Tag Archives: complex issues

$3,000 deduction cap for managing personal tax affairs – non-millionaires caught in the cross-fire?

Labor’s Fairer Tax System plan

The ALP’s Andrew Leigh and Chris Bowen announced their A Fairer Tax System for Millions, Not Millionaires plan on 13 May 2017. The plan is comprised of a number of laudable and progressive policy announcements including transparency improvements that will impede tax avoidance by wealthy taxpayers and multinationals.

These policies are:

  1. $3,000 cap on deductions for managing their tax affairs for individuals.
  2. Public reporting of country-by-country reports.
  3. Whistleblower protection and rewards.
  4. Mandatory shareholder reporting of tax haven exposure.
  5. Public reporting of Australian Transaction Reports and Analysis Centre (AUSTRAC) data.
  6. Government tenderers must disclose their country of tax domicile.
  7. Develop guidelines for tax haven investment by superannuation funds.
  8. Publicly accessible registry of the beneficial ownership of Australian listed companies.
  9. Australian Taxation Office disclosure of settlements and reporting of aggressive tax minimisation.

The first measure, which this blog post concerns, is a proposed cap of $3,000 on the income tax deduction for managing personal tax affairs. There is no doubt this cap will restrict tax deductibility, which is substantially the funding by other taxpayers, of wealthy taxpayers’ tax professional costs of devising ways to avoid paying Australian tax.

Why an arbitrary $3,000 cap?

Still the $3,000 cap is arbitrary and there is, somehow, a disconnect in the announcement between the proposed cap and the millionaires against whom it is targeted. Why is the cap $3,000 rather than $30,000? My point is that it is not so unusual for ordinary taxpayers, particularly property owners who are not millionaires at whom the Fairer Tax System proposals are directed, to rack up tax professional costs of more than $3,000 for managing their tax affairs in an income year. The $3,000 cap includes tax agent costs for annual tax return preparation and lodgment so the remaining cap to deal with remaining tax difficulties or obligations will be something less than $3,000. So, although the measure will achieve its aim to curb deductibility of these costs to millionaires, there will be taxpayers who are not millionaires who will be collaterally caught with non-deductible tax professional costs in excess of the cap.

It is not so clear that the cap has been designed by someone who has real experience of seriously high individual tax professional costs and of situations where they may happen. Sure, all being well, a salary earner who owns real estate and who engages a tax agent, who charges moderately, will have tax professional costs in an income year comfortably under the cap. However, the salary earner with tax difficulties out of the ordinary may find himself or herself with a need to take a considered custom professional tax advice or to have his or her tax advisor non-prejudicially apply for a binding private ruling to protect himself or herself under the self assessment system.

The self assessment system

Out of the ordinary doesn’t mean tax avoidance is going on. Under the self assessment system a taxpayer is responsible for correct reporting and filing of tax information and severe penalties and interest apply if the taxpayer makes an error and a tax shortfall is assessed. If the taxpayer has an activity or activities where the tax treatment is unclear then it is the taxpayer who must ensure his or her return or other statements to the Australian Taxation Office (ATO) complies with tax law adopting, in the least, a reasonably arguable position on items in the return or statements that are contentious.

Something over $2,000 is not a big budget for obtaining a tax advice letter or a position paper or for professional preparation of an application for a private binding ruling or a complex objection. Often issues an individual can face can take a tax professional a couple of days or more to do thoroughly.

It can be costly just to understand obligations imposed by government

Not so long ago I was briefed to give tax advice to an owner of a heritage building about to enter into a sale of “transferable floor space” in compliance with local government heritage laws. The interaction of the relevant capital gains tax (CGT) and goods and service tax (GST) laws with property, environment and local government laws, cases and public rulings took considerable time to work through even in the absence of any live dispute about these matters with the ATO. $2,000 would have been a fraction of fees for the time needed to give advice so that the client understood the client’s CGT and GST obligations on the sale . The correct application of CGT events and tax rules that apply in this client’s situation are notably unclear and difficult and, in its rulings, the ATO takes positions which some may view as confused and ambiguous. A withering array of laws applied to this heritage building owner.

Each of these laws, considered separately, benefit or aim to benefit government, society and thus other taxpayers by the contribution of taxes, the stimulation of commerce and the preservation of heritage buildings. But is it fair for society to impose such a multitude of obligations on a not necessarily wealthy building owner yet severely reduce society’s contribution to the owner’s costs of compliance with them?

You see much of my work, and the work of many other tax advisors who act for clients who are not necessarily wealthy, is just to advise or explain how the tax law applies to them and what their position is. Generally, as the tax laws have been tweaked and greatly expanded over time, the tax laws do not present exploitative opportunities to ordinary taxpayers for avoidance. There are, of course, exceptions.

The CGT provisions are a good example of tax laws that are necessarily intricate and complex. $2,000 in professional advice costs just to understand a CGT position in an advice from a CGT expert won’t go far. The CGT rules can apply, and severely, to taxpayers who own property, securities and other valuables. If the owner dies or is a non-resident the complexity can ratchet up. Not all of the aforementioned are millionaires.

It can be costly to get a ruling or guidance from the Australian Taxation Office

It is frequently the case that an ordinary taxpayer is unable to articulate, or would be disadvantaged having to personally articulate, a technical capital gains tax problem to the ATO without professional assistance in order to obtain guidance or a binding private ruling from the ATO. So an ordinary taxpayer can be justified in seeking substantial tax professional help applying for a private binding ruling from the ATO. If a binding private ruling adverse to the taxpayer is issued by the ATO the taxpayer may seek to dispute the ruling and still further tax professional help is needed. The taxpayer’s professional tax advisor may need to attend the ATO or prepare an objection or appeal.

The intractability of many tax problems, notably capital gains tax problems, is usually not the fault of the taxpayer but is a feature of complex tax law seeking to impose tax obligations in a wide diversity of situations fairly on the tax paying community.

Costly tax problems not of concern to wealthy taxpayers

A taxpayer of modest means suffers an injury at work and receives an ongoing insurance payout. This taxpayer is the opposite of a millionaire. Still the taxation of the insurance payout gives rise to the income versus capital conundrum on which the Australian income tax system continues to rely. The payouts fall through the cracks of types of insurance payout that are afforded tax exempt status under the Income Assessment Acts 1936 and 1997. If the payouts are capital then capital gains on personal injury payouts are exempt from CGT so there is a lot of tax at stake if the payouts should be treated as capital rather than as assessable income.

Pursuing capital treatment of the payouts is not tax avoidance by the wealthy. Inevitably ruling, objection and appeal costs of disputing that the payouts are not assessable income are likely to be way in excess of $3,000.

These kinds of cases appear often enough in published Administrative Appeals Tribunal reports, and there are plenty below the visible tip of that iceberg to show that they still remain a frequent and expensive kind of tax dispute for injury victims. To deprive injury victims of tax deductibility for costs of their tax dispute to target other less deserving taxpayers is tough indeed on taxpayers affected. It is of no consolation to an ordinary taxpayer who can’t claim most of their seriously high tax professional costs that he or she is one of a number of less than 90,000 taxpayers who incur more than $3,000 in tax professional costs each income year.

Australia’s tax system abounds in these kinds of structural challenges. Whether or not an activity of a taxpayer amounts to “an adventure in the nature of trade” and consequently an enterprise carried on by a taxpayer attracting a GST obligation, is another good example of a tax uncertainty a taxpayer who is not a millionaire may find costly to solve in their case and may not solve without taking valuable professional assistance.

The cap binary and alternatives to better target the cap

So if $3,000 might not be enough of a cap to ensure fair operation of the cap, why impose a binary limitation with such a confidence in the announcement that its impact will be on millionaires?

The small business capital gains tax measures themselves show that the demarcation between “small” and bigger business is not necessarily easily achieved as shown by the unwieldy $6 million net asset test. A demarcation between ordinary and “millionaire” taxpayers to qualify for exemption under the cap may be similarly difficult. But might it be possible to devise a targeted cap which looks at the character of the professional tax costs of a taxpayer of managing their personal tax affairs so that the cap operates more equitably?

For instance could costs of professional tax work just directed at establishing the position of a taxpayer under certain tax laws on non-contrived circumstances be exempted from the cap? Most capital gains tax rules could be within that exemption. If the professional work addressed specific anti-avoidance measures, the general anti-avoidance provisions or exploitative tax planning the professional work could be “tainted” by that consideration and so fall outside of the exemption. One difficulty is that some sort of “chinese wall” solution may be needed so privileged thus confidential tax advice could be considered to verify whether the costs of the professional tax law assistance is exempt from a targeted cap on costs of managing tax affairs.

It may be possible to conveniently go through all of the (many) tax laws and classify those where issues and disputes arising from them are benign, in an avoidance context, as exempt from the cap. Often wealthy taxpayers and their advisers have little interaction with these laws and so exempting them would not give wealthy taxpayers any advantage. That would better achieve the aim of the Fairer Tax System plan.

Getting tax advice to take the 50% recklessness penalty out of play

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Self-assessment

Under Australia’s self-assessment system taxes including, notably, income tax and the goods and services tax, are based on returns by each taxpayer where responsibility is on the taxpayer to ensure statements and representations made to the Australian Taxation Office (ATO) reflected in those returns are true and correct.

Penalties when returns are not true and correct

When a taxpayer departs from true and correct disclosure to the ATO, penalties, including base penalties, for false and misleading statements to the ATO, unarguable tax positions and tax schemes are imposed by Division 284 of Schedule 1 of the Taxation Administration Act (C’th) 1953.

To understand the base penalty regime in Division 284 it is helpful to consider simplified categories of a taxpayer’s disclosures relevant to their return viz:

  1. those items that are straight forward where the taxpayer understands how the item should be returned and its impact on the taxpayer’s tax liability, and
  2. those items which are more complex or difficult where the taxpayer does not fully understand how the item should be returned and its impact on the taxpayer’s tax liability.

It is expected, or at least hoped, that matters in the first category will greatly outnumber matters in the second category. Still an item in the second category may involve a large liability and there may be a need for the taxpayer to resolve the complexity or difficulty, by taking tax advice or perhaps by obtaining a binding private ruling from the Commissioner of Taxation about that item to ensure the item is correctly returned.

As a general proposition it can be said that, unless other mitigating factors apply, failure to correctly return an item in the first category attracts the 75% “intentional disregard” base penalty and that failure to correctly return an item in the second category attracts the 50% “recklessness” base penalty based on the reasoning below:  

Deceptively understating assessable income or overstating allowable deductions etc.

If a taxpayer omits an item in the first category from an income tax return which understates true and correct taxable income then the highest base penalty of 75% for intentional disregard of a taxation law under the table in section 284-90 can be imposed. This isn’t the only liability that follows from a tax review, audit or investigation of a tax return. In addition to section 284-90 base penalties, the taxpayer will be held separately liable for the tax on the taxable income that should have been returned, medicare levy, and, to reflect the time value of taxes outstanding to the ATO, the shortfall interest charge and the general interest charge, etc when an amended assessment is raised to amend the original assessment which was not true and correct.

Base penalties, including the 75% intentional disregard base penalty, are imposed on a case by case basis. Thus the ATO will infer from the way the return was completed and surrounding facts whether there was intentional disregard of taxation law justifying imposition of a 75% intentional disregard base penalty. Similar considerations as arise as to whether there was fraud or evasion (which impacts on when an amended assessment can be raised) including whether the conduct giving rise to the omission of assessable income or the overstatement of allowable deductions or offsets etc. was deceptive or calculated, or whether the conduct could be explained as some sort of mistake, which attracts a lesser penalty, are relevant.

50% “recklessness” base penalty applied in PSI cases

The recent personal services income (PSI) cases of Douglass v. Commissioner of Taxation [2018] AATA 3729 (3 October 2018) and Fortunatow v. Commissioner of Taxation [2018] AATA 4621 (14 December 2018) illustrate how the 50% “recklessness” base penalty under the table in section 284-90, one rung down from the highest 75% intentional disregard base penalty, can be applied to a taxpayer who fails to correctly apply taxation law to matters in the second category.

Both cases involved the application of the personal services income measures in Part 2-42 of Income Tax Assessment Act (ITAA) 1997 to the income of professionals (an engineer and a business analyst respectively) which was alienated from the respective individual professionals by arrangements using related companies reducing their overall income tax liabilities.

Complex or difficult?

The personal services income measures in Part 2-42 are relatively complex involving multi-tiered considerations of various tests even though the Commissioner of Taxation expressed this view in the objection decision in Douglass (from para 110 of the AAT decision):

The attribution rule of the PSI is not an overly complex area of the relevant law. There was readily available information on the operation of the PSI rules set out on the ATO website. It was also explained in the Partnership tax return instruction and in the Personal Services income schedule instruction that accompanied the tax return guide for company, partnerships and trusts. You did not make further enquiries to check the correct tax treatment of your PSI.

In both cases, the taxpayers primarily relied on the “results test” in section 87-18 of the Income Tax Assessment Act 1997 to establish that, in each case, a personal service business was being carried on so that alienated income for the personal services of the individuals would not be attributed to the individuals under Part 2-42. On the facts of each case, each AAT found that the individual was not engaged to produce a result in accord with section 87-18 and so could not satisfy the “results test”.

Recklessness

Also, in both cases, the AAT was critical of the way in which each taxpayer tried to ascertain their respective liabilities under the personal services income measures. In Douglass the taxpayer did not take a cogent advice on how the PSI measures can apply. In Fortunatow the taxpayer had received an advice on asset protection considerations from a tax lawyer which inferred that PSI advice should be taken. But that PSI tax advice was not taken by the taxpayer in Fortunatow.

In each case the AAT referred to BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) ATC 4111 where Cooper J. at p.4129 considered “recklessness”:

Recklessness in this context means to include in a tax statement material upon which the Act or regulations are to operate, knowing that there is a real, as opposed to a fanciful risk, that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct, and that a reasonable person in the position of the statement-maker would see there was a real risk that the Act and regulations may not operate correctly to lead to the assessment of the proper tax payable because of the content of the tax statement. So understood, the proscribed conduct is more than mere negligence and must amount to gross carelessness.

It was unhelpful to the case of the taxpayer in Fortunatow that the taxpayer had been made aware by his tax advice that the PSI measures had potential application to him and that there was a real risk that he was not correctly complying with tax laws. The tax advice he received went no further than saying that income would not be attributed under the PSI measures if there was a personal services business but the taxpayer could not show that he had been advised that he had been carrying on a personal services business.

Obligation on the taxpayer to be correct

These AAT decisions leave little doubt that the responsibility on a taxpayer to correctly address and resolve complex or difficult tax questions in completing their tax returns is serious and far reaching. Ordinarily this means that a taxpayer will need a cogent tax advice or will need to take other steps to demonstrate that the taxpayer has adequately addressed each question to mitigate the “real risk” that the taxpayer’s position on a complex question in a tax return is incorrect to avoid “recklessness”.

Interaction with other base penalties and where taking cogent tax advice is desirable

This removes the opportunity to shirk a complex question or issue in a tax return and to rely on the difficulty or character of the question or issue to assert that some lesser base penalty, such as the 25% base penalties under Division 284 either for failure:

  1. to take reasonable care; or
  2. to take a reasonably arguable position;

is applicable.

Base penalties under Division 284 of Schedule 1 of the Taxation Administration Act (C’th) 1953 apply on the basis that the highest base penalty applies to the exclusion of the other applicable base penalties.

Complex PSI cases demonstrate how self-assessment works

The above personal service income cases provide good case studies of how base penalties under Division 284 are likely to apply in cases where a category 2 complex issue arises and a taxpayer fails to adequately address the issue in their return to the ATO.

Although the ATO cannot apply a 75% intentional disregard base penalty where the taxpayer was without intent to disregard taxation law which was or may have been too complex for the taxpayer to appreciate; the 50% recklessness base penalty, on the next rung down, can nevertheless be applied because of the taxpayer’s failure to deal with that complexity. Complexity is dealt with by taking cogent tax advice from a professional tax adviser for example. It can be seen that the 50% recklessness base penalty is thus integral to taxpayers taking responsibility for true and correct disclosure to the ATO under the self-assessment system.

ATO in house facilitation – alternative dispute resolution with them?

Following a pilot program and formative adoption of the in house facilitation process, the ATO has introduced specific guidelines including:

  • a precise IHF process template; and
  • a statement of expectations from the IHF;

for in house facilitation (IHF) of tax disputes with the ATO. The ATO offers IHF as a general means of mediation of tax disputes where the facilitator (mediator) is an ATO officer.

ATO in house facilitation video

ATO in house facilitation video

Getting serious about dispute resolution with in house facilitation

IHF can be a valuable alternative to a taxpayer with a dispute with the ATO. So the move to entrench a correct structure of the facilitation process is to be welcomed. This should overcome the reluctance and non-adherence by some ATO officers who have come less than well prepared and committed to altenative dispute resolution in the formative IHF processes experienced by some taxpayers so far.

Honing the facts and issues in a dispute and saving costs

Indeed one significant benefit to a taxpayer of using IHF should be to normalize how an ATO case officer is dealing with their problem. A case officer may be fixated on a matter or series of matters which are divergent with a taxpayer’s understandings or divergent with the facts understood to be relevant to the taxpayer. IHF can be a real opportunity to engage with and even press the case officer and maybe his or her leadership. That engagement is with the aid of a somewhat detached ATO facilitator in an effort to reach a common or improved understanding of the relevant facts and issues. Even if that facilitation doesn’t result in a final determination of the dispute, it can, at least, lead to a narrowing of issues in dispute. A big reduction in the ultimate cost and effort of resolving the dispute can follow.

Contrast with position paper exchange

IHF is aimed at, and available only to, individual and small business taxpayers. Not all disputes are complex enough, or have tax at stake, which justify the ATO committing resources to preparing a paper setting out their position. With IHF generally available the opportunity is there for both sides to put their positions without going through a time-consuming sequence of preparing and exchanging position papers and responses. If a taxpayer and the ATO observe the entrenched IHF process and the statement of expectations, and are both well prepared at an IHF session, both parties should leave the IHF with a better understanding and honing of the matters in dispute, if not a resolution.

IHF – an open-ended offering

That is not to say that a taxpayer should not pursue IHF and exchange position papers with the ATO too. The ATO offers IHF during and following audit, after audit and after an assessment is raised, before and after an objection is lodged and before or and after an appeal to a tribunal or court is sought. In the latter cases a facilitation may have limited use to a taxpayer because of its interaction with time limits for objections and appeals and the availability of mediation facilities outside of the ATO offered once the matter reaches a tribunal or a court.

Like with a position paper, the best time to pursue IHF will usually be before an assessment is raised, if that is possible. That is the best chance of being before the ATO has a view it wishes to entrench and defend.

Timing of engagement

IHF thus offers a taxpayer some opportunity to control the timing of engagement with ATO case officers. The ATO understands that this can afford both taxpayers and the ATO with opportunities to reach common ground and to resolve tax disputes sooner. That is in everybody’s interests. Even where little progress is made in an IHF due to the nature of dispute, objection and appeal rights are preserved and the IHF process can still be of strategic value to a taxpayer on the long haul to resolving a protracted tax dispute with the ATO.

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.

 

CIRorFOI

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.