Chapter 3

Revenue implications and judicial commentary

3.1        This chapter will discuss submitters' concerns in relation to:

• revenue implications and the retrospective nature of the bill including the impact on open tax disputes and settled cases; and
• judicial rulings on treaty-based transfer pricing rules including obiter comments and SNF Australia Pty Ltd v Commissioner of Taxation [2011] FCAFC 74 (SNF case).

Revenue implications

3.2        Treasury noted that 'the introduction of retrospective legislation is not done lightly' and outlined that it is 'only done where there is a significant risk to revenue that is inconsistent with the Parliament's intention'.[1] The Explanatory Memorandum (EM) to the bill outlined that there will be no revenue gained as a result of the measures in the bill, and stated that 'it is a revenue protection measure'.[2] Treasury elaborated:

The ATO has advised that there is $1.9 billion of tax in dispute related to transfer pricing issues in current audits.

It is important to note that the risk to revenue is not the same as the financial impact of not proceeding with the amendments. This Bill is a revenue protection measure and does not raise additional revenue in the Budget. It ensures the law operates in accordance with the way Parliament intended and the way it has always been administered. That is, it is about maintaining the base and protecting against base erosion rather than expanding the base.[3]

3.3        Dr John Kunkel, Deputy CEO of the Minerals Council of Australia, stated that this was 'a curious juxtaposition' and argued contrary to Treasury—that there is a reasonable expectation that the proposed bill will result in additional revenue:

The government has noted that these measures are aimed only at maintaining the revenue base, not expanding it, and the explanatory memorandum states that there are no financial impacts from these amendments. Yet it has also stated in the EM that the decision to change the law from a date before announcement is not taken lightly and only done where 'there is a significant risk to revenue'. This is a curious juxtaposition... There is a reasonable expectation that there will be additions to revenue. If there will be no revenue impacts, the question may be raised as to why there is the need for retrospectivity from 1 July 2004. The MCA urges this committee to recommend that this legislation not be made retrospective. Quite simply, such extreme action is not justified and the case for it has not been made.[4]

3.4        Some submitters questioned Treasury's statement on revenue and asserted that the bill provides the Commissioner with new powers and, therefore, there is scope to raise revenue under the bill.[5] KPMG stated:

Contrary to paragraph 1.8 of the EM, which states that "There is no financial impact from these amendments as they protect the existing revenue base", passage of the Bill could result in a significant additional tax burden for many taxpayers. The financial impact of the Bill will only be nil if the transfer pricing rules in Australia's tax treaties currently provide a separate and independent power to Division 13 of Part III of the Income Tax Assessment Act 1936 (Division 13). As noted in paragraph 1.35 of the EM, the courts have not directly considered this issue and views differ on what the answer might be under existing law.[6]

3.1        The Tax Institute provided a diagram and flowchart which illustrated the impact on government revenue when the two opposing positions on the scope of treaty taxing powers are adopted. 

Figure 1: Juxtaposition of likely scope of treaty powers and revenue impact

Source: The Tax Institute, Submission 15, Appendix D, pp 69–70.

Decisions currently before the judiciary

3.5        The Corporate Tax Association of Australia (CTAA) highlighted that the Australian Taxation Office (ATO) has a small number of related party debt cases under examination which involve significant amounts. It suggested that the retrospective application could amount to a more favourable outcome for the ATO in these cases and an increase to revenue:

It may well be that the ATO rates its prospects of success on those cases more highly if it had greater powers to recharacterise the transactions actually entered into...

Without purporting to speak for any of the taxpayers involved, it seems likely that a significant amount of additional revenue could be raised from these cases under the existing domestic transfer pricing rules – provided the ATO stops being dogmatic and doesn’t overreach. For those audit cases that are in progress, it would not be accurate to say that there are no prospects of collecting any significant additional revenue under the existing law nor, for that matter, that the collection of a very large amount of additional revenue is virtually assured by 'clarifying' the power of the treaties retrospectively.[7]

3.6        An article provided by PricewaterhouseCoopers (PwC) made the following comment:

In the circumstances, it would seem likely that the ATO has indicated material shortfalls in budgeted revenue collections to the government and this has influenced the government’s decision to retrospectively change the law. It is hoped that these changes are not connected with any particular disputes on foot with the ATO. It would be galling to discover that the ATO were advocating retrospective law changes in an endeavour to "protect" revenue based on controversial and long-held ATO views which have been found to be shaky by the courts.[8]

3.7        PwC strongly opposed the retrospective nature of the bill, and further argued that it was 'unfair' to introduce a law that could impact open disputes:

...illuminating were the comments made by Deputy Commissioner Mark Konza at a Large Business Advisory Group meeting on 1 June 2012, in which he indicated that the ATO has 40 transfer pricing audits in progress which may be impacted by Subdivision 815-A and that the proposed adjustments at stake are worth approximately $1.9 billion.

Introducing a new law which could be applied to disputes that are already in progress is unfair to taxpayers who have made genuine efforts to comply with the law as it stood at the time. This again illustrates that it is inappropriate to introduce the proposed changes retrospectively.[9]

3.8        In response to these concerns Treasury outlined that the bill is not designed to target open tax disputes:

In the context of targeting any specific individual dispute, I think the answer to that is clearly no. But I guess it may, at least in some people's eyes, be difficult to distinguish that from the point that is made in page 5 of our submission, about the revenue risk if this law is not enacted. There are a significant number of transfer pricing issues in current audits and that gives an amount of $1.9 billion in tax that is in dispute. So I would not say that this legislation is designed to resolve specific disputes, because I do not think that is accurate. But on a broader level I can see why some people could get that impression.[10]

3.9        In the context of broadly discussing the retrospective nature of the bill, Mr Bruce Quigley, Second Commissioner at the ATO, commented:

To me, the concern that is being expressed about the retrospectivity is that the commissioner is going to take a different approach. What I am saying is that we will not be changing our compliance approach, nor expanding our audit activity, in this area as a result of this bill, because it merely confirms longstanding practice. To me, that is the important thing about this.[11]

Settled cases

3.10      The EM outlined that despite the retrospective nature of the bill, 'where a taxpayer has properly entered into a settlement with the Commissioner in relation to their non-arm's length international dealings, the Commissioner would generally be prevented by the terms of the settlement deed from applying Subdivision 815-A to impose a less favourable outcome on the taxpayer'.[12]

3.11      Moore Stephens was not reassured by this Treasury and ATO advice:

Treasury states that: "...the ATO has advised that it will not be opening settled cases as a result of the legislative amendments proposed by this bill." This statement appears incorrect and is arguably an oversimplification of the situation. The more appropriate guidance, in any event, is to be sought from the Explanatory Memorandum and not oral non-binding comments that may be made by the ATO. The Explanatory Memorandum states that settled cases "...would generally be prevented by the terms of the settlement deed...." from being reopened. The key words here is the word "generally" (and 'settlement deed') which, absent protective legislation, leaves this matter wide open for interpretation by the ATO. The ATO comment of which I am aware which perhaps touches on this matter is the statement made by our Commissioner of Taxation, when questioned before the Senate Economics Legislation Committee on 30 May, 2012, whereat he stated:

"When we talk about the retrospective application of these laws, we do not see it as if all of a sudden the ATO will be using new laws to go back. It was really a method of maintaining the status quo."[13]

3.12      Mr Frank Drenth, Executive Director of the CTAA, also commented:

The Treasury submission makes the point that settled cases will not be reopened. We have been encouraged by Second Commissioner Quigley from the tax office when he said at a CTA convention last month that the tax office does not propose to reopen settled cases. I am sure Mr Quigley meant what he said. We will do our best to keep the tax office to that. However, I should point out, there is nothing in the law that prevents the tax office from going back to July 2003 in whatever case it deems appropriate.[14]

3.13      Conversely, Deloitte have noted that any attempt by government to prevent taxpayers from reopening cases in order to benefit from the recent ruling in the SNF case, are unfounded and there are substantial impediments to taxpayers to re-open settled accounts:

A further reason offered by Treasury for the Government's decision to retrospectively amend the law is the prevention of taxpayers making credit amendments to reduce taxable profit following the SNF decision. We are of the view that this concern is unfounded, both in practice and as a matter of law. In relation to audit cases and [Advance Pricing Arrangements] that have been previously settled or agreed with the ATO, we note that there would be practical (and possibly legal) impediments to reopening these cases.[15]

3.14      Mr Bruce Quigley, Second Commissioner, reiterated that the ATO had no intention to re-open settled cases using the provisions in the bill:

For decades the ATO has consistently held the view that it is parliament's intention—and the tax treaties provide a separate head of power to make transfer pricing adjustments. We have no intention whatsoever—and have made public statements to this effect—to reopen any cases that have been settled on the basis of the existing law, given that the proposal will clarify what the existing law was. We see no change to our procedures, so we will not be reopening any settled cases, any concluded advance pricing arrangements and also any settled mutual agreement procedure cases...

There is quite a formal process of settling a case, and that involves entering into a deed of agreement and settlement. Indeed...those deeds would preclude any reopening of those settled cases in any event.[16]

Calls for greater transparency

3.15      A number of submitters requested that Treasury release further documentation supporting its claims that the provisions will only be used to protect the revenue base, and not to increase it.[17]

3.16      For example, the Tax Institute have called for greater transparency on the revenue estimates and recommended that:

Treasury make publicly available further information on the inputs and underlying bases of calculation that have resulted in this estimation that there is no financial impact from these amendments'.[18]

3.17      Treasury undertook to provide further information to the committee. It explained that:

At any point in time, a large proportion of the primary tax in dispute figure is attributable to a relatively small number of cases. At this point in time, the 10 largest cases account for around 80% of the primary tax in dispute in the transfer pricing audit program.[19]

Judicial rulings on treaty taxation powers

3.18      The EM to the bill outlined that the court has not made an explicit ruling on the taxation powers contained within treaties:

The application of treaty transfer pricing rules has not been specifically tested before the courts or the Administrative Appeals Tribunal, although judges have made obiter comments in two cases. In neither case was the issue extensively argued before the court or tribunal. And in both cases it was accepted by the parties that the outcome of the case did not turn on this issue. In his obiter comments Justice Downes noted there was a lot to be said for the proposition that treaties do not confer a power to assess; while Justice Middleton saw some force in the argument that by the operation of subsections 170(9B) and 170(14) of the ITAA 1936 there is a clear legislative intention that the Commissioner may rely on either Division 13 or the relevant transfer pricing article.[20]

Obiter comments

3.19      Obiter comments supporting both opposing arguments on the taxation power of treaties were cited in evidence to the committee (see discussion in Chapter 4 on section 170(14)).

3.20      Some submitters highlighted obiter comments that supported the argument that treaties do not confer taxation powers. For example, Chevron asserted:

... the Courts have refuted the notion that separate taxing power is conferred by the [Double Tax Agreements] DTAs on several occasions. Lamesa, Chong and Undershaft are all authority for the proposition that the DTAs do no more than allocate taxing rights. In Undershaft, Lindgren J stated:

"A purpose of a DTA is to avoid the potential for the imposition of tax by both of the Contracting States on the same income. It is appropriate to say that the Contracting States achieve their objective by "allocating" as between themselves the right to bring to tax a particular item to one Contracting State while the other State agrees to abstain from doing so ...

A DTA does not give a Contracting State power to tax, or oblige it to tax an amount over which it is allocated the right to tax by the DTA. Rather, a DTA avoids the potential for double taxation by restricting one Contracting State's taxing power" (emphasis added by Chevron).[21]

3.21      Treasury reiterated that this comment, and others cited by submitters, were obiter comments, and importantly, these cases did not test the law as to the treaty taxing powers:

Submissions in consultation on this Bill cited other judgements commenting on the general role of allocation rules in tax treaties, which considered other treaty rules allocating taxing rights: Goldberg J in Chong v Commissioner of Taxation (2000) 101 FCR 134 at [27], [44]; Middleton J in GE Capital Finance Pty Ltd v Federal Commissioner of Taxation (2007) 159 FCR 473 at [27], [29], [36], [45] and [46]; and Lindgren J in Undershaft (No 1) Ltd v FCT (2009) 175 FCR 150 at [17] and [27]. But, importantly, these cases did not specifically test the question of whether transfer pricing articles had been incorporated into Australia's municipal law so as to give rise to a power to make or amend assessments.[22]

Treaty powers and the SNF case

3.22      Many submitters agreed with Treasury's assertions that the court has yet to specifically make a ruling on the matter; some also noted that the issue was not addressed in the recent SNF case.[23] For example, the Law Council of Australia and the Rule of Law Institute of Australia asserted that in the eight years since 2003, despite questions being raised by the Courts, the ATO has made no attempt to clarify the law.[24]

3.23      Some submitters questioned why Treasury, despite the opportunity, did not raise the taxation power of treaties in the recent SNF case.[25] The Institute of Chartered Accountants in Australia stated:

In SNF, the Commissioner had the opportunity to have the Full Federal Court declare the law on the operation of the arm's length rule in a DTA. For whatever reason, the Commissioner chose not to have the Federal Court declare the law. Had the Commissioner not abandoned the DTA argument during the course of the SNF proceedings, there would be no need to legislatively clarify the existing operation of the law or, in the alternative, any retrospective amendments would unambiguously alter the existing operation of the law.[26]

3.24      A number of submitters suggested that the ATO intentionally avoided raising the matter in the SNF case in order to instead address the matter through legislative amendment. Moore Stephens commented:

Indeed, some say that the very reason that the ATO did not run the Treaty taxing power argument in the SNF case was to provide it with the 'trigger' or excuse for a rewrite of our transfer pricing legislation. Certainly, not to have run the Treaty 'taxing power' argument in either or both these cases evidences a strategy much to be desired.[27]

3.25      Mr Frank Drenth of the CTAA also commented:

In the SNF decision, the commissioner made written submissions about the power of the articles. It is on the public record. Go and look it up. The court did not accept those submissions and the commissioner chose not to appeal against the full federal court decision. Taxpayers have taken this as far as they can. It is the commissioner you have to ask.

The commissioner, as I said, chose [instead] to go to the government and get the government to say that the law has applied since 2003 in the way the commissioner always wished it would. But no amount of foot-stomping by the commissioner should encourage the parliament to enact his view of the law, going back as far as 2003 when taxpayers were entitled to rely on what the law said and what the commissioner said.

...none of the accounting firms were saying that the treaties impose a separate power—not if you look at what they say, carefully. That really leaves the Treasury arguments in about the same spot as Dennis Denuto in The Castle: 'It's the vibe, Your Honour.'[28]

3.26      Treasury refuted assertions that the rules are intended to 'overcome' the SNF decision. It explained that the SNF decision 'related to the application of Division 13 and, as such, is of limited relevance to the question of whether the treaty based transfer pricing rules apply':

While courts have commented broadly on the allocative function of treaties, no case has specifically tested the question of whether the transfer pricing articles as currently incorporated into Australia's domestic law give rise to a power to make or amend assessments, although judges have made obiter comments in respect of this issue in two cases, namely Roche Products Pty Limited v Commissioner of Taxation and SNF Australia Pty Ltd v Commissioner of Taxation. During consultation on this Bill, a number of submissions cited a number of obiter comments, however in none of those cases was the status of the treaty based transfer pricing rules in issue.[29]

3.27      Moore Stephens refuted Treasury's statements that '[t]he SNF case is of limited relevance':

This is misleading and arguably 'false'. This is so insofar as the ATO foreshadowed the need for legislative change in the event that it lost the SNF case; this is well documented in the Financial Press; and secondly, the Commissioner's Annual Report for 2010-2011 alludes to the need to change the law given the loss in the SNF case.[30]

3.28      Mr Andrew England, Chief Tax Counsel for the ATO, commented on the approach taken in the SNF case. He outlined that the Commissioner's approach was taken on the ATO's understanding that Division 13 was likely to give the same kind of outcome as the treaty based transfer pricing rules:

Judgments were made at the time on the basis of our view that essentially the transfer pricing provisions in the division 13 area gave the same kind of outcome as the provisions in the treaty area. A judgment was made at the time, given the complexity of the facts, that there was not any value-add in complicating the case with arguments about the treaty powers. So the argument was run on the basis of the transfer pricing provisions in division 13 and in rules.

...and we thought that our case had merit and that we were able to argue it, given the nature of the facts, on that basis. In hindsight, given everything that has happened, it probably would have been better if we had thrown all of the arguments at the court...but that judgment was not made at the time, and we are where we are now.[31]

Navigation: Previous Page | Contents | Next Page