Signed, sealed, delivered… not exactly: Comfort letters as an ATO dispute resolution tool

The ATO is increasingly using comfort letters instead of settlement deeds and formal rulings. Taxpayers should be aware of the benefits and risks of comfort letters.

Generally speaking, in the regulatory space, a "comfort letter" (or "letter of comfort"), is a letter issued by a regulator stating that it does not intend to use (or further use) its regulatory powers in relation to a particular matter. Comfort letters are used by a range of agencies, including the ATO.

Comfort letters state the position of the regulator at the time they are written, and do not generally prevent the regulator from using their powers in the future against the entity, even in relation to the matters the subject of the comfort letter. Conditions will often be drafted into the letter, setting out specific terms that will cause the letter to be withdrawn.

In the past, the ATO has used comfort letters where the ATO did not seek to displace a practice that had emerged in terms of a particular tax treatment, where the ATO did not strictly agree with the technical correctness of the treatment (but saw little or no mischief in it) or perhaps considered the disruption would be unduly significant, pending specific legislative reform on the particular issue. In that context, the ATO could only issue a formal ruling in accordance with its technical view of the legislation, even where it did not have any intention of seeking to disturb the proposed tax treatment at that time. Comfort letters are useful and practical in this context.

Comfort letters may also be useful where time is a critical factor to the taxpayer, and the ATO is unable to make a formally binding and enforceable decision in the time available. In that context, a taxpayer may find the comfort letter offers adequate certainty, given the time pressures and other commercial motivations.

However, there are increasing reports that the ATO is using comfort letters as an alternative to:

• formal deeds of settlement, in the case of disputes; and
• formal rulings, in non-dispute settings, where the ATO's view is sought and a formal ruling is desired by the taxpayer.

In particular, the ATO may be developing a practice of using comfort letters, in place of settlement deeds, to resolve transfer pricing disputes.

The use of comfort letters by the ATO is significant because:

• comfort letters offer the taxpayer significantly less certainty than a deed of settlement or a formal ruling;
• comfort letters of this nature are unenforceable (although it is worth noting that issuing a comfort letter may have consequences under administrative law);
• third parties cannot rely on comfort letters, which is an important distinguishing and limiting feature when contrasted with the use of product or class rulings; and
• it is not clear whether comfort letters form part of the ATO's external settlement assurance program for review of settlements by retired judges.

That comfort letters offer the taxpayer less certainty than a deed of settlement or a formal ruling is a significant limitation. Taxpayers who accept a comfort letter may be exposed to the ATO changing its view on the law (by way of an ATO U-turn), a judgment that changes the ATO's understanding on an issue or a change of ATO priorities. Further, risks are not finally resolved for issues, including transfer pricing, that do not have limited amendment periods. Taxpayers may continue to be exposed to further compliance activities by the ATO (even where the position taken is correct).

The Inspector-General of Taxation has noted concerns about the ATO's unwillingness to issue rulings, and the apparent preference for letters of comfort, in his 2017 work program. The IGT Work Program 2017 said:

"ATO Advice and Guidance

Stakeholders have raised concerns regarding the ATO’s approach to providing advice and guidance. In particular, they have noted fewer public rulings being issued and the ATO’s use of practical compliance guidelines and website materials both of which provide less certainty for taxpayers. […] In relation to private rulings, the concerns related to timeliness, the ATO’s unwillingness to rule on certain issues and, in some instances, issuing ‘letters of comfort’, which do not provide the same level of certainty. The ATO has informed the IGT that it has more recently undertaken an internal review of its public advice and guidance processes. The IGT will monitor these issues and if concerns persist, a review in this area may be conducted."

Given the above significant limitations and disadvantages of comfort letters, taxpayers should carefully consider whether they are receiving any benefit by accepting a resolution by comfort letter. Ordinarily, one would expect a corresponding benefit for accepting a higher degree of risk, where the other party is taking on a lower degree of risk. If this is not the case, then taxpayers should be asking why a deed of settlement or ruling is not the appropriate and available instrument.

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