Part IVA ITAA 1936 — Australia's income tax general anti-avoidance rule

What Part IVA does

Part IVA of the Income Tax Assessment Act 1936 contains Australia’s income tax general anti-avoidance rule (GAAR). This rule allows the Commissioner of Taxation to disregard income tax benefits derived from a scheme. This is possible when the Commissioner considers the dominant purpose of a party involved in the scheme was to obtain a tax benefit.

Part IVA does not apply automatically. It only comes into effect when the ATO makes a determination that the rule is engaged. This determination relates to a specific scheme and its participants.

Following a Commissioner determination, the onus shifts to the taxpayer. They must then demonstrate why Part IVA should not apply in their particular circumstances.

The dominant purpose test and the eight factors

Section 177D of the ITAA 1936 establishes the dominant purpose test for assessing schemes. This test determines whether a scheme was entered into primarily for the purpose of obtaining a tax benefit. The purpose of a scheme is assessed objectively; the ATO does not consider the subjective motives of individuals participating in the scheme.

The determination of dominant purpose relies on eight statutory factors outlined in section 177D. These factors consider aspects of the scheme such as its manner, form and substance, the timing of its implementation, and the result achieved. They also examine any changes in the financial position of the taxpayer and any connected parties.

To apply the test, a reasonable person assessment is undertaken. The question is whether a reasonable person, considering all the facts, would conclude that the scheme was entered into for the dominant purpose of obtaining a tax benefit.

What is a 'scheme' and a 'tax benefit'

A ‘scheme’ for the purposes of Part IVA is defined very broadly. It encompasses any agreement, arrangement, understanding, promise or undertaking, regardless of whether it is legally enforceable. This expansive definition means that a wide range of actions and processes can be considered a scheme.

A ‘tax benefit’ is similarly defined widely. It includes situations where income is not included in assessable income, a deduction is allowed, a capital loss is incurred, or a foreign income tax offset is allowable. The definition of tax benefit was strengthened by amendments in 2013.

Section 177CB requires the Commissioner to consider the scheme’s effect by comparing the actual outcome against a ‘reasonable alternative postulate’ or an ‘annihilation’ counterfactual. This comparison is central to determining if a scheme has produced a tax benefit.

Recent Federal Court guidance

The Guardian AIT decision provides a recent example of the application of Part IVA to arrangements involving trust distributions to a corporate beneficiary, followed by a fully franked dividend. This case highlights the ongoing scrutiny of complex schemes designed to minimise tax.

Recent Federal Court decisions underscore the importance of an objective assessment when considering the eight factors outlined in Part IVA. This means the focus is on the substance of the arrangement and its overall effect, rather than the subjective intentions of the taxpayer.

The Commissioner of Taxation has achieved increasing success in challenging trust-distribution arrangements that utilise ‘washing entities’. Taxpayers should be aware that Part IVA penalties, as detailed in Schedule 1 of the TAA 1953, can be substantial, potentially reaching 50% of the tax shortfall, and increasing to 75% for reckless or intentional behaviour.