On 16 November 2012, the Commonwealth government released draft legislation amending the general income tax anti-avoidance rule contained in Part IVA of the Income Tax Assessment Act 1936. Importantly, the government no longer proposes to retrospectively apply these changes from the date of its initial press release on 1 March 2012. Instead, the amendments will apply to all “schemes” – defined widely to include any action or course of conduct – entered into or commenced on or after 16 November 2012.

The government’s draft legislation and an explanatory memorandum can be found here.

What is Part IVA?

Part IVA is a general anti-avoidance rule which was originally enacted to counter blatant, artificial and contrived tax avoidance schemes. The proposed amendments will extend Part IVA’s reach and may significantly impact current or planned commercial transactions.

The proposed amendments follow the loss by the ATO of a string of recent Part IVA cases in the Full Federal and High Courts, three of which involved clients who were advised by our Australian tax disputes team.

Changes no longer retrospective

The government first announced its intention to amend Part IVA on 1 March 2012 when it announced a review of Part IVA to “protect the integrity of the tax system”.

The government originally said that the changes would apply to all schemes entered into or commenced on or after 1 March 2012. At that time, no draft legislation had been released and businesses were forced to anticipate the impact of the changes on their transactions.

Proposed amendments – changes to “tax benefit”

Part IVA applies where a taxpayer has obtained a tax benefit in connection with a scheme and it would be concluded, having regard to a number of factors, that a person who entered into or carried out the scheme or any part of it did so for sole or dominant purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme.

The definition of “tax benefit” has been interpreted by the Courts as requiring an analysis of what would or might reasonably be expected to have happened if the scheme had not been entered into or carried out. This process has been referred to as the identification of an “alternative postulate”. In broad terms, it will generally be concluded that the taxpayer has obtained a tax benefit where the most reasonable alternative postulate discloses a greater amount of tax payable than the tax payable under the scheme.

Narrowing the inquiry into the “alternative postulate”

The draft legislation inserts new section 177CB into Part IVA which directs the Court to make certain assumptions in identifying the alternative postulate:

  • First, tax consequences must be ignored.  The Court is to assume that, if the scheme had not been entered into or carried out, each person would have acted or refrained from acting without regard to anyone’s liability to tax. This is designed to prevent taxpayers from arguing that no tax benefit has been obtained because the tax costs of the alternative postulate identified by the ATO are too great.
  • Secondly, if the scheme has any non-tax consequences, the alternative postulate must achieve those same consequences. This amendment reflects the ATO’s concern that Part IVA currently allows for an unconstrained inquiry into the alternative postulate. This enabled taxpayers in recent cases to argue that no tax benefit had been obtained because the ATO identified the wrong taxpayer or the taxpayer would have “done nothing” in the absence of the scheme.
  • Thirdly, if the scheme does not have any non-tax consequences, it is to be assumed that all events and circumstances other than those which formed part of the scheme would have taken place.  This assumption means that the Court must compare the events which in fact took place with those same events absent the steps which make up the scheme. This is designed to ensure that the alternative postulate does not involve a reconstruction of the state of affairs that existed apart from the scheme.

“Purpose” before “tax benefit”

As currently drafted, before the dominant purpose test in section 177D is applied, Part IVA requires a determination as to whether a taxpayer has obtained a tax benefit. The proposed amendments seek to alter this position by restructuring the Part to restore the dominant purpose test as the “pivot” on which Part IVA operates.

Because the dominant purpose test concerns whether a purpose of the scheme was to obtain a “tax benefit”, it not at all clear that the proposed amendments will lead to a shift in the Courts’ approach of the kind envisaged. It seems more likely that Part IVA will continue to be approached in the same way, albeit the ATO will be able to rely on the statutory assumptions contained in new section 177CB.

Two limbs to “tax benefit”?

The explanatory memorandum to the draft legislation also sets out the government’s interpretation of the words “would... or might reasonably be expected” in the definition of “tax benefit”. The explanatory memorandum states that these words allow for two separate ways of working out whether a tax benefit has been obtained:

  • First, the “would” limb creates an annihilation test which allows for the excision of the scheme from events as they occurred. The question to be answered under this limb is whether the alleged tax benefit would have been obtained if all events had taken place except those forming part of the scheme.
  • Secondly, the “might reasonably be expected” limb creates a reconstruction test which requires the existence of a tax benefit to be determined by reference to the identification of an alternative postulate. This limb is consistent with the current approach mandated by the Courts.

In contrast with the two limb approach outlined above, the Courts have tended to interpret the phrase “would… or might reasonably be expected” as a composite phrase which does not give rise to separate tests. Despite comments to the contrary in the explanatory memorandum, there is nothing in the draft legislation to suggest that the two limb approach will be adopted by the Courts.


King & Wood Mallesons recommends that businesses review all commercial transactions entered into or implemented on or after 16 November 2012 to identify the impact of the proposed amendments. Our understanding of the ATO’s arguments in the cases noted above and its current concerns with Part IVA puts us in a unique position to assist in managing the impact of the changes.

If the proposed amendments are passed in their current form, businesses may face an even higher level of uncertainty in undertaking commercial deals.