The Federal Court recently had to consider the application of the scheme promoter penalty regime introduced by the Government in 2006 for the purpose of enhancing “community confidence in the tax system and produce a more efficient market for investment products, including tax effective investments, by providing for promoters to be at risk of penalties when they expose taxpayers to scheme penalties”.
In broad terms the alleged tax exploitation scheme involved the defendants:
- arranging investment in a fully financed timber project which had a product ruling
- arranging a secondary investment being investment in a fund which would engage in foreign exchange trading in order to provide profits to fund the loans used by the investors to acquire the woodlots in the timber project.
The commission received in respect of the acquisition of the woodlots, GST refunds to be obtained in respect of the acquisition of the woodlots and funds obtained from offering the woodlots to subsequent investors were to be paid into this foreign exchange trading fund.
Firstly an entity must not engage in conduct that results in that or another entity being a promoter of a tax exploitation scheme.
The word “promoter is expressly defined, amongst other things, by reference to two types of conduct namely “marketing” and “otherwise encouraging the growth of or interest in a scheme”. However there is nothing contained in the legislation to indicate what constitutes such conduct. Therefore the Court said one had to have regard to the context in interpreting what conduct fell within these expressions.
The question arose in the case as to whether or not mere development or implementation of a scheme was sufficient to constitute an entity as being a promoter of a tax exploitation scheme.
The Court held that the ordinary meaning of “marketing” in this context encompassed the actual, active promotion or selling of a scheme to the public or one or more investors.
It also held that in the context the expression “encouraging the growth of or interest in a scheme” was intended to encompass the promotion of schemes that are not marketed in a particular, “conventional” way such as conduct which might not amount to expressly making offers to investors to participate, but which otherwise encourages participation in a scheme but did not suggest a clear legislative intention to specifically bring conduct comprising mere development or implementation of a scheme within the ambit of the definition of “promoter”. This was supported by the fact that during the consultation period for enacting of the eventual provisions, design and implementation conduct had been deliberately excluded from the definition of ‘promoter”. Importantly, the Court held that this expression is not a limitless phrase that encompasses any type of conduct engaged in by an entity in respect of a scheme. Therefore the mere provision of documents to a taxpayer sign as part of a scheme did not constitute such conduct.
Another requirement to be a “promoter” is that the entity or an associate of the entity receives (directly or indirectly) consideration in respect of the above referred to conduct of marketing or encouragement.
Although the Court found that “consideration” is not to be given a restricted interpretation and therefore may include non-monetary benefits, nevertheless there needs to be a material connection between the consideration received (which may be received either directly or indirectly) and the marketing and encouragement conduct engaged in by the entity.
Therefore in the case before the Court the commissions and increased GST refunds which the Commissioner had said was the relevant consideration was a normal incident of the scheme and was not “related” to any promotion of the scheme. Therefore the alleged promoters had not received any consideration in connection with the promotions of the scheme.
Secondly an entity must not engage in conduct that results in a scheme that has been promoted on the basis of conformity with a product ruling being implemented in a way that is materially different from that described in the product ruling.
The Court held that just because some participants die not fall within the scope of the product ruling and hence are not entitled to take advantage of the tax benefits described in that product ruling did not mean the project was not implemented in accordance with the product ruling. In this case in fact the project had been implemented in accordance with the product ruling in that the woodlots and been planted and allocated in accordance with the ruling. The fact that some of the participants were not covered by the product ruling without more was not sufficient for the scheme not to have been implemented in accordance with the ruling.
The Court also held that because the secondary investment was not and was never intended to be the subject of the product ruling meant it was not caught by this provision.
Accordingly the Commissioner failed in his first case under these new promoter provisions.