The general anti-avoidance provisions contained in Part IVA of the Income Tax Assessment Act 1939 (Cth) (the ITAA) were amended by the introduction of the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 (Cth) (the Amendment Act).
Generally speaking, the anti-avoidance provisions apply to any arrangement or scheme that is entered into by a taxpayer for the sole or dominant purpose of obtaining a tax benefit. The Amendment Act introduces a new section 177CB in substitution for section 177CA of the ITAA. Section 177CB makes it clear that there are two separate and distinct tests available when determining whether a tax benefit has been obtained in connection with an arrangement:
(1) the annihilation approach, which examines, in the context of actual events and circumstances, what would have happened but for the existence of the arrangement; and
(2) the reconstruction approach, which involves considering what might reasonably be expected to have happened in an alternate postulate of events and circumstances if the arrangement had not occurred.
The amendments introduce two important limitations on the reconstruction approach for the purpose of determining whether an alternative postulate is reasonable:
Limitation One: there must be regard to the substance of the scheme and its effect for the taxpayer; and
Limitation Two: the potential tax costs must be regarded.
Although the new section 117CB makes it clear that there are two distinct tests that may apply when identifying whether a taxpayer has obtained a tax benefit, the section fails to identify the circumstances in which each approach should be adopted. Instead we are left with two tests that may quite invariably result in different conclusions based on the same factual scenario.
The explanatory memorandum provides some guidance as to the appropriate circumstances in which each test should be used. It suggests that the annihilation approach should be applied in relation to arrangements that results in a “coherent taxable situation” based upon the existing facts and circumstances comprising the arrangement once the scheme has been removed or “annihilated”.
In relation to the reconstruction approach, the explanatory memorandum provides that this approach should be applied to arrangements where the postulate of events, based on what would have happened if the scheme did not exist, produces an incoherent state of affairs to which tax law cannot be applied and/or where the scheme is an essential step in a broader transaction, such that real commercial or economic consequences arose from the scheme, and in order to demonstrate tax was avoided, the events are required to be “reconstructed”.
At present, it is unclear as to whether the new provision will provide parties with clarity when determining whether a tax benefit has been obtained in connection with an arrangement or whether the amendments complicate the inquiry further and create additional difficulties when applying the Part IVA provisions. This reform highlights the importance of documenting the steps taken in a particular transaction including the intended purpose and effect of each step to ensure that your arrangement does not in breach the anti-avoidance provisions in Part IVA.
Please contact us if you require assistance on the effect of the new Part IVA rules in relation to your business or financial arrangements.