Guardian AIT appeal: round two, split decision – section 100A and Part IVA

By Frank Hinoporos and Todd Bromwich

The Full Federal Court has handed down its written appeal decision in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (24 January 2023). This case considers in detail two important tax integrity provisions: section 100A and Part IVA of the Income Tax Assessment Act 1936 (Cth) (1936 Act).

Both the Taxpayer and the Commissioner had a win in this appeal, the Court having decided that:

  • section 100A did not apply to the relevant transactions that occurred in the 2013 income year: the Court at first instance decided that section 100A did not apply to the relevant transactions that occurred in the 2012 and 2014 and this was not contested on appeal.
  • Part IVA did not apply to enable the Commissioner to make a determination to negate the relevant tax benefit for the 2012 income year but did apply to enable the Commissioner to make a determination to negate the relevant tax benefit for the 2013 income year: the Court at first instance decided that Part IVA did not apply in either income year.

Context and overview

Until recently, judicial guidance on the meaning of section 100A had been limited. Since the introduction of section 100A in 1979, there have been only six judicial decisions considering its application. Since 2021, there have been two significant section 100A disputes making their way through the courts, Guardian AIT and the matter of BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112 (also under appeal).

While there are still some important aspects of section 100A that require clarification, the Court’s further guidance on the interpretation of section 100A is welcome, given this once-obscure and little-used provision has become a central feature in the audits of many mid-market and private taxpayers. In particular, this case highlights how important it is to determine whether an actual agreement was reached between the parties prior to a beneficiary becoming presently entitled to trust income. In an audit context, the Commissioner typically focuses on later conduct and financial and tax outcomes to infer that an agreement existed at the relevant point in time. But proving that an actual agreement (formal or informal) was in fact reached is a crucial threshold issue to the application of section 100A.

Importantly, the fact pattern in this case, involving what has come to be commonly known as a ‘washing machine’ arrangement, is one which the Commissioner has marked as being in the ‘Red Zone’ of Practical Compliance Guidance PCG 2022/2. We now have four judges, one at first instance and three on appeal, who have held that section 100A should not apply to an arrangement exhibiting these high-risk factors. That said, practitioners should not interpret this to mean that such arrangements are without risk: this decision shows the outcome will depend very much on the facts, and there is a risk of Part IVA applying.

With respect to Part IVA, this decision provides some useful guidance on a taxpayer’s onus of proof with regard to determining whether they have in fact obtained a tax benefit, and a somewhat detailed consideration of the various factors to be considered in determining whether a party had a dominant purpose of obtaining a tax benefit in entering into a scheme. It also confirms that following the 2013 amendments to Part IVA and introduction of section 177CB, a court cannot have regard to a higher tax cost of implementing an alternative postulate in determining what might reasonably have occurred in the absence of the identified scheme.

The key point for advisors is that section 100A and Part IVA matters are fought and won on the facts and evidence. The courts will examine the evidence forensically, including witness testimonies and documents and advice prepared years ago. Different facts may lead to different outcomes. So, trusts should be managed with care and diligence and all parties involved in an arrangement involving trusts should understand the effect of trust documentation.

The first instance decision of the Federal Court was covered in detail in our earlier article, ‘Long awaited guidance on s100A, but read with caution!’.

The ATO’s finalised section 100A guidance materials TR 2022/4 and PCG 2022/2 are discussed by Frank Hinoporos in our free on-demand webinar, ‘Section 100A: Final ATO Rulings – but what’s the end game for trusts?’. These draft guidance materials were covered in detail in our earlier article, ‘Section 100A guidance: highway to the danger (red) zone’.

The case in dispute

This case involved transactions between three key entities: a discretionary trust with a corporate trustee (Trust), a corporate beneficiary wholly-owned by the trustee (Company), and an individual (Mr Springer). Mr Springer was the sole shareholder of the trustee, and a beneficiary and ‘Principal’ of the Trust. Mr Springer was a non-resident of Australia at all relevant times.

In the 2012 and 2013 income years, the trustee distributed an amount of the Trust’s non-franked income to the Company. The Company would then draw down on its unpaid present entitlement (UPE) to the extent necessary to pay income tax on the distribution at the corporate rate. In the subsequent income year, the Company declared a fully-franked dividend in favour of the Trust, equal to the outstanding balance of the UPE, and by offset would reduce the UPE balance to nil.

In the same year, the trustee distributed this franked dividend income in favour of Mr Springer. As Mr Springer was a non-resident for these years, these distributions were non-assessable non-exempt income per ss 128B(3) and 128D of the 1936 Act and no further tax was payable by him to the extent they were franked.

The Commissioner’s concern is rooted in the fact that if the income of the Trust was distributed directly to Mr Springer, it would have been taxed to the trustee on his behalf at the non-resident tax rates. By taking these steps, the income was effectively converted to franked income and no ‘top-up tax’ was required to be paid on the distribution to Mr Springer. This ‘conversion’ element was the key concern about the decision which the Commissioner flagged in Taxation Ruling TR 2022/4.  

The section 100A decision

Section 100A works by disregarding for tax purposes a beneficiary’s present entitlement to income of a trust where that entitlement arose because of a ‘reimbursement agreement’. The effect of this is that the trustee, rather than the entitled beneficiary, will be taxed under section 99A (broadly, at the highest marginal tax rate).

There are three main hurdles that must be crossed in order for section 100A to apply:

  • the present entitlement to trust income must have arisen out of a ‘reimbursement agreement’. In broad terms and subject to the below, this is an agreement that provides for the payment of money or the transfer of property to, or the provision of services or other benefits for, persons other than the entitled beneficiary.
  • the agreement must have been entered into for a tax reduction purpose, or purposes that include a tax reduction purpose.
  • a reimbursement agreement will exclude an agreement, arrangement or understanding entered into in the course of ‘ordinary family or commercial dealing’.

The Court set out the following key principles in its decision:

  • for an ‘agreement’ to exist, there must be a common intention or consensus reached between multiple parties (or a representative or controller) all of whom assent to it, expressly or impliedly.
  • an arrangement whereby one entity would act in accordance with the wishes of another is capable of being an agreement – although a mere expectation that an arrangement will be entered into at a later time is not sufficient.
  • as stated in the first instance decision, the alleged reimbursement agreement must pre-exist the present entitlement of a beneficiary to trust income.
  • where the alleged reimbursement agreement requires that a payment be made by a beneficiary, that beneficiary (or a representative or controller) must be a party to the agreement at the relevant time.
  • an understanding reached between advisors to relevant entities will not be imputed to those entities unless there is a reasonable basis for doing so on the evidence, including in circumstances where the advisors are authorised to act on the entities’ behalf.
  • accession to an agreement cannot be inferred solely based upon an entity’s tendency to follow the directions of their advisors.

On a close factual analysis, the Court ultimately held that section 100A had no application to the taxpayer group’s circumstances, determining that no agreement existed between the parties at the relevant times.

Relevantly, the Court held that Mr Springer’s advisors did not communicate a definite plan regarding relevant steps in the purported reimbursement agreement – being the payment of dividends by the Company and subsequent distribution of income by the Trust – before the trustee conferred a present entitlement to income upon the Company.

Coming back to the three ‘hurdles’ that must be crossed in order for section 100A to apply, the Commissioner’s appeal failed at the first hurdle, as the Court found that factually there was no ‘agreement’ between the Trust and the Company (or Mr Springer as the controller of these entities). As such, the Court did not go into any detailed explanation of the other two key elements for section 100A to apply: the requirement that the agreement be entered into with a tax reduction purpose, or the ‘ordinary family or commercial dealing’ exception (the one we all want to hear about!).

We expect the Court will have more to say on these elements later this year when it delivers its decision on the appeal of the decision in the BBlood decision.

The Part IVA decision

The Commissioner’s alternative position was that arrangements (or parts of the arrangements) actually carried out between the Trust, the Company and Mr Springer amounted to a ‘scheme’ that was entered into for the dominant purpose of enabling Mr Springer to obtain a tax benefit, such that Part IVA of the 1936 Act applied to negate the tax benefit. The tax benefit in question was the non-inclusion of the Trust distributions in Mr Springer’s assessable income.

The Court ultimately held that Part IVA applied to enable the Commissioner to make a determination to negate the relevant tax benefit for the 2013 income year, but did not apply in respect of the 2012 income year. The Court provided the following guidance on the application of Part IVA in this case.

The term ‘scheme’ is defined broadly and may be constituted by any agreement, arrangement, understanding, promise or undertaking, whether enforceable or unenforceable. Importantly, a Part IVA scheme may be unilateral or multilateral, unlike an ‘agreement’ for the purposes of section 100A, which requires a common intention or consensus reached between multiple parties.

A scheme can encompass not only a series of steps which together form a scheme or plan, but also the carrying-out of but one of those steps. It is not required to have any commercial or other coherence, but the manner by which the scheme came to be is relevant to determining the parties’ dominant purpose.

On appeal, the Commissioner relied upon two of the narrower schemes originally identified – the ‘2012 related scheme’ and ‘2013 related scheme’.

  • The 2012 related scheme captured each of these relevant steps: the incorporation of the Company, the Company being nominated as a beneficiary of the Trust in June 2012, the distribution of unfranked income by the Trust to the Company, the draw-down of funds against the UPE to enable the payment of tax by the Company, the dividend declared by the Company to the Trust and the distribution of (converted) franked Trust income to Mr Springer in the 2013 income year.
  • The 2013 related scheme largely reflected the above for the subsequent year, excluding the incorporation of the Company and nomination as a beneficiary.

Part IVA only applies where a taxpayer obtains a tax benefit in connection with the identified scheme, determined by comparing the scheme and a prediction as to events which would have taken place if the relevant scheme was not entered into or carried out (an ‘alternative postulate’). That prediction must be sufficiently reliable to be reasonable, and must be more than a mere possibility.

As the taxpayer, Mr Springer had the onus of proving that he did not obtain a tax benefit. To meet this burden, Mr Springer needed to satisfy the Court that if the scheme had not been carried out, he would not have received a direct distribution of unfranked income from the Trust. He would also need to posit what might reasonably have been expected to occur as an alternative to the arrangement actually carried out in fact.

The Court held that Mr Springer did not discharge his onus, and he did in fact obtain a tax benefit in each of the 2012 and 2013 income years. The Court did not accept that, absent the scheme, the Trust would have paid out the Company’s UPE or reinvested the funds with the Trust under a Division 7A compliant investment agreement, stating this was unlikely based on the parties’ evidence.

Importantly, the Court stated that a prediction that has a different commercial outcome from the scheme actually entered into and carried out is not readily accepted as reliable. Additionally, following the 2013 amendments to Part IVA and introduction of section 177CB, the Court may not have regard to a higher tax cost of implementing an alternative postulate, in determining what might reasonably have occurred in the absence of the scheme.

For Part IVA to apply, at least one of the parties to the scheme must have entered into or carried out the scheme or part of it with the sole or dominant purpose of enabling Mr Springer to obtain a tax benefit.

The Court rejected the finding at first instance that the dominant purpose of the scheme was always the minimisation of risk to Mr Springer in retirement and to have a new corporate beneficiary to which distributions might be made and serve as a vehicle for wealth accumulation and passive investment.

Having regard to the eight factors set out in section 177D that are required to be considered in answering this question, the Court determined that:

  • in the 2012 income year, the 2012 related scheme was the product of an evolving set of circumstances. It was not a scheme that any of the parties could be seen to have entered into for the dominant purpose of enabling Mr Springer to obtain a tax benefit, considering that prior to 30 June 2012 on the evidence there was no objective basis for expecting that the Company would declare a dividend back to the Trust to clear out its UPE. The steps carried out in 2013 could not, with the benefit of hindsight, take on a character that they did not actually have at the relevant time.
  • in the 2013 income year, the scheme had become the implementation of a strategy that had been developed with the evolution and implementation of the 2012 related scheme. When the Trust appointed an amount of the Trust’s non-franked income in favour of the Company in the 2013 income year, the benefit of that income was not objectively expected to be retained by the Company, but rather would pass to Mr Springer. Accordingly, the Court held that a party entering into the 2013 related scheme did so with the required purpose.

This article was written with the assistance of Samuel Gard, Law Graduate.


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