7.1 This Chapter examines the Tax Office's application of the outcomes of finalised court and tribunal decisions and recommends changes to the Tax Office's current approach to provide greater assistance and certainty to taxpayers.
7.2 An important aspect of the Tax Office's stated approach to litigation is to clarify the law. Law clarification provides greater certainty to the community in the administration of the tax laws and assists taxpayers to meet their tax obligations.
7.3 The Tax Office's approach to the application of outcomes may be found in a speech by then Second Commissioner Michael D'Ascenzo, where he states that:
… where our understanding of the law is shown to be wrong in a court decision, the Commissioner will either accept the outcome and reconsider the position taken in rulings; or in rare circumstances have the underlying technical issue tested in a different factual matrix; or in some cases will refer the matter to Treasury and Government for a possible change of the law.
7.4 The importance of providing certainty to taxpayers is reinforced in the Tax Office's draft internal legal service agreement, which provides that the Tax Office needs to ensure that:
- its cases are well prepared, and its arguments align with relevant precedential decisions and conform with Tax Office and Australian Government policies; and
- it is consistent in its approach to litigation and, where possible, that the outcomes from its litigation assist the community to comply with the law.
7.5 Submissions to the Inspector-General raised a number of concerns with how the Tax Office applies the outcomes of finalised court and tribunal decisions.87 These include that :
- the Tax Office makes selective use of precedent; and
- the Tax Office does not clearly communicate to taxpayers how it will apply a finalised court or tribunal decision.
Stakeholder issues and concerns
7.6 There is a strong perception in the community that the Tax Office will often confine a case where the Commissioner has been unsuccessful to the facts of that case while attempting to broadly apply cases where the Commissioner has been successful. Taxpayers and their advisers refer to the cases of Budplan88, Vincent89, Essenbourne90 and Cooke and Jamieson91 as evidence of where the Tax Office has applied the outcomes of finalised court or tribunal decisions differently depending on if the Tax Office agrees or disagrees with the decision. Submissions noted that:
… there is a perception that where the Tax Office disagrees with a decision of the court, the Tax Office distinguishes the decision on its facts and where they agree with the decision, they try to apply the decision as widely as possible. The reason for this perception is that the Tax Office is very willing to make media statements where they get a favourable decision and provide a wide interpretation of the consequences of such a favourable decision, meanwhile the Tax Office appear silent on decisions that are unfavourable to it and if pressed, state that the decision turns on its facts and by inference does not have a wide application.
7.7 Submissions suggest that the Tax Office should be more objective in how it handles favourable and unfavourable court decisions.
7.8 It has been further suggested that the Tax Office is reluctant to depart from a view expressed in a ruling notwithstanding case law contrary to that position. There is a perception amongst many tax professionals involved in litigation with the Commissioner (based upon observation) that there are marked inconsistencies in relation to various matters concerning tax litigation and the settlement of such matters.
7.9 Legal practitioners have also expressed concerns that public rulings are attributed a higher authority than warranted with an undue adherence by the Tax Office to rulings, even where it is inappropriate.
7.10 A submission from legal practitioners notes that it has been the experience of legal practitioners that, not infrequently, Tax Office staff regard the Tax Office as bound by the language of the rulings and will not countenance any argument that the ruling is inconsistent with the statute, or with prior authority, or that it has been overtaken by subsequent decisions or legislative amendments. The submission suggests that there is:
… a tendency in litigation to adhere to the views expressed in rulings even where such views cannot respectably be defended: either because they are logically deficient in a manner revealed by the issues in the litigation, or because they have been shown to be wrong by subsequent decisions of the courts or tribunals. There is a tendency to cleave to the language of the ruling regardless, until it is withdrawn or replaced by another ruling.
7.11 The Taxation Institute of Australia also raised as a concern the Tax Office's reluctance to follow case law precedents in circumstances where the precedent has been established against an argument put forward by the Tax Office. It submits that whilst each case turns on its own merits, there is reluctance on the part of the Tax Office to apply precedents in a fair and consistent manner.
7.12 As an example, the Taxation Institute refers to the Tax Office's response following the High Court's refusal to grant the Commissioner of Taxation special leave to appeal the Part IVA issue arising from the Full Federal Court decisions in FCT v Metal Manufactures Ltd92 and Eastern Nitrogen Ltd v FCT.93 It is submitted that notwithstanding these precedential decisions, the Tax Office continued to contest similar sale and leaseback arrangements long after the High Court's refusal to grant special leave.
7.13 The Ombudsman considers that stakeholder concerns with the Tax Office's use of judicial proceedings and finalised tribunal decisions are issues capable of being addressed — at least in part — by the terms of Legal Services Directions and the model litigant principles, as well as the tribunal or judicial processes.
7.14 The Ombudsman is of the view that Tax Office personnel will feel compelled to defer to counsel, to some degree, in relation to decisions to frame argument and cite precedent. The Ombudsman considers that, given the ability of the tribunals and courts to draw their own conclusions about the efficacy and utility of the use of precedent, they are well positioned to sanction egregious or blatant attempts at their misuse. The Ombudsman stated that he is not aware of any such instances in tax litigation in recent years.
Tax Office procedures to consider implications of tribunal and court decisions
Key finding 7.1
Overall, the review found that the Tax Office, through the use of strategic internal litigation committees and the preparation of case summaries and adverse decision reports, has in place procedures to consider the implications of tribunal and court decisions on the Tax Office view.
7.15 Immediately following a decision being handed down in a litigation matter, the Tax Office procedures require that a number of Strategic Internal Litigation Committees (SILCs) be convened including a decision SILC, a post-decision SILC and, if relevant, an appeal SILC.94 There is evidence of these procedures being followed in the examination of case files.
7.16 There is no current corporate document outlining the Tax Office's procedures for managing finalised court and tribunal decisions. However, the Tax Office is in the process of preparing draft Practice Statement PS LA 2005/D111 on this topic. The Tax Office has yet to finalise this Practice Statement for use by staff or public release but similar procedures are already in place. These procedures are contained in previous litigation manuals, instruction sheets and service agreements and continue to be followed by staff conducting litigation.
7.17 This draft practice statement sets out requirements for managing finalised court and tribunal decisions and outlines the purpose of each stage of the Tax Office's procedures. It also provides that any necessary action requiring consideration of the implications of the decision must be identified and responsibility allocated for each necessary action. The identified risks and the person responsible for managing each of those risks are required to be set out in the Adverse Decision Report. The person responsible for managing the risk is required to maintain the responsibility after the litigation is finalised, unless and until any formal escalation process alters the responsibility.
7.18 The finalised Adverse Decision Report is the corporate record of the decision making process and will include the decision on whether an appeal is to be lodged. All finalised Adverse Decision Reports are maintained on the Tax Office's intranet and made available to other staff involved in litigation.
Finding a balance between competing objectives
7.19 In examining the concerns raised by stakeholders it is important to recognise that taxpayers are operating in a self assessment environment.
7.20 Self assessment requires taxpayers to perform certain functions and exercise certain responsibilities in complying with their taxation obligations. As such, Australia's system of self assessment for income tax relies on the principle of voluntary compliance and taxpayers (or their advisers) having a good understanding of the taxation laws in order to meet their obligations. This has placed more responsibility on taxpayers and their advisers to correctly interpret the law.
7.21 This has also meant that taxpayers are more reliant upon the Tax Office to provide summarised, understandable statements that taxpayers may rely upon.
7.22 The Tax Office accepts the importance of this advising role and acknowledges that, as the administrator of tax laws, it must operate as a trusted authority on the law and a professional adviser and educator, ensuring that people have the information and support needed to meet their obligations.95
7.23 It is important to appreciate that the Inspector-General is not able to stand in the shoes of the Commissioner of Taxation and determine how the Tax Office should respond to particular court and tribunal decisions. This means that it is not possible for the Inspector-General to comment on how the Tax Office should have applied the outcome of a particular court or tribunal decision. However, in the Inspector-General's view the Tax Office's current approach in the application of finalised court and tribunal decisions has not supported its aspiration to be seen by the community as the 'trusted authority on the law'. It is clear from submissions and through the Inspector-General's own examination of case files, that there is a need to improve both the timeliness and objectivity of the Tax Office's approach following a court or tribunal decision.
7.24 In the Inspector-General's view the Tax Office's current approach following litigation has been primarily focused on managing the consequences of the decision on the perceived compliance risks and its impact on the Tax Office's view. The Inspector-General believes that the Tax Office's approach must better balance the need of the community to be provided with objective and timely guidance on the operation of the tax laws in a self assessing environment and the need of the Tax Office to manage compliance risks resulting from an unfavourable decision. It has been the absence of such a balance in the Tax Office's approach that has contributed to the perception amongst taxpayers, tax practitioners and legal practitioners that the Tax Office is selective in its use of precedent.
Key finding 7.2
There is no clear statement on the Tax Office's philosophy and approach in applying and communicating to taxpayers and the community the outcome of finalised decisions.
Subsidiary recommendation 7.1
The Tax Office should include, in its comprehensive published policy or guidelines on tax litigation, its philosophy and approach in applying and communicating to taxpayers and the community the outcome of finalised decisions.
Tax Office response
Subsidiary recommendation 7.2
The Tax Office's philosophy and approach in applying and communicating to taxpayers and the community the outcome of finalised decisions should be consistent with its role of administering the tax laws in a fair, timely and cost effective manner, consistent with the rule of law.
Tax Office response
Communication of finalised court and tribunal decisions to taxpayers and their advisers
Key finding 7.3
The Tax Office internally considers the implications of a finalised court or tribunal decision. However, it does not provide taxpayers with timely guidance on how it will apply all finalised court and tribunal decisions to assist taxpayers operating in a self assessment environment.
7.27 The Tax Office has stated that an important aspect of its litigation strategy is to clarify the law and provide guidance to taxpayers and their advisers so as to assist them to voluntarily comply with the taxation laws.
7.28 Currently, the method and manner of communication of the Tax Office's view on finalised court and tribunal decisions is ad hoc and not uniform. In many cases, including those heard by the Federal Court, Full Federal Court and High Court, which involve a question of law, there is no statement by the Tax Office on the implications of the decision on the Tax Office view. Where there is a statement there is no uniform approach; for example, it could be by way of a brief media release, by an announced review of a ruling, by a subsequent change in a ruling (but this may occur one year after the adverse decision, for example as in Ryan96), by a communication directed at a specific industry or forum or by a comment on the Tax Office's website, such as in the case of McNeil.97
7.29 At times the Tax Office will issue a media release to inform the community at large of the Tax Office's response to a court decision, as was done in the cases of Essenbourne, Metal Manufactures and Eastern Nitrogen. Tax and legal practitioners have strongly submitted that media releases alone, which are often focused on producing a compliance response, are inappropriate to convey to taxpayers and their advisers the implications of a court or tribunal decision on the Tax Office view.
7.30 However, this review has found that on most occasions there is little or no response by the Tax Office on the impact that a finalised court or tribunal decision will have on the Tax Office view.
7.31 The Inspector-General finds that this is an unsatisfactory situation for taxpayers and their advisers, especially given that the Tax Office is aware of the impact that a finalised decision may have on the Tax Office view. For example, prior to a case proceeding to hearing, the Tax Office, through the SILC process, will consider why the case should be litigated and the possible impact the case may have on the Tax Office view. Where a case may have an impact on the Tax Office view, because the case is considered to be significant and involves a priority technical issue, then the Tax Counsel Network will also be involved in the course of the litigation. The Tax Counsel Network is the sole arbiter of the Tax Office view on technical issues arising in litigation and also ensures that cases are prepared and presented in a way that best enables the Tax Office view to be presented to the court or tribunal.
7.32 The implications of a court or tribunal decision are also considered following a decision being handed down. This would occur at the Decision SILC, the Post Decision SILC and, if relevant, at the Appeal SILC. Furthermore, as part of the Case Summary and Adverse Decision Report process (as outlined in Appendix 10), consideration must be given to the policy implications or wider risks flowing from the decision and the potential significance of the case. The Adverse Decision Report must also set out the recommendations from the Tax Counsel Network, external counsel and the Legal Services Branch officer on whether the decision should be appealed. These recommendations will often set out the impact of the decision on the Tax Office view and the consequences if the decision is not appealed, for example, that a Taxation Ruling or Determination will need to be reviewed or withdrawn.
7.33 Where litigation is commenced in the AAT then only questions of law give rise to an appeal to the Federal Court. Where litigation is commenced in the Federal Court there is a general right of appeal to the Full Federal Court. Special leave is required for an appeal from the Full Federal Court to the High Court. This means that by their very nature appeal cases may involve important questions of law of significance to taxpayers and tax practitioners. However, even for such cases there is often no publicly available response on why the Tax Office proceeded with the appeal, the outcome of the appeal, the implications of the decision on the Tax Office view and how the Tax Office will apply the decision.
7.34 Notwithstanding the multi-stage consideration within the Tax Office of the impact that a court or tribunal decision may have on the Tax Office's view, there is no publicly available Tax Office response to assist the community in complying with its taxation obligations.
7.35 In light of the above comments, the Inspector-General makes the following recommendations:
Subsidiary recommendation 7.3
The Tax Office should communicate, in a summarised form, its view of the application of all finalised court and tribunal decisions that involve a question of law within eight weeks of the date of the decision. By implication, this will include all finalised decisions considered by the Full Federal Court, the High Court and by the Federal Court on appeal from the Administrative Appeals Tribunal.
Tax Office response
7.36 Agreed in principle. However it may not be logistically possible to do so within eight weeks in all cases. For example, some may require longer consideration (and consultation) where the possible application to other cases is unclear.
Subsidiary recommendation 7.4
The Tax Office should also communicate, in a summarised form, its views of the application of all other decisions within similar timeframes, where it involves a priority technical issue or there is significant community interest in the outcome of the court or tribunal decision.
Tax Office response
7.37 See response to subsidiary recommendation 7.3.
Objectivity of communication of finalised court and tribunal decisions
7.38 Taxpayers and their advisers have identified a number of finalised cases where, in their opinion, the manner in which the outcome was communicated suggests an absence of objectivity by the Tax Office. They point to the Tax Office's approach of releasing a public statement, where there is a decision adverse to the Tax Office view, stating that the decision is confined to the particular facts of the case and will therefore not be widely applied. They also point to other cases, where the Tax Office has been successful, where the Tax Office has sought to broadly apply the decision with no comment that each tax case is to be decided on its facts. These finalised cases include Budplan (Howland-Rose & Ors), Vincent, Essenbourne and Cooke and Jamieson. The Inspector-General's examination of these cases and the Tax Office's handling of them validate community perceptions.
7.39 The Tax Office states that:
… the decision in a case sometimes depends on the facts of that case rather than a particular interpretation of the law. Where this is the case the application of the decision is, of course, limited to similar fact situations. This does not involve a failure to apply a decision but, rather, a recognition that the decision is of limited application.
7.40 Following the Federal Court decision in the Budplan case, the Tax Office stated that:
… today's decision confirms arrangements typically employed in mass marketed tax schemes in an attempt to artificially create tax deductions do not succeed.
This is a great result for the Australian community because it protects our revenue system from the serious threat posed by mass marketed schemes.
Following today's decision, we will be shortly writing to all mass marketed scheme investors with full details of the settlement offer announced on 14 February 2002.
This offer gives investors caught up in these arrangements, often as a result of unscrupulous practices by promoters, the opportunity to put this matter behind them in a fair way.98
7.41 In a similar vein, in Vincent the Tax Office publicly stated that:
… in a strong decision, Vincent v. Commissioner of Taxation, the Federal Court has again confirmed that arrangements typically employed in these schemes, in an attempt to artificially create tax deductions, do not succeed.
Once again, this is a positive result for the Australian community.99
7.42 In both these instances the Tax Office has made broad statements regarding the application of these decisions with no publicly available information on how these decisions have widespread implications for other schemes given the factual nature of tax cases.
7.43 In respect of Vincent, the Tax Office in its media release did not also inform taxpayers and their advisers that the Full Federal Court did allow the taxpayer's appeal in respect of the 1994/1995 year as the Tax Office was outside the four year period allowed under the general amendment provisions and could not rely upon Part IVA. This aspect of the Vincent decision had potential widespread implications to not only other taxpayers who had participated in arrangements similar to Vincent but also other arrangements where the Tax Office was outside the four year amendment period and was relying upon Part IVA to deny deductions.
7.44 The Tax Office did subsequently mention that the Court in Vincent allowed the appeal in the 1994/1995 year on its website in a summary of court decisions in mass marketed scheme cases.
7.45 However, it did not provide any further details of the potential implications of the Vincent decision to other taxpayers. This is despite the Tax Office having considered the implications of the Vincent decision as part of determining its response in the case and also having sought legislative amendments as a result of the Full Federal Court's decision in Vincent.
7.46 In Cooke and Jamieson, a case where the Tax Office appealed and was unsuccessful in the Full Federal Court, the Tax Office publicly stated that:
… the Tax Office sought special leave for matters requiring further legal guidance or where decisions had significant impact. Our view is that this decision does not have widespread implications for other schemes.100
7.47 Quite clearly, this is a decision that the Tax Office has confined to the particular circumstances of the case. The Inspector-General notes that by their very nature appeal cases may involve important questions of law of significance to taxpayers and tax practitioners. There is no publicly available information on what questions of law the Tax Office sought to test when appealing the decision at first instance, the outcome for each of those questions of law that formed the grounds of appeal and why the Tax Office was of the view that this decision did not have widespread implications.
7.48 In correspondence to this review the Tax Office has advised that it does not believe that these examples evidence systemic conduct on the part of the Commissioner to apply the outcomes of cases differently depending on whether he agrees or disagrees with the decision. However, the Tax Office has advised that it recognises that it can always improve in the area of communication.
Key finding 7.4
There are community perceptions that the Tax Office's communication of the implications of finalised decisions indicates an absence of objectivity in the Tax Office's approach in applying finalised court and tribunal decisions. Stakeholders suggest that the Tax Office has applied the outcomes of finalised court or tribunal decisions differently depending on if the Tax Office agrees or disagrees with the decision. The Inspector-General believes that these perceptions are justified.
7.49 In relation to Budplan (or Howland Rose & Ors)), the Tax Office has advised that this case was run not only as the lead case in the Budplan scheme, but as a test case to seek guidance on the application of the general anti-avoidance provision to round-robin financing involved in the Budplan scheme. The Tax Office has also noted in its response that this case illustrated, save for exceptional circumstances, the likely outcome for other participants and gave an indication of how the courts might treat other schemes with similar financing arrangements. The Tax Office has also advised that:
The taxpayers in Howland-Rose and Ors did not pursue appeals from the decision at first instance. No other participant subsequently ran another case on the same scheme to overturn the decision. No other case since has said that the Part IVA reasoning in Howland-Rose was wrongly decided. At no stage has the Commissioner said that Howland-Rose created precedent binding on other participants or other scheme participants.
7.50 In response to Vincent, the Tax Office notes that the Commissioner was successful in showing that the deductions were not available to the participants under the general deduction provision. The Tax Office also notes that the decision found that the six-year period for amending assessments under Part IVA cannot be relied upon where the claimed tax benefit is cancelled under the general provisions of the income tax law. The Tax Office advises that both the Commissioner and the taxpayer accepted the outcome and that the Commissioner accepted that part of the decision in Vincent that was adverse to him, and has at no stage sought to confine that aspect to its facts. The Tax Office has stated that where the claimed tax benefit is ultimately found to be 'cancelled' under the general provisions of the income tax law, Part IVA has no application because there was no tax benefit within the meaning of section 177C.
7.51 The Tax Office has also agreed that it could have been more specific in the March 2002 and May 2002 media releases referred to by the Inspector General, and has indicated that it will ensure in future that it articulates more clearly the reasons behind its decisions about how to apply the results of cases.
7.52 In response to Cooke and Jamieson, the Tax Office notes that the Full Federal Court upheld the original decision that expenses claimed by the taxpayers in relation to their investment in the Australian Horticultural Project (No. 1) were deductible under the general deduction provisions of the income tax law. Further, the Court held that the anti-avoidance provisions did not apply to disallow the deductions.
7.53 The Tax Office notes that this was the only investment scheme case where the Commissioner was wholly unsuccessful and that the Commissioner accepted this decision and applied it to all other affected participants in the scheme who had outstanding disputes before the Administrative Appeals Tribunal (AAT).
7.54 In its response to the remark that the Tax Office has sought to confine this case to its particular circumstances the Tax Office refers to the comments of Hill J, in considering the application of the decision in Cooke and Jamieson to the facts in Sleight, that 'decisions on Part IVA will, inevitably, turn upon the particular facts of the case'.
Improving confidence in the objectivity of the Tax Office's application of finalised decisions
7.55 In the course of this review submissions stated that, at times, the Tax Office does not apply the benefit of a decision as regards the particular taxpayer who has initiated the case where it believes that the decision is incorrect. The Inspector-General has found no evidence for these community perceptions.
Key finding 7.5
The Inspector-General found no evidence that the Tax Office does not give effect to the results of a litigated case as regards the particular taxpayer who has initiated the relevant case.
7.56 Stakeholders have also identified a number of finalised cases where, in their opinion, the Tax Office's approach suggests an absence of timeliness and objectivity leading to uncertainty amongst taxpayers and their advisers. Stakeholders have suggested that in these cases the Tax Office continues to administer the law as if the cases had not been decided. These finalised cases include Marana Holdings101, Metal Manufactures, Eastern Nitrogen and Essenbourne. Each of these is considered below by way of a case study examining the importance of the litigation for the Tax Office and its response following the court's decision. These case studies also consider how, in the Inspector-General's view, the Tax Office in responding to a court or tribunal decision could have achieved a more balanced approach and response.
7.57 Examination of these case files has confirmed stakeholder perceptions that the Tax Office's approach does not adequately balance the need of the community to be provided with objective and timely guidance on the operation of the tax laws in a self assessing environment and the need of the Tax Office to manage compliance risks resulting from decisions.
7.58 The Tax Office has previously stated that it has an ongoing commitment to the clarification of the law in a manner beneficial to the community. However, in the Inspector-General's view the Tax Office is not handling the application of finalised court and tribunal decisions in an objective and timely manner, as evidenced by its approach in these cases. More importantly, such an approach does not assist taxpayers nor provide them with greater certainty in the operation of the tax laws, particularly in a self assessing regime.
7.59 The Tax Office's approach in the handling of the application of the finalised decisions is contributing to the perceptions that the Tax Office is selective in its use of precedent. There is also a perception that the Tax Office is operating behind a veil of secrecy as to implications of finalised court and tribunal decisions. These perceptions are being further fuelled by the Tax Office's approach in issuing media releases and not fully explaining the impact of the decisions on Tax Office policy. This is despite the Tax Office having in place internal procedures to consider and discuss such implications.
7.60 In the Inspector-General's view a key contributor to these concerns and perceptions is the manner in which the Tax Office responds to court and tribunal decisions, in particular those adverse decisions that may impact on a public ruling or public determination, and its approach to communicating the outcome of court and tribunal decisions.
7.61 In the course of this review the Tax Office has also advised that the level of detail included in such a communication product will depend upon a number of factors. These include being able to discern the wider ramifications of a particular case, and a particular issue being referred to the Treasury for consideration of the policy implications of a finalised court or tribunal decision.
7.62 An examination of Marana Holdings, Metal Manufactures, Eastern Nitrogen and Essenbourne has also confirmed the concerns of stakeholders with the timeliness of the Tax Office's response where a finalised decision impacts a view expressed in a ruling, determination or interpretative decision.
Key finding 7.6
The Tax Office does not provide taxpayers with adequate and objective guidance on the application of all finalised court and tribunal decisions to assist taxpayers operating in a self assessment environment and, in some cases, continues to administer the law as if the decision did not apply.
Key recommendation 6
The Tax Office should introduce a standard communication product to communicate the application of finalised court and tribunal decisions. The content of any Tax Office communication should be consistent with its role of administering the tax laws in a fair and objective manner and could include for example:
- the issues to be decided by the tribunal or court;
- the implications of the decision on each of those issues;
- the implications of the decision on the Tax Office view;
- how the Tax Office will apply and follow the finalised decision;
- the reasons why the Tax Office will apply and follow the finalised decision in that manner; and
- whether the Tax Office will be seeking legislative amendments.
Tax Office response
7.63 Agreed in principle.
7.64 We will communicate to taxpayers the implications of adverse court and AAT decisions and significant court decisions. This will include impacts on any published views of the Tax Office, except where this is likely to mislead taxpayers.
7.65 While it would generally be inappropriate for the Tax Office to make its advice to Government public, we will further consult with Treasury as to whether it would generally be appropriate to advise that a matter has been referred to Treasury.
Inspector-General's comments on Tax Office response
7.66 The Inspector-General notes that where Government is considering legislative amendments the Tax Office should nevertheless communicate to the community that it is seeking legislative change or that the matter is with Government. This is important in promoting transparency in tax administration by providing guidance to taxpayers operating in a self assessing environment on the implications of a finalised court or tribunal decision.
Key finding 7.7
The Tax Office does not have appropriate processes and procedures in place to ensure that taxpayers are made aware that the Tax Office's view expressed in a public ruling, determination and interpretative decision may be impacted by a court or tribunal decision and that it is under review.
Subsidiary recommendation 7.5
Following a court or tribunal decision, the Tax Office should promptly make taxpayers aware that the Tax Office's view expressed in a public ruling, determination or interpretative decision may be impacted and that it is under review. It should include identifying the paragraphs that are potentially affected and providing guidance to taxpayers on how they should apply the law until the public ruling, determination or interpretative decision is formally amended or withdrawn.
Tax Office response
7.67 Agreed in principle.
7.68 However this could potentially mislead taxpayers in cases where the Government is considering legislative amendments. In these special cases, administrative common sense should prevail.
7.69 The Full Federal Court handed down its judgment in Marana Holdings Pty Ltd v Commissioner of Taxation on 25 November 2004 in favour of the Tax Office.
7.70 The Full Federal Court confirmed the first instance decision of Beaumont J and the general principles adopted by his Honour in concluding that the sale of a unit, which was previously a room in a motel, was 'new residential premises' and therefore subject to goods and services tax.
7.71 In considering the meaning of the terms 'reside' and 'residence', the Court held that both connoted a permanent or at least long-term commitment to dwelling in a particular place. The Court also considered the meaning of the term 'residential' implied long-term accommodation.
7.72 The Decision SILC considered the implications for the Tax Office view following the Full Federal Court's decision. It was noted at the Decision SILC that the decision, particularly the Court's discussion on the meaning of 'residency', would appear to be inconsistent with the position adopted by the Tax Office in GSTR 2000/20.
7.73 The Adverse Decision Report also noted that the Marana decision might have an impact on the treatment for GST of some units contained in hotel or motel premises where they are supplied by way of lease to an operator providing commercial accommodation. It went on to note that:
… in the past input tax credits have been denied to some purchasers of such units because the premises were considered to be residential premises when leased to the operator. Applications for input tax credits in such cases are expected.
7.74 Concurrent with the Marana litigation in the Full Federal Court, the Tax Office also received a number of objections and applications for review in the Administration Appeals Tribunal on similar issues to those decided in Marana. This included applications for input tax credits by taxpayers in similar circumstances to those described in the Adverse Decision Report.
7.75 In each of the applications for review in the Administrative Appeals Tribunal the Tax Office maintained its position as set out in GSTR 2000/20, namely that the premises were 'residential premises' and no input tax credits were claimable. Following the Marana decision the Tax Office conceded the applications for review in the Administrative Appeals Tribunal, allowing the claim for the input tax credit in full. However, tax officers were instructed not to provide reasons to the taxpayers regarding the grounds that the Tax Office was conceding these cases.
7.76 In relation to conceding these cases, the Tax Office advises these cases were conceded prior to the February 2005 Rulings Panel. The principles relied on to concede those cases were not agreed to by the February Panel. It was subsequently decided that the decision to concede those cases was consistent with the current rewrite of the ruling. This meant that the decision to concede those cases was maintained, however on a different, and still non-communicated, basis.
7.77 External stakeholders at a number of National Tax Liaison Group (NTLG)-GST Subcommittee meetings, have also raised concerns with the Tax Office's handling of the Marana decision. A key issue of concern has been the impact of the Marana decision on the Tax Office's view expressed in GSTR 2000/20.
7.78 At the NTLG-GST Subcommittee meeting held on 1 June 2005, members noted that the Tax Office had not added information to the external website or within GSTR 2000/20 that the ruling was under review. This related to an earlier request by members of the NTLG that the Tax Office advise taxpayers that GSTR 2000/20 was currently under review. The Tax Office advised that it would update its external website and GSTR 2000/20 as a matter of priority. At the time of this report, the Tax Office had yet to provide such an update.
7.79 The Tax Office advises that the rewrite of GSTR 2000/20 has been to the Rulings Panel in December 2004, February 2005 and June 2005 and out of session following the June meeting. The Tax Office also advises that an update on the rewrite of GSTR 2000/20 has been a standing item of the NTLG-GST Subcommittee.
7.80 The Tax Office also notes that there have been assertions that it is not applying the law in accordance with the decision in Marana. In answer to this it states that:
... it should be remembered that Marana Holdings dealt with a particular factual situation and the time taken to rewrite the Ruling has taken into account the application of a principle to a particular set of facts by way of analogy to different sets of facts. The effect of the Decision is wide ranging and its application had to be considered in relation to hotel rooms, serviced apartments, display homes, holiday homes, retirement villages and nursing homes. Certain issues in relation to retirement villages and nursing homes have been long running and there have been a number of dialogues with the Assistant Treasurer.
7.81 The Tax Office has also advised that it has sent to Treasury a copy of the draft rewrite and an explanation of the approach to be taken. This summarises the advantages and disadvantages of the proposed approach in relation to embedded tax, physical characteristics, participation in the GST system, increased compliance, possible structuring of arrangements, agency arrangements and interaction with specific issues relating to retirement villages and nursing homes.
7.82 On 27 February 2006 the Minister for Revenue and Assistant Treasurer announced that the Government will amend the GST law to remove uncertainty in relation to the GST treatment of some types of real property. In a press release announcing the change, the Minister said that:
The decision of the Full Federal Court in the Marana Holdings Pty Ltd v Commissioner of Taxation  FCAFC 307 case has resulted in a blurring of the lines between properties that are subject to GST and those qualifying for input taxed treatment.
The Government will amend the GST law to continue the tax treatment of property that existed prior to the Court's decision.
It is appropriate that supplies involving properties such as serviced apartments and strata units leased to hotel operators remain input taxed. This is consistent with the Government's policy intent and will avoid the need for many small investors to register for the GST.
The amendments will apply from 1 July 2000. As this measure affects the GST revenue base, it will be subject to the unanimous approval of the States and Territories, which receive the GST revenue.
7.83 On 28 February 2006 Justice White of the NSW Supreme Court in the case of Toyama Pty Ltd v Landmark Building Developments Pty Ltd (2006) NSW SC 83 (Toyama) applied the Marana decision to determine whether a supply of land was a taxable supply or input taxed residential premises.
7.84 The Inspector-General notes that his Honour in Toyama rejected the Tax Office's approach in paragraph 19 of the GSTR 2000/20 regarding the extent to which the intended use of premises by a purchaser is relevant to determining whether the sale of those premises is subject to GST.102 To date, there has been no public response by the Tax Office on the implications of this court decision on its view on this issue and how it will administer the tax system going forward, including whether it will be seeking to test this issue in another case. In this case the Tax Office was not a party to the proceedings. The Solicitor-General's opinion contained in Appendix 4 indicates that it would be open for an agency, where they were not a party to the proceedings before a lower court, to depart from existing judicial decisions to produce a further test case seeking to overturn those decisions and uphold the agency's view as to the correct legal position.103
Tax Office's approach post-Marana decision
7.85 In the Inspector-General's view the Tax Office's approach in handling the application of the Marana decision was unsatisfactory on a number of grounds.
7.86 Firstly, notwithstanding numerous requests by external stakeholders of the NTLG-GST Subcommittee to advise taxpayers, by way of information on its external website or within GSTR 2000/20 that the ruling was under review, there is no evidence that this occurred.
7.87 Secondly, there was no information provided by the Tax Office on the potential implications of the Marana decision on the Tax Office view. Such information was available within the Tax Office as the review of GSTR 2000/20 was under way prior to the first instance hearing of Marana, and the broad implications of the Marana decision were considered during the Decision SILC and in the Adverse Decision Report.
7.88 Thirdly, the Tax Office has advised that until GSTR 2000/20 is reviewed and replaced a tax officer must follow the view espoused in the current ruling without considering the implications of the Marana decision. This has meant that taxpayers that have lodged objections where the application of the Marana decision would provide them with a favourable outcome have been requested to consent to their objection being held in abeyance pending the broader review by the Tax Office.
7.89 The Tax Office has advised that where a public ruling is shown to be wrong by a court case or the Tax Office believes the public ruling to be incorrect or inconsistent with the law, then there is a strict internal process that needs to be followed to have the public ruling amended or withdrawn. The Tax Office agrees that when it needs to review and restate its views following decisions of courts and tribunals, it is desirable that this be done in a timely way. However, the Tax Office states that:
…given the importance of the reformulated views that are to be relied upon by the community, it is important that the Commissioner follow a robust process in reviewing his precedential decisions. This can sometimes take time. Dealing with issues promptly is an ideal which the Commissioner seeks to aspire to. There are times when it takes some time for the implications of decisions to be properly considered, analysed and applied. It is therefore preferable for taxpayers to wait until we have come to a final view about the law.
7.90 The Tax Office has also advised that if it was required to decide these objections prior to GSTR 2000/20 being replaced, then the objections would be disallowed regardless of the fact that applying the court decision in Marana would mean that the taxpayers would be entitled to the input tax credits. This is despite a number of objections being received from a class of taxpayers in similar circumstances to those that the Tax Office conceded in the course of litigation in the Administrative Appeals Tribunal.
7.91 The Tax Office advises that in such circumstances, taxpayers are asked to sit back and wait until it can properly reformulate its view of the law and/or the matter is considered by Treasury and/or the Government. The Tax Office also states that those taxpayers are also given assurance that they will be compensated in the event of a favourable decision by the payment of interest on tax that is overpaid.
7.92 In the Inspector-General's view this is an unsatisfactory outcome for taxpayers and the community. The Inspector-General acknowledges that a court or tribunal decision may have broader implications on the Tax Office view than merely the issue considered in the particular decision. This is the case with Marana with the Full Federal Court's decision potentially having an impact on the Tax Office's view with respect to a variety of other issues such as the possible structuring of arrangements, agency arrangements and the interaction with specific issues relating to retirement villages and nursing homes. The Inspector-General also acknowledges, and considers it appropriate, that the reformulation of a public ruling will be subject to internal review processes and also subject to advice being sought from Government, counsel and the community.
7.93 However, where the Tax Office can readily identify how a decision, as in Marana, will impact a particular class of taxpayers then taxpayers should not be expected to hold their dispute in abeyance indefinitely while the Tax Office determines the broader implications of a court or tribunal decision on the Tax Office view espoused in a ruling.
7.94 This approach does not take into account the uncertainty created within the community and potential additional compliance and economic costs where a taxpayer follows the current, though incorrect, Tax Office view that is then later revised.
7.95 In the Inspector-General's view there is a need for an urgent escalation process that will allow such disputes to be handled in a timely case-by-case basis where the decision is made in accordance with the law rather than with the ruling that may have been overtaken by subsequent decisions. This should operate concurrently with the Tax Office continuing to review and revise the broader implications of a finalised decision on the Tax Office view expressed in public rulings, determinations and interpretative decisions.
Key finding 7.8
The Tax Office does not have processes to ensure that objections or disputes on hand involving a public ruling, determination or interpretative decision under review as a result of a court or tribunal decision are handled and resolved in a timely manner, in particular where the decision provides a favourable outcome for taxpayers.
Subsidiary recommendation 7.6
Where the Tax Office can readily identify how a finalised court or tribunal decision will impact a particular class of taxpayers then taxpayers should not be expected to hold their objections or disputes in abeyance indefinitely pending lengthy Tax Office internal processes for amending or withdrawing public rulings, determinations or interpretative decisions.
Tax Office response
7.96 Agreed in principle but subject to the qualification referred to in the response to Subsidiary Recommendation 7.5 above.
Subsidiary recommendation 7.7
The Tax Office should implement processes to ensure that objections and disputes on hand involving a public ruling, determination or interpretative decision under review as a result of a court or tribunal decision are handled and resolved in a timely manner. This could require the resolution process being led by senior tax officers who are able to make a decision based on the current law (the law as interpreted by the courts) rather than the existing Tax Office view.
Tax Office response
7.97 Agreed in principle, subject to the qualification referred to in response to Subsidiary Recommendation 7.5.
7.98 We will review our processes to ensure a timely response to decisions, as appropriate.
7.99 In Taxation Ruling TR 99/5 the Tax Office expressed the view that contributions to an employee incentive trust would be subject to fringe benefits tax ('FBT') as a property or residual fringe benefit under the Fringe Benefits Tax Assessment Act 1986.
7.100 In Essenbourne, which involved an employee incentive trust, the Commissioner assessed Essenbourne on its payment of $252,000 as a property benefit or alternatively as a residual benefit. The Commissioner argued that the benefit arose from the provision of those monies to the trustee as an associate of the employees. The Commissioner submitted that it could not have been intended that a particular benefit provided to one employee could be taxable, but if it were provided to a number of employees it could not be. The taxpayer submitted that the definition of 'fringe benefit' required reference to a particular employee in connection with the benefit said to have been provided.
7.101 In her decision Kiefel J noted that:
The difficulty in the Commissioner's approach is that it does not identify a benefit to a particular employee. The statute may deem a benefit to be provided to an employee where it is provided to the employee's trustee, but this would not obviate the apparent necessity to identify the employee in question. The definition of 'fringe benefit' would appear to require the identification of the employee to whom the benefit is provided...
7.102 The Court held that FBT did not apply to this arrangement, as payment by Essenbourne to the trustee of the employee benefit trust did not qualify as a fringe benefit as defined by the Fringe Benefits Tax Assessment Act 1986.
7.103 Following the decision the Commissioner commented that:
In the Essenbourne case the Court held that an income tax deduction was not allowable for an amount contributed by a company to an employee incentive trust because the payment was simply a distribution of the company's profits to the three principals of the company.
In other words, the Court confirmed that the scheme was not tax effective.
The Court also held that Fringe Benefits Tax did not apply and that Part IVA would not have applied in the particular facts of this case.
Given the scheme was rendered ineffective by denying deductions claimed for the contributions, we saw no point in an appeal to the Full Federal Court.
However we do not accept that the Court's comments in Essenbourne on both Part IVA and the Fringe Benefits Tax were correct. We will be testing the application of those provisions in future cases.104
7.104 In a fact sheet released with the Commissioner's speech, and referred to in the NTLG minutes of 26 March 2003, the Tax Office stated that:
In relation to FBT, the Tax Office is of the view that the Court's construction of the FBT provisions is not correct and inconsistent with the Tax Office's understanding of the intent of the FBT law. However, the Tax Office considered that the Essenbourne case was inappropriate for clarifying the FBT law on an appeal to the Full Federal Court given the Court's finding that the contribution to the employee incentive trust was a profit sharing exercise of the three principals of the company.
As the Court's views about FBT in Essenbourne are not limited in their application to employee benefit trust schemes, it is the Tax Office's intention to seek clarification of the FBT law through litigation of other cases.105
7.105 A number of submissions have raised concerns with the Tax Office's refusal to follow aspects of finalised court decisions and contend that this is evidenced by the Tax Office's approach and response in Essenbourne. They contend that in this case the Federal Court has interpreted a taxation law in favour of the taxpayer, and the decision has not been appealed, yet the Commissioner administers the relevant taxation laws in a manner contrary to the Court's decision, expressly stating that he does not believe the Court decision was correct.
7.106 They contend that this case also demonstrates the Tax Office's selective use of precedent and, more importantly, the absence of a clear commitment by the Tax Office to the rule of law and a misunderstanding by the Commissioner of his role in the tax system, namely being charged with administering the tax laws as set out in various Acts.
7.107 Submissions by various stakeholders have expressed the view that unless and until the judicial interpretation is overridden by a superior court, or the factual situation can be distinguished, the judicial decision is the authoritative statement of 'the law' as it applies in that situation.
7.108 The Tax Office has also been questioned over its approach in Essenbourne at a number of NTLG meetings.
7.109 At the NTLG-FBT Subcommittee on 20 February 2003 the professional bodies requested the Tax Office to provide its view on Taxation Ruling TR 99/5 in light of the Essenbourne decision and the future of the ruling given that the Court rejected the interpretation applied by the Tax Office in Taxation Ruling TR 99/5.106
7.110 Members also expressed concern that the Tax Office's approach, namely to seek further litigation to clarify the FBT law following the Essenbourne decision, would take an unacceptably long time.
7.111 In response the Tax Office advised that it was of the view that the Court's construction of the FBT provisions was not correct and was inconsistent with the Tax Office's understanding of the intent of the FBT law.107 The Tax Office also advised that it would not be withdrawing Taxation Ruling TR 99/5 and that its views and opinions in that ruling would continue to be applied, notwithstanding the judgement of Kiefel J in Essenbourne.
7.112 At the NTLG meeting on 2 September 2003 the Tax Office was again requested to explain the legal basis on which it can administer interpretations of taxation laws that are contrary to 'the law' as stated by the courts. It was also put to the Tax Office that tax practitioners are struggling to understand how the Commissioner, who is charged with administering 'the law', can adopt and apply an interpretation that expressly conflicts with the law as stated by the courts. It was suggested that it was inappropriate that taxpayers were being issued with amended assessments, and charged GIC and penalties, when they have adopted an interpretation of tax laws upheld by the Federal Court and which one would think is therefore 'the law'.108
7.113 The Tax Office responded to the NTLG concerns.109 However, the Inspector-General has a number of concerns with this response and the assumed role of the Tax Office in how it applies the outcome of court and tribunal decisions.
7.114 Firstly, the Tax Office maintained that:
… a decision at first instance may not be appealed for reasons particular to the case (for example, the state of the evidence) or because the particular case is not thought to be an appropriate vehicle to test the issue. In these cases, the Commissioner will usually continue to adhere to his position until the matter is finally resolved in a more appropriate case.
7.115 The Inspector-General is of the view that this is an unsatisfactory outcome for taxpayers. It should be remembered that in tax litigation the taxpayer bears the onus of proving that the assessment was excessive. In a situation where the outcome of the case is adverse to the Tax Office, it would mean that the taxpayer has satisfied that onus. It is the Tax Office's responsibility to ensure that the state of the evidence would support an appeal. It would be inappropriate for the Tax Office not to apply and follow a finalised court or tribunal decision that is contrary to its stated view because of shortcomings in its evidence gathering during audit and objection.
7.116 The Tax Office response also did not provide any indication of what it would consider to be an 'appropriate vehicle to test the issue'. Some stakeholders have suggested that this may mean a case where the Tax Office is more certain that it will win. The Inspector-General is of the view that such an approach inappropriately places a greater emphasis on litigation achieving a compliance outcome for the Tax Office rather than clarifying the law. This seems to be confirmed by the Tax Office's response as to why it did not seek to appeal the decision, with appropriate test case funding to the taxpayer:
In Essenbourne the court held that the taxpayer was not entitled to a deduction for its contribution to an employee incentive trust. In essence, the court held that the payment was simply a means by which the three principals of the company could share profits of the business and at the same time claim tax advantages. Given the court's finding, the Tax Office therefore saw no point in appealing the court's decision that FBT was not payable particularly as the scheme was rendered ineffective by the disallowance of the deduction.
7.117 It would appear that having achieved its compliance outcome, namely to deny the taxpayer's claim for a deduction, the Tax Office did not wish to appeal the fringe benefit tax issue even though it did not agree with the Federal Court decision. The Tax Office also maintains that the particular case was not the appropriate vehicle to test the issue. In the Inspector-General's view this is again an unsatisfactory outcome for taxpayers.
7.118 Secondly, the Tax Office response stated that:
... where the Commissioner has an expressed position that is contested he may seek clarification of the law through the courts, sometimes in more than one test case. The Commissioner administers a test case funding program under which taxpayers are provided funding to assist them in the litigation of cases with precedential value. In such cases, as a general principle, the Commissioner applies the resulting interpretation of the law regardless of whether it is favourable to the Commissioner.
7.119 A submission for an association representing legal practitioners has noted that:
… while it is appropriate for the Commissioner, in Mr D'Ascenzo's words, to 'have the underlying technical issue tested in a different factual matrix' where the 'factual matrix' is properly distinguishable from that of the test case, it is not appropriate for the Commissioner, having abandoned or lost an appeal against an adverse decision, to recontest the same issue in a 'factual matrix' which is not properly distinguishable.
7.120 The Inspector-General notes that in Walstern Pty Ltd v FCT110, the Commissioner submitted that Kiefel J in Essenbourne v FCT wrongly held that the definition of 'fringe benefit' required that a particular employee be identified in connection with the benefit provided in order for such a benefit to be one that was provided by the employer to the employee or an associate of the employee in respect of the employment of the employee.
7.121 In response to the Commissioner's submissions Hill J stated:
As I have already noted, I would, as a matter of comity, follow the decision of Kiefel J in Essenbourne unless the case was either distinguishable or I was of the view that the decision was clearly wrong. On this point the case is not distinguishable. Further, far from being of the view that her Honour was clearly wrong, I am of the view that her Honour was clearly right.
7.122 In analysing the operation of the fringe benefit tax provisions, his Honour went on to observe that:
The definition of 'fringe benefit' in s 136(1) of the FBTAA makes clear the importance of identification of the employee. The benefit itself is one which is said to be 'in relation to an employee'. The benefit is required to have been provided to the employee (or associate of the employee) and is required to be in respect of the employment of the employee. The definition of 'property fringe benefit', (if that is the kind of benefit relied upon) requires relevantly provision of property to a particular person there referred to as 'the recipient'. The valuation formula relevantly here requires that there be a benefit provided 'to a person' in respect of the employment of an employee.
7.123 Following Walstern there have been further decisions where the Tax Office's view as expressed in Taxation Ruling TR 99/5 has been held to be incorrect. In Spotlight Stores Pty Ltd & Anor v FC of T111, Merkel J concluded that the taxpayer was entitled to succeed in its fringe benefit tax objection. In setting out his reasons for his conclusion, his Honour stated that:
In Essenbourne (at ATR 643 ; ATC 5214) Kiefel J concluded that the definition requires that for the benefit to be provided in respect of the employment of 'the employee', a 'particular employee' must be able to be identified in connection with the benefit. In Walstern (at ATR 440-441 -; ATC 5091-5092) Hill J agreed with Kiefel J's view. In the present case, it is clear that when the benefit (that is, the $15 million contribution) was provided it was not provided, whether to 'the employee' or to Spotlight Incentive as an 'associate' of 'the employee', in respect of the employment of any particular employee because the employees of Spotlight were not beneficiaries of the Incentive Trust at that time. The Commissioner contended that I should not follow Essenbourne or Walstern but I am not satisfied those decisions are clearly wrong and, accordingly, propose to follow them. It must follow that Spotlight is entitled to succeed in its appeal in relation to its FBT objection.
7.125 The Inspector-General observes that there are now four decisions of the Federal Court where it has been concluded that the definition of 'fringe benefit' in paragraphs 43 to 49 of Taxation Ruling TR 99/5 is incorrect. However, Taxation Ruling TR 99/5 has yet to be amended or withdrawn. Nor has the Tax Office made any public comment retracting its earlier held view that the decision of Kiefel J in Essenbourne is incorrect. As was noted in one taxpayer submission:
… tax officers are required to apply the Tax Office view contained in taxation rulings and other documents to any private ruling requests that come before them. Tax officers are required to apply the view espoused in paragraphs 45 to 49 of TR 1999/5 to private ruling requests and ignore the decisions of the Federal Court which are favourable to taxpayers.
7.126 On 28 February 2006 the Tax Office also announced that it would be writing to certain employee benefit trust participants advising them that it will be amending to nil the FBT liability in relation to their employee benefit trust arrangements.
7.127 The cases where the Tax Office will be amending the FBT liability are those where there is a high degree of judicial support for assessment of income tax, that is, for cases with facts similar to those considered by the courts in any of the Essenbourne, Kajewski114 or Spotlight/Pridecraft P/L cases. The Tax Office has stated that the courts in each of these cases have found income tax to be properly payable and hence there is minimal risk to the revenue from the Tax Office amending the alternative FBT assessments. The Tax Office has advised that up to 400 multiple assessment cases will be affected and its analysis to date indicates that there are about 200 certain cases with a further 200 potential cases where additional information will be sought prior to any amendment of the FBT liability.
7.128 While the Inspector-General welcomes the Tax Office's change in approach, he notes that this is only confined to instances where a taxpayer has not entered into a settlement with the Tax Office with respect to their arrangement and does not have any outstanding objections or appeals regarding the income tax adjustments. It does not represent a change in the Tax Office view regarding the Essenbourne decision and is intended to finalise outstanding FBT assessments where the Tax Office believes there is a low risk to the revenue.
7.129 In correspondence to this review the Tax Office referred to the findings of Kiefel J in Essenbourne that 'the payment in question is of the surplus profits out of the company' and that '[t]he payment is not referrable to the conduct of its income-producing business', meaning that income tax deductions were not available.
7.130 The Tax Office has also advised that it has not sought to confine this case to its facts. Rather, the Tax Office believes that there is an alternative view that is more consistent with its understanding of the policy intent of the law. The Tax Office has advised that in order to clarify the law on fringe benefits tax it will need to have the matter considered by a higher court in another case.
7.131 The Tax Office also stated that it necessarily followed from the findings in relation to income tax (that is, that the payment was not in respect of employment) that it would have been inappropriate to appeal to the Full Federal Court in this case. If the payment was a distribution of 'surplus profits' to the owners of the company in their capacities as owners, the payment could not also be a payment to the owners in their capacities as employees. The Tax Office states that, in short, it won the case, so in order to clarify the law on FBT it needed to have the matter considered by a higher court in another case.
7.132 The Tax Office goes on to state that even if it adopted the approach of Kiefel J in requiring a link to particular individuals at the time the employer makes a contribution to a related trust, it is likely that in some employee benefit arrangement cases that such a link could be discerned. For example in Walstern, while Kiefel J's view was followed, the result was different, because it was found that the payments could be attributed to individual employees. The Tax Office concluded in its correspondence that it was not appropriate to ignore the legitimacy of seeking judicial clarification of decisions which are arguably not correct. While such action is and should be rare, the decisions in John's115 case (overturning a previous High Court decision in Curran's116 case) and Gregrhon Investments117 (which distinguished Slutzkins118 case) show that such action can be in support of the rule of law.
7.133 Referring to the comments about Essenbourne and Spotlight Stores Pty Ltd & Anor v FC of T, the Tax Office advises that it did not appeal those cases or withdraw Taxation Ruling TR 99/5 as it has stated publicly that it will only seek to collect one tax on each transaction — that is, either income tax or fringe benefits tax. As a consequence, the Tax Office advises that it did not appeal the part of the decision that related to the fringe benefit assessment as it had already won the case. The Tax Office also advises that its position in not seeking to recover both income tax and fringe benefits tax in employee benefit arrangements precluded it from appealing the fringe benefit decision in Essenbourne.
7.134 The Inspector-General refers to an extrajudicial speech by the Honourable Justice McHugh examining the tensions between the Executive and the Judiciary. His Honour commented that:
Professor Pearce said that he has encountered circumstances where Federal agencies were not prepared to follow judicial or quasi-judicial rulings and were prepared to ignore them when they were inconvenient to them. Taxation Ruling IT2612 provided a clear example. There, the Commissioner of Taxation said that he did not accept the decision in Administrative Appeals Tribunal case V135 and ruled 'that where similar facts exist that decision is not to be followed'. No doubt an Executive agency is entitled to disregard a decision where it is truly in conflict with another decision that it thinks is correct. It may sometimes also be justifiable to refuse to follow a decision that is the subject of appeal. But that has problems. Judicial decisions are not provisional rulings until confirmed by the ultimate appellate court in the system. Until set aside, they represent the law and should be followed. Moreover, the Executive can run into serious legal problems where it continues to enforce legislation that a court has ruled invalid. Even more difficult to justify is the refusal to follow a ruling that is not the subject of appeal merely because the agency regards it as wrong and will test it at the next opportunity. The Attorney-General's Department has said that an agency should act inconsistently with a court ruling only on the advice of the Attorney-General's Department. One hopes that this advice is followed meticulously.119
7.135 The observations of Justice McHugh are pertinent to the discussion of the Tax Office's handling of the finalised decision in Essenbourne, in particular his Honour's comments regarding an Executive agency refusing to follow a ruling that is not the subject of appeal merely because the agency regards it as wrong and will test it at the next opportunity. Importantly, his Honour's speech also emphasises the distinct roles of the Executive and Judiciary, noting that a principal aim of the Executive is to administer laws through the creation of consistent, efficient and economical policy. His Honour goes on to say that:
Judicial decisions, however, are not constructed in order to promote either efficiency, support for broad-based policies or budgetary restraint. Judges must give effect to the will of the legislature even when it conflicts with the policies of the Executive Government. The perspective of courts is 'necessarily different' from that of the Executive Government.120
7.136 While the Inspector-General acknowledges the public statements made by the Tax Office regarding its position not to recover both income tax and fringe benefits tax in employee benefit arrangements, it notes that stakeholder concerns were directed at the Tax Office's refusal to accept a clear pronouncement of the law following a number of Federal Court decisions.
7.137 The Inspector-General notes that it is clear from the Solicitor-General's opinion that there is no legal impediment to the Tax Office resisting a finalised court decision in rare and exceptional circumstances. The opinion states that, if the Tax Office considers that a finalised court decision is wrong, it may challenge that decision in a subsequent case provided certain conditions are met. These conditions have been discussed in Chapter 4 of the report.
Metal Manufactures and Eastern Nitrogen
7.138 The Full Federal Court handed down its decision in Federal Commissioner of Taxation v Metal Manufactures and Eastern Nitrogen Ltd v Federal Commissioner of Taxation on 3 April 2001. The Full Federal Court held that the arrangements were effective to confer upon the financier an equitable ownership of the property. The Court decided that this was sufficient to support a lease and that the rental payments were made entirely on revenue account and were deductible. The Court also dismissed the Commissioner's argument that the taxpayer sought, through the rental payments, a collateral advantage by entering into the lease, namely the re-acquisition of the property at the termination of the lease for the residual value. Finally, the Court concluded that Part IVA did not apply to the arrangements.121
7.139 Following the Full Federal Court decision being handed down there was internal consideration of the implications of the decision including the effect of the decision on Tax Office policy. The Tax Office noted that:
… this decision is in conflict with the Commissioner's long standing position as expressed in Taxation Ruling TR 95/30. For instance in paragraph 16 of that ruling, it is clearly stated that a lessor could not make a fixture the subject of a lease. Similar problems are encountered when looking at the sale value of the assets, given that in this case, the valuation was made on an on-going basis. If this decision is not appealed, it is considered that Taxation Ruling TR 95/30 would need to be rewritten.
7.140 The Tax Office further noted that:
… the Commissioner will have great difficulty confining this decision to cases with similar or identical facts, especially as a similar decision was reached in Eastern Nitrogen.
7.141 The High Court refused special leave to appeal the decision relating to the characterisation and deductibility of the rental payments and the application of Part IVA. However, the High Court granted special leave to appeal the decision relating to the deductibility of fees incurred for entering into the sale and leaseback transaction. On 20 June 2002 the parties in the matter consented to the appeal being allowed.
7.142 Following the High Court's refusal to grant special leave to appeal, the Tax Office issued Media Release Nat 02/16. In that media release the Tax Office indicated that it would continue to challenge sale and leaseback arrangements that were primarily designed as tax avoidance measures. It noted that the Tax Office accepted that sale and leaseback transactions are generally acceptable forms of financing for businesses, except where they contain objectionable features such as inflated prices and artificially low residual values. However, the Tax Office stated that:
… the High Court made it clear when refusing Special Leave that these test cases were held to turn on their own facts. In view of this, the Tax Office will continue to challenge the validity of sale and leaseback schemes that are blatant, artificial and contrived.
7.143 The Tax Office also noted that its stated position on sale and leasebacks was set out in Taxation Ruling TR 95/30.
7.144 Despite the Tax Office's view when seeking special leave to appeal to the High Court, as indicated in the Adverse Decision Report, that the decisions in Metal Manufactures and Eastern Nitrogen were in conflict with Taxation Ruling TR 95/30, the Tax Office took approximately five years to release Draft Taxation Ruling TR2006/D5, which is intended to revise and update Taxation Ruling TR 95/30. The Tax Office advises that Taxation Ruling TR 95/30 will be withdrawn from the date of issue of the Final Ruling related to Draft Taxation Ruling TR2006/D5.
7.145 Despite litigating these cases to the Full Federal Court and seeking special leave to appeal to the High Court, the Tax Office, prior to TR 2006/D5, only released a media release outlining its view on sale and leasebacks after these decisions. The Tax Office also did not provide any greater detail on what is meant by the term 'blatant, artificial and contrived' in the circumstances of a sale and leaseback transaction, especially given that the Federal Court dismissed the Commissioner's 'sham' argument in Eastern Nitrogen and the Commissioner in the Full Federal Court did not maintain this argument.
7.146 The Tax Office has also acknowledged that there were two outstanding cases that it considered after the High Court refused special leave to appeal in Eastern Nitrogen and Metal Manufactures. The Tax Office had advised that one case was ultimately conceded and the other was settled. This was after consideration was given to the factual similarities and differences of these cases with Eastern Nitrogen and Metal Manufactures, as well as seeking counsel advice.
7.147 In the course of this review the Tax Office stated that in relation to sale and leaseback cases, it has not disputed that 'normal' commercial sale and leasebacks are an acceptable form of financing. The Tax Office stated that its policy in this regard has been consistent for many years, and is reflected in Taxation Ruling TR 95/30, noting that the ruling says in conclusion:
[As] a rule of thumb, most sale and leasebacks will have their usual tax effect, and Part IVA will not apply, where appropriate values are used (in respect of the sale price of the asset, the lease payments, the residual value of the asset and the balancing charge), where there is no question as to the arrangements having a different tax effect (cf fixtures, arrangements akin to hire purchase or where there may be a capital component), and where there is no dominant purpose of obtaining a tax benefit.
7.148 The Tax Office also commented that in broad terms, in Eastern Nitrogen and Metal Manufactures, Part IVA was held not to apply because the prevailing or most influential purpose of each taxpayer was to obtain a large financial facility on the best terms reasonably available. The taxpayers concerned enjoy the benefit of these decisions.
7.149 In correspondence to this review the Tax Office also provided some further elaboration on how the term 'abusive' should be defined in the context of sale and leasebacks. The Tax Office commented that:
Abusive to my mind is a situation where someone pays grossly excessive amounts facilitating large lease payments, and refreshing depreciation deductions, in circumstances where there is a clear understanding that the plant would be transferred back to the original owner for a residual cost. It has always been our intention to tidy up Taxation Ruling TR 95/30, but other priorities have delayed this task.
7.150 An examination of other public rulings and determinations indicates further instances where the Tax Office has refused to follow the reasoning of a court or tribunal decision, although the Tax Office has accepted the order in relation to the particular taxpayer. In each of these cases the Tax Office has provided an explanation as to why it believes that the court or tribunal has erred and why it will not follow the court or tribunal decision. However, the Inspector-General notes that where the Tax Office has disagreed with the court or tribunal decision it has not sought to appeal the issue to a superior court for possible clarification. These cases include:
- In response to the case of Norris v Federal Commissioner of Taxation122, the Tax Office stated in its draft Taxation Ruling TR 2005/D9 that it did not agree with the Tribunal's conclusion in that case.123 The Tax Office indicated in the draft ruling that in interpreting the parameters of income from eligible employment for the purposes of the 10 per cent rule, the Commissioner considered that the Tribunal's earlier decision in Re Edmonds-Wilson v Commissioner of Taxation (Cth)124provided the most appropriate interpretation of the wording of the provisions. The Commissioner's view in the draft ruling is also contained in the final version of this ruling (TR 2005/24).
- In the case of Gillespie v Federal Commissioner of Taxation125 the Tribunal held that a lump sum workers' compensation payment was made in consequence of the termination of employment because the termination of employment of the taxpayer was antecedent to the payment of the lump sum. In Taxation Ruling TR 2003/13 the Tax Office stated that:
The Commissioner is of the view that the Tribunal erred in finding that the commuted lump sum payment was made in consequence of the termination of employment. Although the termination of employment of the taxpayer was antecedent to the payment of the lump sum, the termination had no causal connection with the payment. The payment was a consequence of the injury and not the termination of employment. It could not be said in that case that but for the termination of employment the payment would not have been made. This is to be contrasted with the facts in Seabright where the injury at work caused the termination which in turn entitled the taxpayer to an invalidity pension. There is a clear causal nexus in the latter case between the termination and the payment which arguably does not exist in Gillespie.
- In response to the Federal Court decision in Trustees of the Indigenous Barristers' Trust v Federal Commissioner of Taxation126 the Tax Office issued an Addendum to Taxation Ruling TR 2000/9. In that Addendum the Tax Office stated that:
In so far as comments by the Federal Court could be taken to imply that needs — such as suffering, helplessness, misfortune or disability — constitute necessitous circumstances independently of financial necessity, they are considered to be inconsistent with the approach of the High Court in Ballarat Trustees. Ballarat Trustees will therefore continue to be followed in the administration of the law.
7.151 In other instances, such as with Taxation Ruling IT 2547 the Tax Office did not update its expressed view for a very lengthy time despite its appeal to the Full Federal Court in Federal Commissioner of Taxation v Jackson127 being dismissed. IT 2547 was only withdrawn during the closing stages of this review.
Improving the Tax Office framework for handling finalised outcomes
Key finding 7.9
There are no uniform governance processes to deal with the identification, consideration and feeding back to all appropriate areas of the Tax Office of any non-technical issues arising from the conduct of litigation.
7.152 The Tax Office has in place a framework, through the SILC process, to ensure that the appropriate stakeholders consider the implications of tribunal and court decisions.
7.153 Draft Practice Statement PS LA 2005/D111 acknowledges the importance of considering and analysing the outcomes and handling of litigation. For example, it provides that in order for the implications of the decision to be properly considered an Adverse Decision Report should include:
- whether any actions need to be taken to draw legislative deficiencies to the attention of Treasury and/or Government, to vary Tax Office compliance approaches or to remedy any deficiencies in the conduct of litigation;
- whether the decision is inconsistent with or has identified any significant flaws in the published Tax Office view of the law; and
- appropriate commentary on the conduct of the litigation that led to the adverse decision, such as any difficulties with evidence, witnesses, the litigation team or any interlocutory decisions of the court that may have adversely influenced the outcome.
7.154 The draft Practice Statement also provides that a finalised decision could have an impact on the Tax Office's technical view as expressed in a ruling, determination, interpretative decision or other publicly available statement. It states that:
… currently, it is the responsibility of the Tax Counsel Network to handle the review of the impact on any published Tax Office view. Alternatively, a finalised decision could also identify deficiencies in the Tax Office's compliance approaches and upstream processes including the audit and objection stages. In such instances it is the responsibility of the business and service lines to handle and address any such identified difficulties or deficiencies.
7.155 However, there is currently no uniform framework in place for identifying, considering and dealing with non-technical issues that arise in the course of litigation, irrespective of whether the decision was finalised by way of hearing or settlement with the aim of improving the quality and efficiency of litigation through better upstream processes. Such procedures would also serve to improve capabilities within other compliance areas and minimise the recurrence of shortcomings in the upstream processes that have a significant impact of the conduct and handling of litigation.
7.156 An examination of the business lines' governance process indicates an absence of uniform quality control mechanisms providing feedback to compliance areas and objection areas on how they handled a dispute that proceeded to litigation.
7.157 Currently, the feedback mechanisms vary between the business lines, are on a case-by-case basis and normally directed to the original case officer rather than more broadly to others undertaking similar work. There do not appear to be any formal procedures in place setting out the circumstances when feedback is required nor any means to determine whether a non-technical issue arising in the course of litigation is a random event, an emerging trend or a systemic problem.
7.158 An examination of case files also indicated that in a number of settled cases litigation was acting as a de facto quality review of the Tax Office's objection/dispute resolution processes due to shortcomings in the upstream processes. This included disputes proceeding to litigation without the proper identification of facts, evidence, issues and application of the law. In a number of sampled cases litigation was the first instance that the facts, evidence and the application of the law to those facts and evidence were first properly considered.
7.159 Internal feedback by the Legal Services Branch to business lines also highlighted problems with the upstream processes including not identifying the relevant facts, not referencing identified facts to the evidence, not gathering the appropriate evidence, inappropriate assumptions and assertions in audit and objection decisions and not gathering all the relevant facts and information.
7.160 A number of submissions from legal practitioners, tax practitioners and tax practitioner associations have also raised concerns with these aspects of the upstream processes, which have been examined by this review. As a result of this examination, the Inspector-General considers that there is a need for a review of aspects of the Tax Office's dispute resolution processes prior to a dispute proceeding to litigation.
Subsidiary recommendation 7.8
The Tax Office should develop uniform corporate governance processes to deal with the identification, consideration and feeding back to all appropriate areas of the Tax Office of any non-technical issues arising from the conduct of litigation with the aim of improving the quality and efficiency of litigation through better upstream processes.
Tax Office response
87 A finalised court or tribunal decision is defined as a decision where the appeal period has elapsed and is not subject to appeal.
88 Howland-Rose v Commissioner of Taxation (2002) FCA 246 (18 March 2002) (the Budplan case).
89 Vincent v Commissioner of Taxation (2002) FCAFC 291 (16 September 2002), Vincent v Commissioner of Taxation (2002) FCA 656 (24 May 2002).
90 Essenbourne Pty Limited v Commissioner of Taxation (2002) FCA 1577 (17 December 2002).
91 Commissioner of Taxation v Cooke (2004) FCAFC 75 (26 March 2004); Cooke v Commissioner of Taxation (2001) FCA 1654 (20 November 2001).
92 Commissioner of Taxation v Metal Manufactures Ltd (2001) FCA 365 (3 April 2001); Metal Manufactures Ltd v Commissioner of Taxation (1999) FCA 1712 (8 December 1999).
93 Eastern Nitrogen Ltd v Commissioner of Taxation (2001) FCA 366 (3 April 2001); Eastern Nitrogen Ltd v Commissioner of Taxation (1999) FCA 1536 (5 November 1999).
94 Appendix 10 provides further detail of these procedures. Strategic Internal Litigation Committees, or SILCs, are part of the Tax Office's litigation process and involve key internal stakeholders including the Legal Services Branch officer, the business line officer and, if necessary, the Tax Counsel Network. SILCs are convened at critical stages during the course of the litigation as a means to manage the litigation and ensure that legal risks for the Tax Office arising out of litigation are minimised.
95 The Treasury, Report on Aspects of Income Tax Self Assessment, August 2004, Commonwealth of Australia, Canberra, p 7.
96 Ryan v Commissioner of Taxation (2004) AATA 753 (19 July 2004).
97 Commissioner of Taxation v McNeil (2005) FCAFC 147 (8 August 2005); McNeil v Commissioner of Taxation (2004) FCA 420 (14 April 2004).
98 Australian Taxation Office, Federal Court backs Tax Office on Mass Marketed Schemes, Media Release — Nat 02/18, 18 March 2002.
99 Australian Taxation Office, Another Federal Court Win on Mass Marketed Schemes, Media Release — Nat 02/33, 24 May 2002.
100 Australian Taxation Office, Tax Office not seeking special leave, Media Release — Nat 04/26, 22 April 2004.
101 Marana Holdings Pty Ltd v Commissioner of Taxation (2004) FCAFC 307 (25 November 2004); Marana Holdings Pty Ltd v Commissioner of Taxation (2004) FCA 233 (15 March 2004).
102 GSTR 2000/20 at paragraph 19 states that it is only the physical characteristics of a property which marks it out as being 'for residential accommodation' and therefore not subject to GST.
103 Solicitor-General opinion, 'Application of Precedent to Tax Cases', Appendix 4, at p 4.
104 Carmody M (Commissioner of Taxation), Tensions in Tax Administration, ICAA NAB Gala Luncheon Address, Melbourne, 14 March 2003. Available at: http://www.ato.gov.au/corporate/content.asp?doc=/content/sp200301.htm.
105 National Tax Liaison Group Minutes, 26 March 2003.
106 National Tax Liaison Group FBT Sub-committee Minutes, 20 February 2003.
108 National Tax Liaison Group Minutes, 2 September 2003.
110 Walstern v Commissioner of Taxation (2003) FCA 1428 (8 December 2003).
111 Spotlight Stores Pty Ltd v Commissioner of Taxation (2004) FCA 650 (25 May 2004).
112 Caelli Constructions (Vic) Pty Ltd v Commissioner of Taxation (2005) FCA 1467 (17 October 2005).
113 In Caelli the Commissioner contended that Essenbourne was distinguishable from the present case. Alternatively, the Commissioner submitted that Essenbourne was wrongly decided to the extent that it required the identification of a particular employee in relation to a fringe benefit.
114 Kajewski v Commissioner of Taxation (2003) FCA 258 (26 March 2003).
115 John v Federal Commissioner of Taxation (1989) 166 CLR 417 (8 February 1989).
116 Curran v Federal Commissioner of Taxation (1974) HCA 46; (1974) 131 CLR 409 (4 November 1974).
117 Federal Commissioner of Taxation v Gregrhon Investments Pty. Limited & Ors (1987) 87 ATC 4988 (26 November 1987).
118 Slutzkin v Federal Commissioner of Taxation (1977) 77 ATC 4076 (25 February 1977).
119 Hon Justice McHugh AC, Tensions Between The Executive And The Judiciary, Australian Bar Association Conference, 10 July 2002. Available at http://www.hcourt.gov.au/speeches/mchughj/mchughj_paris.htm.
121 It is also important to note that in Eastern Nitrogen at first instance in the Federal Court the Commissioner also contended that the sale and leaseback transaction was a sham. It contended that the rentals were not paid for the use of the plant because the documents executed by Eastern Nitrogen and the financiers to give effect to that transaction cloaked the true position in that the parties were 'ambivalent' about whether title to the plant would ever pass from Eastern Nitrogen or, if they intended title to pass, they also intended that Eastern Nitrogen would reacquire title at the end of the lease. The Commissioner in the appeal to the Full Federal Court did not maintain the 'sham' argument.
122 Norris v Federal Commissioner of Taxation 2002 ATC 2091 (2 September 2002).
123 It is of the view that the ordinary meaning conveyed by the text of subsection 82AAS(3) of the Income Tax Assessment Act 1936, taking into account its context in the Act and the purpose or object underlying the Act, does not lead to a result that is manifestly absurd or unreasonable.
124 (1998) 98 ATC 2276; (1998) 40 ATR 1071.
125 Gillespie v Federal Commissioner of Taxation 2002 ATC 2006 (11 December 2001).
126 Trustees of the Indigenous Barristers' Trust v Federal Commissioner of Taxation 2002 ATC 5055.
127 Federal Commissioner of Taxation v Jackson 90 ATC 4990 (31 October 1990).