3.1 This chapter discusses the scope of this review and the nature and extent of the tax litigation which is covered by this review. It also discusses the effect which various environmental factors have on the management of this type of litigation.
3.2 These various environmental factors include:
- the legislative framework for reviews and appeals of taxation decisions;
- the Tax Office's role in the tax system generally;
- the Tax Office's role in the tax litigation process specifically;
- the rules and guidelines which shape the Tax Office's behaviour as an Australian Government agency;
- the role and approach of the Administrative Appeals Tribunal (AAT), the courts, solicitors and barristers to tax litigation; and
- the overall nature and extent of tax litigation.
Scope of this review
3.3 For the purposes of this review, the Inspector-General has defined 'tax litigation' as the process which commences when a taxpayer seeks a review or appeal of a Tax Office decision to disallow an objection to either an assessment of tax or a Tax Office private ruling by referring the disallowance to either the AAT or Federal Court.
3.4 This review process is set out in Part IVC of the Taxation Administration Act 1953 (the TAA 1953). The Part IVC review procedures apply to most types of tax which the Tax Office administers, including income tax, fringe benefits tax, goods and services tax (GST), superannuation surcharge (prior to 1 July 2005), superannuation guarantee, franking deficits tax and most types of withholding tax.
3.5 The litigation process is generally the final stage of any dispute between a taxpayer and the Tax Office concerning an assessment of tax or the contents of a private ruling.
Legislative framework for reviews and appeals
3.6 A significant proportion of tax litigation falls within the review procedures set out in Part IVC. For these procedures to apply, a provision of the relevant taxing Act must specifically provide a person dissatisfied with the relevant assessment, determination, notice or decision with the right to object to it in accordance with Part IVC.
3.7 If the provisions of Part IVC do not apply, the relevant decision may be challengeable under other administrative law appeals avenues, such as those provided in the Administrative Decisions (Judicial Review) Act 1977 and section 39B of the Judiciary Act 1903.
3.8 The choice of whether to have an objection decision referred to the AAT or the Court is one for the taxpayer.
3.9 Relevant factors in this choice include cost, the formality of proceedings, the complexity of the matter, considerations as to evidence, rights of appeal and whether or not the objection decision involves the formation of a judgment or opinion or the exercise of the Commissioner's discretion or the making of a determination by the Commissioner. The last factor can be particularly important as the AAT may exercise all the powers and discretions that are conferred on the Commissioner for the purposes of making the objection decision. This allows the AAT to be the primary finder of fact in review proceedings.
3.10 This review does not examine alternatives to the current legislative framework for reviews and appeals which has changed little since the early days of the federal income tax.1
Liability to pay tax
3.11 The liability to pay tax is not suspended during any review by the AAT or appeal to the Federal Court.2 However, if there is a genuine dispute the Tax Office has a number of policies which it applies to the debt in dispute. These are generally set out in the ATO Receivables Policy.
3.12 One such policy is that the Tax Office will generally allow 50 per cent of the tax in dispute to be deferred until the final outcome of the review or appeal. Another policy is that, if the taxpayer's case depends on the outcome of another taxpayer's case and the second taxpayer wins their case but the case is taken on appeal, the Tax Office will not apply the general interest charge (GIC) to the first taxpayer for the period during which the favourable decision in the second taxpayer's case remains on foot.3
3.13 If tax which is subject to litigation is paid, in whole or in part, and the taxpayer wins their case they will be entitled to interest on any overpaid tax at the rates set out in the Taxation (Interest on Overpayments and Early Payments) Act 1983.
3.14 This report does not generally examine the Tax Office's policies and procedures for recovering tax which is the subject of litigation.
Burden of proof
3.15 Under the current legislative provisions for the review and appeal of objection decisions, the taxpayer bears the burden of proving, on the balance of probabilities, that the assessment is excessive or that the taxation decision concerned should not have been made or that it should have been made differently.4
3.16 In general, the taxpayer must go further than showing the assessment is excessive or wrong and show what the correct assessment should be. It is not necessary for the Commissioner to show that the assessment was made correctly. The effect of the onus provisions is that if the taxpayer fails to lead any evidence on a matter, or the taxpayer's evidence is rejected, the taxpayer fails even if the Commissioner has led no evidence on the issue.
3.17 A taxpayer also bears the burden of proof in the AAT notwithstanding that the Tribunal is undertaking a review of the Commissioner's decision. In this respect, the review of tax decisions is unique from other matters before the Tribunal where neither the applicant nor the respondent agency carries a burden of proof to prove or disprove a fact.
Tax Office's role in the tax system
3.18 The Tax Office's role in the tax system is to administer the tax laws in accordance with the tax legislation and finalised court decisions. The Government's role is to develop policy and propose laws and amendments, the Parliament's role is to consider and enact those proposed laws and the Judiciary's role is to interpret those laws.
3.19 This division of functions that are associated with tax laws is premised on the principles of the rule of law, that is, that all authorities involving in rule making are subject to and constrained by law.5
3.20 The basic administration duty of the Commissioner of Taxation is to assess and collect taxes.
3.21 In performing that duty, there is a strong community expectation that the Commissioner of Taxation will be an independent and impartial administrator. There is also a strong community expectation that the Commissioner of Taxation will perform that duty in a manner that acknowledges the role of Government to develop policy and propose laws and amendments, the role of Parliament to consider and enact those proposed laws and the role and independence of the Judiciary to interpret those laws.
3.22 The general rule is that the Commissioner does not forego tax properly payable (including penalty and interest where appropriate) and will, with minimal delay, seek to collect that tax as near as practicable.
3.23 Where a taxpayer wishes to contest a liability that the Commissioner, on good grounds, considers to be properly payable, the Commissioner has a duty to defend such a challenge.6
Tax Office's role in the litigation process
3.24 The Tax Office's role in the litigation process is principally that of a litigant, rather than an advocate.
3.25 The Australian Government Solicitor (AGS) and members of the independent bar act as the Tax Office's legal representatives in all taxation appeals that are heard by the Federal or High Court.
3.26 The Tax Office perceives that its role as a litigant and client of the AGS and of external barristers in cases that are heard by a court is unique and different to that of other litigants who appear before a court. This is because the Tax Office has a strong interest in having the law clarified. It states that :
The relationship between the ATO, AGS and the bar is somewhat unique in litigation. Unlike most barrister-client relationships, the ATO approaches litigation on tax technical matters as a professional client, who has strong interest in having contentious areas of the law clarified in a sensible and coherent way consistent with the underlying policy of the law.7
3.27 Where litigation involves the AAT or Small Taxation Claims Tribunal (STCT), the Tax Office will sometimes be represented by its own staff. However, Tax Office staff do not appear before these tribunals in an independent solicitor capacity. They do not require certificates to practice as a solicitor and only recently have been required to have legal qualifications.
3.28 The Tax Office's role as a litigant in proceedings brought before the AAT or STCT is different to where proceedings are brought before the Federal Court. In the AAT or STCT, the Tax Office is required to actively assist the tribunal to reach a fair and just decision, while in a court the Tax Office's role is that of a defendant to the relevant proceedings.
3.29 As discussed by the Australian Law Reform Commission, in review tribunal proceedings both parties have an interest in ensuring that the correct or preferable decision is made in the particular circumstances of the taxpayer.8 For the Tax Office, review tribunal proceedings also provide an opportunity for external review of its decision-making process, which contributes to correct and fair administration.
3.30 In 2003/04 the Tax Office's total expenditure on legal services was $86.2 million, of which approximately $30.17 million9 was on litigation.10 From 1 March 2006, the Tax Office, together with all other Australian Government agencies, will be required to make publicly available records of its legal services expenditure for the previous year.11
Rules and guidelines which shape the Tax Office's role in litigation
3.31 Other than the overriding rule of law, the main rules which affect the Tax Office's behaviour as an Australian Government agency litigant are:
- the Legal Services Directions including the obligation to act as a model litigant set out in Appendix B and associated guidance materials;
- guidelines on the procurement of legal services, issued by the Department of Finance and Administration; and
- the Australian Public Service (APS) Values and Code of Conduct guidelines and accompanying Public Service Commissioner's Directions.12
3.32 Of these rules, the most important from the viewpoint of taxpayers and other parties involved in a tax dispute are the Legal Services Directions and accompanying model litigant guidelines.
3.33 The Legal Services Directions are directions that have been issued by the Australian Government's Attorney-General with effect from 1 September 1999. From that date, the Australian Government Solicitor ceased to be the sole provider of litigation services to all Australian Government agencies. Two versions of these directions have been issued. The first version was in effect from 1 September 1999 to 28 February 2006. The second version is effective from 1 March 2006 and was released during the final stages of this review.
3.34 From 1999, the aim of the Directions was to ensure that the quality of the Government's legal work was maintained and that the public interest was protected in the new decentralised legal services environment where agencies were free to choose their legal services provider.
3.35 Under clause 4.2 of both versions of the Directions, litigation is to be conducted by agencies in accordance with the Directions on the Commonwealth's Obligation to Act as a model litigant, (the model litigant rules) which are set out in Appendix B to the Directions. Copies of the old and new versions of the model litigant rules are set out in Appendix 5 to this report.
3.36 In summary, under the model litigant rules which apply from 1 March 2006, the Tax Office is obliged to do all of the following:
- It should not cause unnecessary delay in the handling of litigation.
- It should act consistently.
- It should endeavour to avoid, prevent and limit the scope of legal proceedings wherever possible, for example by the use of alternative dispute resolution processes.
- It should keep the costs of any litigation to a minimum.
- It should not take advantage of claimants who lack the resources to litigate a claim.
- It should not rely on technical defences.
- It should not pursue an appeal unless it believes that it has reasonable prospects for success or the appeal is otherwise justified in the public interest.
- It should apologise where it is clear that it has acted wrongfully or improperly.
3.37 The new model litigant rules also note that these rules may in certain circumstances make it appropriate for the Commonwealth to pay a litigant's costs, for example in test cases in the public interest. They also state that the rules apply to merit review proceedings such as those conducted by the AAT.
3.38 The new model litigant rules differ from those in place before 1 March 2006 by containing an obligation to consider the use of alternative dispute resolution, a specific reference to test cases, and new clauses which state that the rules apply to AAT proceedings. All previous obligations have been maintained in the new rules.
3.39 The Office of Legal Services Coordination (OLSC) is a branch of the Attorney-General's Department which is responsible for investigating and monitoring breaches of the Legal Services Directions, including the model litigant guidelines.
3.40 The model litigant obligation in the Legal Service Directions draws on previous guidelines, which in turn drew on relevant case law, which existed in non-legislative form prior to 1999. The Attorney-General or delegate may determine that there has been a breach of the Directions. Further, a court or tribunal that considers that the Commonwealth has not acted as a model litigant may make adverse comment or take this into account, for example in assessing costs in the relevant case.
3.41 Where a breach is identified, OLSC will seek to identify the underlying deficiency that led to the breach, and work with the agency and its legal service provider to overcome that deficiency. For example, if a requirement of the Directions has been misunderstood, in a manner that may recur, guidance material will be promulgated to overcome that misunderstanding. If an agency has placed insufficient value on compliance with the Directions, OLSC will work to ensure the agency recognises and acts in accordance with its obligations. In extreme cases (for example, deliberate flouting of the Directions) the Attorney-General may issue a specific direction requiring the agency to handle a particular matter or class of matters in a particular manner. There have been three occasions since 1999 when the OLSC has done this, but no case has so far involved the Tax Office.
3.42 The new Legal Services Directions were created as a result of a review process. One issue which was considered during this review was whether the rules should provide more guidance to agencies on the use of the media, particular in relation to describing the nature and conduct of other parties to the litigation. However, the new Legal Services Directions do not contain any additional guidance to agencies on this issue. OLSC provides advice on a case-by-case basis and envisages formulating guidance material as part of its forward work program.
Other parties in tax litigation
3.43 The Tax Office is not in complete control of tax litigation. Rather, taxpayers, the AAT, the courts and lawyers also exercise a degree of control over when a case is litigated and how litigation proceeds.
3.44 This report will not examine the advantages and disadvantages of the present adversarial system of conducting tax litigation before the courts and tribunals exercising federal jurisdiction. This issue was broadly examined by the Australian Law Reform Commission (ALRC) in its inquiry with its findings and recommendations in its report ALRC Report 89 MANAGING JUSTICE: Review of the Federal Civil Justice System.13 The recommendations from the ALRC report were from a whole-of-government perspective with no specific focus on tax disputes.
Role of taxpayers
3.45 There is a community perception that the Tax Office 'initiates' litigation with taxpayers. Under the current review and appeal procedures only a taxpayer may apply to the AAT for review of the decision or appeal to the Federal Court. Apart from disallowing an objection, the Commissioner has no control over which cases are litigated and whether the objection decision is referred to the AAT or the Federal Court. The Commissioner is ordinarily the respondent or the defendant in tax litigation and is not empowered to refer an objection decision to the AAT or the Federal Court.
3.46 Although the Tax Office does not determine which cases come before the AAT or the courts, it does play a role, through its compliance strategy, regarding which issues may be subject to dispute. It also plays a role in the contentions that are argued before the AAT or Court and whether an adverse decision is to be appealed. Furthermore, through its test case litigation program, it can facilitate taxpayers bringing their cases before the AAT or Federal Court by providing funding for the costs taxpayers may incur in pursuing their case.
3.47 There is very little information publicly available on the cost of tax litigation to taxpayers. However, as a part of its research for its review of the federal civil justice system, the ALRC undertook and also commissioned empirical research. In a 1999 research report, it indicated that the mean value of professional fees for applicants in tax matters that came before that Court was $7,962 and for respondents, $54,135.14 The ALRC also reported that the mean value of disbursements in tax matters in the Federal Court were $9,080 for applicants and $21,369 for respondents.15
3.48 Submissions made to this review have estimated that the current minimum costs of running a tax case in the Federal Court are in the order of $100,000 with an additional cost of $50,000 to $75,000 to run any appeal from that decision.
Role of the courts
High Court of Australia
3.49 The High Court is the highest court in the Australian judicial system and was established by section 71 of the Constitution. The functions of the High Court are to interpret and apply the law of Australia, to decide cases of special federal significance including challenges to the constitutional validity of laws and to hear appeals, by special leave, from federal, state and territory courts.16
3.50 In taxation matters, the High Court has stated that it considers that the Full Court of the Federal Court is the ultimate court of appeal subject only to the exceptional cases in which the High Court grants special leave to appeal. Such exceptional cases will need to give rise to a question of fundamental principle before the High Court will grant special leave.17
Federal Court of Australia
3.51 The Federal Court of Australia was created by the Federal Court of Australia Act 1976. The Federal Court's original jurisdiction in tax matters is conferred by the Taxation Administration Act 1953.
3.52 The Court exercises a first instance jurisdiction to hear objections to decisions made by the Commissioner of Taxation. It also hears appeals from decisions of single judges of the Court and taxation matters on appeal from the Administrative Appeals Tribunal, but only on questions of law.
3.53 The primary objective of the Court is to decide disputes according to the law and to determine the existing rights between the parties to the litigation. The Court is required to interpret the statutory law and develop the general law of the Commonwealth. In doing so, the Court exercises the judicial power of the Commonwealth under the Constitution.
3.54 The Federal Court has only limited power to intervene where there has been an exercise of a discretionary power by the Commissioner. The Court may only examine the exercise of the discretionary power to see whether the Commissioner has acted in accordance with correct legal principles. Unlike the AAT, the Court cannot interfere merely because it would have exercised the discretion in a different way. For this reason, disputes involving the exercise of the Commissioner's discretion, for example the remission of tax shortfall penalties, are often referred to the AAT.
Procedural aspects of an appeal to the Federal Court
3.55 The Federal Court of Australia Act 1976 and the Federal Court Rules, in particular Order 52B, govern tax proceedings before the Federal Court. A taxpayer filing an application in accordance with the Federal Court Rules must commence the appeal. The application for appeal must be lodged within 60 days after being served with the Commissioner's objection decision.18 The Federal Court has no power to extend the time for lodging an appeal beyond this 60-day period.19
3.56 Unless the Court orders otherwise, the appeal is limited to the grounds stated in the objection.
3.57 Within 28 days of being served with a taxpayer's application, the Commissioner is required to file a statement outlining succinctly the Commissioner's contentions and the facts and issues in the appeal as the Commissioner perceives them.20
Role of the Administrative Appeals Tribunal
3.58 In the federal jurisdiction, tribunals are part of the executive arm of government and provide administrative, not judicial, decision making and dispute resolution processes.
3.59 Review tribunals are directed to make the correct or preferable decision after considering the whole of the evidence, and to ensure that their decisions are in accordance with relevant legislation. This is referred to as a 'merits' review and requires the AAT to stand in the shoes of the original decision maker, consider all the evidence anew and substitute its own decision for the decision of the original decision maker.
3.60 The AAT's objective has been made explicitly clear in the Administrative Appeals Tribunal Act 1977 which provides that, in carrying out its functions, the AAT must pursue the objective of providing a mechanism of review that is fair, just, economical, informal and quick.
3.61 The role of the AAT is ordinarily different from that of the courts within the review and appeal framework. In a recent extrajudicial speech Justice Downes, President of the Administrative Appeals Tribunal, observed that:
Administrative decision-making, which is an important aspect of Executive Government, is not concerned with dispute resolution as such. There may be a dispute as to the decision which should be made but administrative decision-making must always focus on the making of the correct or preferable decision and not upon the resolution of the dispute relating to that decision. Administrative decisions usually have wider impact than their effect on those in dispute. Litigation concentrates on the resolution of disputes between parties.21
3.62 The contrast between merits review of administrative decisions and litigation was further illustrated by his Honour by reference to the adversarial nature of litigation, observing that:
Litigation is adversarial because it must result from an assertion by one party which is rejected by another party which the first party then seeks to have adjudicated by a court. The assertion and rejection through a court process is the adversarial process.22
3.63 However, participants in AAT hearings — particularly where both parties are represented by lawyers and accountants — can perceive that the dispute they are involved in is conducted in much the same manner as court hearings.
3.64 Once a taxpayer seeks review of a decision, the AAT assumes the role of the decision maker rather than that of an adjudicator of a dispute between the taxpayer and the Tax Office. The Australian Law Reform Commission has aptly described the consequences of this:
Tribunals and other administrative decision making processes are not intended to identify the winner from two competing parties. The public interest 'wins' just as much as the successful applicant because correct or preferable decision making contributes, through its normative effect, to correct and fair administration and to the jurisprudence and policy in the particular area. The values underpinning administrative review are said to encompass the desire for a review system which promotes lawfulness, fairness, openness, participation and rationality.23
Procedural aspects of review by the AAT
3.65 The Administrative Appeals Tribunal Act 1977 and the Practice Directions govern proceedings before the AAT.
3.66 A taxpayer may commence a review of the Commissioner's objection decision by applying directly to the AAT. This application must be lodged within 60 days of the taxpayer being served with the Commissioner's objection decision.24 The AAT has the power to grant an extension to lodge an application in certain circumstances. Where a taxpayer refers a decision to the AAT, it is the whole decision that is reviewed by the AAT and not merely that part of the decision with which the taxpayer is dissatisfied. As such, the Commissioner, subject to the taxpayer being given reasonable time to respond, may advance other arguments to defend his decision.
3.67 Within 28 days after receiving notice of application for review the Commissioner is required to lodge with the AAT the 'T' documents. These documents include a statement of reasons for the decision and every other document in the possession of or under the control of the Commissioner that the Commissioner believes is necessary to the review of the objection.
3.68 The AAT is also empowered to serve notice on the parties requiring the production of documents within a specified time or requiring the person to produce a listing of all documents in that person's possession or control relevant to the objection decision.
3.69 The AAT may exercise all the powers and discretions of the Commissioner for the purposes of reviewing the Commissioner's objection decision. As such, the AAT may confirm, vary or set aside the Commissioner's decision on an objection. In reaching its decision the AAT is bound to follow precedent set by earlier court decisions. The AAT may refer a question of law arising before it to the Federal Court.
3.70 In the AAT each party bears their own costs. This is unlike the Federal Court, where the unsuccessful party normally bears both parties' costs on a party/party basis. Proceedings in the AAT are also required to be conducted with as little formality and technicality, and with as much expedition, as the requirements of the Administrative Appeals Act 1977 and a proper consideration of the matters before the AAT permit. Also the AAT is not bound by the rules of evidence but may inform itself on any matter in such manner as it thinks appropriate. However, the AAT is required to comply with the rules of natural justice, which includes procedural fairness.
Role of lawyers
3.71 As representatives of the client, lawyers are primarily responsible for the preparation and conduct of the litigation. This includes determining the technical issues that are to be litigated, the documentary and other evidence that is to be led in the course of the litigation and the presentation of the case before the AAT or the Court. In many instances, lawyers only become involved in the tax dispute once litigation is commenced. This may mean that technical issues, evidence and strategies are re-examined as part of the matter now subject to litigation.
3.72 The role of lawyers in litigation is, in part, guided by the duty of the solicitor or barrister to the court. A lawyer as a member of the community has an obligation to respect the authority of the court. A lawyer has additional obligations to protect the integrity of the judicial process that arises out of the special role the lawyer has in the judicial process. The lawyer's obligation is to do the best the lawyer can for the client. But the lawyer and other participants in the judicial process (including the parties) have a broader concern. That concern is the pursuit of a just result, that is, the fair and proper application of the law to the facts.25
3.73 One consequence of the existence of the duty to the court will be that in particular circumstances the lawyer will be required to act in a manner that may appear to be contrary to the interests of the client in the proceedings. One example of the lawyer's duty to the court is the requirement in civil cases to insist upon a client producing a document (subject to any claim of privilege) even though the production of the document may be fatal to the client's case. Other aspects of the lawyer's duty to the court include the duty to conduct proceedings with candour and honesty, the duty not to mislead the court as to the law and duty not to mislead the court as to the facts.
Nature of tax litigation
3.74 An important facet of tax litigation is that the application of fiscal statutes to the affairs of taxpayers will to a large extent depend on the particular factual circumstances of each taxpayer. In refusing special leave to appeal to the High Court in FCT v Eastern Nitrogen Ltd B28/2001, McHugh J commented that:
… most tax cases turn on questions of fact and they are not worthy of re-examination in this Court. We have said that the Full Court of the Federal Court is, in all but a small category of cases, the final court of appeal in tax matters.
3.75 A question of law involves a determination of what the law is and may require the interpretation of a statute or the application of precedent. A question of fact involves a decision by the court or tribunal of what happened in the case. This requires the court or tribunal to consider all the evidence and decide what the facts of the case were.
3.76 The distinction between a question of law and a question of fact is important as only questions of law give rise to an appeal from the AAT to the Federal Court. Where an appeal to the Federal Court against an AAT decision does not turn on a question of law then the appeal will be dismissed as incompetent. In contrast, where litigation is commenced in the Federal Court there is a general right of appeal to the Full Federal Court. Special leave is required for an appeal from the Full Federal Court to the High Court.
3.77 The precedential value and effect of decided cases of any court of record, whether at first instance, by an intermediate court of appeal or by a final court of appeal is the legal principle established by or applied in that case. As one submission to this review stated:
… the identification of that legal principle does not depend upon being able to apply some general abstract label to the particular kind of transaction at issue in the case; and then contending that the outcome arrived at in that case is necessarily to be applied to every other case in which the transaction in issue could be said to bear the same label or description. Closer and more refined analysis is necessary. Most particularly, proper account must be taken of whether it can be said that there were factual differences between any two cases.
3.78 The fact-specific nature of tax litigation also means that neither the Tax Office nor taxpayers are bound to follow the tax treatment given to a particular matter in one year to later years of income for the same taxpayer.26
3.79 The significance of the distinct factual circumstances of each taxpayer, and the application of a decision to other cases with similar issues, is an area of some concern, and misunderstanding, amongst a number of taxpayers and their advisers. These issues are considered in further detail in subsequent chapters of this report, in particular Chapter 7 which deals with the role of the Tax Office in providing certainty following a court or tribunal decision.
The extent of tax litigation
Tax Office response
Key finding 3.1
Only a small proportion of active compliance activities and objections lead to litigation.
3.81 Each year the Tax Office makes a large number of decisions that affect the tax liabilities of persons and entities inside and outside Australia. Administrative decisions may be reviewed internally (by another senior officer within the Tax Office, for example, by way of objection), by review tribunals and by the courts (in particular, the Federal Court and the High Court). As the figures below indicate, taxpayers sought to have the decision reviewed by the AAT or appealed to the Federal Court in a small proportion of total active compliance activities. The Tax Office defines 'active compliance activities' as activities which involve the Tax Office checking whether the tax laws are being complied with. These activities include data-matching, telephone calls, letters, walk-in visits, risk reviews, audits and prosecution investigations.
3.82 In 2003/04 the Tax Office carried out 1,167,786 of these active compliance activities. In 2004/05 the Tax Office carried out 1,197,891 such activities.
3.83 In 2003/04, of the total number of active compliance activities, 558,182 resulted in variations to taxpayer liabilities or claims for rebates or refunds. In 2004/05, a total of 679,938 of the active compliance activities gave rise to a liability impact. This includes cases resulting in reductions of carried forward losses and referrals to external organisations such as the Director of Public Prosecutions. In 2003/04 the Tax Office also received 14,793 applications for private binding rulings.
3.84 In 2003/04 the Tax Office received 16,872 objections to assessments and 155 objections to private binding rulings. During the same period, 1,541 matters were lodged for review by taxpayers in the AAT and the STCT and 322 taxation appeals were filed in the Federal Court. Based on Tax Office figures, the number of appeals generated from compliance adjustments is less than 0.3 per cent. Fewer than 10 per cent of objections resulted in an appeal and approximately 3 per cent of objections in non-mass marketed tax arrangement cases proceeded to appeal.
3.85 Although the total number of litigated cases is small, these cases are important to the effective operation of the current self assessment system of tax administration. This is especially so where the cases result in a published Court or AAT decision. Often these published decisions provide the only material which is available to taxpayers and the community to guide them on how the tax law will be applied or interpreted in a given set of factual circumstances.
3.86 The outcome of cases that proceed to litigation and the manner in which these cases are finalised are discussed below.
Outcomes of applications to the AAT and courts
Administrative Appeals Tribunal
3.87 As shown in the Table 3.1, in 2003/04, the AAT received 7,267 applications for review across all jurisdictions. Of these, 1,354 were lodged in the Taxation Division with 187 applications lodged in the STCT.27 In the same period, the AAT finalised 2,980 applications for review of tax decisions in the Taxation Division and 163 applications in the STCT.28
3.88 In 2004/05, the AAT received 7,679 applications for review across all jurisdictions. Of these, 2,140 were lodged in the Taxation Division with 213 applications lodged in the STCT. In the same period, the AAT finalised 1477 applications for review of tax decisions in the Tax Division and 225 applications in the STCT. The large increase in applications for review to the AAT for 2000/01 may be attributed to mass marketed tax arrangements.
|Total applications for review for all jurisdictions||7,330||7,538||8,050||12,863||7,767||7,766||7,267||7,679|
|Applications to the Taxation Division||962||780||1321||6,371||1254||856||1,354||2,140|
|Applications to the Small Taxation Claims Tribunal||312||359||272||220||215||149||187||213|
Source: Administrative Appeals Tribunal annual reports 1997/98 to 2004/05.
3.89 Statistics from the AAT indicate that nearly 85 per cent of applications for review of tax decisions relate to income tax, with the remaining cases predominantly involving goods and services tax and superannuation guarantee issues.
Federal Court of Australia
3.90 In 2003/04, 5,312 cases were commenced in, or transferred to, the Federal Court's original jurisdiction. Of these, 322 were classified as tax appeals. In comparison, the number of matters concerning decisions under the Migration Act filed in, or remitted to, the Court's original jurisdiction was 2,591 and under the Corporations Act, 626.
3.91 As is evident from Table 3.2, apart from 2000/01, the number of tax appeals commenced in the Federal Court and the proportion of tax appeal cases have been fairly constant. The increase in the number of tax appeals in 2000/01 coincides with an increase in the number of applications for review related to mass marketed tax arrangements in the AAT. Likewise the number of appeals to the Full Federal Court has been fairly constant over the previous 15-year period with approximately 5 per cent of all appeals to the Full Federal Court involving tax matters.
3.92 In 2003/04, there were 12 tax appeals to the Federal Court from the AAT. In this same period, the AAT finalised an application for review by way of decision in 201 cases, suggesting that only a small proportion of AAT decisions are appealed to the Federal Court on questions of law.
|Total appeals to Federal Court (including non-tax matters)||N/A||N/A||N/A||N/A||N/A||N/A||5,482|
|Tax appeals to Federal Court||167||330||222||167||515||163||159|
|Tax appeals to Full Federal Court||24||43||36||30||25||24||34|
|Tax appeals from Tribunal||36||17||25||17||313||37||16|
|Total appeals to Federal Court (including non-tax matters)||6,697||7,626||5,869||4,971||3,924||4,218||5,312|
|Tax appeals to Federal Court||216||288||266||958||167||198||322|
|Tax appeals to Full Federal Court||30||27||18||11||17||13||30|
|Tax appeals from Tribunal||12||21||7||18||8||7||12|
Source: Annual Reports of the Federal Court of Australia and the Federal Court Registry.
Resolution of review and appeal cases
Administrative Appeals Tribunal
3.93 In 2003/04 the Commissioner reported that in the AAT and STCT the Commissioner's decision was wholly upheld in 69 per cent of cases, while 11 per cent of decisions were in favour of the taxpayer. The remaining 20 per cent were decided partly in favour of each party.29 Appendix 6 provides greater detail on the information contained in the Tax Office's Annual Report 2003/04.
3.94 In 2004/05 it was reported that the Commissioner's decision was wholly upheld in 76 per cent of cases, while 7 per cent of decisions were in favour of the taxpayer. The remaining 17 per cent were decided partly in favour of each party.30
3.95 However, the Tax Office statistics only represent cases that were finalised by way of decision by the AAT. They do not include cases that were settled between the Tax Office and the taxpayer, cases that were conceded or abandoned by the Tax Office or cases that were withdrawn by the taxpayer prior to hearing.
Subsidiary recommendation 3.1
The Tax Office should publish a more complete picture of the outcomes of litigation to include information on the proportion of applications for review and appeals finalised without a hearing and the outcome.
Tax Office response
3.97 If all finalised AAT tax cases are included, then in 2003/04 approximately 1 per cent of AAT tax cases were finalised by way of the Tax Office decision being affirmed by the AAT following a hearing. Similarly, in 2003/04 less than 1 per cent of AAT tax cases were finalised by way of the Tax Office decision being set aside by the AAT following a hearing. Appendix 6 provides greater detail on the break-up of finalised AAT tax cases.
3.98 Table 3.3 shows the percentage of applications for review of tax decisions in the AAT that were finalised without a hearing over the period from 1997/98 to 2004/05.31 Chart 1 of Appendix 6 indicates that the average percentage of such applications over this eight year period was 88 per cent. The average percentage is influenced by the large number of mass marketed tax arrangement cases finalised in 2002/03 and 2003/04. If these two years are excluded, the average percentage of applications for review of tax decisions finalised without a hearing falls to 85 per cent.
|Small Taxation Claims Tribunal||80||78||66||68||78||73||85||75|
Source: Administrative Appeals Tribunal annual reports 1997/98 to 2004/05.
3.99 Table 3.4 indicates for the same eight year period the number of applications that were finalised without a hearing, broken down into whether the Tax Office's decision at objection was set aside, varied, dismissed, withdrawn or remitted.32 Decisions set aside or varied prior to a hearing would include cases where the substantive adjustment is maintained, but there is a relatively minor concession. Chart 1 of Appendix 6 provides average percentages for each of these results over the last eight years and indicates that approximately 70 per cent of applications that were finalised over these eight years without a hearing resulted in the Tax Office decision at objection being set aside or varied.
3.100 The average percentage is influenced by the large number of mass marketed tax arrangement cases finalised in 2002/03 and 2003/04. If these two years are excluded, the average percentage of applications for review of tax decisions finalised without a hearing resulting in the Tax Office decision at objection being set aside or varied falls from 70 per cent to 63 per cent.
|Percentage of applications set aside or varied||58.6||51.6||77.5||72.0||50.9||92.6||91.6||65.5|
Source: Administrative Appeals Tribunal annual reports 1997/98 to 2004/05.
3.101 The high proportion of settled cases is also confirmed by information provided by the Tax Office. In the period from 1 June 2003 to 30 June 2005 the Tax Office finalised 3,200 review and appeal cases. Of these, 1,858 were classified as 'settled' by the Tax Office, with 257 withdrawn by the taxpayer and 87 conceded by the Tax Office. Table 3.5 provides a more detailed break-up of the appeal cases finalised by the Tax Office.
|Aggressive Tax Planning (ATP)||Non-ATP|
|Part favourable to the Tax Office||282||44||326|
|Favourable to the Tax Office||132||184||316|
|Withdrawn by taxpayer||72||185||257|
|Conceded by Tax Office||3||84||87|
|Affirmed on review in favour of the Tax Office||14||55||69|
|Unfavourable to the Tax Office||8||39||47|
|Abandoned by the Tax Office||5||37||42|
Source: Australian Taxation Office.
3.102 The Tax Office considers that the AAT figures do not give any reflection of the cases conceded or abandoned outright by the Commissioner during litigation. The Tax Office advises that for the 2003/04 and 2004/05 years the total number of cases conceded or abandoned at appeal amounted to 4 per cent of all appeals. In cases other than mass marketed tax arrangements the Tax Office advises that it conceded or abandoned approximately 12 per cent of cases.
3.103 These Tax Office comments overlook the high percentage of cases that are settled. Fieldwork conducted by the Inspector-General on the outcomes of settled cases is discussed in the next chapter.
Key finding 3.2
A relatively high proportion of appeal cases are settled once a matter proceeds to litigation.
3.104 Information from the Tax Office also suggests that the majority of cases 'settled' by the Tax Office involve a question of fact rather than a question of law. This is consistent with the Tax Office's approach in its Code of Settlement, which provides that settlement may be appropriate where there are complex factual or quantum issues in contention, or evidentiary difficulties sufficient to make the case problematic in outcome or unsuitable for resolution through the AAT or the Federal Court.
3.105 The Tax Office's approach to settlement, and the high number of cases settled without the matter proceeding to hearing, suggest that a matter that proceeds to hearing will generally involve either:
- a question of law where the Tax Office has an established view or is seeking a clarification of the law from the AAT or the Court; or
- a question of fact where a taxpayer has not been able to satisfy the Tax Office, through the production of documents or other evidence, that the assessment is excessive or that the taxation decision concerned should not have been made or that it should have been made differently.
Federal Court of Australia and High Court of Australia
3.106 In 2003/04 the Commissioner reports that in the courts the Commissioner's decision was wholly upheld in 68 per cent of cases, while 23 per cent of decisions were in favour of the taxpayer. The remaining 9 per cent were decided partly in favour of each party. Again, the Tax Office statistics only represent cases that were finalised by way of decision by the court and would not include appeals finalised without a hearing. Table 3.6 provides a more detailed break-up of the resolution of appeal cases.
|Court||Favourable to the Tax Office||Adverse to the Tax Office||Partially favourable to the Tax Office||Total|
|Full Federal Court||6||3||3||12|
Source: Australian Taxation Office.
3.107 Unlike the AAT, the Federal Court and High Court do not publish further data which would allow closer assessment of issues such as the extent to which cases pursued in these jurisdictions are settled before hearing and the percentage of such cases which might be settled partly in favour of the taxpayer.
1 Other reviews which have considered reforms in this area include the Review of Business Taxation (Ralph Review) in its publication A Strong Foundation — Discussion Paper 1: Establishing objectives, principles and processes — see especially paragraphs 8.9 to 8.17. See also the discussion of alternative dispute resolution frameworks for income tax in Chapple, S, Income Tax Dispute Resolution: Can we learn from other Jurisdictions? 1999 Australasian Tax Teachers Association Conference.
2 See sections 14ZZM and 14ZZR of the TAA 1953.
3 Taxation Ruling IT 2250.
4 For the AAT, the burden of proof rules are contained in section 14ZZK(b) of the TAA 1953, while for the Federal Court they are contained in section 14ZZO(b) of the same Act. Note that for franking assessments, a taxpayer must only show that an assessment is incorrect.
6 Equally, paragraph 4.3 of the Legal Services Directions provides that litigation against the Commonwealth or its agency is to be conducted by the agency in accordance with legal principle and practice, taking into account the legal rights of the parties and the financial risk to the Commonwealth (including the agency) of pursuing its rights. One example of conducting litigation in accordance with legal principle and practice is acting in the Commonwealth's financial interest to defend fully and firmly claims brought against the Commonwealth where a defence is properly available, subject to the desirability of settling claims wherever possible and appropriate.
8 Australian Law Reform Commission, ALRC Report 89, MANAGING JUSTICE: Review of the Federal Civil Justice System, p 742.
9 Auditor-General, Legal Services Arrangements in the Australian Public Service, Audit Report No 52, 20 June 2005, p 35.
10 ibid, p 37.
11 Attorney- General, Legal Services Directions, issued pursuant to section 55ZF of the Judiciary Act 1903, at paragraph 11.1(ba). These directions are effective from 1 March 2006.
12 These are set out in sections 10 and 13 of the Public Service Act 1999.
13 The Australian Law Reform Commission, as part of its inquiry, considered:
- the civil litigation and administrative law procedures in civil code jurisdictions;
- the procedures and case management schemes used by courts and tribunals to control the conduct of proceedings that come before them;
- the relationship between courts and tribunals;
- the mechanisms for identifying the issues in dispute;
- the means of gathering, testing and examining evidence;
- the use of court-based and community alternative dispute resolution schemes;
- the significance of legal education and professional training to the legal process;
- the training, functions, duties and role of judicial officers as managers of the litigation process; and
- the appellate court processes.
14 T Matruglio Part two: The costs of litigation in the Federal Court of Australia, ALRC Sydney June 1999, p 59. Available at http://www.austlii.edu.au/au/other/alrc/publications/dp/62/report_index….
15 ibid, p 60.
17 Mason C J, Deane and McHugh J J, Application for special leave to the High Court, Federal Commissioner of Taxation v Westfield Ltd, 5 August 1991. In refusing the application for special leave, the High Court held that although the Commissioner contended that the decision of the Full Court of the Federal Court rested on a misinterpretation of the principle enunciated by the High Court in the Myer Emporium case, the case turned on its own facts and did not call for the grant of special leave to appeal.
18 Section 14ZZN of the TAA 1953.
19 Bayeh v Federal Commissioner of Taxation 99 ATC 4895.
20 Order 52B Rule 5 of the Federal Court Rules.
21 His Honourable Justice Garry Downes AM, Government Agencies as Respondents in the Administrative Appeals Tribunal, paper delivered to the Australian Government Solicitor Government Law Group, Canberra 16 June 2005, p 2. Available at: http://www.aat.gov.au/CorporatePublications/speeches/downes/GovernmentA…
22 ibid, p 4.
23 Australian Law Reform Commission, ALRC Report 89 MANAGING JUSTICE: Review of the Federal Civil Justice System, p 742.
24 Section 14ZZC of the TAA 1953.
25 Bennett P, College of Law, Book 1, Duty of Solicitors and Barristers.
26 Caffoor v Commissioner of Income Tax  AC 584;  2 All ER 436.
27 For the 2003/04 year, applications lodged in the Taxation Division of the AAT included 625 taxation scheme cases. For the 2004/05 year, applications lodged in the Taxation Division of the AAT included 1160 taxation scheme cases.
28 For the 2003/04 year, applications finalised in the Taxation Division of the AAT included 2,415 taxation scheme cases. For the 2004/05 year, applications finalised in the Taxation Division of the AAT included 662 taxation scheme cases.
29 Commissioner of Taxation, Annual Report 2003/04, p 220.
30 Commissioner of Taxation, Annual Report 2004/05, p 233.
31 'Applications finalised without a hearing' includes all applications that were finalised otherwise than by an AAT decision following a hearing on the merits. For example, applications finalised by consent pursuant to section 42C of the AAT Act or withdrawn by the applicant under section 42A(1A) of the AAT Act are included in this category.
32 The AAT has the power to vary or to set aside a Tax Office objection decision under review. Where the AAT sets aside the Tax Office objection decision it may make a decision in substitution for the decision set aside or it may remit the matter back to the Tax Office for reconsideration in accordance with any directions or recommendations of the AAT.