New South Wales Supreme Court CITATION : McGrath & Ors as Liquidators of HIH Insurance Ltd [2009] NSWSC 1244 HEARING DATE(S) : 17/11/09 JUDGMENT DATE : 18 November 2009 JURISDICTION : Equity Division Corporations List JUDGMENT OF : Barrett J DECISION : Approval granted under s 477(2B). CATCHWORDS : CORPORATIONS - winding up - agreement to be made by liquidator on company's behalf - obligations may be discharged more than three months after agreement entered into - "tax sharing agreement" among several companies in liquidation - whether court should approve making of agreement LEGISLATION CITED : Corporations Act 2001 (Cth), ss 477(1)(a), 477(2B), 477(2)(m) Income Tax Assessment Act 1997 (Cth), Part 3.90, ss 703.5, 703.50, 721.25(1)(c), 721.30 CATEGORY : Principal judgment Crouch re Heritage Fine Wines Pty Ltd [2007] NSWSC 1055; (2007) 214 FLR 244 Re Bairnsdale Food Products Ltd [1948] VLR 264 Re Cambrian Mining Co (1882) 48 LT 114 CASES CITED : Re G A Listing & Maintenance Pty Ltd (1994) 15 ACSR 308 Re HIH Insurance Ltd [2004] NSWSC 5 Re Spedley Securities Ltd (in liq) (1992) 9 ACSR 83 Re Wreck Recovery and Salvage Co (1880) 15 ChD 353 State Bank of New South Wales v Turner Corporation Ltd (1994) 14 ACSR 480 PARTIES : Anthony Gregory McGrath and Christopher John Honey as liquidators of HIH Insurance Ltd and the other companies listed in Schedule A and Murray Campbell Smith as liquidator of the companies listed in Schedule B - Plaintiffs FILE NUMBER(S) : SC 5298/09 COUNSEL : Mr F Gleeson SC - Plaintiffs SOLICITORS : Blake Dawson - Plaintiffs IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST BARRETT J WEDNESDAY 19 NOVEMBER 2009 5298/09 ANTHONY GREGORY McGRATH & 2 ORS AS LIQUIDATORS OF HIH INSURANCE LIMITED & 81 ORS JUDGMENT 1 The liquidators of each of eighty-two companies apply for the approval of the court under s 477(2B) of the Corporations Act 2001 (Cth) in respect of an agreement proposed to be made among those companies and referred to as a "tax sharing agreement". It is because the agreement involves for the companies obligations that may be discharged more than three months after the agreement is entered into that a need for the court's approval under s 477(2B) arises. 2 One of the companies is HIH Insurance Limited ("HIH"). Each of the others is a wholly-owned subsidiary of HIH. Eight of the companies are subject to a creditors' scheme of arrangement approved by the court on 26 May 2006. 3 Some of the companies incurred tax losses in earlier years. By this, I mean that the assessable income of a particular year was exceeded by allowable deductions for that year. A tax loss of this kind in respect of a particular year may itself be carried forward and claimed as an allowable deduction in a later year. Losses available to be carried forward are valuable if assessable income is expected in later years. The availability of them operates to reduce or perhaps even eliminate taxable income in those later years. 4 If a particular company has tax losses available for carry forward to future years but no prospects of assessable income in those years, those losses cease to have value for that company because there is nothing against which they can be offset. 5 The position I have just outlined relates to a single company viewed in isolation. The picture changes if the company is a member of a group of companies. 6 Under taxation legislation that came into effect on 1 July 2002, a particular company and wholly-owned subsidiaries of that company may become a "consolidated group" within the meaning of s 703.5 of the Income Tax Assessment Act 1997 (Cth). Such a group is formed when the company concerned makes an election in accordance with s 703.50. The electing company thereupon becomes the "head company" of the consolidated group and each relevant wholly-owned subsidiary becomes a "subsidiary member" of the group. 7 A consolidated group is treated, for income tax and capital gains tax purposes, as a single entity. A single consolidated tax return is required. Transactions between separate entities within the consolidated group are ignored for tax purposes. The aggregation of income items and allowable deductions across all group companies means that losses that might not have been utilised by a single company separately assessed may be utilised, at the group level, as deductions against income derived by other group companies without available losses of their own. 8 A consequence of the formation of a consolidated group, however, is that the head company becomes liable for the tax attributable to the taxable income of the group as a whole, computed on a combined basis. If the head company defaults in payment of tax, the subsidiary members become "contributing members" and are jointly and severally liable for the tax. All these matters arise under provisions in Part 3.90 of the Income Tax Assessment Act. 9 There is, however, a means by which contributing members may be freed from this joint and several liability for tax payable by the head company. The joint and several liability of a contributing company is displaced if that company has entered into a "tax sharing agreement", that is, an agreement between the head company and one or more subsidiary members (including, of course, the subsidiary member in question) that allows the group tax liability to be apportioned among group members in a way set out in the agreement. 10 If such an agreement is in place when liability accrues to a contributing member because of default by the head company, the particular contributing member is no longer jointly and severally liable for the whole of the liability. By virtue of s 721.30, it is liable for only its own "contribution amount" determined in accordance with the agreement. The joint and several liability that, by virtue of the creation of the group, would otherwise be incurred by a particular contributing company for the whole of the head company's tax indebtedness is thus replaced by a separate and several liability for only the particular proportion of that whole. 11 In order for the result just mentioned to be achieved, it is necessary that an effective tax sharing agreement be in place. In order for an agreement to be an effective tax sharing agreement, the contribution liabilities it fixes for the several subsidiaries must represent, in the words of s 721.25(1)(c), "a reasonable allocation of the total amount of the group liability among the head company and the TSA contributing members". 12 The legislation does not explain "reasonable allocation". What is reasonable will no doubt be judged on a case by case basis having regard to the circumstances of the particular group and the role and activities within it of the company in question. 13 Against that background, I return to the circumstances of this case. HIH and the eighty-one subsidiaries have, between them, accumulated tax losses of the order of $2.7 billion. As things now stand, those losses can be utilised to reduce the tax impost only to the extent that they reside within a particular company and that company itself generates income. If a company with available losses derives no income, advantage cannot be taken of those losses. Likewise, if another company derives income but has no accumulated losses, the availability of losses in the first company does nothing to reduce the second company's taxable quantum. 14 Some of the eighty-two companies do derive income. Although all are in liquidation and none is engaged in any active trade or business, some hold investments that will continue to generate returns pending completion of the winding up. 15 The liquidators of the several companies are of the opinion that it will be beneficial to all of those companies for a consolidated group to be formed by means of a s 703.50 election, with HIH as the head company and the other eighty-one companies as subsidiary members. That will allow the best use to be made of the accumulated tax losses of $2.7 billion. It will be possible for those losses to be applied against investment income regardless of whether both losses and income exist under a single corporate roof. The intention is that the consolidated group be created with effect from 1 July 2003. Although that date has passed, the tax returns for the year that commenced on 1 July 2003 have not been lodged and, in light of an extension of time that has been granted, are to be lodged by 15 January 2010. 16 Creation of a consolidated group will, however, have two potentially undesirable side-effects. The first is that the whole of the liability for any tax that becomes payable on the group-wide combined income will be a primary liability of HIH as head company; and this will be so regardless of the extent to which HIH itself and in its own right has generated the tax liability. The other potentially undesirable side-effect is that the other eighty-one companies will be together jointly and severally liable for the whole of the tax indebtedness should HIH default; and again this will be so regardless of the extent, if any, to which a particular company with joint and several liability actually caused the tax indebtedness to be incurred. 17 As to the first of these matters, the liquidators consider it extremely unlikely – virtually unthinkable - that the grouped companies could ever derive between them (in periods after 1 July 2003) income even remotely approaching $2.7 billion. All companies are in liquidation and progressing towards a state where their affairs have been fully wound up and dissolution is appropriate. None carries on any business and expected income will be confined largely to investment income pending completion of the winding up and dissolution. The risk that HIH itself, as head company of a consolidated group, may actually become liable for any tax – given the huge buffer of $2.7 billion of losses available for carry-forward - is therefore considered non-existent in practical terms. 18 That leaves the second potentially undesirable side-effect of the creation of a consolidated group, that is, exposure of each of the other eighty-two companies to joint and several liability for the whole of such tax as HIH as head company may become obliged to pay. Again, of course, there is the point just mentioned that HIH will, in practical terms, never have to pay any tax. In addition and as a precaution against that theoretical possibility, the liquidators propose to protect the separate positions of the several subsidiaries by having them enter into a tax sharing agreement with HIH, thus ensuring that each subsidiary's exposure is limited to an appropriate proportion of the whole liability. 19 This is, in the particular context, an important safeguard. Although the various subsidiary companies satisfy the common ownership test on which the particular tax law provisions operate (in that all are wholly-owned subsidiaries of HIH), the situation can no longer be considered one in which the interests of a subsidiary company coincide with the interests of its single member so that there is no need, in any practical sense, to have regard to a particular wholly-owned subsidiary's separate interests. On the contrary, it is essential now to look separately at each subsidiary and the interests of that subsidiary alone. Being in the course of insolvent winding up, each company must be viewed as an embodiment of the interests of its own separate group of creditors. While some of the group companies are creditors of others of them, the fact remains that the resources within each are, in its winding up, applicable solely for the benefit of its own creditors. 20 Before considering the particular tax sharing agreement proposed, I digress to look briefly at the liquidators' powers to follow the course that has been outlined. 21 When I asked Mr Fabian Gleeson SC to identify the heads of power on which the liquidators relied, he referred to the powers made available by s 477(1)(a) and s 477(2)(m) of the Corporations Act. The first of these empowers a liquidator to "carry on the business of the company so far as is necessary for the beneficial disposal and winding up of that business". The second provision allows a liquidator to "do all such other things as are necessary for winding up the affairs of the company and distributing its property". 22 Section 477(1)(a) can be left to one side, since I am satisfied that s 477(2)(m) allows the liquidators to do what they now propose. The word "necessary", as used in s 477(2)(m), has been given a broad meaning. It is not synonymous with "essential" or "indispensable": see, for example, Re Wreck Recovery and Salvage Co (1880) 15 ChD 353 at p 362 per Thesiger LJ. The power is not confined to matters without which the winding up of affairs and distribution of property cannot occur. The test is, rather, one of what "may be thought expedient with reference to the assets of the company": Re Cambrian Mining Co (1882) 48 LT 114 per Kay J. The later case of Re Bairnsdale Food Products Ltd [1948] VLR 264 provides an example of the scope of the power. That case concerned a company which had a right of first refusal in respect of land occupied by it as lessee. After commencement of the winding up, the lessor offered the company the opportunity to purchase. On the evidence, it would have been advantageous to the winding up for the liquidator to buy the land and re-sell it, thus realising the value of the right of first refusal. It was held that the purchase was justified as an incident of the subsequent sale and was therefore comprehended by the liquidator's power to sell. There was subsidiary reliance upon the equivalent of s 477(2)(m). 23 In the present case, it must be considered expedient, with reference to the assets of each subsidiary company, that any income that that company derives should be absorbed, for tax purposes, by the tax losses available for use as allowable deductions within the group (so that the company itself enjoys that income free of any tax impost), provided that the company's own exposure to group tax liabilities – itself purely hypothetical in a practical sense - is limited to an appropriate proportion. It is expedient therefore that a particular subsidiary should both become part of the proposed consolidated group and enter into a tax sharing agreement which has the effect of substituting a separate liability for a given proportion of any overall tax burden for joint and several liability for the whole of it. From the viewpoint of HIH, it is expedient that it have the advantage of losses that would otherwise be available in other companies. 24 It is significant that the proposal now under consideration does not entail any new departure (of the kind considered in Crouch re Heritage Fine Wines Pty Ltd [2007] NSWSC 1055; (2007) 214 FLR 244) and is truly incidental to the advantageous progress of each winding up. 25 The terms of the proposed tax sharing agreement have been settled by the liquidators having regard to detailed advice received from both KPMG and Blake Dawson. Particular attention was given by both firms to the basis of apportionment among the subsidiary companies and whether it satisfies the criterion of reasonableness prescribed by the legislation. It is unnecessary for me to go into the details of the advice. It is sufficient to say that each firm is of the opinion that the particular basis of apportionment of allocation adopted should be accepted by the Commissioner of Taxation as reasonable. 26 The need for the liquidators to approach the court arises, as I have said, from s 477(2B): "Except with the approval of the Court, of the committee of inspection or of a resolution of the creditors, a liquidator of a company must not enter into an agreement on the company's behalf (for example, but without limitation, a lease or a charge) if: (a) without limiting paragraph (b), the term of the agreement may end; or (b) obligations of a party to the agreement may, according to the terms of the agreement, be discharged by performance; more than 3 months after the agreement is entered into, even if the term may end, or the obligations may be discharged, within those 3 months." 27 The proposed tax sharing agreement will continue indefinitely, subject to the possibility that a particular company may elect to "leave the group". The agreement is therefore expected to remain in force (and be enforceable according to its terms) until the conclusion of the windings up and dissolution of the companies, estimated, at this point, as likely to occur in 2014. Approval under s 477(2B) is therefore required. 28 The considerations relevant to an application under s 477(2B) emerge from a number of decided cases (see, in particular Re Spedley Securities Ltd (in liq) (1992) 9 ACSR 83 at 85-6; State Bank of New South Wales v Turner Corporation Ltd (1994) 14 ACSR 480 at 483; Re HIH Insurance Ltd [2004] NSWSC 5 at [15] and Re G A Listing & Maintenance Pty Ltd (1994) 15 ACSR 308 at 311). Those considerations include: (a) the controlling consideration in the interests of creditors concerned in the winding up; (b) the court pays regard to the commercial judgment of the liquidator; (c) although the court is not a rubber stamp for whatever the liquidator puts forward, it is not the role of the court to make an independent appraisal of the commercial desirability and commercial terms of the transaction; (d) the court will generally not interfere unless there can be seen to be some lack of good faith, some error in law or principle, or some real and substantial ground for doubting the prudence of the liquidator's proposal. 29 These considerations, applied to the present case, justify the grant of the approval the liquidators seek. The creditors of a particular company will benefit from any reduction in that company's tax liability that becomes available because of the availability of tax losses generated within another company. The liquidators have made a considered commercial judgment on the basis of advice from leading firms of chartered accountants and solicitors. There is no reason at all to think that the proposal involves any lack of good faith, error of law or principle or lack of prudence. 30 I will therefore make the orders under s 477(2B) sought in the originating process (altered, however, to accommodate correction of a minor drafting anomaly in the proposed form of tax sharing agreement identified in the course of the hearing). ********** DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.