Yesterday, and only one day after the OECD released a report on preventing tax base erosion and profit shifting, the Federal Government unveiled its long-awaited bill for reforming the general anti-avoidance and transfer pricing rules in the Australian income tax law.
Reforms to Part IVA were initially announced by the Government on 1 March 2012 with an exposure draft released for public consultation on 16 November 2012. Broadly, Part IVA applies where a person enters into a scheme for the sole or dominant purpose of obtaining a tax benefit.
The Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 was introduced to Parliament with the aim of strengthening Australia's approach to domestic and international tax avoidance by:
The changes to Part IVA are seen as so significant that the Government expects the reforms to prevent the loss of $1 billion each year, according to explanatory material released with the Bill.
Stated reasons for reforming Part IVA
The stated intent of the reform is:
- to make it clear that there are two alternative limbs in determining whether a person has obtained a tax benefit from a scheme – what "would have" happened but for the scheme and what "might reasonably be expected" to have happened;
- to ensure that what "would have" happened but for the scheme must be determined based solely on the events and circumstances that actually happened or existed, other than those things that formed part of the scheme itself;
- to ensure that what "might reasonably be expected" to have happened but for the scheme must be determined on the basis of an alternative that is reasonable, having particular regard to the substance of the scheme and its effect for the taxpayer but, importantly, disregarding any income tax costs of that alternative; and
- to emphasise the "dominant purpose" element of Part IVA by requiring the application of Part IVA to start with a consideration of whether a person participated in the scheme for the sole or dominant purpose of securing a particular tax benefit.
The way in which the first three elements are sought to be achieved is by the introduction of a new section 177CB. The drafting of this section in the Bill represents a significant improvement over the drafting in the Exposure Draft in terms of clarity and readability. In particular, the confusing concept of "non-tax effects" has been discarded. In its place, a concept of "tax effects" has been introduced, though the meaning of this term seems to be the same as "tax benefit" so the need for a separate definition is unclear.
Key messages about the Part IVA reforms
- If passed, the legislation will apply to schemes that commenced to be carried out on or after 16 November 2012 (the day the exposure draft was released).
- The proposed legislation does not make clear when it is appropriate to apply the "would have" limb rather than the "might reasonably be expected" limb, though this distinction now becomes more important given there are different ways of determining the alternative course of events depending on the applicable limb.
- The explanatory material provided with the Bill indicates that the "would have" limb might generally apply where the particular scheme has no other commercial or economic consequences other than tax. In such a case, "annihilation" of the scheme should still leave a "coherent taxable situation" to which the law can apply. In practice, this might be more targeted towards particularly aggressive schemes which result in deductions being available for no economic loss.
- On the other hand, it indicates that the "might reasonably be expected" limb will apply where there were real commercial or economic consequences arising from the scheme so the relevant events need to be "reconstructed" to reveal the tax that was avoided. However, these concepts do not appear in the Bill itself.
- In determining what "might reasonably be expected" to have occurred but for the scheme, the decision-maker is directed to "have particular regard" to the substance of the scheme and the result of consequence for the taxpayer that is or would be achieved by the scheme but not to have regard to the result under the tax law that would have been achieved. This prevents taxpayers arguing that a particular alternative course of action is not reasonable because it would have resulted in an uneconomic tax liability. However, the matters to which regard must be had is not exhaustive, leaving open the possibility of forensic analyses into other courses of events that the exposure draft had sought to prevent, if not particularly clearly.
- The explanatory material to the exposure draft spoke of making sure that there was one "single, holistic, inquiry" under Part IVA – whether a person participated in a scheme for the sole or dominant purpose of enabling the taxpayer to obtain a particular tax benefit. The explanatory material to the Bill now refers to this simply as a "single inquiry". However, it remains unclear whether this is actually achieved by the drafting of the Bill. More importantly, it is unclear whether such a single inquiry is even practically feasible, given that the inquiry consists of three definite and separately defined limbs. Courts may continue to approach Part IVA in the same way as it remains somewhat more natural to determine that a person had a sole or dominant purpose of obtaining something by first identifying what that something is.
Of course, the legislation has only just been introduced and there may also be further changes to the legislation before it passes Parliament. When it comes to Part IVA, anything is possible.