Why setting up offshore companies for Australians is a tricky business

Suppliers of offshore companies often supply companies to international clients with the promise that the company will give rise to no or little income tax. What they might really mean is the tax that applies in the offshore place of incorporation or the offshore place of operation of the company. The promise may not be informative about income tax implications in the place of tax residence of the client of taking on the offshore company.

It is useful for Australians looking to acquire an offshore company, and for offshore company suppliers who may supply an offshore company to them, to know about how offshore companies may be treated for Australian income tax purposes. And the involvement of the offshore company supplier in the company may be significant to what that treatment may be.

When offshore companies are controlled foreign corporations

Australia has had a controlled foreign corporations (“CFCs”) regime since 1990 which applies to treat an offshore company controlled by Australian tax residents (“AUTRs”) as a CFC. Like with other CFC regimes, the CFC itself is not, by virtue of being a CFC, treated as a tax resident of Australia generally subject to Australian income tax on its worldwide income; nonetheless the regime functions by attributing offshore income of the CFC to its AUTR controllers. So, although tax may be low on the company in the country of operation of the company, the AUTR faces Australian income tax on the income of the CFC even where the income of the CFC remains unrepatriated from the CFC.

The CFC regime has an active income exemption which applies to exclude income earned by a CFC carrying on an active business in an offshore place from attribution to AUTRs. Where the active income exemption can apply to the CFC an offshore company supplier may be better placed to make good on their promise of low income tax to an Australian client.

Another way of making good on the promise, but a way which is not, in any way, legal under Australian laws, including under the associate-inclusive control tests in the CFC rules, is to hide the Australian control of the offshore company from Australian authorities and from others whom it may concern. Offshore company suppliers have been known to do this by providing local-based company directors and nominee shareholders who follow the directions of the client through opaque protocols, which can be in various forms, to give the client the necessary control and assurance that the client’s directions concerning the offshore company will be followed.

Offshore company is an Australian tax resident after all?

A offshore company under covert directions of AUTRs not only faces the risk that its income will be attributed as attributable income taxable in Australia under the CFC regime but also faces possible treatment as an Australian tax resident, itself. In that eventuality Australian tax authorities won’t need to rely on the CFC regime to tax the income of the offshore company in Australia.

When a company will be treated as an Australian tax resident

Under the Australian Income Tax Assessment Act 1936 a company is resident in Australia if:

it is incorporated in Australia or, if not incorporated in Australia, if it carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are residents of Australia

(definition of “resident” or “resident of Australia” in sub-section 6(1))

This is similar to the formulation of tax residence of companies that applies in most OECD countries.

The highest court in Australia, including on tax matters, is the High Court of Australia. In the 1973 case of Esquire Nominees Ltd. v. Federal Commissioner of Taxation, Gibbs J., who lead the High Court in this case, observed that:

“the real business [of a company] is carried on where the central management and control actually abides”; and
“the question where a company is resident is one of fact and degree”.

In Esquire Nominees, the High Court was able to find that a Norfolk Island company was not centrally managed and controlled from Australia despite evidence that Australian-based accountants:

formulated a tax avoidance scheme involving the company acting as the trustee of a number of trusts; and
communicated every aspect of the scheme of the trusts to the directors of the corporate trustee in Norfolk Island including how the scheme was to be carried out.

Gibbs J. was satisfied that the directors of the corporate trustee in Norfolk Island had sufficient independent power in their role, beyond the control of the Australian-based accountants, to support a finding that the central management and control of the company was on Norfolk Island. This was despite what appeared to be the whole reliance of the directors on the communications from the Australian-based accountants. The board of directors of the company did not to have to comply with directions from the Australian-based accountants. Gibbs J. found that the (board of) directors were making the decisions of the company, albeit in line with the strong influence of the Australian-based accountants, and that they met to do so on Norfolk Island.

Bywater Investments Limited v Commissioner of Taxation, Hua Wang Bank Berhad v Commissioner of Taxation

A November 2016 decision of the High Court has shown that:

relevant matters to be taken into account in ascertaining the central management and control of a company include, but are not limited to:
- the location of the company’s registered office;
- the residency of the company’s directors;
- the residency of the company’s shareholders;
- where the company’s meetings, including its directors’ meetings, are held; and
- where the books of the company are kept;
the place where the board of directors meets, in particular, is not sufficient, by itself, to show where the central management and control of a company, and thus the Australian tax resident status of a company is; and
despite the outcome in Esquire Nominees, Australian courts will not always accept, just because a company has a properly appointed and functioning offshore-based board of directors, that the independence or autonomy of those directors can be inferred.

In Bywater Investments Limited v Commissioner of Taxation Hua Wang Bank Berhad v. Commissioner of Taxation [2016] HCA 45 a Sydney accountant (“G”) had complete legal and actual control of Swiss-based and Samoan-based companies despite the considerable lengths taken by G:

to conceal the fact of G’s control of the companies; and
to project apparent control of these companies by boards of directors in Switzerland and Samoa arranged by Swiss-based and Samoan-based offshore company and corporate services providers.

Companies involved were incorporated in the Cayman Islands and in the Bahamas. Only through the course of the Australian investigation and litigation did it become clear that various legal means, including:

in the case of Hua Wang Bank Berhad, the device of an unredeemed secured bearer debenture which operated to suspend the rights of the offshore shareholders of the company to vote or demand a poll; and
in the case of “JA Investments”, another significant company in the structure, appointment of G as “Appointor” with the power to appoint additional members of this company who in turn could remove directors;

had been devised to give G control of the companies.

The abrogation exception

The High Court in Bywater Investments Hua Wang Bank Berhad found that, although the central management and control of a company will ordinarily be where meetings of its board are conducted; a long line of authorities, including Esquire Nominees and the UK House of Lords decision in Unit Construction Co Ltd v Bullock [1960] AC 351, identify a significant exception where a board of directors abrogates its decision-making power in favour of an outsider, and the board operates as a puppet or cypher, effectively doing no more than noting and implementing decisions made by the outsider as if they were, in truth, decisions of the board.

In Bywater Investments Hua Wang Bank Berhad it was found that G was such an outsider in control of companies that made the decisions of each company. These decisions were implemented as decisions of the boards of the Samoan-based and Swiss-based companies and the central management and control of these companies, was with G, the outsider, who was thus carrying on the business of each company in Australia.

Place of effective management of offshore companies

In the case of the Swiss-based companies, where a consideration of the place of effective management was also relevant under the applicable double tax treaty between Switzerland and Australia , the finding viz. that that place of effective management was Australia, was no different. The consequence was that the Swiss-based companies were not entitled to protection from Australian taxation under the double tax treaty.

Demonstrating board autonomy of an offshore company

The company in Esquire Nominees was able to show that it was in the ordinary case, albeit by an indistinct or possibly by a fine margin, in contrast to the boards of directors of the companies in Bywater Investments Hua Wang Bank Berhad which failed to show that they were not puppets or cyphers of its AUTR controller.

The evidence in Bywater Investments Limited Hua Wang Bank Berhad was in stark contrast to the evidence in Esquire Nominees from which the court accepted the contention that the board of the Norfolk Island company had maintained a sufficient autonomy over decision-making by the company. In Bywater Investments Hua Wang Bank Berhad the evidence of the companies unravelled as it was found that:

the documents and evidence produced by directors of the companies where untruthful and falsely contrived to corroborate testimony that the offshore directors operated autonomously;
the offshore directors were a “fake”;
the offshore ownership structure of the companies was a “ruse”; and
the means used by G to conceal that he was the true owner of one of the companies suggested dishonesty. Every decision of consequence for that company was made by G.

It follows that AUTR clients of offshore company suppliers may be challenged to sustain that an offshore company has central management and control in an offshore jurisdiction where the offshore directors are nominees, arranged by offshore company service providers potentially identifiable as “puppets and cyphers” and not directors with real understanding of the affairs of the offshore company who are genuinely involved in the decision-making of the offshore company.

Conclusion

Following Bywater Investments Hua Wang Bank Berhad Australian clients of offshore company suppliers may have reason for concern that an offshore company they procure from an offshore company provider may be an Australian tax resident. Those concerns arise in the absence of real business activity by the company in the offshore place or real autonomy, in relation to the affairs of the company, given to the offshore directors in the offshore place which is evident from a holistic evaluation of the constituent legal documents of the company on which control of the company comes to rely.

Although the appearance of offshore decision-making by the company may initially show that the central management and control of the company is outside of Australia, that conclusion may not withstand a persistent scrutiny should the company be investigated, or more, and forced to produce its constituent legal documents to defend its offshore tax resident status. The outcome may be that the company is dealt with as an Australian tax resident without reliance on the CFC provisions to attribute and tax income of the offshore company to its AUTR controllers.

Are there limits to interest deductions in Australia in participative loan arrangements involving entities in the same economic group?

Question on taxlinked.net members forum about Participative Loan Taxation

Since 1st January 2015 in Spain, interests are (interest is) not tax deductible when the participative loan is agreed to between entities of the same economic group. Is there similar treatment in your countries?

Response to post

Generally not in Australia.

In Australia interest is deductible if incurred on debt finance obtained to earn assessable income or to carry on a business even if debt finance arrangements include entities not dealing with each other at arms length.

These deductibility tests are serious purposive tests so non-arms length transactions attract particular scrutiny and, like in most jurisdictions, the burden of making out either purpose is on the taxpayer. As well as the general construct of sham there are a numerous specific instances where the Australian law denies interest deductions including:

sometimes where deductions are prepaid;
where there is not a sufficient relation between the loan and income received after a “commonsense” or “practical” weighing of the circumstances; and
where deductions are artificial or contrived or have those elements– if specific anti-avoidance rules do not apply.

Australia has a longstanding general anti-avoidance provision that can apply even if the interest deduction was otherwise available under the law. In international outbound financing the deduction can be lost because foreign income can be treated as other than assessable income. International debt/hybrid mismatch rules are being developed in Australia following some taxpayer success resisting anti-avoidance rules and the international experience.

Deductions are also lost if a “loan” is technically found to have characteristics of equity in substance.

Australian courts look at the role of associated entities to understand their purpose and look at transactions holistically. In other words they will focus on the economic units, rather than on juristic entities which seems to happening in Spain from what you say. Hence an interest deduction to an entity can be reduced, for instance, if the debt finance is on-lent to a related entity to earn income palpably less than the deduction.

Australia also has thin capitalisation rules which apply to limit otherwise allowable large cross border interest deductions.

Chevron Australia is involved in the first major transfer pricing case under the new BEPS regime where the Commissioner of Taxation is fighting to contend that interest paid and deducted exceeded the arms length amount based on BEPS arms length principles. The Commissioner won the first stage of the case in 2015.

Is a transfer to a SMSF by a related holding trust, after repayment of a LRBA to purchase residential property, prohibited by s66 of SISA?

Is a transfer to a SMSF by the trustee of a holding trust, who happens to be a related party of the SMSF, after repayment of the borrowing under a limited recourse borrowing arrangement – LRBA, to purchase residential property, prohibited by section 66 of the Superannuation Industry (Supervision) Act 1993 (“SISA”)?

Section 66 of the SISA prohibits a SMSF from acquiring residential property, which is not business real property, from a related party of the fund.

Returning an asset that is already in the SMSF

A similar question arises when a SMSF receives a return of an asset of the fund from a custodian or an investment manager, which incidentally happens to be a related party, which is similarly not covered by any exemption in section 66. Technically the SMSF has acquired the asset from a related party; the legislation could be clearer providing exceptions in section 66 for these cases especially as the scope of acquisition prohibited by section 66 is expressed in very wide terms: see paragraphs 88 to 109 of SMSFR 2010/1.

But an acquisition, being the return or resumption of the asset, not for consideration (value) from a related party, does not really explain the actual transaction happening. In these cases, the SMSF is acquiring or resuming title or legal ownership of an asset it already owns beneficially. So, in the case of a LRBA of residential premises, section 66 would be concerned with who the residential property was originally acquired from, not with the” acquisition” of the asset from the related holding trust once the borrowing is paid out.

As with a custodian or investment manager, the power of the related bare trustee of a holding trust to hold the asset, and the power to transfer the asset back to the trustee of the SMSF, is stated or is implicit in the SISA itself – see sections 67A and 123. As a matter of statutory interpretation those powers should prevail over the prohibition in sub-section 66(1): generalia specialibus non derogant Nevertheless a clearer description of the scope of the acquiring prohibited, and of exceptions, would be preferable to relying on that maxim though SMSFR 2010/1 issued by the Commissioner of Taxation does helpfully state at paragraph 113:

It is therefore necessary to take a holistic approach to the transaction to determine objectively what it is that the trustee or investment manager is actually acquiring. If, for example, something is being purchased by a trustee or investment manager, a relevant question is what is the trustee or investment manager paying money to acquire. While many transactions involve rights, an acquisition is of rights only if the substance of the transaction is rights.

What is the whole LRBA really about?

From a holistic viewpoint the SMSF, which already holds beneficial ownership of the residential property, is, in substance, concluding the acquisition from the original vendor by taking legal title to the residential property by the transfer from the holding trust. It follows that the acquisition of legal title from the related holding trustee is the exercise of a right to acquire legal title which is not the “substance of the transaction”.

The Australian Taxation Office may not necessarily take the same view.

Australia is now tracking & surcharging foreign buyers of land

Turning missing demographics into tax revenue

Hats off to Australian governments who have turned an imperative into a revenue opportunity. The Australian federal government regulator, the Foreign Investment Review Board (the FIRB), has not been well placed to track foreign purchases of real estate to date. The FIRB has been reliant on disclosure, and if prospective foreign buyers didn’t voluntarily disclose their planned land acquisitions, the FIRB has been none the wiser. There has been no register of (foreign) beneficial ownership of buyer entities which the FIRB can go and check even in the case of foreign real estate acquisitions completely prohibited under the foreign acquisitions law: the Foreign Acquisitions and Takeovers Act (C’th) 1975.

That has all changed. Buyers now need to demonstrate that they are not foreign to avoid hiked stamp duty in New South Wales, Victoria and Queensland. Foreigners who buy and sell Australian real estate are now under great scrutiny at both the buyer and seller ends of the land sale especially if the sale is for more than $750,000.

Big city real estate markets are buoyant, prices are high and foreign buyers are not exactly welcome by those looking to buy the same city real estate. The community has been surprised to learn that foreign purchases of Australian land have not been closely monitored. So, politically, it has been an opportune time to introduce these changes. Time will tell if they will be successful. They may well be. They will be a boon to the FIRB, but Australian buyers too will get caught up in the ramp up of imposts on foreign buyers. Why?

Buyers of Australian land

This is the bit for the FIRB. The New South Wales, Victorian and Queensland governments have just introduced hefty stamp duty and land tax surcharges on foreigners. From 21 June, 2016 a sworn Purchaser Declaration (“PD”) is now required from buyers, whether foreign or not, buying real estate in New South Wales. The PD is required along with stamp duty at the band the PD establishes that the buyer should pay to complete the conveyancing of a land sale. If the buyer of land in New South Wales is a foreign person (entity):

a 8% SURCHARGE (for the 2018 tax year, it was 4% for the 2017 tax year) on the stamp duty (i.e. extra) applies (it’s a 7% surcharge in Victoria);
the buyer is not entitled to the 12 month deferral for the payment of stamp duty for off-the-plan purchases of residential property; and
the buyer faces 2% SURCHARGE (for the 2018 tax year, it was 0.75% for the 2017 tax year) on land tax (i.e. extra).

It’s plain on the PD that the information is going to the ATO – it asks for the FIRB application number for the purchase. This will let the Australian Taxation Office (“ATO”) and the FIRB gather comprehensive data on foreign land acquisitions. Coupled with significantly increased penalties for breach of the foreign acquisitions rules, the availability of this information to the ATO and to the FIRB will give the federal government real capability to penalise unlawful real property acquisitions by foreigners.

Where an Australian buyer will be caught out too – example of a buyer that is an Australian-based family discretionary trust

It is notable that the PD doesn’t seek the confidential tax file number (understandable as the ATO can’t get the States to collect those) or the Australian Business Number (if any) of a buyer trust. It relies on the name of the buyer trust and a copy of the trust deed of the buyer trust with all amendments must be included with the PD.

If a foreign individual, company or trust is a potential beneficiary of the usual style of Australian family discretionary trust that is a New South Wales land buyer then, usually, the trustee can distribute 20% or more (Victoria – more than 50%) of the income and capital to that foreign person. That gives the foreign person a “significant interest” in the trust enough to cause the trust to be a foreign trust under these rules to whom the foreign stamp duty and land tax surcharges apply.

So if the copy trust deed supplied with the PD indicates that a remoter family member, who is not an Australian citizen or an Australian permanent resident, but is a foreigner who is a potential beneficiary of an (otherwise) Australian family discretionary trust ABLE to receive 20% of income or capital (more than 50% in Victoria), even if that remoter family member/foreigner may not have:

any current or past entitlement to income or capital of the trust; nor
any strong likelihood of participating in income or capital of the trust;

his or her eligibility under the trust deed exposes the trust to foreign trust/person status and liability for the stamp duty and land tax surcharges under these rules accordingly.

Sellers of Australian land

The ATO has had a problem collecting capital gains tax from sellers who are offshore after the sale of Australian land. Under tax treaties worldwide rights to tax interests in land are almost universally reserved to the governments where the land is. As other forms of assets and activity are moveable and relocatable taxation based on place is not so reserved because it is less effective than taxation based on residence and/or makes less sense.

So, frequently, when a non-resident sells land and makes a capital gain taxable in Australia, the ATO has no interaction with the non-resident, aside from due to their Australian landholding. This has often left the ATO with little leverage to assist them to collect tax debts arising from CGT on disposals of Australian land by non-residents ceasing investment in land in Australia.

The solution is the tried and trusted withholding tax model. From 1 July, 2016, the non-resident capital gains tax withholding tax (“NCGTWHT”) is an obligation on the buyer (statistically likely to be a resident) to pay a non-final withholding tax to cover capital gains tax (likely to be) owing by the non-resident seller.

The NCGTWHT broadly applies as a non-final tax on sales of land worth more than $750,000 (from 1 July 2017, was $2m from 1 July 2016 to 30 June 2017). If the buyer does not receive an ATO clearance certificate from the seller then the buyer must withhold 12.5% (from 1 July 2017, was 10% from 1 July 2016 to 30 June 2017) of the value of the property (so 12.5% of the price for the land if it is an arms length sale, 12.5% of the “first element of the cost base” of the land to the acquirer if a CGT market value substitution rule applies in a non-arms length transaction).

Where an Australian seller will be caught out too – a non-final 12.5% tax

It is of no consequence that the seller is, or might be, an Australian resident/tax resident and the buyer is assured of this. There is no “reason to believe the seller is an Australian resident” exception for sales of freehold interests in land. Even the seller could be wrong – tax residence can a vexed question which is frequently litigated in tax cases.

The liability to the ATO is on the buyer unless the seller can obtain and provide a clearance certificate from the ATO to the buyer no later than settlement of the land sale so, if the seller does not return and pay the CGT on the seller for the sale, the NCGTWHT paid by the buyer on the seller’s behalf won’t be refunded.

Template contracts for the sale of land across Australia have been hastily adjusted to include conditions confirming that, where the land is worth more than $750,000:

the buyer can contractually withhold the NCGTWHT from the price if the clearance certificate is not provided; and
the seller can be assured that the NCGTWHT will be paid immediately by the buyer to the ATO to the credit of the seller.

Are electronic records OK for tax?

They’re OK.

It’s clear on the ATO website that electronic storage of paper records is acceptable:

This article from Addisons explains the big picture:

including in the context of record keeping obligations of companies under the Corporations Act 2001; and
refers to the general requirement that taxpayers keep their (Commonwealth) tax related documents for five years.

ATO record keeping requirements in detail are in Practice Statement Law Administration PS LA 2005/2. PS LA 2005/2 shows that the period for keeping records referred to in the article can be longer than five years in certain cases. Records of documents going back to when an asset was acquired, even if prior to the introduction of capital gains tax in 1985, need to be kept for five years after the CGT asset is disposed of. It is also apparent under PS LA 2005/2 that the ATO can impose a range of penalties for failure to keep records including referring cases for criminal prosecution to the DPP where they perceive deliberate falsifications of records.

The article shows how ATO record keeping requirements reflect the Electronic Transactions Act (C’th) 1999. In essence, section 12 states that electronic records of paper documents required to be kept under Commonwealth law are OK if the electronic system is capable of conveniently and adequately reproducing the paper record. That section is referred to and is in line with Taxation Ruling TR 2005/9 Income tax: record keeping – electronic records.

Implementing electronic tax records

A taxpayer fails these requirements, and risks penalty, if electronic records are lost. Using a backup system is critical whatever electronic system is being used. Moreover electronic records have ease of duplication and filing advantages that make electronic records preferable to paper records.

There are other risks of loss of electronic records that should be borne in mind. Export to other formats from legacy or crippleware systems is an imperative when the records can no longer be retrieved from computer software say because the software becomes, over time, no longer licensed, no longer runs in the taxpayer’s operating system environment or the software itself has inherent restraints on its archiving capability. Many modern bookkeeping systems have easy to use export features which can be worthwhile using as a failsafe to ensure compliance with record keeping obligations.

Is a tax invoice that is only electronic OK?

The position with tax invoices is clear. In para 12 of Goods and Services Tax Ruling 2013/1 the ATO states:

Tax invoices in electronic form

A document in electronic form that meets the requirements of subsection 29-70(1) (and if applicable, subsections 48-57(1) and 54-50(1)), will be in the approved form for a tax invoice. [Footnote 9 – This record must be in English or readily accessible and easily convertible to English as required by subsection 382-5(8) of Schedule 1 to the TAA 1953.]

Using Twitter in tax practice

David Garde presented to the Chartered Accountants Australia + New Zealand Tax Discussion Group No. 15 on “Using Twitter in tax practice” on 7 June 2016.

During and following the presentation David was asked how to get started on Twitter and are there Twitter users he can suggest for a new Twitter user in the tax space:

Getting started on Twitter

The 8 minute youtube video How to Use Twitter on Your iPhone, for Seniors is a helpful getting started step by step guide.

Twitter can also be easily set up from the Twitter website or even by selecting:

the icons at this site to follow @TheTaxObjection;
the similar icon/link at other sites; or
any of the below links to Twitter users.

If you have not joined Twitter then you will be prompted/taken to join Twitter before you can the follow the Twitter user you try to follow.

Microblogging about tax

As mentioned in the presentation there is a huge amount of information microblogged on tax with an emphasis on tax comments on what Twitter users find interesting and worth tweeting about.

It is probably better to follow the feed of interesting users/conversations for a while before posting/making tweets until you are comfortable with the Twitter platform. Lots of Twitter users don’t post tweets at all and so just use Twitter as an information service in quiet moments conveniently on their phone. It’s easy to follow users, and to unfollow them if you don’t want to see them in your Twitter feed (timeline) any more.

Some users to follow who tweet about tax

Views about what is interesting are personal and vary with the type of tax work you do. Some Twitter users tax practitioners could follow are:

Other

and, of course,

CharteredAcctsANZ – @Chartered_Accts

Following conversations

and you can join conversations too like

#austax

#capitalgainstax

#TDGNo15

Once set up why not tweet “#TDGNo15 I am on Twitter” so we can see it on the #TDGNo15 conversation?

Is a family trust a good way for setting up a new franchisor business?

A family discretionary trust structure is a slightly more complicated and costly structure but it has more flexibility than a holding company structure for distributing income tax effectively while also being capable of having limited liability protection for the franchisor along with potential access to the company tax rate through a beneficiary company.

But is one trust enough?

For asset protection and management reasons it may be multiple structures are desirable into the future to separately hold IP and property interests (including lease interests to be sub-let).

Trust a conduit to beneficiaries

A family trust can distribute business profits as trust distributions as a conduit of taxable income to adult resident beneficiaries.

Division 7A would not usually apply

A significant advantage with a family trust structure is that Division 7A does not apply to loans from the trust to associated parties (where companies are not involved) to treat them as taxable/unfrankable deemed dividends.

Capital gains tax advantages

The adult resident beneficiaries of a family trust can also use the CGT discount if the trust makes a capital gain. Sometimes a trust is a more difficult structure than a company if a new franchise venture makes losses (say due to difficulties finding and keeping franchisees on good terms).

Bringing in new equity

A family trust isn’t as good as a unit trust or a company for bringing in new equity participants however it appears that, with the new small business restructure CGT rollover relief, a later conversion to a unit trust structure can be done for a low cost.

CGT discount and small business CGT concessions

Capital gains made by a family trust structure could attract the CGT discount and the small business concessions (a company can only get the latter), such as the 50% active assets reduction. A family trust structure has the tax advantage over a company structure if CGT assets of the business, including goodwill, are at some stage sold for a capital gain by the trust.

A new statutory remedial power for the Commissioner of Taxation

As announced in the 2015 Budget, there is a bill before parliament to introduce a general statutory discretion for the Commissioner of Taxation to be known as the Remedial Power. The Remedial Power is proposed to be introduced in a new Division 370 of the Income Tax Assessment Act (ITAA) 1997.

It gives the Commissioner a power to make substance over form decisions to address technical shortcomings in tax legislation inconsistent with the policy behind the legislation. This power is not unlike the scope the High Court afforded to courts in Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation [1981] HCA 26; 147 CLR 297. However, as with that scope, it can be expected that the power will only be exercised exceptionally and with particular caution.

That said there are many circumstances, including those impacted by Division 35 of the ITAA 1997 concerning non-commercial losses, which could potentially attract remedy by the Remedial Power. That should not be overlooked in the preparation of advice, applications for rulings and in objections.

Exercise of discretion not available for some reason rather than not there at all

The Commissioner will no longer be able to justify decisions that give rise to unjust tax outcomes on grounds that he has no relevant discretionary power under the ITAA beyond the limits of the general power of administration of the tax laws under the Taxation Administration Act 1953. Once the Remedial Power is in place it is expected the Commissioner will rather explain why an unjust decision counter to policy is not worthy of the Remedial Power if the power is not to be used to remedy that outcome.

When is the Remedial Power going to be used?

Broadly the Commissioner may exercise the Remedial Power:

where the outcome under the tax law is inconsistent with the purpose or object of the law by re-aligning the regime in the law applied by him with its purpose or object; and
where the outcome under the law is consistent with the purpose or object of the law, but in achieving that outcome the application of the law imposes compliance costs that are disproportionate to achieving the purpose or object of the law by aligning the regime to reduce those compliance costs in a manner consistent with the purpose or object of the law.

Perhaps the unlegislated regime in Practice Statement Law Administration 2010/4, concerning unpaid present entitlements under Division 7A of Part III of the ITAA 1936, is an example of the kind of modification by the Commissioner which could have legal force under Division 370 in future.

Progressing minor corrections

It is anticipated that this power will reduce the time it takes to give effect to minor legislative corrections.

It may also allow for some minor technical corrections to occur where this may otherwise not occur.

Limits on the Remedial Power

The Commissioner will not be able to use the power to:

alter or extend the purpose or object of the law;
directly amend the text of the law; or
make modifications to the operation of the law which will result in more than a negligible impact on the revenue.

In addition, a taxpayer can ignore a modification made under the Remedial Power if it would produce a less favourable result for the taxpayer i.e. modifications under the power will only apply in the taxpayer’s favour.

As the power is discretionary, the Commissioner cannot be compelled to exercise the power. A bureacracy will be established with the Australian Taxation Office to assist the Commissioner to manage the exercise of the power including a tax expert panel (similar to the General Anti-Avoidance Rules Panel) to advise the Commissioner particularly about costs and impracticalities to the revenue if a modification is to be made under the Remedial Power.

How might complex issue resolution by the ATO help?

A useful service for tax professionals

A new and useful service from the Australian Taxation Office (“ATO”) is Complex Issue Resolution (“CIR”). An escalation is offered for complex or multiple related tax technical issues and abnormal administrative issues which officers contacted through regular channels into the ATO, or who are acting in a regular ATO compliance role, would not usually be able to address.

The limitations of Complex Issue Resolution

CIR is accessible only by tax professionals including tax agents and legal practitioners.

Guidance from CIR is not binding on the Commissioner of Taxation. It is not a substitute for objecting against an assessment, seeking a private binding ruling or making a complaint about how the ATO is dealing with the taxpayer.

Value proposition

The inherent benefit of restricting CIR to tax professionals is twofold:

the restriction is a filter to ensure that issues put by taxpayers to CIR are actually complex better targeting the CIR resource; and
it is more likely that a tax professional can pinpoint and explain a complex issue/s. Careful and thorough explanation can be vital to the ATO correctly appreciating the complex issue and to how the ATO may ultimately deal with it. The Tax Objection is a tax professional and we understand how complex issues should be presented to the ATO.

Thus a taxpayer, through his or her tax professional, can drive recognition of complex tax technical issues and abnormal administrative issues including where an officer of the ATO may not grasp the issue and may not be willing to escalate the issue within the ATO to a more senior or experienced officer who is better equipped to deal with the issue. Equally CIR may be limited to where other escalation has not occurred within the ATO such as allocation of the issue to Interpretative Assistance (IA) or comparable ATO officers who decide objections and private ruling applications.

CIR in a tax dispute/objection strategy

In our post “I’m objecting – do I need freedom of information (FOI)?” we looked at the kinds of tax disputes where seeking freedom of information before, or concurrently while, objecting to a tax assessment is advantageous. It is all about understanding what the ATO position is, or is likely to be, before committing time, effort and resources to a tax objection and dispute.

Applying for CIR may have a number of advantages over applying for FOI in the process of readying to object against a tax assessment:

it looks like obtaining CIR guidance will generally be quicker than obtaining FOI although this is not yet certain as CIR is so new. Where time is running out against the time limit to object to an assessment it may be invaluable to receive guidance from CIR before finalising a notice of objection; and
applying for CIR may resolve the matter entirely. The escalation of a complex issue to a senior and experienced officer may lead to CIR guidance which puts a view either:
- which the taxpayer is inclined to accept for one reason or another; or
- which shows that the ATO has sufficiently adopted the view contended for by the tax professional in the application for CIR.

Either way the problem can be resolved before an objection or application for private ruling is completed saving costs and effort.

Although non-binding, CIR guidance is likely to firm either as the position, or as one of the positions, of the Commissioner on the complex issues on which the dispute turns. This gives a taxpayer objecting to an assessment who has CIR guidance the opportunity to make nimble inclusions in the notice of objection and to revise or abandon arguments to raise prospects of success in the dispute.

Getting a deduction for tax objection and income tax advice costs

A tax deduction is available for costs of preparing and lodging an income tax objection under section 25-5 of the Income Tax Assessment Act 1997 (ITAA 1997). Section 25-5 provides a deduction for taxpayers for the costs of managing their tax affairs.

Further, fees for taking income tax advice, including obtaining a position statement, are deductible where the advice is provided by a “recognised tax adviser”: paragraph 25-5(2)(e). A recognised tax adviser is either a registered tax agent or a legal practitioner.

Legal professional privilege

A further advantage of taking income tax advice from a legal practitioner is that written advice attracts client legal privilege. Unless the taxpayer waives the privilege, the privilege protects the advice from compulsory disclosure to the Commissioner of Taxation or to a tribunal or court.

Deduction for costs relating to tax affairs of a capital nature not excluded

If the expenditure is not of a capital nature then it may also be allowable as a deduction under sub-section 8(1) of the ITAA 1997. If the expenditure relates to tax affairs of a capital nature then that has no impact on the deduction available under section 25-5: sub-section 25-5(4).