Australia: Part IVA anti-avoidance provisions: where is the line now between legitimate tax planning and tax avoidance?

Part IVA was originally introduced to target tax avoidance arrangements that were 'blatant, artificial or contrived'. Following the 2013 amendments, the focus has shifted to identifying arrangements where the substance of the transaction 'could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction'.

The Commissioner notes, in his practice statement PS LA 2005/24, that the 2013 amendments have not yet been considered by the courts, or even extensively in audit activity by the ATO. However, the Commissioner has made it clear that he considers the amendments have significantly altered the operation of Part IVA.

This has resulted in greater uncertainty about where the line between acceptable tax planning and unacceptable tax avoidance lies. The risk for advisers in SME transactions is that what was previously considered sensible tax planning may now be caught by the anti-avoidance provisions.

HOW DOES PART IVA WORK?

Part IVA gives the Commissioner the power to cancel a 'tax benefit' received by a taxpayer where he is satisfied that the following elements exist:

  • there must be a 'scheme' – this requirement will almost always be satisfied because the concept of a 'scheme' is defined broadly
  • the taxpayer must get a 'tax benefit' in connection with the scheme
  • the taxpayer's sole or dominant purpose in entering the scheme must be to obtain a tax benefit – having regard to objective factors listed in the legislation.

IDENTIFYING A TAX BENEFIT

The greatest challenge for advisers may be identifying a 'tax benefit'. There are two alternative approaches:

  • the annihilation approach – what 'would have occurred' if a scheme had not been entered into or carried out
  • the reconstruction approach – what 'might reasonably be expected to have occurred' if the arrangement was structured differently but achieved the same results.

Before the 2013 amendments, the Commissioner had difficulty in a number of cases defending a reasonable alternative postulate. In particular, taxpayers successfully argued that the alternative postulate was not reasonable because the tax costs were too high and would have caused them to do nothing. Parliament responded by specifically excluding tax costs from the consideration of whether the alternative postulate is reasonable.

Now, in determining what is a 'reasonable' alternative postulate, 'particular regard' must be had to:

  • the substance of the scheme – what the scheme achieves
  • the result or consequence of the scheme – but not taking into account income tax implications.

Conceptually, this is a challenge for advisers in SME transactions as taxpayers will invariably want to know the tax cost of their proposed course of action before proceeding with it. To disregard the tax consequences is counterintuitive – it requires an analysis of a fiction that is different from the reality that tax costs are almost always considered in any transaction.

WHAT, THEN, IS A REASONABLE ALTERNATIVE POSTULATE?

An alternative postulate that is reasonable would achieve for the taxpayer results and consequences that are comparable to those achieved by the scheme. Whether an alternative is reasonable can include consideration of:

  • financial consequences, such as transaction costs, stamp duty and payroll taxes; and
  • other consequences, including the effect on personal or family relationships, and satisfying directors' duties, workplace health or safety requirements, environmental standards and other regulatory requirements.

Asset protection is often cited as the motivation for restructures. There is scepticism within the ATO about whether asset protection is a genuine purpose or a mask for an underlying tax purpose.

In identifying whether asset protection is the dominant driver, you should consider:

  • whether the need for asset protection is real, and not fanciful
  • whether the restructuring achieves asset protection
  • whether the asset protection could have been achieved in another, simpler manner.

HOW CAN YOU MANAGE PART IVA RISKS?

Advisers will need to be more aware now of discussing avoidance risks with their clients, particularly given the lack of certainty in the application of the new provisions to SME transactions.

To analyse a Part IVA risk, advisers should consider the following steps.

  1. Define the scheme, both broadly and narrowly, and consider possible variations.
  2. For each defined scheme, work through the eight factors in the legislation to determine whether there was a sole or dominant purpose of obtaining a tax benefit. The test is objective.
  3. For each defined scheme, identify whether there is a tax benefit by:
    1. applying the annihilation approach (if applicable); and
    2. applying the reconstruction approach based on reasonable alternative postulates, remembering to disregard tax consequences in considering what is reasonable.
  1. Check whether an exception applies because the tax benefit is accessed under a choice or election permitted under the legislation.
  2. Check whether the scheme is otherwise excluded or whether the relevant amendment period has expired.

PS LA 2005/24 provides an overview of how auditors will approach Part IVA. It makes sense to refer to that practice statement in getting the method right. However, PS LA 2005/24 is unlikely to provide any black and white results if the issue turns on sole or dominant purpose.

It is possible to apply for a private ruling in relation to Part IVA. However, the Commissioner has declined to rule in the past, so query whether that is an acceptable use of time and money.

Another approach where there is a tax benefit, but tax does not appear to be the sole or dominant purpose, is to gather all of the evidence in relation to the non-tax motivations. Like any tax dispute, the taxpayer has the burden of proof in Part IVA matters. Properly evidencing the non-tax purpose (both through the legal documents and in practice) will be critical to showing that the transactions were motivated by commercial reasons.

© Cooper Grace Ward Lawyers

Cooper Grace Ward is a leading Australian law firm based in Brisbane.

This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please contact Cooper Grace Ward Lawyers.

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