Chapter 3 - Self-Assessment, Certainty and Reasonably Arguable Positions
Self-assessment and
expert advice
3.1
It is by now well-established that many of those
who invested in tax effective schemes did so relying on ‘expert’ opinions which
assured them of the legality of the arrangements. The following testimony,
taken in Kalgoorlie from Mr Michael Burns, is
representative of much of the evidence before the Committee. Mr Burns said:
I tried to seek the best advice available to me
at the time. I did not go to any Kalgoorlie people. I went to a Perth financial adviser in order to get separate advice on this. Many of
my friends and work colleagues are in the same boat as me. They all say that
the financial advisers, accountants and lawyers that they talked to all said
the same thing: these schemes seemed above board and quite safe and sound. They
could not find anything wrong with them. I thought I would do something a
little bit different and go and see a financial adviser in Perth, and he said exactly the same thing.
He said the schemes were quite good; there was nothing wrong with it that he
could see, and he said he was actually in it himself.
With respect to the scheme, I got a prospectus.
In that prospectus were two signed documents from two separate QCs saying that
they were above board and they could not see anything wrong with them
whatsoever, including from the tax department’s point of view, so everything
should be spot on.[1]
3.2
Faced with testimony of this sort, the Committee
was at first inclined to think that investors such as Mr Burns had been the
victims of a deliberately misleading sales pitch, if not of professionally
negligent advice on the part of the relevant accountants and lawyers. Those
who promoted and advised on these schemes, however, dispute this conclusion.
3.3
For example, one of the salesmen who marketed
the schemes aggressively in Kalgoorlie and elsewhere in Western Australia told the Committee that he himself had been convinced of the
legality of the schemes. Mr Rick Shenton said:
I am a professional salesman. I used to be a
state manager of a branch of AMP and I have some background legal
qualifications. I felt, and still do feel, that these schemes were legal and I
promoted them as such. I believed they were legal because I had, when I was selling,
a Queen’s Counsel opinion, a solicitor’s opinion, an accountant’s opinion and
usually Coopers and Lybrand – or one of the top three accountants in the world
– giving opinions to say that these things were legal ... As I understood it, the
taxation department had clearly known of these schemes and had not done
anything about them.[2]
3.4
The Committee also received evidence from
lawyers and accountants who provided favourable opinions in relation to schemes
whose deductions have been disallowed by the ATO, and who stand by their
original opinions.
3.5
For example, the Committee received a submission
from the law firm, Blake Dawson Waldron, which is acting for Cabonne Management
Ltd on behalf of participants in the Central Highlands Wine Grape Projects
(CHWGP) 1-4. While Blake Dawson Waldron did not themselves provide the taxation
opinion in the Central Highlands prospectuses, the firm argued that the
favourable opinions that were provided were soundly based on existing case law.
The submission stated:
Prospectuses in relation to projects of this
nature are required to contain a taxation opinion. In relation to Central
Highlands Wine Grape Project No. 1 (‘Project 1’), a taxation opinion was
obtained from Court & Co, Chartered Accountants. In relation to Project 2,
Project 3 and Project 4 a taxation opinion was obtained from Lear & Co. ...
We note that projects of this nature typically contain taxation opinions from
‘Big 5’ accounting firms. These firms have typically given a similar taxation
opinion to the opinions contained in the prospectuses for CHWGP 1, 2, 3 and 4
and rely on the same income tax principles as were relied upon in the opinions
for CHWGP.[3]
3.6
Both in their submission and in subsequent oral
evidence to the Committee, Blake Dawson Waldron emphasised that the relevant
taxation opinions relied on case law that was relevant at the time, and that
‘the ATO had no published position that was contrary to these decided cases’.[4]
3.7
Mr Colin Thomas of the accounting firm, Hudson
Croft Thomas, commenting on the position ‘as I recall it’ in 1998, told the
Committee:
In my view, no tax professional with specialist
knowledge in this area believed that part IVA would apply to genuine business
transactions where limited recourse or indemnified loans were used to finance
these transactions ... The existing rulings and tax cases gave a clear
indication. It therefore follows that in some schemes participants had no
reason to believe that they were entering into a scheme that did not comply
with the law.[5]
3.8
When asked by the Committee whether ‘with the
benefit of hindsight’ he would not have given positive opinions on schemes
which have since been disallowed by the ATO, Mr Thomas said:
With the benefit of hindsight, knowing now what
I know, I still believe the tax office is wrong, and consequently I would have
been advising people to go into these types of investments because, at the
time, and believing the directors had done their due diligence in preparing the
prospectuses, and that they believed the investments would work, consequently that
they were sound investments.[6]
3.9
Fletcher Securities expressed the view that the ATO’s
position is not ‘supported by case law or tested in the courts’.[7] For that reason:
It is far too premature for the ATO and even
the Committee’s final report to consider and/or discuss the use of penalties
for promoters and designers of prospectus-based schemes as the ATO’s view on
limited recourse funding arrangements that underpinned them is yet to be tested
before the courts ... Schemes that were based on real business activities ...
contained independent taxation opinions often provided by the same large
accounting firms that the government had paid tens of millions of dollars each
year for taxation advice that it relied upon. Securities advisers had a
reasonable basis ... for relying upon these taxation opinions in satisfying
themselves and their clients that the taxation deductions outlined could be
claimed to help fund their investments.[8]
3.10
One of the large accounting firms that provided
taxation opinions for some mass marketed schemes was Deloitte Touche Tohmatsu.
In its submission to the Committee, Deloitte Touche Tohmatsu commented that it
is relatively easy to identify the extreme ends of the schemes market, but
‘much more difficult to comment on the whole spectrum. This is so given the
variety of arrangements, the complexity of our taxation laws and the
uncertainty of their administration from time to time’.[9]
3.11
Deloitte Touche Tohmatsu informed the Committee
that, while the firm never promoted schemes, it provided taxation opinions for
inclusion in a number of prospectuses including Connect the World, Budplan A
Series 1, Personal Budplan 4, Tracknet, and Tentas.[10]
3.12
The Committee emphasises that the point of this
discussion is not to determine the merits, at law, of the ATO’s decision to
disallow deductions and to apply Part IVA to many of the so-called mass
marketed schemes. The point, rather, is to show that some taxation advisers
who provided advice in relation to mass marketed schemes continue to maintain
that their advice was correct, notwithstanding the views of the ATO.
3.13
By way of contrast to this approach, Mr Mark Leibler,
of Arnold Bloch Leibler – Lawyers and Advisers, noted that it would have been
prudent for advisers to inform potential investors of the risk of the ATO taking
a different view even if they considered the scheme arrangements acceptable. In
other words, he advocated that advisers should take a pragmatic rather than an
‘academic’ approach to the question of the possible application of Part IVA,
saying:
How would you feel if I gave you advice that on
balance it ought to be okay under the anti-avoidance provisions and you ended
up getting an assessment from the commissioner with very heavy penalties and
then, seven years later, you won your case in the High Court? I do not think
you would consider that a very productive course of action.[11]
3.14
A solicitor from McKenzie Lalor in Kalgoorlie,
Miss Lisa McLean, told the Committee that when potential investors were
advised of these risks, they usually chose not to invest. She said:
We actually do see people on occasion who have
been given the opportunity to get legal advice ... When they do, we give them the
full picture, the possibilities of what could happen and we have not had
anybody that has left our office and has actually signed up to a scheme if they
have been given that opportunity.[12]
3.15
The Committee is concerned that many advisers do
not seem to have taken responsibility for advising their clients of the full
extent of the risks involved in investing in schemes, particularly the risk of
the ATO taking a different view of the arrangements.
3.16
The difficulty for individual taxpayers is that
the ATO can levy penalties against them for acting on that sometimes incomplete
advice and investing in schemes whose deductions the ATO deems to be not
allowable. In other words, it is the individual taxpayer rather than the
adviser who ultimately bears any risk associated with the ATO taking a
different view of the tax effectiveness of particular schemes.
3.17
This matter may be of less importance following
the introduction of the product ruling system, which gives the investor comfort
that the deduction will be available, providing the schemes is implemented in
accordance with the information provided to the ATO. The issue of ATO rulings is
discussed in the next section.
ATO rulings
Self-assessment
3.18
The Committee notes that there is mechanism
which is expressly designed to mitigate the risk borne by the individual under
the self assessment system. This mechanism is the ATO’s ruling system.
3.19
Prior to 1 July 1986, tax returns were
individually examined by the ATO, the tax calculated and an assessment issued.
After that date, a minimalist self-assessment system was introduced, which
meant that taxpayers were required to calculate their own tax liability. The
ATO accepted that calculation at face value, but retained under law the right
to audit returns for up to four years in ordinary circumstances and for up to
six years if it determined that Part IVA applies.[13]
3.20
The Taxation Institute of Australia (TIA) noted
that the decision to move to a self-assessment system ‘reflected the reality
that in many ATO branches assessors were being asked to process 1,000
individual returns in a standard day. Excessive manpower requirements and
quality assurance were both issues under the old system’.[14] The Australian
National Audit Office explained the background to the introduction of the
self-assessment system in the following terms:
Before the 1986-87 financial year, the ATO had
the role of assessing every tax return submitted by every tax payer ... However,
in reality the assessment process was little more than tick and flick.
With approximately 10 million income tax returns to assess annually and with
quotas applying to assessors, it had been calculated that, on average, an
individual taxpayer’s return would have received less than 2.5 minutes of
scrutiny by the ATO.[15]
3.21
As the TIA explained, however, with the
introduction of a self-assessment system, there were concerns about whether
taxpayers could be certain they had assessed themselves correctly, and about
their exposure to penalty and interest charges in the event of mistakes which
were subsequently identified by the ATO. In response to this concern,
modifications to the self-assessment system were introduced in 1992. Among
other things, these provided for the introduction of a rulings system through
which the Commissioner could communicate how, on his view, the law would apply
to particular arrangements.
3.22
Further, in response to the problems of
taxpayers achieving certainty in relation to mass marketed tax effective scheme
arrangements, the ATO introduced a new class of rulings in 1998. These ‘product
rulings’ aim to give certainty about the tax effectiveness of a scheme, not
just to an individual applicant but to any participating investor.
3.23
As mentioned in Chapter 1, the product ruling
system has helped reduce the risk of investing in arrangements with tax
benefits. However, product rulings do not provide complete protection for
taxpayers. There are still some circumstances which could leave taxpayers, who
have invested in a scheme with a product ruling, exposed to tax penalties. Of
concern is the question of investor control over the implementation of schemes
in conformity with ATO product rulings.
Conformity with a ruling and the application of Part IVA
3.24
In a speech on 15 May 2001 to the Taxation
Institute of Australia, Brisbane, Mr Michael O’Neill, Assistant Commissioner of
Taxation, discussed the use of the ATO’s rulings in terms of investor
certainty. He warned, however, of two respects in which the existence of
rulings would not necessarily guarantee an investor’s immunity from ATO action.
First, he said:
Where the facts presented to the ATO are not
implemented on the ground then no comfort can be drawn. (This issue is
particularly important for product rulings where prudent investors may seek
written undertakings from the promoter that the arrangement is fully
implemented).[16]
3.25
Second, Mr O’Neill observed:
While the ATO can rule on the application of
Part IVA, silence on this issue cannot be taken as consent. On complex schemes
yet to be implemented it may be impossible to rule on Part IVA because some of
the eight requisite factors are yet to happen.[17]
3.26
The Committee notes that, from the ATO’s point
of view, both these hedges seem necessary. A ruling given for one set of
arrangements should not be able to be used to protect a materially different
set of arrangements for which, perhaps, no ruling would have been given.
Further, a ruling given in advance should not be able to prevent the ATO from
determining that the anti-avoidance provisions apply to unlawful subsequent
action on the part of the promoter or operator.
3.27
However, from the point of view of the
individual taxpayer, these caveats make the certainty attainable through the
ruling system seem highly provisional. It is questionable whether an individual
investor in, say, an agribusiness scheme would have any knowledge of, let alone
influence over, actions by the scheme promoter or operator which might fall
foul of the scheme’s product ruling or of the Part IVA provisions. Yet, if
these provisions are contravened, then it is still the individual investor who
is exposed to ATO recovery action.
3.28
The ATO has acknowledged the vulnerability of
investors in cases where promoters ‘recklessly or knowingly’ fail to implement
the scheme in accordance with the terms of the product ruling. It has advised
that, ‘in these cases, it might be appropriate for a reduced tax shortfall
penalty to fall on the unwitting investors’.[18]
Matters for
consideration
3.29
Based on the points raised so far in this
Chapter, the Committee wishes to flag a number of suggestions or
recommendations for consideration by the Government and the ATO. The Committee
will discuss these suggestions under the following headings:
- increasing taxpayer understanding of
self-assessment; and
- judicial resolution of differing interpretations
of law.
Increasing taxpayer understanding of self-assessment
3.30
That the majority of taxpayers do not understand
the implications of the self-assessment system became clearly apparent during
the inquiry. Many witnesses accused the ATO of acting retrospectively by
issuing amended assessments for previous tax years, despite the fact, as stated
earlier, that the law explicitly allows for the ATO to amend assessments for up
to four years in ordinary circumstances and for up to six years if it
determines that Part IVA applies.[19]
3.31
The Committee thus considers that there is an
urgent need for taxpayers to be made aware of the implications of the
self-assessment system and, in particular, that ‘just because they have treated
an item in a particular way last year and the year before without demur by the
ATO, that practice is not to be assumed to be correct or tolerated or
irreversible’.[20]
Indeed, as Mr Ian Phillips, a taxation consultant and former representative on
the Commissioner’s Self Assessment Task Force, warned:
If the matter is at all contentious, no surety
is gained for a long time and no precedents are set unless, exceptionally, the
ATO is specifically bound by a ruling or other determination.[21]
3.32
Both Mr Phillips and the Taxation Institute of
Australia made a number of suggestions aimed at making the self-assessment
system more transparent to taxpayers. The Committee believes that these
suggestions warrant careful consideration by the ATO.
3.33
First, Mr Phillips and the TIA expressed the
view that the use of the word ‘assessment’ may itself be misleading. In
Australian taxation law, ‘assessment’ is defined as the ‘ascertainment’ of the
amount of taxable income and the tax payable.[22]
But, as the TIA, observed:
If the taxpayer’s word is accepted without
review it is difficult to see in the self-assessment environment [that] the
Commissioner has ‘ascertained’ anything in issuing a ‘Notice of Assessment’. At
best a ‘Notice of Assessment’ is no more than a notification of liability in a
self-assessment environment.[23]
3.34
The TIA suggested that the word ‘assessment’ be
reserved for occasions where the Commissioner actually has determined a
taxpayer’s final liability. For example, an ‘assessment’ could be issued
following an audit. Otherwise, the existing document named ‘Notice of
Assessment’ should be renamed to make it clear to the taxpayer that the notice
‘is merely a confirmation of the information supplied by the taxpayer’.[24] The TIA suggested the adoption
of names such as ‘Interim tax calculation’ or ‘Tax calculation sheet’ while, in
a similar vein, Mr Phillips suggested the use of phrases such as ‘payment
requirement based on your return’ or ‘interim payment obligation’.[25]
3.35
Similarly, the TIA was of the view that all ATO
correspondence processing taxpayer instalment variations and amendment requests
should ‘make it plain that no actual review of the taxpayer’s facts and
circumstances has taken place’.[26]
A positive response does not mean that the ATO agrees with the taxpayer’s
claim: it simply means that the taxpayer’s claim has been taken at face value.
Since the response may be reversed in later years, the TIA suggested that the
correspondence carry a prominent ‘health warning’ to that effect.[27]
Recommendation
3.36
The Committee recommends that the ATO, in
consultation with the Taxation Institute of Australia, the Commonwealth
Ombudsman and other relevant bodies, develop measures to educate taxpayers
about their obligations and rights in the self-assessment environment.
Particular attention should be given to ensuring that taxpayers are made aware
of the period over which the ATO may review their returns and amend their
assessments. Further to the recommendation at paragraph 1.59, information about
the ATO’s power to review and amend assessments, and the time periods that
apply, should be clearly stated in the TaxPack and on notices of
assessment sent to taxpayers.
Judicial resolution of differing interpretations of law
3.37
The Committee notes that increasing taxpayers’
understanding of the self-assessment system does not do anything to provide
them with greater certainty that taxation advice upon which they act will be
acceptable to the Commissioner. All it does, is to make them more fully aware
of the risk to which they are exposed.
3.38
The Committee received very little evidence
which addressed the question of how judicial resolution of differences of
interpretation of taxation law might be more comprehensively and swiftly
obtained. Such resolution, however, was seen as desirable by witnesses,
particularly in relation to the scope of the Part IVA provisions.
3.39
An important means of achieving judicial
resolution on disputed interpretations of taxation law is via the ATO’s test
case program. This program provides funds to individuals or organisations to
test a point of tax law in court, where a case raises issues that will affect a
significant section of the tax-paying public.[28]
A number of witnesses, however, were critical of the ATO’s selection of cases
for test case funding.
3.40
For example, the Taxation Institute of Australia
was critical of the ATO’s ‘long-standing ban on the funding of Part IVA cases,
and its reluctance to issue Part IVA assessments [in] the first place’.[29] The result of that reluctance,
claimed the TIA, has been that the power of Part IVA has not been fully exposed
to the community. In the TIA’s view, however, ‘Part IVA is a part of the tax
law like any other, and artificial contracts [on] its use and testing are
detrimental’.[30]
Notwithstanding that criticism, the TIA noted that the ATO has won most Part
IVA cases it has contested in recent times. These decisions have confirmed that
the provision ‘does work’, and have provided some guidance to its meaning.[31]
3.41
Deloitte Touche Tohmatsu also commented upon the
ATO’s seeming reluctance to clarify the scope of the Part IVA provisions. Mr
Michael de Palo, National Managing Partner – Tax, wrote:
... it has been a generally held view in the tax
profession that from the time when Part IVA was first introduced in 1981, and
until recently the ATO has evinced a clear reluctance to have the scope of the
provision clarified, either by public or private rulings or decided cases.
Rather, the ATO strategy seemed to have been to keep the provision hanging over
taxpayers and advisers.[32]
3.42
Similar criticisms were expressed about the
selection of test cases in the mass marketed schemes arena. For example, Mr
Robert O’Connor QC told the Committee that test case funding for the Budplan
litigation was initially refused by the ATO ‘presumably because the case
involved Part IVA’. The ATO finally agreed to fund the case in April 2001 but,
according to Mr O’Connor, ‘that decision should have been made three years
ago’.[33]
3.43
On the other hand, Mr Richard Gelski, Blake
Dawson Waldron, took issue with the ATO’s decision to fund test cases for Budplan
rather than for the Central Highlands Wine Grape Project. He said:
... they have chosen to fund Budplan, which is a
case that I would respectfully submit does not have the merits that Central
Highlands does. That is not to say that Budplan should not obtain test case
financing; it is to say that Central Highlands and Frankland Valley should.
Here are cases which, we would submit, are
completely deserving of obtaining finance, and the only reason that the
Commissioner might choose to reject, as he has done at this stage – or at least
not to accede to the request at this stage – in our view can only be that he is
concerned that he might actually lose.[34]
3.44
The Committee notes that although the ATO’s
Deputy Chief Tax Counsel makes the final decision on whether to fund the case,
the decision is made after consultation with a ‘Litigation Panel’ comprised of
taxation experts from within and outside the ATO. Currently, the ATO’s
Litigation Panel consists of six members, four of whom come from the wider
taxation profession. The ATO has said that the panel was established ‘to ensure
that the Tax Office has community input into the Test Case Program’.[35]
3.45
The Committee further notes that criticisms of
the ATO’s selection of test cases for funding should be seen in the context of
the large number of schemes for which claimed deductions have been disallowed.
Participants in more than 200 schemes have been subject to ATO recovery action.
It is not necessary, for the purpose of establishing general principles
concerning the application of the law to broadly similar arrangements, to fund
test cases in relation to each scheme. Moreover, the broader tax paying
community would be disadvantaged by a decision to fund any more cases than are
required to establish the relevant legal precedents.
3.46
There may, of course, be disagreement over
whether the appropriate cases really have been selected for funding. The
Committee considers that the Litigation Panel should help to ensure that cases
selected are representative, not only from the point of view of the ATO but
also of the broader taxation profession.
3.47
As an additional measure, the Committee
considers that it may assist the tax profession and the wider community if the
reasoning behind the selection of cases for test case funding were published.
This would make transparent the reasons for the choice of some cases for
funding and the rejection of others.
Recommendation
3.48
For this reason, the Committee recommends that
the test case Litigation Panel publish the criteria in the light of which it
will recommend cases for funding and publish the reasons for its
recommendations in particular cases.
3.49
A second issue to be addressed in relation to
the litigation of test cases is the often extensive delay in the court process,
while a third concerns the expertise of different courts in taxation matters
and the need for consistent interpretation of taxation law. The Committee notes
that a measure relevant to both these issues was raised in evidence by Mrs
Jennifer Batrouney SC. She commented that:
From time to time, the spectre of a federal tax
court has been raised. I am very much in favour of the idea of a federal tax
court.[36]
3.50
On the other hand, the Committee notes that the
whole test case model relies on the preparedness of a taxpayer to challenge the
ATO through a full litigation process. This entails, among other things, that
the ATO will never be able to drive this process quickly nor in such a way as
to provide it with judicial certainty before it issues a determination
in relation to a particular matter.
Recommendation
3.51
The Committee recommends that the Government
undertake an analysis of the adequacy of current mechanisms for obtaining
judicial resolution of disputed or contentious tax law interpretation. This
analysis should include consideration of whether and how the ATO might obtain a
legal judgement without having to be taken to court by a taxpayer objecting to
an ATO determination, and consideration of the merits of establishing a
specialist federal tax court.
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