Commissioner of Taxation charges with a Sabre to attack documents held offshore

Following the interlocutory decision of the Federal Court Mylan Australia Holding Pty Ltd v Commissioner of Taxation [2023] FCA 672 (Mylan) made on 21 June 2023, taxpayers facing information requests and statutory notices issued by the Commissioner of Taxation (Commissioner) should now take into account that the Commissioner may seek and obtain discovery in relation to documents not produced. This is the latest in an emerging trend where the Commissioner is actively pursuing access to documents through court processes.

Historically, the prospects of discovery in taxation appeals is extremely rare, owing to the fact that the taxpayer has the burden of proof, and the parties can be assumed to have the relevant facts and information arising from the investigation or audit process in the time prior to an assessment issuing. When considering the facts of this case, one could have been forgiven for assuming that the prospects of the Commissioner’s application being granted were low. That is, the Commissioner’s investigation of Mylan commenced 14 years ago. In that time there were many requests for information, both informal and under the exercise of statutory powers.

However, the decision in Mylan demonstrates that the Federal Court will be minded to exercise its discretion to obtain access to documents, particularly where the Commissioner alleges an anti-avoidance provision applies. The Federal Court noted the submission of the Commissioner, that:

Discovery may be warranted in a Part IVC appeal if the material on which the taxpayer sought to conduct the appeal was selective and material had been hidden from the Commissioner … (emphasis added)

The Commissioner’s power to obtain information and documents

The Commissioner has broad powers to access information and documents pursuant to former sections 264 and 264A of the Income Tax Assessment Act 1936 and sections 353-10 and 353-25 of Schedule 1 to the Taxation Administration Act 1953.

It is an offence to not comply with a notice issued under section 353-10 (previously section 264), and in some cases criminal sanctions can apply. Failure to comply with an offshore notice (former section 264A, now section 353-25) will trigger an evidentiary sanction. That is, without the Commissioner’s consent, information that was the subject of the notice is not admissible in proceedings disputing the assessment.

The Commissioner’s application

In the proceedings, the Commissioner sought discovery and Sabre orders.  A Sabre order is commonly sought in commercial litigation and may be made in proceedings before the Federal Court to require a company to take all reasonable steps available to it to obtain access to documents held by a related third party company.

With the Federal Court making these orders, Mylan Australia Holding Pty Ltd (MAHPL) is required, by 14 July 2023 (approximately 5 weeks) to take all reasonable steps to obtain the specified documents which are in the power, custody or control of Viatris Inc, Mylan Inc, and/or Mylan Laboratories Inc. Further, by 28 July 2023, Mylan is required to file an affidavit of the efforts made and the nature of the searches made to locate the requested documents.

The context of the appeal and Part IVA

MAHPL has appealed to the Federal Court against the decision of the Commissioner to deny deductions for interest costs in relation to a promissory note (PN A2) issued by an Australian subsidiary to a Luxembourg related party. PN A2 formed part of the financing by which the group acquired the shares in Alphapharm on 2 October 2007 (as part of the global acquisition of the Merck worldwide generic business). The principal of PN A2 was set at 75% of the value of Alphapharm. The interest rate was originally floating, and then later fixed at 10.15% per annum with retroactive effect from 2 October 2007 via a journal entry in 2008.

Part IVA applies to a scheme if it would be concluded (having regard to the matters in section 177D(2) of the Income Tax Assessment Act 1936) that the person(s) who entered into or carried out the scheme (or part thereof) did so for the purpose of obtaining a tax benefit in connection with the scheme.

The Commissioner alleges that there has been a tax benefit obtained by MAHPL, as the counterfactual would be that there would not have been debt in Australia, or alternatively, that the amount of the debt should have been much lower (i.e., more equity, less debt).

The evidence filed by MAHPL consists largely of documents (via senior finance and legal personnel of its parent company) and expert evidence. The Commissioner has filed 3 expert reports in response.

Given that in an appeal the taxpayer bears the onus of proof, the Commissioner’s application for discovery is intriguing.

Considerations taken into account by the Federal Court in relation to discovery

2 out of the 3 categories of discovery were granted, with the Federal Court making some modifications in relation to one of the categories to limit the scope. The 2 categories of documents in which discovery was granted related to:

• The modelling of the Australian or US tax consequences; and
• Evidence of consideration of the ability for the Australian subsidiary to service the debt.

The Federal Court was convinced that discovery was appropriate in the circumstances as:

• The documents sought are relevant to the statutory question required by section 177D(2)(a): namely, the manner in which the scheme was entered into or carried out; and
• The previous responses by the taxpayer to the Commissioner’s requests were inadequate and unsatisfactory.

In relation to the final category of documents sought by the Commissioner, which related to the setting of the interest rate, Button J denied the request on the basis that the category of documents, if produced, would potentially open up a new ground of challenge. Had the Commissioner wanted to raise this ground of challenge, he had ample opportunity to do so, but the time for that had passed. It would be inappropriate for discovery orders to be made having regard to the advanced stage in which the parties had prepared their case and evidence for trial.

Potential implications

MAHPL and its parent entities are in a difficult position. While there may be other reasons for the non-production of the documents requested, one of the inferences of non-production is that the document is unhelpful to the taxpayer’s position. Any continued non-production may see the Commissioner asking the Court to draw an adverse inference. On a worst case scenario, this could impact the taxpayer’s ability to discharge its burden of proof.

Taxpayers facing informal requests for information, or statutory notices should consider the worst case scenario of being put to proof on all the matters in the Commissioner’s risk hypothesis, and work backwards from the standard of evidence required to discharge its burden of proof in considering whether or not to produce the documents requested.

The silver-lining in the decision is the boundary the Court has drawn in granting discovery. Requests for discovery made by the Commissioner late in the dispute timeline and shortly prior to trial, when all the evidence has been prepared by the parties and when the taxpayer was not otherwise on notice about the ground of challenge will not be considered by the Court favourably.

Other matters to note

It is understood that following the filing of the taxpayer’s evidence, the Commissioner amended his appeal statement which revealed that he no longer will rely upon the transfer pricing provisions to deny the deductions. The result is that taxpayers will need to wait further for judicial consideration and insights in to the interpretation of Sub-Division 815B of the Income Tax Assessment Act 1997.

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