The impact of this case on ATO policy is discussed in Decision Impact Statement: Lawrence v Commissioner of Taxation (VID 882 of 2008).

LAWRENCE v FC of T

Judges:
Jessup J

Court:
Federal Court, Melbourne

MEDIA NEUTRAL CITATION: [2008] FCA 1497

Judgment date: 10 October 2008

Jessup J

1. The applicant, John Peter Lawrence, appeals pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) ("the Administration Act") against the decision of the respondent, the Commissioner of Taxation, to disallow his objection to an amended assessment of income tax for the year ended 30 June 2003, and to an assessment of penalty tax for that year. The amended assessment was based upon determinations made by the Commissioner under Part IVA of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act"). Each such determination was made under s 177F(1)(a) of the 1936 Act, and was to the effect that a tax benefit, referable to an amount that, according to the Commissioner, had not been included in the applicant's assessable income, be so included for the 2003 year. In each case the Commissioner further determined pursuant to s 177F(2) of the 1936 Act that the amount in question be deemed to be included in the assessable income of the applicant by virtue of s 44(1) of the 1936 Act. The amounts which the Commissioner determined had not been included in the applicant's original assessment were the sums of $1,698,300 and $1,298,700.

2. The Commissioner's determinations under Part IVA were based upon s 177E(1) of the 1936 Act, to the detailed terms of which I shall refer later. That provision deems what I shall for the moment describe as a dividend stripping scheme to be a scheme to which Part IVA applies. The Commissioner took the view that, in relation to the 2003 year of income, companies controlled by the applicant had participated in dividend stripping schemes, or in schemes having substantially the effect of such schemes, the end result of which was that profits which were held for distribution by companies in which the applicant was the only shareholder were effectively converted into capital sums held by another company on trust for a class of discretionary beneficiaries which was confined to the applicant and members of his family. I shall refer in greater detail to the transactions said to constitute the schemes below.

The circumstances leading to the transactions of 8 June 2003

3. At the relevant time, the applicant had, for many years, been engaged in various businesses as a company director. His principal concern was in the wholesale and retail distribution and sale of plaster board and other plaster products for installation in the interiors of residential and commercial premises. He had also been engaged in other businesses, such as timber milling, horse breeding, the assembly and sale of electronic components and the manufacture and sale of motor vehicle mufflers and exhausts. In some cases, the applicant purchased businesses which had liquidity problems, and attempted to make them financially viable. At the point of purchase, those businesses often were subject to what the applicant described as "significant debt and cash flow distress". Sometimes, it took the applicant several years to turn a particular business around, while at other times he was unable to do so, and had to resell the business. In his affidavit, the applicant said:

"In the course of conducting these numerous businesses, I ordinarily enter into supply and other contracts where I do assume significant personal liability. Over the years, I have also had and continue to have an interest in significant real estate, both commercial and residential. For the purpose of conducting these various businesses and holding these various properties, I have been a director and shareholder of numerous companies both as trading entities and as trustees of various trusts. I have also held and continue to hold various assets in my personal name."

The applicant said that he knew his limits, and appreciated the need for obtaining and relying upon sound advice. It was his practice to obtain advice from "suitably qualified and experienced lawyers and accountants". He did so in order to obtain the best possible advice and assistance on all business transactions and financial matters, and to ensure that he had the most effective legal structure "to protect my assets from creditors and to maximize the profit of my businesses and investments". It was always his intention and concern to comply with all legal and taxation obligations.

4. The main entity used by the applicant to conduct his various businesses was a discretionary trust known as the Lawrence Family Trust. The trustee was Lauravale Pty Ltd ("Lauravale"). The applicant, members of his family and some of the companies in which he had an interest were among the class of discretionary beneficiaries of this trust. One of the applicant's companies was Plaster Plus (Vic) Pty Ltd ("Plaster Plus"), of which the applicant had been the sole shareholder, and the only director, since 1998. Plaster Plus had been incorporated for business purposes, but was not needed for those purposes and did not operate actively as a company until the 2002 financial year. On 31 May 2002, the applicant and his wife borrowed the sum of $900,000 from Plaster Plus. That sum was applied to reduce an existing liability to the Lawrence Family Trust. On 1 June 2002, Lauravale nominated Plaster Plus as a general beneficiary of the Lawrence Family Trust. On 29 June 2002, Lauravale decided to distribute income and capital gain in the total sum of $1,904,796 from the trust to Plaster Plus. This amount constituted profit. After various adjustments, Plaster Plus recorded a taxable profit of $1,919,574 for the year ended 30 June 2002. Income tax was paid on that sum. In the result, as at 30 June 2002, Plaster Plus had taxed but undistributed profits of $1,328,924. The applicant said that he was advised that he had no need to distribute those profits in Plaster Plus, and that they could have been retained by Plaster Plus indefinitely.

5. In addition to his own accountant, Mr Hayes, the applicant and his companies received accounting and taxation advice from accountants based in Adelaide. They introduced him to a Queensland solicitor, Ian Collie of the firm Cleary Hoare. In early 2003 or thereabouts, Mr Collie contacted the applicant "to arrange a meeting in Melbourne to discuss a legal and financial transaction which he was recommending to some of his clients." The applicant later learned that the kind of transaction which Mr Collie had in mind was what was described as a "distributable surplus arrangement". In early May 2003, the applicant, Mr Hayes and Mr Collie met at Mr Hayes' office at Glen Waverley. Mr Collie gave verbal advice to the applicant, and discussed technical aspects of the proposed arrangement with Mr Hayes. The applicant did not understand those aspects, and relied upon the expert opinion of Mr Collie and Mr Hayes as to the operation and efficacy of the arrangement, and as to the fact that it was lawful.

6. At the meeting at Glen Waverley, Mr Collie showed the applicant what the latter described as "a supportive opinion from a Brisbane based Queens Counsel about the operation and legality of distributable surplus arrangements"; as a result of which the applicant said that he was "doubly reassured". An extract from the opinion of Senior Counsel obtained by Mr Collie, which may have been that shown to the applicant at the meeting at Glen Waverley, was set out in a letter later sent by Mr Collie to the applicant, and was in the following terms:

"What seems clear is that there must be something more than simply the payment of a dividend or other transfer of property from the company as the Commissioner's Rulings and Determinations acknowledge. The creation of a dividend access share followed by the dividend to the holder of the share who enjoyed the whole of the dividend would not, in my Opinion, fall within the section. Nor would the entry by a company into a transaction as a result of which its assets are diminished. It is in my view an essential part of the concept of dividend stripping that there be some trafficking in the securities of the company. Here there will be none. It follows, in my view, that section 177E will have no application."

In the circumstances, the applicant instructed Mr Collie "to proceed with the necessary legal documents to give effect to and implement the distributable surplus arrangement …."

7. What was recommended to the applicant involved two discrete, but substantially identical, series of transactions. The first related to Plaster Plus. The second related to a company called Zinkris Pty Ltd ("Zinkris"), which was incorporated by Mr Collie on 5 June 2003, and of which the applicant became the sole shareholder and the only director on that day.

8. In both series of transactions, what was involved was a sequence of steps as set out in the following diagram, described as a "confidential transaction summary" and apparently prepared by the applicant's advisers:

The sums set out in this diagram referred to the transactions involved in the first series of transactions (that relating to Plaster Plus). The sums for the second series (that relating to Zinkris) were different, but the steps were the same.

9. By reference to the diagram set out in the previous paragraph, in the first series of transactions the entity marked "G" was Plaster Plus, while the entity marked "C" was a company called Netscar Pty Ltd ("Netscar"), incorporated by Mr Collie on 30 May 2003. In the second series of transactions, the entity marked "G" was Zinkris, while the entity marked "C" was a company called Windainty Pty Ltd ("Windainty"), incorporated by Mr Collie on 2 June 2003. In both series, the entity marked "T" was a company called Clearmink Pty Ltd ("Clearmink"), incorporated by Mr Collie on 2 June 2003. In both series, the entity marked "V" was Denburrow Pty Ltd ("Denburrow"), a company controlled by Cleary Hoare of which Mr Collie and Mr Michael James Patrick Hart, another member of that firm, were the directors.

10. The transactions by which the distributable surplus arrangements were implemented were carried out at the applicant's home at Richmond on 8 June 2003. Although, at the point of incorporation, it may have been otherwise, by 8 June the applicant was the only director of all the relevant companies save Denburrow, and the only shareholder of all the relevant companies save Denburrow, Netscar and Windainty. Changes in the shareholdings in Netscar and Windainty were central aspects of the first and second series of transactions, respectively, in ways to which I shall refer. The transactions to be carried out on 8 June 2003 were, for each of the series, set out in a document headed "Meeting Times - 8 June 2003". For the first series, this required 15 steps to be taken between 10:30 am and 12:55 pm; for the second series, it required 15 steps to be taken between 1:15 pm and 3:40 pm.

11. Although not referred to in the schedules of meeting times for 8 June 2003, on that day two new discretionary trusts were settled by Mr Hart. In each case, the settlement sum was $10. The trustee was Clearmink, and the names of the trust were Clearmink No. 1 Trust and Clearmink No. 2 Trust. The primary beneficiaries were the applicant and any spouse, de facto partner, widow, children, grandchildren, great grandchildren, parents and grandparents of his. There was no evidence as to the time, on 8 June, when these trusts were settled. The fixing of the seal of Clearmink to each trust deed was witnessed by the applicant as director.

12. Immediately before the transactions on 8 June 2003, the share capital of each of Netscar and Windainty was structured as follows. There were 900,000 ordinary shares. There were eight classes of shares, of 10,000 shares each, identified as "A" Class to "H" Class. There were 19,999 "J" Class redeemable preference shares, and there was one "K" Class redeemable preference subscriber share. The only shareholder in each of Netscar and Windainty was Clearmink. There is some confusion as to whether it held one share or two shares in each. Australian Securities and Investment Commission extracts indicate that Clearmink held one share in each of Netscar and Windainty. However, all the other evidence in the case, including the books of account of each relevant entity, suggest that two shares in each company were so held. I shall proceed on that basis, and note that the shareholding in question, in each of Netscar and Windainty, was by way of ordinary shares. There was no other issued share capital in Netscar or Windainty. Before any of the steps were taken on 8 June 2003, there was no discrimination, in the constitutions of Netscar and Windainty, as between the participation rights of "A" Class and "B" Class shares on a return of capital.

The Plaster Plus transactions

13. Dealing then with the first series of transactions done on 8 June 2003, it seems that the first document signed by the applicant was a resolution of himself as director of Netscar to call an extraordinary general meeting of members at 10:30 am on that day. At 10:20 am, acting in his capacity as director of Clearmink, the applicant signed an acknowledgment of having received notice of that meeting. The general meeting of Netscar was duly held at 10:30 am, the applicant being the only person present. Two resolutions of substance were carried. First, it was resolved to amend the constitution of Netscar in a number of ways, including by the insertion of a new clause 127(b) as follows:

"Upon a reduction of capital or winding up of the Company:

….

(b) The said "B" class shares shall as regards return of capital be entitled to the amount paid up on those shares and shall rank pari passu inter se with all other shares in the capital of the company and in the surplus assets and profits."

Secondly, it was resolved to consent to the conversion of the shareholding of Clearmink in Netscar to "A" Class shares. The meeting closed at 10:45 am. At 10:50 am, there was a meeting of the board of Netscar, constituted by the applicant, in which it was resolved to classify the Clearmink shareholding as "A" Class shares.

14. By a document headed "Application for Shares", addressed to the directors of Netscar and dated 8 June 2003, Denburrow applied for 1,700 "B" Class shares in Netscar, with a nominal value of $1,000 per share, payable as to $1 per share upon allotment and as to the balance upon call on seven days' notice. There was no evidence as to the time, on 8 June, when that document was executed. The document was accompanied by a bearer promissory note in the sum of $1,700. At a meeting of the board of Netscar held at 11:00 am on 8 June 2003, attended only by the applicant as director, the receipt of the Denburrow share application was noted, and it was resolved to issue the shares on the basis set out in the application, and to accept the bearer promissory note in satisfaction of the amount payable at allotment. The applicant signed a share certificate recording that Denburrow was the holder of 1,700 "B" Class shares in Netscar.

15. At 11:10 am on 8 June 2003, there was a further meeting of the board of Netscar, attended by the applicant as director. The share allotment to Denburrow was noted. It was resolved to make the call for the balance of the price of the "B" Class shares. The applicant signed a "Notice of Call" addressed to Denburrow, in which the latter was required to pay the sum of $1,698,300, being the balance due in respect of Denburrow's "B" Class shares, on or before the expiration of eight days from the receipt of the notice.

16. At 11:30 am on 8 June 2003, a meeting of the board of Denburrow was held. Messrs Collie and Hart attended as directors. It was resolved to sell to Plaster Plus the 1,700 "B" Class shares "at market value, namely, $1,700". It was noted that that sum represented the amount paid up on the shares, that the amount of $1,698,300 remained subject to call, and that the constitution of Netscar made Plaster Plus, as the new owner of the shares, liable for the call. It was also noted that a call had in fact been made by Netscar. The directors of Denburrow also resolved to accept delivery of a Plaster Plus promissory note in the sum of $1,700 as a payment for the shares. That promissory note was in evidence, and was signed by the applicant on behalf of Plaster Plus on 8 June 2003, but there is no evidence as to the timing of that event. The directors of Denburrow resolved also to deliver the Plaster Plus promissory note to Netscar "in satisfaction of the promissory note for the same amount previously drawn and delivered by [Denburrow] and to seek the return of that note".

17. At 11:40 am on 8 June 2003, there was a meeting of the board of Plaster Plus, attended by the applicant as director. It was resolved to purchase from Denburrow the 1,700 "B" Class shares which the latter then held in Netscar "at market value, namely, $1,700.00 to be paid by delivery of a bearer promissory note for that amount". It was noted that that sum represented the amount paid up on the shares, that the amount of $1,698,300 remained subject to call, and that the constitution of Netscar made Plaster Plus, as the new owner of the shares, liable for that call. The making of the call by Netscar was noted.

18. On 8 June 2003, there was an agreement for sale made between Denburrow as vendor and Plaster Plus as purchaser with respect to the 1,700 "B" Class shares in Netscar. In the recitals to that agreement, it was noted that the shares were paid up to $1 per share, with $1,698,300 at call, and that the holder of the shares was liable to meet the call. Although there is no evidence as to the time at which this agreement was executed (in the case of Plaster Plus, by the applicant), as a matter of sequence it most probably came after the events referred to in the previous paragraph. A share transfer was executed (the applicant signing on behalf of Plaster Plus) on the same day. As director of Netscar, the applicant signed a share certificate stating that Plaster Plus was the holder of the 1,700 "B" Class shares.

19. The next thing that appears to have happened on 8 June 2003 was the signing of a promissory note addressed to Netscar by the applicant on behalf of Plaster Plus. By it, Plaster Plus promised to pay Netscar the sum of $1,698,300 on presentation of the note. At 11:50 am on 8 June, there was a meeting of the board of Netscar, attended by the applicant as director. It was noted that Plaster Plus, which had acquired the shares originally issued to Denburrow, had delivered an "on demand" promissory note to meet the call. It was resolved to accept the promissory note as meeting the call. It was also resolved to accept from Denburrow the delivery of the Plaster Plus bearer promissory note in the sum of $1,700 in satisfaction of the promissory note previously drawn and delivered by Denburrow for that amount, and to return the latter to the drawer.

20. At this point, the shareholding in Netscar was as follows. Clearmink held the only two "A" Class shares issued. It held them as trustee of the Clearmink No. 1 Trust. Plaster Plus held the 1,700 "B" Class shares. It had acquired them from Denburrow, to whom they had originally been issued. As to $1 per share, it had paid Denburrow by way of a bearer promissory note which was subsequently delivered to Netscar. As to $999 per share, it had paid for them by an "on demand" promissory note addressed to Netscar itself.

21. At 12:10 pm on 8 June 2003, the board of Netscar, constituted by the applicant as director, resolved to call an extraordinary general meeting at 12:45 pm that day. It was proposed to amend to constitution of Netscar by replacing clause 127(b), set out in par 13 above, with the following:

"The said "B" shares shall as regards return of capital be entitled only to $1.00 per share but shall not carry the right to any further participation in any surplus assets or profits of the company."

The notice was received by each of Clearmink and Plaster Plus at 12:20 pm. The applicant, as the only shareholder in Plaster Plus, signed a consent to that amendment. At 12:30 pm, the board of Plaster Plus, constituted by the applicant as director, noted that consent, and resolved to consent to the amendment. Plaster Plus then executed a formal form of consent to the amendment, signed by the applicant. At 12:40 pm on 8 June 2003, the board of Clearmink, constituted by the applicant as director, resolved to consent to the proposed amendment to the constitution of Netscar. A formal form of consent was executed by Clearmink, signed by the applicant. At 12:45 pm on 8 June 2003, an extraordinary general meeting of the shareholders of Netscar was held. Clearmink and Plaster Plus were both present, by their director, the applicant, in each case. It was unanimously resolved to amend the constitution of Netscar in the form proposed in the notice of meeting.

22. At some time on 8 June 2003, presumably subsequent to the amendments just mentioned, the board of Netscar, constituted by the applicant as director, resolved to advance the sum of $1,698,300 to Clearmink, as trustee for the Clearmink No. 1 Trust, by way of loan. This was to be done, and was in fact done, by the delivery of a bearer promissory note in that sum. The note was executed by the applicant as director of Netscar; and the receipt of the note by Clearmink was acknowledged by a receipt signed by the applicant as director of that company.

23. The accounts for the Clearmink No. 1 Trust as at 30 June 2003 were in evidence. On the balance sheet, the trust is shown to have current assets of $1,700,008. The $8 was cash (presumably the difference between the settlement sum of $10 and the cost of buying two $1 ordinary shares in Netscar). The remaining current assets, $1,700,000, were said to be "promissory note outstanding". On the evidence, the only promissory note that had been delivered to Clearmink, to be held for the Clearmink No. 1 Trust, was the Netscar promissory note (by way of loan) in the sum of $1,698,300. The balance sheet makes no reference to a promissory note in that sum. Rather, as I have indicated, it does refer to a promissory note in the sum of $1,700,000 as to the existence of which there is no other evidence. There is in evidence a letter from Mr Collie to the applicant dated 22 July 2003, in which the former referred to an "earlier letter" (which is not in evidence) and said that "[p]ending cash flow between the various entities, the transaction can be recorded in accordance with … [a document provided under separate cover - not in evidence] namely…":

"3.1 Plaster Plus (Vic) Pty Ltd

3.1.1 Share purchase

- debit assets $1,700.00

- credit loan from Netscar Pty Ltd $1,700.00

3.1.2 Payment of Call

- debit assets $1,698,300.00

- credit loan from Netscar Pty Ltd $1,698,300.00

2.2 Netscar Pty Ltd

2.2.1 Loan to Plaster Plus (Vic) Pty Ltd

- debit assets $1,700,000.00

- credit issued capital $1,700,000.00

2.2.2 Loan to Clearmink Pty Ltd

- debit assets $1,700,000.00

- credit loans $1,700,000.00

2.3 Clearmink Pty Ltd

2.3.1 Loan to 'shareholder/associates'

- debit assets $1,700,000.00

- credit loan to Netscar Pty Ltd $1,700,000.00"

It is possible that the entries on the balance sheet of the Clearmink No. 1 Trust reflect the advice so tendered by Mr Collie. They do not appear to reflect what actually occurred on 8 June 2003. If they reflect other transactions carried on before 30 June 2003 but not on 8 June, there is no other evidence of them; and, if they did, it would leave the actual promissory note delivered by Netscar to Clearmink unrepresented on the balance sheet.

24. The balance sheet of Clearmink No. 1 Trust showed non-current assets of $3,028,926, made up as follows. First, there was the sum of $1,700,002. The $2 represented the cost value of the shares held by the trust in Netscar. The $1,700,000 was said to be "provision for increase in value". It was common ground, and I would find, that this entry was supposed to represent the increase in value in Clearmink's two shares in Netscar, brought about by the alteration of the participation rights of the "B" class shareholders effected by the substitution of cl 127(b) of the constitution on 8 June 2003. Again, there was no explanation as to why the sum was $1,700,000, rather than $1,698,300, since the sum of $1,700 would still have been due to the "B" class shareholders on liquidation. However that minor anomaly may be, this entry on the balance sheet of the Clearmink No. 1 Trust relates to a central feature of the first series of transactions on 8 June; the result of the alteration of the participation rights of "B" class shareholders in Netscar was that the "A" class shareholder, Clearmink, received a gain by way of a substantial increase in the value of the two shares which it held.

25. Next, the non-current assets of the trust as at 30 June 2003 included the sum of $1,328,924, which had two components. The first was a loan to Lauravale in the sum of $428,924, and the second was a loan to the applicant and his wife in the sum of $900,000. Save for these accounts, there was no direct evidence of the making of those loans. However, it was common ground that I should treat the loans as existing as at 30 June 2003. Additionally, I would note two further things about these loans. First, taken together, they correspond exactly to the accumulated profits of Plaster Plus as at 30 June 2002 (and, I infer, as at 7 June 2003). Secondly, the loan to the applicant and his wife is in the same amount as the loan which had been advanced to them by Plaster Plus in the 2002 year. Later in these reasons (see par 70 below) I refer to evidence from which it should be inferred that the 2002 loan was repaid to Plaster Plus on 8 June 2003. It was submitted on behalf of the Commissioner that the loan of $900,000 from Clearmink put the applicant and his wife in funds such as permitted the repayment of the 2002 loan. I accept that submission. It follows, and I would infer, that the Clearmink loan was made to the applicant and his wife no later than, and most probably on, 8 June 2003.

26. The balance sheet for Clearmink No. 1 Trust as at 30 June 2003 showed also current liabilities of $1,700,000. This was said to be a loan from Netscar. I note that, on the evidence, Netscar had lent the trust a sum of $1,698,300, and that the unexplained variation in the liability section of the balance sheet from this sum corresponds with, and balances, the apparent misstatement as to the face value of the Netscar promissory note referred to as one of the current assets of the trust.

27. As non-current liabilities, the balance sheet showed the sum of $1,328,924. This was said to be a non-secured loan from Plaster Plus. I note that this sum corresponds precisely with the total of the loan said to be made by the trust to the applicant and his wife, and to Lauravale, as described above.

28. The accounts for the Clearmink No. 1 Trust also set out the "trust capital and reserves". This amounted to the sum of $1,700,010, of which $10 was the settlement sum and $1,700,000 was a capital profit reserve, constituted by the provision for the increase in value of the two shares held in Netscar.

29. In the accounts for Plaster Plus for the year ended 30 June 2003, an extraordinary loss item of $1,698,300 was shown in the profit and loss statement. This was said to be a provision for the diminution in value of the shares held in Netscar. When set against the retained profits at the beginning of that financial year, this provision had the effect of causing Plaster Plus to record a loss of $332,079 in that year.

30. In its balance sheet as at 30 June 2003, Plaster Plus showed the value of its shareholding in Netscar at $1,700,000, less provision for diminution in value in the amount of $1,698,000. The value of the shareholding was, therefore, $1,700. Also recorded as a non-current asset was the sum of $1,382,206, said to be an unsecured loan to the Clearmink No. 1 Trust. At the same time, the accounts showed that non-current assets which had existed on 30 June 2002 no longer existed, namely, a loan to Lauravale in the sum of $1,004,796 and the loan to the applicant and his wife in the sum of $900,000 mentioned in par 25 above.

The Zinkris transactions

31. Turning now to the second series of transactions done on 8 June 2003, a preliminary to those transactions was the nomination, on 5 June 2003, of Zinkris as a general beneficiary of the Lawrence Family Trust. It will be recalled that Zinkris itself was incorporated only on that day. It seems that Zinkris received no income between then and 8 June 2003. However, on 29 June 2003 the Lawrence Family Trust distributed income to Zinkris in the amount of $1,762,826. This was shown as operating profit for the year ended 30 June 2003. Tax was calculated at $632,827, leaving Zinkris with taxed, undistributed profits of $1,129,999 as at that date. It is apparent that the transactions of 8 June 2003 were based on an anticipation that profits of about that order would be lying in Zinkris as at 30 June 2003. I should add that, as in the case of Plaster Plus, the applicant said that he had been advised that he had no need to distribute those profits in Zinkris, and that they could have been retained by Zinkris indefinitely.

32. On 8 June 2003, as director of Windainty, the applicant resolved to call an extraordinary general meeting of members at 1:15 pm on that day and, in his capacity as director of Clearmink, he signed an acknowledgement of having received notice of that meeting. The general meeting of Windainty was duly held at 1:15 pm, the applicant being the only person present. Resolutions in the same terms as those passed by the meeting of Plaster Plus at 10:30 am that day were carried (see par 13 above). The meeting closed at 1:30 pm. At 1:35 pm, there was a meeting of the board of Windainty, constituted by the applicant, in which it was resolved to classify the Clearmink shareholding as "A" Class shares.

33. There followed a series of transactions closely corresponding to those set out in par 14 above, the only differences being that Windainty, rather than Netscar, was the company concerned and that 1,300, rather than 1,700, "B" Class shares were involved. Then (at 1:55 pm) the board of Windainty, constituted by the applicant, resolved to call for the balance of the price of "B" Class shares, and a call in those terms was executed and transmitted to Denburrow at 2:05 pm. The sum called for was $1,298,700, being the difference between the face value of the 1,300 "B" Class shares ($1.3 m) and the amount already paid by Denburrow ($1,300).

34. At 2:15 pm on 8 June 2003, a meeting of the board of Denburrow was held. Messrs Collie and Hart attended as directors. It was resolved to sell to Zinkris the 1,300 "B" Class shares "at market value, namely, $1,300.00". It was noted that that sum represented the amount paid up on the shares, that the amount of $1,298,700 remained subject to call, and that the constitution of Windainty made Zinkris, as the new owner of the shares, liable for the call. It was also noted that a call had in fact been made by Windainty. The directors of Denburrow also resolved to accept delivery of a Zinkris promissory note in the sum of $1,300 as payment for the shares. That promissory note was in evidence, and was signed by the applicant on behalf of Zinkris on 8 June 2003, but there is no evidence as the timing of that event. The directors of Denburrow resolved also to deliver the Zinkris promissory note to Windainty "in satisfaction of the promissory note for the same amount previously drawn and delivered by [Denburrow] and to seek the return of that note". At 2:25 pm, there was a meeting of the board of Zinkris, attended by the applicant as director. Business was transacted which corresponded with that set out in par 17 above, mutatis mutandis. Likewise, there was an agreement for the sale of shares between Denburrow and Zinkris which corresponded to that referred to in par 18 above.

35. Next, the applicant, acting as director of Zinkris, signed a promissory note in favour of Windainty in the sum of $1,298,700. At 2:35 pm on 8 June, there was a meeting of the board of Windainty, attended by the applicant as director. It was noted that Zinkris, which had acquired the shares originally issued to Denburrow, had delivered an "on demand" promissory note to meet the call. It was resolved to accept the promissory note as meeting the call. It was also resolved to accept from Denburrow the delivery of the Zinkris bearer promissory note in the sum of $1,300 in satisfaction of the promissory note previously drawn and delivered by Denburrow for that amount, and to return the latter to the drawer.

36. At this point, the shareholding in Windainty was as follows. Clearmink held the only two "A" Class shares issued. It held them as trustee for the Clearmink No. 2 Trust. Zinkris held the 1,300 "B" Class shares. It had acquired them from Denburrow, to whom they had originally been issued. As to $1 per share, it had paid Denburrow by way of a Denburrow promissory note, which was subsequently delivered to Windainty. As to $999 per share, it had paid for them by an "on demand" promissory note addressed to Windainty itself.

37. At 2:55 pm on 8 June 2003, the board of Windainty, constituted by the applicant as director, resolved to call an extraordinary general meeting at 3:30 pm that day. It was proposed to amend the constitution of Windainty by replacing Clause 127(b) with a provision in the same terms as I have set out at par 21 above in the case of Netscar. There followed a series of transactions which corresponded, mutatis mutandis, with those set out in par 21 above in the case of Plaster Plus and Netscar. As in the case of Netscar, the constitution of Windainty was amended to limit the participation rights of the holders of "B" Class shares to $1 per share on a return of capital.

38. Finally on 8 June 2003 (or so it seems) the board of Windainty, constituted by the applicant, resolved to advance the sum of $1,298,700 to Clearmink, as trustee for the Clearmink No. 2 Trust, by way of loan. This was done by the delivery of a bearer promissory note in that sum, executed by the applicant as director of Windainty, and acknowledged by him as director of Clearmink.

39. The accounts for the Clearmink No. 2 Trust as at 30 June 2003 were in evidence. On the balance sheet, the trust is shown to have current assets of $1,300,008. The $8 was cash, presumably the difference between the settlement sum of $10 and the cost of buying two $1 ordinary shares in Windainty. The remaining current assets, $1,300,000 were said to be "promissory note outstanding". On the evidence, the only promissory note that had been delivered to Clearmink, to be held for the Clearmink No. 2 Trust, was the Windainty promissory note (by way of loan) in the sum of $1,298,700. The balance sheet makes no reference to a promissory note in that sum. Rather, as I have indicated, it does refer to a promissory note in the sum of $1,300,000 as to the existence of which there is no other evidence. No such correspondence as is referred to in par 23 above in relation to the Clearmink No. 1 Trust was in evidence in relation to the Clearmink No. 2 Trust.

40. The balance sheet of the Clearmink No. 2 Trust showed non-current assets of $2,952,496, made up as follows. First, there was the sum of $1,300,002. The $2 represented the cost value of the shares held by the trust in Windainty. The $1,300,000 was said to be "provision for increase in value". It was common ground, and I would find, that this entry was supposed to represented the increase in value in Clearmink's two shares in Windainty, brought about by the alteration of the participation rights of the "B" Class shareholders effected by the substitution of clause 127(b) of the constitution on 8 June 2003. Again, there was no explanation as to why the sum was $1,300,000, rather than $1,298,700, since the sum of $1,300,000 would still have been due to the "B" Class shareholders on liquidation. However that minor anomaly may be, this entry on the balance of the Clearmink No. 2 Trust relates to a central feature of the second series of transactions on 8 June; the result of the alteration of the participation rights of "B" Class shareholders in Windainty was that the "A" Class shareholder, Clearmink, received a gain by way of a substantial increase in the value of the two shares which it held.

41. Next, the non-current assets of the trust as at 30 June 2003 included the sum of $1,652,494, which had two components. The first was a loan to Lauravale in the sum of $952,494, and the second was a loan to the applicant and his wife in the sum of $700,000. Save for these accounts, there was no direct evidence of the making of those loans. However, it was common ground that I should treat the loans as existing as at 30 June 2003.

42. The balance sheet for Clearmink No. 2 Trust as at 30 June 2003 showed also current liabilities of $1,300,000. This was said to be a loan from Windainty. I note that, on the evidence, Windainty had lent the trust a sum of $1,298,700, and that the unexplained variation in the liability section of the balance sheet from this sum corresponds with, and balances, the apparent misstatement as to the face value of the Windainty promissory note referred to as one of the current assets of the trust.

43. As non-current liabilities, the balance sheet showed the sum of $1,652,494. This was said to be a non-secured loan from Zinkris. I note that this sum corresponds precisely with the total of the loan said to be made by the trust to the applicant and his wife, and to Lauravale, as described above.

44. The accounts for the Clearmink No. 2 Trust also set out the "trust capital and reserves". This amounted to the sum of $1,300,010 of which $10 was the settlement sum and $1,300,000 was capital profit reserve, constituted by the provision for the increase in the value of the two shares held in Windainty.

45. In the accounts for Zinkris for the year ended 30 June 2003, an extraordinary loss item of $1,298,700 was shown in the profit and loss statement. This was said to be a provision for the diminution in value of the shares held in Windainty. When set against the profits earned by way of distribution from Lauravale as described in par 31 above, this provision had the effect of causing Zinkris to record a loss of $168,701 in that year.

46. In its balance sheet as at 30 June 2003, Zinkris showed the value of its shareholding in Windainty at $1,300,000 less a provision for diminution in value in the amount of $1,298,700. The value of the shareholding was, therefore, $1,300. Also recorded as a non-current asset was the sum of $1,762,826, said to be an unsecured loan to the Clearmink No. 2 Trust .

The s 177F determinations and the amended assessments

47. The applicant returned a total income of $40,996 for the year ended 30 June 2003. It is tolerably clear that no part of that income represented any distribution to the applicant by Plaster Plus or Zinkris. An assessment issued on 9 March 2004 which was based upon that income as so returned. In May 2005, the applicant received a notice under s 264 of the 1936 Act, requiring him to attend for examination and to produce certain documents. I shall refer further to that notice in due course. The notice appears to have prompted a letter which the applicant sent to the Commissioner on 12 May 2005, and in which he disclosed the details of the Plaster Plus and Zinkris transactions to which I have referred above. After the applicant had attended for examination under s 264, and after further correspondence passing between his advisers and the Commissioner, the latter made the determinations, and issued the amended assessments, to which I next refer.

48. In making his first determination under Part IVA of the 1936 Act, the Commissioner took the view that there was a scheme, within the meaning of the definition of that word in s 177A, involving the applicant, Plaster Plus, Netscar, Denburrow and Clearmink. He took the view that the scheme was by way of, or in the nature of, dividend stripping, or that it at least had substantially the effect of such a scheme, within the meaning of s 177E(1)(a) of the 1936 Act. He considered that the diminution in the value of the shares in Netscar held by Plaster Plus constituted a disposal of property by Plaster Plus within the meaning of s 177E(2)(d) of the 1936 Act. He formed the opinion that that disposal represented a distribution of the profits of Plaster Plus within the meaning of s 177E(1)(b) of the 1936 Act. The Commissioner also considered that, if Plaster Plus had paid a dividend out of profits equal to the amount represented by the diminution in value of its shareholding in Netscar, the amount of that distribution would have been, or might reasonably be expected to have been, included in the assessable income of the applicant within the meaning of s 177E(1)(c) of the 1936 Act. In the circumstances, the applicant was taken to have obtained a tax benefit for the purposes of s 177F. The Commissioner determined that $1,698,300 was the amount of profits of Plaster Plus which was represented by the diminution in the value of the Plaster Plus shareholding in Netscar.

49. In making his second determination under Part IVA of the 1936 Act, the Commissioner took the view that there was a scheme, within the meaning of the definition of that word in s 177A, involving the applicant, Zinkris, Windainty, Denburrow and Clearmink. He took the view that the scheme was by way of, or in the nature of, dividend stripping, or that it at least had substantially the effect of such a scheme, within the meaning of s 177E(1)(a) of the 1936 Act. He considered that the diminution in the value of the shares in Windainty held by Zinkris constituted a disposal of property by Zinkris within the meaning of s 177E(2)(d) of the 1936 Act. He formed the opinion that that disposal represented a distribution of the profits of Zinkris within the meaning of s 177E(1)(b) of the 1936 Act. The Commissioner also considered that, if Zinkris had paid a dividend out of profits equal to the amount represented by the diminution in value of its shareholding in Windainty, the amount of that distribution would have been, or might reasonably be expected to have been, included in the assessable income of the applicant within the meaning of s 177E(1)(c) of the 1936 Act. In the circumstances, the applicant was taken to have obtained a tax benefit for the purposes of s 177F. The Commissioner determined that $1,298,700 was the amount of profits of Zinkris which was represented by the diminution in the value of the Zinkris shareholding in Windainty.

50. By reason of the determinations to which I have referred, the Commissioner issued a Notice of Amended Assessment on 25 October 2007. That notice disclosed an increase in the applicant's taxable income of $2,997,000, compared with the original assessment issued on 9 March 2004. The additional tax required to be paid under the amended assessment was $1,451,514.32.

51. The Commissioner also imposed an administrative penalty under subdiv 284-C of Div 284 of Part 4-25 of Sched 1 to the Administration Act. That penalty was calculated at 50% of the "scheme shortfall amount" (ie 50% of $1,451,514.32) pursuant to s 284-160(a)(i) of that Schedule, reduced by 20% pursuant to s 284-225(1) of the Schedule, on the basis that the applicant had disclosed the details of the scheme after the Commissioner told him that a tax audit was to be conducted of his financial affairs. In the result, the penalty imposed was $580,605.70.

The legislation

52. It is now necessary to refer to the provisions of Part IVA of the 1936 Act by reference to which this proceeding must be determined. Central to the operation of that Part is s 177F, subsection (1) of which relevantly provides:

"Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may:

(a) in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income -determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income;
…

and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination."

By s 177A(1), a "scheme" is defined as:

"(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct."

Specifically in relation to dividend stripping, s 177E provides as follows:

"(1) Where:

(a) as a result of a scheme that is, in relation to a company:

(i) a scheme by way of or in the nature of dividend stripping; or

(ii) a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping;

any property of the company is disposed of;

(b) in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);

(c) if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount ) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and

(d) the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia,
the following provisions have effect:

(e) the scheme shall be taken to be a scheme to which this Part applies;

(f) for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and

(g) the amount of that tax benefit shall be taken to be the notional amount.

(2) Without limiting the generality of subsection (1), a reference in that subsection to the disposal of property of a company shall be read as including a reference to:

(a) the payment of a dividend by the company;

(b) the making of a loan by the company (whether or not it is intended or likely that the loan will be repaid);

(c) a bailment of property by the company; and

(d) any transaction having the effect, directly or indirectly, of diminishing the value of any property of the company.

(2A) This section:

(a) applies to a non-share equity interest in the same way as it applies to a share; and

(b) applies to an equity holder in the same way as it applies to a shareholder; and

(c) applies to a non-share dividend in the same way as it applies to a dividend.

(3) In this section, property includes a chose in action and also includes any estate, interest, right or power, whether at law or in equity, in or over property."

The applicant's case

53. It was common ground that the resolutions of the general meetings of members of Netscar (at 12:45 pm on 8 June 2003), and of Windainty (at 3:30 pm on that day) by which the right of "B" Class shareholders to participate in a return of capital was limited to $1 per share, were transactions having the effect of diminishing the value of Plaster Plus's shareholding in Netscar, and of Zinkris's shareholding in Windainty, and were therefore disposals of property for the purposes of s 177E. Neither did the applicant resist the proposition that at least what occurred at Richmond on 8 June 2003 was a "scheme" for presently relevant purposes, or that diminutions in the value of that shareholding resulted from that scheme. The applicant also accepted that the diminutions were in the sums of $1,698,300 and $1,298,700 respectively (as, indeed, the annual accounts of Plaster Plus and Zinkris indicated). Since those sums were the amounts determined by the Commissioner to be the amounts of profits the distribution of which, in his opinion, represented those diminutions in value, and since the applicant was the only shareholder in each of Plaster Plus and Zinkris, it would seem to be clear that, had Plaster Plus and Zinkris paid dividends out of profits of those amounts respectively, they might reasonably be expected to have been included in the assessable income of the applicant, as required by par (c) of subs (1).

54. The applicant challenged the Commissioner's determination under s 177F in the following respects:

1. While it was accepted that the series of transactions carried out on 8 June 2003 fell within the definition of "scheme" in s 177A, it was contended that the schemes did not extend beyond the transactions by which the participation rights of the "B" class shareholders in Netscar and Zinkris were diminished. In particular, it was said that the loans by the Clearmink No. 1 and No. 2 Trusts to the applicant, his wife and Lauravale were not part of the scheme.
2. It was contended that the schemes were not by way of or in the nature of dividend stripping, and did not have substantially the effect of schemes which were by way of or in the nature of dividend stripping, within the meaning of par (a) of s 177E(1) of the 1936 Act.
3. It was contended that, to the extent that the schemes involved disposals of property within the meaning of s 177E, those disposals did not represent distributions of the profits of Plaster Plus or Zinkris; or at least not a distribution to the applicant. It was not sufficient, it was said, for Clearmink to have benefited from the disposals.
4. It was contended that s 177E simply did not apply in the circumstances of the present case, since that section was a "provision of last resort". As I understand it, this contention was based upon the proposition that various other provisions of the legislation expressly permit a taxpayer to take steps of the kind taken by the applicant in the present case, and thereby contemplate that the taxpayer may secure access to the profits of a company in tax-free form. Section 177E, therefore, should not be permitted an operation which would cut across the apparent intention of those other provisions.

The scope of the schemes

55. As to the scope of the schemes, counsel for the applicant relied upon
Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 217 CLR 216 as authority for the proposition that, in a Pt IVA case, the scheme must be identified in a way that gives it a sensible relation to the tax benefits sought to be obtained, and to its dominant purpose: see 217 CLR at 223 [5] and 225 [9]. I accept that submission at the general level, but note that Hart was, relevantly, concerned with the concept of a tax benefit as dealt with in s 177C and with purpose as dealt with in s 177D. In the case of s 177E, Pt IVA applies because the requirements of pars (a)-(d) of subs (1) have been satisfied in a particular case, not because of the operation of s 177D. Likewise, under s 177E the taxpayer is taken to have obtained a tax benefit because of the operation of par (f), without the need for recourse to s 177C. Counsel for the applicant recognised these points of detailed departure from the situation in Hart, but submitted that the observations in Hart had reference to s 177E in a way that required the scheme to be confined to the transactions which, according to the Commissioner, were by way of or in the nature of dividend stripping, or which were said to have that effect. In particular, he submitted that a scheme of the kind contemplated by s 177E could not include any transactions which occurred later in time than the disposal of property by reference to which subs (1) operates, and that any such later transactions had to be ignored. Specifically in the present case, according to counsel for the applicant, nothing later than the resolutions of the general meetings of Netscar and Windainty by which the participation rights of holders of "B" Class shares were altered could be treated as part of the schemes.

56. Although little turns on it in the facts of the present case, I am inclined to think that counsel's submission fails to recognise the distinction between the operation of s 177E, on the one hand, and the characterisation of the scheme which, as at least one of its results, produces a disposal of property of the kind to which the section refers, on the other. Drawing from the definition of "scheme" in s 177A, the latter question will be whether there was any scheme, plan, proposal etc (including a unilateral one - see s 177A(3)) which was by way of or in the nature of dividend stripping, or which substantially had that effect. In answering this question, the court should not, in my view, turn a Nelsonian eye to facts, circumstances or transactions which have the capacity to throw light on the matter merely because they post-date the disposal of property by reference to which the operation of the section is complete. For one thing, s 177E requires only that the disposal of property be a result of the putative scheme: it may be that the plan, proposal etc in question involves, in a particular case, the doing of things after the disposal of property is complete. For another thing, as will appear presently, the concept of "dividend stripping" is not defined in the 1936 Act, and, in one of its aspects, involves a consideration of purpose. There is, in my view, no warrant in s 177E for the a priori exclusion of any facts or events, before or after the actual disposal by reference to which subs (1) operates, from that consideration.

57. Consistently with what I take to have been the High Court's injunction in Hart, I do not propose to divorce my identification of the schemes in the present case from the matter of dividend stripping itself. Whether there were schemes which were by way of or in the nature of dividend stripping, or which had substantially that effect, should, in my view, be approached as a composite inquiry in the context of which all proven facts having a rational tendency to provide the answer should be placed on the table for such assistance as they provide.

58. As I have said, the applicant accepted that there were schemes in the present case but contended that they involved no transactions beyond those by which the participation rights of the "B" Class shareholders in Netscar and Windainty were altered. As will appear below, I consider that the matters arising under s 177E can be decided consistently with that contention and that, for that reason, probably little turns on whether the schemes went beyond those transactions or not. However, to be faithful to the facts as they appear in the evidence, I would have to note that (in the case of the Plaster Plus transactions) the loans from Clearmink to the applicant and his wife ($900,000) and to Lauravale ($428,924) were related closely to the events of 8 June 2003 both in time and in purpose. As to timing, I have held above that the $900,000 loan was made on or very shortly before 8 June 2003. There was no evidence of the actual timing of the $428,924 loan, but it occurred before 30 June 2003. The sum of these two loans corresponded precisely with the accumulated, undistributed, profits of Plaster Plus as at 30 June 2002. In the case of the Zinkris transactions, the loans from Clearmink to the applicant and his wife ($700,000) and to Lauravale ($952,494) could only have been made on 8 June 2003, or between then and 30 June 2003. The applicant, on whom the onus lay, gave no evidence on any of these matters. All these loans were, I infer, the ones to be made by the "trustee of new trust" (ie Clearmink) as shown on the schematic representation in the confidential transaction summary - see par 8 above. As there shown, the loans had every appearance of being part of the "scheme, plan, proposal [etc]" (to use the words of the definition of "scheme" in s 177A) implemented in each of the series of transactions in the present case.

By way of or in the nature of dividend stripping

59. I turn next to the applicant's second main challenge to the Commissioner's determinations. In defending the determinations, counsel for the Commissioner relied upon both limbs of par (a) of s 177E(1) of the 1936 Act. They submitted that the schemes (however they might be defined) were by way of, or in the nature of, dividend stripping or, alternatively, had substantially the effect of such a scheme. Counsel for the applicant submitted that the schemes in the present case fell into neither category.

60. The term "dividend stripping" is not defined in the 1936 Act. The meaning of the term as used in s 177E was the subject of detailed consideration by Hill J in
CPH Property Pty Ltd v Commissioner of Taxation 98 ATC 4983; (1998) 88 FCR 21 and by each of the Full Court and the High Court when that case went on appeal: see
Commissioner of Taxation v Consolidated Press Holdings Limited (No 1) 99 ATC 4945; (1999) 91 FCR 524 ("Consolidated Press (FC)") and
Commissioner of Taxation v Consolidated Press Holdings Ltd 2001 ATC 4343; (2001) 207 CLR 235 ("Consolidated Press (HC)") respectively. That case involved a series of transactions, clearly well-organised and co-ordinated (and in that sense recognisable as a scheme) by which shares in a company with accumulated profits were transferred to other entities in the same group in circumstances which, but for the absence of a tax avoidance purpose, might well have constituted dividend stripping. Hill J held that, because of the absence of that purpose, the transactions were not a scheme by way of or in the nature of dividend stripping. However, his Honour held that the transactions fell within subpar (ii) of s 177E(1)(a) because they had substantially the effect of a scheme by way of or in the nature of dividend stripping, notwithstanding that they were not accompanied by a tax avoidance purpose. In that respect, his Honour's judgment was reversed by the Full Court, and that reversal was upheld by the High Court.

61. In Consolidated Press (FC), their Honours concluded that case law demonstrated that the term "dividend stripping" was "applicable to a range of transactions provided certain essential characteristics are present" (91 FCR at 560 [132]). Specifically, their Honours relied upon the judgment of Gibbs J in
Commissioner of Taxation (Cth) v Patcorp Investments Limited 76 ATC 4225; (1976) 140 CLR 247, and upon his Honour's identification of four previous judgments of the High Court in which dividend stripping operations had been involved. Their Honours in the Full Court continued (91 FCR at 561 [136]):

"These four cases had the following characteristics in common:

• a target company, which had substantial undistributed profits creating a potential tax liability either for 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 the dividend so declared (whether by reason of a s 46 rebate, an offsetting loss on the sale of the shares, or the fact that the shareholders were resident outside Australia); and

• 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 (there being no capital gains tax at the relevant times)."

The Full Court identified "a further common characteristic" of the schemes in the four cases considered by Gibbs J in Patcorp, namely -

"… that they were carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company." (91 FCR at 561 [137])

62. Considering specifically the formula "by way of or in the nature of dividend stripping" in s 177E(1)(a)(i) of the 1936 Act, the Full Court said (91 FCR at 566 [156]-[157]):

"The terms of the first limb of s 177E(1)(a) suggest that a scheme may fall within its scope, even though not all the elements of a dividend standard dividend stripping scheme are present. The use of the words "by way of or in the nature of" suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provided it retains the central characteristics of a dividend stripping scheme.

Since the legislation does not identify those central characteristics, it is necessary to look to the decided cases preceding the 1981 Act and to the extrinsic materials accompanying the relevant legislation. We have identified what we would see as the central characteristics of a dividend stripping scheme, by reference to the High Court decisions discussed in Patcorp. The six characteristics so identified are set out in [136] and [137]. They are similar to those identified by the primary judge as comprising the "essential character" of a dividend stripping operation."

The six characteristics to which their Honours referred were the five identified by bullet points, as set out in par 61 above, together with the predominant purpose of the vendor shareholders avoiding tax on a distribution of dividends by the target company. Their Honours held that, for a scheme to be by way of or in the nature of dividend stripping, it had to display those characteristics at least. It is, therefore, by reference to the presence or absence of those characteristics that the schemes in the present case should be examined for consistency with the broad description contained in subpar (i) of s 177E(1)(a) of the 1936 Act.

63. Counsel for the applicant submitted that, although Plaster Plus had substantial undistributed profits, there was no potential tax liability either for itself or for the applicant. As to Plaster Plus itself, it was pointed out that tax had been paid (in the 2002 year) on the profits in question, and that there was, therefore, no further potential tax liability. As to the applicant, it was pointed out that there was no evidence to suggest that Plaster Plus intended to distribute the profits in question to its only shareholder (the applicant), in which circumstances it could not be concluded that the undistributed profits of Plaster Plus created a potential tax liability for the applicant.

64. I acdcept that, because tax had already been paid, the undistributed profits did not create a potential tax liability for Plaster Plus itself. However, the position is different in the case of the applicant. I do not consider it sufficient to avoid the first of the six points in Consolidated Press (FC) to assert that the profits in question might conceivably have forever remained undistributed. Indeed, the very point of the enactment of s 177E in 1981 was to catch schemes which might not otherwise be caught because it might not be possible to say that dividends would, absent the scheme, most likely have been paid. In the Explanatory Memorandum to the Income Tax Laws Amendment Bill (No 2) 1981 (Cth), which, when passed into legislation, introduced Pt IVA into the 1936 Act, the following appeared:

"Section 177E is designed against the background that, while such schemes are of the general kind to which preceding provisions of Part IVA are to apply, it may not always be able to be concluded that, if the scheme had not been entered into, the relevant dividends would have been (or might reasonably be expected to have been) included in assessable income: the company may simply have retained the profits for the time being."

This passage was among those noted by the High Court in Consolidated Press (HC) (207 CLR at 268-269 [108]), and by the Full Court itself in the same case: see 91 FCR at 564 [150]. The particular aspect of the design of s 177E referred to in the Explanatory Memorandum is to be seen in par (c) of subs (1), which states a hypothesis: it is not necessary that a dividend would, or would probably, have been paid. The requirements of par (c) are satisfied where a dividend, if paid, would have been included, or might reasonably have been included, in the assessable income of the taxpayer.

65. In the circumstances, I do not believe that the first of the six characteristics identified by the Full Court should be understood as requiring that the undistributed profits would, or even would probably, have created a tax liability of the kind indicated. Rather, when they referred to "a potential tax liability … for … shareholders", their Honours were, in my view, speaking of a liability which had the potential to arise if dividends were so paid. The use of the word "potential" makes it clear that their Honours were referring to what probably would happen if profits were distributed in a conventional way. It is, in my view, no answer for the applicant to say that it had not been positively established that profits would inevitably have been so distributed by Plaster Plus in the facts of the present case.

66. As it happens, there is every reason to suppose, and I would find on the probabilities, that Plaster Plus would have distributed its retained profits, or at least a substantial part of them, to the applicant in a form which would represent income in his hands. On the evidence, Plaster Plus never traded. Its only source of income was a distribution from Lauravale in the 2002 year. Had it indefinitely refrained from distributing its retained profits, those profits would have been of no use to anyone. The applicant, as the only shareholder, had an obvious interest in accessing the value represented by those profits. As a matter of reality, it was inevitable that he would take steps to secure, for himself or his associates, the benefit of those profits. Conventionally, he would do so by procuring Plaster Plus to pay dividends. It was submitted for the applicant, however, that, since he had borrowed $900,000 from Plaster Plus in the 2002 year, and since he could effectively remain permanently indebted to Plaster Plus, he had a means of accessing the value tied up in the retained profits which did not involve the payment of dividends. This was said to be because the loan did, and any future such loans would, comply with Div 7A of Part III of the 1936 Act. This submission requires me to consider the requirements of that division in the context of the arrangements made by the applicant with Plaster Plus.

67. Central to an understanding of those arrangements was the effect of ss 109D and 109E of the 1936 Act. Subject to a number of qualifications set out in Subdiv D, s 109D deemed a loan made by a private company to a shareholder, which was not fully repaid in the year in which it was made, to be a dividend paid to the shareholder at the end of that year. Subject to s 109Y, the amount of the dividend was the amount of the loan that remained unrepaid when the company lodged, or was obliged to lodge (whichever was the earlier) its return of income for that year. One of the qualifications in Subdiv D was that for which s 109N provided. A loan was not taken to be a dividend if the agreement for the loan was in writing, if the rate of interest equalled or exceeded the "benchmark rate" and if the term of the loan did not exceed the "maximum term" worked out in accordance with s 109N(3). The loan of $900,000 from Plaster Plus to the applicant satisfied the requirements of s 109N: the agreement for the loan was in writing, the rate of interest specified was the benchmark rate and the term did not exceed the maximum term. This meant that the loan was not deemed to be a dividend in the 2002 year.

68. The 2003 year was the concern of s 109E. At the relevant time, that section provided (subject to presently irrelevant qualifications) that, when a private company made an "amalgamated loan" to a shareholder in a previous income year, when the loan was not repaid at the end of the current year, and when the current year was the first year of income in which the amount paid to the company in respect of the loan was less than the minimum yearly repayment worked out under subs (5), then, subject to s 109Y, the company was taken to pay a dividend to the shareholder (at the end of the current year) in the amount of the unrepaid part of the loan. An "amalgamated loan" was a loan which was not fully repaid during the year in which it was made and which would have been deemed to be a dividend under s 109D (apart from s 109N). The loan of $900,000 by Plaster Plus to the applicant in the 2002 year was an amalgamated loan apropos the 2003 year for the purposes of s 109E. Had the loan not been repaid by 30 June 2003, and had the applicant not made the minimum yearly repayments worked out under subs (5), the unrepaid part of the loan would have been treated as a dividend paid by Plaster Plus to the applicant in the 2003 year.

69. The loan agreement was written specifically to avoid these consequences. It contained a recital to the effect that Plaster Plus and the borrowers (the applicant and his wife) "wish to ensure that the Loan is not deemed to be a dividend pursuant to Division 7A of the Act, by the Loan being an excluded loan pursuant to section 109N of the Act". Section 109N had a role to play in ensuring that the loan was not deemed to be a dividend in the 2002 year. The situation which would arise in the 2003 years, and in later years, was anticipated by the following provisions of the agreement:

"3. INTEREST
In each year of income following the year in which the Loan is made, the Borrowers agree to pay interest on the outstanding balance of the Loan at such rate as agreed between the parties but being not less than the benchmark interest rate, such interest accruing daily and payable annually in accordance with clause 4.

4. MINIMUM YEARLY REPAYMENTS

(1) The Borrowers shall make minimum yearly repayments of the Loan and interest to the Lender as required by section 109E of the Act.

(2) Unless otherwise provided by the Act, the minimum yearly repayments made by the Borrowers pursuant to clause 4(1) shall be calculated in accordance with the formula set out in the Schedule.

5. TERM

(1) Notwithstanding clause 5(2), the whole of the Loan must be repaid to the Lender not later than seven years after the Loan is made.

(2) The Borrowers may repay the Loan prior to the due date for repayment, in which case interest will abate in respect of the Loan."

The schedule referred to in cl 4(2) of the agreement was as follows:

"M = A × I
1-[1/1+I]R

Where -

M = Minimum yearly repayment required to be made by the Borrowers.

A = The amount of the Loan not repaid by the end of the previous year of income.

I = The benchmark interest rate for the year of income for which the minimum yearly repayment is being calculated.

R = The difference between -

(a) the term of the Loan; and

(b) the number of years of income between the end of the year of income in which the Loan was made and the end of the year of income before the year for which the minimum yearly repayment is being calculated,

rounded up to the next higher whole number if the difference is not already a whole number."

The formula so set out in the schedule reflected the terms of s 109E(6) of the 1936 Act (which, by subs (5), yielded the "minimum yearly repayment" in a particular case).

70. Also in the evidence, but apparently not part of the loan agreement as such, was a table headed with the name of Plaster Plus and described as "Break up of interest and principle [sic] compnent [sic] of yearly dividend." The table was as follows:

Division 7A loan agreement			Open Bal	Rate		Total div	Interest	Principle [sic]
			6	900,000.00	0.69311	0.31	184,755	56,700	128,055
			5	771,944.93	0.73677	0.26	184,755	48,633	136,123
Opening balance	$900,000.00		4	635,822.39	0.78319	0.22	184,755	40,057	144,698
Interest rate	6.30%	0.69311	3	491,124.13	0.83253	0.17	184,755	30,941	153,814
No of years remaining	6	0.30689	2	337,309.88	0.88498	0.12	184,755	21,251	163,505
		0.940734	1	173,805.33	0.94073	0.06	184,755	10,950	173,805
							1,108,530	208,530	900,000
Repayment 30 June 2003	$184,755.07

This table appears to have been prepared by those advising the applicant at some time before 8 June 2003, since it contains a handwritten endorsement - the source of which was unknown to the applicant - to the effect that the period between 1 July 2002 and 8 June 2003 amounted to 343 days, and that the amount which was required to be paid as interest for that period was $53,282, not $56,700, for the full year as shown in the table. That endorsement seems to reflect an assumption that the loan was repaid on 8 June 2003.

71. Counsel for the Commissioner submitted that the loan agreement, and the table set out above, made it clear that the applicant intended to avoid the unrepaid part of the loan being treated as a dividend under s 109E by making the minimum yearly repayments for which subs (5) and (6) provided, together with interest. Critically, the way this was proposed to be done was for the applicant to receive dividends as shown in the column in the table headed "total div". Whether or not it was intended that money would in fact change hands either way, it seems inevitable that, if payments of principal and interest had been paid on the loan as intended, and as required to avoid the deeming provisions of Div 7A, the applicant would have received dividends from Plaster Plus.

72. The first requirement of dividend stripping set out in Consolidated Press (FC) is not that profits in the amount of the 177E disposal would necessarily have been distributed as dividends in the year of the disposal. It is merely that the existence of the undistributed profits created a potential tax liability for shareholders. In the present case it is clear that the means chosen by the applicant to have practical access to the undistributed profits of Plaster Plus - the loan of $900,000 - brought with them the need for the applicant to receive dividends sufficient to fund repayments of principal and payments of interest. I consider that, for this reason in addition to those referred to above, the first characteristic identified in Consolidated Press (FC) was present in the circumstances facing the applicant.

73. Turning to the Zinkris scheme, there was no pre-existing loan to the applicant and his wife as there was in the case of the Plaster Plus scheme. What actually happened in relation to Zinkris, and in what order, is complicated by the manifest artificiality of the transactions concerned. As noted in par 31 above, it was not until 29 June 2003 that Zinkris received the distribution (from the Lawrence Family Trust) that appears to have constituted its only income for 2002-2003. But it seems clear that the transactions of 8 June 2003 were based on the anticipation that there would be a distribution, and that the source of the funds which would support the promissory note in favour of Windainty in the sum of $1,298,700 would be the after-tax profits of Zinkris for that year. On any view, Zinkris had substantial undistributed profits creating a potential tax liability for the applicant. In this respect, I would apply the reasoning set out in pars 64-65 above to the circumstances of Zinkris. It is true that there was not a loan, or the repayment schedule, that existed in the case of Plaster Plus, but the existence of the undistributed profits created a potential tax liability for the applicant nonetheless. Indeed, the Plaster Plus loan, and the repayment schedule, demonstrated how that potential could not be avoided merely by the making of such arrangements.

74. However, I could not hold that the second, third, fourth or fifth of the characteristics identified in Consolidated Press (FC) were, or that any of them was, present in this case. There was no sale or allotment of shares in Plaster Plus or Zinkris. Necessarily, there was no payment of a dividend to the allottee (or, should it matter, to the applicant). Since there was no "purchaser" of shares, there was necessarily no question of such a person escaping income tax. There were no "vendor shareholders". Counsel for the Commissioner urged upon me the purpose of Pt IVA of the 1936 Act, and submitted that what the applicant had done here was well within the scope of the evil to which s 177E is directed. The fact is, however that the Full Court in Consolidated Press (FC) held that a scheme would not be in the nature of dividend stripping unless it retained the central characteristics to which their Honours referred, including those mentioned in this paragraph which were manifestly absent from the transactions entered into by the applicant in relation to Plaster Plus and Zinkris. In the circumstances, I would conclude that the schemes were not by way of or in the nature of dividend stripping, as required by subpar (i) of s 177E(1)(a) of the 1936 Act.

75. I shall defer my consideration of the requirement of a dominant tax avoidance purpose until after I have dealt with operation of s 177E(1)(a)(ii).

Having substantially the effect of … dividend stripping

76. In the context of s 177E, the distinction between a scheme which is by way of or in the nature of dividend stripping and a scheme which is not such a scheme but which has substantially the effect of such a scheme is not an easy one. The Parliament has adopted a popular compendious metaphor for an organised series of transactions which itself is not otherwise identified. In subpar (ii) of s 177E(1)(a), the legislation requires the reader to envisage a series of transactions which is not properly described by that metaphor, but which has the effect of a series of transactions which is. Further, the section distinguishes between the effect of the transactions (the concern of subpar (ii)) and the result of them, namely, the disposal of property of the company which, in the opinion of the Commissioner, represents a distribution of all or a part of the profits of the company. Clearly, for a scheme to have such a result is insufficient to justify the conclusion that it has the effect to which subpar (ii) refers. In other words, that subparagraph requires the court to look at circumstances other than the mere fact that company property has been disposed of in a way which represents a distribution of profits.

77. Some indication of what the Parliament had in mind in subpar (ii) may be seen in the following passage of the Explanatory Memorandum in 1981:

"Part IVA will have within it, in section 177E, a supplementary code to deal with dividend-stripping schemes of tax avoidance and certain variations on such schemes, the effect of which is to place company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends."

It seems that the Parliament wanted to catch "variations" on dividend stripping schemes, and considered that the unifying principle of all such schemes and variations was that they had the effect of placing company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. This is, in my view, a significant indication of Parliamentary purpose, since it treats such an effect as distinct from the result of a scheme of the kind contemplated: s 177E does not require that shareholders themselves, as a "result" of the scheme, receive the profits distributed by way of the disposal of property in question.

78. The Explanatory Memorandum also stated of the proposed s 177E:

" Sub-section(1) is the operative sub-section. It lists the conditions which must exist for section 177E to apply and the results which flow from the application of the section.

Paragraph (a) sets out the initial and key test that there be a scheme that in fact is either one by way of or in the nature of dividend stripping or one having substantially the effect of such a scheme. Schemes within the category of being, or being in the nature of, dividend stripping schemes would be ones where a company (the "stripper") purchases the shares in a target company that has accumulated profits that are represented by cash or other readily-realisable assets, pays the former shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company.

In the category of schemes having substantially the same effect would fall schemes in which the profits of the target company are not stripped from it by a formal dividend payment but by way of such transactions as the making of irrecoverable loans to entities that are associates of the stripper, or the use of the profits to purchase near-worthless assets from such associates."

In Consolidated Press (HC), the High Court said that the third paragraph quoted above provided "a clue to the understanding of s 177E(1)(a)(ii)" (207 CLR at 276 [139]). Their Honours continued (at [140]):

"The Explanatory Memorandum had earlier referred, in connection with sub-par (i), to dividends or deemed dividends which, by reason of s 47(1) of the Act, would include distributions to shareholders by a liquidator to the extent to which they represented income, other than income applied to replace paid-up capital. What sub-par (ii) was aimed at was a scheme that would be within sub-par (i) except for the fact that the distribution by the target company was not by way of a dividend or deemed dividend. Dividend stripping does not lose its connotation of tax avoidance purpose. But a scheme may have substantially the effect of a scheme by way of or in the nature of dividend stripping even though some means other than a dividend or deemed dividend is employed to make the distribution."

Their Honours had previously said (207 CLR at 276 [138]):

"The reference in sub-par (ii) to effect does not require the element of purpose to be discarded. In particular, it does not require that any scheme which produces a substantial consequence which is in any respect the same as a consequence of a dividend stripping scheme is within the sub-paragraph. If it were otherwise, a sale of shares cum dividend, followed by a payment of a dividend to the purchaser, would ordinarily be caught."

79. Counsel for the applicant relied on these passages in Consolidated Press (HC) as providing support for the proposition that the only respect in which subpar (ii) travels beyond the scope of subpar (i) is that it catches schemes by which the profits of the target company (once that company is under the control of the new owner of its shares) are distributed otherwise than by payment of a dividend. Only such schemes, it was submitted, had substantially the effect of a scheme by way of or in the nature of dividend stripping. It remained necessary for the shares in the target company first to have been purchased (or otherwise obtained) from the original shareholders. This had not occurred in the present case: the shareholding in Plaster Plus and Zinkris remained in the hands of the applicant throughout.

80. If read as though they purported to stand as exhaustive statements of the reach of s 177E(1)(a)(ii), the words of the High Court judgment, and of the Explanatory Memorandum, do provide support for the submission made on behalf of the applicant. However, I do not so read those words. In the case of the Explanatory Memorandum, the relevant paragraph is expressed as though providing examples or indications only, and not as though definitive. I do not read the paragraph as indicating a legislative intention that there always need be a separate person or entity, into whose hands the relevant shareholding has first passed. Indeed, the reference to the purchase of near-worthless assets, as an alternative to a formal dividend payment, amply accommodates a situation in which the target company itself purchases such assets from associates of its existing shareholders. In the present case, Plaster Plus and Zinkris purchased "B" Class shares in Netscar and Windainty, the consideration for which provided Netscar and Windainty with capital of equivalent value. Plaster Plus and Zinkris then consented to changes in the constitution of Netscar and Windainty, the manifest effect of which was to render their own shareholdings "near worthless". Although I would not construe s 177E through the prism of the fact situation in the present case, that situation does provide an example of a way in which profits of a company may be placed into the hands of an associate of the taxpayer in a tax-free form. That s 177E(1)(a)(ii) should be construed so as to cover examples of this kind is consistent with the operation of the section as explained in the paragraph of the Explanatory Memorandum set out in par 78 above.

81. In the case of the judgment in Consolidated Press (HC), their Honours' concern was to lay out their reasons for holding that the presence of a tax-avoidance purpose was a requirement of subpar (ii), no less than of subpar (i). That was why a scheme which produced a substantial consequence which was in any respect the same as a consequence of dividend stripping would not ipso facto fall within subpar (ii). When they pointed out that the subparagraph was "aimed at" a scheme that would be within subpar (i) save for the fact that the distribution was not by way of dividend, their Honours were, in my respectful view, stressing that the difference between subpar (i) and subpar (ii) lay in the means adopted to distribute the profits of the target company. It followed that the requirement of a tax-avoidance purpose, being basic to the idea of dividend stripping in any form, existed equally under subpar (ii).

82. I do not think that the High Court's words - "except for the fact that the distribution by the target company was not by way of a dividend or deemed dividend" - should be pressed into service to justify the conclusion that a scheme will never fall within subpar (ii) unless it involves the transfer of shares in the target company to a person or entity separate from the original shareholders. That would be to extend the meaning of those words beyond anything that their Honours had in contemplation. Structurally, the scheme in the present case is quite different from that which was before the High Court in Consolidated Press (HC). I think, with respect, that their Honours would be surprised to be told that they had, in that case, ruled that a scheme which involved the stripping of profits out of a target company and the placement of a corresponding capital sum into the assets of a trust for the original shareholder and his family could never be held to have the effect referred to in subpar (ii) for the sole reason that the shareholding in the target company had not changed hands.

83. I return to the central characteristics of dividend stripping as identified in Consolidated Press (FC). The first characteristic cannot intelligibly be applied with reference to the "effect" of a scheme: it is concerned only with the starting point of the scheme, as it were. As was made clear by the Full Court and in Consolidated Press (HC), the tax avoidance purpose is required under subpar (ii), no less than under subpar (i), of s 177E(1)(a). That leaves the second, third, fourth and fifth characteristics, which I have held to be absent from the facts of the present case. Do those facts disclose a scheme that had substantially the effect of a scheme with those characteristics?

84. To answer this question, as it seems to me, requires one to consider a notional scheme which did not in fact exist but which would have had the characteristics to which I refer; and to consider then the effect of that notional scheme. On the facts of the present case -

• had the applicant sold his shares in Plaster Plus and Zinkris to another party (for example, but not necessarily, Clearmink);
• had Plaster Plus and Zinkris then paid dividends to the new shareholder out of their profits;
• had the new shareholder escaped Australian income tax on that dividend; and
• had the applicant received a capital sum for his Plaster Plus and Zinkris shares in an amount the same as or very close to the dividends paid to the new shareholder;

the effect thereof would, in my view, have been substantially the same as the effect of the scheme in fact implemented in relation to Plaster Plus and Zinkris. Both in the notional scheme referred to and in the present case the taxpayer, otherwise presumptively entitled to dividends, would receive a capital payment (or benefit) which would have been funded by the profits of the target company. In the notional scheme the capital receipt would consist of the proceeds of the sale of his or her shares. In the present case an accretion of capital, the same in effect as such a receipt, arose from the increase in the value of the assets held by the Clearmink No. 1 and No. 2 Trusts, to which the applicant and his family were beneficially entitled. In both cases, the profits of the target company would effectively have been disposed of, and would no longer have been a potential source of income tax obligations, either for the taxpayer or for anyone else. Both for the taxpayer and for the revenue, the effects of the schemes in the present case were substantially the same as the effect of a scheme by way of or in the nature of dividend stripping.

85. It is convenient at this point to return to the identification and limits of the schemes which I have held to exist. Having considered the matter of dividend stripping, I have concluded that the schemes had substantially the effect of a scheme by way of or in the nature of dividend stripping. To reach that conclusion, I did not need to look beyond the increase in value in the shareholding of Clearmink in Netscar and Windainty. At that point the value - to use a neutral term - that started out as undistributed profits in Plaster Plus and Zinkris had become accretions to the capital of the Clearmink trusts. Subject only to the discretionary nature of those trusts, the applicant and his associates were beneficially entitled to that capital. To reach the conclusion that the scheme substantially had the effect of dividend stripping, it is sufficient that associates of the applicant had derived the benefit, as capital, of the profits stripped out of Plaster Plus and Zinkris. In the circumstances, the question whether the scheme went no further than the resolutions altering the participation rights of the "B" Class shareholders was, in my view, moot.

86. However, I would go further and indicate that I consider that the schemes did in fact go further than that, and involved loans to the applicant and his wife, and to their family trust, as indicated on the schematic diagram in par 8 above. In the light of the extremely spare nature of the applicant's evidence, it is not easy to identify a purpose for these loans. Perhaps they were thought to be a means by which funds in the form of capital could be transferred to the applicant or his associates, pending the winding up of Netscar and Windainty. The purpose of the loans from the Clearmink No. 2 Trust is rendered more problematic again by the fact that those loans totalled $1,652,494, where as the increase in value of the trust's shareholding in Windainty was $1,298,700 only. Counsel for the applicant did not seek to explain any of these matters, being content to submit that, because of the terms of s 177E(1)(a), no fact beyond the deemed disposal of property could be treated as part of the schemes or either of them. In the circumstances, I would find that the scheme in each case - in the sense of a scheme, plan or proposal - included the loans to which I have referred.

Tax avoidance purpose

87. As mentioned above, both the Full Court and the High Court in Consolidated Press held that, to constitute dividend stripping, a scheme had to have as its dominant purpose the avoidance of tax on the distribution of dividends by the target company. In Consolidated Press (FC), the Full Court said (91 FCR at 570 [174]):

"In our view, the first limb of s 177E(1) embraces only a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax. The requirement of a tax avoidance purpose flows from the use by Parliament of the undefined expression "a scheme by way of or in the nature of dividend stripping". What is important is the nature of the scheme, not the subjective motives or intentions of any of the participants or the beneficiaries. The purpose of the scheme is to be assessed from the perspective of the reasonable observer, having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated."

Their Honours also observed that the purpose was ordinarily to be looked at from the perspective of the vendor shareholders. They said (91 FCR at 569 [171]):

"Since the section is directed at vendor shareholders participating in or benefiting from dividend stripping schemes, the required tax avoidance purpose is ordinarily that of enabling the vendor shareholders to receive profits of the target company in a substantially (if not entirely) tax-free form, thereby avoiding tax that would or might be payable if the target company's profits were distributed to shareholders by way of dividends."

88. Although these observations by the Full Court related to subpar (i) of s 177E(1)(a), they apply equally to subpar (ii), in the context of which a tax avoidance purpose is just as necessary. The only evidence of the applicant's (or, by extension, his companies') actual purpose was that set out in the passage in his affidavit which I have extracted in par 3 above. In answer to the point that that passage is barely sufficient to establish that the applicant had a commercial, non-tax, purpose in mind when he entered into the transactions which effected the distributable surplus arrangements in the present case, his counsel submitted that, in the present context, what matters is the purpose of the scheme rather than that of the taxpayer, and that purpose is to be objectively discerned. He submitted that what the applicant said, or omitted to say, on the subject of his own (subjective) purpose would not advance the argument either way. I accept that submission at the general level, and propose to approach the matter of the purpose of the scheme objectively; although it was the applicant himself who bore the onus in relevant respects and who was best placed to give evidence of surrounding facts and circumstances, if there were any, from which a non-tax purpose might be inferred.

89. Counsel for the applicant submitted that I should find, on the evidence objectively viewed, that the predominant purpose of the scheme was to protect the value which resided in the undistributed profits of Plaster Plus by transferring it to, and then sheltering it in, the discretionary trust of which Clearmink was the trustee. In this respect, counsel pointed out that, by reason of the undistributed profits of Plaster Plus, the applicant's share in that company was a valuable asset. Because of the nature of his regular business dealings, the applicant should be regarded as having every reason to apprehend that proceedings might be taken against him, and that he might become liable to awards of damages. If such occurred, the applicant's share in Plaster Plus, being held absolutely by him, would be exposed to the claims of his creditors. If the value represented by that share were held in a discretionary trust, that risk would not arise. There was, however, no objective evidence from which I could infer that the predominant purpose of the scheme was as so described. The evidence set out par 3 above is manifestly insufficient for the applicant's present purposes. There was no evidence of the applicant ever having been sued, or been threatened with proceedings, in any relevant context. There was no evidence of the actual commercial circumstances facing the applicant in the period leading up to the development of the scheme.

90. By contrast, the idea for the scheme seems to have emerged from sources which were quite separate from the individual commercial imperatives facing the applicant, whatever they were. The idea was put to the applicant by solicitors from whom the applicant received taxation advice. The transactions involved were what Mr Collie "was recommending to some of his clients" (to use the applicant's recounting of Mr Collie's words). It was as clear as could be that the applicant knew nothing about the technical workings of the schemes, and relied wholly on the advice he received. Although this might equally have been the case had the schemes had a commercial purpose, in such a case it seems improbable that the applicant, a seemingly competent and worldly man of business, would have so clearly failed to understand the means by which the schemes would have been of practical utility to him.

91. Counsel for the applicant submitted that I should find that Plaster Plus had no need to distribute its retained profits, and that the applicant, having the benefit of the $900,000 loan from Plaster Plus transacted in the 2002 year, was under no pressure to obtain access to those profits by way of dividend. In the light of the considerations referred to above as to the relationship between the loan and the provisions of Div 7A of Part III of the 1936 Act, I cannot accept that submission.

92. The submissions made on behalf of the applicant that the Zinkris scheme had a purpose other than the avoidance of tax, to the extent that it was made at all, is of no substance. The proposition as to the need to protect the undistributed profits of Plaster Plus in a discretionary trust had no application to Zinkris. As counsel for the Commissioner pointed out, it was not until the Zinkris scheme was in the course of implementation (in fact it was not until 29 June 2003) that Zinkris had any profits at all. The source of its profits was, ironically perhaps, a discretionary distribution from the applicant's family trust. That is to say, having started out in a trust, where, to adopt the applicant's rationale offered in relation to Plaster Plus, they would be protected from third party claims, the funds in question were distributed to Zinkris where, according to that rationale, they would not be so protected. There was neither evidence nor submission from the applicant to explain these manoeuvres. The nature of the scheme, and the background to it, loudly bespeak tax avoidance as the dominant purpose thereof.

93. I am satisfied that the dominant purpose of each scheme in the present case was the avoidance of tax by the applicant. I use the term "avoidance", of codurse, not in any pejorative sense, but as indicating the purpose of bringing about a result in which the applicant would pay less tax than would otherwise be payable. That was in the sense in which the term was used in Consolidated Press (FC).

Distribution of profits

94. Turning to the applicant's third point, it was submitted on his behalf that the disposal of property in the present case did not represent, in whole or in part, a distribution of the profits of Plaster Plus. It was accepted that the Commissioner had in fact formed the opinion required by s 177E(1)(b), but it was submitted that that opinion was not open to the Commissioner in the circumstances, since the facts could not sustain the conclusion that there was a "distribution", or at least that there was a distribution to the applicant.

95. Under s 177E(1)(b), counsel for the applicant submitted first that the diminution in the value of Plaster Plus's shareholding in Netscar and of Zinkris's shareholding in Windainty could not qualify as a "distribution" of the profits of Plaster Plus and Zinkris. I was referred to the judgment of Sweeney J in
Commissioner of Taxation v Black 90 ATC 4699; (1990) 25 FCR 274, where his Honour observed that the word "distribution" in par (a) of the inclusive definition of "dividend" in s 6(1) of the 1936 Act "involves, at least, a dealing out or bestowal": 25 FCR at 281. In that case his Honour held that the forgiving of a debt owed by a shareholder to the company in question did not constitute a "distribution" in that statutory context.

96. In my view, the judgment of Sweeney J in Black does not govern the present situation. First, his Honour was concerned with the question whether the forgiving of a debt was in fact a distribution. Here, the question is whether a disposal of property "represents" a distribution. The language of s 177E(1)(b) is such as to comprehend a movement of property away from the company in question which is effectively the same as, or is tantamount to, a distribution of profits. Secondly, the operation of par (b) cannot, in my view, be divorced from the nature of the transactions which, according to subs (2), might constitute a "disposal" by reference to which the paragraph operates. For example, it would be no answer for a taxpayer to say that a bailment of property, by reason only of it being a bailment rather than a "dealing out or bestowal", did not constitute a distribution of the kind referred to in par (b). In the circumstances of the present case, s 177E, and therefore par (b) of subs (1), has the potential to extend to a transaction which has the effect, even the indirect effect, of diminishing the value of any property of the company. It could not be an answer to what would otherwise be the operation of s 177E to propose that a transaction of this kind cannot represent, in whole or in part, a distribution of the company's profits for the very reason that no observable movement of property has occurred. The section extends to transactions in which there is no "dealing out or bestowal" and, in my view, par (b) of subs (1) must be construed accordingly.

97. It will be apparent from what I have written above with respect to the matter of dividend stripping that I take the view that it was open to the Commissioner to form the opinion that the transactions by which Plaster Plus's shareholding in Netscar and Zinkris's shareholding in Windainty were diminished in value represented distributions of the profits of Plaster Plus and Zinkris within the meaning of s 177E(1)(b). Indeed, they were effectively so represented in the books of Plaster Plus and Zinkris themselves: they were entered on those companies' profit and loss statements for the year ended 30 June 2003 by way of provisions for losses arising from diminutions in the value of shares.

98. It was also submitted on behalf of the applicant that, at most, the disposal of property represented a distribution of profits to Clearmink, but that the applicant himself was not the beneficiary of the distribution. Whether or not there is any factual basis for this submission, s 177E(1)(b) covers a distribution either to a shareholder in the company or to any other person. If it be the case that the applicant was not the beneficiary, that does not affect the operation of par (b).

S 177E a "provision of last resort"?

99. The final contention made on behalf of the applicant was that s 177E was a "provision of last resort", in the sense that it had no operation at all in the context of the transactions by which a taxpayer was expressly entitled to reduce his or her assessable income under other provisions of the 1936 Act or associated legislation. The example in point, according to counsel for the applicant, was Div 7A of Pt III, under which non-arm's-length loans by companies to shareholders were not treated as dividends so long as certain conditions were met (which they were in the case of Plaster Plus). It was submitted that it would be antagonistic to the achievement of the objects implicit in Div 7A if transactions designed to take advantage of, for example, s 109N were then treated as dividend stripping under s 177E.

100. I do not accept the submission made on behalf of the applicant. First, and most obviously, the relationship between Pt IVA and other provisions of the 1936 Act is explicitly dealt with in s 177B. In particular, subs (1) thereof provides:

"Subject to subsection (2), nothing in the provisions of this Act other than this Part or in the International Tax Agreements Act 1953 or in the Petroleum (Timor Sea Treaty) Act 2003 shall be taken to limit the operation of this Part."

Counsel's submission seems clearly to amount to an invitation to the court to hold, contrary to s 177B(1), that the provisions of Pt IVA are limited in their operation by other provisions of the Act.

101. Secondly, to propose that Div 7A of Pt III treats certain loans as not amounting to income, or dividends, under certain circumstances is to misunderstand the provisions of that division. Loans are not income or dividends as ordinarily understood. They are deemed to be so in the circumstances referred to in ss 109D and 109E. In the case of s 109D, exceptions arise under s 109N. Section 109E contains its own exceptions. The effect of these exceptions is to negative what would otherwise be the deeming provisions of s 109D and 109E. In other words, the normal position, as though there were no legislative deeming, is thereby restored. That position is then subject to such other provisions of the 1936 Act as may, in particular circumstances, have something to say about it. Those other provisions are not rendered inoperative just because ss 109D and 109E have no role to play in relation to the loan in question.

102. For the above reasons, I do not accept the submission of the applicant that s 177E is no more than a provision of last resort.

Penalties

103. The applicant challenged the imposition of penalties in three respects. His first point concerns s 284-145(1) of Sched 1 to the Administration Act itself, which provides as follows:

"You are liable to an administrative penalty if:

(a) you would, apart from a provision of a taxation law or action taken under such a provision (the adjustment provision ), get a scheme benefit from a scheme; and

(b) having regard to any relevant matters, it is reasonable to conclude that:

(i) an entity that (alone or with others) entered into or carried out the scheme, or part of it, did so with the sole or dominant purpose of that entity or another entity getting a scheme benefit from the scheme; …."

Although counsel for the applicant included in his written outline a contention that the applicant did not get a "scheme benefit", that contention was not developed in oral submissions. Rather, counsel focussed his attention, relevantly to s 284-145(1), upon subpar (i) of par (b) thereof. He submitted that the applicant did not enter into or carry out the scheme with the sole or dominant purpose of himself, or of any entity, getting a scheme benefit from the scheme.

104. Counsel relied upon
Federal Commissioner of Taxation v Starr 2007 ATC 5447; (2007) 164 FCR 436, in which it was held that the "purpose" to which s 248-145(1)(b)(i) refers is the subjective purpose of the entity entering into the scheme, that is to say (in most cases at least), the taxpayer. With respect to this aspect, counsel reiterated his submission that the applicant's purpose of entering into the transactions which I have held to constitute schemes was to enable him to shelter the profits of Plaster Plus and Zinkris in discretionary trusts.

105. On the evidence, I could not find that that was the applicant's purpose. Although a statement by the applicant that such was his purpose might have been self-serving and of little weight, the fact is that the applicant made no such statement in his evidence in the case. For reasons set out at pars 89-92 above, neither are the surrounding facts and circumstances of any assistance to the applicant in this respect. Although I accept the point made by counsel for the applicant that s 284-145(1)(b)(i) requires consideration of subjective, rather than of objective, purpose, it is a normal and legitimate part of the fact-finding process to infer what was a person's subjective purpose from circumstances confronting him or her, and from things done by, and statements made by, him or her, in response to those circumstances. As I have held above, the circumstances surrounding the applicant's undertaking of the schemes in the present case so strongly bespeak a purpose on his part of obtaining a tax benefit as to have called for a clear and detailed explanation, if he proposed, as he has done, to resist a conclusion of the kind to which s 284-145(1)(b)(i) refers. No such explanation was forthcoming. I regard it as reasonable to conclude, and I do conclude, that the applicant entered into, and carried out, the schemes in the present case with the dominant purpose of him getting a scheme benefit from the schemes.

106. The applicant's second point involves s 284-160(a)(ii) of Sched 1 to the Administration Act. Section 284-160 provides for the calculation of the "base penalty amount". Paragraph (a) deals with schemes to which s 284-145(1) applies (ie the schemes in the present case), and subpar (ii) thereof quantifies the base penalty amount as 25% of the scheme shortfall amount "if it is reasonably arguable that the adjustment provision does not apply". In the circumstances of the present case, the "adjustment provision" is s 177E of the 1936 Act. The present point concerns the question whether it is "reasonably arguable" that that provision did not apply in the circumstances. This takes one to s 284-15(1) of Sched 1 to the Administration Act. In the form it took in 2003, it was there provided that a matter was "reasonably arguable" -

"… if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect."

An earlier provision (which had not been repealed by 2003 but which was not applicable to the circumstances of the present case), s 222C of the 1936 Act, was in the same terms as s 284-15(1), but contained the word "about" before the phrase "as likely to be correct". Speaking of that provision, in
Walstern Pty Ltd v Commissioner of Taxation 2003 ATC 5076; (2003) 138 FCR 1, 27 [108], Hill J said:

"The word 'about' indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right."

Notwithstanding the omission from s 284-15 of the word "about", the parties in the present case made common cause in submitting not only that I should read the subsection as though it contained that word but that I should apply the law as declared in Walstern. I must say that I have reservations about such a course, but, in the light of the parties' submissions, I shall adopt it.

107. The applicant's argument about the operation of s 177E(1)(a)(ii) of the 1936 Act, to which I have referred in par 79 above, had a rational basis both in the Explanatory Memorandum which accompanied the introduction of the legislation and in the judgment of the High Court in Consolidated Press (HC). I have held that argument to be misplaced, but I allow for the prospect that other Judges might have approached the matter differently. I have, perhaps, placed somewhat more emphasis upon the general purposes of Part IVA, and of s 177E in particular, than others might. It would be overstating the matter to say that I thought that the argument advanced on behalf of the applicant was in fact as likely to be correct as incorrect, but I am prepared to hold that that argument is "about" as likely to be correct as incorrect. In relevant respects, the arguments were finely balanced, and I would not be critical of the applicant's advisers for taking a view about the construction of subpar (ii) which, according to the view I take, fell just the wrong side of the line. In the circumstances, I consider that it was reasonably arguable that s 177E(1)(a)(ii) of the 1936 Act did not apply in the present circumstances. It follows that the "base penalty amount" was 25% of the scheme shortfall amount.

108. The applicant's third point concerns the operation of s 284-225(2) of Sched 1 to the Administration Act. In the way that subsection applies to the facts of the present case, if the applicant voluntarily told the Commissioner about the scheme shortfall amount (ie, effectively, informed the Commissioner of the details of the Plaster Plus and Zinkris schemes) before the Commissioner told the applicant that a "tax audit" was to be conducted of his financial affairs in relation to the period in question, then the "base penalty amount" would be reduced by 80%. It was common ground that the applicant made a voluntary disclosure of the details of the schemes by letter dated 12 May 2005. What was controversial was whether a letter sent by the Commissioner to the applicant dated 3 May 2005 told the applicant that a "tax audit" was to be conducted of his financial affairs. Counsel for the Commissioner argued that it did, while counsel for the applicant argued that it did not.

109. The Commissioner's letter of 3 May 2005 opened as follows:

"SECTION 264 NOTICE TO ATTEND AND GIVE EVIDENCE AND TO PRODUCE DOCUMENTS

Enclosed is a notice pursuant to section 264 of the Income Tax Assessment Act 1936. If you have any questions concerning the notice or what you are required to do to comply with the notice you should contact Harvey Dolby on (07) 321 35310 as soon as possible.

If you are having difficulties complying with the notice in the time allowed, you should advise the Commissioner in writing as soon as possible and in any event, before the date stated in the notice. You should state your concerns and reasons for them for consideration by this Office.

You are advised that penalties can apply if you do not comply with all of the requirements of the notice. These penalties are set out below in the notice.

Please note that section 264 does not override legal professional privilege but does override the privilege against self-incrimination.

The documents requested in the attached notice are required for the purposes of the Income Tax Assessment Act 1936. In very limited circumstances, some information may be given to certain parties as prescribed in taxation law. Further details on Privacy can be found in the brochure 'Safeguarding your Privacy' available at your nearest Taxation Office."

Enclosed with the letter was the s 264 notice referred to. The notice required the applicant to attend and to give evidence (at a specified time and place) -

"concerning the income or assessment of the entities specified in Schedule 1 for the period 1 July 1996 to 30 June 2004"

The list of entities specified in the schedule to the notice was extensive. It included the applicant, his wife, Lauravale and Plaster Plus. The notice also required the applicant to produce original minutes and resolutions for two trustee companies, one of which was Lauravale, to the extent that they related to the income or assessment of those companies for the period 1 July 1996 to 30 June 2004.

110. Counsel for the Commissioner submitted that the s 264 notice, and the covering letter dated 3 May 2005, told the applicant that an examination by the Commissioner of his financial affairs for the purposes of the 1936 Act was to be conducted. I cannot accept that submission. I would accept that, acting reasonably, the applicant might well have had his suspicions when he received this correspondence. But the correspondence did not tell him that there was to be such an examination, however much it might have presaged one. It required him to attend, to give evidence and to produce documents concerning the income or assessment of himself and other entities. That is not the same, in my view, as telling the applicant than an examination of his financial affairs was to be conducted.

111. For the above reasons, I consider that the base penalty amount for the scheme shortfall in the present case must be reduced by 80% pursuant to s 284-225(2) of Schedule 1 to the Administration Act.

Disposition of the proceeding

111. I propose to allow the applicant's appeal under s 14ZZ of the Administration Act to the extent only indicated above in relation to penalties. Otherwise, the appeal will be dismissed. I shall hear the parties on the question of costs.

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"3.1	Plaster Plus (Vic) Pty Ltd
	3.1.1	Share purchase
		- debit assets	$1,700.00
		- credit loan from Netscar Pty Ltd	$1,700.00
	3.1.2	Payment of Call
		- debit assets	$1,698,300.00
		- credit loan from Netscar Pty Ltd	$1,698,300.00
2.2	Netscar Pty Ltd
	2.2.1	Loan to Plaster Plus (Vic) Pty Ltd
		- debit assets	$1,700,000.00
		- credit issued capital	$1,700,000.00
	2.2.2	Loan to Clearmink Pty Ltd
		- debit assets	$1,700,000.00
		- credit loans	$1,700,000.00
2.3	Clearmink Pty Ltd
	2.3.1	Loan to 'shareholder/associates'
		- debit assets	$1,700,000.00
		- credit loan to Netscar Pty Ltd	$1,700,000.00"

"M	=	A × I 1-[1/1+I]R
Where	-
M	=	Minimum yearly repayment required to be made by the Borrowers.
A	=	The amount of the Loan not repaid by the end of the previous year of income.
I	=	The benchmark interest rate for the year of income for which the minimum yearly repayment is being calculated.
R	=	The difference between -
		(a) the term of the Loan; and
		(b) the number of years of income between the end of the year of income in which the Loan was made and the end of the year of income before the year for which the minimum yearly repayment is being calculated,
		rounded up to the next higher whole number if the difference is not already a whole number."