Australia: Transfer pricing and Part IVA: Taxpayers are winning the battles but losing the legislative war

Over the past two years taxpayers have won major court battles against the Commissioner of Taxation in relation to the transfer pricing rule, Division 13, and the general anti-avoidance rule, Part IVA. The Commissioner responded to these losses by convincing the Federal Government to enshrine into legislation the Commissioner's interpretation of how the rules were "intended to" operate. Effectively, taxpayers have won the legal battles but lost the legislative war. How and why has this happened and what can be done to prevent this scenario becoming a permanent feature of Australia's tax landscape?

The Commissioner first raised his concerns about the way Part IVA and Division 13 were being interpreted by the courts when he appeared before the Joint Committee of Public Accounts and Audit in September 2011. He commented that "if those general anti-avoidance provisions are found to be ineffective, then it is a matter of concern for government, parliament and the community." While this comment seems reasonable on its face, it ignores the real question; are the provisions operating in the way intended by Parliament? If so, then there is no need for change.

FIRST CAME THE TRANSFER PRICING REFORMS

Only a few weeks after the Commissioner's comments, in November 2011, the Government released a Treasury consultation paper on the review of the transfer pricing rules. The review was prompted, at least in part, by the Commissioner's loss in the SNF Australia case which, in the Government's view, "highlighted some difficulties for Australia to appropriately assess transfer pricing cases in a way that is consistent with our major trading partners".

Following the review, reforms were swiftly introduced which the Government says are designed "to clarify" that the transfer pricing rules in Australia's double tax treaties operate as an alternative to the domestic transfer pricing rules.

PART IVA REFORMS WERE NOT FAR BEHIND

Hot on the heels of the changes to the transfer pricing rules, the Government declared in March this year that it would amend the general anti-avoidance rule, Part IVA, "to protect the integrity of Australia's tax system".

While the specific amendments were not revealed, the Government indicated that the changes would put an end to certain arguments by taxpayers that they did not obtain a "tax benefit". These arguments were successful in several recent Federal Court cases (AXA, RCI and Futuris).

Exposure draft legislation was released on 16 November 2012 to effect these changes ( click here to view our In Brief on the topic). The draft legislation also proposes other changes apparently aimed at restoring the primacy of the "dominant purpose" test. These changes were not referred to in the March 2012 announcement and are not directly relevant to the Federal Court decisions in question.

The Commissioner's approach in seeking legislative reform of the transfer pricing regime and Part IVA is identical. He starts by persisting with technical positions in tax cases with which the courts disagree. The Commissioner then asserts that the positions he is putting in the cases are the way in which the provisions were always intended to operate (in the case of the Part IVA changes) or stated by the legislature to operate (in the case of the transfer pricing changes). The Commissioner points to the court losses as evidence that the relevant provisions are broken and prevails upon the Government to act.

HOW DOES THE COMMISSIONER GET AWAY WITH THIS?

Many individual taxpayers are willing to take on and defeat the Commissioner in tax disputes before the courts. This is proven by the Commissioner's poor recent record in large case tax litigation in the Federal Court.

However, an unhappy truth is that taxpayers as a collective are no match for the Commissioner in lobbying the Government for legislative change. This is an area where the playing field is decidedly uneven. The Government will naturally be alarmed by, and receptive to, the Commissioner's assertions that the law is not operating in the manner intended and that tax revenue must be protected through legislative change. Additionally, the Government has promised to return the federal budget to surplus and any extra revenue generated by the changes will be welcomed. There is no incentive for the Government to scrutinise the validity of the assertions. Rather, prudence dictates the Government will take the Commissioner at his word.

WHAT IS REQUIRED TO LEVEL THE PLAYING FIELD?

A good starting point would be to adopt the Inspector General of Taxation's recommendation that there be a separate appeals section in the Australian Taxation Office. This recommendation emerged from the Inspector General's recent review of the ATO's use of early and alternative dispute resolution. It proposes the separate appeals section would independently assess and determine whether matters should be settled, litigated or otherwise resolved.

It's a welcome suggestion. An appeals section could ensure that litigation is pursued on its merits and in a manner which respects the rule of law and without regard to any broader agenda.

However, to date the proposal has been rejected by the Commissioner and it appears unlikely to happen unless it is imposed upon him by government.

A FINAL SUGGESTION

If individual taxpayers can not match the Commissioner in lobbying for tax changes, then surely their representative industry bodies and professional associations can? The issue here is the number and diversity of these organisations, which makes it difficult to co-ordinate an effective response to the Commissioner's highly professional campaigns for legislative change. Taxpayers would benefit from better co-operation between industry bodies and professional associations.

A starting point for these bodies would be to agree on the circumstances in which they will combine their efforts and the principles they will adopt in pursuing legislative reform. For instance, they might usefully agree that certainty of outcome should not be favoured over robust testing of any claims for the need for legislative reform.

What is perhaps more critical is early identification of the Commissioner's end game and timely intervention where necessary to ensure there is proper balance in the ensuing debate.

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