On 4 November 2026, the High Court of Australia handed down its decision in Commissioner of Taxation v Merchant; Merchant v Commissioner of Taxation [2026] HCA 39 (Merchant). The Court unanimously upheld the cancellation, under the general anti-avoidance rule in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), by the Commissioner of Taxation (Commissioner) of a capital loss of about $56.5 million crystallised on a related party sale of Billabong Ltd (BBG) shares. However, by a 4:3 majority (Gordon, Edelman, Steward and Gleeson JJ; Gageler CJ, Jagot and Beech-Jones JJ dissenting), the Court held that the forgiveness of approximately $54 million of intra-group loans did not have substantially the effect of a dividend stripping scheme under s 177E.
Key takeaways
- A taxpayer need not choose the most highly taxed course. The majority restated the principle from Federal Commissioner of Taxation v Hart (2004) 217 CLR 216 (Hart) that the bare fact that a taxpayer pays less tax in one form of transaction than another does not show that Part IVA applies, and it is not enough to show “another means of achieving the same or a similar outcome which would have resulted in more tax payable”, clarifying the current application of Part IVA. The Court examined a range of alternatives (on-market sale, doing nothing, withdrawing cash from the fund, drawing on debt and selling other assets) as part of the purpose inquiry. The Court concluded that if the evidence shows that an alternative was never a real option, it is not a reasonable alternative postulate.
- Dominant purpose and the absence of any commercial rationale. The majority restated the test in Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 (Spotless), but preserved the distinction “between being influenced by taxation considerations and having the dominant purpose of obtaining a tax benefit”. The BBG share sale achieved “no other meaningful or realistic commercial objective”. As in British American Tobacco Australia Services Ltd v Federal Commissioner of Taxation (2010) 189 FCR 151 (British American Tobacco), it made sense only because of its tax consequences.
- Dividend stripping is confined to the Consolidated Press characteristics. The majority held that the “common characteristics” of dividend stripping as identified by the Full Court in Commissioner of Taxation v Consolidated Press Holdings Ltd [No 1] (1999) 91 FCR 524 (Consolidated Press (FCAFC)), and affirmed by the High Court in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 (Consolidated Press), are “essential”. Schemes with only some of them fall outside s 177E.
- Section 177E is a supplementary code, not a second general anti-avoidance rule. The majority held that s 177E plugs “a specific perceived gap” in Part IVA and does not apply to “any scheme involving a transfer of corporate value in a tax advantaged way”, which “might be, if necessary, a matter for the general anti-avoidance provisions”.
Background
As set out in our earlier alert on the Full Federal Court decision, Wipeout! Merchant the latest decision in wave of anti-avoidance cases, the dispute arose from transactions undertaken in the 2015 income year by a private group controlled by Gordon Merchant, the co-founder of Billabong (the Merchant Group). The transactions accorded with advice from Ernst & Young, prompted by a possible sale of Plantic Technologies Ltd (Plantic), a start-up company wholly owned by Gordon Merchant No 2 Pty Ltd as trustee for the Merchant Family Trust (MFT).
In summary:
- on 2 September 2014, MFT sold 10,344,828 shares in BBG at market value to the trustee of the Gordon Merchant Superannuation Fund (GMSF) for $5,844,827.82, crystallising a capital loss of $56,561,940 (BBG capital loss);
- on 2 April 2015, GSM Pty Ltd and Tironui Pty Ltd, both wholly owned by Mr Merchant, forgave loans owed by Plantic of $50.192 million and $4.215 million respectively, for nil consideration, as a condition precedent to the sale of Plantic (Debt Forgiveness Schemes); and
- MFT then sold its shares in Plantic to Kuraray Co Ltd, a third party, making a capital gain of around $85 million, which was offset in full by the BBG capital loss and MFT’s pre-existing capital losses.
The Commissioner cancelled the BBG capital loss under s 177F(1)(c) on the basis that s 177D applied, and issued an amended assessment to GSM as the beneficiary presently entitled to 100% of MFT’s income. Separately, the Commissioner determined under s 177E that the forgiven debts be included in Mr Merchant’s assessable income as a deemed dividend, increasing his assessable income by $54,407,000.
The decision
The Court dismissed GSM’s appeal on s 177D and the Commissioner’s appeal on s 177E, and allowed Mr Merchant’s cross-appeal in relation to the Tironui forgiveness. Consequently, Mr Merchant’s objection was allowed and the matter remitted to the Commissioner for reassessment to give effect to the High Court’s reasons for judgement.
The analysis below summarises the outcome in the High Court on key issues, as compared with the Full Federal Court and Thawley J at first instance, and expands on each of the key observations above.
The key issues and a snapshot overview of the decision decided at each level are compared below.
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Issue
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High Court reasoning
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Full Federal Court reasoning
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Thawley J at first instance
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Dominant purpose of the BBG share sale (s 177D)
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The Court unanimously found the dominant purpose was to obtain the tax benefit as “[n]o other meaningful or realistic commercial objective” was achieved. |
The majority (McElwaine and Hespe JJ) found no error in the primary judge’s reasoning or conclusions that there was a dominant tax purpose. Logan J would have allowed the appeal. |
Each s 177D(2) matter weighed in favour of a dominant tax purpose and no matter tended against it. |
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Comparison with a third party or on-market sale
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The majority heard that a third-party sale “would have involved real commercial outcomes” and was not comparable. The taxpayer’s five alternatives were “misconceived”. The minority held that the only reasonable alternative postulate was that the sale would not have occurred. |
A routine third-party sale was distinguishable. The BBG share sale was analogous to a wash sale, as control and economic ownership did not change. |
An on-market sale was possible, but Mr Merchant did not want it. This “tends to emphasise that the point of the sale was to realise a capital loss” while keeping the shareholding. |
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Meaning of dividend stripping
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The majority held that the Consolidated Press common characteristics are “essential”. The second limb is concerned with schemes with only limited deviation from the essential meaning of dividend stripping. The minority held that those same characteristics are not “essential prerequisites”. |
The first limb was not engaged because the scheme did not involve the payment of a dividend or a change in control or ownership of GSM or Tironui. The second limb is informed by the content, purpose and effect of the scheme compared to a scheme by way of or in the nature of dividend stripping. |
The first limb does not require “strict adherence to a paradigm example of a dividend stripping scheme”, and some deviation is permissible under the second limb when examining the substantial effect of the scheme. |
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Whether substantial tax must be avoided
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The majority held that it was unnecessary to decide. The minority held that there was no “essential quantitative prerequisite”. |
What is required to satisfy s 177E includes “the avoidance of a substantial liability to tax on a substantial proportion of the balance of the accumulated profits of” the entity the subject of the scheme. |
Section 177E “does not require a complete, or a substantially complete, avoidance of tax”. |
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Effect of the s 177D capital loss cancellation on s 177E
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The majority took this into account as a fact relevant to whether the assessment is excessive. The minority did not take this into account. |
The cancellation must be taken into account because the “effect is evaluated with the benefit of hindsight”. |
Section 177E is applied to the events which in fact occurred, including the crystallised capital loss. |
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Purpose of the debt forgiveness
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The majority did not decide the point, but noted that smaller amounts make a tax avoidance purpose less likely. The minority concluded that the evidence “amply supported” the view that the dominant purpose of the Debt Forgiveness Schemes was tax avoidance. |
The dominant purpose was tax avoidance. |
The main purpose was to avoid top-up tax on the profits of GSM and Tironui. |
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Outcome on the Debt Forgiveness Schemes
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The majority held that neither scheme fell within s 177E. |
In relation to Tironui, s 177E applied. In relation to GSM, s 177E did not apply. |
Both schemes fell within s 177E(1)(a)(ii). |
Part IVA: alternative postulates and the choice of a lower-taxed course
The taxpayer’s central argument was built on Hart. It said a reasonable observer must compare the scheme with “other possibilities”, and that none of five alternatives could deliver all of the non-tax consequences of the BBG share sale. The Commissioner’s concession that an arm’s length sale to a third party to realise a capital loss against an anticipated gain would not attract Part IVA, even though “a crystalised loss of the same amount would thereby have become available”, was critical to this argument.
Quoting Gleeson CJ and McHugh J in Hart, the majority said that choosing a transaction “from a number of possible alternative courses of action because of tax benefits associated with its adoption does not of itself mean that there must be an affirmative answer” under s 177D. The majority concluded that a taxpayer is not required to adopt the most highly taxed alternative, but rather the enquiry requires consideration of what other possibilities existed to achieve the “same commercial end”.
The Court then tested the five alternatives against the evidence. The majority found the taxpayer’s submission “misconceived” because all but the “do nothing” alternative assumed that MFT needed cash or that GMSF benefited from acquiring the shares, contrary to the findings. The minority reached the same result by a different route. Because Mr Merchant would not have sold BBG shares to a third party, “the only ‘postulate that is a reasonable alternative’” under s 177CB(3) was that the sale would not have occurred at all. If the evidence shows that another possibility did not exist, “that possibility is not a reasonable alternative postulate”. Section 177D does not require a hypothetical inquiry “into every possibility (reasonable or not)”.
The Court therefore considered several alternatives at the purpose stage, but it did not hold that each was a reasonable alternative postulate under s 177CB(3). The tax benefit was identified using the annihilation approach, which the taxpayer did not contest. The question whether several reasonable postulates may coexist, which we discussed in our alert Part IVA checks in: Commissioner prevails in Hilton hotel sale, was not squarely decided.
Part IVA: dominant purpose and the absence of any commercial rationale
The majority re-expressed the Spotless test: a dominant tax purpose “will seldom, if ever, be drawn if no more appears than that a change of business or investment has produced a tax benefit”. However, it preserved the distinction drawn in Hart “between being influenced by taxation considerations and having the dominant purpose of obtaining a tax benefit”.
Merchant fell on the wrong side of that line. “No other meaningful or realistic commercial objective was achieved” by the BBG share sale, which endangered “the very rationale of GMSF” (namely, the responsibility of paying Mr Merchant his pension). What remained, “glaringly prominent”, was the value of the capital loss in sheltering the Plantic gain. The Commissioner’s third-party sale concession “compels no different analysis”, because the BBG share sale was analogous to a “wash sale”, occurring “without any transfer of ultimate economic ownership and control”.
The majority drew an analogy with British American Tobacco, in concluding that the BBG share sale made no sense as a commercial proposition and was “only explicable by reference to its valuable tax consequences”.
Dividend stripping: confined to the Consolidated Press characteristics
The Commissioner argued that dividend stripping is a “protean” concept and its essence extended to any arrangement in which profits are converted to capital, denying the revenue the tax that would have been payable on an expected dividend, where there is a tax avoidance purpose. On that view, value stripped out of GSM and Tironui and realised as a sheltered capital gain on the Plantic sale was enough.
The taxpayer argued that reading dividend stripping at that level of generality would make s 177E(1)(a)(i) (a scheme by way of or in the nature of dividend stripping) redundant, because every scheme within that paragraph would also fall within s 177E(1)(a)(ii) (a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping). In substance, the taxpayer’s case was that s 177E(1)(a)(ii) does not reach arrangements that share only a tax avoidance purpose with dividend stripping, and that a scheme must still correspond to the recognised features of dividend stripping before s 177E can apply.
The majority sided firmly with the taxpayer. The High Court in Consolidated Press affirmed that the common features of dividend stripping “are precisely the ‘common characteristics’ identified by the Full Court”. Those characteristics are: a target company with substantial undistributed profits; a sale or allotment of its shares; a dividend paid to the purchaser out of those profits; the purchaser escaping tax on that dividend; the vendor receiving a capital sum close to the dividend; and careful planning for the predominant purpose of avoiding tax. The majority held that these characteristics “were essential”, not “mere illustrations or hypothetical examples”. Dividend stripping has “a fixed essential meaning although flexible in application”.
The majority gave two further reasons for confining the concept. A generic description would “defeat the usual purpose of revenue law where a taxpayer must know with certainty the criterion for a liability to pay tax”. It would also create a parallel anti-avoidance scheme that Parliament did not intend. The Commissioner accepted that the Debt Forgiveness Schemes lacked the common characteristics, and the majority described the deviations as “extreme”.
The minority would have taken a much broader view. The “by way of” and “in the nature of” language in s 177E(1)(a) expands dividend stripping “beyond its historical meaning”. The common characteristics “are not essential prerequisites”, and the essential function of such a scheme is “giving the character of capital to what, apart from the arrangement, would have been received as income”.
The interplay between s 177E and Part IVA more broadly
The majority's reasons address the relationship between s 177E and the general anti-avoidance rule in two ways.
- First, on structure. Section 177E is a “supplementary code” designed to deal with a particular gap. Some dividend stripping schemes might not satisfy the tax benefit requirement in s 177C, because accumulated profits might simply have been retained rather than distributed. Arrangements that bear only some of the common characteristics should be dealt with “either by the general anti-avoidance provisions in Pt IVA, or by some other, specific anti-avoidance rule, or not at all”. Applying s 177E more widely “would promote s 177E as a parallel general anti-avoidance regime within Pt IVA. But that is not what Parliament intended”. Section 177E(1)(a)(ii) “is not open-ended” and does not catch “any scheme involving a transfer of corporate value in a tax advantaged way”, which “might be, if necessary, a matter for the general anti-avoidance provisions”. Inconsistent Full Court decisions “should not be followed”, with Lawrence v Federal Commissioner of Taxation (2009) 175 FCR 277 given as an example.
- Second, on interaction. The Commissioner argued that the s 177D and s 177E assessments were “independent silos of liability”. On that view, Mr Merchant could be assessed in respect of s 177E as if the BBG capital loss existed even though it had been cancelled. The majority rejected that argument. A court hearing a Part IVC appeal is seized of the whole objection decision, and it would be “entirely artificial and unfair” to uphold an assessment “upon an acceptance of a taxable fact which it knows to be false”. The cancelled capital loss was the first step of each Debt Forgiveness Scheme and “an essential fiscal attribute” of them. Once it was gone, “it now cannot be said that there had been a denial to the revenue of tax”. The Commissioner’s undertaking to make compensating adjustments under s 177F(3) was “entirely irrelevant”.
The minority took the opposite view. Sections 177D and 177E “have no function beyond the enabling of the Commissioner to make a determination under s 177F”. Taking a determination into account would make Part IVA “self-defeating”, and any unfairness is addressed by s 177F(3). Thawley J had reached the same conclusion at first instance.
Conclusion
Merchant delivers a clear message on the general anti-avoidance rule. While taxpayers can be influenced by taxation consequences (meaning it is permissible for taxpayers to adopt lower tax courses), it is not permissible to choose a course which only makes sense because of the tax benefit obtained. A related party transaction that changes nothing commercially, and makes sense only because of its tax result, is unlikely to survive s 177D. Taxpayers should continue to contemporaneously document a genuine commercial rationale for any restructure that produces a tax benefit.
On dividend stripping, the outcome favours taxpayers. The majority narrowed the application of s 177E to schemes containing the common features of dividend stripping set out in Consolidated Press (FCAFC), rejected its use as a second general anti-avoidance rule, and held that a cancellation under s 177D must be taken into account when testing an s 177E assessment. We expect the Commissioner to rely more heavily on s 177D rather than s 177E in future.
