Australia: Taxpayers beware: the ATO tightens the noose on Part IVA tax avoidance cases

Last Updated: 8 August 2012

Announced changes to Part IVA will remove a key defence in tax avoidance cases and add to the minefield of risk and uncertainty for taxpayers.

The general anti-avoidance rule, Part IVA, has been the ATO's weapon of choice for some time. So much so, around 80 Part IVA cases were initiated by the ATO in the past five years.

For taxpayers, Part IVA is a minefield of uncertainty and risk as the ATO, having failed in the courts, pushes for its interpretation of the Part to be enshrined in legislation.

Generally, the Commissioner has been successful in Part IVA cases where he has been able to show that the commercial viability of the transaction or arrangement, as compared to a reasonable alternative, is dependent on the tax outcome.

He has also been successful where he has identified that some aspect of the transaction or arrangement is not capable of commercial explanation.

However, the Commissioner has failed to stick to his knitting on Part IVA. He has sought to apply Part IVA in circumstances where he should not have done so. In particular, he appears to consider (erroneously) that the Part ought to apply automatically whenever the tax and economic outcomes of a transaction or arrangement differ. Cases in point include AXA, BHP, Ashwick and Futuris.

He has also sought, with spectacular lack of success, to apply the Part to internal group restructures (RCI, News Australia). In these instances, it would not have made sense for the restructure to have been undertaken if it was to result in a substantial tax cost to the organisation.

The blurred boundaries between impermissible tax avoidance and permissible tax planning and the Commissioner's desire to explore the outer reaches of Part IVA cause substantial uncertainty for taxpayers.

In the last two years, taxpayers have been successful in nine of the 15 Part IVA court cases. However, of greater concern to the ATO than the ratio of losses is the nature of those losses. In several cases (AXA, RCI and Futuris), the ATO was not even able to show that the taxpayer had obtained a "tax benefit". This was because each time the taxpayer demonstrated that, but for the identified scheme, it would have done nothing (and so would not have had an amount included in assessable income) or would have done something that produced a tax outcome at least as favourable as the one achieved under the scheme.

The ATO has always believed that the threshold for identifying a tax benefit is low. It considers all it needs to show is that there is a reasonable alternative course of action to the scheme that would have produced a less favourable tax outcome to the taxpayer. The courts however disagree. They say what is required is the identification of the most reasonable alternative course of action to the scheme and that this may necessitate the conduct of a detailed forensic exercise.

The inherent uncertainty as to when Part IVA will apply has been exacerbated by the Federal Government's 1 March 2012 Part IVA announcement. In response to losing the Part IVA "tax benefit" cases, the ATO prevailed upon the Government to announce changes to Part IVA with effect to schemes commencing after 1 March 2012. While the detail of the changes is yet to be determined, it is clear that taxpayer arguments that, but for the scheme it would have done nothing or done something that produced a tax outcome at least as favourable as the outcome under the scheme, will no longer be available.

The revamped Part IVA will likely presuppose there is a "tax benefit" if a tax advantage (e.g. tax deduction, amount not included in assessable income, etc) is generated by the scheme identified. The main focus of the Part IVA analysis will then be on the purpose of those entering into the scheme.

How then can taxpayers deal with the uncertainty associated with the Government's Part IVA announcement? As unsatisfactory as it undoubtedly is, until such time as the changes are known, the most sensible approach for taxpayers is to assume that any transaction or arrangement they enter into after 1 March 2012 that produces a tax advantage will give rise to a tax benefit.

The question of whether Part IVA could apply to the transaction or arrangement would then be determined by reference to whether it can said that a person entered into the transaction or arrangement with the main purpose of the taxpayer obtaining the tax benefit. It may also be difficult for taxpayers to obtain rulings from the ATO on whether Part IVA applies to a post-1 March transaction or arrangement until the detail of the changes is known and legislated. Again, if the ATO is prepared to rule at all then it may only be on the assumption that the scheme in question gives rise to a tax benefit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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