4.1 This chapter seeks to identify the Tax Office's corporate philosophy on litigation and examine its approach to litigation.

4.2 This chapter focuses on how the Tax Office's philosophy on and approach to litigation impacts upon taxpayers and other parties to a tax dispute that are external to the Tax Office. The next chapter discusses the Tax Office's internal management and policies and procedures in respect of litigation.

Tax Office philosophy on litigation

Concerns and issues raised in submissions

4.3 In the course of the Inspector-General's scoping study in 2003 and this review, stakeholders raised the following issues and concerns in relation to the Tax Office's philosophy on litigation.

4.4 Firstly, a number of submissions noted that there was no public statement by Tax Office as to its philosophy on litigation.

4.5 Secondly, a number of submissions asserted that the Tax Office appeared to be using litigation to confirm its view of the law, rather than to clarify that law.

4.6 Thirdly, a number of submissions stated that the Tax Office acts, in some cases, as though it makes the law rather than administers the law.

4.7 A number of these submissions asserted that one key example of this behaviour was that the Tax Office was not administering the tax system in line with a number of court decisions. A number of these submissions asserted that, by acting in this way, the Tax Office is not acting in accordance with the principles of the rule of law. Under these principles, 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, the Judiciary's role is to interpret those laws and the Tax Office's role is to administer those laws in accordance with finalised court decisions.

4.8 Fourthly, submissions asserted that the Tax Office was unjustifiably focused on winning its case rather than getting it right. The degree to which this was said to occur varied between submissions.

4.9 For example, one organisation observed that, while, in its view, the Tax Office is to a large extent not focused on winning at all costs, there were three types of cases where this focus was evident:

  • cases involving issues of fact (such as cases involving undisclosed income);
  • cases involving complex tax avoidance arrangements; and
  • cases where a judgement has been given which rejected the Tax Office view and the Tax Office proceeds with an appeal in circumstances where the prospects of success are negligible.

4.10 Other submissions stated this 'win at all costs' focus was evident in most tax litigation cases.

4.11 Fifthly, a number of submissions stated that the Tax Office has a seemingly limitless budget and long timeframes available to ensure that cases, especially those involving large tax claims and/or issues of precedent, are litigated. These submissions note that such resources and timeframes are not available to taxpayers to the same extent.

4.12 Finally a number of submissions asserted that the Tax Office's litigation philosophy fails to take into account the adverse effect which various environmental factors concerning the tax and legal systems currently have on taxpayers. These environmental factors include the cost of litigation to taxpayers and the operation of the self assessment system for tax under which taxpayers bear the initial burden of determining how tax laws apply to their circumstances.

4.13 The Inspector-General's findings in relation to the above six stakeholder concerns, and in relation to other concerns about the Tax Office's philosophy on litigation that have arisen as a result of this review, are set out below.

Absence of comprehensive Tax Office statement on its litigation philosophy

4.14 This review has confirmed that there is no formal, consolidated public statement by the Tax Office on its corporate philosophy towards tax litigation.

4.15 The Tax Office's corporate philosophy on litigation needs to be gleaned, to the extent that it can be, by referring to a number of Tax Office statements. Some of these statements are publicly available and located on the Tax Office's website, while other statements are located in internal Tax Office documents. A number of the internal documents are however, outdated.

4.16 These statements include:

  • speeches by Tax Office staff and the Commissioner of Taxation;
  • the Model Litigant Guidelines;
  • the Commissioner's Annual Report;
  • the Legal Services Guidelines;
  • various final and draft Practice Statements, including in particular PS LA 2005/22;
  • the Taxpayers' Charter;
  • the Tax Office's Compliance Model;
  • the Tax Office's Code of Settlement Guidelines;
  • the Tax Office's Test Case Litigation Program booklet; and
  • internal litigation bulletins.

4.17 However, across each of these corporate documents there is no common statement regarding the Tax Office's philosophy towards tax litigation. At times, there are even competing views on the stated philosophy towards litigation in some of these statements. In addition, none of these statements commits the Tax Office to fundamental elements of its role in the tax system. Notably, there is no explicit commitment to the principles of the rule of law.

4.18 The Tax Office directed the Inspector-General to a speech by a Second Commissioner33 and stated that it was one of the primary documents that articulates the Tax Office's philosophy towards tax litigation. In this speech, the importance of law clarification as an aim of litigation was emphasised:

… the ATO … has a strong interest in having contentious areas of the law clarified in a sensible and coherent way consistent with the underlying policy of the law.

4.19 The role of tax litigation is also discussed in the Commissioner's 2003/04 and 2004/05 annual reports. In the 2003/04 Annual Report the Tax Office emphasises the compliance aim of litigation:

… litigation forms an important part of our compliance and dispute resolution program, and clarifying the law helps us administer the revenue.

4.20 In the 2004/05 Annual Report the Tax Office states that:

Litigation is an essential part of our law clarification and compliance programs.

4.21 The above sources appear to indicate that litigation is regarded by the Tax Office as being both part of its compliance program and also a means to clarify the law in line with its understanding of the underlying policy.

4.22 The above statements, however, do not indicate which of these aims will have priority, for example, in cases where the two aims are in conflict.

Tax Office conduct in litigation

4.23 The Tax Office's conduct in litigation also conveys mixed messages as to its philosophy on, and approach to, litigation.

4.24 As noted above, a number of submissions by stakeholders asserted that the Tax Office's conduct in litigation appears to be driven by the compliance aim of ensuring that its view of the law is applied and that this aim is overshadowing any law clarification aim. Submissions also stated that the Tax Office can, at least at times, have a 'win at all costs' approach to litigation.

4.25 The Tax Office has however denied that it ever has a 'win at all costs' approach to litigation. It has stated that

… our purpose is never to win at all costs. We strive to make sure that legislation is given its intended effect as best as we can discern it from the law, informed by our knowledge of the underlying policy. There are circumstances where counsel may suggest an entirely different means of arguing a case inconsistent with the way in which we may have publicly expressed our views of the law… Whilst we are grateful for advice which might assist us in the successful outcome of a particular case, we are mindful as to whether the argument will assist us generally in the law clarification that we seek. The consequences for other taxpayers or other provisions in the range of laws administered by the ATO weigh heavily on our deliberations.34

4.26 From this entire review, the Inspector-General has concluded that there are a number of aspects of the Tax Office's conduct with respect to litigation which strongly suggest that the Tax Office's principal philosophy on litigation is that it is a means of validating the Tax Office view and ensuring that taxpayers comply with its view of the law. This compliance approach is, in certain circumstances, overriding law clarification aims for litigation. These features of the Tax Office's conduct, when coupled with the absence of cost/benefit approaches by the Tax Office in terms of assessing the benefits of litigation against the total internal and external costs of litigated cases (which is discussed further in the next chapter), mean that community perceptions that at times the Tax Office has a 'win at all costs' approach to litigation are justified.

4.27 The Tax Office's conduct in applying the outcome of finalised decisions and in litigating certain test cases particularly evidences a systemic compliance-driven approach to litigation. The following five examples are drawn from both these areas and are discussed in further detail in subsequent chapters of this report.

4.28 Firstly, the Tax Office has not followed certain principles of law established in finalised court decisions and is administering the law as if the relevant cases had not been decided. For example, it has refused to follow the interpretation of the meaning of a 'fringe benefit' established in the case of Essenbourne.35

4.29 Secondly, the Tax Office has also not applied the results of certain court decisions that have altered a previous Tax Office view until that view has been formally changed. This process can take many months or even years. It is also continuing to adhere to previous rulings in litigation where the views expressed in the relevant rulings can no longer be defended because of court decisions. Examples of where both these results have occurred are firstly, in respect of the case of Marana36 and secondly, in the application of the Marana decision to other AAT cases impacted by Marana.

4.30 Thirdly, the Tax Office has not treated a Full Federal Court decision in favour of a taxpayer as having any precedential significance, as in the cases of Metal Manufactures and Eastern Nitrogen37, for example, by promptly updating rulings to reflect the results of these decisions.

4.31 Fourthly, approximately 38 per cent of the total test case litigation program funds expended over the ten year life of the program have been used to fund two cases where the primary purpose in funding was to achieve a compliance outcome, that is, to assist the Tax Office to enforce the law, rather than to clarify the law. Neither of these cases was approved for funding in accordance with the principles which apply under the formal test case program.

4.32 Finally, the Tax Office has settled a number of 'test cases' once it was advised it was likely to lose them. For example, a number of cases were selected as test cases by the Tax Office to consider the application of the income tax anti-avoidance provision (Part IVA of the ITAA 1936) to the alienation of personal services income. After receiving external advice that the Tax Office was likely to lose the Part IVA argument in these cases, the Tax Office settled or did not proceed with four cases out of the total 12 selected for test case funding. The Tax Office indicated that it did so because it wanted to ensure that no Part IVA case it proceeds with detracts from the result reached in the High Court decision in Hart.38

4.33 Another indicator of the emphasis given by the Tax Office to the compliance aim of litigation is that, for internal management purposes, tax litigation is currently part of the Tax Office's Compliance sub-plan. However, since this review began, the Tax Office has announced the creation of a Law sub-plan which may include litigation.

4.34 The above comments lead to the following key finding:

Key finding 4.1

The Tax Office's principal philosophy on litigation is that it is a means of validating the Tax Office view and ensuring that taxpayers comply with its view of the law. This compliance aim for litigation is, in certain circumstances, overriding its involvement in activities which may lead to law clarification. These features of the Tax Office's conduct, when coupled with the absence of cost/benefit approaches by the Tax Office in terms of assessing the benefits of litigation against the total internal and external costs of litigated cases, mean that community perceptions that, at times, the Tax Office has a 'win at all costs' approach to litigation are justified.

Tax Office conduct in applying the outcomes of finalised court decisions

4.35 Submissions to this review have expressed concern that the Tax Office, in some significant cases does not administer the tax system in line with court decisions and that in doing so the Tax Office is not acting in accordance with the principles of the rule of law. Under these principles, all authority is subject to, and constrained by, law and both taxpayers and the Commissioner are bound by finalised decisions of the courts.39

4.36 The Tax Office, however, has stated in the course of this review that it always has and always will give effect to the statutes and to the decisions of courts and tribunals.

4.37 The Inspector-General has found no evidence to suggest that the Tax Office does not give effect to the results of a litigated case as regards the particular taxpayer who has initiated the case. However there is a concern as to whether the Tax Office is prepared to act, has acted, or has given rise to perceptions that it has acted, in ways which inappropriately (unjustifiably) limit the application of a court decision which has gone against the Tax Office.

4.38 The Tax Office has advised in the course of this review that there are a small number of cases where it '… does not automatically follow the decisions of courts and tribunals'. The Tax Office advises that it would only take this course where it'… feels obliged to do so to protect the intention of the Parliament'.

4.39 The Inspector-General considers that protecting the intention of the Parliament or the Tax Office's own understanding of the policy of the law should not become a law in itself; the Tax Office should be independent and guided by the rule of law principles.

4.40 There are also other public Tax Office statements that refer to '… loopholes created by the courts…', or the courts making 'wrong' decisions, or statements that specific court decisions are not correct.

4.41 For example, in the case of Essenbourne the Tax Office has publicly stated the Federal Court's construction of the fringe benefit tax provisions is not correct and is inconsistent with the Tax Office's understanding of the intent of the fringe benefit tax law.

4.42 Submissions to this review have given other examples of cases where there are strong perceptions that the Tax Office has ignored the decisions of courts and tribunals in its administration. These cases are discussed in more detail in Chapter 7.

4.43 The Inspector-General considers that statements and actions of this nature by the Tax Office are sufficient to raise and justify the perceptions raised in submissions to this review.

4.44 In the course of this review the Tax Office has sought to minimise the validity of these conclusions on the basis that they are based on only a handful of examples, a small proportion of the whole.

4.45 The Inspector-General does not doubt that in the vast majority of cases the Tax Office acts consistently with the principles embodied in the rule of law. However, there are a handful of significant cases where the Inspector-General believes that perceptions that the Tax Office has departed from these principles are justified.

4.46 In the continuing absence of a clear public statement about its philosophy on litigation, perceptions that the Tax Office's management of its litigation program is overly susceptible to influence by its compliance culture and by its view of underlying policy will continue to grow. In turn and over time, these perceptions will continue to undermine the integrity of tax administration.

4.47 Also, the principle that taxpayers and the Tax Office are bound by decisions of the courts does not preclude the Tax Office from continuing to test the law, where appropriate, through appeals or providing advice to the Government on law reform. However, the desire to continue to test the law should not mean that the Tax Office administers the tax laws by ignoring decisions it believes are 'incorrect' or 'inconsistent with the Tax Office's understanding of the intent of the law'.

What should the Tax Office's philosophy on litigation be and how should this philosophy be communicated?

4.48 The Inspector-General considers that the Tax Office needs to publicly state its philosophy on litigation. This statement should provide clear guidance on how it serves to advance the Tax Office's role in the tax system as an independent and impartial administrator. Public recognition by the Tax Office of rule of law principles is crucial to community acceptance of the Tax Office as a fair administrator and also to community acceptance of the general role of taxation and of the fairness of the tax system.

4.49 This statement should also cover the Tax Office's approach to litigation. As discussed later in this chapter, this approach is also not evidenced in any public statement.

4.50 A formal, consolidated public statement is needed to reinforce an appropriate culture within the Tax Office and provide guidance and direction to Tax Office staff on what should be the Tax Office's philosophy on litigation. This statement could also act as a yardstick to measure Tax Office performance and set out clear and appropriate expectations for the community on Tax Office litigation.

4.51 The Inspector-General's view is that the Tax Office's formal public statement on litigation should affirm that the primary aim of tax litigation is to resolve a dispute in a fair, timely and cost effective manner. There should also be community consultation in the development of a published policy or guidelines on tax litigation.

4.52 In this document the Tax Office should also affirm its commitment to administer the tax laws, as enacted by Parliament and interpreted by the courts, in an impartial and transparent manner. The Tax Office should also affirm that it will follow the results of finalised court decisions in other similar cases.

4.53 There are differing views in the community on the extent to which the Tax Office should follow finalised court decisions in all situations and whether a failure to follow such decisions in all situations amounts to a breach of the principles of the rule of law.

4.54 These views range from views that a failure to follow finalised court decisions is not justified in any circumstances through to views that failing to follow finalised court decisions is permissible provided certain conditions are met.

4.55 Just prior to the finalisation of this review, when providing its response to this report, the Tax Office provided the Inspector-General with a joint opinion from the Solicitor-General and Australian Government Solicitor's Chief General Counsel on the issue of whether the Tax Office can challenge a previous finalised judicial decision and the circumstances in which it can do so. This joint opinion, together with a further opinion from the Acting Solicitor-General in relation to it, are set out in Appendix 4 of this report.

4.56 The joint Solicitor-General and Chief General Counsel's opinion is an opinion on what constitutes good administration, rather than a matter of strict law. The opinion refers to the rules of precedent40 and notes that it would usually be inappropriate and unwise for an administrative decision maker to depart from decisions of single judges or of higher courts. Subject to following the rules of precedent, the opinion appears to confirm that there is no legal impediment to the Tax Office resisting a finalised court decision in rare and exceptional circumstances. It states that, if the Tax Office considers that a finalised court decision is wrong, it may challenge that decision in a subsequent case provided certain conditions are met. These conditions are:

  • that the Tax Office has credible and robust legal advice (which will withstand public scrutiny) that the court's interpretation is wrong;
  • that the challenge is made as soon as possible;
  • that those affected by the challenge are advised of the Tax Office's proposed course of action;
  • that the Tax Office must take steps to avoid any suggestion that the challenge will unduly burden or prejudice individual taxpayers, and must therefore fund or organise suitable assistance to bring a test case on the issue; and
  • that the challenge must not be made just because, as matter of policy, the Tax Office considers that the decision in the case is wrong or undesirable.

4.57 The Inspector-General has not sought to resolve the debate on whether the Commissioner should challenge finalised court decisions and, if he does so, the circumstances in which this can be done. The Inspector-General considers that this matter is worthy of further debate including in a broader context than the tax system and this review.

4.58 However, the Inspector-General has found during this review that the Tax Office's conduct in this area has not, in relevant cases, met all the strict conditions for making such a challenge that have currently been formulated by the Solicitor-General and Chief General Counsel. Examples include the following:

  • The Commissioner has provided no evidence to this review which indicates that he sought to provide test case funding for any of the cases which were litigated subsequent to Essenbourne where he sought to re-argue his view contrary to Essenbourne.
  • The Commissioner's decision to challenge the interpretation in Essenbourne in subsequent cases was because the Tax Office believed that there was an alternative view that was more consistent with its understanding of the policy intent of the law.
  • The Commissioner did not seek or receive written legal advice as to whether the decision in Essenbourne should be challenged generally in other cases.

4.59 The Tax Office's conduct in this area has therefore amounted to poor administration and has led to legitimate negative community perceptions of its behaviour.

4.60 The above comments lead to the following key findings and recommendations:

Key finding 4.2

There is no formal, consolidated public statement by the Tax Office on its corporate philosophy towards tax litigation. In the continuing absence of such a statement, perceptions that the Tax Office's management of its litigation program is overly susceptible to influence by its compliance culture and by its view of underlying policy will continue to grow. Community perceptions have arisen that the Tax Office is using litigation to confirm its view of the law for compliance purposes rather than to clarify the law.

Key finding 4.3

The Inspector-General finds that a formal, consolidated public statement is needed to provide community confidence, and appropriate guidance and direction to Tax Office staff on the Tax Office's philosophy on litigation. This statement should state that the primary aim of litigation is to resolve a dispute in a fair, timely and cost effective manner. The statement should confirm that the Tax Office's philosophy and approach to litigation is consistent with its role in the tax system as an independent and impartial administrator and that it is committed to administering the tax system in line with the rule of law. The statement should also re-affirm the Tax Office's role in relation to and distinct from the roles of Government, Parliament and the Judiciary.

Key finding 4.4

The Tax Office has stated on a number of occasions that it is prepared to not follow decisions of the courts or tribunals in other similar cases where it believes it is obliged to take steps to protect the intention of Parliament. It has also acted on this policy in a number of cases. The Inspector-General believes that these actions and statements by the Tax Office provide a basis for the perception that the Tax Office is prepared to act, and in some cases has acted, outside the rule of law.

Key finding 4.5

There are differing views in the community on the extent to which the Tax Office should follow finalised court decisions in all situations and whether a failure to follow such decisions in all situations amounts to a breach of the principles of the rule of law.

These views range from views that a failure to follow finalised court decisions is not justified in any circumstances through to views that failing to follow finalised court decisions is permissible provided certain conditions are met.

The Inspector-General has not sought to resolve the debate on whether the Commissioner should challenge finalised court decisions and, if he does so, the circumstances in which this can be done. The Inspector-General considers that this matter is worthy of further debate including in a broader context than the tax system and this review.

Key finding 4.6

The Tax Office has received an opinion from the Solicitor-General and from the Australian Government Solicitor's Chief General Counsel which sets out that the following five conditions need to be met before the Tax Office can challenge a finalised court decision which it considers to be wrong:

  • that the Tax Office has credible and robust legal advice that the court's interpretation is wrong;
  • that the challenge is made as soon as possible;
  • that those affected by the challenge are advised of the Tax Office's proposed course of action;
  • that the Tax Office must take steps to avoid any suggestion that the challenge will unduly burden or prejudice individual taxpayers and must therefore fund or organise suitable assistance to bring a test case on the issue; and
  • that the challenge must not be made just because, as matter of policy, the Tax Office considers that the decision in the case is wrong or undesirable.

The Inspector-General has found during this review that the Tax Office's conduct in challenging finalised court decisions has not, in relevant cases, met all the above conditions.

Key recommendation 1

The Tax Office should clearly articulate its corporate philosophy and approach to litigation in a formal and consolidated published policy or guidelines on tax litigation, such as a Litigation Charter.

The Inspector-General considers that this document should state that the primary aim of litigation for the Tax Office is to resolve disputes in a fair, timely and cost effective manner, consistent with the rule of law.

There should also be community consultation in the development of a published policy or guidelines on tax litigation.

In this document the Tax Office should also affirm its commitment to administer the tax laws, as enacted by Parliament and interpreted by the courts, in an impartial and transparent manner. The Tax Office should also affirm that it will follow the results of finalised court decisions in other similar cases.

There should be wide community consultation in the development of any policy by the Tax Office on whether it should challenge finalised court decisions in certain circumstances. If the result of this process is that the Tax Office still considers that it will challenge finalised court decisions in certain circumstances then the Tax Office should clearly and fully articulate those circumstances and its associated processes in its formal published policy or guidelines on litigation.

Pending the development of any such policy regarding challenging finalised court decisions, and its publication in a formal consolidated set of guidelines on litigation, the Tax Office should publicly affirm that it will follow the results of finalised court decisions in accordance with the criteria which have been formulated by the Commonwealth Solicitor-General and Chief General Counsel.

Tax Office response

4.61 We will issue a practice statement on the Tax Office's approach to, and conduct of litigation, ensuring that it is consistent with Attorney-General directions relating to the conduct of litigation by the Commonwealth. We will consult with professional bodies in the development of the practice statement.

4.62 In relation to the question of whether the Commissioner should challenge finalised court decisions in certain circumstances, we have the benefit of the advice of the Solicitor-General and the Attorney-General's Chief General Counsel. That advice indicated that it may be appropriate in exceptional circumstances for the Tax Office to challenge an earlier decision which it considers to be wrong, where there is credible legal advice (including internal advice) to that effect. The advice also stated that the Tax Office should put those affected on notice of its view and it would normally be appropriate for the Tax Office to fund any further challenge.

4.63 The guidance provided by the advice will be set out in a proposed litigation practice statement.

Inspector-General's comments on Tax Office response

4.64 The Inspector-General considers that the Tax Office should accept and implement Key Recommendation 1 in full.

4.65 While the Tax Office's proposal to develop a practice statement on litigation is a positive step, the Inspector-General's recommendation actually refers to a document being developed which is in a form similar to the existing Taxpayers' Charter. A litigation practice statement of the kind referred to in the Tax Office's response could supplement but should not be a substitute for a Charter-like document.

4.66 The Inspector-General considers that a document of higher status than a practice statement is needed to promote community confidence in the Tax Office's philosophy on litigation. The Inspector-General also believes that this 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. Consultation processes for this document (and any accompanying practice statement) also need to embrace the views of the wider community as well as those of the professional bodies.

Tax Office's approach to and handling of litigation

4.67 The nature of the Tax Office's approach to litigation is shaped by a number of factors. These include:

  • the Tax Office's role in the tax system generally and in the tax litigation process specifically;
  • the laws which govern tax dispute and litigation processes for tax objections and appeals; and
  • the rules and guidelines which shape the Tax Office's behaviour as an Australian Government agency.

These factors have been described in preceding sections of this report.

4.68 Other factors which shape the Tax Office's approach to litigation are:

  • its overall management structure for handling tax disputes; and
  • the particular structure it has adopted for managing disputes which involve litigation.

4.69 This section firstly describes these two factors and then discusses in further detail the nature of the Tax Office's approach to litigation.

Tax Office's overall management structure for disputes with taxpayers

4.70 For the purposes of managing tax disputes with taxpayers, the Tax Office is organised into a number of separate 'business lines' and other areas which are designated as 'strategic partners' to its business lines. The business lines which are involved in tax disputes (including litigation) and their areas of responsibility are:

  • Large Business and International (LBI) which is responsible for tax issues (including disputes) which affect large corporate taxpayers or groups with a turnover of $100 million or more;
  • Small Business (SB) which is responsible for tax disputes involving small business taxpayers with a turnover of less than $100 million;
  • Personal Tax (PTax) which is responsible for tax disputes affecting individual taxpayers;
  • Goods and Services Tax (GST) which handles all disputes involving goods and services tax; and
  • Superannuation (Super) which handles tax disputes which affect superannuation funds. This area also handles disputes involving superannuation guarantee charge and superannuation surcharge issues.

4.71 The areas which are designated as 'strategic partners' which are involved in tax disputes (including litigation) are:

  • the Tax Counsel Network. Members of this network are the Tax Office's most senior technical staff. However, despite their title, they are not always legally trained nor are they always involved in tax litigation;
  • the Serious Non Compliance area, whose role is to investigate tax disputes which give rise to compliance issues which the Tax Office considers to be the most extreme or blatant;
  • the Operations area, which is responsible for the management of tax debt in dispute; and
  • the Aggressive Tax Planning area, which is responsible for most tax disputes (including litigation) which involve the application of the general anti avoidance provision of the tax laws ( Part IVA).

4.72 The Tax Office's in-house legal area, the Legal Services Branch (LSB), is currently located within the Office of the Chief Tax Counsel. The LSB area is not part of the Tax Counsel Network as the Tax Counsel Network reports to a Second Commissioner and not to the Office of the Chief Tax Counsel.

Tax Office's structures for managing litigation

Structures in place prior to 2004

4.73 Up to 1999, the Tax Office had no area within its organisation that acted as a central coordinator of all the litigation to which the Tax Office was a party. In this period, the Tax Office's business lines and/or partner areas were responsible for conducting their own litigation and they created their own separate approaches (including policies and procedures) for this purpose.

4.74 In 1999 a separate internal legal practice was established within the Tax Office, called the Legal Practice.

4.75 The role of the new Legal Practice was to work in partnership with the Tax Office's business lines and strategic partner areas. These lines and areas would retain ownership of litigated cases, responsibility for determining the Tax Office view, legal argument and the gathering of all factual and evidentiary material.

4.76 The Legal Practice was to control the quality of the Tax Office legal position. It was to provide quality feedback to the business lines and other areas on their decision-making processes and assist them in bringing about continuous improvements in their processes, thereby producing cost savings in litigation.

Changes adopted after 2004

4.77 In 2003 the Tax Office conducted an internal review of its management structure for litigation. This review (the Behm report), which is discussed in further detail in the next chapter, concluded that the Tax Office's Legal Practice had not achieved its intended purposes.

4.78 The Behm report canvassed a number of options, including the abolition of a centralised legal area within the Tax Office with all litigation (and debt recovery work) being outsourced to the Australian Government Solicitor. However, this option was considered unworkable, as there was a continuing need for the Commissioner to manage, within his own organisation, the legal risks associated with his role as a collector of revenue.

4.79 The option selected was a new organisational structure under which the Tax Office's Legal Practice would retain its administrative function in relation to litigation, but in a reshaped form.

4.80 Under this new organisational structure, which was implemented in early 2004, the Tax Office's Legal Practice was abolished, and replaced by the Legal Services Branch which is located within the Office of the Chief Tax Counsel.

Present organisational structure for litigation management

4.81 The present roles of each area of the Tax Office which is involved in litigation are now set out in PS LA 2005/22, which was released during the course of this review.

4.82 Under this practice statement, there is no one area of the Tax Office that is responsible for handling all aspects of a litigated case. The division of litigation roles within the Tax Office depends principally on whether a case involves a priority technical issue.

4.83 Priority technical issue cases are cases that involve a technical issue that has been assessed as having a certain priority status by the relevant Tax Office business line responsible for the case.

4.84 The Tax Office has indicated that the following cases will generally be priority technical issues cases:

  • proceedings involving the application of general anti avoidance provisions. This will generally include all cases involving the Aggressive Tax Planning area of the Tax Office;
  • cases where test case funding has been granted;
  • cases involving $50 million or more of revenue;
  • all appeals to the Full Federal Court and all cases that involve or are likely to involve the High Court; and
  • cases that:
    • are likely to attract media interest;
    • involve a challenge to a Tax Office view (including cases where it may be perceived that the Tax Office is arguing against its own views);
    • result in the Tax Office receiving external advice that the underlying legislation is defective; or
    • may have serious consequences for tax administration.

4.85 Under PS LA 2005/22, the roles of each of the main areas of the Tax Office which are involved in tax litigation are now as follows:

Business lines and Aggressive Tax Planning area

4.86 These areas are responsible for managing the risks associated with a case and dependent cases. Throughout the litigation process the business lines retain ownership of the case and are ultimately responsible for determining the desired outcome of the litigation. Their role involves:

  • at the outset of the litigation, the identification of whether the case involves a priority technical issue;
  • development of the Tax Office position on the issues to be litigated and the arguments to be run (both subject to relevant escalation processes within the Tax Office);
  • the gathering of evidence;
  • the management of the ongoing relationship with the opposing party; and
  • the development of a strategy to explain and manage the implications of any resulting court decisions and the associated compliance impact.
Legal Services Branch (LSB)

4.87 The LSB area is responsible for acquiring and/or providing the legal services required by the Tax Office to litigate cases. It is the conduit for the exchange of information between the Tax Office, and AGS and Counsel and also acts as a liaison point for all internal Tax Office areas that are involved in litigation.

Tax Counsel Network

4.88 Members of the Tax Counsel Network are to be involved in all priority technical issues cases. Where they are involved in any case, they are to have the final say on technical arguments run in the case. In effect, this often means that Tax Counsel will have a significant influence over which cases proceed to hearing and which cases are resolved.

Decisions to appeal

4.89 Decisions to appeal a case which is adverse to the Tax Office will be made either by a Deputy Chief Tax Counsel or by the senior executive who is in charge of the Aggressive Tax Planning area.

Stakeholder concerns on the Tax Office's overall approach to litigation

4.90 Stakeholders have raised the following concerns with the Tax Office's approach to and handling of tax litigation.

4.91 Firstly, a number of submissions noted that there was no clear public statement by the Tax Office as to its approach to litigation.

4.92 Secondly, submissions stated that the Tax Office pursues cases that it will not win. Submissions offered differing views on the extent to which this occurred.

4.93 A number of submissions noted that these types of cases occur only relatively rarely. One submission stated that a case of this nature can be appropriate where the aim of the case is to clarify the law or to establish that the law does not operate in the manner assumed by the Tax Office and that a legislative amendment is required. However, this submission noted that these types of cases appeared to be less justified in the following two types of cases:

  • where the case is pursued because either an ATO officer or business line has developed an immutable view of the law which it is unwilling to abandon despite external counsel's advice to do so; and
  • where the case is pursued because the taxpayer is regarded by the Tax Office or tax officer conducting the case as engaging in undesirable behaviour and the Tax Office considers that the pursuit of the case will impede this behaviour.

4.94 Other submissions suggested that these types of 'hopeless' cases occurred more often.

4.95 Thirdly, a number of submissions, particularly from Bar Associations with members who have acted for the Tax Office, asserted that many disputes are reaching the litigation stage without a proper identification of facts, evidence, issues and application of the law being made earlier in the dispute process. This was a major theme in these submissions.

4.96 Fourthly, submissions have stated that the Tax Office has a fragmented and ad hoc approach to the handling of litigation with no one area responsible for all aspects of objectively resolving the dispute once it proceeds to litigation. Several submissions have raised concerns that the current fragmented approach to litigation means that:

  • there is often no one Tax Office person whom the taxpayer or their legal representatives can interface with who is able to make timely and final decisions which may resolve a case; and
  • if there is a key Tax Office decision maker on a case, that decision maker is unable to make an independent, objective decision on the case, because of their prior involvement.

4.97 Fifthly, submissions have stated that the Tax Office's litigation approach is compliance driven, that compliance views can dominate litigation decisions and strategy and that there is no independent and objective review of a dispute once a case proceeds to litigation. These submissions state that these features of the Tax Office's approach are leading to unnecessary litigation.

4.98 For example, one submission referred to a protracted court case involving a sales tax matter that was ultimately won by the taxpayer. The submission asserted that this litigation could have been prevented if the factual evidence gathered by the Tax Office for the case and underlying technical arguments had been subject to an 'independent' review prior to the case proceeding.

4.99 Sixth, submissions have raised concerns that the Tax Office's conduct in litigated cases was sometimes (or many times) in breach of the Attorney-General's model litigant guidelines. Submissions noted that there were also no penalties for breaching these guidelines.

4.100 Pursuing a case that cannot be won is an example of conduct that is prohibited by these guidelines. Submissions raised the following other examples of cases where the Tax Office had engaged in this type of prohibited conduct:

  • cases involving long delays;
  • cases where the Tax Office had not acted consistently;
  • cases where the Tax Office had not made any effort to resolve the dispute outside the litigation process, for example through mediation or other alternative dispute resolution mechanisms;
  • cases where the Tax Office had mishandled cases leading to unnecessary additional litigation costs for both parties to the litigation;
  • cases where the Tax Office had taken advantage of taxpayers who did not have the same resources to pursue litigation;
  • cases where the Tax Office had relied on technical defences; and
  • cases where the Tax Office had refused to apologise for wrongdoing.

4.101 Appendix 7 provides further details of cases involving possible breaches of the model litigant guidelines that were provided in submissions.

4.102 Several submissions suggested that one reason that the above types of cases have arisen is because Tax Office staff are not trained in the model litigant principles.

4.103 A number of other submissions questioned the existence and/or severity of the alleged breaches of the model litigant guidelines outlined in the preceding paragraphs. One representative body submission noted that, in tax litigation, taxpayers and their representatives are not themselves bound by any model litigant guidelines and that taxpayers who engage in non-model litigant behaviour can be the most vocal complainants about similar Tax Office behaviour.

4.104 The Commonwealth Ombudsman in his submission for this review noted that he had received only a very small number of complaints on the Tax Office's conduct in litigation. However, the Ombudsman also noted that this could be because he is reluctant, because of the statutory provisions that govern his powers, and for public policy considerations, to investigate a complaint concerning Tax Office conduct in litigation if the matter is properly one that should be left to a court or tribunal to determine.

4.105 The seventh broad area of concern raised in submissions was that the Tax Office withholds information from taxpayers involved in a litigated dispute.

4.106 The eighth broad area of concern was on the subject of rulings and other written statements of Tax Office policy. A number of submissions stated that the Tax Office had a tendency to adhere to rulings and practice statements during litigation even where the advice of its external counsel was that those rulings and statements were not correct. Other submissions stated that, at times, the Tax Office departs from its previous rulings and practice statements during litigation.

4.107 The ninth concern was that the Tax Office could conduct 'smear' campaigns against its opponents in litigation. One example provided under this heading is the Tax Office's behaviour with respect to taxpayers involved in certain mass marketed tax effective schemes.

4.108 The topic of smear campaigns being conducted by government bodies against opposing litigants was being investigated during the course of this review by the Attorney-General's Department as part of its review of the Legal Services Directions. This matter has therefore not been examined during the course of this review.

4.109 A number of submissions also raised serious concerns in relation to the Tax Office's practices for the recovery of tax that is the subject of a litigated dispute, including its practices in debt recovery litigation. Submissions asserted that these practices are wasteful and oppressive. They asserted that there was a laxity in the administration of tax collection, inflexibility in dealing with the individual circumstances of different taxpayers, a failure by the Tax Office to appreciate the commercial consequences of its actions and oppressive reliance on certain conclusive proof provisions.

4.110 The Tax Office's approaches in this area are set out in the ATO Receivables Policy.

4.111 This review has not examined these last concerns relating to the recovery of tax, except to the extent that they relate to the Tax Office's adherence to the model litigant rules. However, these concerns may be the subject of a future review by the Inspector-General.

4.112 A number of submissions also raised concerns about the Tax Office's practices that relate to the prosecution of taxpayers for matters that are also the subject of Part IVC litigation. These practices are outside the terms of reference of this review, but may be examined by the Inspector-General at a later date.

4.113 The Inspector-General's findings in relation to the eight stakeholder concerns examined for the purposes of this review, and in relation to other concerns about the Tax Office's approach to litigation that have arisen as a result of this review, are set out below.

Absence of comprehensive Tax Office statement on its litigation approach

4.114 The Tax Office's approach to litigation, and the documentation surrounding its approach, are dependent upon whether the litigation involves a priority technical issue (PTI). Although the Tax Office has release a specific practice statement outlining its approach to PTI litigation, this review has confirmed that there is no formal, complete and consolidated statement on the Tax Office's approach to tax litigation.

4.115 Broadly, the Tax Office's approach to litigation is partly contained in the same set of documents listed earlier in this chapter, which set out certain elements of its philosophy on litigation. However, in addition to the documents listed earlier in this chapter, the following documents are relevant for determining the Tax Office's approach to litigation:

  • the Tax Office's Access Guidelines;
  • a number of specific practice statements (including PS LA 2005/22);
  • a draft practice statement on the Tax Office's approach to adverse court and tribunal decisions; and
  • service agreements between LSB and the business lines.

4.116 Appendix 8 contains a list of the publicly available practice statements that are relevant to the Tax Office's approach to litigation.

Tax Office approach to priority technical issue cases

4.117 The Tax Office has developed processes and procedures to identify and handle litigation involving priority technical issues, referred to by the Tax Office as PTI litigation. These processes are now embodied in PS LA 2005/22 that was released during the course of this review.

4.118 All PTI litigation cases are subject to the following processes within the Tax Office:

  • At the commencement of the litigation process, each business line must assess whether a case gives rise to a priority technical issue and must follow internal Tax Office processes, which are set out in PS LA 2003/10, to have that case classified as a priority technical issue case.
  • All PTI litigation cases are subject to internal review in the form of Strategic Litigation Callovers, which are held every six months. All officers involved in the case, including the LSB case officer, Tax Counsel and the business line representative, attend these callovers. The callover panel includes the Senior Tax Counsel (Strategic Litigation) and the Part IVC Litigation Stream Leader.
  • The litigation is tracked against the recorded technical issue on an internal PTI register, as the litigation is expected to clarify the law in relation to the issue. This register is reviewed by a Priority Technical Issue Committee, which is chaired by a Second Commissioner.

4.119 In addition, the most strategically important of priority technical issue cases are separately identified and are managed by a strategic litigation team within the Tax Office's Legal Services Branch (LSB). All other priority technical litigation and strategic cases are managed elsewhere in the LSB, but are monitored by the strategic litigation team.

Tax Office approach to cases which do not involve PTI issues

4.120 There is no formal and consolidated Tax Office statement that outlines the processes and procedures that Tax Office staff are to apply to handle litigated cases that do not involve priority technical issues.

4.121 Currently, the Tax Office only has processes and procedures to deal with specific aspects of such cases, such as the handling of finalised decisions.

4.122 Each of the Tax Office's business lines has also adopted a different approach for handling this type of litigation. These approaches are discussed in detail in the next chapter. They vary markedly, particularly in the degree to which they involve a review within each business line by an officer who has not been previously involved in the case.

4.123 The Inspector-General is of the view that there would be benefit to both staff and the community if the Tax Office's approach to cases that do not involve PTI issues were also consolidated in a formal document such as a practice statement.

Improving Tax Office internal processes to ensure cases are resolved prior to litigation

4.124 Submissions from legal practitioners have raised concerns with the Tax Office's conduct of litigation, in particular about how the Tax Office identifies technical issues and how it identifies and collects the relevant facts and evidence. Submissions noted that these processes must begin at the very earliest stage that the Tax Office deals with a taxpayer in relation to the application of the relevant taxation laws.

4.125 The Legal Services Directions impose an obligation on the Commonwealth and its agencies to act honestly and fairly in handling claims and litigation brought by or against the Commonwealth or an agency by endeavouring to avoid litigation, wherever possible. In the Inspector-General's view this obligation, for the purposes of good taxation administration, should be interpreted to broadly apply to the litigation process as well as the internal dispute processes within the Tax Office (the upstream processes) that lead to litigation. The Tax Office, through these upstream processes, should ensure the precise identification of the relevant facts and the legal principles involved and in dispute between the parties at the earliest possible stage.

4.126 As a result of evidence gathered during the course of this review, the Inspector-General considers that the majority of disputes leading to Part IVC litigation are appropriately concluded by the Tax Office. However, the Inspector-General shares the concerns expressed in submissions regarding the timeliness in identifying the technical issues and identifying and collecting the facts and evidence required to resolve the dispute. The nature of this evidence is set out below.

4.127 Information from the AAT indicates that a large proportion of the applications for review of tax decisions in the Tribunal, approximately 88 per cent, are finalised without a hearing. The Inspector-General considers that it is appropriate for the Tax Office to settle litigated disputes in suitable cases, and that the high percentage of settled cases suggests that the majority of Part IVC appeal cases are appropriately concluded by the Tax Office.

4.128 However, of those applications that are finalised without a hearing approximately 70 per cent result in the decision being set aside or varied, with the majority of the remaining applications either being dismissed or withdrawn.41

4.129 An examination by staff of the Inspector-General of a small sample of cases that were resolved by way of a settlement between the parties indicated that a significant proportion of these cases were settled wholly in favour of taxpayers by the objection being allowed in full.42 This suggests that a significant percentage of the tax cases which reach the litigation stage could have been resolved at an earlier stage. In the Inspector-General's view this could be due to a number of reasons. It could be due to information relevant to the dispute not being sought by the Tax Office earlier in the dispute resolution process or a taxpayer not providing the Tax Office with requested information until the dispute proceeds to litigation. It could also be due to the wrong technical issues being raised by taxpayers' advisers or the Tax Office. The Inspector-General has not sought to examine in greater detail these observations. However they suggest that the earlier stages of the tax dispute process may not be wholly effective in the timely resolution of disputes and may warrant further review.

4.130 During this review, the Inspector-General was also provided with a copy of internal feedback made by LSB staff to the Tax Office's business lines. This feedback highlighted problems with the upstream processes. This feedback raised concerns about the business lines not identifying the relevant facts, not referencing identified facts to the evidence, not gathering the appropriate evidence, making inappropriate assumptions and assertions in audit and objection decisions and not gathering all the relevant facts and information.

4.131 An examination of sampled case files by staff of the Inspector-General also revealed that, in a significant number of cases, LSB officers were often required to seek additional information from taxpayers or their advisers at the litigation stage. This was required to allow the business line officers and Tax Counsel, where necessary, to make an informed decision on how to proceed with the dispute. In the Inspector-General's view this could indicate:

  • 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. This could be due to auditors/review officers not asking relevant questions, not using their information-gathering powers or over-reliance on the burden of proof provisions;
  • that taxpayers are not providing the Tax Office with relevant information until the dispute proceeds to litigation; or
  • that wrong technical issues have been raised by taxpayers' advisers or by the Tax Office.

4.132 The examination of sampled case files also indicated that, where the dispute was settled or conceded by the Tax Office after the commencement of litigation, a significant proportion involved escalation of the technical view or a reconsideration of the application of the law to the facts. This could be due to a number of factors, including those listed above.

4.133 The Tax Office has quality control procedures for objection decisions (called the Technical Quality Review) but these do not adequately test the correctness of the facts relied on for the decision or whether the facts are supported by evidence. The Compliance TQR tests whether the decisions on technical issues were convincing and supported by the facts. The Dispute TQR tests whether the relevant facts were gathered. An examination of sampled case files indicated that for disputes settled at litigation either the facts were not correct or there was inadequate evidence to support the facts as set out in the objection decision.

4.134 The Inspector-General believes that the concerns expressed by submissions and the validation of the concerns through an analysis of information from the AAT and the Inspector-General's own fieldwork suggest that the objection/dispute resolution processes framework and the Tax Office's approach and conduct in relation to objections are areas warranting further review.

Absence of a single Tax Office area with overall responsibility for reviewing and/or resolving a dispute

4.135 As stated elsewhere in this report, submissions have asserted that Tax Office litigation is compliance driven and that compliance views can dominate litigation decisions and strategy. Submissions have also asserted that there is no independent internal review of a dispute once a case proceeds to litigation.

4.136 These perceptions are supported by evidence that has been gathered during the course of this review, including the Tax Office's detailed internal management policies and procedures for litigation that are discussed in detail in the next chapter.

4.137 Key decisions on whether to engage in litigation or on the need for external counsel rest with the Tax Office's business lines, and are open to strong influence by their strong compliance culture. There is also evidence of tension between compliance views and TCN escalating to the point where competing external legal opinions may be sought.

4.138 As previously discussed, the Tax Office's structure for managing litigation involves people from three different areas within the Tax Office, all of whom have varying degrees of involvement in the case. In addition to these three areas, the Operations area of the Tax Office also has a separate responsibility for the management of the tax debt that is subject to litigation. The Tax Office considers that the involvement of TCN, LSB and the business lines ensures that the case is reviewed thoroughly with the appropriate level of technical and litigation expertise.

4.139 However, the division of management responsibilities for litigated disputes between at least three different areas of the Tax Office means that there is no one person or area which has overall responsibility for managing all issues (that is, both technical and procedural) for any one case and no one person on a case team who exercises an independent oversight role.

4.140 The LSB area does not perform either of these roles, even for priority technical issues cases, as confirmed in PS LA 2005/22. The role of LSB is discussed further in the next chapter, but for practical purposes appears largely to be reduced to procedural aspects of the litigation including compiling correct documentation, preparing draft documents for sign-off from business line officers and Tax Counsel, scheduling arrangements and giving effect to business line decisions on, for example, the need for external counsel or to gather additional information or evidence. In addition, where there is a disagreement between the LSB officer, the business line officer and, where relevant, Tax Counsel regarding technical or procedural issues related to the litigation then these must be escalated to the respective managers and stream leaders.

4.141 The Inspector-General believes that the ability for an LSB officer to escalate a concern with the progress of a case or the approach being adopted in litigation does not amount to an internal review function.

4.142 Where a case involves a priority technical issue, then TCN is responsible for the conduct of the litigation including forming the Tax Office view and settling court and tribunal documents including statements of facts, issues and contentions and submissions to be made during the hearing.

4.143 Where the case does not involve a priority technical issue then the business line determines the desired outcome of litigation.

4.144 Consistent with a litigation philosophy of objectively resolving disputes, when cases move into a litigation phase, judgments and decisions need to be made by people who have not previously been deeply involved in the matter. Current Tax Office arrangements for managing litigation do not adequately provide this objectivity.

4.145 The Inspector-General found that Tax Office arrangements do not provide an appropriate internal review mechanism once a case proceeds to litigation. These arrangements do not promote the LSB area having the function of providing an 'independent' review of the dispute once it proceeds to litigation. Nor do these arrangements promote a distinct culture, corporate goal and set of values, separate from those of the compliance areas. This has meant that the approach to litigation has been driven by the compliance area (that is, the business line) where the case originated, rather than by an approach which ensures that in all cases there is a fair, timely and cost effective resolution of the dispute.

4.146 Also, the absence of an internal review mechanism at the litigation stage, and a clear separation between the business lines and the Legal Services Branch, have reinforced the perceptions that Tax Office litigation is compliance driven and that compliance views can dominate litigation decisions and strategy.

4.147 Examination by staff of the Inspector-General of sampled case files also revealed little, if any, evidence on why a case was being litigated, even for some priority technical issues cases. This suggests uncertainty as to why litigation is being continued and uncertainty as to the role and functions of all areas of the Tax Office that are involved in litigation.

4.148 Fieldwork conducted by staff of the Inspector-General for the purposes of this review also indicates that there is little use by the Tax Office of mediation or other alternative dispute resolution processes. Revised model litigant guidelines which operate from 1 March 2006 and which are discussed in the next section of this chapter now specifically require government agencies to consider alternative dispute resolution before initiating legal proceedings and to participate in alternative dispute resolution processes where appropriate. These new guidelines should affect future Tax Office use of these processes.

4.149 The Inspector-General believes that there is a need for a single area within the Tax Office that is able to undertake an internal review of a business line's decision that has led to litigation. The Inspector-General is of the view that such an area is important in promoting community confidence in the appeals and review procedures and, more importantly, in providing an appropriate check on the conduct and approach of the compliance areas and business lines during audit and objection.

4.150 The above comments lead to the following key findings and recommendations:

Key finding 4.7

The Tax Office has developed processes and procedures to identify and handle litigation involving priority technical issues. There is no formal and consolidated Tax Office statement that outlines the processes and procedures that Tax Office staff are to apply to handle litigated cases that do not involve priority technical issues.

Key finding 4.8

The high percentage of settled Part IVC appeal cases suggest that the majority of these cases are appropriately concluded by the Tax Office.

Key finding 4.9

A significant proportion of disputes are proceeding to the litigation stage without the proper identification of the technical issues, facts and evidence, only to be settled once the LSB officer, business line officer and, where necessary, Tax Counsel become involved.

Key finding 4.10

Key decisions on whether to engage in litigation or on the need for external counsel rest with the Tax Office's business lines, and are open to strong influence by their strong compliance culture.

Key finding 4.11

The Tax Office's structure for managing litigation involves people from at least three different areas within the Tax Office, all of whom have varying degrees of involvement in the case. There is no one person or area within the Tax Office which has overall responsibility for managing all issues (that is, both technical and procedural) for any one litigated case and no one person on a case team who exercises an independent oversight role.

Key finding 4.12

The Tax Office has no area that is separate from its business lines that will review a dispute and whether litigation should be continued.

There is a need for an internal review procedure at the litigation stage, with one area responsible for all aspects of resolving a dispute, including technical and procedural issues, once it proceeds to litigation. Such an area should also promote and encourage a distinct culture, corporate goal and set of values, separate from those of the compliance areas.

Key recommendation 2

The Tax Office should establish management arrangements which give a single area of the Tax Office overall responsibility and authority for the management of all aspects of litigated cases.

Tax Office response

4.151 Agreed

4.152 We are reviewing our end-to-end processes for litigation to find efficiency and quality improvements. We will establish arrangements so that all decisions regarding litigated cases will be managed by the Office of the Chief Tax Counsel (OCTC) or the Tax Counsel Network.

4.153 In cases involving a Priority Technical Issue (PTI), the Tax Counsel Network will continue to decide the Tax Office's position.

4.154 In other cases, the Legal Services Branch (LSB) will be responsible for deciding the Tax Office's position. However, we will retain the existing processes through the Law Sub-plan whereby any differences of views on such matters can be quickly resolved through escalation.

4.155 In all cases, the Tax Office business lines will continue to be responsible for the risk ownership and mitigation strategies.

Tax Office adherence to model litigant guidelines

4.156 The Office of Legal Services Coordination (OLSC) has reported to the Inspector-General that the Tax Office is one of the better Australian Government agencies in terms of compliance with the rules and self-reporting any potential breaches.43

4.157 Members of the AAT and Federal Court that were interviewed for the purposes of this review also indicated that, from their perspective, the Tax Office generally acts as a model litigant, although there were some exceptions. However, as indicated earlier in this report, cases that are actually heard by the AAT or Federal Court represent only a small minority of all litigated cases.

4.158 The Tax Office has reported that from January 2005 to May 2005 only 24 cases involving litigation were referred to its internal complaints area. All of these complaints related to litigation concerning the Aggressive Tax Planning area. Of these cases 18 involved settlements and 6 involved ongoing disputes. The Ombudsman was involved in 8 of the 18 settlements and 2 of the 6 disputes. Of the 6 cases involving disputes, 4 had been finalised with one case recording a breach of the Taxpayers' Charter. Of the 18 settlements, 7 had been finalised, with one case showing a breach of the Taxpayers' Charter.

4.159 Nevertheless, there are strong community perceptions that the Tax Office's approach and conduct is not consistent with the model litigant rules.

4.160 The Inspector-General believes that the existence of these perceptions is of concern and that there are grounds for these perceptions at least in some cases.

4.161 Firstly, there are significant shortcomings in the present system for identifying possible breaches of the model litigant rules by the Tax Office. As a result, it is not possible to make an assessment of the extent to which the Tax Office is complying with these rules.

4.162 Secondly, this review and other inquiries have identified cases of possible breaches of the rules which have not previously been detected.

The present system for identifying breaches of the model litigant rules

4.163 The present system for identifying breaches of the model litigant rules may not identify all potential and actual breaches, for a number of reasons.

4.164 Firstly, the OLSC is not actively reviewing compliance with the model litigant guidelines. This has been confirmed in a recent ANAO report which noted that the OLSC's approach to monitoring the Legal Services Directions (including the model litigant rules) relies heavily on alleged breaches being reported by the relevant Australian Government agency and that the OLSC does not proactively monitor agencies' compliance with the Directions.44

4.165 The nature of the OLSC's role in reviewing breaches of the model litigant guidelines reflects Government policy that the chief executive of each Government agency has the principal responsibility for ensuring compliance with the Legal Services Directions and accompanying model litigant guidelines.

4.166 During the course of this review, the Attorney-General has issued revised Legal Services Directions which operate from 1 March 2006. These revised Directions contain a new requirement which is designed to overcome the ANAO's concerns about ensuring that possible breaches of the Legal Service Directions are identified. This new requirement stipulates that each agency chief executive is responsible for giving to the OLSC an annual certification concerning breaches of the Directions.45

4.167 Second, there is evidence that taxpayers, their representatives and Tax Office staff are unaware of:

  • the role of the OLSC as a independent reviewer of breaches of the model litigant rules;
  • the public complaints mechanism which the OLSC has established which permits members of the public to lodge complaints about breaches of these rules;
  • the nature of matters that can be the subject of a public complaint to the OLSC; and
  • the types of behaviour which may constitute a breach of the rules.

4.168 The OSLC considers that, in accordance with the manner in which the OSLC is intended to discharge its role under the Legal Service Directions, measures to address this lack of awareness should be tackled by the Tax Office taking the lead, in consultation with the OLSC.

4.169 The lack of awareness of these matters is evidenced in a number of ways.

Awareness of review role of OLSC

4.170 As late as December 2001, tax professional bodies who are members of the National Tax Liaison group were apparently unaware of the OLSC's role as an independent review mechanism for the model litigant rules. In that month, these bodies raised an agenda item with the National Tax Liaison group calling for such an independent review mechanism to be established. The Tax Office responded to this item by stating that such a mechanism already existed.

Awareness of public complaint mechanism

4.171 During the last two years, the OLSC has investigated only one alleged breach of the model litigant rules in respect of Part IVC litigation in response to a public complaint. However, many more examples of alleged breaches of the model litigant rules have been provided by taxpayers and their representatives to the Inspector-General during the course of this review. While taxpayers may have chosen not to report these breaches, it is also likely, given that there has been only one complaint, that in a number of these cases taxpayers were unaware of the existence of the OLSC's public review mechanism.

Awareness of matters which the OLSC can review

4.172 As noted above, there has been only one public complaint made to the OLSC concerning the Tax Office during the last two years. While the party making this complaint was aware of the OLSC's review role, its submission to the OLSC raised several matters which the OLSC determined it could not review. The OLSC considered that it could not review these matters because they related to the administration of legislation by the Tax Office, for which there were alternative review mechanisms, rather than the Tax Office's conduct of litigation and directly related matters.

4.173 There is no information which expands upon the model litigant guidelines to guide members of the public on what matters are model litigant issues which are reviewable by the OLSC. If such information had been available, the party making the above submission may not have raised with the OLSC matters which it could not review.

Awareness of the rules and their content

4.174 The Australian Law Reform Commission in its 2000 Managing Justice report noted that even several judges and barristers had professed not to have heard of the term 'model litigant' or seen the text of the rules. It recommended that the OLSC should facilitate proper education and training programs to promote awareness of the content and importance of the rules.46 The ALRC also suggested that the rules should contain more commentary and examples, particularly with respect to behaviour which involved 'unnecessary delay', 'technical defences' and 'taking advantage of a claimant who lacks resources'.47

Tax Office staff's awareness of the rules

4.175 The Behm review, which is discussed further in the next chapter, found that there was a lack of awareness in the Tax Office's in-house legal area of the Legal Services Directions, which include the model litigant rules.48

4.176 The Inspector-General's review found that no internal practical guidance has been issued to Tax Office staff on the application of the model litigant rules.

Extent to which breaches of the rules may be occurring

4.177 During its review, the ANAO identified a number of possible breaches by Government agencies of the Legal Services Directions that the OLSC was yet to identify and which had not been self-reported by the agencies concerned.49 The ANAO did not identify whether the Tax Office was involved in these breaches.

4.178 The Behm review found that the ATO's overall compliance with these Directions was uneven.

4.179 The Inspector-General in this review has identified a number of instances of potential breaches of the Legal Services Directions by the Tax Office, in particular of the model litigant rules.

4.180 Examples of potential breaches that were identified included:

  • A case where the Tax Office briefed counsel in a Small Taxation Claim Tribunal matter involving the interpretation of the new commercial loss provisions where the taxpayer was unrepresented. No offer of test case funding was made despite the reason for briefing counsel being that the matter involved the interpretation of a new area of the law.
  • Cases, which are discussed further in a subsequent chapter, where the Tax Office has refused to follow aspects of a finalised decision in similar fact situations and has continued with litigation.
  • Cases such as those referred to earlier in this chapter which suggest that unnecessary litigation (which is causing unnecessary costs to taxpayers) may be being generated by poor upstream processes within the Tax Office.

4.181 The above comments lead to the following key findings and recommendations:

Key finding 4.13

There are strong community perceptions that the Tax Office's approach and conduct is not consistent with the model litigant rules. The Inspector-General believes that there are strong grounds for these perceptions.

Subsidiary recommendation 4.1

The Tax Office should develop practical guidelines for staff on the application of the model litigant guidelines.

Tax Office response

4.182 Agreed

4.183 A proposed practice statement on the conduct of litigation will further guide staff on the Model Litigant Guidelines, in accordance with the Attorney-General's broader policy for Commonwealth departments.

4.184 Since 1999, the Legal Services/ Legal Practice internal website has contained a Legal Practice Note advising staff about the Model Litigant Guidelines.

4.185 All briefs to counsel from the Commissioner in tax litigation contain copies of the guidelines.

Subsidiary recommendation 4.2

The Tax Office, as part of its public statement on its philosophy and approach to tax litigation, should make taxpayers aware of the model litigant guidelines and that the Office of Legal Services Coordination is responsible for administering the model guidelines, including considering any alleged breaches of the model litigant guidelines. This should also include making taxpayers aware of the model litigant guidelines at the outset of litigation.

Tax Office response

4.186 Agreed

Subsidiary recommendation 4.3

The Tax Office should introduce an escalation process whereby senior tax officers or independent counsel, at the request of taxpayers or their representatives, may administratively review alleged breaches of the model litigant guidelines and departures from the Tax Office's stated philosophy and approach to litigation.

Tax Office response

4.187 The Tax Office has a well-established and effective escalation process. Alleged breaches of the Model Litigant Guidelines will continue to be referred to the Office of Legal Services Coordination (OLSC) by the Tax Office General Counsel, who is responsible for the relationship with OLSC.

4.188 Other complaints concerning the conduct of litigation will continue to be reviewed by an independent senior officer.

Inspector-General's comments on Tax Office response

4.189 The Tax Office has not responded to the terms of this recommendation. It confirms that an escalation process for potential breaches of the model litigant rules exists but has not agreed to make this process accessible to taxpayers or their representatives or to extend it to issues concerning the Tax Office's overall conduct in litigation. The Inspector-General believes that the Tax Office should implement this recommendation in full.

Provision of information or documents to opposing litigants

Provision of information and documents by the Tax Office to taxpayers

4.190 A number of submissions asserted that the Tax Office either fails to provide information (including relevant documents) to opposing litigants during litigation or fails to provide information that is adequate. Submissions also asserted that the Tax Office will, at least in certain cases, only provide this information when compelled to do so under various statutory provisions.

4.191 The kinds of information that were referred to in these submissions included the Tax Office's findings on relevant facts, the evidence on which those findings are based, the reasons for the relevant decision and copies of relevant documents held by the Tax Office.

4.192 The Tax Office is only under a duty to provide statements of facts, evidence and reasons to taxpayers once certain statutory conditions have been met. One set of conditions that will activate this requirement is that a dispute has been referred to either the AAT or the Federal Court.

4.193 Any Tax Office failure to meet these obligations, or to meet them adequately, is a matter which can be policed by the relevant tribunal or court. The AAT has advised the Inspector-General that the Tax Office does not fail to provide the statements required for AAT matters, but can sometimes be late in filing these documents. The AAT has advised that the Tax Office has agreed to address this problem. Members of the Federal Court that were interviewed by the Inspector-General for the purposes of this review did not express any concerns over the nature of equivalent statements filed in that jurisdiction.

4.194 The Tax Office asserts that its policy is to provide taxpayers with the statement of facts, evidence and reasons that is required once a matter has been referred to the Federal Court or AAT earlier in the dispute process, that is, at the time when it issues to the taxpayer its notice of decision on the taxpayer's objection.

4.195 However, the Law Council of Australia noted in its submission that:

There have been many experiences with notices (and reasons for decisions) which … do not contain full reasons, set out the material facts relied upon or address each of the taxpayer's substantive grounds of objection.

4.196 As the terms of reference for this review relate to Tax Office administrative practices that are generally applied once a matter has been referred to the AAT or Federal Court, this review has not examined the Tax Office's practices with respect to providing adequate statements of facts, evidence and reasons at the stage when the Tax Office has issued a notice of decision on an objection. However, this matter may be the subject of a future review by the Inspector-General.

4.197 The Tax Office has a general obligation to provide copies of documents to taxpayers in accordance with the provisions of the Freedom of Information Act 1982. The handling of Freedom of Information (FOI) requests has been the subject of a report by the Commonwealth Ombudsman which was released during the final stages of this review.50 The Ombudsman's investigation found that there was an uneven culture of support for FOI among Australian Government agencies, with some agencies displaying a clear commitment to FOI while others do not as firmly demonstrate such a commitment. The report contains no specific comments on the approach of particular agencies, such as the Tax Office, to FOI.

4.198 When a matter has been referred to the AAT, there is also an obligation for copies of relevant documents to be provided to the opposing litigant at the same time as the statement of facts, evidence and reasons. For cases involving the Federal Court, the obligation to provide copies of documents arises if the Court orders discovery of those documents. Any Tax Office failure to provide documents in accordance with these statutory obligations is a matter which can be the subject of review by either the relevant tribunal or the Federal Court.

4.199 The Tax Office's overall administrative practices in providing copies of documents to taxpayers apply to a wider category of matters than those which involve Part IVC litigation. For this reason, these practices have not been examined during the course of this review. However, they too may be the subject of a future review by the Inspector-General.

Provision of documents by taxpayers to the Tax Office

4.200 A number of submissions were also made to this review, particularly by barristers acting for the Tax Office, that the Tax Office fails to exercise its powers to obtain information from taxpayers effectively. These submissions are supported by the fieldwork for this review which indicated that a significant proportion of disputes are reaching the litigation stage without relevant information and documents having been obtained earlier in the dispute process.

4.201 This review has not conducted a detailed examination of the Tax Office's processes for gathering information at either the audit or objection review stages of a dispute. Nor has this review sought to examine the possible reasons for relevant information not being considered or made available until a dispute proceeds to litigation. These matters may be the subject of a later review or reviews. However, the findings of this review raise strong concerns about the possible need for further training and quality control processes to be introduced into these areas of the Tax Office's activities.

Perceived Tax Office failure to adhere to public rulings during litigation

4.202 Submissions stated that, at times, the Tax Office departs from its previous rulings and practice statements during litigation. The Inspector-General found that the Tax Office has a policy of not departing from its rulings and practice statements, although the Tax Office has admitted that this policy was not followed in the recent case of Queensland Rail.51 The Tax Office considers that this departure is a minor transgression from its stated policy.

Key finding 4.14

The Tax Office has a policy of not departing from its published position (as set out in rulings, determinations and similar documents) in the conduct of litigation. It has however not followed this policy in one recent case.

4.203 However, apart from a Second Commissioner's speech52, there is no public statement from the Commissioner affirming the Tax Office's approach to following rulings, determinations and other interpretative decisions in the course of litigation.

4.204 The Inspector-General considers that the Tax Office should include in any formal, consolidated statement on litigation an affirmation that it will follow rulings, determinations and interpretive decisions in the conduct of litigation.

Tax Office adherence to public rulings during litigation

4.205 A number of stakeholders raised concerns that the Tax Office is reluctant to depart from a view expressed in a ruling during the litigation process.

4.206 This concern is discussed in more detail in the last chapter of this review. This final chapter examines a number of case studies which, in the Inspector-General's view, confirm that Tax Office staff regard the Tax Office as bound by the language of the rulings.

4.207 Submissions to this review also strongly urged that there should be a process inside the Tax Office which would allow the terms of a ruling to be urgently reviewed either internally within the Tax Office or by outside parties while litigation which relies on the ruling is under way. This review process would be triggered where doubts arise (for example, from barristers who are briefed to act for the Tax Office) on the correctness of the ruling.

4.208 The Inspector-General considers that the conduct of such reviews should be one of the key responsibilities carried out by the proposed new area that is responsible for the management of all aspects of a litigated dispute.

4.209 The above comments lead to the following key finding and recommendation:

Key finding 4.15

There should be a process inside the Tax Office which would allow the terms of a ruling to be urgently reviewed where litigation which relies on the ruling is under way and doubts arise on the correctness of the ruling.

Subsidiary recommendation 4.4

The new area of the Tax Office responsible for the management of all aspects of litigation should establish a formal process under which the terms of existing Tax Office rulings are urgently reviewed either internally by the Tax Office or by outside parties where, during the litigation process, doubts arise as to the correctness of the rulings.

Tax Office response

4.210 Where doubts arise during the litigation process about the correctness of a Tax Office ruling, the issue will continue to be escalated to the Tax Counsel Network for urgent attention.

Inspector-General's comments on Tax Office response

4.211 The Inspector-General believes that the Tax Office should implement this recommendation in full. An escalation of the matter to the Tax Counsel Network will not achieve an urgent review of a ruling that is the subject of pending litigation if any change to the ruling can only be achieved by the Tax Counsel Network using current lengthy rulings program processes.


33 Michael D'Ascenzo and Steve Martin, A unique taxation partnership for the benefit of the Australian community, ATO/AGS/Counsel Workshop, 3 April 2004.

34 Michael D'Ascenzo and Steve Martin, A unique taxation partnership for the benefit of the Australian community, ATO/AGS/Counsel Workshop, 3 April 2004.

35 Essenbourne Pty Limited v Commissioner of Taxation (2002) FCA 1577 (17 December 2002).

36 Marana Holdings Pty Ltd v Commissioner of Taxation (2004) FCAFC 307 (25 November 2004); Marana Holdings Pty Ltd v Commissioner of Taxation (2004) FCA 233 (15 March 2004)

37 Commissioner of Taxation v Metal Manufactures Ltd (2001) FCA 365 (3 April 2001); Metal Manufactures Ltd v Commissioner of Taxation (1999) FCA 1712 (8 December 1999) and Eastern Nitrogen Ltd v Commissioner of Taxation (2001) FCA 366 (3 April 2001); Eastern Nitrogen Ltd v Commissioner of Taxation (1999) FCA 1536 (5 November 1999). A more detailed discussion of the Tax Office's approach in these cases may be found at Chapter 7 of this report.

38 FCT v Hart (2004) 55 ATR 712

39 Gleeson, M, Courts and the Rule of Law, Melbourne University, 7 November, 2001. Available at http://www.hcourt.gov.au.

40 As a matter of precedent:

(a) single judges must follow the principles established by decisions of Full Courts (that is, of courts superior to them in the appellate hierarchy);
(b) single judges should as a matter of comity follow the decisions of other single judges if they are in point, unless they are clearly persuaded that the other decision is wrong (whether the other decision is distinguishable is another matter);
(c) full Federal courts must follow decisions of a full bench of the High Court if in point;
(d) full Federal courts should follow previous full court decisions unless clearly satisfied the earlier decision is plainly wrong; and
(e) the High Court can depart from its own decisions in limited circumstances.

41 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.

42 The Inspector-General examined a total of 37 cases that were resolved by agreement between the parties in the AAT. Of those 37, the objection was allowed in full in 20 cases with 16 cases where the objection was allowed in part and 1 case where the taxpayer withdrew the application for review.

43 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.

44 Auditor-General, Legal Services Arrangements in the Australian Public Service, Audit Report No 52, 20 June 2005, p 35 at paragraphs 5.12-5.13.

45 Attorney- General , Legal Services Directions 2005, issued under section 55ZF of the Judiciary Act 1903 at paragraph 11.2.

46 Recommendation 25.

47 Recommendation 23.

48 Behm review p 16.

49 ANAO report paragraph 5.15.

50 Commonwealth Ombudsman, Scrutinising Government — Administration of the Freedom of Information Act 1982 in Australian Government Agencies, Report No. 02 of 2006.

51 Queensland Rail v F C of T. First instance appeal before the Federal Court. Decision reserved.

52 Michael D'Ascenzo and Steve Martin, A unique taxation partnership for the benefit of the Australian community, ATO/AGS/ Counsel Workshop, 3 April 2004.