The recent Australian Federal Court decision in Lilyvale Hotel Pty Ltd v Commissioner of Taxation [2008] FCA 103 not only raises some interesting issues for those in the hotel industry on tax losses, but also on 'agency' relationships.
From a tax perspective, the decision has significant ramifications for potential sellers and buyers of hotels across Australia, and should be considered in any share sale transaction involving the removal or replacement of a third party operator. However, the decision also contains some thought-provoking comments on the "agency" relationship that usually exists between a hotel owner and operator under a hotel management agreement. The Agency principle is applied across most common law jurisdictions, and, therefore, this Australian decision is likely to be relevant in many other countries.
The case relates to the sale of the hotel known at the time as the ANA Harbour Grand Hotel (now the Shangri-La Hotel, Sydney), and focused on the "same business test". This test is used in the Australian tax legislation to determine the availability of carry forward tax losses which can be offset against a company's current/future year taxable income in share sale transactions, and in this instance, in circumstances where the third party operator, ANA, was terminated as part of the sale process. Justice Stone ruled that the change in the operational structure of a hotel - that is, an entity's transition from the role of owner (with a third party operator engaged to operate the hotel) to the role of owner-operator - did not satisfy the "same business test". The result was that Lilyvale was unable to carry forward its tax losses and offset them against post-sale income.
Advertisement
The decision highlights the strict interpretation of the same business test used in the tax legislation and enforced by the Australian Taxation Office. The same business test requires that, in order for a company to claim prior year tax losses as an income tax deduction, the company must have carried on the same business before the "test time" as it did during the income year in which the losses are claimed as a deduction. The "test time" is the time when the continuity of ownership failed (i.e. broadly, the time when a change of ownership occurred in the company). Critically, Justice Stone's judgment requires that in order to claim the deductions, the company must carry on its business "in the same way" to show that it is in the "same business". This interpretation accords with the views of the Australian Taxation Office in its Taxation Ruling 1999/9, where the Commissioner of Taxation describes the operation of the same business test.
Lilyvale's role as hotel owner was seen as "so distant from the day-to-day activities of the hotel" - in stark contrast to the "comprehensive control of the operation and management of the hotel" exercised by the operator - that the court found no continuity between the business carried on by Lilyvale as owner and Lilyvale as owner-operator. Rather, the owner had stepped into the operator's shoes post-completion and started carrying on a business of a different nature.
The terms of the management agreement summarized in the judgment are generally in line with the provisions of the vast majority of management agreements used in the marketplace, so other agreements could be similarly interpreted.
Significantly, the agency relationship that underpins many hotel management agreements came under scrutiny by Justice Stone and her findings on this point helped form her decision. After examining the terms of the management agreement that had been in place prior to the share sale and the roles of the two parties in the running of the hotel Justice Stone dismissed the proposition that the operator had been acting as the owner's agent for the purposes of continuity of business (even though the management agreement specifically stated that this was the nature of the relationship). Her Honor did not go so far as to deny that the owner-operator relationship was one of agency for legal purposes, but she held that any agency was insufficient to attribute the activities of the operator to be those of Lilyvale in carrying on its business.
Her Honor did not specify what was, in her view, the real characterization of the relationship between owner and operator. She made it clear that an attempt to describe the relationship as one of agency would not in itself bind a Court: the Court would look to the "true character of their relationship".
The case does show an important limit to one of the industry's norms: the consequence of hotel operators in general acting as agents of hotel owners. There is also an important warning that agency cannot be created by labels - the relationship will be characterized by its true character. The assumed "agency" structure underpins key working assumptions in the industry, such as that as agent, the hotel operator is not personally liable for the debts of the business (as opposed to the hotel owner who is liable) so long as this agency relationship is made known to the outside world.
The judgment provides good reason for those hotel owners and hotel operators who regard themselves as principal and agent for all relevant legal purposes to carefully consider whether they have achieved that result and, if they have, whether the existence of agency carries with it all the consequences which were expected and intended.
We understand that Lilyvale has appealed the decision.
Click here (
Adobe Acrobat PDF file) to download the analysis of Asia Pacific timeshares.
If you would like more information on any of the topics discussed in this article, please contact:
Graeme Dickson
Partner
+61 2 8922 5228
graeme.dickson@bakernet.com
