In Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3, the Full Federal Court dismissed the Commissioner’s appeal in relation to s100A of the Income Tax Assessment Act 1936 (1936 Act) and partially allowed the appeal in relation to the application of Part IVA of the 1936 Act to distributions made by Guardian AIT Pty Ltd (Guardian) as trustee for the Australian Investment Trust (AIT) to AIT Corporate Service Pty Ltd (AITCS), a corporate beneficiary.

Background

The arrangement that triggered the Commissioner’s amended assessments was the fact that the Guardian as trustee of AIT made an unpaid present entitlement (UPE) to its newly established corporate beneficiary, AITCS, and the UPE amount was subsequently offset by Guardian paying to AITCS the tax owed on the UPE and a subsequent dividend declared by the AITCS to Guardian (this happened over the 2012 and 2013 income years). This arrangement evolved over time in response to Mr Springer’s concern about asset protection, wealth accumulation and not leaving a large sum of money sitting in a bank account over which he had no control.

The Commissioner assessed Guardian for the 2012 to 2014 income years under s100A (reimbursement agreements) and s99A. In the alternative, the Commissioner made determinations under Part IVA of the 1936 Act and assessed Mr Springer (the individual principal of the arrangement) in each of those income years to the amounts appointed to AITCS. At first instance, the primary judge held that s100A did not apply in any of the income years in question. His Honour also held that Part IVA did not apply in any of those years on the basis that there was no tax benefit and, if there were a tax benefit, that the requisite dominant purpose was not to obtain the tax benefit.

The Provisions

Section 100A of 1936 Act generally applies to make the trustee, rather than the presently entitled beneficiary, liable to tax at the top marginal rate. Broadly, for s100A to apply there are 4 requirements:

• 'Connection requirement' - broadly stated, the present entitlement (or amount paid or applied for the benefit of the beneficiary) must have arisen out of, as a result of or in connection with a reimbursement agreement 
• 'Benefit to another requirement' - 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.
• 'Tax reduction purpose requirement' - 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.

The 'ordinary dealing exception' is not satisfied - the agreement must not be one that has been 'entered into in the course of ordinary family or commercial dealing' (paragraph 5 of TR 2022/4).

Part IVA of the 1936 Act allows the Commissioner to cancel a ‘tax benefit’ received by a taxpayer where he is satisfied that the following elements exist:

• there must be a ‘scheme’ – this is easily satisfied as ‘scheme’ is defined very broadly
• the taxpayer must get a ‘tax benefit’ in connection with the scheme
• the taxpayer’s sole or dominant purpose in entering the scheme must be to obtain a tax benefit – having regard to objective factors listed in the legislation.

Commissioner’s appeal

The Commissioner did not appeal the primary judge’s decisions in relation to the 2014 income year. The two grounds of appeal were, broadly:

• The primary judge had erred in holding that the present entitlement of AITCS for the 2013 income year did not arise out of a reimbursement agreement or in connection with, or as a result of, a reimbursement agreement. Instead, the primary judge ought to have held that an understanding existed between Guardian and Mr Springer:
  • that Guardian as trustee would benefit from the amount to which AITCS was made presently entitled, and
  • Mr Springer would ultimately benefit from the amount to which AITCS was made presently entitled which constituted a reimbursement agreement.
• The primary judge erred in holding that there was no scheme to which Part IVA applied, but instead ought to have held that Part IVA applied to what were referred to in the primary judge’s reasons as the “2012 related Scheme” and the “2013 related Scheme”.

Conclusion of the Full Federal Court

In short, the Full Federal Court concluded:

• Section 100A did not apply to 2013 income year.
• Part IVA did not apply to the 2012 related Scheme
• Part IVA applied to the 2013 related Scheme.

Section 100A reimbursement agreement

The Full Federal Court affirmed the primary judge’s finding that s100A required a reimbursement agreement to exist at or prior to the time by which a beneficiary was made presently entitled to net income of the trust – in this case the relevant time was 23 June 2013.

The Commissioner submitted that:

• the parties to the agreement or understanding were Guardian and Mr Springer
• it was necessary to focus on the representatives of Pitcher Partners in evaluating whether an arrangement existed as at 23 June 2013 pursuant to which AITCS would pay a dividend to Guardian, and that this understanding could properly be imputed to Mr Springer because of his existing practice of following the advice of Pitcher Partners.

The Full Federal Court found the inquiry under s100A as to whether there was a reimbursement agreement required the existence of an “agreement” (as defined in s100A(10)), invoking a requirement of consensus and adoption. However, evidence showed that no advice or recommendation was communicated to Mr Springer on or before 23 June 2013 – Pitcher Partners’ advice letter was dated 15 January 2014.

Absent any communication prior to 23 June 2013, it was necessary to find that the Pitcher Partners representatives had authorisation to act on or behalf of the relevant entities in order to conclude that there was consensus or adoption by Guardian and Mr Springer. In this case, there was no such evidence.

The Full Federal Court found there was no “agreement” as at 23 June 2013 within s100A(13) which involved the payment of such a dividend and, therefore, there was no “reimbursement agreement” for the purposes of s100A. As a result of this conclusion, it was unnecessary for the Full Federal Court to consider the issues of purpose and the scope of the phrase “ordinary commercial or family dealing”.

Part IVA

The Commissioner’s case on appeal focused on the narrower 2012 related Scheme and the 2013 related Scheme.

2012 related Scheme involved:

• the incorporation of AITCS and the determination by Mr Springer, as principal of AIT, to make AITCS a member of the eligible class of beneficiaries
• the Guardian’s appointment of income of AIT for the 2012 year to AITCS
• the drawing down by AITCS of part of that entitlement to discharge its liability to income tax for the year ended 30 June 2012
• the declaration and payment by AITCS of a fully franked dividend on 1 May 2013 to Guardian as trustee for AIT (reducing AITCS’s UPE from the year ended 30 June 2012 to nil), and
• the Guardian’s appointment of franked income of AIT for the year ended 30 June 2013 to Mr Springer.

2013 related Scheme involved:

• the Guardian’s appointment of the unfranked income of AIT for the 2013 year to AITCS
• the drawing down by AITCS of part of that entitlement to discharge its liability to income tax for the year ended 30 June 2013
• the declaration and payment by AITCS of a fully franked dividend on 27 February 2014 to Guardian as trustee for AIT (reducing AITCS’s UPE from the year ended 30 June 2013 to nil), and
• the appointment of franked income of AIT for the year ended 30 June 2014 to Mr Springer.

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 AIT. Furthermore, having regard to the conclusions expressed by the primary judge on s177C of the 1936 Act the Commissioner submitted on appeal that the new s177CB was relevant to the 2013 year of income and required consideration.

Tax Benefit

Mr Springer bore the onus of providing that he did not obtain a tax benefit in connection with a scheme for the purposes of s177C. This required Mr Springer to satisfy the Court that, in the absence of the scheme, he would not have received a direct distribution of unfranked income from AIT, and what might reasonably be expected to have occurred instead.

The primary judge was satisfied that, in the absence of the scheme, what might reasonably be expected to have occurred was that AITCS would have received and retained in full its UPE in cash or it would have invested that entitlement with Guardian in accordance with a Division 7A compliant loan agreement, or perhaps some combination of these.

The Full Federal Court did not accept the primary judge’s findings. As an alternate postulate, AITCS receiving cash was inconsistent with the concerns Mr Springer expressed to Pitcher Partners at the time about leaving a large amount of funds in a bank account over which he had no control. Furthermore, the commercial substance of the alternate postulate of AITCS entering the “investment agreement’ to be Division 7A compliant was different from the commercial substance of the scheme actually carried out.

Therefore, the Court found Mr Springer obtained a tax benefit in each of the years ended 30 June 2012 and 30 June 2013 in the form of the non-inclusion of an amount in Mr Springer’s assessable income in those years.

Turning their mind to the new s177CB (commenced in June 2013), the Full Court found that, based on s177CB(4)(b), it was not open to the primary judge to have regard to the higher Australian income tax cost that would have applied had the income been distributed directly to Mr Springer in determining what might reasonably be expected to have happened had the 2013 related Scheme not been entered into or carried out.

The primary judge had supported the alternate postulate of the UPE being invested in a Division 7A compliant loan agreement because of evidence from the Pitcher Partners representative - no competent adviser would have recommended that AIT’s unfranked income be distributed to Mr Springer, who was a non-resident, as he would have been taxed at the highest marginal tax rate.

Dominant purpose

Regarding the 2012 related Scheme, the manner in which the scheme was entered into and carried out, and the form which it came to take, were the products of an evolving set of circumstances. Furthermore, there was no objective basis for expecting, prior to 30 June 2012, that AITCS would declare a dividend to Guardian as trustee for AIT. Therefore the Court found it was not a scheme that objectively any party could be seen to have entered into for the dominant purpose of enabling Mr Springer to obtain a tax benefit in the year ended 30 June 2012.

By contrast, the form of the 2013 related Scheme was not the product of an evolving set of circumstances, but was the implementation of a strategy that had been developed with the evolution and implementation of the 2012 related Scheme. The Full Federal Court found that it would be concluded that a party entering into or carrying out the 2013 related scheme did so for the dominant purpose of enabling Mr Springer to obtain a tax benefit in the form of the non-inclusion of an amount in his assessable income in the year ended 30 June 2013.

Therefore, the Full Federal Court concluded that a Part IVA applied to enable the Commissioner to make a determination to include an amount in Mr Springer’s assessable income for the year ended 30 June 2013 but not for the 2012 income year.

Key takeaways

• For s100A to apply, the reimbursement agreement needs to be in existence at or prior to the time the present entitlement is made to the beneficiary
• An agreement for s100A requires evidence of consensus and adoption of the relevant parties to the agreement
• Even if s100A does not apply to an arrangement, the Commissioner may seek to apply Part IVA
• Part IVA may be easier to satisfy as:
  • “scheme” is defined very broadly under Part IVA and it can involve a unilateral arrangement
  • Dominant purpose is an objective test based on factors set out in the legislation so there is no need to find evidence of the subjective intention
• Whether s100A or Part IVA apply will depend on the facts and circumstances surrounding the arrangement so it is important that the parties involved, including their advisors, maintain contemporaneous records of decisions made and transactions that have occurred.