Is there any other social construct that is as maligned as the paying of taxes? Most Australians would have an understanding of why paying tax is necessary, but there are some that are so adverse to the notion, that they would go to significant lengths to avoid paying income tax – such as establishing a trust to avoid their liabilities. It doesn’t take a genius to figure out, that creating a trust with the purpose of evading income tax is frowned upon by the Government, however, trusts can also be created as part of a tax planning vehicle, and it is up to the law to distinguish between legitimate trusts, and those which are not.
Trusts used to evade paying tax are void
Trusts which are created with the purpose of avoiding paying income tax will be void. If we look towards s 177F of the Income Tax Assessment Act (the Act), which states that:
“Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme…” the Commissioner of Taxation can cancel the benefit, if it can be established a person had entered the scheme to obtain a benefit.
What is a ‘scheme’?
Anyone who chooses to enter into a scheme either locally or globally may have the benefit cancelled, if the reason for entering the scheme was to obtain a benefit, but the obvious question remains: What is a scheme? In s 177A(1) of the Act, defines a scheme as:
“(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct.”
However, readers should be aware that the judgment in Federal Commissioner of Taxation v Peabody, prevents the Commissioner from looking at only part of a scheme when trying to determine whether the dominant purpose of the scheme was to secure a tax benefit. The High Court noted in Peabody, that Part IVA of the Act:
“…does not provide that a scheme includes part of a scheme and it is possible, despite the very wide definition of a scheme, to conceive of a set of circumstances which constitutes only part of a scheme and not a scheme in itself. That will occur where the circumstances are incapable of standing on their own without being ‘robbed of all practical meaning’.”
In determining whether a person entered into a scheme with the intention of evading their tax liabilities, the Commissioner will look objectively into the scheme, and then ultimately decide whether the benefit should be cancelled.
What is a tax benefit?
Under s 177C of the Act, a tax benefit is defined in the following manner:
“ (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or
(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or
(ba) a capital loss being incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer during the year of income if the scheme had not been entered into or carried out; or
(bb) a foreign income tax offset being allowable to the taxpayer where the whole or a part of that foreign income tax offset would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out;”
The common thread in the section is the notion of reasonable expectation - which requires more than a possibility, but rather, reasonable expectation involves an assessment to be made as to what would transpire if the scheme was not entered into, and must also be sufficiently reliable for it to be regarded as reasonable, as noted by the High Court in Peabody.
There is no denying that matters related to tax and trusts can be difficult when there are tax and non-tax considerations which need to be assessed. The High Court in Federal Commissioner of Taxation v Spotless Services Ltd recognised the need to establish the ‘dominant’ purpose of a scheme with the justices noting:
“A particular course of action may be, to use a phrase found in the Full Court judgments, both “tax driven” and bear the character of a rational commercial decision. The presence of the latter characteristic does not determine the answer to the question whether, within the meaning of Pt IVA, a person entered into or carried out a ‘scheme’ for the ‘dominant purpose’ of enabling the taxpayer to obtain a ‘tax benefit’… Much turns upon the identification, among various purposes, of that which is ‘dominant’. In its ordinary meaning, dominant indicates that purpose which was the ruling, prevailing, or most influential purpose.”
Trusts and tax matters can be complex and it is essential for anyone who has a concern with such issues to consult with a lawyer, who will be able to assist you with any inquiries that you may have.
