‘Emphatic rejection’ of CoT High Court appeal clarifies section 45B rules

Last Thursday (9 April), the High Court denied special leave for the Commissioner of Taxation (CoT) in its tax avoidance case against City Beach founders Carmelo Ierna and Melville Hicks.

The ruling has ended a multi-year court saga between the ATO and City Beach, affirming a previous Federal Court ruling that determined the 2016 restructure of Australian apparel brand City Beach was not primarily intended to avoid tax.

Ierna and Hicks ran their business through a trust structure called City Beach Trust (CBT). The majority of the trust units flowed through Ierna and Hicks’ family trusts to the corporate beneficiary, Mastergrove, which was ultimately controlled by Hicks and Ierna.

On the advice of Exant Advisory (then known as Hanrick Curran), CBT was restructured in 2016 to address issues with Division 7A loans arising from the taxation ruling TR 2010/2. The ruling, now replaced by TD 2022/11, made unpaid present entitlements owed by trusts to an associated private company Division 7A loans.

The 2016 restructure interposed a new holding company over the CBT and implemented a selective share capital reduction of $52 million, which was used to discharge Division 7A loans owed by entities associated with the group’s principals.

The Commissioner of Taxation sought to apply the anti-avoidance provisions under section 45B and Part IVA, arguing that the restructure was carried out to obtain a tax benefit.

However, the Federal Court determined that City Beach’s primary purpose of entering into its selective capital reduction had been to enable the repayment of Division 7A loans, not to enable the relevant taxpayers to obtain a tax benefit by substituting capital for an assessable dividend.

Liam Telford, RSM Australia technical tax partner, said the High Court decision had affirmed the Federal Court’s “emphatic rejection” of the ATO’s appeal and brought clarity to the application of section 45B, an anti-avoidance rule in place to prevent companies from diverting profits to shareholders in a tax-preferred format, instead of dividends.

“Prior to Hicks, there was no juridical guidance on the application of section 45B. Instead, the ATO were inflexibly applying the much maligned and unilaterally developed PS LA 2008/10, frequently resulting in outcomes prejudicial to taxpayers,” Telford said.

“For example, the ATO may have sought to apply section 45B simply by identifying profits somewhere in a group – this can no longer be the case. This is significant for taxpayers given the many perceived deficiencies in PS LA 2008/10, which has been under review for at least a decade absent any amendment.”

Telford added that the decision was less significant for Part IVA, but seemed to indicate that the High Court did not agree with the ATO’s position that there was some tension between the decisions made in Hicks and a separate tax matter relating to PepsiCo.

“The Commissioner expressed a view that there seemed to be some tension between the decisions in PepsiCo and Hicks on the establishment of a reasonable alternative postulate to a scheme that identifies whether or not a tax benefit has been obtained in relation to a scheme,” he said.

“This issue formed part of the special leave application in Hicks and thus it would seem that either: the High Court did not agree with the Commissioner’s view that there was tension between the decisions, or, that this issue was insufficiently critical to warrant the Commissioner being granted special leave to appeal the decision in Hicks.”

Cameron Blackwood, head of tax at Corrs Chambers Westgarth, also said the High Court decision had provided useful clarifications regarding section 45B and Part IVA.

"The Court confirmed that section 45B is directed at genuine dividend substitution and does not operate simply because profits exist elsewhere in a group. At the same time, the decision is not a blanket endorsement of capital reductions, as section 45B will still apply where capital is, in substance, replacing a dividend,” he said.

“On Part IVA, the Court reinforced that the provision is not engaged merely because there was a more tax‑inefficient way of achieving the same commercial outcome - any counterfactual must be realistic, and the dominant purpose must be the obtaining of a tax benefit.”

Blackwood added that the decision had reinforced that both anti-avoidance provisions turned on substance and purpose, not on hindsight or revenue-maximising hypotheticals.

Following Thursday’s ruling, RSM’s Telford urged the ATO to update its practice statement on the application of section 45B to align with the High Court finding.

“As a tax advisor, I welcome the High Court’s refusal of special leave and urge the ATO to update PS LA 2008/10 as soon as possible to reflect the principles established in the FCAFC decision,” he said.

“The FCAFC decision is a ‘relevant authority’ as defined and it would be negligent of the ATO to not make necessary updates to PS LA 2008/10 and ensure that its practical compliance approach accords with those updates.“