There have been two recent cases involving corporate reconstructions with contrasting results for the taxpayer in relation to the application of Part IVA to those factual situations. It illustrates the evidentiary importance of getting the alternate postulate or counterfactual correct.
Both cases involved the declaration of an inter-group dividend that had the effect of reducing the net capital gain on a disposal of assets.
In the first case the disposal of the assets within the corporate group was done by way of transfer of assets into a company which was then subject to an IPO. However pre-IPO of that company there were various transfers of assets, declaration of inter-corporate dividends and capitalisation of intercompany debts arising from the declaration of the dividends. The effect of the pre-IPO reconstruction transaction was also to engage the value shifting provisions in the income tax legislation so as to “transfer” the cost base of the taxpayer’s investment in one subsidiary to the taxpayer’s investment in the IPO company.
The overall effect of the corporate reconstruction and subsequent IPO was a capital gain to the taxpayer which was a listed holding company. However the amount of the capital gain was considerably reduced as a result of the inter-corporate dividends, the capitalisation of the intercompany debts and the “transfer” of the cost base of the taxpayer’s investment in one company to its investment in the IPO company.
In determining whether a tax benefit was obtained by the taxpayer under a scheme, there is a requirement to consider what would have or might reasonably be expected to have happened on an objective basis if the scheme had not been entered into or carried out by the taxpayer. This is called the alternate postulate or counterfactual test. The test requires a comparison between what has occurred and what might reasonably have been expected to occur if the scheme was not entered into or carried out.
Under the alternate postulate or counterfactual alleged by the Commissioner in this case he argued that had the steps in the scheme not been entered into i.e. the transfer of assets from one company to another company, the declaration of dividends and the subsequent capitalisation of the debt created by the declaration of dividends not taken place, the “transfer” of the cost base of the taxpayer’s investment in one company to the taxpayer’s investment in the IPO company would not have taken place.
However the effect of the Commissioner’s alternate postulate of counterfactual was that there would have been two sales, an internal sale of the assets and an external sale of the assets. The effect of the two sales would be a doubling up of the capital gains made in respect of essentially the same assets. A sale on that basis would not be a rational commercial decision. Therefore the Court held that absent the steps identified by the Commissioner as constituting the scheme, the taxpayer would not, as a matter of reasonable expectation, have carried out the sale by way of a public float in the manner described in the Commissioner’s alternate postulate or counterfactual.
The taxpayer argued that assuming the scheme identified by the respondent had not been entered into or carried out, it would, as a matter of reasonable expectation, have carried out the sale in an entirely different manner which would not have given rise to any capital gain. Therefore there was no tax benefit resulting from the scheme because under the alternate postulate or counterfactual, there was no tax payable whereas a capital gain did arise under the scheme that was carried out by the taxpayer.
The Court held that the taxpayer had established that had the scheme identified by the Commissioner not been entered into or carried out, it would, as a matter of reasonable expectation, have carried out the sale in the manner set out in the taxpayer’s alternate postulate or counterfactual. As a result the Court concluded that that there was no tax benefit in connection with the scheme or the alternate scheme and therefore Part IVA did not apply.
In another case, the taxpayer was an Australian subsidiary of a corporate group. The taxpayer transferred shares that it owned in another subsidiary in that group which was a US based subsidiary. However several months before the sale of the shares in the US company, the US company paid an exempt non-portfolio dividend to the taxpayer following a revaluation of assets. The payment of the dividend was financed primarily by way of a loan made to the US company from another company in the group under a promissory note arrangement involving book entries with only part paid out of cash reserves of the US company. This was the narrow scheme identified by the Commissioner. The wider scheme identified included these steps plus additional steps involving the taxpayer subscribing for additional shares in the US company and the sale by the taxpayer of its shares in the US company to another offshore company in the group in exchange for shares in that other offshore company.
The dividend paid by the US company to the taxpayer drastically reduce the value of the taxpayer’s shares in the US company and therefore the capital gain that the taxpayer would make on the disposal of those shares. The issue of the additional shares increased the overall cost base of the taxpayer in the US company shares
The Commissioner’s alternate postulate was that but for the scheme, the sale of the shares would still have occurred and therefore a tax benefit was obtained as a result of the scheme being the difference between the net capital gain that resulted from the scheme and the net capital gain that would have resulted but for the scheme.
In this case the taxpayer argued that without the benefit of the dividend the transfer of the taxpayer’s hares in the US company could not reasonably be expected to have taken place. However the taxpayer did not provide any evidence that this was the case. As a result the taxpayer failed to discharge the burden it had of proving that the Commissioner’s alternate postulate was unreasonable.
The difference between the two cases is that in the first, the taxpayer was able to satisfy the burden of proof whereas in the second the taxpayer did not satisfy the burden of proof of establishing that the alternate postulate of the Commissioner was not a reasonable expectation.
The two cases show the importance on a taxpayer being able to satisfy the burden of proof that the Commissioner’s alternate postulate is not a reasonable expectation. This will be a matter for evidence. In the first case substantial evidence appears to have been put on to show the alternate postulate of the Commissioner was not reasonable but that in fact at least one of the alternate postulates proffered by the taxpayer was a reasonable expectation if the scheme had not been carried out.