14 Mar 2013

Big loss for Commissioner in the first promoter penalties case - Commissioner of Taxation v Ludekens

by John Middleton, David Cominos, Kirsten Fish

The failure to show the relevant purpose required for a tax exploitation scheme is potentially a dagger in the heart of the promoter penalty provisions

Although the promoter penalty laws have existed since 2006, the first case dealing with the operation of those provisions was only recently handed down by Justice Middleton of the Federal Court (Commissioner of Taxation v Ludekens [2013] FCA 142). The result was a win for the accused promoters on a mixture of substantive and technical grounds, but the result may well be appealed by the Commissioner.

The Commissioner of Taxation seeks promoter penalties

The Commissioner sought imposition of civil penalties upon two advisers on the basis that they had been the promoters of a tax exploitation scheme, or that they had implemented a scheme other than in accordance with a product ruling.

The advisors were conducting what was referred to as a "secondary investment" in the 2006 Gunns Woodlot Project, which had obtained product ruling PR 2006/8. However, the secondary investment "piggy-backed" off the underlying Woodlot Project, and it was clear that the product ruling did not apply to the secondary investment.

Four aspects of the case are relevant to the broader application of promoter penalty provisions, and will be of interest to all tax advisors.

What is a promoter of a tax exploitation scheme?

Firstly, marketing or encouraging a scheme is to be read as being confined to active promotional functions.

Having regard to the words of a section within their statutory context (and also noting the changes in the final legislation from that published in exposure draft), Justice Middleton found that this was not to be read broadly enough to "specifically bring conduct comprising the development or implementation of a scheme within the ambit of a definition of promoter". It was made clear that the term was not a "limitless phrase" that could catch any conduct in respect of a scheme.

Tax exploitation scheme – what would have happened?

A tax exploitation scheme turns upon the identification of a scheme benefit. It was accepted by the Court that there was a reduced income tax liability, but the Court took the view that an "alternative postulate" similar to that required by the Part IVA anti-avoidance rules would need to be made out, to show what would have happened in the absence of a scheme (as the investors might for example have invested in an "approved" scheme to claim a tax deduction). As the Commissioner failed to lead any evidence or plead any alternative postulate at all, he failed to prove that a scheme benefit had arisen.

The requirement concerning an alternative postulate was apparently not anticipated by the Commissioner, and it is likely that it will form a significant part of any grounds of appeal.

Tax exploitation scheme and "purpose"

The Commissioner also failed in his arguments concerning purpose. To establish that there is a tax exploitation scheme it must be:

"reasonable to conclude that an entity … entered into or carried out the scheme did so with the sole or dominant purpose of that entity or another entity getting a scheme benefit from the scheme."

In this respect, the Commissioner argued the accused promoters, who also participated in the scheme, had the relevant purpose.

Justice Middleton adopted the comments of Justice Hill in FCT v Sleight (2004) 136 FCR 211 (an agribusiness Part IVA case where the Commissioner made an issue of the advisers' purpose), where the Court took the view that the dominant purpose of the advisor was to make a profit for himself, rather than to secure a deduction for the investor. The Court there accepted that providing such a deduction was certainly a purpose but it was not the dominant one.

Justice Middleton concluded that he had not fallen into the false dichotomy warned against by the High Court in Spotless and said:

"It is not sufficient for the Commissioner to simply submit that the effectiveness of the scheme depended on the investors obtaining tax refunds or successfully claiming deductions to reduce their income tax liability… it must be possible on the evidence to reasonably conclude that this was the sole or dominant purpose of [the accused]. The Commissioner has not been able to discharge this burden…"

Alternative argument – implementing a scheme other than in accordance with a product ruling

The Commissioner also raised a secondary argument that the accused had committed an offence of implementing a scheme other than in accordance with a product ruling.

The Court took the view that this related to the actual factual implementation of the scheme, and in any event that the secondary investment complained of was outside the terms of the product ruling and was not covered by it. Justice Middleton went on to say that if the relevant offence:

"was intended to prevent the mere promotion of schemes on the basis that they are covered by a product ruling when in fact they are not, the legislature could have expressly provided for this."

What does this mean for the promoter penalty provisions?

For the Commissioner, this result is something of a disaster. It appears that the Commissioner's case was hamstrung because he had to actually prove matters on the balance of probabilities and was not able to rely upon the statutory reversal of onus of proof which he has come to rely upon in tax matters. As a result he led no evidence on critical matters and failed to set out his arguments within the pleadings. This presented procedural difficulties which the Commissioner will presumably be better equipped to overcome in future matters.

However the failure to show the relevant purpose required for a tax exploitation scheme is potentially a dagger in the heart of the promoter penalty provisions. One could well imagine that any promoter could readily give evidence that his primary purpose was to earn a fee or profit. At the same time it exposes potential difficulties for promoters defending future actions – where the Commissioner argues that obtaining the scheme benefit was the dominant purpose of a scheme participant, it will be very difficult for a promoter to lead evidence to the contrary.

This decision is almost certain to be appealed, and if the Full Federal Court agrees with the trial judge then Treasury may consider recasting the promoter penalty provisions.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.