Recently, Dr. Mathew Leighton-Daly, a lawyer and consultant specialising in corporate and taxation law, joined David Turner on Hearsay The Legal Podcast to examine the fine line between asset protection and tax planning, the complexities of Australia’s General Anti-Avoidance Rules (GAAR), as set out in Part IVA of the Income Tax Assessment Act 1936 (Cth), and the interdisciplinary approach needed to advise clients on asset protection.
Working side-by-side with a client’s tax and/or financial adviser on a new deal or a new venture is remarkably common, and often, everyone’s responsibilities seem nicely partitioned - you’ll do the asset protection advice, and the tax adviser will look after the tax effectiveness and efficiency of the structure.
However, modern financial arrangements often blur the boundaries between asset protection and tax avoidance. When might it be ethically incumbent on a lawyer to give advice on the tax consequences of a structure recommended for asset protection purposes? When might the tax adviser’s ‘law-heavy’ advice venture into unqualified legal practice?
Check out episode 137: Getting Down to Brass Tax: Understanding Asset Protection vs. Tax Avoidance on Hearsay the Legal Podcast now.
Defining Asset Protection and Tax Strategies
Asset Protection
Asset protection involves strategies to minimise risks from creditors, litigation, and unforeseen liabilities. While its scope is broad—encompassing insurance, trusts, and corporate structuring—legal measures remain at its core. For example, structuring a business through a trust with a corporate trustee not only facilitates tax efficiency but also provides a layer of protection against unsecured creditors.
Tax Evasion, Avoidance, and Minimisation
The Hearsay episode highlights the key distinctions in these terms:
Tax evasion constitutes illegal acts to reduce tax obligations, such as underreporting income, and is subject to severe penalties under Australian law. An example of tax evasion would be a taxpayer who operates a cash business and deliberately omits income from tax filing. Obtaining property or financial benefits through deception is a crime, under section 134 of the Commonwealth Criminal Code.
Tax avoidance includes schemes that are not illegal and designed to gain tax benefits counter to legislative intent. Such schemes are targeted by GAAR. A recognised avoidance tactic under GAAR would be when a taxpayer borrows funds for both a family home and a business property but then allocates deductible interest payments exclusively to the business loan.
Tax minimisation involves lawful strategies to reduce tax liabilities, such as utilising deductions or restructuring operations. Many businesses incorporate trusts for this purpose, allowing income distributions to beneficiaries in lower tax brackets to reduce overall tax burdens.
The episode underscores how these distinctions, while theoretically clear, become challenging in practice, particularly under the scrutiny of GAAR provisions.
GAAR and the Dominant Purpose Test
Part IVA of the Income Tax Assessment Act 1936 (Cth) introduces Australia’s General Anti-Avoidance Rules (GAAR), aimed at schemes where the dominant purpose is to exploit tax loopholes and obtain tax benefits. These provisions demand that lawyers carefully balance client objectives without inadvertently triggering anti-avoidance rules. With the GAAR, the ATO is able to cancel such benefits, even if the arrangement is not inherently illegal.
The application of the GAAR hinges on the dominant purpose test, an objective evaluation of a scheme's intent. In determining whether a scheme’s dominant purpose is to obtain a tax benefit, an assessment of factors including the form and substance of transactions, timing, and financial outcomes is required. The focus on objectivity also means that the taxpayer’s motivations or subjective intentions are not directly relevant when determining purpose.
The test requires examining each step of a transaction rather than solely its overarching commerciality. This is foregrounded in Hart, where it was held that the presence of one factor may be enough to constitute a dominant purpose. Additionally, the Newton’s case highlighted how the test distinguishes between lawful tax minimisation and avoidance by focusing on whether the scheme aligns with ordinary commercial or family dealings.
The test should not be seen as a simple ‘but for’ exercise. As established in Minerva and Mylan, the Commissioner must establish:
The existence of a tax benefit compared to a reasonable alternate scenario.
That obtaining the tax benefit was the dominant purpose of the scheme.
This approach ensures that tax benefits resulting from legitimate commercial arrangements are not automatically invalidated, provided they can withstand scrutiny under the alternate postulate and dominant purpose tests. In other words, the presence of a tax benefit alone does not suffice; the purpose of obtaining that benefit must dominate other motivations. This nuanced analysis underscores the tentative balance between ensuring GAAR compliance whilst achieving legitimate financial objectives.
Practical takeaways
In the episode, Mathew imparts some wisdom on how to best address the complexities of asset protection and tax planning:
1. Interdisciplinary Collaboration
● Assemble expert teams early in the process, integrating legal, tax, and financial perspectives to ensure comprehensive advice.
● For instance, lawyers should prepare asset protection advice on the basis that it does not consider tax liabilities, then collaborate with tax advisors to evaluate likely outcomes and append preliminary calculations where necessary.
2. Objective Compliance with GAAR
● Practitioners must focus on the eight factors outlined in GAAR, such as the form and substance of transactions and the timing of execution, to ensure compliance.
● Avoid schemes lacking commercial justification as they may be deemed artificial and trigger anti-avoidance provisions.
● Ensure each step in a transaction aligns with legitimate commercial or family dealings to minimise the risk of scrutiny under the dominant purpose test.
3. Lawful Tax Minimisation Strategies
● Explore lawful strategies such as using companies or trust structures to reduce tax liabilities.
● For example, a sole trader paying high marginal tax rates might benefit from incorporating their business to reduce their taxable income. Similarly, a trust with a corporate trustee can allow income distribution to beneficiaries at lower marginal tax rates.
4. Ethical and Professional Accountability
● Lawyers must address tax implications in asset protection advice to avoid potential negligence claims. Disclaimers alone may not fully shield against liability, especially if incidental advice touches on tax considerations.
● Legal practitioners should prepare draft advice and involve tax specialists to validate or refine the approach, ensuring no critical aspect is overlooked.