Tax anti-avoidance law to be amended

Tax anti-avoidance law to be amended

The Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 was introduced into the House of Representatives on 13 February 2013. It contains amendments to Pt IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to ensure its effective operation as the income tax general anti-avoidance provision – see details below. Note that the amendments are different in a number of significant respects and approaches from those that were proposed in the exposure draft legislation that was released for public consultation on 16 November 2012.

(Note that the Bill also contains amendments to “modernise Australia’s domestic transfer pricing rules”.)

Background and summary

The amendments to Pt IVA deal with what the Government considers to be perceived weaknesses in the “tax benefit” concept in s 177C, which are considered to have reduced the effectiveness of Pt IVA in countering tax avoidance arrangements. In particular, the proposed amendments are intended to target these perceived deficiencies in s 177C and the way it interacts with other elements of Pt IVA, especially s 177D. However, the amendments are not otherwise intended to change the operation of Pt IVA.

The Assistant Treasurer said the proposed amendments seek to reinforce the view that the two limbs of the tax benefit element of Pt IVA in s 177C(1) – ie the “would have” and “might reasonably be expected to have” limbs – are alternative tests, and that there is not just one test that merely spans a spectrum of likelihood. The amendments also seek to ensure, in deciding whether an alternative to the scheme is reasonable, that regard is had to both the substance of the scheme and the non-tax results or consequences for the taxpayer that the scheme achieved. In making that decision, the tax consequences of the alternative will be ignored.

According to the Explanatory Memorandum to the Bill, recent decisions of the Full Federal Court concerning the way in which Pt IVA determines whether or not a “tax benefit” has been obtained in connection with an arrangement have revealed a weakness in the capacity of Pt IVA to effectively counter arrangements that, objectively viewed, have been carried out with a relevant tax avoidance purpose. These decisions include FCT v AXA Asia Pacific Holdings Ltd (2010) 81 ATR 180, RCI Pty Ltd v FCT [2011] FCAFC 104 and FCT v Futuris Corporation [2012] FCAFC 32. The object of the proposed amendments is to remedy these perceived weaknesses.

In summary, the amendments are intended to have the following technical effects:

• to require the application of Pt IVA to start with a consideration of whether a person participated in the scheme for the sole or dominant purpose of securing for the taxpayer a particular tax benefit in connection with the scheme and, thereby, to emphasise the dominant purpose test in s 177D as the “fulcrum” or “pivot” around which Pt IVA operates;

• to put beyond doubt that the “would have” and “might reasonably be expected to have” limbs of each of the s 177C(1) paras represent alternative bases upon which the existence of a tax benefit can be demonstrated;

• to ensure that, in situations where obtaining a tax benefit depends on the “would have” limb, that conclusion is based solely on a postulate that comprises all of the events or circumstances that actually happened or existed, other than those forming part of the scheme; and

• to ensure that, in situations where obtaining a tax benefit depends on the “might reasonably be expected to have” limb, that conclusion is based on a postulate that is a reasonable alternative to the scheme, having particular regard to the substance of the scheme and its effect for the taxpayer, but disregarding any potential tax costs.

Key features of amendments

When does Part IVA apply?

The proposed amendments provide that the first question to be answered when determining whether Pt IVA applies to a scheme is to ask whether a participant in the scheme had the requisite “purpose” of securing a tax benefit for the taxpayer in connection with the scheme, and that the question of whether a “tax benefit” was obtained in connection with the scheme follows as a subsidiary question. This amendment is intended to ensure that Pt IVA operates as an integrated whole, that is, by emphasising the central role of the dominant purpose test in s 177D as the “fulcrum” upon which Pt IVA turns and ensuring that s 177C, whose role is to define when a “tax benefit” has been obtained in connection with a scheme, is read in an appropriate inter-related, but subsidiary, way.

Alternative bases for identifying tax benefits

Under proposed new s 177CB(1), a conclusion that one of the paragraphs of s 177C(1) is satisfied would require a conclusion that one of the tax effects specified in that section “would have” or “might reasonably be expected to have” happened, absent a particular scheme. This provision is intended to put beyond doubt that the “would have” and “might reasonably be expected to have” limbs of each of the paragraphs in s 177C operate as equal alternative bases for identifying relevant tax effects.

Under proposed new s 177CB(2), a decision that a tax effect “would have” occurred if the scheme had not been entered into or carried out must be made solely on the basis of a postulate comprising all of the events or circumstances that actually happened or existed, other than those that form part of the scheme. This provision is intended to make it clear that, when postulating what would have occurred in the absence of the scheme, the scheme must be assumed not to have happened (ie it must be “annihilated”, “deleted” or “extinguished”).

However, the postulate must otherwise incorporate all the “events or circumstances that actually happened or existed”. In other words, the speculation that is permitted about any other state of affairs that might have come about if the scheme had not been entered into or carried out is limited to the removal of the scheme. A postulate cannot assume the existence of events or circumstances not in existence, nor can it assume the non-existence of events or circumstances that are in existence (other than those that form part of the scheme).

Accordingly, under this approach, a taxpayer will have obtained a tax benefit in connection with a scheme if it can be demonstrated that a relevant tax effect would have flowed, as a matter of law, from the application of the taxation law to the facts remaining once the scheme is assumed away.

Example: Deborah, a foreign resident, enters into an arrangement under which assessable income that would otherwise be derived by her from Australian sources is instead derived by her from foreign sources, with the result that it is not assessable in Australia. If the scheme had not been entered into, the income would have been included in Deborah’s assessable income because the only operation of the scheme was to change the source of the income for taxation purposes. The tax benefit is the reduction in Deborah’s assessable income. No speculation is necessary or permitted in deciding what else might have happened if Deborah had not entered into the scheme.

Under proposed new ss 177CB(3) and (4), a decision that a tax effect “might reasonably be expected to have” occurred if a scheme had not been entered into or carried out must be made on the basis of a postulate that is a reasonable alternative to the scheme, having particular regard to the “substance of the scheme” and its “results and consequences for the taxpayer”, and “disregarding any potential tax results” and consequences.

This amendment is intended to make it clear that when postulating what might reasonably be expected to have occurred in the absence of a scheme, it is not enough to simply assume the non-existence of the scheme – the postulate must represent a reasonable alternative to the scheme, in the sense that it could reasonably take the place of the scheme. Such a postulate will necessarily require speculation about the state of affairs that would have existed if the scheme had not been entered into or carried out. This may include speculation about the way in which related transactions would have been modified if they had had to accommodate the absence of the scheme. As a result, under this approach, a taxpayer will obtain a tax benefit in connection with a scheme if it can be demonstrated that a relevant tax effect would have flowed, as a matter of law, from the application of the taxation law to the alternative postulate.

Example: Mr and Mrs Heginbothom want to borrow money to acquire both a family home and a holiday house that they plan to rent to holidaymakers. They borrow the money under an arrangement in which the repayments are applied exclusively to the borrowing in relation to the family home. The result is that the deductible interest payments are increased for the holiday home borrowing and the non-deductible interest payments for the family home borrowing are minimised. Merely annihilating the scheme would not leave a sensible result because there would be no borrowing at all, so some reconstruction is necessary. It is therefore necessary to consider what might reasonably be expected to have happened if the scheme had not been entered into. A reasonable alternative in this case might be that the Heginbothoms took out two loans, one for each of the homes they wished to acquire, each of which was entered into on normal commercial terms.

This approach will typically apply to an income scheme (or a withholding tax scheme) that both produces and shelters economic gains and in relation to schemes that result in a taxpayer obtaining a tax advantage in the form of a deduction benefit, a capital loss benefit, a foreign tax offset benefit or a withholding tax benefit (current ss 177CB(1)(b) – (e)). Furthermore, if a postulate that the scheme merely would not have happened would be inconsistent with the non-tax results and consequences sought for the taxpayer by the participants in the scheme, then a reconstruction of the scheme may expose other ways in which the non-tax results and consequences of the scheme could reasonably have been achieved without the impugned tax advantages.

The matters to which particular regard must be had

Specifically, proposed new s 177CB(4)(a) provides that in determining whether a postulate is a reasonable alternative to the entering into or carrying out of the scheme, particular regard must be had to (a) the “substance of the scheme” and to (b) “any result or consequence for the taxpayer that would be achieved by the scheme” (tax results aside). As a result, a tax advantage cannot meaningfully be linked to a scheme by comparing the tax consequences of the scheme to the tax consequences that would have flowed if the parties had chosen to pursue some other objective. Instead, to provide a meaningful comparison, the tax consequences of the scheme should be compared with the tax consequences of an alternative that is reasonably capable of achieving for the taxpayer substantially the same non-tax results and consequences as those achieved by the scheme.

An examination of the “substance of a scheme” requires a consideration of its commercial and economic substance, as distinct from its legal form or shape. Further, in order for a postulate to constitute a reasonable alternative to the entering into and carrying out of the scheme, the substance of the postulate should correspond to the substance of the scheme.

Example: Assume Paul & Co placed $1 million dollars on deposit for 12 months for a return of $50,000, payable in arrears. The income produced by the investment is exempt for taxation purposes. From Paul & Co’s perspective, the substance of the transaction is an investment for a fixed term carrying a right to a non-contingent return. A reasonable alternative to this transaction would be an investment of the same amount, for the same period at a comparable risk and for a comparable return. An investment in ordinary shares would not represent an investment of comparable risk and comparable return.

An examination of the “results or consequences” for the taxpayer that would be achieved by the scheme (tax results aside) requires a consideration of any financial or other consequences for the taxpayer that would be accomplished or achieved as an end result of the scheme having been entered into and carried out. Such matters could include changes in the taxpayer’s financial position that result from the scheme (including the impact of transaction costs such as fees, stamp duties and payroll taxes) and also non-financial considerations (such as the effect that the scheme has on personal or family relationships), or the fact that the scheme, eg satisfied certain regulatory requirements (such as directors’ duties or workplace health or safety requirements).

Importantly, it would be expected that a postulate that is a reasonable alternative to the entering into and carrying out of a scheme would achieve for the taxpayer non-tax results and consequences that are comparable to those achieved by the scheme itself. In short, these amendments are intended to make it clear that the focus is on the results and consequences achieved by the scheme for the taxpayer, as distinct from the results and consequences achieved for one or more of the other participants in the scheme.

Schemes within broader transactions

Under the proposed amendments, where a scheme forms part of a broader commercial transaction, a postulate would be a reasonable alternative to the scheme if it performs the same role in relation to the broader transaction that the scheme itself performs, disregarding its tax effects. Thus, if the scheme itself has no non-tax results and consequences and the broader transaction remains effective without the scheme, there would be no warrant for an alternative postulate involving a reconstruction of the broader transaction.

Where a scheme is integral to a broader transaction and facilitates it in some way, then it would be reasonable for an alternative postulate to involve a reconstruction of the broader transaction, so long as the reconstruction produces the same non-tax results and consequences as were in fact achieved by the broader transaction. However, the extent to which the broader transaction is reconstructed should be limited by the role the scheme plays in that transaction.

Example: Assume that in order for Kerry-Anne to secure a tax deduction for borrowing money to invest in an offshore company (Offshore Co) it is necessary for her to interpose a resident Australian company. She does this by using the borrowed funds to buy shares in an Australian shelf company (Oz Co). In turn, Oz Co buys ordinary shares in Offshore Co. Oz Co performs no other role. The Commissioner makes a Pt IVA determination on the basis that the interposition of Oz Co is a scheme to which Pt IVA applies. Objectively viewed, the interposition of Oz Co achieves two effects. One is securing a deduction for interest on the borrowing, and the other is the acquisition of shares in Offshore Co. A correct alternative postulate should be another way in which Kerry-Anne could reasonably be expected to have acquired ordinary shares in Offshore Co. An alternative postulate that involved Kerry-Anne lending the borrowed monies to Offshore Co would achieve a different effect. So too would a postulate that involved Kerry-Anne investing the borrowed monies in a completely different company.

Disregarding tax costs

Finally, the proposed amendments make it clear that, in determining whether a postulate is a reasonable alternative to the entering into or carrying out of the scheme, regard should not be had to any tax costs that are generated for the taxpayer by the scheme itself or that would be generated for the taxpayer or any other person. In short, potential tax liabilities are not to be taken into account in assessing the likelihood or reasonableness of any alternative postulate. Further, the disregarding of the potential tax liability of a person extends not just to the taxpayer and participants in the scheme but to any person who might be a potential participant in an alternative to a scheme. This amendment intends to make it clear that alternative postulates should not be rejected as unreasonable postulates on the grounds that the tax costs involved in undertaking those postulates (including denial of the tax benefit impugned by Pt IVA) would have caused the parties to either abandon or indefinitely defer the schemes and/or the wider transactions of which they were a part.

Date of effect

The amendments apply in relation to schemes that were entered into, or that were commenced to be carried out, on or after 16 November 2012, the date on which the exposure draft of this Bill was released for public consultation.

Source: Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 and Explanatory Memorandum, www.aph.gov.au/Parliamentary_Business/Bills_Legislation/Bills_Search_Results/Result?bId=r4965.