Australia: Tax audit and controversy trends
Michael Bersten, Paul McCartin and Caleb Khoo PwC
The tax audit and controversy landscape in Australia continues to shift and evolve against a backdrop of the federal government's commitment to addressing base erosion and profit shifting (BEPS) and to increase revenue collections. The focus on the Australian budgetary position has contributed to the Australian government introducing a number of legislative changes with the stated purpose of limiting perceived areas of potential revenue leakage. Recent changes include clarifications to Australia's general anti-avoidance and transfer pricing rules. In addition to legislative responses, the Australian government has provided additional budgetary funding to the Australian Taxation Office (ATO) to enable it to focus on areas considered to be high risk, such as cross-border financing or business restructures. In this environment, the ATO is adopting a far more evidentiary based, or litigation-ready approach to information gathering. This approach has been in response to a number of factors such as court losses which may, at least in part, be attributed to insufficient evidence collection and the recent limitations on the Commissioner's powers of discovery. This has meant that the ATO will increasingly seek to collect its evidence during the audit and objection stage rather than before litigation.
In addition to changing its approach to audits, the ATO is also commencing compliance reviews before the tax return is lodged, for the purpose of obtaining a real-time dialogue with taxpayers. These changes mean that taxpayers with Australian operations are entering a new tax landscape which requires, now more than ever, that they strategically manage their interactions with the ATO.
Audit process and administration trends
Application of general anti-avoidance rules (GAAR)
The ATO has continued to review corporate restructures and transactions and has aggressively sought to apply Australia's GAAR to a number of circumstances. Australia's GAAR was enacted as Part IVA of the Income Tax Assessment Act 1936 (Cth) and applies to cancel tax benefits arising from schemes where the dominant purpose for entering into the scheme is to obtain a tax benefit. The GAAR requires an assessment of the tax benefit obtained by a taxpayer and an analysis of the reasonable alternatives that could have been undertaken to achieve the taxpayer's commercial objectives (alternative postulate).
The ATO will consider the application of Part IVA where there is an indication of contrivance in an arrangement. The ATO will look for warning signs that the arrangement is tax driven including, where the arrangement contains a step or series of steps that appear to serve no real purpose other than to gain a tax advantage, where the tax result of the arrangement appears at odds with its commercial or economic result, as well as instances where the parties to the arrangement are operating on non-commercial terms or in a non arm's-length manner. In court, the Commissioner has been found to have successfully applied Part IVA to a range of transactions resulting in additional assessable income and the denial of deductions, capital losses or foreign income tax offsets. However, taxpayers have been successful in cases when they have submitted key evidence demonstrating the commerciality of an arrangement or the unreasonableness of the Commissioner's alternative postulates.
Following recent court losses, the government amended Part IVA in a manner which seeks to clarify the intended scope and application of the provision.
Increased focus on information gathering
The ATO has significantly altered its approach to information gathering during the audit phase. This is in response to an increasing number of court losses (particularly those involving the potential application of the GAAR) and changes to the court listing rules placing limitations on the Commissioner's ability to undertake full discovery during the litigation phase.
It is now increasingly common in cases involving the potential application of the GAAR for the ATO to seek access to considerable quantities of documents and information. In a number of recent cases, the ATO is using its domestic formal information gathering powers to obtain documents and information. It is also requesting information held offshore by issuing taxpayers with an offshore information Notice (see section 264A of the Income Tax Assessment Act 1936 (Cth)). In this situation, it is important to carefully manage the process as any information that is not provided might not be eligible for use to defend a taxpayer's position in any subsequent court proceedings.
Real-time, pre-lodgement compliance reviews
In an effort to engage with taxpayers before the lodgement of their income tax returns, the ATO has introduced a new compliance product known as pre-lodgement compliance reviews (PCR). A PCR is a real-time review product designed for the largest companies which seeks to assist the ATO in identifying potential tax risks in the period leading up to the lodgement of returns. The nature and scope of the review conducted by the ATO will depend on the specific PCR plan or framework that is established between the ATO and the taxpayer. The scope and nature of the plan will reflect the ATO's assessment of the taxpayer within its risk differentiation framework (the ATO's internal risk profile rating system). At the conclusion of the PCR process, the ATO will determine if there are potential risks outstanding and whether further action by the ATO will be necessary.
Reportable tax positions
In recent times, the ATO has developed and implemented a compliance risk identification product known as the reportable tax position schedule (the RTP schedule). The RTP schedule must be completed by certain large business taxpayers who receive written notification from the ATO informing them of this obligation.
The RTP schedule requires the disclosure of contestable and material aspects of a taxpayer's filing position and addresses three categories. A category A position is one where it would be concluded in the circumstances that the position taken by the taxpayer is as likely to be correct as incorrect, or less likely to be correct than incorrect. Category B is concerned with positions where there is uncertainty about taxes payable or recoverable as recognised by the taxpayer or disclosed in their financial statements or those of its related entities. Category C requires the disclosure of significant transactions or events exhibiting certain tax characteristics set out by the ATO.
The ATO has indicated that the schedule will be used to complement its real time disclosure approach during the PCR processes. The proposed integration is designed to ensure that corporate taxpayers who have not engaged with the ATO in respect of their material and contestable positions will still be required to disclose any reportable positions in their returns.
Identifying it as a useful way of "putting the picture together on a global level", the ATO has continued using its participation in the Joint International Tax Shelter Information Centre (JITSIC) to focus on a variety of tax compliance risks including addressing abusive international tax haven and evasion activities. JITSIC was set up to deter the use of abusive cross-border tax schemes. Members of JITSIC seek to exchange information in respect of complex cases that involve avoidance schemes concerning multiple tax jurisdictions. Members also share expertise, practices, market intelligence and experiences with each other to address cross-border tax avoidance arrangements and joint audits. The ATO has acknowledged that its participation in JITSIC has enabled it to engage other tax administrations in a practical manner at an early stage in relation to abusive international tax haven and evasion activities.
Review of international tax system for businesses
The Australian government has recently announced two new measures to examine the corporate taxes paid by large and multinational companies. The first measure seeks to examine whether there are any tax planning and structuring practices which have an impact on the Australian tax base. Similar enquiries are being made in other jurisdictions including the US, the UK, and France.
The second measure recently passed through Parliament and enables the Commissioner of Taxation to publish certain aggregated tax information (taxable income and tax payable) of large corporate taxpayers with income over $100 million for the 2013-2014 and later income years.
It is clear the Australian tax landscape is entering into a new phase with the Australian government seeking to address BEPS and facing pressure to increase revenue collections, resulting in tightened anti-avoidance and transfer pricing rules. These developments are also against a background of greater transparency and disclosure and the introduction of new ATO compliance products and risk identification tools.
The ATO now has earlier access to a wider range of taxpayer information, for example, through its sharpened focus on information gathering and increased international cooperation between tax administrations. In addition, the ATO is specifically seeking to identify and address risks in a real-time environment by seeking to have conversations with taxpayers in relation to transactions as they occur through their new PCR product and RTP schedule.
Recent legislative changes mean that multinational enterprises should closely review the potential application of Australia's general anti-avoidance rules and the changes to its transfer pricing rules. These developments may affect their future or existing tax positions. To mitigate these potential risks, Australian taxpayers may wish to consider strategies which enable greater certainty regarding their potential tax liability and reduce future exposures.