Draft update to PS LA 2005/24 on Part IVA – are we just expecting too much?

The recent draft update to PS LA 2005/24 represented a once-in-a-decade opportunity for the ATO to provide meaningful and practical guidance to its officers on the many unresolved aspects of the application of Pt IVA.

However, it looks like that opportunity will be squandered.

This article considers the draft update shortcomings.

1 Overview

PS LA 2005/24 is the central ATO guidance product on Pt IVA.  It's a 10-year old document and an updating has been much anticipated.

On 13 August 2015, the ATO released its draft update (Draft Update) – reported at 2015 WTB 35 [1294].  Helpfully, the PDF version of the Draft Update contains mark ups against the current version of PS LA 2005/24.  The ATO sought comments on the draft Update by Friday, 25 September 2015.

Broadly, the Draft Update does 3 things:

  • attempts to address certain of the interpretative issues that have been identified as arising in respect of the 2013 amendments to Pt IVA, which deal mainly with the "tax benefit" element;
  • general updating, including for case law in the intervening 10 years; and
  • relocates much of the purely internal ATO administrative aspects from the PS LA to an internal ATO link.

This article addresses each of those points in turn. 

However, the first point is likely to generate the most interest and comment: essentially, the ATO has not addressed many of the difficult interpretative issues associated with s 177CB.  This raises a number of questions:

  • Can this incomplete approach be explained by the confined role that PS LAs play?
  • Does the ATO have any plans to put "flags in the sand" – or will the 2013 amendments continue to be a largely unpatrolled beach?
  • Does the Draft Update achieve its stated purpose of providing meaningful "instruction and practical guidance" to ATO officers on these issues? 
  • How can this approach be reconciled with the ATO's own review of its guidance?

2 The role of practice statements

2.1 Overview

PS LA 2005/24 is a law administration practice statement (PS LA) and a reminder of how PS LAs fit in the ATO guidance panoply is important context for the Draft Update. 

In that regard:

  • A PS LA is not a ruling and does not bind the ATO to apply the law in a particular way in relation to taxpayers – so provides no protection from primary tax although they do offer protection from penalties and interest if relied upon in good faith: PS LA 1998/1.
  • Rather, practice statements are corporate policy instructions to ATO officers on the way in which they should apply the law.
  • PS LAs are not designed as the platform for expressing a precedential ATO view.  Presumably this is on the basis that the appropriate ATO product for publicly disseminating precedential ATO views is primarily taxation rulings and determinations.
  • However, importantly, technical issues may be discussed" in PS LAs, "to the extent required to give sense to the instruction" to ATO staff: PS LA 1998/1.

There are many examples of PS LAs that have abundant detailed technical discussion and express precedential ATO views: see for example, the PS LAs dealing with the potential application of s 45B in the case of demergers, buy-backs and capital returns: PS LA 2005/21, PS LA 2007/0 and PS LA 2008/10. 

Unfortunately, PS LA 2005/24 is not one of them.

2.2 ATO guidance on Part IVA

A number of ATO rulings address aspects of Pt IVA.  However, PS LA 2005/24 remains the central ATO guidance product on Pt IVA.

The express purpose of PS LA 2005/24 is to "provide instruction and practical guidance to tax officers on the application of Part IVA and other general anti-avoidance rules".

PS LA 2005/24 has always been a bit different to most PS LAs: rather than providing practical guidance to ATO officers, it provides technical guidance – and this almost exclusively involves summarising existing case law on the various elements of Pt IVA, rather than expressing ATO views or directing ATO officers how to apply the provisions. [One of the few practical guidance aspects of PS LA 2005/24 is the "Part IVA Warning Signs" section in para 140 – it has survived the updating process, so far.]  

The Draft Update does little to alter that DNA: the additions are largely confined to recording case law developments. 

But why should PS LA 2005/24 continue to be so severly limited in this way? Surely the issues not resolved by case law are precisely the issues that must be addressed in order for it to fulfil its express purpose of providing practical guidance. 

The ATO visibly wrestles with this issue when it comes to the text addressing the 2013 amendments.

On the one hand, at para 71, the ATO recuses itself from expressing any views:

"It is not possible at present to make many authoritative statements about the correct interpretation of the Part as amended. The other statements about interpretation in this practice statement are mostly grounded in the case law on Part IVA. There is no case law on the amendments at time of publication. The ATO has very little practical experience in applying the amendments in real cases. We have received very few enquiries from practitioners about actual transactions (whether carried out or merely proposed)."

But, on the other hand, paras 78 to 87 proceed to address some of the interpretative issues that have been identified in practitioner articles, providing "an indication of how the ATO would likely apply the law and what submissions we would likely make if any of these issues ever arise in litigation".

That sounds promising but, as we will see, the result is a half-way house: the ATO does express some views, but in a very generalised way – and the difficult interpretative issues remain unaddressed.

If this approach was taken because PS LA 2005/24 is not the right guidance product for the ATO to address these difficult issues, then should we expect that the ATO is in the process of generating that product?  After all, the 2013 amendments apply to schemes that started almost 3 years ago – they are hardly new law.

Unfortunately, Part IVA remains conspicuously absent from the ATO rulings programme – and so remains largely free from meaningful ATO guidance.

We say "largely" because some guidance is found in the minutes to the NTLG consultative meeting held in July 2013 (Minutes) for the express purpose of assisting the ATO to understand whether guidance on the 2013 amendments to aid taxpayers is warranted.   The Minutes were discussed in my article "Hidden Part IVA treasure" at 2014 WTB 10 [317].

Ultimately the Minutes didn't provide much guidance on the 2013 amendments.  As the ATO puts it in the Draft Update:

"Practitioners provided some practical examples which raised questions under Part IVA, and the ATO sought to offer indicative views about the examples, having first had the benefit of discussing them with the group. Despite the intended purpose of the workshop, few if any of the examples supplied raised questions about the effect of the amendments. Their resolution depended chiefly on an analysis of dominant purpose under section 177D in much the same way as they would have under the previous version of Part IVA."

Nevertheless, the Minutes contain a number of really quite useful points regarding the ATO interpretation of the purpose element – and these points are not reflected in the Draft Update.  Some of those points are discussed in section 4 below.

The Minutes indicated that the practical examples considered in the meeting should be reflected in the update to PS LA 2005/24 – but unfortunately this has not been done and PS LA 2005/24 remains an example-free document.  This does not sit well with the ATO's own review of its guidance.

3 The 2013 amendments to Part IVA

3.1 Preliminary

Readers will recall that Pt IVA was amended in 2013, with the amendments largely directed towards the "tax benefit" element of Pt IVA.

New s 177CB does  2 things:

  • First, it bifurcates the composite phrase "what would have happened or might reasonably have been expected to have happened" in s 177C into 2 separate limbs:
    • the "annihilation limb" in s 177CB(2); and
    • the "reconstruction limb" in s 177CB(3)
  • Secondly, it provides (broadly) that a decision under s 177C that adverse tax consequences arise to the taxpayer from what would have occurred or might reasonably be expected to have occurred absent the scheme "must be based on a postulate" that is determined under the annihilation limb or the reconstruction limb.

The drafting of the second aspect of s 177CB is highly unusual and raises a number of threshold statutory construction issues which courts will need to resolve.

A number of articles touch on these issues, including the ones referred to in footnote 4 of the Draft Update. 

3.2 Issues addressed in the Draft Update

The ATO poses and answers 6 interpretative questions on the 2013 amendments.

Questions #1 to #3

The first 3 questions relate to the vexed issue of the interaction between s 177C and s 177CB:

  • Is all of the case law on the concept of tax benefit still authoritative following the 2013 amendments?
  • Does s 177CB merely provide a further limit on the concept of tax benefit, while leaving the operation of s 177C, as previously understood, intact?
  • Does the amended tax benefit test require a two-step process by which one first finds a "postulate" under s 177CB, then feeds that postulate into the expression set out in s 177C?

The ATO view is crystal clear: there is no interaction – rather, s 177CB completely replaces s 177C, rendering irrelevant the existing case law on s 177C.

In enthusiastically embracing this "replacement approach", the ATO clearly rejects the "qualification heavy" approach under which an alternative would have to satisfy both the prediction test under existing s 177C case law and the annihilation or reconstruction limb.

That approach is relatively easy to dismiss.  However, there is a middle ground "qualification lite" approach under which there is still a residual role for existing s 177C case law to play.  This approach recognises that the existing tax benefit definition in s 177C was left untouched and that an alternative postulate produced under the annihilation limb or the reconstruction limb is not expressly deemed (or defined) to be the thing that "would have happened or might reasonably have been expected to have happened" absent the scheme.

The "qualification lite" approach cannot be so easily dismissed and it would be preferable for the ATO to address the approach in order to demonstrate that they have considered it.

The "qualification lite" approach is considered further in relation to question #5 below.

Question #4

Question #4 deals with whether the "would" limb and the "might reasonably be expected limb" are true alternatives.

The ATO view is clearly yes, as one would expect – as it confers on it the tactical advantage of being able to run alternative arguments. 

While it's possible to dispute the EM assertion that these limbs have always been alternatives, the ATO response to this question is unlikely to generate much controversy.

Questions #5 and #6

Question #5 deals with the issue of whether there can be more than one reasonable postulate that satisfies subss 177CB(3) and (4) in a given fact pattern.

The ATO view is a cautious yes on the basis that the text of the legislation appears to leave this possibility open – this simply restates the ATO view expressed in the Minutes.

The real issue is what ATO officers should do in circumstances where multiple reasonable alternatives arise – and this is only partially addressed in question #6.

Question #6 deals with the issue of whether, where there are multiple reasonable alternatives, the reconstruction limb requires that the one which produces the highest tax benefit be chosen.

The ATO response to this question is no – but while the outcome is welcome, the reasoning leaves the real issue insufficiently resolved. 

The ATO considers the situation where there are 2 "equally reasonable" alternatives.  In those circumstances, there is no direction that ATO officers should pursue the alternative that produces the higher amount of tax.  Rather, ATO officers are cautioned to apply common sense and be reasonable.  Indeed the ATO expressly acknowledges that choosing the lower of 2 alternatives may give the ATO a better chance of success in the courts – showing that lessons have been learned from the attempted over-reach which led to a number of Pt IVA losses in the period leading up to 2013.

The inherent difficulties in adopting reasonableness as an objective test are discussed in a number of the articles referred to in footnote 4 of the Draft Update – but this issue remains unacknowledged.

That aside, there are some particularly curious aspects of the ATO response

  • We would have thought that reasonableness is a threshold test and the outcomes are binary: either an alternative is reasonable or it is not.  On that basis, purporting to assign a ranking or degree to the "reasonableness" of an alternative is really ranking probabilities. 
  • That is, any ranking of particular alternatives necessarily involves predicting how likely it is the taxpayer would have pursued those alternatives, absent the scheme.  If that task sounds familiar, it's precisely the task mandated by the s 177C case law – the very same case law that the ATO says is irrelevant to the task of identifying a tax benefit.  We think that the ATO is implicitly adopting a "qualification lite" approach, despite not having addressed it in its analysis of the s 177C/s 177CB interaction.
  • Moreover, although implied, the ATO doesn't provide a clear statement to officers not to pursue a "less reasonable" alternative which - even if it would produce a higher amount of tax.

It must be said that there is also a welcome aspect to the ATO response on this issue: there is express recognition that the ATO will consider cancelling part only of a tax benefit and/or to make compensating adjustments in order to secure more appropriate outcomes.

3.3 Issues NOT  addressed in the Draft Update

As indicated above, the ATO has addressed some the interpretative issues raised by the 2013 amendments, but has chosen not to address much more important issues, identified in articles to which the ATO refers, such as the following.

Annihilation limb

  • Does the annihilation limb apply automatically in all deduction/capital loss/FITO cases (ie, "negation" benefits)?  Or are any barriers to its operation to be found in its history as the "would" end of the certainty spectrum or perhaps in the express qualifications in the explanatory memorandum that accompanied the 2013 amendments (EM) about only applying the annihilation approach if it leaves a coherent state of affairs and is consistent with the commercial consequences?

Reconstruction limb

  • Does the ATO consider there will now always be a reconstruction counterfactual – with the purpose element as the fulcrum upon which Pt IVA turns, as the EM contemplates?
  • The ATO addresses discharging the onus of proof under the pre-2013 amendments law in the Draft Update – but doesn't seem to do so under the 2013 amendments. (At least, paras 95 to 97 appear to relate only to pre-2013 cases.) Given that taxpayers bear the onus of proof, how can they successfully challenge a reconstruction limb counterfactual? Can they point to another more likely alternative? Or do they need to establish that the ATO identified alternative is unreasonable (likely to be a much more onerous task)? Or do they have to prove a complete absence of reasonable alternatives?
  • What does reasonableness mean in this context? Does it mean that the alternative is "sufficiently commercially equivalent" for the taxpayer or does it mean that the alternative is "sufficiently plausible"?  As has been pointed out to the ATO, the difference will be significant in practice where, for example, the scheme and the alternative being tested involve different taxpayers transacting (eg, is a subsidiary selling assets a reasonable alternative to the shareholder selling shares in the subsidiary?  It is clearly commercially different from the shareholder's perspective, but may well be a plausible alternative to a share sale).
  • How broadly or narrowly is the focus to be set in determining the "substance" of a scheme?  For example, is the substance of a sale and leaseback transaction a secured loan (broad focus) or a sale and leaseback (narrow focus)?

4 General updating

4.1 The 2 updating aspects

There are 2 aspects to general updating.

(a) Case law developments

PS LA 2005/24 hasn't meaningfully been updated since it was first issued, and so the Draft Update represents an opportunity for the ATO to reflect the outcomes of case law from the intervening 10 years.

The ATO has adequately performed this task.  See for example: paras 91 to 98, which deal with case law on the tax benefit element  and para 104 which addresses the issuing a Pt IVA determination in a consolidated group joining scenario.

(b) Developments in the ATO approach to Part IVA

There are still many aspects of the interpretation of Pt IVA that are not governed by case law.  Of course, the ATO still has views on these issues.  For example, the Minutes publicly record the ATO views that:

  • the s 177D(2) factors focus on whether the scheme reveals any artificiality or contrivance – and so whether the requisite objective purpose is present (ie, why the scheme was implemented) is determined by looking at how the scheme was implemented; and
  • a change of plans has little impact on the Pt IVA analysis – the fact that a taxpayer has changed plans after seeking tax advice is not relevant to the scheme element, the purpose element or the tax benefit element.

These aspects of the Minutes were addressed at 2014 WTB 10 [317].

These approaches are critical to an ATO officer understanding how to apply Pt IVA.  One would have thought that communicating those views with ATO officers is precisely the sort of guidance that PS LAs are intended to provide.  Yet they are conspicuously absent from the Draft Update.  It is difficult to fathom why they would be omitted.

4.2 Particular updated topics

(a) Does the Commissioner have a discretion to cancel tax benefits under Part IVA?

The Commissioner's ability to cancel a tax benefit under s 177F was originally referred to in paras 39 and 40 as a "discretion", but that has been updated to refer to a "power" on the basis that there is no "over-arching or final discretion independent of … this power".

Cumins v FCT (2007) 66 ATR 57 and FCT v Sleight (2004) 55 ATR 555 are cited as authority for this conclusion. 

Those cases stand for the proposition that once the Commissioner has concluded that the elements of Pt IVA are present, a taxpayer cannot challenge the decision to apply s 177F on the basis of failure to take into account other matters.

The cases do not, in the authors' view, prevent the Commissioner from exercising a discretion to refrain from cancelling the tax benefit.

(b) Tax benefit: quantum only or character as well?

For almost 30 years, the ATO has asserted that a tax benefit can arise where an amount is not included in assessable income under a particular provision - even if the same amount is included in assessable income under another provision.

This "qualitative approach" contrasts with the "arithmetic approach", which looks only to whether the taxpayer's assessable income is impacted.

There is case law support for both approaches: the full Federal Court in FCT vLenzo (2008) 71 ATR 511 endorsed the qualitative approach, but later the Full Federal Court in FCT vTrail Bros (2010) 79 ATR 780 endorsed the arithmetic approach – and this approach finds support in both FCT v AXA Asia Pacific Holdings Limited (2010) 81 ATR 180 and FCT vAshwick (Qld) No 127 Pty Ltd & Ors (2011) 82 ATR 481.

The clear weight of authority now supports the arithmetic approach, yet the ATO clings to the qualitative approach on the basis that "it is not yet clear that the view in Lenzo is certainly [sic] to be rejected": see paras 59, 60, 91 and 92.  An update that better reflects the state of the case law would be preferable.

(c) Wrong taxpayer issues

There have been instances of the ATO assessing the wrong taxpayer – that is, under the relevant counterfactual, the tax benefit arose to a different taxpayer: see for example FCT v Futuris Corporation Limited [2012] FCAFC 32 and AXA.

Paragraph 151 of the PS LA instructs ATO officers to "be alert to this possibility and consider the need to make determinations … for not only the taxpayer considered most likely to have obtained a tax benefit, but for different taxpayers under different alternative postulates".

5 Administrative aspects

A very substantial part of the original PS LA consisted of Attachments dealing with (among other things) various procedural matters concerning issue of determinations, process of decision-making and submissions to the GAAR Panel.

Those Attachments, along with the pre-existing paragraphs concerning private ruling applications, have been deleted. No significant change to relevant administrative processes has been announced. Rather, the administrative aspects appear to have been "internalised", and are accessible only by ATO officers on the "TCN Share Point": see para 6.

"Draft update to PS LA 2005/24 on Part IVA " was originally published in Thomson Reuters Weekly Tax Bulletin 42 - 2/10/15.



Tim Neilson

Special Counsel