FEDERAL COURT OF AUSTRALIA

Merchant v Commissioner of Taxation [2025] FCAFC 56

ORDERS

THE COURT ORDERS THAT:

1.    Within 14 days the parties:

(i)    Must file any agreed short minutes of orders to give effect to these reasons, including as to costs; or

(ii)    Failing agreement, their competing proposed orders and their respective submissions (not exceeding three pages).

2.    Subject to any further order, final orders will be made on the papers.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

LOGAN J:

1    I have had the benefit of reading in draft the reasons for judgment to be delivered by McElwaine and Hespe JJ (joint judgment).

2    The thoroughness with which the facts of this case, the reasons of the primary judge and the issues on the appeal are rehearsed in the joint judgment enables me to state relatively briefly why I would allow this appeal, except insofar as it relates to the Taxation of Financial Arrangements Provisions (TOFA) in the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). I would dismiss so much of the appeal as relates to the TOFA.

3    I refer to the facts only to the extent necessary to explain my conclusions.

SECTIONS 177D AND 177C OF THE INCOME TAX ASSESSMENT ACT 1936 (CTH)

4    In his youth, Mr Gordon Stanley Merchant was a surfer and a maker and repairer of surfboards. He travelled the world undertaking these activities. By the early 1970’s, when he was in his late twenties, Mr Merchant had settled in rented farmhouse accommodation in Springbrook in the Gold Coast hinterland. There he continued his business of building surfboards. During this time and through surfing, he met his future wife, Rena. Rena also then had a business serving the surfing community. She made bikinis and simple boardshorts, selling them to other surfers on the Gold Coast. In 1973, they decided to start making boardshorts at home and sell them to local surf shops on the Gold Coast. Together, they made about 20 pairs of boardshorts a week on their kitchen table.

5    Over time, the business so founded grew and evolved into the successful “Billabong” brand of surf ware. Billabong Limited (BBG), which came to conduct that business, was listed on the Australian Securities Exchange (ASX) on 11 August 2000.

6    Even before the listing of BBG on the ASX, there had been challenges for Mr Merchant in the conduct and direction of the Billabong business. These were created by the introduction of external shareholders (notably entities controlled by the Perrin brothers) and related tensions in corporate decision-making. These continued after the listing. A principal source of tension was Mr Merchant’s view that the Billabong business should continue to concentrate on wholesale, rather than, as more recently introduced shareholders wished, retail, operations.

7    In about August 2002, Mr Matthew Perrin, who was CEO of BBG at the time, sold a large block of BBG shares. This was controversial and caused a fall in BBG’s share price. Mr Perrin eventually stood down as CEO of BBG because of these events.

8    As at 1 March 2006, the Merchant Group, via Gordon Merchant No. 2 Pty Ltd (GM2) as trustee for the Merchant Family Trust (MFT), an entity controlled by Mr Merchant, held about 25% of the issued capital in BBG. This was significantly more than the next largest shareholder. The Merchant Group shareholding of BBG Shares represented a large proportion of Mr Merchant’s wealth. He was concerned about having such wealth concentration in BBG shares. So he decided to sell down the Merchant Group’s BBG shareholding. To this end, on 1 March 2006, MFT sold 13,403,000 BBG shares to Citigroup Global Markets Australia Pty Ltd for total consideration of $199,838,730. After that sale, the Merchant Group held approximately 15% of the issued capital in BBG. That share parcel meant that the Merchant Group remained the largest single shareholder in BBG. Retention of that status was important to Mr Merchant both as a founder of BBG and for the influence it gave him in BBG.

9    The selling down of the BBG shareholding allowed Mr Merchant to diversify his investments. However, the sale proved controversial. Mr Merchant was reprimanded by BBG’s then chairman, who told him that he was not happy that he had not told him he intended to sell the shares before he did so. The issues surrounding Mr Perrin's earlier sale of BBG shares made this a particularly sensitive issue. In combination, Mr Merchant’s observation of Mr Perrin’s fate after he sold his shareholding and his experience after he sold down MFT’s made him cautious from that time about BBG management and board members.

10    Although the selling down of MFT’s shareholding enabled greater wealth distribution for Mr Merchant, even before then the success of the BBG business had enabled Mr Merchant, or entities related to him, to acquire interests in entities carrying on other businesses.

11    So it was that, on 31 March 2005, MFT acquired 14% of the issued capital in Plantic Technologies Limited (Plantic). Mr Merchant was appointed as a director of Plantic.

12    Plantic was a “start up” company that developed technology for recyclable and reusable material in plastic packaging. It produced a “plastic-like” material made of corn starch, which formed a barrier said to work as effectively as glass. Plantic’s product was an invention of Commonwealth Scientific and Industrial Research Organisation but which Plantic owned and was seeking to commercialise.

13    Related to Plantic’s then status as a “start up” company, it was not then profitable. There was a need, met from entities within the Merchant Group which Mr Merchant controlled, to fund its operations until such time, as was then hoped and expected, it became profitable. As it turned out, Mr Merchant underestimated how much subsidising funding Plantic would require.

14    In November 2010, MFT acquired all the shares in Plantic under a scheme of arrangement. MFT paid approximately GBP 6.38 million (which was then approximately AUD $10.3 million) to acquire all the shares in Plantic. Plantic then had about $10 million in its bank account.

15    Entities within the Merchant Group continued to fund Plantic while it worked to become financially viable on its own. During the time that MFT owned shares in Plantic, it did not make a profit. It required regular, monthly funding from entities within the Merchant Group. Plantic generally required funding of at least $1 million each month from January 2011. However, it was difficult to predict Plantic’s funding requirements for a given month, because cash flow projections provided to Mr Merchant by Plaintic proved not to be accurate. An example of the variation is that, in August 2014, entities within the Merchant Group made loans to Plantic of $700,000; in September 2014, loans made to Plantic by entities within the Merchant Group amounted to $1.4 million.

16    Over time, Mr Merchant was forced to sell properties in Hawaii owned by entities he controlled to assist in funding Plantic, because other resources within the Merchant Group were insufficient.

17    Each year, the Merchant Group was required to provide a “comfort letter” to Plantic’s Board, containing assurances that it would continue to provide financial support to Plantic.

18    Entities within the Merchant Group continued to fund Plantic by loans until March 2015, when MFT sold all its shares in Plantic.

19    By the end of March 2015, loans made to Plantic from within the Merchant Group comprised the following:

(a)    in the period between 1 January 2011 to 30 March 2015 GSM Pty Ltd (GSM), an entity within the Merchant Group, loaned Plantic - $50,192,000 (GSM Loan);

(b)    in the period between 1 January 2011 to 30 June 2012 Tironui Pty Ltd (Tironui) loaned Plantic - $4,215,000 (Tironui Loan);

(c)    in the period between 1 January 2011 to 30 June 2012 Kahuna Pty Ltd as trustee for the Angourie Trust (Angourie) loaned Plantic - $790,854.

(the Plantic Loans)

20    From around 2011, a number of companies expressed interest in Plantic’s technology and in acquiring the company. One such company was Sealed Air; another was Kuraray. Ultimately, by an agreement made in March 2015, Kuraray acquired all of the shares in Plantic from GM2 as trustee for the MFT.

21    A feature of the sale to Kuraray, as it had been in relation to earlier but ultimately failed negotiations with Sealed Air, was that amounts owed to various entities within the Merchant Group by Plantic were forgiven. In other words, Kuraray, as with Sealed Air before it, was interested only in acquiring shares in Plantic if that company were a “clean” company, free not only of any ongoing shareholding by MFT but free of debts to entities controlled by Mr Merchant.

22    Thus, on 2 April 2015, the Plantic loans were forgiven by GSM, Tironui and Kahuna as part of the transaction whereby MFT sold its shares in Plantic to Kuraray.

23    On 2 April 2015, Kuraray paid GM2, as trustee of the MFT, $59,803,400 cash for the whole of the shares in Plantic. The sale resulted in GM2 making a capital gain of $84,885,502.

24    This sale brought to an end the need of the Merchant Group to continue to fund Plantic’s operations.

25    The BBG share price was generally on a downward trend from around 2007. The global financial crisis of 2008 negatively affected BBG and more particularly led to reduced retail sales due to decreased consumer spending and currency movements. In the 2009 income year, BBG ended with underlying net profit after tax down by 9.2% on the 2008 income year.

26    At the end of 2011, BBG reviewed its capital structure. Following this review, BBG received proposals to purchase its issued capital. There were a number of trading halts placed on BBG during 2012. BBG also stopped paying dividends in 2012.

27    Even after BBG stopped paying dividends, Mr Merchant caused entities in the Merchant Group to continue to buy BBG shares. There were several, inter-related reasons for this. He believed that BBG would be successful again. He had always seen BBG as his personal venture and, related to that, had always believed in the Billabong brand. These beliefs were rooted in his knowledge of the business as a Board member and from his longstanding involvement with the business. In turn, Mr Merchant believed that BBG’s poor financial results were due to mismanagement by key staff. He wanted to retain a controlling stake in the company to prevent mismanagement in the future. He believed that if the necessary changes in the management approach were taken it was likely that BBG would become successful again.

28    The primary judge accepted that Mr Merchant had a unique and distinctive connection with the BBG business, which caused him to wish to retain, via entities he controlled, his shareholding in BBG (PJ 267).

29    On 2 September 2014, GSM Superannuation Pty Ltd (GSMS) as trustee for the Gordon Merchant Superannuation Fund completed an off-market purchase of 10,344,828 shares in BBG for $5,844,827.82 ($0.565 per share) from GM2 (BBG Share Transfer). The BBG Share Transfer crystallised a capital loss for GM2 of $56,561,940 in the 2015 income year.

30    Although a transaction between related parties, the primary judge found (PJ 295) that the BBG Share Transfer was at market value. Neither party questioned this finding on the hearing of the appeal.

31    The Commissioner expressly conceded on the hearing of the appeal that, had the BBG Share Transfer entailed a sale not to a related party but to an unrelated third party, consideration of the factors in s 177D(2) of the Income Tax Assessment Act 1936 (Cth) would not have led to a conclusion that the dominant purpose of any person in entering into or carrying out the scheme he posited would have been to obtain a tax benefit. He likewise expressly conceded that this would remain so even though a crystalised loss of the same amount would thereby have become available.

32    In my view, the appellants demonstrated that the reasoning of the learned primary judge with respect to s 177D was affected by an error of principle. His Honour approached (PJ 250(a)) s 177D(1) on the basis that it “provides an objective test used to determine actual purpose” and that it “requires a conclusion about the intention of a person who entered into or carried out the scheme or a part of it to be determined objectively by reference to the eight matters in s 177D(2): Commissioner of Taxation v Hart (2004) 217 CLR 216 (Hart) at [37]”.

33    The second proposition is correct; the first, with respect, is not. Another case referred to by the primary judge for these propositions was Commissioner of Taxation v Zoffanies Pty Ltd (2003) 132 FCR 523 (Zoffanies) in particular observations made by Hill J at [54]. Hill J there stated:

It is sometimes said that the conclusion under s 177D is a conclusion of objective purpose. That way of putting it is correct if what is meant by it is that the conclusion is not one drawn from evidence of the actual purpose of the relevant taxpayer or other taxpayers. It may perhaps contribute to confusion if it is suggested that the conclusion to be drawn is other than a conclusion about the actual purpose of the taxpayer. Particularly, the conclusion required to be drawn is not a conclusion about the transaction itself but the state of mind of a person. To this extent Pt IVA differs from the previous general anti-avoidance provision (s 260) which was concerned inter alia with the purpose of the contract agreement or arrangement of the kind to which the section referred and not the purpose of a person party thereto.

[Emphasis added]

34    This passage from the judgment of Hill J in Zoffanies reveals, with respect, a confusion of understanding about s 177D uncannily similar to that of the primary judge. That understanding was not shared by the other members of the Full Court in Zoffanies. This is evident in the judgment of Gyles J (with whom Hely J, at [84], materially agreed) in his Honour’s statement, at [91], “The difference between the actual purpose of a taxpayer, on the one hand, and the purpose which is to be imputed to the taxpayer based upon an exclusive set of criteria, on the other hand, is not without subtlety and has been misunderstood before”.

35    There was much evidence at trial about subjective motivations of Mr Merchant and others, including advice furnished by EY. This was in turn much rehearsed by the primary judge. Reading the reasons for judgment as a whole, it is tolerably clear, as the appellants submitted, that the end to which this rehearsal was directed was the drawing of a conclusion as to actual purpose. This is most stark in the following passage (PJ, at [362]):

Each of these documents, understood in the context in which they were written, make it plain that the real reason for the BBG Share Sale was to crystallise a capital loss in the MFT which was regarded as beneficial whether Plantic was sold by way of asset sale or by way of share sale.

36    Further, as the appellants also submitted, to focus upon the “real reason” is to depart from the language of s 177D, which requires an objective conclusion, having regard to the eight factors specified in s 177D(2), as to what was the dominant purpose of a person who was a party to the scheme.

37    Of course, by the extinguishment via capital losses crystalised by the BBG Share Sale of a capital gain made by GM2 as trustee for the MFT on the sale of its Plantic shares, a tax benefit was obtained by GM2. Objectively, at the time of the BBG Share Sale, it was possible that the Plantic shares might be sold when and on the terms which came about but it could hardly be said this was at that time a matter of reasonable expectation. The failure of the proposed sale to Sealed Air is proof perfect of that. In the Full Court in Peabody v Commissioner of Taxation (1993) 40 FCR 531, at 541, Hill J (with whom Ryan and Cooper JJ agreed) explained that the expression “reasonable expectation” that, “the word ‘reasonable’ is used in contradistinction to that which is ‘irrational, absurd or ridiculous’. The word "expectation" requires that the hypothesis be one which proceeds beyond the level of a mere possibility to become that which is the expected outcome”. A later appeal to the High Court by the Commissioner was dismissed by the High Court: Commissioner of Taxation v Peabody (1994) 181 CLR 359 (Peabody HCA). The High Court did not gainsay the explanation offered by Hill J in the Full Court; indeed, the Full Court’s reasoning was affirmed: see, esp. at Peabody HCA, at 385-386. In the absence of a capital gain against which to offset those losses, there could be no tax benefit, only losses to carry forward. “Reasonable expectation” is an important element both of whether there is a “tax benefit” (s 177C(1)(a)) and predicating a change in financial position for the purposes of s 177D(2)(e) and s 177D(2)(f).

38    Hindsight is apt to confer an expectation that the timing and terms of the ultimate sale of the Plantic shares is likely. However, that expectation could not exist at the time when the BBG Share Sale actually occurred. At the time of the BBG Share Sale, and in terms of the change in financial position considerations in s 177D(2)(e) and s 177D(2)(f), the only change in financial position was the capital losses. Nothing more could then reasonably be expected. A sale of the shares in Plantic and certainly one which generated the capital profit concerned, was then but a possibility. Yet for the posited tax benefit to exist, the “scheme” necessarily, had to include the sale of the shares in Plantic: Hart, at [9].

39    Further, as Gleeson CJ and McHugh J stated in Hart, at [15], taking up a point made in Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404, at 416, as to the routineness of revenue law considerations influencing the form of commercial transactions, “even if a particular form of transaction carries a tax benefit, it does not follow that obtaining the tax benefit is the dominant purpose of the taxpayer in entering into the transaction”.

40    The Commissioner’s concession that losses so crystalised by a third party sale would not lead to a conclusion that the dominant purpose was securing a tax benefit by their application against a later capital gain recognised a pervasive reality of holding shares in ASX-listed companies. Sometimes share investments made for reasons thought good at the time in terms of an apprehended dividend yield and increase in share value prove good, sometimes they do not. When they do not, it can be prudent to cut one’s losses and to do so at a time when it is prudent to realise a capital gain on a share investment which has proved good. The Commissioner did not suggest that an application of s 177D to such a scenario would inexorably lead to a conclusion that the imputed purpose was the obtaining of a tax benefit by the application of the capital loss against the capital gain. Any such imputation would be difficult because an obvious additional purpose is just cutting one’s losses.

41    There was no difference between form and substance (s 177D(2)(b)) with respect to the BBG Share Sale. In form and in substance it was a sale at market value of shares in a company listed on the ASX. That exact symmetry is hardly a factor supportive of a conclusion that the dominant purpose was the obtaining of the tax benefit.

42    In terms of s 177D(2)(g), there were multiple other consequences of the BBG Share Sale, apart from crystalising capital losses. The sale was to the trustee of a superannuation fund, GSMS. Sale of shares in a company listed on the ASX was one of the permissible related party transactions for a superannuation fund trustee. Yet the sale maintained an overall interest in BBG by entities controlled by Mr Merchant. Maintenance of major shareholder status was a purpose and one singularly important to the founder of the BBG business. A sale to a third party would not have achieved this purpose. Selling to an entity controlled by Mr Merchant avoided the acrimony which had attended earlier sales of large parcels of shares in BBG by those involved in its governance or management. It could not be perceived as a vote of no confidence in BBG.

43    Another consequence of the BBG Share Sale was that GM2 as trustee of the MFT received an immediate cash benefit of $5.8m from GMSF. It was a permissible way for funds to be paid out from the GMSF. Given the Commissioner’s concession about the unremarkable quality of a sale to a third party at a like price (and thus a like cash injection of $5.8 million), it is just a distraction as to whether GM2 really then needed that cash. Further and in any event, care needs to be taken about the false wisdom of hindsight. Objectively and at the time of the BBG Share Sale, Plantic continued to need regular monthly injections of funds from entities in the Merchant Group to continue to operate. It bears repeating that when and on what terms there would be a sale of GM2’s shares in Plantic admitted of a possibility that this would occur, as it came to, but not of a “reasonable expectation”.

44    With all respect to those who have a contrary view, consideration of the factors specified in s 177D(2) should lead, inexorably, to a conclusion that the obtaining of the posited tax benefit was not a dominant purpose.

S 177E OF THE INCOME TAX ASSESSMENT ACT 1936 (CTH)

45    Section 177E creates a sui generis regime directed to dividend stripping. It is singularly important that its meaning not be affected by notions imported from s 177D or, in relation to what constitutes a tax benefit, from s 177C. The section creates a “supplementary code” applicable in circumstances where it is not likely that s 177D will be applicable: Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 (Consolidated Press Holdings), at [109].

46    I have concluded that s 177D is inapplicable. I do not in any event consider it appropriate to embark on a consideration of the applicability of s 177E influenced by a conclusion that s 177D was applicable. Further, a reason for the enactment of s 177E was, as mentioned, to serve as a “supplementary code”. The notion that it might be applicable in circumstances where s 177D was applicable is odd.

47    Rather than favour the so often futile endeavour of prescriptive definition, Parliament has in s 177E instead favoured concept-based drafting. Thus, there is no definition of what amounts to “dividend stripping” for the purposes of s 177E(1). Which is not to say, as is explained in Consolidated Press Holdings, that, when s 177E was enacted, what amounted to “dividend stripping” did not have certain well-understood characteristics. As to this, in Consolidated Press Holdings, at [105], the High Court (Gleeson CJ, Gaudron, Gummow, Hayne and Callinan JJ) cited with apparent approval an understanding of the term, as given in Halsbury’s Laws of England, which had commended itself to Windeyer J in Investment & Merchant Finance Corporation Ltd v Commissioner of Taxation (Cth) (1970) 120 CLR 177, at 179:

Dividend stripping is a term applied to a device by which a financial concern obtained control of a company having accumulated profits by purchase of the company’s shares, arranged for these profits to be distributed to the concern by way of dividend, showed a loss on the subsequent sale of shares of the company, and obtained repayment of the tax deemed to have been deducted in arriving at the figure of profits distributed as dividend.

48    Subject to one caveat, the High Court also favoured in Consolidated Press Holdings, at [127], an explanation of “dividend stripping” offered by the Full Court of the Federal Court of Australia:

The widely understood connotation [of the expression 'dividend stripping'] was explained in the pre-1981 case law to which we have referred. The so-called dividend stripping cases invariably had as their dominant, if not exclusive, purpose the avoidance of tax that otherwise would or might be payable by the vendor shareholders in respect of the profits of the target companies. The apparent exceptions ... are readily explicable on the basis that the particular scheme, insofar as it involved vendor shareholders, was complete before the dividend stripper began its operations and thus could not itself be described as a dividend stripping operation. The case law preceding the 1981 Act strongly supports the view that Parliament framed s 177E(1)(a) on the basis that dividend stripping operations necessarily involve a predominant tax avoidance purpose.

49    The caveat voiced by the High Court in Consolidated Press Holdings, at [129] was out of abundant caution and to avoid a possible misunderstanding of this statement. The High Court made clear that the Full Court’s view at intermediate appellate level in that case that “s 177E was intended to apply only to schemes which can be said to have the dominant purpose of tax avoidance”. Without being prescriptive, the High Court added that, also at [129], that the required tax avoidance purpose would ordinarily be that of the enabling vendor shareholders.

50    The test posited by each limb of s 177E(1) is outcome or result focussed and it is an objective one.

51    The primary judge stated (at PJ [506]):

    No commercial and objective onlooker could sensibly conclude that the object of the structure was to permit GSM and Tironui to access the increase in value in the MFT. It is plain that Mr Merchant would not choose to make a capital distribution to GSM and Tironui, and thereby expose himself again to top up tax as a shareholder of those entities, rather than to distribute the profits to himself in a manner which avoided that consequence.

[Emphasis added]

52    In the first sentence in the passage quoted, the primary judge has apparently proceeded on the basis that the test was an objective one. So to proceed would be correct. However, and with respect, whether that was indeed the basis upon which his Honour proceeded is immediately challenged by what is stated in the second sentence (emphasised). The appellants’ submission that the second sentence evinces an “actual purpose” error by his Honour analogous to that made with respect to s 177D should be accepted. An “actual purpose” analysis permeates the primary judge’s analysis of s 177E (see, especially, PJ 541, 548 and 549).

53    Objectively, the contemporaneous evidence disclosed, as the appellants correctly submitted, the dominant purpose of the debt forgiveness had nothing to do with “dividend stripping”. The relationship between GSM, Tironui, MFT and Mr Merchant was such that the forgiving of the Plantic loans benefited the MFT and, in turn, each of GSM and Tironui as beneficiaries of the MFT. The debt forgiveness just increased the amount of the capital gain that MFT made on the sale of the shares in Plantic. The reason why MFT did not derive a net capital gain for the year was because it had available to it, not as a result of the debt forgiveness, capital losses.

54    After the remaining capital losses are exhausted, the balance of the capital gain derived by MFT from the sale of its shares in Plantic remain as a potential source of income tax obligations. If there are no other available capital losses MFT will be faced with choices. If paid to GSM to extinguish in part its unpaid present entitlements, there will be income tax consequences. If it distributes the gain to GSM as capital, GSM will face a choice of paying the amount to Mr Merchant as either a dividend or a capital amount. In either case, as the appellants submitted, there will be income tax consequences. If the former, “top up” tax on a dividend at an effective rate of 27.14% after franking credits would be attracted. If paid to Mr Merchant as a capital amount, tax at an effective rate of 24.5% for a concessional capital gain would be attracted.

55    The point is that nothing about the debt forgiveness rendered the capital gain made on the Plantic shares “tax free”. The debt forgiveness increased the amount of the capital gain.

56    These features are difficult, if not impossible, to reconcile with a dominant purpose of “dividend stripping”. The practice of “dividend stripping” as explained in Consolidated Press Holdings, entails a conversion of corporate profits which might have been taxed into something that will not be taxed (in the absence of a measure such as s 177E). In these circumstances and as Consolidated Press Holdings, at [133] highlights, s 177E was inapplicable.

TOFA

57    In addition to provision for cash payments, the agreement for the sale of MFT’s shares in Plantic also included a range of economic performance clauses (termed “Future Payment Rights” by the primary judge).

58    Economic performance clauses of one sort or another are a not uncommon feature of corporate mergers and acquisitions and related share sale agreements. There is no one type of such clause.

59    Some such clauses take the form of an “earn out” arrangement whereby, in addition to lump sum consideration of the purchase of shares, an additional amount may become payable depending on whether specified income targets are met for a specified period or periods after settlement of the share sale. That type of clause can be attractive where it is desired that previous owners of the shares in a company continue to work for the company after its acquisition by new owners, although that is not their only use or attraction. An “earn out” provides an incentive for such persons not just to continue to work for the company but also to maintain or improve its profitability. Kilgour v Commissioner of Taxation [2024] FCA 687 was decided against a background which included such a clause.

60    Other such clauses in a share sale agreements focus upon post-settlement performance milestones in respect of sales or production volumes. Sometimes a feature of such clauses is that a failure to achieve a milestone triggers an obligation on the part of the vendor shareholder an obligation to refund a proportion of a lump sum previously paid by the purchaser to the vendor. Sometimes also a share sale agreement contains a combination of various types of economic performance clauses.

61    In each instance, an economic performance clause lends a contingent quality to the total consideration in respect of a share sale. But they provide a means by which, even in circumstances of some uncertainty about the value of shares, parties can nonetheless reach agreement with respect to their sale.

62    This share sale agreement contained a variety of economic performance clauses:

(a)    Milestone Amounts (as detailed by the primary judge under a heading of that title at PJ 578 and following); and

(b)    Earn Out Amounts (as detailed by the primary judge under the heading “Earn Out Amount” at PJ 589 and following).

63    The appellants submitted that the expression “contingent only on the economic performance of the business” in s 230-460(13) of the Income Tax Assessment Act 1997 (Cth) did not, as the primary judge considered the position to be, carry its ordinary meaning, but rather than a meaning “informed by” the meaning of the expression “contingent on the economic performance” as defined in s 974-85(1) of that Act. The effect of the latter expression is that a right is not relevantly contingent merely because it is contingent on “the receipts or turnover” of the entity.

64    A consideration which was said to support the construction promoted by the appellants was that Div 974 and Div 230 each formed part of a series of “reforms” progressively introduced into the Act with respect to the TOFA, Div 974 as part of the first stage and Div 230 as part of a combined third and fourth stages.

65    Considered at this level of abstraction, the submission made by the appellants is correct. It may also be said of the TOFA amendments generally that in such circumstances as they apply, they change the focus from legal form to economic substance. But that is where the commonality in the stages stops.

66    Division 974 was introduced by amendments made by the New Business Tax System (Debt and Equity) Act 2001 (Cth) and the New Business Tax System (Thin Capitalisation) Act 2001 (Cth). The amendments introduced rules for classifying financial instruments as debt interests or equity interests according to the economic substance of an instrument rather than its legal form. These rules can be seen to have a single organising purpose, which is that an instrument is a debt interest where an issuer has an effectively non-contingent obligation to return, to the investor, an amount at least equal to the amount invested. The wording of s 974-85(1) is adapted to that end. Further, unlike later stage TOFA reforms, Div 974 contains no direct taxing provisions. It just deals with the debt/equity classification of an instrument, leaving the resultant tax outcomes to be determined by taxation legislation elsewhere.

67    Division 230 was introduced by the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (Cth). It is directed to the tax treatment of gains and losses from “financial arrangements”. Where applicable, it permits a taxpayer to recognise the gains or, as the case may be, losses, over the life of a financial arrangement and to ignore distinctions between income and capital.

68    There are exceptions to the applicability of Div 230. These are found in Subdiv 230-H. One of these is that specified in s 230-460(13). The primary judge observed (PJ, at 636) of s 230-460(13) that it “addresses financial benefits arising from the sale of a business under an earn out arrangement”. I agree. The obvious purpose of the qualification “only” in the chaussette of that provision is to narrow the focus of the exception to arrangements based solely on economic performance rather than, for example, profitability.

69    Had parliament wanted s 974-85(1) to affect or supply the meaning of “contingent only on the economic performance of the business after the sale” in s 230-460(13), it would have been very easy to have stated this. Like the primary judge (PJ at 638), I find the difference in the text as between s 230-460(13) and s 974-85(1) reason enough not to regard s 974-85(1) as “informing” the meaning of s 230-460(13). Consideration of context and purpose, as discussed above, serves to confirm this.

70    It follows that I agree with the primary judge’s assumption that, assuming what his Honour termed the “Future Payments Rights” were “financial arrangements” to which division 230 would otherwise have applied, the rights were subject to the exception in s 230-460(13).

71    As with the primary judge, that conclusion means that it is strictly unnecessary to express a view on the subject. However, I respectfully agree with the primary judge, for the reasons his Honour gives, that each of what his Honour termed “the Expired Future Payment Rights” is a “financial arrangement” within the meaning of s 230-45.

72    More particularly, the use in the text of s 230-45(1) of “legal or equitable right” and “legal or equitable obligation” more naturally direct attention to the right or obligation itself, as described and sourced in a specific contractual provision, rather than to the contract in which that right or obligation is found as a whole. In turn, that meaning is congruent with s 230-55 (Rights, obligations and arrangements (grouping and disaggregation rules)) and with the reference to “right” in s 230-460(13).

73    I would therefore dismiss so much of the appeal as related to the TOFA provisions.

OUTCOME

74    In summary, if one steps back and examines events which transpired informed by the considerations specified in s 177D(2), a number of purposes are evident:

(a)    crystallization of tax losses via a sale of BBG shares, which did not in itself confer any tax benefit, only the contingency that a benefit of uncertain nature and extent might in the future become available depending on whether and on what terms MFT’s shares in Plantic could be sold;

(b)    a purchase at market value of those BBG shares by GSMS, bringing with it the benefit of retention under the control of Mr Merchant of an influential parcel of shares and without any potential for criticism for the sale to be construed as a loss of confidence by a founder in BBG’s business;

(c)    liberation of funds from within a superannuation fund and bringing the shares within the superannuation regime;

(d)    bringing to an end via the Plantic share sale of an investment that was occasioning a monthly haemorrhaging of funds by other entities with the Merchant Group (and it was not necessary in order to find an absence of dominant purpose that those entities be proved to already have been bled white financially).

75    So viewed and objectively, no single purpose is dominant.

76    If one adds to this consideration of s 177E, a debt forgiveness which maximises an assessable capital gain is, in itself, the antithesis of “dividend stripping”.

77    Subject to the TOFA related dismissal noted, I would, for the above reasons, allow so much of the appeal as relates to objection decisions which confirmed assessments grounded in determination under s 177F, based on the applicability of s 177D and s 177E. I would, to this extent, set aside the objection decisions and in lieu thereof order that the objections be allowed and the related assessments quashed. I would remit the matter to the Commissioner for reassessment accordingly.

78    In their written submissions in relation to s 177D, the appellants put that “one of the root problems with the Commissioner’s approach in this matter was that ‘schemes’ are filleted out for forensic reasons, divorced from their wider and non-fiscal context, in order to support a conclusion about ‘purpose’ that is essentially myopic”.

79    It is a corollary of the conclusion I have reached when looking to s 177D(2) and s 177C(1) that, with all respect to the Commissioner, I agree with this characterisation. Indeed, it is likewise applicable, in my view, to the s 177E aspect of this matter. In each, another ophthalmological analogy is also applicable, “tunnel vision”.

80    There is a considerable risk in the administration of taxation legislation of seizing upon beneficial taxation outcomes and seeing in them a dominant purpose on the part of a person to obtain the tax benefit. It is all too easy in such circumstances to leap to that conclusion and to tailor the logic to fit. Especially that is so where there is revealed in exchanges with tax advisors references to apprehended tax benefits. The Commissioner’s role in the general administration of taxation legislation and as a revenue collector makes him peculiarly prone to his decision-making being affected by this risk. Tax collection is, after all, “core business” for him. Outside the Commissioner’s office, in businesses large and small across Australia, taxation considerations, including tax benefits, are often but one of the many factors those in business routinely take into account. As Peabody illustrates, where discernible commercial purposes are present, as well as the obtaining of a tax benefit, a conclusion that the latter is the dominant purpose is fraught. On the other hand, as Spotless Services and Hart illustrate, where a scheme can, objectively, be seen to be but an artificial construct inexplicable in its occurrence other than for the purpose of obtaining a tax benefit, it is likely that purpose will be the dominant, if not sole, purpose.

Associate:    

Dated:    22 April 2025

REASONS FOR JUDGMENT

MCELWAINE AND HESPE JJ:

81    The primary judge heard three appeal proceedings brought by Mr Gordon Merchant and a related corporation against amended assessments issued by the Commissioner of Taxation concerning transactions entered into between September 2014 and April 2015 relating to a sale of shares in Billabong International Ltd (BBG) and in Plantic Technologies Ltd. For reasons published on 14 May 2024, his Honour dismissed each proceeding: Merchant v Commissioner of Taxation [2024] FCA 498 (PJ).

82    Broadly, on 2 September 2014, Gordon Merchant (No 2) Pty Ltd (GM2) as trustee of the Merchant Family Trust (MFT) transferred approximately 10 million BBG shares to GSM Superannuation Pty Ltd (GSMS) as trustee of the Gordon Merchant Superannuation Fund (GMSF) for a consideration of $5,844,827.82. In doing so, GM2 incurred a capital loss of $56,561,940. At the time, GM2 held all the issued shares in Plantic, which was not profitable and relied on cash injections from GM2 and loans from other Merchant Group companies.

83    In April 2015, GM2 sold all of its shareholding in Plantic to Kuraray Co Ltd, an unrelated Japanese corporation, which resulted in the MFT deriving a capital gain of approximately $85 million. A condition of the sale required that related company loans (totalling of approximately $55 million) be waived or forgiven.

84    On 20 July 2020, the Commissioner made determinations under Part IVA of the Income Tax Assessment Act 1936 (Cth) (1936 Act) to cancel identified tax benefits from two schemes:

(1)    the BBG Share Sale Scheme. The Commissioner made a determination under s 177F in reliance upon s 177D of the 1936 Act (s 177D Determination). The Commissioner determined that the BBG Share Sale Scheme was entered into or carried out for the dominant purpose of enabling the MFT to obtain a tax benefit, being the capital loss incurred by it on the BBG Share Sale (BBG Capital Loss), which at the time of making the determination, the Commissioner had calculated as $56.5 million. The Commissioner cancelled that benefit by determining under s 177F(1)(c) that the whole of the capital loss was not incurred by the MFT, with the effect of increasing the taxable income of the MFT. An amended assessment giving effect to the determination was issued to GSM Pty Ltd as the beneficiary presently entitled to the income of the MFT.

(2)    the Debt Forgiveness Schemes. The Commissioner made determinations under s 177F in reliance upon s 177E of the 1936 Act. The Commissioner determined the debt forgiveness by each of the related company lenders, GSM and Tironui Pty Ltd, to be schemes having substantially the effect of schemes by way of or in the nature of dividend stripping under s 177E. The Commissioner determined pursuant to s 177F(1)(a) that the entirety of the forgiven amounts be included in the assessable income of Mr Merchant, the sole shareholder of each of GSM and Tironui, for the 2015 year.

85    To give effect to those determinations, on 24 and 27 July 2020, the Commissioner issued amended notices of assessment and penalties. Mr Merchant, GSM and GM2 relevantly objected. The objections were disallowed. On 3 September 2021, Mr Merchant and GSM (the appellants) commenced proceedings in this Court pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) in respect of the amended assessments for primary tax concurrently with review proceedings in the Administrative Appeals Tribunal (AAT) in respect of the penalty assessments.

86    The primary judge summarised what was in issue at PJ [9]-[16] as follows:

The MFT’s capital gain on the sale of its shares in Plantic to Kuraray was around $85 million. The capital proceeds included a cash payment of about $60 million, a working capital adjustment and future payments, including what have been referred to as “Milestone Amounts” and “Earn-Out Amounts”, which were valued in the accounts at the time at around $51 million (the Future Payment Rights). The acquisition costs were around $24 million and the cost base in the Plantic shares included amounts paid to lawyers and the payout of employee options, costing a little over $2 million. The capital proceeds were calculated to be about $111 million and the cost base was about $26 million, resulting in a capital gain of about $85 million.

The preceding transactions – particularly the debt forgiveness and the crystallising of the MFT’s capital loss – piqued the interest of the Commissioner of Taxation, resulting in an audit of the affairs of Mr Merchant and the Merchant Group. After the audit, the Commissioner issued two sets of “Reasons for Decision” on 20 July 2020.

One concerned the “BBG Share Sale Scheme”. The Commissioner considered that, for the purposes of s 177D(1) in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), it would be concluded that a person entered into or carried out a scheme, or part of it, for the dominant purpose of enabling GSM to obtain a tax benefit, GSM being the only presently entitled beneficiary of the MFT. In summary, the Commissioner took the view that the predominant reason why the GMSF acquired the BBG Shares from the MFT on 4 September 2014 was to crystallise a capital loss in the MFT which could be applied against the capital gain from the MFT’s anticipated sale of its shares in Plantic, resulting in a reduction in GSM’s assessable income. The Commissioner considered that the BBG Share Sale was analogous to a ‘wash sale’ given that the BBG Shares would remain in the Merchant Group of which Mr Merchant was the ultimate owner.

The Commissioner made a determination under s 177F(1)(c) of the ITAA 1936 that the amount of $56,561,940, referable to a capital loss incurred by the MFT in the year ended 30 June 2015, was not incurred by the MFT in relation to that financial year (the s 177D Determination). As a consequence of this:

(a)     the MFT’s net income increased from $5,482,423 to $28,111,179 to reflect the net capital gain (at the 50% discount) of $22,628,756;

(b)     an amended assessment dated 24 July 2020 was issued to GSM (the GSM Amended Assessment), increasing GSM’s tax payable by $12,877,000.90 (because GSM was the beneficiary with a 100% present entitlement to the income of the MFT in the 2015 year): CB695; and

(c)     although no amount of the net capital gain was assessed to the [trustee of the] MFT, a penalty assessment issued to the [trustee of the] MFT on 27 July 2020, which assessed it as liable to a penalty of $6,438,500.45 being 50% of the BBG Share Sale Scheme shortfall amount, pursuant to Division 284-C of Sch 1 of the Taxation Administration Act 1953 (Cth) (TAA 1953): CB788.

The second transaction concerned the “GSM and Tironui Debt Forgiveness Scheme”. The Commissioner considered that the forgiveness of debts by two of the three lenders – GSM and Tironui – were schemes having substantially the effect of schemes by way of or in the nature of dividend stripping within the meaning of s 177E(1)(a)(ii) in Part IVA. No consideration was provided for the forgiveness of debt such that the forgiveness had the effect of:

(a)     reducing the undistributed profits of GSM and Tironui; and

(b)     converting the Plantic Loans to equity, thereby increasing the value of Plantic’s shares and the consideration paid by Kuraray for those shares.

The Commissioner made a determination under s 177F(1)(a) of the ITAA 1936, that the debts forgiven by GSM and Tironui be included in Mr Merchant’s assessable income in the 2015 income year as dividends (the s 177E Determination).

To give effect to the s 177E Determination, on 27 July 2020, the Commissioner issued an amended assessment to Mr Merchant (the Merchant Amended Assessment) in relation to the 2015 year. This increased Mr Merchant’s assessable income by $54,407,000 (being the tax benefit considered by the Commissioner to have been obtained from the release and forgiveness of the Plantic Loans) with the result that Mr Merchant’s tax liability increased to $30,570,438.12, comprising an increase in tax payable and a shortfall interest charge: CB696.

Mr Merchant, the MFT and GSM lodged a joint objection on 22 September 2020 objecting to each of the assessments: CB790. The objections were disallowed on 27 July 2021: CB797; CB798; CB5. In deciding the objections, the Commissioner concluded:

(a)     that the MFT had obtained a tax benefit from the BBG Share Sale Scheme, and that the MFT and the GMSF entered into the BBG Share Sale Scheme for the dominant purpose of obtaining a tax benefit such that s 177D(1) applied, with the consequence that the Commissioner was entitled to make a determination under s 177F(1)(c) cancelling the capital loss: CB798; and

(b)     in respect of Mr Merchant, that the GSM and Tironui Debt Forgiveness Schemes had the substantial effect of a dividend stripping scheme, attracting the operation of s 177E of the ITAA 1936: CB797 at [59].

87    Another issue before the primary judge concerned the application of Div 230 of the Income Tax Assessment Act 1997 (Cth) (1997 Act) (the TOFA Provisions) to the right of the MFT to receive the Milestone Amounts, where the right to receive components of those amounts expired in the 2017 and 2018 income years. Mr Merchant had originally claimed the expiry of the rights as capital losses in the amounts of $1,019,505 and $418,558. Mr Merchant objected to his assessments for the 2017 and 2018 income years to claim the amounts as deductions on revenue account pursuant to the TOFA Provisions. The Commissioner disallowed the objection and on 10 November 2021, Mr Merchant commenced a further appeal proceeding in this Court (the TOFA Proceeding).

88    On the matters in issue before the primary judge, his Honour:

(i)    Concluded that s 177D was satisfied. It was not disputed that the MFT had obtained a tax benefit for the purposes of s 177C, being a capital loss on the sale of the BBG shares to the GMSF. The primary judge found that it was reasonable to conclude that the dominant purpose of each of Mr Merchant, the MFT and the GMSF in entering into and carrying out the BBG Share Sale Scheme was one of obtaining a tax benefit for the MFT. The appellants failed to discharge their onus to the contrary: PJ [408]. However, his Honour was satisfied that GSM had discharged its onus of establishing that the capital proceeds were incorrectly calculated and hence the amended assessment was excessive to the extent of approximately $11 million. His Honour remitted the recalculation to the Commissioner: PJ [433];

(ii)    Concluded that s 177E was satisfied. The primary judge found that the Debt Forgiveness Schemes, were each schemes having substantially the effect of a scheme by way of dividend stripping for the purposes of s 177E(1)(a)(ii). Mr Merchant failed to discharge his onus to the contrary: PJ [571]-[573]; and

(iii)    Concluded that the TOFA Provisions did not apply because the exception in s 230-460(13) of the 1997 Act was satisfied: PJ [627]. Although it was unnecessary to reach a conclusion about whether the Expired Future Payment Rights were each a financial arrangement, his Honour proceeded to determine that question and concluded that they each were “when assessing the matter in a commercial, practical way in light of the apparent object of the TOFA provisions”: PJ [632].

89    The AAT proceedings in relation to the penalty assessments were adjourned, pending the determination of the primary tax assessments and the making of a request for a compensatory adjustment depending on the outcome of the proceedings relating to the primary tax assessments (PJ [489]).

90    The appellants’ Notice of Appeal to this Court was filed on 11 June 2024 and comprised 18 grounds with multiple sub-grounds. The scope of the grounds reduced somewhat in the form of the Amended Notice of Appeal as attached to the appellants’ written submissions dated 8 October 2024. The Commissioner raised no objection, and we granted leave to amend in the course of the hearing. In summary, the amended grounds traverse whether the primary judge erred in finding:

(i)    That the appellants had failed to discharge the onus of proving that the BBG Share Sale was not a scheme in respect of which it would be concluded that a person who entered into or carried out the scheme did so for the dominant purpose of enabling a relevant person to obtain a tax benefit in connection with the scheme: s 177D of the 1936 Act;

(ii)    That Mr Merchant had not discharged the onus of establishing that the Debt Forgiveness Schemes were each schemes having substantially the effect of a scheme by way of or in the nature of dividend stripping: s 177E(1)(a)(ii) of the 1936 Act; and

(iii)    That the exception at s 230-460(13) of the 1997 Act applied to the Expired Future Payment Rights.

91    The Commissioner resists the appeal and relies on a Notice of Contention (relevant to (c)) that the order made by the primary judge ought to be affirmed on the ground that his Honour should also have found that each of the Expired Future Payment Rights were not a financial arrangement within the meaning of s 230-45 of the 1997 Act because those rights, properly construed, constituted part of a single arrangement arising under the agreement for the sale of the shares in Plantic and the other rights were not insignificant in comparison with the rights to receive future payments.

THE FINDINGS OF THE PRIMARY JUDGE

92    At the outset it should be noted that that the parties requested his Honour to hear the related AAT proceedings together with the three appeal proceedings, with the evidence in the Court proceedings being evidence in the AAT proceedings and vice versa. His Honour agreed in the interests of expedition and efficiency. At PJ [24], his Honour summarised the AAT proceedings:

(1)     Gordon Merchant No 2 Pty Ltd as trustee for Merchant Family Trust v Commissioner of Taxation (AAT Case 2021/6296): The Commissioner issued a notice of assessment of scheme shortfall penalties to GM2 as trustee of the MFT for 50% of a scheme shortfall of $12,877,000.90, being $6,438,500.45. This proceeding is GM2’s application for “review” of the Commissioner’s disallowance of its objection.

(2)     Gordon Merchant v Commissioner of Taxation (AAT Case 2021/6294): The Commissioner issued a notice of assessment of scheme shortfall penalties to Mr Merchant in connection with the s 177E assessment. Mr Merchant was assessed as having a scheme shortfall of $26,659,429.97 and was assessed to a 25% penalty, being $6,664,857.24. This proceeding is Mr Merchant’s application for “review” of the Commissioner’s disallowance of his objection.

(3)     Gordon Merchant v Commissioner of Taxation (AAT Case 2020/6932): This is Mr Merchant’s application for review of the Disqualification Decision.

93    The Disqualification Decision is a reference to a decision made by the Commissioner on 21 July 2020 pursuant to the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) to disqualify Mr Merchant from acting as a trustee or responsible officer of corporate trustees of superannuation entities. The Commissioner made that decision on the basis GSMS as trustee of the GMSF contravened respectively the operating standards under s 34 of the SISA, by failing to give effect to the investment strategy requirements, the sole purpose rule at s 62 of the SISA and the requirement at s 65 of the SISA, by using the resources of the fund to give financial assistance to a member.

94    On 16 May 2024, the primary judge, in his capacity as Deputy President of the AAT, set aside the disqualification decision: Merchant and Commissioner of Taxation [2024] AATA 1102.

BACKGROUND FINDINGS

95    The appellants do not contend that the primary judge erred in making relevant background findings of fact. His Honour set out a detailed chronology of relevant events at PJ [1]-[240]. We summarise the material findings as follows.

96    The primary judge commenced by identifying the Merchant Group of companies and the key players at PJ [1]–[4].

97    Mr Merchant co-founded the business which became Billabong Holdings Australia Ltd in 1973. Following a name change to Billabong International Ltd, it was listed on the Australian Stock Exchange (ASX) in August 2000. Mr Merchant at all times was the director and controlling mind of each company in the Merchant Group.

98    GM2 as trustee of the MFT held 100% of the issued shares in Plantic. It first acquired 14% of the Plantic shares in 2005, and then acquired the balance of the Plantic shares in November 2010 pursuant to a scheme of arrangement. The cost base of the MFT’s entire Plantic shareholding was approximately $26.9 million. Mr Merchant at all material times was one of the directors of Plantic together with Ms Colette Paull, his management assistant and Mr Luke McGrath, an investment adviser. Plantic was established as a start-up company to develop technologies in the manufacture and distribution of plant-based packaging materials as a substitute for oil based products.

99    Mr Merchant held all of the issued shares in Tironui, GSM, Kahuna Pty Ltd as trustee of the Angourie Trust and GSMS as trustee of the GMSF.

100    The primary judge set out the history of the Merchant Group shareholdings in BBG at PJ [42]–[50], [62]–[79], [86]–[90], [101]–[102], [126]–[129]. The effect of the transactions was that by March 2014, the Merchant Group held approximately 10% of the voting power in BBG and was no longer the largest shareholder: PJ [129]. On 2 September 2014, Mr Merchant transferred 10,344,828 BBG shares from the MFT to the GMSF, in consideration of $5,844,827, a price of 56.5 cents per share: PJ [185]–[186].

101    Mr Merchant’s evidence, which the primary judge accepted, was that for many years he sought to maintain a controlling shareholder interest in BBG. When BBG was listed on the ASX in August 2000, the Merchant Group owned approximately 23% of the issued capital and Mr Merchant remained on the board as a non-executive director: PJ [43]. The Global Financial Crisis in 2008 badly affected the retail operations of BBG, but Mr Merchant remained optimistic that the corporate fortunes would improve and, to that end, continued to purchase BBG shares despite his concern that the business had moved from its core area as a wholesaler: PJ [50]. In February 2012, BBG announced that it had received a proposal from TPG Capital to acquire all of its issued shares at a price of $3 per share. Mr Merchant did not agree with the offer price and responded by causing the GMSF to purchase approximately 2.5 million BBG shares at a price of $3.13 per share. He did so because of his belief that BBG would trade out of its difficulties: PJ [70]-[78]. His Honour, contrary to the evidence of Mr Merchant, found that these shares were also acquired to maintain the position of the Merchant Group as a substantial shareholder: PJ [79]. The TPG Capital proposal did not proceed.

102    In June 2012, BBG announced a non-renounceable entitlement offer. Mr Merchant caused the margin loan facility of the MFT with NAB to be increased to $25 million to acquire more shares in BBG. The loan facility was increased and on 27 June 2012, $30 million was paid out to acquire approximately 29.5 million BBG shares: PJ [86]-[90].

103    In October 2012, the MFT acquired a further 900,000 shares in BBG for a consideration of $753,895: PJ [96]-[102].

104    In September 2013, BBG announced that it had entered into a long term financing arrangement, the effect of which was that it would borrow $386 million, an equity placement of $135 million would be issued to the lender and a $50 million renounceable rights issue would be made available to BBG shareholders. The equity placement and rights issue would dilute the interests of the Merchant Group. This caused Mr Merchant to seek advice as to whether the GMSF could acquire BBG shares through the entitlements of other Merchant Group entities. He was informed that this raised taxation issues and was decided against: PJ [114]-[115], [126].

105    More BBG shares were acquired by the Merchant Group pursuant to the rights issue. On 31 March 2014, the MFT acquired 24,679,850 shares for approximately $6.9 million, GSM acquired 850,873 shares for approximately $238,000 and the GSMF acquired 946,350 shares for approximately $265,000: PJ [128]. Mr Merchant gave as one of his reasons for these acquisitions that he disagreed with the proposal of another significant shareholder to cheapen the Billabong brand by selling at discount through lower end retailers: PJ [130].

106    As at 30 June 2014, the GMSF recorded the value of its BBG shareholding at $1,734,975: PJ [140].

107    By May 2014, Mr Merchant was frustrated with the fact that Plantic continued to require funding from him. Mr Merchant had considered that Plantic should have been self-funding by that time: PJ [131]. In about May 2014, Mr McGrath approached Ernst & Young (EY) to provide taxation advice on an appropriate structure for the sale of Plantic: PJ [134].

108    Negotiations for the sale of Plantic to Sealed Air Corporation Inc commenced in June 2014. A non-binding offer was proposed by 24 July 2014 with a target closure date of 30 September 2014 and an up-front payment of between USD $55 and $70 million: PJ [141]-[147]. Mr Merchant received advice from EY that a sale of shares rather than an asset sale was preferable: PJ [149]-[152].

109    On 24 July 2014, Sealed Air provided a letter of intent to Plantic for USD $70 million: PJ [153]. The offer was conditional on completion of due diligence. A closing date of 15 September 2014 was contemplated. A draft share purchase agreement was provided by Sealed Air’s solicitor on 19 August 2014.

110    Between August and September 2014, Mr Merchant sought taxation advice about the potential sale of Plantic. Modelling was undertaken comparing the consequences of an asset sale or a share sale, including the waiver of the loans from the Merchant Group entities: PJ [157]-[164]. Draft taxation calculations were provided to the Merchant Group on 21 August 2014, which his Honour summarised at PJ [166], [168] and [169]:

The calculations in relation to a sale of Plantic’s business considered alternatives on the basis that the business would be sold at $75 million or $100 million: CB264. The analysis shows that it would not have been necessary to use capital losses from a sale of BBG shares if the Plantic business was sold for $75 million. However, if the business was sold for $100 million, the analysis was that the best tax result would be achieved if the MFT realised a capital loss of $51,426,942 from the sale by the MFT of BBG shares to the GMSF, and then applied about $30.3 million of that loss to offset the capital gain on the windup of Plantic, following the sale of its business.

The calculations show that EY had estimated that the number of BBG shares that the GMSF could acquire with available cash of $6 million, being 10.3 million shares, would give rise to a capital loss on those shares of $51,426,942 in the MFT.

It is clear from these calculations that, whether the sale of shares in Plantic occurred at $75 million or $100 million, it was desirable for the BBG Share Sale to occur. It was also desirable for the BBG Share Sale to occur if the sale was a sale of Plantic’s business, because it was only if the business was sold at the lowest end of the range that the capital loss would not be required. EY had consistently been advising that it was preferable for Mr Merchant that the transaction occur by way of share sale.

111    More taxation advice was received between 21 August 2014 and 3 September 2014: PJ [171]-[178]. This culminated in the preparation of a document provided to the Merchant Group on 3 September 2014 which the primary judge summarised at PJ [179]:

The email attached a document headed “Project Maize – Summary of Sale Options and Tax Outcomes”: CB270. The document stated that its purpose was to “illustrate the tax implications of the different alternatives for disposing of Plantic Technologies Limited” but did “not constitute advice in relation to any scenario”. It stated that its analysis was based on the following assumptions:

•    Regardless of the form that the deal takes, consideration for the disposal will be an upfront payment of AU$75M, plus deferred consideration contingent on the quantum of future sales of product by Sealed Air.

•    We have assumed that AU$25M will be received from the earn out right. We have also assumed that this is the market value of the rights at the date of sale. However, it may be that a much lower value of the earn out can be supported at sale date because of the contingent nature of the right. Where this would make an impact on the option under consideration we have highlighted this (in particular, the ‘Business Sale 5’ scenario).

•    The value of the loans to Plantic from GSM Pty Ltd (GSM) and Tironui Pty Ltd (Tironui) at the time of the transaction is $50M.

•    The Merchant Family Trust’s (MFT) cost base in Plantic is $24M.

•    The issued capital in Plantic is $76M.

•    As at 30 June 2014, Plantic has group losses of $20M and transferred losses of $58M with an available fraction of 0.840.

•    MFT has $10M capital losses at 30 June 2013. MFT will sell Billabong International Limited (BBG) shares to the Gordon Merchant Superannuation Fund (GMSF) during the 2015 year and realise further capital losses of $60M.

112    The document also addressed the anticipated taxation outcome if the related party loans were forgiven: PJ [183]-[184]. The primary judge emphasised the summary of the analysis conclusion at PJ [184]:

The ‘Summary’ on the right hand side states:

•    Debt forgiveness gives a higher capital gain (and therefore use of more capital losses) but a reduction in top-up tax payable i.e. reduce current tax but potentially increase future taxes if would otherwise be able to use capital losses.

•    Risk of anti-avoidance provisions applying to this tax benefit mitigated because occurs as normal part of commercial sale process with an arm’s length party.

113    In an email sent on 3 September 2014 to BBG, Mr Merchant advised that on 2 September 2014, he had transferred 10,344,828 BBG shares from GM2 to the GMSF. He signed a standard transfer form to that effect on 4 September 2014 for a consideration of $5,844,827.82. The consideration was paid to the MFT on 5 September 2014: PJ [185]-[186].

114    The primary judge rejected Mr Merchant’s evidence that the BBG shares were sold for the purpose of funding Plantic, or the MFT more generally: PJ [187]-[194]. His Honour found that the BBG shares were sold, consistently with the taxation advice received, to “crystallise a capital loss which could be used against the capital gain which was anticipated to be higher by reason of the proposed forgiveness of the Plantic Loans”: PJ [189].

115    His Honour also found that Mr Merchant “must have known” that the BBG Share Sale would result in a large capital loss in the MFT: PJ [192].

116    Negotiations with Sealed Air continued until 26 November 2014, but did not result in a concluded contract because of the assessed taxation consequences for the purchaser of a share sale: PJ [197]-[212].

117    In the meantime, Kuraray had expressed interest in purchasing Plantic. By 26 February 2015, the board of Kuraray resolved to approve the acquisition of Plantic as a share purchase if the related party debts were forgiven: PJ [214]-[221]. A Share Sale Agreement (SSA) was executed on 31 March 2015: PJ [222]-[226]. The SSA contained clauses requiring that the GSM, Tironui and Angourie debts must be forgiven before settlement.

118    A Deed of Forgiveness of debt was executed on 2 April 2015 between GSM, Tironui, Angourie and Plantic, by which each lender “irrevocably and unconditionally forgives and releases Plantic from all liability under or in respect of the total amount owing” by Plantic: PJ [227].

119    The sale of the Plantic shares to Kuraray completed on 2 April 2015 and the MFT received USD $45,558,827.30 as the up-front payment: PJ [228]-[229].

120    Something more needs to be said about the operation of the GMSF. From 1 July 2009, an account based pension was paid to Mr Merchant, who was then aged 66 and had retired. Thereafter, various resolutions were passed to commute the income stream pension and to start a new income stream pension in the 2010, 2011 and 2012 financial years. Mr Merchant received a pension of at least $450,000 in 2010: PJ [54]-[55]. Consideration was given to Mr Merchant accessing funds from the GMSF in July 2012. Mr Merchant received advice that as he was over age 65, he was not restricted as to the amounts he could withdraw as tax free lump sum benefits: PJ [91]-[94]. As at 30 June 2009, the GMSF balance was approximately $17.8 million: PJ [51]-[53]. As at 30 June 2012, the GMSF balance was approximately $10 million: PJ [55].

121    The GMSF adopted an investment strategy on 15 March 2012, following resolutions made at a meeting on 16 February 2012: PJ [80]-[85]. That strategy determined that the primary investment objective was to achieve an after tax rate of return above the rate of inflation by, inter alia, not holding any investments in real estate and investing up to 40% of the fund assets in listed securities. That, as the primary judge noted, did not reflect the fact that at that time approximately 9% of the fund assets were invested in real estate.

122    Dividends had not been paid on BBG shares since 2012 (PJ [50]). A consequence of the BBG Share Sale was that the GMSF ceased to pay a pension to Mr Merchant from 1 July 2015 and reverted to the accumulation phase: PJ [55], [232] – [236].

123    A new investment strategy for the GMSF was formulated on 19 November 2015: PJ [238]-[240]. It targeted asset allocations of up to 80% in listed securities and up to 20% in real property, amongst other forms of investment.

124    The primary judge made multiple findings about the financial support provided by the Merchant Group to Plantic over time. It will be recalled that the MFT acquired all of the shares in Plantic in November 2010. Mr Merchant, Ms Paull and Mr McGrath were each the appointed directors of Plantic until it was sold on 2 April 2015.

125    Initially, Plantic received funding from government grants, which reduced over time. It was not profitable, and funding from external sources proved difficult to secure: PJ [58]-[59]. The MFT provided “comfort letters” to the effect that it would ensure that sufficient funds were made available to Plantic to meet its financial obligations in the ordinary course of its business. Those letters were essential to be satisfied that Plantic was solvent: PJ [60]-[61].

126    The primary judge made findings about the extent to which Plantic was reliant on continued funding from the Merchant Group before the events of September 2014: PJ [256]-[261], [293]-[309]. In oral submissions, the appellants and the Commissioner differed in their interpretation of the financial evidence. We return to this point when considering the appeal grounds. For present purposes we reproduce the ultimate finding of the primary judge at PJ [309]:

There was ample funding available as at 4 September 2014 to meet the forecast funding requirements of Plantic if the funding needed to be met. The funding would not be required if Plantic was sold, which was strongly desired on the part of Mr Merchant. The additional forecast cash requirements of Plantic up until 30 June 2015 could have been met from existing cash reserves and, to the extent these proved insufficient because of other expenditure of the MFT or for other reasons, could have been met in the same way as the MFT had funded its expenditure over the period 2012 to 2014. That is not to say that any such funding requirement had to be funded in that way; it is only to say that – objectively – Plantic’s funding did not need to be sourced from the sale of BBG shares by the MFT to the GMSF. There was no expenditure of an unusual or unforeseen nature on the part of Plantic that Mr Merchant pointed to in connection with the assertion in his affidavit at [243], that he “transferred the BBG shares to GMSF on 2 September 2014 because I needed to free up cash as soon as possible to continue funding Plantic”.

127    The appellants challenge that finding as impermissibly intruding into the subjective purpose of Mr Merchant in respect of the BBG Share Sale.

SECTION 177D FINDINGS

128    At PJ [241], the primary judge set out the Commissioner’s identification of the BBG Share Sale Scheme:

The scheme includes all of the actions and decisions that resulted in the transfer of 10,344,828 BBG shares from MFT to GMSF. This includes Mr Merchant and Ms Paull, as directors of GM2 executing a standard share transfer form to transfer the BBG shares off-market to GMSF for $5.8 million, with a recorded transfer date of 2 September 2014.

129    The parties to the BBG Share Sale Scheme include Mr Merchant, GM2 as trustee of the MFT and GSMS as trustee of the GMSF: PJ [242].

130    At [243]-[245], the primary judge recorded the narrow field of dispute:

There is no dispute that:

•    the BBG Share Sale Scheme so identified is a scheme within the meaning of that term as defined in s 177A(1) of the ITAA 1936;

•    the BBG Share Sale Scheme so identified resulted in a tax benefit under section 177CB(2); and

•    Division 6 of the ITAA 1936 operated such that GSM was properly assessed to 100% of the net income of the MFT. 

The only issue raised as to whether s 177D of the ITAA 1936 applies is the issue of dominant purpose: whether, on the proper application of Part IVA, it would be concluded under s 177D(1) that a person who entered into or carried out the BBG Share Sale Scheme did so for the dominant purpose of obtaining the tax benefit.

There is also an issue which goes to the amount of the assessment. GSM contended that the GSM Amended Assessment is excessive because that part of the capital proceeds of the MFT’s sale of the Plantic shares associated with the Milestone Amounts and Earnout Amounts, was incorrectly valued for the purposes of s 116-20(1)(b) of the ITAA 1997.

131    His Honour set out s 177D(1) and summarised the legal principles at PJ [246]-[252]. The appellants contend that in doing so, his Honour erred by referring to the “actual purpose” of one or more of the BBG Share Sale Scheme participants, which we return to in detail later in these reasons. His Honour summarised the competing submissions at PJ [256]-[266]. The appellants do not contend that his Honour misunderstood their case.

132    His Honour’s consideration and findings are set out in great detail at PJ [267]-[408], to which we return in our analysis of the appeal grounds. At this juncture, we provide the following high-level summary.

133    The primary judge accepted that Mr Merchant had an “affinity” for holding a substantial parcel of BBG shares; initially to maintain a seat on the board and later as a strategy to prevent dilution of the Merchant Group holdings. Importantly, as at September 2014, Mr Merchant “did not want to sell, and would not have sold, BBG shares to unrelated third parties”: PJ [267]-[268]. That finding was emphasised by the appellants as very significant on the dominant purpose question, characterised as the maintenance of control.

134    The appellants contended before the primary judge that the BBG Share Sale was in part driven by a need to free up cash in the MFT, particularly as Plantic required funding of approximately $1 million per month, the MFT had expended approximately $37 million in acquiring BBG shares between 2012 and 2014 and Mr Merchant’s private expenditure was about $6 million per annum: PJ [269]-[271]. These cash requirements could not be met from the investments of the MFT; in particular there was no realistic prospect that dividends would be received from the BBG shareholdings: PJ [272]-[280].

135    The primary judge did not accept those contentions and found as follows. Decisions were made to use cash in the GMSF to maintain a substantial shareholding in BBG and not for the purpose of raising cash for the MFT: PJ [281].

136    While industrial land in Hawaii was sold in June 2014 to provide additional funding to Plantic, the evidence did not support the finding that the later decision taken by the MFT to sell BBG shares to the GMSF was connected to a decision about funding Plantic: PJ [282].

137    The primary judge found that as at September 2014, the MFT “had ample funding available for the anticipated funding needs” and his Honour rejected the contrary evidence of Mr Merchant: PJ [268]-[289]. The contemporaneous documents (particularly those recording advice from EY) related the BBG Share Sale to the anticipated sale of Plantic. It was Mr Merchant’s evidence that he did what he was “directed to” by EY: PJ [290]-[292].

138    The steps taken by the MFT to realise assets and produce cash between June 2012 and January 2015 did not objectively establish that the purpose of the BBG Share Sale was to address a cash shortfall in the MFT: PJ [293]-[301]. Between May and September 2014, the aggregate cash balance of the MFT exceeded $8 million: PJ [302]. In addition, the MFT had access to a new margin loan facility of $25 million as at 2 September 2014, of which approximately $3.5 million remained available. On that day, the NAB facility was replaced by the CBA facility of $35 million, of which $21.5 million was used to pay out the NAB facility, leaving $13 million in available funds: PJ [303]-[307].

139    Having rejected the appellants’ arguments that the BBG shares were sold to free up cash, his Honour concluded that the shares were sold for the purpose of structuring the sale of Plantic (PJ [316]) and summarised his reasons for that conclusion at PJ [319]:

I do not accept that the BBG Share Sale was undertaken to free up cash for the MFT, in light of the matters referred to above and (to the extent they have not already been referred to):

(a)     the lack of documentary evidence in the months immediately before 4 September 2014 suggesting a need for the GMSF’s cash to fund Plantic or any other expenses of the MFT;

(b)     the amount of cash available to the MFT as at 4 September 2014; 

(c)     the availability of easy means for the MFT to obtain cash, if it were really necessary, from the sale of assets, consistently with how the MFT had been funded from 2012, including the availability of the CBA Facility;

(d)     the documentary evidence from 5 May 2014 onwards which indicates that the BBG Share Sale was suggested by EY in the context of the contemplated sale of Plantic;

(e)     Mr McGrath’s evidence that EY suggested the BBG Share Sale (T158.25-28), and his statement in his email to Mr Merchant on 21 July 2014 that the BBG Share Sale would provide “a good ‘loss’ on paper” so that there would be “zero tax payable”;

(f)     Mr McGrath’s advice on 21 August 2014, consistent with the calculations prepared by EY, that the BBG Share Sale was advisable “either way”, which I conclude was a reference to whether the anticipated sale was a Share Sale or an asset sale; and

(g)     Mr Merchant’s evidence that he undertook the BBG Share Sale because he was “directed” to by EY.

140    The primary judge next addressed a number of submissions of the appellants that the purpose of the BBG Share Sale was to secure exposure of the GMSF to the BBG shares and away from its low yielding cash deposits. His Honour rejected the submissions and in doing so specifically rejected evidence of Ms Paull and Mr Merchant to the contrary: PJ [320]-[341]. In particular, his Honour did not accept that Mr Merchant had considered that BBG would return to paying dividends at any time in the then reasonably foreseeable future: PJ [331].

141    His Honour then turned to the eight matters that are required to be addressed at s 177D(2) at PJ [342]-[431] and in summary found as follows.

142    In relation to the manner in which the BBG Share Sale Scheme was entered into or carried out (s 177D(2)(a)), the primary judge found that the BBG Share Sale Scheme was entered into and then carried out in the context of the anticipated sale of Plantic by the MFT to crystallise a capital loss in the MFT (PJ [343]-[364]). In doing so, his Honour deployed language that the appellants criticise as demonstrating subjective inquiry, such as “because” (PJ [344]), and “the real reason” (PJ [362]). His Honour concluded that the factor set out in s 177D(2)(a) weighed in favour of a conclusion that the BBG Share Sale was carried out to obtain the admitted tax benefit: PJ [364].

143    In relation to the form and substance of the BBG Share Sale Scheme (s 177D(2)(b)), the primary judge concluded that the form of the BBG Share Sale matched its substance: PJ [365]-[370]. The primary judge found that the form of the BBG Share Sale Scheme was an off-market transfer of shares at market value, the substance of which included that Mr Merchant would retain economic ownership of the BBG shares, but crystallise a capital loss which could be used to offset significant capital gains which were then anticipated to arise in the MFT: PJ [369]. The primary judge considered the factor in s 177D(2)(b) weighed in favour of a conclusion that the dominant purpose of the BBG Share Sale was to obtain a tax benefit for the MFT: PJ [370].

144    In relation to the time the scheme was entered into and the length of the period over which the scheme was carried out (s 177D(2)(c)), the primary judge found that the reason the BBG Share Sale went ahead when it did was that the trading window to sell the BBG Shares opened on 2 September 2014 and that it was likely that Plantic would be sold before the end of the financial year: PJ [376]-[377]. The primary judge concluded that the timing of the BBG Share Sale weighed in favour of it being concluded that the BBG Share Sale was undertaken to crystallise a loss in the MFT and that the dominant purpose of the BBG Share Sales was to obtain a tax benefit: PJ [379]-[380].

145    In relation to the result that, but for Part IVA, would be achieved by the scheme (s 177D(2)(d)), the primary judge observed that the appellants did not dispute that a tax benefit was obtained from the scheme. As a result of the scheme, neither the discretionary objects nor the trustee of the MFT were liable to be assessed on the capital gain from the sale of the Plantic shares: PJ [381]-[383]. The primary judge concluded that the matter in s 177D(2)(d) weighed in favour of a conclusion that the dominant purpose was to obtain a tax benefit and “certainly does not weight against” that conclusion: PJ [383].

146    In considering the change in financial position of the relevant taxpayer (s 177D(2)(e)), his Honour considered the other possibilities that may have been open at the time: PJ [384]-[390]. The effect of the BBG Share Sale Scheme was to not only convert the BBG shares into cash, but to convert unrealised capital losses into realised losses, which were then deployed to offset the capital gain from the sale of the Plantic shares to the financial benefit of the MFT beneficiaries. Absent the BBG Share Sale Scheme, the MFT would have had a substantial capital gain which would have been taxable in the hands of the trustee or in the hands of the presently entitled beneficiary: PJ [387].

147    His Honour addressed an issue that was pressed in submissions before us: the BBG shares could have been sold to arm’s length third parties, with the same consequence for the MFT and the discretionary objects. His Honour did not consider that possibility to weigh in favour of a conclusion that the dominant purpose was not to obtain the admitted tax benefit (at PJ [389]):

If the BBG Share Sale Scheme had not been carried out, then the MFT could have realised a capital loss by selling sufficient high cost BBG shares on-market to third parties. Mr Merchant did not want to do this. The fact that this possibility existed does not weigh in favour of the dominant purpose not being one of obtaining the (admitted) tax benefit which was obtained. Rather, it tends to emphasise that the point of the sale was to realise a capital loss whilst maintaining the Merchant Group’s shareholding in BBG by transferring the shares at market value between members of the Merchant Group.

148    His Honour concluded that the factor in s 177D(2)(e) “weighs in favour” of a conclusion that the dominant purpose was to obtain a tax benefit: PJ [390].

149    In relation to the change in the financial position of others from the BBG Share Sale Scheme (s 177D(2)(f)), his Honour accepted the Commissioner’s submission that three parties are to be considered: (1) GSM as the presently entitled beneficiary of the MFT, was “sheltered” from paying tax on the capital gain derived from the BBG Share Sale; (2) the position of the GMSF was altered in that its cash assets were converted into non-current assets of the same value, which affected Mr Merchant’s pension but which at the same time maintained his financial position within the Merchant Group; and (3) Mr Merchant’s position was prejudiced by the loss of the GMSF’s ability to continue to pay a pension to him, offset by the substantial benefits that accrued to the MFT and GSM: PJ [391], [397]–[399].

150    In accepting each of those submissions, the primary judge also appears to have endorsed a further submission of the Commissioner that: “the whole scheme involved transactions between related parties, all controlled and ultimately owned by the same person” and hence it “was simple to look through and observe the significant benefits that accrued to Mr Merchant’s interests as a whole”: PJ [392].

151    These matters led his Honour to the conclusion that this factor weighs in favour of a conclusion that the MFT and the GMSF entered into the BBG Share Sale Scheme for the dominant purpose of obtaining a tax benefit: PJ [400].

152    As to any other consequences of the BBG Share Sale Scheme (s 177D(2)(g)), his Honour found that the transfer of the BBG shares from the MFT to the GMSF resulted in the latter “having a heavy investment in BBG shares, contrary to its investment strategy” by replacing approximately 74.4% of cash assets with shares that were not paying a dividend and which objectively were not likely to pay dividends in the future. His Honour considered that this factor also weighed in favour of it being concluded that the dominant purpose was to obtain a tax benefit: PJ [401] – [402].

153    Finally, his Honour considered the connection between the relevant taxpayer and any connected persons (s 177D(2)(h)) and found that each entity that participated in the BBG Share Sale Scheme were related and ultimately controlled by Mr Merchant. The outcome was that “the economic owner of the BBG shares remain the same”, which matters also tended to support the dominant purpose conclusion: PJ [403] – [404].

154    The primary judge summarised his conclusions as to purpose at PJ [405] – [408]. His Honour reasoned that no matter at s 177D(2) tended against the dominant purpose conclusion; and each weighed in favour of it, albeit with varying assessed weight: PJ [405]. His Honour drew together each of his findings at PJ [406]-[408] as follows:

Assessing the matter globally, having regard to those of the eight matters in s 177D(2) which are most pertinent, it would (objectively) be concluded that the dominant purpose of Mr Merchant, the MFT, and the GMSF was to obtain a tax benefit:

•    The BBG Share Sale was conceived or established, and then carried out, in the context and for the purposes of the anticipated sale of Plantic by the MFT.

•    At the time of the BBG Share Sale, it was contemplated that a future sale of Plantic would involve the forgiveness of the Plantic Loans (or most of them) such that a third party purchaser would pay more for the shares with a consequent increase in capital gain in the MFT.

•    The MFT did not have sufficient capital losses to offset a capital gain from a sale of Plantic shares unless the BBG Share Sale occurred.

•    The main result of the transfer was to crystallise a capital loss in the MFT.

•    The BBG Share Sale occurred at a point in time when Mr Merchant had decided to sell Plantic and a sale of Plantic was reasonably likely. Although a sale was not definite, the window to sell the BBG shares opened on 2 September 2014.

•    Objectively assessed, the BBG Share Sale was not required for the purposes of funding the MFT.

•    Although the MFT disposed of an asset – the BBG Shares – those shares were transferred to the GMSF such that the shares remained in the Merchant Group and the ultimate economic owner did not change.

•    The acquisition of the BBG Shares by the GMSF was inconsistent with the GMSF’s documented investment strategy.

•    Were it not for the operation of Part IVA, the BBG Share Sale would have resulted in significant improvement in the MFT’s financial position.

It was not a substantial purpose of the BBG Share Sale to provide funding to the MFT. Even if funding of the MFT (or Plantic) was a purpose behind carrying out the BBG Share Sale, it was at best a subsidiary purpose. That is evident from the matters referred to earlier, including: the genesis of the BBG Share Sale and its importance to the planned structure of the sale of Plantic; the anticipated level of funding that was required for Plantic and the MFT’s other expenses; and the funding already available to the MFT.

The dominant purpose of each of Mr Merchant, the MFT, and the GMSF in entering into the BBG Share Sale Scheme was one of obtaining a tax benefit for the MFT, being the capital loss obtained by the MFT on the sale of the BBG Shares to the GMSF. It follows that the applicants have not discharged the onus of establishing that the general anti-avoidance provisions in Part IVA do not apply.

THE S 177D APPEAL GROUNDS

155    The appellant’s amended grounds are:

1.     The primary judge erred by:

(a)     finding (at [405]-[408]) that the appellants had failed to discharge the onus of proving that the BBG Share Sale scheme was not a scheme in respect of which it would be concluded that a person who entered into or carried out the BBG Share Sale Scheme (or any part of the BBG Share Sale Scheme) did so for the dominant purpose of enabling a relevant person to obtain a tax benefit in connection with the BBG Share Sale Scheme for the purposes of s 177D of the [1936 Act] (the Adverse Dominant Purpose Conclusion); and

(b)     failing to find that the appellants had discharged that onus by proving that the BBG Share Sale scheme was not a scheme in respect of which it would be concluded that a person who entered into or carried out the BBG Share Sale Scheme (or any part of the scheme) did so for the dominant purpose of enabling a relevant person to obtain a tax benefit in connection with the BBG Share Sale Scheme for the purposes of s 177D of [the 1936 Act] (a Favourable Dominant Purpose Conclusion).

2A.     Further, the primary judge erred by:

(a)     assessing the dominant purpose of those who entered into or carried out all or part of the BBG Share Sale scheme by reference to the actual purpose of such persons (at [250](a) and also [170], [189], [281]-[283], [289]-[290], [292], [295], [310]-[311], [316]-[319], [335], [337], [339], [344], [353]-[354], [358], [362] and [376]) when the proper approach to s 177D is to assess the purpose of such persons objectively;

(b)     finding that the BBG Share Sale crystallising a capital loss ‘was desirable whether the sale of Plantic was a sale of assets or a sale of the shares in Plantic’ (at [344] and see also [168]-[169] and [374]), and that ‘there was no real point in not proceeding with the BBG Share Sale at a time when it [the sale of Plantic] was known to be possible’ (at [377]), in circumstances where:

(i)     at the time the BBG Share Sale occurred, it was uncertain whether any sale of Plantic would occur, and if so in what form;

(ii)     the financial consequence of the BBG Share Sale in terms of reduction in tax for MFT or its beneficiary on a sale of Plantic would be significantly different if the sale of Plantic occurred by way of a sale of assets by Plantic instead of a sale of shares by MFT;

(iii)     therefore, the extent to which the BBG Share Sale crystallising a capital loss was ‘desirable’ in a sense material to an Adverse Dominant Purpose Conclusion differed significantly depending on whether the sale of Plantic was a sale of assets or a sale of shares;

(iv)     the BBG Share Sale could have occurred later in the income year ended 30 June 2015 and achieved the same tax benefit that the BBG Share Sale in fact achieved;

(v)     had the dominant purpose of the relevant persons been to obtain the tax benefit from the BBG Share Sale in connection with the sale of Plantic, the matters in (i), (ii) and (iv) would be reasons for not proceeding with the BBG Share Sale at a time when a sale of Plantic by 30 June 2015 was merely known to be possible or likely;

(vi)     on a proper application of s 177D, the primary judge should have found that the BBG Share Sale occurring when it did, notwithstanding the matters in (i) to (v), supported a Favourable Dominant Purpose Conclusion;

(c)     finding that Mr Merchant retaining ‘the economic ownership of’ the BBG shares and the crystallising of a capital loss by MFT were features of the substance but not the form of the BBG Share Sale scheme (at [368]-[369]) and that this supported an Adverse Dominant Purpose Conclusion (at [370]) in circumstances where:

(i)     the matters identified by the primary judge were equally features of both the substance and the form of the BBG Share Sale Scheme;

(ii)     on a proper application of s 177D(2)(b), there was no difference between the substance and the form of the BBG Share Sale Scheme; and

(iii)     on a proper application of s 177D, the primary judge should have found that:

(A)     there was no difference between the substance and the form of the BBG Share Sale Scheme for the purposes of s 177D(2)(b);

(B)     such lack of difference between the substance and the form of the BBG Share Sale scheme was material to an objective assessment of the dominant purpose of those who entered into or carried out all or part of the BBG Share Sale;

(C)     such lack of difference between the substance and the form of the BBG Share Sale scheme supported a Favourable Dominant Purpose Conclusion;

(D)     the Commissioner’s determination had the practical effect of distorting the CGT regime, for Part IVA would be attracted or potentially attracted whenever a taxpayer sells a loss-making asset at time when a capital gain is in prospect, which is not how Parliament intended Part IVA to operate, and would lead to the capture of routine transactions not intended to fall within the reach of Part IVA;

(d)     failing to find that:

(i)     the context provided by the proposed sale of Plantic required a Favourable Dominant Purpose Conclusion, because the BBG Share Sale was wholly incidental to the dominant purpose of the taxpayers, which was to exit the Plantic business, the sale of which was an ordinary commercial transaction having no fiscal purpose; and

(ii)     the non-tax changes in financial position of relevant persons resulting from the BBG Share Sale scheme, and the other consequences of the BBG Share Sale scheme for relevant persons (namely, MFT receiving $5.8m in cash from GMSF; GMSF receiving 10.3m BBG shares from MFT; and those matters occurring without any reduction in the Merchant Group’s stake in BBG), when assessed objectively in light of its wider context (as addressed in (d)(i) above), the timing of the BBG Share Sale scheme (as addressed in (b) above) and the lack of any difference between the form and substance of the BBG Share Sale scheme (as addressed in (c) above), required a Favourable Dominant Purpose Conclusion.

156    The first ground fails to expose why it is contended that the primary judge erred: Bahonko v Sterjov [2008] FCAFC 30; 166 FCR 415 at [3], Gyles, Stone and Buchanan JJ. It may be put to one side.

157    Despite the complex way in which the second ground is expressed in the amended notice of appeal, in oral submissions the appellants’ arguments reduced to four core points:

(i)    First, whether the primary judge misunderstood s 177D as being directed to a subjective (actual) purpose analysis.

(ii)    Second, and relatedly, whether his Honour in fact undertook a subjective purpose analysis by examining why steps were taken and transactions were entered into, including by adopting a cause and effect analysis.

(iii)    Third, whether an analysis was undertaken of each of the objective purposes, before his Honour reached the dominant purpose conclusion. The other purposes identified in submissions were to maintain control over the BBG shares, to liberate cash from the GMSF, to place the BBG shares in the protected environment of the GMSF and to provide for the funding needs of the MFT.

(iv)    Fourth, whether looked at as a whole, the BBG Share Sale Scheme was artificial or contrived.

158    We consider each of those points before examining whether any additional error is revealed by the amended appeal grounds.

LEGISLATION

159    Section 177D of the 1936 Act relevantly provides:

Schemes to which this Part applies

Scheme for purpose of obtaining a tax benefit

(1)      This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of:

(a)    enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or

(b)    enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers.

Have regard to certain matters

 (2)      For the purpose of subsection (1), have regard to the following matters:

 (a)      the manner in which the scheme was entered into or carried out;

 (b)      the form and substance of the scheme;

 (c)      the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

 (d)      the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

 (e)      any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

 (f)      any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

 (g)      any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

 (h)      the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Note:      Section 960-255 of the Income Tax Assessment Act 1997 may be relevant to determining family relationships for the purposes of paragraphs (f) and (h).

Tax benefit

(3)      Despite subsection (1), this Part applies to the scheme only if the relevant taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme.

…

First issue: Did the primary judge misunderstand s 177D?

160    The appellants’ submissions fasten on PJ [250(a)] and the words “actual purpose”, which is part of his Honour’s summary of the relevant principles. His Honour set out s 177D(1) at PJ [246]. At PJ [248], there is a reference to Commissioner of Taxation v Spotless Services Ltd [1996] HCA 34; 186 CLR 404 at 416; that the purpose must be understood as the dominant purpose, and where there is more than one, the “ruling, prevailing or most influential purpose”. At PJ [249], his Honour set out s 177D(2) and then continued at PJ [250]:

It is unnecessary to set the principles out at length. It is sufficient to record the following:

(a)     Section 177D(1) provides an objective test used to determine actual purpose. It requires a conclusion about the intention of a person who entered into or carried out the scheme or a part of it to be determined objectively by reference to the eight matters in s 177D(2): Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216 at [37]; Commissioner of Taxation v Zoffanies Pty Ltd [2003] FCAFC 236; 132 FCR 523 at [54]; Commissioner of Taxation v Sleight [2004] FCAFC 94; 136 FCR 211 at [67]; Commissioner of Taxation v Guardian AIT [2023] FCAFC 3; 115 ATR 316 at [180].

(b)     The purpose the subject of s 177D(1) is the purpose of a person, not the purpose of the scheme: Hart at [63]; Guardian AIT at [179]; Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28 at [60(2)].

(c)     It is necessary to have regard to each of the eight matters set out in s 177D(2), which are “posited as objective facts”: Guardian AIT at [180]. Some matters may point one way and some matters may point another way. While regard must be had to all of the eight matters in s 177D(2), the assessment of purpose may be undertaken globally by directing attention to those of the eight matters in s 177D(2) as are relevant and probative in the circumstances: Commissioner of Taxation v Consolidated Press Holdings Ltd [2001] HCA 32; 207 CLR 235 at [94] (CPH HC); Hart at [58]; Mills v Commissioner of Taxation [2012] HCA 51; 250 CLR 171 at [73]; Minerva at [60(10)].

(d)     The drawing of a conclusion about purpose from the eight matters identified in s 177D(2) may require consideration of what other possibilities existed to achieve the same commercial end: Hart at [66]; Minerva at [60(12)].

(e)     The fact that a course of action might be a rational commercial decision, whilst relevant, does not necessarily supply the answer to whether a person entered into or carried out the scheme for the dominant purpose of enabling the taxpayer to obtain a tax benefit: Spotless Services at 416; Hart at [64].

161    It is settled that the conclusion required by s 177D is not one about the actual subjective purpose of any of the scheme participants. As this Court recently observed in PepsiCo Inc v Commissioner of Taxation [2024] FCAFC 86; 303 FCR 1 at [107] (Perram, Colvin and Jackman JJ) (albeit in the context of s 177J):

It is necessary at this point to note that the purpose referred to in s 177J(1)(b) is an objectively determined construct. The actual purposes of  PepsiCo  are not relevant to the exercise. The objective nature of the inquiry emerges from the language of s 177J(1)(b): ‘it would be concluded (having regard to the matters in subsection (2)) that the person...who entered into or carried out the scheme..did so for a principal purpose...’. It is underscored by the objective nature of the eleven matters which are to be considered in reaching a conclusion on the question of purpose. Thus, the actual subjective intentions of the taxpayer are not under examination. This approach to purpose under s 177D(2) is well established: Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28 (‘Minerva’) at [60(11)] per Besanko, Colvin and Hespe JJ citing Hart at 243 [65] per Gummow and Hayne JJ (‘it does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers’).

162    The reference by the primary judge to “actual purpose” is perhaps unfortunate but reflects the language of Hill J in Commissioner of Taxation v Zoffanies [2003] FCAFC 236; 133 FCR 523 at [54]. That paragraph in Zoffanies needs to be read in light of the issues raised in that case. The conclusion to be drawn under s 177D is a conclusion about the purpose of a party as an objectively determined construct. Reference to actual purpose is apt to cause confusion because it may be taken to refer to a conclusion as to subjective purpose drawn from evidence of state of mind and is best avoided.

163    The attributed error unfairly focuses on two words in the first sentence of the summary of principles. In the second sentence, his Honour correctly identified that the statutory task is to reach a conclusion about the intention of a scheme participant objectively by reference to the eight matters in s 177D(2), and for that proposition there is reference to four authorities; including Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216 at [37] where Gummow and Hayne JJ stated that the inquiry “is an objective, not subjective, inquiry”. In our view, when the summary is read in entirety and with the cross referencing to the authorities, it cannot be concluded that the primary judge fundamentally misunderstood the statutory task. The balance of his Honour’s reasons (as demonstrated in addressing the second issue) are replete with reference to the objective task.

Second issue: Did the primary judge in substance undertake a subjective purpose analysis?

Submissions

164    The appellants are critical of the many references by the primary judge to why as a fact the BBG Share Sale took place, and to the cause-and-effect findings: but for the fiscal outcome, the transaction would not have occurred as it did.

165    In written submissions, the appellants described these inquiries as related:

[A]n inquiry into subjective motive tends naturally toward an inquiry into whether, but for the taxation benefit of the scheme, it would have been carried out. Both inquiries are misdirected. For this reason, Part IVA does not strike at every arrangement that is entered into with an eye to tax minimisation. Given that the dominant purpose test is applied to the carrying out of a ‘scheme’ or any part of a scheme, if a subjective or ‘but for’ analysis were undertaken, then most commercial transactions which have in fact been ‘shaped’ by tax considerations would attract Part IVA. That is because those carrying out the ‘shaped’ part of the transaction no doubt wished to obtain the tax benefit associated with it.

166    The written submissions, in a footnote, identify 24 paragraphs which are said to expose the subjective analysis error. In oral submissions, the appellants emphasised PJ [293]-[295], [320], [335], [339], [353], [355], [358], [362], [364], [374], [388], and [401]. It is not necessary to essay each of those paragraphs to understand the submission (though each is addressed in our analysis). A few examples will suffice.

167    At PJ [293]-[295], the primary judge dealt with the appellants’ submission about the funding needs of the MFT as follows:

In relation to the funding for the MFT’s expenses, the applicants referred to ten “realisation events” in closing submissions: AOCS[9D]. The MFT:

•    “sold $11.579m of ASX listed shares between 20 June 2012 and 28 June 2012” (Event 1);

•    “sold around $1m of ASX listed shares between 25 and 30 July 2012” (Event 2);

•    “realised its MSSF investment on 5 November 2012 for $6.2m” (Event 3);

•    “realised its Arowana investment on 28 May 2013 for $6.8m” (Event 4);

•    “sold three properties in Hawaii on 16 August 2013, 19 June 2014 and 17 July 2014 for $2.5m, $2m and $2.5m” (Events 5, 6, and 7);

•    “sold some more ASX listed shares on 4 September 2014 for $5.8m” [sold the BBG Shares to the GMSF] (Event 8);

•    “sold even more ASX listed shares between 18 September 2014 and 30 September 2014 for $13.7m” (Event 9); and

•    “sold a helicopter on 27 January 2015 for $3.4m” (Event 10).

The applicants submitted that it is objectively reasonable to conclude – from the fact of a significant cashflow shortfall and significant realisation activities being undertaken with the effect of funding the shortfall – that assisting in meeting the shortfall was the purpose of the realisation activities: AOCS[9E]. The applicants submitted that it was common ground that the realisation events numbered 1, 2, 3, 4, 5, 6, 7, 9, and 10 were all undertaken for that purpose; it was only the Event 8 that was said by the Commissioner to be done for a different dominant purpose.

The short answer to this submission is that each of the ten transactions referred to by the applicants – except Event 8 – were transactions taken independently of the contemplated sale of Plantic and with unrelated third parties. Except Event 8, the transactions were explicable by, or inferentially undertaken for, a variety of purposes, including: funding Plantic and the MFT’s other expenses; because the investments had come to an end; because it was perceived that the proceeds could be better invested elsewhere; or for a combination of these purposes. Having regard to the evidence as a whole, it is clear that the BBG Share Sale was undertaken for the purpose of the sale of Plantic, not for the purpose of funding the MFT. Unlike the other transactions referred to, the BBG Share Sale was a transaction between related parties, albeit at market value. I do not accept that the BBG Share Sale was undertaken for a purpose of funding any cash shortfall in the MFT.

168    The appellants submit that the analysis of his Honour was subjective: an inquiry as to why the BBG Share Sale was undertaken, rather than to determine objectively, by reference to the history of funding, why the realisation of $8.5 million in cash was of objective benefit to the MFT.

169    Another example, which is described as most clearly revealing the error, is PJ [362] where the primary judge addressed a submission about the taxation advice provided to Mr Merchant by EY on 21 August and 3 September 2014. The context of the impugned paragraph is the submission dealt with at PJ [361]:

It was submitted that (AOCS[12]):

(a)     these identified the easiest and best tax outcome for Mr Merchant, but also considered the different variations of a possible sale of the assets; and

(b)     it was clear that tax considerations and ease of implementation were secondary to achieving the sale.

170    In response, the primary judge reasoned at PJ [362]:

Each of these documents, understood in the context in which they were written, make it plain that the real reason for the BBG Share Sale was to crystallise a capital loss in the MFT which was regarded as beneficial whether Plantic was sold by way of asset sale or by way of Share Sale.

171    The appellants further submit that the impermissible actual purpose inquiry also infected how the primary judge characterised the “non-fiscal features of the BBG Share Sale”; particularly the analysis at PJ [316] that the sale was “effected for the purposes of structuring the sale of Plantic”. Further reference is made to PJ [388] that the MFT did not particularly “need” $5.8 million at the time and to PJ [335]:

In his affidavit at [249], Mr Merchant stated that he reviewed the GMSF’s bank statements for September 2014 and identified what he understood to be the interest rates on cash balances. Mr Merchant did not suggest that this was a review he conducted in September 2014. I do not accept that a substantial reason for the transfer of the shares from the MFT to the GMSF was for a purpose of providing a good investment to the GMSF. It was done for the predominant purpose of crystalising a capital loss in the MFT.

172    In oral submissions, the appellants emphasised the two references to “not conceived” at PJ [353] as demonstrating the error:

The BBG Share Sale was not an independent transaction entered into for its own reasons. It was not conceived for investment considerations so far as concerned the GMSF and it was not conceived for providing cash to the MFT. Rather, the BBG Share Sale was connected to the sale of shares in Plantic as one part of a structure which also involved a forgiveness of the Plantic Loans of about $55 million. The forgiveness of the Plantic Loans:

•    increased the capital gain to the MFT by the same amount as the Plantic Loans; and

•    reduced “top up tax” payable by Mr Merchant on dividends which might otherwise be paid from GSM and Tironui.

173    As explained by Hayne and Gummow JJ in Hart at [65] and in Eastern Nitrogen Ltd v Commissioner of Taxation [2001] FCA 366;108 FCR 27 at [76]-[88] (Carr J, Sundberg J agreeing) the subjective intention of the scheme participants is not relevant to the dominant purpose question posited by s 177D. More recently this Court in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28; 302 FCR 52, Besanko, Colvin and Hespe JJ, in a compendious summary of the principles applicable to the purpose question in s 177D at [60], explained at point (11):

Statements about why the taxpayer acted as they did or about why a party to the transaction structured the transaction the way they did are not statements which are an answer to the question posed by s 177D(2). That section requires a conclusion about purpose to be drawn from the eight objective matters; it does not require or even permit any inquiry into the subjective motives of the taxpayer or others who entered into or carried out the scheme or any part of it: Hart at [65].

174    At [68] the Court focused on the irrelevance of subjective evidence:

 The question posited by s 177D is not addressed by a consideration of the subjective purpose of a party to the scheme. It is not addressed by testimony of a person as to their reasons for taking a particular action or step. The statutory question is to determine purpose by an objective assessment of objective facts. A person’s subjective understanding of a commercial reason or motive does not answer the question posited by Part IVA.

175    The Commissioner submits that the appellants’ submissions mischaracterise the primary judge’s reasons. The retrospective inquiry required by s 177D(1) is concerned with the drawing of a conclusion as to purpose by reference to the objective facts. The paragraphs criticised by the appellants at PJ [344], [353]-[354], [358], [362] and [376] that sit within the analysis of the eight factors at s 177D(2) are examples of the drawing of conclusions about what would objectively be concluded about the purpose of a party to the BBG Share Sale.

176    The Commissioner submits that the balance of the criticised reasoning falls into two overlapping categories. One, where the primary judge addressed the appellants’ positive case which sought to prove several non-taxation motivations for the BBG Share Sale: PJ [170], [189], [281]-[283], [289]-[290], [292], [295], [311], [316]-[319], [335], [337] and [339]. The primary judge did not err in considering and then ultimately rejecting the non-fiscal reasons based as on his assessment of the objective facts.

177    The other category concerns references to, and evidence of advice given to Mr Merchant, recommending that the BBG Share Sale be undertaken for a tax purpose: PJ [170], [189], [289], [292] and [310]-[311]. The Commissioner submits that advice given by a scheme participant prior to entry into a scheme “is plainly relevant to the question of whether it would be objectively concluded that a person’s dominant purpose was fiscal.” Reliance is placed on Commissioner of Taxation v Consolidated Press Holdings Ltd [2001] HCA 32; 207 CLR 235 (CPH) at [93] and [95] and Commissioner of Taxation v Macquarie Bank Ltd [2013] FCAFC 13; 210 FCR 164 at [256]-[257], Middleton and Robertson JJ. The manner in which a scheme is implemented permits inquiry into internal and external communications with advisers. The primary judge having made findings relevant to manner, deployed them in his consideration of the s 177D(2) matters at PJ [345]-[351], [357]-[358] (manner), [374]-[376] and [378] (timing and length).

Consideration

178    We begin with why the evidence of advice, which underpins the appellants’ grounds, was adduced as relevant and relied on before the primary judge.

179    On 19 March 2024, the appellants filed a Further Amended Appeal Statement and Statement of Facts, Issues and Contentions (SFIC). This document framed the issue at [85] that it should not be concluded on the basis of the eight matters at s 177D(2), that any of the parties entered into or carried out the BBG Share Sale for the dominant purpose of enabling the MFT to obtain a capital loss. Rather, it should be concluded that the purpose was to convert the BBG shares to provide the MFT with cash so that it could continue to meet the funding needs of Plantic in particular and that the MFT acquired the shares as an asset that was expected to appreciate in value.

180    In amended opening submissions filed by the appellants on 7 February 2024, there is considerable reference to the subjective evidence of Mr Merchant. For example [150] – [156] is a summary of his affidavit evidence as to why he decided to effect the BBG Share Sale, in particular that he needed to “free up cash as soon as possible to continue funding Plantic”: [153]. At [154] there is a summary of Mr Merchant’s explanation of that decision. The relevance of this evidence was identified at [197]-[199] including at [198] after acknowledging that Part IVA does not authorise a consideration of subjective purpose or motivation evidence of any person:

Nevertheless, the determination of purpose may be assisted by “looking at the wider transaction” in order to understand and explain the scheme, when considering the eight matters listed in s 177D (2): CPH at [96].

181    At [199] it was submitted that if it be the case that the objective purpose is consistent with the subjective purpose of one or more of the scheme participants, and if that subjective intention “is reflected in objective evidence, no error is made by taking that evidence into account”: Commissioner of Taxation v News Australia Holdings Pty Ltd [2010] FCAFC 78 at [30].

182    In an outline of closing submissions dated 22 March 2024, at [46A] the appellants contended that the dominant purpose of the BBG Share Sale was to secure cash and maintain the Merchant Group’s holding in BBG. In support of that submission, the primary judge was invited to consider alternative possibilities to a sale of the BBG shares as “they inform the purpose question” and the submission continued:

The reason why alternative transactions were not pursued helps identify the purpose of the transaction undertaken.

183    That outline also addressed the relevance of the taxation advice received from Mr Burgess of EY at [12]-[13], where the submission is made that taking professional advice about taxation implications does not support the dominant purpose conclusion as the taxation regime “is part of the context in which business activity takes place – and the fact that it influences the form a transaction may take does not mean the dominant purpose of the arrangement is to secure a tax benefit”: Hart at [15].

184    It was not an error for the primary judge to consider the overt acts of the scheme participants; what steps were taken, when and by whom. The manner in which the BBG Share Sale Scheme was entered into or carried out is the first of the eight matters at s 177D(2)(a). The scheme manner “includes consideration of the way in which and the method or procedure by which the particular scheme in question was established”: Spotless Services at 420.

185    What is not emphasised in the appellants’ submissions before this Court is the structure of the primary judge’s reasons and each of the explicit objective findings made when addressing the s 177D(2) matters. The reasons commence with a detailed chronology of the events as they occurred. The impugned subjective findings at PJ [170] and [189] are findings of fact within the chronological sequence of relevant events. They do not reveal a subjective causal analysis. At PJ [170], the primary judge rejected Mr Merchant’s evidence the BBG shares were sold to “free up cash” based on an assessment of the objective facts. At PJ [189], the primary judge repeated that rejection.

186    The findings at PJ [281] – [283] respond to the appellants’ commercial context and purpose submissions at PJ [264] – [266], concerning the manner in which the BBG Share Sale Scheme was entered into: s 177D(2)(a). The submissions identified three purposes: (1) to keep the BBG shares in the Merchant Group; (2) to free up cash in the MFT; and (3) to provide the GMSF with the prospect of greater returns than it was receiving from its cash deposits.

187    The findings at PJ [281] – [283] appear under the heading: The asserted need for, or objective of providing funding to, the MFT. The appellants do not criticise each of the objective fact findings made by the primary judge at PJ [269] – [280], which concern amounts that were expended by the MFT within the relevant period, the unlikelihood that further dividends would be received from the BBG shareholdings, that between 2012 and 2014 the operating expenses of the MFT substantially exceeded the income from the shares and unlisted investments and the actual cost of investments held as at 30 June 2012 in the MFT.

188    Having made findings as to those matters, the primary judge from PJ [277], addressed the appellants’ submission that the BBG shares were sold to raise cash for the MFT. His Honour directly responded to the submission that a series of decisions were made which resulted in the BBG Share Sale. Those decisions were said to be the raising of cash for the MFT and the use of cash held by the GMSF to buy the BBG shares as a means of providing cash to the MFT.

189    His Honour commenced by referencing the evidence relied on by the appellants for those contentions, including email communications in late 2013 and early 2014. His Honour concluded at PJ [281] that the emails did not establish that there was a decision taken to raise cash for the MFT that was operative in September 2014. In rejecting the appellants’ contention, his Honour concluded at PJ [283] that, upon review of all of the contemporaneous communications between May 2014 and September 2014, they “overwhelmingly support the conclusion that the BBG Share Sale was undertaken to crystallise a capital loss in the context of an expected future sale of Plantic”. There is nothing in that reasoning which supports the subjective error contention.

190    At PJ [285] – [319], his Honour addressed the same submission of the appellants, by reference to other evidence on which they relied. The findings of his Honour at PJ [289] – [290] reject the submission that contemporaneous decisions were made to raise cash for the MFT, because Mr Merchant had a dislike of external borrowing. No error is revealed at PJ [289], which is a finding of objective fact that the BBG Share Sale was related to the anticipated sale of Plantic, and not to its funding needs, based on a review of the contemporaneous documents. Similarly, his Honour did not err in the finding at PJ [290], which is simply a finding based on the evidence given by Mr Merchant under cross- examination that with respect to the BBG Share Sale, he did “whatever I was directed to do”, by his taxation adviser. This finding is relevant to the manner in which the BBG Share Sale Scheme was entered into. It was not a finding of subjective purpose. The finding at PJ [292] is in the same category.

191    As to PJ [295], his Honour found that each of the realisation events relied on by the appellants as objectively establishing the need to provide funding for the MFT, save for the BBG Share Sale, were undertaken independently of the contemplated sale of Plantic. However, “having regard to the evidence as a whole”, his Honour found:

[I]t is clear that the BBG Share Sale was undertaken for the purpose of the sale of Plantic, not for the purpose of funding the MFT. Unlike the other transactions referred to, the BBG Share Sale was a transaction between related parties, albeit at market value. I do not accept that the BBG Share Sale was undertaken for a purpose of funding any cash shortfall in the MFT.

192    That is an inferential objective finding.

193    The primary judge reasoned to the same effect at PJ [310]-[311], in rejecting evidence of Mr Merchant that he “had in mind” selling the BBG shares to free up cash.

194    The findings at PJ [316] – [319] relate to the contention that the timing of the BBG Share Sale was affected by a trading window which opened on 2 September 2014 and which Mr Merchant was concerned would close on 31 December 2014. His Honour rejected the evidence of Mr Merchant that the BBG Share Sale was undertaken to “raise cash to fund Plantic” as inconsistent with the contemporaneous email of 21 August 2014 from Mr Ian Burgess which stated that the sale should occur “either way” as soon as the trading window opened. His Honour went on to conclude that it was “clear” that the BBG Share Sale was undertaken for the purpose of structuring the sale of Plantic, it being evident at the time that conclusion of the Sealed Air deal was a reasonable prospect and in any event, it was evident that at that time Mr Merchant wanted to sell Plantic: PJ [317].

195    At PJ [318] his Honour concluded that the contemporaneous documentary evidence before 4 September 2014 “provides no real support for a conclusion that the BBG Share Sale was motivated by either a need on the part of the MFT for funding at that time or a desire to provide it with funding”. That is an objective finding based on consideration of the evidence.

196    His Honour then drew each of his findings together in summary form at PJ [319] (set out above) by listing seven matters as to why it should be concluded that the BBG Share Sale was not undertaken to free up cash the MFT. Each is an objective conclusion.

197    His Honour next dealt with the appellants’ contention that several decisions were taken to expose the GMSF to an investment in BBG: PJ [320]-[341]. His Honour commenced by considering the evidence relied on by the appellants in support, comprising a statutory declaration of Ms Paull and her interview record, the affidavit of Mr Merchant and contemporaneous documents: PJ [322] – [334]. The appellants make no complaint about the assessment of that evidence, or the primary judge’s rejection of the evidence of Ms Paull about the investment strategy for the GMSF: PJ [331] – [333].

198    The complaint that is made concerns PJ [335] (set out above). The appellants characterise the finding in this paragraph as an inquiry by the primary judge about “why” the BBG Share Sale was effected, rather than would it be concluded, having regard to the statutory matters, that the dominant purpose was to create a capital loss. We do not accept that is the correct characterisation of this finding. The context of PJ [335] includes the finding at PJ [331] that there was no objective basis for believing at the time that BBG would resume paying dividends at any time in the foreseeable future and the absence of any contemporaneous documentation to the effect that an investment in the BBG shares by the GMSF would be an appropriate one for it to make. His Honour reinforced the objective consequence of the absence of supporting contemporaneous documents at PJ [333] – [334].

199    The context extends to rejection of Mr Merchant’s evidence that there was a formulated and reviewed investment strategy for the GMSF, which included the acquisition of BBG shares: PJ [337] – [340]. Primarily, his Honour rejected the evidence as inconsistent with the objective evidence of the adopted 2012 investment strategy: PJ [339] - [340]. This was an objective finding.

200    Thus, when PJ [335] is read in context, the contended subjective analysis error is not made out. His Honour’s finding that he did not “accept that a substantial reason for the transfer” of the BBG shares was “for a purpose of providing a good investment” to the GMSF, but was undertaken for “the predominant purpose of crystallising a capital loss in the MFT” was one about the scheme manner, objectively founded in the contemporaneous documents, which his Honour concluded were inconsistent with the contended good investment purpose as set out in the evidence of the appellants.

201    To the extent that the primary judge examined Mr Merchant’s evidence that the BBG Share Sale was his idea at PJ [337] – [340], he did so for the purpose of rejecting the “why it was done” evidence, as inconsistent with the contemporaneous documents and the absence of any documents supportive of the claimed investment purpose. The finding in the last sentence of PJ [339]:

The evidence establishes that the predominant reason for entering into the BBG Share Sale was to crystalise a capital loss in the MFT, not for the investment purposes of the GMSF.

was about the scheme manner as based on each earlier findings at PJ [321]-[338].

202    The next series of paragraphs identified by the appellants as evidencing the subjective reasoning error are in that part of the reasons which address the 177D(2) matters from PJ [342]. They are PJ [344], [353]-[354], [358], and [362], each of which concern the manner in which the BBG Share Sale Scheme was carried out, and [376] which concerns the time the BBG Share Sale Scheme was entered into.

203    In commencing this part of the reasons, the primary judge at PJ [343] referenced Spotless Services at 420 where the plurality stated:

In the context in which they appear in par (i), the terms “manner” and “entered into” are not given any restricted meaning. “Manner” includes consideration of the way in which and method or procedure by which the particular scheme in question was established.

204    The appellants’ criticism of the reasoning at PJ [344] unfairly focuses on the penultimate and ultimate sentences. The entire paragraph reads:

The scheme was conceived or established, and then carried out, in the context of the anticipated sale of Plantic by the MFT. Although a sale of Plantic’s assets was a possibility, a sale of shares was the preferred option and the most likely. It was not certain as at 4 September 2014 that Plantic would be sold, but the sale of Plantic was the desired outcome and a sale to Sealed Air was a reasonable possibility. If a sale to Sealed Air did not occur, Mr Merchant would continue to pursue other avenues for the MFT to sell Plantic and it was reasonably likely that Plantic would be sold. The BBG Share Sale occurred because it was anticipated that Plantic would be sold in the reasonably foreseeable future, probably by 30 June 2015, and because EY had recommended the BBG Share Sale in order to crystallise a capital loss in the MFT in anticipation of a sale. This was desirable whether the sale of Plantic was a sale of assets or a sale of the shares in Plantic.

205    The “because” reference by the primary judge to the BBG Share Sale is consistent with the earlier objective findings at PJ [189], [260] and [289] to the same effect which then founded in his Honour’s analysis of the objective evidence at PJ [345]-[364]. It is not a stand-alone subjective finding, which takes us to the next series of challenged paragraphs.

206    We have set out PJ [353] above and have noted the emphasis that the appellants place upon the two references to “not conceived” for investment or for the provision of cash to the MFT. That paragraph reflects the conclusion which flows from a number of the preceding paragraphs (PJ [345]-[352]), where his Honour sets out the contemporaneous evidence about which the appellants make no complaint. Included within that sequence is the fact that on 21 July 2014, Mr McGrath advised Mr Merchant in writing that a sale of shares to the GMSF would get him “a good loss on paper” and the contextually important finding at PJ [352] that:

The MFT transferred the BBG Shares to the GMSF by way of off-market share transfer, with relevant documents being executed on 3 and 4 September 2014. Both before and after the transfer, the BBG Shares were held in trusts which Mr Merchant controlled and of which he was either the sole beneficiary (the GMSF) or one of a number of discretionary objects (the MFT). The transfer did not result in any real economic change in ownership.

207    That must then be read with the next scheme manner finding at PJ [354]:

The increased capital gain to the MFT was a deferred tax cost rather than a current tax cost if the capital gain could be offset by capital losses. The BBG Share Sale was conceived of and recommended because it would crystallise a capital loss.

208    Thus, the “conceived” references in the challenged paragraphs when read in context are concerned with the scheme manner.

209    For similar reasons there is no merit in the challenge to PJ [358], which expresses the second reason for rejecting the appellants’ submission that for some years prior to September 2014 the possibility of releasing cash from the GMSF to the MFT had been discussed and considered. The first reason that his Honour gave was that the BBG Share Sale was first raised in the context of the sale of Plantic: PJ [357]. The second at PJ [358] was:

Secondly, it is not accurate to say that the possibility of releasing cash to the MFT by buying BBG shares had been raised and discussed “for years”. It was raised by Mr McGrath in his email of 23 December 2011 and it was not ultimately pursued: CB69. The possibility of the GMSF acquiring BBG shares from the MFT was also raised in an email from Mr Burgess to Mr McGrath on 20 July 2012: CB106. The affidavit evidence did not address why the transaction did not proceed or what advice had been received. A purchase by the GMSF of BBG shares from the MFT was not something which was being considered by the Merchant Group at the time of the sale negotiations with Sealed Air independently of that transaction. Even after it was raised by EY, the contemporaneous documents do not establish that the BBG Share Sale was entered into for a purpose of releasing cash to the MFT. Rather, the BBG Share Sale was raised by EY and embraced by the MFT because it would crystallise a capital loss.

210    That is not subjective purpose reasoning. They are the objective facts relied upon for rejecting the contention that the BBG Share Sale was unrelated to the anticipated sale of Plantic. The reference by his Honour to the BBG Share Sale as “not something which was being considered” at the time is a finding about the scheme manner based on the contemporaneous documents that he set out in detail at PJ [345] – [354]. Further, it is important not to overlook the third reason at PJ [359] where his Honour specifically put to one side whether or not Mr Merchant “subjectively considered that there were no regulatory issues with a purchase by the GMSF of BBG Shares from the MFT” and then found:

The structure being recommended was one which, objectively assessed, maximised the benefit to Mr Merchant personally in the context of a proposed commercial sale and was not, objectively assessed, one which was being recommended to benefit the GMSF. Whatever Mr Merchant may have subjectively thought, the MFT entered into the BBG Share Sale having been provided with information which objectively indicated that the proposed transaction may present problems from both a tax and superannuation regulatory perspective

211    That reasoning demonstrates that the primary judge did not commit the subjective purpose reasoning error as contended by the appellants.

212    The primary judge next addressed the appellants’ submission that the fact that advice was sought from and given by EY about the taxation implications did not support the dominant purpose conclusion and three emails were referred to in support: PJ [360]. His Honour rejected the submission at PJ [362] which is criticised for reflecting subjective reasoning:

Each of these documents, understood in the context in which they were written, make it plain that the real reason for the BBG Share Sale was to crystallise a capital loss in the MFT which was regarded as beneficial whether Plantic was sold by way of asset sale or by way of Share Sale.

213    This is a scheme manner finding. The existence of the advice and the content of the documents recording the advice are objective facts. It may be accepted that the seeking and obtaining of advice about the taxation implications of transactions of itself does not support a conclusion that the dominant purpose of a party to the scheme was to obtain a tax benefit. However, where a transaction is the product of advice, it is both possible and appropriate to take that advice into account in forming a conclusion as to purpose under s 177D: CPH at [95].

214    The final paragraph that the appellants’ criticise is PJ [376]. This forms part of the reasoning on the time and length considerations at s 177D(2)(c). It directly addresses the appellants’ submissions, which are summarised at PJ [371], that the sale occurred to provide cash to the MFT for deployment to Plantic as needed. At PJ [374]-[375], his Honour found that it was “objectively clear”, from the advice which the MFT had received, that whether the sale of Plantic was a sale of the assets or a sale of the shares, the GMSF should acquire BBG shares from the MFT whilst the BBG share trading window was open and, ultimately, it was “objectively likely” as at 4 September 2014 that Plantic would be sold to Sealed Air, or if not to another party. Having made those findings, his Honour identified the reason for the timing of the BBG Share Sale at PJ [376]:

The reason the BBG Share Sale went ahead when it did was that the window to sell the BBG Shares opened on 2 September 2014. The trading window was scheduled to close on 31 December 2014, but Mr Merchant considered there was a risk it could close sooner: Merchant at [244(e)]. Mr McGrath had advised Mr Merchant to sell the BBG Shares as soon as possible after the trading window opened on 2 September 2014 – see: CB260. Mr Merchant and Ms Paull signed the transfer form on 4 September 2014, although the transfer was stated to have effect on 2 September 2014.

215    This is not a subjective finding. It flows from the preceding objective findings (about which there is no complaint) and it is followed by the confirming finding at PJ [377] of likelihood that Plantic would be sold in the foreseeable future.

216    For these reasons, we conclude there is no merit in the submission that the primary judge impermissibly strayed into findings about the subjective purpose of the BBG Share Sale Scheme participants.

Third issue: Were all purposes considered?

Submissions

217    The appellants’ submissions commence by noting that the primary judge accepted at PJ [557(c)] that the adopted structure was “consistent with securing the commercial end of selling Plantic and the broader transaction within which the BBG Share Sale and the Debt Forgiveness Schemes occurred was the sale of the Plantic shares and that the purpose of the sale was for Mr Merchant to divest himself of his interest in Plantic and the associated requirement to provide funding”. The appellants submit the effect of those findings is that obtaining a tax benefit from the BBG Share Sale was incidental to the overarching objective of selling Plantic for the best return. Part IVA does not apply merely because less tax is paid by selecting one form of transaction (Hart at [15], [52]-[53]) or if taxation planning played a part in the shaping of the transaction (Spotless Services at 416). The scheme was neither artificial nor contrived.

218    The appellants’ contention commences with the proposition that a sale of shares which realises a capital loss does not attract the operation of Part IVA. The appellants emphasise that the Explanatory Memorandum to the Income Tax Laws Amendment Bill (No. 2) 1981 states that Part IVA was intended as a general measure against “blatant, artificial or contrived” tax avoidance arrangements and was not intended to affect “arrangements of a normal business or family kind, including those of a tax planning nature”: at 3-4.

219    In oral submissions, the appellants identified five purposes which he submitted the primary judge failed to correctly evaluate in reaching the dominant purpose conclusion.

220    The first is that a reasonable person would understand that the communications with the taxation advisers was directed to the achievement of the best price for the sale of Plantic as the most important consideration. That conclusion is anchored by two emails (a component of the scheme manner) from Mr Burgess. The first was sent on 28 August 2014 at 9:16 pm to Mr McGrath and Ms Paull, which the primary judge extracted at PJ [175]:

I think we are all on the same page that a Share Sale gives the best outcome for Gordon and we should push for that. However, at some stage I would like to take you through some options we have considered to manage the tax cost to Gordon if you had to do an asset sale – that is, if you are deep in negotiation next week trying to get the transaction across the line and it appears that an asset sale might be the only way to get that done, that you have an understanding of what the fall back positions might be for Gordon to help make the judgement on price etc.

221    The second was sent on 3 September 2014 at 11:16 am, which the primary judge extracted at PJ [178]:

Further to my earlier note below, attached is a paper which outlines the options to manage the tax costs for Gordon if Plantic did an asset sale rather than a Share Sale. The paper confirms that a Share Sale is the easiest and most tax effective option for Gordon. However, I think it also shows that if the ‘cost’ of getting Sealed Air to accept a Share Sale is much more than $2m-$3m, then it might be better to agree to an asset sale and aim for an increase in the sale price to compensate Gordon for his increased costs. For example, if SA come back and say they want a reduction in sale price of $5m to compensate for the extra tax costs they think they will incur on a share purchase (even if that is part of an overall increase in sale price over the current 70mUSD because of other factors such as quality of product etc) then it would appear to be better to accept an asset sale and ask for a $5m increase in the price to compensate for Gordon’s extra tax cost (i.e. an improvement in price of $10m for an upfront tax cost to Gordon of $2m as per the best options in attached slides).

222    Thus, so the submission went, the BBG Share Sale was incidental to achieving the best price for the sale of Plantic.

223    Second, the MFT received a cash injection of $5.8 million in circumstances where it had suffered an annual cash flow shortfall of approximately $12 million since April 2012, when BBG ceased paying dividends. Within that period, the MFT went from having a cash headroom of approximately $20 million to running very short of cash on a number of occasions. Steps were taken to raise cash by selling assets, before and after the BBG Share Sale.

224    Third, the acquisition by the GMSF of the BBG shares was for a non-fiscal reason. There are advantages of holding the BBG shares in the protected environment of a superannuation fund.

225    Fourth, there was a non-fiscal purpose in the liberation of cash from the GMSF as a means of providing for the funding needs of the MFT.

226    Fifth, the sale occurred at market price, Mr Merchant wished to retain control (repeatedly emphasised during oral submissions) of a significant parcel of BBG shares because of his belief in the true value of the company and the fact that it had provided the vast bulk of his wealth over many years. Mr Merchant disagreed with the management direction of the company. His commitment is demonstrated by his consistent acquisition of large parcels of BBG shares in November 2007 until April 2015: PJ [267].

227    The Commissioner submits that the genuine commercial transactions submission anchored by PJ [557 (c)] is selective: in the latter part of that paragraph the primary judge reasoned that it does not follow that a scheme carried out in pursuit of a commercial objective cannot have the dominant purpose of tax avoidance: British American Tobacco Australia Services Ltd v Commissioner of Taxation [2010] FCAFC 130;189 FCR 151 at [51] – [53], Dowsett, Jessup and Gordon JJ. The primary judge extensively analysed the genuine commercial purpose submission at PJ [549]-[557], applied the correct principles and reached the correct conclusion. The submission of the appellants is an invitation for this Court to reconsider all of the evidence without identifying why the primary judge erred in his ultimate conclusion.

228    Further, the appellants’ reliance on the taxation advice of Mr Burgess is misplaced. Objectively understood, the advice was concerned with the structure of the Plantic sale and the fact that there was room to negotiate the structure, having regard to the taxation implications, does not grapple with why implementation of the BBG Share Sale was not for the dominant purpose of crystallising a capital loss.

229    As to the non-tax consequences of the transaction, the Commissioner submits that there is no dichotomy between a rational commercial outcome and the obtaining of a tax benefit and the appellants’ submissions invite error by adopting such a false dichotomy: Hart at [64], Spotless Services at 415. That there were identified commercial consequences does not demonstrate error by the primary judge in his rejection of those consequences as constituting the dominant purpose of any party to the BBG Share Sale. His Honour rejected the proposition that the BBG Share Sale was undertaken to free up cash for the MFT: PJ [277] – [319] and that the acquisition of the BBG shares by the GMSF was consistent with the fund investment strategy: PJ [320] – [340].

230    As to the maintenance of control proposition, Mr Merchant had economic control over the BBG shares before and after 2 September 2014. The BBG Share Sale did not confer control. Further, there is no support for the proposition that moving the BBG shares into the GMSF was commercially rational from a dividend or growth perspective: PJ [272], [331]. In fact, the effect of the BBG Share Sale was to deprive the GMSF of the capacity to pay Mr Merchant’s pension: PJ [399].

Consideration

231    We address first an issue that prominently featured in the oral submissions. It concerns the routine transaction where a shareholder sells shares and incurs a capital loss in a year of income, which is then applied to offset a capital gain achieved on the sale of other shares in the same or subsequent years.

232    The Commissioner accepted that a sale of shares to a third party to realise a capital loss to offset a likely corresponding capital gain does not attract Part IVA. However, a distinguishing feature of this case is that the sale of the BBG shares was to a related party and had no other practical, commercial or economic consequence for Mr Merchant as the ultimate controller.

233    With respect to the submissions of the appellants, there are two difficulties with the analogy between the BBG share sale and a sale of shares to a third party. One, resolution of the dominant purpose question in this case does not turn on a high level analogy as though it stands apart from the specific and limited matters at s 177D(2) to which regard must be had. The exampled routine transaction distracts attention from what objectively occurred in this case. Here, Mr Merchant had ultimate control of the BBG shares as an asset of the MFT. The divestment of the shares by the MFT and their acquisition by the GMSF did not alter that control. The BBG Share Sale did not divest the Merchant Group of the risk of holding the BBG shares. Nor did the Merchant Group forgo the benefits of continued ownership; the exercise of voting rights, the prospect of future dividends or the right to receive a distribution of any surplus on winding up. It is these aspects of the transaction which invite close objective attention to the capital loss in issue by application of the s 177D(2) matters. Intercompany transactions often excite the closest attention to the possible application of Part IVA: Noza Holdings Pty Ltd v FCT [2011] FCA 46; 82 ATR 338 at [315], Gordon J .

234    The second difficulty is that the submission proceeds on a false premise. There is no general rule that a sale to a third party that results in a realisation of a capital loss can never attract Part IVA. Where the sale to the third party has features that do not result in the vendor divesting the risks and benefits of ownership or where the sale is accompanied by an immediate repurchase (a wash sale), Part IVA may well apply. It may be seen that the BBG Share Sale was analogous to a wash sale of the type identified by Nicholson J in Cumins v Commissioner of Taxation [2006] FCA 43 at [38], by reference to the first edition of the Australian Legal Dictionary (2004):

The sale and repurchase of the same security for tax purposes. A wash sale allows an investor to lock-in capital losses for tax purposes even though the fall in share or asset price may be temporary.

235    The appellants correctly accepted that a wash sale opens for consideration the application of Part IVA, but sought to distinguish the present case by submitting that it would be objectively concluded that the BBG Shares were not sold into the market because the purpose of the transaction was to maintain control of the shares within the Merchant Group. In our view the submission is circular and exposes the weakness of the market sale analogy: if there could not be a divestment of the BBG Shares because Mr Merchant was not willing to relinquish control, one is outside the paradigm example of a sale to an arms-length party.

236    The appellants’ submissions to the effect that the primary judge did not identify all purposes of the transaction or, having done so, did not weigh those purposes in reaching his overall conclusion requires more detailed consideration. Section 177A(5) requires that the purpose of obtaining a tax benefit by a scheme participant must be the dominant purpose, which requires ascertainment of the “ruling, prevailing, or most influential purpose”: Spotless Services at 416. The contended error is that the primary judge narrowly focused attention on the fiscal features of the transaction, which on proper analysis were incidental to its wider commercial purposes. Particular reliance is placed on Eastern Nitrogen and Macquarie Bank each of which is said to be relevantly indistinguishable, where in substance the taxpayer carried out a commercial transaction in a manner designed to achieve the best after tax return.

237    We deal seriatim with the five other purposes that were identified in submissions. The first is that the tax benefit was incidental to the primary objective of selling Plantic for the best economic return.

238    Commencing at PJ [141], the primary judge summarised the evidence concerning the sale negotiations to Sealed Air from June 2014 which resulted in it providing a letter of intent to acquire Plantic for USD $70 million “as an asset or stock sale, as mutually agreed by the parties” and “based upon the understanding that the Buyer is acquiring the Business free and clear of all liens and encumbrances, and that the Company will be cash and debt free”: PJ [153]. To meet the latter requirement, Mr Burgess of EY advised that all loans from associated entities should be waived: PJ [158]. Mr Burgess then prepared some calculations which compared the taxation implications of a sale of the business with a sale of the shares: PJ [161]. Draft taxation calculations were provided on 21 August 2014, assuming a sale at $75 million or $100 million. The primary judge found at PJ [166]:

The analysis shows that it would not have been necessary to use capital losses from a sale of BBG shares if the Plantic business was sold for $75 million. However, if the business was sold for $100 million, the analysis was that the best tax result would be achieved if the MFT realised a capital loss of $51,426,942 from the sale by the MFT of BBG shares to the GMSF, and then applied about $30.3 million of that loss to offset the capital gain on the windup of Plantic, following the sale of its business.

239    The primary judge also found at PJ [169]:

It is clear from these calculations that, whether the sale of shares in Plantic occurred at $75 million or $100 million, it was desirable for the BBG Share Sale to occur. It was also desirable for the BBG Share Sale to occur if the sale was a sale of Plantic’s business, because it was only if the business was sold at the lowest end of the range that the capital loss would not be required. 

240    On 3 September 2014, Mr Burgess gave further advice about the structure of the intended sale, including (PJ [178]):

Further to my earlier note below, attached is a paper which outlines the options to manage the tax costs for Gordon if Plantic did an asset sale rather than a Share Sale. The paper confirms that a Share Sale is the easiest and most tax effective option for Gordon. However, I think it also shows that if the ‘cost’ of getting Sealed Air to accept a Share Sale is much more than $2m-$3m, then it might be better to agree to an asset sale and aim for an increase in the sale price to compensate Gordon for his increased costs. For example, if SA come back and say they want a reduction in sale price of $5m to compensate for the extra tax costs they think they will incur on a share purchase (even if that is part of an overall increase in sale price over the current 70mUSD because of other factors such as quality of product etc) then it would appear to be better to accept an asset sale and ask for a $5m increase in the price to compensate for Gordon’s extra tax cost (i.e. an improvement in price of $10m for an upfront tax cost to Gordon of $2m as per the best options in attached slides).

241    By 9 November 2014, Sealed Air had stated its preference for an asset sale: PJ [200]. This was not an attractive option for the Merchant Group because of the likely greater taxation burden: PJ [208]-[212]. The Sealed Air transaction was not finalised and negotiations commenced with Kuraray in October 2014. Kuraray was accepting of a share sale: PJ [214].

242    On 31 March 2015, the MFT and Kuraray executed the SSA which provided for three components of the consideration. First, an initial purchase price of USD $45 million plus the “Target Cash Amount” (later determined as USD $558,827). Second, the “Milestone Amounts” and third, the “Earn-out Amounts”: PJ [222]. The agreement required the vendor to procure forgiveness of the Plantic Loans.

243    The primary judge did not make a specific finding, in his analysis of the s 177D matters, whether the tax benefit obtained by BBG Share Sale was incidental to the objective of selling Plantic at the highest price. He did, however, when resolving the s 177E proceeding make the following findings at PJ [557(c)]:

It is true that the structure adopted was consistent with securing the commercial end of selling Plantic. It is also true that the broader transaction within which the BBG Share Sale and the Debt Forgiveness Schemes occurred was the sale of the Plantic shares and that the purpose of the sale was for Mr Merchant to divest himself of his interest in Plantic and the associated requirement to provide funding – see: AOS[255], [259], [260], [261], [266]. However – as mentioned – that does not prevent a conclusion that there was a scheme with a tax avoidance purpose. It may be accepted that the sale of the Plantic shares to Kuraray was a genuine commercial transaction. It does not follow from that fact that the BBG Share Sale Schemes carried out in pursuit of that ultimate objective did not have the dominant purpose of tax avoidance – see, in addition to the cases already mentioned: British American Tobacco Australia Services Limited v Commissioner of Taxation [2010] FCAFC 130; 189 FCR 151 at [51] and [53].

244    The appellants submit that these “findings should have supported a conclusion about purpose in favour of the taxpayers. Their effect is that obtaining a tax benefit from the BBG Share Sale was incidental to the overarching objective – which was not fiscally motivated – of selling Plantic for the best ultimate return.” As such the facts “are relevantly similar” to those in Eastern Nitrogen and Macquarie Bank.

245    We reject the submission. It echoes in the “false dichotomy” explained by the High Court in Spotless. As the High Court said at 416:

[I]f the taxpayers took steps which maximised their after-tax return and they did so in a manner indicating the presence of the “dominant purpose” to obtain a “tax benefit”, then the criteria which were to be met before the Commissioner might make determinations under s 177F were satisfied.

246    Whilst it is objectively true that the MFT sought to maximise the sale price of Plantic, as any informed vendor would, that does not explain why the BBG Share Sale was incidental to that objective. It was a separate transaction entered into between the MFT and the GMSF unrelated to the determination of the price negotiated and agreed for the sale of the MFT shares in Plantic. The BBG Share Sale had no effect on the price negotiated for the sale of the Plantic shares. The fact that the capital loss realised by the BBG Share Sale may have maximised the after-tax return does not mean that s 177D is not satisfied.

247    The primary judge well understood why the fact that the BBG Share Sale occurred in the context of a genuine commercial sale of the Plantic shares did not mean that the BBG Share Sale was not entered into or carried out for the dominant purpose of obtaining a tax benefit when distinguishing the appellants’ reliance on Macquarie Bank at PJ [552] – [557]. It is well to emphasise how his Honour dealt with the genuine commercial purpose submission at PJ [554] (having accepted at PJ [553] that the “mere fact” that a taxpayer chooses one form of transaction over another, informed by revenue considerations, does not establish the dominant purpose of tax avoidance):

But the presence of a rational commercial objective, or a discernible commercial end, does not preclude a finding that a particular form of transaction was selected for the dominant purpose of tax avoidance. As Gleeson CJ and McHugh then stated in Hart at [16] (footnotes omitted):

Even so, a transaction may take such a form that there is a particular scheme in respect of which a conclusion of the kind described in s 177D is required, even though the particular scheme also advances a wider commercial objective. In Federal Commissioner of Taxation v Spotless Services Ltd, Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ, after noting that revenue law considerations influence the form of most business transactions, and that the presence of a fiscal objective does not mean that a person entered into or carried out a scheme for the dominant purpose of obtaining a tax benefit, said:

Much turns upon the identification, among various purposes, of that which is ‘dominant’. In its ordinary meaning, dominant indicates that purpose which was the ruling, prevailing, or most influential purpose. In the present case, if the taxpayers took steps which maximised their after-tax return and they did so in a manner indicating the presence of the ‘dominant purpose’ to obtain a ‘tax benefit’, then the criteria which were to be met before the Commissioner might make determinations under s 177F were satisfied.

248    In our view, the primary judge was correct to distinguish the facts in Macquarie Bank on the basis that a comparison of the factual outcomes in other cases “is rarely particularly useful” (PJ [556]), and as explained at PJ [557]:

Macquarie Bank involved a situation in which the structure adopted was recorded as having beneficial tax outcomes, but was also found to have had other non-tax advantages that the Court concluded were dominant in the decisions taken.

249    In this case, as we have explained, the BBG Share Sale had no effect on the negotiated price for the Plantic shares. The tax benefit derived from the sale of the BBG Shares was not incidental to the commercial objective of selling the Plantic shares.

250    For similar reasons we reject the appellants’ reliance on Eastern Nitrogen, which again turned on its specific facts. (That case concerned a sale and lease back of industrial plant and equipment with an obligation to repurchase at an agreed value on expiry of the lease.)

251    Here the primary judge well-understood the need to evaluate and balance the s 177D(2) matters: PJ [364], [370], [379], [380], [383], [389] – [390], [392], [400], [402] and [405]. There is nothing in Eastern Nitrogen which assists the appellants’ arguments.

252    The second commercial purpose identified by the appellants is the objective benefit to the MFT of a cash injection of $5.8 million at a time when it had a cash shortfall.

253    The primary judge at PJ [269] summarised a “central component” of the appellants’ case: the BBG Share Sale was driven partly to provide cash to the MFT so that it could meet its expenses. His Honour carefully analysed the appellants’ evidence relied on in support of that contention at PJ [285]-[308] and which he summarised at PJ [319]. We have set out above his Honour’s analysis of the 10 realisation events between June 2012 and January 2015 at PJ [293]-[295].

254    The appellants contend that his Honour was wrong to conclude that the BBG Share Sale was not undertaken for the purpose of funding a cash shortfall of the MFT: PJ [295], [319] and [353]. In oral submissions the argument was put in various (though not mutually exclusive) ways: (1) there is objective value to the MFT of a cash injection of $5.8 million; (2) even if it would be objectively expected that the cash drain on the MFT would alleviate with the expected sale of Plantic, there were still various expenses of the business of the trust and the evidence demonstrated that the MFT “kept on running out of money”; and (3) by September 2014, the MFT had “effectively run out of cash”, despite that illiquid assets had been realised to that time to fund expenses.

255    In support of those arguments, the appellants referenced a document marked as “MFI 9” before the primary judge. In chart form it sets out the total cash at bank of the MFT from 1 July 2011 to 1 April 2015. The Commissioner relied on a different chart marked as “MFI 15.” It was not in dispute before the primary judge that each chart accurately summarised the bank statements and other financial records in evidence. The difference lies in how the evidence is presented. On the Commissioner’s chart the cash at bank and the margin loans of the MFT are aggregated. In our view, it is the more appropriate representation of the objective evidence.

256    The Commissioner’s chart is:

257    The annotations on the Commissioner’s chart in part align with those on MFI 9. The differences arise in the presentation of the data. The Commissioner’s chart focuses on the total cash and loan funds available. The explanations are:

258    What is not listed in the Commissioner’s annotations is the receipt by the MFT of $5,844,827 on 4 September 2014, from the sale of the BBG shares to the GMSF. Immediately prior to the receipt of that amount, the total of all cash held by the MFT in bank accounts was approximately $8.5 million (which is more clearly depicted on MFI 9 between items 10 and 11).

259    The MFT balance sheet as at 2 September 2014, disclosed total assets of $248 million, total liabilities of $28.6 million and net equity of $219 million. The assets included cash at bank with Westpac of approximately $8.5 million, foreign unlisted investments of $48.5 million, “other” unlisted investments of $27.3 million and shares in listed entities and funds of $133 million. The primary liabilities were an unsecured loan from Mr Merchant of $7.14 million and the NAB margin loan at $21.5 million.

260    The primary judge made unchallenged findings about the funding needs of the MFT and Plantic at PJ [269]-[310]. His Honour accepted that between 2012 and 2014, the operating expenses of the MFT substantially exceeded its income, which was addressed by selling down investments. As a broad comparison, the cost of investments recorded in the MFT’s balance sheet as at 30 June 2012 was $302 million and as at 30 June 2014, $287 million. His Honour rejected the subjective evidence of Mr Merchant that he transferred the BBG shares on 2 September 2014 in order to “free up cash as soon as possible to continue funding Plantic”: PJ [287]. His Honour concluded that in early September 2014, the MFT “had ample funding available for the anticipated funding needs”: PJ [288]. The analysis in support of that conclusion commences at PJ [296] and concludes at PJ [309]. In particular, his Honour found at PJ [308] – [309]:

The funding requirements which had been forecast on 28 May 2014 for Plantic for the months of June, July and August 2014 had, as at 4 September 2014, proved accurate: CB649 at page 9 ($500,000 in June 2014); CB689 at page 1 ($600,000 in July 2014); CB689 at page 2 ($700,000 in August 2014).

There was ample funding available as at 4 September 2014 to meet the forecast funding requirements of Plantic if the funding needed to be met. The funding would not be required if Plantic was sold, which was strongly desired on the part of Mr Merchant. The additional forecast cash requirements of Plantic up until 30 June 2015 could have been met from existing cash reserves and, to the extent these proved insufficient because of other expenditure of the MFT or for other reasons, could have been met in the same way as the MFT had funded its expenditure over the period 2012 to 2014. That is not to say that any such funding requirement had to be funded in that way; it is only to say that – objectively – Plantic’s funding did not need to be sourced from the sale of BBG shares by the MFT to the GMSF. There was no expenditure of an unusual or unforeseen nature on the part of Plantic that Mr Merchant pointed to in connection with the assertion in his affidavit at [243], that he “transferred the BBG shares to GMSF on 2 September 2014 because I needed to free up cash as soon as possible to continue funding Plantic”.

261    Each finding is supported by the objective evidence. As the Commissioner’s chart demonstrates, the cash on hand of the MFT declined to approximately $1 million in mid-May 2014. It was then replenished by drawing down an amount of $3 million from the NAB margin loan. Despite the relatively low cash on hand before that draw down, the MFT had available cash and a margin facility of approximately $7 million in total. Thereafter, proceeds were received from asset sales in June and July 2014. Within that period, Plantic required between $500,000 and $700,000 per month in funding. The MFT did not have other significant expenses in that period.

262    The effect of the BBG Share Sale was to increase the combined cash and undrawn margin loan facility of the MFT from approximately $8 million to approximately $13 million. Moreover, on 2 September 2014, the MFT refinanced with the CBA and in doing so increased the margin loan facility to $35 million. That was one step taken to address the cash flow requirements of the MFT. The other was to pursue the sale of Plantic, which was reasonably in prospect at the time.

263    The appellants criticise the finding of the primary judge at PJ [316], as impermissibly straying into the territory of subjective analysis, where his Honour rejected the evidence that the BBG Share Sale was for the purpose of raising cash to continue the funding of Plantic. They submit that an amount of $5.8 million is of itself significant in the context where cash available to the MFT fell from approximately $20 million as at April 2012 to “effectively running out of cash on a number of occasions”. It is true that the available cash did decline significantly from April 2012, but the error in that submission is to ignore the total funds available to the MFT within that period by adding the undrawn amounts from the NAB margin facility.

264    Relatedly to the last point, at trial the appellants led evidence to the effect that Mr Merchant had an aversion to debt. Objectively that evidence cannot be reconciled with the history of drawdowns from the NAB margin loan and the new CBA facility with a limit of $35 million, as set out in the Commissioner’s chart. The primary judge was correct to reject that evidence at PJ [304]-[307].

265    For these reasons, we reject the appellants’ submission that the primary judge erred in his reasoning to conclude that the BBG Shares were not sold to address a need for cash in early September 2014: PJ [293]-[319].

266    The third purpose, moving the BBG shares into the protected environment of the GMSF, and the fourth, liberating cash from the GMSF, are considered together.

267    In oral submissions, the appellants emphasised “the concessionally taxed” environment of the GMSF as an objective purpose of transferring the BBG shares from the MFT. The submission elided with the corresponding objective advantage of liberating cash from the GMSF, each as relevant to s 177D(2)(e): any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme and; (f): any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme.

268    On 1 July 2009, the GMSF commenced an account-based superannuation income stream for the payment of a pension to Mr Merchant, who was then 66 years of age and retired: PJ [54]. On 30 April 2015, a decision was made to cease the payment of a pension to Mr Merchant and to revert the GMSF to the accumulation phase from 1 July 2015: PJ [55], [232].

269    When $5.8 million was drawn out of the GMSF account on 4 September 2014 to purchase the BBG shares, the fund retained a cash balance of $1.8 million: PJ [393]. Prior to that time, Mr Merchant had been paid an annual pension in the 2013 and 2014 income years of approximately $500,000: PJ [328]. To 30 June 2015, Mr Merchant made a non-concessional contribution of $180,000 to the GMSF: PJ [396].

270    The primary judge analysed these facts when considering the s 177D(2)(f) matter at PJ [391] – [400]. Importantly, his Honour found as follows at PJ [397] – [400]:

If the BBG Share Sale Scheme had not been entered into, GSM would have paid substantial tax on the capital gain that would have been retained by the MFT, assuming that it continued to be the sole beneficiary entitled to income for the year. Its position was, accordingly, substantially improved by the BBG Share Sale Scheme.

The GMSF’s position was altered, because its cash assets were converted to a shareholding in BBG of the same value, at least on the day of the transfer. The BBG Shares were a riskier asset than cash. The BBG Shares were unlikely to earn dividend income. The BBG Shares would not be sold by the GMSF, at least in the short to medium term, because Mr Merchant would not countenance a reduction in the Merchant Group shareholding in BBG.

The BBG Share Sale Scheme resulted in the cessation of Mr Merchant’s pension. The GMSF did not strictly have to cease the pension given it still had about $1.9 million in cash reserves, but it could not have continued to pay the pension it was then paying for very long. The practical consequence of the BBG Share Sale was the need to commute Mr Merchant’s pension and return the fund to the accumulation phase, with Mr Merchant’s loss of pension being funded elsewhere, presumably by the wider Merchant Group. Mr Merchant’s position was improved by the benefits that accrued to the MFT through the BBG Share Sale, despite the loss of pension.

A consideration of the matter in s 177D(2)(f) weighs in favour of a conclusion that the MFT and the GMSF entered into or carrying out the BBG Share Sale Scheme for the dominant purpose of obtaining a tax benefit.

271    The amended appeal grounds do not challenge these findings.

272    Whilst it is perfectly correct that assets held in the GMSF were subject to restrictions that did not apply to the MFT, we do not accept the broad submission that there was an objective advantage in moving an amount of $5.8 million from the “shackles of the superannuation environment”, which is how the appellants put the submission. The fact is that in September 2014, the GMSF was in the pension phase. It was open to Mr Merchant, to withdraw cash in any amount from the fund and apply it to the MFT. He had reached the preservation age of 55 years and the transfer balance cap did not commence until 1 July 2017: 1997 Act, Division 295, s 294-35. The appellants in argument, accepted that was so, but then put the somewhat circular submission that objectively it would be concluded that Mr Merchant wished to maintain control over the BBG shares. The obvious answer to that proposition is that control already resided in the MFT.

273    The protection afforded to assets held in the GMSF submission is inconsistent with his Honour’s findings that the BBG shares were a risky asset, unlikely to earn dividends in the future, and the effect of the purchase was to impair the capacity of the MFT to continue paying Mr Merchant a pension. Objectively, that was not an advantage.

274    Further, the appellants’ submissions do not engage with the disparity between the liberation of $5.8 million in cash from the GMSF and the value of the tax benefit obtained by GSM (as the only presently entitled beneficiary of the MFT in the 2015 income year) in the form of the realised capital loss on the sale of the BBG Shares. The MFT incurred a $56.5 million capital loss on the BBG Share Sale, with a tax effected value of approximately $16.95 million (at GSM’s tax rate). In argument before us, it was accepted that the net tax effect obtained in respect of the capital loss incurred on the BBG shares in the year ended 30 June 2015 by GSM was approximately $12.8 million.

275    Objectively, the liberation of cash purpose was disproportionate in value to the ultimate economic advantage to GSM of the BBG Capital Loss.

276    The final identified purpose is the control issue, which featured prominently in the appellants’ submissions.

277    It was common ground before the primary judge that Mr Merchant was the director and controlling mind of GSMS as trustee of the GMSF, of GM2 as trustee of the MFT (PJ [3]-[4]) and that the BBG shares, both before and after 4 September 2014, “were held in trusts which Mr Merchant controlled and of which he was either the sole beneficiary (the GMSF) or one of a number of discretionary objects (the MFT)” which led to the primary judge to conclude that “the transfer did not result in any real economic change in ownership”: PJ [352].

278    The primary judge, as summarised above, made detailed findings about Mr Merchant’s history of acquiring, holding and dealing in BBG shares from August 2000, when BBG was listed on the ASX at PJ [42] – [44], [47] – [48], [62] – [69], [70] – [79], [86] – [90], [96] – [102] and [114] – [130]. None of those findings are in issue. The effect of the investment strategy was that Mr Merchant through his corporate entities held 25% of the issued capital in BBG in September 2004, 21% in June 2005, 15% in March 2006 and 10% in March 2014. The primary judge accepted Mr Merchant’s evidence that he required between 12% and 15% of the issued shares in BBG to have “some control”: PJ [78]. See also the findings at PJ [87] – [88].

279    The primary judge found at PJ [267] – [268]:

The applicants observed that a part of the context was that Mr Merchant, and members of the Merchant Group, had an “affinity” for holding a substantial parcel of shares in BBG: AOCS[8], [17(b)]. That proposition is to be accepted. Whilst the MFT sold a substantial number of shares in BBG in 2006, Mr Merchant wanted to maintain a substantial shareholding by the Merchant Group in BBG and wanted to retain a position on the BBG Board. From November 2007 until sometime after the sale of the Plantic shares on 2 April 2015, Mr Merchant consistently acquired BBG shares, including in share issues or capital raisings so as not to have the Merchant Group’s shareholding diluted – see: Exhibit 2.

At the time of the BBG Share Sale on 4 September 2014, Mr Merchant did not want to sell, and would not have sold, BBG shares to unrelated third parties.

280    The appellants’ submissions commence by embracing those findings as foundational to the maintenance of control purpose. In their written submissions, the appellants’ put the argument as:

GMSF’s acquisition of BBG shares was also, objectively, significant for non-fiscal reasons. The acquisition was at market price and so reflected the market’s assessment of the risks and potential rewards of the investment. It is also objectively important that Mr Merchant founded BBG and had been heavily involved in it for over four decades by September 2014. BBG generated the vast bulk of the wealth of the Merchant Group (including all that was invested in Plantic). Mr Merchant wanted to maintain his stake in BBG because he disagreed with the direction the company had taken after listing, and wanted to use his control of the company to improve its position for the future….. Mr Merchant had spent tens of millions of dollars acquiring shares, in various of his entities (including GMSF), both before and after the BBG Share Sale scheme. There were non-fiscal purposes for GSMF buying BBG shares that a reasonable person would conclude weighed against the notion that the sole or dominant purpose was simply to obtain a capital loss.

281    In oral submissions, the appellants emphasised the objective material purpose of the BBG Share Sale Scheme, explicable by the acquisition history, was that Mr Merchant maintained control of a significant parcel of BBG shares which purpose could only be achieved, in conjunction with the provision of cash to the MFT, by utilising the funds that were available in the GMSF. Objectively, Mr Merchant would not countenance a sale of BBG shares to a third party. The economic purpose of the scheme, and its effect, is that control of the BBG shares was maintained. Control of the shares has real world consequences.

282    The appellants submit that the primary judge erred in failing to give weight to that non-fiscal purpose; in so doing he failed to resolve the tension between realising a capital loss by selling shares at market price to a third party in anticipation of offsetting the loss against an actual or anticipated capital gain (to which Part IVA would not apply) and this sale at market price to a related party.

283    In oral submissions attention was drawn to the reasoning at PJ [389] – [390] as exposing a tension between the last sentence of PJ [389] and the dominant purpose conclusion at PJ [390]:

If the BBG Share Sale Scheme had not been carried out, then the MFT could have realised a capital loss by selling sufficient high cost BBG shares on-market to third parties. Mr Merchant did not want to do this. The fact that this possibility existed does not weigh in favour of the dominant purpose not being one of obtaining the (admitted) tax benefit which was obtained. Rather, it tends to emphasise that the point of the sale was to realise a capital loss whilst maintaining the Merchant Group’s shareholding in BBG by transferring the shares at market value between members of the Merchant Group.

A consideration of the matter in s 177D(2)(e) weighs in favour of a conclusion that the MFT and the GMSF entered into or carrying out the BBG Share Sale Scheme for the dominant purpose of obtaining a tax benefit.

284    The appellants submit that the primary judge, having identified the non-fiscal control purpose at PJ [267]-[268], then failed to evaluate it before reaching this conclusion.

285    We do not accept the appellants’ submissions. First, they gloss over the obvious point that objectively there was no need or requirement for any step to be taken by the Merchant Group to maintain control of the BBG shares in September 2014. Control of the parcel of 10,344,828 shares within the Merchant Group did not alter in consequence of the BBG Share Sale. The effective economic ownership of the shares remained the same: PJ [403]. The scheme did not result in divestment of the risk of ownership of the shares. It did not add to the benefits of being a shareholder. The Commissioner was correct to submit, as recorded by the primary judge at PJ [392]:

[T]he whole scheme involved transactions between related parties, all controlled and ultimately owned by the same person, it was simple to look through and observe the significant benefits that accrued to Mr Merchant’s interests as a whole. Those changes weigh in favour of the BBG Share Sale Scheme being entered into for the sole or dominant purpose of obtaining the tax benefit.

286    As we explained above, the scheme is not analogous to the appellants’ exemplar of a sale of an asset to a third party for the purpose of realising a capital loss, which may then be offset against an actual or anticipated capital gain.

287    Second, the appellants’ arguments do not address the timing issue of the sale. Mr Merchant resolved to sell the BBG shares on 2 September 2014 and the transfer forms were signed on 4 September 2014: PJ [185]-[186]. The trading window for a sale of BBG shares opened on 2 September 2014 and closed on 31 December 2014: PJ [376]. The primary judge correctly explained the timing of the sale of the BBG shares by reference to the likelihood that Plantic would be sold at PJ [375]:

As at 2 to 4 September 2014, Sealed Air was still in its period of exclusivity (which ended on 15 September 2014), during which the MFT could negotiate exclusively with Sealed Air: CB244 at page 4, cl 8. The sale to Sealed Air was progressing reasonably close to the transaction timetable: CB246. The timetable anticipated the signing of a share purchase agreement by 5 September 2014 and completion of that agreement by 15 September 2014. Draft documents had been completed by the solicitors and ongoing steps were being discussed: CB279. The draft documents contemplated a Share Sale: CB259. Mr McGrath considered that the issues outstanding between the MFT and Sealed Air as at late August early September 2014 were able to be addressed and that the negotiations were still very much on foot: T150.7-154.7. A sale to Sealed Air was a real possibility, even objectively reasonably likely, as at 4 September 2014. The fact that it did not occur should not distract attention from what was objectively likely as at 4 September 2014. In any event, it was likely that Plantic would be sold even if a sale to Sealed Air did not procced. Mr Merchant wanted to sell.

288    That finding led to his Honour’s conclusion at PJ [377] that: “it was objectively likely that Plantic would be sold and there was no real point in not proceeding with the BBG Share Sale at a time when it was known to be possible”. The appellants’ control submissions offer no objective explanation why the maintenance of control purpose required the sale to be timed as it was.

289    Third, the transfer of the BBG shares to the GMSF was contrary to the adopted fund investment strategy. The fund adopted an investment strategy on 15 March 2012. Amongst other things, the strategy included an investment of up to 40% in shares in listed companies, the pursuit of “a high growth strategy in order to provide strong returns with diversification of risk” and an investment objective of earning “an investment rate of return above the inflation rate on assets under its control”: PJ [80] – [81]. The primary judge found, and the appellants do not dispute, at PJ [401]:

The scheme resulted in the transfer of the BBG Shares from one entity in the Merchant Group (the MFT) to another (the GMSF). This resulted in the GMSF having a heavy investment in BBG shares, contrary to its documented investment strategy. The BBG Shares replaced about 74.4% of the cash assets of the GMSF. The BBG Shares were not paying dividends and there was nothing which would objectively support a conclusion that dividends were likely in the future. The acquisition of the BBG Shares resulted in a decrease in the income to the GMSF which was likely to persist.

290    The maintenance of control submissions do not address that inconsistency.

291    Finally, we do not accept that there is a non sequitur (or indeed any tension) at PJ [389] – [390] when read with the preceding context from PJ [384]. In this component of the reasons, his Honour addressed the matter of change in the financial position of the relevant taxpayer in accordance with s 177D(2)(e). His Honour continued at PJ [385] – [387]:

For the MFT, the BBG Share Sale converted shares it held in BBG into cash. However, it also substantially improved the MFT’s financial position:

•    the BBG Share Sale crystallised $56.5 million in capital losses; and

•    those losses could be offset against the expected capital gain from the sale of Plantic, whether that sale was a sale of Plantic shares or Plantic’s assets.

The scheme thus converted unrealised losses into realised losses, which could then be used to allow the trust corpus to increase without any immediate tax consequences for the MFT or its discretionary objects.

If the BBG Share Sale Scheme had not been entered into or carried out, the MFT would have had a substantial capital gain for the year, which would either have been taxable in its hands, or in the hands of the presently entitled beneficiary, GSM.

292    In our view, those reasons are unassailable. The primary judge did not err in the way in which he addressed the asserted control purpose. The sale of the BBG shares to the related party did not affect the economic ownership and control of the BBG shares that Mr Merchant was intent on retaining. The other practical, economic or commercial consequence for the Merchant Group (being the transfer of $5.8 million in cash to the MFT and the transfer of the by then non-dividend paying BBG shares to the tax-preferred environment of the GMSF) was not the predominant purpose of any party to the BBG Share Sale. The reasonable conclusion to be drawn from the s 177D factors was that the dominant purpose of the parties to the BBG Share Sale was the obtaining a tax benefit.

Fourth issue: was the BBG Share Sale Scheme artificial or contrived?

293    The appellants invoked the purpose of Part IVA as set out in the Explanatory Memorandum to submit that there was in the circumstances nothing artificial or contrived in the scheme and no difference between its substance and form, being a sale of shares in an ASX listed corporation to a related entity at market price. They submit that the primary judge erred when considering this matter pursuant to s 177D(2)(b) at PJ [368] – [370]. His Honour reasoned that the form of the transaction matched its substance:

The form of the scheme was an off-market transfer of shares at market value, the substance of which included that Mr Merchant would retain the economic ownership of the BBG Shares, but crystallise a capital loss which could be used to offset significant capital gains which were then anticipated to arise in the MFT.

A consideration of this factor weighs in favour of a conclusion that the dominant purpose of the transfer of shares between the MFT and the GMSF was to obtain a tax benefit for the MFT.

294    The appellants’ submission is that Mr Merchant’s retention of economic ownership of the BBG shares was a consequence of the identity of the parties to the transaction: Mr Merchant retained economic ownership because he controlled each entity. That the MFT crystallised a capital loss was a consequence of those features of the transaction. The fact that the parties were related did not make the BBG Share Sale Scheme contrived: “because, while related, the two entities were quite different in character, one being a superannuation fund”, which point emphasises the protected character of the superannuation fund, which we have addressed.

295    It is further submitted that “critically” the BBG Share Sale was neither artificial nor contrived: the BBG Capital Loss was real and caused by factors beyond the control or influence of the parties. The only control that rested with the parties was the timing of the realisation of the loss. The appellants further submit that it is “routine for taxpayers to own multiple assets bought for investment purposes, some showing unrealised losses and other showing unrealised gains” and they should not be “required to defer realising real (and not contrived) capital losses until a time when those losses are unlikely to have any capital gains to offset”, lest they be subject to an adverse determination pursuant to Part IVA. But that is the consequence, so the submission proceeds, of the approach of the primary judge.

296    We reject the submission. The abstract level at which it is framed passes over the detailed reasoning of the primary judge in his consideration of each of the s 177D(2) matters at PJ [342] – [408]. The submission fails to focus on the crystallisation of a capital loss by the sale of the BBG shares to a related party, without any alteration in the effective economic ownership and control of the shares, with the outcome that the vendor realised a significant capital loss which could then be applied to offset a likely anticipated significant capital gain on a transaction which was well-advanced at the time of the sale.

297    As we have explained, what stands this case apart from the “routine” realisation of a capital loss to be offset against an actual or anticipated capital gain are the objective facts that the BBG shares would not have been sold to an outside party, the control of the shares and the effective economic ownership did not alter and there was no divestment of investment risk. These matters, when considered with each of the other findings of the primary judge concerning the absence of need in the MFT for a cash injection of $5.8 million, the acquisition was contrary to the investment strategy of the GMSF and the absence of a link between the BBG Share Sale and the objective of obtaining the best price for the sale of Plantic, distinguish this scheme from ordinary commercial transactions with real economic and practical consequences where the dominant purpose is not to obtain a tax benefit. The primary judge was correct to reject the appellants’ submission that there was no contrived capital loss: PJ [264], [565] – [568].

298    Finally, we do not consider that any additional asserted error is raised by the amended appeal grounds and observe that no other arguments in support were pressed before us.

CONCLUSION ON THE S 177D GROUNDS

299    There is no merit in the appellants’ arguments in support of the s 177D grounds.

DIVIDEND STRIPPING

300    This is a further recent occasion in which the Court has been required to consider the concept of dividend stripping. Unlike Bblood Enterprises Pty Ltd v Commissioner of Taxation [2023] FCAFC 114, but like Commissioner of Taxation v Consolidated Press Holdings Ltd [1999] FCA 1199; 91 FCR 524 (CPH FFC), the context is s 177E of the 1936 Act.

LEGISLATION

301    Part IVA of the 1936 Act relevantly covers a number of categories of schemes. Section 177D applies to a scheme if it would be concluded (having regard to enumerated matters in s 177D(2)) that the person or persons who entered into or carried out the scheme or any part of the scheme, did so for the dominant purpose of enabling the obtaining of a tax benefit in connection with the scheme. Section 177E applies to a distinct category of schemes.

302    Section 177E provides:

(1)    Where –

(a)    as a result of a scheme that is, in relation to a company:

(i)    a scheme by way of or in the nature of dividend stripping; or

(ii)    a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping;

any property of the company is disposed of;

(b)    in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);

(c)    if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this sub-section referred to as the notional amount) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and

(d)    the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia;

the following provisions have effect:

(e)    the scheme shall be taken to be a scheme to which this Part applies;

(f)    for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and

(g)    the amount of that tax benefit shall be taken to be the notional amount.

(2)    Without limiting the generality of subsection (1), a reference in that subsection to the disposal of property of a company shall be read as including a reference to:

(a)    the payment of a dividend by the company;

(b)    the making of a loan by the company (whether or not it is intended or likely that the loan will be repaid);

(c)    a bailment of property by the company; and

(d)    any transaction having the effect, directly or indirectly, of diminishing the value of any property of the company.

(2A)     This section:

 (a)     applies to a non-share equity interest in the same way as it applies to a share; and

 (b)     applies to an equity holder in the same way as it applies to a shareholder; and

 (c)     applies to a non-share dividend in the same way as it applies to a dividend.

 (3)     In this section, property includes a chose in action and also includes any estate, interest, right or power, whether at law or in equity, in or over property.

303    Unlike s 177D, s 177E is self-contained in so far as it deems the identification of the tax benefit and the quantum of the tax benefit. Section 177E identifies the tax benefit obtained by the shareholder as the entire amount of a notional dividend that is deemed to have otherwise been paid out of the profits represented by the disposal of the company’s property. Unlike s 177C, the amount of the tax benefit for the purposes of s 177E is not identified by reference to what might reasonably be expected to have happened without the scheme. Section 177F enables the Commissioner to make a determination to include that entire amount in a taxpayer’s assessable income. Unlike s 177D, s 177E makes no express reference to purpose and does not expressly require the drawing of a conclusion as to purpose of a party by reference to enumerated factors. Instead, s 177E is founded on an undefined concept of dividend stripping. As explained further below, the statutory language provides limited assistance in construing the concept of dividend stripping.

The s 177E Determinations

304    In this case, the Commissioner made determinations under s 177E. The Commissioner identified the forgiveness by each of GSM and Tironui of loans made to Plantic in the sums of $50.192 million and $4.215 million respectively, on 2 April 2015 as schemes “having substantially the effect of a scheme by way of or in the nature of dividend stripping” for the purposes of s 177E(1)(a)(ii) of the 1936 Act ( defined above as the Debt Forgiveness Schemes). The Commissioner:

(a)    formed the opinion required by s 177E(1)(b) that the forgiveness of the debts by GSM and Tironui was a disposal of property (a chose in action within the definition of property in s 177E(3)), and represented a distribution of profits to the MFT (as “another person”); and

(b)    identified that, if – immediately before the Debt Forgiveness Schemes – GSM and Tironui had declared and paid dividends to Mr Merchant in the amounts forgiven, those amounts would have been included in Mr Merchant’s assessable income for that year, and therefore s 177E(1)(c) was satisfied in respect of those notional amounts.

305    The Commissioner made a consequential determination under s 177F(1)(a) to include amounts equivalent to the sums forgiven by GSM and Tironui (being the notional amounts calculated in accordance with s 177E(1)(c)), in Mr Merchant’s assessable income in the 2015 income year by virtue of s 44 of 1936 Act. The Commissioner issued the Merchant Amended Assessment for the 2015 income year to give effect to that consequential determination.

Reasons of the Primary Judge

306    The primary judge found that s 177E applied to the schemes which he termed the “GSM and Tironui Debt Forgiveness Schemes” (at PJ [13] and [435]). The schemes to which his Honour accepted s 177E applied comprised the following steps (PJ [473]–[477]):

(1)    First, the MFT sold the BBG Shares to the GMSF on 4 September 2014, crystallising a capital loss of $56,561,940 in the 2015 income year.

(2)    Secondly, on 31 March 2015, the MFT entered a contract for the sale of the Plantic shares to Kuraray containing as condition 3 of cl 2.1 of the SSA a condition precedent that the MFT must procure the release and forgiveness of Plantic’s loans to GSM and Tironui.

(3)    Thirdly, on 2 April 2015, GSM and Tironui released and forgave the Plantic Loans, in the sums of $50.192 million and $4.215 million respectively, for nil consideration from either Plantic or the MFT, with a corresponding increase in the market value of the Plantic shares.

(4)    Fourthly, the sale of the shares in Plantic to Kuraray.

307    His Honour formed the view that the schemes involving forgiveness of the debts by each of GSM and Tironui were schemes “having substantially the effect of [schemes] by way of or in the nature of a dividend stripping” within the meaning of s 177E(1)(a)(ii). Because no consideration was provided by Plantic for the forgiveness of the debts, the primary judge considered that the forgiveness had the effect of (PJ [571]):

(1)    reducing the undistributed accumulated profits of GSM and Tironui; and

(2)    “converting the Plantic Loans to equity” by increasing the value of the Plantic Shares and the consideration paid by Kuraray for those shares.

308    The primary judge was satisfied that each of the GSM and Tironui Debt Forgiveness Schemes was carefully planned for the predominant purpose of Mr Merchant avoiding tax on a distribution of dividends by each of GSM and Tironui. The primary judge concluded that there was no requirement that each and every party must be involved in “careful planning” or act “in concert” with the others before a scheme can fall within the second limb of s 177E(1)(a) (PJ [513]).

309    The primary judge considered the effect of the schemes through the prism of the submissions made to him. The primary judge records (at PJ [482]) that it had been submitted on behalf of Mr Merchant that:

“[t]he essential characteristic of dividend stripping is that something becomes tax free (or perhaps substantially so …) and that is missing here” because “the sum which but for the debt forgiveness might have been paid out to Mr Merchant as dividends remains in fact taxed or as potentially liable to be distributed to Mr Merchant and taxed in the same way”…

310    It was submitted before the primary judge that the debt forgiven amounts remained liable to substantial tax “in two ways” (at PJ [483]):

(1)    First, if the Commissioner succeeds on his s 177D case, the BBG Capital Loss is to be treated as not incurred. The sum of the debts forgiven have become taxable capital gains for the MFT and included in the taxable income of GSM. The “entitlement to the money is a sum which might thereafter be distributed by GSM to Mr Merchant as dividends”.

(2)    Second, and in any event, the increased sale price, by reason of the amount the subject of the debt forgiveness, is received by the MFT as an increased capital gain. It is not tax free in its hands. Nor is the money it holds free of tax when or if distributed to GSM and its shareholder.

311    It had been submitted to the primary judge that “the s 177E scheme viewed in context of the s 177D Determination is really the inverse of a dividend strip” and that (PJ [486]):

It does not ensure that company profits will be free of tax, but rather that they will be taxed at least twice (the assessments to both Mr Merchant and to GSM), and possibly a third time (if GSM pays the capital gain distributed to it on to Mr Merchant as a dividend).

312    The primary judge rejected these submissions (at PJ [487]–[488]).

313    The primary judge concluded that each of the Debt Forgiveness Schemes was a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping within the meaning of s 177E(1)(a)(ii) of ITAA36 (at PJ [573]).

Grounds of Appeal

314    By their amended notice of appeal, the appellants contend that:

(1)    The primary judge erred in concluding that each of the Debt Forgiveness Schemes was a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping within the meaning of s 177E(1)(a)(ii).

(2)    The primary judge erred in determining the effect of the Debt Forgiveness Schemes without having regard to the effect of the s 177D Determinations which cancelled the BBG Capital Loss.

(3)    The primary judge erred in finding that s 177E does not require a complete or substantially complete avoidance of tax (at PJ [497]).

(4)    The primary judge erred in finding that s 177E can apply if the debt forgiven amounts “remained a potential source of future tax obligations” (cf PJ [506]–[508]).

(5)    The primary judge erred in concluding that the dominant purpose of the Debt Forgiveness Schemes was tax avoidance. The primary judge ought to have concluded that the dominant purpose of the debt forgiveness was to enable the sale of the Plantic shares to an unrelated third party by extinguishing related-party debt.

315    There is no appeal against the primary judge’s conclusion that schemes identified solely as comprising the forgiveness of the debts by each of GSM and Tironui were not capable of constituting schemes having substantially the effect of schemes by way of or in the nature of dividend stripping. His Honour was correct in his conclusion that the single step of forgiving debts effected a value shift but did not have the substantial effect of a scheme by way of or in the nature of dividend stripping (PJ [472] and [477]). The forgiveness of the debt does not result of itself in avoidance of tax. His Honour was also correct in concluding that absent the sale of the Plantic shares, profits are not converted to a capital sum.

316    There is also no appeal against the primary judge’s conclusion that there was no requirement that all parties must be involved in “careful planning” or to act “in concert” with the others before a scheme can fall within the second limb of s 177E(1)(a) (PJ [513]).

Consideration

The concept of dividend stripping

317    The concept of dividend stripping underpinning s 177E is undefined and, as Hill J observed in CPH Property Pty Ltd v Commissioner of Taxation (1998) 88 FCR 21 (CPH First Instance) at 44, is not one of “great clarity”. Although the legislature appears to have assumed that the concept was understood widely enough so as not to require definition, the words have no recognised technical meaning.

318    The history of the term “dividend stripping” was considered by Hill J in CPH First Instance, the Full Court in CPH FFC (French, Sackville and Sundberg JJ), the High Court in CPH (Gleeson CJ, Gaundron, Gummow, Hayne and Callinan JJ) and summarised in B&F Investments Pty Ltd v Federal Commissioner of Taxation [2023] FCAFC 89; 298 FCR 449 (Moshinsky, Colvin and Hespe JJ).

319    In construing s 177E, recourse has been had to the Explanatory Memorandum which accompanied the Income Tax Laws Amendment Bill (No. 2) 1981 (and which became Act No. 110 of 1981) and to the case law history in which concept has been referenced or discussed.

320    As the Full Court in CPH FFC observed at [144]–[145], s 177E is one of a number of provisions in the income tax legislation that deals with schemes in the nature of dividend stripping and looked to address the advantages obtained by the vendor of the shares in the target company (or, as here, the pre-scheme shareholder). Other provisions addressed the advantages obtained by the stripper of the profits in the target company (usually the purchaser of the shares in the target company). One of those sections was s 46A of the 1936 Act. That section, unlike s 177E, “specified matters that the Commissioner was obliged to consider when determining whether he or she was satisfied that the scheme was by way of dividend stripping” (at [146]). In substance, these were (s 46A(3)):

•    whether the effect of the dividend to the new shareholder substantially reimbursed the shareholder for the acquisition cost of the shares;

•    whether the value of the shares was substantially reduced by reason of the payment of the dividend;

•    whether the right to receive dividends on the shares was subject to some limitations; and

•    any other relevant matters.

321    The Full Court at [147] noted that the Explanatory Memorandum issued in conjunction with the 1972 Bill (which introduced s 46A) stated that cl 46A(3) of the Bill directed:

the Commissioner to consider features common to dividend stripping as the term is ordinarily understood. These features do not exist in normal commercial transactions, eg, in the purchase in the ordinary way of shares cum div and the subsequent sale of those shares.

322    The Full Court identified the central characteristics of dividend stripping at [136]–[137] in the following terms:

What is helpful for present purposes is that Gibbs J identified four cases as involving dividend stripping operations: Bell v Commissioner of Taxation (Cth) (1953) 87 CLR 548; Newton v Commissioner of Taxation (Cth) (1958) 98 CLR 1 (PC); Hancock v Commissioner of Taxation (Cth) (1961) 108 CLR 258; Commissioner of Taxation (Cth) v Ellers Motor Sales Pty Ltd (1972) 128 CLR 602. These four cases had the following characteristics in common:

•    a target company, which had substantial undistributed profits creating a potential tax liability either for the company or its shareholders;

•    the sale or allotment of shares in the target company to another party (a company in three cases and individuals resident in the then Territory of New Guinea in Bell);

•    the payment of a dividend to the purchaser or allottee of the shares out of the target company’s profits;

•    the purchaser escaping Australian income tax on the dividend so declared (whether by reason of a s 46 rebate, an offsetting loss on the sale of the shares, or the fact that the shareholders were resident outside Australia); and

•    the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax at the relevant times).

See C J Vincent, “Dividend Stripping: stricto sensu or strictly senseless” (1989) 24 (2) Taxation in Australia 82 at p 92.

A further common characteristic of each of the schemes in the cases considered by Gibbs J, was that they were carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company. …

323    The Full Court at [158] went on to identify features of the arrangement before it, which are considered to be consistent with a scheme that was one by way of or in the nature of dividend stripping. Those features included:

•    prior to the commencement of the scheme the UK companies had substantial undistributed profits;

•    had dividends been declared out of the available profits, the shareholders (CPH and MLG) would have incurred a substantial liability to pay Australian tax, since the dividends would have formed part of their assessable income;

•    the dividends actually declared by the UK companies virtually exhausted the total profits available for distribution;

•    CPH and MLG sold their shares in the UK companies to CPIL(B) cum dividend;

•    CPIL(B) received a distribution of the assets of the UK companies, partly in purported satisfaction of the dividend;

•    CPIL(B), as a Bermudan resident, was not liable to Australian tax in respect of the distribution; and

•    CPH and MLG were allotted shares in CPIL(B) which, in part, were referable to the dividend component of the sale of their shares in CPIL(B).

324    The Full Court further observed at [159] that (emphasis added):

The fact that CPH and MLG each received an allotment of shares, rather than cash, as the consideration for their shares in the UK companies, is compatible with a dividend stripping scheme. While the vendor shareholders usually receive a cash payment for their shares in the target company, the fact that the consideration takes a different form is not a significant departure from the paradigm. The critical point is that the vendor shareholders receive a consideration which is in a tax-free or largely tax-free form.

325    The Full Court at [160]–[162] also identified features in the case before it that were “not easy to reconcile” with the central characteristics of a dividend stripping scheme. The first of these features was that the assets of the UK companies did not consist wholly or even primarily of accumulated or current year profits. While CPIHL(UK) and CPIL(UK) had substantial profits available for distribution (but not required to be distributed), they each had other assets. The Full Court considered that “independently of purpose” the fact that the target company has very substantial assets other than profits acquired by the purchaser, suggests that the scheme might not readily be described as a scheme by way of or in the nature of dividend stripping.

326    The second objective feature which the Full Court considered “perhaps most strongly suggesting that the scheme in this case was outside the first limb of s 177E(l)(a)” was that the consideration received by each of the taxpayers for the sale of its shares in the UK companies attracted capital gains tax in Australia.” The Full Court at [162]–[163] reasoned:

As has been seen, CPH included a net assessable capital gain of $11.5 million in its return for the 1990 year, while MLG returned a gain of about $40 million. The “classic” dividend stripping operation was of course developed in Australia prior to the introduction of capital gains tax in 1985. As the Explanatory Memorandum accompanying the 1981 Bill shows, a dividend stripping operation was thought to have the effect of placing “company profits in the hands of shareholders in a tax-free form”…. Since s 177E has survived the introduction of the capital gains tax regime, it may be that the receipt by the vendor shareholders of a relatively small assessable capital gain (in comparison with the available profits of the target company) is compatible with the application of the first limb of s 177E(l)(a). Nonetheless, the fact that the vendor shareholders in this case reported a significant assessable capital gain by reason of the sale of their shares tends to suggest that the scheme may not fall within the first limb of s 177E(l)(a).

327    Because of the view it took in relation to purpose, it was not necessary for the Full Court in CPH FFC to resolve the question of whether these two departures, independently of the question of purpose would prevent the scheme before it from falling within s 177E(1)(a) (at [164]).

First limb of s 177E(1)(a) does not apply

328    In the present case, it was accepted (correctly) that there was no scheme by way of, or in the nature of, dividend stripping. The scheme did not have the content of a scheme by way of or in the nature of dividend stripping. Amongst other things, the scheme did not involve the payment of a dividend to a shareholder or a change in the control or ownership of either GSM or Tironui (as the target companies). The first limb of s 177E(1)(a) is therefore not engaged.

329    The issue is whether each of the GSM and Tironui Debt Forgiveness Schemes had substantially the effect of a scheme by way of, or in the nature of, dividend stripping and therefore within the second limb of s 177E(1)(a).

330    The issues raised in B&F Investments, which concerned s 207-155 of the 1997 Act, do not arise for consideration in the present case. It is sufficient for present purposes to merely observe that we see no necessary tension between the observations made in B&F Investments and the decision of the Full Court in Lawrence v Federal Commissioner of Taxation [2009] FCAFC 29; 175 FCR 277 (Lawrence FFC) at [50]–[53] (Ryan, Stone and Edmonds JJ). In Lawrence FFC, the Full Court held that the second limb may be engaged notwithstanding the presence of divergences from a scheme by way of (or in the nature of) dividend stripping that are over and above the fact that the form of the (in substance) distribution of profits was not by way of a dividend. The Full Court in Lawrence FFC at [52(3)] considered that a scheme within the first limb of s 177E(1)(a) would never be within the second limb (cf PJ [457]).

A scheme having substantially the same effect as dividend stripping

331    The second limb of s 177E(1)(a) applies to a scheme that has substantially the same effect as a scheme by way of, or in the nature of, dividend stripping.

332    The second limb is drafted on the basis that a scheme by way of, or in the nature of, dividend stripping has an identifiable and defining effect. As the primary judge recognised (at PJ [459]), it is not possible to determine if the second limb is satisfied without comparing the effect of the scheme in question with the effect of a scheme by way of or in the nature of dividend stripping. The primary judge in Lawrence v Commissioner of Taxation [2008] FCA 1497; 70 ATR 376 (Lawrence First Instance) (at [76]–[77] (Jessup J)) made the following observations in respect of the second limb of s 177E(1)(a):

In the context of s 177E, the distinction between a scheme which is by way of or in the nature of dividend stripping and a scheme which is not such a scheme but which has substantially the effect of such a scheme is not an easy one. The Parliament has adopted a popular compendious metaphor for an organised series of transactions which itself is not otherwise identified. In para (a)(ii) of s 177E(1), the legislation requires the reader to envisage a series of transactions which is not properly described by that metaphor, but which has the effect of a series of transactions which is. Further, the section distinguishes between the effect of the transactions (the concern of para (a)(ii)) and the result of them, namely, the disposal of property of the company which, in the opinion of the Commissioner, represents a distribution of all or a part of the profits of the company. Clearly, for a scheme to have such a result is insufficient to justify the conclusion that it has the effect to which para (a)(ii) refers. In other words, that paragraph requires the court to look at circumstances other than the mere fact that company property has been disposed of in a way which represents a distribution of profits.

Some indication of what the parliament had in mind in para (a)(ii) may be seen in the following passage of the Explanatory Memorandum in 1981:

Part IVA will have within it, in section 177E, a supplementary code to deal with dividend-stripping schemes of tax avoidance and certain variations on such schemes, the effect of which is to place company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends.

It seems that the Parliament wanted to catch “variations” on dividend stripping schemes, and considered that the unifying principle of all such schemes and variations was that they had the effect of placing company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends…

333    As observed in B&F Investments (at [103] (Moshinsky, Colvin and Hespe JJ)), the concept of a scheme by way of, or in the nature of, dividend stripping is informed by the content of the scheme, the sole or dominant purpose of the scheme and the effect or outcome achieved by the scheme.

Content

334    Because the second limb is concerned with schemes having “substantially the same effect as a scheme by way of or in the nature of dividend stripping”, the content of the scheme has a much lesser role to play in considering the application of s 177E(1)(a)(ii) than in considering s 177E(1)(a)(i).

335    The High Court in CPH HC suggested that the second limb of s 177E(1)(a) is engaged where the distributable profits of a company are extracted otherwise than by payment of a dividend. So much is consistent with statements made in the Explanatory Memorandum which accompanied the Income Tax Laws Amendment Bill (No 2) 1981, quoted by the High Court in CPH HC at [140].

336    The Full Court in Lawrence FFC at [52] held that where the profits of a company are extracted otherwise than by payment of a dividend, the second limb of s 177E(1)(a) could apply notwithstanding the absence of other core characteristics of the content of a scheme by way of dividend stripping – such as a disposal or issue of shares in the company to the stripper. It follows from Lawrence FFC that the content of a scheme is of little assistance in determining whether a scheme has substantially the same effect as a scheme by way of or in the nature of dividend stripping.

Purpose

337    When discussing the second limb of s 177E(1)(a), the Full Court in CPH FFC held that purpose was “an element in assessing the ‘effect’ of a scheme” (at [180]). It took the view at [183]–[184] that:

It is true that the second limb identifies a wider range of schemes that will be caught by s 177E. But a scheme is not defined by its content alone. The word, in its ordinary meaning and its statutory definition still connotes purpose, a purpose not to be defined merely by effect …

It follows that a scheme is not within the second limb unless the dominant purpose of the scheme is that of tax avoidance in the sense explained earlier. It follows that the scheme in the present case was not within the second limb of s 177E(1)(a).

338    The High Court upheld the decision of the Full Court.

339    Following the High Court’s decision in CPH HC, a scheme does not have substantially the same effect as a scheme by way of or in the nature of dividend stripping, unless the scheme has a tax avoidance purpose. As Jessup J in Lawrence First Instance recognised at [81], following the decision of the High Court in CPH HC:

… the presence of a tax-avoidance purpose was a requirement of subpara (ii), no less than of subpara (i). That was why a scheme which produced a substantial consequence which was in any respect the same as a consequence of dividend stripping would not ipso facto fall within subpara (ii).

340    However, it is not “tax avoidance” in some broad sense that is relevant to determining whether a scheme has the same effect as a scheme by way of, or in the nature of, dividend stripping. As the High Court observed in CPH at [104], the concept of dividend stripping has a history in tax avoidance discourse. It is the avoidance of tax of the same kind as that which is characteristic of a scheme by way of or in the nature of dividend stripping.

341    In the context of s 177E, it is the avoidance of tax on a distribution of profits to the pre-existing shareholder of the company, had that distribution been made immediately before the scheme was entered into. As Hill J identified in CPH First Instance at 44, the hypothesis in s 177E(1)(c) that must be satisfied is that if before the scheme was entered into a dividend had been paid out of profits, to the extent the Commissioner determines profits were treated as having been distributed, it could reasonably be expected that amounts would have been included in the assessable income of a taxpayer in a year of income. In other words, s 177E requires the element of tax avoidance to be determined from the perspective of the pre-scheme shareholder in the target company and on the premise that absent the scheme, a dividend would have been paid to that shareholder out of profits at a time prescribed to be immediately prior to the entry into the scheme.

342    Purpose in this context looks to the intended outcome of the scheme. As Gleeson CJ said in News Ltd v South Sydney District Rugby League Football Club Ltd [2003] HCA 45; 215 CLR 536 at [18] “in describing, for the application of a law relating to tax avoidance, the purpose of an individual, or of an arrangement, it will be necessary to look at what is sought to be achieved that is of fiscal consequence” (see too Automotive Invest Pty Ltd v Federal Commissioner of Taxation [2024] HCA 36; 98 ALJR 1245 at [112]–[117] (Edelman, Steward and Gleeson JJ)). Purpose has a prospective connotation. In the context of s 177E and dividend stripping it looks to what might have been expected to have been achieved by the scheme, for income tax purposes.

343    The primary judge considered that the s 177D Determination made by the Commissioner to cancel the capital loss on the transfer of the BBG shares was not relevant to a consideration of the purpose of the GSM and Tironui Debt Forgiveness Schemes. The primary judge reasoned (at PJ [487]) that:

The s 177E(1)(a)(ii) scheme here was carried out on the basis that a capital loss had crystallised in the MFT as a result of the BBG Share Sale Scheme. The question of purpose is not addressed on the basis that the Commissioner had cancelled the tax benefit arising from the BBG Share Sale Scheme.

344    We agree with those observations. Purpose looks to the intended outcome of the scheme. Each of the GSM and Tironui debts was forgiven with the principal intended outcome that the MFT would receive a higher price for the Plantic shares, thereby deriving a higher capital gain that was objectively intended to be sheltered by the capital losses that the Merchant Group believed had been incurred on the transfer of the BBG shares. The fact that those capital losses were taken to have not been incurred by reason of a subsequent action taken by the Commissioner that was not intended by the parties to the scheme is not relevant in considering the intended outcome, being the purpose, of the schemes. The s 177D Determination is not relevant to a consideration of the purpose of the Debt Forgiveness Schemes.

345    The primary judge found that the objective purpose of the Debt Forgiveness Schemes was to permit the amounts forgiven to be accessed by Mr Merchant or his associates in a way in which substantially less tax would be paid than if those amounts were repaid to GSM and Tironui and received by Mr Merchant by way of dividends (PJ [508]). That finding was correctly made on the basis that there was an expectation by the Merchant Group parties to the scheme that an amount equal to the total debt forgiven amounts would be sheltered by capital losses in the hands of an associate of Mr Merchant. As Jessup J in Lawrence First Instance at [85] correctly held:

To reach the conclusion that the scheme substantially had the effect of dividend stripping, it is sufficient that associates of the applicant had derived the benefit, as capital, of the profits stripped out.

346    In the present case, because the debt forgiven amounts were expected to be sheltered by capital losses, the entirety of the income of the MFT was distributed to GSM. This had the result that GSM was subject to tax on the entirety of the taxable income of the MFT (which taxable income was not expected to include a net capital gain because of the BBG Capital Losses). As explained below at [387], GSM was not entitled as a matter of trust law, as a result of the income distribution resolution, to a distribution of the capital sum received by the MFT on the sale of the Plantic shares. Objectively viewed, that capital sum would have been expected to have remained in the MFT and accessible by Mr Merchant. Each of the GSM and Tironui Debt Forgiveness Schemes had the requisite tax avoidance purpose.

347    The appellants submitted that the primary judge erred in concluding that the Debt Forgiveness Schemes had the requisite tax avoidance purpose. The appellants submitted that:

(a)    The primary judge had incorrectly focussed on the actual purpose rather than objectively ascertained purpose.

(b)    The primary judge should have found that the dominant purpose of the Debt Forgiveness Schemes was to facilitate the sale of the Plantic shares. It was necessary to resolve the related party debt as part of a sale of the Plantic shares to a third-party purchaser of those shares.

348    The primary judge did not accept that the dominant purpose of the Debt Forgiveness Schemes was to facilitate the sale of the MFT’s shares in Plantic to an arm’s length purchaser by extinguishing related-party debt (PJ [525]–[532]). The primary judge accepted that the related party debt needed to be addressed having regard to the sale of the Plantic shares but reached the conclusion as to dominant purpose by considering the alternative ways in which the related party debt may have been discharged in addition to the chronology of events.

349    The primary judge observed (at PJ [524]) that:

Looking at the position practically and commercially, a third-party purchaser (such as Kuraray) would either:

•    pay more for the Plantic shares if Plantic did not have the related-party loans of about $55 million (and was therefore essentially debt free); or

•    pay less for the Plantic shares on the basis that Plantic would need to refinance or pay out the loans which had been made to Plantic.

350    Plantic was not insolvent. Indeed, the very reason the Merchant Group’s advisors were of the view that the debt forgiveness did not have tax consequences for Plantic, or the purchaser, was because debts owed by Plantic to each of GSM and Tironui were fully recoverable (PJ [532]–[537]). There was no economic reason for GSM and Tironui to each bear a loss on fully recoverable loans. There was no sensible commercial objective from the point of view of either GSM or Tironui in forgiving fully recoverable loans (PJ [539]–[540]). There was a myriad of ways in which the related party may have been dealt with prior to or upon the completion of the sale. Examples include the MFT subscribing for further Plantic shares to finance the repayment of the loans and then sell the new shares as part of the sale of Plantic. Or the loans may have been assigned to the purchaser or the purchaser may have paid less for the Plantic shares and refinanced the loans from GSM and Tironui with either new debt or an equity injection.

351    The appellants contend that each of the alternative ways in which the related party debts may have been addressed had other commercial consequences which objectively explained why those alternatives were not adopted. For example, it was contended that the commercial consequences of involving the purchaser in the discharge of intercompany debt would have quite different commercial consequences from discharging the intercompany debt by a debt forgiveness solely within the Merchant Group.

352    The appellants’ contention is not accepted. It is premised on an assumption that the intercompany debts could only be discharged within the Merchant Group by way of debt forgiveness. That assumption is unsupported by the evidence. Furthermore, the evidence does not suggest that, to the extent that different commercial consequences would follow from the alternatives, those different commercial consequences objectively explained the dominant purpose of the debt forgiveness in this case. The contemporaneous evidence was that the debt forgiveness was a major issue for the purchaser and required the purchaser to “be comfortable” that the loan forgiveness would not result in any potential liability to Plantic or the purchaser and the MFT was required to give the purchaser warranties to that effect.

353    The appellants further contended that objectively the dominant purpose of the debt forgiveness was to facilitate the sale of the shares in Plantic because if the dominant purpose had been to avoid tax, no other form of transaction would have been considered. The appellants submitted that because the contemporaneous evidence was that the vendor contemplated a sale that did not involve a debt forgiveness if a higher price was paid, it followed that the dominant purpose was not tax avoidance. If the dominant purpose was tax avoidance, no other structure would have been considered.

354    This submission is not accepted. The appellants’ contention supports a conclusion that the dominant purpose of the sale of the Plantic shares was not tax avoidance. That has never been in issue. The evidence was that Mr Merchant was not willing to sell the Plantic shares without a debt forgiveness unless he was compensated for the loss of tax benefit that was expected to have been enjoyed. That evidence is consistent with the dominant purpose of the debt forgiveness being the obtaining of an expected tax benefit.

355    As the primary judge found (at PJ [531]–[532]), the forgiveness of the loans made to Plantic by GSM and Tironui was not something which had its genesis in any requirement suggested by Kuraray. Nor was it sourced in any requirement suggested by Sealed Air. Neither Sealed Air nor Kuraray had any requirement that the Plantic Loans be addressed by being forgiven. Rather, the forgiveness of the Plantic Loans had its origin as the preferred structure of the vendor, Mr Merchant having received and considered advice from EY on the issue. The proposal for the debt forgiveness was initially resisted by the purchaser.

356    The alternative ways in which the related party loans may have been addressed and the chronology of the events leading up to the forgiveness of those loans were objective matters to be taken into account in determining the dominant purpose of the arrangement. A consideration of those matters is not inconsistent with ascertaining the objective purpose of a scheme. An objective consideration of purpose without regard to the alternatives open to address the related party loans is artificial and sterile.

357    As an objective matter, the loss incurred by GSM and Tironui on their respective loans to Plantic was not reflective of nor justified by Plantic’s financial position. Nor was it a requirement suggested by the purchaser of the Plantic shares. The form of the transaction in relation to the debt forgiveness was predominantly explicable by the tax advantages expected to be conferred on the Merchant Group and in particular by the expectation that it would avoid tax otherwise becoming payable on a distribution of the profits of GSM and Tironui without a substantial tax liability being incurred by the trustee or beneficiaries of the MFT. In the circumstances of this case, the appellants have not established that it ought not objectively be concluded that the predominant purpose of the debt forgiveness by each of GSM and Tironui was to secure the tax advantage identified at [345] above.

358    However, to say that a scheme does not have substantially the same effect as a scheme by way of or in the nature of dividend stripping, unless the scheme has the requisite tax avoidance purpose, is not to say that a scheme does have substantially the same effect as a scheme by way of or in the nature of dividend stripping solely by reason of a tax avoidance purpose. The requisite tax avoidance purpose is one element that must be present in order for a scheme to have substantially the same effect as a dividend stripping scheme, but it is not the only element that must be present.

Effect

359    The application of the second limb of s 177E(1)(a) requires a comparison between the effect of the scheme in question and the effect of a scheme by way of or in the nature of dividend stripping.

360    This comparison in turn requires the identification of the effect of a scheme by way of or in the nature of dividend stripping.

361    A dividend strip generally involves more than a payment of a dividend or a disposal of property that has the consequence of reducing the profits of a company. It involves a “stripping” (see for example, Rowdell Pty. Ltd v Federal Commissioner of Taxation [1963] HCA 61; 111 CLR 106 at 112 or “milking” (see for example, Hancock v Federal Commissioner of Taxation (1961) 108 CLR 258 at 264, 266, 271, 277, 292). For a scheme to have the effect of a dividend strip, the assets of the company will usually be substantially reflected in the accumulated past and current year profits of the company and the dividend (or series of dividends or disposals) will result in the substantial depletion of those accumulated profits. It is these attributes that have the combined effect of “stripping” the target company, providing the pre-scheme shareholders with a capital sum substantially reflecting the accumulated profits of the target company and resulting in the purchaser shareholder being reimbursed for the purchase of the shares in the target company by a current or future dividend out of the accumulated profits of the target company.

362    One of the characteristics of dividend stripping referred to by Hill J (at 47) in CPH First Instance in his Honour’s summary of the submissions of the Commissioner was the size of the dividend (or profits) relative to other assets. In his Honour’s discussion on the effect of a scheme by way of or in the nature of dividend stripping, Hill J (at 48) referred to the accumulated profits being “stripped” by a liquidation distribution (reflecting the form of the distribution in that case). Justice Hill summarised the effect of the scheme in relation to one of the companies in that case (CPIHL(UK)) by reference to an examination of the balance sheet of that company at 49–50:

What then was the effect of the scheme? Before the sale of the shares each of the applicants had shares in CPIL(UK) and CPIHL(UK). As at 30 June 1989 CPIHL(UK) had, according to its audited accounts to that date, accumulated profits of US$86,825,000 …

In the period from 1 July 1989 to 30 September 1989, CPIHL(UK) had an operating profit after taxation of US$17,557,000 bringing retained profit carried forward to US$94,048,000. As at 10 May 1990 an unaudited balance sheet of CPIHL(UK) showed accumulated profits of US$33,456,205.29, although the discrepancy is not easily explained, it might take into account the dividend that had been declared and was payable on 8 May 1990, that is to say, two days before the balance sheet was drawn up.

The purchase price of the shares (that is to say, ultimately, the number of shares to be allotted by way of consideration) which the applicants transferred in CPIL(UK) and CPIHL(UK) to CPIL(B) and CPIHL(B) was calculated by reference to the net value of the assets of the companies transferred.

… the purchasers subsequently received a distribution of assets from CPIL(UK) and CPIHL(UK) by way of a transfer of assets in the liquidation.

….

in the case of CPIHL(UK), where as well as current year profits there were considerable accumulated profits, ... the result was that the shareholders received capital for their shares in an amount including the amount standing to the credit of the accumulated profits account, and as a result of the liquidation there was a distribution in specie to the purchaser.

… the scheme, but only in respect of CPIHL(UK), was capable of being seen as one having the effect of a dividend stripping scheme such as to make s 177E applicable,

363    Justice Hill’s conclusion that the scheme in respect of CPIHL(UK) as one having the effect of a dividend stripping scheme was overturned on appeal. The Full Court in CPH FFC at [167] held that his Honour had erred in concluding that the purpose of the scheme had no role to play in considering whether a scheme had the substantial effect of a scheme by way of or in the nature of dividend stripping. The Full Court did not otherwise elaborate on what the substantial effect of a scheme by way of dividend stripping involved.

364    Lawrence FFC concerned a series of transactions which essentially had the effect of transferring value from two target companies (Plaster Plus and Zinkris Pty Ltd) with accumulated or current year profits. The transactions did not involve the sale or allotment of shares in the target companies (see Lawrence FFC at [29]). Rather, the target companies acquired partly paid-up shares in another company (Strip Co) at a time when a call had been made for the unpaid amount, and the target companies paid those calls. Following the payment of the calls, the rights attaching to the shares were altered to essentially strip the value of the shares (converting them to B Class shares). The result was an increase in the value of the other (now A Class) shares which were held by another company (A Class Shareholder), on trust for the shareholder of the target companies. Strip Co loaned the call amounts to the A Class Shareholder.

365    When considering the application of the second limb of s 177E(1)(a) in Lawrence First Instance, the primary judge undertook an analysis of the financial statements of the target companies (Plaster Plus and Zinkris) in that case. The primary judge in Lawrence First Instance found (at [25]–[26]) that, as at 30 June 2002, Plaster Plus had taxed undistributed accumulated profits of $1,328,924. In the accounts of Plaster Plus for the year ended 30 June 2003 (after the transactions had been carried out), an extraordinary loss of $1,698,000 was recorded in the profit and loss statement, reflecting the diminution in the value of the B Class shares. The primary judge found that for the year ended 30 June 2003, the accounts of Zinkris recorded it deriving after tax income of $1,129,999 (at [39]) and an extraordinary loss of $1,298,700, reflecting the diminution in the value of its B Class shares. In each case, the result of the scheme was to deplete substantially all of the accumulated profits of the two target companies.

366    The primary judge in Lawrence First Instance concluded at [85] that the schemes had the requisite purpose and the effect of a dividend stripping scheme:

To reach that conclusion, I did not need to look beyond the increase in value in the [Class A] shareholding … At that point the value – to use a neutral term – that started out as undistributed profits in Plaster Plus and Zinkris had become accretions to the capital of [two] trusts…

367    The decision of the primary judge was upheld on appeal: Lawrence FFC. The Full Court at [52(2)] considered the transactions to be “paradigm examples of a scheme to which the second limb [of s 177E(1)(a)] was intended to apply”.

368    Dividend stripping also generally involves the recipient of the profits (or the value of the profits) of the company not being subject to substantial tax on those profits. As the Full Court in CPH FFC observed at [159], a “critical” aspect of a dividend stripping operation is that the vendor shareholders (or their associates) receive consideration in a “largely tax-free form”. The consideration may be largely free from tax because it is sheltered by a tax offset or tax loss or because the shares sold by the vendor shareholder were acquired prior to the introduction of capital gains tax.

369    By contrast, if the recipient of the value of the profit pays tax at the same or greater rate as that which the pre-existing shareholder would have been liable to pay on the distribution, the scheme does not have substantially the same effect as a scheme by way of or in the nature of dividend stripping. We agree with the observations of the Full Court in CPH FFC at [163] that the fact that the vendor shareholders in that case reported a significant assessable capital gain by reason of the sale of their shares suggested that the scheme would not fall within the first limb of s 177E(l)(a). So too, where the recipient of the capital proceeds is an associate of the pre-scheme shareholder in the target company, and the associate of the pre-scheme shareholder reports a significant assessable capital gain by reason of the receipt of a capital sum, suggests that the scheme does not fall within the second limb of s 177E(l)(a).

370    The existence of a scheme having substantially the effect of a scheme by way of, or in the nature of, dividend stripping, cannot be ascertained without taking account of the tax payable by the recipient of the capital proceeds. Merely pointing to the conversion of accumulated profits to a capital sum is not sufficient. Whilst the Full Court in Lawrence FFC made an obiter observation at [44] that “the methods of calculating capital gains inevitably lead to a lower amount of tax”, the conversion of an amount of profits that would otherwise be distributable as a fully franked dividend into an increased capital gain will not in all circumstances inevitably lead to a lower rate of tax or a lower amount of tax.

Effect of the Debt Forgiveness Schemes

371    What was the effect of the schemes in the present case? As the primary judge recognised (at PJ [478(1)]) there are two distinct schemes to be considered: the GSM Debt Forgiveness Scheme and the Tironui Debt Forgiveness Scheme. Each is required to be considered separately because by its terms s 177E(1)(a) applies to a scheme “in relation to a company” (emphasis added).

372    The primary judge considered that the effect of each of the GSM and Tironui Debt Forgiveness Schemes was to be determined without regard to the effect of the s 177D Determination. The primary judge reasoned (at PJ [488]) that:

ss 177D and 177E operate according to their terms. In a situation such as the present, one determines whether s 177E applies in relation to the events (the “scheme”) which in fact occurred. The scheme included the BBG Share Sale resulting in the crystallisation of the capital loss. One does not determine whether s 177E applies on the basis of events which did not occur.

373    We do not accept that reasoning in so far as it relates to determining the effect of a scheme. Whilst purpose looks to the intended outcome, the effect looks to the outcome in fact produced by the scheme. In other words, purpose has a prospective connotation whereas effect is evaluated with the benefit of hindsight. The Commissioner made a determination under s 177F(1)(c) to cancel the capital losses incurred by the MFT on the transfer of the BBG shares because s 177D was satisfied. The effect of that s 177D Determination made under s 177F(1)(c) was that the capital loss incurred by the MFT on the transfer of the BBG shares “was not incurred by the taxpayer during that year of income”. Once made, the determination had the retrospective effect of deeming the capital loss to have not been incurred. The effect of the statutory language is to deny the crystallisation of the capital loss. One cannot properly determine the effect of each of the GSM and Tironui Debt Forgiveness Schemes without having regard to the statutory effect of the s 177D Determinations that were in fact made. It follows, in our view, that in evaluating the effect of the two Debt Forgiveness Schemes, it is necessary to have regard to and take into account the effect of the s 177D Determinations.

Effect of the s 177D Determination on the MFT

374    To understand the effect of the s 177D Determinations, it is necessary to examine the capital loss position of the MFT for the year ended 30 June 2015.

375    In the present case, in respect of the year ended 30 June 2015:

(1)    The Commissioner accepted that irrespective of the debt forgiveness by each of Tironui and GSM, the MFT would have made a capital gain of $19,132,297 on the disposal of the Plantic shares (after taking into account the findings of the primary judge in relation to the value of the earn-out amounts, none of which were subject to appeal).

(2)    The Commissioner accepted that the MFT had prior and current year capital losses of $40,093,792.12 that were not attributable to the disposal of the BBG Shares (Non-BBG Capital Losses) and were available to be applied by the MFT in the year ended 30 June 2015.

(3)    The Non-BBG Capital Losses were required to be applied by the MFT to offset:

(i)    the capital gain of $19,132,297 that would otherwise have been derived on the sale of the Plantic shares even in the absence of the debt forgiveness by each of Tironui and GSM.

(ii)    capital gains of $465,805 derived by the MFT on disposals other than the disposal of the Plantic shares.

(4)    The balance of Non-BBG Capital Losses available to be applied by the MFT in the year ended 30 June 2015 was $20,495,690. This balance was not affected by the s 177D Determination.

376    It is in this context that the effect of each of the Tironui and GSM Debt Forgiveness Schemes is to be considered.

Effect of Tironui Debt Forgiveness

377    In so far as Tironui is concerned, its balance sheet for the year ended 30 June 2015 disclosed:

Retained Earnings    $4,572,067.06

Current Year Earnings    $1,759.88

Loss on Plantic loan    -$4,215,000.00

378    The effect of forgiveness of the loan made by Tironui to Plantic was to deplete substantially all the accumulated earnings of Tironui.

379    As explained above; in evaluating the effect of the Tironui Debt Forgiveness Schemes, it is necessary to have regard to and take into account the effect of the s 177D Determination which had the effect of cancelling the BBG Capital Loss.

380    As shown above, the amount of net Non-BBG Capital Losses available to the MFT after taking account of the s 177D Determination was $20,495,690. This was sufficient to entirely shelter any increased capital gain on the Plantic shares attributable to the Tironui debt forgiveness of $4,215,000. Neither the trustee nor the beneficiaries of the MFT were liable to pay tax on an amount referable to the Tironui debt forgiven amount in the year ended 30 June 2015.

381    The tax effect of the Tironui debt forgiveness was to enable the MFT (an entity associated with Mr Merchant, the shareholder of Tironui) to receive a capital sum that was free from income tax as a result of available net capital losses (even after taking account of the s 177D Determination). The amount of the debt forgiveness represented substantially all of the retained profits of Tironui. The purpose of the scheme was to enable an associate of Mr Merchant to receive capital proceeds in an untaxed form whilst relieving him of the potential liability for top up tax on a distribution of profits of Tironui. The Tironui debt forgiveness had the substantial effect of a scheme by way of or in the nature of dividend stripping.

Effect of GSM Debt Forgiveness

382    The position in respect of GSM is more complex.

383    In so far as GSM is concerned, its balance sheet for the year ended 30 June 2015 disclosed:

Retained Earnings    $218,876,141.14

Current Year Earnings    $3,664,116.45

Loss on Plantic loan    ($50,192,000.00)

384    The GSM debt forgiveness amount of $50,192,000 represented less than 25% of the retained earnings of GSM.

385    The GSM debt forgiveness amount of $50,192,000 exceeded the amount of net Non-BBG Capital Losses available to the MFT after taking account of the s 177D Determination.

386    Once account is taken of the total of:

(a)    the capital gains made by the MFT on assets other than the Plantic shares;

(b)    the capital gain that would have been made on the Plantic shares irrespective of any debt forgiveness; and

(c)    the increased capital gain on the Plantic shares as a result of the Tironui debt forgiveness of $4,215,000,

a capital loss amount of $16,280,690 remained to shelter the increased capital gain of $50,192,000 attributable to the forgiveness of the GSM loan . This left a balance of $33,912,00 taxable as part of the taxable income of the MFT in the year ended 30 June 2015.

387    On 25 June 2015, the trustee of the MFT resolved to distribute 100% of the trust’s income to GSM for the 2015 income year. No separate resolution was made addressing capital gains. The resolution of 25 June 2015 was in the following terms:

388    As a result of the operation of Div 6 of the 1936 Act, GSM is liable for tax on any capital gain made by the MFT in the year ended 30 June 2015. As a company, GSM is not entitled to a CGT discount. Any capital gain taxed in the hands of GSM is taxed at 30%. The tax payable by GSM as a result of the debt forgiveness of its own loan is in the vicinity of $10,173,600.

389    If a fully franked dividend had been paid by GSM in the amount of $50,192,000 to Mr Merchant in the year ended 30 June 2015, Mr Merchant would have been liable for tax on the dividend amount at the effective rate of 27.1%, being approximately $13,602,000. (The 27.1% takes account of the fact that a fully franked dividend is grossed up by the franking credit of 30% with a tax offset for the 30% company tax paid and the fact that in the year ended 30 June 2015, the top marginal rate was 49% inclusive of Deficit Reduction Levy.) There was evidence that GSM had sufficient franking credits to fully frank such a dividend.

390    Because companies are not entitled to the CGT discount, as a general practice (and subject to sufficient flexibility being conferred by the governing trust deed), net capital gains are distributed by trustees of discretionary trusts to individual beneficiaries and not distributed to corporate beneficiaries. The resolution made by the trustee of the MFT in the year ended 30 June 2015 to distribute all the trust income to GSM reflects the fact that the trustee expected no net capital gain to be derived by the MFT in that year.

391    The appellant’s submission that GSM’s retained earnings will be increased by the amount of the capital gain on which it is assessed is not supported by the evidence and appears premised on an unfounded assumption that under Div 6 of the 1936 Act trust income necessarily equates to tax law income of the trust. GSM received a distribution of the former but was taxable by reference to the latter (a circumstance recognised in Commissioner of Taxation v Bamford [2010] HCA 10; 240 CLR 481 at [36]–[39] (French CJ, Gummow, Hayne, Heydon and Crennan JJ)). Although GSM was liable to income tax on the capital gain, the evidence does not establish that GSM was entitled to receive a distribution of the amount of the capital gain because no resolution was passed to distribute the capital gain as income of the trust or to separately distribute the capital gain. On the evidence, GSM is thus rendered liable to tax on an amount which it did not have an entitlement to receive.

392    The debt forgiveness by GSM represented about 25% of the accumulated profits of GSM.

393    The capital gain made on the MFT’s sale of the Plantic shares attributable to the GSM debt forgiveness is taxed in the hands of GSM (as the beneficiary of the MFT presently entitled to the income of that trust) in the year ended 30 June 2015 at a higher rate than the effective rate of tax than would have been payable by Mr Merchant on a fully franked dividend paid out of those accumulated profits in that income year. As a result of the cancellation of the BBG Capital Loss, significant tax is to be paid by GSM on that resulting capital gain.

394    The scheme identified by the Commissioner was formulated by the advisors to the Merchant Group on the premise that the BBG Capital Loss existed and had as its first step the incurrence of the BBG Capital Loss. The scheme did not operate as intended because of the cancellation of those BBG Capital Loss. In the totality of the circumstances, as a result of the cancellation of the BBG Capital Loss, the GSM Debt Forgiveness Scheme does not have the substantial effect of a scheme by way of or in the nature of dividend stripping.

395    Had the scheme operated as intended and the capital gain attributable to the debt forgiven amount been wholly or substantially offset by capital losses, a different conclusion may have been reached. Contrary to the submissions of the appellant, a scheme can have the substantial effect of dividend stripping notwithstanding that it is possible (but not certain) that tax may be payable on the capital sum in some future period by some unidentified associate of the pre-scheme shareholder: Federal Commissioner of Taxation v Michael John Hayes Trading Pty Ltd [2024] FCAFC 80; 303 FCR 62 (at [40] (Bromwich, Thawley and Hespe JJ)).

Conclusion regarding s 177E

396    The primary judge considered that s 177E did not require a complete, or a substantially complete, avoidance of tax (PJ [497]). The primary judge reasoned:

Section 177E is capable of applying where the tax avoidance purpose is to avoid the higher tax which would have been payable on dividends, albeit a lower amount of tax is still payable as a result of the scheme. One of the central stated purposes of the structure of the Plantic share sale was to avoid tax on dividends from GSM, achievable “because the debt forgiveness on the loans reduces top up tax payable by [Mr Merchant] on getting cash out of GSM”…

397    The difficulty with that reasoning is that it conflates effect with purpose. Where a scheme operates as intended, the extent of tax avoided can form part of the objective circumstances taken into account in forming a conclusion about the dominant purpose of the scheme. However, where a scheme does not operate as intended, the conclusion as to dominant purpose concerns the intended effect of the scheme. The actual effect of the scheme is a distinct consideration in reaching a conclusion about the substantial effect of the scheme. By his reasoning, and perhaps reflective of the submissions made to him, his Honour conflated a consideration of purpose with the consideration of effect. In so doing his Honour erred.

398    As explained above, and as reflected in the Commissioner’s identification of the Debt Forgiveness Schemes, those schemes were formulated on the understanding and expectation that the capital gain to be made on the sale of the Plantic shares would be sheltered by capital losses. The Debt Forgiveness Schemes had the relevant tax avoidance purpose. However, as a result of the cancellation of the BBG Capital Loss, the intended outcome was not achieved. Indeed, it is unlikely that the Debt Forgiveness Schemes would have been carried out in the way they were in fact carried out had the parties expected the BBG Capital Loss to have not existed.

399    As explained above, s 177E is not engaged merely because some potential tax saving on a dividend can be identified. The history of dividend stripping and its core characteristics have quantitative elements. Those quantitative elements are an integral part of the substantial effect of a scheme by way of or in the nature of dividend stripping.

400    In the present case, for the reasons explained above, and once account is taken of the cancellation of the BBG Capital Loss by reason of the s 177D Determination, those quantitative elements are satisfied in respect of the Tironui Debt Forgiveness Scheme. The Tironui Debt Forgiveness Scheme had the substantial effect of a scheme by way of or in the nature of dividend stripping.

401    The effect of the debt forgiveness was to transfer value from the target companies (GSM and Tironui) to the MFT and by the sale of the Plantic shares and crystallise that transferred value in the form of an increased capital gain (cf PJ [505]). In the case of the value transferred from Tironui, that value was sheltered entirely by capital losses and not subject to tax in the hands of any of the trustee of the MFT, GSM (as the beneficiary made presently entitled to the income of the MFT) or Mr Merchant. In the case of the value transferred from GSM, that value was only partly sheltered by capital losses and the balance subject to tax in the hands of GSM (as the beneficiary made presently entitled to the income of the MFT) at a rate higher than if the accumulated profits had been distributed to Mr Merchant as a fully franked dividend.

402    The quantitative elements of dividend stripping are not satisfied in respect of the GSM Debt Forgiveness because, taking account of the cancellation of the BBG Capital Loss, the GSM Debt Forgiveness did not have the effect of the avoidance of a substantial liability to tax on a substantial proportion of the balance of the accumulated profits of GSM. The amount of the loan forgiven by GSM represented less than 25% of the accumulated profits of GSM. The effect of the cancellation of the BBG Capital Loss was to subject an amount equal to a substantial proportion of the debt forgiven amount to tax at a higher rate than would have been payable by Mr Merchant had he received a fully franked dividend from GSM (and in fact GSM had the available franking credits to fully frank that dividend).

403    The primary judge was correct (at PJ [460]) in observing that: “[w]hilst at least some deviation from the paradigm is permissible to fall within the second limb, the scheme must always involve a dominant tax avoidance purpose…it is always necessary to examine the substantial effect of the scheme, this being the central inquiry under the second limb, and it is always necessary to compare that effect with the effect of a scheme in the nature of dividend stripping in order to reach a conclusion about whether the effect of the scheme being considered is substantially the same as the effect of a scheme by way of or in the nature of dividend stripping.” Where we differ from his Honour is in the assessment of the substantial effect of a scheme in the nature of dividend stripping and the comparison of the effect of the two schemes in question here.

404    The Commissioner submitted that s 177E should not be construed as requiring a substantially complete avoidance of tax because “s 177F(1) empowers the Commissioner to determine that either the whole or part of the assessable income of the tax benefit be included in the taxpayer’s assessable income”. A similar contention was accepted in Futuris Corporation Ltd v Federal Commissioner of Taxation [2010] FCA 935 at [85] in the context of the application of s 177D.

405    Where s 177E(1) applies, ss 177E(1)(f) and (g) deem the relevant taxpayer to have obtained a tax benefit in an amount equal to the notional amount. Section 177F(1)(a) permits the Commissioner in his discretion to determine that part only of an amount which is the tax benefit obtained by the taxpayer under the scheme may be disallowed by the Commissioner: Commissioner of Taxation v Sleight [2004] FCAFC 94; 136 FCR 211 at [114], Hill J.

406    The existence of the scheme and the obtaining of the tax benefit are posited in s 177F(1) as objective facts: Commissioner of Taxation v Peabody [1994] HCA 43; 181 CLR 359 at 382. The existence of a scheme to which s 177E applies is to be determined by the criteria set out in s177E(1)(a) to (d). Whether a scheme has the substantial effect of a scheme by way of or in the nature of dividend stripping for the purposes of s 177E(1)(a)(ii) is to be determined by reference to the effects of a dividend stripping scheme. We do not consider that the discretion under s 177F(1) results in the GSM Debt Forgiveness Scheme in the present case having the substantial effect of a scheme by way of or in the nature of dividend stripping. The effects identified above are not consistent with the effect of a scheme by way of or in the nature of dividend stripping, even on a broad construction.

407    The implication in the Commissioner’s contention that s 177F(1)(a) ameliorates unfairness is hardly reflected in the facts of this case. The discretion under s 177F(1)(a) is exercised at the time of the making of the determination and is to be reflected in the assessment to give effect to that determination. On the facts here, the Commissioner determined the whole of the notional amount (to be included in the assessable income of GSM) and no consideration was given to whether only part of the notional amount ought to be included in the taxpayer’s assessable income. Both sides argued this case on an “all or nothing” basis, that is, that either the whole amount of the debt forgiveness was assessable or none of it was.

408    The Commissioner also submitted that s 177E should not be construed as requiring a “complete or substantially complete” avoidance of tax because s 177F(3) empowers the Commissioner to make compensatory adjustments.

409    This submission is not accepted for the reasons given above.

410    The primary judge acknowledged that his conclusions that both ss 177D and 177E applied in the present case resulted in unfairness but considered that s 177F(3) has a potential role to play once it is appreciated that the BBG Share Sale Scheme (which gave rise to the BBG Capital Loss) was part of or interrelated with the two Debt Forgiveness Schemes: PJ [490]. It is of concern that neither party raised the potential application of s 177F(3) in their submissions prior to the issue being agitated by the Court below. Before us, the Commissioner conceded that the outcome of the decision of the primary judge (which upheld both the s 177E Determinations and the s 177D Determinations) was not “fair and reasonable” but declined to articulate what, if any, s 177F(3) compensating adjustments were contemplated. That position is of concern when one appreciates that the assessments giving effect to those determinations relate to income tax years ending nearly a decade ago.

TAXATION OF FINANCIAL ARRANGEMENTS (TOFA)

Overview

411    The TOFA Proceedings concern the income years ended 30 June 2017 and 30 June 2018 and concern the application of the TOFA Provisions to the MFT’s rights under the SSA to receive components of the Milestone Amounts, which expired without the conditions to the MFT becoming entitled to receive payment of those amounts being satisfied. If the TOFA Provisions apply to those expired components of the Milestone Amounts, the MFT is entitled to a deduction for those expired components. It appears to have been common ground that if the TOFA Provisions do not apply, the MFT is instead entitled to a capital loss.

412    A subsidiary issue concerns the timing of a deduction if the TOFA Provisions do apply. The timing issue is if the TOFA Provisions apply, whether the deduction arises in the 2017 and 2018 year or in a later income year. In this case, this issue of timing depends upon whether the rights to receive each component of the expired Milestone Amounts is a separate financial arrangement (in which cease the deduction would arise in the year the rights to each component expired) or whether the rights to receive the components of the expired Milestone Amounts are a single financial arrangement (in which case the deduction would arise only once all the rights to receive the components of the Milestone Amounts have expired).

Expired Rights to Milestone Amounts

413    The rights to Milestone Amounts under the SSA were described by the primary judge at PJ [578]–[588]. The primary judge also described the Earn-Out Amounts provided for in the SSA at PJ [590]–[591].

414    The TOFA Proceedings concerned the expired rights to Milestone Amounts (set out at PJ [594]). The Milestone Amounts are more readily understood when considered in pairs:

(1)    CY15 Australasian Sales Milestone and CY16 Australasian Sales Top-Up Milestone.

The CY15 Australasian Sales Milestone required a sales target of 3,724MT in Australasia to be met, by 31 December 2015 and, if not achieved in that year, in the following year via the CY16 Australasian Sales Top-Up Milestone. If achieved, the amount payable would either be $3.4 million (if Kuraray had approved the capital expenditure required so as to make the USD $5 million Extrusion Coating Milestone capable of being achieved) or USD $5.1 million (if Kuraray had not approved such expenditure – in which case part of the amount of the USD $5 million Extrusion Coating Milestone was effectively added to the first Australasian Sales Milestone). The Extrusion Coating Milestone was met on 30 September 2016.

As neither sales target was met in CY15 or CY16, Mr Merchant contended that the right to receive the CY15 Australasian Sales Milestone Amount expired on 31 December 2016, in the 2017 financial year.

(2)    CY16 Australasian Sales Milestone and CY17 Australasian Sales Top-Up Milestone.

The CY16 Australasian Sales Milestone required a sales target of 5,134MT in Australasia to be met by 31 December 2016 and, if not achieved in that year, in the following calendar year by meeting the CY17 Australasian Sales Top-Up Milestone. If achieved, the amount payable would be USD $5 million.

As the sales target was not met in either CY16 or CY17, Mr Merchant contended that the right to earn the CY16 Australasian Sales Milestone Amount expired on 31 December 2017, in the 2018 financial year.

(3)    CY16 International Sales Milestone and CY17 International Sales Top-Up Milestone.

The CY16 International Sales Milestone required a sales target of 3,100MT (excluding Australia and certain overseas jurisdictions) to be met by 31 December 2016 and, if not achieved in that year, in the following year by the CY17 International Sales Top-Up Milestone. As the sales target was not met in either CY16 or CY17, Mr Merchant contended that the right to earn the CY16 International Sales Milestone Amount expired on 31 December 2017, in the 2018 financial year.

(4)    CY15 J&G Foods Sales Milestone and CY16 J&G Foods Sales Top-Up Milestone.

The CY15 J&G Foods Sales Milestone required a sales target of 100MT to be met by 31 December 2015 and, if not achieved in that year, in the following year via the CY16 J&G Foods Sales Top-Up Milestone. As the relevant target was not met in CY15 or CY16, Mr Merchant contended that the right to receive the CY15 J&G Foods Sales Milestone Amount expired on 31 December 2016, in the 2017 financial year.

Legislative Context

415    The legislative context is set out at PJ [608]–[623]. To that summary we add the following.

416    The operative provision is relevantly, s 230-15(2) of the 1997 Act:

Losses

 (2)     You can deduct a loss you make from a *financial arrangement, but only to the extent that:

(a)     you make it in gaining or producing your assessable income; or

(b)     you necessarily make it in carrying on a *business for the purpose of gaining or producing your assessable income.

Note:     This Division does not apply to losses that are subject to exceptions under Subdivision 230-H.

417    To be entitled to a deduction under s 230-15(2), the loss must be from a “financial arrangement”. That term takes its meaning from s 230-45:

230-45 Financial arrangement

(1) You have a financial arrangement if you have, under an *arrangement:

(a) a *cash settlable legal or equitable right to receive a *financial benefit; or

(b) a cash settlable legal or equitable obligation to provide a financial benefit; or

(c) a combination of one or more such rights and/or one or more such obligations;

unless:

(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and

(e) for one or more of the rights and/or obligations covered by paragraph (d):

(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii) the right or obligation is not cash settlable; and

(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

Note 1: Whether your rights and/or obligations under an arrangement constitute a financial arrangement can change over time depending on changes either to the terms of the arrangement or external circumstances (such as particular rights or obligations under the arrangement being satisfied by the parties). For example, a contract may provide for the transfer of a boat in 6 months time and payment of the contract price at the end of 2 years. Until the boat is delivered, there is no financial arrangement because of the operation of paragraphs (d), (e) and (f) above. Once the boat is delivered, there is a financial arrangement because those paragraphs are no longer applicable.

…

418    The term “financial benefit” is defined in s 995-1 to have “the meaning given by section 974-160”. Section 974-160 is set out at PJ [614]. Notably, that section commences with “In this Act”. It thus provides a definition of general application throughout the 1997 Act. The definition is very wide, extending to anything that is of economic value.

419    As the primary judge explained, there are grouping rules which determine whether a number of rights and/or obligations constitute a single arrangement or two or more separate arrangements. These are set out in s 230-55(4).

420    Relevantly, the TOFA Provisions do not apply to gains and losses from a financial arrangement to the extent that rights and/or obligations under the arrangement are the subject of an exception in Sub-div 230-H. The relevant exception was that provided for in s 230-460(13) which at the relevant time was in the following terms:

Proceeds from certain business sales

A right to receive, or an obligation to provide, *financial benefits arising from the sale of:

(i)    a business; or

(ii)    shares in a company that operates a business; or

(iii)    interests in a trust that operates a business;

is the subject of an exception if the amounts, or the values, of those benefits are contingent only on the economic performance of the business after the sale.

Does an exception to Div 230 apply?

421    The first issue for determination is whether the exception from Div 230 applies in relation to the losses from the expired rights to Milestone Amounts. As the primary judge observed (at PJ [627]) if an exception applies, it is unnecessary to determine any of the following issues raised by the Commissioner’s notice of contention:

(i)    Whether the losses from the expired rights to Milestone Amounts were losses made from a financial arrangement; and

(ii)    If one or more of the losses were made from a financial arrangement whether there was more than one financial arrangement.

422    The primary judge (at [627]) found that the exception in s 230-460(13) (as it stood prior to 31 March 2015) applied to all of the expired rights to Milestone Amounts. The parties had accepted that the rights to the Milestone Amounts arose from the sale of shares in a company that operates a business. The primary judge (at [641]) found that the exception was engaged because “the amounts, or the values, of those benefits are contingent only on the economic performance of the business after the sale”.

423    The reasoning of the primary judge on this issue is set out at PJ [638] – [642]:

[638]     The words “contingent only on the economic performance of the business after the sale” mean what they say. The phrase “economic performance” is not the same as, or equivalent to, the word “profitability”. Profitability is one way to measure the success or otherwise of a business’s “economic performance”, but “economic performance” refers to a business’s performance, not its profitability.

[639]     If the legislature had wanted to limit the exception to profitability, it could have done so by using the phrase “contingent only on the profit of the business after sale”.

[640]     It is clear enough that the exception was intended to address, amongst other things, earn-out arrangements. These are commonly structured by reference to performance of the business other than by way of profit. Earn-out arrangements might be structured, for example, by reference to numbers of clients retained or gained or volume of sales. These are both appropriately described as matters of “economic performance”. They are indicators of performance or profitability and are commonly used because they do not turn on choices that the incoming purchaser might make about business operations or the cost of sales being matters which affect profitability.

[641]     The Milestone Amounts were contingent only on sales volumes. They were contingent only on the economic performance of the business after the sale. Each of the rights said to have expired was a right contingent only on the economic performance of the Plantic business after the sale, and so is within the exception set out in s 230-460(13). It does not matter that the contingency (volume of sales) does not also factor in the cost of sales such that the contingency is not one which calculates profit.

[642]     It is true that the amount to be paid in respect of the Australasian sales milestones and the milestones for J&G Foods and Valley Fine Foods was affected by whether or not the Extrusion Coating Milestone was met (which it was not), but that does not mean that the rights which expired were relevantly contingent on anything other than the economic performance of the Plantic business after the sale. The Extrusion Coating Milestone was not a contingency which affected whether or not the sales milestones were payable. And, in any event, it was appropriately classified as a contingency about economic performance.

424    Mr Merchant contends that the primary judge erred in concluding that the exception in s 230-460(13) was engaged. In particular, Mr Merchant contends that the primary judge made two errors.

425    First, Mr Merchant contends that the primary judge erred in his construction of the expression “contingent only on the economic performance of the business” in s 230-460(13) by failing to ascribe that expression a meaning “informed by the meaning of the expression contingent on the economic performance” as defined in s 974-85(1).

426    Section 974-85(1) provides:

974-85 Right or return contingent on economic performance

 (1)     A right, or the amount of a return, is not contingent on the economic performance of an entity, or a part of the entity’s activities, merely because the right or return is contingent on:

 (a)     the ability or willingness of an entity to meet the obligation to satisfy the right to the return; or

 (b)     the receipts or turnover of the entity or the turnover generated by those activities.

427    Mr Merchant contends that when informed by s 974-85(1), the expression “contingent only on the economic performance” of the business does not extend to contingencies based on sales volume because such a contingency is one based on receipts or turnover. It was submitted that the expression “contingent only on the economic performance” should be taken to refer to a contingency based only on profitability.

428    Second, Mr Merchant contends that the primary judge erred because the expired rights were each a right to payment of a fixed sum. It follows that it could not be said that “the amounts, or the values, of” the benefits payable were relevantly contingent.

429    We do not accept that the primary judge erred in the manner contended for by Mr Merchant.

430    In relation to Mr Merchant’s first contention, at the relevant time, s 974-85 defined the expression “contingent on the economic performance”. At the relevant time s 230-460(13) did not use the expression “contingent on the economic performance”. Most defined terms in the 1997 Act are identified by an asterisk appearing at the start of the term: s 2-10(2). No asterisk appears in s 230-460(13). Defined terms not identified with an asterisk are set out in s 2-15(2). The expression “contingent only on the economic performance” did not appear in that section.

431    The fact that Div 974 and Div 230 of the 1997 Act were enacted as different stages of tax reform, described in the report titled Review of Business Taxation: A Tax System Redesigned (July 1999) under a general rubric of taxation of financial arrangements, does not require that differences in the language of Div 230 and Div 974 be ignored. Division 974 was directed at the test for distinguishing between debt interest and equity interests. Division 230 concerns the timing and characterisation (as revenue rather than capital) of financial arrangements. Where Div 230 engages defined terms from Div 974 it does so expressly (by the convention of using the asterisk).

432    The expression “contingent only on the economic performance” when it was used in s 230-460(13) bore its ordinary meaning. The primary judge did not err in concluding (at PJ [640]) that the volumes of sales made by a business in a particular geographic region is one indicator of the economic performance of the business. Economic performance may be measured in different ways and for different purposes. It is not limited to accounting concepts of net profit or gross profit or a variation to those concepts. Sales volumes can be a measure of economic performance because, for example, it may be a measure of the strength of demand for the products or services of the business.

433    The value of some of the expired rights to Milestone Amounts were affected by whether Kuraray had approved the capital expenditure required so as to make the Extrusion Coating Milestone capable of being achieved. The primary judge found at PJ [642] that:

It is true that the amount to be paid in respect of the Australasian sales milestones and the milestones for J&G Foods and Valley Fine Foods was affected by whether or not the Extrusion Coating Milestone was met (which it was not), but that does not mean that the rights which expired were relevantly contingent on anything other than the economic performance of the Plantic business after the sale. The Extrusion Coating Milestone was not a contingency which affected whether or not the sales milestones were payable. And, in any event, it was appropriately classified as a contingency about economic performance.

434    The last sentence of this paragraph was not the subject of separate submissions. The primary judge had found that the Extrusion Coating Milestone had been met and that the amount of USD $5 million had been paid (at PJ [593]). Mr Merchant’s grounds of objection for the year ended 30 June 2017 stated (at [3.57]) that “[t]he rights related to the schedule 9 amounts that were satisfied/expired during the year ended 30 June 2017 were contingent on Plantic achieving specified sales (in metric tonnes) of particular products” and (at [3.59]) that “turnover is the sole contingency”.

435    We have proceeded on the basis that at the time of their expiry, the only contingency related to sales turnover. The loss was claimed to have been incurred at the time of expiry of the right. As is recognised in note 1 to s 230-45 (notes forming part of the 1997 Act: s 950-100), rights and obligations can change over time. At the time the loss arose, the only contingency was based on the economic performance of the business being volume of sales. Mr Merchant’s first contention is not accepted.

436    Mr Merchant’s second contention focusses on the requirement in s 230-460(13) for “the amounts, or the values, of those benefits” to be relevantly contingent. Mr Merchant’s contention is that that requirement is not satisfied if the contingency relates to the right to receive a fixed amount.

437    Mr Merchant did not seek to rely upon the use of the plural (“amounts” or “values”). Grammatically, the use of the plural is explained by the reference in that sub-section to “financial benefits” (also in the plural).

438    The Commissioner contends that the amount or value of the financial benefit is contingent if the amount to be received as a financial benefit is binary (in the sense that either a fixed nominated sum is received or an amount of zero is received).

439    The Commissioner’s contention is accepted. It is sufficient for the exception in s 230-460(13) that the payment of an identifiable sum is contingent upon the economic performance of the underlying business, regardless of whether the sum to be paid on satisfaction of the contingency is variable. The value of the right is contingent if a fixed sum is payable upon satisfaction of the contingency or nil if the contingency is not satisfied.

440    Because the exception to Div 230 is engaged, it is unnecessary to consider the issues raised by the Commissioner’s notice of contention.

CONCLUSIONS

441    For the reasons set out above:

(1)    The appellants’ appeal grounds in respect of s 177D are not made out.

(2)    The appellants have established that the primary judge erred in respect of the application of s 177E in relation to the GSM Debt Forgiveness but not in relation to the Tironui Debt Forgiveness.

(3)    The appellants’ appeal grounds in relation to the application of Div 230 are not made out. It is unnecessary to determine the issues raised by the Commissioner’s notice of contention.

442    Notwithstanding that three separate sets of orders were made in respect of separate proceedings relating to different taxpayers, different issues and different years of income, a single notice of appeal was filed. This is not a practice to be encouraged.

443    The fact that there were separate proceedings before the primary judge and three separate sets of orders made, but a single notice of appeal filed, makes the framing of orders on appeal particularly difficult. The parties should confer with a view to agreeing orders to give effect to these reasons and provide the Court with a short minute of order including any agreement as to costs within 14 days. Failing agreement, the parties are to file their competing submissions (not exceeding three pages) and subject to any further order, final orders will be made on the papers.

Associate:    

Dated:    22 April 2025