In brief

  • The 4 February 2015 decision of the Federal Court in Commissioner of Taxation v Arnold (No 2) [2015] FCA 34 (Arnold), provides further evidence that the promoter penalty regime in Division 290 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) will be used by the Commissioner to deter the marketing and promotion of schemes.
  • Whilst this case dealt with a scheme relating solely to income tax, it is important to note that Division 290 applies not only to schemes involving income tax, but applies to all taxes and imposts payable to the Commissioner including but not limited to the goods and services tax (GST).
  • The decision in this case follows the Full Federal Court in Commissioner of Taxation v Ludekens [2013] FCAFC 100 (see October 2013 TaxTalk – Other news update) where the Commissioner was successful on appeal to the Full Court. Both Ludekens and Arnold concerned the marketing of a scheme to a number of participants.

In detail

In Arnold, the Commissioner brought an action against Mr Arnold and two associated companies (the respondents) seeking declarations that the respondents were ‘promoters’ of a ‘tax exploitation scheme’ in contravention of sub-section 290-50(1) of Division 290 of Schedule 1 to the TAA 1953. The Commissioner also sought monetary penalties for such contraventions as prescribed in Division 290.

Briefly, the respondents engaged in marketing to taxpayers, a scheme under which taxpayers claimed a tax deduction for pharmaceuticals purchased by the taxpayers and donated to charities for their use outside Australia. These pharmaceuticals were purchased from entities associated with Mr Arnold, and the purchase price was heavily inflated relative to the market value of the pharmaceuticals. Under the scheme, the taxpayers were only obliged to pay 7.5 per cent of the purchase price of the pharmaceuticals on entering into the scheme, with the balance payable some 50 years later. There was a nominal interest rate that applied to the outstanding balance and this was payable on entering into the scheme. Notably, the scheme operated on the basis that because the value of the pharmaceuticals was purportedly equal to the full purchase price, a tax deduction (donation deduction) was able to be claimed for this full value in the year that each participant entered into the scheme and paid the initial amount to acquire the pharmaceuticals.

The result of the promotion of the scheme was that 96 taxpayers participated in the scheme for the 2010 tax year, entering into purchase agreements for pharmaceuticals to a total invoice amount of $6,036,000 and total deductions claimed by these participants in that aggregate amount. These participants paid a total cash amount of $741,802 up to 30 June 2010.

In determining that the scheme was a tax exploitation scheme, Justice Edmonds was required to determine whether it was reasonable to conclude that the respondents had entered into the scheme with the sole or dominant purpose of each participant obtaining the donation deduction, and if so, whether it was reasonably arguable that the ‘scheme benefit’ (i.e. the tax saving derived from the donation deduction claimed by each participant) was available at law.

In determining that it was not reasonably arguable that the ‘scheme benefit’ was available at law, his Honour identified five grounds for so concluding. These grounds included that the participants were only required to pay 7.5 per cent of the purchase price of the pharmaceuticals; that there was no actual delivery of the pharmaceuticals to the relevant charities in the year of income in which the deduction was claimed; that the purchase agreements were void under Australian laws relating to the purchase of pharmaceuticals and were thus unenforceable for statutory illegality; and that in any event, the scheme would attract the operation of Part IVA of the Income Tax Assessment Act 1936 to allow the Commissioner to cancel any tax deduction for each participant’s donation. On this point, Justice Edmonds was of the view that if the Commissioner cancelled any such deduction under Part IVA, and issued an assessment to the participant accordingly, it was “beyond argument that any objection decision disallowing an objection against that assessment would be upheld by this Court”.

Justice Edmonds also determined that it was reasonable to conclude that the respondents had entered into the scheme with the sole or dominant purpose of each participant obtaining the donation deduction, and that each respondent had played a substantial role in promoting the scheme to participants. In this respect his Honour said that “the fact that the respondents may have also had the purpose of making a commercial profit or facilitating donations to charity is not inconsistent with the conclusion that they had a dominant purpose of enabling the participants to obtain the scheme benefit”.

Based on these findings, Justice Edmonds made the declarations sought by the Commissioner and in the course of his decision, made the observation that there is a contravention of s 290-50(1) even where the entity did not know that his, her or its conduct would have that result. Therefore the subjective knowledge of Mr Arnold and the other respondents was not relevant in determining whether they were each a promoter of a tax exploitation scheme.

His Honour then proceeded to impose Division 290 civil penalties totalling $1,500,000, with $1 million being payable by Mr Arnold – as the architect of the scheme and the controller of the other two respondents. Based on the Commissioner’s calculation, the maximum penalty that could have been levied on Mr Arnold was $4,665,528 and in the case of the two other respondents the applicable maximum was $2,750,000 for each company. In ordering that the respondents pay these amounts to the Commissioner, Justice Edmonds accepted the Commissioner’s submission that - “potential promoters must be left in no doubt that acting on the commercial temptation to engage in the proscribed conduct in relation to tax exploitation schemes, so as to realise the significant potential rewards that can be available, will result in substantial penalties. The penalties need to be substantial enough to persuade potential promoters that it is not worth the risk of whether a tax exploitation scheme will escape detection by the Commissioner.”

This message of strong deterrence for potential promoters is consistent with the policy intent of introducing the promoter penalty regime as an alternative to adopting a disclosure regime with increased reporting requirements (as initially contemplated). Relevantly, the promoter penalties regime is intended to provide a “more targeted and transparent measure that provides for substantial remedies to be imposed by the Federal Court against illegitimate promoters, while imposing low or no compliance costs on legitimate businesses.” (Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1 ) Act 2006 (Cth))

The takeaway

Following the earlier decision of the Full Court in Ludekens and now this decision in Arnold, it is clear that any previous concerns that Division 290 would be difficult to enforce have been misconceived.

Additionally, the penalties ordered by the Court in Arnold are, despite being less than the maximum, at a level that should have the effect of deterring behaviour that might otherwise result in a contravention of Division 290.

With a trend towards Courts imposing severe civil penalties for contravention of the promoter penalty rules, it is important to be cautious, and risk averse when participation in a scheme might be viewed as conduct within the scope of Division 290. In this respect it is important to recognise that the mere provision of advice by an entity about a scheme, will not result in the entity being a promoter of a ‘tax exploitation scheme’. It is important that taxpayers seek advice regarding their taxation affairs, and the promoter penalty regime in Division 290 provides no impediment to the proper provision of advice by suitably qualified tax practitioners.