Background

Recent anti-avoidance decisions such as Mylan [2024] FCA 253, Minerva [2024] FCAFC 28, PepsiCo [2025] HCA 30 and Hilton [2026] FCA 1325 involved large corporate or multinational groups.

Merchant concerns arrangements much more familiar to private groups – restructuring ownership and rationalising related party loans in preparation for a sale.

Gordon Merchant, Billabong’s co-founder, controlled a private group that included the Merchant Family Trust, a related SMSF and two companies, GSM Pty Ltd (GSM) and Tironui Pty Ltd (Tironui). The Merchant Family Trust held shares in Billabong International Ltd and was the sole shareholder in Plantic Technologies Ltd (Plantic), which was being prepared for sale. GSM and Tironui had lent substantial amounts to Plantic.

The Commissioner challenged two arrangements in the income year ended 30 June 2015:

1. The Billabong sale: in September 2014, the Merchant Family Trust sold Billabong shares to the SMSF for approximately $5.84 million at market value, generating a capital loss of $56.6 million. The SMSF exchanged cash for the shares, while the investment remained within the Merchant group; and
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2. The debt forgiveness: in April 2015, GSM and Tironui forgave approximately $54.4 million of Plantic’s debts for no consideration. The forgiveness was a condition of the sale of Plantic’s shares to an outside purchaser and drove up the capital gain made on the Plantic shares.

The Merchant Family Trust applied the Billabong capital loss and pre-existing capital lossesagainst the capital gain on the Plantic share disposal, originally assessed atapproximately $85 million.

The Commissioner applied Part IVA of the Income Tax Assessment Act 1936 (Cth) in two ways:

1. Capital loss cancellation: applying the general anti-avoidance rule in section 177D, he cancelled the Billabong capital loss under section 177F(1)(c). This increased the trust’s net income and the amount assessed to GSM as its corporate beneficiary; and
2. Dividend stripping: applying the dividend stripping provisions in section 177E, he made a determination under section 177F(1)(a) including approximately $54.4 million in Mr Merchant’s assessable income as deemed dividends arising from GSM and Tironui’s forgiveness of Plantic’s debts.

Key Issues

The appeals raised two principal questions:

1. Did section 177D apply because a participant entered into or carried out the Billabong share sale scheme for the objectively dominant purpose of enabling the trust to obtain the capital loss tax benefit?
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2. Did the debt forgiveness schemes have substantially the effect of dividend stripping under section 177E(1)(a)(ii)?

At first instance, Thawley J upheld cancellation of the Billabong loss and found that both debt forgiveness schemes attracted section 177E (Merchant [2024] FCA 498). The Full Court, by majority, upheld the loss cancellation but set aside the dividend stripping assessment concerning GSM’s loan forgiveness, leaving the Tironui component standing (Merchant [2025] FCAFC 56).

Key Findings

1. Pre-sale transfer achieved no meaningful commercial objective

The existence of the scheme and capital loss tax benefit was conceded by the taxpayer. The contested question was the dominant purpose under section 177D, assessed objectively through the eight matters in section 177D(2).

The Court considered the transfer of cash, the different beneficiaries and regulatory regimes of the trusts, and the potential for the shares to appreciate within superannuation. Those differences did not provide a commercial explanation on the facts. The Merchant Family Trust did not need additional cash, while the SMSF acquired shares unlikely to produce dividends, contrary to its investment strategy and to the detriment of its capacity to pay Mr Merchant’s pension.

The Commissioner accepted that selling the shares to an outsider to realise the same loss would not attract Part IVA as an outside sale would have divested ultimate economic ownership and control. On the facts, Mr Merchant was not willing to entertain an outside sale. The internal transfer preserved both while crystallising the loss, making it analogous to a wash sale.

Here, however,the claimed funding and investment benefits were not supported.

2. Advice showed how the tax outcome was designed

The communications and transaction documents recorded the development and implementation of the sale structure as follows:

• 21 July 2014: Mr Merchant’s investment adviser reported EY’s proposal to sell Plantic’s shares and transfer high cost Billabong shares to the SMSF, generating losses against the anticipated gain;
• 11 August 2014: EY proposed making forgiveness of the related party loans a requirement of the Plantic share sale agreement;    
• 3 September 2014: EY’s Project Maize paper modelled the combined outcome including additional Billabong losses sheltering a Plantic share-sale gain increased by loan forgiveness;
• 4 September 2014: The Billabong share transfer form was signed, stating a transfer date of 2 September 2014; and
• 31 March and 2 April 2015: The Plantic share-sale agreement was signed on 31 March. The debt forgiveness deed was executed, and the sale completed, on 2 April.

The documents connected the Billabong transfer with the anticipated Plantic sale and the creation of capital losses to shelter the capital gain. Considering tax costs is an ordinary part of commercial decision making, choosing a transaction because it produces less tax does not itself establish dominant tax purpose. The significance here was that the contemporaneous documents supported the substantial tax explanation, while the asserted funding and investment purposes were unsupported by the evidence.

3. Dividend stripping defined

By 4:3, the Court held that section 177E did not apply.

The majority reaffirmed the historical meaning of “dividend stripping” settled in Consolidated Press Holdings (2001) 207 CLR 235. Broadly, dividend stripping involves a new shareholder extracting accumulated company profits tax free while the original shareholders receive a corresponding capital sum, under an arrangement predominantly directed at avoiding tax on a distribution to them.

Section 177E(1)(a)(ii) permits limited variations, including extracting profits otherwise than by dividend. The majority held that it does not capture every transfer of company value producing favourable tax consequences.

The majority identified fundamental departures from conventional dividend stripping as Mr Merchant retained his shares in GSM and Tironui, the trust owned neither company, and no dividend was paid to a dividend stripper. A further distinction was that forgiveness increased Plantic’s profits and share value, rather than converting the profits of GSM and Tironui into capital.

It is worth noting the comments of Logan J, dissenting in the Full Court, that “a debt forgiveness which maximises an assessable capital gain is, in itself, the antithesis of ‘dividend stripping’” (Merchant [2025] FCAFC 56 at [76]).

The clarification of section 177E’s limits is welcomed. However, it is worth noting debt forgiveness may still have tax consequences under the general anti-avoidance provisions in Part IVA, the commercial debt forgiveness rules in Division 245, and CGT event C2.

Takeaways

Merchant has direct implications for family groups reviewing ownership, retirement arrangements and a proposed business exit:

1. Obtain Part IVA advice before implementation. Part IVA is complex and fact dependent, requiring an objective assessment of the arrangement and its material steps through the eight matters in section 177D(2).
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2. Be cautious about crystallising losses through internal transfers. A market value transfer that preserves economic ownership and control warrants scrutiny, particularly where the loss will offset an anticipated gain.
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3. Consider privilege when commissioning advice. Tax advice is not automatically privileged, so confirm the clients, purpose and confidentiality of the communications before circulating or disclosing them.

To discuss the taxation implications of a proposed restructure, loan forgiveness or business sale, contact Velocity Legal’s tax team.

This article in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.