January 19, 2016

The value of legal expertise in tax disputes

Key Points

  1. Court appeals will often cost in excess of $200,000, which most clients will not want to pursue and will wish to avoid (a cost benefit analysis will not pass).
  2. Where the dispute involves an application of the law (as opposed to the calculation of an amount) the ATO view can often be misguided.
  3. A focused and powerful legal submission based on legal principles can often cause the ATO to change their view. This should be adopted no later than the objection stage to avoid the Court Appeal cost.
  4. A valuable example is included in this article.

Background
The Australian income tax system is based on self-assessment. Under this system, the ATO generally accepts returns as lodged. It then selects certain returns for review on various bases. For example, taxpayers in a particular occupation, returns disclosing a particular deduction or type of income, or returns disclosing deductions well above average or income well below average. On occasions, these reviews can occur prior to assessment but usually occur after assessment.

Many would understand that the tax review system adopts the following general process:
Audit/Position Paper > Amended Assessment > Objection > Appeal (AAT or Court)
The Appeal phase of the tax review process is expensive – the cost of running an appeal generally exceeds $200,000, and costs of up to $1 million are not uncommon.

In our experience, where the review concerns application of the law to the client circumstances, the view of the ATO can be misguided. In that instance, a focused submission based on legal principles can achieve the desired results. To minimise costs, these submissions should usually be put forward at the position paper/objection phase.

A recent example illustrates the advantages of focused legal assistance:

The taxpayer had inherited a large area of bushland, comprising several hundred acres. By the time of inheritance, the zoning allowed the subdivision of the bushland into rural residential allotments of between 2 to 10 acres per lot. The taxpayer engaged with a developer who performed all development works and in exchange received a portion of the lots resulting from the development. The arrangement between the taxpayer and the developer, in our view, had the characteristics of a property joint venture. However, the legal document entered into some 20 years ago was described as an Agreement for Sale. The taxpayer’s only activities was the realisation of this land and work as an employee. The taxpayer had registered for GST shortly after the year 2000 on the advice of an accountant, even though they received a private ruling for income tax that the development was a mere realisation.

The review concerned the application of GST. The period covered by the review was the final stage of development which occurred more than 20 years after commencement and concerned 53 lots to be realised by the taxpayer (the developer itself receiving 53 lots from that stage of the development) for a total sale price of around $12 million.

Notwithstanding the figures involved, our view was that the realisation by the taxpayer was a mere realisation and not business income nor resulting from a profit-making undertaking. The taxpayer was an individual, so characterising the transaction as a mere realisation reduced the taxable profit by the CGT discount and had the effect that the sales were not liable for GST.

The ATO initially considered the sale of land was not a mere realisation on six separate bases:

  1. Resale immediately after acquisition evidences income producing intention (Response: realisation of inheritance is capital unless ventured into business or profit-making undertaking);
  2. Change of purpose/ventured into profit-making undertaking relying on Whitfords Beach (Response: limited relevance of Whitfords Beach);
  3. Borrowings in the form of delayed payment of development works to developer (Response: misconstrued terms of the Agreement for Sale);
  4. Development period (Response: not supported by the cases);
  5. Acquisition of additional land (Response: additional land acquired as compensation for project land subject to compulsory acquisition by the Council);
  6. Business organisation and coherent plan of subdivision (Response: organisation and coherent plan arose from activities of the developer under the Agreement for Sale).

We put forward a detailed submission containing the responses outlined above and the ATO backed down on all six points and confirmed the realisation was a mere realisation, the taxpayer was not liable for GST and only taxable for income tax under the CGT regime.

A further point is as you move further along the process from Amended Assessment to Appeal, you will engage with ATO personnel further up the chain and receive more common sense. In this case, it became apparent the person dealing with the objection was quite inexperienced and our involvement resulted in an ATO supervisor becoming involved which was key in characterising the Agreement for Sale as in the nature of a property joint venture.