A single judge of the Federal Court has upheld a decision of the Commissioner of Taxation (Commissioner) to apply the general anti-avoidance rule, Part IVA, to arrangements that include the income distribution decisions of a trustee. This is despite the judge also finding that Part IVA did not apply to the establishment of the underlying structure within which the trustee made its income distribution decisions. Whilst the case concerns a stapled structure, the reasoning underpinning the judge’s decision could conceivably apply to a wide range of trusts as well as the exercise of other types of choices or discretions more generally. Subject to any clarification on appeal, this case could potentially extend the scope of application of Part IVA to many transactions and arrangements to which the Part has not previously been thought to apply.

The latest Part IVA case was handed down by Justice O’Callaghan of the Federal Court on 16 September 2022 in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2022] FCA 1092 (Minerva).

In Minerva, Justice O’Callaghan held that Part IVA did not apply to a scheme involving the creation of a stapled structure. In particular, on the facts, Part IVA did not apply to a scheme involving the creation of two “silos” within a corporate group structure for holding the group’s assets (a “Corporate Silo” and a “Trust Silo”) and steps taken so that income from investments in securitisation trusts were distributed to the Trust Silo. However, His Honour then held that Part IVA did apply to two schemes that included decisions by the trustee of a trust in the Trust Silo to distribute only nominal amounts of income to the Corporate Silo such that almost all of the income was distributed through the “Trust Silo”. This resulted in only small amounts of the net income of the trust being taxed at the 30% corporate tax rate and the significant balance of the net income being taxed ultimately in the hands of non-residents at the 10% withholding tax rate. As discussed further below, the trustee’s distribution decisions was the only part of the two schemes that His Honour appeared to have concerns with from a Part IVA perspective.

His Honour’s decision to find that Part IVA applied to two schemes, each of which included a trustee’s distribution decisions, challenges traditional thinking as to the manner in which the purposes of those who entered into or carried out a putative Part IVA scheme are to be determined and, consequently, the scope of application of the Part. Whilst the two Part IVA schemes in the Minerva case included other steps in addition to the trustee’s distribution decisions, it was the distribution decisions that seem to have led Justice O’Callaghan to conclude that these were schemes to which Part IVA applied. Generally, one might think that, viewed objectively, you cannot predicate from looking at a trustee’s distribution decision in isolation that the trustee made the decision to enable a taxpayer to obtain a tax benefit unless some collateral attendant step/s and/or circumstance/s alter that view. If, however, that is wrong and Part IVA can apply to, or because of the making of, something as straightforward as a trustee’s distribution decision, then presumably the Part could also apply to a broad range of other transactions previously thought to be of a normal business or family kind. This challenges the traditional notion of Part IVA’s scope of application being limited to addressing arrangements that are blatant, artificial or contrived.

A possible logical extension to His Honour’s reasoning and conclusion is that, wherever a taxpayer is faced with a choice of two ways of proceeding, one of which generates a greater Australian tax liability than the other, for Part IVA not to apply to a scheme comprising the course of action which generates the lesser tax liability, the taxpayer would need to show that there is one or more cogent commercial (non-Australian tax) reason/s why it chose the course of action which generated the lesser Australian tax liability which outweigh/s the tax benefit of not choosing the course of action which would have generated the higher Australian tax liability. This can obviously become problematic where, as appears to have been the case for the taxpayer in Minerva, although there is a genuine commercial rationale for the existence of the choice in the first place, there is no significant commercial rationale for making one choice over the other (apart from the tax reflex of the choice).

However, Part IVA was only ever intended to apply to tax avoidance arrangements that are blatant, artificial or contrived and, conversely, not to arrangements of a normal business or family kind, including those of a tax planning nature (refer to the Explanatory Memorandum to the Income Tax Laws Amendment Bill (No.2) 1981 which introduced Part IVA into the Tax Act (EM) at pages 2-3). As noted in the EM (at page 3): Part IVA may be seen as effectuating in general anti-avoidance provisions of the income tax law a position akin to that which appears to emerge from the decision of the Privy Council in Newton v Federal Commissioner of Taxation (1958) 98 CLR 1. The essence of the views expressed in that case was that a tax avoidance situation covered by section 260 exists only if it can be predicated from looking at an arrangement that it was implemented in that particular way so as to avoid tax.

Applying the purpose test in section 177D of the Income Tax Assessment Act 1936 (Cth), with its eight factors to be assessed objectively, one is able to predicate from looking at an arrangement whether it was implemented in the particular way in which it was so as to avoid tax. Having regard to the eight section 177D factors, assessed objectively, it may be difficult to conclude (without more) that a trustee’s income distribution decision constituted an arrangement implemented in the particular way in which it was in order to avoid tax. That should be the case provided that the distribution decision was not attended by some additional step/s and/or circumstance/s or, if it was, then that one could not predicate from looking at the distribution decision and the additional step/s and/or circumstance/s that together they constitute an arrangement implemented in the particular way in which it was in order to avoid tax. This is because the main purpose of a trustee’s income distribution decision, assessed objectively and viewed in isolation, is to distribute income to beneficiaries in whatever proportions or shares the trustee determines appropriate having regard to the terms of the trust.

The first scheme that Justice O’Callaghan found that Part IVA applied to (the second scheme alleged by the Commissioner) contained three broad steps: (i) certain restructure steps which resulted in the non-residents being entitled to the income from the Trust Silo; (ii) the trustee’s distribution decisions resulting in the substantial majority of the income of the Trust Silo being distributed to the non-residents rather than to the Corporate Silo; and (iii) funds being loaned to the Corporate Silo and unpaid present entitlements being left unsatisfied.

The second scheme that His Honour found that Part IVA applied to (the third scheme alleged by the Commissioner) was comprised of the two steps in (ii) and (iii) above.

As such, the trustee’s distribution decisions were attended by (in the case of the second scheme alleged) two additional steps and (in the case of the third scheme alleged) one additional step.

However, Justice O’Callaghan’s analysis of the eight factors in section 177D identifies the trustee’s distribution decisions as the key step or consideration from which one predicates that each of the second and third schemes was entered into with a tax avoidance purpose. In that regard, His Honour determined that the manner in which the restructure steps referred to in (i) above were carried out was a neutral factor. Further, in relation to the steps in (iii), His Honour held that there was nothing unusual or unorthodox in the loans to the Corporate Silo being interest free, unwritten and not repaid in cash. He was also unprepared to make findings of fact sought by the Commissioner that the loans were provided from funds related to the income received from the securitisation trusts and replaced the Corporate Silo’s previous income stream from that source. Instead, His Honour placed significant emphasis on the taxpayer’s inability to provide any cogent reason, other than the tax benefit, for the trustee’s distribution decisions when determining in his assessment of the section 177D factors that a person entered into the second and third schemes with the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit.

We anticipate that the decision in Minerva will likely be appealed.