29 September 2021
All tax controversy advisers, on the matters they are engaged with, are invariably faced with the question of whether their clients should settle or litigate a looming or actual tax dispute.
For tax controversy practitioners, the answer to this question sometimes can be no easier than that posed to Douglas Adam’s Deep Thought supercomputer seeking the answer to the ultimate question of life, the universe and everything (from the comic science fiction series, The Hitchhiker’s Guide to the Galaxy). And for tax controversy, the answer is not 42.
Every client and every fact pattern is unique and must be interpreted through that lens.
But there are some criteria that should be considered. At the risk of over-simplification, some of the main ones are explained below.
First and foremost, one needs to have a view on the strength of the tax technical position. But so many of the matters that end up in dispute are contentious precisely because the tax technical position is not clear. Examples include capital versus revenue account, residency cases, transfer pricing, anti-avoidance provisions, GST apportionment and classification to name a few. Before proceeding further, it is good practice for taxpayers to get a second opinion from an independent and objective adviser skilled in the area.
The next question to ask is: ‘Can the taxpayer discharge the onus of proof?’. The onus of proof is nearly always on the taxpayer. It is one thing to have what you believe is a solid tax technical position, but if you can’t back it up by reference to verifiable contemporaneous documentation then problems will likely emerge in the preliminary information exchanges – and will certainly emerge once the matter gets to court.
Some disputes by their nature rely heavily on expert evidence, so the credibility and credentials of experts can be key to winning a tax dispute in court. For example, transfer pricing and valuation cases for stamp duty or taxable Australian real property calculations are matters where the expert evidence is often determinative. Care, however, is required. If the experts stray into becoming advocates for the taxpayer’s position rather than first and foremost there to assist the court, then they will likely be discredited by the court.
Some matters are simply not worth fighting as the dollars are not large enough. Despite this, one does see tax matters in court over relatively small amounts. Some lawyers may recall the infamous case of  HCA 83 that went all the way to the High Court over a one penny ferry fare (thankfully, this was not a tax case).
Litigating a tax matter can take many years, particularly where appeals are involved. It is not uncommon for fact patterns being ventilated in court to be more than 10 years old. This can be acute in some matters like transfer pricing where the Commissioner, at least in some cases, has unlimited time periods within which to amend an assessment notice. The evidential challenges of this can be many — documents get lost or destroyed, people move on, etc. Furthermore, time delays can have adverse implications for the calculation of the general interest charge (GIC). The GIC rate is very high relative to current general interest rates and this is exacerbated by a daily compounding accruals calculation being required for the GIC.
Litigation can be expensive. Every potential litigant faces a commercial decision around the cost of proceedings. This can also be a factor in the choice of jurisdiction to contest the matter – the Administrative Appeals Tribunal (AAT) and the Federal Court have different rules around cost recovery for the successful party. Cost does not just refer to the costs of litigation. It also includes reputational costs. Every taxpayer deserves their day in court if they want it but there are some journalists and the like who won’t see it that way. Some matters can be heard in private in the AAT if certain conditions are met, but if the taxpayer loses and has to appeal to the Federal Court, the cloak of anonymity is shed.
What is their appetite to litigate? This can vary a lot. I have encountered taxpayers who are prepared to litigate but should not and vice versa. A tax lawyer needs to objectively consider how will their client potentially stand up in court? Will they be seen as credible? So much can turn on performance in the witness box and in cross examination. It can be hard to plan for these outcomes but an assessment upfront of who your client is and how compelling they might be is crucial.
This is a question that can be as important as all the others combined. I once had two clients with largely identical fact patterns. They were brothers who were high wealth individuals. They were caught up accidentally in the ATO’s focus on the Wickenby dragnet. If you weighed up all the abovementioned factors, the advice would be the same for the two of them. However, one brother was prepared, even keen, to litigate; the other was stressed and losing sleep because of the ATO’s focus on him and wanted to settle. The brothers wanted to act together. The matter settled which was the right result in the circumstances. The emotional state of your client is a factor to be taken account of. However, emotions are best kept out of the courtroom.
Author: Chris Kinsella
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.