An analysis of the amendments to Part IVA
Banking on Tax, Issue 9
Following several losses by the Commissioner in significant tax disputes involving Part IVA of the Income Tax Assessment Act 1936, most notably when the High Court refused the Commissioner’s application for special leave to appeal the decision in RCI v Commissioner of Taxation  FCAFC 104 on 10 February 2012, the Commonwealth Government announced that it would tighten key aspects of the general anti-avoidance rule effective from 1 March 2012. This was primarily to remove the ability of a taxpayer to argue that they would not have proceeded with the particular scheme or transaction if it would have resulted in the tax liability that the Commissioner was seeking to impose by applying Part IVA.
There was a great deal of debate and controversy surrounding the need for these changes and, following significant consultation, the Government subsequently released exposure draft legislation on 16 November 2012 giving effect to the announcement, effective to schemes entered into from that date. The Government finally introduced the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 (the bill) into Parliament on 13 February 2013.
The key components of Part IVA
To understand the amendments, one needs to consider the key components of Part IVA when it was originally introduced in 1983, which have remained largely unchanged until now. Part IVA was originally introduced to deal with tax avoidance schemes that were blatant, artificial and contrived. The bill and explanatory memorandum (EM) preserve the key components of Part IVA, while incorporating new changes to strengthen the Commissioner’s hand and reduce the scope for a taxpayer to defend a Part IVA determination made by the Commissioner.
Part IVA applies where a taxpayer obtains a tax benefit in connection with a scheme and it would be concluded, having regard to numerous factors specified in the legislation, that a person who entered into or carried out the scheme did so for the sole or dominant purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme. Examples of tax benefits include an amount not being included in assessable income, an amount not being subjected to withholding tax, a deduction being allowed, or a foreign income tax offset being allowed.
Where the three requirements for Part IVA to apply are met, the Commissioner can cancel the tax benefit. For example, if the scheme resulted in a deduction for a taxpayer, the Commissioner could deny the deduction.
The amendments - determining if there is a "tax benefit"
The amendments are, for the most part, targeted at addressing weaknesses in the concept of “tax benefit” highlighted by recent court decisions. The definition of “tax benefit” has been interpreted by the courts as requiring a comparison of the tax consequences of the scheme in question with the tax consequences that either would have arisen, or might reasonably be expected to have arisen, if the scheme had not been entered into or carried out (known as the “alternative postulate”). In broad terms, it is generally concluded that the taxpayer has obtained a tax benefit where the most reasonable alternative postulate discloses a greater amount of tax payable than the tax payable under the scheme. The amendments would significantly change this analysis by creating artificial assumptions for the alternative postulate.
The critical change is that in deciding whether a tax benefit exists in relation to a scheme, consideration of the alternative postulate is done assuming that the taxpayer would have acted without regard to the tax outcomes while still achieving all of the non-tax effects of the scheme. Accordingly, it could not be argued that a scheme would not have been entered into if, all else being equal, it would have resulted in a tax liability.
The EM gives the example of a company placing $1 million on deposit for 12 months for a return of $55,000, payable in arrears. For reasons that are not specified in the EM, this income is treated in the example as exempt for tax purposes. From the company’s perspective, the substance of the transaction is considered to be an investment for a fixed term carrying a right to a non-contingent return. The EM states that a reasonable alternative to this transaction would be an investment of the same amount, for the same period at a comparable risk and for a comparable return. An investment in ordinary shares, for example, is not considered to represent an investment of comparable risk and comparable return.
The result of the amendments, if passed, would be that the focus of a Part IVA analysis will be squarely on discovering the objective dominant purpose of entering into a tax benefit scheme. This is consistent with the newly stated object of Part IVA. The amendments would apply to schemes entered into, or commenced to be carried out, from 16 November 2012, which was the date when the draft legislation was released.