The following material was used in presentations to the Regional Tax Practitioners Working Groups in the first half of 2012.
As a tax adviser, the information in the presentation will help you manage promoter penalty risks that potentially affect you and your clients. It also includes an email address and telephone number to report specific concerns about tax planning arrangements.
Despite the impact of the promoter penalty laws, we are seeing an increase in the sophistication and complexity of aggressive tax avoidance schemes, as well as changes in how these arrangements are being marketed.
We are seeing boutique arrangements being offered to a smaller and more select audience, often to larger entities with more complex tax affairs and to higher wealth or higher income individuals. The marketing of this type of arrangement is not as visible as the previous mass-marketed schemes, as they are promoted via one-to-one channels or word-of-mouth contacts. However, such marketing usually involves an individual within an advisory firm or a financial institution who has a history of association with previous arrangements with controversial tax features.
While we are focusing on many areas as part of our compliance program, three key issues which concern us currently are:
Employment arrangements
Aggressive employee remuneration schemes, including variations on:
- employee benefit arrangements
- abusive labour-hire schemes
- personal services income avoidance schemes
- excessive living-away-from-home allowance arrangements
- non-complying employee share schemes.
The key feature of these types of arrangement is that they try to avoid tax on what is economically employment income, taxation of fringe benefits or the liability to superannuation guarantee. Some of these arrangements use structures like discretionary trusts to avoid PAYG(W) or super guarantee on employment income, while also attempting to allow income splitting between the economic 'employee' and associates.
Other arrangements try to re-characterise or defer receipt of employment income through transactions between an employer, employee benefit trusts and eventual distribution to employees without triggering FBT or income tax consequences.
Widely offered financial products
We are seeing some emerging risks within the financial products market, especially for arrangements that seek to claim excessive tax benefits through the use of complex structures, such as derivatives, to cloak the true economic impact of the arrangement. The ATO is making this another area of particular focus in the next two years, both through encouraging increased engagement with financial institutions on the ATO Product Ruling system, and through promoter penalty reviews of products in the market that appear to have higher risk features.
Examples include retail and wholesale financial products using structures that attempt to replicate exposure to underlying market positions in order to generate tax benefits, like abusive Deferred Purchase Agreements, deferral of income and some franking credit generators.
Mortgage structuring
Case study
The promotion and use of loan structuring arrangements involving residential property investments is an emerging risk. These arrangements include what are often referred to as 'split loans'.
Under these arrangements, investors seek to convert non-deductible interest on a private residential home loan into deductible interest on an investment loan.
Investors do this by using the existing equity in their home to obtain a loan for the purpose of purchasing a rental property - this may involve the use of a line of credit to pay the interest on the investment loan. This results in additional allegedly deductible interest being incurred on the line of credit.
Payments are directed to paying off the private home loan while the investment loan (and/or the line of credit) accumulates interest.
This type of arrangement is promoted to investors as a means of paying down the mortgage on their residential property sooner - however, they are doing this through increasing the allegedly deductible interest claims over time.
There are no issues with people using loan facilities like lines of credit to finance investments, so long as they do not try to claim additional interest through artificially increasing the interest costs on the investment property in order to obtain further tax deductions, while decreasing their non-deductible private expenses.
We have now issued Tax Determination TD 2012/1. This public ruling is about whether the general income tax anti-avoidance provision, Part IVA of the Income Tax Assessment Act 1936, can be applied to deny interest deductions that would otherwise be allowable where the interest expense arises from an investment property loan interest payment arrangement.
The determination states that, provided that the interest is otherwise an allowable deduction, a taxpayer's purpose of 'paying their home loan off sooner' or 'owning their own home sooner' does not prevent the application of section 177F to these arrangements.
Although the determination refers to an investment from a rental property, an arrangement with all the same relevant features but with an investment in shares (that is, a loan used to acquire shares, and a line of credit used to pay interest on that loan) is capable of attracting the operation of the general anti-avoidance rules in the same way.
In addition to this TD, the ATO is using a range of strategies to highlight this issue to the public, including through our Compliance Program and our website. We also gather information from financial institutions, mortgage brokers and tax practitioners who appear to be involved with such arrangements (such as through recurrent themes in private ruling applications). For the highest-risk variations, we are also considering whether the promoter penalty laws may apply to those who market or encourage such schemes.
The main point is that these arrangements work outside the intent of the law - disrupting the level playing field and creating disadvantages for those in the community that willingly pay their fair share. As the economy continues to recover and the tax planning environment changes, we need to support and encourage the community to better deal with tax planning risks - after all, it is the community's tax and superannuation system that is threatened by promotion of, or participation in, tax avoidance schemes.
This year we have been undertaking a number of initiatives to work more closely with you and the broader tax practitioner community.
We have visited 26 professional firms to discuss good governance practices. As a basis for these discussions, we have used the Good governance and promoter penalty laws guide, which provides information to help tax advisers manage promoter penalty risks potentially affecting them and their clients.
We also visited 43 tax agents in regional areas to talk about tax avoidance schemes, and phoned over 50 agents to get an understanding of what schemes they are seeing.
Response from agents has been extremely positive, with all agents giving positive feedback that the visits were informative - in a number of cases, agents supplied valuable intelligence. An ongoing program of visits and calls is planned.
The promoter penalty laws stem from an announcement in December 2003 by the former government that it would introduce a civil penalty regime to deter the promotion of tax avoidance schemes. The laws came into effect on 6 April 2006. The main objective of these laws is to:
- deter the promotion of tax avoidance schemes
- enhance the integrity of the Australian Taxation Office (ATO) product ruling system by deterring implementation of schemes that are in a materially different manner to that described in its product ruling.
Having worked with the laws for six years now, our perception is that the introduction of the promoter penalty laws has had a positive effect on the tax planning industry in deterring people from engaging in behaviour that goes against the intent of our taxation laws and creates an unbalanced playing field.
The environment that brought about the need for the laws is a vastly different one from that in which we operate today. Prior to the laws, scheme participants could be penalised, while many promoters of the schemes escaped without penalty (unless they were subject to the criminal prosecution process).
The introduction of these laws has had a sobering effect on the market - the possibility of being penalised for promoting tax avoidance schemes is deterring would-be promoters from engaging in dodgy behaviour, while forcing others to curtail their activities.
Most entities that we have contacted about specific conduct regarding doubtful arrangements have willingly and immediately self-corrected their conduct without us needing to impose sanctions under the promoter penalty laws. This includes removal of material from their websites, changing seminar material, removing commentary about tax benefits from marketing materials, ceasing marketing of particular products or services, and modifying the implementation of arrangements to comply with the law.
Several entities involved in more complex or higher-value arrangements have offered us enforceable voluntary undertakings (EVUs), which we have accepted. These entities have included advisory firms, financial institutions and large- market taxpayers.
Applications to the Federal Court are reserved for the relatively few intermediaries who are most aggressive in their promotion or implementation of controversial tax planning arrangements.
We have made three applications to the Federal Court to date. It is important to note that once a matter is in court, the alleged contraventions move into the public domain - the alleged schemes being marketed are revealed for others to consider and the individuals and entities promoting them are named in court documents.
Some of the cases we are currently investigating, which may (or may not) result in applications to the Federal Court, include the following:
Case 1
In the SME market (small-to-medium enterprises), we are looking at a number of entities involved in the promotion of research and development (R&D) schemes with features similar to those described in TA 2009/21. In one case, the promoter and its associate entities have assisted Australian registered companies (with a group turnover of less than $5 million) to access their current and future R&D tax offset entitlements to provide enhanced cash working capital at the beginning of the new financial year. The participating companies claim the maximum allowable amount of R&D income tax offsets (being $375,000) prior to commencing or only after an insignificant amount of R&D work has actually been completed. The claim for the offset is substantiated by advanced tax invoices issued by the promoter to the participant company, after the signing of the R&D services agreement. The promoter was subject to an Access Without Notice and several participants have been formally interviewed. The promoter has ceased promoting this arrangement and commenced another business unrelated to R&D.
Case 2
In another R&D case, as a result of compliance activity, the promoters parted company and no further R&D offsets have been made by participants. The review of the promoters is ongoing.
Case 3
In the large market, we are investigating the potential promotion of an arrangement where an entity interposed an associated 'financial supply facilitator' to enhance claims for reduced GST credits for expenses incurred in the course of a company takeover. This arrangement appears to have been marketed by a large accounting firm. Documentation has been requested under notice and is currently subject to claims under accountant concession and legal professional privilege arrangements.
We have found with potential promoter penalty cases that we need to use our formal access and information-gathering powers more frequently than for other compliance cases. The reason for this is largely due to two key factors - firstly, confidentiality is claimed by promoters on client details, so requiring us to make a formal request for the relevant information; secondly, many promoters impose contractual duties of confidentiality on the participants in their schemes, so we need to protect these participants from threats of action by the promoter entity if they provide us with relevant information. Some promoters, who often rely on hiding the facts of their activities in the first place, go to great lengths to delay, defer or defeat attempts to secure relevant information.
To help reduce demand for potential tax avoidance schemes and the activities of those who supply them, we want to continue working together with tax practitioners and their clients so people can:
- Recognise the features of potential tax avoidance schemes.
- Reject potential involvement with such schemes.
- Report the scheme, and those who are promoting it, to us.
Not all tax avoidance schemes are obvious. Many are designed in complex ways that make them look like they are legitimate arrangements that a taxpayer believes will deliver the promised tax consequences. However, on closer examination, they have features that make them higher risk. It's not only complex investment structures that spell trouble for investors.
Avoidance schemes can be very well marketed - urging would-be investors to act quickly to make the most of the opportunity, and instilling in them a false sense of trust about the legality of the arrangement. Sometimes they falsely suggest that the ATO approves the arrangement, or require participants to enter into secrecy or confidentiality agreements so that they believe they can't tell us about the arrangement.
In an example from a recent tax avoidance scheme, investors fell victim to convincing sales pitches. Home owners were sold a 'mortgage management' plan where they were promised a way of paying off their mortgage faster by using the existing equity in their home to obtain additional loans for the purpose of claiming investment deductions that were equivalent to their home loan interest payments. The arrangement was eventually revealed to be a tax avoidance scheme and shut down by the ATO. Unfortunately, this did not happen before investors lost hundreds of thousands of dollars. Many are now faced with the possibility of having to sell their homes to pay the money owed in taxes, interest and penalties.
If it looks too good to be true, it probably is.
ATO education and support
We have developed a number of education and support tools and services to help you recognise a tax avoidance scheme:
- Investigating tax-effective arrangements.
- Taxpayer alerts - an 'early warning' of significant new and emerging higher- risk tax planning issues or arrangements the ATO has under risk assessment, or where there are recurrences of arrangements that have been previously risk assessed. We remind people that they still need to exercise their own judgment and seek independent professional advice about other arrangements because these alerts are not a complete list of every scheme that may be in the market.
- ATO product rulings - an important way for people to obtain certainty about the tax consequences of investing in widely offered products, provided the arrangement is implemented in accordance with the description in the ruling.
- Private rulings - we encourage people to apply for private rulings to obtain certainty about the tax consequences in their particular circumstances.
- Engagement visits - helping tax agents and key intermediaries recognise what might be considered tax avoidance and promotion of schemes.
We are seeing more evidence of situations where taxpayers and tax practitioners are recognising tax avoidance schemes and rejecting involvement because they:
- have participated in schemes previously and been burnt
- are more cautious
- have sought independent advice.
We have also been informed of situations where some agents are refusing to lodge returns on behalf of taxpayers who are involving themselves in contestable arrangements.
Example
Many taxpayers approached about the tax avoidance scheme that offered massive tax deductions on donations made to overseas charities chose not to become involved. Also, some tax or financial advisers advised their clients not to enter into the arrangement - including at public seminars on the arrangement. Unfortunately, a small number of advisers decided to help market the scheme and we are now dealing with the original promoters, these advisers and the tax compliance of their clients.
The ATO is responsible for administering the tax and super system, but we are all responsible for ensuring it operates fairly and effectively.
Tax practitioners play a crucial role in helping us identify tax avoidance schemes. You can contact us on the Schemes hotline by phoning 1800 177 006.
The good news is we are seeing an increase in the number of referrals we are getting, especially from tax agents who often feel the brunt of tax avoidance schemes through loss of their client base to less scrupulous agents who may offer attractive deals and incentives to lure new clients.
Example
We were recently approached by an agent who made a complaint about another accounting firm in the local area who was attracting a number of wealthier clients by offering to generate larger deductions through a potentially abusive trust arrangement. The agent became suspicious of the arrangement when he examined the documentation from one of his existing clients. Suspecting it was a tax avoidance scheme, he referred it to the ATO and we are now following up with the appropriate compliance action.
Taxpayers are also helping us protect the tax system by reporting tax avoidance schemes to us.
Example
We recently received a report from a taxpayer who received a phone call about an alleged new government incentive that would allow taxpayers to claim 50% of their mortgage back on tax. The taxpayer thought it was suspicious and sent it to us for investigation.
We encourage taxpayers to let us know when they see arrangements in the market that offer 'too good to be true' tax benefits. One trigger that sees more taxpayers contact us is after we publish Taxpayer Alerts on particular arrangement types - they are contacting us to report similar schemes being promoted to the community.
Help us to identify tax avoidance schemes
If you come across an arrangement you think might be a tax avoidance scheme, phone the ATP hotline on 1800 177 006.
Work with us to benefit the community by stopping tax avoidance schemes.
Email any specific concerns to reportataxscheme@ato.gov.au
If you would prefer to provide information anonymously, phone us on 1800 177 006.
Last Modified: Wednesday, 5 December 2012