On 9 June 2023, the Full Federal Court handed down its decision in B&F Investments Pty Ltd as trustee for the Illuka Park Trust v FCT [2023] FCAFC 89 (BBlood). BBlood was the result of the taxpayer appealing the decision of Thawley J in BBlood Enterprises Pty Ltd v FCT [2022] FCA 1112 that we wrote about here.
In BBlood the taxpayer unsuccessfully argued against the decision of Thawley J at first instance that section 100A of the Income Tax Assessment Act 1936 applied to a set of transactions in the 2014 income year. Thawley J also held that the transactions were a dividend stripping operation within the meaning of section 207-155 of the Income Tax Assessment Act 1997. The taxpayer was successful in its appeal on the dividend stripping aspects, albeit on a technical not substantive basis.
This article focuses on the section 100A aspects.
What was BBlood about?
BBlood concerned a buy-back in the 2014 income year of shares in a company (IP Co) owned by a discretionary trust (IP Trust). The issues arose because of the difference in treatment of the proceeds of the buy-back for income tax purposes and for trust law purposes.
The facts in BBlood can be summarised as, in the 2014 income year:
the IP Trust received ordinary income of approximately $300,000;
the IP Trust deed was varied to change the definition of income to relevantly mean the income of the IP Trust determined by the trustee according to ordinary concepts;
a newly incorporated beneficiary (BE Co) was made presently entitled to the income of the IP Trust;
IP Co bought back the shares held in it by the IP Trust. The proceeds of the buy-back (about $10 million) paid by IP Co to IP Trust were a dividend for tax law purposes (deemed dividend) but not for trust law purposes; and
IP Trust made BE Co presently entitled to all the IP Trust’s trust law income.
These are referred to in BBlood as the Illuka Park Steps.
The consequence of BE Co being presently entitled to the trust income was that it was assessed on the trust’s net (tax) income of $10.3 million, which included the deemed dividend. The tax payable by BE Co in relation to the deemed dividend was offset by the franking credits attached to that dividend.
Because the buy-back proceeds were not income of the IP Trust according to ordinary concepts, the IP Trust retained the buy-back proceeds that were treated as an accretion to corpus.
Absent the application of section 100A, the IP Trust was not assessed on the deemed dividend treated as an accretion to corpus.
At first instance, Thawley J held that:
section 100A applied; and
in the alternative, the transactions were a dividend stripping operation.
The taxpayer appealed on both counts with the Full Court holding that:
Thawley J’s conclusion that section 100A applied was correct; and
because section 100A applied, the appeal on the dividend stripping aspects should be allowed (although it was not necessary to consider whether the transactions were a dividend stripping operation).
What did the Full Court consider?
In extremely broad terms, section 100A applies when:
a beneficiary is made presently entitled to trust income;
there was an agreement that another person (usually another beneficiary or the trustee) gets a benefit attributable to that trust income;
a purpose of the agreement was someone paying less (or no) tax (subsection 100A(8)); and
the agreement was not “entered into in the course of ordinary family or commercial dealing.”
In BBlood, on appeal, there was no dispute that that the Iluka Park Steps constituted an agreement and neither that agreement nor the agreement to implement those steps was an agreement “entered into in the course of ordinary family or commercial dealing”.
Therefore, the sole issue for discussion related to subsection 100(8) - purpose of paying less tax - which is awkwardly drafted in a series of negatives.
The Full Court made the following observations about subsection 100A(8):
the task under subsection 100A(8) is not of identifying the effect of an agreement; it is one requiring a view about the purposes of a person (at paragraph 43);
the time at which the relevant purpose is to be ascertained is the time of entry into the agreement (at paragraph 43);
subsection 100A(8) will be satisfied if the proscribed purpose is one of the purposes of a party – there is no requirement that the proscribed purpose be the sole or dominant purpose (at paragraph 43);
the parties to the agreement are the parties to the understanding for the payment of money to a person other than the beneficiary. Advisors formulating and implement the arrangement with the knowledge and assent of the controllers of the entities who are parties to the agreement are themselves parties to the agreement (see paragraph 44);\
it is not part of the statutory task to establish what the parties to the agreement would have done if the agreement had not been entered into (see paragraph 46);
ascertaining purpose in this context does not require or dictate an inquiry as to certainty of an outcome, consequence or effect (see paragraph 48);
the relevant purpose is that a party intends that, by entering into the agreement, someone is liable to pay less tax or no tax. Whether that intention would in fact be realised is not the point (see paragraph 49);
because the enquiry is to the purpose of a party, the party’s understanding of the effect of the arrangement is relevant to the statutory task, regardless of whether that party’s understanding may be objectively assessed as correct, particularly with the benefit of hindsight (see paragraph 49);
simply pointing to another means to achieve the same commercial objective does not, of itself, address the statutory question (see paragraph 51);
the taxpayer bears the onus of demonstrating that the assessment is excessive and would ordinarily discharge their onus of proving that a party to an agreement did not have a proscribed purpose by showing what the purpose of a party entering into the agreement in fact was (see paragraph 53); and
relevant to the consideration of a party’s purpose in entering into an arrangement is a consideration of how that arrangement marries with the historical behaviour of the parties. Arrangements which involve departures from historical patterns of behaviour without commercial justification and which departures contribute to an expected tax outcome can support a conclusion as to the purpose of a party in entering into the arrangement (see paragraph 56).
In applying the law to the facts, the Full Court concluded that a party, and in particular one of the advisors, entered into the arrangement for a purpose of ensuring that the retained earnings of IP Co could be distributed to and retained by the IP Trust without paying tax. Therefore, section 100A applied.
But what about the Explanatory Memorandum?
The Full Court did not refer to the Explanatory Memorandum introducing section 100A. However, the Full Court did say that “[f]rom the outset, it needs to be recognised that it is the text of s 100A which must be construed. Extraneous material cannot and must not be a substitute for the statutory text.” Similarly, “[t]he mere fact that s 100A can be characterised as a specific anti-avoidance provision does not demonstrate that it should be given a narrower construction than its ordinary meaning and grammatical sense suggest.”
This coupled with the comments by Thawley J at first instance (see here) and Logan J at first instance in Guardian AIT Pty Ltd ATF Australian Investment Trust v FCT [2021] FCA 1619 (see here), must mean that beginning to argue against section 100A, based on the ‘policy’ in the Explanatory Memorandum, if it has not passed its ‘use by’ date, is rapidly approaching that date.
The purpose of advisors
The Full Court in BBlood held that the purpose of advisors can be relevant for the statutory test under subsection 100A(8) where “advisers formulating the documentation and implementing the arrangement with the knowledge and assent of the controllers of the entities who were parties to the transactions are themselves parties to the reimbursement agreement”.
This was different to FCT v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (Guardian) where the Full Court did not attribute the purpose of advisors (see here). This was because in that case, Logan J at first instance did not find that the advisors had the authority to act on behalf of the controller of the entities in Guardian.
Ordinary family or commercial dealing
Unfortunately, the Full Court in BBlood did not consider the “entered into in the course of ordinary family or commercial dealing” exception, nor did the Full Court in Guardian.
This means that the legislative concept of “entered into in the course of ordinary family or commercial dealing,” one of the key exceptions in section 100A, remains a source of limited judicial interpretation. That said, the first instance decisions of Logan J (Guardian) and Thawley J (BBlood) include useful views in interpreting the phrase:
the adjective ‘ordinary’ is used in contradistinction to ‘extraordinary’ and refers to a dealing which contains no element of artificiality. [Logan J, at paragraph 144];
the use of a corporate beneficiary does not necessarily bear the stamp of tax avoidance or is it ‘necessarily incompatible’ with an ‘ordinary family or commercial dealing.’ [Logan J, at paragraph 152];
you must look at the whether the entire agreement was ‘entered into in the course of ordinary family or commercial dealing,’ not individual steps carried out in implementing the agreement. [Thawley J at paragraph 91];
it is not sufficient to reason that, because each step in a series of connected transactions is capable of being described individually as ‘ordinary,’ therefore the whole agreement is ‘ordinary’ (Thawley J at paragraph 93);
it is up to taxpayers to ‘establish sensible commercial or family rationale’ for their steps (Thawley J at paragraph 102);
“A dealing might not be an “ordinary family or commercial dealing” if the dealing, or the agreement which arose out of the dealing, is contrived or artificial or involved more than was required to achieve the relevant objective. The fact that the objective is achieved through numerous transactions, or that the transactions are complex, is not of itself sufficient to show that the dealing is not “ordinary”. Many ordinary commercial transactions are effected by an interlocking set of documents that might be characterised as complex. Likewise, agreements entered in the course of a family dealing can be complex.
‘On the other hand, if the dealing, or the agreement which arose out of the dealing, is overly complex, involving more than is needed to achieve the relevant objective, or includes additional steps which are not necessary to achieving the objective, then the dealing might more readily be seen as not being “ordinary”.” (Thawley J at paragraphs 95 to 96).
“Read in context, the adjective “ordinary” in “ordinary family or commercial dealing” has particular work to do. It is used in contradistinction to “extraordinary”. It refers to a dealing which contains no element of artificiality. This is confirmed by reference to the relevant explanatory memorandum, where one finds reference to addressing the mischief of specially introduced beneficiaries having a fiscally advantageous status. This explanatory memorandum confirms what a reading of s 100A would suggest, which is that the section is directed to addressing, according to its terms, “trust-stripping”.” (Logan J at paragraph 144).
On this last point, Logan J did not begin with the Explanatory Memorandum. As he said, “to begin with such subjects would apt to distract from a necessary starting point, which is the text of the relevant provision.”
What does BBlood mean?
BBlood was a complex arrangement that looked to exploit the differences between trust and tax income including by varying the trust deed to influence an outcome. Perhaps, in some ways, it is no surprise that section 100A applied.
While the Full Court in BBlood was focused on subsection 100A(8), and provided additional clarity on that subsection, BBlood, at first instance but not overturned on appeal, confirmed interesting points about the scope of section 100A:
the payment that constituted the reimbursement agreement required to enliven section 100A was the actual buy-back payment received from IP Co rather than an amount relating to the present entitlement of the beneficiary of the IP Trust;
while section 100A refers to a beneficiary being ‘presently entitled to a share of the income of the trust estate’, due to differences between trust income and net (tax) income of the IP Trust, section 100A applied in BBlood to an amount that was capital under trust law concepts of income; and
(related to the previous point), that the beneficiary received the benefit of the present entitlement to the trust income, and that the reimbursement agreement arose out of the capital amount paid to the IP Trust, is not a defence to section 100A applying.
This last point is important because, in certain circumstances, it does not mean that if the beneficiary is paid the amount of the present entitlement to income, section 100A does not apply. (The Australian Taxation Office in Practical Compliance Guideline PCG 2022/2 says that in many cases payment of the present entitlement to a beneficiary is a ‘green zone’ arrangement but read the green zone exclusions in paragraph 32 carefully!)
The judgment in BBlood adds to the jurisprudence on section 100A and is welcomed given the awkward drafting of subsection 100A(8). However, even if the taxpayer in BBlood is granted special leave to appeal to the High Court, further judicial guidance on the obscure nature of the ‘ordinary family or commercial dealing’ exception to section 100A, has been left to another day.
Finally, as the Full Court held in Guardian, section 100A is not the only consideration, Part IVA can apply even when section 100A does not.
Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au
Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327 | T +61 3 9611 0105
E: dsmedley@sladen.com.au
Rob Warnock
Principal Lawyer
T +61 3 9611 0155 | M +61 419 892 115
E: rwarnock@sladen.com.au
