Australian Government - Australian Taxation Office crest

Mr David Vos
Inspector-General of Taxation
GPO Box 551
Sydney N.S.W 2001

Dear David

Research and Development (R&D) Case Study

Thank you for the final draft report on the case study. Our response to the report is enclosed.

As mentioned in your letter to the Commissioner, the report refers to the mediation which was subject to a confidentiality agreement between the Tax Office and the other party. I understand from your officers that the other party has indicated agreement to the publication of the mediation material which was in an earlier draft of your report. Provided the other party agrees to the publication of the relevant material in your final report, the Tax Office will also agree to its publication.

Yours sincerely

[Signed]

Kevin Fitzpatrick
Chief Tax Counsel
13 April 2007


Report: Research and Development (R&D) Case Study

I refer to the final draft report on this case study.

It is evident from the report that R&D syndication has been a very complex issue. It has raised some very difficult issues for the Tax Office including in particular questions about the valuation of core technology.

As you have concluded, the 'Tax Office was right to be concerned about compliance in this area and exploitation has been identified by the Tax Office in a number of cases'. This concern is reflected in the fact that over $140 million has been raised to date as a result of non-compliance by 19 taxpayers.

While it is clear that the Tax Office had to address non-compliance by some taxpayers who sought to exploit the concession provided in the law to encourage R&D, it is equally clear that the finalisation of the Tax Office compliance action has taken too long.

I also accept the conclusion in the report that the Tax Office's communication with affected taxpayers was not always effective and could have been better.

As noted in the report, there have been a number of changes to tax administration since the R&D syndication issue commenced. As a result of those changes, it is clear that many of the adverse findings in the report would not arise today. In other words, the improvements identified in the report have largely been implemented.

This particularly applies to the timeframes for finalising audit action, the ability to provide rulings and other guidance on valuation issues and improved communication with taxpayers. This is rightly recognised in the report.

While we accept some of the report's conclusions, there are others which we do not accept. In our view they are not soundly based and, at least to some extent, result from a misunderstanding of the facts. This is probably not surprising because the R&D syndication issue is very complex. Despite our best endeavours during the course of the review to clearly explain the facts and circumstances and respond to issues and assertions raised, the draft report contains some factual errors or omissions. A summary of key factual errors and omissions is set out in an attachment to this letter.

Inspector-General's comments on the Tax Office's submission

The Tax Office fully accepts that the finalisation of its compliance action has taken too long and the communication with affected taxpayers could have been better. It also fully accepts 7 of the 10 conclusions in the report.

However in relation to the conclusions with which it does not fully accept, the Tax Office submission appears to focus on the final stages of its resolution with somewhat of a blind eye to the prior 10 years. In some places it truncates the facts to the point of misrepresentation, perhaps a result of trying to achieve brevity. The Tax Office submission also gives a misstated view of the facts. In relation to the gratuitous implication that the facts have been misunderstood because the issue is complex, I have examined the key 'factual errors' attached to the submission. Most are not errors but re-statements of the Tax Office's perspectives. None are material to the conclusions. Critically, the submission does not address the substantive issues identified in the report. In my view, the submission does nothing to dispel the conclusions drawn in the report.

The Tax Office also appears to infer that the problems encountered in its handling of R&D syndication would never arise again because the improvements I have identified in the report have since been implemented. Although many improvements have been made to tax administration since 1991, I do not agree that my finding can be so stretched to conclude that the adverse findings in the report would not arise today. In fact, some of the adverse findings relate to recent and continuing conduct — for example, the Tax Office's continuing failure to communicate adequately with taxpayers on issues that are critical to their claims and its continuing unchecked culture. Further, in Chapter 3 at paragraph 3.119, I have signalled many areas in need of further improvement. In particular, there is still a major systemic gap with the mechanisms to trigger involvement of top management in complex issues experiencing delays, rather than relying on 'bottom-up' escalation processes. I intend to discuss the possible improvements in these identified areas further with the Tax Office in the process of finalising the fourth report on this review.

I have inserted comments in the text below on the specific matters raised in this submission to reduce duplication and the length of the report.

I now turn to those conclusions which we do not fully accept.

Conclusion 3: The Tax Office took far too long to give practical guidance.

As noted in the report, the Tax Office issued a public ruling, IT2635, in 1991 which drew attention to key considerations on arm's length values for core technology. That ruling provided guidance to potential investors in R&D syndicates on the application of the relevant provisions of the tax law. The discussion in the ruling on the arm's length price for core technology was also relevant to the enactment later in 1991 of the specific anti-avoidance provision dealing with arm's length dealings.

It should also be recognised that investors involved in R&D syndicates were sophisticated taxpayers with professional advisers. They would have been well aware of the hallmarks of a dealing entered into on an arm's length basis.

While reasonable views can differ on the sufficiency and appropriateness of guidance on issues, given the nature of these arrangements it is difficult to understand what further practical guidance should or could have been provided before arrangements were entered into by syndicate investors.

Inspector-General's comments on the Tax Office's submission

The Tax Office submission indicates that its public ruling IT2635 gave adequate practical guidance and that the Tax Office could do no more. It also implies that the Tax Office is absolved from the need to provide clear guidance where, in its view, taxpayers are sophisticated or the Tax Office assumes they are well aware of the implications. Both of these propositions are highly contestable.

In relation to what more the Tax Office could have done, the Tax Office ignores the fact that there was considerable uncertainty around this issue very early on. In fact, another Government body publicly recommended that the Tax Office remove this uncertainty in 1994. The Tax Office ignored this recommendation. The TCC (the other body administering the R&D tax concession) gave syndicate applicants practical guidance in late 1995 and publicly announced this guidance in early 1996. The Tax Office failed to provide practical guidance until late 2004. Further, the Tax Office provides practical guidance on many other areas of emerging compliance risk. If the Tax Office is suggesting that there is no need to provide practical guidance on how to comply in relation to complex matters until arrangements are entered into then this, of itself, would indicate a major systemic tax administration issue.

In relation to being absolved of the need to provide clear guidance where taxpayers are sophisticated, the Tax Office ignores the private binding rulings and advance opinions requested by most, if not all, syndicate participants. If the Tax Office is suggesting this proposition as a point of principle then it would run counter to its cooperative compliance approach to large business. One expects large taxpayers' requests for Tax Office certainty to be made in complex matters — failure to do so would risk protracted and unnecessary disputes where contrary views are taken by the tax administrator many years after the fact. In the case of R&D syndication, the consequence of the Tax Office not providing practical guidance earlier was to extend the resolution of this compliance issue for more than 15 years and impose tens of millions of dollars of compliance costs on the investors concerned and the community generally.

I have flagged this issue in Chapter 3, paragraph 3.119 of the report as an area that may be the subject of further recommendations in my fourth report on this review.

Conclusion 7: Unchecked cultural influences of 'hitting tax abuse hard'

The Tax Office does not accept this conclusion and some of the findings in this section of the report.

There are factual errors or omissions in the report which impact on the conclusion. There are also misleading inferences in the report.

For example, at paragraph C7.8 of the report, it is stated that the Tax Office has disregarded the mediator's advice and commented that the mediator's advice on the relevant tax law provisions was unrealistic. This is not correct. The evidence referred to in the report to support the assertion that we have disregarded the mediator's advice is a reference to an internal Tax Office report in respect of a particular case. The views expressed in the quoted extract from the report were not accepted by senior tax officers as the correct conclusion. Importantly, the views in this internal report were not conveyed to the taxpayer.

The circumstances and outcome of this particular case are much different to what is inferred in the report. The Tax Office accepted the advice of the mediator in finalising its position in respect of this case.

At no stage during the course of this review did the Tax Office state, or hold the view, that the mediator's advice was unrealistic. The evidence clearly points to a contrary conclusion. Following the mediation we have applied the guidelines, which were settled by the mediator, in finalising cases. In doing so, we have been guided by the advice provided to us by the mediator.

Inspector-General's comments on the Tax Office's submission

The Tax Office submission accepts that it took too long to resolve this matter, but it makes no attempts to address my conclusion on why it took so long. My conclusion here is that a Tax Office cultural view that investors in R&D syndicates were all tax abusers (while an appropriate stance where justified) continued unchecked in its handling of the matter for many years and was a major factor in delaying resolution. Stakeholders recounted much Tax Office conduct, prima facie, evidencing this attitude. The Tax Office itself demonstrated orally and in writing an attitude of hitting tax abuse hard, even where 'tax abuse' was not established. By 2004, the impact of this attitude had been felt strongly. Even now there is clear evidence that this attitude continues to exist. This has been made clear in written responses to this review.

Notwithstanding the Tax Office's choice to focus on later events in its submission, I have updated paragraphs C7.8.1 to C7.8.5 of the report to substantiate further our views on the points raised by the Tax Office in its submission on this conclusion.

The Tax Office also makes some unfounded assertions in its submission on this conclusion, assertions that I must correct. I have inserted my comments on these assertions in the text below and in the attachment to this submission.

While it is clear that the finalisation of the Tax Office compliance action has taken too long, the report's finding that we took far too long to objectively reassess our view and were eventually forced to do so indicates a misunderstanding of the facts.

The Tax Office views about syndication arrangements prior to the mediation were formed after audits of a range of cases and having regard to valuation advice from qualified valuers and legal advice from external counsel. It was clear to us that the application of the relevant anti-avoidance provisions in these cases depended on the particular facts including assessments by valuation experts. The legal advice we received supported this view.

Prior to the AAT decision in the Zoffanies case, we were approached by taxpayer representatives to enter into mediation as a means to help resolve cases rather than protracted case by case litigation. We agreed to the mediation. It was always our objective to test our views of the application of the law through the mediation. The agreed objectives of the mediation were 'to determine guidelines for reviewing research and development syndication arrangements'. The report is wrong in stating that 'the Tax Office was eventually forced to objectively reassess its view'.

Inspector-General's comments on the Tax Office's submission

The Tax Office submission on this point misrepresents the course of events and is contrary to the Tax Office's previous statements that it was its intention to test its views through litigation. The agreed facts are set out in Chapter 4 in some detail. In summary, the Tax Office agreed to mediate with an investor before the AAT decision in the Zoffanies case. However, this investor pulled out of negotiations because the Tax Office continued to pursue litigation and refused to provide adequate reasons for its decision in denying the deductions. From March 2001 through to July 2003, the Tax Office also expressly decided not to pursue mediation until it had conducted litigation so that the Tax Office would 'be in a stronger position to achieve resolution on other cases on an acceptable basis to the Tax Office' (see Chapter 4, paragraphs 4.90, 4.92, 4.101-4.103, 4.107 and 4.112-4.114). When litigation failed to achieve its purpose of strengthening its position, the Tax Office entered a mediation agreement in July 2003. This was well after the AAT case and only after the Tax Office abandoned its appeal on the AAT's findings on the specific anti-avoidance provision. The issue is discussed in Chapter 3 at paragraphs C7.17 and C7.18.

In finalising cases since 2004 the Tax Office has taken into account the outcomes of the mediation as well as the Zoffanies decision.

The report comments that the Tax Office should have published not only the guidelines which were settled by the mediator but also further information contained in the mediator's report to the parties involved in the mediation. We do not agree with this view. The mediator's report was in respect of the particular syndicate which was the subject of the mediation. In accordance with the mediation agreement, the mediator's report to the parties remained confidential between the parties and the relevant investors. The mediator's report had a different purpose to that of the guidelines.

Inspector-General's comments on the Tax Office's submission

The Tax Office infers that the confidentiality clauses did not allow it to provide further guidance. This assertion is already considered in Chapter 3 at paragraph C7.26. In relation to the alternative Tax Office argument of the purpose of the guidelines and the report, I have updated the report to reflect this additional Tax Office submission in paragraph C7.26. The specifics of the mediator's report provided a line of thought of general application to the application of other R&D syndication cases. Notwithstanding who was responsible for settling the guidelines or the purpose of the advice the mediator gave, the Tax Office remained responsible for clearly articulating its forward compliance approach. There was also nothing preventing the Tax Office from publishing this further guidance in addition to the guidelines coming out of the mediation.

As I noted earlier, reasonable views can differ on the sufficiency of guidance on issues. It was our view that the published guidelines provided clear guidance to investors on how the Tax Office would determine whether the relevant anti-avoidance provisions would be applied to reduce claimed deductions.

In the light of the published guidelines I find it difficult to understand how investors would have been left with the impression that the Tax Office would continue to value core technology in accordance with our previous approach. In no case was this approach adopted following publication of the guidelines.

Inspector-General's comments on the Tax Office's submission

This difficulty in understanding how investors would be left with the impressions mentioned above is contrary to evidence that senior officers were made well aware of these impressions in October 2004, around one month after the guidelines were published. I have updated the report to reflect this additional Tax Office position and contrary evidence in paragraph C7.27.

Conclusion 10: In some cases the Tax Office acted unfairly

We do not accept that we acted unfairly in some specific cases. Cases which have been settled were done so on the basis that deductions claimed were excessive in accordance with the law.

In relation to those seven syndicates referred to in the report which were subject to additional scrutiny by the Tax Concession Committee (TCC), the Tax Office has not made adjustments to the claimed deductions because we were not satisfied that the amount paid by each investor for core technology was greater than an arm's length amount. In coming to this conclusion, the additional TCC scrutiny was one of the factors taken into account.

The report discusses three cases in some detail. Unfortunately, the report contains some factual errors concerning these cases. These errors are corrected in the attachment.

In a further matter, the report makes some adverse findings and also a recommendation concerning two investors who 'settled with the Tax Office while the Tax Office was involved in the mediation' (see paragraph C10.1.21). The facts outlined in the report concerning these two cases are, in our view, misleading for the reasons detailed in the attachment.

I also point out for completeness that a further four cases were settled during the course of the mediation. I understand that the investor representatives in these cases were aware of the mediation but wished to finalise settlements on behalf of their clients.

Inspector-General's comments on the Tax Office's submission

The Tax Office submission disputes only a few of the areas of unfairness identified in this conclusion. However, conclusion 10 extensively considers other cases dealing with a range of behaviours in the handling of this protracted issue, ranging from the lack of adequate procedural fairness to inconsistent treatment. It is a much wider range than the Tax Office deals with in its submission on this conclusion.

The Tax Office refers to the seven cases registered after the TCC announced it would give additional scrutiny to core technology valuations. The TCC did this to address the risk of overvaluation. The issue is that taxpayers would have relied on the additional TCC scrutiny as giving them assurance that the Government considered the core technology prices were not overvalued. Whether that scrutiny actually occurred or what form it took is a subsidiary issue, given that more than 10 years have passed since the syndicates were scrutinised. The Tax Office appears also to submit that because no adjustments were made to these taxpayers' claim they were treated fairly — alls well that ends well. This does not address the unfairness identified in the report. Regardless of the outcome of the case, the fact that the Tax Office did not tell investors that TCC scrutiny was a determinative factor was, of itself, unfair.

The Tax Office submission of 'factual errors' 'omissions' and 'misleading inferences' (sic) is addressed in detail in the attachment.

Recommendation

The Inspector-General recommends that the Tax Office fully reconsider whether it has fairly struck settlements with:

  1. the 19 investors that it did not formally advise that their investments made more than eight years previously would be subject to review; and
  2. those investors with whom it negotiated settlements without telling them that at the same time it was mediating a case to develop guidelines for the resolution of R&D syndicate cases.

Response

In relation to the 19 investors mentioned in paragraph (a), it should be noted that settlements have been made in respect of only 6 cases with another 3 cases yet to be finalised. In the remaining cases, adjustments have not been made to claimed deductions.

The Tax Office accepts that it would have been better if direct contact was made with these investors earlier. However, it is our view that most, if not all, of those investors and their advisers would have been aware of the Tax Office's ongoing review of R&D syndication arrangements.

In the small number of these cases where adjustments have been made, the settlements were entered into in good faith and were based on the fact that the deductions claimed by investors were not fully allowable under the law. To unwind these settlements for the reasons suggested in the report would raise questions of fairness to other taxpayers who have complied with their tax obligations under the law. It would also raise questions of fairness to other taxpayers who have settled or otherwise finalised assessments in circumstances where the Tax Office has reviewed old issues, for example, loss company cases.

It should also be noted that in reviewing these cases the Tax Office did take into account the length of time since the transactions took place in considering our position and the terms of settlement in each case.

In response to the cases settled during the course of the mediation mentioned in paragraph (b), each case was settled at a time when the Tax Office had not contemplated making a general settlement offer. This offer was considered towards the end of the mediation and was announced following the mediation. The cases were also settled before the Commissioner announced in April 2004 that the general anti-avoidance provisions in Part IVA of the Act would not be applied to deny deductions for core technology expenditure. The timing of the events relating to the two cases referred to in the report is set out in the attachment.

While not raised in the report, the overall complex and special circumstances of the R&D syndication issue may warrant that consideration should be given to reviewing any case settled on less favourable terms than the general settlement offer made towards the end of 2004. Although these cases would have been settled in good faith, there is an issue whether such investors have been unfairly disadvantaged compared to other investors simply because they chose to finalise their case in a more timely way. We will review this matter further taking into account all of the circumstances relating to these cases.

Inspector-General's comments on the Tax Office's submission

I am pleased that in the last paragraph above the Tax Office has accepted my recommendation to reconsider the fairness of some of its settlements, albeit not on the basis set out in the recommendation.

In relation to the 19 investors mentioned in recommendation (a), the Tax Office accepts that it should have directly contacted these investors earlier. But, the Tax Office fails to acknowledge as unfair the fact that it did not. It also fails to acknowledge that apart from the lack of adequate communication there were also other aspects of unfair treatment of these taxpayers. Unlike other loss company cases, it was aware of all the relevant facts before arrangements were entered (including the details of the syndication arrangements and their tax effect), it was aware that this matter was, in its view, a significant compliance issue 12 to 14 years ago, and it was aware that the losses were utilised by the investors at least eight years ago. It was aware of these matters many years before it sent the investors a settlement offer out of the blue (see paragraphs C10.3 to C10.3.5 in Chapter 3).

The Tax Office agrees that there was no fraud or evasion in these cases. In this context the Tax Office should have acted promptly within normal period for review time limits. After those periods it should have moved on, noting that in 2004 it pragmatically chose not to pursue over three-quarters of investors.

Further dialogue on these recommendations will be undertaken as part of the process leading up to the finalisation of my final and overall report on the Tax Office's ability to deal with major complex issues within reasonable timeframes.


Attachment

Summary of key factual errors or omissions
Report ATO response IGT comment

Page 24, Para 3.91

'The published guidelines did not disclose the factors that the mediator considered relevant in determining the arm's length amount'

This is incorrect. The guidelines which were published following the mediation were settled by the mediator following submissions by both parties to the mediator. They therefore reflected the factors and issues which the mediator considered relevant to this issue.

The Tax Office response merely re-states the Tax Office's position already set out in the report. Paragraph 3.91 is factually correct.

The Tax Office does not address the key issue that it had information in its possession to give further certainty to taxpayers but did not to provide that guidance. This issue and the Tax Office's position are discussed in detail in paragraph C7.25 of Chapter 3.

Page 25, Para 3.91

The report states that other 'special characteristics of the parties' which the mediator said should be accounted for include the following factors:

  • the cost of development of technology
  • timeframes for successful development
  • researcher funding constraints
  • timing of tax benefits etc
This statement is misleading. None of the items mentioned were referred to as 'special characteristics of the parties' by the mediator. The guidelines state that the Commissioner will consider any relevant material put to him by an investor. This includes any special characteristics of the parties.

The Tax Office infers that the report misquotes or misrepresents the mediator. This assertion is unfounded because the report clearly states the factors that are distilled from the mediator's advice. Also, the Tax Office agrees that the mediator considered these factors as relevant.

The Tax Office does not address the underlying issue that these and other factors (including the Tax Office intention to consider the special characteristics if raised by the investor) were not communicated to investors. This issue is discussed in detail in paragraphs C7.20 to C7.27.

Page 40, Para C7.8.1

'In applying the guidelines to a key investor's claim the Tax Office ignored the advice of Sir Anthony Mason in determining section 73B(31)(b)(ii) and 73B(31)(d) issues and continued to apply the approach that merely substituted a zero value for the investor's claimed core technology expenditure.'

This is incorrect. The ATO did not ignore the advice of the mediator in applying the guidelines.

The suggested zero value was not adopted as the ATO position, nor was it communicated to the taxpayer.

I have updated the paragraph to state that the position was never communicated to the taxpayer. I have also added further material demonstrating that the Tax Office did not follow the mediator's advice in this case.

Page 41 , Para C7.8.5

'While applying the guidelines the Tax Office repeatedly stated and inferred during the review that this investor and others had engaged in tax abuse. Also during discussions, comments were made that the mediator's advice on section 73B (31)(b)(ii) (d) were unrealistic.'

This statement is incorrect. In applying the guidelines it was not the Tax Office practice to repeatedly state and infer that investors had engaged in tax abuse. We were seeking to apply the law and make adjustments to claims where, in our view, there was non-compliance with the law.

At no stage has the ATO asserted that the mediator's advice was unrealistic.

The Tax Office appears to be distancing itself from comments made by tax officials orally and in writing to Inspector-General staff during the review. This Tax Office response appears to consider such comments as immaterial where it is not 'Tax Office practice'. These comments fail to consider appropriately my conclusion that an unchecked cultural influence of 'hitting tax abuse hard' has been a major contributing factor to why the R&D syndication issue has taken well over a decade to near resolution.

I have elucidated the wording used in the report to 'Tax officials told Inspector-General staff that it was unrealistic to expect the Tax Office to follow the mediator's guidance on determining an arm's length amount because it was "not practical" to follow that advice'. The elucidation does not change the fact that in the case in question the Tax Office did not follow the mediator's advice on determining section 73B(31)(b)(ii) and (d) issues —the factors to consider in quantifying the arm's length price.

Page 54, Para C9.3

'The Tax Office did not effectively communicate its review and resolution strategies … it did not communicate its change to its long held approach to quantifying an arm's length amount following the mediation. This would have allayed investors' concerns that the Tax Office would merely continue to substitute investors' valuations with the Tax Office commissioned 'close to zero' valuations'

As stated in the report, the Tax Office disputes this conclusion. The change was communicated in the guidelines at Part C Para 6(1) which states 'the core technology licence fee is likely to have a positive value (as distinct from a negative or nil value)'.

The Tax Office response merely re-states the Tax Office's position already set out in the report. Paragraph C9.3 is factually correct.

I have updated that paragraph to include evidence that senior tax officials were made well aware of investors' impressions that if they go to Part C, they 'get nothing'.

Pages 57–58, Paras C10.1.9-16 There are several factual errors in this section of the report. The facts in relation to these three cases are:
In summary, the report concludes that three clients of an advisor were unfairly treated, as their investments were perceived to amount to 'tax abuse'. Case 1: In November 2006, the ATO accepted that the guidelines had been satisfied. A factor taken into account was the additional TCC scrutiny of the core technology valuation.

The Tax Office appears to downplay the weight it gave this factor. The Tax Office told the Inspector-General in October 2006 that this factor was the reason the Tax Office accepted that the guidelines had been satisfied in 6 of 7 of these cases. It was unsure of the date on which the seventh case had its finance scheme assessed by the TCC. This was again confirmed by the Tax Office in February 2007. The Tax Office also told an investor's representative in February 2007 that this factor was 'determinative'.

Now in its final submission on the report, the Tax Office, for the first time, asserts that this factor was not the key factor

Case 2: In November 2006, the ATO had formed a preliminary view that the guidelines were not satisfied. Copies of TCC documents held by the Tax Office show TCC close consideration of some aspects of the finance scheme but no scrutiny of the core technology valuation. The statement at para 10.1.14 that 'The Tax Office had evidence that indicated the TCC may have scrutinised the initial valuation' is therefore wrong.

These comments imply that the Tax Office formed its preliminary view after considering the TCC documents. However, the Tax Office has failed to point out that it only accessed the TCC documents after the Tax Office had formed its preliminary view and only after the matter had been raised by Inspector-General staff. Until that time the Tax Office did not appear to consider as relevant documents in its possession that showed the rejection of the syndicate's finance scheme. Inspector-General staff pointed out that it would be better public administration to uncover the basis for that rejection and whether that basis was the core technology price or some other reason. This issue is discussed in paragraphs C10.1.12 to C10.1.20 in detail. The Tax Office should have determined this issue before rejecting the investor's claim. It did not. It only accessed this information when urged to do so.

Pages 57–58, Paras C10.1.9-16 (continued) Case 3. In November 2006, the ATO had formed a preliminary view that the guidelines were not satisfied. Copies of TCC documents held by the Tax Office do not indicate any scrutiny of the core technology valuation. The statement that 'The Tax Office assumed that the TCC did not scrutinise the syndicate's core technology value because that syndicate's finance scheme was examined by the TCC shortly before the issue of the new finance scheme guidelines', is therefore incorrect. The inaccuracy of the statement is further evidenced by the fact that the core technology valuation had not even been commissioned at the time the finance scheme guidelines were approved.

I am disappointed that these additional facts have come so late in the review. It appears that the Tax Office only discovered these facts after final discussions on the Inspector-General's report.

Nevertheless, these 'factual errors' do not alter the fundamental unfairness identified at paragraph C10.1.19 — that the Tax Office did not tell taxpayers before they made submissions on the issue that reliance on the additional TCC scrutiny was a factor in resolving their case. Also it was a reasonable assumption that investors who had their applications considered after the TCC announced that it would apply additional scrutiny would rely on that additional scrutiny as having been applied.

In both cases 2 and 3 the advisor sought additional time to make further submissions and the requests were granted.

The Tax Office has failed to point out that the adviser's initial requests for additional time were declined. The additional time was given only after Inspector-General staff told the Tax Office that not to do so in the circumstances would likely be the focus of specific adverse comment in the report.

Page 60, Paras C10.1.21-22

'Two investors settled with the Tax Office while the Tax Office was involved in the mediation ... The Tax Office did not inform the investors of the mediation or its purpose … It therefore settled on an unfair basis.'

This is misleading as it omits material facts. The following events occurred:

9/3/2001 — Tax Office decision to 'continue work on leading cases through to litigation with a view to obtaining outcomes which are capable of application across the syndicate population; and mediation not to be pursued at this point.'

4/9/2002 — the AAT hands down its decision in the Zoffanies case and the ATO soon after appeals to the Federal Court;

25/7/2003 — Amendment issued to first taxpayer adjusting syndicate claims;

The facts referred to by the Tax Office are in the report, and were previously fully considered and discussed with the Tax Office in considering those issues discussed in paragraphs C10.1.20 and C10.1.21.

The Tax Office appears to imply that it could not have known at the time it settled with the first taxpayer that more favourable settlement terms would be issued at the end of the mediation. However, the Tax Office submission has failed to point out key facts adverse to its position. I have inserted these opposite and highlighted them in red.

Page 60, Paras C10.1.21-22 (continued)

25/7/2003 — the Tax Office withdrew its appeal to the Federal Court of the AAT's decision in Zoffanies on the specific anti-avoidance provisions grounds

29,30/7/2003 — Federal Court (appeal) hearing in Zoffanies;

30/07/2003 — Mediation agreement entered into with a purpose to 'determine guidelines for reviewing R&D arrangements, thereby potentially removing the need for detailed syndicate audits and/or litigation';

8/9/2003 — settlement terms agreed with first taxpayer without telling the taxpayer of the mediation or its purpose;

24/10/2003 — Federal Court outcome in Zoffanies — referred back to AAT;

10/12/2003 — settlement deed with first taxpayer signed;

From 24/10/2003 to 14/4/2004 — senior officers seek external advice on the applicability of Part IVA to core technology overvaluation and recommend to the Commissioner not to apply Part IVA to these deductions;

14/4/2004 — ATO announces decision not to apply Part IVA and announces for the first time the existence of mediation and the mediation's purpose;

Between 14/4/2004 and 14/7/2004 — second taxpayer becomes aware of the ATO announcement and asks ATO to hold off settlement;

14/7/2004 — ATO advises second taxpayer that ATO prepared to hold off settlement discussions until outcome of mediation;

24/9/2004 — general settlement offer made to second taxpayer;

10/12/2004 — settlement deed with second taxpayer signed.

The Tax Office's purpose for entering the mediation was to determine guidelines for the resolution of other R&D syndication cases. The Tax Office did not tell the first taxpayer it entered mediation or the purpose of that mediation. The second taxpayer became aware of the mediation through the Commissioner's 14 April 2004 announcement and asked the Tax Office to hold off finalising the settlement pending the outcome of the mediation. The Tax Office agreed to this and advised the taxpayer on 14 July 2004.

It is clear that the mediation, whose output was intended to have wide application, would likely affect settlement terms for all R&D syndication cases involving disputes over core technology deductions. However, taxpayers in settlement negotiations (and taxpayers generally) were never told of the mediation or its purpose until the Commissioner's April 2004 speech, more than eight months after the mediation started. The second taxpayer who held off settlement received better terms of settlement merely by settling their case later.

These facts led me to find that the Tax Office continued negotiations with, and entered into a settlement with, the first taxpayer at the same time it was developing a global policy to deal with all matters of that kind, without notice to that taxpayer. This action was not in good faith, and was unfair.