Investment advisers caught in tax scheme promoter net

Key Points:
Although the laws are meant to curb the activities of promoters of tax avoidance and evasion schemes, they cast a very broad net and could cover legitimate tax planning and investment advice.

Few would argue about the need for legislative controls over the activities of promoters of tax avoidance and evasion schemes. However, the response should not confer unduly wide powers on the Commissioner of Taxation. The measures should be targeted. They should not be cast in a way that throws a very broad net and then effectively requires those caught to demonstrate that they should not be sanctioned.

Yet this is the structure of the amendments being introduced by the Tax Laws Amendment (2006 Measures No 1) Act 2006, in the form of a new Division 290 in Schedule 1 of the Tax Administration Act 1953. The object of the amendments is to curb the activities of "promoters in their capacity of designing, marketing, selling or implementing tax avoidance and tax evasion schemes".

They do this by casting an extremely broad net over any and all persons involved with arrangements that have tax benefits and which are the subject of some element of "marketing or encouragement". There is no carve-out for informed or sophisticated investors. The measures can apply to one-to-one transactions. They impact broadly on banks and financial institutions, financial planners and investment advisers, accountants and lawyers.

This is then moderated somewhat by certain limited carve-outs, but in most cases not by specific limits to the scope of the legislation. Instead, the only protections are provided in the form of some so-called "exceptions" that apply to the civil proceedings permitted by the legislation. The person defending the action must then incur the expense of a defence and satisfy the civil standard of proof that the "exception" applies, on the balance of probabilities.

Not just promoters

While it is true that the legislation requires that there be an entity that is the promoter of a tax exploitation scheme, it is also true that:

• persons other than promoters can be the subject of civil penalty or injunctive action by the Commissioner, where only a very low level of nexus with the promoter is required. The law prohibits an entity engaging in conduct that results in either that entity or another entity being a promoter of a tax exploitation scheme;
• consideration for the promotion is a necessary element but indirect consideration and consideration received by associates are also taken into account;
• the scope of who is a "promoter" is based on a very broad concept of "marketing or encouragement" and uses a broad standard as to whether it can reasonably be concluded that the entity had a "substantial role" in respect of the marketing or encouragement; and
• there are only two express carve-outs, one for an entity who "merely" provides advice, and the other for employees who merely distribute material prepared by others. However, these "exceptions" apply only to being a "promoter", not to entities which may be found to have engaged in conduct that results in someone else being a promoter.

In essence, the provisions apply where any entity engages in conduct that results in that entity or another entity being a promoter of a scheme that is within the definition of a tax exploitation scheme. Any individual or organisation may be within this net, not just persons or businesses active in the promotion of tax-based investment schemes. Any bank, financial institution, insurance company, financial planner, or superannuation adviser may be affected, as well as professional accounting and legal firms.

Not tax exploitation schemes

The promotional activity that may be the subject of action relates to "schemes", a term which has an established and extremely broad definition that covers all likely arrangements, existing and proposed.

To this the legislation adds the requirement that the marketing or encouragement must relate to a scheme that meets the conditions of a "tax exploitation scheme". However, this description is also a misnomer because:

• the definition of a "tax exploitation scheme" is not based on any concept of "exploitation" or even tax avoidance or evasion as such;
• instead it is based on a purpose test relating to "scheme benefits" in the form of either less tax payable by the taxpayer or more amounts payable or creditable to the taxpayer, which would not have resulted apart from the scheme;
• the purpose test is supplemented by a "not reasonably arguable" test, which is met if the scheme tax benefits (for schemes proposed or implemented) are not reasonably arguable at law.

More accurately, the schemes affected are schemes where it would be concluded that the sole or dominant purpose was obtaining a tax benefit where it is not reasonably arguable the benefit would be available at law. The number of taxpayers involved is not relevant and it is immaterial whether or not there is a "mass marketed" investment scheme of any kind.

This is a much less stringent standard than the term "tax exploitation" implies. It is set at a level well above that of tax fraud, which normally implies intentional dishonesty, and also above that of evasion, which has generally been considered to involve unlawful conduct to escape payment of tax. While it would probably not catch ordinary business tax planning or tax minimisation arrangements, areas of uncertainty will inevitably arise in relation to both the purpose test and the "not reasonably arguable" test.

The looseness of these requirements is not the only concern - a further concern arises due to the fact that these broad elements are all the Commissioner needs to establish in order to commence civil penalty actions or injunctive relief against a wide range of persons associated in particular ways with the marketing or encouragement of arrangements that have tax benefits. In addition, there is a risk that these measures could become a de facto anti-avoidance regime in their area of application, without the safeguards available to taxpayers under the general anti-avoidance provisions in Part IVA of the 1936 Act.

Severe penalties

The civil penalty for the promoter of a tax exploitation scheme is intended to be greater than the expected benefit from the forbidden conduct. The maximum amount of penalty the Federal Court can impose is the greater of:

(a) 5,000 penalty units (currently equal to $550,000) for an individual, or

(b) 25,000 penalty units (currently equal to $2.75 million) for a body corporate; and

(c) twice the consideration received, directly or indirectly, by the entity and associates of the entity from the promotion or implementation of the scheme

Where there is more than one promoter of a tax exploitation scheme, each promoter may be subject to a different individual penalty, taking account of any differences in the consideration received. The Commissioner can seek injunctive relief, which may lead to restraining orders or mandatory performance orders. This action may be taken as an alternative to, or in conjunction with, a civil penalty action.

Improper implementation of a product ruling

A second branch of the civil penalty regime applies only a particular investment product or scheme is the subject of a product ruling issued by the Commissioner, usually following application by or on behalf of the promoters of the product. Such an investment product may then be promoted on the basis of conformity with the product ruling.

The civil penalty sanctions may be attracted if an entity engages in conduct that results in such a scheme being implemented in a way that is materially different from that described in the product ruling. There is no contravention (even if the implementation is not entirely in conformity with the product ruling) if in fact the actual tax outcome for scheme participants is the same as that described in the product ruling.

If a particular investment product is covered by a product ruling, but is implemented in a way that materially differs from that described in the product ruling, the civil penalty regime means that a promoter may face the civil sanctions and/or injunction proceedings separately from, and in addition to, the penalties and interest that might be imposed on the investors.

According to the Explanatory Memorandum, whether implementation is materially different depends on the extent of tax impact attributable to the departure from the product ruling. However, the difference is in implementation and potential tax impact, not in the actual tax treatment that is ultimately applied in fact to the investors in the scheme.

Promoters, employees and contractors

The coverage of the legislation has a limited carve-out for employees who merely distribute information or material prepared by someone else. This is limited to "employees" in the traditional sense and does not apply to non-employee contractors. It does not apply to any other marketing activities or 'encouragement' outside distribution.

Persons outside the employee carve-out (and the carve-out for 'mere' advisers) who are involved in marketing or encouragement that potentially falls within the provisions must rely on being able to demonstrate that:

• no consideration was received by them or their associates, directly or indirectly, that relevantly relates to the marketing or encouragement (for example, ordinary contract remuneration for services rendered); and/or
• having regard to a range of matters, it can reasonably be concluded that they did not have "a substantial role" in respect of the marketing or encouragement.

These two key elements must be present for the measures to apply. The legislation gives no indication of the factors relevant to a "substantial role" although the explanatory memorandum refers to the nature and extent of involvement, and consideration received, relative to other participants.

Where it can be shown that broad conditions are met, the Commissioner may commence proceedings in the Federal Court for civil penalties and/or injunctive relief. If the Commissioner satisfies the burden of proof concerning an alleged contravention, there is then a question whether one of the "exceptions" or defences can be established.

Exceptions and defences

The main general defences to civil penalty proceedings are that the challenged conduct:

• was due to a reasonable mistake of fact (not of law); or
• was due to the act or default of someone else, or to an accident, or to some other cause beyond your control, and you took reasonable precautions and exercised due diligence to avoid the conduct.

In addition, the Court may not make orders for contravention of the provisions relating to promotion or implementation if it can be shown that you did not know, and could not reasonably be expected to have known, that the conduct would result in the contravention.

This may assist contractors and others who unknowingly participate in a breach of the legislation - but they must prove their defence. There is one further limited protection for individuals involved in breaches - proceedings cannot be commenced against them if the Court has already made a civil penalty order against their employer.

The only other limited protection applies where the Commissioner has actually provided advice to the person concerning the application of the tax laws, or has issued a publication approved in writing about the tax laws, and the promotion relates to a tax treatment that "agrees with" that advice or publication. This is intended to apply to administratively binding advice provided by the Commissioner and is not reference to general tax rulings.

Proceedings by the Commissioner

For conduct that is alleged to contravene the prohibition on the promotion of a tax exploitation scheme, or improper implementation of a product ruling scheme, where "tax evasion" is not involved, the Commissioner must commence proceedings within four years of the relevant conduct. The exception means that no time limit applies to cases involving tax evasion. Although the wording does not use the phrase that appears in other contexts, "fraud or evasion", it would apply to conduct of that kind.

Where a penalty is imposed, the Commissioner may enforce payment as a civil judgment debt and may apply for payment of judgment interest. No allowable deduction may be claimed for payment of a civil penalty.

The regime also establishes mechanisms for voluntary undertakings by promoters in relation to schemes potentially within the legislation. It is intended that such undertakings may be given and accepted without any admission of liability. However, there is no obligation on promoters or on the Commissioner to give or accept such undertakings. Provision is made for enforcement if the undertakings are breached.

Implementation of the regime

The legislation applies to conduct on or after 6th April 2006 (the date the legislation received Royal Assent) - whether it is conduct within the branch that results in an entity being the promoter of a tax exploitation scheme, or conduct within the branch relating to the improper implementation of a scheme covered by a product ruling.