Presented at the TIA National Conference, March 2020
The GST and other indirect taxes (such as Luxury Car Tax) operate as “transaction taxes”, with the tax imposed at each stage of a supply chain. However, the legislative regimes do not intend that the tax will impose an economic burden at each stage throughout a supply chain – resulting in a “cascading” of the tax. Rather, the intention is that the economic burden of the tax should only be imposed once, generally upon the ultimate consumer.
This legislative aim is achieved through purchasers funding the GST liability of suppliers through a gross-up to the price and, to the extent that transactions within a supply chain involve “business to business”, the purchaser will be entitled an input tax credit to reimburse it for the cost of funding the supplier’s GST liability. This entitlement may crystallise through a reduction in the GST liabilities otherwise payable the purchaser on taxable supplies it makes, or a cash refund to the extent that the entitlement exceeds those GST liabilities. At the end of the supply chain, a “business to consumer” transaction, there is no entitlement to an input tax credit and the consumer purchaser bears the economic burden of the GST payable on the value added throughout the supply chain.
The system generally works well, however it is open to exploitation and to fraudulent activity. Where the ATO investigates such activity, parties in a broader supply chain may find themselves caught with funding the cost of the GST payable by a supplier, or thought to be payable, but the ATO disputes the entity’s entitlement to claim a corresponding credit.
This paper will explore the following matters:
- The scope of the ATO’s ability to retain refunds otherwise payable to entities and the operation of the controversial regime in s 8AAZLGA of the Taxation Administration Act 1953 (TAA).
- The potential impact on the availability of credits and refunds where another entity in the supply chain fails to comply with its statutory obligations or is involved in fraud or tax evasion. Should a purchaser be denied credits in such circumstances?
2 The operation of GST and other indirect taxes in a supply chain
2.1 Indirect taxes
In HP Mercantile Pty Ltd v Commissioner of Taxation  FCAFC 126; 143 FCR 543 Hill J at  described indirect taxes in the following terms:
Indirect taxes may be single stage taxes, for example, a tax on retail sales found in many countries in the world, or a bed tax as imposed in New South Wales in respect of hotel accommodation. They may also, if taxing the consumption of goods, operate at multiple stages in the course of goods being manufactured or imported until such time as they go into consumption, such as the wholesale sales tax in operation in Australia until the commencement of the GST.
The GST falls within the second category and is imposed upon each entity that makes a taxable supply within a supply chain. To address the issue of GST being imposed at multiple stages in the supply chain and there being the potential for “GST on GST”, the GST Act seeks to remove the cost of GST from each “business to business” stage of the supply chain, until the tax is ultimately borne by the end consumer. In HP Mercantile, Hill J (at ) described the input tax credit regime in the following terms:
The genius of a system of value added taxation, of which the GST is an example, is that while tax is generally payable at each stage of commercial dealings (“supplies”) with goods, services or other “things”, there is allowed to an entity which acquires those goods, services or other things as a result of a taxable supply made to it, a credit for the tax borne by that entity by reference to the output tax payable as a result of the taxable supply. That credit, known as an input tax credit, will be available, generally speaking, so long as the acquirer and the supply to it (assuming it was a “taxable supply”) satisfied certain conditions, the most important of which, for present purposes, is that the acquirer make the acquisition in the course of carrying on an enterprise and thus, not as a consumer. The system of input tax credits thus ensures that while GST is a multi-stage tax, there will ordinarily be no cascading of tax. It ensures also that the tax will be payable, by each supplier in a chain, only upon the value added by that supplier.
Other Australian indirect taxes that can operate at multiple stages in a supply chain are the luxury car tax (LCT) and the wine equalisation tax (WET). As with the GST, the LCT and WET are intended to only be borne once within a supply chain. This is achieved through a system of “quoting” by entities within the supply chain and the availability of various adjustments and credits. The focus of this paper will be on the operation of the GST, although it should be noted that the issues discussed in this paper will generally also be relevant to the operation of LCT and WET.
2.2 ABN and GST Registration
The trigger for the operation of GST, LCT and WET regimes is the registration of an entity as an “enterprise” under the A New Tax System (Australian Business Number) Act 1999 and the GST Act. Each registered entity will receive an Australian Business Number (ABN) and will be required to file Business Activity Statements (BAS) with the Australian Taxation Office (ATO) for each tax period, being monthly or quarterly periods. Each BAS must disclose the entity’s liabilities, credits and adjustments, and thereby its net liability (known as a “net amount”), for GST, LCT and WET to the extent applicable to the entity. If the net amount is a positive figure, that amount is a liability payable by the entity to the ATO. If the net amount is a negative figure, a refund is payable by the ATO to the entity.
The legislative regime establishes a system of taxation where the duty of assessing the liability to make a payment or an entitlement to receive a refund is placed on the entity, not the ATO. The amount reported in the BAS will reflect the legal position as between the entity and the Commissioner until such time the Commissioner issues an amended assessment.
2.3 The entitlement to input tax credits and the payments of refunds
That an entity may have a negative net amount for a tax period, and will be entitled to be paid a refund of that amount, is an intended outcome of the legislative scheme. An entity may acquire goods and services as taxable supplies – thereby funding the GST liabilities of its suppliers by paying a “grossed up” price – but make GST-free supplies such as fresh food, or export what would otherwise be taxable supplies. The obligation on the ATO to promptly pay refunds to those entities (within 14 days) is an important part of the efficient operation of the legislative regime and the failure to pay the refund may require the Commissioner to pay interest to the taxpayer. In many cases, the receipt of this refund forms a significant part of the working capital of the entity, as it is required to initially fund the cost of their suppliers’ GST liability on the goods and services supplied to the entity and wait to recover that cost by reporting the input tax credit entitlement in their BAS. This is particularly the case for high turnover, low margin, businesses that are required to finance an additional 10% in order to fund the GST liability of suppliers.
However, the statutory entitlement of an entity to be paid a refund where it reports a negative net amount in its BAS can be exploited by the making of fraudulent or unsubstantiated claims for input tax credits.
Under the initial legislative scheme, where the Commissioner had concerns about the entitlement of the entity to a refund amount reported in a BAS, other than by issuing an assessment, he had no ability to defer the payment of the refund while he investigated the issue. The issue was highlighted by the decision of the Full Federal Court in Commissioner of Taxation v Multiflex Pty Ltd  FCAFC 142; 197 FCR 580 where the Court rejected the Commissioner’s contention that it was implicit in the legislative regime that he was allowed a reasonable time to pay the refund, including such time as was reasonably necessary to determine by investigation whether the net amount was truly payable to the taxpayer.
To address this issue, section 8AAZLGA of the Taxation Administration Act 1953 (TAA) was introduced to give the Commissioner the right to retain and verify refunds in certain circumstances. The section seeks to strike a balance between protecting the revenue and recognising the statutory entitlement of taxpayers to be paid a refund. The operation of those provisions has been somewhat controversial, with the Inspector General of Taxation (IGOT) being asked to prepare a report in the administration of those provisions by the Commissioner. The IGOT’s report was provided to the Minister on 16 March 2018 and was released to the public on 16 August 2018. The IGOT found that overall the provisions were working well, but that problems were identified where the Commissioner sought to apply the provisions to address non-compliance and fraudulent activities of taxpayers.
2.4 The issue of “missing trader” or “carousal” fraud
The statutory regime can also be exploited in the context of a broader supply chain. Throughout the supply chain, prices paid between registered businesses will generally be “grossed up” on account of GST with the expectation that the supplier will pay GST and the acquirer will receive an input tax credit. In this respect, the entitlement to the input tax credit could be said to fund the GST liability of the supplier, or at least reimburse the purchaser for that funding cost. Where each party complies with their statutory obligations and the GST is paid, the legislative regime works as intended and the transaction is GST neutral for the supplier, the purchaser and the Revenue. However, problems can occur where a supplier within a supply chain, upon being funded the GST by the acquirer through the increase in price, fails to pay GST or is engaged in fraud or non-compliance with regards to their statutory obligation to pay GST.
Whether it is mobile phones, gold, or other activities, the statutory regime can be taken advantage of. As an example, in 2002 a UK newspaper reported that Customs officially estimated the size of fraud through the international trade of mobile phones at 2.6 billion pounds in the 2001 financial year.
Australia is not immune. On 31 March 2017, the “The Australian” reported that an elaborate GST scam involving gold had so far cost taxpayers more than $700 million in lost tax revenues. The issue was further highlighted by the recent decision of the Administrative Appeals Tribunal in ACN 154 520 199 Pty Ltd (in liq) and Commissioner of Taxation  AATA 5981. In that case, the Tribunal upheld the Commissioner’s decision to deny the applicant’s entitlement to over $100m in input tax credits with respect to the purchase of gold.
3 Refunds and s 8AAZLGA of the TAA
3.1 Multiflex – where it all began
In Commissioner of Taxation v Multiflex Pty Ltd  FCAFC 142; 197 FCR 580 the Full Federal Court upheld a decision of the Federal Court to make an order of mandamus directing the Commissioner to comply with s 35-5 of the GST Act and s 8AAZLF of the TAA by “forthwith paying to the applicant the net amount notified to the respondent in the applicant’s GST return for each of the tax periods January, February, March, April and May 2011”.
At the time, s 35-5(1) of the GST Act provided as follows:
- If the *net amount for a tax period is less than zero, the Commissioner must, on behalf of the Commonwealth, pay that amount (expressed as a positive amount) to you.
And s 8AAZLF(1) of the TAA provided as follows:
- The Commissioner must refund to an entity so much of:
- an RBA surplus of the entity; or
- a credit (including an excess or non-RBA credit) in the entity’s favour;
as the Commissioner does not allocate or apply under Division 3.
The primary judge and the Full Court rejected the Commissioner’s contention that despite the otherwise imperative language of s 35-5, it was implicit that he was allowed a reasonable time to pay the refund, including such time as was reasonably necessary to determine by investigation whether the net amount was truly payable to the taxpayer. The Courts were unable to draw such an implication. The Full Court observed (at ) that “[i]f that be a defect in the scheme of taxation, the defect is one for Parliament to address”.
The Full Court found (at ) that the general scheme of the GST Act was that Parliament consigned to the registered entity concerned the task of working out its “net amount” using the formula in s 17-5 of the GST Act (essentially “GST – input tax credits”). Further, (at [25) the net amount worked out by the entity was to be treated as the entity’s net amount and the obligation on the Commissioner to refund a net amount to the entity did not, in any way, depend on the Commissioner first having made an assessment. The net amount reported by the taxpayer reflected the entity’s obligation to pay GST, or the Commissioner’s obligation to pay a refund – until such time as the net amount was “superseded” by the issue of an assessment by the Commissioner.
The decision of the Full Court was addressed in 2012 by the insertion of s 8AAZLGA into the TAA. The Explanatory Memorandum to the amending Bill described the context of the amendments in the following terms:
A taxpayer’s entitlement to be paid an amount is generally provided for in the relevant taxation law. These credits may be offsetagainst other taxation debts of the taxpayer, or refunded. For example, section 35‑5 of the A New Tax System (Goods and ServicesTax) Act 1999 (GST Act) provides that the Commissioner is required to refund a negative net amount. Section 35‑10 of the GST Actprovides that the taxpayer’s entitlement to be paid that refund arises when he or she lodges their goods and services tax (GST) return with the Commissioner.
Section 8AAZLF of the TAA 1953 requires the Commissioner to refund a running balance account surplus or other credit.
Prior to the Full Federal Court’s decision in Commissioner of Taxation v Multiflex Pty Ltd  FCAFC 142 (Multiflex), the Commissioner’s administrative practice with respect to negative net amounts was to retain certain refunds in exceptional circumstances pending verification checks on the basis that the ability to do so was implied by the TAA 1953 and the GST Act, and within the Commissioner’s general powers of administration.
These amendments are intended to address the outcome in Multiflex, and ensure that the Commissioner has the ability to verify refund claims before paying them to a taxpayer.
These amendments seek to restore the Commissioner’s previous administrative practice of retaining certain refunds for verification prior to payment to protect the integrity of the tax system. At the same time, the provision seeks to strike a balance between this need to preserve the integrity of the tax system and curtailing the opportunities for refund fraud on the one hand; and the principles of self assessment and like systems and a taxpayer’s expectation of a prompt refund on the other.
A question is whether the provisions have succeeded in the goal identified in the last paragraph. Have the provisions struck an appropriate balance between the need to preserve the integrity of the tax system and the expectations of taxpayers to promptly receive a refund? This issue was considered by the IGOT in his report.
In his report, the IGOT concluded that overall, the ATO’s approach to GST refund verification was operating well. The review also examined the ATO’s current approach to using refund retention as part of a broader project to address fraud within the precious metals industry and identified a number of difficulties associated with that approach. The IGOT recommended that the Government consider possible amendments to the legislation to better empower the ATO to address serious risks of fraud.
3.2 The legislation
Section 8AAZLGA of the TAA includes four sub-headings, reflecting the four stages of operation of the provision. Each stage is considered below.
3.2.1 Stage 1 – The Commissioner may retain an amount
Section 8AAZLGA(1) gives the Commissioner the power to retain a refund in the following circumstances:
(1) The Commissioner may retain an amount that he or she otherwise would have to refund to an entity under section 8AAZLF, if the entity has given the Commissioner a notification that affects or may affect the amount that the Commissioner refunds to the entity, and:
(a) it would be reasonable to require verification of information (the notified information) that:
(i) is contained in the notification; and
(ii) relates to the amount that the Commissioner would have to refund; or
(b) the entity has requested the Commissioner to retain the amount for verification of the notified information, and the request has not been withdrawn.
The first requirement is that the entity has given the Commissioner a notification that affects or may affect the amount that the Commissioner refunds to the entity. The Explanatory Memorandum states as follows:
This could be a GST return, or another document which has resulted in a running balance account surplus or credit that the Commissioner must refund under section 8AZLF.
Accordingly, it would appear that the provisions are intended to apply broadly – not just to GST returns that report a negative net amount, but also to other information provided to the Commissioner that results in a running balance account surplus.
The second requirement is that it must be reasonable to require verification of information contained in the notification (eg, the GST return or BAS) that relates to the amount of the refund.
In determining whether it is reasonable to require verification of the information (and to withhold the refund), s 8AAZLGA(2) requires the Commissioner to have regard to a number of matters, as far as the information available to him at the time reasonably allows. Requiring the Commissioner to have regard to each of these factors is to ensure a balance between the risks to the revenue and the taxpayer’s entitlement to be paid the amount. The factors are as follows:
- the likely accuracy of the information;
- the likelihood that the information was affected by fraud or evasion, intentional disregard of a taxation law or recklessness as to the operation of a taxation law;
- the impact of retaining the amount on the entity’s financial position;
- the possible impact on the revenue;
- the complexity that would be involved in verifying the information;
- whether the Commissioner has sufficient information on which to make an assessment relating to the amount;
- whether the information provided by the taxpayer is consistent with information previously provided by the taxpayer; and
- any other relevant matter.
The ATO provides guidance to its officers on the operation of these provisions in PSLA 2012/6 ‘Exercise of Commissioner’s discretion to retain a refund’. The practice statement states as follows:
In some circumstances, and particularly where there is little information available to you, one factor alone might be sufficient to support a decision to retain the amount. However, in all cases you must consider each of the factors, and determine whether there is information available relevant to each one. You should then objectively consider each factor and determine whether it is reasonable in all the circumstances to retain the amount.
3.2.2 Stage 2 – Informing the entity of the retention of the amount
Section 8AAZLGA(3) requires the Commissioner to inform the entity “by serving a document on the entity or by other means” that he has retained the refund. Where paragraph 8AAZLF(1)(a) applies (there is a RBA surplus in the entity’s running balance account), this must be done by the end of the “RBA interest day” within the meaning of s 12AF of the Taxation (Interest on Overpayments and Early Payments) Act 1983 (Overpayments Act) for that RBA surplus. This is the day delayed refund interest would become payable if the refund was not otherwise paid to the entity.
In other cases, this must be done by the 30th day after the notification is given by the entity to the Commissioner.
Section 8AAZLGA(4) entitles the Commissioner to request information as part of informing the entity that the refund is retained.
3.2.3 Stage 3 – How long the amount may be retained
Section 8AAZLGA(5) sets out how long the Commissioner is entitled to retain the refund. The section provides as follows:
(5) The Commissioner may retain the amount under this section only until:
(a) if paragraph (1)(a) applies – it would no longer be reasonable to require verification of the information; or
(b) if the Commissioner fails to inform the entity, in accordance with subsection (3), that he or she has retained the amount under this section – the end of the day after the time by which, under that subsection, the Commissioner is required to inform the entity; or
(c) in any case – there is a change of how much the Commissioner is required to refund, as a result of:
(i) the Commissioner amending an assessment relating to the amount or
(ii) the Commissioner making or amending an assessment, under Division 105 in Schedule 1, relating to the amount;
whichever happens first.
Effectively, this sub-section operates as follows:
- If the Commissioner does not notify the entity that he is retaining the refund within the time specified in s 8AAZLGA(3), the provisions are not engaged and the Commissioner must pay the refund – unless he issues an assessment within the notification period.
- If the Commissioner notifies the entity that he is retaining the refund within the specified time, he is entitled to retain the refund until “it would no longer be reasonable to require verification of the information” or the Commissioner issues an assessment.
The “reasonableness” test imposed on the Commissioner is an ongoing one and it is not open to the Commissioner to simply make a decision to withhold the refund and to maintain that decision until he completes his investigation and concludes that the entity is entitled to the refund (refund is paid) or it is not entitlement to the refund (assessment or amended assessment is issued). In this context, the provisions operate differently to an audit of an assessment, where the Commissioner will come to a final view on the taxation obligations (or entitlements) of a taxpayer at the completion of the investigation. The Commissioner is required to continually re-visit his decision to retain the refund, regardless of whether he has completed his investigations. The provisions envisage that circumstances may dictate that the refund should be paid, notwithstanding that the Commissioner’s investigations ultimately reveal that the entity was not entitled to the refund. In that case, the Commissioner would need to issue an assessment to the entity and recover the refund in the usual way.
3.2.4 Stage 4 – Objecting to the decision to retain the amount
Section 8AAZLGA(6) gives the entity a right to object under Part IVC of the TAA to the Commissioner’s decision to retain the refund. Section 14ZW(1)(aad) of the TAA sets out the time period in which an objection can be lodged:
(aad) if the taxation objection is made under subsection 8AAZLGA(6) of this Act (retaining refunds while Commissioner verifies information) – the period:
- Starting at the end of the 60 day period after the end of the day before which, under subsection 8AAZLGA(3), the Commissioner is required to inform the entity mentioned in section 8AAZLGA that the Commissioner has retained an amount under that section; and
- Ending on the day (if any) on which there is a change, of a kind mentioned in paragraph 8AAZLGA(5)(c), to how much the Commissioner is required to refund in relation to the amount.
The objection period therefore starts 60 days from the last date on which the Commissioner was required to notify the entity that the refund was being retained. Section 8AAZLGA(7) provides that before the end of 7 days after the start of this period, the Commissioner must inform the entity of its objection rights.
However, there is a sting in the tail – s 14ZW(4) of the TAA provides as follows:
(4) The 60 day period mentioned in subparagraph (1)(aad)(i) (including the period as extended by a previous application of this subsection) is extended by the number of days during that period in relation to which the following paragraphs apply:
(a) on or before the day, but during the period, the Commissioner requests information from the entity for the purposes of verifying the notified information mentioned in section 8AAZLGA;
(b) the Commissioner does not receive the requested information before the day.
Accordingly, the 60 day period to object to the refund decision stops each time the Commissioner requests information and does not start again until that information is provided. This can happen repeatedly – there is no limit on the number of information requests that can be made. This can be contrasted with s 14ZYA(1)(b) of the TAA which extends the 60 day period in which an objection will be deemed to be disallowed where an information request is given – however it appears that only one such extension is allowed.
3.2.5 What if the Commissioner issues an assessment?
If an entity’s objection rights have been engaged, those objection rights are extinguished if the Commissioner issues an assessment. This also appears to be the case if the objection had been disallowed and even if the entity has brought proceedings before the Tribunal or the Federal Court with respect to the disallowance of the objection.
This issue arose in Sanctuary Australasia Pty Ltd and Commissioner of Taxation  AATA 371. In that case, the entity objected to the Commissioner’s decision to retain the refund and the objection was disallowed. The entity lodged an application for review with the Tribunal. However, between the date of the objection decision and the application, the Commissioner issued an amended assessment for the tax period in question whereby the negative net amount reported in the original GST return was reduced to nil. The entity wished to proceed with the review proceedings but the Tribunal agreed with the Commissioner that the proceedings could not be brought because the amended assessment had issued. The Tribunal’s reasons can be found at  which are as follows:
36. In this scheme, the decision to retain an amount while information is verified is merely a holding decision, as it were. It is not a decision relating to an entity’s substantive liabilities or entitlements. The decision enables the Commissioner to hold the money but only for so long as s 8AAZLGA(5) permits. An entity may object to the Commissioner’s retention decision but only for so long as there is no change of the sort mentioned in s 8AAZLGA(5)(c) i.e. there has been no assessment or amended assessment relating to how much the Commissioner must refund in relation to the amount. That is the effect of s 14W(1)(aad) of the TAA. It is clear that the right to object to the decision to retain an amount must come to an end at that time because the amount, if any, that the Commissioner must refund to the entity is not then determined under s 8AAZLGA(5)(a) or (b) but by the assessment or amended assessment. That is the decision to which the entity must object and which determines its liability to pay or entitlement to receive a refund.
The avenue left to the applicant was to object to the amended assessment of net amount issued by the Commissioner.
In reality, it may be expected that a decision of the Commissioner to retain a refund may never get to be judicially determined. This is because the Commissioner will likely have completed his “verification” of the refund (and either paid the refund or issued an assessment) before the Tribunal or the Federal Court has the opportunity to hear and determine a review of the decision to the refund.
3.3 The operation of the legislation in practice
It is fair to say that the provisions have given rise to controversy and the Inspector General of Taxation (IGOT) was asked to prepare a report on the operation of s 8AAZLGA of the TAA. The background to the Terms of Reference to the report includes the following statement by way of background:
Stakeholders have indicated to the Inspector-General of Taxation (IGT) that, generally, the administration of the GST refund process works well. However, concerns have been raised with the GST refund verification process through the IGT’s complaints handling service and in submissions to his current work program. These concerns include:
- a lack of clarity on the scope and nature of verification activities, including information requests;
- inadequate engagement with taxpayers and their representatives;
- inaccurate risk identification processes and inappropriate administration of the retention provisions including unexpected offsetting of GST refunds against future liabilities; and
- the adverse financial and emotional impact on taxpayers, particularly where the ATO does not fully appreciate their commercial arrangements as well as cash flow, working capital and profit margin implications.
This IGT review will consider the GST refund verification process, in particular the above concerns, in order to identify improvement opportunities which minimise adverse impact on taxpayers whilst ensuring that the ATO has sufficient time to adequately address risks to government revenue.
The report was provided to the Minister on 16 March 2018 and was released to the public shortly before this paper was completed.
3.3.1 The IGOT Report – an overview
After engaging with a number stakeholders including taxpayers, tax practitioners and their representative bodies as well as senior staff in other government departments, the IGOT observed that the concerns raised could be broken down into three broad themes:
- the accuracy of the ATO’s risk assessment tools to detect incorrect or potentially fraudulent GST refunds;
- the adequacy of the ATO’s engagement with taxpayers and their representatives during the GST refund verification process; and
- the adverse impacts that delayed GST refunds may have on taxpayers.
The IGOT also noted that he had been approached by a number of businesses operating within the precious metals industry (as well as their representatives). Their concerns mainly related to the intensity of the ATO’s actions in the industry, the significant delays in issuing refunds and the corresponding financial and personal impacts on affected taxpayers.
The IGOT recognised that the prompt processing and issuing of GST refunds was critical in alleviating cash flow pressures, particularly for small businesses or those business operating in industries with low margins. However, the IGOT also noted that the ATO was tasked with the responsibility of upholding the integrity of the GST system which it may carry out by verification processes prior to paying GST Refunds.
The Report observed that the ATO’s risk assessment system uses BASs as input data and automatically selects a number of cases where retention of refund and further checking should be considered. The selection was then further refined by manual intervention. Specifically:
- The risk assessment consists of two parallel processes, namely the Risk Rating Engine (RRE) and the Suspect Refund (SR) models:
- The RRE model was implemented following the introduction of GST in 2000 and comprises a set of system-based rules which process BAS lodgements in real time. The inputs include: data such as registration details; lodgement history for BASs and income tax returns; compliance history; geographical profile; AUSTRAC, Auskey and bank details; activity statement benchmarks and ratios; and linked entities.
- The SR model was created to address high risk refund cases, in response to the higher volume, low value refunds that circumvented the RRE identification. This model was primarily focused on risks of fraudulent behaviour including identity fraud, links to fraud risk groups or anomalous reporting patterns.
- In cases that are classified as high risk by either process, refunds were retained for pre-issue verification. The cases are allocated to ATO case officers and actioned as reviews in most instances but may also be escalated to audit.
- In cases where the highest risk category attributed by either process is medium risk, the refund is issued immediately but the case is flagged for potential post-issue audit action.
- In cases that are classified as low risk by both processes, the refund is issued immediately without further checking.
The IGOT concluded that overall, the administration of GST refunds was operating efficiently, with the vast majority of refunds processed and released promptly. Less than 1 per cent of activity statements claiming refunds were stopped for verification, representing less than 6 per cent of total GST refunds claimed.
3.3.2 Refund verification in the precious metals industry – is s 8AAZLGA effective as a fraud prevention measure?
The Report contains an entire chapter dealing with the operation of the GST refund verification process in the precious metals industry. The IGOT included this chapter to illustrate how the ATO addresses heightened risks and suspicions of GST refund fraud.
The IGOT acknowledged, as did all stakeholders, that there was non-compliant behaviour and serious risk of tax fraud in the precious metals industry and that these risks have to be addressed without impacting compliant taxpayers. The IGOT also considered that in the audits and objections examined in relation to retention of refunds in the precious metal industry, the ATO had adhered to its obligations under s 8AALGA of the TAA. It appeared to the IGOT that the fundamental problem was a mismatch between the expectations of both parties regarding the administration of these provisions. The report stated as follows:
- On the one hand, the ATO has to conduct reviews and audits to fully explore, and where necessary prosecute, the issues under investigation, including undertaking enquiries of other parties in the supply chain which invariably requires significant time.
- On the other hand, taxpayers are expecting prompt processing of refunds based on their understanding of section 8AAZLGA of TAA 1953
From my own experience in advising a number of gold refiner clients, I agree with this observation. The major difficulties have centred on the delay (or repeated delays) in the ability of the taxpayer to engage its statutory rights, in circumstances where they believe that the Commissioner is holding onto a refund that they consider is rightfully theirs. Further, being in a high volume – low margin business, they were financially reliant on the GST refund as a substantial part of their working capital. This resulted in a significant level of frustration for those taxpayers.
The IGOT also observed that the underlying cause for the lack of understanding appeared to be the meaning of the word ‘verification’ in s 8AAZLGA of the TAA. The IGT noted that the Tax Institute and the Law Council of Australia, in their joint submission to Treasury on the initial drafting of this section, warned that the use of the word ‘verification’ could be read as setting a high forensic threshold. They submitted that a lower threshold should be set.
I agree. From my involvement with gold refining clients, the Commissioner does appear to be applying a high forensic threshold to the “verification” of refunds where he suspects fraud or non-compliance. By this I mean adopting an “audit” approach whereby – once a decision has been made to retain a refund, that refund will be retained until such time that a firm decision is made, one way or another, on the entitlement to the refund. The difficulty with applying such an approach is that it may fail to properly take into account the Commissioner’s ongoing obligation to re-visit the reasonableness of his decision to retain the refund. For example, as time goes on, it may be expected that the financial impact on the taxpayer of not paying the refund will grow as they are left without funds. Also, as the Commissioner receives further information, either from the taxpayer or third parties, he may not be able to finally determine the taxpayer’s entitlement to the refund (ie, to complete the audit), but he may have sufficient information before him to determine that it is no longer reasonable to retain the refund and that he should pay the refund. If, upon completion of the audit, he forms the view that the taxpayer is not entitled to the refund, an amended assessment can be issued and the money recovered in the ordinary way.
Noting that the meaning of “verification” is ultimately a matter for the Tribunal and Courts to determine, the IGOT considered that it was clear that there would be benefits in amending s 8AAZLGA “to allow the Commissioner to effectively investigate and address serious risk of fraud such as those currently in the precious metal industry”, but that these exceptions should only be triggered where serious risks of fraud are clearly established. The IGOT outlined a number of options:
- Requiring the ATO to seek a Federal Court order before it could classify a case as posing a serious risk of non-compliance.
- An approach akin to the ATO’s General Anti-Avoidance Rules (GAAR) Panel in which the ATO seeks advice from a panel comprising senior ATO staff as well as members from the private sector.
The ATO’s response to this recommendation to consider amending s 8AAZLGA was a matter for the Government. In its response, the Government stated that it would consider options that would balance the integrity of the GST system and the prompt issuing of GST refunds and that careful consideration will be given to any impact on the ability of the ATO to conduct covert taxpayer reviewed in cases of deliberate or egregious taxpayer fraud.
4 Fraud or tax evasion by another entity in the supply chain
Under the GST regime, if a registered entity makes a “creditable acquisition” within the meaning of s 11-5, that entity is entitled to an input tax credit that equals the GST payable by the supplier: s 11-25. The credit can generally only be claimed where the entity has received a tax invoice from the supplier. The tax invoice informs the entity of a number of matters, including the supplier’s ABN, the nature of the supply, the amount of the GST payable and the price. The tax invoice is intended to be a statement by the supplier that can be relied on by the acquirer to confirm that it is acquiring a taxable supply from the supplier and that the supplier is liable to pay GST of a particular amount to the ATO. As noted in GSTR 2013/1 ‘GST: tax invoices’ at paragraph 5:
The requirement to issue a tax invoice is a key component of the integrity of the GST system. It forms an essential part of the audit trail and is an important indicator that a taxable supply has been made.
Another important indicator that a taxable supply has been made is that the supplier is registered for GST and has an ABN. In addition to the inclusion of the supplier’s ABN on the tax invoice, an acquiring entity is able to conduct an independent verification of that ABN and GST registration by conducting a search on the “ABN Lookup” website.
Other than ensuring receipt of a valid tax invoice, and potentially verifying the information by carrying out a search of the supplier’s ABN, an entity is not required to do anything else in order to claim an input tax credit. Its statutory entitlement to the credit operates pursuant to the operation of the GST Act.
But what if the supplier fails to pay the GST?
4.1 The failure of the supplier to pay GST – general observations
Under the basic rules in Chapter 2 of the GST Act, the failure of the supplier to pay its GST liability has no impact on the entitlement of the acquiring entity to claim an input tax credit. The amount of the input tax credit equals the GST “payable” by the supplier – whether or not the GST is actually paid is irrelevant. It is also irrelevant whether the purchaser knew, or should have known, that the supplier has not paid, or was not intending to pay the GST.
This is an intended outcome of the legislative regime, as the statutory rights and obligations of the supplier and the acquirer under the GST Act operate independently of each other. The respective BASs lodged by the supplier and the acquirer are deemed to be an assessment of that entity’s net amount. They are separate and independent assessments. If the supplier fails to report its GST liabilities to the ATO or fails to pay the net amount reported in its BAS, that is a matter between the ATO and the supplier. Any unpaid amounts will be a debt due by the supplier to the ATO.
An acquiring entity is under no obligation to enquire as to whether the supplier has paid, or will pay, the GST.
An example of an arrangement where a supplier fails to comply with its GST obligations is the practice of “phoenixing” by property developers. Under this practice, a registered entity undertakes a property development and recovers input tax credits with respect to the development costs. During the construction phase, no taxable supplies are made and for each BAS the developer is entitled to a cash refund of the input tax credits. Once the development is completed, the developer makes taxable supplies of the developed lots and receives the GST component of the price from purchasers. However, the developer dissolves its business before lodging its BAS to avoid remitting the GST. The developer thereby pockets the cash refunds from the input tax credits plus the unpaid GST.
In February 2018, legislation was introduced to address this practice by requiring purchasers of new residential premises to withhold the GST and to pay the GST directly to the ATO at or before settlement.The Explanatory Memorandum to the Bill stated that phoenixing to avoid paying GST had grown significantly over the last decade and as of November 2017 the ATO had identified 3,731 individuals that had actively engaged in that activity over the last 5 years. These individuals controlled over 1,200 insolvent entities responsible for $1.8 billion in debt that had been written off and had claimed $1.2 billion in input tax credits.
Where the supplier is involved in “phoenix” activity, or the supplier simply fails to pay its GST liabilities, the purchaser will usually be an innocent participant in the transaction. In such circumstances, the purchaser should not be denied its right to claim input tax credits or a refund (if available under the Act).
But what if the purchaser has actual knowledge, or should have known, that its supplier was not going to pay the GST – or that its acquisition was part of a broader supply chain when where one of the participants was engaged in fraud or tax evasion? Should the purchaser’s entitlement to input tax credits be questioned in those circumstances?
The issue is illustrated by a consideration of “missing trader” schemes which are common in VAT regimes around the world.
4.2 “Missing trader” schemes
A “missing trader” scheme is where one of the parties to a supply chain engages in fraud or tax evasion, fails to pay its GST liabilities and goes into liquidation or disappears. That party will effectively “pocket” the GST component of the price paid to it by a purchasing entity. If the purchasing entity claims an input tax credit and the ATO is ultimately unable to recover the GST from the supplier entity, there will be a loss to the revenue. The ATO will have paid the input tax credit to the acquirer but cannot recover the GST liability from the supplier.
In POWA (Jersey) Ltd v HMRC  UKUT 50 Roth J described the concept (referred to as “MTIC fraud”) in the following terms:
5…goods (almost always small but valuable items such as mobile phones and computer chips) are acquired by a registered trader in the United Kingdom from a trader in another member State, and sold to a second UK-registered trader. The goods then usually change hands several times within the UK before they are sold to an overseas trader which, if it is located in a member State of the European Union, is registered for VAT in that member State. Commonly the transactions all occur within a few days of the entry of the goods into the UK, sometimes even on the same day, so that goods enter the UK in the morning, pass through the hands of several UK traders during the day, and are exported again in the afternoon.
6. The first UK vendor, the acquirer from overseas, charges VAT on the consideration paid by his purchaser, but fails to account to the respondent Commissioners for that tax, and disappears. Such documentation as he may have had – if any – relating to his acquisition is never produced to the Commissioners. For the scheme to work he must be a VAT-registered trader who provides the purchaser with a genuine VAT invoice, on the strength of which the purchaser claims an input tax credit. The purchaser’s own sale, and those of the other UK traders save the last in the sequence, usually generate a small profit and, consequently, a small net VAT liability, for which the traders account. The last trader, selling overseas, claims credit for the input tax he has incurred, but has no output tax liability since the sale is zero-rated. Usually this trader makes a significant profit, though that is not invariably the case: occasionally one of the antecedent traders can be shown to have made the greatest profit of all those in the chain. All of these sales and purchases, including the sale to the overseas buyer, are almost always properly documented.
One can readily see how a similar scheme could operate with respect to GST in Australia. For example, a registered entity sells goods to another registered entity for a “grossed up” price that includes GST, fails to account to the ATO for the GST and disappears. The purchasing entity then sells the goods to one or more entities as taxable supplies until the final entity exports the goods as a GST-free supply. The final entity has no GST liability because the supply is GST-free but is entitled to an input tax credit and will therefore be in a refund position. The Revenue is out of pocket because it has paid an input tax credit but has not received the GST.
“Missing trader” schemes can also be implemented where a particular good can have different tax treatments. A ready example is precious metal, such as gold, the supply of which can be taxable, GST-free or input taxed, depending upon the form of the gold and the nature of the transaction. In each of Australia, New Zealand, Canada and the United Kingdom, the treatment of gold can be as follows:
- Input taxed if the gold is of a fineness of at least 99.5% and, other than New Zealand, if the gold is also in a tradeable form (such as a bullion bar with a hallmark) – here referred to as “precious metal”.
- GST-free if it is the first supply of “precious metal” after its refining.
- Taxable if it is not “precious metal”.
In the course of the IGOT investigation into refunds, the ATO provided the following illustration of a hypothetical “missing trader” arrangement involving gold.
Figure 8: Hypothetical ‘missing trader’ illustration
The ATO described the stages of the arrangement as follows:
- Stage 1 – the Missing Trader purchases gold bullion from a Bullion Dealer for $1,030. It is treated as an input taxed supply of precious metal or is GST-free if it is the first supply following its refinement.
- Stage 2 – the Missing Trader melts, scratches or cuts the bullion to make it taxable as scrap gold and sells it to a Gold Seller for $1,078. GST attached to the transaction is $98. The mischief arises where the Missing Trader does not lodge its BAS or remit the GST and, therefore, makes a profit of $48. If the Missing Trader had lodged its BAS and remitted the GST, they would have made a loss of $50.
- Stage 3 – the Gold Seller sells the scrap gold to a Gold Refiner for $1,100. The sale has $100 GST attached to it which the Gold Seller remits. The Gold seller is also entitled to a credit of $98 (for the GST paid in Stage 2) and remits a net amount of $2, making a profit of $20.
- Stage 4 – the Gold Refiner refines the scrap gold and sells it as bullion for $1,020 to the Bullion Dealer. This transaction is treated as the first supply of bullion after refinement which is GST-free. The Gold Refiner is not required to remit any GST but is entitled to claim an input tax credit of $100 (for the GST paid in Stage 3). The credit offsets the loss of $80 that would otherwise have been made and the Gold Refiner makes a profit of $20.
- The cycle commences again with the Bullion Dealer and Missing Trader transactions at Stage 1.
The total loss of GST revenue from each set of the above hypothetical transactions was $98. The ATO characterised the loss as representing the $100 refund received by the Gold Refiner (stage 4) and the net GST of $2 remitted by the Gold Seller (stage 3). However, the loss could equally be characterised as simply the failure of the Missing Trader to pay GST (stage 2).
To address the operation of these schemes, in 2017 the GST Act was amended to introduce a reverse charge on the taxable supply of precious metals. The effect of the amendment is to impose the GST liability on the recipient of a taxable supply of precious metals. The Explanatory Memorandum explained the rationale for the amendment as follows:
1.1 This Bill introduces a mandatory reverse charge for taxable supplies between suppliers and purchasers of gold, silver and platinum. This removes the opportunity for fraudulent input tax credit claims by the purchaser and for the supplier to avoid paying goods and services tax (GST) to the Commissioner by liquidating…
1.5 The objecting of the announced changes is to combat ‘missing trader’ schemes in the gold industry, which if left unaddressed would continue to present an integrity risk to the GST system…
1.6 The schemes identified have involved entities altering gold such that it no longer meets the definition of a ‘precious metal’ under the GST Act…
1.8 The ‘form’ of gold and other metals can be readily changed without any sophisticated process. This may include defacing, scratching off hallmarks, melting, granulating, cutting or chopping the metal, such that it is no longer in ‘investment form’.
1.9 A supply of the altered metal would be treated as a taxable supply under the GST Act, whereas supplies of precious metals are input taxed under section 40-100 or GST-free under section 38-385 and are therefore not taxable supplies (refer section 9-5)
Missing trader schemes
1.10 Generally, when a taxable supply of goods is made, the purchaser (i.e. recipient of the goods) pays GST to the supplier of the goods and then later claims an input tax credit when lodging their business activity statement (BAS) with the Commissioner. The supplier typically receives the GST component as part of the sale price at the time of sale and is required to remit GST to the Commissioner later, when they lodge their BAS.
1.11 The missing trader schemes identified have involved taxable supplies of altered metal, where the supplier liquidates or otherwise goes missing without remitting the GST to the Commissioner. The purchaser of the altered metal then claims an input tax credit on the supply.
The amendments apply from 1 April 2017, which was the date of the announcement of the amendments.
4.3 The knowledge of the purchaser
4.3.1 The United Kingdom
In the United Kingdom, the Courts developed an approach whereby the entitlement of an acquiring entity in a supply to claim a credit (referred to as a deduction) with respect to the VAT paid to a supplier will be lost where it is established that the entity “knew or should have known” that, by his purchase, he was taking part in a transaction connected with the fraudulent evasion of VAT. Under this approach, the entitlement to a credit may be denied even if the claimant did not profit from the transaction.
The legal basis for the approach was established in Kittel v Belgium, Belgium Recolta Recycling  ECR 1-6161. The Court observed as follows:
55. Where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retroactively…It is a matter for the national court to refuse to allow the right to deduct where it is established, on the basis of objective evidence, that the right is being relied on for fraudulent ends…
56. In the same way, a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods.
57. That is because in such a situation the taxable person aids the perpetrators of the fraud and becomes their accomplice.
58. In addition, such an interpretation, by making it more difficult to carry out fraudulent transactions, is apt to prevent them…
61….where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct.
The test was further clarified by Moses LJ in Mobilx Ltd v Revenue and Customs  EWCA Civ 157. His Lordship observed (at ) that the scope of VAT, the transactions to which it applies, and the persons liable to the tax are defined according to objective criteria of uniform application and that:
…the objective of the common system of VAT of ensuring legal certainty and facilitating the measures necessary for the application of VAT by having regard, save in exceptional circumstances, to the objective character of the transactions concerned.
His Lordship then observed (at ):
…the Court made it clear that the reason why fraud vitiates a transaction is not because it makes the transaction unlawful but rather because where a person commits fraud he will not be able to establish that the objective criteria which determine the scope of VAT and the right to deduct have been met.
On the question of knowledge, his Lordship provided the following guidance:
52. If a taxpayer has the means at his disposal of knowing that by his purchase he is participating in a transaction connected with fraudulent evasion of VAT he loses his right to deduct, not as a penalty for negligence, but because the objective criteria for the scope of that right are not met. It profits nothing to contend that, in domestic law, complicity in fraud denotes a more culpable state of mind than carelessness, in the light of the principle in Kittel. A trader who fails to deploy means of knowledge available to him does not satisfy the objective criteria which must be met before his right to deduct arises.
The approach in the UK operates as an exception to the basic VAT rules and it gives the Revenue an effective tool with which to combat VAT and fraud and “missing trader” schemes. The approach also imposes an obligation on entities involved in supply chains to undertake a level of due diligence and risk assessment. The Revenue’s view on the scope of this obligation is outlined in its internal manual on “VAT Fraud”. The manual includes the following matters:
- Taxable persons should not undertake due diligence and risk assessments just to satisfy the Revenue but to help ensure that the business is managed effectively and to ensure the integrity of their supply chains.
- The due diligence and risk assessments should be reasonable and proportionate and demonstrate that the taxable person is managing any risks to his business.
- Before entering to a transaction or a particular market, a taxable person should consider the risks associated with that transaction and/or market. This can mean anything from undertaking research on the product/market, researching the supplier(s) and customer(s), entering into written contracts etc. The taxable person also needs to take into consideration the way in which the transaction has occurred or is about to occur.
- The mere failure of a taxable person to carry out due diligence/risk assessment will not by itself be sufficient to establish that a taxable person “should have known” it was involved in VAT fraud. However:
- Where the Revenue can establish that checks on the taxable person’s suppliers, customers, freight forwarders etc, would have given cause for concern, this will be highly relevant in deciding whether the taxable person “should have known”.
- If other indicators suggest that the transactions were contrived, deficiencies in the due diligence/risk assessment may help support a case where the Revenue allege that the taxable person knew that it was involved in VAT fraud or that its transactions were connected with fraudulent evasion of VAT, since it may be inferred that the taxable person failed to carry out meaningful due diligence/risk assessment because it knew it was unnecessary, since the transaction(s) had been pre-arranged.
To date, the United Kingdom approach has not been considered in Australia. My research has not identified any decision of a Tribunal or a Court where the decisions in Kittel or Mobilx have been considered. If such an approach was adopted, it would likely operate as an exception to s 11-5 of the GST Act, with the effect that an entity would not have made a creditable acquisition (and would thereby not be entitled to input tax credits) if the entity knew, or should have known, that, by his purchase, he was taking part in a transaction connected with the fraudulent evasion of GST.
The first real opportunity for a Court or Tribunal in Australia to consider the issue of GST fraud and “missing trader” schemes was the recent Tribunal decision in ACN 154 520 199 Pty Ltd (in liq) and Commissioner of Taxation  AATA 5981. The Tribunal affirmed the decision of the Commissioner to deny the applicant’s entitlement to input tax credits with respect to the acquisition of scrap gold where other entities in the supply chain had fraudulently failed to pay GST.
The Tribunal concluded that (at ) the applicant was “on notice (and in some cases had actual knowledge) of the fraudulent activities of the [missing traders]” and (at ) that the applicant was “at best, wilfully blind to the creation of a contrived market in gold transactions which entitled it to claim input tax credits upon its acquisitions of scrap gold from [the missing traders]”. While these factual findings would likely satisfy the requirements for the UK approach, the Tribunal did not consider whether it was appropriate to introduce a similar approach in Australia and the Commissioner did not appear to make any submission to this effect. Instead, the Tribunal agreed with the Commissioner that the applicant’s entitlement to input tax credits should be denied by reason of the application of the anti-avoidance provisions in Division 165 of the GST Act. This was on the basis that: there was a “scheme”; the applicant’s entitlement to input tax credits was a “GST benefit” that the applicant got from the scheme; and that the sole or dominant purpose of the applicant (and other participants in the scheme) in entering into or carrying out the scheme was to create the applicant’s entitlement to input tax credits.
The decision of the Tribunal establishes Division 165 as a path whereby the ATO may look to address impact of “missing trader” GST schemes and the loss of revenue that follows. The effect of the Tribunal decision is that where an entity in a supply chain makes a creditable acquisition in circumstances where that price is “grossed up” for GST and the entity claims an input tax credit to recover the cost of funding that GST, the entity may be exposed to the operation of Division 165 if another entity within the supply chain fails to pay its GST liability to the ATO.
Noting that the decision has been appealed to the Federal Court, this paper will undertake a detailed review of this important decision.
4.4 The anti-avoidance provisions in Division 165 of the GST Act and “missing trader” fraud
4.4.1 An outline of Division 165
In Commissioner of Taxation v Unit Trend Services Pty Ltd  HCA 16; 250 CLR 523 the High Court observed that Division 165 contains anti-avoidance provisions that operate to nullify schemes which have the purpose or effect of reducing GST, increasing refunds, or altering the timing of payment of GST or refunds – with such effects being described as “GST benefits”. The Court observed that, in broad summary, Division 165 applies where:
- There is a scheme, from which an entity gets a GST benefit;
- The entity or some other entity entered into or carried out the scheme for the sole or dominant purpose of getting the GST benefit;
- Alternatively, the principal effect of the scheme was that the entity or some other entity gets the GST benefit; and
- The GST benefit is not attributable to the making by the entity of a choice expressly provided for by the Act.
Where those requirements are satisfied, the Commissioner is empowered to make a declaration negating the GST benefit.
“Scheme” is defined broadly to mean:
- any arrangement, agreement, understanding, promise or undertaking;
(i) whether it is express or implied; and
(ii) whether or not it is, or is intended to be, enforceable by legal proceedings; or
- any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.
An entity will get a “GST benefit” from a scheme if, inter alia:
- an amount that is payable by the entity under this Act, apart from this Division is, or could reasonably be expected to be, smaller than it would be apart from the scheme or a part of the scheme; or
- an amount that is payable to the entity under this Act, apart from this Division is, or could reasonably be expected to be, larger than it would be apart from the scheme or a part of the scheme…
In Unit Trend, the High Court (at ) observed that in the context of a liability to pay GST the GST benefit the entity gets from a scheme is the difference, as to quantification, between: (a) an amount that would be payable by the entity under the GST Act absent Division 165 with the scheme in existence; and (b) such amount as would have been payable by the entity under the GST Act without the scheme in existence. Applying this reasoning to the receipt of an input tax credit, the GST benefit is the difference, as to quantification between: (a) an amount that would be payable to the entity under the GST Act absent Division 165 with the scheme in existence; and (b) such amount as would have been payable to the entity under the GST Act without the scheme in existence.
In determining whether an entity (whether alone or with others) entered into or carried out the scheme with the sole or dominant purpose of that entity or another entity getting a GST benefit from the scheme, or the principal effect of the scheme was that the avoider gets the GST benefit from the scheme, the matters set out in s 165-15(1) must be taken into account. These matters include:
- the manner in which the scheme was entered into or carried out;
- the form and substance of the scheme;
- the timing of the scheme;
- any change in the avoider’s financial position that has resulted, or may reasonably be expected to result, from the scheme; and
- the circumstances surrounding the scheme.
4.4.2 Division 165 of the GST Act and “missing trader” schemes
The result of “missing trader” schemes is that the Commonwealth is out of pocket to the extent that it has not received any GST from the missing trader but has paid out input tax credits to another entity in the supply chain that made a creditable acquisition (the “claimant”). This creditable acquisition may or may not have been made directly from the missing trader as there may have been one or more intermediate taxable supplies.
If it is accepted that the arrangement is a “scheme” for the purposes of Division 165, and the relevant scheme includes the taxable supply by the missing trader and the creditable acquisition by the claimant, the GST benefit to the claimant could be said to be the difference between: (a) the input tax credits payable with respect to the creditable acquisition absent Division 165 with the scheme in existence; and (b) such amount as would have been payable to the entity under the GST Act without the scheme in existence. Without the scheme, there would be no taxable supply by the missing trader and no creditable acquisition by the claimant and no input tax credit entitlement.
The same result could be said to occur for any creditable acquisition made by an entity, whether as part of a supply chain or as a single transaction. Any transaction where an entity makes a creditable acquisition could be regarded as a “scheme” and the acquirer’s entitlement to an input tax credit could be said to be a “GST benefit” within the literal meaning in s 165-10(1)(b).
It appears therefore that the critical question to be answered in each case is whether the acquirer (whether alone or with others) entered into or carried out the relevant “scheme” with the sole or dominant purpose of getting the GST benefit or that was its principal effect. Where, as will usually be the case, the price paid for the creditable acquisition has been grossed up for GST, the entitlement to input tax credits does not give the acquirer any net financial benefit – rather it simply reimburses the acquirer for the cost of paying the GST component to the supplier. In this regard, where an isolated transaction is involved, it is difficult to see how the receipt of that input tax credit can be regarded as the sole or dominant purpose or the principal effect of that transaction. The dominant purpose and principal effect would appear to be the acquisition of the good or service in question, with the GST an incidental or secondary matter.
The question is whether a different result may flow where the transaction is part of a broader supply chain and an entity in that supply chain fails to discharge its GST liabilities – such as a “missing trader” schemes. In ACN 154 520 199 Pty Ltd (in liq) and Commissioner of Taxation  AATA 5981 the Tribunal agreed with the Commissioner that it could.
4.4.3 ACN 154 520 199 Pty Ltd (in liq) and Commissioner of Taxation  AATA 5981
The Tribunal (at ) observed that the case arose “out of an arrangement, in which the applicant played an integral role, that exploits features of the [GST Act] to conjure input tax credits out of dealings in gold”. This was a very substantial matter, being heard over 13 days and involving more than 60,000 “T documents” being filed with the Tribunal and a hearing book consisting of 13 folders.
The applicant, a refiner of precious metal, claimed it was entitled to input tax credits because: it paid a GST-inclusive price when it acquired scrap gold for refining from third-party suppliers; processed the scrap gold into investment-grade bullion with a metallic fineness of at least 99.5% (being “precious metal” as defined in the GST Act); and made GST-free supplies of that bullion dealers pursuant to s 38-385 – being the first supply of that precious metal after its refining.
The Commissioner’s primary argument was that the applicant did not make creditable acquisitions because the supplies of bullion were not GST-free pursuant to s 38-385 – rather, they were input taxed supplies of precious metal pursuant to s 40-100. This was because the gold acquired was already at 99.99% fineness and the process applied by the applicant to put the gold into bullion form was not “refining” for the purposes of s 38-385 – the gold had already been refined to the requisite standard before it was acquired by the applicant. The Tribunal agreed with the Commissioner’s argument.
In the alternative, the Commissioner relied on declarations made under Division 165 disallowing the input tax credits for a sub-set of the acquisitions. The issue was summarised by the Tribunal as follows:
6. Broadly, it transpired that a number of the third-party suppliers were pocketing the GST they should have remitted to the Commissioner after making taxable supplies of scrap gold to the applicant. The applicant shrugs at this, saying any loss to the revenue is a matter between the Commissioner and the rogue suppliers who have failed to comply with their GST obligations. The applicant says it claimed its input tax credits in the usual way, and that it paid GST to the rogue suppliers in the GST-inclusive prices for the scrap gold. The Commissioner does not allege the applicant was a party to any fraud by third-parties, but he says Div 165 was applicable because:
(a) the applicant had obtained a GST benefit in the form of the input tax credits from a scheme; and
(b) one or more entities (including the third-party suppliers) entered into or carried out the scheme for the dominant purpose of giving the applicant the GST benefit, or the principal effect of the scheme was that the applicant got the GST benefit.
The Tribunal observed (at ) that the Commissioner made clear that he was not alleging the applicant was a party to the fraud being perpetrated by the missing traders, namely the tax evasion, but he contended that the applicant was a willing and informed beneficiary of the scheme because it received the benefit of input tax credits in connection with its acquisition of this suspiciously rich and surging taxable supply of gold.
The Tribunal agreed with the Commissioner’s argument and, while it was strictly unnecessary to do so given the finding on the “refining” issue, the Tribunal provided detailed reasons for its decision. In taking this course, the Tribunal observed (at ) that there was limited guidance from the courts and the Tribunal as to the operation of Division 165 and, specifically, none that address “missing trader” or “carousel fraud” arrangements of which the present arrangement was an example. This paper will focus on this aspect of the decision.
The Tribunal’s conclusion in the application of Division 165 appears to be heavily reliant upon its evidentiary findings, which included the following:
- The applicant was a refiner of precious metals and it acquired a large volume of scrap gold from a relatively small pool of suppliers as part of a business strategy which targeted suppliers of secondary material.
- The applicant did not always know where the suppliers sourced their material because suppliers tended to be secretive for reasons of their own. But the applicant did know:
- that a few of its main suppliers were sourcing material from an associated company (a dealer in precious metal) to whom, with and to another company, the applicant sold most of its precious metal; and
- that a proportion of the material delivered to the applicant was in the form of damaged bars or in other forms which were likely to have been comprised of gold that had been in investment form but which had been melted to disguise its provenance.
- The suppliers of scrap gold to the applicant were engaged in tax evasion through the non-remittance by the suppliers of the GST on its taxable supplies of scrap gold – the suppliers were in that sense the ‘missing traders’ in the supply chain.
- There was a circular flow of gold between the dealer associated with the applicant, the missing trader and the applicant.
- It was to be inferred that the same gold (or at least some of it) was being recycled in these supply chains.
- With regards to the knowledge of the applicant as to the activities of the missing traders, the Tribunal made the following findings:
- The applicant was aware that the missing traders were acquiring investment-grade bullion from dealers, especially in the case of its associated entity.
- The applicant more than likely knew that the missing traders were altering the bullion so it no longer satisfied the investment form requirement of precious metal to make taxable supplies to the applicant.
- The applicant was on notice that the missing traders were not remitting the GST because it would have been uneconomic for them to do so. In making this finding, the Tribunal observed as follows:
224…We reach that conclusion, in particular, based on the prices at which they bought the precious metal from the Dealers or other intermediaries, namely, ‘spot price plus a premium’, and the prices at which the [missing traders] later sold the scrap gold (whether or not it was the same gold) to the applicant for refining. The price paid by the applicant was a GST-inclusive price, namely, ‘spot price less a discount plus GST’ with the GST liability owed to the Commissioner. However, it was only economically feasible for the suppliers to undertake the transactions if they recovered the GST in the price of the scrap gold from the applicant but did not remit the GST to the Commissioner.
The alleged scheme
The Commissioner alleged that there was a wider and a narrower scheme. The wider scheme broadly comprised the following elements:
- the supply by the applicant to dealers of gold of 99.99% in investment form for an amount roughly equivalent to the prevailing spot price for gold;
- the purchase by the missing traders of gold of 99.99% in investment form;
- the scratching, melting or altering of the gold such that, while still of 99.99% fineness, the gold was no longer in investment form for the purposes of the definition of “precious metal”;
- the supply of the gold by the missing traders to the applicant for an amount that was less than the prevailing spot price for gold, before the addition of GST; and
- the refining by the applicant of the gold to produce “precious metal”.
The narrower scheme did not include the first and last of the above elements.
The Tribunal (at ) gave the following description of the Commissioner’s explanation as to the scheme:
239. Broadly, the Commissioner explained that the scheme required the participation of a refiner, here the applicant, that would acquire the scrap gold to make supplies of precious metals…The Commissioner further submitted that the purpose of defacing the precious metal that was acquired from the Dealers into non-investment form precious metal, which was an integral step in both the wider and narrower schemes, was fundamental to the scheme as it enabled the [missing traders] to make taxable supplies to the applicant such that it would pay the higher GST-inclusive prices to the [missing traders]. In this way, the making of taxable supplies to the applicant enlivened the entitlement to claim input tax credits. The Commissioner says it was the GST net amounts paid by the Commonwealth to the applicant that funded the arrangement and that made it attractive to the [missing traders].
With respect to the schemes posited by the Commissioner, the applicant contended that it did precisely the things it did in its day-to-day operations – its relevant involvement in the scheme was buying scrap gold, refining it and selling it as precious metal. Further, there was no agreement, arrangement or understanding between the other persons involved in the scheme and the applicant – the alleged schemes were merely a temporal sequence of independent, unplanned and unco-ordinated sequence events.
The Tribunal (at ) concluded that there was a scheme, being comprised of the steps in the wider scheme referred to by the Commissioner. In coming to this conclusion, at - the Tribunal made the following observations:
- The missing traders did not have access to legitimate scrap metal or the ability to fund transactions of that value on a repetitive basis.
- The Tribunal was satisfied that the missing traders mostly acquired investment-grade bullion from the dealers and then altered the bullion into scrap gold to make taxable supplies to the applicant.
- The Tribunal agreed with the Commissioner that the scheme only works to the extent that there is a refiner, here the applicant, that acquires and sells metal on its own account and produces “precious metal”.
- The evidence supports a finding that there was a level of sophisticated planning and interaction between the parties that were involved in each of the supply chains.
- The “scheme” involved a carousel type arrangement based on supplying gold for refining after deliberately altering its form. This was not plain carousel fraud involving transactions with the missing traders not remitting GST on their taxable supplies to the Commissioner. There was an additional feature that was key to the arrangement, being the contrived and artificial defacing of the precious metal to take advantage of the different treatments of metal under the GST Act – that was an integral step in both the wider and narrower schemes.
- The applicant acquired the scrap gold from the missing traders at a GST-inclusive price that always exceeded the spot price. No refiner would pay those prices unless they were entitled to claim the input tax credits.
- The applicant made a profit because of the input tax credits. Without the input tax credits, the transactions with the missing traders at just below the spot price plus GST would not have been economically feasible for the applicant.
- The reality is that the GST was never factored into the prices charged by the missing traders to the applicant because they never intended to pay the GST to the Commissioner, and never did pay it. The applicant made its profit from the input tax credits it claimed in relation to the pricing of scrap gold in an artificial market sustained by the missing traders who never paid their GST liability.
- The Tribunal concluded that the applicant was not an innocent party in the wider or narrower scheme. Further:
- The applicant knew that it was uneconomic for the missing traders to sell scrap gold to it at a price that was effectively less (on a GST-exclusive basis) than that for which the missing traders were buying essentially the same gold, in the form of precious metal from the dealers, unless they were not remitting the GST on those taxable supplies.
- The scheme was perpetuated by the applicant due to the input tax credits it received from the Commissioner. That was the economic benefit being shared amongst the participants to the scheme.
- It was unnecessary to find whether the applicant had a role in orchestrating the scheme and in procuring the missing traders to carry out their part, including the defacing of the precious metal before presenting it for refining to the applicant.
In the absence of evidence from the applicant to suggest what it would have done apart from the scheme, the Tribunal inferred (at ) that it was unlikely that the applicant would have made the same number of acquisitions of scrap god, or at all. The Tribunal considered that this seemed to be the obvious and inevitable outcome. In the absence of the scheme, the arrangement would not have been economically feasible and the applicant would not have acquired scrap gold in that volume and of that quality at those prices.
Dominant purpose or principal effect of the scheme
The Tribunal (at ) observed that the heart of the application of Division 165 in a case like this was whether the scheme, or a part of the scheme, was entered into or carried out by any of the participants for the sole or dominant purpose of enabling the applicant to get a GST benefit from the scheme. The Tribunal also observed that the relevant purpose need not be attributed to the taxpayer, it was sufficient that the purpose can be attributed to any one participant in the scheme.
The Commissioner contended that the applicant and the missing traders entered into or carried out the scheme with the sole or dominant purpose of the applicant getting a GST benefit which was the input tax credits for its acquisitions and for which the applicant paid GST-inclusive prices to the missing traders.
The applicant’s contention was as follows:
- It was not reasonable to conclude any participant in the scheme (in either formulation) entered into or carried out the scheme, or a part of the scheme, for the dominant purpose of the applicant getting a GST benefit.
- The applicant accepted (based on the evidence produced), that certain rogue suppliers altered the gold to make taxable supplies to the applicant, collected GST-inclusive prices from the applicant and then fraudulently retained that GST.
- However, the applicant distanced itself from that fraudulent conduct and argued its dominant purpose was not to secure input tax credits but to acquire scrap gold it needed to produce precious metal.
- It was irrational to suggest the dominant purpose of a taxpayer acquiring goods that are critical to its business is not to obtain the goods themselves but to simply obtain the input tax credits.
- In any event, the availability of input tax credits to the applicant was an expected and natural incident of the payment of GST-inclusive prices.
- It was not the principal effect of the scheme that the applicant received the GST benefit. The principal effect was to enable the rogue suppliers to sell scrap gold to third party purchasers including the applicant as a taxable supply, thereby enabling those suppliers to recover GST-inclusive prices and fail to remit the GST to the Commissioner.
- This was a step that could not be explained other than by reference to tax evasion on the part of the missing traders.
- The availability of input tax credits to the applicant was irrelevant to the purpose and effect of any scheme participant.
The Tribunal (at ) considered that the applicant’s arguments had a superficial appeal. However, the reality was that the applicant’s entitlement to the input tax credits were more important to the operation of the scheme than the GST liabilities evaded by the missing traders. The Tribunal observed as follows:
The input tax credits paid by the Commonwealth to the applicant funded the round-robin arrangements because, in simple terms, it was only economically feasible for the applicant to pay those GST-inclusive prices to the [missing traders] in the knowledge that the applicant would receive the input tax credits. Without the entitlement to the input tax credits, the applicant would not have paid those prices to the [missing traders] and, consequently, there would have been no acquisition of precious metal by the third party suppliers (including the [missing traders]) from the Dealers. There would have been no defacing of that precious metal, no taxable supplies in altered form to the applicant, no processing of the metal by the applicant, and no sale of an equivalent amount of precious metal back into the market by the applicant to the Dealers, and so on. In other words, the round robin arrangements would have fallen over if the applicant had not been able to claim the input tax credits. It was the GST benefit in the form of the larger input tax credits payable by the Commonwealth to the applicant, because of the [missing traders] making taxable supplies to the applicant, that underpinned the scheme.
In coming to this conclusion, the Tribunal appears to have accepted that the entitlement of the applicant to input tax credits and the evasion of tax by the avoiders were both relevant to the operation of the scheme – however, it concluded that the entitlement to input tax credits was the more important. In doing so, the Tribunal appears to have applied a “but for” test. But for the entitlement of the applicant to input tax credits – nothing else would have happened.
4.4.4 Implications of the decision
The Tribunal conducted a detailed review of the evidence. A matter of clear concern to the Tribunal was the significant quantity of gold purchased from entities with limited trading histories and limited financial capacity, and the apparent lack of any real due diligence by the applicant. At  the Tribunal stated as follows:
As the Commissioner pointed out, this is not what one would expect from businesses trading in the volumes of gold the applicant was acquiring from them. Ordinarily, one would expect the applicant to pause before dealing with newly established companies claiming to have the financial means to engage almost immediately in gold dealings of such large volumes and values, but it appears the applicant was not at all concerned.
Further, while the Commissioner did not contend that the applicant was a party to the fraud, the Tribunal concluded (at ) that the applicant was, “at best, wilfully blind to the creation of a contrived market in gold transactions which entitled it to claim input taxed credits upon its acquisitions of scrap gold from the [missing traders]” and that “the applicant facilitated and willingly participated in the round robin arrangement and benefited from the input tax credits that were created”.
In coming to its decision on the application of Division 165, the Tribunal appears to have taken a similar approach to that in the United Kingdom – at least at an evidentiary level. The applicant “knew or should have known” that, by its purchase of scrap gold, it was taking part in a transaction connected with the fraudulent evasion of GST. This was sufficient to engage Division 165 as, but for the applicant’s entitlement to input tax credits that flowed from the acquisition of scrap gold, the scheme would not have been entered into.
It would appear that it was the applicant’s knowledge that the missing traders were deliberately altering investment grade bullion and were engaged in tax evasion, or wilful blindness to those matters, that gave rise to the relevant “scheme” and elevated the applicant’s entitlement to input tax credits to the dominant purpose, or principal effect, of that scheme. If the missing traders were engaged in the same activities and scrap gold was purchased by an entity who had no knowledge of those activities and an entity who carried out due diligence into the suppliers, it would appear more difficult to conclude that there was a relevant “scheme” for the purposes of Division 165 and that the applicant’s entitlement to input tax credits to the dominant purpose, or principal effect, of that scheme.
Noting of course that the decision is being appealed, going forward, taxpayers would be well advised to undertake due diligence and risk assessment activities over and above being provided with a tax invoice by the supplier and confirming the supplier’s GST registration by undertaking an ABN search. This is particularly the case for low value, high turnover, transactions which may be a sign of missing trader fraud. However, such activities may also be prudent for isolated high value transactions where a large input tax credit claim will be made. A guide to the types of activities that may be required is found in the UK Revenue “Fraud” publication discussed above. These activities may include:
- Undertaking research on the product and or the market.
- Researching suppliers and customers, including company searches to establish trading history and share capital.
- Entering into written contracts with suppliers and purchases.
- Fully documenting transactions.
- Considering the way in which the transaction is to occur and whether there are any unusual or non-commercial elements.
While GST is imposed on each entity that makes a taxable supply within a supply chain, the legislative regime seeks to ensure that the economic burden of the tax is only imposed once – so that there is no “cascading” of GST. This is achieved by the purchaser funding the GST liability of the supplier by paying a “grossed up” price that includes the GST and the purchaser being entitled to claim a refund of that additional amount from the ATO by way of an input tax credit – leaving the end consumer (who is not entitled to an input tax credit) to bear the economic burden of the GST.
Input tax credits and refunds are an integral part of the GST regime. The entitlement of an entity to an input tax credit is a statutory right as against the Commissioner and the entitlement may crystallise by way of a reduction of the net GST liability payable by the entity or a cash refund payable to the entity. The statutory entitlement to be paid the input tax credit or refund also exists regardless of whether the supplier pays its GST liability to the ATO. These matters give acquiring entities certainty as to their ability to recover from the ATO the cost of funding the supplier’s GST liability.
Being paid cash refunds is a matter that can be exploited. The current regime for refunds (s 8AAZLGA of the TAA) seeks to strike a balance between the obligation on the Commissioner to pay taxpayers their entitlements and addressing the risk of non-compliance and fraud. On the whole, the system does appear to be working. However, as identified by the IGOT in his recent report, the Commissioner and taxpayers appear to hold quite different perspectives on the role of that provision where the Commissioner considers that there may be elements of non-compliance or fraud. The IGOT has suggested reform to s 8AAZLGA to better enable the Commissioner to combat these concerns.
An issue also arises where a supplier fails to pay its GST liability and the Commonwealth is left out of pocket because it has paid input tax credits to the purchaser. Are there circumstances in which the supplier’s failure to pay GST should impact on an acquiring entity’s entitlement to claim input tax credits? The United Kingdom VAT regime has a long-standing approach where an entity is denied the entitlement where it knew or should have known that, by his purchase, he was taking part in a transaction connected with the fraudulent evasion of VAT. Australian has not formally adopted this approach, but the recent decision of the Administrative Appeals Tribunal in ACN 154 520 199 Pty Ltd (in liq) and Commissioner of Taxation  AATA 5981 arguably establishes a regime where a similar outcome may arise by way of the operation of the anti-avoidance provisions in Division 165 of the GST Act. The decision is being appealed to the Federal Court and this will provide the Court will an opportunity to give clarity on the scope of the operation of Division 165 and the circumstances in which an entity’s entitlement to input tax credits may be impacted where a supplier fails to pay GST.
25 February 2019
 Commissioner of Taxation v Multiflex Pty Ltd  FCAFC 142; 197 FCR 580 at .
 Inspector General of Taxation, ‘GST Refunds’, March 2018.
 The Guardian Newspaper, “Mobile phone scam costs VAT billions”, 17 August 2002.
 The Australian Newspaper, ‘Tax office: $700m GST scam saw gold mules sell in parks’.
 Multiflex Pty Ltd v Commissioner of Taxation  FCA 1112.
 On 9 December 2011, the High Court dismissed the Commissioner’s application for special leave to appeal.
 Tax Law and Superannuation Laws Amendment (2012 Measures No.1) Act 2012
 Explanatory Memorandum, 7.32.
 Report, 1.3.
 Report, 2.15.
 Report, 3.4.
 Report, 6.35.
 Report, 6.39.
 Australian Government response to the Inspector-General of Taxation report: GST refunds, June 2008.
 Treasury Laws Amendment (2018 Measures No.1) Act 2018, Schedule 5 introducing Subdivision 14E into Schedule 1 of the Taxation Administration Act 1953.
 Section 86-5 of the GST Act which was introduced by the Treasury Laws Amendment (GST Integrity) Act 2017.
 HMRC internal manual VAT Fraud: Due Diligence and risk assessment: Why a taxable person should undertake due diligence and risk assessment. Published 10 April 2016, last updated 13 January 2020.
 At  referring to s 165-1.
 Section 165-10(2).
 Section 165-10(1).
 At : The evidence of the applicant’s director was that every piece of scrap gold received was melted down and subjected to a smelting and fluxing process. This was said to be the invariable practice, even where the scrap in question was defaced or damaged precious metal bars that bore a recognised hallmark confirming the bar was of 99.99% fineness. The Tribunal found that the motivation for the practice was clear from the evidence. No refinery, and certainly not the applicant, was prepared to accept anybody else’s word for the purity of the product it acquired. The Tribunal observed that the director insisted that nothing could be accepted at face value and the material always had to be melted and analysed for quality control purposes.
 Referring to Federal Commissioner of Taxation v Macquarie Bank Ltd (2013) 210 FCR 164 at -; Federal Commissioner of Taxation v Ludekens (2013) 214 FCR 149 at -.