Administration of the Promoter Penalties Regime and recent Court decisions
NSW 7th ANNUAL TAX FORUM
Thursday 22 May 2014
Dalton House Sydney
Tim Dyce, Deputy Commissioner, Aggressive Tax Planning
'Administration of the Promoter Penalties Regime and recent Court decisions'
This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.
End of attention
The history and context of the promoter penalty regime has been presented to the tax community at various TIA conferences over the past. This paper draws on those previous papers.
This paper outlines the strategies used by the ATO to prevent aggressive tax planning, detect current risks and deal with breaches of the regime, in particular the factors influencing case selection and the choice of appropriate remedies to be applied. These strategies allow the ATO to align its actions to protect the integrity of the tax system and guard the community against unwittingly entering into tax schemes. Further, this paper summarises recent Court decisions on the application of Promoter Penalties.
“Keeping between the flags” is an expression the ATO regularly uses to alert tax professionals and the community to questionable arrangements. While we respond firmly to tax avoidance arrangements through compliance monitoring and casework, our primary focus is on prevention, helping people recognise, reject and report such arrangements. The ATO’s approach to promoter penalty risks is to act quickly to stop the proliferation of potential tax avoidance and tax evasion schemes and to disrupt the supply and demand for these products. Applications to Court for the imposition of civil penalties are a last resort in ensuring compliance.
We would like to thank the bulk of tax professionals for ensuring that the tax system works as it was intended and for helping contribute to our nation’s advancement.
Background to Promoter Penalties
The ATO has encountered a multitude of schemes over preceding decades – from the “bottom of the harbour” schemes of the 70s and 80s, mass marketed schemes and employee benefit arrangements in the 90s, to certain offshore structures and complex financial instruments over recent years.
Prior to the introduction of the promoter penalties in 2006, there was an imbalance in sanctions, creating risks for taxpayers, while promoters often escaped any liability. Taxpayer participants eventually paid the tax and, in many cases, substantial interest and penalties. Promoters were not sanctioned unless criminality could be proven. Effectively, promoters profited from generating problems for taxpayers, the tax system and the community. Sometimes, unscrupulous promoters enjoyed an unfair competitive edge over other, more principled, professionals. The introduction of the promoter penalty legislation helped redress this imbalance and supports a “prevention rather than cure” strategy.
The explanatory memorandum that accompanied the passage of the promoter penalty laws noted that:
The introduction of a penalty regime will remedy an existing asymmetry in the risks faced by scheme promoters and investors. By putting promoters at risk financially for the promotion of ineffective tax schemes, rather than allowing all risks to be passed on to the investors, the market for investment schemes is likely to operate more efficiently with the potential for investment capital to be redirected to legitimate and productive investments.
Reiterating this theme on 6 April 2006, former Commissioner Michael D’Ascenzo stated the intent of the legislation:
(the) legislation is aimed at eliminating unscrupulous operators who peddle unsustainable arrangements to the detriment of both the taxpayers and ethical advisers.
The Government made it clear that its policy objective was not confined to mass-marketed tax avoidance or evasion schemes, but to deter all forms of scheme promotion. Therefore, marketing a scheme or otherwise encouraging its growth or interest in it need not involve multiple participants.
Many entities that the ATO has contacted about potential promoter penalty cases have held a false impression that these laws do not apply to boutique or even wholesale promotional activities. As a result, these entities may not have effectively managed the risks flowing from their conduct, which could lead to adverse consequences for their business.
Structure of Promoter Penalties
The legislation is contained in Division 290 (the promoter penalty laws) and Subdivision 298-B (the civil penalty procedural provisions) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953).
The promoter penalty laws rely on two provisions to proscribe two different types of conduct. The first provision proscribes:
conduct that results in that or another entity being a promoter of a tax exploitation scheme.
To avoid contravention of this provision an entity must not engage in conduct that would result in them being a promoter of a tax exploitation scheme. This would ordinarily encompass authorised acts of the entity’s employees and act of agents on behalf of the entity.
Additionally, an entity must not engage in conduct that would result in another entity being a promoter of a tax exploitation scheme. This approach, generally known as a ‘look through’ mechanism, is important to enable action to be taken against key individuals (for example, a managing director or a partner in a partnership) operating through another entity in promoting a tax exploitation scheme.
The second civil penalty provision proscribes:
conduct that results in a scheme that has been promoted on the basis of conformity with a product ruling being implemented in a way that is materially different from that described in the product ruling.
The note to this provision emphasises that the material difference relates to the tax outcome for participants in the scheme. However this does not require an actual adjustment to the income tax return of such participants, just the potential for an adjustment. This ties in with other elements of these laws, such as the object of deterring such conduct and the availability of injunctions as a remedy (where an application might be made in order to prevent material differences arising during the financial year before an adjustment would be possible).
How the ATO manages risk of potential contravention of the promoter penalty laws
The ATO has developed a Risk Differentiation Framework to differentiate its engagement approaches for entities that may be subject to the promoter penalty laws. This framework was first presented publicly in late 2009 by the then Deputy Commissioner for Aggressive Tax Planning, Stephanie Martin, and has since been published in Guide for tax intermediaries: Good governance and promoter penalties.
The Risk Differentiation Framework looks at the likelihood of a potential contravention of promoter penalty laws occurring versus the consequences of a contravention. This is similar to other Risk Differentiation Frameworks used by the ATO to manage tax compliance risks for taxpayers in other contexts. However, this framework focuses on the potential for a contravention of the promoter penalty laws.
Figure 1: Promoter Risk Differentiation Framework
This framework has significantly improved the nature of the ATO’s engagement with entities by categorising entities based on their risk characteristics. For example higher risk entities generally warrant more frequent and intense ATO risk review activity. The four categories involve:
- Higher risk intermediaries (Category 1): Deter and deal with in real time. These entities are subject to more frequent and more intensive ATO action.
- Key intermediaries (Category 2): Monitor and maintain behaviour. These matters concentrate on engagement to help the entity recognise risks and to deal with them, especially through governance input and seeking ATO rulings to provide certainty to clients/investors.
- Medium risk intermediaries (Category 3): Deal with and deter. These matters are done on a periodic and less intensive project basis, although some entities may be escalated to higher risk status, depending upon the nature and extent of risks detected and responses to ATO concerns.
- Lower risk intermediaries (Category 4): Monitor and detect shifts. This makes up the majority of entities who are risk assessed, with ATO strategies involving monitoring changes in status and leveraged communication to support and encourage compliance with these laws.
The ATO’s Approach to Administering the Promoter Penalty Laws
The ATO adopts the approach of supporting the tax community by detecting tax schemes, and protecting people from unwittingly being drawn into them. We do this using a range of communication channels.
Through the organisation’s publications, including Guide for tax intermediaries: Good governance and promoter penalties, Investigating tax effective arrangements and our YouTube video Recognising tax avoidance schemes we aim to educate the community about the warning signs to look for before entering into a tax effective arrangement. Other resources such as Taxpayer Alerts can help taxpayers and tax intermediaries recognise and deal with schemes in a timely manner; Private Rulings and Product Rulings allow the taxpayer the opportunity to seek the ATO’s opinion on arrangements before implementation. Taxpayers and tax intermediaries are encouraged to perform their own due diligence before entering into tax effective arrangements to ensure they comply with the law.
The ATO encourages taxpayers and tax professionals to engage in Early Dispute Resolution and speak to us about extricating themselves from arrangements in order to avoid costly and time-consuming disputes.
The ATO’s approach to promoter penalty risks is to act quickly to stop the proliferation of potential tax avoidance and tax evasion schemes and to disrupt the supply and demand for inappropriate products.
This bolsters other mitigation strategies for taxpayer compliance risks, such as Taxpayer Alerts, warnings to participants, voluntary disclosure offers or widely based settlements.
Most entities contacted by the ATO on promoter penalty matters act quickly to self-correct and to limit reputational damage to their business as well as damage to their clients/customers with some electing to pay tax related liabilities arising from arrangements on behalf of taxpayers.
Practice Statements on the administration of each provision were released by the ATO on 17 April 2008. They contain detailed guidance on the application of the provisions with flowcharts that help identify whether a contravention may have occurred. In addition the Guide for tax intermediaries: Good governance and promoter penalties, released on 7 April 2011, contains a useful overview of the key elements of these laws – an updated version of the guide was issued in December 2012.
The role of the Promoter Penalty Review Panel
The ATO established a Promoter Penalty Review Panel to assist it in its administration of the promoter penalty laws. The panel provides independent advice on the strengths and weaknesses of a case, the appropriateness of remedies (including other options available) and the sufficiency of existing evidence. It is made up of senior tax officers and other professional persons external to the ATO, chosen for their ability to provide expert and informed advice.
Some professionals have questioned aspects of the ATO’s information gathering approach, including the stage at which section 264 notices are issued and the implication that promoter penalty issues exist when a section 353-10 notice is issued.
We are mindful of the potential reputational issues associated with the promoter penalty laws, but consider this unavoidable given that section 353-10 notices by their very nature relate to these laws.
The context of promoter penalty enquiries, reviews and investigations differs from that in general taxpayer compliance cases. As a result the ATO adopts a different approach to information collection in these cases. This was explained by the Commissioner in a speech to the National Convention of the Institute of Chartered Accountants in Australia on 7 April 2011. The reasons for this approach may be summarised as:
- tax intermediaries (including advisory firms, financial institutions and implementers of product ruling arrangements) are subject to contractual and/or statutory duties of confidentiality that require the exercise of ATO access and information gathering powers.
- many arrangements that taxpayers participate in either impose a contractual duty of secrecy on participants or involve confidential materials and protected intellectual property. Further, many participants are reluctant to provide information about the potential culpability of another entity (i.e. a potential promoter) without the security of being compelled to comply.
- Higher evidentiary burdens apply to civil penalty matters.
Accordingly, in cases involving promoter penalty enquiries, the ATO exercises its statutory access and information collection powers at first instance, rather than seeking the provision of information ‘informally’ on a voluntary basis.
In addition, we routinely issue identical section 264 notices as well as section 353-10 notices to overcome concerns about ‘purpose’, should the information later be used to raise assessments against a participant.
However, except in urgent cases – which appear to be more prevalent for higher risk intermediaries, the ATO will generally engage with affected entities to explain the nature of our enquiries and to discuss framing of notices and timing for compliance.
Applying the Promoter Penalty Laws
Is there a tax exploitation scheme to which the promoter penalty laws apply?
The promoter penalty provisions apply in circumstances where an entity is the promoter of, or causes another entity to be the promoter of, a tax exploitation scheme (‘TES’, as defined in section 290-65 of the Taxation Administration Act 1953). That is, a scheme, whether implemented or not, in respect of which it is reasonable to conclude that those who entered into or carried out the scheme (or would have done so if it was not implemented) had the dominant purposed of the obtaining of a scheme benefit, and where it is not reasonably arguable that the scheme benefit is (or would be) available at law.
Who do the promoter penalty laws apply to?
If a TES is identified, an entity will be considered to be a promoter if all three of the following elements are present:
- the entity markets the scheme, or otherwise encourages the growth or interest in it
- the entity, or an associate of the entity, receives (directly or indirectly) consideration in respect of that marketing or encouragement, and
- it is reasonable to conclude that the entity had a substantial role in respect of that marketing or encouragement, having regard to all relevant matters.
There may be a number of entities involved in a particular instance of prohibited conduct. Numerous entities may be involved with, or participate in, the marketing or encouragement of the growth of, or interest in, a TES. However, not all of these entities will necessarily be subject to the promoter penalty laws. Only those entities that have a substantial role in the marketing and encouragement activities (in addition to receiving consideration) will be promoters. An entity that has only minor involvement in marketing or encouraging the growth of, or interest in, a TES, or whose conduct is peripheral to the marketing or encouragement of a TES, will not satisfy this element of the promoter definition.
We are seeing individuals engaging in prohibited conduct who attempt to structure their affairs to avoid sanctions under the promoter penalty laws. Some examples are individuals:
- operating through another entity
- formally or informally controlling the acts of a corporate entity
- instituting complex entity structuring
- employing others to carry out the prohibited behaviour, and
- using contrived employment arrangements to remove the appearance of being the controlling mind of another entity.
We will seek to commence action under the promoter penalty laws in relation to the most appropriate entity or entities in the circumstances to advance the objects of those laws. This entails examining the source or cause of the conduct to identify the individuals controlling or directing the engagement in the prohibited conduct.
Strategic approach to aggressive tax planning case selection
Our approach to case selection is based on a carefully considered assessment of the strategic value of each case. There are a number of factors that we weigh up in order to arrive at a view of whether there is sufficient strategic value to commence action in relation to an arrangement. These factors include:
- Commercial context: Does the arrangement have a legitimate commercial purpose or is the dominant purpose to obtain a tax benefit?
- Whether an arrangement is reasonably arguable: Whether it would it be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.
- The age of the arrangement: The longer an arrangement has proliferated, the more important intervention may be.
- Likelihood of proliferation: An outbreak has the propensity to undermine both the integrity of the tax system and community confidence when taxpayers either intentionally, or because of incorrect advice, cease to voluntarily comply with the tax system.
- Role of the promoter in the scheme.
- Number and role of participants involved in the scheme: The scale of participation and their level of non-compliant behaviour.
- Risk to revenue: Those cases with a significant assessed risk to the revenue will be of greater strategic value.
Is action under the promoter penalty laws appropriate?
Once we have established that an arrangement is of sufficient strategic value to commence action in relation to it, we then need to determine the most effective action to be taken to achieve the objectives of the laws. There are a number of considerations that will inform this decision, described below.
Facts and circumstances of the conduct
This incorporates considerations such as the entity’s motivation for engaging or not engaging in the conduct, the entity’s availability of alternative income sources and other factors that may impact on its behaviour, such as the entity’s health. These all influence the strategic value in pursuing action under the promoter penalty laws.
Seriousness of the conduct
The weighting of this factor is determined after considering a number of sub-factors which assist us to establish the degree of seriousness:
- The revenue estimated to be at risk if the arrangement is allowed to continue without any intervention by the ATO
- The level and extent of consideration received. This provides an indication of the reliance the promoter places on the activity for their business success. We will also seek to determine whether any payments, however else described, represent consideration for involvement in promotion
- The potential level and extent of participation (both generally and within industries or sectors of the economy)
- The consequences for participants such as the loss or damage suffered (which includes likely penalties, but could also include non-monetary damages)
- The degree to which the scheme benefit is arguably available at law
- The duration of the prohibited conduct. The longer it has been occurring, the more likely it will be that we will commence action under the promoter penalty laws.
Deliberateness of the conduct
The deliberateness of the prohibited conduct may have a material impact on the decision to undertake action under the promoter penalty laws in a particular matter. We will consider whether the entity was wilfully blind to the result of its conduct, and whether the results of its conduct were reasonably foreseeable. That is, whether the promoter knew, or ought to have known, what the impact of their conduct would be.
Of higher strategic value would be cases involving a promoter with a history of promoting aggressive arrangements, who is promoting an arrangement with no commercial value, which is contrary to a published view and/or a private ruling, or which has elements of fraud.
Steps the entity took to curtail its conduct
This factor involves a consideration of the steps taken by the promoter (if any) to curtail the effect of its conduct. Such steps may include internal governance procedures, controls and caveats, or limitations in marketing documents. If a promoter takes high levels of care and due diligence in the marketing of an arrangement the less likely it is that action under the promoter penalty laws would be taken.
An entity’s compliance history as a taxpayer and any past promotional conduct will influence a decision on the appropriateness of a promoter penalty application as a remedy to address current behaviour.
Cooperation with the ATO
The level of the promoter’s cooperation with the ATO’s enquiries about their own conduct and the conduct of others may influence the decision as to whether action under the promoter penalty laws will commence. We take into account whether there is full and frank cooperation with regulatory authorities, or whether the promoter exhibited non-compliant behaviour when dealing with regulatory authorities.
Willingness to address the conduct
In any given case that is being considered for potential action under the promoter penalty laws, we take into account the willingness of the promoter to address the prohibited conduct, which may include recompensing participants as well as changing its own future behaviour.
Merits and deterrent effect of remedies
We make judgments on the merit and/or deterrent effect of each remedy, including the effect of litigation on the entity or other entities that may be affected:
Balancing deterrence with other risks
We consider the risks associated with action under the promoter penalty laws. This involves a balancing of the effect of the deterrence of prohibited conduct through taking action with the legal, administrative and commercial risks resulting from it. A case will be higher risk where it presents difficulties for the ATO in applying the promoter penalty laws.
Availability of sanctions
We consider whether there are other sanctions that are more appropriate to deal with the entity’s behaviour and circumstances. Sanctions that could be considered include potential referrals to the Tax Practitioners Board or to other Government Agencies.
Choosing the Appropriate Remedy
The legislation provides guidance on how to deal with potential breaches of the provisions. The Commissioner has the flexibility to seek an enforceable voluntary undertaking, an injunction, or civil penalty against the entity.
The Federal Court can, on application by the Commissioner, order an entity to pay a civil penalty or grant an injunction in relation to a contravention of either civil penalty provision. The ATO believes that civil penalty action is the last resort for compliance activity for this type of behaviour.
There may be circumstances where it will be appropriate to seek more than one remedy to effectively address the conduct. In this context, civil penalties focus on providing a sanction against past prohibited conduct and voluntary undertakings and injunctions are focused on deterring future prohibited conduct.
Similarly, in circumstances where there has been past prohibited conduct, a civil penalty may not be appropriate in all cases. This may include where the promoter entity has otherwise made restitution for the consequences of their prohibited conduct (for example, by payment of relevant participant penalties). The level of cooperation shown by the entity may also be relevant, such as where a voluntary undertaking has been entered into and the promoter has then complied fully with it (for example, in the case of conduct under the first limb, immediate removal of advertising content, changes to website materials, cessation of seminar presentations, etcetera).
Written undertakings that are enforceable may be accepted by the Commissioner from an entity in a broad range of circumstances, that is, in furthering the objects of the Division. The Commissioner cannot require an entity to furnish an undertaking, and the Commissioner is not required to accept an undertaking from an entity.
A voluntary undertaking will often be a more flexible, timely, and cost-effective outcome than an injunction or civil penalty application. It also provides entities with the option of voluntarily modifying their conduct and therefore potentially avoiding the reputational damage that might arise from proceedings in the Federal Court. Voluntary undertakings do not require admissions of liability and are kept confidential unless their terms are breached. The ATO will always require that such undertakings address cessation of conduct in relation to the relevant scheme or arrangement. If any of the terms of the undertaking are breached, the Commissioner may apply to the Federal Court for an order.
The ATO will generally seek a voluntary undertaking as a remedy where the aim is to deter future prohibited conduct. It would generally be appropriate in cases where there is a high likelihood of the entity voluntarily complying with the undertaking and where other factors do not argue more strongly in favour of seeking an injunction.
Factors that might weigh in favour of an undertaking as the appropriate remedy include that:
- the entity is willing to provide full disclosure about its own activities and the activities of others involved in the scheme
- the entity is willing to rectify its conduct including by recompensing participants
- the entity has alternative sources of income other than that derived from engaging in the prohibited conduct
- the entity was lower in the chain of command/decision making structure than other entities involved in the scheme
- the risk to revenue is low
- the argument in relation to the availability of the scheme benefit is not clear cut and/or
- the conduct was apparently inadvertent.
The Commissioner may apply to the Federal Court for injunctive relief. The Federal Court may:
- grant an injunction against an entity on such terms as it considers appropriate, and may discharge or vary an injunction granted, at any time, and/or
- grant an interim restraining injunction against an entity to restrict its conduct prior to the full consideration of the Commissioner’s application for an injunction.
Where there is evidence of contemplated or current and ongoing prohibited conduct, the granting of an injunction will potentially limit the period in which there is a risk of prohibited conduct. In seeking to achieve future deterrence, an injunction would be a more appropriate remedy than a voluntary undertaking where a promoter is unwilling to voluntarily modify its behaviour. This might include situations where the promoter is either unwilling to give a voluntary undertaking, or where the promoter’s tax compliance history or previous conduct indicates that they would be unlikely to comply with a voluntary undertaking.
Factors that might weigh in favour of an injunction application as the appropriate strategy include where:
- there is potential for further participation in the arrangement as a result of future prohibited conduct
- there is a significant ongoing level of risk to revenue
- the entity has an adequate degree of control over whether the prohibited conduct occurs
- the entity is not willing to assist the Commissioner in resolving the issue or to modify its conduct without compulsion and/or it has breached or circumvented undertakings, and/or
- there is a need for urgency in addressing prohibited conduct (such as a forthcoming promotional seminar).
Civil penalty applications
The Federal Court can, on application by the Commissioner, order an entity to pay a civil penalty in relation to a contravention of either civil penalty provision. A civil penalty is a strong deterrent measure and also ensures that there is not an imbalance between promoters and their clients with regard to the consequences of involvement in a TES. However the ATO believes that civil penalty action is the last resort for compliance activity for this type of behaviour.
It may be appropriate to recommend a civil penalty application where a course of conduct has concluded, or where the conduct forms part of a pattern of similar conduct over time which is unlikely to be deterred through other means. The prevalence of such conduct can undermine the integrity of the tax system and will greatly affect the wider community.
Factors that might weigh in favour of a civil penalty application as the appropriate remedy include where the entity:
- is knowingly engaging in conduct that is likely to be prohibited and evidence indicates that the entity is unwilling to modify its behaviour
- has as its main income source the promotion of schemes
- has a history of promoting as a major source of income
- has a large degree of control or influence over whether the prohibited conduct occurs
- uses tactics to frustrate the progression of the ATO’s investigation
- has engaged in prohibited conduct on a significant scale in terms of the number of entities or amounts involved, and/or
- has promoted a TES for which participants have or will receive penalties.
Tax compliance action
The promoter penalty laws are only one tool for addressing the risk of promotion. The tax compliance risk in relation to a promoter's own tax affairs or the affairs of the promoter’s associates is another tool available. Relevant factors in considering whether tax compliance action is appropriate include:
- Whether tax risks are identified in relation to the promoter or an entity associated with the promoter
- the nature of the tax compliance risk
- the revenue impact of the risk
- the number of income years involved
- whether there are period of review issues
- whether any period of review issues are affected by fraud or evasion
- the tax compliance history of the promoters and /or associates
- the promoter’s sphere of influence (how many taxpayers could be adversely influenced if the ATO does not address the risk), and/or
- whether there would be an adverse impact to the ATO’s reputation and community confidence if the ATO does not address the risk.
Promoter Penalties and Litigation
Commissioner v Ludekens and Van de Steeg
On 11 April 2014, the High Court (French CJ and Bell J) dismissed applications by Ludekens and Van De Steeg for special leave to appeal the decision of the Full Federal Court which held that the appellants had promoted a TES.
This case involved the first civil penalties application to be brought before the Federal Court against entities for promoting a TES under subsection 290-50(1) of Schedule 1 to the TAA 1953.
In this case, Ludekens and Van De Steeg conducted a scheme which involved the following steps:
- Registration of partnership interests in a number of managed investment schemes (MIS), in their own names, as well as the names of their employees;
- Offering ‘secondary investments’ in the partnerships to a number of investors, who would finance the investments by a loan and service the loan by forwarding income tax refunds obtained by claiming deductions in respect of the investment;
- Receipt of sales commissions from the responsible entity of the MIS, and GST refunds in respect of the registered partnerships; and
- The moneys were to be used to finance a foreign exchange business controlled by Ludekens and Van De Steeg, for the purposes of obtaining profit.
In March 2013, Middleton J of the Federal Court handed down a decision that was favourable to Ludekens and Van De Steeg, finding that neither had promoted a TES. The issues, as decided by Middleton J, included:
- Whether Ludekens and Van De Steeg were considered to be ‘promoters’ under the definition in subsection 290-60(1) of Schedule 1 to the TAA 1953, including:
- Whether they marketed the scheme or otherwise encouraged the growth of the scheme or interest in it.
Middleton J found that, in order to prove this requirement, the Commissioner must show that any respondent conducted active promotional activities – that activities more properly classified as ‘design and implementation’ were necessarily excluded from the definition of ‘promoter’. Most activities carried out by Ludekens and Van De Steeg were found to have been ‘design and implementation’ activities.
- Whether they received consideration in respect of that marketing or encouragement.
Middleton J found that the term ‘in respect of’ required a material connection between the consideration and the marketing or encouragement, and where the consideration would have been received regardless of the marketing and encouragement, this was not ‘consideration’ for the purposes of determining whether an entity was a promoter. Middleton J found that, apart from the tax refund actually paid by one investor to Van De Steeg, the consideration would have been received irrespective of any marketing or encouragement.
- Whether the scheme promoted by Ludekens and Van De Steeg was considered to be a TES under the definition in subsection 290-65(1) of Schedule 1 to the TAA 1953, and whether they entered the scheme with the sole or dominant purpose of obtaining a scheme benefit.
Middleton J determined that, to find a sole or dominant purpose, the Commissioner would need to show an ‘alternative postulate’, being what the entity would have done had it not entered into the scheme. He would then need to show that the dominant purpose of entering the scheme was to obtain a scheme benefit. In this case, Middleton J determined that the Commissioner failed to show an alternative postulate, and that in any event the dominant purpose of Ludekens and Van De Steeg was to make a profit, not to obtain scheme benefits.
The Commissioner appealed the decision of Middleton J to the Full Federal Court. On 29 August 2013, the Full Federal Court allowed the Commissioner’s appeal, concluding that:
- Each respondent engaged in conduct which resulted in each being a promoter of a TES in contravention of subsection 290-50(1) of Sch 1 to the TAA 1953, the first limb of the promoter penalty legislation; and
- The question of penalties be remitted for hearing by a single judge of the Federal Court.
The Full Federal Court agreed with the Commissioner that:
- In respect of whether or not the scheme was a TES:
- The proper construction of ‘scheme benefit’ in the context of section 290-65 did not require the establishment of an alternative postulate. Subsection 290-65(1) is concerned with the ‘purpose with which an entity entered into or carried out the scheme… or the purpose with which an entity would have entered into or carried out the scheme’. The focus is on what the entity was proposing to do and why – and not on any hypothesised events requiring one to posit what might have been done. An alternative postulate is inconsistent with the objects of Division 290, which is to deter the promotion of tax avoidance schemes, whether or not the promotion was successful or participants actually entered the scheme.
- The respondents carried out the arrangement with the dominant purpose of getting a scheme benefit from the arrangement. The Full Court stated that obtaining a scheme benefit and making a profit are not competing purposes and concluded that the arrangement was centrally driven by the scheme benefits obtained through GST and income tax refunds.
- In respect of promotion of the TES:
- Middleton J’s construction of ‘promoter’ was too narrow. Conduct described as development or implementation may, in its proper context, form part of a body of conduct, which amounts to marketing, or encouraging the growth of or interest in, a scheme.
- Middleton J’s approach to the relationship between ‘consideration’ and ‘marketing or encouragement’ was too narrow. Rather, the Full Court determined that consideration does not only have to be ‘for’ marketing or encouragement, but can also be ‘in respect of’ the relevant promotional activity.
Ludekens and Van De Steeg sought special leave to appeal to the High Court on the sole ground that their dominant purpose was to make a profit rather than receive scheme benefits, and as such the scheme was not a TES under the definition in subsection 290-65(1) of Schedule 1 to the TAA 1953.
In refusing special leave, their Honours found that the approach of the Full Federal Court to the question of dominant purpose in the definition of TES in section 290-65 of Schedule 1 to the TAA 1953 was merely one of characterisation of the purposes of the scheme, in a way that did not raise a question of statutory construction that would warrant consideration by the High Court.
The case will now be remitted to a single judge of the Federal Court for a further hearing about the quantum of civil penalties that are to be imposed on the promoters for their contravention of subsection 290-50(1).
Commissioner v Barossa Vines Ltd & Ors
In Federal Commissioner of Taxation v Barossa Vines Ltd & Ors, the Federal Court imposed civil penalties on the responsible entity of a viticultural managed investment scheme (MIS) as well as its directors and a director of an associated entity.
This case was the first in which the Commissioner was successful in applying to the Federal Court for the imposition of penalties against an entity for implementing a scheme, which had been promoted on the basis of conformance with a product ruling, but in a way that was materially different from the scheme described in that ruling. It was also the second case, after the Ludekens decision, in which the Federal Court considered the application of the promoter penalty provisions generally, and subsection 290-50(2) of Schedule 1 to the TAA specifically.
The respondents in this case applied for, and received, three product rulings in respect of viticultural MIS that they purported to carry out in the 2007 and 2008 income years. These product rulings imposed specific responsibilities and duties on the respondents in implementing the schemes, including:
- The responsibility to plant healthy grapevine rootlings on each of the grower lots allocated to the project by 30 June in the 2007 and 2008 years respectively; and
- The responsibility to establish and maintain the vineyards in accordance with good viticultural practices for the benefit of growers, with the ultimate purpose of obtaining proceeds for those growers from grape sales.
Following concerns reported by community members, the Commissioner commenced a civil investigation to determine whether the schemes had been implemented in a materially different way to that described in the product rulings. Through this investigation, the Commissioner obtained evidence to establish that:
- The respondents failed to plant approximately 44% of the grower lots allocated to participants in the 2007 scheme by 30 June 2007, and these grower lots remained unplanted until at least January 2008. Furthermore, one or more of the BVL directors had taken steps to conceal this information from the Commissioner, investors and even the BVL non-executive board members.
- The respondents also failed to plant healthy grapevine rootlings on the 2008 project grower lots, instead planting cuttings taken straight from vineyards grown for other projects. While rootlings were unavailable due to the default of a supplier, the respondents did not take steps to monitor the rootlings, and furthermore continued to sell the project to investors even after they became aware of the supply issue.
- After initial plantings on the 2007 and 2008 project blocks failed, the respondents abandoned approximately 19% of the 2007 grower lots and 21% of the 2008 grower lots. These grower lots could never be expected to produce assessable income for investors.
The respondents and the Commissioner attended court-appointed mediation in June 2013. Through this process, an agreement was reached as to the facts and appropriate quantum of penalties that the parties would jointly recommend to the Federal Court.
On 4 February 2014, Besanko J handed down his judgment, which accorded with the statement of agreed facts and the submission on penalties jointly presented to him by counsel for both the Commissioner and the respondents. Besanko J held that:
- The respondents had promoted a managed investment scheme on the basis of conformity with product rulings, but had implemented the scheme in a materially different way. Each of the four contraventions listed above were considered proven.
- Furthermore, each of the contraventions were chiefly caused by incompetent management and staffing difficulties. The respondents failed to heed the warnings of the viticultural experts and others in respect of the resources being allocated to the schemes, putting their own commercial interests ahead of their important obligations to investors.
- While the respondents’ lack of candour and cooperation during the investigation could not be relied upon in mitigation of penalty, the resolution of the matter by agreement of facts was taken into account. Furthermore, while the contraventions related to two separate schemes, Besanko J applied the totality principle to avoid penalising the respondents twice for the same conduct.
The Federal Court ultimately awarded civil penalties of $625,000 against Barossa Vines Limited and $125,000 each against the four individual respondents.
Further Promoter Penalty Cases before the Federal Court
The ATO currently has 1 cluster of promoter penalty cases involving different taxpayers in the Federal Court, and another cluster is being considered for possible application to the Court.
How to report potential contraventions
The ATO is responsible for administering the tax and superannuation systems, but we are all responsible for ensuring they operate fairly and effectively.
Tax intermediaries play a crucial role in helping us identify tax schemes. You can contact us through the ATP hotline 1800 177 006 or by email at firstname.lastname@example.org to provide information on schemes and the entities involved.
The reporting of financial arrangements to the ATO for our review helps protect the integrity of the system and reduces any unfair competitive advantage that promoters may have in the market.
We are seeing an increase in the number of referrals we are getting, especially from tax agents who bear the brunt of tax avoidance schemes through loss of their client base to less scrupulous entities who may offer attractive deals and incentives to attract new clients.
Taxpayers are also increasingly helping us protect the tax system by reporting tax avoidance schemes to us.
We encourage taxpayers and intermediaries to let us know when they see arrangements in the market that offer “too good to be true” tax benefits. Taxpayer Alerts on particular arrangements have been a good trigger for intermediaries and taxpayers reporting similar schemes being promoted to the community, which helps us deal with the problem.
All information provided is kept confidential and is protected from disclosure to entities who may be involved.
Download a copy of Administration of the Promoter Penalties Regime and recent Court decisions speech (pdf 207kb)
Download a copy of Administration of the Promoter Penalties Regime and recent Court decisions slides (pdf 220kb)