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Focus: Tax – August 2008

Beyond Futuris and Carpenter – taxpayers' appeal rights

In brief: The High Court recently handed down its judgments in two cases concerning the right of taxpayers to challenge decisions of the Commissioner of Taxation. Partner Malcolm Stephens (view CV), Senior Associate Chris Peadon and Lawyer Pouyan Afshar of our Tax Dispute Group discuss the effect of these decisions.

How does it affect you?

  • The High Court confirmed that taxpayers may challenge a decision by the Tax Commissioner on the grounds of 'jurisdictional error' (which includes, for example, a decision made in bad faith). However, the High Court has emphasised that such relief will only be available in limited circumstances, and that taxpayers will usually be required to pursue any appeal through the Part IVC process.
  • The High Court held that the Commissioner may apply the transfer pricing provisions in the Income Tax Assessment Act 1936 (Cth) (the ITAA) whether or not the taxpayer had a 'tax avoidance purpose' or a 'profit shifting motive'. In reaching its decision, the High Court considered the extent to which the taxpayer can request 'particulars' of the grounds on which the Commissioner decides to exercise his powers.
  • These decisions illustrate the importance of strategic planning in tax litigation, so that costs are not incurred pursuing avenues of appeal that have limited prospects of success.

Introduction

The High Court recently handed down two decisions that affect taxpayers' rights in appeals. In Commissioner of Taxation v Futuris Corporation Limited1, the High Court held that an assessment issued by the Commissioner which included 'double-counting' should not be set aside for jurisdictional error. The High Court's decision was influenced by its view that taxpayers should generally pursue rights under the usual objection/determination/appeal process under Part IVC of the Taxation Administration Act 1953 (the TAA), rather than seeking to set aside decisions of the Commissioner for jurisdictional errors. In the second case, W.R. Carpenter Holdings Pty Limited v Commissioner of Taxation,2 the High Court dismissed an application by a taxpayer for particulars concerning the Commissioner's decision to apply the transfer pricing provisions in the ITAA on the basis that the information sought was not relevant to any of the grounds on which the taxpayer could challenge the assessment.

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Appeal process

Most disputes regarding taxation are dealt with under the provisions of Part IVC of the TAA, which sets out a procedure under which a taxpayer can object to an assessment. The Commissioner must rule on the objection, and the taxpayer has the right to appeal any such decision either to the Administrative Appeals Tribunal or to the Federal Court.

In some circumstances, a taxpayer may also challenge a decision made by the Commissioner under section 39B of the Judiciary Act 1903 (the Act) on the basis that the Commissioner's decision to issue the assessment is affected by 'jurisdictional error' (for example, it was issued in bad faith or on some other administrative law ground). An issue raised in both these proceedings, although only discussed in the judgment in Futuris, is the circumstances in which an appeal may be brought under s39B of the Act where a taxpayer is also entitled to appeal in accordance with the Part IVC process.

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Futuris

The dispute in Futuris arose from assessments issued by the Commissioner relating to certain capital gains from the sales of shares and assets of a number of Futuris Corporation Limited's (Futuris) subsidiaries. Futuris objected to the decision on a number of grounds, including that the assessment involved a double-counting of nearly $20 million (ie this amount had appeared in a previous assessment also subject to appeal).

Futuris commenced proceedings under Part IVC and also separately commenced a proceeding seeking a declaration that the assessment was invalid on the basis that it was issued in bad faith (and was therefore affected by 'jurisdictional error'). The taxpayer pursued the declaration in priority to the Part IVC proceeding because, if successful, the Commissioner would have been out of time to issue an amended assessment. At first instance, the judge found for the Commissioner. On appeal, the Full Federal Court found for the taxpayer.

The High Court subsequently found for the Commissioner and made the following observations:

  • Taxpayers may challenge decisions on the basis that the Commissioner has acted outside his powers (ie committed a 'jurisdictional error'). If the Commissioner acts in 'bad faith', this may constitute a jurisdictional error.
  • The Commissioner believed, in good faith, that the legislation entitled him to issue an assessment that included double-counting, because there was a mechanism in the legislation to make adjustments for this. On this basis, the High Court held that the Commissioner had not issued the assessment in bad faith. The claim by Futuris therefore failed on the facts.
  • Where there has been a jurisdictional error, the courts have a discretion as to whether or not to set aside a decision. One very important factor in tax appeals is whether the taxpayer is entitled to pursue an appeal under the Part IVC process. In this case, the High Court held that the availability of that right should have caused the Full Federal Court to exercise its discretion not to grant relief.
  • An allegation that the Commissioner acted in bad faith is a serious allegation and should not be made lightly. The High Court further observed that it would therefore be a rare case for a taxpayer to succeed in setting aside a decision on this ground.

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Carpenter

The Carpenter case concerned the application of the transfer pricing provisions of the ITAA to transactions between the taxpayers and related non-resident entities, including interest-free loans.

Under subsection 136AD(1), the Commissioner issued assessments to the taxpayers on interest imputed on the loans on the basis that the transactions were not considered to be at arm's length.

The taxpayers commenced appeals in the Federal Court under Part IVC and sought particulars of the Commissioner's decision to issue the assessments. The application for particulars was an interlocutory step in the proceedings in the Federal Court.

The High Court found for the Commissioner and made the following observations:

  • Section 136AD applies where three objective criteria are satisfied and the Commissioner determines that the section applies. The taxpayers sought particulars of whether the Commissioner took into account matters not referred to in the section in exercising his discretion (such as whether the Commissioner considered the absence of a tax avoidance purpose or a profit shifting motive). These, however, were not matters the Commissioner was required to consider. It followed that they were not relevant to the issues in the Part IVC appeal. Consequently the court denied the taxpayers' application on this ground.
  • The court also observed that the request for particulars seemed to be a 'fishing expedition', that is, the taxpayers were seeking to locate some state of affairs that may or may not provide them with an issue to pursue in the appeals. The court appears to have been influenced by this finding in its decision to deny the application.
  • It was not necessary for the court to determine whether the Commissioner's 'discretion' in s136AD was open to challenge in a Part IVC proceeding. This leaves this issue open for future appeals.

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Conclusion

These decisions confirm the limits on avenues for challenging determinations by the Commissioner and the limits on requests for particulars in tax disputes. Where a taxpayer is entitled to challenge a decision of the Commissioner under the Part IVC procedure, a court will seldom (if ever) set aside that decision in proceedings under s39B of the Act alleging a 'jurisdictional error'.

In light of the above, taxpayers should think carefully before embarking on a potentially costly appeal other than through the Part IVC process or to pursue an application for information from the Commissioner that does not strictly concern the issues in dispute.

Footnotes
  1. [2008] HCA 32.
  2. [2008] HCA 33.

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