In our last edition of Be Informed, we cautioned that the Australian Government has been considering changes to the general anti-avoidance provision – Part IVA of the Income Tax Assessment Act 1936.
Part IVA was introduced to counter blatant, artificial and contrived tax avoidance arrangements. This original purpose has evolved and developed over time such that the types of arrangements that Part IVA can apply to is much broader than was initially expected.
A series of amendments to Part IVA have now been proposed. The amendments are proposed to apply to arrangements entered into on or after 16 November 2012. The amendments are quite specific, but will have wide ranging implications, as outlined below.
The “do nothing” counterfactual will no longer be valid
Previously, taxpayers could argue that if they didn’t enter into the arrangement or scheme that the Australian Taxation Office (ATO) are alleging constitutes tax avoidance, they would have done nothing – hence the concept of the “do nothing” counterfactual.
This has the implication of meaning no tax benefit arises and Part IVA cannot apply.
Under the new laws, this argument will not be possible. Rather, the assumption will be that a taxpayer will have done something else (the “alternative hypothesis”) that achieves the same commercial or non-tax effects.
The intent of the change is to ensure a Part IVA analysis focuses on the question of the taxpayer’s dominant purpose rather than technical analysis of the concept of tax benefit.
The ATO’s’ analysis of alternative arrangements or schemes disregards the tax outcome
For Part IVA to apply there needs to be a tax benefit. The tax benefit is calculated as the difference between the tax that you paid on the transaction that took place and the tax outcomes that would be achieved under the “alternative hypothesis” – i.e. the alternative scheme that would achieve the same commercial outcomes. An alternative hypothesis needs to be reasonable.
Previously, a taxpayer could argue that an alternative hypothesis proposed by the ATO was unreasonable as the tax effects of the alternative were such that they would not have entered into the arrangement.
Under the proposed new laws, the tax effect of the alternative is ignored and the focus is purely on the commercial outcomes. It is this change which could have the biggest impact on taxpayers.
Tax is a valid commercial cost of doing business and like all such costs, it is one that is managed and factored into the cost/benefit analysis of decisions. Without any intent to avoid tax, taxpayers will often dismiss a course of action because of the associated tax costs.
For the ATO to ignore the tax cost when assessing what a taxpayer’s alternative course of action would have been, risks producing a distorted and unfair outcome.
When is an arrangement caught by Part IVA?
The key test around which Part IVA operates is the dominant purposes test. This is an objective assessment, with eight factors to find the dominant purpose behind the arrangement or scheme.
If the dominant purpose is to obtain a tax benefit, Part IVA applies. The amendments to the law are intended to ensure any analysis focuses on the dominant purpose test. It is vital for taxpayers to appreciate that this is an objective test – your stated purpose and your subjective intent are largely irrelevant.
When undertaking a transaction that Part IVA could potentially apply to, simply saying that you did it for a specific non-tax reason is not enough. Increasingly you will need to prepare evidence to substantiate your non-tax purposes, evidence that is sufficient to enable an objective assessment to reach the same conclusions.
The new laws have been released as an exposure draft for consultation (noting that they have already been subject to detailed consultation) and William Buck will be active in ensuring issues like this are identified and raised.
It is highly likely, however, that the new laws will be enacted as outlined in the draft and will apply from 16 November 2012. Consequently any tax planning or transactions being considered need to be assessed in the light of the changed anti-avoidance framework. Please contact your local office for assistance in these matters.