Bblood – Full Federal Court confirms section 100A applies

On 9 June 2023, the Full Federal Court delivered its highly anticipated verdict in B&F Investments Pty Ltd as trustee for the Illuka Park Trust v Commissioner of Taxation [2023] FCAFC 89, widely known as Bblood. This landmark decision carries significant implications, as the Full Federal Court unequivocally upheld the primary judge’s ruling, confirming the application of section 100A to a share buy-back arrangement.

Of particular importance in this decision was the Court’s attention to the involvement of the taxpayer’s accountants in the arrangement. The Court observed that the advisors had initiated the arrangement with an intention to craft a favourable tax outcome for the taxpayers. The accountants were deemed to be a party to that arrangement, and their purpose ultimately resulted in the conclusion that section 100A applied.

What are reimbursement arrangements?

Section 100A is an anti-avoidance provision contained in the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). It can apply where there is an arrangement under which a beneficiary is made presently entitled to trust income and:

1. A party other than the beneficiary receives a benefit in connection with the arrangement; and
2. At least one of the parties entered into the agreement for the purpose of reducing tax.

There are some exclusions that can apply to deem arrangements not to be subject to section 100A. This includes the highly topical exception that applies “in the course of ordinary family or commercial dealings”.

What happened in the Bblood case?

Bblood considered the treatment of proceeds from a buy-back of shares and the differences between trust and tax law concepts of income. In the relevant financial year, the following steps had occurred:

1. the deed of a discretionary trust (IP Trust) was amended to change the definition of “income” to mean income determined by the trustee of the IP Trust (Trustee) according to ordinary concepts. This meant that any receipts that were capital in nature would not be income of the Trust;
2. the Trustee made a newly incorporated corporate beneficiary (BE Co) presently entitled to the income of the Trust;
3. the Trust received its first dividend from a company it held shares in, IP Co; and
4. IP Co bought back shares held in it by the IP Trust and debited this to its retained earnings account.

(the Arrangement)

As a result of the Arrangement the following tax consequences followed:

1. the buy-back proceeds were treated as a deemed dividend for income tax purposes (deemed dividend). IP Co had significant franking credits and was able to fully frank the deemed dividend.
2. due to the Trust’s amended definition of income, BE Co was not entitled to payment of the deemed dividend. The buyback proceeds were instead retained in the Trust and treated as an accretion to the corpus of the Trust.
3. however as BE Co has been made presently entitled to all the Trust’s income it was taxed on the deemed dividend. As the dividend was fully franked a tax offset was available and BE Co was not liable to further tax.

The ultimate result of the Arrangement was that retained profits of IP Co was able to be distributed to, and then accrued by, the Trustee of the IP Trust without further tax being payable.

This case was an appeal from the Federal Court. There were two questions for the Full Federal Court to consider:

1. whether section 100A applied to the Arrangement; or
2. in the alternative, whether section 207-150 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) (dividend stripping provisions) applied to the Arrangement.

What did the Full Federal Court decide in the Bblood case?

In summary the Full Federal Court determined:

1. section 100A applied to the Arrangement as the Trustee received the benefit of the deemed dividend rather than the beneficiary (BE Co); and
2. as a result, consideration of the dividend stripping provisions was not necessary. The assessment issued to BE Co, based on the application of the dividend stripping provisions, was not appropriate.

The Court found that on the facts as determined by the primary judge, the Trustee received a benefit of the deemed dividend not the beneficiary. Analysis and consideration were given to the second requirement of section 100A – whether a party or parties entered into the agreement for the purpose of reducing tax.

The Full Federal Court considered whose purpose would satisfy this and noted that the purpose of taxpayer’s accountant was relevant. Referencing Commissioner of Taxation v Prestige Motors Pty Ltd [1998] FCA 221; (1998) 82 FCR 195 the Court stated:

The advisers formulating the documentation and implementing the arrangement with the knowledge and assent of the controllers of the entities who were parties to the transactions are themselves parties to the reimbursement agreement: see PJ [138]; Prestige Motors at 218 (Hill and Sackville JJ).

The Court found that the taxpayer’s accounting company could be regarded as a party to the arrangement. Further the accountant’s understanding of the intended effect of the arrangement (the Trustee paying less tax than otherwise on retaining distributions) was relevant to a conclusion as to his purpose of entering into the reimbursement agreement.

At paragraph 62 of Bblood the Court confirmed its conclusion that a reimbursement agreement therefore existed:

The examination of the facts and circumstances relevant to an investigation of the purpose of a party as required by s 100A(8) supports the conclusion that a party (and, in particular, Mr Buckley [the accountant]) entered into the reimbursement agreement for a purpose of ensuring that the retained earnings of IP Co could be distributed to and retained by the IP Trust without IP Trustee being liable to tax. It was therefore to be concluded that the reimbursement agreement was entered into for a purpose of securing that IP Trustee who, if the agreement had not been entered into, would have been liable to pay income tax in respect of the 2014 income year, would not be liable to pay income tax in respect of that year of income. The primary judge was correct to hold that the appellant had not discharged its onus of establishing that the carve out provided for in s 100A(8) applied.

Similar arrangements were rolled out to other clients of the accounting firm. Proceedings were previously commenced against five of those clients and have been stayed pending the outcome of Bblood.  It is expected they will now proceed with unfavourable decisions for taxpayers, consistent with Bblood.

What does this mean for taxpayers and advisors?

1. Increased ATO attention on Trusts

Trusts have remained under the scrutiny of the Australian Taxation Office (ATO) for an extensive period. Since 2014, a dedicated Tax Avoidance Taskforce has been actively targeting taxpayers engaged in trust-based tax avoidance or evasion schemes. Furthermore, trusts have consistently featured in the ATO’s Top 500 and Next 5000 compliance programs. Recent rulings and the issuance of Taxpayer Alerts by the ATO underscore its ongoing efforts to curtail the tax advantages associated with trusts.

Given this intensified focus and the significant developments in this area, it is imperative for taxpayers and advisors to stay abreast of the evolving trust laws. When incorporating trusts into structures it is crucial to ensure that all actions align with the interpretations of the law by both the courts and the ATO. Any positions taken that contravene these established positions are susceptible to scrutiny by the ATO and may even face legal proceedings. Therefore, seeking advice from suitably qualified professionals becomes an absolute necessity.

2. Advisor’s purposes are relevant for some aspects of s100A

An advisor would not be a party to an agreement between its clients and would not execute such an agreement in that capacity. However, the recent case of Bblood demonstrates that courts are willing to examine the true architects behind arrangements and place importance on the purpose those architects.

It is imperative for advisors to exercise caution and ensure that their involvement in structuring transactions is rooted in genuine commercial objectives. Merely relying on tax-based motivations may expose clients to anti avoidance legislation, such as section 100A.

3. Ordinary family and commercial dealings remains unclear

In Bblood there was no dispute as to whether the ‘ordinary family or commercial dealings’ exception applied. There was unanimity among all parties involved regarding the inapplicability of the ‘ordinary family or commercial dealings’ exception. Consequently, no additional guidance was provided on this particular aspect of section 100A.

4. Dividend stripping

The Court allowed BE Co’s objection to assessments which had been issued based on the application of dividend stripping. As the finding in respect of 100A was in the affirmative then dividend stripping could not also apply.

It was not necessary for the Court to consider this alternative argument presented by the Commissioner. Nevertheless, in their decision the justices did offer some insightful observations about dividend stripping.

These observations specifically focused on the two limbs in section 207-144 of ITAA 1997. The justices provided an analysis of key cases, legislative provisions, and amendments pertaining to each limb. However, in terms of resolving the issues identified ultimately the justices noted:

It is not necessary to resolve these issues in the present case. In our view, these matters are best addressed in circumstances where any tax liability depends upon their resolution.

Therefore, while the justices’ observations offer valuable reading material and shed light on the intricacies of dividend stripping, a resolution on the issues noted was not provided. The dividend stripping provisions continue to b a complex area of the law and one which professional advice should be sought in respect of.

This is a significant decision for trust and tax law. It demonstrates the importance of understanding all consequences of transactions. If you have any questions or would like to further understand yours, or your client’s position, please contact our Tax & Structuring team.

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