Law Council of Australia
Taxation Law Workshop
26 - 28 October 2001
Aitken Hill, Victoria
Michael D'Ascenzo
Second Commissioner
Size of Mass-marketed Scheme Problem
As at 30 September 2001 the ATO had reviewed 196 mass-marketed schemes of the type considered by the Senate Economics References Committee.
The number of assessments that are involved is 57 495, of which 45 468 have already been raised. The number of participants is around 35 000, because a number of taxpayers participated in more than one scheme.
The deductions claimed under these schemes total $3.67 billion.
We currently have 2897 references to the AAT and 412 appeals to the Federal Court in relation to these matters.
Role of Promoters and Advisers
The following quote from extracts of a tape that record a briefing on the sales pitch to be used when selling a franchise scheme says it all:
"Now, you might want to go in with that you could say "now isn't a great deal, how can you lose $134, keep repeating that $134 is all that you're going to pay, circle it. ...
From there then would go in and do the tax workout sheet. Make sure as accurately as you can find out what they're earning. I almost insist every time on getting a payslip....
Work it out - I don't generally explain the tax work out sheet till I've fully written it out. Then when you've written it out, turn it so they can read, it's upside down to you, you know what you've written, then go through it. Ok, you've earned $100,000 that means you gonna pay $39, 302 in tax. We're doing this all the time, we recommend that you buy three Franchise Ltd licences. That's gonna create for you, as shown here on the back of the sheet, $40,000 the Franchise Ltd licence is worth, so that's gonna create for you this year $40,000 tax deductible expenses times three - that’s $120,000 worth of tax deductions.
From $100, 000 means you're going to end up with a loss in your tax return showing of a loss of $20,000. Now if you're showing a loss of $20,000 that means you pay zero tax. That means you get the whole $39,302 back as a tax refund....$30,000 has to go to Franchise Ltd and you're left with $9302 in your hand, this year from your refund cheque at about the period July/August.
Furthermore you've got a $20,000 loss which you can forward on to next year and because you're on 48.5 cents in the dollar means you'll get another $9,700 in your hand next year in July or you've got a choice of about $800 a month. Now here come the first close that I use.
Now John, what would you prefer? $800 a month or the other $9,700 at the end of next July as a lump sum? And shut up. Let them make the choice 'cos by them making the choice they're already going to say yes to the deal. ...
When you're doing the recourse loan bit and written down the words "limited recourse loan across one of the arrows", open up the information on page 6 and show them the paragraph relating to limited recourse loans, it'll be in bold print, turn it around to them so they can read it, and read it to them upside down where the limited recourse loan is a self-funding loan where the loan is repaid by - I forget the words, by the licensee - and when you say the words 'licensee' say "you, now owning a licence, are the licensee" - refer to them as the licensee. It also helps to gives them the impression that they've already bought because you're starting to call them the licensee.
Then go down to the bottom of that section and talk through the bit about security - "as you'd know when you're buying a house you give the bank a mortgage over your house which is their security. Here the security is the people who've taken security over your agreement or your licence. The worst that can happen is that you'd have to give your licence back and the $134 you paid for your licence, you forfeit that. In fact because it's tax deductible you've really only end up forfeiting $70. No real big deal, no real big risks. ...
Some people say, but you know, we've been in business and it's the best thing we've ever seen. And it's even concerned us because it seemed to us to be too good to be true and again I think it's worthwhile doing that - I've noticed I've done that a bit in the last few - before they bring up the objection that it's 'too good to be true', you bring it up. Yes, it looked like it was too good to be true for us, and to give you an idea how actually good it is look at this piece of paper and it says, they will even guarantee the first two years income - that's never ever been done before. ...
...We've taken this to lots of accountants in Perth umm there's a guy called - for instance if you look in the information memorandum - there's AB Accounting. They did the work for it in Perth, and the fella who did the work for them a guy called Fred was so impressed with this he bought a licence for himself. Please feel free to ring Fred, he'll tell you he's bought a licence. What's more he's even recommended his father buy one. When that happens we're impressed with that sort of thing.
No we've also went to find out from a guy in BC Accounting the other day, another very big firm of accountants, a fellow was called to see what he thought about Franchise Ltd and he said, well I bought one. Same again, another guy called Bob, one of the accountants we use knows Bob he went to Bob to ask Bob's opinion on Franchise Ltd and he said, George I've already bought one. Enough said. We don't need to know how good it is because Bob's already got one.
We took it to a guy called George he just happens to be the guy that went to university with a QC called Fred. Fred has written an opinion on this which I'll show in a moment. When George found out that Fred had written an opinion George said you've got me. If Fred says it's ok it must be ok. We said, "why do you say that". He said, well I went to university with Fred ..................
Now be careful when you're talking about a QC ask your audience do they know what a QC is. Don't assume that they know. And explain to them what a QC is and if you're involved in a big legal fight and please God that you're not - but if you ever get involved in one and you know you're in the right and you've got big heaps of money - if you're smart you'd be employing a QC to look after you. By the way, QCs are expensive, they cost anything from $2,000-$30,000 a day to represent you in court. Fred's done an opinion on this because we still weren't happy and we said no, we want you to take this to a lawyer, preferably one of the better ones in Perth to tell us if this is ok.
Well they went to Fred. - and he says here on the last page, that the proposal makes good sense even without the tax benefits. When we read that we're staggered because I never thought I would see a lawyer use the words that the proposal makes good sense ...inaudible......oh yes I usually open up the opinion and show them that bit..."
No ATO Green Light
It is noteworthy that nowhere in the tape recording do we see a reference to the ATO having accepted these arrangements.
In relation to mass marketed schemes only 5 favourable rulings were issued which have proven to have been unsustainable because of the way the scheme was implemented and the extent and nature of the underlying activity. These related only to 2 of the 196 schemes and the ruling requests did not disclose the financing details associated with the arrangement, and made assumptions as to the extent and nature of the underlying activity.
Risk Management
Tax administration is all about allocating scarce resources to areas of risk or focus.
The following table outlines claims for scheme deductions which increased to over $1b in 1997.
YEAR
|
SCHEME DEDUCTIONS $M
|
1987
|
13
|
1988
|
113
|
1989
|
73
|
1990
|
2
|
1991
|
7
|
1992
|
54
|
1993
|
54
|
1994
|
176
|
1995
|
288
|
1996
|
666
|
1997
|
1095
|
1998
|
960
|
The first point that needs to be remembered is that on a relative basis the risks associated with mass marketed schemes were low in terms of tax administration 'until they took off like wild fire', around 1996 and 1997. Moreover, any reallocation of resources involves a trade-off against the effectiveness of other areas of ATO operations.
The chart below shows how ATO actions became more intensified and innovative as we grew to understand the dimensions of the problem - particularly the human dimension and the competitive entrepreneurial market.
For example, we had commenced examining at least 28 schemes where deductions were disallowed before the schemes proliferated post 1996. An ATO Schemes Taskforce was established in July 1997.
Has the ATO been taking an "overly empathetic" approach?
Our actions in relation to mass-marketed schemes have been strictly in accordance with the legislative framework that supports a self assessment system of taxation and in accordance with our responsibilities under the law.
Under our self assessment system people have the ability to gain certainty - and avoid facing the consequences of a later review of a particularly questionable investment of the kind embodied in these arrangements - by applying for a private binding ruling.
With the exception of a handful, the 35 000 or so investors did not do that. Reliance was placed on the views of people other than the Tax Office. If these views are wrong, the investors' right of recourse is against those on whose views they relied.
It has been said that investors in these schemes were not sophisticated in the ways of self-assessment.
However investors in these schemes almost invariably engaged the services of a tax agent in making their claims - 97% according to our records. It is inconceivable to me that tax agents were unaware of the very foundations of the operation of our tax system.
We have sought to recognise the circumstances of people caught up in these schemes where the law provides us with that capacity. We have done that in our approaches to penalties, interest, collection and settlement.
- We have held of on collection action while test cases funded by us are heard.
- We have given investors the opportunity to benefit from greatly reduced penalties - down from 50% to 10%, 5% in some cases.
- We have reduced the interest rate on debts for most investors from 11.89% to 4.72%. This interest is tax deductible so that for many the effective interest is only around 2.4%.
- We have made it clear that we will further accommodate the circumstances of people facing financial difficulties as a consequence of being caught up in these schemes.
- We have offered settlement on a cash basis in agricultural arrangements where there has been a reasonable level of productive activity.
In the Committee's interim report there was a call for a partial or full amnesty on penalties or interest.
By taking the steps we have we have already done that.
A difficult, even contentious, balancing act is required here.
Go too far in reducing penalties and interest and it may be difficult to justify the result to the community generally and to those who face penalties and interest for debts unrelated to any participation in tax avoidance schemes in particular.
The following comments made by Barbara Smith, the technical director of Taxpayers Australia, to an Australian Law Reform Commission conference suggest we are close to realising that risk:
"The new interpretation seems to treat some tax debts as being more heinous crimes against the revenue than allegedly being involved in tax avoidance."
"Those categorised as a tax avoider are better treated than a taxpayer who makes a minor misdemeanour."
We have sought to meet a difficult balancing act in recognising particular circumstances according to the law, and in taking an "empathetic" approach to investors.
Seeking Certainty through the Courts
We have, it seems, reached the point where one way forward is to allow the course of the law to resolve these issues through the courts.
On this front, the Budplan test cases is well advanced and we are hoping for an early decision.
We have announced we would also fund test cases in relation to certain film schemes.
We have agreed to fund test cases because we are keen to get judicial clarification of these issues as soon as possible. We remain confident that our views will be upheld.
For example in Budplan the lender delivered a bill of exchange to the researcher for research fees and a bill to the manager for management fees. The researcher and manager negotiated the bills (within one minute of delivery) so they were payable to the lender, and then delivered the bills back to the lender. The lender then cancelled the bills. The up-shot of these arrangements was that very little real money was actually available for any productive activity.
In relation to a film scheme, the 6 taxpayers who were to be test cases for the scheme pulled out virtually on the steps of the court.
In a recent AAT mater handed down on 17 September 2001 Senior Member Pascoe said in relation to that scheme:
"it is clear that JOPL had no funds available and that its purported capital contribution was part of the 'round robin' of back entries with its only source, the alleged interest payable to it by the partnership.
... it can readily be accepted that [the company's] purported capital contribution to the partnership was again part of the round robin of book entries and, in particular, a contra for the purported investment of the same amount in the ... Partnership by JOPL. ...
As such, it is difficult to regard CCILP as having incurred the expenses claimed. There was no possibility and, likely, no then intention that such expenditure could be met by the partnership. ...
In my view, the alleged transaction was a sham. ...
The Tribunal is satisfied that these documents were prepared to create the appearance of establishing rights and obligations without any intention of satisfying such rights and obligations, perhaps unless some unlikely miracle attracted some $10 million of investment in CCILP. At the time the documents were created there was no prospect of such a miracle. In finding that the alleged transactions were a sham, it follows that the claimed expenditure of interest paid to JOPL was not incurred. ...
It should be said that I accept that the bulk of the individual outside investors in CCILP thought that they were investing in potentially profitable projects of JOPL. This belief may also have been in the mind of X, although as a director and shareholder of JOPL she might have been expected to have greater knowledge of the "smoke and mirrors" which sought to disguise the nature of the structure.
Even if I am wrong in finding that the expenditure claimed by CCLIP was neither incurred nor for the purpose of producing assessable income, the provisions of Part IVA of the Act apply so that the deductions claimed are not allowable.
For the same reasons that the Tribunal has given for the non-deductibility of amounts claimed for purported interest on unpaid shares, the amounts claimed on deductions by ;the applicants for interest on purported funds borrowed for their partnership contributions and management fees are not deductible. There was no valid borrowing from the finance companies and the funds ultimately paid by them were not used for the purpose of producing assessable income. Again, the scheme adopted and the objective criteria of s 177D lead to the conclusion that s 177F of the Act disallows any deduction.
The applicants submitted that they were somewhat innocent victims in their participation in the scheme ... In relation to the interest component, the Tribunal has no jurisdiction but is prepared to recommend to the respondent that consideration be given to a reduction of the relevant rate of interest recently announced in relation to "taxation schemes". ... With some reservations regarding X I am prepared to accept that the applicants were somewhat naïve in their participation in CCILP and were misled by B into believing that their investment would assist in development of projects in their local area and that the deductions claimed were legitimate. I am conscious also of the considerable expenditure incurred by them in seeking to overturn the respondent's decision in the belief, unfortunately mistaken, that they had done nothing wrong. In the circumstances, I am prepared to exercise the discretion under s 227 of the Act to remit the additional tax being the penalty component under s 223 or under s 226G to 15 per cent of the tax shortfall."
Conclusion
Unfortunately, there has been a lot of misleading or false information, often peddled by vested interests, that have caused some investors to have a mistaken belief about the legitimacy of their claims.
The Senate Economics References Committee concluded in its Interim Report of June 2001 that:
"it is the view of the Committee that a large number of these schemes appeared to be designed specifically to defraud the tax system and to use ordinary taxpayers in that process. Not only have they left many taxpayers with large tax bills, but many of these schemes have ceased to exist. The Committee is of the view that few schemes represented 'a good investment' in the ordinary meaning of the term, and that without the 'tax deductibility' factor, very few would have got off the ground."
In its Second Report of September 2001 the Senate Economics Committee concluded that:
"the vast majority of taxpayers involved in these mass marketed schemes may be described as 'unwitting', in that they were unaware of the alleged tax mischief of the schemes. Others have undoubtedly been victims of unscrupulous practices ...
the Committee is of the view that the majority of the schemes were principally designed in such a way as to make a profit for promoters, by using ordinary investors to defraud the tax system. The Committee criticises in the strongest terms those promoters who sought to abuse both investors and the tax system in this way."
Last Modified: Friday, 5 September 2003
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