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Ruling

Subject: Application of Part IVA of the Income Tax Assessment Act 1936

Question

Does Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme?

Answer

No.

This ruling applies for the following period:

Income year ending 30 June 2009

Relevant facts and circumstances

The entity is a personal services business on the basis of the unrelated clients test and meets the 80% rule.

The entity stated that its after-tax profits will be paid to its associates where profits are not retained to meet working capital requirements and acquire plant and equipment, as required.

The entity stated that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) (Part IVA) should not apply as the entity is carrying on a personal services business, and the arrangements were not entered into for the sole or dominant purpose of obtaining a tax benefit.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 177A.

Income Tax Assessment Act 1936 Section 177C.

Income Tax Assessment Act 1936 Section 177D.

Income Tax Assessment Act 1936 Section 177F.

Income Tax Assessment Act 1997 Section 86-15.

Reasons for decision

Part IVA of the ITAA 1936

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) (Part IVA) is a general anti-avoidance provision that can apply in certain circumstances if you obtain a tax benefit in connection with a scheme, and it can be concluded that the scheme, or any part of it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort.

Section 177F of the ITAA 1936 gives the Commissioner discretion to cancel a tax benefit that has been obtained, or would, but for section 177F of the ITAA 1936 be obtained by a taxpayer in connection with a scheme to which Part IVA applies.

Before the Commissioner can exercise the discretion in section 177F of the ITAA 1936, the following questions must be addressed:

- Is there a scheme as defined by section 177A of the ITAA 1936?

- Is there a tax benefit which was obtained in connection with the scheme as defined by section 177C of the ITAA 1936?

- Is the scheme a scheme to which Part IVA applies, as determined by section 177D of the ITAA 1936, where it would be concluded that the taxpayer's main or dominant purpose of entering into the scheme was to obtain the tax benefit?

Scheme

Subsection 177A(1) of the ITAA 1936 defines a scheme widely as follows:

"scheme" means:

- any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

- any scheme, plan, proposal, action, course of action or course of conduct;

Subsection 177A(3) states that the reference in subsection (1) to a scheme, plan, proposal, action, course of action or course of conduct shall be read as including a reference to a unilateral scheme, plan, proposal, action, course of action or course of conduct, as the case may be.

Tax benefit

For Part IVA to apply, a taxpayer must have obtained, or would, but for section 177F of the ITAA 1936 obtain, a tax benefit in connection with a scheme. Subsection 177C(1) of the ITAA 1936 defines four kinds of tax benefit, relating broadly to:

- an amount not being included in the assessable income of the taxpayer of a year of income

- a deduction being allowable to the taxpayer in relation to a year of income

- a capital loss being incurred by the taxpayer during a year of income, and

- a foreign tax credit being allowable to the taxpayer.

The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an alternative hypotheses or an alternative postulate. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. This alternative hypothesis or postulate also forms the background against which the objective ascertainment of the dominant purpose of a person occurs in accordance with section 177D of the ITAA 1936.

Objective purpose test

Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. The person referred to need not be the taxpayer.

Subsection 177A(5) of the ITAA 1936 clarifies that the purpose referred to includes the dominant purpose where there are two or more purposes. Section 177D of the ITAA 1936 requires an objective conclusion as to purpose to have been reached having regard to the objective facts. The actual subjective purpose of any relevant person is not a matter to which regard may be had in drawing the conclusion under section 177D.

A conclusion about a relevant person's purpose for section 177D of the ITAA 1936 is the conclusion of a reasonable person based on all the facts and evidence that are relevant to considering the eight factors for the scheme. However, not all of the factors will be equally relevant in every case. Provided the eight factors are each taken into account, it is possible to arrive at the conclusion as to purpose by making a global assessment of purpose.

These eight factors are as follows:

i the manner in which the scheme was entered into or carried out

ii the form and substance of the scheme

iii the time at which the scheme was entered into and the length of the period during which the scheme was carried out

iv the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

v any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

vi any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

vii any other consequence for the relevant taxpayer, or for any person referred to in (vi), of the scheme having been entered into or carried out; and

viii the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in (vi)

Consideration of the eight factors involves comparison of the scheme with the alternative arrangement. In other words, the conclusion about the dominant purpose of a person entering into or carrying out the scheme, or any part of it, necessarily requires consideration of what may otherwise have occurred. This is the reasonable expectation test.

The scheme

The scheme that the entity has identified is described in the facts as follows:

The retention of taxable income in the entity. The taxable income of the entity will be determined after payment of all deductible expenses that relate to the business of the entity, including commercial wages to the personal services provider and their spouse and superannuation contributions.

The payment of after tax income to the entity's associates where profits are not retained in the entity to meet working capital requirements and acquire plant and equipment, as required.

The tax benefit

You stated that:

The personal services provider's remuneration from the entity would be the lesser of:

- A commercial salary or

- The net taxable income derived by the entity after the payment of all deductible expenses, but before a commercial salary.

A tax benefit would arise, where the net taxable income of the entity exceeded the market salary to the personal services provider.

The tax benefit under section 177C is that provided in paragraph (a), being an amount not included in assessable income.

The objective purpose test

Based on all the relevant facts and evidence pointing to the commercial basis of the establishment of the entity and the subsequent scheme, a reasonable person could not conclude that a scheme, or any part of it, was entered into for the dominant purpose of enabling the personal services provider to obtain a tax benefit.

Conclusion

Part IVA does not apply to this scheme.

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