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The Full Federal Court has, by majority (Dowsett and Jessup JJ, Edmonds J dissenting) dismissed the taxpayer's appeal from the decision of Emmett J in Mills v FCT [2011] FCA 205 (11 March 2011).

Emmett J held that s 177EA of Part IVA of ITAA 1936 applied to securities issued by the New Zealand branch of the Commonwealth Bank (the Bank), such that the Commissioner was entitled to make a determination under s 177EA(5)(b) that no imputation benefits arose in respect of a distribution that was made to the taxpayer.

The relevant securities (PERLS V) consisted of unsecured subordinated notes which were regared as equity interests for Australian tax purposes, and the distributions made in respect of them were regarded as non-deductible non-share dividends that were potentially frankable for Australian tax purposes. However, the distributions were deductible against New Zealand income for New Zealand tax purposes.

The prospectus under which the securities were issued stated that the Bank expected that distributions would be fully franked. If distributions were fully franked, holders of the securities would receive a combination of cash and franking credits. The amount of the distribution (or distribution rate) was calculated by taking into account the value of the franking credits. However, if a distribution was unfranked or not fully franked, the cash component would generally be increased to compensate holders for the unfranked portion of the distribution.

The question before the Court was whether, having regard to the relevant circumstances of the scheme, it would be concluded that one of the persons who entered into or carried out the scheme did so for a purpose (whether or not the dominant purpose, but not including an incidental purpose) ("the relevant purpose") of enabling the taxpayer to obtain an imputation benefit, as required by s 177EA(3)(e). If so, s 177EA applied.

Jessup J (with whom Dowsett J agreed) said, at para 220:

"Under the scheme in the present case, the delivery of imputation benefits to the appellant was not simply something that happened as the natural incident of the capital raising undertaken by the Bank. It was intended by the Bank. The architecture of PERLS V – specifically the rewards made available to the appellant in return for his investment – included the fact of franking as a specific component. Absent franking, the distribution rate would, I infer, be quite unattractive to the appellant. Recognising this, the prospectus provided for a kind of Plan B under which the distribution rate would be adjusted if imputation benefits were denied the security-holders. Any conclusion that the purpose of enabling the appellant to obtain imputation benefits was, on the part of the Bank, only incidental would, in my view, be quite at odds with the important features of PERLS V as I have attempted to explain them."

Mills v FCT [2011] FCAFC 158 (Full Federal Court; Dowsett, Edmonds and Jessup JJ; 8 December 2011).


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