6.1 This chapter discusses the Tax Office's test case litigation program and other arrangements which the Tax Office has in place to fund the cost of certain cases that are litigated under Part IVC of the TAA 1953 (Part IVC cases).

6.2 The chapter also details community concerns with these arrangements for funding litigated cases and sets out certain recommendations to address these concerns.

Introduction — types of cases which the Tax Office has funded

6.3 There are four categories of Part IVC litigated cases which the Tax Office currently funds. These categories of funded cases are:

  • cases funded under the formal test case litigation program. These are cases where the taxpayer makes a formal application for test case funding, in accordance with funding criteria that have been publicised by the Tax Office, and that funding is approved by the Tax Office in accordance with those criteria, in conjunction with external consultation arrangements;
  • cases where the Tax Office will fund a taxpayer's appeal costs where the Tax Office has lost a case at the AAT;
  • cases where the Tax Office will fund the taxpayer's appeal costs where the Tax Office appeals to the High Court; and
  • cases funded by the Commissioner of his own volition. In this report these cases have been described as 'other cases the Tax Office will fund'.

6.4 The Tax Office considers that the first and last categories of funded cases together comprise the formal test case litigation program. Since 2004 the Tax Office also considers that the second and third categories of case form part of this formal program, in the sense that these cases can be funded out of the amount budgeted for the formal test case program.

6.5 However, submissions made to this review indicate overwhelmingly that the community has never perceived that cases which fall into the second, third and fourth categories above form part of the formal test case litigation program. Throughout the life of the test case program, the community's perceptions have been that the formal test case litigation program only covers cases that fall into the first of the above categories of funded cases.

6.6 The Tax Office's definition of cases which fall into the formal test case program effectively means that the program consists of cases which meet the formal criteria for funding which the Tax Office has set for category 1 cases and those which do not meet these criteria. This definition is logically flawed and effectively makes the formal test case funding criteria meaningless. These criteria therefore do not, in practice, operate as a means of controlling which cases will and will not be funded by the Tax Office.

6.7 This chapter uses the community's concept of the formal test case litigation program as this concept relies on the existence of certain criteria which must be met for funding to be granted. It therefore ensures that appropriate transparency, accountability and consistency mechanisms can be introduced into the Tax Office's funding of certain cases.

6.8 Using this definition, this chapter identifies that there have been types of cases funded by the Tax Office which have fallen outside the Tax Office's formally stated test case litigation program criteria. In this chapter, the Inspector-General is not providing comments on whether or not the Tax Office should have funded particular cases (such as Budplan70and Stone71) outside these criteria. The Inspector-General acknowledges that the Commissioner is entitled to fund any litigated case, under his general administration powers. However this chapter argues that appropriate transparency, accountability and consistency mechanisms should operate on these other types of funded cases as well as cases funded under the formal test case program.

6.9 This chapter also argues that the formal test case program should be managed in a way that overcomes perceptions that the program is overly subject to influence by the Tax Office. This could include removing the program to a government body other than the Tax Office. If this is done, there will automatically be a separation between cases which are funded under the formal test case program and cases funded by the Commissioner of his own volition. Under a new structure, the problems set out in this chapter which have emerged from the Tax Office's failure to be transparent about its objectives for funding particular litigated test cases should be less likely to arise.

6.10 The above comments lead to the following key findings:

Key finding 6.1

There are four categories of litigated cases which the Tax Office currently funds. These are cases funded under the formal test case program, cases where the Tax Office will fund a taxpayer's appeal costs where the Tax Office has lost a case at the AAT, cases involving the Tax Office appealing to the High Court and other cases it will fund under its general administrative powers.

Key finding 6.2

The Tax Office has defined cases which fall into the formal test case program as cases which consist of those which meet the formal criteria for funding which the Tax Office has formally communicated to the community as well as cases which do not meet these criteria. This definition is logically flawed and means that the formal communicated criteria for funding test cases are meaningless and do not operate as a means of controlling which cases will and will not be funded by the Tax Office. If the test case program were to be managed more independently of the Tax Office, perhaps by moving it to another Government body, there would automatically be a separation between cases which are funded under the formal test case program and cases funded by the Commissioner of his own volition, and the problems which have emerged from the Tax Office's failure to be transparent about its objectives for funding particular litigated test cases should be less likely to arise.

6.11 The Tax Office's definition of cases which fall into the formal test case program has also led the Tax Office to argue that cases which have achieved 'law clarification' in the sense of clarifying how existing law applies to a given set of facts have fulfilled one of the purposes of the program. This argument ignores the definition of 'law clarification' which is set out in the formal test case program and is discussed further later in this chapter. In the formal program, the term 'law clarification' is effectively defined narrowly to mean only those cases which result in new law.

6.12 In this chapter the term 'law clarification' is generally used in this narrow sense of the creation of new law, except where otherwise indicated.

Features of the four categories of cases which the Tax Office may fund

Internal Tax Office management arrangements for funded cases

6.13 The Tax Office has advised that, up to 2004, there was no one area within the Tax Office which was responsible for managing all the above four categories of funded cases. Decisions to fund cases under the formal test case litigation program were generally made by the officer who was responsible for this program. This officer is presently located in the Strategic Litigation Team of the Tax Office's Legal Services Branch.

6.14 The responsibility for making decisions to fund cases that fall into the other three categories of funded cases generally lay within the business line which owned the relevant case. However, the manager of the formal test case litigation program was generally consulted for their opinion on whether all these types of cases should be funded.

6.15 The Tax Office has advised that since 2004 the decision to fund all four categories of Tax Office funded cases has been within the control of the manager of the formal test case litigation program.

Cases funded under the test case litigation program

6.16 The first category of cases funded by the Tax Office consists of cases that are funded under the formal test case litigation program.

6.17 Under the program, taxpayers can apply to the Tax Office to have their case funded by that Office on the basis that it meets certain specified law clarification criteria. These criteria specify that the case must raise questions relating to an area of the law where there is uncertainty or contention, rather than questions of fact where the law is already settled. These criteria have been communicated to the community via a test case litigation program booklet which is available on the Tax Office's web site.

6.18 The program is not a legal aid program and is open to all taxpayers, regardless of their financial circumstances. The Tax Office has advised that it has been unable to identify any similar programs existing in any revenue authority elsewhere in the world.

6.19 The program was established by the Tax Office in the 1995/96 year in response to a set of recommendations made in a 1993 report by the Commonwealth Parliament's Joint Committee of Public Accounts (JCPA) into the operation of the self assessment system.

6.20 The program implemented by the Tax Office has differed however in a number of major respects from the JCPA's recommendations.

6.21 The JCPA's recommendations envisaged that the Tax Office would fully fund taxpayers' expenses at no cost and with no penalty to the taxpayer.

6.22 At the start of the program, the Tax Office determined that costs funded under the formal test case program were to be limited to those costs which were usually awarded to a successful party in litigation, unless very special circumstances existed. These are generally known as party/party costs. Party/party costs are usually less than the costs which a party actually incurs in connection with a case and do not cover, for example, fees paid to an accountant in connection with the case. This basis of funding was selected because this was the basis used in most legal aid programs. More recently, costs funded under the program have been awarded on a solicitor/client basis. This generally results in a higher amount of costs being paid to the taxpayer than would be the case if party/party costs applied.

6.23 The thrust of the JCPA's recommendations on test case funding also involved transferring some of the litigation power from the Tax Office to taxpayers. Funding decisions were not to be solely in the hands of the Tax Office.72 However, from its inception funding decisions under the program have been made solely by the Tax Office. External input to funding decisions has consisted of advice received from an advisory panel (the test case panel) which is made up of both Tax Office and non-Tax Office members. This panel is chaired by a senior tax officer who normally makes the final decisions on funding, although this decision may also be taken by a Deputy Chief Counsel, Second Commissioner or the Commissioner.

6.24 Just prior to finalisation of this review, and after all fieldwork had been completed, the Tax Office advised that there were a total of 61 cases funded under this program, with a further 64 cases being funded in accordance with one of the Tax Office's other three funding practices.

6.25 The formal test case litigation program is the main way in which the Tax Office funds cases and is the principal focus of this chapter. However, Tax Office material on the cases it funds has not clearly distinguished the formal test case program from the other types of litigation cases that it has funded or will fund. To understand the nature of the formal test case program, it is therefore necessary to understand the three types of funded cases which are not part of the formal test case program. These types of cases are discussed in the next three sections of this report.

Cases where the Tax Office funds the costs of appeals it makes against decisions of the AAT

6.26 The second category of Tax Office funded case arises from its longstanding practice of funding a taxpayer's reasonable costs of appeal where the Tax Office appeals against a decision of the AAT or Small Taxation Claims Tribunal. This category of funded case was established in response to a press release issued in June 1967 by the then Treasurer, the Rt Hon William McMahon, under which the Australian Government undertook to pay, irrespective of the outcome, the taxpayer's reasonable costs in such cases.73 These cases do not form part of the formal test case program. Only 15 cases have been funded under this category of funded cases from 1995/96 to 2004/05.

6.27 Funding is not granted under this category for cases involving alleged tax avoidance. However, where funding is granted it will generally also be extended to any further appeals that arise from the case, whether the further appeals are made by the Commissioner or by the taxpayer.

6.28 Funding under this arrangement is also made on a 'party/party' basis which can often be less than the solicitor/client basis which applies where a case is funded under the formal test case program. Therefore, a taxpayer who qualifies for funding under this other funding practice may also seek test case funding under the formal test case program.

Cases involving High Court appeals

6.29 The third category of funded case is where the Tax Office offers to fund the costs of a taxpayer's appeal where the Commissioner appeals to the High Court. These types of cases do not form part of the formal test case program, although a taxpayer may use the test case program processes to receive the benefit of this form of funding. The Tax Office has no recorded policy for these types of funded cases. Costs are not offered in all cases. Funding is determined on a case-by-case basis, depending on a range of factors including the advice of counsel, the importance of the case and how the High Court might perceive the ability of the taxpayer to meet their own costs or be inconvenienced by the grant of an appeal.74 The amount of costs provided under this category are the usual reasonable party/party costs calculated in accordance with the High Court's rules.75

6.30 Just prior to finalisation of this review the Tax Office advised that there were nine cases funded under this category in the period from 1995/96 to 2004/05.

Other cases funded by the Tax Office

6.31 At the time the fieldwork was conducted for this review, management practices within the Tax Office did not enable it to readily identify other cases it has funded under the fourth category referred to above. The Tax Office still does not prepare any reports for the Tax Office's Executive which separately identify the number, cost and progress of 'other' types of funded cases. Reports to the Tax Office's Executive on these cases are currently bundled with reports on cases that are funded under the formal test case program.

6.32 The Tax Office has also not been clear in its communications to the community about the existence and nature of these other funded cases. Its only public statement on these types of cases is in the test case litigation booklet. This booklet states that these cases are funded for 'law clarification' and consist of cases where the Tax Office agrees in principle that a 'test' case (involving either a known taxpayer or a taxpayer that is yet to be found) should be developed. The booklet strongly suggests that the only cases which fall into the category of 'other cases' funded by the Tax Office are cases which meet the usual law clarification criteria (in the sense of creating new legal principles) necessary for funding under the formal test case program, but which are at too preliminary a stage to seek test case funding.

6.33 The Tax Office has also not issued any statement to the community which indicates that, in accordance with an opinion which it has received from the Solicitor-General and Chief General Counsel in December 2005, it will fund or organise suitable assistance to bring a test case in circumstances where the Tax Office launches a challenge to an earlier finalised judicial decision.

6.34 Owing to the Tax Office's internal management practices for these cases, during the fieldwork for this review, the Inspector-General's staff were not readily able to identify the cases which fell into this category. Since this fieldwork and just prior to the finalisation of this review, the Tax Office provided the Inspector-General with figures indicating that over the 10-year period from 1995/06 to 2004/05 there were 40 funded cases which fell into this category. Due to the very late provision of this material, the Inspector-General was not able to confirm the correctness of this figure.

6.35 All of the cases identified during the fieldwork for this review as being 'other' types of funded cases have the following common elements:

  • The decision to fund the case was made by the Tax Office alone (usually by the relevant business line responsible for the case in conjunction with the manager of the formal test case program). The case was not initially approved for funding by the test case program's test case panel. The case is therefore not part of the formal test case program.
  • The case does not fall into any of the other two categories of Tax Office funded cases.

6.36 One high profile case which falls into this category of other funded case is the case of Howland-Rose & others v Commissioner of Taxation (the Budplan case)76, which was handled by the Tax Office's Aggressive Tax Planning area.

6.37 In a response provided just prior to the finalisation of this review the Tax Office has disputed that this case is one which was funded purely on the Commissioner's own volition. The Tax Office asserts that this case was approved for funding by the test case panel.

6.38 However, funding for this case was not initially granted when the case was first considered by the panel. Funding was only granted retrospectively after the Tax Office had already decided to fund the case.

6.39 Furthermore, the minutes of the relevant test case panel meeting indicate that the panel considered that this case still did not meet the general policy of the test case program, but nevertheless should be funded on an exception basis. The panel's reasons for retrospectively approving funding were because of the circumstances in which the case had come to the panel (the case was being reconsidered by the panel because funding was recommended by the Commonwealth Ombudsman), the length of time already involved in obtaining Tax Office approval to fund and the expectations of the relevant taxpayers. The Inspector-General considers that these factors all indicate that this case was funded by the Commissioner of his own volition, and not via normal test case program processes.

6.40 Other cases that were identified during the fieldwork for this review as falling into this category were handled by the following Tax Office business lines: Aggressive Tax Planning, Large Business and International, Small Business and Personal Tax.

6.41 Contrary to the Tax Office's public statement on the nature of these other types of funded cases, the Inspector-General's review team found that a number of the cases which fall into this category were not funded in accordance with the normal funding arrangements that apply to cases funded under the formal test case program.

6.42 In two of the other types of funded cases identified by the Inspector-General's staff, the relevant funding files indicated that funding for the case was provided to the relevant taxpayers on a full indemnity basis. This funding is more generous than the party/party or solicitor/client basis for funding that has been applied to cases funded under the formal test case program.

6.43 The Inspector-General's review team also found that a number of the cases which fall into this category were not funded in accordance with any of the formal test case program criteria.

6.44 For example, in one of the cases examined, which involved the Aggressive Tax Planning area, the basis for the funding decision was evident from email communications on the relevant Tax Office file. These indicated that the basis was that the case would provide 'the necessary precedent' on the relevant scheme. The file did not suggest that the case was being funded to establish any new principle of law, but rather that it was being funded to apply or enforce the relevant law.

6.45 The Budplan case is another example of a case that was not funded in accordance with any of the formal test case program criteria. In this case, the reasons for the funding decision were made public in an information sheet issued on 20 April 2001. This sheet makes no reference to the case being funded in accordance with the usual formal test case criteria, such as the need to clarify/establish a principle of law. Instead this information sheet states that the case would be funded 'if funding is a barrier to these progressing in a timely way'. It states that the reason for this decision was that:

the Tax Office believes that one of the most effective ways to put an end to so called 'tax effective' investment schemes is to secure strong judicial decisions reinforcing the strength of the law including anti–avoidance provisions … We are now prepared to fund cases if this is what it takes to get the matter heard.

6.46 Another group of 'other funded cases' that were identified for the purposes of this review were the cases which the Tax Office has agreed to fund to test certain issues concerning the application of the anti-avoidance provision of the income tax law (Part IVA) to the alienation of personal services income.

6.47 The decision to fund these cases was made public in a speech given by the Commissioner in March 2003. In the press release which accompanied this speech the Commissioner stated that these cases will be funded:

in order to get further clarification from the courts on how general anti-avoidance rules apply to these arrangements

6.48 However, of the 12 cases chosen for this type of funding under this program, four have been settled or not proceeded with prior to the case proceeding to a court hearing. The reason for settling or not proceeding with these cases was that the Tax Office received external advice that it was likely to lose all these cases.

6.49 These cases illustrate that the Tax Office's primary role as the collector of the revenue (and as a party to most litigated tax cases) will, in certain cases, override its role to help clarify the application of the law (that is, law clarification in a wide sense) for the benefit of the community in cases where the two roles are in conflict. These cases strongly suggest that the Tax Office does not have the required degree of independence and objectivity to properly select all the types of cases which should be funded for the purpose of clarifying the application of the law for the benefit of the community.

6.50 During this review, the Tax Office has responded to this by asserting that the Tax Office's model litigant obligations required it to not proceed with these cases. However, the Tax Office has not in other contexts asserted that the model litigant obligations prevent it from being involved in cases that it will not win.

6.51 The above comments lead to the following conclusions:

6.52 Firstly, the Tax Office does not have adequate governance processes in place to ensure that either the decision to fund these cases or the method of funding these cases is subject to appropriate internal scrutiny.

6.53 Secondly, the Tax Office has not adequately communicated to the community the existence and nature of the fourth category of 'other funded cases'.

6.54 Thirdly, it has also not communicated to the community the criteria that it applies in deciding to fund cases that fall into this category.

6.55 Fourthly, it has failed to ensure that cases funded under this category have been funded on a basis which is consistent with that which it applies to cases funded under the formal test case program.

6.56 Fifthly, the Tax Office's abandonment of cases which it initially funded for law clarification purposes once it became clear it would lose these cases strongly suggests that the Tax Office may be giving preference to funding 'test' cases which result in achieving compliance with its own view of the law. This strongly suggests that the Tax Office does not in all cases objectively determine whether it should be involved in a case which clarifies the application of the law.

6.57 Finally, it should be noted that during this review, a number of submissions stated that the Tax Office's funding of the Budplan case and other similar cases were evidence of the Tax Office's mismanagement of the formal test case program. These submissions have pointed to the publicly known features of the Budplan case and other cases and have stated that these features do not seem to allow these cases to qualify for funding under the formal test case funding rules. These submissions indicate the confusion that underlies perceptions about the test case program. The Tax Office has failed to address these perceptions by failing to state that Budplan and certain other cases were not funded in accordance with the criteria that apply to cases funded under the formal test case program.

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

Key finding 6.3

The Tax Office has failed to adequately communicate to the community the existence of the fourth category of 'other funded cases', and the criteria it will apply to fund such cases. This lack of communication has led taxpayers to believe that taxpayers funded under the fourth 'other' category of funding have been funded under the formal test case program. This has fuelled community perceptions that the Tax Office is not consistently applying its test case program criteria to all cases that are funded under that program.

Key finding 6.4

The Tax Office does not have adequate governance processes in place to ensure that either the decision to fund the 'other' category of cases it will fund or the method of funding these cases is subject to appropriate internal scrutiny.

Subsidiary recommendation 6.1

The Tax Office should establish appropriate governance arrangements to allow appropriate oversight by the Tax Office's Executive of all litigated cases which it funds. These governance arrangements should distinguish between cases where the Tax Office has obtained no external advice on its decision to fund the case and those where it has obtained, and followed, that advice.

Tax Office response

6.59 We currently report this information to the Priority Technical Issues Committee (PTIC) which is chaired by the Second Commissioner Law.

Inspector-General's comments on Tax Office response

6.60 The Inspector-General believes that the Tax Office should implement this recommendation in full. As the report indicates, at the time of the Inspector-General's review, the Tax Office did not prepare internal management reports (which identify details such as the number, cost and progress) either for cases which it funds of its own volition, or for cases which it funds under the formal test case program. The Tax Office's response indicates that the practices observed by the Inspector-General have not changed. The Inspector-General does not believe that the Tax Office can assert that it is appropriately managing its decisions to fund any of these cases when no such internal reports are prepared.

Subsidiary recommendation 6.2

The Tax Office should take steps to clearly notify the community of the existence of funding arrangements for cases which fall outside the formal test case program and the other rules for funding Tax Office appeals against AAT decisions and appeals to the High Court. It should notify the community of the types of cases that it will fund in this way and of the circumstances in which this funding has been and will be used by the Tax Office.

Tax Office response

6.61 Agreed in principle.

6.62 Commentary on the different types of cases funded is now in the booklet 'Test Case Litigation Program', published in April 2005. In developing the booklet, we consulted externally before finalising its content and mailing it to major stakeholders. It was placed on our external website and a media release announcing its availability was issued.

6.63 The Test Case Funding Program includes cases funded for law clarification purposes that are in the public interest. This includes cases where the Tax Office agrees to fund cases based on an application by a taxpayer, and those cases where the Tax Office funds a case without the taxpayer needing to apply. The booklet identifies when the Tax Office will fund appeals from decisions of the Administrative Appeals Tribunal and Small Taxation Claims Tribunal. It also makes clear that the Tax Office sometimes offers to meet the taxpayer's costs when special leave is being sought to appeal a case to the High Court.

6.64 Ideally we would prefer to make these funding arrangements totally transparent, but we have been advised by the Australian Government Solicitor (AGS) that there may be problems in doing this in some aspects because of the secrecy provisions contained in the tax law. We will continue to consult with AGS to clarify this.

Subsidiary recommendation 6.3

The Tax Office should ensure that where it funds cases under its general administrative powers, the method of funding (such as the basis and timing of funding) provided is consistent with that which is provided under the formal test case program. This would be to ensure that litigants who achieve funding for law clarification purposes are not disadvantaged when compared with litigants who have achieved Tax Office funding of their case for purposes other than law clarification.

Tax Office response

6.65 We have not drawn any distinctions in our funding practices based on whether it was commenced by a taxpayer application or funded by the Commissioner offering funding in important cases. That said, while the intention is to provide consistent approaches to funding cases, there needs to be some flexibility in appropriate cases having regard to individual circumstances so that all cases are appropriately supported under the program.

6.66 All cases funded are for the purposes of law clarification.

Inspector-General's comments on Tax Office response

6.67 The Inspector-General welcomes the Tax Office's intention to provide consistent approaches to funding cases but notes that, as indicated in the report, this intention has not been put into practice by the Tax Office over the life of the test case program.

Formal test case litigation program

6.68 To evaluate the Tax Office's formal test case program the Inspector-General and/or his staff met with a number of key stakeholders and received 22 submissions which commented on the operation of the program.

6.69 The Inspector-General and/or his staff also examined 36 test case program files (21 of which were commenced prior to 2004). A member of the review team attended two meetings of the test case panel as an observer. Interviews were conducted with non-Tax Office members of the test case panel. Information was also obtained from various internal and external reports prepared by the Tax Office on the operations of the program.

6.70 The Inspector-General also conducted an analysis of whether the formal test case program was meeting its aims of law clarification for cases that had resulted in a court or tribunal decision.

6.71 The Inspector-General's findings fall into two groups. The first group of findings relate to the overall structure of the program. These structural findings include findings relating to the overall purpose of the program, whether that purpose is desirable and whether the Tax Office's activities have achieved that purpose. The second group of findings deal with the Tax Office's management of the program in relation to all the individual cases which have been subject to the program.

Structure of the test case program

Purpose of the program

6.72 The test case program was established because of a perceived need for there to be a publicly funded program for litigating major points of dispute and grey areas of the tax law in an environment where taxpayers (rather than the Tax Office) are largely responsible for determining what tax laws apply to their financial transactions.

6.73 The Inspector-General considers that this reason for a publicly funded test case program still remains valid.

6.74 The Tax Office has publicly confirmed that it considers that the purpose of the formal test case program is law clarification for the benefit of the community. It has stated that this purpose will be met in cases which meet the following three criteria:

  • There is uncertainty or contention about the operation of areas of law.
  • The issue is of significance to a substantial segment of the public or has significant commercial implications for an industry segment.
  • It is in the public interest for the issue to be litigated.77

6.75 The Inspector-General believes that the Tax Office's statement is an appropriate statement of what should be the purpose of the program.

Budget for the program

6.76 The budget for the program is administered by the Tax Office. $2 million has been allocated to the program each year. From 1999/2000, the program has been funded out of the Tax Office's normal operating budget. Prior to that date, it was funded as part of a separate budget appropriation. This amount was fully expended only in the 2001/02 year.78

6.77 Under the current funding arrangements for the program the Tax Office has the discretionary power to expand or contract the program without reference to any external party.79

Number of cases funded under the program

6.78 Just prior to the finalisation of this review, the Tax Office advised the Inspector-General that the Tax Office has considered 262 cases for funding, either under its formal test case program, its programs for funding adverse AAT appeals and High Court appeals, or its program for funding other cases. At this time it also provided for the first time a break up of these 262 funding applications into cases that were not funded and that were funded either in accordance with a recommendation by the test case panel, or in accordance with the Commissioner's policies for funding adverse AAT appeals and appeals to the High Court. This break up is shown in Appendix 11.

6.79 The 262 cases referred to in Appendix 11 do not reflect figures reported in the Commissioner's annual reports or in other published material for the relevant years, such as reports for these years made to the National Tax Liaison Group.80 They also include 28 cases that were not identified as cases for which funding was sought at the time of the fieldwork conducted by the Inspector-General for this review. The Inspector-General has therefore not examined any of these 28 additional cases, nor has he examined the extent to which the figures in Appendix 11 accurately represent a break up between the four categories of funded cases identified during this review.

6.80 The material in Appendix 11 indicates that, of the 262 cases where funding was sought, 125 cases (48 per cent) were funded under one of the four Tax Office funding practices and that of these cases 61 were funded under the formal test case program. There were 137 cases (52 per cent) where funding was sought under one of these practices but where funding was denied.

6.81 Other material provided by the Tax Office indicates that there were 110 cases funded by the Tax Office, other than the 15 cases that were funded under adverse AAT decision funding. These 110 cases led to 44 cases which resulted in a final court decision. Of these cases, 21 have been cases ultimately won by the Tax Office, 20 have been cases won by the taxpayer and 3 have been cases won partly by the Tax Office and partly by the taxpayer.

Criteria developed by the Tax Office to determine cases to be funded under the program

6.82 The Tax Office has developed nine internal criteria that it will apply to determine which cases may be funded under the formal test case program. These criteria have been communicated to the community in the Test Case Litigation Program booklet which the Tax Office has published on its website.

6.83 The first three criteria are essential criteria, and mirror each of the three elements of the purpose of the test case program. The remaining criteria are additional and are applied flexibly. The nine criteria are:

  • that the issue in question relates to an area of the law where there is uncertainty or contention;
  • that the issue is of significance to a substantial segment of the public or has sufficient commercial implications for an industry segment;
  • that it is in the public interest for the issue to be litigated;
  • whether the case has issues involving questions of fact where there are established legal principles (as questions of fact are not normally funded);
  • whether the case is to be brought before a court (as preference is given to cases brought before the courts);
  • whether the case involves a challenge to an administrative decision under the Administrative Decisions (Judicial Review) Act 1977 (as preference is given to cases which involve the review of objections or private rulings which are litigated through Part IVC of the TAA 1953);
  • the financial capacity of the taxpayer to pursue litigation (although applicants of financial substance would not necessarily be excluded);
  • whether the case involves a tax avoidance scheme or an attempt to gain a benefit not intended by the legislation (as tax avoidance cases are not generally funded); and
  • whether the taxpayer is prepared to cooperate to achieve an early hearing.

6.84 The above nine criteria have been in place since April 2005. Prior to that date, there were the following additional criteria:

  • that the issues in the case were of relative significance to the administration of tax law;
  • that the issue had been noted as having high priority for resolution under the Tax Office's rulings program and judicial determination might be preferable; and
  • the case involved a challenge to a controversial ruling or issues seen to be contentious in issued or draft rulings.

6.85 The Tax Office has removed these three criteria during the course of this review because of concerns that they suggested that the Tax Office would only fund cases under the program that were of interest to the Tax Office, rather than of interest to taxpayers generally.

6.86 The pre-April 2005 criteria also indicated that administrative law cases would not be funded. As a result of the April 2005 changes these cases now qualify for funding.

6.87 The pre-April 2005 criteria did not make it clear that cases involving avoidance issues would not generally be funded. The present criteria now state that this is the case.

6.88 The Inspector-General believes that the nine present criteria for the formal test case program (as altered by the April 2005 changes) are appropriate, but that an additional criterion should be added which reflects the opinion which the Tax Office received in December 2005 from the Solicitor-General and Chief General Counsel that funding should be made available in cases where the Tax Office challenges an earlier judicial decision.

6.89 A number of submissions asserted that, although these criteria indicate that funding under the program is available to all, in practice it seems to be restricted to small taxpayers. These submissions asserted that the program should be administered so that it provides funding for suitably representative and significant cases, even where the taxpayer has the means to fund the case.

6.90 In this review, the Inspector-General has found that there was one case involving a large taxpayer that has been funded by the Tax Office. However, this funding was not done under the umbrella of the formal test case program.

6.91 As discussed further below, the Inspector-General considers that the Tax Office should use its own internal resources to be more proactive in seeking out all cases that are suitable for test case funding. In the light of the above comments it should, in doing this, take particular steps to ensure that all suitable cases involving large taxpayers are identified and funded, where appropriate.

Is the Tax Office administering the program so that law clarification is being achieved in all appropriate cases?

Amount budgeted for and spent on the program and number of cases funded

6.92 From the program's inception, concerns have been expressed that the budget for the program has been too low overall.81 Concerns have also been raised that the Tax Office has been unwilling to spend the total funds allocated to the program.

6.93 Submissions made to this review also suggested that the Tax Office does not do enough to ensure that its test case budget is spent. These submissions noted that the Tax Office could, for example, make better use of its own internal resources or of other publicly available material to find taxpayer cases that would be suitable vehicles for the formal test case program.

6.94 The Inspector-General considers that the above concerns are well founded. This review has established that the Tax Office has spent only $5.97 million on its formal test case program over its ten years of operation. However, the total budgeted funds available for this program over these ten years have been $20 million.

6.95 In addition, there have been only 44 cases funded either under the program or in accordance with the Tax Office's practices for funding other cases and High Court appeals which have reached the stage of a hearing.

6.96 Furthermore, a 2000 Tax Office internal review of the program found that the Tax Office's business lines were unwilling to come forward with suitable formal test case program cases.

6.97 The Tax Office has submitted that its formal test case program budget has not been fully expended because there have been insufficient applications which have met the criteria for funding under the program. It has also pointed to recent efforts to locate cases that could be funded to test certain issues arising from the alienation of personal services income. However, as noted earlier in this report, the Tax Office has now settled or decided not to proceed with a significant percentage of these cases and, as a result, these cases will not proceed to a hearing.

Types of cases that have been funded from program monies

6.98 A number of cases (including Budplan) that have not met the formal test case program criteria have been funded out of the $5.97 million spent on funded cases. At least two of these cases, both of which were funded for enforcement purposes, together used up 38 per cent ($2.25 million) of this $5.97 million. These two cases exhausted 83 per cent of the $2 million of budgeted test case funds in one year. This meant that few other cases could be funded during that year under the formal test case program.

6.99 This strongly indicates that the Tax Office has given preferential funding to cases that it wants to have heard for enforcement or other purposes, rather than for the purposes of clarifying the law for the benefit of the community.

Basis of funding formal test case program cases versus other cases

6.100 A number of the cases funded for enforcement purposes out of the $2 million annual budget for funded cases have been funded on a full indemnity basis. However, cases funded in accordance with the formal test case program have generally been funded only on a party/party or solicitor/client basis. This again strongly indicates the Tax Office has given preferential funding to cases involving law enforcement purposes.

Role of the test case panel

6.101 Aspects of the operation of the test case panel raise questions as to how effective it has been in independently ensuring that only cases which meet the formal test case program criteria have been funded.

6.102 Firstly, a number of cases have been funded by the Tax Office without reference to this panel.

6.103 Secondly, there have been at least two significant cases which the independent panel recommended be funded at certain stages but which the Tax Office decided not to fund. There has also been at least one case which the panel recommended not be funded but which the Tax Office funded through its processes for funding other cases, then sought retrospective approval from the panel for this action.

6.104 Thirdly, test case panel members have played no role in monitoring the implementation of funding decisions and are not aware when their funding recommendations have been overturned.

6.105 Fourthly, extensive experience in tax is not an essential requirement for panel membership.

6.106 These features of the operation of the test case panel are further evidence that the Tax Office is giving preferential funding treatment to cases which meet its corporate objectives (for example that of law enforcement), rather than cases which may give rise to law clarification (in the wide sense) for the benefit of the community.

Results of funded and decided test cases

6.107 Of the 44 funded cases which have ultimately decided by a court or tribunal, 21 have been won by the Tax Office, 20 by the taxpayer and 3 partly by the Tax Office and partly by the taxpayer. At face value, these figures may suggest that there is an even split between funded cases that have been won by the taxpayer and cases won by the Tax Office, and that the Tax Office may therefore not be giving preferential treatment to test cases that will vindicate its view on an issue.

6.108 However these figures do not include the significant number of funded cases which were settled or not proceeded with after funding was granted. The number of these cases is the difference between the 110 cases which were initially funded by the Tax Office and the 44 cases which have led to a final court or tribunal decision.

6.109 The figures on the results of funded and decided cases therefore do not give any clear indication of bias in the Tax Office's funding of test cases.

Conclusion

6.110 In view of the above findings, the Inspector-General has concluded that the Tax Office could do more to administer the formal test case program to achieve law clarification in more areas of tax law.

Have the decided cases which have been funded under the program met the stated purpose of the program?

6.111 The Inspector-General has conducted an analysis of finalised court or tribunal decisions that have been funded under the program. The purpose of this analysis was to see if, for these cases, the program has met its stated purpose of clarifying the operation of the tax law by establishing new legal principles.

6.112 The cases analysed were drawn from the Tax Office's internal list of test case program funded cases that had been finalised by way of a court hearing. Just prior to the finalisation of this review, the Tax Office advised that there were 44 such cases.

6.113 The Inspector-General's analysis assessed firstly whether the final decision in the case had established a principle of law or had been decided only on its facts.

6.114 The results were that 33 of the 44 cases (that is, 75 per cent of these cases) established a principle of law, although in some cases the importance of this principle was open to question. In the remaining 11 cases (that is, 25 per cent) no principle of law was established, with the case being decided on its facts or on other grounds.

6.115 During this review, the Tax Office rejected this finding and asserted that a higher number of these cases have led to law clarification. However, the definition of 'law clarification' which the Tax Office has used in arriving at its conclusion is that law clarification arises where a case either leads to new legal principles or results in an outcome which shows how settled law applies to a novel set of facts. As indicated earlier in this chapter, this definition of law clarification is not the one which is used in the formal test case program guidelines. The Inspector-General does not dispute that some of these cases might have been worthwhile for other reasons.

6.116 The second part of the Inspector-General's analysis assessed the degree to which any legal principles established by the cases were still of relevance.

6.117 The results here were that of the 33 cases which established a legal principle, in 19 of these cases (or 58 per cent) these principles were still relevant and in 7 cases (or 21 per cent) these principles were no longer relevant (for example, because of changes in legislation). The principles from the remaining 7 cases (or 21 per cent) were possibly still relevant.

6.118 The third aspect of this analysis was to see whether any cases had led to the Commonwealth Parliament changing the law that was considered in the case. The results here were that in only 8 cases (18 per cent) was the law changed after the decision, while in the remaining cases it was not.

6.119 The above findings suggest that the test case litigation program is substantially achieving its aims of law clarification, at least for the cases that have been decided by a court or tribunal under the program. However, even for these cases there is some room for improvement.

6.120 The final part of the Inspector-General's analysis examined whether the Tax Office had taken any action as a result of the case (for example, by issuing a media release or changing a ruling). The findings on this aspect were that in 22 cases (50 per cent) the Tax Office had made no response to the case while in the other 22 cases they had made a response.

6.121 This aspect of the Tax Office's processes concerning the application of the outcomes of test case funded decisions is discussed further in the next chapter.

6.122 A number of submissions to this review raised concerns about the nature of cases funded under the program. These appear to be borne out by the results of the above analysis. These submissions noted the Tax Office has funded a number of cases under the program which have involved issues of fact rather than issues of law. These submissions note that the funding of these types of cases is contrary to test case guidelines.

6.123 In this regard, the Inspector-General notes that a number of submissions asserted that Stone's case82 was an example of a case which should not have been funded under the program as it was decided on issues of fact and therefore will not directly apply to other similar taxpayers.

6.124 The Inspector-General further notes that, at a test case panel meeting held in June 2005, the Tax Office agreed to seek out test cases involving the issue of the deductibility of expenses paid by athletes. This issue is essentially the opposite side of the income assessability issue that was considered in Stone's case. Its resolution is therefore highly likely to turn on questions of fact. Accordingly, the decision to seek possible test case funding on this issue under the formal test case program may need to be re-examined. This observation is aimed at improving perceptions of consistency about formal test case program decisions. It is not a criticism that funding Stone's case was not in the public interest per se.

Internal management of the formal test case program

Governance and organisational framework for the program

6.125 From 1 December 2003, the formal test case program has been managed within the Strategic Litigation Team of the Tax Office's Legal Services Branch. This branch is located within the Office of the Chief Tax Counsel. The manager of the test case program is assisted by one to two other Tax Office staff.

6.126 The review notes that the management of the program appears to have recently improved, especially when compared to the observations of poor past administration below.

6.127 The internal reporting arrangements for the program are not clear and reflect the nature of the Tax Office's current governance processes for litigation generally. For administrative and reporting purposes, the manager of the program reports to a Senior Assistant Commissioner who in turn reports to the National Program Manager of the Office of Chief Tax Counsel. However, for technical purposes, the manager of the program works to a Deputy Chief Tax Counsel who in turn reports to a Second Commissioner of Taxation and then the Commissioner.

6.128 No specific internal management reports are prepared for the Tax Office's Executive on the formal test case program. Any internal reporting on the program is combined with internal reporting for the other types of cases which are funded out of the $2 million budget. The extent of internal reporting arrangements for all funded cases that are managed by the manager of the formal test case program is as follows:

  • the number of cases funded out of the $2 million budget are identified in monthly reports prepared for lower level management within the Tax Office;
  • these funded cases are identified in Significant Litigation reports circulated to the Tax Office's Executive and Treasury; and
  • these cases are also included in reports prepared for a cross-business line committee which deals with priority technical issues.

6.129 Internal reports on and records for the Tax Office Executive do not record the amount of tax involved in any of the above cases, nor the amount the Tax Office has spent on the case to date, both internally and under the formal budgeted funding arrangements. This practice reflects the Tax Office's current governance processes for litigation generally.

6.130 There is no quality assurance process for the formal test case program.

6.131 The Tax Office was unable to locate any written charter setting out the role and structure of the test case panel. A charter for the panel was, however, in existence during 2000 when the Tax Office conducted an internal review of the test case program.

Record keeping practices and file management for funded cases

6.132 During the fieldwork stage of this review, the Tax Office was unable to provide the review team with a complete listing of cases that have been subject to any form of funding, including cases funded under the formal test case program. This was because the Tax Office did not, at that time, have a detailed register of all cases that had been subject to funding. The Tax Office has since completed a 'best estimate' listing of all cases that have been subject to funding.

6.133 During the fieldwork stage of this review, the Tax Office was also unable to provide the review team with any minutes of the meetings of the test case panel that were held prior to June 1999.

6.134 Furthermore, most files for pre-July 2004 funded cases that were identified during the fieldwork stage of this review were not able to be located by the Tax Office. This was particularly true for files which pre-dated 1999. During the final stages of this review, the Tax Office advised that it has now located all test case files post 1998, but the Inspector-General has not verified this statement.

6.135 As a result of the above, this review has not been able to fully assess the operation of the formal test case program in respect of cases that were subject to the program prior to July 2004.

6.136 An internal Tax Office review of the program was done in 2000. The results of this review offer some insight into the internal administrative processes for the program prior to and, to a certain extent after, 2000.

6.137 This internal review found that there was a lack of proper record keeping for the program. Files were poorly maintained and there was no central register of all applications for funding with the critical information (such as the amount of tax in dispute) well recorded.

Controls over amounts funded under the program

6.138 Until recently, amounts funded under the program have not been sufficiently controlled. As noted above, there have been inconsistent funding practices applied to funded cases, with certain cases funded from the formal test case budget being funded on a full indemnity basis, while other cases have been funded on either a party/party or solicitor/client basis.

6.139 The 2000 internal review into the formal test case program noted that this lack of control over the costing arrangements was due to the Tax Office not having experienced or qualified staff to determine costs to be awarded under the program.

6.140 From 2004, the Tax Office has implemented measures to try to address this issue. From 2004, it has progressively implemented a formal test case funding deed (rather than what was formerly an exchange of letters) to set out the terms of the funding agreement. This deed has been drawn up in consultation with advisers from the Attorney-General's Department who have expertise in costing issues.

Public reporting of identity of cases funded under the program

6.141 The Tax Office has not, during the life of the formal test case program, publicly disclosed the names of all cases that have been funded under the formal test case program. This practice has continued since new management arrangements for the program were introduced in 2004.

6.142 The Tax Office has advised the Inspector-General that the secrecy provisions of the income tax legislation prevent any further public disclosure of the names of cases which have been funded under the test case program.

6.143 A list of cases that have received test case or other funding according to publicly available material (such as the Commissioner's Annual Reports and/or reports to the National Tax Liaison group) is in Appendix 12.

6.144 A number of submissions, particularly from the bodies representing professional associations, have asserted that the Tax Office has not been sufficiently transparent about the current operation of the test case program by publishing only the above details on the program. The Inspector-General agrees with these assertions.

6.145 A number of these submissions also assert that the Tax Office has also not published any financial information on the operation of the program. The Inspector-General also agrees with these assertions.

6.146 As a result of this financial information being unavailable, the community has not been aware of the extent of the total budgeted funds for the program, the extent of money actual spent under the program and the extent of cases funded under the program that have either not been funded for law clarification purposes or have been funded for such purposes but have not in fact achieved the aim of law clarification.

6.147 The Inspector-General notes that the Tax Office has investigated overcoming the lack of publicity on the identity of cases funded under the test case program by seeking the agreement of the Federal Court and/or AAT to insert a reference to the funding arrangements for a case in the relevant court or tribunal's published decision. Another means of addressing this lack of publicity would be for there to be a requirement of funding that the taxpayer agrees to the Tax Office publishing their name, a brief description of the issue in the case and a description of how that issue was eventually resolved.

6.148 However, the Tax Office has rejected both these possible solutions because it considers that the secrecy provisions of the ITAA 1936 (which impose a statutory obligation on the Commissioner and Tax Office not to disclose matters relating to the tax affairs of a taxpayer) cannot be overridden by having a taxpayer agree to waive their rights to secrecy.

Application processes for the formal test case program

Nature of application processes

6.149 Cases that are administered under the formal test case program must be initiated by the taxpayer or their representative completing a submission for test case funding.

6.150 The submission needs to address the nine criteria that the Tax Office currently applies for test case program approvals.

6.151 The Tax Office's fact sheet on test case litigation indicates that decisions on test case funding will be made within three months of the application being received. Once an application is registered, comments are first sought from the Tax Office business line responsible for the relevant matter. The next step currently involves consultation with the test case litigation panel, although urgent cases may be considered by the chairman of the panel without reference to other panel members.

6.152 If funding is approved the Tax Office will advise taxpayers in writing of the details of the costs that are offered under the test case program. The most common type of test case program funding arrangement agreed to by the Tax Office involves the taxpayer entering into a test case deed under which the Tax Office agrees to pay the reasonable costs incurred at the relevant approved stage of litigation on a solicitor/client basis. Costs are limited to a single stage of proceedings and may not cover all the taxpayer's expense of running the case.

6.153 Taxpayers can seek a review of any decision to decline funding where there have been further developments in the case since the initial application. The review process normally takes about a month and is undertaken by a senior tax officer.

Taxpayer concerns with test case application processes

Attendance by taxpayers at meetings of the test case panel

6.154 A number of submissions raised concerns with the current application processes for test case funding. Several suggested that the taxpayer should be able to personally attend test case panel meetings to make submissions for funding and noted that such appearances were now a feature of the operation of other Tax Office panels, such as the Part IVA panel.

6.155 The Inspector-General sees merit in this suggestion.

Tax Office's treatment of individual test case applicants

6.156 Several submissions also provided examples of where the Tax Office had treated test case applicants less than satisfactorily.

6.157 Examples included letters where the Tax Office had adopted an unnecessarily adversarial tone in responses to letters that were sent to unsuccessful applicants for test case funding. The Inspector-General notes that such correspondence is against the principles set out in the Taxpayers' Charter.

6.158 Several submissions also claimed that a test case could involve adverse publicity being directed to a particular test case taxpayer. One example of this was where the taxpayer had volunteered to create a dispute for the purpose of having a test case heard, but was ultimately found as a result of that process to have engaged in tax avoidance.

6.159 Submissions noted that most taxpayers are usually more willing to settle a dispute rather than litigate it. This is generally because of the possible impost on their time and resources and because court processes may give rise to confidential information being aired about their financial affairs. The failure of the test case process to protect test case taxpayers against possibly adverse personal publicity therefore gives rise to a further negative factor which will weigh against any taxpayer being willing to become involved in the test case program.

6.160 The Inspector-General notes that these concerns could possibly be addressed by having the Tax Office include, in any public material which it issues on a test case, an explanation of the role which the relevant taxpayer has played in achieving clarification of the law for the benefit of the community.

Fieldwork conducted on application processes

6.161 The review team's examination of the applications filed for 36 test case program applications has led to the following findings.

Taxpayer awareness of test case criteria

6.162 In a number of the test case program files examined, applications for funding were poorly drafted and did not address the test case criteria that the Tax Office applied in determining funding decisions. In a number of these cases the applications appear to have been constructed of material that was 'cut and pasted' from documents created for other purposes. The poor form of these applications suggests that the applicants might not have been aware of the relevant Tax Office guidelines that were applied in granting test case funding. However, there are other possible explanations. One such explanation could be that these poorly drafted applications reflected the applicant's belief that the funding application would be denied and that therefore there was no reason to put much effort into the form of the application.

6.163 Prior to April 2005, the test case program application form that was included with the test case litigation booklet did not itself specify that the application needed to address the criteria that the Tax Office applies for granting test case funding. This omission has now been addressed, with the current application form now specifying that any application needs to be accompanied by a comprehensive submission addressing the Tax Office's test case funding criteria.

Conformity with requirements of the Taxpayers' Charter in responding to applications

6.164 The Inspector-General's fieldwork indicated that the test case program appears to be currently meeting Taxpayers' Charter requirements for dealing with individual taxpayers as regards responding to applications for funding. For example, it is currently meeting the Charter requirement to provide, on a timely basis, adequate written reasons to individual taxpayers for decisions made. For all applications made after 2004 that were reviewed where funding was denied, adequate written reasons for this decision were given to the applicant on a timely basis.

6.165 However, this commitment was not uniformly met in the case of the pre-2004 applications that were reviewed. Ten of these pre-2004 applications involved decisions not to fund. In six of these, either no written reasons for the decision were given to the applicant or the reasons given did not appear to address the relevant test case funding criteria that were in place at the time of the application.

Funding processes for test case program cases

Quantum of funding

6.166 A number of submissions have noted that the design of the test case program has never fully implemented the original JCPA recommendation that the Tax Office should fully fund the cost of the test case taxpayer's case at no cost or penalty to the taxpayer.

6.167 Submissions have also suggested that the costs paid by the Tax Office under the program for counsel and solicitors should be aligned to market rates. Currently these costs are pegged to the rates paid by the Commonwealth for its own legal representation.

6.168 Submissions have further stated that the current test case funding arrangements only allow sufficient funding for one legal representative for the taxpayer, while the Tax Office can employ a larger number of legal counsel to represent its case.

6.169 The Tax Office considers that the current solicitor/client basis for funding, which incorporates pegged rates for counsel and solicitors, is appropriate. It argues that, if funding extended to all costs that might be incurred at the sole discretion of the taxpayer, the program would be unduly expensive and no incentive would exist to be economical in the use of public resources, including the time of the courts. The Tax Office also argues that there would be difficulties if the Tax Office were funding a case under the program and paying counsel employed by the Tax Office at one rate and counsel employed by the taxpayer but funded by the Tax Office at a higher rate.

6.170 The Tax Office has further noted that the Tax Office's test case program arrangements are more generous than legal aid type arrangements as most legal aid schemes contribute to the applicant's legal costs; they do not, unlike the test case program, guarantee the reimbursement of costs should the legal aid applicant be unsuccessful in their litigation and have costs awarded against them.83

6.171 The Tax Office also asserts that its current policy for funding the number of legal representatives for a taxpayer is stated in its April 2005 Test Case Litigation Program booklet. This booklet indicates that the Tax Office will fund a taxpayer no more than the same number and seniority of counsel that the Tax Office will itself engage to run the case.

6.172 The Inspector-General has concluded that the current rules which determine the quantum of funding for test case program cases are appropriate.

Delays in receiving funding

6.173 Some submissions also raised concerns that amounts paid to successful applicants under the program have been only paid at six monthly intervals. Other commentators on the test case program have noted that, in some cases, costs have only been paid at the conclusion of the case.84

6.174 Some submissions from barristers involved in acting for taxpayers in test cases have noted that payment of their bills has not been delayed and that delays in payment could be due to how quickly and regularly the solicitor acting for the taxpayer in the relevant case prepares relevant accounts.

6.175 The Inspector-General notes that the current test case funding deed states that invoices will generally be paid only after every six months or immediately after each significant court appearance, whichever occurs first, although it does indicate that alternative arrangements may be available.

6.176 The Inspector-General notes that the six monthly terms of payment are not consistent with normal commercial terms for the payment of legal bills.

Extension of funding to objections stage

6.177 Submissions have also asserted that the funding for a test case, once granted, should also cover the objection stage of a dispute. The Inspector-General notes that when the test case program was first established the original rationale for not extending test case funding to the objection stage of a dispute was to achieve parity with the rules for funding that apply in the legal aid area. Legal aid funding only extends to the cost associated with an actual hearing.

6.178 The Inspector-General however notes that in the tax context the form and content of an objection is in effect the originating document for tax litigation. It serves to define the dispute in the same way that pleadings do in a non-tax context.

6.179 The Inspector-General therefore considers that test case funding should generally be extended to the stage of preparing an objection for cases that have been approved for funding. The present test case guidelines indicate that the cost of objections will only be funded in certain cases.

Conclusions on internal management of the test case program

6.180 Based on all the above material, the Inspector-General has concluded that the formal test case program has been poorly managed, at least up until the time when the Inspector-General flagged that this program would be the subject of a review in his 2003 scoping study. There have been improvements in the internal management of the formal test case program since this time (for example in respect of controlling costs funded under the program, in giving reasons to taxpayers if their funding request is denied and in record-keeping). However, a number of key internal management deficiencies remain.

6.181 The principal internal management deficiencies of the program which remain are as follows:

  • There is no quality assurance process for the program.
  • The Tax Office has not performed and does not perform any analysis of the success of the formal test case program in meeting its aims of clarifying the law.
  • The Tax Office does not do enough to ensure that all cases warranting funding are identified and funded to an appropriate extent.
  • The Tax Office is not sufficiently proactive in seeking out possible test cases.
  • The Tax Office does not make publicly available key aspects of the operation of the program including:
    • details of the budget for the program and the extent to which it has been spent each year;
    • the number of applications made for funding and the number granted, rejected or held over; and
    • the identity of cases funded under the program and the reasons why they have been funded.
  • The Tax Office has not during the life of the program maintained a complete and up to date listing of all cases that it has funded under the program.
  • There are no specific internal management reports prepared for the Tax Office's Executive on the test case program.
  • The Tax Office has failed to protect test case taxpayers against adverse publicity arising from their involvement in the program.
  • Taxpayers costs are generally only funded at six monthly intervals.

Overall conclusions on the formal test case program

6.182 The Inspector-General concludes that the test case program is important, is generally achieving its purpose and should be continued to provide public funding for litigating major disputes and grey areas of the law. The existing Tax Office criteria are appropriate criteria for determining what types of cases should be funded for this purpose as part of the formal test case program, but there should be an additional criterion added which reflects the opinion which the Tax Office received from the Solicitor-General and Chief General Counsel that funding should be made available in cases where the Tax Office challenges an earlier judicial decision.

6.183 The Inspector-General notes that a number of submissions made to this review recommended that any such program should not be administered by the Tax Office but should be administered by a body which is entirely independent of the Tax Office. One submission suggested that the Attorney-General's Department should administer the program, while others suggested it should be administered by an independent board.

6.184 Many submissions which called for the program to be administered by an independent body did so because of a perception that the Tax Office has administered the formal program poorly, unfairly and not openly.

6.185 The findings of this review confirm that the formal test case program has not been well managed internally by the Tax Office, although there have been recent improvements.

6.186 These findings also confirm that the program has not been administered fairly, in the sense of achieving its aim of law clarification in all cases that warrant funding determined on an objective basis. The Tax Office appears to have used the program's funds, together with other public funds, to support its organisational objectives of collecting revenue and enforcing the tax laws, rather than using these funds primarily to ensure that certain areas of the tax law are clarified by the courts. A large percentage of the funds employed in the formal test case program have been used by the Tax Office to fund cases for law enforcement purposes, rather than for any purpose of clarifying the law in the sense of creating new legal principles. Certain 'test' cases funded by the Tax Office purportedly for law clarification purposes have been settled or not proceeded with once the Tax Office became aware that it would lose the case.

6.187 The program has not been administered openly in that the Tax Office has not published the names of cases that it has funded under the program and continues to assert that the secrecy provisions prevent it from publishing these names. It has also not published financial data on the operation of the program which would allow the community to properly assess the operations of the program.

6.188 These findings lead to a conclusion that responsibility for the formal test case should be administered by a body which is independent of the Tax Office.

6.189 The above comments lead to the following key findings and key recommendation:

Key finding 6.5

The Inspector-General concludes that the test case litigation program is important, is generally achieving its purposes and should be continued to provide public funding for litigating major disputes and grey areas of the tax law. The existing Tax Office criteria, which have been changed during the course of the Inspector-General's review, are appropriate criteria for determining what types of cases should be funded for this purpose, but an additional criterion should be added which reflects an opinion obtained by the Tax Office from the Solicitor-General and Chief General Counsel that funding should be made available in cases where the Tax Office challenges an earlier judicial decision.

Key finding 6.6

The formal test case program has not been well managed internally by the Tax Office. Although there have been recent improvements, including processes to control costs funded under the program, to ensure that taxpayers are given reasons if their funding request is denied and in respect of record-keeping for the program, key deficiencies in the Tax Office's internal management of the program remain. These include:

  • an absence of adequate quality assurance processes for the program;
  • a general failure by the Tax Office to ensure that all cases warranting funding are identified and funded to the appropriate extent; and
  • a lack of appropriate internal governance arrangements for the program.

Key finding 6.7

The test case program has not been administered fairly by the Tax Office in the sense of achieving its aim of law clarification in all cases that warrant funding determined on an objective basis. The Tax Office appears to have used the program's funds, together with other public funds, to support its organisational objectives of collecting revenue and enforcing the tax laws, rather than using these funds primarily to have certain areas of the tax law clarified by the courts.

Key finding 6.8

The test case program has not been administered openly. For example, the Tax Office has not published the names of cases that it has funded under the program and continues to assert that the secrecy provisions prevent it from publishing these names. It has also not published financial data on the operation of the program which would allow the community to properly assess the operations of the program.

Key finding 6.9

New arrangements for the management of the test case program are needed to overcome community confusion abut the operations of the program, to improve its administration and overcome perceptions that the program is overly subject to Tax Office influence.

Key recommendation 4

The formal test case program (defined as the program under which a taxpayer makes a formal application for test case funding in accordance with funding criteria that have been publicised by the Tax Office) which is designed to fund cases which will clarify the law by establishing new legal principles should remain but new arrangements for the management of the test case program are needed. Precedents for an appropriate structure which deliver independence without being overly bureaucratic could be the existing Tax Agents' Boards or the Board of Taxation.

Tax Office response

6.190 The establishment of a panel independent of the Tax Office to decide applications for test case funding is a matter for government.

6.191 The existing Test Case Panel comprises seven members, five of whom are external to the Tax Office, including a former judge of the NSW Court of Appeal, a barrister, a solicitor and two accountants.

Inspector-General's comments on Tax Office response

6.192 The Inspector-General notes that the Tax Office's response does not address the suggestion made in the recommendation that possible precedents for an appropriate structure for the formal test case program which deliver independence without being overly bureaucratic could be the existing Tax Agents' Boards or the Board of Taxation.

6.193 The Inspector-General also believes that the detailed findings contained in this report on the manner in which the Tax Office has managed the program speak for themselves.

Public accountability mechanisms required if the program is transferred to another body

6.194 This chapter has discussed the lack of public accountability for the operation of the current test case program. Public accountability for the current program has been minimal as the Tax Office has not published the names of all cases funded under the program, the issues involved and the nature of the eventual outcome of these cases.

6.195 The Tax Office has also not published financial information on the operation of the program.

6.196 If administration of the test case program is transferred to a new body these issues of transparency will need to be addressed in the future by that body.

6.197 The Inspector-General therefore makes the following recommendation:

Subsidiary recommendation 6.4

The Inspector-General recommends that any new arrangements for administering the formal test case program should involve making publicly available to taxpayers an annual report on the operations of its processes for funding cases. This report should at a minimum contain the following:

  • an annual assessment of the degree to which test cases funded by the relevant body have achieved the aim of law clarification;
  • details of the extent to which the budget for test cases has been spent; and
  • details of the number of test case applications made, the number granted and the number rejected, with broad details of the reasons for the rejections.

Tax Office response

6.198 Agreed

6.199 We will make publicly available the details of funded cases in our Annual Report, or some other publication.

Other taxpayer concerns with the Tax Office's practices for funding cases

6.200 A number of other concerns have been raised about the present Tax Office funding arrangements for cases. These concerns are discussed below.

Should Tax Office funding be extended to cover all cases where the Tax Office appeals against a court or tribunal decision?

6.201 The 1993 JCPA report which led to the establishment of the formal test case program also contained a recommendation that the Tax Office should fully fund the taxpayer's expenses in all cases where the Tax Office has been unsuccessful at any stage of litigation and decides to appeal the relevant decision. This recommendation was made principally because of the perceived mismatch between the limitless nature of Commonwealth legal resources and those which are available to ordinary taxpayers.

6.202 The Inspector-General considers that it is inappropriate in many cases for the taxpayer to bear any further costs where they have won any stage of a case but the Tax Office then decides to appeal that case.

6.203 The current structure of the Tax Office's arrangements for funding cases means that there is at least one significant group of cases which receive no funding. These are cases which a taxpayer commences and wins in the Federal Court but which the Tax Office then takes on appeal to the Full Federal Court.

6.204 In the Inspector-General's view, cases of this nature should be at least subject to the same types of funding rules as apply to appeals made by the Tax Office from decisions that have been made in the taxpayer's favour at the AAT. This type of funding would be similar, in effect, to the orders that the Full Federal Court made in the time when appeals to that Court could only be made with the leave of that Court.85

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

Key finding 6.10

The Tax Office's funding of cases does not presently extend to all cases where the Tax Office appeals against a court or tribunal decision in relation to Part IVC litigation matters.

Key recommendation 5

The Tax Office should fund taxpayers' expenses in defending the case in all cases where the Tax Office has been unsuccessful at any stage of litigation, a decision is made to appeal the relevant decision and it is fair and in the public interest for the Tax Office to fund the taxpayer's expenses. The Tax Office should develop and publicise appropriate guidelines for the funding of such cases.

Tax Office response

6.206 Agreed in principle where it is fair and in the public interest to do so, and the test case program does this.

6.207 At present, the Tax Office funds the costs of taxpayers in small claims where the Tax Office appeals a decision of the Administrative Appeals Tribunal or Small Taxation Claims Tribunal to protect small taxpayers from the costs of court litigation. Considerations of capacity to pay are relevant to this practice.

6.208 The Tax Office has also established the Test Case Funding Program to fund cases where it is fair and in the public interest to do so. We will review the Test Case funding criteria in consultation with others to determine whether the capacity to pay should remain a factor, and whether the other factors clearly reflect the requirements of fairness and the public interest.

Inspector-General's comments on Tax Office response

6.209 The Inspector-General welcomes the Tax Office's acceptance of this recommendation. However, the Tax Office's response also refers to the test case funding program when this recommendation and the report's finding leading up to this recommendation indicate that the recommendation is dealing with cases funded under the Tax Office's other funding practices.

Should funding for AAT and other appeals be extended to tax avoidance cases?

6.210 Tax avoidance cases are currently expressly excluded from the processes for funding AAT cases which the Tax Office appeals.

6.211 A number of submissions to this review asserted that there should be no express exclusion of tax avoidance cases from the AAT adverse appeals program. These submissions claimed that there was no reason to deny funding in these types of cases. This was because a decision in the taxpayer's favour in this type of case means that an independent body has found that taxpayer's case does not involve tax avoidance.

6.212 On the other hand, some submissions noted that there were arguments against the AAT adverse appeals program being extended to tax avoidance cases. For example the Commonwealth Ombudsman in its submission stated:

We can also understand the rationale underlying the setting in the ATO guidelines:

  • If successful in asserting there was no avoidance, the taxpayer can seek funding in the form of a costs award or possibly by retrospectively applying to the ATO for the grant of test case funding;
  • If unsuccessful, it would generally appear contrary to the public interest for the ATO to provide funding to a taxpayer who has been found to have engaged in tax avoidance behaviour.

6.213 The Inspector-General considers that a taxpayer should receive assistance for the cost of any appeal of the Tax Office if an independent tribunal has determined that the case does not amount to tax avoidance.

6.214 The Tax Office's acceptance of key recommendation 5 and subsidiary recommendation 6.5 below would mean that tax avoidance cases like Sleight86 (which was won at the first instance by the taxpayer) would qualify for Tax Office funding during all subsequent appeal stages if it was fair and in the public interest to fund such a case.

6.215 The above comments lead to the following key findings and recommendation:

Key finding 6.11

Taxpayers who are involved in a case involving alleged tax avoidance do not generally receive assistance for the cost of any appeal of the Tax Office if an independent tribunal has determined that their case does not amount to tax avoidance.

Subsidiary recommendation 6.5

The Inspector-General recommends that the current exclusion of tax avoidance cases from the AAT adverse appeal funding arrangements be removed. The Tax Office should develop guidelines which allow funding for the costs of an appeal to be provided to taxpayers in cases involving alleged tax avoidance where the AAT determines that there was no such tax avoidance, the taxpayer wins their case and the Tax Office appeals against that AAT case to the Federal Court.

Tax Office response

6.216 Tax avoidance cases will not be automatically excluded where it is fair and in the public interest to fund an appeal.

Tax Office's use of the term 'test case'

6.217 During the review, the Inspector-General noted that the Tax Office has used the term 'test case' in a number of different ways in its communications to taxpayers both generally and individually.

6.218 In some public statements, it has used the term to apply to any case which is being litigated in the courts whose outcome may affect more than one taxpayer. In a second set of statements it has used the term to refer to cases that have been funded under the formal test case program. In a third group of statements it has used the term to refer to cases which have been funded, but not under the test case program. In a fourth group of statements it has used the term to refer to a case which has been funded by a private sector organisation which is acting on behalf of a number of taxpayers.

6.219 These diverse uses of the phrase 'test case' have had a number of adverse consequences.

6.220 Firstly, taxpayers can assume that where the Tax Office has described a case as a 'test case', the Tax Office will apply the result of the case to all cases with similar facts. This misconception can particularly arise where the Tax Office advises individual taxpayers in writing that their current dispute with the Tax Office has been held over because it is dependent on the outcome of a test case.

6.221 One means of overcoming this misconception would be for the Tax Office to refrain from calling any case a 'test case'. This suggestion was made in one submission.

6.222 Another means of addressing this problem is for the Tax Office to refer to any case whose outcome may affect other cases as a 'leading case' or a 'representative case' rather than a 'test case'. The Aggressive Tax Planning area of the Tax Office has adopted these terms in some, but not all, of its correspondence with taxpayers.

6.223 The term 'test case' is however widely used outside a tax context and its use cannot therefore easily be curtailed or substituted. Furthermore, the Tax Office cannot readily abandon this term while it is involved in a program which is called the test case litigation program.

6.224 An alternative suggestion is as follows. The Tax Office could clearly explain to any taxpayer whose case is being held over because of a 'test case' that the result of that other case may not resolve the taxpayer's particular dispute. This is because the other 'test' case may be decided on a technicality or because the court's ultimate decision may depend on the presence of facts in the test case which are not present in the taxpayer's case.

6.225 The second misconception that can arise from the use of the term 'test case' arises where the Tax Office refers to a 'test case' and also states that the case has been 'funded'. Taxpayers can assume that this means that the Tax Office has funded the case when another third party has actually provided the funding. This can lead to perceptions that the Tax Office is funding more test cases than it is actually funding.

6.226 This misconception may be overcome by the Tax Office refraining from referring to any test case as a funded case unless it has been responsible for funding the particular stage of the case which is being referred to. This suggestion is also consistent with the Tax Office's obligation not to disclose directly or indirectly any aspect of the private affairs of taxpayers.

6.227 Thirdly, taxpayers can assume that, where the Tax Office has referred to a test case which has been funded, not only has the Tax Office funded that case but it has done so in accordance with its formal test case program.

6.228 Once taxpayers have made this assumption, they may then assert that the Tax Office is not consistently applying the criteria it has developed for its test case program. This situation will arise where certain features of this funded 'test case' seem to disqualify it from funding under the formal test case program.

6.229 The Budplan case, which involved a mass marketed tax effective investment, and was not funded under the formal test case program, is one case where taxpayers have made these types of assertions. Claims have been made that this case should not have been funded for at least one of two reasons. Firstly, the scheme should not have been funded because it involved tax avoidance and tax avoidance cases are not generally funded under the program. Secondly, it is asserted that the case should not have been funded because it was not sufficiently representative. This was because the Budplan scheme involved research and development expenditure while the majority of MMTEI schemes involved agricultural or franchise projects.

6.230 The above findings lead to the following key finding and recommendation:

Key finding 6.12

The Tax Office has used the term 'test case' in a number of different ways in its communications to taxpayers both generally and individually. This has led to taxpayers in a number of cases making the following incorrect assumptions:

  • that the Tax Office will apply the result of the case to their case and all cases with similar facts;
  • that the case has been funded by the Tax Office; and
  • that the Tax Office's funding of the case has been in accordance with the formal test case program.

The last of these assumptions has added to taxpayers' concerns that the test case program is not being applied consistently.

Subsidiary recommendation 6.6

The Tax Office, when describing a case as a test case or leading case in any communication whether to taxpayers individually or to the public at large, should clearly indicate:

  • whether it has funded the case and if so, its reasons for funding the case;
  • whether or not the case is expected to determine the tax disputes of taxpayers in similar circumstances;
  • if the case is expected to determine other disputes, the nature of the other disputes that will be determined by the case and the nature of disputes that the case is not expected to determine; and
  • that the above are subject to the actual findings of the relevant tribunal or court.

Tax Office response

6.231 Agreed in principle.

6.232 However, we will need to clarify our position with the Solicitor-General on possible issues around the secrecy provisions of the various tax laws.


70 Howland-Rose & others v Commissioner of Taxation (the Budplan case) (2002) 49 ATR 206.

71 Federal Commissioner of Taxation v Stone (2005) 59 ATR 50.

72 Joint Committee of Public Accounts, JCPA: Concerns about Tax Reforms, media release, 21 November 1995.

73 ATO Minute No: IGT 62-2005, dated 11 October 2005.

74 ATO Minute No: IGT 72-2005, dated 12 November 2005.

75 Australian Tax Office, Test Case Litigation Program, April 2005 at p 8.

76 (2002) 49 ATR 206.

77 Australian Taxation Office, Test Case Litigation Booklet, April 2005 p 2.

78 Just prior to finalisation of this review, the Tax Office has indicated that amounts spent on the program have been as follows: 1995/1996: $10,616; 1996/1997: $228,250; 1997/1998: $316,621; 1998/1999: $421,949; 1999/2000: $528,373; 2000/2001: $466,611; 2001/2002: $2,008,967; 2002/2003: $692,775; 2003/2004: $904,578; 2004/2005: $393,917.

79 ATO Minute No: IGT-18-2005, dated 27 June 2005.

80 The figures do not, for example, reflect the numbers shown in the National Tax Liaison Group Minutes for the meeting of 7 September 2005, available at www.ato.gov.au, which were publicly released on 26 March 2006.

81 See for example, comments by the National Tax & Accountants Association made on 13 August 1997, quoted in Weekly Tax Bulletin, August 1997.

82 Federal Commissioner of Taxation v Stone (2005) 59 ATR 50.

83 Comments prepared in October 2004 by the Tax Office in response to October 2004 paper by the Law Council on test case funding.

84 Gordon, M, 'Tax Litigation — does the Commissioner make a difference?' paper for the ATO Litigation Workshop, Melbourne Law School, University of Melbourne, 3 April 2004 p 20.

85 See for example, the conditions for leave to appeal by the Commissioner that were applied by the Full Federal Court in the case of Applegate v F C of T.

86 Federal Commissioner of Taxation v Sleight (2004) 55 ATR 555.