Tax managers will need to give careful thought to governance policies, including tax risk management policies, to support corporate actions.
On 16 November 2012, the Assistant Treasurer released for public comment draft legislation and explanatory material on the proposed amendments to Australia's general anti-avoidance regime – Part IVA of the Income Tax Assessment Act 1936.
The proposals go beyond the anticipated elimination of the "do nothing" counterfactual for determining whether a taxpayer has obtained a tax benefit from a scheme. When considering the application of Part IVA to a contemplated transaction, tax managers should consider alternative transactions that give rise to the same non-tax commercial outcome. A legislative constraint has been placed around the formulation of the counterfactual. This is a significant change that tax managers will need to factor into their corporate governance framework.
The changes are now proposed to apply from 16 November 2012, instead of 1 March 2012 as previously indicated. This is to be commended given the uncertainty taxpayers have faced since the initial March 2012 announcement. However, it is also clear recognition of the substantive change to the operation of Part IVA as we have known it over the last 30 years.
- As expected, the proposed changes focus on the concept of "tax benefit" for Part IVA purposes. The changes introduce several assumptions into the analysis of whether a "tax benefit" has been secured. For instance, tax costs associated with the alternatives must be ignored. This means that taxpayers will not be able to argue that, if the scheme had not been entered into, they would have otherwise "done nothing" because of the tax costs of an alternative postulate. However, the proposed rules go well beyond this – limiting the counterfactual to the same economic and commercial outcome achieved for the particular taxpayer by the alleged scheme; and
- The changes also call for a "single, holistic inquiry into whether a person participated in the scheme with a sole or dominant purpose of securing for the taxpayer a particular tax benefit in connection with the scheme". This is compared in the explanatory material with what is perceived as the current approach of starting the inquiry with a consideration of whether a particular taxpayer has secured a particular tax benefit in connection with the scheme. We expect that the main effect of the "holistic" approach will be that the identification of the tax benefit will not be a stand-alone question. Instead, it will be identified as part of analysing the sole or dominant purpose of the relevant parties, through applying the 8 factors listed in the redrafted section 177D.
Tax benefit – a more limited consideration of "alternative postulates"
While analysis of the alternative postulates or forms that a transaction may have taken remains an element of Part IVA necessary to identify the tax benefit obtained under a scheme, the proposed changes introduce several assumptions that limit what factors may be considered in the comparison.
The assumptions introduced by the proposed section 177CB are:
- that each scheme participant would have acted without regard to tax costs. This assumption is intended to prevent taxpayers arguing that, if the scheme had not been entered into, they would have otherwise "done nothing" because of the prohibitive tax costs of an alternative postulate. It is intended to deal with arguments successfully made by taxpayers in cases such as RCI Pty Ltd v FCT  FCAFC 104;
- that each scheme participant would have acted with the intention of achieving the same "non-tax effects" in connection with the scheme. "Non-tax effects" are defined to be effects other than those relating to the taxpayer's liability to income or withholding tax. This assumption is intended to prevent taxpayers from making arguments that, for example, if the relevant scheme had not been entered into, a different taxpayer would have disposed of a different asset to a different purchaser. Such an argument had been successfully advanced by the taxpayer in FCT v AXA Asia Pacific Holdings Ltd  FCAFC 134; and
- if the scheme did not achieve any non-tax effects, that all events and circumstances that existed but did not form part of the scheme would still have existed. This basically means that a hypothesis about what might have happened absent the scheme cannot involve a reconstruction of the state of affairs that existed apart from the scheme where the scheme had no non-tax effects.
As expected, the proposed assumptions effectively remove the taxpayer's ability to argue that in place of the scheme, the taxpayer would have done nothing if that conclusion resulted from the transaction being rendered uneconomic due to tax cost (proposed section 177CB(1)(a)). The "do nothing scenario" which the ATO found troublesome is mostly relevant to internal reorganisations, where the decision to act was voluntary. The majority of potential situations which call for a consideration of Part IVA (particularly where the tax benefit takes the form of a deduction) do not involve a do nothing alternative.
The more difficult aspect of the proposals will be whether mandating a "single, holistic inquiry" and directing that assumptions be made about the actions of persons have the effect of unduly widening the scope of Part IVA (proposed section 177CB(1)(b) and (c)). Measuring conduct against a hypothetical construct that may never in all reality have been acted upon seems a dubious and uncertain standard by which to measure tax avoidance. It also appears contrary to case law confirming that considering tax costs of a transaction are a normal part of doing business.
Next steps for tax managers
As a first step, tax managers will need to give careful thought to governance policies, including tax risk management policies, to support corporate actions.
When analysing a proposed transaction, you should also consider:
- What are the non-tax effects of the transaction?
- Are there other ways in which the same non-tax effects can be achieved for the particular taxpayer, regardless of any higher tax cost or the ability to carry out a different transaction in another vehicle?
- Are all the steps in the transaction capable of being explained by commercial or economic reasons?
- What evidence is available to support my position?
Interested parties may also wish to provide submissions to the Treasury on the draft legislation. Submissions are due on 19 December 2012.