The Government has introduced a bill into the House of Representatives (Bill) to amend the income tax general antiavoidance rules in Part IVA of the Income Tax Assessment Act 1936 (Part IVA). the Bill follows exposure draft legislation (ED) which was considered by Corrs at http:// www.corrs.com.au/publications/corrs-inbrief/the-part-iva-changes/.
The ED was heavily criticised when it was released and the Government seems to have taken on board some of this criticism. The result is a Bill which is markedly different to the ED. Below we identify what has changed and what has remained the same, and the practical implications of the Bill for taxpayers.
What has changed
The most significant difference between the ED and the Bill relates to the formulation of the alternative postulate under s177C of Part IVA.
Section 177C defines the circumstances in which taxpayers are taken to have secured a "tax benefit". The explanatory memorandum which accompanied the ED (EM to the ED) stated the ED was intended to cure a "blurring" of the "would not have" and "might reasonably be expected to not have" limbs in s177C(1) and confirmed that the limbs should be treated as alternatives. However, the ED itself included no specific changes to this effect and this led to criticisms that there was a disconnect between the ED and the accompanying EM to the ED.
The Bill confirms that the two limbs of s177C(1) represent alternative bases upon which a tax benefit can be demonstrated:
- the first limb, called the "Annihilation Approach", involves considering an alternative postulate which consists solely of the events or circumstances that happened or existed other than those that formed part of the scheme; and
- the second limb, called the "Reconstruction Approach", involves considering an alternative postulate which is based on a reasonable reconstruction of what the taxpayer might have done if the scheme was not entered into.
The Annihilation Approach would typically be used where the scheme in question does not produce any material non-tax results for the taxpayers or the scheme shelters economic gains already in existence. The Reconstruction Approach would be used where the scheme achieves substantive non-tax results; typically, where the scheme both produces and shelters economic gains and annihilating the scheme would not leave a sensible result so reconstruction is necessary.
What has stayed the same
There are two main changes which are common to the ED and the Bill, albeit the changes are dealt with in slightly different ways in each set of draft provisions.
Restoration of the purpose test to its central role
According to the EM to the ED and the EM to the Bill, the question of whether Part IVA applies should not start with a consideration of whether a taxpayer has obtained a tax benefit under a scheme. Rather, it should involve a single, holistic inquiry into whether a person participated in the scheme with the sole or dominant purpose of securing a particular tax benefit for the taxpayer in connection with the scheme.
It appeared that the ED sought to make this change through subtle redrafting and reordering of existing provisions and adding other provisions which change slightly the emphasis of Part IVA. It appears that the Bill seeks to make this change solely through the redrafting and reordering of existing provisions.
Nature of inquiry permitted in constructing an alternative postulate
Each of the ED and the Bill includes measures designed to ensure that, in constructing an alternative postulate, certain arguments adopted by taxpayers in recent Federal Court cases about what is and isn't reasonable are no longer available.
The ED proposed a number of constraints on how the alternative postulate could be formulated. The specific constraints that were included in the ED are not included in the Bill. However, under the Bill, in determining whether a postulate is a reasonable alternative:
- regard must be had to the substance of the scheme and any result or consequence for the taxpayer that is or would be achieved by the scheme other than as a result of Australian income tax laws. This means that the alternative postulate must achieve the same commercial outcome for the taxpayer as the scheme; and
- the Australian income tax outcomes of the scheme for any person are disregarded (s177CB(4)(b)). This means taxpayers will not be able to argue that the alternative postulate is not reasonable because of the potential tax costs of that postulate.
Practical implications of the Bill for taxpayers
Once enacted, the Bill will apply retrospectively from the date of the ED, 16 November 2012.
Some of the practical implications of the Bill for taxpayers are as follows:
- for schemes involving income tax deductions or capital losses, the "Annihilation Approach" will necessarily lead to the identification of a tax benefit. However, it will still be necessary to take the "Reconstruction Approach" in deduction or capital loss cases where annihilating the scheme would produce a postulate that does not achieve the non-tax results or consequences for the taxpayer achieved by the scheme;
- in many cases, taxpayers will still need to consider whether the scheme gave rise to a "tax benefit" by reference to what might reasonably have occurred but for the scheme (ie the "Reconstruction Approach"). The alternative postulate might not be what is most reasonable or realistic because factors that would inevitably impact upon what would or would not occur but for the scheme (Australian income tax consequences for the taxpayer and tax and non-tax consequences for others) must be ignored;
- in determining whether a postulate is a reasonable alternative to the scheme, regard must be had to the "substance of the scheme" and "any result or consequence for the taxpayer" of the scheme (other than an Australian income tax result). This may add to the difficulty, uncertainty and potential for argument over whether or not a particular postulate is a reasonable alternative;
- the range of taxpayer defences to Part IVA has been narrowed in a limited number of cases. Taxpayers will no longer be able to argue that tax outcomes for the taxpayer and non-tax objectives for others are relevant in formulating the alternative postulate;
- as is currently the case, in most Part IVA cases there will be a scheme and an identifiable tax benefit. The main focus will be on identifying a person who has the sole or dominant purpose in entering into the scheme of obtaining the tax benefit for the taxpayer; and
- that said, the reasonable alternative postulate retains an important role in the Part IVA analysis. It will still be necessary to determine whether the taxpayer has obtained a tax benefit in connection with the scheme. In most cases this will involve an application of the Reconstruction Approach. This means that, in many cases, it will still be necessary to undertake a detailed forensic exercise to identify the reasonable alternative postulate. The alternative postulate also plays an important part in assessing purpose under s177D(2).
|CURRENT LAW||NEW LAW UNDER THE BILL|
|Construction of s177C(1)||Whether s177C(1) should be considered as two separate limbs or as a composite, single test is debateable. Several cases have considered the section to contain a single, composite test.||The Bill confirms that the two limbs of s177C(1) represent alternative bases upon which the existence of a tax benefit can be demonstrated. Each must be considered separately.|
|Approach to formulating alternative postulates||In determining whether a tax benefit has been received, Part IVA allows an unconstrained enquiry into what other alternatives were open to the participants in the scheme.||The alternative postulate must achieve the same commercial outcome for the taxpayer as the scheme and tax consequences of the alternative must be disregarded.|
|Restoration of purpose test to its central role in Part IVA||On one view, the current provisions allow for the analysis of whether Part IVA applies to begin with a consideration of whether a taxpayer has secured a particular tax benefit in connection with the scheme.||The question of whether Part IVA applies requires the examination of a tax benefit to occur within the broader inquiry into a person's purpose for securing a tax benefit in connection with a scheme. This change in emphasis is sought to be made solely through a subtle redrafting of Part IVA.|
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