This article is written by Jerome Tse, John Boyagi, Taseen Rafi and David Blight.
Australia has one of the most complex taxation systems in the world, coupled with one of the world's most active tax administrations.
These factors expose multinational enterprises (MNEs) to a significant risk of dispute with the Australian Taxation Office (ATO), in the form of ATO reviews, audits and investigations, and where unavoidable, litigation.
There has been a notable increase in the number and size of tax investigations involving MNEs in recent years. The establishment of the ATO's Tax Avoidance Taskforce in 2016 after the "Panama Papers" leaks has contributed significantly to the ATO's increased focus on MNEs. Such programs have been well funded, allowing the ATO to deploy significant resources to investigate MNEs (for example, the Taskforce received $1 billion from 2019-20 to extend its operation to 2022-23). This is not surprising given Australia's prominent role in the OECD's Base Erosion and Profit Shifting (BEPS) project, its ongoing efforts to seek multilateral solutions in the global tax environment where possible and its willingness to "go it alone" with unilateral measures where it is deemed necessary.
Good governance principles have resulted in boards seeking independent advice to test the positions taken during the original transaction and to objectively guide MNEs through the disputes process. These trends have also highlighted the growing importance of retaining independent expert lawyers with proven specialist tax advisory and litigation skills to assist in resolving tax disputes at the earliest opportunity.
With this in mind, there are several key strategies MNEs should consider to ensure disputes can be resolved quickly, efficiently and effectively.
1 Tax risk management and governance frameworks are critical
The best dispute management protocol is to avoid disputes altogether.
MNEs that develop robust and sophisticated tax risk management and tax governance frameworks are far less likely to become embroiled in long-term disputes with the ATO.
Taxpayers can generally minimise the risk of intense ATO scrutiny by developing frameworks which secure the "justified trust" of the ATO. Increasingly, the ATO's policy is to assist taxpayers in avoiding tax risk before a dispute arises – in other words, rather than initiating costly reviews and audits, the ATO generally prefers to assist taxpayers (including MNEs) by releasing guidance and engaging in programs to help taxpayers "swim between the flags".
Justified trust and the ATO's areas of focus
Various ATO interactions with large businesses, including the ATO's "Streamlined Assurance Reviews", are designed in part to assess the compliance frameworks of MNEs and to allow the ATO to achieve "justified trust". Even if a business views "justified trust" with some scepticism, having regularly reviewed tax risk management is a matter of good governance and will assist the business' tax function advise its internal stakeholders. In other words, such frameworks help to ensure that the tax tail doesn't wag the dog.
The ATO regularly publishes guidance about activities that attract its attention. For instance (and of particular relevance to tax and finance teams of MNEs), the ATO published guidance on 29 June 2020 in relation to its Top 1,000 Tax Performance Program in order to assist large public and multinational entities to maintain or improve assurance ratings. The ATO's key message was to stress the importance of contemporaneous documentation and governance frameworks in order to manage tax risk.
The ATO has stated it will focus its attention on insufficient supporting documentation and poor tax governance frameworks relating to:
- deductions claimed under the capital allowance regime;
- the making of R&D tax incentive claims;
- the utilisation of carried forward losses and the application of the "continuity of ownership" test and the "business continuity test"; and
- various compliance and reporting issues connected with tax consolidation.
Accordingly, and to minimise the risk of protracted investigatory activities by the ATO, MNEs should ensure they retain contemporaneous documentation in support of significant transactions that have a material tax impact. Several examples of key materials that should be prepared and evidenced contemporaneously were outlined in KWM's update on the ATO's Top 1000 Tax Performance Program dated 2 July 2020.
2 Understand the ATO's investigatory processes
It is not always possible to have a light touch interaction with the ATO, though it is always possible and preferable to maintain a positive working relationship with the regulator. Given the considerable complexity of the Australian taxation system and the varied risk appetites of different organisations, it is inevitable that differences will arise between the MNE's view of certain tax provisions and the ATO's view. It is not always possible to "swim between the flags".
It is critical that the decision makers in an MNE's legal, tax and finance departments have a solid understanding of the ATO's investigatory processes. An awareness of how each stage in the investigation operates, the severity and potential risks of each stage and knowing when to engage specialist legal assistance can mean the difference between a drawn-out dispute and a successfully and cost-effectively resolved outcome.
The ATO's investigatory processes range from informal ATO reviews requesting clarification on compliance issues to wide-reaching investigations involving several stages. An intensive and broad ATO investigation of an MNE will typically follow a defined path:
- Risk review: In many circumstances, before initiating a formal audit, the ATO will initiate a taxpayer risk review, with a view to determining whether there are taxation issues which require further attention. This can come in the form of pre-lodgement compliance reviews, streamlined assurance reviews or other ATO review products.
- Audits and formal notices: If the ATO identifies an issue at the risk review stage, the ATO will usually proceed to audit. A hallmark of the audit process is the use of either informal requests for information or more formal domestic or offshore statutory information demands under the ATO's formal notice powers. It is critical at this stage that taxpayers clearly define the boundaries of any formal or information request in writing, for instance by ensuring that all terms in a formal notice are clearly defined. Non-compliance (even if it is unintentional or inadvertent) can have dire consequences, ranging from civil penalties to criminal sanctions in extreme circumstances for directors and public officers.
It is essential for taxpayers to seek independent legal advice to assist with responding to such requests for information or formal notices. In this regard, independent legal advice can be key to shaping the taxpayer's approach in responding to the request or notice and the broader audit, and critically, can provide greater assurance that legal professional privilege is maintained over key documents.
- The audit decision: Following the information gathering process and before the finalisation of the audit, the ATO will issue a position paper outlining the ATO's views and details of proposed tax assessments arising from the process. The taxpayer will be given an opportunity to respond and seek review before the ATO issues its Statement of Audit Position (SoAP). Once again, independent legal advice can help taxpayers to assess the relative strength of the ATO's audit position, and to identify the counterarguments and evidence which may be put to the ATO for consideration prior to the issuance of the SoAP. Depending on the strength of its position, the taxpayer may also consider entering into settlement discussions with the ATO at this juncture.
- Independent review: Upon the issuance of the SoAP, taxpayers with a turnover of over A$250 million may, within 10 days, seek an independent review of the SoAP. The independent review is undertaken by a senior officer from the ATO's 'Review and Dispute Resolution' team who has no prior involvement in the audit, and will culminate in a recommendation to both the audit team and the taxpayer as to what the reviewer considers the 'better view'.
- Penalties and interest: In the later stages of the audit process, the ATO and the taxpayer will engage with each other in relation to submissions and determinations as to the imposition (and remission) of penalties and interest. In this regard, MNEs that are "significant global entities" should be aware that they face substantially increased penalties in cases of non-compliance. At a high level, a "significant global entity" is an entity whose annual global income is A$1 billion or more, or is a member of a group that is either consolidated for accounting purposes or a "notional listed company group" and whose annual global income is A$1 billion or more. Separately, directors of MNEs should be cognisant that they can become personally liable for some tax liabilities of a company under the director penalty regime.
3 Understand the appeal process
At a high level, the appeal process may involve some or all of the following steps:
- Amended Assessments: If the SoAP is unfavourable to the taxpayer, and provided the independent review process does not impact the ATO's position, the ATO will make adjustments to the taxpayer's tax return via a notice of amended assessment, specifying additional amounts payable by the taxpayer.
- Objection: Where a taxpayer disagrees with the amended assessment, it can lodge a formal objection with the ATO outlining its grounds of objection. Time is of the essence in lodging an objection, as there are statutory timeframes within which objections must be lodged, which can be as little as 60 days from the date an amended assessment was issued. The grounds of objection and any arguments put forth must be carefully considered to ensure anything the taxpayer may wish to raise in future litigation are included. These are typically settled by independent lawyers.
- Objection decision: The Commissioner will then issue an objection decision either accepting or rejecting the taxpayer's arguments. Where there is an unfavourable objection decision, the taxpayer can appeal that decision as outlined below. In complex taxation matters, often the ATO may not make an objection decision until several months or years after the taxpayer has filed its notice of objection with the ATO. In such circumstances, a taxpayer may be able to compel an objection decision by lodging a notice to that effect with the ATO. This should be done with careful consideration and thought into the broader litigation strategy. Once an objection decision is made, the taxpayer has a limited time (60 days) within which to lodge an appeal.
- Federal Court or Administrative Appeals Tribunal (AAT): Taxpayers can appeal objection decisions either in the AAT or the Federal Court. The decision as to which appeal avenue is pursued can be critical, and will depend on the issues in dispute. In some cases, an appeal may be to the Federal Court on the underlying tax issue and to the AAT on the issue of penalties, which is heard by a Federal Court judge simultaneously sitting as a Presidential member of the AAT.
- Reverse burden of proof: For taxation matters, the burden of proof is on the taxpayer. In other words, it is up to the taxpayer to adduce evidence to demonstrate that the taxpayer's position is correct or the ATO's position is incorrect, rather than on the ATO to demonstrate its position is correct or that the taxpayer's position is incorrect.
- Prepare evidence as early as possible: For a taxpayer to put forth its strongest case (particularly when significant sums of money are involved, as is the case with large tax disputes), it is prudent to invest the necessary resources into early evidence gathering, as the strength of the evidence will often determine the strategy to deploy in resolving disputes. This is particularly relevant in a transfer pricing context where, in some circumstances, the ATO has an unlimited period of review. Given the unpredictable timing of when a taxpayer may receive an objection decision, and the potentially tight timeframes once the appeals process commences, it is prudent for taxpayers to begin preparing evidence well before the ATO determines an objection, as the evidence gathering process can be time consuming and may require liaising with many people external to the taxpayer (such as ex-employees, experts or institutions like banks who hold records which may support a taxpayer's position). It may also involve, for example, investing the necessary resources looking for documentary evidence that may be decades old to support the taxpayer's position.
4 Engage independent legal advisors
It is critical to retain independent lawyers as soon as it becomes clear that the ATO audit will occur. Independence brings a robustness to any view on prospects of success, which is now becoming even more critical as businesses apply AASB Interpretation 23 and its international counterparts. Boards are becoming more sophisticated in understanding their organisation's tax obligations and will often seek out fresh eyes to ensure compliance with their directors' duties.
Specialist legal advisors should have the expert tax technical skills and proven litigation experience to ensure that overall strategy, litigation processes and technical tax concepts are simultaneously considered. Law firms such as King & Wood Mallesons can provide privileged advice as all our tax advisors are qualified lawyers, and in many cases, have worked in the large accounting firms as well. Our specialist tax disputes team is experienced in large scale discovery and privilege claims, often relying on our legal technology team to maximise the use of AI to ensure a cost effective solution.