6.1 ATO-taxpayer community engagement on technical issues (such as the interpretation of the law or application of the law to particular facts) needs to deliver cogent views that properly consider the potential range of applicable factual circumstances.
6.2 The ATO has a range of vehicles for community engagement to assist in developing its views — for example, the public rulings process and consultative forums. Determining the right vehicle for community engagement on technical issues is a difficult matter.
6.3 On the whole, and concerns with timeliness aside, the ATO as a Government agency generally engages with the community well — for example, the public rulings program provides a means for significant taxpayer community input and a general level of transparency in the technical decision-making process.
6.4 However, there is room for improvement in relation to the use of technical discussion papers (such as 'Discussion Papers', 'Consultation Papers' and 'Issues Papers'), specifically concerning:
- the purpose of technical discussion papers and their interaction within the broader ATO-taxpayer community consultation framework; and
- the manner and tone of some technical discussions and interactions.
6.5 There is also room for improvement in relation to a number of other issues that may arise during the development and finalisation of the ATO's technical views, including:
- the potential to give interim guidance pending the development and finalisation of ATO views;
- the use of various other vehicles to alert taxpayers and initiate technical discussions;
- the use of circuit breakers to overcome impasses in the technical development process; and
- the treatment of contemporaneous compliance action.
6.6 In relation to issues of timeliness, the quick identification of significant revenue risks and the quick resolution of technical issues minimises the adverse effect of retrospectively applied views. However, the examples that were raised in submissions to the IGT show that there are long periods of delay due to:
- the time taken to finalise ATO views; and
- the time elapsing before the ATO becomes aware of its compliance concerns.
6.7 These issues are discussed further below.
Discussion of technical issues including discussion papers
6.8 Discussion of technical issues with the taxpayer community — such as through a discussion paper — can better inform technical decisions through impartial discussions on issues. Developing an ATO technical view that involves open consultation with relevant parties ensures that the ATO correctly understands the arrangements and their context and that alternative views are robustly considered before the ATO finalises its view. There is potential to use technical discussion papers as a vehicle to gain knowledge (if approached in an impartial manner) and arrive (in a collegiate manner) at a robust view based on a sound understanding of the relevant arrangements and implications.
6.9 However, the examples show that the underlying purpose and objective of technical discussion papers within the consultation framework, and the wider perception of these papers, may not be currently well articulated or understood.
6.10 As a result of raising this issue with the ATO, the ATO advised that it is considering tightening the internal processes for release of discussion papers on technical issues. It considers that there are at least two areas where discussion papers could be issued:
- pre-public ruling consultative documents, which the ATO considers should in the future rarely be issued (as a general rule) because draft public rulings provide an appropriate consultation mechanism in most cases. A standard template may be adopted providing for a standard disclaimer, a preferred view (if available) and alternative views; and
- National tax liaison group (NTLG) discussion papers, which the ATO considers should be issued generally in response to issues raised through NTLG forums or to facilitate the implementation of new measures.
6.11 The IGT observes that draft rulings will provide the community with the ATO's preliminary view for comment and is part of its usual ruling program process. The 'pre-public ruling consultative document' also appears to be an intended precursor to a future public ruling. 'NTLG discussion papers' should provide a vehicle for the community to initiate discussion on technical issues.
6.12 Although the ATO's advice above clarifies its intended use of the above documents in a public ruling process, it remains unclear how the ATO will interact with the taxpayer community while it develops its technical views that arise in audits and in the process of developing private rulings. This is important because the ATO's compliance concerns that arose during audits and private rulings were the areas which generated most of the examples of purported delayed or changed ATO views in submissions to the IGT. This indicates a need for a clearer framework for taxpayer engagement on the development of ATO views, especially in circumstances where the ATO is progressing compliance action on the basis of undeveloped ATO views.
6.13 The IGT has observed that in compliance projects the ATO has a preference for developing views as it progresses a small number of compliance cases with the intention of applying that view more broadly. This may be a result of the ATO's preference for leveraged activities. However, there are inherent risks in developing a view for broader application through a particular compliance case — namely, the risk that such views do not sufficiently consider variations on the examined arrangement or that the examined arrangement is not representative of the issue. The IGT has observed this result in other reviews also — see for example, Point 2 under paragraph 3.21 in the Review into Aspects of the Tax Office's Settlement of Active Compliance Activities: Report to the Assistant Treasurer.
Tone and manner of ATO engagement on technical discussions
6.14 The examples show that technical discussion papers are currently perceived as promoting a particular ATO view rather than an impartial discussion of the technical issues. Such perceptions promote defensive positions and hinder effective technical discussions. For example, tax practitioners considered that the December 2008 draft practice statement, Taxation of the section 95 net income of a trust, did not sufficiently represent the alternative arguments. This was important because the document set out how compliance staff should take action in compliance activities pending the resolution of the technical issue.
6.15 These perceptions are strongly held where the views in technical discussion papers are applied in compliance activities. For example, in 2008, the ATO was consulting on its views regarding research and development expenditure in relation to contracts for result (amongst others). At the same time it was assessing taxpayers as 'high risk' in relation to these issues and in accordance with the views set out in the consultation paper, which it acknowledged to be 'more controversial'.
6.16 Promoting a particular favoured ATO view or approach in technical discussion papers may be a result of ATO experience that community engagement is greater on issues when it indicates some of its thinking. It may also be a result of the ATO's willingness to reserve an ATO position on issues in an environment where it may be uncomfortable to formally express its view, particularly on emerging contentious areas.
6.17 However, it appears that this ATO approach has been perceived as 'testing the market'. While this may be appropriate in certain circumstances, it causes an adverse reaction (especially, in combination with other ATO conduct) by taxpayers and their advisers that result in them taking defensive positions.
6.18 The examples also show that there are other factors that appear to impact negatively on taxpayers and their advisers in these circumstances. These factors include:
- disagreements over whether ATO action is 'changing' previous ATO approaches or just 'clarifying' them — for example, in response to private sector submissions that there was a change in ATO approach on the interaction of Division 820 of the Income Tax Assessment Act 1997 (ITAA 1997) and the transfer pricing provisions in relation to guarantee fees and interest deductions (the 'Division 820 issue'), the ATO said in its discussion paper that nothing was intended to be contrary to previously issued ATO advice and the ATO considered it appropriate to retrospectively apply the views. The IGT has observed these disagreements in other reviews also. For example, the ATO views taken in relation to taxpayers' GST claims in the charter boat industry which the IGT examined in the review into aspects of the ATO's settlement of active compliance activities. See also chapter 2 of Review of Tax Office's management of complex issues — Case study on service entity arrangements.
- insufficient ATO assurances that views (being adopted in active compliance activities at the same time that they are subject to technical development processes) have been subject to an appropriate level of technical due diligence and the views are that which the ATO will stand by. For example, in relation to the Division 820 issue, during this review the ATO withdrew its discussion paper (which it was seeking to apply in some of its compliance activities) and provided (as a result of significant industry urging to do so) a revised draft ruling and a 'rule of thumb' as a measure of interim guidance.
- the ATO not clearly demonstrating to taxpayers that it understands how its views interact with other areas of the law. As a result, taxpayers say that they are concerned that the ATO does not dispel their apprehension that the view will be applied to circumstances that the ATO has not foreseen — for example, the discussion paper issued in relation to the Division 820 issue was said to omit a range of unconsidered issues, such as the impact on section 974-80 requirements, the potential exposure to double taxation with foreign jurisdictions and how the matter would be handled under the Mutual Agreement Procedures.
- (in circumstances where the ATO does not give interim guidance) technical discussion papers that are left in abeyance, or development into a public ruling is significantly delayed, following critical feedback or pending Treasury's action or further consideration — for example, the ATO's draft discussion paper on section 974-80 of the ITAA 1997 which was withdrawn after substantial industry critical feedback and pending the ATO's discussions with Treasury. Also, the ATO withdrew taxation ruling TR93/15 (concerned with the capital gains tax implications of earn-out arrangements) and issued a replacement draft ruling TR2007/D10 in October 2007. This draft ruling has not been finalised. Tax practitioners are concerned with the prolonged delay, especially as they consider that the view was settled by TR93/15 and was relied on for more than 14 years. They were also concerned that the ATO has signalled in its Compliance Program that it will examine this issue in compliance activities for small to mid-sized businesses and therefore there is no binding advice on which taxpayers can rely. The January 2010 Rulings Program notes that the finalisation date for the ruling is yet to be announced, pending consideration of its discussions with Treasury.
6.19 These factors directly impact on the positions taken and the manner of engagement adopted, significantly impeding the ATO's ability to effectively engage with the taxpayer community on the significant technical issues.
6.20 However, the examples also show that some of the approaches that the ATO has taken lend themselves to minimising this defensive reaction and improving taxpayer community engagement — for example, the ATO informally engaging with tax practitioners by talking through the issues with interested parties (either over the phone or in meetings) before 'putting pen to paper' and formally consulting on the development of its view. Also, providing taxpayers with a mechanism to enable them to raise the implications of views as those views were being developed appeared more likely to improve taxpayer confidence and engagement.
6.21 For example, in relation to a proposed capital markets ruling, tax practitioners comment favourably that ATO officers sought to test views by phoning key practitioners before releasing a draft ruling. As a result of these conversations, the ATO became aware that it had only considered one of four possible applicable commercial arrangements. Through these calls the ATO was able to avoid significant adverse comment if the ruling had been released without taking these other arrangements into account.
6.22 Although these approaches may not be commonly used, where they are used it has enabled the ATO to arrive at a reasonably informed view and improved taxpayer engagement in technical discussions.
6.23 Potential exists to use technical discussion papers more broadly as an opportunity for greater community engagement and mutual understanding through genuine dialogue. If a paper is to benefit the community more appropriately it must deliver its message more effectively and be better understood. This understanding needs to be in respect of the role of the paper in itself and the community engagement framework of which it forms a part. The IGT considers that if technical discussion papers are used as a tool to engage in dialogue and develop a common understanding of the issues, real success will come from genuine and perceived commitment by broader stakeholders.
Interim ATO guidance to taxpayers
6.24 Interim ATO guidance to taxpayers is important to provide prospective certainty during the periods in which significant technical issues are being resolved. Without interim guidance taxpayers are exposed to an increased risk of adverse ATO views. This erodes prospective taxpayer certainty and erodes confidence in the ATO.
6.25 The examples also show that, notwithstanding the fact that the ATO may take many years to finalise its views, the ATO provides no interim guidance unless significant external pressure is brought to bear on the ATO to do so.
6.26 For example, in the F C of T v Phillips case ((1978) 8 ATR 783), the Full Federal Court affirmed that fees paid to a related service entity are deductible provided they are commercially realistic. In 1998, the ATO commenced a compliance project on particular industries which it considered may have uncommercial fee arrangements. Audits were started. From 1999 to 2005, tax practitioners consistently asked the ATO at various forums (such as consultative forum meetings, meetings with tax practitioner bodies as well as in relation to press coverage of the issue) the question of what were commercially realistic rates. The ATO gave indicative guidance in its ruling, TR 2006/2, and an associated booklet in April 2006.
6.27 On the one hand it may be difficult for the ATO to give firm indications until the range of existing arrangements is understood. However, interim guidance may be needed to help taxpayers minimise the risk of subsequent adverse active compliance action, especially where resolution of technical issues is expected to take many months or years.
6.28 The ATO may not be able to, as a matter of course, adopt a 'middle ground' that taxpayers can use as an interim measure pending finalisation of an ATO view. On one view, the Commissioner may not knowingly countenance an approach that he considers may be contrary to that law. (Note, however, that paragraphs 3.59 and 3.60 of the explanatory memorandum to the Tax Laws Amendment (Improvements to Self Assessment) Bill (No. 2) 2005 may indicate an intent that the Commissioner may do so where the interests of certainty are important). Also, as a practical matter, sometimes there may not be any middle ground or the need for an interim measure is not apparent before consultation with the community has taken place.
6.29 In light of the extended delays in some cases in finalising ATO views and the need for the taxpayer community to take steps to avoid subsequent adverse ATO action, the IGT considers that the ATO should do what it can to provide guidance that would minimise the risk of subsequent adverse compliance action — for example, examining the potential for 'interim' rulings that either only apply for a limited period of time or protect against penalties but not primary tax (as was the case in the November 2009 practice statement PS LA 2009/7 Approach to certain trust issues involving Division 6 of Part III of the Income Tax Assessment Act 1936 pending resolution of the Bamford litigation).
ATO taxpayer alerts
6.30 Taxpayer alerts issued by the ATO allow it to quickly communicate to taxpayers its concerns that certain arrangements amount to tax avoidance. This alerts taxpayers to take great care when dealing with these specific arrangements. The IGT considers that notwithstanding that a technical discussion process is underway, where the ATO reasonably understands a compliance concern and the ATO is concerned that the specific arrangement amounts to tax avoidance, the ATO should not be prevented from issuing a taxpayer alert. In these circumstances it is in taxpayers' interests to be quickly alerted to ATO concerns over tax avoidance.
6.31 Submissions have also raised concerns that some taxpayer alerts covered a wide range of arrangements that also appeared to capture compliant arrangements as subjects of possible tax avoidance action. The IGT has observed that the ATO has made efforts to target taxpayer alerts towards those specific arrangements with which it is concerned. The IGT considers that there is a need to ensure that such targeting is improved promptly and continually.
6.32 The examples show that there is a degree of uncertainty about the purpose of certain ATO public statements — such as compliance concerns raised in speeches or public documents issued by senior tax officials. On one view they could be seen as alerting taxpayers to ATO concerns. However, they may not be sufficiently understood by the taxpayer community without further explanation and interaction. Therefore, when compliance action is taken, it transpires that the technical issues may not have been sufficiently discussed with externals to an extent that the ATO action can be seen by the broader community as justified.
6.33 For example, in August 2006 the ATO highlighted as a compliance risk 'significant acquisitions and divestments, especially the tax outcomes of private equity investment groups, infrastructure groups and financial intermediaries to businesses conducting significant acquisition or divestment transactions' in its 2006-07 Compliance Program. In late 2009, the ATO took action to stop payments made to an offshore private equity firm following the public float of an Australian company group. This subsequent action raised significant adverse public comment.
6.34 Better public understanding of the ATO's actions and views could have been facilitated through a discussion paper (which could have been issued shortly after the concern was raised in the Compliance Program) with the ATO's preferred view being subsequently set out in a draft ruling. This would have provided the ATO with an opportunity to obtain information and intelligence in a non-adversarial form more quickly, while at the same time allowing the taxpayer community to give input on the technical issues as well as the factual circumstances to which the views could apply.
Who should initiate technical discussions and when
6.35 Raising significant compliance concerns to public awareness as soon as the ATO becomes aware of them helps taxpayers to take action to minimise the risk of subsequent adverse ATO views — either by structuring arrangements differently to avoid the risk, or by electing not to enter the arrangements.
6.36 However, the examples show that the ATO may wait several months, sometimes years, before it alerts taxpayers of its compliance concerns in a manner that helps taxpayers avoid the risk of subsequent adverse ATO views. For example, the ATO issued class rulings (a form of public binding advice) for around a ten-year period in the late-1990s to mid-2000s. The rulings considered a certain type of payment as exempt income because of a broad view that the ATO took of the legislative provisions. A few years ago, the ATO narrowed its interpretation of the legislative provision — leading to a different tax outcome for the type of payment in question. However, the ATO did not alert taxpayers to this new view and did not withdraw the previous rulings. A couple of years ago, a taxpayer applied for a materially similar class ruling to the previous class rulings. The ATO made numerous information requests but never indicated a change in the prior view. After several months, when the ruling became urgent the ATO disclosed its concern that it had changed its interpretative approach to the provision. However, after more taxpayer interactions (hampering the taxpayer's operations), the ATO obtained a better understanding and a favourable ruling was issued.
6.37 The examples also show that in many cases broader public awareness of the ATO's concerns were often initiated by the private sector — for example, questions asked of the ATO at national tax liaison group meetings because of dissatisfaction with ATO responses given during specific compliance activities that were conducted over several years. Where the ATO did initiate public awareness of concerns with sufficient particularity (for example, through discussion papers or discussions at technical consultative forums), resolution was comparatively faster.
6.38 The IGT considers that the ATO could do more to help taxpayers avoid the risk of subsequent changed or delayed ATO views by alerting taxpayers to its compliance concerns earlier. The question of when the ATO should inform taxpayers and tax advisers about technical issues it is considering involves the exercise of judgement. On the one hand, some taxpayers want to be made aware of all of the ATO's concerns as soon as possible so that they may take action to mitigate their tax risk exposure. However, routinely publishing a list of all ATO concerns could be counter-productive, since it would require corporates to risk manage issues that may not eventuate as matters of significance. Therefore there is a need for some threshold for the disclosure. This threshold would be best set through ATO and taxpayer community dialog.
ATO delays in finalising technical views and the need for accessible technical decision-making circuit breakers
6.39 The examples also show that once the ATO becomes aware of a significant compliance concern it engages its technical and information gathering resources to develop its view. In some cases it may not have enough information to fully understand the issues. In other cases it has the information but the issues raise alternative views on the law or alternative applications of the law to the facts. It may take many years before the ATO finalises its views on its compliance concerns.
6.40 The reasons for these delays are said to include: a desire to provide advice on theoretical 'grey areas' of the law; a lack of enough people with the requisite skills or experience to quickly conclude the issue; protracted internal debates while the ATO is formulating its view, such as issues 'bouncing back and forth' between different ATO officers; and, the ATO's technical escalation processes may be attempting to operate on limited facts because officers were unable to gather enough information from taxpayers.
6.41 The taxpayer community acknowledges that reliable ATO views may take some time to develop and finalise, but is concerned with the actual periods of elapsed time to do so — especially where this is compared to the timeframes in which taxpayers are expected to determine the application of the tax laws to their affairs.
6.42 This issue has been identified in many other IGT reviews (an aspect of which is being assessed in the follow-up review of the implementation of the recommendations in the IGT's Report on improvements to tax administration arising from the Inspector-General's case study reviews of the Tax Office's management of major, complex issues).
6.43 The examples highlighted potential to improve the use of 'circuit breakers' to overcome impasses in the resolution of technical and compliance issues.
6.44 In relation to significant issues resulting in new, changed or clarified views, there is no recognised process to trigger a circuit breaker. The examples show that this depends upon the type and amount of pressure brought to bear by external organisations and the degree to which they can access senior tax officials.
6.45 Also where hotly contested issues rely on policy views, there is broad taxpayer distrust that the ATO has presented alternative arguments to Treasury in a manner that accurately puts the alternative argument and that properly tests the ATO's position (in examining the examples provided to the IGT, there was insufficient evidence to make a finding in this regard).
6.46 On one hand it could be said that any reductions in timeframes would result in a reduction of robustness of views. For example, the public rulings process is considered to be one of the more robust technical development processes — but it involves extended timeframes.
6.47 However, the IGT has observed that where round table discussions have occurred they have facilitated the quick and considered resolution of complex matters so long as they involved key ATO decision-makers, key taxpayer/industry representatives and, where the underlying policy was uncertain, key Treasury officials.
6.48 For example, in November 2008 the ATO developed a potential view that deductions under section 25-90 of the ITAA 1997 would be quarantined to the year in which relevant non-assessable non-exempt income was derived in relation to section 25-90. A senior ATO technical officer raised this thinking with a key practitioner in February 2009 and then in a consultative forum in March 2009. Industry thought that this view would be contrary to the underlying purpose of the provisions because the tracing and quarantining concepts were no longer relevant to deductions in relation to non-assessable, non-exempt income and that industry understood this to be a deliberate Government policy decision. After industry's urging to do so, key tax practitioners, key ATO technical decision-makers and key Treasury officials met in May 2009 to discuss the issues. This enabled a real-time examination and appraisal of the strengths and weaknesses of the alternative views, in an environment in which the policy setting could be explored. The process also obviated concerns about a lack of taxpayer trust in the ATO correctly conveying to Treasury the private sector views in a manner that tested the ATO's view. As a result, ATO technical decisions were made within a matter of months and a draft ruling was issued in September 2009 and finalised in December 2009. Compare this example with the Division 820 issue in which such a circuit-breaker was not used. The ATO became aware of the issue in October 2003 and it was raised to broader public awareness by industry in August 2005. The ATO developed and publicly consulted on its views by releasing a draft tax determination in November 2007 and a discussion paper in June 2008. It met with Treasury in September 2009 and then withdrew those earlier papers and issued draft rulings in late 2009. The ATO plans to finalise the rulings by June 2010.
6.49 Circuit breakers are resource intensive for senior management and external senior partners. However, the cost of downstream disputes can be avoided by investing time and effort up front. These triggers should balance the significance of the issue and the imposition on senior ATO technical decision makers' and senior private sectors advisers' time. The IGT considers that these processes would be best co-designed and implemented by tax practitioner and industry representatives and the ATO. The involvement of Treasury in matters of significant economic implication is also important so it can quickly appraise and alert Government to potential need for policy or law change. Taxpayer involvement in these discussions would improve the quality of that advice.
6.50 The above discussion on the ATO's engagement with the taxpayer community on technical issues leads to the following recommendation.
The ATO should, in collaboration with the taxpayer community, improve its framework for taxpayer engagement in developing its technical views and ensures that all staff adhere to the improved framework. The following should be incorporated into the improved framework:
- Use the most appropriate vehicle in the circumstances to engage the taxpayer community on technical issues.
- Engage and be seen to be engaged impartially on matters of uncertainty and in particular, ensure that any ATO technical discussion paper has been independently reviewed by an appropriate peer in the law sub-plan before public release;
- Alert taxpayers to ATO compliance concerns as soon as practicable, but not in a manner that alarms them before such concerns are substantiated and ensure that its alerts are sufficiently targeted towards the issue of specific concern.
- Engage with taxpayers in an appropriate tone and manner, including informal engagement with the taxpayer community on issues of compliance concern before formal engagement commences.
- In relation to any consultation process (including where any technical discussion paper is issued), develop a project plan and adhere to that plan without sacrificing the quality of process.
- In relation to any consultation process (including where any technical discussion paper is issued), provide interim guidance (to compliance staff as well as taxpayers) to the extent the ATO can. If it cannot, it should explain why not and give an indication of the timeframe in which it could expect to do so.
- Use circuit-breakers for impasses on technical issues and involve Treasury where advice regarding the purpose or object of the relevant provisions would be helpful.
- Ensure that delays in developing and finalising ATO technical views are minimised, and reasons are given for those delays.
The Tax Office agrees with the recommendation.
We have already advised the tax professional bodies through the National Tax Liaison Group that we will be tightening our processes and practices around the use of discussion papers. Feedback received from the professional bodies has been to the effect that discussion papers can be useful but that they need to take a balanced approach with both the preferred ATO view or thinking as well as alternative views. We agree with the Inspector-General's comments at paragraph 6.28 that we are not able, as a matter of course, to provide interim guidance pending finalisation of our view on a particular issue. But we will continue to consider interim approaches on a case by case basis such as we did in 2009 with the 'rule of thumb' approach in relation to the transfer pricing of interest payable on certain cross-border related party loans.
The concept of circuit breakers for resolving significant or contentious issues is already deployed within the Tax Office. For example, priority technical issues are closely monitored by the Chief Tax Counsel and the senior level Priority Technical Issues Committee which intervenes when issues remain unresolved after a reasonable period of time.
As pointed out in response to recommendation 2, the ATO does consult sometimes with Treasury in seeking to understand the purpose or object of particular provisions as part of the process for deciding the ATO's interpretative view.
We agree that we should continue to improve the use of circuit breakers to try to resolve issues in a timely way.
Contemporaneous ATO compliance action
6.51 The examples also show that in some cases the ATO compliance area will move to apply views, even though the views are subject to consultation and discussion.
6.52 For example, in relation to Division 7A of the ITAA 1997, the ATO was pursuing approaches in audits that were inconsistent with its answers to FAQs on its website, even before a senior officer gave public indications that the ATO was re-examining its response to the issue. Another example saw the ATO release a consultation paper in relation to certain research and development deductions. That paper acknowledged that certain views were 'more controversial'. However, taxpayers were concerned that the ATO was applying these more controversial views in risk reviews to arrive at conclusions that the taxpayer arrangements were of high risk.
6.53 On one hand, the ATO must take action to investigate and address compliance concerns as and when it identifies them. The ATO may not be able to give a moratorium on compliance action while a general ATO view on technical issues is finalised. This may be due to concerns about time limits, competitive neutrality and public debt interest considerations and the need for certainty. Generally speaking, the ATO also finds that compliance activity expedites its understanding of the issue and its resolution through consideration in relation to real factual scenarios. However, these objectives need to be balanced with fairness where prior ATO conduct appeared to accept prior views and practices.
6.54 This issue is closely linked to the Commissioner's exercise of his power of general administration not to undertake compliance action for prior periods on particular issues, which is discussed further above.
- the ATO comes across a taxpayer practice or view in a compliance activity, such as an audit or risk review;
- the ATO does not agree with that practice or view; and
- the taxpayer had acted in accordance with that practice or view because the taxpayer perceived that the practice or view was accepted by the ATO,
the ATO should follow the process and criteria set out in recommendation 2 and deal with the compliance activity accordingly.
The ATO agrees with the recommendation to follow the agreed process and criteria set out in recommendation 2 in applying its view of the law in audit cases.
Delayed ATO awareness of compliance concerns
6.55 The impact on taxpayers of adverse ATO views that are applied retrospectively increases where extended periods of time elapse before the ATO becomes aware of its compliance concerns.
6.56 The examples show long time periods (sometimes amounting to many years) between taxpayers adopting practices or views and the ATO identifying its compliance concerns (concerns with practices that are perceived to be of sufficient risk to revenue). In some cases this may be due to the ATO not acting on information available to it. In other cases it may be because of changing business arrangements. For example, in 1993 the ATO issued a tax determination TD 93/135 (a form of binding advice) which the banking industry relied on (together with wording in the explanatory memorandum to the relevant law) to effectively allow an entity to choose whether to book a qualifying offshore banking activity on the entity's offshore banking unit or domestic unit. Affected taxpayers claim that for 14 years the ATO did not disagree with the practice in audits or otherwise. However, in 2007 the ATO considered that some emerging business arrangements were inconsistent with the intention of the Tax Determination. The ATO expressed reservations about the practice to the industry. It released a consultation paper that contradicted this practice and proposed a withdrawal of that tax determination. It should be noted that, at the time of writing, the issue is not finalised.
6.57 As another example, section 73B of the ITAA 1936 was enacted in 1985 to provide concessional deductions for certain research and development (R&D) expenditure. In 1987, the ATO issued taxation ruling IT 2442 (non-binding advice, although the ATO will consider itself administratively bound by it) in which it stated at paragraph 45 that:
It might be that a company is approached by a client and asked to develop a product or process which is required by the client for use in the client's business. If the R&D necessary to develop the product was done at risk of the company — i.e., the client was required to pay for the final product only if the R&D was successful [a contract for result] — the company performing the R&D could qualify for the section 73B concession since it would in fact be performing the R&D activities on its own behalf — i.e. to produce a saleable product.
6.58 A specific anti-avoidance provision, section 73CA, was later enacted in 1990. In June 2008, the ATO issued a technical discussion paper (a 'Consultation Paper') in which it indicated that section 73CA could now apply to commercial contracts for result notwithstanding the fact that the contract might be predominantly for the production of a product or good, and notwithstanding the possibility that failure to perform the contract might mean an absence of consideration flowing to the company. It is also important to note that in relation to section 73B deductions, there is no time limit for their subsequent amendment. Therefore, taxpayers' claims made many years ago were exposed to the potential retrospective application of ATO views. However, ultimately the ATO did not adopt the view, based on the advice of the Public Rulings Panel.
6.59 The reasons for delays may be that the ATO may not become aware of, or concerned with, a particular practice until it is of a sufficient level of revenue risk. The issue may also not always be obvious until something triggers the ATO's awareness — such as new law which interacts with pre-existing law, or, audits on emerging business arrangements. This means that when the ATO finds that its view does not properly reflect the law, it must change or clarify its view.
6.60 The examples show that, generally, the ATO becomes aware of emerging issues either through audits or by taxpayers and their representatives raising matters to the ATO's attention, which are, to a large extent, through the ATO's consultative forums (such as the national tax liaison group), and to a smaller extent through the ATO's binding advice products (such as private ruling applications and the public rulings program).
6.61 On one view, taxpayers and their advisers could alert the ATO to compliance concerns before practices develop — for example by applying for private rulings or seeking to put the issue on the public rulings program. This would go some way to minimising the time that elapses between practices developing and ATO awareness of compliance concerns. However, the purpose of the binding advice regime is to provide certainty to taxpayers. Even if one were to impose an obligation on taxpayers to do so it may not be able to be practically fulfilled in a timely manner if this significantly increases the demand for binding advice. Even then, the examples show that it would not have alerted the ATO to a substantial number of the practices with which the ATO was concerned. This is because in these examples taxpayers and their advisers did not believe there was any uncertainty about the application of the law until subsequent ATO action — they believed that there was a settled position.
6.62 There is scope for taxpayers to better contribute to ATO awareness of areas of uncertainty and compliance concerns. However, the IGT considers that there is a need to further improve the framework for taxpayer engagement to facilitate this type of interaction to achieve that outcome. Over-reliance on the community to identify significant compliance concerns forces the ATO to become reactive to developments, sometimes many years after the development has taken place. Also, consultative forums themselves may not become aware of these matters.
6.63 The IGT also considers that the ATO could do more to minimise the time that elapses between taxpayers adopting practices or views and the ATO identifying its concerns.
To reduce the timeframes elapsing between industry practices developing and the ATO becoming aware of its compliance concerns (i.e. concerns with practices that are perceived to be incorrect at law), the ATO should be more proactive in identifying areas of compliance concern as early as possible, including:
- supplementing existing consultative forums with technical issues forums (for example, core workshops on sensitive areas and technical discussions with externals with particular expertise in the relevant area); and
- in relation to developing guidance on new law, making better use of ATO and industry knowledge learned from the development of the relevant legislative provisions.
The ATO agrees that it should be proactive in seeking to identify areas of uncertainty or compliance risks by engaging with taxpayers and their representatives. We are committed to engaging with professional and industry bodies and professional firms to identify issues. Our existing range of consultative forums is extensive but we agree to supplement existing forums by initiating technical discussions with legal and accounting firms.
However, in order to improve the timely identification of areas of uncertainty and compliance concerns, tax advisers and professional bodies also need to play their part by proactively bringing issues to the ATO's attention and engaging in discussions with us.
Another way of improving the timeliness in identifying areas of compliance concerns would be for taxpayers to disclose potential issues in their annual tax returns.
Broader concerns with ATO technical processes
6.64 The examples raised in submissions also indicate that the taxpayer community is concerned with certain elements of the ATO's technical development processes, including:
- The extent to which the ATO is prepared to be bound by material not cleared by the tax counsel network (TCN);
- The extent to which the ATO fully and robustly tests alternative views when resolving technical issues that are the subject of significant compliance action;
- the degree to which taxpayers can be confident in ATO assurances that its views are aligned with Treasury's understanding of the policy objective of the relevant law; and
- whether in resolving compliance concerns in specific cases, the ATO adequately considers the implications for the broader community of the position taken — for example, by adopting a new technical interpretation in relation to what the ATO perceives to be a particular egregious arrangement in an audit, without considering the possible effect of that interpretation on other taxpayers who may have taken appropriate positions and reasonably relied on previous ATO guidance in good faith.
6.65 An examination of these concerns is outside the scope of this review, but has arisen in a number of other contexts and may be a potential review topic on the IGT's forward work program.