Gearing up a company before sale: Federal Court upholds Part IVA challenge to MEC group sale structure

The sale of the iconic Sydney Hilton Hotel in 2015 is the background of a groundbreaking Federal Court tax case that held the vendors of the hotel into a tax avoidance scheme to obtain a $173 million tax benefit. The judgment in Hilton International Australia Pty Ltd v Commissioner of Taxation (No 2) [2026] FCA 1325 (Hilton) was delivered on 9 September 2026 in which the court confirmed the Australian Taxation Office (ATO) position and ordered the Taxpayer to pay the Commissioner's costs.

Hilton decision highlights Part IVA risk in pre-sale restructures

A tax consolidated group may seek to sell an appreciated asset by transferring it to a subsidiary, creating intra-group debt broadly equal to the asset's market value and then selling the subsidiary rather than the asset.

For example, an asset with a tax cost of $100 and a market value of $1,000 may be transferred to a subsidiary in return for a $1,000 intra-group loan. The subsidiary is then sold for nominal share consideration, with the purchaser effectively paying the $1,000 by discharging the debt.

Within an ordinary tax consolidated group, gearing up the subsidiary generally does not produce the intended tax benefit. When the subsidiary leaves the group, the exit allocable cost amount (ACA) calculation under Division 711 broadly resets the cost base of its shares by reference to the tax value of its assets, less its liabilities. In the example above, the asset's $100 terminating value is reduced by the $1,000 liability, potentially producing a negative exit ACA and a gain under capital gains tax (CGT) event L5. The exit ACA rules therefore prevent the group from converting the underlying $900 asset gain into a nominal or nil gain on the shares.

The position is different for a multiple entry consolidated (MEC) group where the company sold is an eligible tier-1 (ET-1) company. Division 711 and CGT event L5 do not apply in the ordinary way because ET-1 companies are subject to the modified pooling rules in Subdivisions 719-J and 719-K. This creates the potential for intra-group debt to reduce the market value of the shares without an equivalent exit ACA gain arising when the company leaves the group.

ATO views and MEC groups

Taxpayer Alert TA 2019/1 specifically targets arrangements that exploit this distinction by gearing up an ET-1 company before sale, with the purchaser effectively funding the repayment of the intra-group debt as part of the acquisition.

The practical significance of the debt depends on whether the shares being sold constitute taxable Australian property (TAP). Where the shares are not TAP, a foreign resident vendor may already disregard any capital gain under Division 855, such that the debt itself may do little work from a tax perspective. However, where the shares are TAP, the debt may materially reduce the value of the shares and therefore reduce the amount of gain that remains subject to Australian CGT.

Accordingly, the Commissioner's concern is directed at arrangements that seek to obtain the economic proceeds of an asset sale whilst producing a more favourable tax outcome through the interaction of MEC group rules, intra-group debt and, in some cases, Division 855.

The case

The Commissioner's concerns raised in TA 2019/1 manifested recently in Hilton, where the Commissioner successfully defended the application of Part IVA to a restructuring and sale arrangement involving an ET-1 company and substantial intra-group debt.

The identification of the relevant scheme was not contentious. Rather, the case focused on whether the taxpayer had obtained a tax benefit under the post-2013 reconstruction provisions and, if so, whether the scheme had been entered into or carried out for the dominant purpose of obtaining that tax benefit.

Applying section 177CB, the Court considered four alternative postulates under which the transaction could reasonably have been undertaken:

• A direct sale of the hotel and business assets
• A sale of the company already owning the hotel and business assets
• A share sale of the relevant company on a debt-free basis (being the taxpayer's preferred postulate)
• A sale through a newly incorporated company which held the hotel and business assets.

The Court ultimately accepted that several of the Commissioner's alternatives were reasonable and would have resulted in substantially higher assessable income than arose under the implemented arrangement with Court satisfied the implemented arrangement was attended by the dominant purpose of obtaining a tax benefit.

Why the decision matters

The decision is significant for two separate reasons. First, it represents the first major judicial consideration of the Commissioner's concerns regarding ET-1 company gearing arrangements of the kind described in TA 2019/1. While the Taxpayer Alert foreshadowed the ATO's position, Hilton demonstrates a willingness by the Court to scrutinise closely whether a pre-sale restructuring involving ET-1 companies and intra-group debt was genuinely required to achieve the taxpayer's commercial objectives.

Secondly, and potentially more importantly, the decision contains substantial analysis of the 2013 amendments to Part IVA involving tax benefit provisions and the operation of the “Reconstruction Approach” under section 177CB.

Critically, the Court did not appear to proceed on the basis that a single "most reasonable" alternative postulate must first be identified before a tax benefit can be quantified. Rather, the judgment suggests that where multiple reasonable alternative transactions exist, the existence of one or more alternatives producing higher assessable income may be sufficient to establish a tax benefit, with the amount of the tax benefit being determined by reference to the alternative producing the highest taxable outcome.

This proposition may be difficult to reconcile with aspects of the Full Federal Court's approach in Commissioner of Taxation v Hicks and other authorities concerning the identification and role of alternative postulates in Part IVA analysis.

Whether this issue is revisited on appeal will be closely watched, given the significance of the reconstruction provisions to modern Part IVA jurisprudence.

Commercial purpose remains critical

Perhaps the most important practical lesson from the case is that Part IVA scrutiny does not stop once a taxpayer identifies a legitimate commercial objective.

Hilton was able to point to a range of conventional M&A considerations supporting the transaction, including the sale of a high-profile asset, the preservation of key commercial arrangements and the implementation of a corporate carve-out. However, the Court was not persuaded that those objectives required the business to be transferred into an ET-1 company carrying substantial intra-group indebtedness immediately before sale.

The Court repeatedly focused on a simple question: why was it necessary to undertake the transaction in this particular way?

While the taxpayer could point to commercial objectives associated with the disposal, the Court considered that substantially the same commercial outcome could have been achieved through simpler alternatives, including a direct asset sale, a sale of the existing operating company or a sale utilising a newly established acquisition vehicle. In the Court's view, the implemented structure introduced additional complexity, due diligence requirements and execution risk without delivering corresponding commercial advantages, or just incidental to the dominant commercial purpose.

Importantly, the Court was not persuaded on the evidence that the ET-1 company and debt structure produced meaningful commercial benefits beyond those available under simpler alternatives. By contrast, contemporaneous materials identified the tax consequences as a significant driver of the chosen structure.

In that regard, observers will note the similarities to British American Tobacco Australia Services Ltd v Federal Commissioner of Taxation [2010] FCAFC 130 (“BAT”) which also involved a significant asset disposal preceded by a deliberate pre-sale restructuring that altered the legal form of the transaction and substantially reduced the Australian tax that would otherwise have arisen. 

In each case, the Commissioner successfully argued that the restructuring steps were not driven by the commercial objectives of the sale itself but were inserted principally to secure a more favourable tax outcome. The Courts were therefore required to look beyond the form of the transaction and consider whether the same commercial result could have been achieved through a more straightforward disposal structure. 

As in BAT, the focus in Hilton was not on whether a sale occurred, but on whether the particular pathway chosen to effect the sale was selected because of the tax advantage it produced, thereby attracting the operation of Part IVA.

Hilton therefore reinforces that the critical inquiry in many Part IVA disputes is not whether a transaction had a commercial purpose, but whether the particular features generating the tax advantage were themselves commercially explicable.

Broader implications

Although the case arose in the context of a MEC group and ET-1 company, the implications are potentially much wider. The decision signals that courts may be prepared to examine closely:

• Pre-sale restructures undertaken shortly before divestment
• Arrangements involving significant intra-group debt creation
• Transactions designed to convert an economic asset sale into a share sale outcome; and
• Structures where the tax outcome depends upon the interaction of multiple relieving provisions.

The judgment also reinforces the importance of contemporaneous evidence. Where a restructuring step creates a significant tax advantage, taxpayers should be able to articulate clearly why that step was commercially necessary and why simpler alternatives were not capable of achieving the same commercial outcome and contemporaneously document those reasons.

Key takeaways

When contemplating M&A transactions involving MEC groups, taxpayers and advisers should carefully consider the following:

• ET-1 company gearing arrangements remain firmly within the ATO's compliance focus. Hilton demonstrates that the concerns raised in TA 2019/1 are capable of attracting a successful Part IVA challenge
• Commercial objectives alone are not enough. Taxpayers should be able to explain why every material restructuring step was necessary and why alternative structures were commercially inferior
• Contemporaneous documentation is critical. Board papers, transaction memoranda and implementation documents should consistently articulate the commercial rationale for the chosen approach.

The section 177CB reconstruction exercise warrants renewed attention. The Court's approach may have implications extending beyond MEC groups and could influence the assessment of Part IVA risk across a broader range of corporate restructures and M&A transactions.

Looking ahead

While Hilton is immediately relevant to MEC group transactions and ET-1 company structures, its broader legacy may lie in the Court's treatment of the reconstruction exercise under section 177CB.

If followed in future cases, the decision plainly may strengthen the Commissioner's ability to identify tax benefits by reference to multiple reasonable alternative transactions rather than a single preferred counterfactual. That possibility alone means the decision deserves close attention from taxpayers and advisers involved in corporate restructures, private equity transactions, real estate disposals and other transactions where the form of the arrangement materially affects the tax outcome. 

The onus falls heavily on the taxpayer often many years after the transaction was completed, with the Commissioner having the benefit of hindsight with 20/20 vision and limitless information gathering capability in order to make a determination.

The case serves as a reminder that Part IVA continues to focus on substance over form and that taxpayers contemplating complex pre-sale restructures should ensure that the chosen structure can be justified by robust commercial considerations, rather than merely by the tax outcomes it produces.

How BDO can help

If you are planning a sale, restructure or M&A transaction, our tax experts can help you identify potential Part IVA risks and strengthen your supporting evidence.