The Federal Government has released-ed an Exposure Draft of legislation, "Promotion and implementation of schemes," and accompanying Explanatory Material. The stated objective of the legislation will be "to deter the promotion of tax exploitation schemes," and to "deter the implementation of schemes that have been promoted on the basis of conformity with a product ruling in a way that is materially different to that described in the product ruling."
The Exposure Draft allows the Commissioner of Taxation to:
- seek very large civil penalties
- seek an injunction to stop the promotion of a tax exploitation scheme, and
- enter into voluntary undertakings with promoters or implementers that address concerns about the way in which a scheme is promoted.
Despite the Explanatory Material’s soothing comments, the Exposure Draft in its current form is "red in tooth and claw." For example the Explanatory Material talks about how the legislation will not apply to a tax or legal practitioner, "if, on request, they design a tax effective arrangement for a client that is later found to be a tax exploitation scheme."
This exaggerates the extent of the exception which the Exposure Draft provides for legal and tax practitioners. This states an individual will not be a promoter "merely because the individual provides advice about the consequences of entering into a scheme (as opposed to encouraging or helping entities to enter into the scheme)."
Fairly clearly designing "on request, a tax effective arrangement" goes beyond merely providing advice, and could be seen as "implementing" or "advancing" the scheme. As such, this conduct could be subject to the big penalties proposed in the Exposure Draft, which is directed only at individuals, not other entities, and could result in a maximum penalty which is the greater of 5,000 penalty units (currently equal to $550,000) or "twice the consideration received or receivable (directly or indirectly) by the individual and associates…in respect of the scheme."
Who is a promoter?
An individual is a promoter of a tax exploitation scheme "if the individual promotes the scheme by implementing it, advancing it or encouraging its growth or interest in it…and the individual or an associate…receives consideration in respect of the scheme; and…having regard to all relevant matters, including the extent of the individual’s participation in the management of the scheme, it is reasonable to conclude that the individual has a substantial role in promoting the scheme."
There is a limited exception, referred to above, if the individual "merely… provides advice about the consequences of entering into a scheme…"
What is a tax exploitation scheme?
A scheme is a tax exploitation scheme "if…it is reasonable to conclude that an entity that…entered into or carried out the scheme, or part of it, did so with the sole or dominant purpose of…getting a scheme benefit from the scheme; and… the scheme benefit is not available at law."
A notable feature of this definition is that the prosecutor does not have to demonstrate that the entity entering into the scheme did not get the scheme benefit because, for example, a court has upheld an assessment by the Commissioner under the general anti-avoidance provision, Part IVA. In fact, the individual may be liable even if there has been no adverse assessment of the entity that entered into the scheme if the prosecutor can establish "the scheme benefit is not available at law." It is possible, although perhaps not likely, that an individual could be made liable for a civil penalty in respect of a scheme, whose validity is later upheld by another court.
Defences
The Exposure Draft does not refer to "defences" as such but it lists two exceptions where an individual will not be liable for a civil penalty. These are if the individual satisfies the court that:
- "the conduct…was due to a reason-able mistake of fact"; or
- "the conduct…was due to the act or default of another entity [not being an employee or agent of the individual], to an accident or to some other cause beyond the individuals control; AND…the individual took reasonable precautions and exercised due diligence to avoid the conduct." (emphasis added)
The heading of these exceptions is "reasonable mistake or reasonable precautions." This heading, is some-what misleading, because if the exception in the second dot point is relied upon, the individual would have to satisfy a court that he or she had done much more than take reasonable precautions. He or she would have to prove that someone else, not being his or her employee or agent, was to blame or there was "an accident or...some other cause beyond the individual’s control."
Tax and legal practitioners and financial planners could face savage penalties
The Explanatory Material states: "Tax or legal practitioners, including financial planners, tax agents and accounting and legal practitioners, who merely provide advice on arrangements, or prepare tax returns based on information provided by other legal or tax advisers are not considered promoters and will not be caught under the provisions."
Consider the following facts. A financial planner working for a financial institution advises a client about a tax effective arrangement, and then helps the client to implement it, for example by filling in suitable documentation. The financial planner is paid a substantial success fee for having signed up the client. Is he or she a promoter? The answer is probably yes, because the financial planner has gone beyond giving advice and has received consideration in respect of the scheme, being the success fee. The financial planner would seem to have had a substantial role in promoting the scheme to this particular client.
Can the financial planner rely on the "reasonable mistake of fact" or "reason-able precautions" exceptions? If the financial institution obtained legal advice that the scheme worked, and the financial planner was aware of, and relied on this advice, this would not seem to be a "reasonable mistake of fact," which would seem to be quite a narrow exception.
The existence of this advice might be construed perhaps as "the act or default of another entity." But the advice might have to be defective in some way to be able to rely on this exception.
What if the legal advice had been suitably qualified, while expressing optimism about the effectiveness of the scheme? Even if the financial planner conveys these qualifications to the client, the planner might still be liable for a civil penalty if he or she helps the client to implement the scheme.
Tax and legal practitioners and financial planners who implement tax effective schemes for clients, as well as merely advise on them, even if they are merely employees, could well find themselves liable for large civil penalties in cases where they receive success fees directly related to the scheme which they help their clients to implement.
The path ahead
At present the legislation is "a bit rough around the edges" as it is merely an Exposure Draft. It is likely that further improvements will be incorporated following consultation. For example, it is quite possible the legislative exception for "mere advice" could be extended along the lines suggested in the Explanatory Material.
However, the general concept of the legislation has the endorsement of Federal Cabinet, and few would quarrel with penalties being imposed on, to quote the Explanatory Material, "promoters… [who] actively market tax exploitation schemes or proactively advertise and solicit investment in schemes that are tax exploitation schemes." Many would also support the Commissioner of Taxation being given the ability to pre-empt such schemes, by way of injunction against the promoters, before members of the public have invested their money.
We anticipate there could be further modifications to the Exposure Draft - which has already undergone major changes from an earlier draft circulated on a confidential basis. There is also likely to be continuing controversy when the legislation is introduced.
But we do not expect that the Federal Government will back down from its main objective, which is to make individuals liable for large monetary penalties if they have a substantial role in the implementation of tax exploitation schemes. With further improvements this is legislation which can provide additional protection for taxpayers that need not provide an impediment to appropriate tax planning and the provision of objective tax advice.
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