Robert Richards CPA sniffs out a new direction for Part IVA in his review of cases.
Part IVA not needed by ATO for franchise cases
The trouble with deciphering Part IVA (the general anti-avoidance rules) is that for the most Part IVA cases have involved agriculture tax shelter schemes and the like (which only the naive would conclude were not tax-driven).
As a consequence, Part IVA has been seen to be more directed to artificial tax-planning arrangements rather than to arrangements that have some genuine underlying commercial purpose.
Agriculture tax-planning schemes have been particularly associated with residents of Western Australia. I sometimes think that something must have been put in the water of Western Australia to cause residents of that state to have so enthusiastically embraced such schemes.
However, agriculture schemes are not the only such schemes. During September there were two decisions of the Western Australian Administrative Appeals Tribunal (Leggett & Ors v FC of T, Administrative Appeals Tribunal, 3 September 2007 and Hyde & Ors v FC of T, Administrative Appeals Tribunal, 25 September 2007) that involved 'franchise schemes'.
But before one goes to Part IVA, income must be included in a taxpayer's assessable income, or deductions must be allowable as a matter of general principle. This is what Leggett and Hyde were about.
In the Leggett case taxpayers claimed to be entitled to income tax deductions for expenses incurred by them in acquiring franchises to market 'electronic commerce services'.
The taxpayers were granted rights to sell services to nominated people picked at random out of telephone books. As a consequence the taxpayers had a 'ha ha' factor working against them.
The tribunal held that the taxpayers were not entitled to the deductions claimed by them. It said the taxpayers were not in business, since they were not engaged in repetitive and regular business activities and because even the very limited activities that they did undertake were not organised in a businesslike manner. The tribunal also concluded that the acquisitions were capital in nature.
Hyde also involved franchise agreements (in this case to sell 'Freedom Express'' products ). Again, the names of people to whom the services could be sold were drawn out of telephone books (so again the taxpayers had to overcome the 'ha ha' factor). Again the Administrative Appeals Tribunal held that the taxpayers were not entitled to the deductions sought by them as a matter of general principle.
This was because the taxpayers were passive investors, were not carrying on a business, or alternatively, the claimed deductions were incurred by the taxpayers not for the purpose of gaining or producing assessable income, but simply to obtain a tax deduction. The tribunal also considered that outgoings were capital in nature.
This meant that there was no need for the tribunal to consider Part IVA.
But just in case Western Australians consider I am being too harsh to them, I should also mention the decision on the Western Australian District Registry of the Federal Court in Lenzo v FC of T (Federal Court, 7 September 2007) where a Part IVA issue was decided in favour of the taxpayer.
This was a decision where the Federal Court said that the Australian Tax Office could not apply Part IVA to disallow a deduction to a taxpayer who had participated in an agriculture scheme.
Justice French said that considering the transaction overall:
'... I accept that there were tax benefits to be derived from the way in which the investment structure was set up. Aspects of the investment structure were indicative of a purpose of deriving a tax benefit from the scheme. I do not accept, however, having regard to the factors already mentioned [which in particular were that the scheme was entered into as a serious commercial project' and that the taxpayer had assumed a 'real liability with no non-recourse exit'], the significant returns which could reasonably be expected from a moderately successful outcome to the project, independent of any tax benefits, and the ready availability of any financing arrangements to the [taxpayer] that it would be concluded that he or the manager or promoter entered into or carried out the scheme for the dominant purpose of enabling him to obtain a tax benefit in connection with the scheme.'
I suspect that cases such as Leggett and Hyde, particularly when considered with dicta of the late Justice Hill (in HP Mercantile Pty Limited v FC of T, 8 July 2005) indicate that Part IVA may not be as important as thought. Justice Hill seemed to have formed the view (contrary to his earlier philosophy) that in interpreting tax law the courts must give effect to the policy of the law. An extreme but logical extension of Justice Hill's dicta would indicate that in many cases Part IVA is not that important at all.
Verbose case law The Leggett decision was 40 pages long. The Hyde decision was 48 pages long. There seems to some sort of competition among tribunal and court members to see who can produce the longest judgements. This disturbs me. I dislike long judgements; I am always concerned that I am going to miss a tree in the wood. I am a great believer that less is more. Courts (including the High Court) limit the length of submissions that litigants can make I would hope the courts and the tribunals might adopt a similar principle.
When is someone's garage their office?
In last month's Taxing Times I looked at the 'results test' exemption to the alienation of personal services rules contained within Division 86 of the Income Tax Assessment Act 1997.
These rules (which are designed to stop the alienation of personal services income) do not apply where a 'results test' is satisfied that is the taxpayer's personal services income is for producing a result, the taxpayer or the taxpayer's entity is required to supply the plant and equipment or tools of trade needed to produce the result, and the taxpayer or the taxpayer's entity is liable for the cost of rectifying any defect in the work performed.
Alternative tests apply where less than 80 per cent of a taxpayer's personal service income comes from more than one person (or that person and associates of that person).
If that is the case the alienation of personal services rules will not apply if that person or that person's entity satisfies either an 'unrelated client's test' (which will be satisfied if the taxpayer's or the entity's income comes though advertising or the offering of services to the public at large), an 'employment test' (meaning persons unrelated to the taxpayer perform work that by market value accounts for at least 20 per cent of the taxpayer's personal services income) or a 'business premises test'.
The 'business premises test' will be satisfied (section 87-30(1) of the Act) if the taxpayer or the taxpayer's entity maintains and uses premises:
at which the taxpayer or the entity mainly conducts activities from which personal services income is gained or produced
of which the taxpayer or entity has exclusive use
that are physically separate from the premises that the taxpayer, or any associate of the taxpayer, uses for private purposes
that are physically separate from the premises of the entity or an associate of the entity to whom the services are provided.
The decision in Dixon Consulting Pty Limited v FC of T (Administrative Appeals Tribunal, 21 September 2007) shows a difficulty in satisfying this test.
The issue there was whether a two-storey building that consisted of garages and an office were 'business premises'.
The garages and office were located in the one building. On the same block of land there was a separate residence (which meant that the garages and office were physically separate from the residence).
The taxpayer's and his wife's cars were parked in the garage. The garages were also used for storage space for items such bicycles and a boogie board (I am showing my age here by admitting that I have no idea what that is) for the taxpayer's children.
The decision had somewhat of a history. First, the tribunal held that the taxpayer satisfied the 'business premises test' (Administrative Appeals Tribunal, 3 March 2006) but that decision was overturned by the Federal Court (15 December 2006).
The Federal Court felt that the tribunal had made a mistake in holding that premises had to be 'mainly' for use by the taxpayer rather than 'exclusively so'.
Accordingly it remitted the matter back to the tribunal for it to be decided in accordance with law.
This time around the tribunal decided against the taxpayer. It concluded that 'the exclusive use test is directed to exclusive use by the [taxpayer]; that is, free of a use, other than possibly a de minimis use, by any other person or entity'.
The tribunal concluded that because Dixon's family also had use of the garage, the 'business premises' exception did not allow the taxpayer to escape the alienation of personal services income rules.
This is a very harsh, if correct, reading of the rules and one can understand why the tribunal at first instance would have wanted to find for the taxpayer.
It might also be observed that whoever drafted the rules does not appear to know their own Acts. As a matter of law the 'business premises' rules can never be satisfied.
This is because taxpayers never have exclusive use of their premises. Section 264 of the Income Tax Assessment Act 1936 gives the Tax Office 'full and free access to all buildings'. The Tax Office in the course of an audit expects to be provided with suitable office accommodation (and photocopying facilities, morning teas, and so on).
I remind readers that the Federal Court will soon (in Fowler v F C of T, an appeal against a decision of the Administrative Appeals Tribunal of 21 September 2006) consider the very validity of the alienation of the personal services income provisions. If the taxpayer wins the government is sure to change the law.
This means taxpayers who want to take advantage of a possibly favourable decision should be objecting against alienation of personal services assessments.
This could also apply to any other assessment, such as a controlled foreign companies assessment (except where the trust provisions apply) where one taxpayer is assessed to tax on income derived by another.
Debt collection is end game
Last month I had a matter - such as I do from time to time - involving the Tax Office causing a taxpayer to go bankrupt.
Most practitioners share my belief that when it comes to trying to negotiate with the Tax Office as to payment of a client's debt one is wasting one's time.
The inspector-general of taxation issued a report on this in 2005 but that report seems to have just caused the Tax Office to become even more bureaucratic. To give an example of the Tax Office approach I was once told by one of its debt collectors (and I am not making this up): 'Mate, I used to work for a [commercial] debt collector. You will be surprised at how much we manage to get paid once we put the screws on people'.
The problem is, of course, that the law is so one-sided against taxpayers - if an assessment is issued the law says you must pay up even if you have a dispute with the Tax Office.
In practice, the Tax Office will not normally insist on collection of taxes while a genuine dispute is afoot. There is more of a problem where there is a dispute as to tax instalments and BAS liabilities.
The Tax Office will not admit that its running accounts can ever be wrong. Rather it rather puts the obligation on taxpayers to prove this.
Furthermore, the Tax Office appears to prefer to shoot itself in the foot rather than have to make commercial decisions. In the matter in which I was involved, the Tax Office would have received a much better return had it been prepared to respond first to correspondence and then to discuss the matter with me.
I sometimes think practitioners should be eligible for appointment as commissioners of taxation. They don't even need to be paid a salary. They would be rewarded simply by taking a percentage of additional tax collected - which they could do so at the same time as allowing the tax rates to be lowered.
Robert Richards CPA is a solicitor specialising in tax matters.
