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The founder of surfwear brand Billabong used advice from EY to minimise tax from the sale of his bioplastics company, according to the Federal Court.
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Court rules against Qld businessman’s EY-inspired tax schemes
17 May 2024
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The Federal Court has ruled against a prominent Gold Coast businessman after he used advice from EY to structure transactions between companies he controlled to offset an $85 million capital gain and used “dividend stripping” to reduce his tax bill.
Gordon Merchant, who founded global surfwear brand Billabong in the 1970s, disputed a $45 million amended tax assessment following an ATO audit of nine Merchant Group companies he controlled in 2017.
The Tax Office believed Merchant used MFT, his family trust, to engage in an asset “wash sale” by selling $5.8 million in Billabong shares to his SMSF to crystallise a $56.6 million capital loss. The capital loss was then used to offset an $85 million capital gain on MFT’s sale of Merchant’s shares in bioplastics company Plantic Technologies to Japanese buyer Kuraray.
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Evidence was also produced suggesting that Merchant had engaged in a form of tax avoidance known as dividend stripping, reducing the distribution of Merchant group company profits by forgiving $55 million in related party debts to avoid paying tax at his marginal rate.
In a judgment released on Tuesday, Justice Tom Thawley found section 177D of the ITAA applied because MFT “obtained a tax benefit from the Billabong share sale scheme, and that the MFT and the [SMSF] entered into the scheme for the dominant purpose of obtaining a tax benefit”. This allowed the Commissioner to make a determination under section 177F(1)(c), cancelling the capital loss.
However, Justice Thawley said the ATO had miscalculated capital proceeds from MFT’s sale of Plantic shares, valuing future payment rights at $51.5 million when evidence showed they were worth around $40 million.
“GSM has discharged its onus of establishing that the capital proceeds were incorrectly calculated. It follows that GSM has discharged its onus of establishing that the GSM amended assessment is excessive to the extent identified,” he said, with GSM being a Merchant group company with a 100 per cent present entitlement to MFT income.
The debt forgiveness scheme also fell within the scope of s177E, Justice Thawley said, ruling it amounted to dividend stripping.
Forgiveness of $55 million in related party debts between 2011 and 2015 was arranged, including $50 million GSM loaned to Plantic and $4 million loaned from another Merchant company called Tironui.
“Were it not for the forgiveness of the Plantic loans, GSM (the target company) would have had substantial undistributed profits creating a potential tax liability for Mr Merchant who would have had to pay tax at marginal rates on dividends paid to him,” Justice Thawley said.
“The practical effect of structuring the transaction in the way it was, was that the capital received by the MFT was augmented rather than GSM’s and Tironui’s retained earnings being augmented. The advantage was increased by the fact that the Billabong share sale had occurred, because the capital losses crystallised by that transaction offset the capital gains from the sale."
The structure of the transactions – the Plantic sale, selling Billabong shares to crystallise a capital loss and forgiving related party debts – was suggested by EY, Merchant’s long-time accountants, according to testimony from his investment adviser Luke McGrath during cross-examination.
“Mr McGrath considered that EY was recommending that the transaction occur in order to create the capital loss,” Justice Thawley said.
Following Justice Thawley's reasons, Merchant and the ATO were asked to confer with a view to agreeing orders to give effect to them within 14 days.
A separate lawsuit against EY and former tax partner Ian Burgess is also underway in the Queensland Supreme Court, with Merchant alleging the firm gave negligent advice and owed around $58 million in damages.
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