Mylan Australia v Commissioner of Taxation: The Commissioner loses again on Part IVA

by Toby Eggleston, Ryan Leslie, Graeme Cooper

Key Points

The Federal Court found in favour of the taxpayer Mylan Australia Holding Pty Ltd (MAHPL), ruling that the Commissioner of Taxation's amended assessments disallowing interest deductions under Part IVA of the Income Tax Assessment Act 1936 (ITAA36) were excessive.

The Court rejected the Commissioner's primary argument that, if the relevant "scheme" had not been entered into, MAHPL would not have acquired the Australian pharmaceutical business Alphapharm and thus would have had no debt and claimed no interest deductions at all in Australia.

While aspects of how the scheme was carried out, particularly the failure to refinance related party debt in light of falling interest rates, suggested some tax motivation, overall the Court was not persuaded that the dominant purpose of the scheme was to obtain an Australian tax benefit.

Key factors included the commercial rationale for related party debt over equity funding, evidence the initial interest rate was set with regard to market rates, and that prioritising Australian interest deductions did not neatly align with managing Mylan's inability to utilise foreign tax credits in the US (its "overall foreign loss" position).

The decision confirms that Part IVA requires an objective analysis of purpose, assessed by weighing the eight factors in s177D(b). Obtaining and even desiring tax benefits is not sufficient - the tax benefit must be the ruling or most influential purpose of the scheme.

The decision is consistent with the Full Federal Court's recent decision in Minerva Financial Group Pty Ltd v Commissioner of Taxation (Minerva), which emphasised the need to weigh all eight factors and consider the commercial and financial consequences of a scheme beyond any tax benefit obtained.

Background

In October 2007, the Mylan pharmaceutical group, headquartered in the US, entered into a Share Purchase Agreement (SPA) with Dutch tax resident company Merck Generics Group B.V. to acquire five Merck group companies for approximately USD 7 billion. The Merck subsidiaries acquired included Alphapharm, the leading generics business in Australia. The SPA permitted Mylan to substitute an ‘Affiliate’ to acquire the shares in the target entities. Following the receipt of tax advice, the SPA was amended to facilitate the acquisition of the Australian Merck target by a newly incorporated Australian Mylan subsidiary. The Australian Mylan entity then used a mixture of equity and related party debt – within the thin capitalisation ‘safe harbour’ which applied at the time – to fund the acquisition.

To acquire Alphapharm, Mylan incorporated an Australian holding company, MAHPL, which owned another Australian company (MAPL). MAPL acquired the Alphapharm shares for AUD 1.23 billion, funded 25% by equity and 75% by an intercompany AUD denominated loan from a Luxembourg Mylan subsidiary at a fixed interest rate of 10.15% (Promissory Note A2 or PN A2). The overall Mylan group borrowing for the global acquisition was similarly highly leveraged.

The Australian Taxation Office (ATO) issued amended assessments to MAHPL, the head company of the Australian tax consolidated group, disallowing around AUD 589 million of interest deductions claimed on PN A2 over the 2007-2017 tax years. The ATO had initially pursued the structure as a transfer pricing matter, but eventually argued the deductions should be disallowed under the general anti-avoidance rule in Part IVA.

The Schemes and Counterfactuals

In broad summary Part IVA applies where a taxpayer enters into a “scheme” for the sole or dominant purpose of obtaining a tax benefit. To determine the tax benefit, it is necessary look at the taxpayer’s tax position under the scheme compared to the tax position that would arise, or may reasonably be expected to, if the taxpayer had not entered into the scheme.

The ATO argued two alternative "schemes" were entered into for the dominant purpose of MAHPL obtaining a "tax benefit" (the interest deductions):

A wider scheme involving incorporating the Australian holding companies, amending the SPA to have MAPL acquire Alphapharm shares, and the issue of PN A2. The "counterfactual" was that MAPL would not have existed and Alphapharm would have been acquired by a Mylan group company with no debt pushdown into Australia.

A narrower scheme, assuming the Australian holding companies were incorporated, involving just the issue of PN A2 at a high interest rate and principal, capitalisation of interest, and refinancing of PN A2. The counterfactuals involved MAPL borrowing a lesser amount at the lower variable interest rate and terms of Mylan's external borrowing for the global acquisition.

Mylan proposed two counterfactuals of its own both of which retained MAPL as the buyer, it would have financed the acquisition in part with intra-group debt (or perhaps external debt), but some of the terms of the borrowing might have been different.

Just to make things more complicated, the judge came up with another counterfactual which was a combination of the parties’ arguments: MAPL would have been the buyer, it would have financed the acquisition in part with debt, but borrowed by MAPL directly from external financiers with the consequence that some terms would have been different.

The Tax Benefit Issue

On the tax benefit issue, the Court rejected the ATO's primary counterfactual of no debt pushdown into Australia at all. Key reasons included:

• the Alphapharm acquisition 100% with equity was inflexible and commercially more complex compared to a structure with some debt funding.
• Contemporaneous evidence showed Mylan intended to repatriate foreign cash to repay its external debt, which favoured debt over equity funding.
• Mylan's inability to claim US foreign tax credits due to its overall foreign loss position meant a 100% equity funded acquisition would have attracted a prohibitive global effective tax rate of 65%. (see note below on the proposed change to Part IVA)
• MAPL borrowing externally was seriously considered and the switch to related party debt was not tax driven, as withholding tax meant it was more costly.

However, the Court concluded MAHPL did obtain a tax benefit compared to the judge’s preferred counterfactual - MAPL borrowing a lesser amount externally on the terms of Mylan's global acquisition debt, at a floating AUD interest rate, without capitalised interest or retrospective changes to the principal and rate.

The Dominant Purpose Issue

On the key question of whether the scheme was entered into or carried out for the dominant purpose of obtaining that tax benefit, weighing the eight factors in s177D(b), the Court concluded it was not. Only one factor - the failure to refinance the loan as interest rates fell - suggested prioritising interest deductions over costs. Other factors were neutral or pointed to non-tax purposes:

• Intercompany debt provided important commercial benefits over equity in flexibility of payments. Fixing the interest rate of foreign subsidiaries was also common to manage risk centrally.
• Matching MAPL's debt level to Australia's thin capitalisation limit did not bespeak a dominant tax purpose, given the US overall foreign loss issue and advantages of debt.
• No evidence the initial 10.15% interest rate was excessive or designed to maximise deductions when set pre GFC. The ATO abandoned transfer pricing arguments.
• Debt deductibility was incidental to, not the driver for, the holding structure. Deferring an interest rate decision in a fast-paced, complex global acquisition was understandable.
• The commercial and financial consequences of the arrangement beyond the tax benefit obtained pointed away from a dominant tax purpose, consistent with the Full Court's reasoning in Minerva.

The Court emphasised that obtaining and desiring tax benefits is not sufficient for Part IVA to apply - the tax motivation must objectively be the ruling or most influential purpose. This is consistent with the Full Court's rejection in Minerva of the argument that choosing between alternative transactions based on tax outcomes is itself sufficient to trigger Part IVA.

Comparison with Minerva Decision

The Mylan decision applies very similar reasoning to the Full Federal Court's recent decision in Minerva. Both cases involved the application of Part IVA to arrangements that delivered tax benefits to the taxpayer, but where the Court ultimately found that Part IVA did not apply because, weighing all eight factors in s177D(b), it could not be concluded that the dominant purpose of the arrangements was to obtain that tax benefit.

Key parallels between the cases include:

• Both Courts emphasised that identifying an alternative course of action that would result in more tax being paid is not sufficient to attract Part IVA. The eight factors must be considered holistically, with regard to the commercial and financial consequences of the arrangement.
• Both Courts cautioned against viewing the tax benefit factor in isolation. The mere fact that less tax is paid under the scheme than under an alternative is not determinative.
• Both Courts looked at evidence of the commercial and financial consequences of the arrangements beyond the tax benefit in assessing purpose. In Minerva, this included the real economic impact of distributions on the recipient entities. In Mylan, it included the commercial rationale for intercompany debt, the evidence that the interest rate was initially set with regard to market rates, and the significance of Mylan's inability to utilise foreign tax credits in assessing the role of the Australian tax saving.
• Both Courts rejected the ATO's attempts to focus on particular counterfactuals or a particular point in time in assessing purpose. In Minerva, the Court cautioned against comparing the position before and after a broader restructure (that the ATO had accepted was not a scheme to which Part IVA applied to) to assess purpose. In Mylan, the Court rejected a counterfactual that would have seen MAHPL never incorporated, when this was not the basis on which the assessments were raised.

However, some key differences between the cases include:

• Minerva involved Australia-outbound arrangements (distributions from an Australian trust to foreign entities), whereas Mylan involved inbound debt funding into Australia.
• In Minerva, the distributions were made consistently with the legal form and rights attaching to the different units. In Mylan, the Court accepted that some aspects of the arrangement (particularly the failure to revisit the interest rate) suggested an influence of tax considerations.
• Minerva involved a clearer delineation between the initial restructure that the ATO accepted was not a Part IVA scheme, and the narrower scheme of the distributions themselves. In Mylan, there was more overlap between the initial acquisition structure and the narrower financing scheme.

Despite these differences, the core reasoning and principles applied by the Courts in each case were consistent - particularly the emphasis on weighing all eight factors and considering the commercial and financial consequences holistically in assessing purpose.

Key Implications and Takeaways

The Mylan decision, together with Minerva, confirms some important principles on the operation of Part IVA:

• The "dominant purpose" assessment requires an objective weighing of the eight factors in s177D(b). The actual subjective purpose of the taxpayer is not determinative. Purpose here refers to the main objective or reason for what occurred, evaluated objectively in context.
• Obtaining tax benefits, even where they are desired and an alternative transaction would have resulted in more tax, is not sufficient. The tax purpose must objectively be the ruling or most influential purpose.
• Commercial and other non-tax purposes must be carefully evaluated. Here factors like a US overall foreign loss, repatriation plans, avoiding prohibitive global tax rates, and general commercial benefits of related party debt were key. In Minerva, the real financial impacts of the distributions on the recipient entities were crucial. In the last Federal Budget the Treasurer announced that the Government would amend Part IVA “so that it can apply to …schemes that achieve an Australian income tax benefit, even where the dominant purpose was to reduce foreign tax.” The measure is stated to have effect from income years commencing on or after 1 July 2024, regardless of when the scheme was entered into. No legislation has been released to date, however, if enacted it could (depending on how the provision is drafted) be taken into account on an appeal after 1 July 2024.
• Some influence of tax considerations (as in the failure to refinance in Mylan) does not necessarily equate to dominant purpose. However, the more contrived the features of the scheme, or the more artificial the distinctions from the alternative, the greater the Part IVA risk.
• The ATO cannot selectively focus on particular aspects of an arrangement in assessing purpose. The arrangement must be viewed holistically, in its full context. Attempts to compare the position before and after a broader restructure that is not itself challenged (as in Minerva) are unlikely to be persuasive.

The ATO will undoubtedly appeal both this and the Minerva decision.