Tax litigation to watch in 2022

The Australian Taxation Office’s (ATO) stated approach to tax disputes is to seek to prevent them where appropriate. In the event that a dispute arises, the ATO’s website states that it works to resolve the dispute as early as possible, noting that company taxation is complex, especially in relation to the affairs of large corporations. This complexity and its application to large corporates can lead to differences in opinion between the ATO and taxpayers about how the law applies to particular arrangements.

The ATO will seek to litigate cases where:

• There is a contentious or uncertain point of the law that requires clarification
• The ATO’s perception of taxpayer behaviour is such that the ATO desires to improve compliance
• The dispute is intractable and an acceptable outcome cannot be achieved via alternative dispute resolution

We set out below a snapshot of some of the upcoming cases this year which will see the Federal Court consider the interpretation of previously untested tax legislation.

Diverted Profits Tax (DPT)

Two multinational companies have filed notices of appeal in the Federal Court of Australia in relation to DPT assessments issued in relation to distribution arrangements in Australia. The DPT assessments assert a tax benefit obtained in the form of the multinational company not being liable to pay royalty withholding tax for the use of, or right to use trademarks and/or other intellectual property. This is significant as this is the first time DPT assessments have been issued by the Commissioner and will be the first time the new legislative provisions will be considered judicially. In addition to the DPT assessments, the Commissioner has issued notices on the companies imposing royalty withholding tax. The ATO is prepared to litigate matters which it thinks are of strategic importance, particularly if there is a desire to re-calibrate tax compliance behaviours.

As part of its review activities, the ATO is actively considering the application of the DPT to a number of structures including:

• the use of offshore procurement hubs to bifurcate the procurement functions;
• the migration of IP and arrangements where intangible assets are not appropriately recognised for Australian tax purposes. e.g., manufacturing and distribution contracts that allow for limited use of trademarks or other IP, without separate consideration to the supply of the goods, or on a royalty-free/embedded royalty basis;
• restructures which purportedly transfer functions offshore to a centralised regional entity without any change in the underlying substance of the arrangements; and
• arrangements which provide funds to Australian associates through interposed entities in treaty-partner countries.

It is important to note that the ATO has an enormous body of information available to it, and can raise the DPT assessment based on limited information (i.e. you may not know until after a DPT assessment has issued). If the ATO forms the view that the DPT applies, then a 40% penalty rate of tax is to be paid upfront within 21 days. Following that, there is a 12 month period of review, during which further information can be provided. The ATO may amend the assessment as a result of the information received, and to the extent that there is still an adverse tax liability, the taxpayer can appeal to the Federal Court within 60 days against the Commissioner’s decision to make an amended assessment of an amount of DPT which is treated as an objection decision. Twelve months to provide additional information to the ATO and to prepare to litigate is a relatively short period of time, especially as in tax matters the taxpayer bears the burden of proof. A case like this will typically require significant evidence from lay witnesses plus independent expert evidence. There is usually a range of evidentiary issues to navigate, including the availability of evidence and witnesses with the requisite knowledge, as well as strategic decisions regarding the management of evidence held offshore (with evidentiary sanctions applying if the information located offshore is not brought to Australia).

Of course, the DPT is not the only area of focus by the ATO in relation to IP, with the ATO examining a number of aspects of international arrangements connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets and/or the migration of intangible assets. The ATO has issued a number of Taxpayer Alerts, Taxation Rulings and Practical Compliance Guidelines about its revised approach to the interpretation of the law and its concerns. Taxpayers should be aware of this shift in approach, as well established arrangements are likely to come into focus by the ATO.

An examination by the ATO regarding international intangible arrangements will involve a detailed examination of the IP rights between the related parties in the group. Comprehensive analysis will be required regarding the identification and classification of the rights at law from an IP perspective, before moving on to conduct an assessment of the taxation consequences, including how to apportion undissected arrangements and whether the consideration reflects an arm’s length price. It would be prudent to embark on such analysis with the benefits of a legal team that understands both the IP and taxation issues.

New Part IVA, New Transfer Pricing, Losses

A global group lodged an appeal in the Federal Court of Australia in relation to assessments issued by the Commissioner. The Commissioner has denied deductions (December 2007 to 2017) on interest paid on loans taken out almost 15 years ago in relation to an acquisition in Australia. The Commissioner alleged that there has been a tax benefit obtained, because the Australian purchaser should not have made the acquisition. Instead the other way to conduct the acquisition was via another subsidiary in the global group. In addition to the application of the General Anti Avoidance Rule (GAAR, or Part IVA) regarding the mix of debt and equity, the Commissioner claims that the relevant consideration under the international agreement was not arm’s length. Further, the Commissioner has denied the utilisation of carry forward losses incurred in relation to the acquisition.

The case is of interest for several reasons including that ‘old’ and ‘new’ Part IVA provisions potentially apply to the deductions for the 2007 to 2017 years. Part IVA is a measure of last resort, designed to protect the integrity of the Australian tax system. Its focus is blatant, artificial or contrived arrangements entered into for the sole or dominant purpose to obtain a tax benefit. Purpose is measured objectively with regard to the facts and circumstances of each case. To quantify the existence of a tax benefit, the Commissioner will look at the position under the scheme and compare that to the position that would arise, or may reasonably be expected to arise, if the scheme had not been entered into.

In about 2010 – 2011, the Commissioner suffered a string of losses in the Federal Court with respect to the old Part IVA provisions, as the Court found that there was no tax benefit in those cases as the taxpayer would have abandoned its commercial project altogether if it could not avoid the tax on it (e.g. Commissioner of Taxation v News Australia Holdings Pty Ltd [2010] FCAFC 78; Commissioner of Taxation v AXA Asia Pacific Holdings Pty Ltd [2010] FCAFC 134 and RCI Pty Ltd v Commissioner of Taxation [2011] FCAFC 104).

From 12 November 2012, the Commissioner is armed with two ways to determine a tax benefit, one which simply ignores the steps that comprise the scheme (annihilation approach), and the other that reconstructs the relevant steps in the scheme (reconstruction approach). This will be the first time the new Part IVA provisions will be judicially considered. There has not been an equivalent case of this complexity regarding the application of Part IVA before the Federal Court since about 2015. It is also noteworthy to mention that the Commissioner appears to have noted the observations made by the bench in previous transfer pricing cases of Chevron Australia Holdings Pty Ltd and Commissioner of Taxation [2017] FCAFC 62 and Glencore Investment Pty Ltd v Commissioner of Taxation [2019] FCA 1432 that whilst Part IVA was considered in those cases, no adjustments to tax were sought on that basis. Whist there has been an increase in transfer pricing litigation in recent years, the focus of those has been in relation to Division 13 and Subdivision 815-A of the Income Tax Assessment Act 1997 (ITAA 1997). With the reconstruction power in the transfer pricing legislation (Subdivision 815-B of the ITAA 1997) coming into effect from 29 June 2013, it is expected that this case will also consider the interpretation of those provisions (which until now, has not been considered by the Courts).

Singapore Telecom - appeal?

It is too early to tell whether an appeal will be filed in relation to the decision handed down on 17 December 2021, with the most recent orders of the Federal Court made in February requesting the parties to propose orders and make submissions during the course of February 2022. Whilst detailed reasons were issued by Moshinsky J on 17 December 2021, as he accepted only certain parts of the expert evidence, and not its entirety, the parties and the court require additional consideration of the impact of His Honour’s findings. Once final orders have been made, any appeal is to be filed and served within 28 days.

Read our further analysis and insights about the 17 December 2021 decision.