If you think you’ve been dudded by the taxman, you can always challenge his ruling in court. But while launching legal action can be expensive, stressful and risky, the benefits may be worth it. SALLY SCOTT and ANDREW O’BRYAN report.
By Sally Scott and Andrew O’Bryan
If you think you’ve been dudded by the taxman, you can always challenge his ruling in court. But while launching legal action can be expensive, stressful and risky, the benefits may be worth it.
It is not uncommon to object to an Australian Taxation Office assessment, determination or ruling. However, there is often great reluctance to issue legal proceedings to appeal against a tax office decision.
A key reason for issuing proceedings is to get an independent review – that is, one from outside the tax office.
Issuing legal proceedings will escalate the matter to another level. This will involve a series of procedures that require court documents, directions hearings, pre-trial steps and ultimately a hearing. Proceedings in such cases are issued in the Administrative Appeals Tribunal (AAT) or the Federal Court. The Federal Court has just announced a new approach for dealing with tax matters more expeditiously. This should appease many who are concerned with the delays of litigation.
Key reasons for the reluctance to issue proceedings include fear of the unknown, concern about cost, and a belief that the tax office must be correct with the objection decision.
On the other hand, some people launch into litigation without giving sufficient consideration to the pros and cons of such an act. They might end up waist deep in litigation, with costs spiralling out of control, poor prospects of success, but stuck by a belief that “well, we’ve spent so much money so far, we just have to continue”.
The decision to litigate should be considered in similar terms to any other business decision. There should be a cost/benefit analysis upfront. Some of the considerations will be the same as those involved in other business decisions. Other considerations will be different. Considerations will carry more or less weight for different taxpayers because of factors such as the amount of tax involved or the flow-on effect to other companies in a group.
There are various considerations that should be given to determining whether to issue legal proceedings in relation to an objection.
Strength of legal arguments and evidence
An obvious first consideration is the strength of legal arguments and the evidence that is available to prove facts. Legal cases are not decided on factors such as fairness, who deserves to win and who is in the right.
Cases are determined by judges (or members in the AAT) on the basis of facts (or more precisely, what evidence is available to prove necessary facts) and law.
The first aspect – fact needs to be proven with evidence, preferably written or documentary evidence, but there can also be oral evidence.
Consideration needs to be given to what evidence is available to prove necessary facts, as opposed to merely what someone believes/says was the factual position. If evidence is not available, a case may not succeed, regardless of the strength of legal arguments. It is best to know this upfront so that an informed decision can be made regarding whether to commence legal proceedings.
It is worth noting that an adviser’s evidence may be critical in a tax case. Documentary evidence is generally far more effective than oral evidence. It is important for advisers to ensure that they make contemporaneous notes on all files, and that the file notes are accurate and contain sufficient information.
File notes need to record all advice and instructions given, and a clear chronology of events. Inaccurate, incomplete or non-existent file notes will not only harm a client’s case, but could also leave an adviser exposed. “It’ll never stack up in court” is an oft-repeated phrase. Would your file notes?
The second aspect – law requires legal submissions often involving very technical legal arguments concerning interpretation of one or two aspects of the tax legislation. QCs can spend a day in court arguing about one sub-section of an act. Reference is often made to many past cases, policy, other parts of the act and the like.
Therefore, when considering the law in the context of whether to issue proceedings, more analysis needs to be involved than simply briefly reading the words of a particular section of the act and considering a likely interpretation.
Giving insufficient consideration to these matters before issuing proceedings can be costly.
Amount of money involved
The next consideration is how much money is involved. Other considerations will carry more or less weight depending on the amount involved.
For example, is the case worth $10,000 or $10 million? If the strength of legal arguments results in prospects of success being less than say 50%, it may be worth proceeding with a case worth $10 million but not with a case worth $10,000.
Cost and test-case funding
Put simply, litigation is expensive. However, the good news with tax matters is that in many cases, the cost of litigation tends to be less than other types of litigation. The main reason for this is that there are usually fewer (or no) factual disputes, which means less evidence and less time in court. The majority of tax cases are largely based on legal arguments about tax law, which often involves a day or so of submissions at a hearing as opposed to say a month’s worth of evidence from witnesses.
Nevertheless, cost remains an important consideration. Although a successful party may recover costs, the most it can generally recover is a proportion of its costs.
Consideration should also be given to whether funding can be obtained. The tax office has a fairly extensive and under-utilised test-case funding program, which can result in negligible or no legal costs being incurred by a taxpayer.
In addition to considering the strength of the legal arguments and evidence, there is an inherent risk with all litigation, which must be taken into account.
For example, if factual evidence is to be given and it is largely unsupported by documentation, the success of a case may depend on how a witness “performs” in the witness box. For example, it is possible that a witness may become nervous and/or confused and lose credibility, which may severely damage a case.
It is also possible that another party could produce unexpected evidence.
There can be no certainty in relation to legal arguments, although it is important to give consideration to the strength of the arguments to form a view on prospects of success.
Litigation involves stress. If a taxpayer is required to give evidence at a hearing (which fortunately is not common in tax cases), it can be a very stressful experience. It can also be stressful for a taxpayer to endure the process of litigation without knowing what the outcome is, enduring countless rounds of procedural steps and applications, waiting for an outcome and the like.
This can have an impact on family life, business and health.
Time away from business
Although tax cases often involve fewer factual disputes than other cases (and therefore less documents, preparation, evidence), a taxpayer will still need to provide instructions during the course of litigation.
Fortunately, accountants often undertake a lot of this work for taxpayers. However, taxpayers can still find that they need to spend a large amount of time going through old records, and meeting with lawyers and accountants.
Taxpayers need to consider whether time and effort are better spent on their business as opposed to litigation. And they need to consider time to reach judgement, and time involved in any appeals. Litigation can be a very slow process.
Fortunately tax cases often involve few procedural steps and shorter hearings, which generally results in a quicker process. However, that might mean, say, one year or so between the time of issuing litigation and judgement, compared with two or more years in other matters. The recently announced new Federal Court procedure for dealing with tax matters is aimed at speeding up the process even more.
On the other hand, tax cases tend to be more prone to appeals, which extends the process.
Ongoing penalty interest
Unless payment is made upfront or an arrangement is entered into with the tax office to stop or avoid ongoing penalty interest, it is important to take into account that penalty interest will continue to be incurred until payment is made.
This could involve an extra few years of penalty interest if an objection decision is litigated. A decision may have a flow-on effect for other companies/entities within a group. The value of a decision may be higher than just the amount of tax involved in a particular case concerning one assessment.
On the one hand, there is a significant cost to litigation, both in terms of expenses and also time and stress. On the other hand, not proceeding with litigation can result in losing an opportunity to be in a better financial position – sometimes a significantly better financial position. Although there is always risk involved in litigation, there is often risk involved in business ventures. The decision to litigate should be considered in a similar way to any other business decision.
For example, a taxpayer may form the view that even with prospects of success of say 30%, the value of the disputed amount may be so high that they cannot afford not to proceed with the opportunity.
In most matters, proceedings should not be commenced unless there has been an attempt to try to resolve the matter with the tax office. Of course, if there is an impending deadline, discussions may need to take place after proceedings have been issued.
To proceed or not?
In many cases taxpayers are advised not to proceed. Many assume lawyers will push everyone into litigation because “that’s their business”.
But a good lawyer will encourage taxpayers to take into account the various relevant considerations, and will also assist and advise taxpayers in relation to their decision regarding whether to issue litigation proceedings. On many occasions, accountants are also very much involved in that process.
Once again, the key is to treat litigation as a business transaction. Do the homework before committing.
Sally Scott and Andrew O’Bryan are partners of law firm Hall & Wilcox. Together with Keith James, they head the firm’s tax litigation practice, which incorporates both the tax and litigation expertise at the firm. They have handled many prominent tax litigation cases.
This article first appeared in CPA Australia’s magazine, In the Black