An assessment known to be excessive found to be not in bad faith

• the Commissioner believed he could correct any error by making a ‘compensating adjustment’ under Part IVA, and
• the taxpayer could challenge the excessiveness of the assessment in appeal proceedings which were then on foot.

The facts

Futuris Corporation Limited (Futuris) undertook an asset reorganisation prior to the disposal of one of its divisions. The reorganisation had consequences for this division’s cost base for capital gains tax purposes. There was a dispute between Futuris and the Commissioner about what those consequences were.

• Futuris contended that the cost base of the division had increased by around $83 million.
• The Commissioner initially contended that the cost base of the division had only increased by around $63 million.

The Commissioner issued an amended assessment for the difference of around $20 million.

The Commissioner then issued a second amended assessment, relying on the application of Part IVA, on the basis that absent the reorganisation, Futuris’ cost base would not have increased at all. On this basis, the Commissioner assessed Futuris for an additional $83 million—in addition to the first amended assessment. The effect of the second amended assessment, with the first amended assessment, was to double count the original $20 million difference between the Commissioner and Futuris. This difference had been assessed in the first amended assessment and then also included as part of the second amended assessment.

Futuris challenged the second amended assessment in the Federal Court outside the usual objection, review and appeal procedures (the appeal procedure). It contended that it was ‘tentative’ or ‘provisional’ and/or had been issued in ‘bad faith’ because the Commissioner knew the amount assessed under the second amended assessment was wrong; he knew he could not collect the full amount of the first and second amended assessments. The Full Federal Court agreed with this argument.

The High Court’s decision

All five judges found for the Commissioner. Four judges (Justice Gummow, Justice Hayne, Justice Heydon and Justice Crennan) found that, in making the second amended assessment, the Commissioner had not made a ‘jurisdictional error’; that is, any error by the Commissioner only went to the manner in which the Commissioner exercised his power, rather than one which took the Commissioner beyond the exercise of his powers. Any error made by the Commissioner in this case could effectively be addressed in the appeal procedure available to Futuris. Further, the Commissioner had not issued the relevant assessment in bad faith because he believed that he could remedy any error through a compensating adjustment under Part IVA. Nor did his acknowledgement of the likelihood of issuing a compensating adjustment make the assessment ‘tentative’ or ‘provisional’.

Justice Kirby substantially agreed with the other judges, albeit he left open the possibility that a taxpayer may be able to challenge an assessment, without resort to the appeal procedure, where that assessment was otherwise ‘fundamentally flawed’.

Significance of the decision

Commissioner of Taxation v Futuris Corporation Limited confirms that the ability of taxpayers to challenge the validity of amended assessments outside the appeal procedure will, in practice, be limited. A taxpayer may still be able to challenge validity outside an appeal, for example, where the assessment is shown to be tentative, provisional or issued in ‘bad faith’. But the latter term is to be interpreted narrowly, connoting only ‘corruption’ or ‘deliberate maladministration’ of the tax law. In addition, any taxpayer wanting to make that allegation should consider raising it as part of the appeal procedure. Further, evidentiary difficulties will stand in the way of a taxpayer making such an allegation.

More generally, a taxpayer’s ability to challenge the validity of amended assessments outside the appeal procedure will be dependent upon showing a ‘jurisdictional error’. Distinguishing between a ‘jurisdictional error’ (an error which takes the decision maker outside their power) from an error in a decision which only goes to the manner of the exercise of the relevant power, is a difficult area. However, a jurisdictional error may be broader than cases where an assessment is tentative, provisional or issued in bad faith (in the limited sense explained above). For this reason, and ironically, given the Commissioner was successful, it may be that, after Commissioner of Taxation v Futuris Corporation Limited, taxpayers will be more likely to challenge the manner of the making of an amended assessment, provided that that they can properly allege a case of ‘jurisdictional error’. Even in those cases, taxpayers should give consideration to advancing such an allegation as part of the appeal procedure.

Finally, the court’s willingness to recognise the prospect of a ‘compensating adjustment’ under Part IVA as a factor in favour of prima facie validity of an amended assessment may have an impact on the administration of Part IVA by the Commissioner. In particular, the Commissioner can be expected to issue amended assessments under Part IVA for excessive amounts where he expects he can address any error by a compensating adjustment. Similar considerations may apply in other areas, such as transfer pricing. This may provide the Commissioner with the ability to address one difficulty presented by the relatively recent amendment to decrease the time limit for issuing an amended assessment in reliance of Part IVA from six years to four years; where the Commissioner comes up against the new four-year time limit and faces a choice about assessing for either a larger or smaller amount, the Commissioner might be expected, in cases of doubt, to assess for the larger amount. The Commissioner may then plan to subsequently correct an error, if any, by a compensating adjustment, for which there is no time limit.

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

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