Australia: Recent Developments—From A Tax Litigator’s Perspective

Last Updated: 29 January 2007
Article by Paul Wenk

Originally published in Lawyers Weekly.

This article seeks to briefly identify a number of recent developments in the area of tax litigation that are likely to have an impact on the commencement and conduct of tax disputes in the near future:

  • the approach of the Australian Tax Office to litigation
  • promoter penalty legislation
  • Part IVA
  • privilege and access to documents.

The Approach of The Australian Tax Office (ATO) to Litigation

The Commissioner of Taxation is one of the most active litigators in Australia. There has been a great deal of recent focus on the commissioner's compliance and litigation activities. Perhaps the most notable recent items are:

  • ATO Compliance program for 2006/07—released 30 August 2006
  • Inspector General's Report on the Management of Litigation by the ATO (Inspector General's report)—released publicly on 7 August 2006
  • Inspector General's Annual Report 2006—released 10 October 2006.

According to the Inspector General's report, the commissioner was involved in 3,200 appeals and disputes over the past two years. The Inspector General has made a number of observations and recommendations in relation to the commissioner's approach to litigation.

These include:

  • The ATO's own statements indicate that the ATO sees 'litigation as an important element of its compliance program', and 'in clarifying the law'. However, the ATO's conduct of litigation indicates that the ATO primarily uses litigation as a means of validating its own views of the law and ensuring taxayers comply with those views—views which 'may not be the same as the actual terms of the law'. One consequence is that perceptions of the ATO's 'objectivity and fairness in litigation is compromised by a perceived over-emphasis on achieving compliance with its views'.
  • In some cases, 'the ATO is also not giving effect to the results of a litigated case to taxpayers other than the particular taxpayer who has initiated the relevant case'. Again, the ATO's stated objective of clarifying the law through litigation has not been achieved 'because the tax office has refused to follow relevant legal principles which have been established by the case to any other similar case'. In the Inspector General's view, where the ATO fails to follow such cases it 'can be perceived to be in breach of the principles of the rule of law' and this undermines 'the community's confidence in the tax litigation process and the tax office's administration generally'.

The main recommendations flowing from the report are that the ATO:

  • develop and publish policy or guidelines on the conduct of tax litigation
  • give a single ATO area responsibility and authority for litigation management
  • introduce risk management techniques in litigation management
  • communicate the application of court and tribunal decisions to the public.

More recently, the Inspector General stated in his Annual Report 2006 that '[r]elationships with the tax office during the year have been considerably strained in respect of some reviews'.

The ATO has already responded to the Inspector General's Report—for example, the ATO has recently started to publish 'Decision Impact Statements' providing the ATO's view of recent court decisions.

The increased scrutiny placed on the ATO's conduct of litigation, and its response, may have important implications for the ATO's future management of disputes. Any taxpayer involved in tax disputes would be well advised to carefully monitor these developments as they may be important to their overall strategic approach.

Promoter Penalty Legislation

On 6 April 2006, the Tax Laws Amendment (2006 Measures No 1) 2006 Act (Act) became operative. The Act contains a regime dealing with conduct resulting in an entity being a 'promoter' of a 'tax exploitation scheme'.

Under the regime, the ATO will be able to take action against a person whose conduct results in that, or another, person being a 'promoter' of a 'tax exploitation scheme'.

In general terms:

  • a person is a promoter of a 'tax exploitation scheme if they have 'a substantial role' in marketing or encouraging the growth of a scheme, and the person receives consideration in respect of that marketing or encouragement, and
  • a scheme is a 'tax exploitation scheme' if it is reasonable to conclude that a person who entered into (or would enter into) the scheme did so with the dominant purpose of securing a tax benefit. However, the scheme will not be a 'tax exploitation scheme' if it is reasonably arguable that the tax benefit is available.

The ATO will be able to take action by seeking a written undertaking from the person, or by applying to the Federal Court to impose civil penalties or grant an injunction.

It is too early to gauge the precise impact of this legislation. In his speech at the commencement of the legislation, the commissioner stated that the legislation is aimed at 'key promoters who make large profits from abusive tax schemes', and that the legislation is designed to 'apply to arrangements that are clearly beyond the pale'. However, the drafting of the legislation gives it a much wider potential effect.

It remains to be seen whether the ATO will, in practice, use the legislation beyond the areas indicated by the commissioner. Only time will tell—for the present, the ATO has observed (including in its Compliance Program) that this new legislation is one of its key focus areas for this financial year.

Part IVA

Part IVA continues to be a difficult area to apply and advise on. The ATO had a major win in Commissioner of Taxation v Hart (Hart)in May 2004, when five judges of the High Court overturned the decision of three judges of the Full Federal Court and found that Part IVA applied to the particular transaction at hand.

The implications of Hart's case are starting to flow through the courts. The most important case to have considered Hart is the decision of Justice Hill at first instance and the Full Federal Court in Macquarie Finance Limited v Commissioner of Taxation [2005] FCAFC 205. Although that case was decided on another issue, each of the judges specifically opined on the operation of Part IVA. Faced with the same facts and statutory test, two judges held Part IVA applied and two judges held that it did not.

Both Justice Hill at first instance and Justice Gyles on appeal considered that because MFL's participation in the transaction was not critical, the tax benefit was the dominant purpose for structuring the scheme in the manner and form it took. Conversely, Justice Hely (with whom Justice French agreed), considered this same factor indicated that the tax purpose was not dominant.

Justice Hely considered that MFL's business aim of on-lending to another entity in the MBL group (with interest) was a relevant consideration when assessing whether the scheme was entered into to obtain a tax benefit. Conversely, Justice Gyles placed little if any emphasis on this.

Justice Hill concluded that the scheme only took the shape and form it did to meet the dual objectives of a share capital raising (commercial purpose) and an interest deduction (tax purpose), but that the tax purpose was predominant. Justice Hely disagreed. His Honour found that the dominant purpose was to secure all of the commercial advantages associated with debt financing (including the tax deduction).

As this and other cases demonstrate, judges at all levels are apt to reach different conclusions about whether there has been tax avoidance, even though dealing with the same facts and same statutory test. A sophisticated understanding of the legal principles and the approaches taken by different judges, together with an intimate understanding of the factual issues surrounding the particular transaction, are imperative if the taxpayer is to have the best chance of success in response to allegations of tax avoidance.

A number of disputes concerning Part IVA are currently being fought out in the courts. Whether the decisions in these cases lead to any greater practical understanding of Part IVA remains to be seen.

Privilege and Access to Documents

A number of cases have been decided both in the tax field and elsewhere that have the potential to impact on claims for privilege and access to documents in a tax litigation context.

In Rio Tinto v Commissioner of Taxation [2006] FCAFC 86 the Full Federal Court held that the commissioner had impliedly waived legal professional privilege over specified documents because his conduct was inconsistent with the continued maintenance of the confidentiality. The commissioner's waiver arose when he stated that 'the matters, things, circumstances and events taken into consideration' in reaching the required state of satisfaction were 'evidenced by' specified documents (including documents that would otherwise have been privileged). The court considered that the commissioner had opened these communications up to scrutiny and acted in a way inconsistent with the maintenance of privilege.

The decision is significant as it potentially opens up to scrutiny documents that the commissioner may previously have held back. Importantly, the court also considered that the issue was not whether the commissioner put his state of mind in issue but whether he put the content of otherwise privileged communications in issue.

In Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd [2006] NSWSC 530, a case dealing with commercial issues, Justice Bergin considered that an AAT proceeding was a 'non adversarial proceeding' and consequently, communications prepared for the purpose of providing professional legal services in relation to proceedings in the AAT were not privileged under the 'litigation privilege' limb of legal professional privilege.

This decision is significant as it restricts the availability of litigation privilege in AAT proceedings and, together with other cases, seriously calls into question the availability of litigation privilege in proceedings before other administrative decision makers, including those involving the Commissioner of Taxation.

While 'advice privilege' will generally be available unless expressly excluded by statute, preparation for any AAT hearing (and arguably in relation to other administrative decision makers) should undoubtedly be approached on the basis that litigation privilege will not be available.

Whether the Ingot decision may lead to taxpayers electing to have their disputes decided by the courts rather than the AAT remains to be seen. In Richardson v Commissioner of Taxation [2006] FCA 1306, the court confirmed that the Statement of Facts, Issues and Contentions (now called 'Appeal Statement') filed by the commissioner was in the nature of a pleading as it defined the controversy the court is asked to decide. As such, members of the public (in this case, the press) were permitted access to the court file to inspect the document. The importance of the case for high profile litigants in particular is clear: it may potentially impact on their willingness to litigate in the courts. One option may be to litigate in the AAT—a hearing of the proceeding before the AAT must be private if the taxpayer so requests. For the future, taxpayers may need to balance the competing interests of privilege and privacy in deciding where to litigate tax matters.

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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