Earlier this year the Commissioner was handed an overwhelming defeat at trial in his first attempt to utilise the promoter penalty laws. Given the magnitude of the loss, the Commissioner was bound to appeal and his view has now been upheld by the Full Federal Court (Commissioner of Taxation v Ludekens [2013] FCAFC 100).

The heart of the decision is the Full Court finding that no "alternative postulate" is required to be affirmatively proved by the Commissioner before he can allege that there is a "scheme benefit". That is, he need not prove that there was a "scheme benefit" by reference to what would have happened had the scheme not been entered into.

While the other issues on which the Commissioner was successful are also relevant, the "alternative postulate" issue is the most unwelcome change to the decision, at least for the tax advisers.

More to the point, without the Commissioner needing to rigorously prove that there was "tax avoidance" pursuant to the provisions of the tax law that actually relate to tax avoidance, the decision creates a disconnect between the anti-avoidance provisions of the law and the promoter penalty provisions.

The requirement for an alternative postulate

At trial the judge found that for the Commissioner to prove a scheme benefit (remembering that unlike in tax cases it is the Commissioner that bears the onus of proof) he would have to plead and prove what the position would have been if the scheme had not been entered into or carried out (this is known in Part IVA litigation as the alternative postulate).

The Full Federal Court criticised the drafting of the provision, and took the view that all that is required is a focus on what the entity who entered into the scheme was proposing to do and why. There is no requirement to consider any hypothesised events, circumstances or decisions, requiring one to posit what might have been done.

In part the alternative postulate argument was undone as the Court could not see any way to apply it where a scheme was promoted or marketed, but not in fact actually implemented. This seems to be adding only one more hypothetical argument onto a number of already quite fragile concepts where such a scheme is promoted and marketed but not actually entered into in any event.

The dominant purpose of making a profit

The dominant purpose issue went to whether a specific purpose of obtaining the scheme benefit had to be found, or whether it was open to the alleged promoter to say that their purpose in marketing the scheme was to earn a profit – a line of reasoning that harks back to comments first made by Justice Hill in CPH Property Pty Ltd & Ors v Commissioner of Taxation [1998] FCA 1276.

Again, the Full Federal Court criticised the drafting of the section but nonetheless tried to give it its fullest operation, despite it clearly having a penal character. Arguably also, this purposive approach is not reflected in the black letter of the law, which may mean that if the High Court chooses to hear the case the result might be different once again.

In any event, the decision should be confined to circumstances where the alleged promoter is a participant in the scheme and, at least arguably, where the profit of the alleged promoter is dependent upon the obtaining of the relevant scheme benefit.

The balance of the issues were of less importance as matters of principle.

The definition of promoter by reference to activities undertaken

Here the Full Court considered the historical development of the legislation, which it said as passed was a conscious refinement of earlier drafts, and acknowledged the removal of "development" and "implementation" from the defined prohibited conduct.

However, the Full Court concluded that, while implementation of a scheme of a "day to day" kind would be insufficient to trigger the section, it is a mistake to exclude all activities which, if considered individually, answer the description of development or implementation. Combining implementation with other conduct answering the description of marketing or encouragement might well constitute "promotion" of a scheme.

Further, the Full Court found that, where a continuum of action could be found that extended into the four year period in which the Commissioner has to issue a civil penalty notice, the Commissioner could rely on all prior acts of marketing or encouragement within that continuum to make his case.

The implementation of the scheme

In the alternative the Commissioner argued that what had happened was that a scheme receiving the blessing of a product ruling had not been carried out in accordance with the ruling. The Full Court found against the Commissioner here, essentially agreeing with the primary judge that the Commissioner was complaining about conduct which was outside the scheme defined in and implemented under the product ruling. The conduct properly fell within the marketing and promotion offence rather than the failing to implement a scheme offence.

It is now clear that secondary marketing of a scheme outside of the terms of a product ruling does not mean that the scheme itself is not carried out in accordance with the product ruling – in effect there is a second scheme which does not have the benefit of a product ruling in the first place.

Was it reasonably arguable that the input tax credits were available?

The cross-appeal was disposed of in just a few short paragraphs.

Because the partnerships formed to acquire the underlying investment before sale to another party did not have a reasonable expectation of profit or gain, they had no ability to be carrying on an enterprise and therefore to obtain input tax credits. As a result, it could not be argued that the scheme benefit was available at law. This seems a somewhat trite response to the argument and, as the Full Court did not delve into the meaning of "reasonably arguable" in its reasons, it can only be assumed that the case itself was not well put or strongly pressed.

What the Ludekens appeal means for tax advisors

The decision is disappointing on a number of levels, but primarily in respect of the "alternative postulate" issue and the implications this has for the conduct of future proceedings.

The conclusion facilitates the operation of the provisions outside of the income tax context (for example, to wine equalisation tax reduction schemes). However, in an income tax case the excision of the alternative postulate requirement makes it much easier for the Commissioner to allege that tax avoidance has occurred without having to prove that in any sort of technical sense as would be required in litigation of the substantive issue.

The result is that, while evidence is required for a court to find what "would have" or "might reasonably be expected to have" occurred apart from the scheme in applying Part IVA to a participant, the Commissioner may not need to prove that same element in any action against a promoter of the same scheme.

The matter will now be remitted to a single judge of the Federal Court to determine the quantum of penalty to be imposed