Can the ATO settle a tax dispute and ignore the settlement?

Following the settlement, Ziegler executed a series of restructuring transactions. He caused Orrong’s shares to be transferred to himself, becoming Orrong’s sole shareholder. Orrong then declared a fully franked dividend. After deductions and carried forward losses, Ziegler received a refundable tax offset of $2,993,610, recovering a substantial proportion of what had been paid under the deed.

The Commissioner, as the court noted, was “displeased” (at [4]). He made a determination under section 177EA(5)(b) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) denying the imputation benefit and sought recovery of the offset.

The assessments and penalty escalation

The Commissioner also took the view that GIC previously claimed as a deduction by Ziegler was an assessable recoupment under section 20-20(3) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), bringing it back into assessable income. 

Penalties were initially assessed at 25 per cent. However, during the objection process, the Commissioner concluded that the correct rate was 75 per cent, with a 20 per cent uplift applied for some years, resulting in effective penalties exceeding 90 per cent (at [8], [49]–[50]).

The taxpayer challenged the Commissioner’s power to increase penalties at the objection stage. The Full Court (Bromwich, Thawley and Jackman JJ) held that the earlier decision in Aurora Developments Pty Ltd v Commissioner of Taxation (No 2) [2011] FCA 1090, which had found an implied power to amend penalty assessments under section 14ZY of the Taxation Administration Act 1953 (Cth) (TAA 1953), was incorrect (at [56]–[66]).

However, the court reached the same result by a different route. Section 298-30(1) of Schedule 1 to the TAA 1953 requires the Commissioner to make an assessment of administrative penalties. The court held that this duty is not “spent” once first exercised. If the Commissioner later forms the view that an earlier penalty assessment is incorrect, the Commissioner must continue to exercise the assessment power under section 298-30(1) and notify the revised liability under section 298-10 (at [74], [78]).

This means the Commissioner can increase penalties at the objection stage, not because section 14ZY confers a power to do so, but because the underlying assessment power in section 298-30(1) is ongoing.

A settlement deed is a contract, not a constraint on statutory power

The most significant aspect of the decision for practitioners is Ground 4: whether a taxpayer can establish that an assessment is “excessive” within the meaning of ss 14ZZK and 14ZZO of the TAA 1953 by proving that the Commissioner departed from a Settlement Deed.

The taxpayer argued that the Commissioner had agreed, for valuable consideration, to exercise his general power of administration on a particular view of the taxing statutes and that the assessments were inconsistent with that agreement (at [136]).

The court rejected this.

Citing a line of authority beginning with Federal Commissioner of Taxation v Wade [1951] HCA 66, the court reaffirmed that the Commissioner cannot bind himself by administrative practice or by contract to give the tax laws an operation which they do not have (at [142]).

The court drew a critical distinction between statutory rulings and contractual agreements. Where a ruling is binding under section 357-60(1) of Schedule 1 to the TAA 1953, an assessment inconsistent with that ruling is excessive because of the substantive operation of the statute itself. A settlement deed carries no equivalent statutory force (at [149]).

The principle was stated clearly at [150]: a taxpayer’s liability is determined according to the operation of the tax laws, not by contractual promises made by the Commissioner, nor by his conduct in the administration of the tax laws, unless the tax laws give those promises or that conduct some statutory consequence for the taxpayer’s substantive liability.

The court acknowledged that the taxpayer might have a contractual remedy for any breach of the deed, but those proceedings were separate and had been stayed (at [152]–[153]). A breach of a settlement deed does not make an assessment “excessive” for the purposes of Part IVC.

Practical implications for accountants

This decision carries real consequences for practitioners advising clients on ATO settlements.

Understand what a settlement deed provides. A settlement deed is a contract. It gives the taxpayer contractual rights. It does not give the taxpayer statutory protection. The Commissioner’s power to assess under the substantive provisions of the tax law is not constrained by the terms of a deed.

Penalty risk does not crystallise at the first assessment. In Ziegler, the taxpayers objected to penalties assessed at 25 per cent. During that process, the Commissioner increased penalties to 75 per cent with a 20 per cent uplift for some years. The court held that the power to assess penalties under section 298-30(1) is not spent once first exercised, so the Commissioner can reassess penalties upward. The court noted that this power is not subject to the express period of review limitation rules that apply to primary tax assessments, though it may be subject to an implicit condition that it be exercised within a reasonable time (at [77]).

The remedy for breach lies in contract, not in Part IVC. If a client believes the Commissioner has acted inconsistently with a settlement, the taxpayer cannot challenge the assessment as “excessive” by pointing to terms of a deed. The assessment must be challenged on the basis that it does not correctly reflect the taxpayer’s substantive tax liability under the relevant statutes.

Post-settlement planning matters. The restructuring transactions that followed the Ziegler settlement attracted Part IVA scrutiny under section 177EA. Practitioners should ensure that any post-settlement steps are considered through a Part IVA lens, particularly where those steps have the effect of recovering a substantial portion of the settlement amount through imputation benefits.

The section 357-60 distinction matters. If a client needs certainty from the Commissioner, a private ruling under the statutory framework offers protection that a contractual settlement cannot.

Conclusion

Ziegler is a sobering reminder that a settlement deed, however carefully negotiated, operates in the contractual sphere. It does not alter the substantive operation of the tax laws. The Commissioner retains full authority to assess according to the law as he sees it, even where that differs from what the parties contemplated in their settlement.

The question for practitioners is not whether a settlement deed is valuable. It is. But its value lies in the contractual rights it confers, not in any constraint on the Commissioner’s statutory powers. Any practitioner advising on ATO settlements must be clear-eyed about this distinction.

Credit to the team at West Garbutt who acted for the taxpayer in this matter. The willingness to test these boundaries is how the law develops.

Arda Ahmed is a specialist tax lawyer.