In a major victory for the Australian Taxation Office, the Full Federal Court has found in favour of the commissioner of taxation and held that the general anti-avoidance rules (Part IVA) applied to a scheme undertaken by several related-party entities controlled by Gordon Merchant, the founder of Billabong (BBG), a leading Australian clothing and surf wear retailer. The court also considered other tax issues, such as dividend stripping and the taxation of financial arrangements (TOFA).
This Full Federal Court decision, handed down on April 22 2025, emphasises the risks of Part IVA applying when entering into ‘wash sale’ transactions. Broadly, these transactions involve the artificial crystallisation of tax losses without a material change in the economic or beneficial ownership of the underlying assets, in order to offset taxable gains from another transaction.
The facts of the case
In 2005, Merchant Family Trust (MFT) acquired shares in a startup company, Plantic Technologies Limited (Plantic). Gordon was appointed as a director of this company. Plantic was never profitable and required substantial funding from entities within the Merchant Group. Relevantly, loans made to Plantic from within the Merchant Group comprised:
A loan from GSM Pty Ltd (GSM) of approximately A$50 million (the GSM Loan); and
A loan from Tironui Pty Ltd (Tironui) of approximately A$4 million (the Tironui Loan).
In 2011, a third-party purchaser, Kuraray, acquired all the shares in Plantic from MFT. As part of the pre-sale restructure, the GSM Loan and Tironui Loan were forgiven.
The sale resulted in MFT making a capital gain of approximately A$54 million. Prior to the Plantic sale, MFT transferred shares in BBG to the Gordon Merchant Superannuation Fund (GMSF). Gordon controlled MFT and GMSF. This sale of BBG shares crystallised a capital loss of approximately A$56 million, which was then used to offset the capital gain from the Plantic sale.
Part IVA
The commissioner’s primary contention was that the sale of BBG shares was carried out with the dominant purpose of obtaining a tax benefit for the purposes of Part IVA, as set out in Section 177D of the Income Tax Assessment Act 1936 (Cth). The tax benefit was the crystallisation of a capital loss for MFT in order to offset the capital gains from the Plantic sale.
The commissioner considered that the BBG share sale was analogous to a wash sale given that these shares were effectively transferred between entities controlled by Gordon, and ownership of these shares effectively remained in the Merchant Group, of which Gordon was the ultimate owner.
By majority, the court agreed with the commissioner’s position, and held that various facts distinguished this scheme from ordinary commercial transactions with real economic consequences. The key points that supported the application of Part IVA included the objective facts that:
The BBG shares would not have been sold to an outside party;
The effective ownership of the shares remained with Gordon;
There was an absence of need in MFT for a cash injection; and
The acquisition was contrary to the investment strategy of GMSF.
Justice Logan, who was in dissent, held that Part IVA is an objective test and the primary judge erred by conflating the subjective and objective purposes of the taxpayer. While the majority acknowledged that the primary judge did refer to the “actual” purpose of the taxpayer, they held that the primary judge did, in fact, have proper regard to the objective purpose under Part IVA.
Dividend stripping
In its classic form, dividend stripping generally involves the acquisition of controlling shares in a company, where the acquiring entity arranges for the company to declare a large dividend and subsequently sells the shares for a loss. The primary judge held that the forgiveness of the GSM and Tironui loans effectively amounted to dividend stripping schemes because they had the effect of reducing the undistributed accumulated profits of GSM and Tironui, and converting the loans to equity by increasing the value of the Plantic shares, which were not subject to tax for Gordon when sold to GMSF due to the capital losses of MFT.
The majority judges supported the primary judge’s findings in relation to the forgiveness of the Tironui Loan and held that it amounted to a dividend stripping scheme.
In contrast, the majority upheld Gordon’s appeal in relation to the larger GSM Loan. The forgiveness of this loan was held not to constitute a dividend stripping scheme because after the tax benefit/capital losses were cancelled by the commissioner after applying Part IVA, the capital gain would have been taxable in the hands of GSM at a higher rate compared with if a (franked) dividend was distributed to Gordon instead by GSM and Tironui.
The taxation of financial arrangements
Another issue considered by the court was whether losses with respect to an earnout arrangement could be deducted under the TOFA rules.
Broadly, MFT had certain rights to receive earnout amounts (the Milestone Amounts), which were contingent on certain future events, such as the achievement of sales targets. When these targets were not met and the Milestone Amounts were not payable, the taxpayer claimed a tax deduction under the TOFA rules for the lost amounts. However, if TOFA did not apply, MFT would instead be entitled to a capital loss.
The court held that the TOFA rules did not apply, due to an exception to the TOFA rules in Section 230-460(13) of the Income Tax Assessment Act 1997 (Cth) dealing with business sale proceeds. However, the TOFA exception was amended after the case, so the court’s judgement on this issue may have less relevance in subsequent years.
