Introduction:
The Salomon V Salomon & Co Ltd [1897] AC 22 case was a precedent to the modern company law in Australia which recognizes incorporated companies as legal entities separate from their parent company or their shareholders (Grantham & Rickett, 1998)1. Within The Corporations Act 2001 (Cth) 2, this principle is instituted as law where a company is said to be a separate legal entity with a separate personality and legal capacity. This implies that incorporated companies are separate entities and cannot be liable for debts incurred either by subsidiary companies or by parent companies, unless in a special case where the corporate veil is pierced to determine the reason behind the relationship between the corporations. It also means that shareholders of a corporate company cannot be liable to debts or torts incurred by the company (Harris, Hargovan & Adams, 2008)3. This principle has been practiced for over a hundred years in the Australian Judicial system and many corporate cases over the years have been based upon this principle. This paper researches, analyses and applies the relevant provisions of The Corporations Act 2001 (Cth) and relevant company law precedents to the case study of Iron Ore Ltd and Finance Pty Ltd v The Commissioner of Tax. It specifically analyses the principle of separate legal entity, circumstances of piercing the corporate veil, and the legal position held the Commissioner of Tax.
1) Grantham, R and Rickett, C 1998, ‘Corporate Personality in the 20th Century, (Eds) Hart Publishing, Oxford. P. 197-198.
2) Corporations Act, 2001, (Cth) 119 (Austl) p. 6-8.
3) Harris, J, Hargovan, A, Adams, M 2008, ‘Australian Corporate Law (2nd Ed)’, LexisNexis Butterworths, Victoria Ave Chatswood.
Legal issues:
Iron Ore’s Pilbara project failed and its written down value was insufficient to pay Finance Pty Ltd the loan. This is a big loss to Iron Ore Ltd. Finance Pty Writes off the loan as a bad debt to Iron Ore Ltd and wants a tax deduction on the debt. The commissioner of tax disallows the tax deduction and argues that Finance Pty is an extension of Iron Ore Ltd. The Commissioner of tax could have rationalized that Finance Pty should not receive a tax deduction due to the degree of control that Iron Ore Ltd exercised over it. It could also be due to Finance Pty Ltd acting as an agent for Iron Ore Ltd to cover its debts and losses.
Piercing the corporate Veil:
Incorporated companies are usually separate legal entities but this personality can be disregarded by the court if it is shown that there is partnership between firms in a group to avoid responsibility or the creation of the subsidiary company was a means to enable fiduciary or legal obligation to be evaded, or a means to enable perpetration of fraud (Jenkinson, Woodward and Foster) [1] Several factors may lead to the piercing of the corporate veil.
Group Enterprises:
Within a group of companies the separation of each company as a separate entity is usually respected by courts in Australia. Each company within a group of companies is viewed as a separate legal entity with its own legal rights and accounting for its own liabilities (Harris, Hargovan & Adams, 2008)3. One company within the group can not be held accountable for the liability of another within the group. This limited liability helps protect the assets of one company within the group in case the other company within the same group faces financial failure. The corporate veil protects the company from having its assets seized.
From the above case study, Finance Pty Ltd is an incorporated company and subsidiary of Iron Ore and so under the Corporations Act 2001, section 119, Finance Pty is a Separate entity from Iron Ore Ltd, and the Tax Commissioners argument that it is an appendage of Iron Ore cannot hold2. But looking at the reformed statutory law in section 588V, it shows that a corporate veil may be lifted and make the holding company liable for the debts of its subsidiary company if it is suspected within reasonable ground that the subsidiary company was insolvent when it incurred the debt (Harris, Hargovan & Adams, 2008)3.[2] Iron Ore Ltd has a market capitalization value in Excess of AUS $ 165 billion and the failed project was worth $ 300 million. This implies that Iron Ore was not insolvent at the time of incurring the debt from the Pilbara project, and therefore Finance Pty Ltd cannot be held liable for this debt. It was therefore unreasonable for Finance Pty Ltd to declare Iron Ore’s debt as a bad debt since Iron Ore Ltd is in a position to repay the debt and Finance Pty Ltd has not exhausted all reasonable efforts to collect the debt. In this way the two entities are working as one.
Agency:
A case can be made against Finance Pty Ltd by the Commissioner of Tax based on the grounds of agency. For an agent relationship to exist the parent company is said to have a high degree of control of the subsidiary company in such a way that the subsidiary company is viewed to be an agent of the parent company. This argument has been refuted though on grounds that most parent companies usually have strong control over the operations of their subsidiary companies and so such an argument cannot be used to show an agent relationship. The acceptable way of gauging agency is by analyzing whether the profits of the subsidiary were treated as the profits of the parent company (Harris, Hargovan & Adams, 2008)3. In this case, the profits of Finance Pty Ltd were distributed to Iron Ore Ltd as dividends and were not claimed by Iron Ore Ltd. Based upon this ground then Finance Pty was not an Agent of Iron Ore Ltd and the argument that the operations of Finance Pty Ltd are fully controlled by Iron Ore can not hold since this does not give enough reason to pierce the corporate veil and hold the debt accountable to both companies (Nolan, 1993)5[3]. But basing our argument on the fact that all the employees of Finance Pty Ltd were from Iron Ore Ltd and also basing our argument that all of Finance Pty Ltd borrowings were determined and guaranteed by Iron Ore Ltd, then an agency relationship would be established. With Iron ore as the guarantor of borrowings made by Finance Pty Ltd then there was proximity between these two companies. The Board of Directors of Finance Pty Ltd was drawn from the Board of Directors of Iron Ore, and they were the ones who incorporated Finance Pty Ltd to solve the Problem of debt finance of Iron Ore Ltd. Their decision of writing off Iron Ore’s debt under improper circumstances would weaken their argument in court.
Fraud:
A case can also be made based on grounds of fraud. Fraud in this case implies a controller using the corporation to evade a fiduciary or legal obligation. In order for this to hold then the parent company must be proved to have the intention of using its subsidiary to deny the Tax office its pre existing legal right (Ramsay and Noakes, 2001, pp. 116; Payne, 19977[4]). In this case, the parent company Iron Ore Ltd fully owns and controls Finance Pty Ltd and its employees and board of directors are also in the subsidiary company. This implies that Iron Ore Ltd is in complete control of Finance Pty Ltd. Iron Ore Ltd has a market capitalization value in Excess of AUS $ 165 billion and the failed Pilbara project was worth $ 300 million. This implies that Finance Pty Ltd did not have any reasonable cause to write off the debt as a Bad debt since Iron Ore was in a position where it could have settled its debts. Finance Pty Ltd did not exhaust all reasonable efforts to collect the debt from Iron Ore Ltd, and by so doing was favoring Iron Ore to cover its debts and losses, and so denying the Tax Commission office revenue from tax. However evidence would be needed to prove that the Finance Pty Ltd had the intention of avoiding a legal obligation of paying taxes.
Conclusion:
From the above analysis, it has been established that where as Finance Pty Ltd may be viewed as a separate entity from its parent company Iron Ore Ltd; the corporate veil may be pierced to investigate the activities of the businesses. In the first point, it has been noted that Finance Pty’s decision to declare Iron Ore’s debt as a bad debt was unreasonable since Iron Ore was in a position to repay its debt. In the second point, taking into account that the board of directors and the employees were drawn from the parent company and that Iron Ore was the Guarantor for the borrowings undertaken by Finance Pty, then there is a possibility that agency relationship could be established. On the third point, Finance Pty’s actions may be viewed as fraud if they try to remove responsibility from the parent company and deny the Tax office revenue. From the analysis, the position of Finance Pty Ltd would not be favorable if they go to trial. Their main argument would be that they are a separate entity, but if the corporate veil is pierced, they would probably loss.