Key Highlights

  • A 4–3 majority found the two Debt forgiveness transactions were not dividend stripping.
  • No. All seven justices upheld cancellation of the approximately $56 million Capital loss.
  • Section 177E has a specific scope, while section 177D applies the general anti-avoidance test.
  • Mr Merchant's objection was allowed and the assessment was remitted for reassessment.

Forgiving a related-party debt just before selling a company is a common step in Business sales. In Commissioner of Taxation v Merchant, handed down on 4 November 2026, the High Court split 4–3 and held that two such debt forgiveness transactions were not dividend stripping. The decision narrows the reach of one of the ATO's specific anti-avoidance tools, but the same judgment also unanimously upheld a capital loss cancellation under the general rule, so it is no free pass.

Two anti-avoidance rules, two different results

The case, Commissioner of Taxation v Merchant; Merchant v Commissioner of Taxation [2026] HCA 39, turned on two provisions in Part IVA of the Income Tax Assessment Act 1936.

Section 177D is the general anti-avoidance rule. It allows the Commissioner to cancel a tax benefit where, looking objectively at the scheme, the dominant purpose was to obtain that benefit. On that issue, all seven justices sided with the Commissioner and upheld the cancellation of a capital loss of about $56 million.

Section 177E is narrower. It deals specifically with Dividend Stripping and similar schemes, and can treat an amount as if it were a dividend. On that issue, the court divided 4–3 in favour of the taxpayers.

The debt forgiveness at the centre of the case

According to the High Court's judgment summary, the arrangement took place in the 2015 income year. The Merchant family trust sold shares in Plantic Technologies to an unrelated buyer, Kuraray Co Ltd, producing a Capital Gain of approximately $85 million.

Before that sale, debts owed by Plantic to two related companies, GSM Pty Ltd and Tironui Pty Ltd, were forgiven for nil consideration. The debts totalled around $54 million. Forgiving them increased the price paid for the Plantic shares.

GSM was presently entitled to the trust's 2015 income. The Commissioner argued that the arrangement amounted to a dividend stripping scheme, so that section 177E should apply to the forgiven amounts.

Hypothetical example: a company holds Assets worth $10 million and owes $3 million to a related lender. A buyer would pay about $7 million for its shares. If the lender forgives the $3 million first, the company is debt-free and the buyer might pay about $10 million. The vendor's sale proceeds rise by $3 million, while the lender gives up a $3 million receivable. Across the group, the value received is broadly the same, but more of it arrives as capital proceeds on the share sale. These figures are illustrative and are not the Merchant amounts.

What the majority said about 'dividend stripping'

The majority, Gordon, Edelman, Steward and Gleeson JJ, held that "dividend stripping" has a fixed essential meaning, drawn from the High Court's 2001 decision in Consolidated Press Holdings. They said section 177E is not a general anti-avoidance rule.

In other words, the provision does not catch every arrangement that moves value out of a company in a tax-effective way. It applies only to schemes that have the essential character of dividend stripping as the courts have long understood it, or that are substantially of the same effect.

Applying that approach, the majority dismissed the Commissioner's appeal relating to the larger debt forgiveness, by GSM. It also allowed the taxpayer's cross-appeal on the smaller debt forgiveness, by Tironui. Chief Justice Gageler and Justices Jagot and Beech-Jones dissented.

The majority also said it would be "entirely artificial and unfair" to uphold an assessment based on a capital loss known to be cancelled. Ultimately, Mr Merchant's objection was allowed and the assessment was remitted to the Commissioner for reassessment.

How the lower courts saw it

The case has had a mixed history. The Federal Court gave its decision on 14 May 2024. On 22 April 2025, the Full Federal Court found that section 177D applied to the capital loss by a 2:1 majority.

On section 177E, the Full Court took a middle path, finding that it applied to the Tironui debt forgiveness but not to the GSM forgiveness. The High Court majority has now gone further, finding that it applied to neither.

The 4–3 margin, with the Chief Justice in the minority, shows how finely balanced the question was. Future cases involving different facts may still test where the line sits. For the ATO, the overall result is mixed: a decisive win on the general rule and a narrow loss on the specific one.

What it means for business sales and group restructures

For vendors and advisers, the most direct takeaway is that a debt forgiveness before a sale is not automatically dividend stripping under section 177E. The provision must be applied according to its settled meaning rather than as a catch-all.

That does not mean such steps are free of risk. In Merchant itself, the general rule in section 177D still cancelled the $56 million capital loss used against the Plantic gain, a point on which the court was unanimous.

The decision provides no general exemption for intra-group debt forgiveness or for the use of capital losses.

Other rules may also be relevant to debt forgiveness, including the commercial debt forgiveness provisions and Division 7A for private companies. Each transaction needs to be considered on its own facts, and the documented commercial reasons for each step are likely to matter if the ATO later reviews it.

What to watch

The ATO has yet to publish a decision impact statement on Merchant. That document will indicate how the Commissioner intends to apply the majority's narrower reading of section 177E, and whether any existing guidance on dividend stripping will be revised.

The reassessment of Mr Merchant, required by the outcome on section 177E, will follow.

Separately, the ATO's decision impact statement on Commissioner v Hicks, dealing with section 45B and Part IVA where capital distributions were used to repay Division 7A loans, is open for comment until 20 November 2026. The ATO is also reviewing practice statements PS LA 2005/24 and PS LA 2008/10.

The Senate Economics Legislation Committee is due to report on 13 November 2026 on the trust tax bills, which are not yet law. Together, these developments make the coming months an active period for private group tax planning.