Talking Tax – Issue 51

ATO updates

Part IVA Practice Statement Law Administration (PSLA) update

On 20 September 2016 the ATO released a new version of its practice statement on the application of the General Anti-Avoidance Rules (GAARs) in Part IVA of ITAA 1936.

PS LA 2005/24 is designed to assist tax officers in considering the application of Part IVA to an arrangement.

The purpose of the update is to align the practice statement with the significant amendments to Part IVA made by the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013. Accordingly, amongst other things, PSLA 2005/24 now states the Commissioner’s position on the application of the rules to the concept of the ‘alternative postulate’ and the ‘annihilation’ approach in relation to a deciding whether a tax benefit exists.

The updated PSLA also incorporates recent court decisions about Part IVA, such as Orica Limited v Commissioner of Taxation [2015] FCA 1399 (Orica) and Federal Commissioner of Taxation v Futuris Corporation Ltd (2012) 205 FCR 274 (Futuris) and Federal Commissioner for Taxation v RCI Pty Ltd (2011) FCAFC 105 (RCI).

In our view, a key limitation of the PSLA is that whilst it refers to the application of section 177DA to schemes that limit a taxable presence in Australia, it does not provide significant guidance on how the application of principles will be approached. Instead, the ATO warns that it has “very little practical experience” in applying the new amendments to the legislation and that “extreme caution” should be taken when applying the existing case law in light of the amendments. The PSLA goes as far as to say that Futuris and RCI may no longer represent the law regarding the tax benefit concept.

In this regard, the practice statement flags that tax professionals should be careful when dealing with the GAAR provisions following the 2013 amendments.

Legislation and Government policy

Stamp Duty (Tasmania): Duties Amendment (Landholder and Corporate Reconstruction and Consolidation) Bill 2016 (Tas)

The Duties Amendment (Landholder and Corporate Reconstruction and Consolidation) Bill 2016 (Tas) has been passed by the Tasmanian House of Assembly without amendment and has progressed to the Legislative Council. We discussed the introduction of this Bill and its consequences in Talking Tax issue 46. The Bill brings Tasmania into line with the rest of Australia in respect of the contemporary ‘landholder’ model.

Innovation incubation

The Federal Minister for Industry, Innovation and Science, The Honourable Greg Hunt MP, launched the Government’s Incubator Support Initiative on 20 September 2016. The initiative links to the recent tax incentives for early stage investors released in May this year and reflects the Government’s policy of encouraging innovation and assisting with the acceleration of start-ups.

The initiative, which was launched at Sydney fin-tech hub Stone & Chalk, aims to help new Australian business and start-ups accelerate and scale-up their operations to launch into global markets. It includes a fund of $23 million to assist with creating new business incubators to help start-up companies access advice, capital and valuable connections.

The Incubator Support initiative is a new element of the Entrepreneurs’ Program and is one of the measures under the Turnbull Government’s National Innovation and Science Agenda.

Case law

Taxing Indian royalties under the Double Tax Agreement

Tech Mahindra Limited v FC of T 2016 [2016] FCAFC 130

An Indian resident company has been found liable to pay tax in respect of the income from IT services to Australian customers performed in India. The company carried on business in Australia providing IT services to Australian customers through an Australian permanent establishment, using employees located in both Australian and India.

The Full Federal Court considered whether the services were ‘royalties’ within the meaning of Art 12 of the Australia/India Double Tax Agreement (DTA) and whether Australia was therefore able to tax the payments.

Art 12(2) allows the royalties that comprise payments or credits made as consideration for the rendering of certain types of services (such as technical or consulting services), to be taxed by either State (Australia or India). This would allow Australia to tax the royalties even though they relevantly arose from IT services provided in India. However, Art 12(4) provides an exception where the services for which the royalties are paid are ‘effectively connected with’ a permanent establishment or fixed base of business in the other State (in this case, Australia).

The Full Court considered the proper construction of Art 12(4) and held that Justice Perry at first instance had been correct in holding that the phrase “effectively connected with the permanent establishment”, encapsulated the test in Art 7(1)(a) and requires business activities that give rise to the royalty to be of the same or a similar kind as those carried on through the permanent establishment.

This required that there was a real or actual connection between the services provided in India with the activities carried on through the permanent establishment in Australia. It was insufficient that the services provided in India merely “served to effect the purposes of the permanent establishment”. Thus, the services income was not effectively connected to the Australian permanent establishment, article 12(4) did not apply and Australia was able to tax the income services that arose in India as royalties.

This case is an important reminder to seek advice on the operation of DTAs when dealing with cross-border arrangements.

Seven years of bad timing - objections out of time

Benjamin v Federal Commissioner of Taxation [2016] FCA 1157

The Federal Court has refused a taxpayer’s application to review the Commissioner’s decision to disallow an objection. The taxpayer had objected to assessments in years ending June 2000 to 2005, on the basis that certain amounts relating to a property development were not ‘assessable income’.

The taxpayer, who made his objection nearly seven years out of time, claimed that he never received notification of the decision of the Commissioner to disallow the objection, which had been sent to his former tax agent in 2008.

The Commissioner obtained a judgement in default of appearance against the taxpayer for the amount of $2,734,107.99 in June 2014 and issued a bankruptcy notice against the taxpayer based on the judgement debt. The taxpayer claimed that this was the first notice he had of the disallowance of his objection.

Upholding the AAT decision, the Federal Court found that there was no reason to allow the objection.

The taxpayer argued that the decision should be overturned by the Federal Court because the AAT had incorrectly applied the principles for determining that an extension of time be granted because it had focused too heavily on the merits of the proposed substantive application. The Court then considered two important principles when it comes to exercising discretion to allow an objection out of time: the ‘arguable case’ principle and the ‘prejudice’ principle.

Whether the taxpayer had an arguable case:

• Justice Davies noted that the authorities make it clear that the merits of the substantive application are a relevant consideration in determining whether to exercise a discretion to grant an extension of time, but this, of itself, does not involve a determination of the substantive application.
• The matter to be addressed is whether an arguable case on the merits of the application is shown to be based upon the material relied upon by the applicant, and not upon an inquiry into the true existence of the facts.
• Justice Davies found that the Tribunal made no error in its application of the principles. It did not engage in a fact finding exercise or undertake an assessment of the merits of the proposed review application, but considered whether the material showed an arguable case.

Whether the Tribunal adequately considered the likely prejudice to the taxpayer:

• Regarding prejudice, the taxpayer argued that the Tribunal failed to have due regard to the considerable prejudice he would suffer by being unable to dispute the decision. Davies J held that the taxpayer lost the right to a merits review long ago, and that there was no error in the Tribunal’s reasoning.

In our view, this case is a useful reference for understanding the factors which are relevant where the Commissioner decides that it is appropriate to exercise his discretion to allow an objection out of time, especially in light of the recent updates to the SRO practice note, discussed in Talking Tax - Issue 50, which uses broadly the same language as identified in this case.