the devaluation of the AUD, at the same time that Visy USA's equity in its US subsidiaries increased, its liability under the Forward Exchange Contract increased. 57 Throughout 1998, members of the Finance Committee had frequent discussions about what (if anything) should be done about Visy USA's exposure under the Forward Exchange Contract. To regard the Forward Exchange Contract as an effective hedge for accounting purposes, the auditors needed to be satisfied that Visy USA would be able to meet its liability under the Forward Exchange Contract if it was called upon to do so. 58 On 17 April 1998, Mr Nixon-Smith prepared a briefing paper for the Pratt Group Board entitled "USD Private Placement Foreign Currency and Interest Rate Hedging Position". The paper stated: It is almost one year since we re-financed Visy Industries Australia through a Private Placement with a group of US based institutional investors. This is an appropriate time to review and refresh Board Members with the current situation regarding the hedging strategy. At the time of closing it was agreed that a hedging strategy should be implemented that eliminated our exposure to rising interest rates and/or a depreciation of the Australian Dollar. In accordance with this position hedge arrangements were negotiated with four of Visy's Australian Bankers. They include ANZ, Westpac, Citibank and Societe Generale. The Private Placement raised USD 400 million of debt. USD 35 million was invested directly into Visy USA to assist with the purchase of Bell Packaging and the start up of the Staten Island mill. We entered into hedge contracts for USD 365 million for terms ranging between 3 to 18 years (Refer Appendix 10). You will note the maturity profile of these hedge arrangements reveal maturities in two years and four years from now. This profile was structured to permit Visy the opportunity to use the Nett Asset position of Visy USA as a "Natural Hedge" or internal hedge for certain portions of the Private Placement Debt (Refer Appendix 11). The validity and effectiveness of this strategy depends upon the growth and value of the investment in Visy USA. Based on the Nett Asset value after deducting all intercompany entries in the February Balance Sheet (USD 139 million), the use of the US Investment as a "Natural Hedge" for the Australian Private Placement remains valid. 59 By the middle of 1998, the AUD had fallen below USD0.59 and Visy USA had an unrealised loss under the Forward Exchange Contract of AUD80 million. Meetings were held between Mr O'Halloran and US representatives of Pratt Group and AMG officers. 60 At a meeting held in early September 1998, concern was expressed about the effect of the liability under the Forward Exchange Contract on the Pratt Group's overall balance sheet and the ability of Visy USA to meet the liability if it was called upon to do so. Those concerns and the decisions that were taken were recorded on 7 September 1998, when Mr O'Halloran sent a memorandum to Messrs Byrd, Nixon-Smith and others entitled "Foreign Currency Hedges": … [I]t was agreed that given the recent volatility in the A$ against the US$ it would be prudent to revisit all of our current hedging strategies. This includes both the external hedge positions held by the AMG with local banks and the natural hedge on the equity in the US balance sheet. There was concern with the large unrealised loss position in the total Australian group balance sheet. The general consensus view was that at 56c. we should not take cover but have a stop loss strategy in place. If the A$ fell below 50c. we should take external cover on the natural hedge position as the out of the money position would be simply too high for the group. If the A$ rises we should find a reset point which would give a degree of comfort to the group. … … [W]e agreed that it made no sense for a 100% privately owned group with significant assets and liabilities in cross currencies to pay substantial sums for external currency hedging cover. Where possible we agreed that where no natural hedge existed within a balance sheet we should try to match positions in both Australia and the United States for the better good of the group as a whole. We agreed to meet again in November to discuss these issues in greater depth. 61 At about the same time, the auditors questioned the effectiveness of the Forward Exchange Contract. The auditors told the Pratt Group that the effectiveness of the hedge for accounting purposes was dependent on them being satisfied that Visy USA was able to meet any liability it might incur under the Forward Exchange Contract – the internal hedge. It must be recalled that although Visy USA was the ultimate holding company of the OMG (which included the US group), Visy USA did not have direct access to the cashflows of the US businesses. 62 By November 1998, the AUD had recovered but Mr O'Halloran remained concerned about Visy USA's accrued liability under the Forward Exchange Contract. So, on 25 November 1998, he sent a further memorandum to Messrs Byrd, Nixon-Smith and others entitled "Foreign Currency Strategy" which contained his notes of a meeting from the previous week. Relevantly, under the heading "Impact of A$ movement", the memorandum stated: In August we agreed not take (sic) cover in relation to the natural hedge. Fortunately this looks to have been a very good idea as rates have moved up since then. There also appears to be good signs on the US market front considering the recent merger activity and a slight movement up in linerboard prices. At the current 63.5c rate we have clawed back A$43m since September. We are still out of the money by A$56m. The general consensus view was that we should now take advantage of the recent surge in the A$ to mitigate any possible future losses in Australia. This should involve taking a direct position against the US assets in the USA to align US$ denominated debt with our US$ held assets ... … I refer to my earlier comments on the need for the group to match currency positions on a global basis. This seems an ideal opportunity to do something in this regard. If [Visy USA] were to make a payment for an indemnity to Pratt [Investments] against downward movement in the A$ against the US$ we can achieve the same economic effect as the put option. If this can be achieved it is a better long term proposition for the group in terms of both security and long term earnings potential. … The best alternative would be to match the repayment profile with US cash flows. The projections for the US operations are for excess cash flows (ie EBITDA) in excess of US$200m annually providing ample cash flow to service the current shortfall … … It will be necessary to keep the [Visy USA] forward exchange agreement with Pratt Finance on foot as this is still the best mechanism to protect its balance sheet. [Visy USA] should then take a position with the appropriate Pratt US company (say [Pratt Investments]) which will ensure delivery of the US$ to [Visy USA] on the prescribed dates…We have tried to assess the indemnity payment price based on the NPV of the payments using A$ forward rate projections and believe that A$27m is about right at the current rates. (Emphasis added.) Mr O'Halloran accepted that the "we" identified in the highlighted passages was a reference to Visy USA. 63 Various other options were considered to take advantage of the surge in the AUD. That included looking to external hedges. Mr O'Halloran sought from Macquarie Bank Limited (MBL) a price to match Visy USA's exposure under the Forward Exchange Contract. On 19 January 1999, MBL suggested that to close out the exposure under the Forward Exchange Contract would best be achieved by way of novation of Visy USA's obligations under the existing Forward Exchange Contract to MBL. The indicative price was AUD88.83 million. Unsurprisingly, that option was considered but rejected. 64 In early 1999, Mr Carroll too had become concerned about the volatility in the value of the AUD and about Visy USA's ability to meet its liability under the Foreign Exchange Contract. The value of the US group was not increasing at the same rate as Visy USA's liability and, being a holding company, Visy USA did not have direct access to USD. Accordingly, the only way Visy USA could meet its liability if it were called upon to do so would be either to raise US debt itself or sell some of its USD assets. Neither option was considered appropriate. The Pratt Group did not want to have to raise debt to discharge a liability between two Pratt Group companies at a time when the Pratt Group was considering raising debt for the purposes of further expanding its business operations. Visy USA did not want to sell US assets which were part of its long term business strategy. 65 Mr O'Halloran asked Mr Carroll to obtain a price from the Commonwealth Bank of Australia (CBA) for entering into an option to purchase USD in exchange for AUD at an exchange rate of 0.775 on various dates from 2015 to 2017. The estimated price provided to buy these options was USD18 million. 66 Four months later, Mr O'Halloran received a memorandum from Mr Byrd entitled "Forward Indemnity Agreement". The memorandum recorded a decision made the previous week about a forward indemnity agreement contingent upon four issues being resolved in the following terms: 1. Pricing: I have discussed the payment with J.P. Morgan & Co. (who have been advising us on matters pertaining to interest-rate and currency risk) and I will obtain a quote from them. 2. Security: You mentioned that the Australian directors and auditors are concerned with the level of security to support the future obligations under the indemnity. Could you please confirm your requirements? 3. Balance Sheet: I can confirm that the funds will be off-balance sheet to the core U.S. manufacturing operations and that the lenders to Pratt Industries (U.S.A.), Inc. will not be affected by the position. 4. Timing: The directors are due to confirm the transaction at next week's board meeting. Can we please ensure all negotiations are completed by then. 67 The contemporaneous documentation records that the price obtained for providing the indemnity under the Forward Agreement was to be an arm's length price. Quotes were sought from JP Morgan and CBA. JP Morgan estimated the cost of the indemnity to be USD17.6 million using the most recent spot USD/AUD rate of 0.6485. CBA used the same parameters and priced the indemnity at USD18,013,200. 68 By 26 April 1999, the AUD had reached 0.645. It was agreed that the Forward Agreement should be entered into. The terms of the Forward Agreement were negotiated. On 28 April 1999, the terms of the Forward Agreement were agreed. JP Morgan quoted a rate of USD17,801,325 which Mr O'Halloran accepted. 69 The Forward Agreement between Pratt Investments and Visy USA was dated 28 April 1999. It was signed by Mr Byrd on behalf of Pratt Investments and by Mr Richard Pratt on behalf of Visy USA. The recitals recorded that: A. [Visy Industries] entered into a forward exchange contract with [Pratt Finance] whereby [Visy Industries] agreed to sell to [Pratt Finance] US$200 million at the agreed fixed exchange rate of 0.7750 on various dates from 2015 to 2017. B. [Visy Industries] now wishes to protect itself from the possibility that it may incur a foreign exchange loss in respect of the Contract. C. [Pratt Investments] has agreed to enter an agreement with [Visy Industries] whereby it shall indemnify [Visy Industries] against any and all losses arising under the Contract in consideration of the payment by [Visy Industries] to [Pratt Investments] of the Payment Amount. 70 Under the terms of the Forward Agreement, in consideration of Pratt Investments entering into the Forward Agreement and undertaking to indemnify Visy USA against its potential loss under the Forward Exchange Contract, Visy USA was required to pay and did pay the Indemnity Fee, a once-off non-refundable amount of USD17,801,325, upon execution of the agreement. A copy of the Forward Exchange Contract was attached as an Annexure. There is no dispute that Visy USA paid the Indemnity Fee (AUD27,053,685) to Pratt Investments on 18 June 1999. It is this fee Visy USA claimed as a deduction. As the AUD had increased in value against the USD since 28 April 1999, Visy USA recorded a realised foreign exchange gain of AUD396,315 as a result of the payment. C. LEGISLATION AND RELEVANT LEGAL PRINCIPLES FOR DEDUCTIBILITY 71 Section 8-1 of the 1997 Act provides: (1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. … (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. (Emphasis added.) 72 The relevant principles may be summarised as follows: 1. the expression "incurred in gaining or producing the assessable income" requires no more than that the occasion for the loss or outgoing should be found in whatever is productive of the assessable income, or, if none be produced, would be expected to produce assessable income: Ronpibon Tin NL & Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 57; 2. the notion of "gaining or producing" income within the meaning of s 8-1(1)(a) is wider than those activities which may be said to earn income. It extends to obtaining, securing or acquiring income: Federal Commissioner of Taxation v Anstis (2010) 241 CLR 443 at [29]; 3. therefore, essential to the enquiry of deductibility is identifying that which is productive of assessable income: Anstis at [30]; Federal Commissioner of Taxation v Day (2008) 236 CLR 163 at [31]; Spriggs v Federal Commissioner of Taxation (2009) 239 CLR 1 at [55] and Federal Commissioner of Taxation v Payne (2001) 202 CLR 93 at [11]. 73 I turn then to a critical issue – identifying whether the claimed deduction can be found in the assessable income that Visy USA expected to produce. I will then deal with the other limbs of s 8-1 of the 1997 Act. D. ASSESSABLE INCOME EXPECTED BY VISY USA? (1) The Issue 74 In the present case, it is common ground that deductibility of the Indemnity Fee under s 8-1 of the 1997 Act depends on whether the Forward Exchange Contract was a commercial transaction or an adventure in the nature of trade entered into for the purpose of making a profit. That statement needs further explanation. 75 Visy USA submitted that the Forward Exchange Contract was a commercial transaction or an adventure in the nature of trade entered into for the purpose of making a profit because: 1. any profit Visy USA would have made on the Forward Exchange Contract would have been assessable to it and any loss it incurred would have been deductible; 2. the Indemnity Fee was incurred by Visy USA to decrease the amount of an otherwise potential deductible loss under the Forward Exchange Contract; and 3. the occasion for the outgoing is to be found in the profit making undertaking comprising the Forward Exchange Contract and the steps taken by Visy USA to mitigate the potential loss from the Forward Exchange Contract. It is not in dispute that any profit or loss Visy USA made on the Forward Exchange Contract would have been assessable or deductible (as the case may be). It is also not in dispute that the Indemnity Fee was incurred by Visy USA to decrease the amount of an otherwise potential deductible loss under the Forward Exchange Contract. 76 The issue is whether the Forward Exchange Contract and the steps taken by Visy USA to mitigate potential loss by entering into the Forward Agreement was a 'profit making undertaking', such that it amounted to a 'commercial transaction' or an 'adventure in the nature of trade'. (2) Relevant principles 77 What then are the principles relevant to determining whether the Forward Exchange Contract was a commercial transaction or an adventure in the nature of trade entered into for the purpose of making a profit? 78 It is well established that a gain from a transaction will be assessable as ordinary income under s 6-5 of the 1997 Act if it was realised in an isolated business operation or commercial transaction in circumstances in which the taxpayer, at the time it engaged in the transaction, had the intention or purpose of making the gain: Westfield Ltd v Federal Commissioner of Taxation (1991) 28 FCR 333; Commissioner of Taxation v Cooling (1990) 22 FCR 42; Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 and Federal Commissioner of Taxation v Whitford's Beach Pty Ltd (1982) 150 CLR 355. 79 In order for an isolated transaction to constitute ordinary income, two criteria must be satisfied: 1. the transaction must be a commercial transaction or an adventure in the nature of trade; and 2. the transaction must be entered into for the purpose of making a profit. Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 672-677; Westfield at 342; Myer Emporium at 211. 80 The concept of a "commercial transaction" stands in contradistinction to a private, recreational or other non-business activity: Federal Commissioner of Taxation v Haass (1999) 91 FCR 132 at [16]-[18] and Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729; cf Paramedical Services Pty Ltd v Ambulance Service of New South Wales (2005) 217 ALR 502 at [86]; Argy v Blunts & Lane Cove Real Estate Pty Ltd (1990) 26 FCR 112 at 127-130 and Lubidineuse v Bevanere Pty Ltd (1984) 3 FCR 1 at 11-12. 81 So, for example, where a transaction occurs in the ordinary course of, or is an incident of, carrying on a business, it will generally be stamped with the character of a commercial transaction: Myer Emporium at 209. Consistent with those principles, a one-off transaction entered into by a taxpayer may still be a commercial transaction or an adventure in the nature of trade. Moreover, it is not necessary that the sole purpose of an isolated transaction be to obtain a profit. It is enough if a not insignificant purpose of the transaction, at the time it was entered into, was to obtain a profit: Cooling at 56-57. On the other hand, windfall gains and gains from games of chance do not constitute income: cf Myer Emporium at 211. (3) Analysis 82 What then is the position here? 83 Visy USA submitted that the Forward Exchange Contract was a commercial transaction or an adventure in trade for six principal reasons. I will deal with each of the reasons in turn. (a) Visy USA was a company 84 Visy USA was a company. Visy USA submitted that as a matter of common experience, companies are usually established for the purpose of carrying on a business: Brookton Co-operative Society Ltd v Federal Commissioner of Taxation (1981) 147 CLR 441; American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1979] AC 676 and BHP Billiton Finance Ltd v Federal Commissioner of Taxation (2009) 72 ATR 746 at [96]. Indeed, Visy USA was a company; it was a holding company. It was not however in the business of entering into forward exchange contracts: see [8] above. That last fact is not, however, itself a disentitling factor. (b) A forward exchange contract was a recognised form of dealing 85 A forward exchange contract was a recognised form of dealing. The Commissioner accepted that a forward exchange contract was a recognised form of dealing but rejected that the Forward Exchange Contract in this case fell into such a recognised form of dealing because Visy USA could not establish that the Forward Exchange Contract represented a commercial dealing of a kind found between third parties in the marketplace. As will become evident, the focus of this debate was, at times, misconceived. 86 The relevant statutory question was whether the outgoing (the Indemnity Fee) was incurred in the course of an income-producing activity: Commissioner of Taxation v Roberts and Smith (1992) 37 FCR 246 at 257; Kidston Goldmines Ltd v Commissioner of Taxation (1991) 30 FCR 77 at 85 and Federal Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd (2011) 192 FCR 325 at [31]. Thus, a critical question is whether the Forward Exchange Contract constitutes an income producing activity? Put another way, did Visy USA enter into an agreement, the Forward Exchange Contract, which was capable of producing, and which Visy USA intended would produce, a profit? 87 The answer to that question is not resolved by simply ascertaining whether a third party institution would enter into the same transaction on the same terms. Why? Because it is for the taxpayer to determine the scope of its undertaking: Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213 at 222 and Tweddle v Commissioner of Taxation (1942) 180 CLR 1; Ashwick at [104]. Moreover, in the present case, there was no suggestion that the transaction was artificial, attracted the operation of Pt IVA of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) or that the provisions of Div 13 of the 1936 Act applied to the Forward Agreement: see [108] below. 88 The concept of a forward exchange contract is not foreign or new: see, by way of example, Robb Evans of Robb Evans & Associates v European Bank Ltd [2009] NSWCA 67 at [134]; National Australia Bank Ltd v Meeke [2007] WASC 11 at [37]; Specialised Printing Equipment v de Vries [2003] NSWSC 1168 at [37]; Lamesa Holding BV v Commissioner of Taxation [1999] FCA 612 at [26]; Drambo Pty Limited v Westpac Banking Corporation Limited (1996) 96 ATC 4737; Development Finance Corporation of New Zealand Ltd v Bielby [1991] 1 NZLR 587 at [590]; Re David Securities Pty Limited v Commonwealth Bank of Australia [1990] FCA 186 at 22; Comptroller-General of Customs v AMI Toyota Ltd [1989] VR 231 at 231-232; LNC (Wholesale) Pty Ltd v Collector of Customs (1988) 77 ALR 347; Guy, A.F, Foreign Exchange Risk Management (1985) Australian Mining and Petroleum Law Association Yearbook 178-195. 89 As the Full Court of the Federal Court said in LNC (Wholesale) at 353 (and adopted by the Full Court of the Supreme Court of Victoria in AMI Toyota): The very purpose of a forward exchange arrangement is to protect the forward purchaser of foreign exchange against unfavourable fluctuations in the exchange rate and therefore to protect against the exchange rate actually prevailing at a relevant time. … In addition, a review of the authorities (see [88] above) reveals (as is to be expected) that the terms of forward exchange arrangements can and do vary. 90 It is then necessary to address the facts and matters identified by the Commissioner in support of his submission that the Forward Exchange Contract lacked the "essential features" of a commercial dealing. There were two – pricing and lack of a market. I will deal with each in turn. 91 In relation to the first factor, price, the Commissioner submitted: … [T]he Forward Exchange Contract was at no cost to Pratt Finance and provided no revenue to [Visy USA]. By contrast, the pricing for the cross currency swaps was approximately 1.2% per annum. Cross currency swaps and forward exchange contracts are similar instruments, both providing the means of hedging future payments or receipts in different currencies. They differ, however, in terms of the structure of the cash flows exchanged. This means that the pricing of a forward exchange contract is similar to that of a cross currency swap but the mechanism by which the cost is paid differs. In a cross currency swap, the cost is paid over time by way of the difference in interest rates paid in the relevant currencies. In a forward exchange contract, the cost is paid by way of adjustment to the forward exchange rate relative to the current market or spot currency rate. A fundamental feature of forward exchange is that- the pricing of the contract reflects the interest differential between market rates in the relevant currencies for the specific maturities. … This means that, in practice, where market interest rates between the currencies are different, the forward rate under the forward exchange contract (that is, the rate used to calculate the amounts paid and received in the respective currencies as at the future date) is different (higher or lower) than the current market or spot foreign exchange rate. In the present case, the Forward Exchange Contract uses the rate applicable under the cross currency swaps. That rate was appropriate to the cross currency swaps because Pratt Finance … would be paying the cost, by way of the interest differential of 1.2% per annum over the life of the transaction. Had a genuine arm's-length forward exchange contract (rather than documentation to satisfy the accounting requirements for the internal hedge) been sought by the parties, the rate used would have been significantly different from that used, reflecting the effect of the 1.2% per annum. 92 There are a number of difficulties with this submission. I will identify four. First, as noted at [87] above, there was nothing to suggest that the arrangement was artificial or contrived. The Commissioner did not make a determination under s 177F of the 1936 Act. Second, the use in the Forward Exchange Contract of the exchange rate in the cross-currency swaps (cf [31] and [51] above) did not, and could not, mean that Visy USA was precluded from deriving a profit on the Forward Exchange Contract if the AUD / USD exchange rate increased. Visy USA would make a profit if the AUD as against the USD was above US 77.5 cents. Third, even if the terms of the Forward Exchange Contract would be different if entered into by a third party financial institution, the enquiry is not how much a taxpayer ought to spend obtaining income but how much a taxpayer has spent: Ronpibon Tin NL at 60 and Cecil Bros Pty Ltd v Federal Commissioner of Taxation (1964) 111 CLR 430 at 434; Commissioner of Taxation v Lau (1984) 6 FCR 202 at [216]; Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 at 18; Esso Australia Resources Pty Ltd v Commissioner of Taxation [2011] FCA 565 at [76]; Ashwick at [83]; IEL Finance Ltd v Commissioner of Taxation (2010) 272 ALR 640 at [15]; Federal Commissioner of Taxation v Day (2007) 164 FCR 250 at [54]. 93 Fourth, if the submission is that there was not a sufficient prospect to amount to an expectation that assessable income would be produced, that submission finds no support in the legislation or in the facts. Section 8-1 does not contain a requirement that there be a "sufficient prospect" of assessable income as a precondition to deductibility. Moreover, the fact that no assessable income was produced does not preclude deductibility of a loss where the gaining of assessable income was an object which viewed objectively the taxpayer had: see by way of example, Spassked Pty Ltd v Commissioner of Taxation (2003) 136 FCR 441 at [61]. Moreover, merely labelling the payment as a "mere punt" does not answer the question posed by s 8-1 of the 1997 Act – whether the expenditure was incurred in gaining or producing assessable income. 94 At a factual level, the submission also fails. For the reasons outlined earlier at [32] to [42] above, objectively, Visy USA stood to make a profit if the AUD appreciated above USD0.775. That rate was not arbitrary. It was based on the market rate of exchange and one accepted by the third party financial institutions (see [31] above), and on the "nearest comparable amount" available, being the cross-currency swaps (see [40] above). The historical volatility of the AUD as against the USD, and the long duration of the Forward Exchange Contract, made it reasonable to expect that that some point over that duration the value of the AUD would increase above 0.775. Furthermore, the investment grade credit rating of Pratt Finance (see [17] above) increased the prospects of Visy USA being able to "lever" value. By incurring the Indemnity Fee, Visy USA limited its "downside risk" whilst preserving its ability to profit from increase in the value of the AUD. 95 Before leaving this issue, it is necessary to address Visy USA's contention that the rate used in the Forward Exchange Contract represented the future prospects of each currency. I reject that submission. Mr O'Halloran's evidence was no more than the exchange rate fixed by the currency swaps was that prevailing at the time of the initial debt raising and [he] thought the exchange rate used in those contracts … was the outcome of negotiation between independent parties and thus should be adopted as the exchange rate for the forward contract. However, for the reasons earlier stated (see [92]-[93] above), that does not result in the Indemnity Fee not being deductible for Visy USA. 96 The Commissioner also referred to the fact that quotes received at the time the Indemnity Fee was priced were in response to a request for a price for an exchange rate at a requested rate: see [64] and [67] above. That submission does no more than confirm that the Indemnity Fee was priced by reference to Visy USA's exposure under the Forward Exchange Contract, a rate which was considered "reasonable": see [40] above. In any event, in assuming Visy USA's risk under the Forward Exchange Contract, Pratt Investments did not also assume Visy USA's potential to make a profit under the Forward Exchange Contract if the AUD as against the USD rose above 77.5 cents: see [92] above. 97 The second factor, the lack of a market, was described by the Commissioner as "the market provided no instrument for hedging Pratt Finance's debt out to maturity, as the Forward Exchange Contract did". In support of this contention, the Commissioner referred to the fact that the cross-currency swaps: 1. specified Break Points, being intervals at which the Banks would review the strength of Visy's credit; and 2. contained provisions for early termination following events of default which were also events affecting credit risk and which contained mechanisms for determining settlement amounts by reference to the market. 98 For those reasons, the Commissioner submitted that, in the absence of a pricing mechanism and a market for an instrument of its tenor, the Forward Exchange Contract could, at best, ape the provisions of the cross-currency swaps. There are two answers to that submission. First, it is contrary to the facts. There was (and is) a developed market for dealing in foreign currency exchange derivatives (such as the Sydney Futures Exchange), and it was open to Visy USA to realise any gain at any time by taking an offsetting position in the foreign currency market. Secondly, even if there was not a pricing mechanism and a market, the Forward Exchange Contract: 1. permitted Pratt Finance to request early delivery with Visy USA to determine the exchange rate to be applied should it accept any such request: see [46.4] above; and 2. provided for adjustment between the parties at prevailing exchange rates should Pratt Finance default on the due maturity dates: see [46.5] above. Under the terms of the Forward Exchange Contract, control remained with Visy USA and, so far as is relevant, the terms were to the commercial advantage of Visy USA, not Pratt Finance. This issue is considered in further detail below. (c) Exchange rate used in the Forward Exchange Contract was same as that used by independent financial institutions 99 As mentioned above (see [94]), the exchange rate of 0.775 was used because it represented the best available estimate of the market value of the AUD at the time the Forward Exchange Contract was entered into. (d) Fundamental terms of the Forward Exchange Contract substantially similar to cross-currency swaps 100 Both the Forward Exchange Contract and the cross-currency swaps provided for the counterparty to deliver a fixed amount of USD at a future rate in exchange for AUD at a fixed exchange rate: see [46] and [50]-[51]. Both also made provision for early termination: see [97]-[98] above. (e) Forward Exchange Contract involved business skill and judgment 101 The Commissioner accepted that entry into the Exchange Forward Contract involved the exercise of business skill and judgment and careful consideration of the risks and benefits not of the Forward Exchange Contract itself, but of the hedging strategy and the continuing effectiveness of the internal hedge. In this context, the Commissioner submitted that it was because the effectiveness of the strategy depended on the net worth of the US assets matching Pratt Finance's US dollar liability to the extent of USD200 million that there was close monitoring of movements in the Australian dollar. 102 As a result, the Commissioner submitted that, at best, the possible risks of the strategy to Visy USA were considered. So, for example, the Commissioner submitted that the contemporaneous evidence (see, for example, [13]-[51] above), did not reveal any consideration of possible benefits of the Forward Exchange Contract to Visy USA. I reject that contention. The benefits to Visy USA were considered and find formal expression in the resolutions approving entry into the Forward Exchange Contract (see [44]-[45] above) as follows: 1. in respect of Visy USA: IT WAS RESOLVED that the Company would enter into inter-company foreign exchange hedge contracts with Pratt Finance Pty Ltd given the common interest and benefits to both companies. 2. in respect of Pratt Finance: IT WAS RESOLVED that the Company would enter into inter-company foreign exchange hedge contracts with Pratt Trading Pty Ltd to manage certain foreign exchange exposures arising in connection with the Note Issue. As is apparent, the contention that the contemporaneous evidence did not reveal any consideration of possible benefits of the Forward Exchange Contract to Visy USA is wrong. Benefits were not only considered but existed. (f) Forward Exchange Contract entered into for the purpose of making a profit 103 The intention to make a profit is determined by objective consideration of all the facts and circumstances: Cooling at 50. The test is objective, not subjective. 104 Here, the starting point was the Forward Exchange Contract and, in particular, its terms. For the reasons stated earlier, the terms of the Forward Exchange Contract, and the context in which it was entered, support the finding of a not insignificant purpose of profit making. Those reasons include: 1. the nature of the contract – a forward exchange contract: see [88]-[89] above; 2. the selection of the exchange rate: see [94]-[95] above; 3. the length of the Forward Exchange Contract and the expected volatility of the exchange rate over that period: see [94] above; 4. the fact that Visy USA would profit under the Forward Exchange Contract if the exchange rate of the AUD was higher than USD 0.775 at any time over the course of the contract (up to 20 years): see [94] above; 5. the fact that Visy USA had the capacity to profit from the Forward Exchange Contract as a result of an increase in the value of the AUD as against the USD even prior to maturity of the contract: see [98] above; 6. the fact that Pratt Finance, the counterparty to the Forward Exchange Contract, had been assigned an investment grade credit rating of BBB+ by a reputable credit rating agency (see [17] above) and was therefore an appropriate counterparty from a commercial perspective; and 7. the fact that if Pratt Finance repudiated the contract or failed to take delivery of or pay the USD amounts at maturity (or any other date which the parties had agreed), Visy USA would be entitled to compensation from Pratt Finance: see [98] above. 105 The Commissioner submitted that the evidence amounted to nothing more than that Visy USA might have realised a gain on the Foreign Exchange Contract by entering into "some form of derivative transaction" (see [32] above). In particular, the Commissioner submitted that "no-one gave any serious consideration to the means by which a profit could be realised in respect of the Forward Exchange Contract", and that in the absence of a "real plan" as to how such a profit might be derived, a profit-making purpose is not established. As the evidence establishes, there were a number of "mechanics" and "tools" available to Visy USA to realise a profit. It was open to Visy USA to enter into derivative arrangements with third parties that did not involve termination of the Forward Exchange Contract, for example the Forward Agreement, and the put and call options that were quoted by the CBA and JP Morgan that were used as the basis for pricing the Forward Agreement: see [32]-[39], [63] and [67]-[68] above. 106 Furthermore, the fact that the Forward Exchange Contract had its genesis in a consideration of Pratt Finance's hedging and accounting requirements did not preclude Visy USA from profiting from it via any of those means. Contrary to the Commissioner's submissions, Visy USA's profit-making purpose was not inconsistent with or antithetical to Pratt Finance's hedging and accounting requirements. 107 Finally, I reject the Commissioner's submission that there was no contemporaneous evidence that the Forward Exchange Contract was made with a view to profit. The terms of the Forward Exchange Contract, and the contemporaneous evidence of the context in which it was entered into, are the best evidence of Visy USA's objective intention: see [9] to [70] above. 108 Before leaving this aspect of the case, it must be recalled that it is not open to the Commissioner to second guess the commercial attributes of the arrangement. There is no suggestion that the arrangement was artificial or contrived resulting in the application of Pt IVA of the 1936 Act. It is irrelevant whether the Commissioner agrees or disagrees with Visy USA's assessment of likelihood of profit or gain. It is an objective test. It is not: … the function of income tax Acts or of those who administer them to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically. The Act must operate upon the result of a taxpayer's activities as it finds them. Tweddle at 7. (g) A wager? 109 Finally, it is necessary to deal with Visy USA's contention that the Forward Exchange Contract was analogous to a form of wager. Forward exchange contracts on occasion have been described as straightout punting: see by way of example Ferneyhough v Westpac Banking Corporation (unreported, Federal Court of Australia, 18 November 1991). Gains made from wagering in an entirely commercial context are on revenue account: Brajkovich v Federal Commissioner of Taxation (1989) 89 ALR 408. The fact that the outcome of a particular activity may be dependent, at least in part, on chance does not negate a business activity being carried on: Babka v Federal Commissioner of Taxation (1989) 89 ATC 4963 at 4968. So, for example, it has long been established that a futures trader using transactions as hedges for actual transactions for the prices of commodities, although in a sense gambling transactions, was involved in a trade: Cooper (Inspector of Taxes) v Stubbs [1925] 2 KB 753 at 769 and Graham v Green (Inspector of Taxes) [1925] 2 KB 37 at 41; Babka at 4968-4969; see also TR 2005/15: Income tax: tax consequences of financial contracts for differences (Commissioner of Taxation, 31 August 2005) at [30]-[33] and the authorities referred to therein. 110 As Warrington LJ said in Cooper, whether they were gambling transactions was irrelevant: at 769. The question was (and in this case is) whether these dealings and transactions were entered into with a view to producing, in the result, income or revenue for the person who entered into them? 111 Here, the circumstances (see [9] to [70] above) objectively establish that (1) the Forward Exchange Contract and the Forward Agreement were entered into for a commercial purpose and (2) the existence of a profit making intention. Objectively, the circumstances are not consistent with a person merely engaging in recreational gambling or punting: cf Jones v Federal Commissioner of Taxation (1932) 2 ATD 16. E. INCURRENCE OF THE INDEMNITY FEE 112 The Indemnity Fee was incurred by Visy USA to decrease the potential loss to it under the Forward Exchange Contract. That conclusion requires further explanation. 113 As discussed above, Visy USA's liability under the Forward Exchange Contract had exponentially grown as the value of the AUD as against the USD collapsed as a result of the Asian crisis. As a result, the Forward Agreement under which the Indemnity Fee was payable emerged from discussions concerning the most appropriate means to address Visy USA's liability under the Forward Exchange Contract: see [52] to [70] above. 114 The essential purpose and effect of the arrangement was to indemnify Visy USA against losses under the Forward Exchange Contract in exchange for a fee – the Indemnity Fee – equal to the cost of the option to purchase USD. A number of particular facts and matters should be noted. 115 First, the pricing of the Indemnity Fee resulted from negotiations reflecting quotes each party received from external financial institutions: see [63]-[68] above and GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 at 137 and Commissioner of Taxation of the Commonwealth of Australia v Citylink Melbourne Limited (2006) 228 CLR 1 at 43. 116 Secondly, as Visy USA submitted, no expenditure, strictly and narrowly considered, actually gains or produces income. Its character is therefore determined in relation to the object of the person making the expenditure: W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 at 301. It is Visy USA's purpose in entering into the Forward Agreement which is of importance. That purpose is properly understood in light of the Forward Exchange Contract. 117 Put another way, for the purposes of s 8-1 of the 1997 Act, the fact that the Forward Agreement itself was not expected to, and did not, itself give rise to assessable income is not determinative. Expenditure incurred for the purpose of reducing or avoiding losses or outgoings is not prevented from being incurred in gaining or producing assessable income for the purposes of s 8-1. What must be examined is the purpose of the losses or outgoings so reduced or avoided: W Nevill & Co Ltd at 307. 118 In the present case, the Indemnity Fee was incurred for the purpose of mitigating a deductible loss that would have been incurred by Visy USA as a result of its profit-making undertaking, being the Forward Exchange Contract. Any loss on the Forward Exchange Contract would have been incurred by Visy USA in the gaining or producing of assessable income. The Indemnity Fee, as "substituted expenditure", was incurred in gaining or producing assessable income. The occasion of the outgoing is to be found in the profit-making undertaking comprising the Forward Exchange Contract and the steps taken by Visy USA to mitigate a potential loss arising from that contract. 119 For those reasons, the Indemnity Fee is deductible under s 8-1 of the 1997 Act. F. NOT A LOSS OR OUTGOING OF CAPITAL OR OF A CAPITAL NATURE 120 The Commissioner submitted that even if the Indemnity Fee was incurred in gaining or producing assessable income for the purposes of s 8-1(1)(a) of the 1997 Act, the Indemnity Fee was not an allowable deduction as it was a loss or outgoing of capital or in the nature of capital: s 8-1(2) of the 1997 Act. I reject that contention. 121 The test to be applied is well known: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. [footnotes omitted.] Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 359-360. 122 Of these, the most critical factor is the character of the advantage sought by making the expenditure: GP International Pipecoaters at 137 and Citylink at 43. 123 The character of the advantage sought depends on what it "is calculated to effect", to be judged from "a practical and business point of view rather than upon a juristic classification of the legal rights, if any, secured, employed or exhausted in the process": Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 at 648. The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure. The analysis requires "both a wide survey and an exact scrutiny of the taxpayer's activities": Western Gold Mines NL at 740. That is, one must examine the whole business context of what was done: BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386 at 399 (the "whole picture") and National Australia Bank Ltd v Commissioner of Taxation (1997) 80 FCR 352 at 363. 124 What then was the position here? Visy USA paid the Indemnity Fee for the purpose of obtaining the benefit of the indemnity provided by the terms of the Forward Agreement. The legal obligations or rights for which the payment was made (as set out in the Forward Agreement) provided some assistance in identifying what the payment was for from a practical and business point of view: cf Commissioner of Taxation v Raymor (NSW) Pty Ltd (1990) 24 FCR 90 at 99. To take just one example, the recitals to the Forward Agreement record (see [69] above), as was the fact, that Visy USA had entered into the Forward Exchange Contract and wished "to protect itself from the possibility that it might incur a foreign exchange loss" in respect of that contract. 125 Therefore, the Forward Agreement formed part of a broader commercial transaction that had its origin in the Forward Exchange Contract and must be determined in light of that factual matrix. In the end, what determines the issue is the business purpose for which the outgoing was incurred from Visy USA's point of view: Federal Commissioner of Taxation v Midland Railway Co of Western Australia Ltd (1952) 85 CLR 306 at 313 and Ashwick at [103]-[104]. 126 Here, from a practical and business point of view, Visy USA incurred the Indemnity Fee to obtain the advantage of mitigating its potential loss arising under the Forward Exchange Contract. A purpose recorded in the Forward Agreement itself which was not contended to be (and no evidence suggested it to be) artificial or contrived. The potential loss that was sought to be mitigated was a loss of a revenue nature, incurred as a result of an isolated adventure in the nature of trade. The Indemnity Fee did not secure any enduring asset to Visy USA or enlarge its business structure. The fact that Pratt Finance may have incidentally derived an advantage in which Visy USA did not share is not of itself sufficient to give the Indemnity Fee the character of capital: Federal Commissioner of Taxation v South Australian Battery Makers (1978) 140 CLR 645 at 656-657. 127 The Commissioner submitted that the Indemnity Fee was a loss or outgoing of capital or in the nature of capital. The Commissioner identified four facts or matters. First, that Visy USA incurred the Indemnity Fee in relation to the Forward Exchange Contract, which was an asset, with a 20 year term, that had been brought onto the balance sheet of both Visy USA and Pratt Finance in support of a long-term strategy for financing and expanding the Pratt Group's business activities: see [29] above. Secondly, that from a practical and business point of view (see [123] above), the advantage obtained by Visy USA in incurring the Indemnity Fee was to ensure that the Forward Exchange Contract remained effective as a hedge for accounting purposes by satisfying the auditors that Visy USA was able to meet any liability it might incur under the hedge: see [61] above. Thirdly, that the purpose of mitigating the potential and unrealised loss arising under the Forward Exchange Contract had to be viewed in the context of the role that the Forward Exchange Contract, an asset of both Pratt Finance and Visy USA, was intended to perform in their respective accounts. Fourth, the Commissioner submitted that ensuring the Forward Exchange Contract remained effective as a hedge: 1. strengthened Pratt Finance's structure established for the purpose of obtaining profit having regard to the minimum net worth and debt level requirements in the Notes Agreement: see [19] above; and 2. strengthened the profit making structure of the Pratt group as a whole: Sun Newspapers at 359. In relation to this last matter, the Commissioner submitted that to satisfy the auditors that Visy USA could meet its liability under the Forward Exchange Contract, Visy USA could have entered into the Forward Agreement, raised debt itself or sold some of its US assets. As stated above, the latter two options were considered inappropriate and entry into the Forward Agreement was ultimately preferred: see [64] above. 128 In my view, the Commissioner's submissions proceed from the wrong perspective. The Commissioner accepted that the fact that Visy USA had regard to the broader interests of the Pratt Group in making the decision to enter into the Forward Agreement and pay the Indemnity Fee did not mean that Visy USA was not undertaking a transaction for its own benefit: Federal Commissioner of Taxation v BHP Billiton Finance Limited (2010) 182 FCR 526 at [19] and Ashwick at [42]-[43]. So much is trite law. 129 Moreover, as noted above (see [125]), what determines the issue is the business purpose for which the outgoing was incurred from Visy USA's point of view: Midland Railway Co of Western Australia Ltd at 313 and Ashwick at [103]-[104]. There was a business purpose for which the outgoing was incurred from Visy USA's point of view. In the present case, that was the purpose recorded in the recitals to the Forward Agreement – "to protect itself from the possibility that it might incur a foreign exchange loss" in respect of that contract. 130 It was a one-off, lump sum payment. It was not recurrent. However, the nature of the payment was not dissimilar to a payment for insurance. Yes, the payment secured an enduring benefit in Visy USA and the Pratt Group's accounts (Sun Newspapers Ltd at 363) but it did so in the same way that as payment, for example, for business interruption insurance. 131 For those reasons, the Indemnity Fee was not a loss or outgoing of capital, or of a capital nature. G. ORDERS 132 The parties will be directed to bring in orders to give effect to these reasons for decision by 4.00pm on 21 September 2011. I certify that the preceding one hundred and thirty-two (132) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gordon. Associate: Dated: 14 September 2011