Part IVA overcomes deficiencies of the former section 260 of the Income Tax Assessment Act (ITAA), exposed by judicial decisions. Part IVA was introduced, albeit with limitations on scope, to provide an appropriate balance between combatting tax avoidance without discouraging commercial and familial transactions.
Section 260 was rendered largely ineffective due to excessive literal interpretation and judicial extrapolations. The decision of Keighery Pty Ltd v Federal Commissioner of Taxation (Keighery), highlighted that even where the taxpayer that a corporate restructure was to obtain a tax benefit, section 260 was not able to apply to the transaction.
Part IVA aims to overcome:
- The choice principle – its interpretative pitfalls, the ease of sidestepping its application, and discretion afforded to taxpayers (as seen in Keighery) who despite conceded to tax-avoiding intentions but didn't fall foul of its provisions;
- Lack of consideration of the motives in entering into an arrangement, and not limiting an arrangement's purpose to its effect;
- Lack of clarity regarding what was considered 'appropriate' or valid; and
- The Commissioner's inability to reconstruct an arrangement to arrive at a taxable situation, after an arrangement was considered 'void'.
It was "designed to apply where, on an objective view of the particular arrangement and its surrounding circumstances, it would be concluded that the arrangement was entered into for the sole or dominant purpose of obtaining a tax deduction or having an amount left out of assessable income."1
Noticeably different between section 260 and Part IVA was the former, if applicable would render the entire arrangement as void. The latter would allow the Commissioner change the tax consequences or benefit by making a determination under section 177F. 2
Operation of Part IVA
General anti-avoidance provisions apply as a safety net in tax laws, established to underpin the primary operative provisions when the primary provisions don't achieve their purpose. Under Part IVA, taxpayers can obtain the best tax outcome, within the bounds of the law.
Part IVA's purpose is to assess the facts of an arrangement and tax an amount that would otherwise not have been assessed due to the rigidness of the tax laws. The application of Part IVA is often mistakenly conflated with assessing the commercial appropriateness and subjective intentions of entering into an arrangement. This is however outside the bounds of the provisions.
For the Anti-avoidance provisions to apply there must be a scheme and a tax benefit obtained in connection with that Scheme. The linchpin is the making of determination by the Commissioner under section 177F to cancel a tax benefit obtained by a taxpayer in connection with a scheme.
Elements of Part IVA
What is a scheme?
Section 177A(1) defines a scheme as:
"(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal proceedings and;
(b) any scheme, plan, proposal, action, course of action or course of conduct."
The High Court in FCT v Peabody held that an error made by the Commissioner in identifying a scheme won't invalidate a determination – although, a taxpayer's would. Where a scheme comprises of a series of steps, each step is seen as a component of the scheme. 3
Part IVA is not dependent upon the Commissioner's subjective opinion but the objective facts which produce the tax benefit(s).
Tax benefit
The original tax benefit definition was confined to the non-inclusion of an amount that would or might reasonably be expected to be included in the taxpayer's income or the allowance of a deduction that would or might not have been expected to be allowable, but for the scheme: section 177C(1).
This definition posed many issues. Namely, any tax benefit such as a rebate or credit wouldn't fall under this definition and thus was not subject to Part IVA. The definition has now been expanded to include issues such as capital loss and foreign tax credits.4
The burden of proof to establish that there is no tax benefit rests with the taxpayer to establish facts that displace the Commissioner's assessment and to satisfy the court that there was no tax benefit.
Dominant purpose
Eight factors in section 177D determine if a tax benefit has been or would be obtained in connection with a scheme. It isn't necessary to determine a taxpayer's intention but what a reasonable person would conclude the scheme's purpose to be.
In assessing a scheme in accordance with the eight objective factors of section 177D, the actual subjective intention of a taxpayer is not necessary to be determined, but objectively what a reasonable person would conclude the purpose of the scheme to be.
The dominant purpose was considered to be, amongst the various purposes of a transaction to be considered the most influential purpose.5 In the case of Spotless, the taxpayer argued the dominant purpose of the investment was to secure a satisfactory rate of return, which was achieved and despite having commercial benefits, the dominant purpose of the transaction was the non-derivation of Australian sourced interest income.
In Consolidated Press Holdings, whether the overall commercial purpose of a transaction would be conclusive of a portion of a transaction, where a tax benefit was obtained was considered. It was argued that it was artificial for the Commissioner to select part of an overall transaction as the scheme to be caught by Part IVA.
This sentiment is prevalent in Minvera Financial Group Pty Ltd v FCT (Minerva) and Mylan Australia Holdings Pty Ltd v FCT (No 2) (Mylan) – where taxpayers argued the dominant purpose of a scheme must be considered in light of its commercial and economic context.
Insertion of Section 177CB
Section 177CB was inserted to combat the slurry of cases ruled against the Commissioner. The Courts found in favour of the taxpayers, principally on the question of whether there was a tax benefit within section 177C. Taxpayers successfully argued that in the absence of the scheme, it would be unreasonable to expect that they would have entered into a different transaction that attracted adverse taxation consequences. Therefore, Part IVA did not apply. The alternative postulate was that the taxpayer would 'do nothing' – RCI Pty Ltd v FCT (RCI Pty Ltd).
In RCI Pty Ltd, the Full Federal Court concluded that the scheme had not been carried out and the taxpayer was able to argue they would not have entered into a scheme as the cost to do so would be too great. If the scheme hadn't been entered into or carried out, operation of Part IVA could be avoided. Hence, section 177CB was inserted to avoid this line of argument.
Section 177CB inserted two 'limbs' under which a tax benefit can be established:
- The "would have" limb
Section 177CB(2) compares the tax consequences of a scheme with what 'would have' taken place had the scheme not occurred (the 'annihilation approach'). In considering prospective consequences, the scheme must be assumed to have not taken place, whilst considering facts and circumstances that occurred.
It was designed to address allowable deduction schemes and deal with problems associated with the decision of FCT v Trail Bros Steel & Plastics Pty Ltd (Trail Bros). Here, it was held that if the taxpayer hadn't entered into a scheme that gave rise to the tax deduction, other transactions would have been performed that also gave rise to a tax deduction. The tax benefit under section 177C was the difference between the two deductions, and the deductions generated from the scheme that was cancelled by Part IVA.
- The "might reasonably be expected to have limb"
This limb requires comparing tax consequences of the scheme with those of an alternative transaction (the "alternative postulate" or "reconstruction approach").
The alternative postulate must be a reasonable alternative when the potential tax consequences are ignored. The Commissioner is not required to find an alternative to the scheme but to identify an alternative transaction. The reconstruction approach aims to identify a tax benefit in relation to a scheme and also non-tax consequences.
In FCT v Guardian AIT Pty Ltd ATF Australian Investment Trust, the Full Court found Mr Springer had not proved, in the absence of the schemes, he would have been reasonably expected to undertake an alternative scheme that would not have entitled him to trust income in 2012 and 2013. However, the Full Court found the dominant purpose to obtain a tax benefit existed for the 2013 but not 2012 income year.
Current Part IVA landscape
Recent Part IVA have observed a win for taxpayers, namely providing further guidance on the application of section 177D, and the need to consider the context of a transaction when assessing application of Part IVA.
Minerva
A trustee's failure to exercise its discretion to distribute income to special unitholders, that attracted a greater tax liability, was insufficient in demonstrate the dominant purpose of a scheme was a tax benefit. The Court's approach in considering the factors in section 177D is a reminder to view transactions in its context.
Mylan
As with Trail Bros, the tax benefit was the differential between the amount claimed and deductions arising from the alternative postulate. The Court considered the eight factors to determine if the scheme's dominant purpose was to obtain a tax benefit and in doing so, was reliant on the taxpayer's failure to refinance the intragroup loan when interest rates declined.
The Court rejected the Commissioner's argument that the decision to fix interest rates between subsidiaries was indicative of a dominant purpose to obtain a tax benefit. The other factors were considered neutral.
Relevantly, the Court emphasised that a taxpayer's choice to perform a particular form of transaction is not, in and of itself, indicative of a dominant purpose to obtain a tax benefit.
Grant v Commissioner of Taxation
The Administrative Appeals Tribunal upheld the Commissioner's assessments, despite the commercial rationale, that the artificiality of the scheme entered into by Principals of a legal practice to avoid income and debts incurred personally portrayed a dominant purpose of obtaining a tax benefit.
Similarities were drawn between the decision of Hart v Federal Commissioner of Taxation, where the High Court upheld the Full Federal Court's decision that the scheme entered into by Principal Michael Hart, was for tax avoidance. Despite Hart's assertions that the arrangement was for asset protection, the court concluded there was a tax benefit.
Key takeaways
These cases demonstrate alternative transactions that realise a greater tax liability are insufficient to demonstrate the dominant purpose of a scheme is obtaining a tax benefit, and accordingly the application of Part IVA. Objective factors must be considered to determine the most influential purpose was to obtain a tax benefit, and not to assess the commercial efficacy.
The subjective purpose of the taxpayer isn't relevant in applying the objective factors in context. The ATO can't selectively focus on aspects of an arrangement in determining a scheme's purpose but must view it in context of all commercial and economic considerations.
Footnotes
1 Explanatory Memorandum, 1-
2.
2 Income Tax Assessment Act 1936 (Cth); FCT
v Spotless Services Ltd (1996) 96 ATC 5201 at 5205.
3 FCT v Spotless Services Ltd (1996) 96 ATC
5201.
4 FCT v Peabody (1994) 94 ATC 4663.
5 FCT v Spotless Services Ltd (1996) 96 ATC
5201.
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