A6.1 The purpose of this appendix is to record the nature and current status of disputes between the ATO and groups of taxpayers involved in retirement village investments, equity linked bond investments and security lending arrangements. Taxpayers involved in these arrangements have also received standardised settlement terms from the ATO.

A6.2 The Inspector-General has not examined in detail the ATO's remission practice for the interest charge in relation to these three disputes. The following material is therefore descriptive in nature and is largely based on material provided to the Inspector-General by the ATO and in submissions during the course of this review.

A6.3 Unlike Employee Benefit Arrangements (EBAs), the ATO has, from an early stage, distinguished these investments from other forms of Mass-Marketed Tax Effective Investments (MMTEIs). For example, the Commissioner of Taxation's Annual Report for 1999/2000 indicates that these investments were not a form of 'mass-marketed arrangement' but were often tailor-made for higher income taxpayers.

Retirement village arrangements

Background

A6.4 In 1994, the ATO issued Taxation Ruling TR 94/24. This ruling dealt with the taxation treatment of commercial retirement village operators who recovered the costs of developing or acquiring a retirement village by granting long-term occupancy rights to incoming residents.142 Under this ruling, expenditure incurred by the owner in acquiring or developing the village, though normally treated as capital expenditure, was considered to be expenditure of a revenue nature. Accordingly, a deduction would be allowed for that expenditure in the year in which it was incurred.

A6.5 On 19 April 2000, following investigations by the ATO into these arrangements, the ATO issued a media release announcing the release of a draft ruling on the income tax treatment of investments in retirement villages, replacing Taxation Ruling TR 94/24.143 This draft was released as a final ruling, Taxation Ruling TR 2002/14, on 28 June 2002.

A6.6 In the media release the ATO stated that the review of Taxation Ruling TR 94/24 was caused by evidence of aggressive tax planning arrangements that sought to exploit the ruling. In particular, the ATO indicated that it would be challenging some of these more aggressive planning arrangements, including:

  • investments with highly leveraged non-recourse funding involving artificial prepayments to bring forward deductions ahead of construction of the retirement village; and
  • investments involving payment of a deposit for purchase of a land and retirement village package, where a deduction for the full purchase price is claimed immediately, even though settlement will not occur until construction of the retirement village is completed.

A6.7 As a result of these rulings, the Commissioner adopted an alternative position in respect of the taxation consequences for retirement village investments. Importantly, the ATO indicated that the costs of developing or acquiring a retirement village to operate an ongoing business were outgoings of capital or of a capital nature and hence not deductible on revenue account.

A6.8 The ATO has indicated that there was ongoing dialogue between the ATO and industry representatives following the media release being issued in 19 April 2000. According to the ATO, the purpose of this ongoing dialogue and consultation with industry and their representatives was to arrive at a position that might be acceptable for investors in order to meet their tax obligations in relation to their investment in retirement village arrangements.144

A6.9 Following this dialogue with industry representatives, the ATO advised that in October 2003 it issued the 'Offer of Closure' letters to taxpayers who had invested in the retirement village arrangements. This offer indicated that the ATO would settle its dispute with these taxpayers on the following basis:

  • a deduction would be allowed for the deposit paid on signing the contract in the year of income in which it was paid;
  • a deduction would be disallowed for the balance of purchase monies in respect of the retirement village claimed in the year the contract of sale was signed;
  • a deduction would be allowed equal to the cash payment contributed by way of the balance of purchase monies in the year of income that Certificates of Completion and Occupancy were/are issued in respect of the retirement village;
  • a tax shortfall penalty of 5 per cent would apply; and
  • the pre-amended assessment interest charge would be remitted for the period up to 19 April 2001.

A6.10 Along with the Offer of Closure the ATO provided investors with an ATO position paper outlining its general view on the tax deductions that may have been claimed by investors.

ATO position in relation to tax consequences of retirement village arrangements

A6.11 The ATO view on retirement village arrangements, as described in the settlement offers made to investors in retirement villages, was as follows:

  • Investors were not entitled to an income tax deduction for the full amount of the purchase price in the year in which the contract was signed. This is because the amount is not considered to have been incurred for the purpose of the ruling.
  • The deposit paid by investors on signing their investment contract was incurred and therefore considered deductible in the income year in which it was paid (subject to the village not including rental or certain hostel arrangements).
  • The balance of the purchase price was only incurred and consequently was only considered deductible in the income year in which payment of the balance was required by the developer (subject to the village not including rental or certain hostel arrangements). The reason for this position was that the amount was not incurred until it became due and payable. The due and payable position was usually reflected by the issuing of the certificates of completion and occupancy together with the transfer of ownership of the retirement village to the investors.
  • In some cases, where the retirement village was not developed the deposits paid would be refunded to the investors. These refunds would be considered as assessable income in the income year in which they were refunded.

ATO position in relation to tax shortfall penalty and interest

Penalties

A6.12 As discussed, the ATO took the view that the purchase price of the retirement village, claimed in the year of signing the purchase contract, was not an allowable deduction for taxation purposes except for the deposit paid. In its settlement offer to investors in the retirement village arrangements, the ATO view on penalties was that investors failed to take reasonable care to ensure that, in accordance with Taxation Ruling TR 94/24:

  • the amount invested had been actually incurred for tax purposes; and
  • the ruling covered the accommodation arrangements.

A6.13 As such, the ATO indicated that a tax shortfall penalty of 25 per cent arising out of the disallowance of the deduction would ordinarily be imposed. The penalty actually applied on settlement therefore represents an 80 per cent reduction with the acceptance of the settlement offer being treated as a voluntary disclosure by the ATO.

Interest charge

A6.14 In its settlement offer to investors in the retirement village arrangements, the ATO view was that in a typical case of this nature, the full rate of interest would be payable on the tax shortfall for the period from the due date of the original assessment to the date of the issue of the amended assessment.

A6.15 However, subject to the settlement deed being signed, the ATO indicated that it would take into account the time elapsed before taxpayers were advised of the ATO's concerns in relation to these arrangements and a period of time elapsed thereon. Accordingly, pre-amended assessment interest was remitted up to 19 April 2001 and interest was imposed in full from 20 April 2001 to the date of acceptance of the Offer of Closure. If the tax liability was not paid when it was due then GIC was imposed in full up to the date of payment of the liability.

Concerns raised with ATO action in relation to retirement village arrangements

A6.16 The Inspector-General has not requested detailed information from the ATO specifically in respect to ATO actions and settlements for retirement village arrangements.

A6.17 However, a number of investors and representatives acting for investors in the retirement village arrangements have raised with the Inspector-General the following concerns.

  • The Offer of Closure was sent to all investors in various projects regardless of the individual circumstances of a particular retirement investment. Some projects had been completed and were operational whereas other arrangements appeared to be aggressive tax planning arrangements. The blanket approach by ATO in dealing with participants regardless of their circumstances was raised as a concern by a number of participants.
  • The time taken between the Commissioner announcing his initial and general view on Taxation Ruling TR 94/24, on 19 April 2000, and when the final Offer of Closure was sent to investors in October 2003. According to the offer of closure, the interest charge was imposed in full rate from 20 April 2001 to the date of acceptance of the Offer of Closure.
  • Participants relied upon Taxation Ruling TR 94/24 to claim deductions associated with their investment. In these circumstances, and given the change and clarification by the ATO of their view in respect to taxation consequences arising from investment, the imposition of GIC at full rates from 20 April 2001 to the date of payment is not fair and equitable.
  • The ATO have refused to countenance that taxpayers' exercised reasonable care or adopted a reasonably arguable position in relying on a public ruling.
  • In the Offer of Closure the ATO did not provide taxpayers with an opportunity to provide additional information pertaining to their individual circumstances, such as legal and accounting advice, so as to demonstrate that they had in fact taken reasonable care.
  • The fact that the ATO only provided investors 45 days (extended to 66 days) to understand the Offer of Closure, consider its implications in respect of their position and communicate their acceptance of the offer.
  • Participants do not understand why the date of 19 April 2001 was selected by the ATO as the date up to which the interest charge would be remitted. This date appears to have been chosen because it is one year after Taxation Ruling TR 94/24 was withdrawn.
  • The ATO has taken an inconsistent approach between the Offer of Closure made to participants in retirement villages as compared to the offer made in relation to MMTEIs. These submissions state that in many cases retirement village investments were marketed to unsophisticated investors in the same way as in MMTEIs. They assert that there is a need to look at the circumstances of each individual participant and the characteristics of each arrangement and how it was marketed and implemented in determining the remission of penalties and interest charge.
  • Differential tax treatment was not applied according to whether the retirement villages were partly constructed or not and whether the participants invested as a going concern.

ATO response to concerns raised by Inspector-General in relation to retirement village arrangements

A6.18 The ATO considers that the representations received from external stakeholders do not accurately reflect the extent to which the ATO undertook to consult with relevant stakeholders representing the investors. For example, the ATO indicates that it undertook negotiations with an accounting firm that represented twenty-four of twenty-eight retirement village syndicates and many investors. These discussions included the impact of the GIC and the submissions received from stakeholders that had been considered at very high levels in the ATO.

A6.19 In addition, in its response to the concerns raised by stakeholders, the ATO emphasised the extent of consultation with taxpayers and industry representatives prior to the Offer of Closure being provided to investors. The ATO indicated that the Offer of Closure was very carefully constructed after lengthy discussions and input from external taxpayer representatives. Also, the ATO has advised that it was their understanding that there was constant contact between particular representatives acting for the investors and the syndicate members.

A6.20 The ATO noted the concerns raised by external stakeholders with the ATO's differentiation of retirement villages from the MMTEIs settlement offer. In response, the ATO has stated that they differentiated the retirement village investments from the MMTEIs settlement offer as:

'… taxpayers did not suffer a real financial loss of the full deduction claimed and they were generally considered to be sophisticated investors who were not subject to the same marketing techniques as the typical investor in the mass marketed investment schemes.'

Current status of ATO action in relation to retirement village arrangements

A6.21 The ATO has identified 1900 participants in the retirement village arrangements. This number does not include the beneficiaries of trusts where the trust was the actual participant. Of those, 558 adverse assessments have been raised so far, which include identified beneficiaries of trusts and those who were about to fall outside the statutory time limit for amendment purposes. The ATO has also noted that investigations into other retirement village arrangements are on-going.

A6.22 As at May 2004, there were 1,060 cases in which taxpayers have entered into a settlement arrangement and 447 (including trust beneficiaries) have been issued with amended assessments. Current ATO estimates on the total primary tax, GIC and penalty amounts imposed on taxpayers who have settled and whose assessments have been amended are as follows:

Primary tax $43,154,496
GIC $14,621,189
Penalty tax $2,350,012

A6.23 Due to the recent processing of settlements, the ATO is unable to provide information relating to the payment of primary tax, GIC and penalties raised in these amended assessments.

A6.24 The ATO has also noted that there is only one instance where a retirement village arrangement had settled on terms different to the general offer, with a later GIC 'start date'. The ATO has stated that this was due to delays in participants receiving the ATO letter of settlement.145

A6.25 The ATO has indicated that there are currently 574 cases in which taxpayers have not entered into a settlement offer. They have noted that settlements are still being received. Of the 574 cases, 111 amended assessments have been issued so far with the remainder to issue shortly. The ATO has estimated that, to date, the total primary tax, GIC and penalty amounts imposed on taxpayers who have not settled and amended assessments have issued are as follows:

Primary tax $11,367,461
GIC $6,416,132
Penalty tax $2,767,045

A6.26 In relation to the 574 cases mentioned above, the ATO has indicated that there are some participants who have requested extensions of time to settle, due to factors outside of their control.

A6.27 Finally, the ATO has identified eight unfinalised dispute cases, with the disputed tax comprising the following amounts:

Primary tax $744,137
GIC $468,818
Penalty tax $159,372

Inspector-General's view

A6.28 The ATO, as part of the settlement offer to investors in the retirement village arrangements, has imposed the interest charge in full for underpaid tax after 19 April 2001, but only a 5 per cent penalty.

A6.29 The fact that the taxpayers made a voluntary disclosure in respect of their conduct in claiming a deduction for the purchase price of the retirement village is recognised by statute as a factor warranting the remission of penalty from 25 per cent to 5 per cent.

A6.30 Key Finding 1 of the report provides that in certain circumstances the pre-amended assessment interest charge without remission may have a far broader and punitive-like effect. Where out of the ordinary circumstances exist then the interest remission guidelines must be flexible and responsive to remove inappropriate punitive-like consequences.

A6.31 The imposition of the interest charge in full without remission from 20 April 2001 to the date of acceptance of the Offer of Closure that was issued by the ATO to investors in October 2003, could have such an effect notwithstanding the voluntary disclosure made by taxpayers.

A6.32 Consistent with Key Findings 1 and 5 of the report, to the extent that factors were considered relevant by either statute or the ATO to reduce or remit penalties imposed in the above arrangements, these same factors may also be relevant considerations for the remission of the interest charge for this group of taxpayers.

Changes to ATO position on retirement village arrangements

A6.33 Since the Inspector-General's draft report was sent to the Tax Office, it has made certain changes to its previous offer regarding retirement village arrangements. These changes were conveyed to investors in the retirement village syndicates by way of letter.

A6.34 The ATO has now stated that investors in the retirement village syndicates will not have to forgo their rights of objection and appeal if they wish to take advantage of reduced penalties where they make a voluntary disclosure.

A6.35 In addition, the ATO has indicated that they propose to remit the GIC payable up to 19 April 2001 for all participants, whether or not they make a voluntary disclosure and/or exercise their review rights.

A6.36 For investors who have already accepted the original 'Offer of Closure', which included an undertaking not to lodge an objection or appeal, the ATO has indicated that they will now provide them with an opportunity to lodge an objection or appeal into this matter. An extension of time will also be granted to lodge objections, should this be required.

A6.37 For those investors who have not yet made a voluntary disclosure, the ATO has stated that they will extend the time that investors can lodge a voluntary disclosure schedule to 31 August 2004. For those taxpayers that take up the offer, the relevant letter provides that the tax shortfall penalty which applies will be reduced from 25 per cent to 5 per cent and investors will still be able to exercise their review rights, that is, be able to object or appeal against their amended assessment.

A6.38 The Commissioner has also announced that he proposes to run a test case to provide judicial finality on the issue of whether the balance of the purchase price (which is payable when the terms of the contract are met) is only deductible at that time. The Commissioner has indicated that taxpayers who want to be considered as a test case can lodge an application to a specified address for consideration.

Equity-linked bonds arrangements

Background

A6.39 The ATO announced that tax deductions claimed by taxpayers participating in linked bond, or note, arrangements were to be disallowed.146 Such bonds combined the features of a bond paying fixed interest on maturity with potential bonus for a return. This return was linked to the performance of a pre-selected equity, interest rate or exchange rate.

A6.40 According to the ATO, the usual features of such equity-linked bonds, as outlined in Media Release 99/21, were:

  • the investor borrows 100 per cent of the face value of the bond and pre-pays the interest, of which a significant portion is borrowed from the issuer in the first year of the arrangement;
  • the investor returns the fixed interest on maturity of the bond in the second year of the arrangement; and
  • the bond offers potential for a bonus return linked to the movement of a share price, exchange rate or other contingent event.

A6.41 According to the ATO, depending on the amount borrowed, these arrangements had the effect of allowing the deferral of income from the current year to the next year with the potential for a bonus return linked to the movement in share price, exchange rate or other contingent event.

A6.42 The ATO also outlined the terms of settlement to be made to taxpayers who had invested in equity-linked bonds.147 Essentially, the terms of settlement allowed note holders an income tax deduction for the amount of their actual cash outlay for interest charged on the notes. Money borrowed from the note issuer to prepay the balance of interest charged was not deductible.

ATO position in relation to pre-amended assessment interest

A6.43 In its settlement offer to investors in the equity-linked bond arrangements, tax shortfall penalty was imposed at the rate of 10 per cent. Interest was imposed at the full rate from the due date of the original assessment for each year until the date the taxpayer originally disclosed their involvement in the equity-linked arrangements to the ATO. Alternatively, if no voluntary disclosure was made, then the full rate of GIC applied until the date of the ATO's settlement offer.

A6.44 The ATO's decision to remit the interest in cases of voluntary disclosure was based on the view outlined in the ATO Receivables Policy. It provided that where there is sufficient information to issue an amended assessment and the ATO contributes to the delay in actioning the cases, then there are grounds for the remission of the GIC.

A6.45 Accordingly, in these circumstances the ATO decided that the GIC would be remitted from the date the taxpayer made a voluntary disclosure until the date the amended assessment was issued.

A6.46 The ATO has advised that the penalty rate that would otherwise be applied to these arrangements was 50 per cent.148 The penalty actually applied by the ATO on settlement therefore represents an 80 per cent reduction of the amount of penalty that would normally apply. This accords with the statutory position where there has been a voluntary disclosure by a taxpayer.

Current status of ATO action in relation to equity-linked bond arrangements

A6.47 In information provided to the Inspector-General, the ATO has identified 5510 participants in the equity-linked bond arrangements, which includes the beneficiaries of trusts where the trust was the actual participant. Of that number, 4920 adverse assessments have been raised with 590 outstanding pending the finalisation of the audit project. Current ATO estimates place the tax outstanding after the disallowance of the total year-one interest deductions at $668 million with an estimated tax recoupment in year-one of $324 million.

A6.48 There are 4266 cases in which taxpayers have entered into a settlement with the ATO. Within this group, there are the following categories of amounts outstanding.

A6.49 There are 681 cases where settlement offers have not been accepted with the primary tax, tax shortfall penalty and GIC outstanding as follows:

Primary tax $35,649,350
GIC (pre-amendment) $5,765,242
Penalty tax $5,084,149

A6.50 There are nine disallowed objections in which the participants have not subsequently settled. However they have yet to lodge appeals to either the Administrative Appeals Tribunal or the Federal Court. There are also 249 unfinalised dispute cases, with the amounts in dispute as follows:

Primary tax $17,992,064
GIC (pre-amendment) $2,341,373
Penalty tax $2,041,197

A6.51 In information provided to the Inspector-General, the ATO identified six cases that were settlements outside the general settlement offer to participants. Of these, there were five cases where there was remission in whole or in part of the GIC.

Inspector-General's view

A6.52 The ATO, as part of the settlement offer to investors in the equity-linked bonds arrangements, has imposed the interest charge in full for underpaid tax from the due date of the original assessment for each year until the date the taxpayer originally disclosed their involvement in the arrangement to the ATO. However, as part of the settlement offer, only a 10 per cent penalty was imposed with the acceptance of the settlement offer being treated as a voluntary disclosure.

A6.53 The fact that the taxpayers made a voluntary disclosure in respect of their conduct in claiming a deduction in respect of the bonds is recognised by statute as a factor warranting the remission of penalty from 50 per cent to 10 per cent.

A6.54 Key Finding 1 of the report provides that in certain circumstances the pre-amended assessment interest charge without remission may have a far broader and punitive-like effect. Where out of the ordinary circumstances exist then the interest remission guidelines must be flexible and responsive to remove inappropriate punitive-like consequences.

A6.55 In particular, the imposition of the interest charge in full without remission from the due date of the original assessment for each year until the date the taxpayer originally disclosed their involvement in the arrangements to the ATO, could have such an effect. In these instances the rate of the interest charge exceeded the penalty rate, notwithstanding that investors had made a voluntary disclosure.

A6.56 Consistent with Key Findings 1 and 5 of the report, to the extent that factors were considered relevant by either statute or the ATO to reduce or remit penalties imposed in these arrangements, these same factors may also be relevant considerations for the remission of the interest charge for this group of taxpayers.

Security lending arrangements

Background

A6.57 Security lending arrangements occur when a holder of securities agrees to transfer them for a period to a borrower for an additional return on the securities by way of fees. These arrangements are entered into because of the margin and settlement requirements of the securities markets.

A6.58 The ATO undertook an audit into a security lending arrangement entered into by an individual taxpayer. As a result of the audit, an amended assessment was issued to the individual taxpayer and further action was undertaken by the ATO to identify other participants in the arrangement.149 Other participants in this arrangement were contacted by the ATO and after receiving responses from those identified, the ATO commenced issuing amended assessments to these participants.

A6.59 Following representations on behalf of an individual participant, the ATO offered a settlement on standard terms to all taxpayers who had received an amended assessment in relation to pre-13 May 1997 security lending arrangements.

ATO terms of settlement

A6.60 The terms of the ATO's settlement offer were as follows:

  • the dividends received under the arrangement were to be included in assessable income;
  • the franking rebate on those dividends would be disallowed;
  • a deduction would be allowed for so much of the compensatory fee and other fees incurred under the arrangement that did not exceed the amount of the dividend received under the arrangement; and
  • the penalty tax otherwise payable for the tax shortfall would be remitted to nil.

A6.61 The ATO has advised that the penalty rate that would otherwise be applied to these investments was 50 per cent.150 The penalty actually applied on settlement, namely nil, therefore represents a 100 per cent reduction in the amount of penalty that would apply under the statutory rules for penalties.

A6.62 The settlement offer also provided for the remission of interest on the tax shortfall:

  • for the period from the due date for payment shown on the original notice of assessment to 30 June 1999, to the 13 week Treasury Note rate;
  • for the period 1 July 1999 to 30 June 2001, to the Treasury note yield rate; and
  • for the period 1 July 2001 and onwards, to the 90 day bank bill rate.

A6.63 Also, the interest rate was remitted to nil for the period from the date a participant made a voluntary disclosure until the date the amended assessment issued. The settlement offer also provided that the interest charge for late payment would be imposed in full if the tax outstanding after settlement was not paid within 28 days of the date of issue of the amended assessment reflecting the settlement.

Current status of ATO action in relation to security lending arrangements

A6.64 The ATO identified 247 taxpayers who had entered into a security lending arrangement. Of those, there have been 206 adverse amended assessments issued. No adverse assessment was issued in 41 cases either due to a lapse of the four year amendment period or because the taxpayers had been subject to an audit on their dividend and interest deduction prior to the audit project.

A6.65 For the 206 taxpayers who received an adverse amended assessment, information provided by the ATO lists the amount of tax outstanding prior to settlement as follows:

Primary tax $28,507,677
Tax shortfall penalty and GIC $13,403,292

A6.66 The above figure representing tax shortfall penalty and GIC was provided by the ATO. The Inspector-General has been informed that a break-up of the amount into the individual components is not available.

A6.67 Of those 206 taxpayers who had received an adverse amended assessment, 196 have entered into settlement agreements. Following settlement, the total tax outstanding prior to any payment being received was a follows:

Primary tax $10,821,570
GIC (pre-amendment interest) $1,722,293
Penalty tax Nil

A6.68 Whilst all participants were offered settlement on the same terms, there were three cases that were settled on the basis that exceptional individual circumstances existed that warranted further concessions by the ATO.151

A6.69 Finally, there are 10 disputed cases that have not yet settled and the amount of tax is still in dispute, with the amount of outstanding disputed tax as follows:

Primary tax $1,133,358
GIC (pre-amendment interest) $423,762
Penalty tax $107,620

Inspector-General's view

A6.70 As part of the settlement offer, the Commissioner remitted the penalties from 50 per cent to nil. The penalty remission policy states that in order for the Commissioner to exercise his remission powers, he will look at the facts and circumstances of the taxpayer. With the security lending arrangement cases, the Commissioner has taken the view, as demonstrated by the actual exercise of the remission power, that there were factors that warranted the remission of penalties in full.

A6.71 The Commissioner also remitted the interest charge to the 13 week Treasury note rate and the 90 day bank bill rate between the due date of payment and the date of voluntary disclosure. The interest rate was remitted to nil for the period from the date a participant made a voluntary disclosure until the date the amended assessment issued.

A6.72 Consistent with Key Finding 1, the flexible approach adopted by the Commissioner alleviated any punitive-like effect in the application of the interest charge for the pre-amended assessment period.


142 Australian Taxation Office, 'Tax Office Releases New Draft Ruling on Retirement Villages', Media Release — Nat 2000/35, 19 April 2000.

143 ibid.

144 ATO Minute No: IGT 26-2004, dated 11 May 2004.

145 ibid.

146 Australian Taxation Office, Media Release Nat 99/21, dated 15 June 1999.

147 Australian Taxation Office, Media Release Nat 99/84, dated 30 November 1999.

148 Information provided to the Inspector-General of Taxation by the ATO in an email dated 1 April 2004.

149 ATO Minute No: IGT5-2004, dated 27 January 2004.

150 Information provided to the Inspector-General of Taxation by the ATO in an email dated 1 April 2004.

151 Information provided to the Inspector-General of Taxation by the ATO in an email dated 10 March 2004.