Tax Brief
8 April 2011
Part IVA Outbreak
It was almost 15 years before the first significant judgment on the operation of
Part IVA was handed down. In the last 2 years the Federal Court has delivered
ten more, and the Part IVA world became even busier when Treasury released a
Discussion Paper in November 2010 on ‘improving the operation’ of Australia’s
anti-avoidance rules. This Tax Brief examines these recent developments, both
for the light they shed on the current operation of Part IVA and for what they
reveal about how Part IVA might be changing in the near future.
Background
The cases
The spate of judgments on Part IVA began in March 2009 with the decision in
BHP-Billiton Finance followed later in the year by Ashwick, AXA Asia Pacific
Holdings and British and American Tobacco Australia Services Ltd. The cases in
2010 were News Australia Holdings Pty Ltd (May 2010), Trail Bros Steel and
Plastics Pty Ltd (July 2010), Citigroup Pty Ltd (August 2010), Futuris Corporation
Limited (August 2010) and RCI Pty Ltd (September 2010) and so far in 2011 the
Federal Court has handed down the decision in Noza Holdings (February 2011)
and the appeal in Ashwick (April 2011).
The results of these cases were initially split – the ATO won four (British and
American Tobacco, Trail Bros, RCI and Citigroup) while the taxpayers won six
(BHP-Billiton, Ashwick, AXA Asia Pacific, News Australia Holdings, Futuris and
Noza Holdings). The appeals process in relation to some of the cases has come
to an end with the High Court refusing to accept the appeal application (AXA Asia
Pacific and BHP-Billiton). In other cases, appeal courts have heard the appeal but
decided not to change the result in the lower Court (News Australia Holdings,
Trail Bros and Ashwick). At the time of writing, appeals are pending from some of
these decisions (British American Tobacco, Citigroup, Futuris, RCI and Noza
Holdings). While it is possible that these figures could yet change, the results so
far unquestionably show the highly contingent nature of all Part IVA proceedings.
Each of the cases involved complex commercial structures and transactions
which we will not attempt to describe in detail. But, at the risk of over-simplifying
them, in general terms the cases involved:
•
BHP-Billiton Finance and Ashwick: deducting accruing interest and losses on
writing off sizeable bad debts owed by group companies to an in-house
finance company;
•
AXA Asia Pacific Holdings: the sale of a subsidiary in exchange for shares,
and electing to apply the scrip-for-scrip rollover provisions to defer tax on the
resulting gain;
•
British and American Tobacco Australia Services Ltd: the intra-group transfer
of assets occurring prior to a corporate merger, the subsequent sale of those
assets to parties outside the merged group, and offsetting of the resulting
capital gains against existing capital losses;
•
News Australia Holdings Pty Ltd: transactions implemented in order to
relocate the headquarters of News Corporation from Australia to the USA;
•
Trail Bros Steel and Plastics Pty Ltd: contributions to a fund for employees;
•
Citigroup Pty Ltd: fund-raising through a structured finance product which
generated a liability to foreign tax and a claim in Australia for a foreign
income tax offset;
•
Futuris Corporation Limited: the reorganisation of a corporate group prior to
the public listing of a subsidiary;
•
RCI Pty Ltd: the payment of a dividend from an offshore subsidiary which
occurred prior to the sale of the subsidiary; and
•
Noza Holdings: the deductibility to the Australian company of dividends paid
on shares that were re-classified as debt under Australia’s debt-equity rules,
and the liability to Australian withholding tax of the US-resident shareholders.
In these cases, the ATO appears to have decided to adopt the practice of adding
a Part IVA claim to each of the substantive issues involved. Whether or not this
represents a new tactic in the conduct of tax litigation, it is certainly proving a
fertile source for fresh case law on the operation and interpretation of Part IVA.
The scope of the ‘scheme’
Many of the early cases on Part IVA involved disputes about the definition of the
‘scheme’ which was said to have been implemented. The results of those cases
had led to a sense of resignation – a general impression that there was little to be
gained from protracted disputes about the exact size and contents of the
‘scheme.’ The decision at first instance in Ashwick is, therefore, a little surprising
in that the judge based his conclusion that Part IVA did not apply on the
proposition that lending money at interest to related companies did not amount to
a ‘scheme’ at all for the purposes of Part IVA. This approach was not confirmed
on appeal, with the Court concluding that there was a ‘scheme’ evident on the
facts.
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Part IVA Outbreak
Leaving Ashwick to one side, several of the recent cases have tried new
approaches to challenging Part IVA determinations, relying on arguments about
the ‘scheme.’
There had always been an intuition that defining the scope of the relevant
scheme quite broadly could prove to be important for taxpayers facing a Part IVA
determination. The logic was that it would be harder to conclude that tax
avoidance was the taxpayer’s principal objective if the taxpayer had done many
things under the identified (broad) scheme. Earlier cases had cast doubt on that
wisdom.
British and American Tobacco Australia Services Ltd was an attempt to see if the
reverse argument would fare any better. In this case, the taxpayer was about to
be absorbed into another corporate group (which had available capital losses)
and was being obliged to divest itself of certain assets (which would generate
capital gains when sold to a third party external to the taxpayer’s corporate group)
as part of the merger process. The taxpayer’s management decided to sequence
these events so that the taxpayer became part of the acquiring group, transferred
the assets to another group company (electing to rollover the resulting gain),
which then sold the assets to the outside buyer, triggering the gain, which could
be grouped with the losses of companies in the acquiring group. Part of the
taxpayer’s argument was that the scheme for Part IVA purposes consisted just of
making the election to roll-over the asset, and a scheme that consisted of making
such an election was immunised from Part IVA under a special provision. This
provision gives effect to the obvious notion that if one part of the Act deliberately
offers a taxpayer some form of tax relief, Part IVA should not contradict that offer.
The taxpayer lost the argument that the ATO’s scheme was too big largely on the
basis that its management was alive to the tax issues involved for a long period of
time:
… the planning for and implementation of the scheme identified by the
Commissioner and described above, in relation to the making of the
choice by the Taxpayer … commenced many months before the actual
disposal by the Taxpayer of the [assets] on 3 September 1999 and
continued for some time after that disposal. Thus, the scheme consisted
of much more than the mere making of the rollover choice or election.
The conclusion is perhaps not surprising and was upheld on appeal to the Full
Federal Court.
Schemes that are protected from Part IVA. As was noted above, a specific
provision in Part IVA switches off its effects where another part of the Act
deliberately offers a taxpayer some form of tax relief. Part IVA should not defeat
that provision on the assumption that any tax concession was intended.
At first instance, the judge in Ashwick took the view that the deductions claimed
by the recipients of tax losses, transferred to them by other group companies,
were protected from challenge by this provision – the deductions arose from ‘the
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Part IVA Outbreak
making of [an] agreement [that was] expressly provided for by this Act …’ The
appeal court approached the matter somewhat differently, relying instead on a
finding that the scheme was not carried out with the necessary purpose of
securing the tax benefit.
Noza Holdings also sought to rely on this section to immunise a transaction
against attack under Part IVA. In this case, the taxpayer claimed that the election
to consolidate all the Australian subsidiaries of the US parent into a consolidated
entity for tax purposes, protected it. The Court disagreed finding that the tax
benefit in question – the deduction for dividends paid on shares that are reclassified as debt – arose from a fact that bore no connection to the decision
Noza had made to form a consolidated group.
Connecting the scheme and the tax benefit. Two of the cases, RCI and Futuris
involved a slightly different argument about the scope of the relevant scheme.
The question in these cases was, what happens where the scheme identified by
the ATO does not actually involve a step which triggers a lesser amount of
taxable income?
RCI arose out of the reorganisation of James Hardie Industries. An offshore
subsidiary paid a substantial tax exempt dividend to its Australian parent in March
1998. In October 1998, the parent sold the shares in the offshore subsidiary. The
ATO’s argument was that the payment of the dividend was done to deplete the
value of the offshore subsidiary and thus reduce the amount of taxable capital
gain realised on the sale of the subsidiary some seven months later. The ATO
argued (as its narrow definition of the scheme) that the ‘scheme’ undertaken by
the parent consisted just of the payment of the dividend. The taxpayer’s response
was that no tax benefit (a reduced capital gain on sale of the shares) arose from
that step – any tax benefit arose as a result of the sale of the shares, and the sale
was not included in the scheme as the ATO had defined it. The court, however,
disagreed. It noted that the tax benefit only has to arise ‘in connection with the
scheme.’ The reduced capital gain was sufficiently connected to the payment of
the dividend.
The same issue arose in Futuris. This case involved the public float of a division
of the company and, in particular, the tax consequences of the various steps
undertaken in order to consolidate the relevant assets into the float vehicle.
These steps involved the movement of assets, the tidying up of cross
shareholdings and the capitalisation of the various debts into additional equity.
Again, the narrow scheme identified by the ATO focused on the steps involved in
tidying up the corporate structure; it did not include the sale of the shares in the
float vehicle. Nevertheless, the court considered that any tax benefit that might
have arisen on the eventual sale of the shares would still have arisen ‘in
connection with’ the restructuring transactions.
One scheme or several schemes? RCI also raises a more general question: a
dividend was paid by a subsidiary and 7 months later, a parent sold shares in that
company, but should these transactions be linked to form a single scheme? A tax
benefit must arise in connection with a scheme but why was the sale not its own
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‘scheme’ – that is, just another subsequent transaction? Companies often pay
dividends; why was this dividend not just a discrete transaction, unrelated to the
sale, especially considering that it was paid 7 months prior to the sale?
The court was clearly alive to this issue but decided that the two transactions
were in fact connected on the documentary evidence. The dividend and the share
sale were both mentioned in the documents emanating from ‘Project Chelsea’ –
the name given to the project established to bring about the divestiture of the
offshore subsidiary – including documents which pre-dated the payment of the
dividend by many months.
Purpose
The least predictable element in the operation of Part IVA is always determining
the sole or dominant purpose of one or more persons who implemented the
scheme. The new cases show again just how contentious the process of finding
purpose can be, especially when purpose is intended to be determined
‘objectively.’ That is, asking why this taxpayer did what it did is the wrong
question. The right question is, why would somebody else have done what this
taxpayer did?
Significance of the taxpayer’s stated purpose. The dispute in News Australia
Holdings arose from the complex series of transactions implemented in order to
relocate News Corporation’s headquarters from Australia to the USA and
subsequent internal reorganisations. One of the contested issues in the case
arose from the restriction that the relocation was to be undertaken subject to a
strict requirement that it should generate ‘no tax and no tax risk.’
Ordinarily, in Part IVA cases, the taxpayer will attempt to argue that tax
considerations were the furthest thing from its mind. But the taxpayer in News
Australia Holdings had clearly made tax considerations a critical element in
planning its restructuring and had gone on the record about just how vital tax
issues were (albeit limiting tax risk, rather than seeking a tax benefit). So this
case presented a novel twist on the usual pattern.
Earlier cases had established that the taxpayer’s own assertions that tax was
insignificant were not relevant in deciding the case. But what should follow when
the taxpayer asserts, instead, that tax was extremely significant in its planning?
The ATO was on the horns of a dilemma. It was clearly very tempting to use the
‘no tax; no tax risk’ policy as evidence that the taxpayer had implemented the
relocation in a particular manner with the sole or dominant purpose of avoiding
Australian tax. The ATO, however, did not rise to the bait. Instead, in the appeal
from the decision of the AAT, the ATO put its case entirely on the basis that the
taxpayer’s own reasons were irrelevant in applying the purpose test, whether to
exonerate the taxpayer or to damn it. In the result, the court concluded that it
could find no error in the decision of the AAT (that the “no tax, no tax risk” edict
was an objective fact to which reference could be made) and its holding that Part
IVA did not apply.
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Part IVA Outbreak
Inconsistent goals. Another issue which arose in RCI was how to reconcile two
competing and inconsistent purposes.
As was noted above, the case revolved around the payment of a substantial
dividend back to Australia by a subsidiary which was sold 7 months later. There
was evidence that the taxpayer was suffering losses in Australia and it wanted
funds in Australia which would be invested to generate income that could be
applied against those losses. This evidence was led, presumably, to suggest that
the purpose of procuring the dividend was to derive greater assessable income in
Australia rather than less, from the return of those funds to Australia as a
dividend. The ATO’s case was that the dividend was paid in order to reduce the
capital gain that would be derived when the foreign subsidiary was sold. If that
interpretation was accepted, the purpose of procuring the dividend would be to
ensure a smaller amount of taxable capital gain. Which of the two conflicting
goals should be considered the taxpayer’s dominant purpose?
Again, the court resolved this question largely on the evidence. The court
concluded that, ‘careful consideration of the evidence’ did not support the
argument that the payment of the dividend had its own independent commercial
rationale. This finding, of course, makes the conceptual problem disappear. If the
dividend was paid principally to deplete the assets of the offshore subsidiary,
there is no inconsistency. It seems inevitable that all such arguments will end up
being handled in this manner – the court will draw its own conclusion about which
of two or more competing purposes was the more influential, and decide the case
accordingly.
Significance of timing on finding purpose. In British and American Tobacco
Australia Services Ltd the Court was obviously influenced by the fact that the
taxpayer’s management had consciously waited until the merger was complete
before entering the contract to sell the assets to an external party. The terms of
the asset sale were largely agreed in April 1999, and formalised in July 1999 but
on terms such that the contract for sale would not arise until after the share
transaction was complete, which happened in September 1999. It was not just
that completion would not occur until after the merger; no contract would arise
until after the merger, even though the terms of the sale had largely been
finalised in July. The court was obviously influenced by the fact that the taxpayer
consciously chose to defer the asset sale for 6 months until the group relationship
could be established.
The taxpayer’s principal argument – that what it was doing was being done to
comply with requirements of the competition regulator – was not decisive. Indeed,
it was probably never going to be sufficient because the scheme was regarded as
all about how that asset divestiture was done. As the court put it, the relevant
question is why the taxpayer went to the effort of creating a situation where it was
possible to elect to rollover the gain. Other arguments about the commercial
convenience and neatness in having all the assets in a single vendor were
dismissed by the court.
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Part IVA Outbreak
On the other hand, the taxpayer in Noza Holdings successfully relied on the
timing of the various events to diminish the inference that its dominant purpose
was to avoid tax. The taxpayer’s evidence was that it had finalised the relevant
share issues and dividend flows at a point in time, and then happened to uncover
a new and significant accounting difficulty arising from US GAAP with respect to
foreign exchange gains and loss rules. And so, it was in order to solve an
accounting problem that the taxpayer then modified its plans and made the
foreign exchange issues disappear. As it happened, those steps also triggered
the circumstance that a large tax deduction arose in Australia. But the Court was
clearly not satisfied that the Australian tax effect had been sought:
“When then it is observed (1) that the transactions had been partly
effected (2) a problem emerged that required solution and (3) the
solution chosen (which it was thought had very favourable taxation
consequences) was chosen to avoid disturbance of the arrangements
that had already been made and upon which the participants had relied
in securing a favourable Private Letter Ruling from the [US tax
authorities], the conclusion that [Part IVA] is not engaged must follow.”
Seeking a commercial profit v. seeking a tax benefit. The 1996 High Court
decision in Spotless Services had already considered whether a taxpayer could
defeat a Part IVA determination on the basis that its goal was simply to enhance
its profit, rather than secure a tax benefit. The High Court concluded that this was
a false dichotomy where the profit only happened from the taxpayer securing the
tax benefit. If the tax benefit generated the profit, then pursuing the profit meant
the same thing as pursuing the tax benefit. The decision in Citigroup involves the
same kind of territory.
The taxpayer in Citigroup was apparently keen to give itself higher visibility in a
Hong Kong bond market and embarked upon a coupon-stripping transaction as
the means of doing so. In the process, it raised about USD50m from external
parties. The effect of the coupon strip was to trigger a liability to tax in Hong
Kong, the amount of tax being based on the gross proceeds from the sale of the
coupons and being payable in the year when the strip occurred. In Australia,
however, the amount of income would be spread over several years, leading to a
surplus foreign tax credit in the first year, which could be applied against the tax
due on other lightly-taxed foreign source income.
Judging from the report of the case, the taxpayer’s arguments as to purpose
appeared to revolve around three propositions: that the transaction was entirely
unexceptional in Hong Kong (indeed it even had the benefit of a tax ruling from
the Hong Kong tax authorities); the company could not have been trying to save
tax because an Australian tax offset can only arise from paying tax; and the
company had little interest in having a tax offset because it did not expect to be
earning lightly-taxed foreign income from other sources.
Ultimately, the court was unpersuaded by these arguments. The fact that the
transaction was untoward in Hong Kong was not relevant to Part IVA; the fact that
the group’s total tax cost was unaffected was not relevant – what matters for Part
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Part IVA Outbreak
IVA is whether the Australian component of the tax was reduced; and the
evidence did not support the argument that the tax offset was not likely to be
useful – there was sufficient evidence to suggest that the taxpayer was probably
going to be earning other lightly-taxed foreign income.
But the core of the judgment appears to be the judge’s conclusion that securing
the tax offset in Australia was critical to making a profit on the transaction. The
judge’s analysis was that (i) the transaction was, at best, slightly profitable before
tax; (ii) loss-making after the Hong Kong tax was subtracted (but before the
Australian tax offset was factored in); and (iii) slightly profitable again once the
Australian tax offset was considered. As the judge put it, ‘the post-tax position is
negative or in loss … but applying foreign tax credit relief in both situations …, the
tables both disclose post-tax positive or profit situations.’ Viewed in this light, the
conclusion that securing the tax offset in Australia was an important consideration
is probably not surprising.
The relevant counterfactual
One of the critical questions in any Part IVA case is to determine the relevant
counterfactual: what might have happened, but didn’t. The existence of a tax
benefit and the amount of the tax benefit is dictated by the counterfactual. But this
is obviously a very fraught process because it involves speculating about what
the taxpayer might have done. The range of things that a taxpayer might have
done – but didn’t – is almost unbounded, and yet it is a vital step in the operation
of Part IVA.
Until now, apart from Peabody’s case, ascertaining the counterfactual has not
been an especially contentious step. Several of the cases being examined in this
Tax Brief offer new and important insights into this aspect of Part IVA. Indeed,
some of the cases have been won because the taxpayer was able to show that
there was no reasonable counterfactual – the alternatives advanced by the ATO
were simply unreasonable or failed to accomplish the same commercial outcome.
Reasonableness of the alternative. The structure of the legislation imposes
some constraints on this enquiry. It requires that the counterfactual be
‘reasonable.’ In AXA Asia Pacific Holdings the taxpayer, a parent company, sold
a subsidiary and claimed it was entitled to enjoy the benefit of the scrip-for-scrip
rollover provisions. The ATO submitted that the taxpayer would have embarked
upon a number of possible alternatives, were it not for the purpose of securing the
tax benefit that the scrip-for-scrip provisions afforded, although it offered no
evidence about this.
The taxpayer won at first instance and on appeal largely because the court
disagreed with the counterfactuals proposed by the ATO. The court considered
them unreasonable for two main reasons. First, the relevant counterfactual must
have been one in which the investment bank would still have been able to collect
a sizeable fee on the transaction. Secondly, a counterfactual which involved the
investment bank buying the subsidiary was unreasonable because of the
contemporaneous documentary evidence indicating that the bank did not want
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the subsidiary complicating the process of entry into the consolidation system
which the bank was undertaking at about the same time. The court considered it
highly likely that the investment bank, ‘would, in my estimation, have had every
reason to insist that there was some other, ideally structural, ingredient of the
proposed transaction that insulated [the investment bank] from the risk of having
[the target company] included as part of its consolidated group.’
In short, while the sellers might have been more than willing to enter the
alternative transactions that the ATO offered, the buyer in those hypothesised
transactions would not have made the offers upon which the Commissioner’s
case depended. That made the alternatives unreasonable and the attack under
Part IVA miscarried. The validity of this analysis was upheld on appeal.
The same kind of issue arose in Futuris. The taxpayer wanted to float a portion of
its business and, in order to do so, transferred a number of assets to other group
companies, tidied up some cross shareholdings and capitalised some existing
debts. These transactions had the effect of triggering capital gains tax, deferred in
some cases by rollovers, and invoking the value shifting rules. The court decided
in the taxpayer’s favour on the basis that it simply would not have implemented
some of the possible counterfactual transactions. One possibility – that all of the
assets would have been transferred to a new float vehicle – was discounted on
the basis that it would have triggered substantial stamp duty. Another possibility
– that the assets would have been transferred to one of the existing subsidiaries –
was discounted on the basis that it would have triggered capital gains tax twice
within the corporate group. A third possibility – that the assets would have been
sold to a different existing subsidiary – was discounted on the basis that it would
have generated an even larger capital gain than the second alternative.
Before moving on, it is worth pausing to note the interesting role that triggering
higher tax plays in the judge’s reasoning in Futuris. A tax benefit can only arise
from an alternative which involves higher tax. But the judge viewed some of the
alternatives which triggered higher gains (and thus tax) as being unreasonable for
that very reason. There is a tension here. There must an alternative which would
have triggered higher tax, but the very fact that it triggers higher tax could make
the alternative unreasonable.
Perhaps the lasting importance of this case is in what it says about handling Part
IVA controversies. It shows the importance of the use of expert evidence and the
role that experts may increasingly play – to opine on what was commercial or
implausible.
Who has the responsibility? Several of the cases have involved disputes about
the onus of proving what might have happened in lieu of the actual events. Must
the ATO set out a reasonable alternative that leads to higher taxable income, and
which the taxpayer must then defeat? Or is it the taxpayer’s responsibility to set
out the range of alternatives and then demonstrate why (i) some are not real
alternatives – they do not achieve the same commercial outcome; (ii) some are
unreasonable – they are simply too expensive to implement; (iii) the rest would
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not have involved a higher amount of tax; and (iv) the ones that did involve more
tax, would have involved other taxpayers?
It now seems reasonably clear that the ATO does not have to show what would
have happened instead of the scheme. In Futuris, the taxpayer had applied to the
court in earlier proceedings for an order that the ATO provide particulars of the
relevant counterfactual being used to calculate the amount of the alleged tax
benefit. The court refused to give the order and this was noted in the later
litigation in August 2010. In the second case, the court quoted from the earlier
decision that, ‘it is for the [taxpayer], who bears the onus, to establish a series of
transactions or arrangements which, it contends, would have ... resulted ...’
Further, the court observed that if the ATO does propose a counterfactual, ‘it is
not enough for [the taxpayer] to disapprove any alternative ... put up by [the
ATO]... [It] must also adduce evidence which satisfies the court that it had an
alternative ... which it would have been able to implement and which would have
resulted in the same taxable position as ... the scheme ... [or] some other taxable
position.’
In short, it is the taxpayer’s responsibility, and the taxpayer is entitled to win if it
proposes a reasonable alternative and can convince the court that the alternative
was plausible, likely and would have resulted in no more tax, or perhaps even
less. And presumably the taxpayer is also entitled to win if it can demonstrate that
there is no reasonable alternative that would accomplish the commercial objective
that it sought.
The possibility that there might be no alternative that could accomplish the same
commercial outcome arose in Noza Holdings. In that case, the taxpayer claimed
deductions for dividends on shares that were re-classified as debt under
Australia’s debt-equity rules. The ATO argued that all the companies in the chain
could instead have issued ordinary shares, which would be classified as equity
instruments in Australia, and not generated a tax deduction when dividends were
paid from Australia. However, one of the offshore companies had already
negotiated its position with US tax authorities on the basis that the share issues
would be debt for US tax purposes, and the ATO was not able to identify any
instrument that could successfully straddle the debt-equity divide in both
countries, for both tax and commercial purposes.
Is the alternative affected by the circumstances of the taxpayer? It is now
well established that, in Part IVA, the search for the ‘purpose’ of the scheme is
objectively determined – that is, the issue is not why did this taxpayer do what
they did? Rather, the issue is why would somebody else have done what the
taxpayer did?
When it comes to the counterfactual, the same question is in play. That is, given
the broad range of alternatives that might have been implemented, does the court
ask, what is it reasonable to expect that this taxpayer would have done instead?
Or does the court ask, what is it reasonable to expect that some putative
representative taxpayer might have done? To put it a little more colourfully, is it a
defence to a Part IVA assessment to argue that this taxpayer is the kind of person
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who would have just kept on looking for some other ‘no tax’ option, and would
have continued down that path until one was found? Can the taxpayer win its
case on the argument that, the idea that it would just have given up, and agreed
to implement the transaction in a way that triggered tax, is simply implausible?
This question lay behind the dispute in Trail Bros. The case arose out of the
enactment of the age-based limits on deductible superannuation contributions in
1997. Faced with a cap on the amount that it could contribute in a tax effective
manner, the employer ceased contributing to the superannuation fund and began
instead to make contributions to an employee benefit trust, claiming a deduction
for the contributions. The Administrative Appeals Tribunal which heard the case
at first instance found for the taxpayer on the basis that there was no ‘tax benefit.’
The tribunal came to this conclusion because of its view that, assuming the
taxpayer did not make a contribution to the employee benefit trust, it would simply
have implemented some other transaction that triggered a similar tax deduction.
When the case came to the Full Federal Court, it was affected by the lack of
evidence led before the AAT. However, it seems clear that the court considered
that the relevant counterfactual is to be determined by looking at this taxpayer. It
was unfortunate for the taxpayer, therefore, that it had not led any evidence to
suggest what it would have done instead of implementing the employee benefit
trust structure.
The same kind of approach was adopted in Futuris. The judge was content to
conclude that none of the alternative transactions proposed by the ATO was
reasonably likely, and so no tax benefit arose. The judge approached the
question by asking in effect, what would this taxpayer have done instead? And he
answered that question by concluding it was unreasonable to expect that the
taxpayer would have implemented some of the options that were more expensive
in terms of tax.
A similar issue arose in News Australia Holdings where the court appeared to
accept the taxpayer’s argument that if it were not able to implement the
restructuring transaction without tax, it would have persisted with a tax inefficient
structure until a “no tax” means of restructuring could be identified. A similar
approach is evident in AXA Asia Pacific Holdings where the first instance judge
placed significant reliance on testimony of representatives of the investment bank
and the taxpayer that the alternative transactions identified by the ATO were not
ones they would have contemplated.
However, in Futuris the court cautioned that, ‘the counterfactual must not itself be
a scheme with a dominant tax purpose.’ This seems to suggest that the relevance
of the taxpayer’s own preferences is limited. So there appears to be a tension that
has to be managed. On the one hand, the taxpayer is free to argue that it would
have pursued some other tax-effective option, but the argument will not help the
taxpayer if the tax-effective option is considered by the court to be just a different
tax avoidance scheme.
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What survives to be considered? There is another conceptual conundrum
underlying the process of identifying what might have happened, but didn’t. How
much of what actually happened is to be disregarded? Does Part IVA require
everything that happened to be ignored, or can some of the things that did
happen survive to form part of the counterfactual?
This issue was argued in AXA Asia Pacific Holdings. The taxpayer argued that an
earlier decision, Lenzo, put serious obstacles in the ATO’s path because the
counterfactuals being offered involved some of the steps that actually occurred.
The taxpayer had argued that the Lenzo decision stood for a series of
propositions: that Part IVA (a) required the ATO to cancel everything that did
happen, and (b) to set out what would have happened but didn’t, but that (c) in
doing step (b), the ATO could not put up as part of the counterfactual an
alternative which involved any of the steps which had actually occurred. In the
words of the legislation, the taxpayer is to be dealt with on the basis that would
have applied ‘if the scheme had not been entered into or carried out.’
The issue arose because the counterfactual presented by the ATO involved AXA
selling its subsidiary to a specially-incorporated company, but that transaction
was also part of ‘the scheme’ that the ATO had identified. If the counterfactual
required the elimination of everything identified as forming part of the scheme,
then the buyer would not have existed and the ATO’s counterfactual collapses.
The court was not convinced. The Court said it agreed with the lower court that
the relevant counterfactual could – and likely would – involve some of the steps of
the scheme which the taxpayer had actually implemented. The lower court put it
this way: examining what the taxpayer did, ‘is likely to shed much light on what
they would have done in the absence of the scheme ...’
There is a flip-side to this question. Can the taxpayer insist that everything that
did happen has to be included in the counterfactual? This was at issue in the
appeal in AXA. As was noted above, the lower Court had concluded that the
Commissioner’s counterfactuals were not reasonable because they would have
deprived the investment bank of its fee. On appeal, therefore, the Commissioner
argued that the relevant counterfactual should exclude the contracts that gave
rise to the fee, or else, if the fee mattered, the Court should simply assume that
there was some other basis for which a fee might have been charged. The Court
rejected both arguments as being contrary to the evidence that was led, and not
supported by any other evidence.
So, the counterfactual hypothesis need not be an entirely dissimilar transaction.
Rather it is quite likely to be a transaction which involves some of the events
which actually occurred, and perhaps some of the critical steps which occurred.
The implication of this is it becomes more likely there will be no tax benefit – the
alternatives will end up looking very much like what actually happened.
A counterfactual with consequences. In some situations, in order for a tax
benefit to arise, the counterfactual transaction has to involve an amount of
income or capital gain being derived. That is, for the ATO’s case to bite, it is not
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sufficient simply to say that the taxpayer would have done something else; it is
also necessary to show that the ‘something else’ would have led to a larger
amount of income or gain. Where the tax benefit involved is a tax deduction, no
such problem exists – the ATO needs only to assert that the deduction would not
have been available in order for a higher amount of tax to appear.
The court was alive to this in AXA Asia Pacific. It noted that the relevant
counterfactual had to involve some form of transaction which would have
triggered additional capital gain and tax. In AXA that meant some kind of sale of
the target. The court said, ‘the Commissioner needed to replace the
presumptively eliminated scheme with some positive transaction ...’
The ‘do nothing’ option. The decision in News Australia Holdings raised
consideration of a counterfactual where the taxpayer simply does nothing.
It has often been argued that, in many cases, the most likely counterfactual is that
the taxpayer will simply sit on its hands if it cannot undertake a particular
transaction without triggering a tax cost. Part IVA operates by taxing the taxpayer
as if it had undertaken the alternative transaction instead of the one it did. If the
most likely alternative is one that does not trigger an amount of income or capital
gain, the argument is that Part IVA simply miscarries.
The issue arose in News Australia Holdings because of evidence the taxpayer
gave that it would not have executed one of the final steps in its relocation if doing
so would have triggered tax. Rather, it would have been prepared to live with an
inefficient corporate structure.
Unfortunately, the court did not have to address the substantive merits of this
argument. It simply noted the argument and moved on. It is worth pointing out
that this argument has concerned the ATO for some time. Indeed, there was a
recommendation by the Ralph Review in 1999 that would have attempted to
overcome this argument. That recommendation has never been acted upon.
It is worth noting that the drafting of Part IVA recognises this issue in the special
regime for dividend stripping. A taxpayer with a redundant company that can only
eliminate the company through receiving a liquidating dividend or other
distribution will in fact often do nothing with the company, as the existence of
many redundant companies testifies. In such a case, the ‘do nothing’ argument is
very plausible: if the taxpayer cannot take out the dividend, the company would
simply be sitting there. However, this argument is effectively bypassed by
deeming a tax benefit to arise where dividend stripping occurs and a dividend
paid just before the scheme would have been included in assessable income.
There is no need to prove what would have happened instead of the dividend
strip.
The ‘do (almost) the same thing’ alternative. A variant on this was also
presented in News Australia Holdings. The taxpayer argued that whatever
counterfactual the ATO proposed, it had to be one which satisfied the ‘no tax, no
tax risk’ condition which had been imposed on the entire relocation project. The
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argument was that, given the taxpayer’s commercial goals and restrictions, the
most likely alternative, assuming that some course of action would have
happened, would still have to be one which met the ‘no tax, no tax risk’
requirement. So, even if the ‘do nothing’ alternative was not available,
nevertheless, anything else would have had to lead to no tax consequences as
well.
Again the issue was noted by the court but the court was able to resolve the
appeal without needing to address the validity of this argument directly.
Timing. Finally, there is a discussion in AXA Asia Pacific about the time at which
all this conjecture and speculation has to be undertaken. Obviously, something
may be implausible at one point in time but very plausible at another. So, what is
the point of time at which one looks to determine whether the counterfactual is
reasonable or not?
The issue arose in AXA because the transaction was being put together at about
the time that the investment bank was trying to put together a consortium of
investors to buy the target. The fact that the parent company would have lost a
fee on the transaction only became an impediment once the contract that created
the entitlement to the fee had been signed. The transaction was also occurring at
about the same time as the investment bank was organising to enter the
consolidation regime. At some other time, neither impediment would have been
important.
The court did not address this issue in abstract, although it was clearly in the
mind of the judge. There is, however, some intuition that can be gained from
looking at the court’s method of dealing with the issue. With regard to the fee
income issues, the court considered the timing dimension by looking only at a
single point in time. For example at one point in the judgment the court said that
evaluating what was reasonable, ‘must be asked, notionally, at 3 June 2002, or
some other point in time thereabouts ...’ In other words, reasonableness was to
be determined at a single point in time. This leaves open the more difficult
question whether the ATO is entitled to win if it can point to any time when the
counterfactual might be considered reasonable.
With regard to the consolidation issue, however, the court considered a range of
times but with a terminal point. The investment bank was planning to elect to
consolidate with effect from 1 October 2002. The transaction documents, which
had been signed in June 2002, suggested that completion of the sale of the target
might occur at any time between August 2002 and mid October 2002. The court
was apparently convinced by the evidence of one of the experts that the
existence of the target within the group as at 1 October 2002 would not have
been acceptable. Given that completion could have occurred prior to 1 October
2002, with the effect that the target company might have been on hand on the
date of consolidation, the court considered this made the ATO’s counterfactual
unreasonable. Presumably this same logic would have applied if the
hypothesised sale might not have occurred until some time after 1 October 2002.
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A tax benefit for this taxpayer. Finally, it is worth noting that the tax benefit
must be one that would have arisen for the taxpayer which the ATO has
assessed. The ATO failed in its attempt to apply Part IVA in Futuris in part
because the Court found that under the only acceptable counterfactuals, other
companies in the group would have obtained a tax benefit and not the taxpayer.
This result harks back to the Peabody case – the first High Court decision on Part
IVA – where the ATO failed because it issued the assessment to the wrong
taxpayer.
It remains to be seen whether the outcome of the result in Futuris is that the ATO
will issue multiple Part IVA assessments to every conceivable taxpayer, and then
promise at trial to abandon the unsuccessful overlapping and conflicting
assessments once a judgment is handed down.
Part IVA and other anti-avoidance rules
Futuris raises another question which has dogged the operation of Part IVA –
how does Part IVA fit with other anti-avoidance provisions in the Act?
In Futuris, the ATO determined that the taxpayer had derived a tax benefit in
connection with the float of its subsidiary of $82.9m. This amount was in fact the
outcome of an increase to cost base because of transactions which triggered the
operation of the value shifting rules.
The taxpayer argued that Part IVA could not be invoked to defeat consequence
that another anti-avoidance regime had intentionally brought about. It also argued
that an increase in cost base caused by the value shifting rules could not be a tax
benefit. Further, it argued, it was nonsensical to argue that a series of
transactions which enlivened an anti-avoidance rule, was actually undertaken for
the sole or dominant purpose of securing a tax benefit. After all, it does seem
more than a little surprising to suggest that when a taxpayer succumbs to the
effects of an anti-avoidance rule its intention is to gain a tax advantage.
The court, however, did not accept the taxpayer’s arguments. Rather, the court
took the view that the taxpayer’s scheme could be one which worked by triggering
an anti-avoidance rule like the general value shifting rules. It has not been
unknown in the past for anti-avoidance rules to be turned to a taxpayer’s
advantage and this case is a demonstration of the possibility.
Thus, it seems, specific anti-avoidance rules do not preclude the operation of Part
IVA. Indeed, specific and general anti-avoidance rules will likely operate
cumulatively and sequentially. If, as Futuris shows, Part IVA can still operate
where a specific anti-avoidance rule has been triggered, the case that Part IVA
can apply must be even stronger when an anti-avoidance rule that might have
applied has not actually been enlivened.
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Treasury’s Discussion Paper
As part of the May 2009 Budget, the former Assistant Treasurer Chris Bowen
announced that, ‘the Government [would] shortly release a discussion paper
canvassing options to consolidate, streamline and improve the operation of
provisions designed to counter tax avoidance.’ That Paper was released by
Treasury in November 2010.
The two substantive chapters of the Paper give equal attention to possible
changes to Part IVA and options for rationalising the many specific anti-avoidance
rules in the legislation. So far as Part IVA is concerned, the Paper addresses
only one substantive issue: options for expanding the concept of ‘tax benefit’ for
the purposes of Part IVA to include other mechanisms by which the amount of tax
payable might be reduced or deferred. It is assumed that the current list of
possible ‘tax benefits’ is inadequate; the only discussion is on the best means of
expanding it. The Paper includes some matters of form such as re-writing and relocating Part IVA into the 1997 Act and how best to switch off s. 260, as it hasn’t
applied to tax schemes entered into after 1981.
The rest of the Paper examines how to consolidate and co-ordinate the many
specific anti-avoidance rules.
Submissions on the Paper were due with Treasury by 18 February 2011.
For further information, please contact
Sydney
Andrew Mills
Chris Colley
Director
Director
61 2 9225 5966
61 2 9225 5918
mailto:andrew.mills@gf.com.au
mailto:chris.colley@gf.com.au
Melbourne
Tim Neilson
Andrew de Wijn
Director
Senior Associate
61 3 9288 1054
61 3 9288 1227
mailto:tim.neilson@gf.com.au
mailto:andrew.deWijn@gf.com.au
These notes are in summary form designed to alert clients to tax developments of general
interest. They are not comprehensive, they are not offered as advice and should not be
used to formulate business or other fiscal decisions.
Liability limited by a scheme approved under Professional Standards Legislation
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Greenwoods document 510133664
Greenwoods & Freehills Pty Limited (ABN 60 003 146 852)
Sydney
Level 39 MLC Centre Martin Place Sydney NSW 2000 Australia
Ph +61 2 9225 5955, Fax +61 2 9221 6516
Melbourne
17
101 Collins Street, Melbourne VIC 3000, Australia
Ph +61 3 9288 1881 Fax +61 3 9288 1828
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