FCAFC rejects Commissioner's appeal in Hicks

On 3 December 2025, the Full Bench of the Federal Court of Australia (FCAFC) dismissed the Commissioner of Taxation’s (Commissioner) appeal in Commissioner of Taxation v Hicks [2025] FCAFC 171 (Hicks), affirming the primary judge’s conclusions[1] that neither section 45B nor Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applied to a business restructure that resulted in the effectively synchronous extinguishment of Division 7A loans and extraction of $52 million tax-free. 

Hicks, which represents yet another loss for the Commissioner on Part IVA, also provides novel guidance with respect to the construction and application of section 45B, arguably placing significant constraints on the Commissioner’s ability to apply the provision. 

Facts

Background

City Beach, a streetwear retail business, was established in March 1985 by Mr Hicks and Mr Ierna by the establishment of the City Beach Trust (CBT)[2], through with the business has operated since inception[3]. The units in CBT were initially held as follows:

• Mr Ierna – 14 units (acquired pre-20 September 1985;
• Trustee for the Ierna Family Trust (IFT) – 1 unit (acquired in June 1991); and
• Trustee for the William Hicks Family Trust (WHFT) – 15 units (acquired pre-20 September 1985).

Both IFT and WHFT are discretionary trusts with corporate trustees respectively controlled by Mr Ierna and Mr Hicks. The units in CBT did not carry fixed income entitlements, and CBT’s net income was, until the 2016 restructure (see below), distributed evenly between IFT and WHFT[4], despite IFT holding just one unit in CBT.

Prior to 30 June 2012, Mastergrove Pty Ltd (Mastergrove) was the corporate beneficiary receiving distributions from both IFT and WHFT. Mastergrove, controlled by Messrs Ierna and Hicks, retained profits and made loans to them and their  related entities (namely the trustee for the Ierna Property Trust (IPT) and the trustee for the Hicks Property Trust (HPT)). These loans were subject to Division 7A, and therefore placed on terms compliant with sections 109E and 109N. 

From the 2023 income year onwards, IFT and WHFT ceased distributions to Mastergrove, instead distributing to Ierna Beneficiary Pty Ltd (IBPL) and Hicks Beneficiary Pty Ltd (HBPL), respectively. These companies similarly loaned funds to Messrs Ierna and Hicks on terms compliant with sections 109E and 109N, rather than distributing dividends to them.  

Messrs Ierna and Hicks and the trustees for HPT and IPT each required funds to service required interest payments and principal repayments on the loans. Mastergrove paid dividends to Messrs Ierna and Hicks from 2005 to 2013. It was accepted by the Commissioner that for the 2013-2015 income years, either no relevant dividends were paid by Mastergrove or if they were paid, no amount thereof funded the repayment of loans made by IBPL or HBPL.

2016 Restructure

In the income year ended 30 June 2016, following an earlier proposal by the advisors to Messrs Ierna and Hicks that was not proceeded with, the pair implemented the following restructure:

• Methuselah Holdings Pty Ltd (Methuselah) was interposed between CBT and its unitholders as a result of a unit-for-share exchange. Rollover relief was applied pursuant to Division 615 of the Income Tax Assessment Act 1997, which resulted in, inter alia, the  Methuselah shares received by Mr Ierna and the trustee for WHFT inheriting the pre-CGT status of the CBT units;
• After becoming CBT’s sole unitholder, Methuselah undertook a selective share capital reduction whereunder a portion of the shares issued to Mr Ierna and the trustee for WHFT were cancelled for consideration payable of $52 million (i.e., $26 million each). Both agreed to lend half of the cancellation consideration to Methuselah by way of forbearance, with Methuselah having no obligation to pay interest or provide security, but an obligation to repay the loan on demand;
• Mr Ierna and the trustee for the WHFT then assigned the debts owed to them by Methuselah to Mastergrove, IBPL, and HBPL in satisfaction of the loans owed thereto by Mr Ierna, Mr Hicks, IPT, and HPT; and
• Methuselah and CBT then formed an income tax consolidated group with Methuselah as head company. It was intended that thereafter, the net income of CBT would accumulate within Methuselah absent and adverse income tax consequences. 

Consequentially: (1) the cancellation of the Methuselah shares did not give rise to a taxable capital gain because of their deemed pre-CGT status, and (2) the proceeds of the capital reduction were not assessable to either Mr Ierna or the trustee for WHFT. 

Events subsequent

Subsequently, the Commissioner issued alternative determinations Mr Ierna and the trustee for WHFT that:

• The capital benefits received from Methuselah’s selective share capital reduction were unfranked dividends under section 45B; or
• Section 177F of Part IVA operated to include a dividend and franking credit gross up in the assessable income of each of Mr Ierna and Mr Hicks on the basis that, absent the scheme, they might reasonably be expected to have received franked dividends from Mastergrove equivalent to the amounts owed under loans made by each of Mastergrove, IBPL, and HBPL. 

Amended assessments issued on the basis of the foregoing, with Mr Ierna’s and Mr Hicks’ respective objections thereto rejected by the Commissioner. 

The matters were appealed to the Federal Court, with the primary judge allowing those appeals, concluding that neither section 45B nor Part IVA applied. 

FCAFC decision

Section 45B

Derrington, Feutrill and Hespe JJ of the FCAFC concurred with the primary judge with respect to section 45B, observing at 107 that the Commissioner’s contentions ‘suffered from a lack of precision and coherence’. 

Although both a ‘scheme’ and ‘tax benefit’ were inferred, the Commissioner’s contention that at least one of the parties entered into the identified scheme did so for a more than incidental purpose of enabling a taxpayer to obtain the tax benefit was rebuffed. This rejection was on the basis that the Commissioner failed to engage with or give effect to the express statutory purpose of section 45B, which per paragraph 45B(1)(b) is (outside of a demerger context), and as supported by the Explanatory memorandum to the Taxation Laws Amendment (Company Law Review) Bill 1998, is to prevent dividend substitution arrangements. 

More specifically, the relevant circumstances enumerated under subsection 45B(8) are directed to an evaluative exercise requiring the conclusion of a party’s purpose,  which must be reached in light of and give effect to the statutory purpose of section 45B as evinced by paragraph 45B(1)(b). In this regard, it was held that the ‘attributable to profits’ question at paragraph 45B(8)(a) can only be answered in the affirmative where the profits of the company or an associate thereof might have, in the absence of the scheme, been distributed as a dividend that would have been assessable to the ultimate recipients.  Critically, although Methuselah’s share capital account was a reflection of CBT’s unrealised profits, and therefore the share capital reduction could be attributed thereto, the requisite purpose could not be established as CBT is a trust, which is incapable of paying dividends. (i.e., no distribution by the trustee for CBT would have been assessable as a dividend to either of the parties). Also relevant was the fact that CBT’s profits accumulated prior to Methuselah’s acquisition of the units in CBT and therefore a distribution of those profits to Methuselah would represent a return of the investment made by Methuselah in CBT.  Similar conclusions were reached with respect to the other factors under subsection 45B(8) – i.e., that consideration thereof with regard to the dividend substitution purpose of section 45B could not impel an adverse conclusion.

Part IVA 

In relation to Part IVA, the taxpayers successfully contended that, absent the scheme, a transfer of the units in CBT to Methuselah in exchange for shares and a receivable would have instead occurred, with the receivable offset against the outstanding Division 7A loans. Because this alternative postulate would not have resulted in any additional assessable income for either of Messrs Ierna or Hicks (owing to the pre-CGT status of their CBT units), the taxpayers discharged their onus of showing that they did not obtain a tax benefit in connection with the scheme. 

In concluding thus, Derrington, Feutrill and Hespe JJ affirmed various principles from the recent High Court decision of Commissioner of Taxation v PepsiCo Inc [2025] HCA 30, particularly with respect to the identification of a ‘tax benefit’ (see paragraphs 188 & 189). Other principles relevant to the construction and application of Part IVA that were affirmed or established in Hicks include:

• Entry into a transaction following the receipt of tax advice or the fact that the advice refers to ‘no adverse tax consequences’ does not of itself support a conclusion of dominant purpose^[5];
• Just like the assessment required under subsection 45B(8), the subsection 177D(2) factors are not a checklist of questions to which the answers are ‘yes’ or ‘no’, but must instead be considered on an evaluative basis with regard to the relevant statutory purpose;
• Whereas a taxpayer’s rejection of the commercial consequences of an alternate postulate can be important evidence in determining what would have or might reasonably be expected to have occurred if the scheme had not been entered into or carried out, it is not the mere fact that the alternate postulate was rejected that is important but why it was rejected:
• The bare fact that a taxpayer pays less tax, if one form of transaction rather than another is made, does not demonstrate that Part IVA applies

Takeaways 

Hicks (and the preceding primary judgment) represent the first time section 45B has been judicially considered and provide welcome clarity on the appropriate construction and application of section 45B beyond the controversial PS LA 2008/10 that was unilaterally developed by the Commissioner and has been obdurately applied by the Australian Taxation Office (ATO) in the context of compliance activity for nearly two decades. Taxpayers will be particularly gratified by the emphatic nature of remarks of Derrington, Feutrill and Hespe JJ regarding the primacy of the express statutory purpose per paragraph 45B(1)(b) in the relevant context.

The decision also establishes a number of principles relevant to the application of Part IVA, and affirms contemporarily evolving principles, such as the importance of identifying and demonstrating a reasonable alternative postulate in connection with Part IVA matters. 

In summary, a welcome decision for taxpayers, particularly given the level and nature of recent ATO activity in this area. 

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