Chapter 2
Views on schedule 1: The general anti-avoidance rule
2.1
As explained in chapter one, schedule 1 of the bill makes amendments to
the general anti-avoidance rule, as contained in Part IVA of ITAA 1936.
2.2
According to the Explanatory Memorandum, these amendments will ensure
Part IVA is effective in countering arrangements carried out for the sole or
predominant purpose of avoiding tax.
2.3
As previously noted, the government suggests that the amendments are an
appropriate and measured response to potential weaknesses in the capacity of
Part IVA to protect the integrity of the income tax law from contrived or
artificial arrangements designed primarily to avoid tax.
2.4
However, a number of submissions and witnesses appearing before the
committee argued that the amendments were an unnecessary overreaction to recent
court decisions, and would introduce new uncertainty into the tax law.
2.5
The committee also heard concerns from some organisations that the
requirement to disregard the tax consequences of an alternative postulate based
on the 'reconstruction' approach (referred to below as the 'disregard tax'
provisions) would prohibit genuine commercial considerations from being
considered when establishing whether an alternative postulate was reasonable.
2.6
Several submissions and witnesses also suggested that the bill provided
the Commissioner with an overly broad power to use an 'annihilation' approach
to determining a tax benefit.
2.7
Many of the concerns raised during this inquiry have been raised
previously during the Treasury consultation process.
Have recent court decisions exposed weaknesses in Part IVA?
2.8
A number of submissions and witnesses appearing before the committee
suggested that the proposed amendments are an overreaction to recent court
cases that were lost by the Australian Taxation Office (ATO). These submissions
and witnesses argued that rather than exposing weaknesses in the operation of
Part IVA, the court decisions in fact applied the current anti-avoidance rules
appropriately and as intended by the Parliament.
2.9
For example, the Tax Institute argued that the amendments were an
overreaction to recent court case decisions against the ATO. Rather than
compromising the integrity of Part IVA, these decisions, according to the Tax
Institute, had in fact applied the current rules appropriately to find that a
tax benefit only exists in those cases where the taxpayer's actions have
resulted in a loss of revenue.[1]
2.10
Similarly, the Institute of Chartered Accountants Australia (ICAA)
argued that the amendments were an example of 'bad cases leading to bad law'.
Specifically, ICAA suggested that rather than being the result of legislative
defects, the court cases that appear to have prompted the amendments have
turned upon evidence regarding the commerciality or otherwise of arrangements,
consistent with the intent that the existing anti-avoidance regime should only
apply to blatant, artificial and contrived arrangements.[2]
2.11
The Tax Institute further noted that the changes would introduce new
uncertainty into an area of the tax law where, after 30 years, the courts have
provided a fair degree of understanding of how the law operates. The Tax
Institute, like ICAA, therefore took the position, 'if it ain't broke, don't
fix it.'[3]
2.12
Similarly, the Corporate Tax Association (CTA) wrote in its submission
that the amendments at schedule 1 'represent an overreaction to the
Commissioner of Taxation's lack of success in a couple of court cases that
actually have quite limited application.'[4]
CTA further argued that the amendments would introduce new uncertainty into the
tax law:
The business community remains concerned that the amended
legislation could be administered in a way that would create unexpected tax
liabilities in relation to genuine commercial transactions containing no
element of contrivance or artificiality. The uncertainty that would persist
until a judicial determination of a number of the new concepts introduced would
constrain commercial activity and adversely affect everyday business
decision-making.[5]
2.13
The Law Council of Australia also argued that rather than recent court
cases revealing weaknesses in the operation of Part IVA, the decisions against
the ATO were the result of the ATO seeking to use Part IVA in situations where
it was never intended to operate.[6]
Specifically, the Law Council suggested that it was concerned that the ATO had
been attempting to apply Part IVA in cases where there was a genuine underlying
transaction taking place. Moreover, while the amendments were directed toward the
concept of 'tax benefit' in Part IVA, those cases would have been lost regardless
on the dominant purpose test:
In other words, I guess what I am saying there is that the
focus of this discussion is on tax benefit when in fact in many of those cases
I would submit that the Commissioner might well have failed on dominant purpose
if he had not already failed on tax benefit.[7]
2.14
The Law Council told the committee that while it was entirely
appropriate for the Commissioner to use cases to test the law, almost all of
the cases that have prompted this reform:
...are really cases that have been decided on the evidence
and not on legal principle. It seems to me that the matter has perhaps eroded
the credibility of the policy argument for the change. These are cases decided
on their own individual evidence, facts and circumstances rather than some
issue of law.[8]
Treasury and ATO view
2.15
Treasury maintains that the amendments are a necessary and measured
response to exposed weaknesses in the operation of the 'tax benefit' concept,
not a reaction to whether the Commissioner won or lost a particular case.
2.16
As Treasury told the committee:
The fact that the commission might well have lost on other
grounds is not really to the point. The relevant point is: as a matter of
policy and principle, are the right tests being applied to this specific
question of tax benefit? The judgement that has been made, which underlines the
amendments, is that the existing state of the law in part IVA does not produce
the right outcome on what a tax benefit is. The example that Ms Roff gave just
now of the Futuris case brings that out really well. The court, in the first
instance, found that there was indeed an intention to avoid tax but that, as a
matter of construction of part IVA, you could not quantify the tax benefit in a
way that would enable the Commissioner to deal with that intended tax
avoidance. So the amendments are very specific in their targeting in that
respect. They are not about the outcome of particular cases but about making
sure that the fabric of part IVA, if you like, is intact and works properly in
the future.[9]
2.17
Expanding on this point, Treasury told the committee that in one of the
cases that had prompted the amendments, the RCI case, the Commissioner had lost
not only on grounds of whether there was a tax benefit (which the amendments
are directed at) but also on the grounds of whether there was a tax avoidance
purpose (which the amendments are not directed at changing). Treasury
did not, in this respect, think that the amendments, had they been in place at
the time, would have actually led to a different outcome in the RCI case in
terms of purpose, nor are they intended to change the existing law in this
respect.[10]
2.18
Addressing suggestions that the court decisions were a consequence of
poor case selection, the ATO explained to the committee how the ATO applies
Part IVA, and in the process defended the rigour of the process behind its case
selection:
Where part IVA is concerned we have a rigorous process for
decision making, and it has to be followed in every case before we apply part
IVA. In the first place, only our most senior, internal legal officers who are
members of our tax council network are authorised to allow part IVA to be
applied to any taxpayer. Secondly, we have a panel called the General
Anti-Avoidance Rules Panel, which consists of not only some of our most
high-level legal officers but also a number of external panel members,
including some former Federal Court judges—I think there are three currently on
our panel. Although that panel was not a decision-making body, it gives advice
to the Commissioner about whether the Commissioner would be acting reasonably
or not in applying part IVA. Almost invariably, if the advice of that panel
were that the Commissioner would not be acting reasonably, we would discontinue
the matter. Thirdly, once we decide to go to court, we invariably get external
lawyers involved. That would normally involve an external firm of solicitors
and a junior counsel. In the more important, significant cases that would
involve an eminent senior counsel from the private bar. Once again, if the
advice from those individuals were that the Commissioner's case is a bit weak
and not sustainable, it would be very rare for us to proceed with the case—at
least not without seeking a second opinion. That gives you a sense of the kind
of rigour we have.
I point out that on case selection, if we look at the RCI
case in particular—which is one of the main drivers of the amendments in
schedule 1—the Commissioner actually won that case at first instance before a
single judge of the Federal Court. Of course, we were overturned on appeal, and
we accept that, but this suggestion that we are somehow missing the mark or
missing the point of part IVA does not really ring true when you see that at
least one Federal Court judge agreed with our position. We cannot be that far
off the mark.[11]
Disregarding the potential tax consequences of an alternative postulate
2.19
Some organisations, including the Tax Institute, ICAA and Cleary Hoare
Solicitors, expressed concerns to the committee that an alternative postulate
put by the Commission using the reconstruction approach (as described in
chapter 1) would not allow for any consideration to be given to the tax
consequences of the postulate. According to these organisations, the 'disregard
tax' provisions at sections 177CB(4)(a)(ii) and 177CB(4)(b) of the bill would
be inconsistent with the fact that taxpayers legitimately take tax into account
when weighing alternative business decisions.
2.20
As Cleary Hoare Solicitors put it in their submission, the 'disregard
tax' provisions:
...demonstrate a complete disregard for the commercial reality
of decision making that relates to the profitability of an enterprise and the
employment of Australians in those enterprises. By seeking to close the door on
the 'do nothing' and the 'unreasonable tax burden' alternative, the legislation
will be stepping away from the realities of commercial decision-making.
Australian businesses routinely decide to not enter transactions on the basis
that an excessive tax burden will make a transaction uncommercial. Preventing
this reality from being examined when hypothesising alternative postulates
would create an incongruency between regular business decisions making and the
General Anti-Avoidance Rules.[12]
2.21
These witnesses argued that not only were the 'disregard tax' provisions
inappropriate in that they prohibited genuine commercial considerations from
the alternative postulate, they were also unnecessary in preventing abuse of
the 'do nothing' defence.
2.22
The Tax Institute told the committee that it appeared that the amendments
have primarily arisen out of the government's desire to address the 'do-nothing'
scenario – that is, where the taxpayer successfully argues that an alternative
postulate is unreasonable on the basis that if the tax benefit had not existed,
they would not have entered into another arrangement that attracted tax, but
instead would have done nothing or deferred their arrangements indefinitely.
However, the Tax Institute believed that the do-nothing scenario 'really has
only arisen in very special and specific cases.'[13]
Moreover, the Tax Institute suggested that the 'do nothing' alternative
postulate 'does not come into play if the Commissioner is able to posit another
reasonable alternative postulate that involved doing something.' As such, the
current law already includes an integrity mechanism in this respect.[14]
2.23
Similarly, the Law Council of Australia argued that the government's
concerns about the 'do nothing' defence could have been dealt with by a
minimalist and clear legislative amendment. Instead, the Law Council argued,
the amendments go far further that is necessary to address the 'do nothing'
counterfactual.[15]
2.24
ICAA argued that the elimination of the 'do nothing' defence and what it
viewed as a disregard to a taxpayer's normal commercial considerations would
unduly restrict a Part IVA enquiry in determining whether a tax benefit had been
obtained, despite the fact that Part IVA already includes:
...sufficient restraints on the operation of the Tax Benefit
test. That is, an alternative postulate can only be considered if it is a 'reasonable
expectation' of what might have occurred, absent the scheme.[16]
2.25
The Tax Institute expressed concern that the Commissioner's
determination of whether a tax benefit exists was too broad, and that it was
unnecessary to include the 'disregard tax' provisions:
[The Commissioner] has to face an unrestricted question or
range of questions as to which is the most appropriate tax benefit and consider
so many things [that] we just do not think [it] is an appropriate basis on which
to go forward or to underpin the legislation in the sense that the Commissioner
has extremely wide powers to obtain information and we are concerned that he
should use those powers properly and appropriately to determine a proper basis
on which to pull the part IVA trigger. We do not believe that the 'disregard
tax assumptions' requirement in the legislation is necessary. Again, to repeat
what I have already said, it is sufficient to have regard to the substance of
the arrangements in making that determination.[17]
2.26
According to the Tax Institute, the amendments would bestow excessively
wide powers on the Commissioner to levy tax on the basis of an unreasonable
alternative postulate. As a consequence, the amendments could potentially erode
taxpayer rights, leading to heightened taxpayer risk and damaging business
sentiment.[18]
2.27
The Tax Institute told the committee that it was not recommending that
the 'disregard tax assumption' be removed entirely from the bill, 'but for it
to be subject to a reasonableness clause so that a reasonable outcome results
in all situations.'[19]
2.28
ICAA told the committee that did not think the 'disregard tax' provision
was appropriate or necessary:
The rule that we are talking about here in Part IVA is the
tax benefit rule. This essentially goes to one single question: has tax been
avoided? What the rules currently, and as amended, try to do is work out what
the reasonable alternative is to what you would have done, to work out whether
tax has been avoided. We think that artificially removing considerations like
tax actually produces an entirely artificial and contrived drafting of the law,
which is bad for the community and the tax power in the long run. We think that
the [courts have] been very successful at sorting out the cases based on the
facts. We think that this is going to create uncertainty, and probably some
prejudice to some taxpayers—[20]
2.29
CTA also argued that the 'disregard tax' provision was unnecessary to
overcome the 'do nothing' defence, as the 'substance of the scheme' and 'result
or consequence of the scheme' rules already have that effect.[21]
Treasury view
2.30
In explaining the 'disregard tax' provisions to the committee, Treasury
emphasised that:
...the thrust of Part IVA is to peel away the artificial and
contrived elements of a transaction and to reveal its economic substance. From
that point of view, you could say that the rule that says you should disregard
tax is, in a sense, part of that peeling away because what you are looking for
is the underlying commercial intent of the transaction and that is not about
tax. So we are looking for a comparable transaction, a reasonable alternative,
that is about everything except tax, if I can put it that way.[22]
2.31
In its submission to the inquiry on the bill by the House Standing
Economics Committee, Treasury maintained that:
Having identified a substitute for the scheme, it would
undermine the operation of Part IVA to permit the tax consequences of that
substitute to be a reason for concluding that the substitute is unreasonable.
To do so would be to allow the very tax advantage that Part IVA is seeking to
identify and measure to function as a shield against its operation.[23]
2.32
Making the same point in its appearance before this committee, Treasury stressed
that if the tax consequences were allowed to be considered in an alternative
postulate under the reconstruction approach:
...then you actually have the perverse result that the greater
the tax advantage in doing the transaction in the artificial and convoluted
way, the less likely it is that you will be able to identify that there is a
tax benefit.'[24]
2.33
Treasury told the committee that the situations where this issue would
actually arise were relatively uncommon:
Normally you look at what [the taxpayer has] actually done
and how much tax they paid, and the obvious alternative is some more natural,
ordinary way of carrying out a transaction. There is really only one other
level of tax they would have paid. I think the scenario you painted was that
there might have been three or four other ways of undertaking the transaction
with varying levels of tax. That is perhaps theoretically possible but we have
not seen those very often. Normally the argument is that 'we would not have
undertaken the transaction at all; we just would have abandoned the whole thing.'[25]
The Commissioner's capacity to use an annihilation approach
2.34
In its written submission, the Tax Institute suggested that while the
Explanatory Memorandum suggests the annihilation approach would be used 'where
the scheme in question does not produce any material non-tax consequences for
the taxpayer' (paragraph 1.82 of the Explanatory Memorandum), there is no
restriction in the legislation itself on when this approach is to be used. As
such, the legislation provides the Commissioner with a broad power to
annihilate a scheme 'in a way that produces an unreasonable basis on which the
tax benefit is calculated without any capacity for taxpayer challenge.'[26]
2.35
The Tax Institute picked up on this point during the hearings, telling
the committee that it believed the annihilation provision, as set out in the bill,
is:
...almost boundless. The difficulties of relating to what is
said in the explanatory memorandum to how the annihilation provision is
intended to work cause the Institute real concerns.[27]
Treasury and ATO view
2.36
In response to criticisms that the annihilation provision is too broad
and that the limits in the Explanatory Memorandum on when the annihilation
approach should apply are not included in the legislation itself, Treasury has noted
elsewhere that the Commissioner is entitled to rely on either the
reconstruction limb or the annihilation limb, and that which limb the
Commissioner relies on will depend on the facts of the case.[28]
2.37
However, as Treasury explained to the committee, the concept of a 'tax
benefit' is simply one concept that must be considered in deciding whether Part
IVA applies; it is also necessary for the 'tax benefit' concept to work in an
interrelated way with the concepts of 'scheme' and 'purpose' in order for a
Part IVA to be applied. As such, it would not be effective for the Commissioner
to apply an annihilation approach to schemes that achieve substantial non-tax
results:
The point [is] if the Commissioner is able to establish that
there is a tax benefit, that does not compel the conclusion that Part IVA is
going to apply to enable the Commissioner to cancel that tax benefit. In order
for the Commissioner to be able to cancel a tax benefit he has got to be able
to demonstrate that a person entered into, or carried out, the scheme for the
sole or dominant purpose of the taxpayer obtaining a tax benefit. That means
that if the Commissioner is going to seek to rely on the annihilation approach
to identify a tax benefit then he effectively has to say to a court that the steps
that constituted the scheme achieved nothing of any significance or materiality
for the taxpayer other than obtaining the tax benefit.[29]
2.38
When questioned as to why the legislation did not expressly limit the
application of the annihilation approach to instances where there were not any
material non-tax results or consequences for the taxpayer, and why this intent
is limited to the Explanatory Memorandum, Treasury responded:
One of the things we were very conscious of when we were
trying to formulate the amendments was to tinker with Part IVA in as minimal a
way as possible—to go with very simple provisions that would fit seamlessly
into Part IVA as it is understood by the courts to be operating. [...]
When we were trying to formulate the amendments, it was
pointed out to us that we needed to be careful not to do anything that would
prevent the courts being able to take that very simple, straightforward
common-sense approach in those kinds of cases.
2.39
Treasury also rejected the suggestion that the amendments give
additional power to the Commissioner, and informed the committee that the 'intention
is to restore the operation of Part IVA to basically where we thought it was.'[30]
2.40
Treasury also told the committee that the amendments would actually
simplify and narrow the scope of the determination of a tax benefit under Part
IVA:
That is because 'tax benefit', as it is currently operating,
requires a really open-ended inquiry into what would be the next most likely
thing the participants in the scheme would have done if they had not entered
into the scheme. That is highly speculative. It permits consideration of
anything, providing there is some sort of foundation evidence for it. Whereas
section 177C, the definition of 'tax benefit', if amended in the way proposed,
narrows that inquiry considerably, certainly on the reconstruction approach, to
being a question about: were there any other ways that the taxpayer could
reasonably have achieved what they had actually achieved, from the perspective
of the substance of the arrangement and the effect of the arrangement? That
very much confines the inquiry.[31]
2.41
Treasury further noted that because the amendments were directed toward
the determination of a 'tax benefit' (section 177C), and not to establishing
the dominant purpose of a scheme (section 177D), the amendments would not
create significant new compliance costs:
Most of the issues around the application of Part IVA are
actually going to come back to the question of whether the taxpayer has a
dominant purpose of achieving a tax advantage. Those have not changed as a
result of this. What this is about is ensuring that, where there is an
intention of that sort, the tax benefit can be appropriately quantified. That
is what the tax benefit amendments are aimed at. So, from that point of view,
there would be no significant change to the compliance costs because we are not
changing the dominant purpose test.[32]
2.42
The ATO told the committee that if it had believed there were
significant interpretive problems with the amendments then it would have
already raised this with Treasury and sought to have the bill amended.
Notwithstanding this point, the ATO noted that it intended to update its
document, Law administration practice statement, to reflect both the
current amendments and developments in case law in recent years. The ATO told
the committee that it planned to release a draft of that document for public
consultation in the winter of 2013, with a view to finalising it before the end
of the year.
The second thing we are doing, at the request of the National
Tax Liaison Group, is soliciting from them some examples of the kinds of
concerns that they consider the bill might raise and that the Tax Office might
usefully provide guidance on. So we are going to sit down in a more informal
way and see if we can develop some kind of useful guidance, at least in the
interim, that we can give through them.[33]
The sequencing of determining when Part IVA applies
2.43
As noted in chapter one, the amendments change the sequencing of a Part
IVA inquiry. Whereas currently a Part IVA inquiry begins with a consideration
of whether the taxpayer has secured a tax benefit in connection with the
scheme, the amendments would require that an inquiry starts with a
consideration of the dominant purpose of the scheme. According to the
Explanatory Memorandum, this will ensure that 'the examination of the tax
benefit happens in the context of examining a participant's purpose.'[34]
2.44
The Law Council of Australia told the committee that:
...logically, it is difficult to see how one can sequence
consideration of dominant purpose having regard to tax benefit before
determining what the tax benefit actually is. We do not believe that there is
actually any damage done by the traditional way of determining what the tax
benefit is and determining if there is indeed a tax benefit—which, on any view,
is a thing that has to be cancelled at the end of the day—and then making an
inquiry about dominant purpose. It seems to us illogical and counterintuitive
to reverse that inquiry to really no good end.[35]
Treasury view
2.45
Treasury's view, as expressed in the Explanatory Memorandum, is that
the:
...objects of Part IVA are more likely to be served if the
analysis starts with the section 177D inquiry about whether a person
participated in a scheme for the sole or dominant purpose of enabling the
taxpayer to obtain a tax benefit.[36]
Committee view
2.46
The committee believes the amendments are an appropriate and measured
response to exposed weaknesses in the operation of Part IVA. The committee is
not convinced by arguments that the amendments represent an overreaction to
recent court decisions, and in this respect notes that the amendments are only
directed toward the issue of the determination of a 'tax benefit.' Although some
recent cases have also turned on the issue of 'purpose', the amendments do not
go to that aspect of Part IVA.
2.47
The committee also agrees with Treasury that, in determining whether an
alternative postulate is a reasonable alternative to a scheme, it is necessary
to disregard tax consequences. This will remove the possibility of alternative postulates
being rejected on the grounds that the tax costs involved in undertaking those
postulates would have caused the parties involved to do nothing or indefinitely
defer doing anything. The committee believes removing this possibility is
necessary to ensure the continued efficacy of Part IVA in countering tax
avoidance.
2.48
With respect to concerns that the annihilation provisions are too broad,
the committee notes that there is an inherent limit on the application of the
annihilation approach in instances where a scheme has substantive non-tax
results.
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