TITLE: High Court Upholds $56.6 Million Capital Loss Cancellation in Merchant Case
On 4 November 2026, the High Court of Australia delivered a split decision in Commissioner of Taxation v Merchant; Merchant v Commissioner of Taxation [2026] HCA 39. The Court unanimously upheld cancellation of a $56.6 million capital loss under section 177D. By a 4:3 majority, it ruled that section 177E did not apply to related-company debt forgiveness as dividend stripping.
For Australian taxpayers, the ruling highlights two different risks: transactions that change tax outcomes without changing commercial ownership can attract the general anti-avoidance rule, while section 177E has a more defined reach. Read the High Court judgment and PwC Australia’s case summary for the full reasoning.
Separate the two rulings before assessing risk
Gordon Merchant, co-founder of Billabong, controlled a group of companies, trusts and a self-managed superannuation fund (SMSF).
In September 2014, the Merchant Family Trust (MFT) sold Billabong International Ltd shares to the Gordon Merchant Superannuation Fund (GMSF) for $5.8 million at market value. The sale crystallised a capital loss of about $56.6 million. Mr Merchant retained control of the shares through the related entities.
Later, MFT agreed to sell Plantic Technologies Ltd to Kuraray Co Ltd. Before the sale, two Merchant companies forgave Plantic’s loans: GSM Pty Ltd forgave $50.2 million and Tironui Pty Ltd forgave $4.2 million, for nil consideration. MFT then sold Plantic for a capital gain of about $85 million. That gain was sheltered by the Billabong loss and $40.1 million in earlier capital losses. GSM was presently entitled to all MFT income for the 2015 income year.
The Commissioner made two determinations under Part IVA. Section 177D was used to cancel the Billabong capital loss, with an amended assessment to GSM. Section 177E was used to treat the $54.4 million debt forgiveness as a deemed dividend in Mr Merchant’s assessable income. That assessment increased his 2015 liability to about $30.6 million, including shortfall interest.
Understand why the $56.6 million loss failed
All seven High Court judges agreed that the Billabong share sale had the dominant purpose of obtaining a tax benefit. The majority described it as a “purely internal transfer of shares” that made no sense as a commercial proposition but made perfect sense as tax planning.
Several facts mattered. MFT had no need for cash. The purchase cut across the SMSF’s investment strategy and put its ability to pay Mr Merchant’s pension at risk. Despite the sale, Mr Merchant retained control and economic ownership of the shares. The arrangement resembled a wash sale: it created a loss on paper without a meaningful change in ownership.
The Commissioner accepted that a sale to an independent third party would have involved real commercial outcomes and would not have attracted Part IVA on the same basis.
This does not mean that choosing a transaction partly because of its tax result automatically triggers Part IVA. The Court restated the Hart line: tax influence is not the same as a dominant purpose of obtaining a tax benefit. Paying less tax under one form of a transaction than another is not enough by itself. In this case, however, the internal transfer had no other meaningful or realistic commercial objective.
Recognise where section 177E draws the line
The majority held that section 177E is a “supplementary code”, not a second, general anti-avoidance rule. It said the essential meaning of dividend stripping, set out in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001), requires a close resemblance to the established pattern.
That pattern includes a company with substantial undistributed profits, a transfer of its shares, a dividend paid to a purchaser who escapes tax, and a capital sum received by the vendor. The arrangement must also be carefully planned to avoid tax on the dividend.
The debt forgiveness differed in extreme ways. No shares in GSM or Tironui were sold. No dividend was paid to a stripper. MFT was treated as both stripper and vendor, even though it held no shares in the lender companies. Any dividend from those companies would have been fully franked.
The three dissenting judges took a broader view. They considered that “by way of or in the nature of” extends section 177E beyond the classic pattern, and that the established characteristics are guides rather than essential requirements. The outcome was close: the dividend-stripping assessment failed by one vote.
Do not treat this result as blanket protection for intra-group debt forgiveness. The general anti-avoidance rule or another integrity provision may still apply.
Check how the two assessments interact
The majority also considered the relationship between the two Part IVA determinations. In deciding whether the section 177E assessment was excessive, it took account of the cancellation of the capital loss under section 177D. The judges said it would be “entirely artificial and unfair” to uphold an assessment based on a taxable fact, the existence of the loss, that the Court knew to be false.
Once the loss was cancelled, the capital gain was taxed. The majority therefore rejected the claim that the debt forgiveness had denied the revenue tax. The Commissioner’s undertaking to make compensating adjustments under section 177F(3) did not alter whether the assessment was excessive. The majority described the potential double taxation and unfairness as “glaring”.
Keep contemporaneous records and test the narrow scheme
For Australian businesses and private groups, the decision reinforces the value of a clear contemporaneous record. Test Part IVA against the narrowest scheme the Commissioner could identify, not just the broader commercial transaction surrounding it.
In Merchant, a message relaying advice that the sale would produce a “good ‘loss’ on paper” and “zero tax payable” undermined commercial explanations later offered at trial. Documents cannot create a commercial purpose that was not genuinely there. Record the business drivers before tax steps are settled, and examine the assumptions behind each assessment where schemes overlap.
The outcome also sits within a fact-specific body of section 177D cases. The Commissioner recently succeeded in Hilton at first instance and in Merchant, while losing Minerva, Mylan and Hicks. Each arrangement must be assessed on its own facts.
What did the High Court decide in Merchant?
The Court unanimously upheld cancellation of the $56.6 million loss under section 177D. By a 4:3 majority, it held that section 177E did not apply to the $54.4 million debt forgiveness.
Why did the related-party share sale fail?
The sale did not change economic ownership or control, and the Court found no meaningful commercial rationale or need for cash. The transaction resembled a wash sale. A genuine sale to a third party would have stood differently.
Does the decision make intra-group debt forgiveness safe?
No. The majority confined section 177E to classic dividend strips and close variants. The general anti-avoidance rule and other integrity rules can still apply.
What should private groups do now?
Review related-party steps and contemporaneous records. Test the narrowest scheme the Commissioner could identify, and check the fiscal assumptions behind each assessment where schemes overlap.