High Court upholds Part IVA capital loss cancellation but clarifies the limit of the dividend stripping rule

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. The case considered the application of the Part IVA provisions in the Income Tax Assessment Act 1936 (Cth) (the 1936 Act), being the general anti-avoidance rule in section 177D and the specific dividend stripping rule in section 177E in relation to two sets of transactions within a privately controlled group of companies, trusts and a self-managed superannuation fund.  

The High Court unanimously upheld the application of section 177D to cancel a capital loss which was crystallised through a related-party sale of listed shares prior to the third-party sale. By a 4:3 majority, the High Court held that section 177E did not apply to the forgiveness of intra-group loans for nil consideration prior to the third-party sale. The majority confirmed that ‘dividend stripping’ has a fixed essential meaning and that section 177E is not a parallel general anti-avoidance rule. The majority also held that, in deciding whether the section 177E assessment was excessive, the Court had to take into account that the capital loss had been cancelled.  

Background

In the 2015 income year, entities controlled by Mr Gordon Merchant entered into two related transactions:

• Billabong International Ltd share sale: The Merchant Family Trust (MFT) sold a parcel of shares in Billabong International Ltd (BBG) to a related self-managed superannuation fund (GMSF) at market value. This crystallised a capital loss of approximately $56 million (the BBG capital loss).

• Plantic share sale: MFT later sold its shares in Plantic Technologies Ltd (Plantic) to an unrelated purchaser, Kuraray Co Ltd (Kuraray). This generated a capital gain of approximately $85 million (the Plantic capital gain).

Prior to the sale by MFT of the shares in Plantic, two debts Plantic owed to other companies in the Merchant group, namely GSM Pty Ltd (GSM) and Tironui Pty Ltd (Tironui), were forgiven by GSM and Tironui for nil consideration. The forgiven debts totalled around $54 million, increasing the sale price of Plantic. MFT sought to use the BBG capital loss (together with other capital losses it held) to eliminate the income tax otherwise payable on the Plantic capital gain, reducing the assessable income of GSM, as the beneficiary presently entitled to all of MFT’s income in the 2015 income year.  

The Commissioner made two determinations under section 177F in Part IVA of the 1936 Act: 

• In reliance on section 177D, he determined that one or more persons had entered into a scheme comprising the sale of the BBG shares for the dominant purpose of enabling MFT to obtain a tax benefit, being the BBG capital loss. As a result, the Commissioner cancelled the BBG capital loss and issued an amended assessment to GSM. 

• In reliance on section 177E, the Commissioner determined that the forgiveness of each of the debts Plantic owed to GSM and Tironui constituted a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping scheme, with the Commissioner including in the assessable income of Mr Merchant an amount equal to each of the debts forgiven as a deemed dividend. 

Two appeals arose from these transactions.

The table below summarises how the case progressed through the courts.

At the High Court, the taxpayers' appeal concerning cancellation of the BBG capital loss was dismissed unanimously with costs. By a 4:3 majority, the High Court dismissed the Commissioner's appeal concerning the larger debt forgiveness and allowed the taxpayer’s cross-appeal concerning the smaller debt forgiveness, both with costs. Mr Merchant's objection was allowed and his assessment remitted for reassessment. 

When intra-group dealings are caught by section 177D

The issue on appeal was whether the BBG share sale scheme was entered into or carried out by any party to the scheme for the dominant purpose of obtaining a tax benefit, being the capital loss. The High Court unanimously held it was. 

The established principles in applying section 177D were restated, including that the inquiry as to the dominant purpose is objective. Gordon, Edelman, Steward and Gleeson JJ (the majority) noted that: 

• while regard must be had to all of the eight matters in section 177D(2), the assessment of purpose should be undertaken globally by directing attention to those matters that are relevant and probative in the circumstances, and 

• the drawing of a conclusion about purpose from the eight matters identified will require consideration of what other possibilities existed to achieve the same commercial end. 

Importantly, the majority stated that Part IVA does not apply merely because a taxpayer has arranged its business or investments in a way that derives a tax benefit. Additionally, the bare fact that a taxpayer pays less tax in one form of a transaction than in another does not demonstrate that Part IVA applies. Neither does it suffice to show that there was another means of achieving the same or a similar outcome which would have resulted in more tax payable. 

GSM advanced two submissions in seeking to demonstrate that no person who entered into or carried out the scheme had a dominant purpose of obtaining a tax benefit. 

The first was that the majority of the Full Court failed to take into account the legal, commercial, financial and taxation differences between MFT and GMSF. This included aspects such as the different regulatory regime once the BBG shares were held by GMSF, the transfer of cash to the MFT and the fact that the beneficiaries of MFT differed from those of GMSF. 

The majority, however, decided that there was no other meaningful or realistic objective that was achieved by the share sale, other than the tax benefit. The majority described the transaction as a ‘purely internal transfer of shares’ between entities under common control that, as a commercial proposition, ‘made no sense’. However, as an example of tax planning, ’it made perfect sense’. 

The second submission was that a comparison of five alternative ways of carrying out the scheme showed that none of them were capable of securing the commercial outcomes achieved by the actual scheme, which was said to support a conclusion that the share sale scheme was explicable having regard to its non-fiscal attributes. The majority held that all but the ’do nothing’ alternative were premised on an assumption that MFT needed cash or that GMSF would benefit from owning the BBG shares transferred to it. However, the majority relied on the primary judge’s findings that MFT did not have any need for additional funds and that transferring the BBG shares did not benefit GMSF. 

The majority noted the Commissioner’s acceptance that Part IVA would not have applied had the BBG shares instead been sold to a third party. Such a sale would have had real commercial consequences and was not comparable to the internal transfer undertaken here. By contrast, the BBG share sale scheme was analogous to a ’wash sale’, whereby a sale occurs without any transfer of ultimate economic ownership and control but results in tax advantages. 

A limited reach for the dividend stripping rule in section 177E

Section 177E applies where, as a result of a scheme 'by way of or in the nature of dividend stripping', or a scheme 'having substantially the effect of' such a scheme, property of a company is disposed of. Subject to its remaining conditions, section 177E deems the relevant scheme to be one to which Part IVA applies and deems a tax benefit equal to the notional amount calculated by reference to a hypothetical dividend. The Commissioner may then determine under section 177F that the relevant amount be included in assessable income.

The issue on appeal was whether each debt forgiveness referred to above was a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping. 

The Commissioner argued that dividend stripping is a 'protean' concept. On his view, its essence is any arrangement, entered into with a tax avoidance purpose, that converts profits into capital and denies the tax that would have been payable on a dividend. He contended that value had been stripped from the two lender companies (GSM and Tironui), which could otherwise have paid dividends to their sole shareholder, into the MFT in a form that was largely sheltered from tax. 

The majority rejected this approach. The majority held that the essential meaning of dividend stripping was settled by the High Court in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235. The majority referred to the ‘common characteristics’ of dividend stripping schemes that had been identified in Consolidated Press and stated that these characteristics are not mere illustrations or hypothetical examples of some more abstract conception of dividend stripping, but that they were essential. The ‘common characteristics’ identified were:

• a target company with substantial undistributed profits creating a potential tax liability for either the company or its shareholders; 

• the sale or allotment of shares in the target company to another party; 

• the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits; 

• the purchaser escaping Australian income tax on that dividend; 

• the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers; and 

• a carefully planned arrangement for the predominant, if not sole, purpose of avoiding tax on a distribution of dividends by the target company.

Section 177E(1)(a)(ii) also extends to schemes having substantially the effect of a scheme by way of or in the nature of a dividend stripping scheme, including where profits are distributed otherwise than by a dividend. While the majority allowed limited deviation from the meaning of dividend stripping, it held that the scope and application of section 177E is not open-ended and does not apply to any scheme involving a transfer of corporate value in a tax-advantaged way. The majority added that dividend stripping is a distinct type of tax avoidance arrangement with a fixed essential meaning, although flexible in application. 

Applying this test, the majority found that the debt forgiveness schemes set out above departed from dividend stripping in ‘extreme’ ways and that the debt forgiveness schemes bore no substantive resemblance to commonly deployed dividend stripping schemes. The majority noted that there was no sale of the shares in either lender company (GSM or Tironui); there was no payment of a dividend to any stripper; no stripper sold the shares in the target companies at a loss; MFT was identified both as being the stripper (even though it held no shares in the target companies) and as being equivalent to the vendor of shares in the target company who receives a capital sum (even though the shares in the target companies were never sold); and any dividend that might have otherwise been paid to Mr Merchant by the lender companies (GSM or Tironui) would not have been fully taxable in his hands, as such dividends would have been fully franked. The majority also noted that in any event, there was no substantial avoidance of tax by reason of the entering into and carrying out of the debt forgiveness schemes.  

The majority did not decide whether stripping a substantial proportion of accumulated profits and avoiding substantial tax are necessary attributes of dividend stripping. It observed that the smaller the value stripped and tax avoided, the less likely a dominant tax avoidance purpose would be found. 

The minority took a broader view. Gageler CJ, Jagot and Beech-Jones JJ considered that the words 'by way of or in the nature of' expand the concept of dividend stripping beyond its historical form, and that the Consolidated Press Holdings characteristics are helpful considerations rather than essential prerequisites. On their Honours' view, the function of such a scheme is to give the character of capital to what would otherwise have been received as income, and section 177E has no fixed quantitative threshold.

How sections 177D and 177E interact, and the risk of double tax

The Commissioner submitted, in respect of the application of section 177E, that the cancellation of the BBG capital loss (pursuant to section 177F) should have been ignored when determining the tax outcome of the debt forgiveness scheme. The Commissioner’s objection decision in respect of the application of section 177E depended upon the assertion that MFT had incurred a capital loss on the sale of the BBG shares. 

The majority disagreed and held that, in deciding whether Mr Merchant’s assessment was excessive, the Court had to take account of the upheld section 177F determination which cancelled the BBG capital loss. The majority considered it would be 'entirely artificial and unfair' for a court to uphold an assessment based on a taxable fact, here the existence of the capital loss, that it knows to be false. Once the cancellation of the loss was upheld, substantial tax was payable on the capital gain, so it could not be said that there had been a denial to the revenue of tax as a result of the debt forgiveness schemes.

Before the High Court, the Commissioner gave an undertaking that, if he succeeded on both appeals, he would make compensating adjustments under section 177F(3) whereby he would exclude the net capital gain made in the 2015 income year by MFT and make consequential interest and penalty reductions and remissions. The Commissioner conceded that success on both would otherwise result in an economic overlap. The majority described the resulting double taxation and the unfairness as 'glaring', with the effect of the assessments being to tax the amount stripped out of GSM and Tironui twice: once in the hands of MFT and its beneficiaries (including GSM) as a capital gain and again in the hands of Mr Merchant as income. The majority held the undertaking was irrelevant to whether the assessments were correct.

The minority took the opposite view. Their Honours held that sections 177D and 177E must each be applied without regard to any existing or potential determination under section 177F, and that any resulting unfairness is addressed by the Commissioner's power to make compensating adjustments under section 177F(3), which a taxpayer may request and, if dissatisfied with the decision, object to.

In respect of the general anti-avoidance provision in section 177D, the High Court’s decision confirms that moving assets between related entities to crystallise a capital loss, without any real change in economic ownership or control, and without a commercial rationale that stands up to objective scrutiny, may be treated as having a dominant tax purpose. 

The Court’s focus on the timing of the sale, the absence of any need for cash, and the inconsistency with the superannuation fund’s investment strategy, shows that the commercial reasons for intra-group steps need to be genuine and supported by evidence at the time. The sale of a loss-making asset to an unrelated party, with real commercial consequences, should stand in a different position. 

In respect of the dividend stripping provisions, the majority rejected treating section 177E as a general rule covering every tax-advantaged transfer of corporate value. Whether a particular arrangement falls within section 177E remains dependent on its characteristics and effect. An arrangement outside that provision may nevertheless attract the general anti-avoidance provisions or another specific rule. 

The outcome is therefore not a general exemption for intra-group debt forgiveness or the use of capital losses. As the majority endorsed the Consolidated Press Holdings characteristics as essential and indicated that inconsistent Full Federal Court authority should not be followed, groups that previously relied on, or were concerned about, a broader view of section 177E may wish to revisit their position. 

Where Part IVA determinations concern interconnected schemes, the fiscal assumptions supporting each assessment require close examination. In this case, the capital loss was the first step in the identified debt forgiveness schemes, and its cancellation, upheld on appeal, was relevant to whether the assessment was excessive in determining the application of section 177E. The majority rejected maintaining that assessment on a premise the Court had found to be false and the Commissioner's undertaking to make compensating adjustments did not cure that error.

If you are planning a group restructure, a sale of a group business, or the use of losses within a group, or if you are currently in a Part IVA review or dispute, we recommend considering the implications of this decision. Please contact us to discuss how it may affect you.