LAWRENCE v FC of TJudges:
Full Federal Court, Melbourne
MEDIA NEUTRAL CITATION:
 FCAFC 29
ATC 9475Ryan, Stone and Edmonds JJ
1. This is an appeal from a judge of this Court dismissing an appeal against the respondent's decision to disallow an objection lodged by the appellant against his amended assessment of income tax for the year ended 30 June 2003 ("the year of income"). The amended assessment was based upon determinations made by the respondent ("the Commissioner") under Pt IVA of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act"). Pursuant to s 177F(1)(a) of the 1936 Act, the Commissioner determined to include in the appellant's assessable income for the year of income the sums of $1,698,300 and $1,298,700 and, pursuant to s 177F(2), determined to include those amounts in the appellant's assessable income by virtue of s 44(1) of the 1936 Act.
2. The Commissioner's determinations under Pt IVA relied on s 177E of the 1936 Act which, in the context of Pt IVA, is concerned with schemes by way of or in the nature of dividend stripping or schemes having substantially the effect of such schemes. It is with the latter that this appeal is concerned.
The factual context
3. The facts as found by the primary judge were not put in issue by either party on the hearing of the appeal. They are set out at  -  of his Honour's reasons.
4. Relevantly, the primary judge found that there were "[mldr ] two discrete, but substantially identical, series of transactions" (), described by those advising the appellant, in particular, Mr Ian Collie of the firm Cleary Hoare, as a "distributable surplus arrangement". The first involved a company called Plaster Plus (Vic) Pty Ltd ("Plaster Plus") of which the appellant had been the sole shareholder and the only director since 1998. As at 30 June 2002, Plaster Plus had taxed but undistributed profits of $1,328,924. The second involved a company called Zinkris Pty Ltd ("Zinkris"), which was incorporated on 5 June 2003, and of which the appellant became the sole shareholder and the only director on that day. It had no undistributed profits at the time it entered into the relevant series of transactions, but it subsequently derived income in the form of a trust distribution in the sum of $1,762,826 before the end of the year of income.
5. The primary judge canvassed in some detail:
- (1) The identity and ownership of the participants in each series of transactions which he referred to as "the Plaster Plus transactions" and "the Zinkris transactions" respectively. We will adopt the same nomenclature.
- (2) The transactions by which the distributable surplus arrangements were implemented; they were all carried out on 8 June 2003.
6. As the primary judge observed, the two series of transactions were discrete but substantially identical. Some of the participants were common to both series of transactions; some were different. On the hearing of the appeal, the appellant's submissions principally addressed the Plaster Plus transactions and it is convenient that we do likewise in these reasons. It was not suggested that a different result might follow in the case of the Zinkris transactions by reason that Zinkris had no undistributed profits at the time it entered into those transactions. This was undoubtedly the correct position to take having regard to the terms of s 177E(1); see
Bishop v Finsbury Securities Ltd  3 All ER 105 (HL); (1966) 43 TC 591 concerning "forward-stripping".
The Plaster Plus transactions
ATC 9476The primary judge described both series of transactions by reference to a diagram and it is convenient if we do likewise with respect to the Plaster Plus transactions:
8. Netscar Pty Ltd ("Netscar") was incorporated by Mr Collie on 30 May 2003. Clearmink Pty Ltd ("Clearmink") was incorporated by Mr Collie on 2 June 2003. It was the trustee of what was called the "Clearmink No. 1 Trust", a discretionary trust under which the appellant and any spouse, de facto partner, widow, children, grandchildren, great grandchildren, parents and grandparents of his were the primary beneficiaries. Denburrow Pty Ltd ("Denburrow") was a company controlled by Cleary Hoare of which Mr Collie and Mr Michael James Patrick Hart, another member of that firm, were the directors.
9. Although it may have been otherwise at the point of incorporation, by 8 June 2003 the appellant was the only director of all the relevant companies save Denburrow, and the only shareholder of all the relevant companies save Denburrow and Netscar.
ATC 9477Immediately before the transactions on 8 June 2003, the share capital of Netscar was structured as follows. There were 900,000 ordinary shares. There were eight classes of shares, of 10,000 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 Netscar was Clearmink. There is some confusion as to whether it held one or two shares; the primary judge proceeded on the basis that it held two ordinary shares. There was no other issued share capital in Netscar. Before any of the steps were taken on 8 June 2003, there was no discrimination, in the constitution of Netscar, as between the participation rights of "A" Class and "B" Class shares on a return of capital.
11. It is unnecessary to detail the transactions to the same extent as the primary judge; it suffices if we paraphrase the primary judge's description of them, albeit in the same temporal order as they occurred on 8 June 2003.
12. At an extraordinary general meeting of Netscar, at which the appellant was 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:
- [mldr ].
- (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."
Second, it was resolved to consent to the conversion of the shareholding of Clearmink in Netscar to "A" Class shares.
13. At a subsequent meeting of the board of Netscar, constituted by the appellant, it was resolved to classify the Clearmink shareholding as "A" Class shares.
14. Denburrow applied for 1,700 "B" Class shares in Netscar, with a nominal value of $1,000 per share, payable as to $1.00 per share upon allotment and as to the balance upon call on seven days notice. The application was accompanied by a bearer promissory note in the sum of $1,700.
15. At a meeting of the board of Netscar, attended only by the appellant as director, 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.
16. A little later, there was a further meeting of the board of Netscar attended by the appellant as director. It was resolved to make the call for the balance of the price of the "B" Class shares. The appellant 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.
17. 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 in Netscar "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 the Plaster Plus promissory note in the sum $1,700 as a payment for the shares. 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".
18. There followed a meeting of the board of Plaster Plus, attended by the appellant 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.
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 appellant on behalf of Plaster Plus. By it, Plaster Plus promised to pay Netscar the sum of $1,698,300 on presentation of the note. There was a meeting of the board of Netscar, attended by the appellant 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 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. The board of Netscar, constituted by the appellant as director, resolved to call an extraordinary general meeting later that day. It was proposed to amend the constitution of Netscar by replacing cl 127(b), set out in  above, with the following:
"The said 'B' class 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. The appellant, as the only shareholder in Plaster Plus, signed a consent to that amendment. The board of Plaster Plus, constituted by the appellant 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 appellant. The board of Clearmink, constituted by the appellant as director, resolved to consent to the proposed amendment to the constitution of Netscar. A formal form of consent was executed by Clearmink and signed by the appellant. Subsequently, an extraordinary general meeting of the shareholders of Netscar was held. Clearmink and Plaster Plus were both present, by their director, the appellant, 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 appellant 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 appellant as director of Netscar, and the receipt of the note by Clearmink was acknowledged by a receipt signed by the appellant as director of that company.
23. 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.
24. 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
ATC 9479$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.
The statutory context
25. Section 177E provides as follows:
- (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."
26. Section 177E was rightly described in the Explanatory Memorandum (circulated by authority of the then Treasurer, the Hon. John Howard MP) to the Income Tax Laws Amendment Bill (No. 2) 1981 which became Act No. 110 of 1981, by which Pt IVA was inserted into the 1936 Act, as being "[mldr ] a self-contained code, within the framework of Pt IVA, designed to apply to schemes of a dividend stripping kind which would otherwise effectively place company profits in the hands of shareholders in a tax-free form." The Explanatory Memorandum went on to explain, in the following terms, why there was a need to deal with schemes of this kind by a self-contained code within Pt IVA:
ATC 9480"Schemes of the kind to which section 177E is directed could on occasions come within the general ambit of section 177D, but section 177E is needed for situations where, for example, although profits are in fact stripped from a company, it may not be a reasonable hypotheses that, but for the scheme, the profits would have been paid as dividends. But for the scheme they would formally have remained in the company, at least for the time being. If that were so in a particular case, the situation would not fall within section 177D because there would not, under section 177C, be a 'tax benefit' - i.e., an amount not included in assessable income that but for the scheme would have been, or might reasonably be expected to have been, included.
Also, without section 177E Part IVA may not operate to counter a dividend strip carried out in relation to current-year profits of a company, where tax purposes other than those of avoiding tax on dividends may also be present."
27. The Explanatory Memorandum further explains that subs (1) is the operative subsection and lists the conditions which must exist for s 177E to apply and the results which flow from its application. Relevantly, it makes the following observations with respect to para (a):
"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."
The findings and conclusions of the primary judge
28. Before the primary judge, counsel for the Commissioner, in defending the determinations and the assessment to give effect to them, relied upon both limbs of para (a) of s 177E(1). It was submitted that the schemes (however they might be defined) were by way of or in the nature of dividend stripping (the first limb) or, alternatively, that the schemes had substantially the effect of such a scheme (the second limb). Counsel for the appellant submitted that the schemes fell into neither category.
29. His Honour concluded that the schemes were not by way of or in the nature of dividend stripping, as required by the first limb of s 177E(1)(a) (at ). His Honour reached this conclusion after considering what a Full Court of this Court in
Commissioner of Taxation v Consolidated Press Holdings Ltd (No. 1) 99 ATC 4945; (1999) 91 FCR 524 ("Consolidated Press (FC)") had identified as common characteristics of transactions considered in a number of cases to involve "dividend stripping". These common characteristics were identified by the Full Court in Consolidated Press (FC) at  of the Court's reasons and are reproduced at  of his Honour's reasons. At  his Honour observed that the first characteristic identified in Consolidated Press (FC) was present in the circumstances facing the appellant. However, at  his Honour concluded:
"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."
30. Not surprisingly, no appeal is brought from his Honour's conclusion on the first limb; more relevantly, the Commissioner does not, correctly in our view, put his Honour's conclusion on the first limb in issue by way of notice of contention.
31. However, at  his Honour concluded that the schemes in the present case had substantially the effect of a scheme by way of or in the nature of dividend stripping. His Honour came to this conclusion notwithstanding passages to which he was taken by counsel for the appellant in the reasons of the Full Court in Consolidated Press (FC) and in
Commissioner of Taxation v Consolidated Press Holdings Ltd 2001 ATC 4343; (2001) 207 CLR 235 ("Consolidated Press (HC)") as providing support for the proposition that the only respect in which the second limb "travels beyond" the scope of the first limb, 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 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 appellant throughout.
32. His Honour's conclusion on this issue constitutes the first ground of the appellant's appeal to this Court and we return to it below.
33. The primary judge observed (at ), correctly in our view, that 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. His Honour further observed (at ) that these observations apply equally to the second limb, in the context of which a tax avoidance purpose is just as necessary. Counsel for the appellant submitted to the primary judge that he 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.
34. At  the primary judge said that he was satisfied that the dominant purpose of each scheme in the present case was the avoidance of tax by the appellant; not in any pejorative sense, but as indicating the purpose of bringing about a result in which the appellant would pay less tax than would otherwise be payable: Consolidated Press (FC).
35. His Honour's conclusion on this issue is not the subject of any ground of appeal to this Court.
36. The appellant's third point before the primary judge was 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 appellant.
37. His Honour rejected this submission and at  expressed the view that it was open to the Commissioner to form the opinion that the transactions by which Plaster Plus' shareholding in Netscar was diminished in value represented distributions of the profits of Plaster Plus within the meaning of s 177E(1)(b). His Honour's conclusion on this issue is the appellant's second ground of appeal to this Court.
38. Finally, his Honour rejected (at ) the appellant's contention that s 177E had to be applied in the context of other provisions of the 1936 Act dealing with specific activity or
ATC 9482conduct, such as Div 7A of Pt III of the 1936 Act, and that, so applied, s 177E is no more than a provision of last resort. The appellant's third ground of appeal to this Court puts this in issue, albeit on a broader basis.
The appeal to this Court
39. The appellant's notice of appeal, his written submissions filed in accordance with the practice directions of the Court and his oral submissions on the hearing of the appeal, all raise the same three issues. They are:
- (1) Whether the relevant transactions had substantially the effect of a scheme by way of or in the nature of dividend stripping within s 177E(1)(a)(ii) of the 1936 Act;
- (2) whether the transactions by which the relevant shareholding diminished in value represented distributions of the profits of the relevant entities within s 177E(1)(b) of the 1936 Act; and
- (3) whether, as a matter of statutory interpretation, s 177E of the 1936 Act applies to the appellant in respect of the relevant transactions.
The first issue
40. The appellant contended that the primary judge erred in concluding (at ) that the relevant transaction constituted a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. Indeed, it was put that his Honour's conclusion was contrary to what was said by both the Full Court and the High Court in Consolidated Press.
41. Sub-paragraph (ii) of para (a) of s 177E(1) is concerned with the effect of a scheme; whether a scheme had substantially the effect of a scheme by way of or in the nature of dividend stripping. Clearly, it is referring to a scheme which does not qualify as a scheme by way of or in the nature of dividend stripping within sub-para (i). On the other hand, it predicates a knowledge of the effect of a scheme by way of or in the nature of dividend striping; otherwise, one would not be able to determine whether the scheme in question met the test of substantially having the same effect. That might suggest that, under sub-para (ii), one is not concerned with what is a scheme by way of or in the nature of dividend stripping, only its effect. But that would be a mistake because at least one of the indicia identified by the courts as being common to transactions characterised as dividend stripping schemes looks to the effect of the scheme - the vendor shareholders receiving a capital sum for their shares the same as, or very close to, the dividends paid to the purchasers.
42. As the primary judge observed at  of his reasons, the term "dividend stripping" is not defined in the 1936 Act. In Consolidated Press (FC) the Full Court, in reliance upon the judgment of Gibbs J in
Commissioner of Taxation (Cth) v Patcorp Investments Limited 76 ATC 4225; (1976) 140 CLR 247, said (at ):
"What is helpful for present purposes is that Gibbs J identified four cases as involving dividend stripping operations:
Bell v Commissioner of Taxation (Cth) (1953) 87 CLR 548;
Newton v Commissioner of Taxation (Cth) (1958) 98 CLR 1 (PC);
Hancock v Commissioner of Taxation (Cth) (1961) 108 CLR 258;
Commissioner of Taxation (Cth) v Ellers Motor Sales Pty Ltd (1972) 128 CLR 602. 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 (a company in three cases and individuals resident in the then Territory of New Guinea in Bell);
- • 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)."
43. At , the Full Court identified a further common characteristic of each of the schemes in the cases considered by Gibbs J, namely:
"[T]hat 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."
44. We would merely add that, notwithstanding the advent of comprehensive taxation of capital gains, this characteristic remains relevant because the methods of calculating capital gains
ATC 9483inevitably lead to a lower amount of tax.
45. At  the Full Court referred to the precise terms of sub-para (i) and observed:
"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."
46. In Consolidated Press (FC) the Full Court, for reasons which are not relevant to the present case, came to the conclusion (at ) that the scheme in that case was not by way of or in the nature of dividend stripping within the first limb of s 177E(1)(a). This conclusion was upheld in the High Court. The Full Court then turned to consider the application of the second limb - a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. It is important to understand why it did so. The primary judge had held that the scheme, insofar as it concerned the shareholders in CPIHL(UK), had "substantially the effect of a scheme by way or in the nature of dividend stripping". It was therefore within the second limb of s 177E(1)(a) although that did not matter because the primary judge had concluded, with respect to both CPIL(UK) and CPIHL(UK), that the Commissioner's opinion under s 177E(1)(b) had miscarried and s 177E had no application to the shareholders in either company.
47. But in considering the primary judge's approach to the second limb of s 177E(1)(a), the Full Court said (at  and ):
- " His Honour's reasoning proceeded on the basis that there was a difference between the purpose and effect of a scheme. The effect was to be judged by reference to the vendor of the shares in the target company and the target company itself. With respect, the difficulty with this approach is that it leaves no work for the first limb of s 177E(1)(a) to do. If purpose is not an element in assessing the 'effect' of a scheme, there would never be a case within the first limb of s 177E(1)(a), which was not also within the second limb. In any given case it would be necessary only to consider the effect of the particular scheme.
-  In our view, the drafter had something rather different in mind. It will be recalled that the Explanatory Memorandum addressed the distinction between the first and second limbs of s 177E(1)(a): see . The examples given of schemes within the first limb were those in which a dividend or a deemed dividend are paid by the target company. (Section 47(1) of the ITAA provides that distributions to shareholders by a liquidator, to the extent to which they represent income, other than income applied to replace paid-up capital, are deemed to be dividends paid to the shareholders out of the company's profits.) The example given of schemes within the second limb was one in which the profits of the target are not stripped from it 'by a formal dividend payment' but by way of transactions having the effect of dividends. The particular illustrations provided were the making of irrecoverable loans to associates of the stripper or the use of accumulated profits to purchase near worthless assets, presumably at an overvalue."
48. Critically, from the point of view of the appellant's argument on the first issue, the Full Court then said (at ):
"Having regard to the Explanatory Memorandum, it can be seen that the second limb of s 177E(1)(a) is intended to catch schemes by way of or in the nature of dividend stripping, where the distribution by the target company takes a form other than a formal dividend or a deemed dividend. The reference to 'having substantially the effect of' a dividend stripping scheme is to a scheme that would be within the first limb, except for the fact that the distribution by the target company is not by way of a dividend or deemed dividend . If the distribution has substantially the effect of a dividend or deemed dividend, it will be within the second limb."
ATC 9484The emphasised words were repeated in the High Court (207 CLR 235 at 276 ):
"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."
50. Counsel for the appellant, both before the primary judge and before this Court on appeal, pressed the argument, in reliance on those passages, that a scheme would not fall within the second limb of s 177E(1)(a) unless it would have fallen within the first limb of s 177E(1)(a) but for the fact that the profits of the target company were not distributed by way of dividend but by some other means. In other words, for a scheme to fall within the second limb of s 177E(1)(a) it had to have all the characteristics of "dividend
ATC 9485stripping" identified by the Full Court in the passage extracted in  above except that the distribution of profits was otherwise than by way of dividend. In short, the scheme must involve the sale or allotment of shares in the target company and the distribution of the target company's profits to the purchaser or allottee otherwise than by way of dividend. The schemes in the present case did not involve all these characteristics and, therefore, so the argument went, the schemes did not fall within the second limb of s 177E(1)(a).
51. The primary judge responded to this argument at  -  of his reasons in the following terms:
" 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 [mldr ] purchased 'B' Class shares in Netscar [mldr ], the consideration for which provided Netscar [mldr ] with capital of equivalent value. Plaster Plus [mldr ] then consented to changes in the constitution of Netscar [mldr ], 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.
 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).
 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."
52. With respect, we agree with his Honour's response, but would add the following:
- (1) What the Full Court and the High Court said in Consolidated Press in the passages relied upon by the appellant is clearly obiter. Consolidated Press was a first limb case - the distribution of profits was in the case of both CPIL(UK) and CPHIL(UK), by way of dividend. The only reason the second limb of s 177E(1)(a) was considered by the Full Court and the High Court was because of the primary judge's reasoning that the second limb did not require the presence of a tax avoidance purpose. As indicated in  above, even that aspect of the primary judge's reasoning was obiter because he had decided the case at first instance in relation to the shareholders of both companies on the basis that the formation of the Commissioner's opinion under s 177E(1)(b) had miscarried.
- (2) Having regard to the terms of the second limb of s 177E(1)(a) and the extrinsic material referred to in  above, the Plaster Plus transactions (and the Zinkris transactions) are paradigm examples of a scheme to which the second limb was intended to apply.
- (3) Finally, the appellant's argument that acceptance of the construction and application of the second limb adopted by the primary judge and this Court would render the first limb otiose, does not withstand scrutiny. The first limb is concerned with schemes which are by way of or in the nature of dividend stripping; the second limb is concerned with other schemes, that is, schemes that are not by way of or in the nature of dividend stripping but which are schemes having substantially the same effect. A scheme falling within the second limb may not, as in this case, fall within the first limb. On the other hand, a scheme falling within the first limb will never fall within the second limb.
53. The first ground of appeal is, for these reasons, rejected.
The second issue
54. The appellant contended that while there was a disposal of property of Plaster Plus (under s 177E(2)(d)) as a result of the scheme constituted by the Plaster Plus transactions (similarly of Zinkris as a result of the scheme constituted by the Zinkris transactions), it was not open for the Commissioner to form the opinion required by s 177E(1)(b) that the disposal of that property represented in whole or in part, a distribution (whether to a shareholder or another person) of profits of Plaster Plus (or Zinkris, as the case may be).
55. Reliance was placed upon what was said by Sweeney J in
Commissioner of Taxation v Black (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" (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.
56. In response to this submission, the primary judge at  said:
"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."
57. His Honour was of the view that it was open to the Commissioner to form the opinion that the transactions by which Plaster Plus' shareholding in Netscar was diminished in value represented distributions of the profits of Plaster Plus within the meaning of s 177E(1)(b).
58. We agree with the view of the primary judge. The transactions into which Plaster Plus (and Zinkris) entered had, as their objective, a diminution in the value of the company's property. That was just as much a disposal of property of the company (under s 177E(2)(d)) as the payment of money to purchase assets at an overvalue or the sale of assets at an undervalue. Moreover, it as much represented a distribution of the company's profits as such a purchase or sale. What was said by Dixon CJ in
Davis Investments Pty Ltd v Commissioner of Stamp Duties (NSW) (1957) 100 CLR 392 at 406 - 407 in relation to a transaction involving the transfer by a company of shares it owned to its sole shareholder at a significant undervalue, is precisely in point:
"Neither the nature nor the effect of the transaction is open to much question. The matter is really one of 'characterisation'. Must the price be characterised as the consideration or is it proper to characterise the further elements in the transaction which determine or govern its real effect the consideration? Assuming, as I think we should, that the transfer of the shares would not deprive the transferor company of assets representing paid-up share capital, the shares to be transferred must contain, in point of value, either accumulated trading profits or some accretion to capital over and above the equivalent of the paid-up share capital of the company. Such a 'fund', whether real or notional, would be 'distributable'. In any case to sell and transfer these shares to the only shareholder of the company at a price which must amount to a nominal or book price effects a 'distribution' of the trading or capital profit contained in or represented by the shares. It places in the shareholder's hands the trading or capital profit contained in or represented by the shares. It may be described in the terms employed in business or accountancy as a liberation or a distribution of or a transformation of title to the 'fund' of profits. Doubtless it is not accomplished by a means provided by the company law, but if there is no interest involved but that of the shareholder, that is Davis Investments Pty. Ltd., no legal interest is invaded, and there is no one who is entitled to complain."
59. The second ground of appeal is, for these reasons, rejected.
The third issue
60. The argument on the third ground of appeal was that, as a matter of statutory construction or interpretation, s 177E did not apply. It is not dissimilar to the final contention made on behalf of the appellant below, which the primary judge rejected, 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 was given of 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.
61. The primary judge did not accept the submission for two reasons. 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."
62. His Honour viewed the submission as amounting 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 1936 Act and of the other legislation referred to.
63. 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 ss 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.
64. On appeal, this argument was more broadly based. Reference was made to the value shifting rules in Divs 723, 725 and 727 of the Income Tax Assessment Act 1997 (Cth) ('the 1997 Act'), as well as other provisions in the 1936 Act and the 1997 Act that deal with non-arm's length transactions that diminish or remove value from a company, such as s 47 of the 1936 Act to the extent that it applies to informal liquidations; the market value substitution rule in Div 116 of Pt 3-1 of the 1997 Act; Div 7A of the 1936 Act; s 109 of the 1936 Act; and Sch 2C of the 1936 Act.
65. Reliance was placed on what was said by McHugh, Gummow, Kirby and Hayne JJ in
Project Blue Sky Inc & Ors v Australian Broadcasting Authority (1998) 194 CLR 355 at 382:
"Reconciling conflicting provisions will often require the court 'to determine which is the leading provision and which the subordinate provision, and which must give way to the other'. Only by determining the hierarchy of the provisions will it be possible in many cases to give each provision the meaning which best gives effect to its purpose and language while maintaining the unity of the statutory scheme."
66. Counsel for the appellant submitted that the test adopted by the primary judge would undermine the operation of some provisions, and introduce a significant element of uncertainty in the operation of many other provisions, of the income tax legislation. Parliament could not have intended s 177E to have such an uncontained and undefined operation. Section 177E, it was submitted, must not be permitted to deprive the other provisions of their intended and substantive operation.
ATC 9488The problem with this argument is threefold:
- (1) None of the provisions in the 1936 Act or the 1997 Act to which reference was made is in conflict with s 177E and so no reconciliation is necessary;
- (2) no specific basis has been established for the assertion that the test adopted by the primary judge, and now by this Court, will undermine other provisions of the 1936 Act and the 1997 Act and will lead to the consequential uncertainty in their operation; and
- (3) there is no reason why the terms of s 177B should not be given their full force and effect.
68. For the foregoing reasons, this ground of appeal must also be rejected.
69. The appeal must be dismissed. The appellant must pay the respondent's costs, as taxed or agreed.