Preparing for ATO review in an ever-evolving tax landscape

Focusing on tax through the lens of governance, and not just the tax returns lodged and positions adopted, is not a new concept. Both the Federal Government and the Australian Taxation Office (ATO) have placed an increased emphasis on tax governance and evidence, tax reporting and the regulation of tax practitioners in recent years, and this is only set to continue.

Together with a number of recent tax developments, trends in case law and the ever-increasing regulatory scrutiny of corporate taxpayers, some form of ATO review should be expected. Taxpayers should establish and maintain robust internal tax governance frameworks which appropriately manage risks and ensure positions are documented with supporting objective and contemporaneous evidence.

In Australia, the ATO has been at the forefront of ensuring corporate tax compliance – both in articulating what the regulator expects and reviewing corporate tax governance through the ‘Justified Trust’ program. The ATO summarises its tax governance expectations for both boards and management generally as follows:

Boards

1. Have a formalised tax control framework, which can include tax risk appetite of the group.
   
   
2. Clearly understand roles and responsibility for tax risk management. This includes ongoing briefings by management for directors regarding tax risk management strategies and allocating tax risk to an appropriate and independent board sub-committee, for example an audit committee.
   
   
3. Be appropriately informed.
   
   
4. Regularly assess policies and controls.

Management

1. Ensure sufficient capacity and capability

• Roles and responsibilities clearly understood
  
  
• Senior management confident of capacity and capability
  
  
• Significant transactions identified

2. Ensure IT controls are in place

• Controls in place for data
  
  
• Record-keeping policies are determined

3. Assure the flow of information from accounting records

• Control frameworks are documented, including procedures for reviewing tax returns and supporting workpapers and document retention
  
  
• Procedures to explain significant differences
  
  
• Complete and accurate tax disclosures

4. Deal with law and administrative updates

• Legal and administrative changes are addressed, including assessing whether such changes require updates to the internal control framework as well as reviewing and implementing changes.

These principles are expanded upon in the ATO’s Tax risk management and governance review guide, which was developed for large and complex corporations conducting business in Australia. In addition, the regulator’s income tax management and governance publication, which is intended to assist taxpayers in preparing for a Top 1,000 combined assurance review, builds on this framework and sets out the ATO’s rating system for assessing a taxpayer’s tax governance, including how the taxpayers may evidence the existence of key controls.

Even with good governance, expect an ATO review

All taxpayers in the Top 1,000 public and multinational taxpayer population, and Top 500 and Next 5,000 private group populations, will be regularly reviewed by the ATO. Having good tax governance is critical. Taxpayers must be ATO ‘audit ready’, which means having contemporaneous objective evidence to support all material tax positions, as well as supporting tax legal advice and/or engaging early with the ATO.

Recent developments

The focus of the Federal Government and the ATO on tax governance, tax reporting and the regulation of tax practitioners is also reflected in a number of recent developments:

• Reforms of regulatory arrangements for tax practitioners. This includes the introduction of the Treasury Laws Amendment (Fairness and Accountability) Act 2024 (Cth) (which included promoter penalty law reform, extending tax whistleblower protections, Tax Practitioners Board (TPB) reform and information sharing between government agencies about misconduct) and consultation on the registration requirements for tax practitioners.
  
  
• Increased scrutiny of taxpayer claims for legal professional privilege. This is particularly the case in a non-legal context (but noting the ATO’s expectation for taxpayers to provide detailed information to justify such claims). The ATO’s views and expectations regarding privilege claims and the surrounding governance environment in which they were made takes on even more significance given the willingness of the Tax Commissioner to challenge incomplete claims, as seen in recent high profile Federal Court proceedings.
  
  
• The overall tendency for new tax legislation to contain detailed and specific reporting and self-executing anti-avoidance provisions. For example, the new thin capitalisation rules and their incorporation of a highly specific anti-avoidance rule and the ‘equity funded’ special dividend rules. This approach can make obtaining appropriate comfort for what are clearly commercial transactions challenging at times.

Recent Court decisions

The way Australia’s anti-avoidance provisions are being used by the ATO is particularly relevant for the expectations placed on boards and management regarding the identification of significant transactions and ensuring adequate corporate tax function capability.

Specifically, recent litigation on the general anti-avoidance rule (GAAR), known as Part IVA (which can impose tax where a transaction is undertaken for sufficient tax reasons) illustrates the ATO’s expansive interpretation and reliance on these provisions where tax risk is perceived by the ATO to be high. In turn, from a tax governance perspective, the length of time taken for Part IVA proceedings to be resolved highlights the need for strong corporate governance processes to be in place from the time of the transaction and beyond.

For example, in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28 (Minerva), the ‘true gist’ of the schemes to which Part IVA was asserted by the ATO to apply was the taxpayer’s failure to exercise its discretion as trustee of a unit trust to make distributions to the holder of special units in the trust. In rejecting the ATO’s argument, the Full Federal Court observed that there was nothing extraordinary about distributions flowing in accordance with the trust constitution and that such payments were not an objective matter that pointed to a party carrying out the scheme for the dominant purpose of enabling the taxpayer to obtain a tax benefit. The decision highlighted the requirement to consider the specific commercial consequences achieved by the relevant transaction, and that the relevant factors pertinent to determining the taxpayer’s purpose must not be viewed in isolation.

This reasoning is consistent with another recent Part IVA decision in favour of the taxpayer, Mylan Australia Holding Pty Ltd v Commissioner of Taxation (No 2) [2024] FCA 253 (Mylan). In Mylan, the ATO’s argument was narrowly focused on the tax implications of the ‘scheme’, while the Federal Court emphasised the need to consider the broader commercial rationale surrounding the relevant transaction, observing that the tax benefit cannot be considered apart from other factors, nor is obtaining or desiring a tax benefit sufficient for Part IVA to apply.

Looking ahead

The ATO’s increased emphasis on tax governance and evidence, together with other recent developments and trends, is illustrative of the ever-increasing regulatory scrutiny that corporate taxpayers face, demonstrating the need for taxpayers to establish and maintain robust internal frameworks to address and appropriately manage tax risks.

This includes having detailed records supporting the existence of internal tax controls which are in line with and have regard to ATO guidance, as well as support for any tax positions taken. Recent cases on Part IVA also illustrate the importance of having contemporaneous evidence and documentation in place to support the commercial rationale behind significant transactions, which taxpayers should expect will be subject to ATO scrutiny.