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A practical guide on part IVA. Taxation Institute of Australia, 15th National Convention: Ahead of the wave, Sydney, 22-24 March 2001
Download PDF TAXATION INSTITUTE OF AUSTRALIA - AHEAD OF THE WAVE
1 ST’ NATIONAL CONVENTION - SYDNEY
22-24 MARCH 2001
Michael D’Asceaeo Second Commissioner Austdian Taxation Office
A practical guide on Pad IVA
Guidance provided by the AT0 on the application of Part IVA
In Australia we now have the guidance of decided cases that clarify the application of Part TVA eg Peabody, Spotless, and Richard Walter. The AT0 has also expressed its view on the application of Part IVA (eg PS 2000/l 0 and the rulings, and papers, referred to in that practice statement). These reference points arguably provide a more certain basis than is available in other jurisdictions as to when the General Anti-Avoidance Rule (GAAR) is likely to
be applied, or, in jurisdictions which do not have a GAAR, as to when the courts will intervene on the basis of judicial doctrines that have been developed in rhose jurisdictions to counter tax avoidance.
The reality is that there is always some degree of subjectivity as to where to draw the line between acceptable aud unacceptable arrangements. Whether there is a GAAR in the law, or whether
there is reliance on court-based anti-
avoidance rules, the same question of drawing the line arises.
The AT0 has tried to help make it clear where the line falls by:
- clarifying the AT0 position in Public Rulings such as TR 2000/8 (investment schemes); JR 98/22 (linked or split loan facilities); and TR 95/30 (sale and leaseback). In fact 39 public rulings and 9 tax determinations which have relevance to Part IVA are cited in
PS 2000/10;
- publication of its administrative approach to Part WA, as outlined in Practice Statement PS ZOOO/lO;
- publication of views on administrative questions relating to Part IVA (the Addendum to the Code of Setiement Practice does not relate directly to Part IVA, but relates to penalties, remission, and to our view
on the degree of tax mischief);
- Product Rulings;
- Private Rulings on Part lVA where requested (see IT 2500 and
PS 2001/4); and
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- publication of non-binding Case Decision Summaries involving Part IVA matters ( 19 such CDSs are cited in PS 2000/l 0).
The AT0 also ensures that there are internal checks and balances on where the AT0 draws the line on the application of Part TVA:
- Part IVA Panel whose mle is clarified in PS 2OWlO and which includes external consultants provides advice on the application of Part IVA to novel or complex cases; and
- compulsory escalation of Part IVA issues to the Tax Counsel Network to ensure the proper application of Part WA, including that only appropriate cases are being pursued.
Attachment 2 of PS 2000/10 illustrates the ATO’s frameworks of internal
checks and balances:
n is duly authorised or has the ommissioner’s delegation.
in AT0 Offker who ersons who are authorised officers are required to s either authorised or the determination in the name of the delegate and t in their own name. It is important to follow the licable format for determinations in Attachment 1.
s to be involved
s it necessary to refer em 3. If it is a significant or novel matter
this matter to the
not previously been considered it must be
‘art IVA Panel before eferred to the Part IVA Panel. To be exempt from a decision is made? requirement to refer a matter to the Panel a ckarancc
the Deputy Chief Tax Counsel,
Existing law
Part IVA Practice Statement: PS2000/10
PS 2000/10 was issued on1 8 December 2000. It was issued after consultation with the professions via the National Tax Liaison Group (NTLG), representatives of the Bar, and the external consultants on the Part IVA Panel. The Practice Statement is intended as practical guidance for AT0 officers.
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It is also a useful guide for practitioners on the AT0 views in certain areas, in particular in relation to administrative questions.
The Practice Statement covers:
. the legislative provisions of Part IVA including settled jurisprudence that provides useful guidance to officers on the application of the provisions;
. making, drafting and executing Part IVA determinations;
. giving effect to determinations in various sihtations (such as where there are multiple schemes or multiple tax benefits, where an amended assessment has already issued);
. when and bow to make compensating adjustments;
. proper escalation of Part WA issues witbin the Tax Office;
l role of the Part IVA Panel; and how officers make submissions to the Part IVA Panel.
Attachment 2 of PS 2000/10 provides a framework which the AT0 uses to make it’s decisions on Pti WA.
btain all the relevant factual material, including
Examine the legal and commercial effect of the factual
Consider all the facts in light of the eight matters in
circumstances graph 177D(b) that led to the party or parties entering to the relevant scheme or schemes.
alternative arguments for Consider the possible application of the general provision the AT0
f the Act.
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Consider whether the taxpayer’s view is consistent with e documents and other factual material available to the
onsider the possible application of Part lVA on the
Some of these questions would be relevant to taxpayers in considering whether their proposed arrangement is likely to be subject to Part
TVA.
Attachment 2 also outlines our decision-making process:
Is there a scheme?
Step One:
Is there an alternative scheme?
Are there more than two schemes?
P What are the steps of the scheme or schemes? b Is there a tax benefit? 1
P IS there an alternative tax benefit?
Step Two:
Are there two or more tax benefits?
P What is the greatest amount that can be included or
Step Three: P Is there an alternative taxpayer?
p Are there two or more taxpayers?
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of the scheme did so for the purpose or the ommant purpose of enabling the relevant taxpayer to btain a tax benefit in connection with the scheme or f enabling the relevant taxpayer and another taxpayer r other taxpayers each to obtain a tax benefit in
ection with the scheme (whether or not that son who entered into or carried out the scheme or art of the scheme is the relevant tax
If yes, a determination must be made and evidenced
Step Five:
writing. The reasons for the determination should e documented separately.
Is it flecesq to make an alternative determination
Is it necessary to make more than two
B Consider how to give effect to the determination.
step Sk
The normal and preferred method of giving effect tc determination is to use an amended assessment. In d cases, s. 169A(3) may be relied on to give to a determination made as part of the decision
Consider whether it is necessary to issue an temative assessment (or assessments) or amended
Step Seven:
Iassessments (or assessments)? E, Are there circumstances that warrant making any ,compensating adjustment or adjustments?
You will also note that PS 2000/10 looks at whether the arrangements involve the following drivers:
l exploiting mismatching of deductions and derivations; l tax benefit transfers; I double dipping on benefits; l interpolation of business vehicle to get around legislation;
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0 recharacterisation of transactions;
l profit or value shifting; l creating a Clayton’s acquisition/disposal etc.
We also focus on:
0 the commercial reality of the arrangements;
l what aspects achieve genuine commercial outcomes; and l what parts achieve only a tax saving?
Cases
A number of significant cases are currently awaiting decision/have just been decided that will clarify the way Part IVA works:
P Consolidated Press Holdings, in the High Court, heard in December 2000. There are two main issues:
(9 Part IVA appeal - relevance of adviser’s purpose; global purpose without considering each factor in s. 177D individually; identification of scheme - is narrow scheme appropriate in the circumstances of the case? This case provides an example of using an interposed vehicle to get around legislation.
(ii) Dividend stripping - what is dividend stripping and does it require a tax avoidance purpose?
B Eastern Nitrogen/Metal Manufacturer, heard in Full Federal Court last year, the cases both involved sale and leasebacks of plant. In both cases the taxpayer argued that they were in need of finance. We could accept that that was their ultimate intention (as in
Spotless, the ultimate intention was
to get a better after tax return) but it was the way things were done which we argued stamped these arrangements as tax schemes.
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hrdan, [2OOO] FCA 1807, confirmed the Commissioner’s position taken in PS 2000/l 0 @am 60) that a determination made at the objection stage can be given effect to by a prior amended assessment imposing the same tax liability (see para 32 of decision: determinations were to be treated as part of the making of tie amended assessment and likewise afforded the protection of s. 177( 1).
Aggressive Tax Planning
Litigation is part of our strategy against Aggressive Tax Planning Schemes because of the potential leverage it offers - courts may set a precedent which helps resolve a large number of other cases: These decisions will also play a part in establishing community norms as to what amounts to acceptable behaviour.
A strong legal team has been in place since mid 1999 to litigate on behalf of the ATO.
Over the last two years, 9 cases have been final&d by the courts on procedural issues. It is perhaps significanr on the question of delay to consider that taxpayers seem readier to throw procedural road blocks in our way rather than meet us in court quickly on the tax liability issue, given our currently 9-O win record.
As at the end of February 2001 we have issued almost 35 000 amended assessments, received and determined almost 3500 objections and there have been 1146 appeals to the MT and 187 appeals to the Federal Court. These appeals relate to 27 schemes in the AAT and over 20 schemes in the Federal Court. Part IVA is one of the arguments against the effkacy of these schemes,
One of our firs major representative scheme test cases resulted in a walkover victory for the AT0 because the 6 representative test cases all withdrew at the last minute.
Our next major representative test case on mass
marketed schemes, Budplan, is
scheduled for hearing in the Federal Court in the first week of June 200 1. A large number of other schemes arc at various stages before the courts or the AAT. We are confident that if any case comes before the court or the AAT our position will prevail. We are confident because these schemes exhibit some or all of the following features:
FOCUS AREA (i) Grossly excessive/inflated fees
FEATURES
* Large, up-front initial lease and/or management fees charged.
* Subsequent year lease and/or management fees significantly less than the initial large up-front fees.
* The tax deduction for initial lease and management fees far exceeds any cash outlays made by the investor.
Are fees with one or more of these features q&cable OR a commercial basis and not associated wirh mechanisms to inflate, OY
und robin arrangements.
Are mechanisms ofthis kind commercially
limited or non-recourse loans.
* Full recourse loans with lengthy repayment periods.
* Loans made on unusual terms, e.g., interest rates above or below market rates, security for loans of little value in comparison to the principal amount, repayment of loan substantially deferred until the end of a lengthy repaymmt period.
* Dual funding arrangements (see
Are thejinance urrangements consistenr with a&s length &alirzgs (see $.utIzer
hr I32 to 133) and not structured ie or artificially create, taz
saving is taken into account. This may be because of one or more of the following:
- the tax savings made by the investor wholly or substantially fund any cash contributions made by tie investor, e.g., the investor’s initial loan repayments and/or
interest payments are funded by tax
- subsequent principal repayments and/or interest payments are to be met only out of income generated by the afForestation scheme, or are
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investors to extricate themsejves without being liable to pay the whole or part of the loan.
- later year fees payable only out of and to the extent of sale proceeds from harvested timber.
Is the luck of business risk associated with arrangements to injlate, or artificially create, tar deductions?
rfforestation activity for management setices in the f$rst 13 months obtained principally from the principal repayments and /or interest payments made by the investor.
* The manager/promoter entities borrow f%om external sources and/or access retained earnings to enable the manager (or other promoter entities) to actually carry
out the necessary services on behalf of the investor, and/or to fund capital expenditure.
l The actual cash funds employed by the manager in the provision of services in the first 13 months represent a small proportion of the large up-fkont fees charged by the manager and claimed as a tax deduction by
Do the arrangements represent a non- commercial and abnormal way of
promoter entities enter into arrangements t0 eliminate or reduce tax liabilities as a complimentary feature to the arrangements.
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arrangements.
* The promoters enter into successive schemes to fUnd earlier schemes.
Are the arrangements based on genuine commercial considerations and noi associated with avangements to inflate, or artificially creak? tax deductions to produce large up-front profits for the promoters?
Taxation Ruling TR 2000/8 outiines how these features would @ve rise to the reasonable expectation that the scheme was entered into for the dominant purpose of avoiding tax. As one would note, the AT0 approach gives to Part IVA a construction that confines its effect to a reasonable application.
The Indicia of Tan Avoidance
I agree with Mr Pagone QC ’ that one bridge between section 260 and the current Part IVA is the predication test enunciated by the Privy Council in Newton v FC of T (1958) 98 CLR 2. What was required to be done under the predication test was to look at the overt acts by which the arrangement was
implicated and to ask the question: Was it implemented in that particular way so as to avoid tax? The emphasis given by the High Court in FCT Y SpotZess 96 ATC 520 1 to criteria (i) and (ii) of s. 177D(b) -
(i) the manner in which the scheme was entered into or carried out; and
(ii) the form and substance of the scheme
support an analysis which takes into consideration the way things were done.
As Mr Pagone QC points out in relation to FC of T v Consulidated Press
Holdings Lrd 9 ATC 4946,
“For present purposes it is sufficient to note that both at first instance and on appeal it was held that the overall, or ultimate, commercial objective of participation in a major takeover battle did not prevent the operation of Part IVA to the legal structure by which the funds were employed by the group.” *
To adopt a construction that allows all manner of contrivance to achieve a tax outcome under a wider umbrella of achieving a commercial end is in the words of the High Court an “acceptance of a false dichotomy.” 3
’ Pagone G T. “And-Avoidance Provisions and Tax Reform”, Taxaim lnstimte of Australia, 24 March 2001 ’ Pagone ibid., p 9 3 Spotless p 5206
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While the shape of transactions may be influenced by revenue considerations, implementation of an arrangement in a particular way may allow a reasonable person to conclude that that arrangement was entered into for the dominant purpose of avoiding tax.
Much turns on the identification, among various purposes, of that which is dominant in relation to the implementation of that transaction/arrangement in that particular way.
This question lies very much at
the heart of Eastern Nitrogen Ltd v FC ofT
99 ATC 5 163 and Metal Manufactures Ltd Y FC of T 99 ATC 5229. In Taxation Ruling TR 95130 the Commissioner expressed the view that Part IVA might not have general application to sale and leaseback arrangements, but that close attention needs to be given where:
(a) an appropriate balancing charge and/or capital gain is not included in the assessable income of the lessee and lessor as applicable;
(b) at the time the sale and leaseback is entered into there is an intention to assign the right to income arising from ownership of
the asset during the period of the lease;
(c) appropriate values are not used (both in relation to the sale of the asset (see paragraphs 10 to 12 above), and for the purpose of setting the residual value for the asset (see Taxation Ruling IT 28));
(d) the overall sale and leaseback arrangement itself was not designed to provide a positive cash result to the lessor before taking into account the tax benefits, subject to the effect of investment an&or development allowance (see Taxation Rulings
IT 2220 and IT 205 1); or
(e) the tax elements of the scheme, having regard to the facts of the case, outweigh the commercial elements.
In
Eastern Nitrogen Drummond J found the following matters relevant to s. 177D (b):
(1) The transaction originated in an approach to the taxpayer by a fmance broker with a proposal for changing the basis upon which the taxpayer obtained its finance requirements. It did not originate in a need to make such a change first perceived by the taxpayer.
(2) The taxpayer’s evidence that its own primary objective in entering into the transaction was to obtain an advantage that was not tax related is not sufficient to establish that.
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(3) Though in form the transaction involved the sale of the taxpayer’s asset and its lease back, it was, in substance, an arrangement under which financiers advanced business funding to the taxpayer.
(4) The transaction, by way of sale and lease back, had a number of elements of artificiality about it: the asset was a fixture not intended to
be severed from the taxpayer’s land despite its sale to the financiers; it was sold at a figure unrelated to its market value, but arrived at entirely by reference to the taxpayer’s financial requirements; the taxpayer entered into the transaction with the intention of retaining control of the asset at the end of the lease because it would continue,
for a time thereafter, to be essential to its manufacturing operations; there was a high degree of certainty that it would reacquire ownership of the asset at the end of the lease because of its nature as a large item of plant fixed to the taxpayer’s soil.
(5) The broker’s proposal offered the taxpayer finance at lower after- tax cost than alternative methods of borrowing and it was that feature that was its chief attraction to the taxpayer, although the proposal had other, secondary advantages for the taxpayer.
(6) The lower after-tax costs of finance offered by the proposal included Nl deductibility of lease rentals, large in amount because the plant the subject of the transaction was sold to the financiers at a figure greatly in excess of its market value. The taxpayer also anticipated an enhancement to the tax benefits in the form of rental deductions by way of the depreciation to which it would be entitled after its intended reacquisition of the plant at the end of the lease period.
(7) Completion of the transaction was timed to ensure that the tax advantages offered by it to the taxpayer already refer& to would not be diluted by the taxpayer having to pay tax on the balancing charge that arose on the sale of the asset.
An objective consideration of these matters lead to the conclusion that Eastern Nipogen’s dominant purpose in entering the particular scheme was to obtain
the tax benefits in the form of deductions for the whole of the lease rental payments.
In Metal Manufmrures Emmett J found that
6) as to manner, -
“there was a degree of carelessness involved in the performance of the Arrangements”. -. . and that those “considerations tend to suggest that the Taxpayer treated the Plant and Equipment as though it was still the unencumbered beneficial owner. The absence of complaint from the Bank suggests that the Bank did not
regard the Plant and
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Equipment as its primary security for ensuring that it would be paid the moneys provided for under the Lease.” 4
His Honour found that the form of finance adopted by the taxpayer was unprecedented so f’ar as the taxpayer was concerned and the tax benefit made the sale and leaseback attractive. ’
(ii) as to form and substance -
“the nature of the Plant and Equipment was unsuitable for the Arrangements and that the “Arrangements were therefore somewhat artificial” 6
His Honour said:
“Further, as I have indicated above, the form of the Lease was hardly apt for the Arrangements. The &mess of the language of the Lease empbasises the artificiality of the Arrangements.
The artificiality, and the apparent disinterest of the Bank in the value of the Plant and Equipment to the Bank in the event of default, tend to suggest that the form of the Arrangements may have been regarded as more important than the substance of the rights and obligations that the parties recognized.” ’
(iii) as to time -
His Honour found that, “The idea of a sale of plant to a financier and its lease back originated in the approach from Macquarie Bank in March 1987. That approach related to ways in which the taxpayer “might improve its taxation position”.” ’
Nor was there any urgency in the steps taken by the Taxpayer to enter into the Arrangements. 9
(iv) as to result -
‘There is a sign&ant difference between the operating profit after tax under the proposal and the operating profit after tax under conventional borrowing” ‘O
’ pS279. Note that a rationale suggested by Mr Pagone QC at p 10 hat the form of a Sale and Leaseback might be necessary to adequately secure an financier’s interen does not apply here. ‘P5281 ’ p 5280 ’ p 5280
B p 5280 9 p 5280 lo p 5280
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(VI as to change in financial position -
the improvement could have been achieved equally well by a conventional loan, without the disadvantage of disposing of ownership. ‘I
(vi) as to consequences for the taxpayer -
the Taxpayer gave to the Bank a proprietor-y interest in the Plant and Equipment ‘2 even the “gh the plant was absolutely fundamental to the taxpayer’s operations 3 , and that there was no legal entitlement on the Taxpayer to reacquire the plant I4 ,albeit tbat there was a firm expectation that the Taxpayer would reacquire the Plant IS
It is also worth noting that in Metal Manufactures the residual
value was fixed
without reference to the expected value of the Plant and Equipment at the expiration of the term. I6 His Honour found that the residual value was ‘tiealistic”. ” Also the relevant Plant and Equipment did have a low original cost such that the balance over the cost price to the Taxpayer wouId not be the
subject of any balancing charge. I8 Moreover, the going concern valuation reflected the Bank’s indifference at the time of entering into the Arrangement to a.scertain the value of the Plant and Equipment as security. I9
His Honour concluded that the sale and lease back form of financing, as distinct from any other form of financing, was chosen because of the tax benefit that would ensue. ” Nevertheless, His Honour concluded that Part TVA did not aPPlYa
The Full Federal Court should clarify for us whether that amounts to a false dichotomy, and whether the obtaining of a tax benefit was the dominant purpose for implementing that transaction in that particular way.
Part WA and Tax Reform
The Review of Business Taxation recommended a number of integrity measures be adopted, including:
. improvement of reasonable hypothesis test;
“p5281 I2 p 5281 I3 p 5267 IA pp 5275,5279 ” p 5270 but cf the evidence of Mr Dudley as per Emmett J at p 5270 I6 p 5277
” p 5278 ” p 5277 I9 p 5277
20D 5281
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. improvement of tax benefit;
. single determination;
. consistent penalties;
l dividend streaming and Wing credit trading rules;
l s. 177EA (franking credit trading) be repealed; and
l repeal of s. 177’E (dividend stripping) be considered.
The Government, in its Stage 2 response (Press Release No. 074), agreed to provide:
. an improved ‘reasonable hypothesis’ test;
l an expanded concept of ‘tax benefit’;
l powers to allow the Commissioner to issue a single determination in respect of a scheme; and
. a consistent penalty structure.
The changes were expressed to apply to schemes entered into or carried out after lpm, Australian eastern summer time, 11 November 1999.
Significant legislative pressures associated with tax reform have meant that these proposed amendments have not yet been introduced.
The Government has appreciated that the start date, without legislarion, leaves taxpayers and advisers in a difficult position. Accordingly, the Government has announced (Treasurer Press Release No 16 of 22 March 2001) that any amendments to Part IVA will take effect
from the date of introduction into
Parliament of the relevant legislation (rather than 11 November 1999 as originally intended).
Conclusion
There are now extensive reference point.5 in drawing the line between normal family and commercial dealings and tax avoidance schemes. The High Court will soon provide further guidance.
But in the meantime, beware if your arrangement includes the features outlined in TR 2000/8 and PS 2000110. Where in doubt ask the Tax Of&e.
