A.3a.1 This appendix sets out the Tax Office's detailed responses to Chapter 2 of the review, with the Inspector-General's comments.

Tax Office detailed reply to Chapter 2

Tax Office response

A.3a.2 This chapter provides an overview, summary and outline of the key recommendations of the report. Our response to this chapter deals with the matters the Inspector-General claims have been identified by the review (see diagram 2.1 in his report) and the Key Recommendations made in the report.

A.3a.3 More detailed discussion can be found in our response to the other chapters of the report.

Outcome of disputes

A.3a.4 The report relies on Administrative Appeals Tribunal (AAT) figures which indicate that the majority of Tax Office decisions which enter the litigation phase and are referred to the AAT are varied in some way. From this, the Inspector-General draws the conclusion that a significant percentage of the tax cases which reach the litigation stage are reaching that stage unnecessarily, and that the earlier stages of the tax dispute process are not wholly effective and warrant further review. However, the opposite conclusion could also be drawn.

A.3a.5 The scope of litigation needs to be put into context. The report at the commencement of Chapter 2 highlights the information we provided, that only 0.3 per cent of compliance adjustments lead to litigation. This suggests that the Tax Office gets the bulk of its decisions right up-front.

A.3a.6 When cases do get to litigation we again continually review our cases and strive to resolve those cases that can still be resolved without the need for expensive litigation. Nevertheless taxpayers have the right to have their matters reviewed by the AAT or the courts. An analysis of the figures extracted from Table 3.5 (in Chapter 3 of the report) indicates that for the two year period from 1 July 2003 to 30 June 2005, only 25 per cent128 of non aggressive tax planning appeals are settled. The large volume of aggressive tax planning appeals which are settled (73 per cent) reflects the Commissioner's attempt to respond to the recommendations of the Ombudsman and the Senate Economic Reference Committee regarding mass marketed investment schemes, and employee benefits schemes appeals by offering concessions such as reductions in penalties and interest.

More revealing is the fact that only 4 per cent of the appeals are wholly conceded or withdrawn by the Tax Office.129

A.3a.7 While this data indicates that the Tax Office has taken the right approach at the objection stage in most instances, we are reviewing our end-to-end process for objections and appeals to see whether further improvements can be made.

Inspector-General's comments on Tax Office response

A.3a.8 The Inspector-General's figures for cases that do not proceed to a hearing (88 per cent of cases) and which are varied (70 per cent of these 88 per cent of cases) are drawn from published third party AAT data. The Tax Office's analyses are based on its internal records which have internal data quality issues.

A.3a.9 The Tax Office's reference to its internal data which shows that only 4 per cent of cases are wholly conceded or withdrawn by the Tax Office overlooks those cases which the Tax Office's internal records show are settled. Fieldwork conducted by staff of the Inspector-General for this review indicated that a significant percentage of cases that are recorded as settled by the Tax Office in its internal records are settled wholly in favour of the taxpayer. As discussed in the report this may be due to a number of reasons including the possibility that information relevant to the dispute has not been sought earlier in the dispute resolution process (at the audit and objection stages) so as to allow the dispute to be properly considered, that taxpayers are not providing the Tax Office with relevant information until the dispute proceeds to litigation or that the wrong technical issues have been raised by taxpayers' advisers or by the Tax Office.

A.3a.10 The Inspector-General welcomes the Tax Office's comment that it is now reviewing its end-to-end process for objections and appeals to see whether further improvements can be made.

Tax Office litigation philosophy

A.3a.11 The Inspector General's references to the Tax Office having an 'overriding compliance approach to litigation' is difficult to understand.

A.3a.12 Generally, litigation arises because taxpayers disagree with our assessments or decisions and are exercising their rights to challenge them. We respect those rights and, if we believe that our assessment of tax (or decision as the case may be) is correct, we defend our objection decisions to ensure that taxpayers are treated equally.

A.3a.13 Sometimes a taxpayer's challenge to our position provides law clarification from the courts and Tribunal, which helps the Tax Office and the community better understand the law. Whether the Commissioner wins or loses, there may be affirmation of our existing views of the law or a need to alter our position as previously expressed in a precedential view. In such cases, either way the result is greater law clarification and certainty for the community.

A.3a.14 The report also states that 'principles of ensuring compliance with or clarification of the law should be subject to the overriding purpose of ensuring that a just and fair result is achieved for taxpayers engaged in litigation with the Tax Office'. We agree with that.

A.3a.15 Our practices clearly show that we attempt to come to the correct view about the law which we believe the courts will ultimately agree with. Often our views have been formed with extensive external involvement and advice, through Rulings Panels, consultation with professional associations and industry body liaison groups and, in the case of Public Rulings, wider community consultation.

Inspector-General's comments on Tax Office response

A.3a.16 The Tax Office's response states that it finds it difficult to understand the Inspector-General's comment that it has a compliance approach to litigation.

A.3a.17 This response contradicts other public statements the Tax Office has made (for example, in its annual reports) which are referred to in the report. In these public statements the Tax Office has stated that litigation is an essential part of its compliance program.

A.3a.18 The Tax Office's response also does not take into account the litigated cases which are referred to in the report where the Tax Office's conduct appears to have been driven by compliance objectives.

Win at all costs approach

A.3a.19 We disagree that the Tax Office has a 'win at all costs' approach to litigation. The Tax Office's approach to litigation has always been to conduct itself as a model litigant. This means that it is not the Tax Office policy to engage in unfair tactics or practices to win a case, and the evidence shows that this is not the case in practice.

A.3a.20 Taxpayers and their advisers are able to refer (either directly or through the Tax Office) any concerns in this regard to the Office of Legal Services Co-ordination in the Attorney General's Department. The Attorney General's Department has reported that the Tax Office is one of the better Commonwealth Government agencies in terms of compliance with the rules and in self-reporting any potential breaches. This view is also supported by the Ombudsman.

A.3a.21 The Inspector General's assertion seems to be based on a view that the Tax Office does not undertake a cost-benefit analysis in litigation. The reality is that all litigation by the Tax Office is based on an overall appreciation of the risks associated with a case. We agree that this could be better articulated.

Inspector-General's comments on Tax Office response

A.3a.22 Contrary to the Tax Office's response, the report does not assert that the Commissioner has a win at all costs approach to litigation. It states that there are features of the Tax Office's conduct which justify community perceptions that, at times, the Tax Office has such an approach.

A.3a.23 The review found that the Tax Office has no overall risk management framework for Part IVC litigation. Cost-benefit analysis is just one facet of an overall risk management framework. In any event, the review found that a very limited form of formal cost–benefit analysis for litigation existed within only one business line of the Tax Office.

Formal Test Case Litigation Program

A.3a.24 We welcome the comments that the 'Test Case Litigation Program is generally achieving its purpose' and that the analysis undertaken by the Inspector-General showed that most of the cases that reached a hearing were generally meeting the test case litigation objectives.

A.3a.25 We have difficulty in understanding the comment that we fund cases for compliance purposes, 'to assist the Tax Office to enforce the existing law, rather than to clarify the law by establishing new legal principles'. The Inspector-General premises these comments later in Chapter 6 by an overly narrow interpretation of law clarification.

A.3a.26 The administration of the Tax Office's Test Case Program is described in the Test Case Booklet. It describes the purpose as being to clarify the operation of the laws administered by the Commissioner of Taxation where:

  • there is uncertainty or contention about the operation of areas of law;
  • the issue is of significance to a substantial segment of the public or has significant commercial implications for an industry segment; and
  • it is in the public interest for the issue to be litigated.

A.3a.27 Although we do not generally fund cases where there are well established legal principles, there will be occasions when court considerations of different factual cases will describe the scope of the law and resolve uncertainty for large segments of the community.

A.3a.28 The Inspector-General places great store in the funding of two cases which he regards as being for compliance purposes. Only one of those cases went to hearing. The taxpayer in the other, which related to a film scheme, accepted the Tax Office's general settlement offer. The decision in Howland-Rose, which related to the Budplan mass marketed investment scheme, plainly resolved significant uncertainty for very large numbers of taxpayers and provided guidance on how the courts would apply the law in similar cases. It was treated as a test case by the court. There was a strong public interest served by funding these cases, as is evidenced by the views of the Ombudsman and the Senate Economics Reference Committee.

Inspector-General's comments on Tax Office response

A.3a.29 The Inspector-General's definition of 'law clarification' for the purposes of the test case program is not 'overly narrow'. It is the definition that was in place at the time when the decisions to fund Budplan (also known as Howland-Rose) and the other cases referred to in the report were made and is the definition which is still in the Tax Office's current test case litigation booklet.

A.3a.30 The Tax Office has confirmed in its response to Chapter 6 that the Commissioner's decision to fund Budplan was not made in accordance with relevant applicable test case program criteria, nor was it funded in accordance with normal test case program procedures.

Following court decisions and the rule of law

A.3a.31 The Inspector-General has questioned our behaviour in not following a small number of finalised court decisions and concluded that our conduct has amounted to poor administration. We reject this conclusion. Advice received from the Solicitor-General and the Attorney-General's Chief General Counsel has confirmed that we have acted properly in accordance with the rule of law.

Inspector-General's comments on Tax Office response

A.3a.32 The advice received from the Solicitor–General and Chief General Tax Counsel makes no comment on whether the Tax Office has acted properly in respect of the particular cases referred to in the report.

A.3a.33 The opinion sets out a number of conditions for good administration in this area.

A.3a.34 In the Inspector-General's view, the Tax Office has not met these conditions in all cases to which they apply (such as that of Essenbourne). For example, the Tax Office has not (as contemplated in the opinion) provided test case funding for any of the cases which were litigated subsequent to Essenbourne where it sought to re-argue its view contrary to Essenbourne. Also, the Tax Office's decision to challenge Essenbourne in subsequent cases was because it believed that there was an alternative view that was more consistent with its understanding of the policy intent of the law. This is also contrary to the opinion. Furthermore, the Tax Office did not (as contemplated in the opinion) seek or receive written legal advice as to whether the decision in Essenbourne should be challenged generally in other cases.

Risk management

A.3a.35 The Tax Office does apply a risk management approach to its internal management of litigation.

A.3a.36 There is a sound and extensive process for risk assessment and management within the Tax Office, but it is agreed that this process could be better documented.

Inspector-General's comments on Tax Office response

A.3a.37 The report finds that the Tax Office does not employ risk management and assessment techniques to its legal risk issues overall, including litigation issues. It notes that a previous internal review (the Behm review) also made this finding and associated recommendations which have not yet been implemented.

Communication to the public

A.3a.38 We agree that there should be more public communication on the status of the Tax Office's litigation program. We will do so in our Annual Report or other publications.

A.3a.39 In addition the Tax Office will issue a formal consolidated practice statement to guide its conduct in litigation.

Inspector-General's comments on Tax Office response

A.3a.40 The Inspector-General welcomes the Tax Office's intention to develop a formal statement to guide its conduct in litigation but believes that a document similar to the Taxpayers' Charter is needed to provide community confidence on the Tax Office's philosophy on litigation. A practice statement could supplement this higher status document. The Charter-like document needs to contain a formal affirmation of the Tax Office's role in relation to litigation as distinct from the roles of Government, Parliament and the Judiciary.

128 This figure may well be overstated, due to apparent errors in that some cases that were wholly conceded were recorded as settlements (see footnote 129 below).

129 Tax Office figures on cases conceded are indicative only. The Inspector General has correctly identified that there are some cases which have been recorded as settled on the Tax Office database which should more correctly be categorised as conceded. Without a complete analysis of the error in recording it is difficult to be precise. However, to the extent that cases conceded are higher the rate of settlements will be lower.