Federal Court finds late election to cancel tax losses was ineffective

The decision makes clear that the consolidation provisions are deeply interconnected, and that particular attention should therefore be directed at their statutory context and functional operation. A provision's true meaning may not be apparent in isolation; limitations that are not express on the face of one provision may become apparent when it is construed in its proper context.

We note that the Commissioner has filed an appeal of this decision, which will require leave given that the appeal relates to an interlocutory decision.

How the dispute arose

In 2011, Evolution Mining Ltd (Evolution) acquired all the share capital of Conquest Mining Limited (Conquest) and those entities were consolidated for tax purposes with Evolution as the head company of the tax consolidated group. At the time of the acquisition, Conquest had tax losses of $31,292,880. The treatment of tax losses when an entity becomes a member of a tax consolidated group is set out in s707-145 of the Income Tax Assessment Act 1997 (the Tax Act) which provides:

1. The head company of the joined group may choose to cancel the transfer of the loss.

2. If the head company of the joined group does so, this Act (except this section) operates for all income years ending after the transfer as if it had not occurred under section 707-120.

3. The choice cannot be revoked.

This provision effects an automatic transfer of losses to the head company of the tax consolidated group unless a choice is made to cancel that transfer. If any such choice is made, that choice cannot be revoked. Critically, the legislation does not provide any timeframe within which this choice must be made.

The provisions set out various adjustments where the tax loss is cancelled, being:

a) an increase to the allocable cost amount for a joining entity when that entity becomes a subsidiary. That is, the provisions recognise an increased cost of acquiring the asset (being the subsidiary) to reflect the fact that the losses can no longer be utilised. This may be relevant when that entity exits the tax consolidated group as a higher recognised cost may offset any gain recognised on that exit (being, effectively, a disposal of an asset); and

b) preserving the available fraction for the utilisation of losses transferred to the head company by other entities. Very broadly, the consolidation provisions rely on this concept to ensure that losses are utilised at around the same rate as they would have been had the transferring entity not joined. Where losses are cancelled, adjustments are made to ensure that the available fraction remains properly calibrated to this aim.

In this case, Evolution made the following lodgements:

a) the tax return for the 2012 income year was lodged on 25 June 2014;

b) the tax return for the 2013 income year was lodged on 22 August 2014; and

c) the tax return for the 2014 income year was lodged on 13 March 2015.

For each of the 2012 and 2013 income years, Evolution expressly did not make the choice set out in section 707-145 of the Tax Act. That is, Evolution did not choose to cancel the transfer of the tax losses. However, Evolution made that choice in the tax return for the 2014 income year. Evolution then sought to use the transferred losses in 2017. The Commissioner contended that these were not available given the choice made in the 2014 tax return. Evolution contended that this was not a choice that was available to it at that time and that the choice must be made in the year Conquest joined the tax consolidated group. As such, the losses were transferred and were available to be applied.

The missing mechanism

The parties made various submissions as to the proper construction of section 707-145 particularly given that there was no time specified in the legislation within which the choice was to be made. The Commissioner made reference to various case authorities for the proposition that, in the absence of clear necessity, it is wrong to read words into a statute which are not there (see Thompson v Goold [1910] UKHL 685; Vickers, Sons & Maxim Ltd v Evans [1910] UKHL 697) and that it is no part of the judicial function to fill gaps disclosed in legislation (see Marshall v Watson [1972] HCA 27).

While Evolution made a variety of submissions, it appears from the decision that the most persuasive consideration was the absence of any legislative mechanism for recalculating the allocable cost amount - a recalculation that would be required if the choice could be made in years subsequent to joining. This was considered a "striking feature of the legislative context" given that the architecture of these provisions generally provides a mechanism for such outcomes in other contexts. In this respect, Jackman J said:

It is a striking feature of the legislative context of s 707-145 that there is no provision which expressly contemplates these matters being re-calculated in the event that a choice to cancel the transfer under s 707-145 is sought to be made in relation to an income year after the joining year. The point is not merely that such a re-calculation and re-assessment may well be very difficult, especially after four years have elapsed; rather, the real force in Evolution’s submissions is that the legislation does expressly deal with similar problems in circumstances where the legislation contemplates that they might arise but contains no such provision in relation to s 707-145. There is no statutory mechanism for a subsequent recalculation of the allocable cost amount, and the events which can cause a re-calculation of the available fraction under s 707-320(2) do not include a subsequent choice under s 707-145 by the head company in relation to a later income year to cancel the transfer of the loss. Further, there is no regime corresponding to Subdivision 705-E to deal with such a subsequent choice in circumstances where it would be unreasonable to require recalculations of capital gains or losses…

As Evolution submits, the absence of any mechanism to deal with the obvious potential and problematic consequences of a choice to cancel the transfer being made in relation to an income year after the joining year provides a strong indication that the choice to cancel the transfer (like the transfer itself) is contemplated as necessarily taking root in various aspects of the tax profile of the head company in the joining year. A key purpose of the legislation is to provide the head company with the choice between (a) utilising transferred losses from a joining entity, and (b) cancelling the transfer and avoiding an adjustment to the allocable cost amount and available fraction, and not to allow both those outcomes.

His Honour considered that construing section 707-145 as limiting the choice to the year of joining did not require reading words into that provision nor otherwise undertaking a process of 'judicial repair' of the legislation. Rather, this was an orthodox application of the principles of statutory construction which invites an inquiry of the meaning of provisions construed in their proper context.

It followed that Evolution's choice in its 2014 tax return was too late to be effective such that the transfer of losses was not cancelled.