Tax Brief - More Amendments to Self-Assessment

The second instalment of legislation to give effect to the recommendations in Treasury’s review of the self-assessment system for income tax was introduced into Parliament on 10 November.  A draft of this legislation had been released earlier in the year, but the final version contains several important changes.

This has been a protracted project – the review of self-assessment was announced in March 2004; Treasury released its Report on Aspects of Income Tax Self-Assessment System (“the Report”) in December 2004; and the first instalment of legislation to enact the Report’s recommendations was introduced into Parliament in March 2005. We have detailed the history of the various stages in prior Tax Briefs:

• our three Tax Briefs discussing the recommendations of Treasury’s Report are available at http://www.gf.com.au/articles_336.htm, http://www.gf.com.au/articles_338.htm, and  http://www.gf.com.au/%20articles_339.htm, and

• our Tax Brief on the first tranche of legislation is available at http://www.gf.com.au/articles_398.htm.

The new Bill will enact more of the legislative measures needed to give effect to Treasury’s Report.  It deals principally with the making and amending of assessments, and introduces a new rulings system.

Nil assessments

The Bill addresses one of the more irksome features of the current income tax law – that a taxpayer without a tax liability for a year is exposed to the issue of an assessment indefinitely because the tax statute of limitations is not triggered for that year of income.  This rule affects taxpayers with losses and those with only exempt or non-assessable non-exempt income for a year.

The Bill amends the definition of an assessment to include a determination by the Australian Taxation Office (“the ATO”) that the taxpayer does not have taxable income or that no tax is payable for a year.  The Bill also makes the limitation period commence from the date on which notice of an assessment was issued.

Two points worth noting follow from the change.  The first is that, while an assessment will now arise where the taxpayer has a loss, a special provision ensures a taxpayer cannot object against the amount of a tax loss.  The taxpayer will have to wait until the year in which the benefit of the tax loss is being claimed as a deduction and object against the assessment of that year. 

More importantly, as we pointed out in an earlier Tax Brief, the new regime does not achieve real parity between tax-paying and tax-loss taxpayers.  Even though a loss suffered by a taxpayer will not be able to be adjusted after the limitation period has expired, the deduction arising from the loss can be denied in the year in which the loss is effectively enjoyed.  The Explanatory Memorandum gives an example which demonstrates the problem:

The $10m loss reported in Year 1 is later found after an audit in Year 5 to be erroneous – the ATO makes an $18m upward adjustment, which results in taxable income of $8m in Year 1 instead of the $10m loss.  While the ATO cannot amend the assessment made in Year 1 to disclose and impose tax on taxable income of $8m, the ATO is allowed to deny the effect of the $10m loss in year 5 when the benefit of the Year 1 loss is claimed.  The taxpayer’s assessment for Year 5 will be amended and increased to $20m.

The lack of parity with a taxpaying entity can be seen by comparing a taxpayer which had reported taxable income of $1m in Year 1.  After audit in Year 5, the ATO attempts to make an upward adjustment of $18m which would result in taxable income of $19m for Year 1.  In the absence of special circumstances, the ATO could not collect tax on any of the additional $18m.

However, the regime in the Bill is an improvement on the current position.  At present, the ATO could both deny the $10m loss and raise an assessment for tax on the $8m taxable income.  In addition, the ATO could impose interest on the additional unpaid tax which would run from Year 1.  Under the system in the Bill, while the $10m loss is still in jeopardy, the extra $8m will not be assessed and interest will run from Year 5.

The amendment applies for assessments made for the 2004-05 year of income and later years of income.

Assessments for pre- 2004-05 years of income

The Bill contains a further amendment to benefit taxpayers who do not have an assessment for a year of income prior to the commencement of the regime just described: for example, taxpayers who incurred losses in the 2003-04 or prior income years.  The amendment will ensure that years of income prior to 2004-05 are not open to review indefinitely.

However, the drafting appears not to extend to one other affected group – taxpayers who derived only exempt income or non-assessable non-exempt income for a year.  This is probably an oversight, but it will affect, for example, onshore holding companies deriving only branch profits or dividends from subsidiaries operating offshore in comparable countries.  For these taxpayers, years of income prior to 2004-05 will remain open to review indefinitely on the current drafting.

The extent of the protection afforded by the amendments to the taxpayers to whom they apply depends upon a variety of factors, most notably whether the taxpayer’s open years are affected by losses or not.

• If the taxpayer has filed a return for the 2003-04 or prior year which disclosed a tax loss for the year, and the taxpayer has fully utilised the loss by the 2004-05 year, the ATO will have 6 years to issue an assessment from the date of lodgement of the 2004-05 return.  So, for example, a taxpayer with a tax loss for the 2000-01 year of income which it utilised in part in the 2001-02 year and the balance in the 2002-03 year, will be exposed to the issue of an assessment for the 2000-01 year until around 15 January 2012 – i.e., 6 years after the return for the 2004-05 year was lodged on 15 January 2006.

• If the taxpayer has filed a return for the 2003-04 or prior year which disclosed a tax loss, and the taxpayer has not fully utilised the loss before the 2004-05 year, but the taxpayer notifies the ATO of the existence of the loss in the approved form, the ATO will have 6 years to issue an assessment for the loss year from the date of notification to the ATO.  It will therefore be important for taxpayers with pre-2004-05 losses to notify the ATO as soon as possible after the legislation commences and the “approved form” determined.

• If the taxpayer has filed a return for the 2003-04 or prior year which used a tax loss (disclosed in an earlier year’s return) to reduce its taxable income for that year to 0, and the taxpayer has not fully utilised the balance of the loss before the 2004-05 year, the ATO will have 6 years to issue an assessment from the from the date of lodgement of the 2004-05 return – i.e., generally 15 January 2012.

• If the taxpayer has filed a return for the 2003-04 or prior year and there are no losses involved – that is, no loss was generated in the year, nor was a loss utilised in the year – the ATO will not be able to issue an assessment after the later of (a) 31 October 2008, or (b) 4 years from the from the date of lodgement of the relevant return.

Shortened time for amending assessments

Another set of amendments in the Bill affects the ATO’s power to issue amended assessments.  Under current law, the ATO is generally limited to a period of four years after making an assessment, or 6 years where the ATO relies on the general anti-avoidance rule in Part IVA, in which to issue an amended assessment.

The Bill confirms the general 4-year amendment period for corporate taxpayers, but extends it to apply to arrangements which are challenged under Part IVA.

Other provisions in the Bill shorten the review period to 2 years for individual taxpayers and for companies or trusts which have elected into the Simplified Tax System.  However, what the Bill gives with one hand, the regulations takes away with the other – new income tax regulations were released with the Bill which allow the 2 year period to be extended to 4 years in some circumstances.

New Rulings regime

One of the most important developments in the Bill is the establishment of a new Rulings system.  The Bill repeals the rules which underpin the current Public Rulings system, including Class Rulings and Product Rulings, the Private Rulings System and the Oral Rulings system.  It replaces these rules with a single rulings system and removes some of the difficulties that have become apparent in the operation of the current regimes.  The changes do not apply at this stage to the GST, Wine Equalisation Tax or Luxury Car Tax, although they may later be included in the system.

Broader coverage

One important feature of the new Rulings regime is that it allows the ATO to make enforceable Rulings on a wider range of topics.  Many documents issued by the ATO since 1992 which appear to be legally binding are not in fact within the range of matters on which the ATO can make a legally binding Ruling.  (Although they are not legally binding the ATO, the ATO has said it will treat them as administratively binding.)

The new regime is designed to rectify this limitation – to authorise the ATO to make legally binding Rulings with respect to matters of administration, questions of fact, the exercise of discretions and so on.  The Explanatory Memorandum to the Bill says that “the Commissioner may make Rulings on all matters and circumstances in which rulings are currently made and the authority is extended to cover any aspect of the tax … including the collection and recovery of the tax, and its administration …”

While the new Rulings regime has a broader coverage, it is still limited with respect to the taxes covered.  The ATO can issue Rulings about most aspects of the income tax system, including fringe benefits tax, franking deficits tax and withholding tax issues.  However, there are technical deficiencies in the drafting which mean that some of the ancillary “taxes” that combine to make up the income tax system may not be covered.  For example, there are reasons to doubt the ability of the ATO to make a legally binding Ruling on family trust distribution tax, ultimate beneficiary non-disclosure tax and untainting tax.

Making a Ruling Effective

The new regime restates the outcomes of the current Rulings system – when a Ruling applies to a taxpayer, it protects the taxpayer against the assessment of any further primary tax, interest and penalty.

The current system achieves these outcomes by provisions in the Act which preclude the ATO from issuing an assessment which is inconsistent with either a Public Ruling or a Private Ruling that applies to the taxpayer. 

While the current provisions are repealed by the Bill, interestingly, no replacement prohibition is enacted.  Instead, the Bill states the general proposition that “a ruling binds the Commissioner …” when certain conditions are met.  The assumption seems to be that that this phrase is sufficient to prohibit the ATO from issuing an assessment for primary tax, where tax would be due according to the terms of the Act but the assessment would be inconsistent with an issued Ruling.  The further assumption is that where the ATO is prohibited from assessing primary tax, it is also precluded from insisting on payment of interest or a penalty because there is no tax deficiency.

Reliance

One confusing aspect of the new regime that we highlighted in an earlier Tax Brief is that a Ruling only binds the ATO if the ruling applies to the taxpayer’s circumstances (which is the current test) and the taxpayer relies on the ruling “by acting or omitting to act in accordance with the ruling.”  On an ordinary reading of the text, it would seem that a taxpayer would have to demonstrate that it was aware of the Ruling, and then took action in reliance on it. 

However, the Bill tries to make clear that (a) a taxpayer doesn’t have to be aware of a Ruling in order to rely on it, and (b) that reliance on a Ruling will be demonstrated in most cases simply by the way the taxpayer prepared its tax return.  If that is so, the requirement of reliance is effectively otiose, and we are left just with the current requirement that the Ruling “applies” to the taxpayer.

So, if it turns out that the taxpayer’s return is consistent with the Ruling (even, it would seem, a Ruling issued after the income year in question), the Ruling has been relied on, and if the return is inconsistent with the Ruling, the Ruling has not be relied on. If one year’s return is prepared in a manner consistent with the Ruling and the next year’s return inconsistent with the Ruling, the taxpayer will have relied on the Ruling in the first year and not in the second – that is, taxpayers can change their approach to a Ruling from year to year (bearing in mind that there may be some penalty and interest risk in doing so).

Changes to the Private Ruling process

The mechanics of the new regime for Private Rulings replicates much of the current system.  Private Rulings are still issued on application which must be made in the approved form.  The Ruling appears to bind the ATO only for the stated scheme and for the provisions identified in the Ruling (including any re-enactment of those provisions).

A Private Ruling must state the identity of the person to whom it applies.  However, applications can now be made by a trustee and the impact of the Ruling will apply to beneficiaries and succeeding trustees.  Further because the new regime applies to entities rather than taxpayers, a partnership will now be able to apply for a Private Ruling and the partners will be entitled to the protection of the Ruling.

With the extension of Rulings to administrative matters, it is now possible to apply for a Private Ruling in relation to a valuation.  With consolidation and other recent measures, market valuations now permeate the corporate tax system.  If the Ruling request does not contain a valuation, then the ATO can seek one from a valuer; if the Ruling request includes a valuation which one assumes will be the norm, the ATO can seek review of the valuation from a valuer.  In either case the ATO will be able to charge the applicant for the valuer’s services in accordance with a schedule of fees in the regulations.  The issue of charging for Private Rulings has often been debated; this is the first example of charges in relation to Private Rulings being authorised by legislation.

Another new feature is that taxpayers now have the ability to insist that the ATO issue a Private Ruling.  The process requires the taxpayer to give the ATO a notice requiring the issue of the Ruling.  If the ATO has not responded within 60 days, the Ruling request is deemed refused, which triggers the taxpayer’s rights to object against the refusal.  However, the 60 day period can be affected by other facts such as the ATO requesting further information, and there are other provisions which permit the ATO to refuse to issue a Private Ruling.

The process for challenging Private Rulings continues – taxpayers can object to a Private Ruling.  The ATO may consider further information when considering the objection.  Indeed the ATO can consider information from third parties in making the initial Ruling if it notifies the applicant that it proposes to take such information into account.  However, a taxpayer cannot object against a Ruling if the ATO has issued an assessment for the year in question.

The new regime is generally silent on the process surrounding the withdrawal of Private Rulings.  The ATO is permitted to issue a Private Ruling with a limited term.  Indeed, if the Ruling does not state a term, it ceases to apply at the end of the year of income in which it commenced.  If the Ruling has a longer term, the ATO may revise the Ruling and the revised Ruling will apply thereafter in lieu of the former Ruling, but only if the taxpayer had not begun to carry out the relevant scheme and the relevant year of income had not commenced.  It is likely that, in the absence of an explicit power to withdraw an issued Private Ruling, the ATO will continue its current practice of limiting the life of each Private Ruling.  The other point to note is that a Private Ruling is withdrawn by implication if the ATO subsequently issues an inconsistent Public Ruling unless either the relevant income year has begun or the taxpayer has begun to carry out the relevant transaction.  This is discussed more fully below.

Inconsistencies

The Bill deals explicitly with the various inconsistencies that can arise – between the text of the law and a Ruling, between Rulings of the same type and between different types of Rulings.

The Bill provides:

• the ATO may of its own volition apply the law instead of a Ruling where the taxpayer has followed the Ruling provided the law is more favourable to the taxpayer than the Ruling;

• if the ATO has issued a Public Ruling and then issues any other kind of Ruling, the taxpayer can rely on either Ruling;

• if the ATO has issued a Private Ruling and then issues an inconsistent Public Ruling:

if the relevant income year has begun or the taxpayer has begun to carry out the relevant transaction, the taxpayer can rely on either Ruling;

if the relevant income year has not yet begun and the taxpayer has not begun to carry out the relevant transaction, the taxpayer cannot rely only on the earlier Private Ruling – it is withdrawn by implication;

• if the ATO issued a Private Ruling to the taxpayer and then the taxpayer applied for another Private Ruling:

if the taxpayer did not inform the ATO of the first Private Ruling when it applied for the second, the taxpayer can rely only on the first Ruling;

if the taxpayer did inform the ATO of the first Private Ruling when it applied for the second, the taxpayer can rely only on the second Ruling.

Commencement and transition

The new system applies to Rulings made after 1 January 2006 or the date of Royal Assent, whichever is later.

The Bill purports to deal with the plethora of existing Rulings once the new regime commences.  It provides that any Public, Private or Oral Ruling in force when the new system commences is taken to be a Ruling made under the new regime.  It is interesting to speculate whether this provision makes legally binding all the Rulings issued since 1992 which are currently only administratively binding.  The translation of existing Rulings into the new regime does not extend to rulings in the “IT” series issued prior to 1992 – they will remain only administratively binding on the ATO.

Any Ruling applications in train which have not been completed before the commencement of the new regime are taken to be applications for Rulings under the new system.

The Bill also tries to anticipate the future by providing that a Public or Private Ruling on a particular provision is taken to be a Ruling in respect of a new provision that re-enacts or re-makes the existing provision.

Non-Ruling documents, advice and practices

The Bill also extends the existing limited protection available to taxpayers who rely on other non-Ruling advice given by the ATO or who follow the ATO’s long-standing general administrative practices.

The Bill provides that taxpayers will not be liable to interest if they follow the ATO’s non-Ruling advice, information pamphlets and long-standing practices.  Existing legislation already provides that no penalty can be applied in these circumstances, though it is couched in slightly different terms and subject to different requirements.  There is, however, no protection against the assessment of primary tax where the taxpayer has followed advice, publications or long-standing practice.

In order to be protected against the imposition of interest, there is a requirement that the taxpayer relied on the advice or publication but, in contrast to the reliance requirement for Rulings discussed above, this time the legislation seems to mean ‘real’ reliance – that is, prior knowledge and subsequent action.  (The existing legislation which provides protection against the imposition of a penalty contains no similar reliance requirement.)  And there is an additional requirement that it was reasonable for the taxpayer to rely on the advice or publication.

The ATO can, however, eliminate this protection against the imposition of interest by labelling its advice or written publications as non-binding.  (The existing legislation which provides protection against the imposition of a penalty contains no such power for the ATO to disown its advice or publications.) 

Precisely which ATO practices are covered by these provisions is a matter that will be of interest to taxpayers (and ATO staff!). The Explanatory Memorandum contains some detail which was not included when the earlier penalty provision was enacted.  Practice Statements issued by the ATO will be evidence of the ATO’s general administrative practice as will drafts of Public Rulings.  The issue by the ATO of several similar Private Rulings on the same topic is evidence but not conclusive evidence of the ATO’s general administrative practice.

These provisions on protection against interest do not contain an explicit transitional rule so it would appear that the protection operates from the later of the date of Royal Assent to the Bill or 1 January 2006.  This has the interesting consequence that protection against interest will apply to documents already issued by the ATO unless the ATO embarks upon a mass campaign to attach a disclaimer to their myriad existing publications.  The protection against penalty has applied since the 2000-01 year of income.

For further information, please contact,

Michael Moschner
61 2 9225 5969
michael.moschner@gf.com.au

Andrew Mills
61 2 9225 5966
andrew.mills@gf.com.au

http://www.gf.com.au/