Guardian: the Full Federal Court confirms Part IVA applies on round two of trust distributions

The Commissioner of Taxation (Commissioner) has been actively pursuing the application of the anti-avoidance provisions to trust structures and trust distributions. In the most recent decision, the Full Federal Court has found that the Commissioner’s secondary argument (Part IVA) was partially successful - Part IVA only applied to the distributions made in the second year (2013). Part IVA did not apply to the 2012 year. In addition, the Commissioner’s primary appeal in relation to the application of s 100A failed.

The case contains some important insights as to how the Court will approach the application of s 100A and Part IVA to structures where a corporate beneficiary was established to receive trust distributions. For the structure under consideration, the stated commercial reasons for the structure included risk mitigation, retirement planning and wealth accumulation.

The case highlights the nuances in the consideration of the eight factors in s 177D of Part IVA to a scheme. The schemes for the 2012 and 2013 years were similar, with the Full Federal Court finding that the key difference between the two years was that the manner and form of the 2012 scheme was a product of an “evolving” set of circumstances, such that it could not be said that the dominant purpose of those who entered into the 2012 scheme was to enable the taxpayer to obtain a tax benefit.

In addition, taxpayers contemplating the application of s 100A will likely find the Court’s analysis of the meaning of an “agreement” helpful, albeit that the decision does not deal with the meaning of “ordinary family or commercial dealing”.

On 24 January 2023, the Full Federal Court, in a judgement by Justice Hespe, (Justices Perry and Derrington agreeing) issued its decision in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (Guardian).

The Commissioner had assessed Guardian as trustee for the Australian Investment Trust (AIT) for the 2012 to 2014 years under s 100A and s 99A and in the alternative, made determinations under Part IVA and assessed a beneficiary of the AIT, Mr Alexander Springer.   

At first instance, Justice Logan of the Federal Court found that the taxpayer had discharged his onus of proof through a combination of evidence, both his own, that of witnesses and overwhelmingly and consistently, by reference to contemporaneous correspondence and events. 

The Commissioner did not appeal Logan J’s decisions in relation to the 2014 income year.  The Commissioner’s appeal concerned the application of s 100A for the 2013 income year only and Part IVA for the 2012 and 2013 income years.  The Commissioner contended that for the 2013 year, Guardian (as trustee of the AIT) and Mr Springer reached an understanding that Guardian as trustee would benefit from the amount of trust income of the AIT to which AIT Corporate Services Pty Ltd (AITCS) was made presently entitled and Mr Springer would ultimately benefit from that amount. According to the Commissioner, the understanding was a reimbursement agreement under s 100A. Alternatively, Part IVA applied in relation to a scheme (with the structure established in 2012) and the choice to distribute income (in 2012 and 2013).

In summary, the Full Federal Court concluded that:

• s 100A did not apply to the 2013 income year;
• Part IVA did not apply to enable the Commissioner to make a determination in relation to the 2012 income year; and
• Part IVA did apply to enable the Commissioner to make a determination in relation to the 2013 income year.  

Section 100A

On appeal, in relation to the s 100A ground, the Commissioner expressly challenged some of the findings made by Logan J, and disputed His Honour’s construction of correspondence (although the Commissioner did not challenge the credibility of the evidence). Justice Hespe accepted in part some of the challenges to the factual findings made at first instance. However, this did not ultimately assist the Commissioner in his pursuit of an application of s 100A. In order for s 100A to apply, there needed to be the existence of an “agreement” (which requires consensus and adoption) for the payment of a dividend by AITCS to the AIT as at 23 June 2013 (the date of the appointment of the net income of the AIT to Mr Springer). It was noted that, in the absence of a finding that a communication had been made to Mr Springer or his agent of a plan or recommendation prior to 23 June 2013, it was necessary to find that his advisors had authorisation to act on or behalf of AITCS and the AIT in order to conclude that there was consensus or adoption by Guardian and Mr Springer. No such finding had been made at first instance and whilst it would be concluded from the evidence that the payment of a dividend by AITCS to the AIT as at 23 June 2013 was not wholly conjectural there was no agreement within s 100A(13) for the payment of such a dividend and so no reimbursement agreement for the purposes of s 100A.

Given the finding in relation to “agreement”, the Court did not need to deal with issues of purpose and the meaning of “ordinary family or commercial dealing”.  However, the Full Federal Court did agree with the Commissioner that the mere inclusion of a corporate beneficiary as an eligible beneficiary and the fact that a distribution may be made to such a beneficiary is not sufficient to demonstrate a dealing that is not an ordinary family or commercial dealing.

Part IVA

In relation to Part IVA, the approach was to consider whether the taxpayer had obtained a tax benefit in relation to a scheme, and if so, then whether a person had entered into or carried out the scheme with the requisite dominant purpose of enabling the taxpayer to obtain the tax benefit. In doing so, the Court had regard to the existing Part IVA jurisprudence. Justice Hespe found that Part IVA did not apply to the 2012 year, but did apply to the 2013 year.

Identification of the scheme

At first instance, the Commissioner had identified, in the alternative, a broader scheme and three related narrower schemes, each of the narrower schemes focussed on one of the 2012, 2013 and 2014 income years.  Many of Justice Logan’s conclusions in relation to Part IVA appeared to the Full Court to have flowed from the manner in which the Commissioner had identified the broader scheme, including the incorporation of AITCS and its inclusion in the class of eligible beneficiaries.  On appeal, the Commissioner did not seek to rely on the broader scheme and instead focussed on the narrower 2012 related scheme and 2013 related scheme.  In relation to the 2012 related scheme, the Commissioner’s emphasis was on the steps involving the appointment of income to AITCS and the subsequent dividend paid by AITCS to the AIT, rather than on the reasons for the incorporation of AITCS and its inclusion in the class of eligible beneficiaries.       

Tax benefit

In relation to the tax benefit for the 2012 and 2013 years, Mr Springer bore the onus of satisfying the Court as to what might reasonably be expected to have occurred in the absence of the scheme. This required Mr Springer to prove that, in the absence of the scheme, he would not have received a direct distribution of unfranked income from the AIT, and what might reasonably have been expected to have occurred instead. Ultimately, the Full Court decided that the evidence showed that, absent the scheme, AITCS would:

• not have received and retained in full its present entitlement in cash; and
• nor invested the funds representing its present entitlement with the AIT.

It was not contended that in the absence of the scheme, the income would have been accumulated by the trustee. The Court noted that this was not surprising, given the evidence was that the trustee of the AIT (Guardian) had not exercised a power of accumulation in the past.

Mr Springer had not discharged his onus of satisfying the Court as to what might reasonably be expected to have happened in the absence of the scheme and so had obtained a tax benefit in each of the 2012 and 2013 income years in the form of the non-inclusion of amounts in his assessable income in those years. 

Justice Hespe noted that, with respect to the 2013 related scheme, the existence of a tax benefit is further supported by s 177CB(4). Section 177CB is a statutory directive as to how the alternative postulate for the purposes of s 177C is to be determined. Section 177CB was introduced into the Act in 2013 following cases like RCI Pty Ltd v Commissioner of Taxation [2011] FCAFC 104 (RCI) and FCT v Futuris Corporation Limited [2012] FCAFC 32 (Futuris) where the taxpayers successfully argued that there was no tax benefit because the scheme would not have been implemented (but for the tax benefit obtained) as the costs to do so, including the tax cost, were too high (RCI at [145]-[150] and Futuris at [71]).  The legislative response to these cases included, at s 177CB(4), a directive that in determining whether a postulate is a reasonable alternative to entering into or carrying out the scheme, you must have particular regard to the substance of the scheme and any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of the Act) but you must disregard any result in relation to the operation of the Act that would be achieved by the postulate for any person. 

In Guardian, the Full Court found that, by reason of s 177CB(4)(b), the primary judge had erred in taking into account the higher Australian income tax cost that would have applied had the income been distributed directly to Mr Springer for the purposes of considering what might reasonably be expected to have happened had the 2013 related scheme not been entered into or carried out.

Purpose

In addition to finding a tax benefit existed, in order for Part IVA to apply, it was necessary to show that it would be concluded that at least one of the parties who entered into or carried out the scheme did so for the sole or dominant purpose of enabling Mr Springer to obtain a tax benefit in connection with the scheme (s 177D of the ITAA 1936). The Full Court considered each of the eight factors in s 177D, with the most noteworthy analysis in relation to the first two factors: (i) the manner in which the scheme was entered into or carried out (manner) and the form and substance of the scheme (form and substance).

Manner

As to manner, the Commissioner’s submissions did not draw a distinction between the 2012 and 2013 schemes and emphasised the circularity in the form of the trust distribution by the AIT to AITCS followed by a dividend back from AITCS to the AIT for the same amount (less the amount needed to pay the income tax liability of AITCS). The Commissioner was of the view that the circularity revealed an element of artificiality, the existence of which was to be readily explained by a tax purpose. Justice Hespe rejected this, saying:

…in considering the manner element, it is necessary to consider how the scheme came to take the form it did. To describe the schemes as involving circularity is a description of the form or consequence of the scheme. It does not address the manner in which the scheme came to be entered into or carried out.

There was a distinction in the application of the manner element to the 2012 related scheme and the 2013 related scheme. While the steps to implement the schemes were similar, in objectively assessing the circumstances, the distinction between the two years was that at the time the 2012 AIT trust income was appointed to AITCS, there was nothing in the objectively ascertainable circumstances that would have given rise to an expectation that a dividend would be declared by AITCS in the AIT’s favour.  At that time (28 June 2012), Mr Springer had expressed no discomfort with AITCS holding a significant cash balance in its account and the existence of AITCS as a “clean skin” company in which to accumulate wealth was consistent with Mr Springer’s transition to retirement wishes.  The dividend that came to be declared and paid by AITCS out of its 2012 AIT trust distribution was entirely referable to objective circumstances that came to exist after the creation of the present entitlement.  It was after that time that Mr Springer expressed concern about AITCS having a cash balance and his accounting advisors came up with the proposal that AITCS would pay a dividend to the AIT and the trustee of the AIT (Guardian) would distribute the franked income to Mr Springer.  As such, there was nothing in the way in which the chronology of events unfolded in relation to the 2012 unpaid present entitlement that would support a conclusion that any party to those steps carried them out for the dominant purpose of enabling Mr Springer to obtain a tax benefit in the 2012 year.

By contrast, at the time that the 2013 AIT trust income was appointed to AITCS, Mr Springer had received advice that any unpaid present entitlement created in AITCS would need to be cleared out before lodgement of the AIT’s tax return for that income year, Mr Springer had expressed concerns about AITCS holding large cash balances, and Mr Springer had procured a dividend to be paid by AITCS to the AIT and a distribution of franked income paid by the AIT to himself. 

The essential difference between the 2012 related scheme and the 2013 related scheme was that objective circumstances would support a conclusion that, at the time that AITCS’s present entitlement to the AIT income was created for the 2013 income year, Mr Springer or his advisors would procure payment of a dividend by AITCS to clear out the present entitlement and following the payment of tax by AITCS flow the franked dividend income back to Mr Springer.  Unlike the 2012 related scheme, the Full Federal Court considered that the manner in which the 2013 related scheme was entered into or carried out supported a conclusion that Mr Springer, Guardian, AITCS or those advising them had entered into or carried out that scheme for the dominant purpose of enabling Mr Springer to obtain a tax benefit. 

Form and substance

In conducting a comparison of the form and substance of the scheme, the Court found that it supported a conclusion that the dominant purpose of a person who entered into or carried out the scheme was to enable Mr Springer to obtain a tax benefit. The form of each of the 2012 related scheme and the 2013 related scheme involved making AITCS presently entitled to net income of the AIT but the substance of the scheme was that Mr Springer would enjoy direct ownership and control of the value of that present entitlement (after AITCS had first paid its tax liability) within a few months of AITCS becoming presently entitled. The outcome achieved by the schemes was the direct enrichment of Mr Springer, and this was not consistent with the stated commercial benefits of retirement risk mitigation and wealth accumulation.

Other s 177D factors

The Full Federal Court held that the third s 177D factor (the time at which the scheme was entered into and the length of the period during which the scheme was carried out) and the fourth s 177D factor (the result in relation to the operation of the Tax Acts that would be achieved by the scheme but for Part IVA) were neutral in reaching any objective conclusion as to the dominant purpose of a party to either of the 2012 related scheme or the 2013 related scheme.  The seventh s 177D factor (any other consequence of the scheme for Mr Springer or any other person) was considered to be of no weight in reaching the conclusion required by s 177D.

In relation to the fifth s 177D factor (any change in the financial position of the taxpayer that has resulted from the scheme), the Full Federal Court noted the importance of bearing in mind what the High Court said in Commissioner of Taxation v Hart (2004) 217 CLR 216 regarding there being a false dichotomy between a commercial end and the obtaining of a tax benefit and the presence of a commercial end not assisting in answering the query posited by s 177D.  As such, the Full Court decided that it was important in considering the fifth s 177D factor to have regard not only to the scheme but also the counterfactual under which Mr Springer would have received the distribution of net income from the AIT direct rather than the net income first being distributed to AITCS.  That being the case, the improvement in Mr Springer’s financial position resulting from the scheme (compared to the counterfactual of receiving a distribution of unfranked income from the AIT) could be attributed to the tax advantage he obtained by receiving a distribution of franked income rather than a direct distribution of unfranked income.  This pointed towards a person having entered into or carried out the scheme for the dominant purpose of enabling Mr Springer to obtain the tax benefit.

In relation to the sixth s 177D factor (any change in the financial position of a connected person), the Full Court decided that the primary judge’s conclusion that AITCS had accumulated substantial assets from being presently entitled to the income of the AIT was incorrect as a matter of fact (since AITCS distributed the income in the following year).  According to the Full Court, the use made of AITCS was consistent with a conclusion that a party to the 2012 related scheme and the 2013 related scheme had a dominant purpose of enabling Mr Springer to obtain a tax benefit in the 2012 and 2013 income years by enabling Mr Springer to obtain the benefit of the AIT trust income for those years at a tax cost not exceeding the corporate tax rate.

In relation to the eighth s 177D factor (the nature of any connection between the relevant taxpayer and any connected person), the Full Federal Court noted that the use of AITCS as a result of it being made presently entitled to a share of the net income of the AIT for the 2012 and 2013 income years meant that there was undoubtedly a connection between Mr Springer and each of AITCS, Guardian and the AIT and that the primary judge’s evaluation of the nature of the connection between the parties had miscarried.

The Full Federal Court’s s 177D Conclusion

Importantly, the Full Federal Court noted that the exercise that needs to be undertaken in relation to the s 177D factors is not in the nature of a mathematical equation adding up the two different sides of a notional ledger.  Were that the case, based on the discussion above, the Full Court would have concluded that each of the 2012 related scheme and the 2013 related scheme was a scheme to which Part IVA applied. 

The Full Federal Court noted that the evaluative task required by s 177D is more nuanced.  What was critical to consider was what was driving the form of the transactions.

In that regard, the chronology of events demonstrated that the manner in which the 2012 related scheme came to be entered into and carried out, and the form that it came to take, were the products of an evolving set of circumstances.  Given that there was no objective basis for expecting, prior to 30 June 2012, that AITCS would declare a dividend to the AIT, it would not be concluded that any of the persons who carried out the scheme after that time did so for the dominant purpose of enabling Mr Springer to obtain a tax benefit in the 2012 income year.

By contrast, the form of the 2013 related scheme was not the product of an evolving set of circumstances.  Rather, it was the implementation of a strategy developed with the evolution and implementation of the 2012 related scheme.  The 2013 related scheme commenced with the creation of a present entitlement in AITCS that it was expected would not be retained by AITCS but rather be passed on to Mr Springer.  As such, the Full Court was able to conclude that a party entered into or carried out the 2013 related scheme for the dominant purpose of Mr Springer obtaining a tax benefit in the form of the non-inclusion of unfranked amounts in his assessable income in the 2013 income year.                      

Concluding remarks

Section 100A

There are four requirements that need to be established in order for s 100A to apply:

• the present entitlement must have arisen out of, or as a result of or in connection with a reimbursement agreement (being an agreement, understanding or arrangement);
• the agreement must provide for the payment of money or transfer of property to, or provision of services or other benefits for, a person other than that beneficiary;
• a purpose of one or more of the parties to the agreement must be that a person would be liable to pay less income tax for a year of income; and
• the agreement must not be one that has been entered into in the course of an ordinary family or commercial dealing.

The Commissioner’s challenge on the basis of s 100A failed at the first requirement. We await further guidance from the Court in relation to the other elements, which may arise in relation to the appeal to the Full Federal Court to be heard later this year in relation to BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112.

Importance to the Part IVA analysis of identifying the integers of the scheme

Because of the very broad definition of scheme in s 177A and the fact that the Commissioner is able to identify multiple alternative schemes, it is easy to lose sight of the importance in the Part IVA analysis of identifying the integers of the scheme that you want the Court to focus on when determining whether it is a scheme to which Part IVA applies.  Whilst inevitably it will generally always be possible to identify a scheme as defined, the importance of identifying the scheme and steps for examination is that the tax benefit must be obtained in connection with the scheme (the requirement in s 177C) and at least one person must have entered into or carried out the whole or a part of the scheme for the purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme (the requirement in s 177D).  It appears that the Commissioner’s focus (and consequently also that of Logan J) on the broader scheme at first instance may have contributed to Justice Logan coming to the decision that he did with the focus on the reasons for the incorporation of AITCS and its inclusion in the class of eligible beneficiaries (risk mitigation, retirement planning and wealth accumulation).  The Commissioner’s case on appeal to the Full Federal Court focussed on the narrower 2012 related scheme and the 2013 related scheme with the focus on the steps involving the appointment of income to AITCS and the subsequent dividend paid by AITCS to the AIT.             

The Court’s views on the tax benefit test and s 177CB

This is the first time the Full Federal Court has considered s 177CB since its introduction in 2013. The explanatory memorandum (EM) to the Bill that introduced s 177CB expressly states that the amendment was intended to make it clear that alternative postulates should not be rejected as unreasonable postulates on the grounds that the tax costs involved in undertaking those postulates (including the tax benefit) would have caused the parties to either abandon or indefinitely defer the schemes and/or the wider transactions of which they were a part.

Following the introduction of s 177CB, the Commissioner released PS LA 2005/24 Application of General Anti Avoidance Rules (PS LA 2005/24), which expresses the view that s 177CB replaces, rather than supplements, the “prediction” approach which was established by case law, including Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359. PS LA 2005/24 goes on to note that s 177CB so significantly alters the conceptual framework to the tax benefit test that cases such as RCI and Futuris can no longer be wholly regarded as representing the law, so far as the tax benefit concept is concerned, and should be treated with “extreme caution”. The EM is relied upon to support this position.

The Guardian decision may cause the Commissioner to revisit the views expressed in PS LA 2005/24. The Full Federal Court refers to RCI at [128] – [131] with approval when describing the onus of the taxpayer in relation to proving that he did not obtain a tax benefit in connection with a scheme. The reliance of the Full Federal Court on the approach set out in RCI in relation to onus and tax benefit, and noting the Court’s comments at [172] that s 177CB “further support[s]” that approach, suggests that s 177CB supplements, rather than replaces the “prediction” approach.

Evolution of a set of circumstances that do not constitute a scheme to which Part IVA applies into a scheme to which Part IVA applies

Perhaps the most interesting aspect of the case is how the Full Court came to the conclusion that:

• the 2012 related scheme was not a scheme to which Part IVA applied because the chronology of events demonstrated that at the time that the scheme was entered into, the manner of it being entered into and its form were the products of an evolving set of circumstances which meant that it could not be concluded that a person had entered into the scheme with the requisite purpose required for s 177D to apply;
• but that the 2013 related scheme was not a product of an evolving set of circumstances; rather the implementation of a strategy developed with the evolution and implementation of the 2012 related scheme, and so the s 177D analysis and conclusion in relation to the 2013 related scheme were entirely different.

This also highlights that what is particularly critical to a Part IVA analysis is to understand any unusual features of the transaction which, in this particular case, meant understanding what was driving the manner in which the scheme was entered into and its form.  What is critical from a taxpayer perspective is to be able to lead objective evidence regarding any such unusual features of the transaction from which (hopefully) it would be concluded that none of the persons who entered into the putative scheme did so to enable the taxpayer to obtain the identified tax benefit.