Avoiding grey areas around tax avoidance comes down to preparation and documentation, writes Peter Murray, Partner, Hall & Wilcox.
In light of the recent Federal Court decision in BCI Finances Pty Ltd (In Liq) v Binetter (No 4)  FCA 1351 (Binetter), it is crucial that company directors are attuned to their common law and statutory duties relating to tax avoidance.
The case serves as a stern reminder to directors about discharging their duty to act with “care, skill and diligence”, especially when considering whether an arrangement may constitute a scheme to reduce income tax within Part IVA of the Income Tax Assessment Act 1936 (Cth) (the Act).
Duties imposed on directors
As all directors should be aware, they are subject to both a statutory and common law duty to act with care, skill and diligence in the discharge of their duties. While company directors have a general understanding of the need to act with care, skill and diligence, these duties are not always clearly defined. There is potential for interpretation, which can make it a grey area, especially so in the context of tax risk management.
Directors are required to perform their duties to the standard expected of a “reasonable person” in the particular circumstances of the director and corporation.
The “reasonableness” assessment creates some ambiguity in an otherwise relatively straightforward duty by requiring assessment of the director’s conduct from an objective standard. A number of factors relating to the director’s particular circumstances are considered, including their experience, skills and role in the business.
The Binetter decision
In Binetter, the liquidators of four companies successfully proved that the directors had breached their duty to act with care, skill and diligence due to their conduct in relation to “back to back” arrangements. The arrangements involved the use of funds held by directors and associated entities in Switzerland and Israel as security for advances from the Israeli banks to the four companies, which were equivalent to the offshore deposits.
The court held that the directors breached their duties by participating in “back to back arrangements”, which amounted to a scheme between the companies and the banks under Part IVA of the Act. The court held the directors personally liable on the basis that the scheme was entered into solely to provide tax benefits to the directors; the sole purpose of the scheme was to avoid tax, with no benefit to the company.
The court found the directors had intentionally concealed the offshore deposits, obscured evidence regarding the scheme to prevent its true nature being revealed, and failed to minimise the companies’ liability for tax penalties and interest charges.
Part IVA of the Act
Part IVA of the Act targets taxpayers who obtain a tax benefit by entering into a scheme for the dominant purpose of obtaining a tax benefit. The onus then falls on the taxpayer to demonstrate that there was a commercial reason for the transaction.
As highlighted in the Binetter decision, Part IVA is where company directors are most vulnerable to tax avoidance charges. Under Part IVA, directors not only need to comply with the tax law, they must also consider their actions or omissions when discharging their statutory and fiduciary duties. The nature of corporate restructures (which often result in a “tax benefit”) makes them particularly susceptible to being caught by Part IVA.
Directors must understand the structuring and other commercial imperatives of the company – they must balance a transaction’s commercial drivers against any tax benefit received pursuant to the transaction or arrangement. They must be able to demonstrate that a transaction’s dominant purpose was clearly to benefit the company, rather than to provide a tax benefit to the directors.
This balancing exercise is particularly important for the directors as it, along with the corresponding documentation, may protect them from personal liability if the Australian Taxation Office (ATO) were to apply Part IVA of the Act to a transaction.
The court made it clear in Binetter that directors will not discharge their duty to act with care, skill and diligence where they are complicit in the company’s participation in a scheme against which the ATO might apply Part IVA.
Protection for directors
The onus is on directors to assess whether a transaction may risk being liable to Part IVA, and prepare robust documentary evidence.
Board and company documentation will show that due consideration has been given to any risk Part IVA of the Act could apply to a transaction. The documents should include an objective assessment of the commercial rationale compared with any potential tax benefit. There must also be a reasonable explanation describing the dominant purpose for proceeding with the transaction that clearly benefits the company.
Retaining this documentation may provide crucial evidence around the dominant purpose of a transaction, even when originating from the earliest stages of contemplating the transaction. By providing a rationale and insight into the transaction at the time, these documents are potentially more powerful than an explanation of the transaction produced after the fact during an ATO audit.
In some cases, a transaction may be investigated years later, and may involve personnel who have since left the business. Practically speaking, the timely preparation of a tax-focused transaction bible of contemporaneous documentation helps avoid situations where a company is required to rebuild a file of evidence and material relating to a long-forgotten transaction. In short, the earlier the relevant material is prepared, the better.
Documentation for inclusion in such a transaction bible includes, but is not limited to:
- Correspondence between directors and other stakeholders about the transaction.
- Correspondence between the company and external advisors (including lawyers, bankers and accountants) about the transaction.
- Directors’ diary notes.
- Detailed board minutes and papers which evidence a discussion of the commercial drivers of the transaction.
- All the relevant information and documentation from a transaction.
- Privileged advice opining on the potential application of Part IVA to the proposed transaction.
Any document that shows why the company has chosen to proceed with a transaction, or even why the company has chosen to carry out the transaction in a particular way, might become relevant later if the ATO wishes to confirm that Part IVA does not apply.
The tax advantages of a transaction should not be ignored in preparing contemporaneous documentation. Tax considerations are an expected commercial consideration and will often have a significant effect in structuring a transaction.
The absence of evidence explaining the tax motives in a transaction is commercially unrealistic and any such evidence should not be concealed. Instead, the documentation should clearly show that while tax was a consideration in structuring, the dominant purpose of the transaction was not tax driven.
Contemporaneous documentation will not only assist a company to defend a Part IVA determination, but will also help directors to demonstrate that they have discharged their duty to act with care, skill and diligence.
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