Part IVA: Shifting the
goal posts – will you
have to take the highest
taxed alternative?
September 2012
Contact
Bill Thompson +61 7 3119 6221
[email protected]
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Part IVA: shifting the goal posts –
will you have to take the highest
taxed alternative?
1.
Introduction
3
2.
Development of jurisprudence on Part IVA
4
3.
Changes to the 'Reasonable Expectation Test'
6
4.
Framing and proving the alternative postulate
9
5.
Exclusion of Assessable Income - The 'Do Nothing' Alternative
Postulate
11
6.
Allowable Deduction – Alternative Postulate
12
7.
The Commissioner's Grievances with the Alternative Postulate
13
8.
Policy
16
9.
Basis of amendment to 'reasonable expectation test'
18
10.
Is an amendment necessary to focus on specific steps in the
identified scheme?
23
11.
What will the amendments in relation to steps in a scheme be? 24
12.
Likely effect of proposed changes
25
13.
Are the proposed amendments anti-tax avoidance laws? Are they
constitutional?
27
14.
Retrospective Operation
APPENDIX A
28
29
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1.
Introduction
This paper addresses the approach of the courts in 2012 to determining if a Part IVA
scheme gives rise to a tax benefit in connection with the Part IVA scheme, with
particular reference to the so-called 'do nothing' alternative postulate. The law in this
regard will retrospectively change as from 1 March 2012, in the light of the
government announcement of that date.
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2.
Development of jurisprudence on Part IVA
There has been, in the last three years, a veritable avalanche of cases in which the
Commissioner has sought to apply the general anti-avoidance provision in Part IVA of
the Income Tax Assessment Act 1936 ('ITAA 1936').
On the one hand, this is not surprising as the developing jurisprudence on Part IVA has
in many ways been favourable to the Commissioner. The explanation of the
application of Part IVA given by the courts has led to a number of principles which lead
logically to its increasing use:
•
Part IVA is to be interpreted according to its terms, and just as any other provision
of the tax law. As was said in the joint reasons in Federal Commissioner of Taxation
v Spotless Services Ltd 1 ('Spotless'):
'Part IVA is to be construed and applied according to its terms, not under the
influence of "muffled echoes of old arguments" concerning other legislation.
...
Part IVA is as much a part of the statute under which liability to income tax is
assessed as any other provision thereof.' 2
•
by its terms it may apply to any wider arrangement or single step which produces a
'tax benefit' as defined, even ordinary commercial transactions 3; and
•
by its terms Part IVA is a provision of last resort (applied by its terms only if the tax
benefit is otherwise available).
It is not perhaps remarkable, therefore, that the ATO seeks to argue that Part IVA
applies to commercial transactions which but for Part IVA would not produce tax
despite an economic benefit being obtained from a favourable tax structure.
However, the cases also illustrate that the application of Part IVA is dependent upon
the facts of each case.
Recent cases demonstrate that:
•
The ATO is applying Part IVA to a range of high value transactions by significant
listed companies;
•
Part IVA is being tested, and applied by the courts, in what might have been
thought to be normal commercial dealings. This shows that arrangements may be
within the operation of Part IVA, and not be in the nature of 'artificial or contrived'
arrangements in ordinary understanding or 'paper' tax schemes or marketed
arrangements;
•
The fact that other provisions of the Act may give rise to a tax benefit despite
specific anti-avoidance rules, or perhaps because of them, eg CGT rollovers, CGT
market value substitution rule and share value shifting, does not prevent Part IVA
from applying;
•
Part IVA is not all about dominant purpose. It is vital to understand and analyse
the elements of Part IVA addressing the asserted scheme and the tax benefit and
the concept of the alternative postulate, as much as purpose;
1
(1996) 186 CLR 404, 414 (Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ) .
Ibid.
Hart v Commissioner of Taxation (2002) 121 FCR 206, 85 (Hely J); See also Commissioner of
Taxation v Hart (2004) 217 CLR 216 ('Hart').
2
3
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•
The question of dominant purpose must be decided by reference to the asserted
scheme and the alternative postulate. This was discussed in Hart, where Gummow
and Hayne JJ, in their joint judgment, notably said:
'In the present matters, the respondents would obtain a tax benefit if, in the
terms of s177C(1)(b), had the scheme not been entered into or carried out,
the deductions ‘‘might reasonably be expected not to have been allowable’’.
When that is read with s 177D(b) it becomes apparent that the inquiry directed
by Pt IVA requires comparison between the scheme in question and an
alternative postulate. To draw a conclusion about purpose from the eight
matters identified in s 177D(b) will require consideration of what
other possibilities existed.' 4 (emphasis added); and
•
There can be a decade or more between a client entering an arrangement and final
resolution of any adverse assessment. The resulting uncertainty needs to be
factored in when weighing up the commercial risk, arising from the tax risk, when
entering the arrangement.
Some conclusions to be drawn from these cases are that:
•
it is necessary to recognise that Part IVA is a fact-based test; and
•
it is not possible to substitute general rules of thumb as to the meaning of Part IVA
or its application in the facts of a particular case, for a precise application of the
words of Part IVA to the facts of the case.
Until now, for example, it was not correct to summarise Part IVA as requiring a
taxpayer to choose the alternative from among a range of possible courses of action
which results in the payment of the most tax. Part IVA may not apply to an
arrangement, whether a step, an action or a course of action, if in relation to an
identified Part IVA scheme there is no 'tax benefit' as defined (by reference to a
reasonably available alternative postulate); and in respect of that tax benefit, having
regard only to the eight prescribed factors, it would be concluded, that the objectively
attributed purpose of any person in carrying out that scheme was to obtain that tax
benefit for a taxpayer.
In relation to the 'reasonable expectation' test in the definition of tax benefit, the
Commissioner has not always been successful in court, and, as we shall see, it would
now seem apparent that this has been a major driver for the Commissioner to
undertake high value litigation on Part IVA in recent times.
4
Hart (2004) 217 CLR 216, 243 (Gummow and Hayne JJ).
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3.
Changes to the 'Reasonable Expectation
Test'
In 1999 the Review of Business Taxation ('the Ralph Review') recommended that
Part IVA be amended in several respects, including that:
'the reasonable hypothesis test...be improved by ensuring that the
counterfactual (that is saying what has not happened) to a tax avoidance
scheme reflects the commercial substance of the arrangement.' 5
The reference to 'the reasonable hypothesis (or expectation) test' is a reference to the
requirement in the definition of 'tax benefit' in section 177C of the ITAA 1936, to
determine the existence of a tax benefit by reference to what would have happened, or
might reasonably be expected to have happened, if the identified scheme had not been
entered into or carried out. In other words, what happened under the identified
scheme must be compared with what would or reasonably might be expected to have
happened absent the scheme. The use of the words 'would' and 'reasonably' points to
the comparison being an objective one.
Section 177C(1)(a) states:
'... a reference in this Part to the obtaining by a taxpayer of a tax benefit in
connection with a scheme shall be read as a reference to:
(a)
an amount not being included in the assessable income of the
taxpayer of a year of income where that amount would have been
included or might reasonably be expected to have been
included in the assessable income of the taxpayer of that year of
income if the scheme had not been entered into or carried out;
or
(b)
a deduction being allowable to the taxpayer in relation to a year of
income where the whole or a part of that deduction would not
have been allowable or might reasonably be expected not to
have been allowable to the taxpayer in relation to that year of
income if the scheme had not been entered into or carried out;or
...' (emphasis added)
The High Court, in Commissioner of Taxation v Peabody 6 ('Peabody') explained the
reasonable expectation test' in the definition of tax benefit, in this way:
'A reasonable expectation requires more than a possibility. It involves a
prediction as to events which would have taken place if the relevant scheme
had not been entered into or carried out and the prediction must be sufficiently
reliable for it to be regarded as reasonable'. 7
The events which might reasonably be predicted to have occurred if the scheme had
not been entered into or carried out have come to be referred to as the alternative
postulate, or alternative hypothesis (or to the concern of Justice Gummow, the
counterfactual).
5
6
7
Review of Business taxation, A Tax System Redesigned, July 1999, p 246.
(1994) 181 CLR 359.
Ibid 385 (Mason CJ, referring to Dunn v Shapowloff [1978] 2 NSWLR 235, 249 (Mahoney JA)).
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In a publication released 3 December 2000, the ATO stated that:
'... the tax benefit could be identified by comparing the result obtained by the
actual scheme with the tax consequences obtained under the most likely
transaction which could have been undertaken to achieve the same economic
result regardless of tax effects.' 8
While initially the then government accepted the recommendations, ultimately on
22 March 2001 the then Treasurer issued a press release that said:
'... the Government is continuing to develop measures that will streamline the
existing anti-avoidance provisions along the lines identified by the Ralph
Report. Any amendments to the existing Part IVA provisions announced by
the Government will now have effect from the time of introduction into the
Parliament of the relevant legislation ...' 9
A review of Part IVA had effectively been on the backburner, though perhaps never off
any Government's agenda since 2001.
In November 2010, the government released a discussion paper 10 which, among other
things, identified three options that the government would consider, in order to
'maintain an appropriate definition of tax benefit' 11. The three options were:
•
retaining and expanding the existing list-based approach;
•
replacing the list with a comprehensive definition designed to capture all forms of
income tax avoidance; or
•
combining a comprehensive statement of principle with a list of the most common
tax benefits. 12
The government did not seek to clarify the 'reasonable (expectation) hypothesis' test
in its 2010 discussion paper, instead deferring to the High Court's decision in Hart on
this issue.
On 1 March 2012 former Assistant Treasurer, Mark Arbib, announced that the
Government would be enacting amendments to Part IVA with retrospective effect to
that date. The press release identified the Government's reasons for acting now to
amend Part IVA, and gave some hint as to the content of the proposed amendments in
the following passages:
'In recent cases some taxpayers have argued successfully that they did not get
a "tax benefit" because without the scheme they would not have entered into
an arrangement that attracted tax ... For example, they could have entered
into another scheme that also avoided tax,
deferred their arrangements indefinitely or done nothing at all. Such an
outcome potentially undermines the overall effectiveness of Part IVA and so
the Government will act to ensure such arguments will no longer be successful.
The Government amendments will confirm that Part IVA always intended to
apply to commercial arrangements which have been implemented in a
8
Document no longer available on the Australian Taxation Office website.
Hon. Peter Costello, 'Business Tax Reform – Implementation Timetable', (Press Release,
22 March 2001).
10
Australian Government, 'Improving the operation of the anti-avoidance provisions in the
income tax law', (Discussion Paper, 18 November 2010).
11
Ibid 5.
12
Ibid.
9
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particular way to avoid tax. This also includes steps within broader
commercial arrangements.' 13
Analysing that statement, the Government says it has been driven to act to amend
Part IVA by its concern over losses by the Commissioner of Taxation ('Commissioner')
in a number of recent significant cases because:
1. In some cases taxpayers have argued successfully that they did not get a tax
benefit because, absent the scheme, they would not have entered into an
arrangement that attracted tax. The examples of situations where this has
occurred cited in the press release were cases where the taxpayer 'could have'
entered into another scheme that:

also avoided tax, perhaps Commissioner of Taxation v Trail Bros Steel &
Plastics Pty Ltd 14 ('Trail Bros'); or

deferred their arrangements indefinitely, perhaps Commissioner of Taxation v
AXA Asia Pacific Holdings Ltd 15 ('AXA'); or

done nothing at all, likely, RCI Pty Ltd v Commissioner of Taxation ('RCI') 16
and Commissioner of Taxation v Futuris 17 ('Futuris') (not a 'do-nothing'
alternative but the alternative absent the scheme was not reasonable for
similar reasons to RCI).
2. In some cases, the taxpayer was held not to have obtained a 'tax benefit' even
though particular steps in a broader commercial arrangement may have been
taken 'to avoid tax'.
13
Mark Arbib, 'Maintaining the Effectiveness of the General Anti-Avoidance Rule', (Press Release,
1 March 2012).
14
(2010) 272 ALR 40.
15
(2010) 189 FCR 204.
16
[2011] FCAFC 104 (Edmonds, Gilmour and Logan JJ).
17
[2012] FCAFC 32 (Kenny, Stone and Logan JJ).
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4.
Framing and proving the alternative
postulate
As identified by the High Court in Peabody, the reasonably expected alternative if the
scheme had not been entered into or carried out must be more than a possibility – it
must be a prediction established with enough certainty for it to be reasonable to
consider that it would have occurred if the scheme had not been entered into or
carried out.
Peabody also established that the question of whether or not there is a tax benefit
does not turn on the Commissioner's opinion whether or not there is a tax benefit.
Also, the question whether or not a tax benefit 'in connection with' the identified
scheme is not a matter for the Commissioner's opinion. Rather, those are matters to
be determined as objective facts. 18
The tax benefit need only arise 'in connection with' the identified scheme. It need not
arise within the identified scheme 19.
The requirement of the words of section 177C is to examine what the taxpayer 'would'
or 'might reasonably' have done. The enquiry is not what the taxpayer 'could' have
done 20.
The taxpayer bears the onus of establishing that it did not obtain a tax benefit in
connection with a scheme or a tax benefit less than that determined by the
Commissioner 21.
This is a positive burden of proof. It is not enough for the taxpayer to disprove any
alternative postulate put up by the Commissioner. It must persuade the court by
evidence that it had an alternative postulate which it would have been able to
implement and which would have resulted in the same taxable position as if the
scheme had remained in place or which would have resulted in some other taxable
position. 22
How the taxpayer discharges this burden is a matter for the taxpayer. As the Full
Federal Court stated in RCI.
'It may, for example, lead evidence that the taxpayer would have undertaken
a particular activity, or adopted a particular course, in lieu of the scheme; or it
may lead evidence that the taxpayer would not have undertaken a particular
activity, or adopted a particular course, in lieu of the scheme; see, for example
Commissioner of Taxation v News Australia Holdings Pty Ltd [2010] FCAFC 78.
Generally, such evidence is unlikely to be sufficient to discharge the onus
unless it is supported by objective indicia to be gleaned from the context and
matrix of underlying or "foundation" facts, as they have been called (see
McCutcheon F FCT (2008) 168 FCR 149 at [37]-[39] per Greenwood J) as well
as the logic of the taxpayer's counterfactual having regard to the commercial
or financial aspirations and limitations of the parties to the scheme; without
such support, such evidence is likely to be regarded as no more than purely
speculative.
18
Peabody (1994) 181 CLR 359, 382.
Futuris [2012] FCAFC 32, 34 (Kenny, Stone and Logan JJ).
20
See Commissioner of Taxation v Lenzo (2008) 247 ALR 242, 266-267 (Sackville J) ('Lenzo').
21
Trail Bros (2010) 272 ALR 40, 49.
22
Futuris v Commissioner of Taxation (2009) 75 ATR 365 and approved on appeal in Futuris.
19
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On the other hand, in a given case, such evidence may not be necessary
because, for example, the result of any objective enquiry as to the
counterfactual is, at best, inevitable, or, at worst, compelling. In such a case,
the failure to lead evidence to say that the taxpayer would have undertaken a
particular activity or adopted a particular course, in lieu of the scheme' or the
failure to lead evidence that the taxpayer would not have undertaken a
particular activity, or would not have adopted a particular course, in lieu of the
scheme, will not lead to the taxpayer failing to discharge the onus.
Yet again, a taxpayer may not lead any direct evidence, but establish that
there is no tax benefit through expert evidence: see Futuris Corporation Ltd v
Cmr of Taxation 2010 ATC 20-206. And as Peabody itself establishes, the
absence of any tax benefit obtained in connection with the scheme might be
established by demonstrating the illogicality of the taxation consequences
upon which the Commissioner's counterfactual is predicated, in that case the
lack of any rebate of tax on dividends on the Kleinschmidt shares held by TEP
Holdings as trustee.' 23
23
RCI [2011] FCAFC 104, 133-136 (Edmonds, Gilmour and Logan JJ).
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5.
Exclusion of Assessable Income - The 'Do
Nothing' Alternative Postulate
In order to understand the first of the Government's expressed concerns in its March
2012 press release, it is necessary to consider the definition of 'tax benefit' in
section 177C.
Taking the words of the definition of the 'exclusion of assessable income' tax benefit in
section 177C(1)(a) on their face, requires the conclusion that the taxpayer did not
obtain a tax benefit if the amount would not have been included or might reasonably
be expected not to have been included in the taxpayer's assessable income if the
scheme had not been entered into or carried out.
It will be seen that, framed in this way, there may be facts situations where if the
taxpayer did not enter the impugned scheme, the reasonable alternative postulate is
that it would have done nothing, and no amount would have been included in its
assessable income.
This has come to be referred to as the 'do nothing' alternative postulate. If the
identified reasonable alternative postulate is that you would have done nothing in the
absence of the scheme, then any other suggested alternative postulate to the scheme
must not have been reasonably possible, for example, because:
a.
the identified alternative to the scheme would not have achieved a
reasonable commercial result – because the identified alternative
commercial result was not feasible – cases in which this occurred included
Peabody and AXA. (In Futuris, this was the case in relation to the
alternative postulate which arose on the Commissioner's description of the
scheme; another alternative in Futuris was the reasonable alternative but
it did not give rise to a tax benefit in connection with either of the
identified schemes); or
b. the amount of tax payable if the identified alternative to the scheme was
entered into or carried out was so high that the taxpayer would not have
entered into or carried out that alternative. Cases in which this has been
seen to occur are RCI and Futuris. In truth, this second example is a
specific case or subset of the first example in 1. above.
Cases where a 'do-nothing' alternative postulate has not been or could not have been
advanced successfully by the taxpayer include Spotless and Macquarie Bank Ltd v
Commissioner of Taxation 24 (the 'Macquarie Bank/Mongoose' case).
Importantly, each of these cases demonstrate that in order for the 'do nothing'
alternative postulate to be available, the evidence must support that, instead of the
impugned scheme, the alternative scenario is what the taxpayer would (not could)
have done. 25
24
25
[2011] FCA 1076.
See Lenzo (2008) 247 ALR 242, 266-267 (Sackville J).
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6.
Allowable Deduction – Alternative Postulate
Because the words of section 177C(1)(b) are different from those in
section 177C(1)(a), the identification of the alternative hypothesis in relation to the
'allowable deduction' tax benefit raises different issues from those under
section 177C(1)(a) in relation to the 'assessable income' tax benefit. There cannot be
an 'allowable deduction' tax benefit if 'that deduction' under the impugned scheme
would have been allowable (or might reasonably be expected to have been
allowable) if the impugned scheme had not been entered into or carried out.
If the expression 'that deduction' in the definition means the very same deduction as
under the impugned scheme, then it is impossible that the same deduction as under
the impugned scheme would be allowable, or might reasonably be expected to be
allowable, if the impugned scheme was not entered into or carried out.
There is an apparent difference of opinion between the Full Federal Court in Lenzo and
a differently constituted Full Federal Court in Trail Bros, in relation to the following
issues:
•
What does 'that deduction' in the definition of the 'allowable deduction' tax benefit
mean? If it means the same deduction as under the impugned scheme, then the
definition is robbed of all meaning; but if the interpretation is not limited in that
way, does 'that deduction' mean a deduction of the same type, or something else?
Contrary to the decision in Lenzo, the Full Federal Court in the later decision in
Trail Bros, held that the alternative postulate need not give rise to the same kind
of deduction as that obtained by the impugned scheme. The reference to 'that
deduction' is a reference to the amount of the deduction not to the same type or
category of deduction. 26
•
What does the expression 'if the scheme had not been entered into or carried out'
require in relation to the framing of the alternative postulate under
section 177C(b)? Must the alternative scenario be one which has no common
features with the impugned scheme?
The Full Federal Court in Trail Bros, while agreeing with the Full Federal Court in
Lenzo that section 177C requires that the alternative postulate must be premised
on the assumption that the scheme had not been entered into or carried out,
explained that that does not preclude an activity or event which includes some of
the 'integers' of the impugned scheme from being the alternative postulate or
comprising some of the integers of the alternative postulate. 27
26
27
Trail Bros (2010) 272 ALR 40, 56 (Edmonds J).
Ibid 48 (Dowsett and Gordon JJ).
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7.
The Commissioner's Grievances with the
Alternative Postulate
Appendix A sets out case notes of recent cases in which the courts have considered
the application of the 'reasonable expectation test', including Lenzo, Trail Bros, AXA
and RCI, the facts of which cause a focus on the 'do nothing' alternative, and on the
accepted principle that the test requires identification of the reasonable alternative
hypothesis.
In RCI the Full Federal Court unanimously decided that the capital gain on the sale of
the shares in the relevant US subsidiary company was so large (some US$318M) that
the amount of the capital gain would not have been included or might reasonably be
expected not to have been included in the assessable income of the taxpayer if the
scheme had not been entered into or carried out, as the reasonable conclusion as to
what the taxpayer would have done if the scheme had not been entered into or carried
out is that the share sale giving rise to the gain would not have occurred.
'... It is to be observed that the Commissioner did not put his case on the
higher level that, in lieu of the scheme, RCI would have nevertheless
transferred its shares in JHH(O) to RCI Malta, but only on the lower level that,
such a course was one which, in lieu of the scheme, might reasonably be
expected to have occurred.
... [in other words, which 'could' have not 'would' have occurred]
... the cost of implementing the proposal is obviously a relevant consideration
as to whether it would be implemented in accordance with its terms. That a
step in the proposal would increase the transaction costs from $35 million to
$207 million, or from 2.5% of market capitalisation to 15% of market
capitalisation, equivalent to what was going to be, but never was, floated on
the New York Stock Exchange, compels the conclusion that if the transaction
impugned as the narrower scheme or, it and the other steps which together
are impugned as the wider scheme, were not entered into or carried out, the
reasonable expectation is that the proposal, insofar as it involved the transfer
by RCI of its shares in JHH(O) to RCI Malta would not have occurred; indeed,
in our view, there is no possibility, let alone an expectation, that it would have
occurred.
...
For the foregoing reasons, in our view, if the scheme in either of its
manifestations had not been entered into or carried out, the reasonable
expectation is that the relevant parties would have either abandoned the
proposal, indefinitely deferred it, altered it so that it did not involve the
transfer by RCI of its shares in JHH(O) to RCI Malta or pursued one or more of
the other alternatives referred to in the Information Memorandum; but they
would not have proceeded to have RCI transfer its shares in JHH(O) to RCI
Malta at a tax cost of $172 million. On this view, RCI did not obtain the tax
benefit it was alleged by the Commissioner to have obtained in connection with
the scheme.' 28
In AXA, the Full Federal Court unanimously (on the Part IVA issue) decided that a
capital gain on the sale by AXA of its shares in AXA Health would not have been
included or might reasonably be expected not to have been included in the assessable
28
RCI [2011] FCAFC 104, 137-150 (Edmonds, Gilmour and Logan JJ).
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income of AXA if the presumptive scheme had not been entered into or carried out, as
there was no other alternative postulate, which was reasonably possible, under which
the capital gain might have been included in AXA's assessable income if the scheme
had not been entered into or carried out. The fundamental reason for this which the
Full Federal Court accepted was that Macquarie Bank, one of the architects of the
presumptive scheme, would not have been part of a direct acquisition of the shares in
AXA Health, not least because it would not derive the significant anticipated fee
income from that direct acquisition which it derived from the transaction as
undertaken.
In Futuris, the taxpayer disposed of its Building Products Division by a public float of a
wholly owned subsidiary. Prior to the float, Futuris undertook a number of internal
restructuring steps with the result that the assets of the Building Products Division
were owned by the subsidiary to be floated. Broadly, these steps included the transfer
of assets within the Group to a second subsidiary, the declaration of a dividend out of
accounting profits arising from those asset transfers, and the satisfaction of the
dividend by the issue of shares, and the internal transfer of shares in the second
subsidiary at an undervalue to the subsidiary to be floated. None of the internal
restructuring steps gave rise to tax by use of CGT rollovers. The issue of additional
shares and transfer of shares at an undervalue as part of these steps, increased the
cost base of Futuris in the subsidiary to be floated, including by operation of the share
value shifting provisions. The effect was that the sale of the shares in the float gave
rise to a significantly lower capital gain due to the higher cost base for the shares
arising after the completion of those steps. The Commissioner identified one scheme
as the internal sale of assets and the declaration of a dividend from the profit on that
sale, satisfied by the issue of additional shares; and a second scheme being those
steps and the internal transfer of shares to the float subsidiary at an undervalue which
attracted an increase in cost base. The Commissioner did not identify an alternative
postulate but, on the basis that either identified scheme was not carried out, one
alternative postulate would be a sale of the float subsidiary without the scheme steps.
The Full Federal Court upheld the trial judge's decision that there was no tax benefit in
connection with either scheme identified by the Commissioner as an alternative
postulate comprising the transaction as undertaken, but absent the steps under either
scheme identified by the Commissioner, was not reasonable. The Full Federal Court
accepted the trial judge's view that:
'I do not think it can be concluded that the applicant would have sold its
Building Products Division, worth $250M, in a manner which would have given
rise to capital gains totalling $235M. It is highly likely that if this was the only
option the applicant would not have disposed of its Building Products
Division.' 29
The Full Federal Court accepted the trial judge's decision that the reasonable
alternative postulate would have been a float of another subsidiary in the Group
following certain other restructuring steps. That identified reasonable alternative
postulate would not have given rise to a tax benefit 'in connection with' either of the
Commissioner's identified schemes.
With respect, these outcomes make logical sense based on the words of the definition
of the 'assessable income' tax benefit in section 177C(1)(a).
29
Futuris [2012] FCAFC 32, 42 (Kenny, Stone and Logan JJ, citing Besanko J in Futuris
Corporation Limited v Commissioner of Taxation [2010] FCA 935).
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From the Commissioner's view point in 2012, those outcomes which the courts must
be taken to consider were intended in 1981 are counter-intuitive. The Government
considers it to be 'perverse' 30 that it is arguable that because significant (or
extraordinary) amounts of tax were not payable in respect of a scheme, that that may
be evidence of an alternative hypothesis which establishes that there was in fact no
'tax benefit'.
30
Commissioner of Taxation v RCI Pty Ltd [2012] HCATrans 29 (10 February 2012).
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8.
Policy
The policy behind Part IVA may be deduced from the words of section 177C.
The Full Federal Court in Futuris said that:
'... the issue is "whether a tax benefit has been obtained which would not have
been obtained without the scheme"' 31
The policy evident in requiring a tax benefit to exist before Part IVA applies, is that if
you were not subject to tax on an amount by reason of the identified scheme, and you
would not have been subject to tax on that amount if you had done the proven, only
reasonable alternative which you would have undertaken if you had not entered the
scheme, then you do not obtain a tax benefit. In that situation, the scheme has not
altered your tax position. Part IVA does not apply.
That reflects a policy that if no tax would have been payable under the only reasonable
alternative on the amount which was not taxed by reason that the scheme was carried
out, then there was no social wrong which needed to be redressed by bringing the
amount to tax under Part IVA.
The actual words of section 177C lead to the conclusion that there can be no tax
benefit in connection with the identified scheme in the following situations (subject to
the evidence establishing the case). Recently, cases have been determined which
were examples of these situations.
1. If you had not entered the scheme, there would have been no assessable income
of the amount in question anyway under the alternative which you would have
undertaken, eg RCI and AXA, there would have been no share sale triggering a
capital gain;
2.
If 'that' deduction would have been obtained, under the alternative you would
have undertaken, eg Trail Bros - if 'that' deduction refers only to the amount of
the deduction obtained. [There may still have been a tax benefit to the extent the
welfare fund contribution exceeded the superannuation contribution limit].
The exact changes which the Government would make to Part IVA are not yet known.
It appears from the submissions made by Senior Counsel for the Commissioner in the
special leave applications in the AXA 32 and RCI 33 cases, the Government March press
release 34, and early consultation, that the reason the Government has sought to
challenge this policy is that, in 2012, it considers that if an economic gain has been
made by what the taxpayer did, regardless that that economic gain would not have
been taxed if the taxpayer had undertaken the proven only alternative to what it did,
the economic gain should be taxed if the taxpayer's dominant purpose in doing the
exact thing that produced the economic gain was to obtain the economic gain. This is
so even if the tax cancels the economic gain, as the tax ensures the correct allocation
of resources in society.
The Commissioner's view is exemplified by his position in the Full Federal Court appeal
in Futuris. The Full Federal Court noted:
31
Futuris [2012] FCAFC 32 (Kenny, Stone and Logan JJ at paragraph 62, citing GT Pagone, Tax
Avoidance in Australia, The Federation Press, 2010 at 52).
32
Commissioner of Taxation of the Commonwealth of Australia v AXA Asia Pacific Holdings Ltd
[2011] HCATrans 63 (11 March 2011).
33
Commissioner of Taxation v RCI Pty Ltd [2012] HCATrans 29 (10 February 2012).
34
Mark Arbib, above n 6.
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'Futuris does not suggest that the Presumed Counterfactual would be legally
impossible nor does it suggest that it would be commercially impossible.
Rather, the submission is that it would not be commercially feasible and that
the evidence ... is sufficient to establish this. ... The Commissioner does not
dispute that the Presumed Counterfactual would be attended by commercial
disadvantages. That of course would be an inevitable result of Futuris'
increased liability to capital gains tax'. 35
In the writer's submission, the interpretation of Part IVA for which the Commissioner
has argued, and which the government's announcement of amendments to Part IVA
heralds, represent a fundamental shift in policy. This shift, however, is not obvious
because of the claim that Part IVA is either defective or is being wrongly applied.
The Government has sought to challenge the statutory policy evident in the language
of section 177C by:
1. challenging the judicial interpretation of section 177C to date. What is in fact
being done in the writer's view, is an attempt to stretch Part IVA to apply to
situations to which it was not meant to apply. This has failed.
2.
seeking to create a policy rationale, retrospectively, in the public debate;
3.
amending Part IVA retrospectively to 1 March, 2012. The amendment will be to
neuter 'tax benefit' as an element so that the focus is on the scheme and the
question of the taxpayer's dominant purpose in entering the scheme.
35
Futuris [2012] FCAFC 32, 59-60 (Kenny, Stone and Logan JJ).
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9.
Basis of amendment to 'reasonable
expectation test'
The starting point in the analysis of the 'reasonable expectation' test is the explanation
by the High Court in Peabody quoted above. 36
In Spotless, the High Court dealt with a submission from the taxpayers that if the
scheme for investment of moneys in the Cook Islands had not been entered into or
carried out, an amount of income from the use of the money would not have been or
would not reasonably be expected to have been included in the assessable income of
the taxpayers for the year of income.
'... They submit that there is no possible way of knowing whether the amount
actually derived from the investment, or any other particular amount, would
have been included in the assessable income of the taxpayers had they chosen
not to make the investment that they did. It is said, that, if the taxpayers had
not entered into the scheme, there would have been no interest and no
amount would have been included in assessable income with the result that
the definition of "tax benefit" set out above makes no sense in the context of
the present case.
The submission turns upon the use in para(a) of s177C(1) of the expression
"an amount not being included". This applies where, but for the scheme, "that
amount" would have been included in the assessable income or might
reasonably have been expected to be so included. The submission is that the
reference in this case is to the amount of interest actually received from EPBCL
after the imposition of withholding tax. It is said that without the scheme
there would have been no investment in EPBCL, that amount would not have
existed, and para(a) of s177C(1) would have had no subject-matter upon
which to operate.
In our view, the amount to which para(a) refers as not being included in the
assessable income of the taxpayer is identified more generally than the
taxpayers would have it. The paragraph speaks of the amount produced from
a particular source or activity. In the present case, this was the investment of
$40 million and its employment to generate a return to the taxpayers. It is
sufficient that at least the amount in question might reasonably have
been included in the assessable income had the scheme not been
entered into or carried out (emphasis added).
...
The taxpayers were determined to place the $40 million in short-term
investment for the balance of the then current financial year. The
reasonable expectation is that, in the absence of any other acceptable
alternative proposal for "off-shore" investment at interest, the
taxpayers would have invested the funds, for the balance of the
financial year, in Australia. The amount derived from that investment
then would have been included in the assessable income of the
taxpayers.' (emphasis added). 37
36
Peabody (1994) 181 CLR 359, 385. See footnote 6.
Spotless (1996) 186 CLR 404, 423 (Brennan CJ, Dawson, Toohey, Gaudron, Gummow and
Kirby JJ).
37
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Various panels of judges of the Full Federal Court in Lenzo, Trail Bros and AXA have
followed the explanation given by the High Court in Peabody as to the reasonable
expectation test. It appears from the submissions made by Senior Counsel for the
Commissioner in the special leave application by the taxpayer after Lenzo in 2008, that
the Commissioner at that time had no difficulty with that understanding of the
reasonable expectation test.
The Commissioner's Senior Counsel submitted to the High Court:
'The words of the legislation require that an analysis of the facts be undertaken
to determine what would have happened or might reasonably be expected to
have happened if the scheme had not been entered into or carried out. The
Full Court stated that that reference to "scheme" in the section means the
whole of the scheme. In our submission that is an unexceptional conclusion
and right on the legislation. So the enquiry in the present case was to
identify the scheme ... and to determine what would or might
reasonably be expected to have happened if those things had not been
undertaken or entered into. It becomes then a matter to be
determined on the evidence. The taxpayer's evidence before the Court was
that if he had not entered into the scheme he would have invested into a
superannuation contribution. There was no evidence before the Court that if
the taxpayer had not entered into some of the agreements that constituted the
scheme ... he would nonetheless have continued to have invested in the
scheme through some other mechanism such as entering into the lease and
management agreement and borrowing from ANZ or using his own funds.
There was no evidence at all about that. .... In applying section 177C (tax
benefit) it is a matter of applying the test to the facts or to the evidence. This
court in Peabody indicated the nature of the enquiry to be undertaken.' 38
(emphasis added)
Senior Counsel for the Commissioner then referred to the passage from Peabody
quoted above. He went on to say:
'So it is a predication test – reasonable it has to be based on evidence' 39
(emphasis added).
In 2011 however in the special leave application by the Commissioner in AXA, Senior
Counsel for the Commissioner, in reverse of the position put on behalf of the
Commissioner in Lenzo, submitted that:
'... the key issue raised by this application for special leave is whether or not
the Court needs to undertake a hypothetical fact finding exercise to determine
in effect what would have happened absent the scheme. We submit that that
is not necessary. However there is a line of cases in the Full Federal Court
[Lenzo, Trail Bros. AXA] which indicates that it is necessary.' 40
While citing the same passage from Peabody quoted above, and quoted with approval
by Senior Counsel for the Commissioner in the special leave application after Lenzo,
Senior Counsel went on to say:
'We submit that the hypothetical fact finding approach adopted in this line of
Full Federal Court cases distorts the whole operation of Part IVA. In our
submission, section 177C the obtaining by a taxpayer of a tax benefit in
38
Lenzo v Commissioner of Taxation (Cth) [2008] HCATrans 371 (12 November 2008).
Ibid.
40
Commissioner of Taxation of the Commonwealth of Australia v AXA Asia Pacific Holdings Ltd
[2011] HCATrans 63 (11 March 2011).
39
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connection with the scheme is intended to be a gateway provision rather
than a major forensic exercise. However what has occurred in this case
and is occurring in other cases now is that it has become a major forensic
exercise to determine whether or not there is a tax benefit. In our
submission in most cases the main issue in Part IVA is the question of
dominant purpose and section 177D(b).' 41 (emphasis added)
The Commissioner's submission to the High Court was put in two ways:
a.
Where looking at the scheme an amount of assessable income has not been
included in the taxpayer's assessable income (in AXA's case some $383M) an
analysis which requires a determination of what would have happened absent the
scheme, leaves open the ability for the taxpayer to establish that it would have
done nothing, with the result that there would no tax benefit as defined. That
produces an anomalous result. An interpretation of section 177C leading to that
result must be incorrect.
b.
The alternative interpretation of section 177C advanced by the Commissioner
which does not produce that result is one under which it is not necessary to
determine the one alternative postulate which would have happened, but to
determine if any one of a number of reasonable expectations might have
happened. If on any of those reasonable expectations the amount would have
been included in assessable income, then there is a tax benefit.
Special leave to appeal to the High Court on the basis of the submission was refused.
The Commissioner sought to persuade the High Court to consider this approach again
in the special leave application after RCI in 2012. 42
The submission made on behalf of the Commissioner was put first on the basis that it
is an incorrect reading of the passage from Peabody quoted above to say that the
Court in Peabody required that a reasonable expectation requires a determination of
the one alternative postulate which would have occurred if the scheme had not been
entered into or carried out. It was sufficient for a tax benefit to arise as was said in
Spotless that at least the amount in question might reasonably have been included in
the assessable income had the scheme not been entered into or carried out [in other
words, what 'could' have occurred]. This was how the Commissioner argued his case
in the Full Federal Court also.
The riposte by Senior Counsel for the taxpayer was to point out that the High Court in
Spotless did, in fact, go on to identify the one reasonable alternative postulate.
The effect, which acceptance by the courts of this submission would have on the
operation of Part IVA, was explained in the following exchange between Hayne J and
the Commissioner's Senior Counsel in the special leave application after RCI:
41
42
Ibid.
Commissioner of Taxation v RCI Pty Ltd [2012] HCATrans 29 (10 February 2012).
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'HAYNE J: Peabody is looking, is it not, for a singular reasonable
possibility.
MR WILLIAMS: No. Every case has to be understood according to the facts
then under consideration, but Peabody was applying – the critical part of
Peabody I will go to in a moment ...
HAYNE J: The central point you want to make is, as I would understand it,
the words "or might reasonably be expected to have been included" are met if
there is a range of possibilities, all of them reasonable, and one of
them, whether or not it is the more probable or more likely, is a
possibility which would see the amount brought to tax?
MR WILLIAMS: Yes, and we rely on Spotless. 43' (emphases added).
The second way in which the submission made for the Commissioner was put and a
summary of the effect of the submission, however it is put, is explained in the
following exchange between senior counsel for the Commissioner and Hayne J:
'MR WILLIAMS: ... to construe section 177C as not being triggered where the
tax benefit is so large that it is essential, is to give the Part a perverse
operation. ...
HAYNE J: 'But does that proposition come to more than this transaction
could have been done in two ways? One would have been brought to
tax the other is not, therefore Part IVA is engaged. Is it as simple as
that?
MR WILLIAMS: ... The tax benefit did ultimately come home and that,
we say, is enough. ...The function that section 177C serves in the scheme is
to ask whether there was a tax consequence of the transactions for the
taxpayer. Here there was a very clear tax consequence, very clear and very
large, so large the court said that it was critical to the entire Project Chelsea
re-organisation. Nevertheless the court concluded that there was no tax
benefit and moreover that there was no dominant purpose.' 44 (emphases
added).
The High Court refused special leave to appeal, specifically on the basis that the Court
did not consider that the Commissioner had sufficient prospects of success in
demonstrating error by the Full Federal Court in its finding regarding the criterion in
section 177C.
In summary therefore, the arguments presented by the Commissioner's counsel in the
special leave applications in the AXA and RCI cases boil down to a submission that
there must be something wrong in the approach taken by the Full Federal Court in its
decisions in relation to the 'reasonable expectation test' if the Full Federal Court can
find that there is no 'tax benefit', and Part IVA does not apply, in cases where clearly
the taxpayer (AXA and RCI respectively) might or could have obtained a tax benefit
from the way in which the taxpayer entered into or carried out a transaction; in fact,
did obtain the tax benefit; and where the taxpayer, if the question of dominant
purpose had been allowed to be tested, on the evidence may have been found to have
entered into the transaction for the dominant purpose of obtaining that tax benefit.
The difficulty facing the Commissioner in both the AXA and RCI special leave
applications was that to adopt the approach submitted by the Commissioner required
43
44
Ibid.
Ibid.
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the High Court to ignore first, the words of section 177C and second, the explanation
in Peabody, and in the jurisprudence since Peabody about how to interpret that
statutory definition. That is, the reasonable expectation test is a predication test as to
what would have occurred. In those circumstances evidence, for example, of the size
of the tax cost is legitimate evidence of what would have happened as an alternative
postulate to the impugned scheme.
In the Macquarie Bank/Mongoose case, the difficulties for the Commissioner in the
application of Part IVA were not in relation to the definition of 'tax benefit' but arose
from:
1. the fact that an assessment could not be validly made against a company in
respect of a capital gain which it had realised on a sale of shares in the year in
which it became a member of the Macquarie Bank tax consolidated group, because
Part IVA had not been amended (when other parts of the Act had been) to impose
a tax liability on subsidiary members of a consolidated group, despite
consolidation; and
2.
no dominant purpose could be established on the facts, the issue being
compounded by the fact that no party to the impugned scheme had been involved
in each step in the scheme.
In the Macquarie Bank/Mongoose case, Edmonds J referred to broad submissions on
behalf of the Commissioner as to how Part IVA should operate as an 'elastic'
construction of Part IVA 45. That description seems apposite in relation also to the
Commissioner's submissions in relation to 'tax benefit' in the AXA and RCI special
leave applications.
The writer contends that the problem with the Commissioner's submissions in AXA,
RCI and the Macquarie Bank/Mongoose cases is that it is not the interpretation by the
Courts of Part IVA which is causing the Part not to apply (to be 'sterilised' in the
advocacy language of the Commissioner's submissions in the Macquarie
Bank/Mongoose case 46), but, rather, that the Commissioner is trying to stretch
Part IVA to apply in cases and in ways which its words were not designed for
(especially in light of later changes to the Act, such as consolidation). This has been
evident elsewhere in the operation of the Act in recent decades, particularly in relation
to the taxation of trusts and the operation of Division 6 of the ITAA 1936, with the
failure to amend it for the introduction of capital gains tax and dividend imputation.
The Commissioner has appealed against the decision of Edmonds J in the Macquarie
Bank/Mongoose case to the Full Court of the Federal Court. 47
45
Macquarie Bank/Mongoose [2011] FCA 1076 (Edmonds J at paragraph 44).
Ibid.
47
As at the date of writing, the hearing has been adjourned and judgment reserved by the Full
Court (Emmett, Middleton and Robertson JJ).
46
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10. Is an amendment necessary to focus on
specific steps in the identified scheme?
The definition of 'scheme' already allows the Commissioner to focus on one action or
step, eg in Commissioner of Taxation v Consolidated Press Holdings Ltd, 48 the
interposition of an Australian company.
The Part also allows the Commissioner to frame the putative scheme in different ways,
a broad scheme and a narrow scheme.
The scope is not yet known of the High Court's comment in Peabody that:
'... Part IVA does not provide that a scheme includes a part of a scheme and it
is possible … to conceive of a set of circumstances which constitutes only part
of a scheme and not a scheme in itself. That will occur where the
circumstances are incapable of standing on their own without being "robbed of
all practical meaning". In that event it is not possible … to say that those
circumstances constitute a scheme rather than part of a scheme … That of
course does not mean that if part of a scheme may be identified as a scheme
in itself the Commissioner is precluded from relying upon it as well as the
wider scheme'. 49
The discussion by the High Court in Hart and a comparison of the different approaches
to this issue taken by the judges in the High Court in that case, leave open the
question of whether and if so to what extent the meaning of the expression 'scheme'
can be read down or limited.
Some at least of the Commissioner's recent losses in court have not been due to the
interpretation of 'tax benefit' but to his failure to argue the narrow scheme, eg
Commissioner of Taxation v Mochkin 50 or to assess the correct taxpayer, eg AXA.
In Hart v Commissioner of Taxation 51 (in the Full Federal Court), it was recognised that
by arguing the narrow scheme and focusing on the very step which produced the 'tax
benefit' it became likely that the conclusion as to dominant purpose in relation to that
step was inevitable. The High Court said that was as it may be, but was permissible
for the Commissioner to do.
48
49
50
51
(2001) 207 CLR 235.
Peabody (1994) 181 CLR 359, 383 - 384.
(2003) 127 FCR 185.
(2002) 121 FCR 206, 85 (Hely J).
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11. What will the amendments in relation to
steps in a scheme be?
The proposed amendments go further than this though.
While the precise amendments to be made are not known, it would appear that they
will fall into 2 categories:
a.
amending the reasonable expectation test so that it will not be necessary to
identify the one reasonably possible alternative - there will be a tax benefit simply
if an amount would have been included in assessable income under any one of a
number of reasonable alternatives. This seems to substitute a 'could have' test for
the 'would have' test; and
b.
focusing on the step producing the tax advantage. At present, while the question
of dominant purpose is decided by reference to the purpose of persons in entering
the whole scheme, or part of a scheme, the test of 'tax benefit' must be decided
by reference to what would have happened if the whole scheme had not been
entered into, not by reference to what would have happened if part of the scheme
had not been entered into.
The Government's announcement indicates that the Government wants to determine if
a tax benefit has been obtained by reference to what would (could?) have happened if
the particular step (which may be part of a scheme) which caused tax not to be
payable, had not occurred.
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12. Likely effect of proposed changes
How would this have affected recent cases?
In RCI, the Commissioner might ignore the payment of the tax exempt dividend so
that the gain on sale of the shares was significantly higher.
In AXA, the Commissioner might ignore the steps in the CGT rollover through an
interposed company to look at the end result of the sale of the sales in AXA, resulting
in a direct capital gain.
It should not change the result in Commissioner of Taxation v BHP Billiton Finance
Ltd 52 as the debt was already bad before BHPB revoked the letter of comfort.
Further, changes might be needed to the words of the 'allowable deduction' tax benefit
to achieve the Government's goal. The Government seems concerned at the outcome
in Trail Bros and may seek to legislate that 'that deduction' must be the same
deduction or that the alternative hypothesis must be framed without reference to any
of the factors or integers of the impugned scheme.
The likely outcome of the changes, as Justice Hayne identified in the RCI special leave
application 53 is that, where there is a number of reasonable possible courses of action,
that Part IVA will be engaged if the alternative which does not produce tax, is chosen.
The effect of that will be that the taxpayer will be taxed on the alternative which
produces tax (and by extension, produces the most tax) subject to dominant tax
purpose being established. Dominant tax purpose will become much easier to
establish if tax benefit is defined by reference to the step (even if not itself a 'scheme')
which caused tax not to be payable.
Further, as the change to the meaning of 'tax benefit' must alter the determination of
the alternative postulate, the analysis of the question of dominant purpose will also be
affected, even if no change is made to the drafting of section 177D. 54
The cases on Part IVA continue to demonstrate that, prior to 1 March 2012, it was not
possible to reduce the application of Part IVA to rules of thumb or general statements
of its intended scope of application. In determining the application of Part IVA there
was no substitute for applying the words of the Part itself. So, for example, the
common refrain heard from clients that when a number of alternative courses of action
are available to a taxpayer, the taxpayer must choose the course which results in the
payment of the highest tax, was simply incorrect. Part IVA is a facts based test.
There was no alternative but, on a close analysis of the facts, to determine whether
there had been a tax benefit, as defined, in relation to an identified scheme, by
reference to the reasonable alternative postulate; and in relation to any such tax
benefit by reference only to the eight factors in section 177D(b), to determine whether
or not objectively the sole or dominant purpose of any person involved in the scheme,
by reference to the alternative postulate, would be considered to have been to obtain
that tax benefit for a taxpayer.
This approach equally applied in rebutting submissions by the Commissioner to give
effect to a presumed 'policy' that 'tax benefit' is a mere gateway to testing for
dominant purpose.
52
(2010) 182 FCR 526. This case was subsequently appealed to the High Court however special
leave was refused on the Part IVA issue.
53
Commissioner of Taxation v RCI Pty Ltd [2012] HCATrans 29 (10 February 2012).
54
The writer is grateful to Karen Payne, Tax Partner, Minter Ellison, for this comment on the
consequential effect that a change in the framing of the alternative possibilities will have on the
determination of dominant purpose.
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It would seem this is about to change – and retrospectively from 1 March 2012.
From what we know from the arguments put to the High Court in the special leave
application in AXA and RCI; from the 1 March 2012 press release; and from
government consultation documents, it appears that the amendments to Part IVA will
water down the definition of 'tax benefit'. Determining the relevant dominant purpose
as one of obtaining the tax benefit will consequently be much easier to do as the
inquiry will be around the purpose of taking the exact step which produced the tax
benefit, in the context of a range of alternative postulates.
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13. Are the proposed amendments anti-tax
avoidance laws? Are they constitutional?
The change to the meaning of 'tax benefit', by reference to a number of possible
alternative postulates, will be fundamental.
It will enable the use of Part IVA to tax gains you may have made if you might have
done something which you would not have done. This will not be anti-avoidance
legislation. As Gummow and Hayne said in Hart, a purpose of obtaining a tax benefit
requires a consideration of the alternative. You cannot avoid tax if you would never
have been liable for tax on what you prove you would have done in the alternative. To
tax people on gains on things they would not have done is not anti-avoidance
legislation. It is something else.
What is it?
Maybe it is a windfall gains tax or an old section 160M(6) or M(7) tax?
Is it a tax at all? Or is it a confiscation of property? While we cannot know without
seeing the terms of the amendments, the proposed amendments may well raise this
constitutional question as, from what the government has said, the changes may well
allow you to be taxed on a transaction which is not the transaction which you prove
you would have entered into or carried out if you had not done what you did (in other
words, you may be taxed on a transaction you would not have entered into). This
must be approaching a situation of taxation at the Commissioner’s discretion. 55
55
MacCormcik v Federal Commissioner of Taxation (1984) 158 CLR 622; Deputy Commissioner of
Taxation v Truhold Benefit Pty Ltd (1985) 158 CLR 678
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14. Retrospective Operation
One final word – the retrospective operation to 1 March 2012, of changes which have
not been described with any precision, is inimical to the rule of law. Is guarding the
revenue against the loss of a court case or cases more important than protecting the
rule of law?
Bill Thompson
Minter Ellison
September 2012
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APPENDIX A
Relevant applications of the Reasonable Expectation Test
RCI Pty Ltd v Commissioner of Taxation 56 – 2010
In RCI, the taxpayer was the immediate parent of companies within the US sub-group
of the James Hardie Group of Companies. A wholly owned US subsidiary of the
taxpayer re-valued its shares in another US company creating an asset re-valuation
reserve of some US$318 million. The US subsidiary declared a dividend equal to the
amount of the revaluation reserve to the taxpayer. The dividend was exempt from
Australian tax under section 23AJ of the 1936 Act. The effect of the dividend was to
reduce the value of the taxpayer's shares in the US subsidiary. Subsequently, the
taxpayer sold its shares in the US sub-group holding entity for an amount which was
correspondingly reduced. The extent of the reduction was equal to the amount of the
dividend being US$318 million (or A$478 million).
The transaction had occurred, broadly, in the context of a number of previous
proposed transactions which had been considered by the group and as part of an
overall commercial purpose of achieving a restructuring of the US group.
Stone J considered that the reasonable alternative postulate was that if the scheme
constituted by the asset revaluation and dividend payment, had not been entered into,
the shares sold by the taxpayer would have been sold in any event despite the large
capital gain which would be realised. There was therefore a tax benefit in proceeding
with the transaction in the way in which it had proceeded.
The Full Federal Court reversed the trial judge on this finding. The Commissioner was
denied special leave to appeal to the High Court.
Commissioner of Taxation v AXA Asia Pacific Holdings Ltd 57 - 2010
AXA Health Insurance Pty Ltd was a wholly owned subsidiary of AXA Asia Pacific
Holdings Ltd (AXA) and operated a profitable health insurance business.
From 2000 AXA was considering the future of AXA Health while in mid-2001 it had
received an indicative proposal from MBF for the purchase of AXA Health. By late
2001 it was investigating either an initial public offering of AXA Health or a leveraged
buy-out (LBO) proposal.
The LBO was proposed by Macquarie Bank Limited (MBL) and would involve AXA
selling its shares in AXA Health into an unlisted leveraged company. The investors in
that company would include MBL and other investors and debt funding of $300 million
would be obtained. As the LBO proposal developed, MBL proposed that part of the
transaction would include that the sale by AXA of its shares in AXA Health to the LBO
acquisition company would be the issue of shares in the LBO acquisition company and,
that to the extent that the consideration was comprised of shares, scrip for scrip
rollover relief would be obtained under Sub-division 124M of the 1997 Act. The effect
of obtaining scrip for scrip rollover relief is to defer the making of a capital gain on the
disposal of the shares until a later CGT event occurs in respect of the replacement
shares.
As a result of separate agreements entered into between AXA and the other
shareholders in the LBO acquisition company, AXA could call for the transfer to it of
56
57
(2010) 272 ALR 347.
(2010) 189 FCR 204.
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Part IVA: Shifting the goal posts page 30
the shares held by MBL and the other shareholder in the LBO acquisition company.
Conversely, AXA could require a company co-owned by MBL and the other shareholder
to acquire AXA's shares in the LBO acquisition company.
Finally, the LBO acquisition company had entered into an arrangement with the
company co-owned by MBL and the British insurer for the on-sale of AXA Health.
In the result, AXA did call for the transfer to it of the shares held by the other
shareholders in the LBO acquisition company; the LBO acquisition company did on-sell
AXA Health to the company co-owned by MBL and the British insurer. The result was
that AXA continued to hold the replacement shares in the LBO acquisition company
when the only asset of the LBO acquisition company (it having on-sold the shares in
AXA Health) was cash in the sum of $558 million.
In effect, AXA had sold AXA Health and indirectly held the proceeds of sale through its
100% ownership of the LBO acquisition company. By reason of the scrip for scrip
rollover, only the $57 million received in cash was exposed to capital gains tax on the
sale of AXA Health. Tax on most of the capital gain could be indefinitely deferred by
AXA continuing to hold the cashbox company.
The Commissioner asserted that these arrangements constituted a Part IVA scheme.
The tax benefit was a capital gain in the amount of $383 million which would have
been or might reasonably be expected to have been included in AXA's assessable
income if the scheme had not been entered into or carried out. The Full Federal Court
unanimously (on the Part IVA point) upheld the primary judge's conclusion that
Part IVA did not apply. The reason was that the Full Federal Court agreed with the
primary judge that AXA did not derive a tax benefit in connection with the presumptive
scheme. The Commissioner contended that the alternative postulate was that AXA
would have entered into a direct sale of AXA Health to the company co-owned by MBL
and the British insurer which was the eventual buyer of AXA Health from the LBO
acquisition company. Both the primary judge and the Full Federal Court rejected this
as an alternative postulate which was reasonably possible. The uncontroverted
evidence was that MBL would never have been part of a direct acquisition by that coowned company of AXA Health, not least because it would not derive the significant
anticipated fee income from that direct acquisition which it derived from the
transaction as undertaken.
The Full Federal Court noted, by way of obiter dicta that the other possibility which
might reasonably have been expected was a direct sale of the business of AXA Health
to MBF. However, that was not an alternative postulate to the sale of the shares in
AXA Health by AXA as MBF was not interested in acquiring the shares in AXA Health
but only its business. A sale of the business would have produced a capital gain for
AXA Health, not for AXA.
The Commissioner filed an application for special leave to appeal to the High Court.
The High Court refused to grant special leave for the appeal.
Commissioner of Taxation v Lenzo 58
In Lenzo, the taxpayer had obtained various deductions through participation in a tree
farming scheme. This included deductions for management fees and interest. In
relation to Part IVA, the taxpayer had contended that the relevant 'counterfactual' if
the investment in the tree scheme had not been paid was that a corresponding
deduction would have been obtained by making contributions to superannuation.
Sackville J wrote the leading judgement, in which he:
58
(2008) 247 ALR 242.
E_103789091_1 (W2007)
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Part IVA: Shifting the goal posts page 31
a.
concurred with the trial judge that the contribution to superannuation was not a
'relevant counterfactual' on the basis that the definition of 'tax benefit' required, in
the case of an allowable deduction, that a deduction of the same kind would be
obtained as the deduction obtained under the impugned scheme;
b.
considered a further alternative postulate which had been accepted by the trial
judge that the taxpayer instead of borrowing to make the investment in the tree
scheme could have used his own funds (which were available) and obtained the
same deductions. Sackville J considered that a difficulty with that alternative
postulate was, because the definition of 'tax benefit' in section 177C(1) required
that the alternative postulate be assessed on the basis that the scheme had not
been entered into or carried out, that that meant that no part of the scheme could
form part of the alternative postulate.
Special leave to appeal to the High Court was refused to the taxpayer.
Commissioner of Taxation v Trail Bros Steel & Plastics Pty Ltd 59
The decision in Trail Bros overtakes the decision of a differently constituted Full
Federal Court in Lenzo. Although the Full Federal Court in Trail cited sections of
Sackville J's reasons in support of the decision in Trail, it is apparent that the Full
Federal Court's decision in Trail departs significantly from that of the Full Federal Court
in Lenzo.
In response to changes in the superannuation law limiting the tax deductible
contribution which could be made in respect of employees to age based contribution
limits in the 1997 year, the taxpayer company and certain of its employees orally
agreed to vary their employment contracts so that instead of the taxpayer making
superannuation contributions to the company's superannuation fund, the taxpayer
would make payments to the Trail Bros Pty Ltd Employee Welfare Fund. Instead of the
age based superannuation contributions of approximately $75,000 in aggregate which
the taxpayer might have made to the superannuation fund, a contribution of $210,000
was made to the Welfare Fund.
The Administrative Appeals Tribunal (AAT) had found that the payments to the Welfare
Fund were deductible under section 51(1) of the 1936 Act and under section 8-1(1) of
the 1997 Act for the relevant years. While the AAT found that there was a relevant
Part IVA scheme, it considered that there was no tax benefit as if the scheme had not
been entered into, the taxpayer would have made payments 'in a way that would have
entitled the taxpayer to deduct the amount of the payments'.
On appeal, the trial judge found that the taxpayer had obtained a tax benefit in each
year and that the tax benefit was not the $210,000 paid to the Welfare Fund in each of
the relevant years but the difference between the $210,000 and the superannuation
contributions which might have been made. The Commissioner and the taxpayer
appealed. The issues in dispute were whether the taxpayer obtained a tax benefit and
if so the amount of the tax benefit. The significance of the Trail Bros case is its
explanation of:
a.
how the analysis of the counterfactual or alternative postulate at the core of the
definition of 'tax benefit' is to be undertaken; and
59
(2010) 272 ALR 40.
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Part IVA: Shifting the goal posts page 32
b.
how the amount of the tax benefit is to be calculated;
effectively changing the explanation of those issues by the differently constituted Full
Federal Court in Lenzo's case.
The Full Federal Court unanimously agreed that the definition of tax benefit requires
two things:
a.
A determination of what would or might reasonably be expected to have happened
if the scheme had not been entered into or carried out. The burden of proving this
alternative postulate lies with the taxpayer, not the Commissioner. The
fundamental problem with the decision by the AAT in this case was that the AAT
had no evidence in front of it from the taxpayer as to an alternative postulate.
b.
That alternative postulate must be premised upon the assumption that 'the
scheme had not been entered into or carried out'. They are the words of the
definition in the statute. That requirement means that the assumption which must
be made is that the entire scheme had not been entered into or carried out.
Significantly, however, the Full Federal Court in Trail Bros explained that that
requirement does not preclude an activity or events which include some of the
'integers' of the impugned scheme from being the alternative postulate.
'A scheme is usually comprised of a number of 'steps' or 'integers'. It is
conceivable that a scheme (comprising just some of the integers of a
wider scheme to which Part IVA applies) may be a scheme to which
Part IVA does not apply. If the narrower scheme is the particular
activity or the events that would have or might reasonably be
expected to have taken place in the absence of the scheme, then that
is the alternative postulate. The difference between the deduction claimed
in relation to the scheme and the allowable deduction from the narrower
scheme is the tax benefit. Similarly, the alternative postulate may
comprise some of the integers of the scheme to which Part IVA applies
and other integers which do not form part of that wider scheme. … The
"integers" that are relevant to that objective enquiry are not limited and "may
not always permit the precise identification of … all the integers of a particular
'scheme'": Hart 217 CLR 216 at (43). The integers will be different for each
case and the onus is on the taxpayer to identify those integers which establish
the alternative postulate.' 60 (emphases added)
The alternative postulate requires a 'prediction as to events which would have taken
place if the relevant scheme had not been entered into or carried out and that
prediction must be sufficiently reliable for it to be regarded as reasonable'. 'A
reasonable expectation requires more than a possibility' 61
The taxpayer may satisfy the burden of proof upon it in relation to the alternative
postulate as it sees fit. The taxpayer's evidence of what it would have done but for
entering the scheme is relevant to the extent it reveals facts or matters that bear upon
the objective determination of the alternative postulate. 62
60
Ibid 48.
Ibid 47 (Dowsett and Gordon JJ) citing Commissioner of Taxation v Lenzo (2008) 247 ALR 242,
122 (Sackville J).
62
Ibid 49.
61
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If the relevant tax benefit is in relation to an allowable deduction, then the
alternative postulate need not engage a provision of the Act giving rise to the
same kind of deduction as that engaged by the impugned scheme. The
reference in section 177C(1)(b) to 'that deduction' not being allowable or not
reasonably being expected to have been allowable if the scheme had not been entered
into or carried out is not a reference to the same type or category of deduction
but to the amount of the deduction.
If the alternative postulate gives rise to a deduction under whatever provision of the
Act, then the tax benefit is the amount by which the deduction allowed to the taxpayer
under the impugned scheme exceeds the deduction which would have been allowable
under the alternative postulate. Such an understanding of the definition of 'tax
benefit' in relation to allowable deductions is consistent with the explanation of the
definition of 'tax benefit' in relation to the exclusion of amounts from assessable
income which was given in Spotless. The Full Federal Court noted that 'any suggestion
to the contrary in earlier authorities (eg Lenzo) may now be put to one side as
explained in Spotless.' 63
In Trail, the Full Federal Court agreed with the trial judge that the alternative postulate
was that the employer taxpayer would have contributed to superannuation up to the
relevant age based contribution limits rather than contributing to the Welfare Fund.
The tax benefit was not the total of the amount contributed to the Welfare Fund but
the excess of the contributions to the Welfare Fund over the contributions which would
have been made to the superannuation fund based on age based limits.
The matter was remitted to the AAT for re-analysis on the basis of these explanations
of the concept of 'tax benefit' and for a consideration of the question of dominant
purpose which the AAT had not considered given its finding that there was no tax
benefit.
Commissioner of Taxation v BHP Billiton Finance Ltd 64 - 2010
In broad terms, the Commissioner's Part IVA argument was that BHPB Finance
obtained a bad debt deduction in respect of the inter-company loan to a BHPB
subsidiary (TM) by writing off the debt owed by TM instead of forcing TM into
liquidation so that the liquidator would pursue a contractual claim against BHPB on the
most recent letter of comfort provided by BHPB to TM. That course, it was argued,
would have provided TM with the funds necessary to repay its loan and interest to
Finance.
The Commissioner made an important concession on appeal. He accepted that the
debt owed by TM was bad. Accordingly, if it would be concluded that the debt was bad
before BHPB revoked its comfort letter, then Finance would have derived no tax
benefit by the asserted scheme of acquiescing in BHPB revoking the letter before
Finance wrote off the debt. The debt would already have been bad and the deduction
would have been available regardless of whether the letter of comfort was revoked or
not.
The question which the Full Federal Court therefore considered was, was the TM loan a
bad debt prior to the revocation by BHPB of the comfort letter.
The Full Federal Court considered that on the authorities 65 a debt is bad if it is
reasonably to be regarded as irrecoverable. It is not necessary in making that decision
to establish that nothing can ever be recovered. It must simply be 'conjecturally' bad.
63
64
Ibid 53.
(2010) 182 FCR 526.
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Part IVA: Shifting the goal posts page 34
On the basis that the TM debt was bad irrespective of the withdrawal of the comfort
letter, there was no tax benefit. Part IVA did not apply.
By way of obiter dicta, the Full Federal Court offered however that even if there was a
tax benefit it was difficult to see how the conclusion of dominant purpose to obtain the
asserted tax benefit could be reached having regard to the eight factors in
section 177D(b).
British American Tobacco Australia Services Limited v Commissioner of
Taxation 66 - 2010
In 1999, as part of a global merger of the British American Tobacco Group of
Companies (BAT Group) and the Rothmans International Group of Companies
(Rothmans Group) the taxpayer (a member of the BAT Group formerly known as WD &
HO Wills Australia Limited) was required by the Australian Competition and Consumer
Commission (the ACCC) to divest itself of nine tobacco brands which it owned at that
time (the nine Wills brands).
Following the merger of the BAT Group and the Rothmans Group, the taxpayer sold
the nine Wills brands to Rothmans Pall Mall (Australia) Limited for a price of
approximately $182 million. The taxpayer claimed rollover relief for that transfer. The
transferee, Rothmans, immediately on-sold the nine Wills brands for the same price to
companies within the group of Imperial Group PLC (an unrelated company).
The Commissioner asserted that the transaction constituted a Part IVA scheme. The
Rothmans Holdings Group had in excess of $163 million of capital losses which could
be utilised to offset against capital gains arising in the Rothmans Holdings Group. The
transfer of the nine Wills brands to the Rothmans Group had the effect of locating the
capital gain on the on-sale to the Imperial Group within Rothmans where it was
sheltered by the available capital losses.
The taxpayer submitted that the scheme was the choice which it made to obtain the
rollover relief under sub-division 126B of the 1997 Act. Where the scheme consists
solely of the non-inclusion of an amount in the assessable income of a taxpayer
attributable to the making of a choice under sub-division 126-B, no relevant tax
benefit arises – section 177C(2A)(a). The Full Federal Court rejected that submission
on the basis that the scheme did not consist solely of the making of the roll-over
choice. The making of the choice was part of a wider scheme involving steps both
before and after the rollover occurred.
The reasonable alternative postulate was that the taxpayer would have disposed of the
nine Wills brands directly to the Imperial Group. The tax benefit identified on the basis
of that alternative postulate was a net capital gain of $118 million.
The taxpayer did not challenge that alternative postulate but submitted that the trial
judge had focused on the taxpayer's object as being the utilisation of tax losses,
thereby focusing on a tax benefit different from the exclusion of the capital gain which
was the subject of the scheme identified by the Commissioner. The Full Federal Court
rejected that submission on the basis that references by the trial judge to the
utilisation of tax losses was not a reference to the relevant tax benefit but to a matter
to be taken into account in considering the eight factors relevant to purpose under
section 177D(b).
Commissioner of Taxation v Mochkin 67
65
GE Crane Sales Pty Ltd v FCT 1971 126 CLR 177 at 194-195 and Elder Smith & Co Ltd v CofT
(NSW) 1931 31 SR NSW 639 at 643.
66
(2010) 189 FCR 151.
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Part IVA: Shifting the goal posts page 35
The taxpayer had established two family trusts with separate corporate trustees to
enter into commission-sharing agreements with stockbrokers. These trusts employed
the taxpayer and his 'team' in the conduct of their broking businesses. The trusts
derived substantial commission income which, after expenses, they distributed to the
beneficiaries of the trusts, being the taxpayer and certain other family trusts, including
a loss trust, and a charity. In a period of 8 years, the taxpayer received a salary from
the trusts of a relatively minor amount in one year only.
The Commissioner contended that the commissions were generated by the taxpayer's
personal services and that these amounts would have been paid to the taxpayer and
formed part of his assessable income in the absence of a Part IVA scheme comprising
the use of the trusts to provide the taxpayer's personal services. The Commissioner
asserted that the scheme had the effect of diverting income from the taxpayer's
personal exertion to the trustees, thereby reducing his assessable income.
The Commissioner did not rely on any narrower scheme, such as the use of the
trustees to distribute net income as the taxpayer directed without regard to the value
of the services he provided.
At first instance, the court determined that the taxpayer was deriving a tax benefit by
the ability to distribute income from the stockbroking business to the trust
beneficiaries. However, the court found that the taxpayer's dominant purpose in
entering into the scheme was not to obtain that tax benefit. There were two reasons
for this:
1. The accepted evidence was that prior to conducting the stockbroking business
through trusts, the taxpayer had conducted a similar business in his own right
and had been the subject of legal action which exposed him to significant
personal liability. The taxpayer would not have conducted business
subsequently except through a structure which provided him with limited
liability.
2. The income of the business was not derived merely from the personal exertion
of the taxpayer. Unlike the facts in cases such as Tupicoff v Federal
Commissioner of Taxation 68, Bunting v Federal Commissioner of Taxation 69 and
AAT Case W58; No 5219 70, the business was not a 'one person business'. The
trustee company provided guarantees of the obligations of defaulting clients
which the taxpayer refused to provide personally; there was a 'team' of persons
who provided services to clients and brokers; the trustee maintained an
administration structure including an extensive array of information technology.
These features also enabled the business to build up goodwill which the trial
judge found could be detached from the taxpayer's personality and continued
participation in the business.
The trial judge's conclusions on dominant purpose were upheld on appeal. The Full
Federal Court took the opportunity on appeal, in comments which were not necessary
for the decision (given their agreement with the conclusion on dominant purpose) and
therefore were obiter dicta, to say that if the scheme had been narrowly defined as
one of operating the business through the trust structure without paying a fair reward
to the taxpayer for the services he would have provided, then a finding of a dominant
purpose to obtain the tax benefit of excluding that reward for his services from his
assessable income, might have been made.
67
68
69
70
(2003)
(1984)
(1989)
(1989)
127 FCR 185.
4 FCR 505.
90 ALR 427.
89 ATC 524.
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Part IVA: Shifting the goal posts page 36
Bill Thompson
September 2012
E_103789091_1 (W2007)
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Part IVA: Shifting the goal posts page 37
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