Application of the income tax anti-avoidance rule

Overview of Part IVA

Part IVA is the general anti-avoidance rule in the Income Tax Assessment Act 1936 (Cth). It gives the commissioner power to cancel certain defined ‘tax benefits’ obtained by a taxpayer in connection with a ‘scheme’ where it is concluded, objectively, that one of the persons who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling a taxpayer to obtain a ‘tax benefit’.¹

Part IVA was introduced by the Income Tax Laws Amendment Bill (No 2) 1981 (Cth). In introducing the Bill, the Treasurer distinguished between the transactions which it was intended Pt IVA would apply to, which were described as ‘blatant, artificial or contrived’ and those which it would not, which were described as ‘ordinary’ or ‘normal commercial transactions’. However, as has been pointed out in the High Court²,  labels such as ‘ordinary transaction’ are not repeated in the text of Pt IVA itself.

The application of Pt IVA relies upon the existence of ‘a scheme to which Part IVA applies’. Such a scheme exists where two conditions are satisfied:

• a taxpayer would obtain a tax benefit in connection with a scheme (the tax benefit test); and
• having regard to eight specific matters, it would be concluded that one of the persons who entered into or carried out the scheme or any part of it did so for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme (the purpose test).

If there is ‘a scheme to which Part IVA applies’, the commissioner may cancel the tax benefit, or a part of it.

Accordingly, Pt IVA revolves around three interrelated concepts: ‘scheme’, ‘tax benefit’ and ‘purpose’.

The concept of ‘scheme’ is defined as including ‘any scheme, plan, proposal, action, course of action or course of conduct’, (including any such unilateral scheme). The courts have given the concept a wide meaning.

A ‘tax benefit’ for the purposes of Pt IVA is one which would not have been, or might reasonably be expected not to have been, obtained by the taxpayer in the year of income if the scheme had not been entered into or carried out. In other words, it requires a hypothetical to be constructed of the events which would have, or might reasonably be expected to have, transpired absent the scheme.

The purpose test involves the examination of eight specified factors to reach what the courts have decided to be an ‘objective’ conclusion concerning the purposes of those who were a party to the scheme, or a part of it. The actual subjective purpose of such persons has been held to be irrelevant.³

While Pt IVA was enacted more than 25 years ago, considerable doubt remains as to its application:

• in Hart in 2004, the five judges constituting the High Court held, in three different judgments, that Pt IVA applied, albeit that three senior tax judges sitting as the Full Federal Court held it did not;
• in Macquarie Finance, decided after Hart, two judges of the Federal Court held that Pt IVA applied, whereas two judges held it did not;⁴ and
• numerous commentators have pointed to the difficulty of determining when Pt IVA will apply, and some have called for the introduction of a new general anti-avoidance rule to replace Pt IVA.⁵

Legislative issues

Legislative expansion of Pt IVA and the enactment of derivative legislation do not bode well for those who have called for Pt IVA to be abandoned or for businesses that ignore the implications of these legislative developments.

When it was initially introduced, Pt IVA applied to transactions giving rise to only two kinds of ‘tax benefits’⁶,  being:

• amounts of income which, absent the scheme, would have been obtained by the taxpayer, and
• deductions which, absent the scheme, would not have been obtained by the taxpayer.

The scope of Pt IVA has been expanded by parliament widening the definition of ‘tax benefit’ so that Pt IVA also applies to the following tax benefits:

1. capital losses and foreign tax credits which, absent the scheme, would not have been obtained by the taxpayer; and
2. amounts on which the taxpayer would, absent the scheme, have been liable to pay withholding tax.

By drafting the concept of tax benefit in this way, Pt IVA does not address all types of tax advantages which may be obtained by an Australian taxpayer:

• it does not apply to schemes to reduce foreign tax;⁷
• it generally does not apply to steps taken to circumvent future legislation;⁸ 
• it does not apply to steps taken to minimise state taxes, such as stamp duty; and
• it does not apply to other tax credits or offsets which may reduce tax liability.

Indeed, it may be possible to argue that Part IVA should not apply because, while a taxpayer may have obtained a ‘tax benefit’ within the meaning of Pt IVA, the dominant purpose of the parties entering into the scheme was to obtain a tax advantage of the kind referred to above, to which Pt IVA does not apply.

The architecture of Part IVA has also been adopted in other legislation:

• in 1997, by introducing legislation which denies imputation benefits, such as franking credits, where such benefits are obtained in connection with a scheme entered into with a more than incidental purpose of enabling a taxpayer to obtain such imputation benefits;
• in 1999, by introducing a similar, albeit broader, general anti-avoidance rule as part of the GST legislation;⁹
• in 2000, by adopting a test similar to the Pt IVA test on purpose in relation to imposing ‘scheme penalties’; and
• in 2006, by introducing a regime to deter the promotion of ‘tax exploitation schemes’ – the definition of such a scheme is derived from that used for ‘scheme penalties’ and, therefore, draws upon the test of purpose in Pt IVA.

In December 2006, the government indicated, when introducing the Tax Laws Amendment (Simplified Superannuation) Bill 2006, the possibility of amending Pt IVA ‘to ensure that superannuation-related avoidance is dealt with appropriately’, with any such amendments ‘backdated to the date of this announcement’.¹⁰ The ATO has separately disclosed that it is focussing on improving its ‘capability to detect schemes that use superannuation as an aggressive tax planning mechanism’. Whilst the government did not release any specimen amendments to Pt IVA when it introduced the Bill, if history is any guide, if there are to be any amendments to Part IVA to deal with superannuation, they are likely to be made to expanding the notion of tax benefit to cover superannuation concessions.

Administration of Part IVA by the ATO

In relying upon Pt IVA, the ATO is, presumably, mindful of balancing the desire to apply Pt IVA to cases of ‘tax avoidance’ against not establishing an adverse precedent which could undermine its interpretation of Pt IVA following Hart. It can be expected that, in the first instance, the ATO will attempt to address this balance internally. This will not be easy, for two reasons:

• first, different views can be formed as to whether Pt IVA applies in any given case;¹²
• secondly, consideration of the application of Pt IVA is widespread within the ATO.

The ATO’s primary solution to the second issue rests with the General Anti-Avoidance Rule Panel (Panel). If ATO case officers consider that Pt IVA applies, then they must refer the case to the Panel for advice.¹³ The taxpayer may attend and argue their case before the Panel. However, there are two limitations to the Panel’s role:

• the Panel’s role is limited: not only is it merely an adviser to the relevant Tax Office decision maker, it does not investigate or find facts.  This is difficult when ‘always the question must be whether the terms of the Act apply to the facts and circumstances of the particular case’;¹⁴ and
• the taxpayer may argue its case to the Panel, but is generally not present during the ATO’s presentation to the Panel.

It appears that, following Hart, the ATO is considering expanding the range of cases to which it will consider applying Pt IVA. In a recent speech, Deputy Commissioner Jim Killaly referred to ‘tax planning [which] is structural in the sense that frameworks have been put in place that have an ongoing tax effect’ He cited ‘corporate financing’, ‘capital structuring’ and ‘cross-border arrangements between related parties’ as raising such ongoing issues. Mr Killaly noted that the:

‘[t]he Tax Office approach to risk assessment is increasingly having regard to structural aspects of tax planning that evolve with the business over time….The terms of Part IVA are not limited to transactional tax planning that starts and finishes within the same year of income. ….the reality is that the tax benefit can arise as a consequence of a structure that was put in place years before and has evolved over time.’

Mr Killaly noted that this was an issue which would develop because the Panel had ruled in one such case that ‘there is a sound basis for arguing the application of Part IVA.’

Accordingly, it appears the ATO will continue to explore the application of Pt IVA to new cases, including those referred to by Mr Killaly. In the type of case referred to by Mr Killaly, this involves the application of Pt IVA to a business structure which, whilst it did not commence as a Pt IVA scheme, may have evolved into a structure which included actions to which Pt IVA could apply.

For business, the implications of the increasing application of Pt IVA by the ATO are:

• first, an awareness that the application of Pt IVA is evolving: in particular, the ATO may seek to apply Pt IVA to a transaction or structure, even where there was a sound basis for believing that Pt IVA would not apply when the transaction or structure was first entered into. In some cases, it may be advisable for businesses to review whether current transactions and structures are susceptible to attack based on the current interpretation of Pt IVA;
• second, greater auditing by the ATO of complex transactions, even spanning over a number of years, to determine whether Pt IVA applies. The ATO appears more willing to use its compulsory powers to seek production of documents relating to the conception, marketing, design and implementation of the transaction in question to assist it in this regard. The ATO also appears more willing to conduct compulsory interviews of relevant taxpayers, and potentially, promoters, in relation to their recollections of these issues. Audits of this nature can place a heavy compliance burden on business since the evidentiary material which may be relevant to the application of Pt IVA can be broad; and
• finally, with the introduction of the regime to deter the promotion of ‘tax exploitation schemes’, the ATO is likely to consider acting quickly to prevent what it considers to be ‘blatant’ tax avoidance schemes being undertaken. A scheme is a ‘tax exploitation scheme’ if:
• it is reasonable to conclude that participants had entered into the scheme, or would enter into the scheme, with the sole or dominant purpose of securing a tax benefit, and
• it is not ‘reasonably arguable’ that the tax benefit is available to the taxpayer at law.

The ATO has the ability to attempt to prevent conduct that results in the promotion of such schemes, by obtaining undertakings from those engaging in such conduct, or by seeking an injunction. The ATO may also apply to the court for civil penalties to be imposed. Accordingly, the ATO now has the power to take action against transactions to which Pt IVA could apply even before these are implemented.

The ATO has recently released draft practice statements to provide guidance on how it will apply these rules in the future. On its terms, the legislation has the potential to apply to a wider range of circumstances than the ATO has indicated in the draft practice statements. Accordingly, it will be important to monitor how the ATO comes to apply the regime in order to understand its practical reach and implications. However, the key practical implications of this regime for business are likely to be:

1. how to determine whether the relevant taxpayer’s position is ‘reasonably arguable’; and
2. establishing proper internal processes to enable businesses to rely upon the defences and exceptions embodied in the legislation.

Conclusion

The expansion of the application of Pt IVA is to due to legislative amendments, case law developments and the administration of the Part by the ATO. This is likely to continue, at least until such time as the courts set a limit on its operation, or until calls for its amendment from the business community compel reform. The former may occur with elaboration from the courts as to how the alternative is to be constructed on the tax benefit issue, and, following Hart, the role of alternatives in assessing purpose. On the other hand, it seems that calls for legislative amendments to Pt IVA, in order to narrow its application, are likely to go unheeded. For now, businesses need to contend with the heightened risk that Pt IVA may apply to their dealings, or at least the ATO will contend that it does.

A longer version of this article first appeared in Inside Tax.

Endnotes

1. The provision dealing with dividend stripping in Income Tax Assessment Act 1936 (Cth) P IVA s 177E is outside the scope of this article.
2. Commissioner of Taxation v Hart (2004) 206 ALR 207; [2004] HCA 26; BC200403006 (Hart), per Gummow and Hayne JJ at [53].
3. Hart, at [65].
4. Macquarie Finance Ltd v Commissioner of Taxation (2004) 210 ALR 508; [2004] FCA 1170; BC200405973 per Hill J (Macquarie Finance); Macquarie Finance Ltd v Commissioner of Taxation (2005) 225 ALR 694; [2005] FCAFC 205; BC200506889 per French, Hely and Gyles JJ (Macquarie Finance Appeal).
5. For example, see Bevan, “Income tax system of Australia: The case for a new general anti-avoidance rule” (2005) 79 ALJ 364 and Donovan, “The aftermath of Hart’s case – a case for reform of Part IVA?” (2004) 39(5) Taxation in Australia 253
6. Apart from dividend stripping cases.
7. Commissioner of Taxation v Consolidated Press Holdings Ltd  (2001) 179 ALR 625; [2001] HCA 32; BC200102756 (Consolidated Press) at [51].
8. Consolidated Press , above, at [71].
9. Considered in Re VCE and Commissioner of Taxation [2006] AATA 821.
10. Joint Media Release by Treasurer and Assistant Treasurer, 7 December 2006.
11. ATO 2006-07 Compliance Program p 62.
12. See the comments of the present Commissioner after Hart, D’Ascenzo, “Part IVA: Post-Hart”, (2004) 7(2) Journal of Australian Taxation 357 p 367-368.
13. ATO Practice Statement 2005/24, Application of General Anti-Avoidance Rules, [18].
14. Ibid, [24].
15. Per Gummow and Hayne JJ in Hart [52]. See also D’Ascenzo, supra n. 12 at 366.

This article was written by Hugh Paynter, Senior Associate, Sydney.

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