Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3

On 24 January 2023, the Full Court of the Federal Court of Australia (Perry, Derrington and Hespe JJ) unanimously handed down its decision in the Guardian case.  The case considers the application of section 100A and Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to an arrangement that has been colloquially referred to as a ‘washing machine’.

The case centres on trust distributions made by a trust to a wholly owned corporate beneficiary, which subsequently declared fully franked dividends back to the trust, which then distributed the fully franked dividends to a non-resident beneficiary.

Similar arrangements have been the recent focus of significant ATO attention, with the ATO’s guidance on section 100A reimbursement agreements (Taxation Ruling TR 2022/4 and Practical Compliance Guidance PCG 2022/2) being finalised in late 2022.

Facts

• The Australian Investment Trust (the Trust) is a discretionary trust that was settled on 25 June 1998 of which Guardian AIT Pty Ltd (Guardian) is the trustee.
• On 27 June 2012, AIT Corporate Services Pty Ltd (AITCS) was incorporated, with Guardian (as trustee for the AIT) holding 100% of the issued shares in AITCS.
• Following the incorporation of AITCS, the following steps were undertaken in the 2012 and 2013 income tax years:
• Guardian appointed part of the income of the Trust to AITCS but did not pay these amounts to AITCS, creating unpaid present entitlements (UPEs).
• AITCS drew down on the respective UPEs to discharge its tax liability for each of the 2012 and 2013 income tax years (as the trust distributions appointed by the Trust created assessable income for AITCS pursuant to section 97 of the ITAA 1936).
• In May of 2013, AITCS declared a fully franked dividend in favour of the Trust equal to the remaining value of AITCS’ 2012 UPE. Similarly, in February 2014, AITCS declared a fully franked dividend in favour of the Trust equal to the remaining part of the 2013 UPE.
• Guardian, as trustee of AIT, subsequently appointed the income of the Trust that was attributable to franked dividends to Mr Springer for each of the 2013 and 2014 income years. As a tax resident of Vanuatu, Mr Springer received these distributions with no further liability to Australian income tax.
• In 2014 Guardian also appointed income of the Trust to AITCS but entered into a Div 7A loan agreement for the unpaid balance of AITCS’ unpaid entitlement which was repaid in 2016.
• The Commissioner assessed Guardian under sections 99A and 100A for the 2012, 2013 and 2014 years on the basis that AITCS’ present entitlement in each year arose out of a ‘reimbursement agreement’. The Commissioner also assessed, on an alternative basis, Mr Springer under Part IVA for each of those income tax years on the basis that the transactions were part of a scheme to obtain a tax benefit.
• The primary judge, Logan J, found that a reimbursement agreement did not exist for 2012 to 2014, such that section 100A did not apply. In respect of Part IVA, his Honour held that while there was a “scheme” in the relevant years, there was neither a tax benefit nor a dominant purpose of obtaining a tax benefit.

Appeal – Section 100A Reimbursement Agreement

The Court was only required to consider the application of section 100A to the transactions relating to the 2013 year and the key issue considered by the Court was whether an ‘agreement’ existed for the purposes of section 100A.

While the guidance provided by the Court as to the existence of an ‘agreement’ for section 100A purposes is welcome, the question as to whether an ‘agreement’ will arise in a particular set of circumstances will largely depend upon the facts of the case and the evidence which is presented by the taxpayer (noting that the taxpayer bears the burden of proof).  

The Commissioner argued on appeal that Guardian and Mr Springer reached an understanding on or before 23 June 2013 that Guardian, and ultimately Mr Springer, would benefit from the amount to which AITCS was made presently entitled.  The Commissioner submitted that a section 100A agreement may be imputed from an understanding reached by Mr Springer’s accountants, Ms Burke and Mr Fischer, because of Mr Springer’s practice of following their advice.

The Court did not agree that an ‘agreement’ existed in this case.  While noting that ‘agreement’ is defined broadly in section 100A, following Re Day (2017) 340 ALR 368, 386 (Gordon J), the Court emphasised that an agreement requires consensus and adoption between at least two parties.

This part of the decision appears to be inconsistent with the position taken in TR 2022/4. At [11], TR 2022/4 suggests that ‘an exact understanding of the nature and extent of the agreement’ is not required between the relevant parties, while the decision implies that an understanding should not be inferred when there is no express consensus. In considering whether the accountant’s understanding could be inferred to Mr Springer, Hespe J emphasised that there needs to be evidence that the accountants were acting as authorised representatives of the relevant party. This approach appears to be narrower than the Commissioner’s view in TR 2022/4 (at [10]), which cited Commissioner of Taxation of the Commonwealth of Australia v Consolidated Press Holdings Limited (2001) 207 CLR 235 for the proposition that attributing the purpose of a professional advisor ‘is both possible and appropriate’. However, this case was rejected by the Hespe J, and its application was confined to Part IVA.

Subject to any appeal proceedings before the High Court, it is expected that TR 2022/4 will need to be updated to reflect the Court’s decision..

Part IVA Schemes

Overview

The Commissioner pressed the Part IVA issue in relation to the 2012 and 2013 income years. The Commissioner’s argument on appeal focused on narrower schemes in 2012 and 2013, in which the appointment of income to AITCS was said to facilitate the appointment of franked dividends to Mr Springer each year.

Mr Springer submitted that the alternative to the identified schemes was for AITCS to enter into a Div 7A loan agreement with the Trust in each of the relevant income tax years.

The Full Federal Court reversed the primary judge’s findings that there was no tax benefit arising from the identified schemes because Mr Springer had not discharged the onus of proving that, in the absence of the schemes, he would reasonably have been expected to have undertaken an alternative course of action that would not have resulted in him being made presently entitled to the income of the Trust in the 2012 and 2013 income years.

Referring to RCI Pty Limited v Federal Commissioner of Taxation [2011] FCAFC 104, the Court emphasised that it is ‘not sufficient for [a taxpayer] to show that the Commissioner’s alternative postulate was not reasonable’, and that a taxpayer bears the onus of further proving that a more reasonable alternative (than that posited by the Commissioner) would have happened absent the scheme. On these facts, the Court was unconvinced by Mr Springer’s submission that a Div 7A loan agreement would have been entered into by the Trust.

The Court also held that the primary judge made an error of law by considering the tax effects of the alternative postulates. By reason of section 177CB(4)(b), it was not open to his Honour to have regard to the higher tax cost applicable if the income had been directly distributed to Mr Springer in determining whether an alternative postulate was reasonable or not.

Therefore, it was held that Mr Springer did receive a tax benefit in each of the relevant income tax years pursuant to the identified schemes.

Dominant Purpose

On appeal, the Court found that a dominant purpose existed in relation to the scheme for the 2013 year, but not in relation to the scheme for the 2012 year. The Court held that the following factors were material in reaching its conclusion:

• Form and substance: in both 2012 and 2013, while AITCS was formally made presently entitled to AIT’s income, substantively Mr Springer enjoyed direct ownership and control of the amount of the present entitlement.
• Change in financial position: in both 2012 and 2013, Mr Springer’s financial position improved because he was to receive a distribution of franked income rather than a direct distribution of unfranked income.
• Change in financial position of connected person: in both 2012 and 2013, AITCS was not being used to accumulate wealth and the benefits of a clean skin company were not in fact realised.
• Nature of any connection: by 2013, AITCS’ present entitlement was not explicable as being for the purpose of accumulating wealth, given Mr Springer’s concerns about his lack of control over the account. Rather, it could only have been a calculated move to help Mr Springer reduce tax liability.

The Court did not consider it useful to determine whether the dominant purpose is to be tested at the time the scheme is entered into or when it was carried out or completed. Rather, Hespe J held that the assessment of dominant purpose necessarily depends on the application of each of the 8 factors in section 177D, which shape or refer to the time of inquiry.

Of the 8 factors in section 177D, the Court gave significant weight to the differences in the manner in which the 2012 and 2013 schemes were entered into – the payment of the 2012 present entitlement having been made in consequence of Mr Springer’s accountants correcting his assumption that he was the shareholder of AITCS. These differences led to the Court’s finding that a Part IVA dominant purpose existed only in relation to the 2013 scheme.