Tag Archives: AAT

Self-represented perils contesting Australian tax residence

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Impending change to the individual Australian income tax residence rules

A measure in the Federal Budget 2021–22 is to replace the current individual tax residence rules with residency tripwires for an individuals who are tax resident where an individual is any one of:

ordinarily resident in Australia (resides test) – based on legal case precedent;
has an Australian domicile (domicile test) – which can activate unless the Commissioner of Taxation (Commissioner) is satisfied the permanent place of abode of the individual is outside of Australia;
present in Australia for more than a half of the year of income (183 day test) – which can activate unless the habitual place of abode of the individual is outside of Australia and the Commissioner is satisfied that the individual does not intend to take up residence in Australia ; or
a member of certain government superannuation funds;

in a year of income with an “improved and simplified” individual tax residence test based on:

a bright-line test derived from the 183 day test under which an individual who is physically present in Australia for more than 183 days are taken to be resident; and
the prospect of still being a resident nonetheless “in more complex cases” where the individual is physically present in Australia for less than 183 days such as where an individual is physically present for 45 days or more and has two or more of these other attributes/triggers of Australian tax residence:
- a right to reside permanently in Australia;
- Australian accommodation;
- Australian family; and
- Australian economic interests.

(45 day triggers) based on recommendations of the Board of Taxation. The reform of the individual tax residence rules is justified in the announcement on the grounds that the current rules are difficult to apply, create uncertainty and result in high compliance costs, including need to seek “third-party” aka professional advice, despite individuals having otherwise simple tax affairs.

Sanderson v. Commissioner of Taxation

The recent case of Sanderson v. Commissioner of Taxation [2021] AATA 4305 is an instance of an individual unsuccessfully running his tax residence appeal under the current rules without professional representation. Mr. Sanderson may or may not have had simple tax affairs but, in any case, the Administrative Appeals Tribunal decision reveals he had an income of $494,668 in the 2016 income year in dispute which suggests professional advice and representation might have been accessible to help him resist the adverse outcomes of his tax appeal.

Self-representation – the statistical ugliness

Self-represented taxpayers can run their own tax appeal and, in the Tribunal at least, rules of evidence and other procedural requirements are relaxed so that a person without legal training can so present their case.

In most tax appeals against income tax assessments, brought to either the Tribunal or the Federal Court, the Commissioner succeeds where the appeals progress to full hearing and decision. When the statistics concerning cases where appellants who are professionally represented and appellants who are self-represented are compared the proportion of Commissioner wins becomes even more lop-sided. As someone involved as a representative in, and who follows, these cases I can conclude that tax appeals, where self-represented taxpayers take the Commissioner on and succeed, are rare and reflect that self-represented taxpayers:

struggle to comprehend complex tax laws, understand them in context or appreciate how to present contentions about their case in a contested environment; and
do not appreciate how facts relevant to their case need to be presented so those facts are accepted or likely accepted as evidence.

Inadequate evidence

As the Budget measures and Board of Taxation suggest, the current individual tax residence rules have amplified challenges for a self-represented appellant to the Tribunal in a tax residence case that made likelihood of success for Mr. Sanderson even more remote. As I have noted in this blog in many places (see the Onus tag) the burden of proof of facts in tax appeals is with the taxpayer but there is more that can go wrong with evidence in tax appeal cases than that. In Sanderson Senior Member Olding of the Tribunal made these findings about the evidence concerning the taxpayer in the case:

29. One is the manner in which Mr Sanderson completed incoming passenger cards when he returned to Australia. He declared that he was a ‘Resident returning to Australia’ and on various cards indicated an intention to stay in Australia for the next 12 months. Mr Sanderson’s response to cross-examination about the passenger cards – ‘I guess I lied on the form’[18] – does not help his credibility, but is probably correct in respect of the latter question since his stays were for less than 12 months.
^{[18] Transcript of proceedings, P-46, ln 27.}
30. Another is a loan application form completed by Mr Sanderson in March 2011. The Benowa property was listed as Mr Sanderson’s residential address with the status box ‘Own home’ selected and the property described as ‘live in’. Again, Mr Sanderson’s response to questioning – ‘Maybe I lied to get the loan I don’t know. I don’t recall.’[19] – was unhelpful. What is clear is that either the statement was not accurate or Mr Sanderson’s evidence that he did not intend to live in the home at the time was not truthful; both statements cannot be correct.
^{Sanderson v. Commissioner of Taxation [2021] AATA 4305 at paragraphs 29-30}

As Senior Member Olding observes, propensity to lie revealed in evidence in a tax appeal depletes credibility of a taxpayer which is generally decisive in a case against the Commissioner whose officers and witnesses are usually thoroughly credible. So the Commissioner’s witnesses will be believed and the taxpayer won’t be believed about contested questions of fact with near inevitable consequences.

Self-serving evidence

Self-represented taxpayers often over-estimate how persuasive their own statements of fact and intent will be in a tax appeal forum. In Sanderson Senior Member Olding reminds us that a taxpayer’s self-serving evidence needs to be approached with caution:

Has Mr Sanderson proved the amounts transferred to his account were repayments of loans?
38. In approaching this issue, I am mindful of two judicial warnings. One is that self-serving evidence of taxpayers should be approach (sic.) with caution. The other is that nevertheless a taxpayer’s evidence should not be regarded as prima facie unacceptable unless corroborated.[24]
^{[24] Imperial Bottleshops Pty Ltd v Commissioner of Taxation (1991) 22 ATR 148, 155; and generally: Federal Commissioner of Taxation v Cassaniti [2018] FCAFC 212.}
^{Sanderson v. Commissioner of Taxation [2021] AATA 4305 at paragraph 38}

The resides test and the weight of facts

So the evidence in Sanderson accepted by the Tribunal diverged from how the taxpayer tried to present it. It transpired that Mr. Sanderson, who had spent 83 days in Australia in the 2016 income year, and was claiming not to be a tax resident of Australia was found by the Tribunal to have:

had a home in Benowa on the Gold Coast with his family;
business interests in Australia;
returned to Australia in the 2016 income year for business purposes where the Sanderson Group maintained a serviced office;
held directorships in Australian companies which he had had for some 30 years by 2016;
had access, with his wife, to a company car in Australia which he regarded as his own vehicle;
been treated by medical professionals in Australia with whom he had longstanding relationships; and
maintained Medicare and medical insurance coverage in Australia, although he also had health insurance coverage elsewhere;

in that income year.

From those findings the Tribunal decided that the taxpayer was ordinarily resident in Australia (viz. satisfied the resides test) and, based on that decision, it was unnecessary, according to the Tribunal, for the Tribunal to consider the domicile test. Although the taxpayer was an Australian citizen, thus clearly with Australian domicile, the issue with the domicile test would have been whether the Commissioner should have been satisfied or not that the taxpayer had a permanent place of abode outside of Australia.

What might a professional representative have contributed?

A saving in time and resources may have been achieved if this case had been professionally evaluated at an early juncture. Evidence where the taxpayer eventually admitted to lying could have been considered to understand how detrimental it would be, how it would come across and whether it deprived the taxpayer of realistic prospect of success in the case.

Professional advice could have been taken about the exceptional nature of cases where taxpayers, whose immediate families were living in Australia, had successfully established that they were not tax residents of Australia. A notable instance of an exceptional case is Pike v. Commissioner of Taxation [2019] FCA 2185 which I considered in my December 2019 blog – Tax residence – is it administrable after Pike? https://wp.me/p6T4vg-gW. In Pike the taxpayer was accepted as a credible witness able to establish that he was residing in Thailand while his family lived in Australia at the times in dispute. Mr. Pike’s connections to Australia were comparatively more tenuous to Australia than Mr. Sanderson’s.

In the conduct of Sanderson, the self-represented taxpayer appears not to have raised or agitated the question of residence under the relevant double tax agreement (DTA) which was a key matter in Pike. Despite the long list of factors on which the Tribunal could find that Mr. Sanderson was ordinarily resident in Australia, a taxpayer can still assert that a “tie-breaker” provision in an applicable DTA, where the taxpayer is ordinarily resident in both places (a dual resident), applies to make the taxpayer not ordinarily resident in Australia by virtue of the DTA. Perhaps the taxpayer in Sanderson could have contended that he was a resident of Malaysia who had been lodging income tax returns in Malaysia and that he should have been treated as a resident of Malaysia under the Australia Malaysia DTA?

Or maybe these inferences shouldn’t be drawn from the Tribunal’s decision? We’ll never know, of course, because the taxpayer opted to self-represent.

And what would have happened under the reform had it been the individual tax residence regime?

The taxpayer in Sanderson would not have been a resident under the “bright-line” 183 day test having spent 83 days in Australia in the relevant income year. However, as the taxpayer spent more than 45 days in Australia and these 45 day triggers are enlivened as the taxpayer had:

a right to reside permanently in Australia;
Australian accommodation; and
Australian economic interests,

two of the 45 day triggers are enough to cause the taxpayer to be hypothetically treated as a tax resident of Australia under the reform.

Some other thoughts on the 45 day triggers

This deceptively simple outcome expected in future under the reform is in tension with DTAs and international taxing norms where other countries will generally be looking to tax individuals, present in their country for up to around 320 days (365 – 45) in the country’s fiscal year, as tax resident in their country. Situations were individuals are taxed as resident in both Australia and other countries will abound as the reform, unlike the current rules, is not closely aligned to DTAs and international taxing norms when a 45 day benchmark for residence is used in “complex” cases where the 45 day triggers apply.

45 days is meagre especially in an era where travel plans of expatriate Australian citizens, who return to Australia for a visit planned as short, can be disrupted by border closures. Many such expatriates are eager to avoid, and the reform should be adjusted to prevent, structural impact to their tax affairs on being made Australian tax resident due to a visit which exceeds 45 days for reasons beyond his or her control.

Determining the AAT fee on a tax appeal to the AAT

The applicable fees to appeal

Unless a taxpayer is disadvantaged and qualifies for a concessional $100 fee – see our blog post: Small business now has its own dedicated taxation division of the AAT at https://wp.me/p6T4vg-dx, fees for review of the Commissioner of Taxation’s decisions reviewable by the AAT are now:

$952 for review by the Taxation & Commercial Division; and
$511 for for review by the Small Business Taxation Division (SBTD).

These fees have gone up since our blog post in March 2019.

Who can appeal to the SBDT?

As explained in our earlier blog post, appeal to the SBTD is available where the appellant is a small business entity under section 328-110 of the Income Tax Assessment Act (ITAA) (C’th) 1997. A small business entity is an entity (see section 960-100 of the ITAA 1997) carrying on business with an aggregated turnover of less than $10 million in an income year.

Multiple decisions – single fee on an applicant

Where the appeal is against more than one decision that relates to the appellant, the AAT can allow appeals to be dealt with together so only one fee applies. For instance, if a taxpayer is appealing against decisions to disallow a series of objections against multiple assessments of tax across multiple tax periods then the AAT can apply a single fee.

The AAT also allows for a single fee to be imposed on an “organisation” rather than separately on each of the members of the organisation applying to appeal.

Partnership CGT SBDT appeal

We have a client seeking review of objections against multiple assessments of income tax in the SBTD. The client is a partnership under State law (viz. a general law partnership carrying on business) and is a section 328-110 small business entity eligible to appeal to the SBTD.

The appeal concerns decisions by the Commissioner to disallow objections by the partners against income tax assessments seeking reduction in amounts included as assessable net capital gains to the partners in a series of income years.

Net capital gains made on partnership assets are assessed as income to the partners individually in a partnership. That is capital gains on partnership assets are not included in partnership income nor are they included in a partnership’s income tax return.

Soon after the introduction of capital gains tax (CGT) in September 1985 to include capital gains in assessable income it became apparent that it was impractical to assess partnership capital gains as partnership income to partnerships. Not only is a partnership not a legal owner of partnership property, and thus not apparent as the entity against which to assess a gain on a CGT asset, partnership property is often not owned by partners in the same names or proportions as partners share in the income and losses of the partnership.

Should a single fee have applied to the partnership?

The treatment of a partnership as an entity for some purposes, but not for others, can be confusing. It is via the small business entity regime that our client, a partnership, qualifies as a small business entity and this also impacts how the capital gains on partnership assets in dispute are assessed to the partners. The partnership is an “organisation”. Should a single fee apply to appeals by all of the partners of the partnership relating to the partnership asset CGT issues which are in common to all of the partners?

For the moment the AAT Registry say no. The AAT Registry has sought the $511 fee from each of the partners and has raised the appeals as separate cases (at odds with how the Australian Taxation Office dealt with binding private ruling applications and objections from the client in substance). The AAT Registry have raised the prospect that partners can seek to have their cases combined into one case and can seek a refund of the further instances of the $511 fee at a later point in the proceedings.

If the client is successful in obtaining a refund of the additional $511 fees we will update this story with a comment below.

Woes of a beneficiary of a discretionary trust in getting a tax deduction for interest: Chadbourne v. C of T.

In the recent Administrative Appeals Tribunal case Chadbourne and Commissioner of Taxation (Taxation) [2020] AATA 2441 (10 July 2020) the AAT confirmed the disallowance of tax deductions to Mr. D. Chadbourne (the Applicant).

The Applicant was a beneficiary of the D & M Chadbourne Family Trust (DMCFT) and the Applicant was denied deductions for:

interest on money borrowed by the Applicant to fund the acquisition of real estate and shares by the DMCFT; and
other expenses incurred by the Applicant expended;

so the DMCFT could earn income.

The discretionary trust

The DMCFT was a discretionary trust. In Chadbourne Deputy President Britten-Jones usefully described a discretionary trust:

I note that the meaning of the term ‘discretionary trust’ is disclosed by a consideration of usage rather than doctrine, and the usage is descriptive rather than normative. It is used to identify a species of express trust, one where the entitlement of beneficiaries to income, or to corpus, or both, is not immediately ascertainable; rather, the beneficiaries are selected from a nominated class by the trustee or some other person and this power (which may be a special or hybrid power) may be exercisable once or from time to time.
Chadbourne at paragraph 8

The mere expectancy of a beneficiary of a discretionary trust

Because the beneficiaries of a discretionary trust are not immediately ascertainable and are to be selected, a prospective beneficiary only has an expectancy of earning trust income unless and until the beneficiary is so selected by the trustee to take income:

Unless and until the Trustee of the discretionary trust exercises the discretion to distribute a share of the income of the trust estate to the applicant, the applicant’s interest in the income of the discretionary trust is a mere expectancy. It is neither vested in interest nor vested in possession, and the applicant has no right to demand and receive payment of it.
Chadbourne at paragraph 57

or in the case of a beneficiary who takes in default of exercise of discretion they have no more than a similar expectancy.

The Applicant was a beneficiary of the DMCFT with an expectancy interest.

The available tax deduction

The Applicant could not satisfy the first limb of the general deduction provision, now in the Income Tax Assessment Act (ITAA) 1997, which allows an income tax deduction for a loss or outgoing to the extent:

it is incurred in gaining or producing your assessable income
paragraph 8-1(1)(a) of the ITAA 1997 (emphasis added)

In Chadbourne the Applicant’s expenditure was incurred to gain or produce income for the trustee of the DMCFT, a separate legal entity. Applying authority including Federal Commissioner of Taxation v Munro (1926) 38 CLR 153, Antonopoulos and FCT [2011] AATA 431; 84 ATR 311, Case M36 (1980) 80 ATC 280, Commissioner of Taxation v Roberts and Smith (1992) 37 FCR 246, where Hill J. referred to Ure v Federal Commissioner of Taxation (1981) 50 FLR 219, Fletcher v Commissioner of Taxation (1991) 173 CLR 1 and other cases, the AAT required a nexus between loss or outgoings of the Applicant and the assessable income of the Applicant; not the DMCFT. Although the Applicant stood to earn income indirectly as the likely beneficiary of the DMCFT the AAT found:

The Trust is a discretionary trust the terms of which require the Trustee to exercise a discretion as to whom a distribution of net income is to be made. It is an inherent requirement of the exercise of that discretion that it be given real and genuine consideration. There must be ‘the exercise of an active discretion’. There were numerous beneficiaries in the Trust. There was no certainty provided by the terms of the Trust that the Trustee would exercise its discretionary power of appointment in favour of the applicant.
Chadbourne at paragraph 53

and the Applicant thus had not incurred the expenditure in gaining or producing the assessable income of the Applicant.

Why did the Applicant run the AAT appeal?

The Applicant in Chadbourne was self-represented. With the benefit of professional advice or assistance the Applicant may have:

more readily foreseen the outcome of his appeal to the AAT which, in the light of the authority applied by Deputy President Britten-Jones, could be seen as inevitable; or
moreover, arranged the loan to achieve the required section 8-1 nexus between the outgoings and the assessable income of a taxpayer.

Safer alternative 1 – trustee loan

The most obvious alternative would have been for the trustee of the trust to have been the borrower and to have directly incurred the relevant expenses though those actions would have been different commercial arrangements to those that were done.

These actions may have been more complicated and expensive to arrange: not the least because the financier may have required the Applicant to personally guarantee repayment of the loan by the trustee of the trust which was a corporate trustee with limited liability. Nonetheless these precautions would have ensured section 8-1 deductions were available to the trustee of the trust.

(Somewhat) safer alternative 2 – on-loan to the trustee

The other and perhaps commercially easier alternative would have been an on-loan of the borrowed funds by the Applicant to the trust.

The Applicant in Chadbourne may have belatedly considered an on-loan solution. At paragraph 11 of the AAT decision it was observed that the Applicant had abandoned a contention that there was a “written funding agreement” between the Applicant and the trustee of the DMCFT which the Commissioner had suggested was an invention to assist the Applicant in the appeal.

In the event of a genuine on-loan the trustee of the trust would hold the borrowed funds as loan funds with a clarity as to whom interest and principal is to be repaid rather than as a capital contribution or gift to the trust without that clarity.

On-loan – interest free

Clearly the on-loan by the Applicant to the trustee of the trust should not be interest free as the Applicant then faces the Chadbourne problem of having no assessable income with which to justify a section 8-1 deduction. In the words of Taxation Determination TD 2018/9 Income tax: deductibility of interest expenses incurred by a beneficiary of a discretionary trust on borrowings on-lent interest-free to the trustee:

A beneficiary of a discretionary trust who borrows money, and on-lends all or part of that money to the trustee of the discretionary trust interest-free, is usually not entitled to a deduction for any interest expenditure incurred by the beneficiary in relation to the borrowed money on-lent to the trustee under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)…
TD 2018/9 – paragraph 1

On-loan – at low interest

An on-loan at low interest was arranged in Ure v. Federal Commissioner of Taxation (1981) 11 ATR 484. In Ure the borrower borrowed funds at up to 12.5% p.a. interest and on-lent the funds to his wife and his discretionary trust at 1% p.a. The Full Federal Court found that the deduction Mr. Ure could claim under the first limb of the general deduction provision, sub-section 51(1) of the ITAA 1936, was limited to the 1% p.a. by which the interest income earned by Mr. Ure from his on-loan was confined.

On loan – at equivalent interest

It thus follows from TD 2018/9, Ure and Chadbourne that, to achieve deductibility in full for interest on funds borrowed and on-lent to a related discretionary trust, the interest earned by the beneficiary/on-lender on the on-loan should be the interest payable by the on-lender on the loan from the financier. This should leave the beneficiary/borrower in a tax neutral position on his or her loan on-loaned with assessable interest earned under the on-loan equalling deductible interest paid on the loan.

Related loan issues

As the on-loan is a related loan there are further considerations which will attract the scrutiny of the Commissioner:

A related on-loan should ideally be carefully documented and it should be clarified that the beneficiary/on-lender has an indefeasible right to the interest even though the on-lender is a related party of the borrower. It is also important that commitments in the on-loan agreement are met and generally interest due to the beneficiary/on-lender shouldn’t be capitalised and, especially, shouldn’t be aggregated with unpaid present entitlements due to the beneficiary.

The Commissioner could take these positions:

that the on-loan with interest is inadequately documented and can’t be proved so accounting entries capitalising interest shouldn’t be considered conclusive; or
the on-loan may be documented but it is a sham and the failure of the trust to pay interest when due shows this.

See my blog post at this site “Only a loan? Impugnable loans, proving them for tax and shams” https://wp.me/p6T4vg-8a which shows the fallibility of related party loans when these questions are contested with the Commissioner.

Woes with hybrid trusts

A hybrid trust, also a descriptive rather than a normative structure, can also fit the Deputy President Britten-Jones formulation of a discretionary trust where the entitlement of beneficiaries of the hybrid trust to income is not immediately ascertainable and is subject to the exercise of a discretion. It has been recognised, including in the Commissioner’s Taxpayer Alert TA 2008/3 Uncommercial use of certain trusts that the considerations of the AAT in Chadbourne can similarly apply to deny a section 8-1 deduction to the holder of an interest in a hybrid trust who incurs expenditure to earn income through a hybrid trust structure.

In passing I note my wariness of hybrid trusts which are typically aggressive and sometimes tax abusive arrangements. The Commissioner’s Tax Alerts are particularly directed against tax aggressive activity.

That said, the trust in the case of Forrest v Commissioner of Taxation [2010] FCAFC 6, which was referred to in a citation (sic.) in Chadbourne, appears to have been an instance of a hybrid trust where entitlement of unit holders to ordinary income was ascertainable and not subject to a discretion. On appeal to the Full Federal Court, the unit holders in Forrest could establish a nexus between borrowing expenditure incurred and assessable income.

Small business now has its own dedicated taxation division of the AAT

To give effect to a bi-partisan initiative, changes aimed at making it easier, cheaper and quicker for small businesses to appeal to the Administrative Appeals Tribunal (AAT) against decisions by the Australian Taxation Office (ATO) commenced on 1 March 2019. Small business taxpayers contemplating a tax appeal to the AAT with scant legal knowledge or representation will benefit most from the changes. Represented small business taxpayers too can benefit from the easier, cheaper and quicker AAT tax appeals and may improve their prospects of obtaining funding by the ATO of legal representation costs of their appeal.

Under the changes small business taxpayers can appeal adverse tax objection decisions to the new Small Business Taxation Division (SBTD) of the AAT. The Small Business Concierge Service (SBCS) within the office of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) also commenced on 1 March 2019 to assist small business taxpayers with appeals to the SBTD.

Tax and related review by the AAT

The AAT can review decisions on objections against tax assessments and other specified decisions made by the Australian Taxation Office (ATO) in the ATO domain on appeal under the Taxation Administration Act (C’th) 1953 viz decisions on:

Commonwealth taxes: income tax, goods and services tax, excise, fringe benefits tax, luxury car tax, resource rent taxes (petroleum and minerals) and wine equalisation tax;
Australian Business Numbers, fuel schemes, fuel tax credits, the ATO’s superannuation administration; and
penalties and interest relating to a. and b.

The SBTD can review these decisions where the taxpayer/applicant is a small business entity under section 328-110 of the Income Tax Assessment Act (C’th) 1997. A small business entity is an entity carrying on business with an aggregated turnover of less than $10 million in the current income year.

Cheaper – fees for AAT review

The ordinary filing fee for review of (appeal against) a reviewable decision by the ATO in the Taxation & Commercial Division of the AAT is $920 as at 1 March 2019. A single fee can apply if there are related multiple decisions in relation to the same appellant. A concessional fee of $91 applies for disadvantaged appellants: https://is.gd/1s5Vtt

The ordinary filing fee for review by the SBTD is a reduced $500. AAT regulations apply so that a SBTD taxpayer/applicant who the AAT finds is not a small business entity must pay an uplift to the ordinary $920 fee and their appeal will transfer to the Taxation & Commercial Division of the AAT.

Easier – Small Business Concierge Service

The SBCS of the ASBFEO assists a small business taxpayer with the SBTD appeal process and with advice about the appeal or prospective appeal to the SBTD the small business taxpayer plans. Although the SBCS is within the office of the ASBFEO and does not itself give legal advice, the SBCS:

offers a one hour consultation with an experienced small business tax lawyer to an unrepresented small business taxpayer prior to the appeal so the lawyer can review the facts pertaining to the ATO decision and provide advice on prospects of success of the appeal. In arranging a pre-appeal consultation the taxpayer needs to be aware of the 60 day time limit that generally applies for making appeals to the AAT on these decisions. A co-payment of $100 for the consultation is required from the small business taxpayer and the balance of the small business tax lawyer’s fee for the consultation is paid by ASBFEO;
assigns an ASBFEO case manager (not to be confused with the AAT case manager who will manage the appeals for the AAT) to help the small business to compile the relevant documents to maximise the benefit of the one hour pre-appeal legal consultation;
assists with the appeal to the SBTD if the small business chooses to go ahead with the appeal. The ASBFEO case manager assists with the applications and submissions to the SBTD and with engagement by the small business taxpayer with the AAT process; and
offers a second one hour consultation with an experienced small business tax lawyer to an unrepresented small business taxpayer after the appeal commences with the cost of the second consultation met by the ASBFEO without a co-payment.

Even if an unrepresented small business taxpayer utilises both hours of consultation with the assistance of the ASBFEO case manager it is still cheaper for the small business taxpayer to commence their appeal to the AAT for $600 in the SBTD, including the $100 co-payment, than to commence for $920 in the Taxation & Commercial Division.

Quicker – 28 day turnaround of reasons for decision

Decisions of the SBTD are to be “fast tracked” so that reasons for decisions will be given to the small business taxpayer usually within twenty-eight days of the hearing where the appeal goes that far. Where practicable an oral decision is to be given at the end of SBTD hearings.

Cheaper – further support for legal costs for SBTD appellants

Although the AAT, and the SBTD and the Taxation & Commercial Division in particular:

is not a court;
does not make cost orders;
isn’t bound by the legal rules of evidence; and
of itself, imposes no imperative to have legal representation;

the reality is that, where significant tax is in dispute in an appeal to the AAT, most informed appellants are legally represented and present their case in conformity with rules of evidence as if the AAT was a court. The ATO, too, selectively attends the AAT with external legal representation and, if not, ATO officers who conduct cases and appear at the AAT for the ATO are likely to have legal skills and experience. AAT decisions are reported/published and are used as legal precedent. Appellants can, though, more readily request and obtain anonymity from the AAT in tax cases than they can in courts which operate on the principle that justice is to be done in public.

The SBTD initiative partly synchronises the legal representation choice of a small business taxpayer and the ATO in a SBTD case. The ATO has transparent policy positions on when the ATO will use external legal representation in the AAT. The ATO’s position generally is that the ATO will use external legal representation where the case has high legal or factual complexity or where the case has implications for other taxpayers. Where the ATO is to engage legal representation in the SBTD then the ATO:

must inform the appellant that it proposes to engage external legal representation; and;
may meet the legal costs of the legal representation of the small business appellant that do not exceed the ATO’s legal costs of its own external legal representation. That is a possibly contentious integer as the ATO has and uses its leverage, which a small business doesn’t have, to negotiate lower fees from legal counsel with expectation of more ATO briefs.

Cheaper – greater opportunity for ATO litigation funding

This opportunity for a small business taxpayer to obtain the assistance of the ATO with their costs of legal representation in the SBTD dovetails with the test case funding policy of the ATO. Like under that policy the decision to assist a small business taxpayer with its legal costs of a SBTD appeal is with the ATO. Where the case has implications for other taxpayers then it is more likely that the ATO will both seek its own external representation and will fund the small business taxpayer’s legal costs up to the same level. Although time will tell, a small business taxpayer appears to be in an enhanced position to obtain ATO assistance with their legal representation costs in the SBTD as compared to taxpayers generally who appeal to the Taxation & Commercial Division of the AAT or who appeal directly to the Federal Court which involves significantly greater costs.

Unlike the Federal Court, the AAT does not order costs. That means that the legal fees and costs of a small business taxpayer running an appeal in the SBTD will only come from the ATO SBDT case funding or ATO test case funding, if not self funded, as legal costs won’t be awarded by the AAT even where the small business taxpayer is successful in a tax appeal case.

ASBFEO already acts as a gateway and assists small businesses to access funding for small business disputes. It is understood that the SBCS will be similarly resourced to act as a gateway to assist small businesses to obtain legal representation funding under both SBTD or ATO test case funding guidelines.

Getting tax advice to take the 50% recklessness penalty out of play

Self-assessment

Under Australia’s self-assessment system taxes including, notably, income tax and the goods and services tax, are based on returns by each taxpayer where responsibility is on the taxpayer to ensure statements and representations made to the Australian Taxation Office (ATO) reflected in those returns are true and correct.

Penalties when returns are not true and correct

When a taxpayer departs from true and correct disclosure to the ATO, penalties, including base penalties, for false and misleading statements to the ATO, unarguable tax positions and tax schemes are imposed by Division 284 of Schedule 1 of the Taxation Administration Act (C’th) 1953.

To understand the base penalty regime in Division 284 it is helpful to consider simplified categories of a taxpayer’s disclosures relevant to their return viz:

those items that are straight forward where the taxpayer understands how the item should be returned and its impact on the taxpayer’s tax liability, and
those items which are more complex or difficult where the taxpayer does not fully understand how the item should be returned and its impact on the taxpayer’s tax liability.

It is expected, or at least hoped, that matters in the first category will greatly outnumber matters in the second category. Still an item in the second category may involve a large liability and there may be a need for the taxpayer to resolve the complexity or difficulty, by taking tax advice or perhaps by obtaining a binding private ruling from the Commissioner of Taxation about that item to ensure the item is correctly returned.

As a general proposition it can be said that, unless other mitigating factors apply, failure to correctly return an item in the first category attracts the 75% “intentional disregard” base penalty and that failure to correctly return an item in the second category attracts the 50% “recklessness” base penalty based on the reasoning below:

Deceptively understating assessable income or overstating allowable deductions etc.

If a taxpayer omits an item in the first category from an income tax return which understates true and correct taxable income then the highest base penalty of 75% for intentional disregard of a taxation law under the table in section 284-90 can be imposed. This isn’t the only liability that follows from a tax review, audit or investigation of a tax return. In addition to section 284-90 base penalties, the taxpayer will be held separately liable for the tax on the taxable income that should have been returned, medicare levy, and, to reflect the time value of taxes outstanding to the ATO, the shortfall interest charge and the general interest charge, etc when an amended assessment is raised to amend the original assessment which was not true and correct.

Base penalties, including the 75% intentional disregard base penalty, are imposed on a case by case basis. Thus the ATO will infer from the way the return was completed and surrounding facts whether there was intentional disregard of taxation law justifying imposition of a 75% intentional disregard base penalty. Similar considerations as arise as to whether there was fraud or evasion (which impacts on when an amended assessment can be raised) including whether the conduct giving rise to the omission of assessable income or the overstatement of allowable deductions or offsets etc. was deceptive or calculated, or whether the conduct could be explained as some sort of mistake, which attracts a lesser penalty, are relevant.

50% “recklessness” base penalty applied in PSI cases

The recent personal services income (PSI) cases of Douglass v. Commissioner of Taxation [2018] AATA 3729 (3 October 2018) and Fortunatow v. Commissioner of Taxation [2018] AATA 4621 (14 December 2018) illustrate how the 50% “recklessness” base penalty under the table in section 284-90, one rung down from the highest 75% intentional disregard base penalty, can be applied to a taxpayer who fails to correctly apply taxation law to matters in the second category.

Both cases involved the application of the personal services income measures in Part 2-42 of Income Tax Assessment Act (ITAA) 1997 to the income of professionals (an engineer and a business analyst respectively) which was alienated from the respective individual professionals by arrangements using related companies reducing their overall income tax liabilities.

Complex or difficult?

The personal services income measures in Part 2-42 are relatively complex involving multi-tiered considerations of various tests even though the Commissioner of Taxation expressed this view in the objection decision in Douglass (from para 110 of the AAT decision):

The attribution rule of the PSI is not an overly complex area of the relevant law. There was readily available information on the operation of the PSI rules set out on the ATO website. It was also explained in the Partnership tax return instruction and in the Personal Services income schedule instruction that accompanied the tax return guide for company, partnerships and trusts. You did not make further enquiries to check the correct tax treatment of your PSI.

In both cases, the taxpayers primarily relied on the “results test” in section 87-18 of the Income Tax Assessment Act 1997 to establish that, in each case, a personal service business was being carried on so that alienated income for the personal services of the individuals would not be attributed to the individuals under Part 2-42. On the facts of each case, each AAT found that the individual was not engaged to produce a result in accord with section 87-18 and so could not satisfy the “results test”.

Recklessness

Also, in both cases, the AAT was critical of the way in which each taxpayer tried to ascertain their respective liabilities under the personal services income measures. In Douglass the taxpayer did not take a cogent advice on how the PSI measures can apply. In Fortunatow the taxpayer had received an advice on asset protection considerations from a tax lawyer which inferred that PSI advice should be taken. But that PSI tax advice was not taken by the taxpayer in Fortunatow.

In each case the AAT referred to BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) ATC 4111 where Cooper J. at p.4129 considered “recklessness”:

Recklessness in this context means to include in a tax statement material upon which the Act or regulations are to operate, knowing that there is a real, as opposed to a fanciful risk, that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct, and that a reasonable person in the position of the statement-maker would see there was a real risk that the Act and regulations may not operate correctly to lead to the assessment of the proper tax payable because of the content of the tax statement. So understood, the proscribed conduct is more than mere negligence and must amount to gross carelessness.

It was unhelpful to the case of the taxpayer in Fortunatow that the taxpayer had been made aware by his tax advice that the PSI measures had potential application to him and that there was a real risk that he was not correctly complying with tax laws. The tax advice he received went no further than saying that income would not be attributed under the PSI measures if there was a personal services business but the taxpayer could not show that he had been advised that he had been carrying on a personal services business.

Obligation on the taxpayer to be correct

These AAT decisions leave little doubt that the responsibility on a taxpayer to correctly address and resolve complex or difficult tax questions in completing their tax returns is serious and far reaching. Ordinarily this means that a taxpayer will need a cogent tax advice or will need to take other steps to demonstrate that the taxpayer has adequately addressed each question to mitigate the “real risk” that the taxpayer’s position on a complex question in a tax return is incorrect to avoid “recklessness”.

Interaction with other base penalties and where taking cogent tax advice is desirable

This removes the opportunity to shirk a complex question or issue in a tax return and to rely on the difficulty or character of the question or issue to assert that some lesser base penalty, such as the 25% base penalties under Division 284 either for failure:

to take reasonable care; or
to take a reasonably arguable position;

is applicable.

Base penalties under Division 284 of Schedule 1 of the Taxation Administration Act (C’th) 1953 apply on the basis that the highest base penalty applies to the exclusion of the other applicable base penalties.

Complex PSI cases demonstrate how self-assessment works

The above personal service income cases provide good case studies of how base penalties under Division 284 are likely to apply in cases where a category 2 complex issue arises and a taxpayer fails to adequately address the issue in their return to the ATO.

Although the ATO cannot apply a 75% intentional disregard base penalty where the taxpayer was without intent to disregard taxation law which was or may have been too complex for the taxpayer to appreciate; the 50% recklessness base penalty, on the next rung down, can nevertheless be applied because of the taxpayer’s failure to deal with that complexity. Complexity is dealt with by taking cogent tax advice from a professional tax adviser for example. It can be seen that the 50% recklessness base penalty is thus integral to taxpayers taking responsibility for true and correct disclosure to the ATO under the self-assessment system.

Rights to object to a tax assessment lost when waived under a deed to settle a tax dispute

In EE&C Pty Ltd as Trustee for the Tarcisio Cremasco Family Trust v. Commissioner of Taxation (Taxation) [2018] AATA 4093 (30 October 2018) the taxpayer, after concluding a minute of terms of agreement with the Commissioner of Taxation (the Commissioner) on 18 January 2011, entered into a deed to settle a tax dispute with the Commissioner for the 1999 to 2005 years of income on 23 March 2011 (the Deed of Settlement).

Assessments in line with settlement

On 2 June 2011 the Commissioner issued a series of assessments for those years primarily increasing, and in some income years reducing, the taxable income of the taxpayer in line with the Deed of Settlement.

Under the contractual terms of the Deed of Settlement the taxpayer was precluded from objecting against the assessments which issued as negotiated and set out in the terms.

Despite that the taxpayer had its lawyers prepare and lodge “objections” against the 2 June 2011 assessments on 4 June 2014.

Right conferred by statute overrides the terms to settle?

Apparently the lawyer had explained to the taxpayer that the taxpayer’s right to object against a taxation assessment, or more precisely a “taxation decision” under Part IVC of the Taxation Administration Act (C’th) 1953 (the TAA), is a statutory right which had lead the taxpayer to understand that their right to object persisted despite the apparent waiver of their right to object against the assessments in the Deed of Settlement.

Commissioner relied on the taxpayer’s waiver in the Deed of Settlement

The Commissioner took a contrary view and refused to treat the 4 June 2014 “objections” as valid objections.

Waiver did impact the statutory right to object

The AAT found that the Commissioner was correct in his approach. Deputy President Forgie of the AAT concluded that, as the 4 June 2014 “objections” were invalid, the AAT had no jurisdiction to review how the Commissioner dealt with them under the TAA and the Administration Appeals Tribunal Act (C’th) 1975.

Capability to waive right to object/appeal an imperative in settling tax disputes

At paragraph 89 of the AAT decision, Deputy President Forgie described a functional imperative that a taxpayer can waive their statutory right to object or appeal to settle Part IVC review and appeal proceedings:

The authorities of Cox, Grofam, Fowles and Precision Pools all support the Commissioner’s reaching a settlement with the taxpayer. The taxpayer must be permitted to forego his rights of objection and review or appeal just as the Commissioner may fulfil his obligation to decide the objection and respond to the review or appeal in terms that do so but are reached by way of agreement with the taxpayer rather than by, for example, imposition of a decision of the Tribunal or judgment of the Court. Agreement may be reached before a taxpayer engages in the formal processes of taxation objection leading to an objection decision and on to review or appeal or at some point during the process.

Why a Part IVC right to object or appeal is a type of right that can be waived

The AAT drew a distinction between a statutory right that can be waived under a contract and a statutory right that cannot. At paragraph 90, Deputy President Forgie referred to the general rule, expressed by Higgins J. in Davies v. Davies [1919] HCA 17; (1919) 26 CLR 348, at p 362:

Anyone is at liberty to renounce a right conferred by law for his own sole benefit; but he cannot renounce a right conferred for the benefit of society.

and gave examples of other statutory rights where the recipient of the right may abandon the right or not pursue the right. It follows that as a taxpayer is the sole recipient of the legal right to object under Part IVC, the taxpayer is able to renounce that right in the course of settlement of a Part IVC dispute.

Trouble objecting to a tax assessment again

In an earlier blog post we observed that the practical way and thus the only way to challenge Federal and State tax assessments is by objecting against the assessment with an objection.

The Taxation Office raises the tax assessment & decides the objection!

Like the decision to issue a tax assessment, the objection to that assessment, if any, is decided by the (office of the) relevant Federal or State Commissioner of Taxation too. The Commissioner will usually require that the objection is decided by an objections officer other than the officer who raised the tax assessment.

Still, even if that process is followed, an objections officer will be inclined to support the position of their colleague unless the taxpayer can show, with the objection, that the assessment is wrong. The burden of showing it is wrong is on the taxpayer. So the objection needs to make out a convincing case before the tax liability in the tax assessment raised by a colleague will be reduced by the objections officer.

Objection – a one off chance

Where the taxpayer has given the Taxation Office a hastily prepared document objecting against an assessment, the objection right is used up. If the objections officer disallows the objection then the tax law doesn’t give the taxpayer any further right to object against that assessment again.

After an objection against an income tax assessment is disallowed the taxpayer faces the generally expensive option of appeal to the Administrative Appeals Tribunal or the always expensive option of appeal to the Federal Court. Either way the taxpayer is usually required to appeal within sixty days of the disallowance and will generally be limited to the grounds and arguments raised in the objection unless the taxpayer can convince the tribunal or the court that there are reasons why further grounds not set out in the objection that should be taken into account.

Had the taxpayer known this then he or she may have been more wary about rushing to lodge an objection – in the case of a disputed original income tax assessment, the taxpayer will have either two years or four years following the original notice of assessment to lodge an objection.

It is important that the taxpayer uses this time advisedly to ensure an objection (only one per disputed tax assessment) is prepared which:

demonstates that the tax assessment is wrong; and
establishes grounds of objection rigorous and comprehensive enough to be used in a tribunal or court appeal should the objection be disallowed.

Withdrawal

Sometimes a hastily or inadequately drawn objection doesn’t raise valid grounds at all. The Australian Taxation Office has been known to invite taxpayers to withdraw their objection in these cases. Then they no longer have to decide to disallow the objection. In that situation it may be possible to object again, with better grounds, but it is open to the ATO to contend that the taxpayer has used up their right to object.

It’s clearly best objecting with rigour first time.

Pleading grounds in a tax objection

We have mentioned how facts and evidence in dispute should be systematically presented in an objection in a considered and rigorous way.

Restriction on grounds that can be argued in a tax case

If an income tax objection is disallowed by the commissioner of taxation then the taxpayer is generally restricted to the grounds set out in the objection on appeal to the Administrative Appeals Tribunal or to the Federal Court. The grounds so set out become the equivalent of “pleadings” in a court claim or writ commencing litigation.

The law changed in 1986, to allow a limited discretion to the tribunal or the court, to alter the grounds of an objection on which an appeal could be based. The Treasurer then stated in the explanatory memorandum to the changes:

It is expected that, in exercising the discretion, the general principles on which courts have permitted amendments of pleadings in other areas of the law will generally be applied. For example, the discretion is likely to be exercised where the need for an amendment of the grounds of objection arises as a result of the Commissioner relying on arguments in defence of an assessment where the particular basis was not adverted to in the adjustment sheet accompanying the notice of assessment.

Lawyer-prepared pleading can be worthwhile

So we recommend legal input in to the preparation of a tax case at the objection stage:

where the case is of importance to the taxpayer; or
particularly where the taxpayer wants to be able to appeal the case if the objection is disallowed by the commissioner of taxation.

If a taxpayer has used a simple objection letter that does not adequately plead the taxpayer’s case, prospects of success on grounds not pleaded are diminished. Trained tax lawyers like The Tax Objection can prepare or review an objection with legal “pleadings” method to prevent loss of prospects of success on appeal like that.

Save dispute costs by getting your objection right

Usually a tax objection is the only feasible way to dispute a tax assessment.

One time opportunity

That said, an objection is a valuable and relatively low cost opportunity to put a case to a commissioner that an assessment needs to be corrected.

Don’t miss it

Costs ratchet up where a taxpayer still wants to dispute the assessment once the objection is disallowed. The objection opportunity should be taken. Assistance from a tax disputes legal professional, like The Tax Objection, can be valuable. The right lawyer can draft objection documents, or review documents already prepared, suggest a strategy and let you know the prospects of success of the proposed objection.

Appeal after disallowance of a tax objection

If an income tax objection is disallowed by the commissioner then the taxpayer has sixty days from the issue of the disallowance to appeal to either of the Administrative Appeals Tribunal (“AAT”) or the Federal Court of Australia. So time is a factor as well as cost if an objection is disallowed.

Administrative Appeals Tribunal

The AAT is a lower cost dispute resolution forum than the Federal Court. Generally the AAT will not award costs meaning that if a taxpayer loses an appeal to the AAT then the taxpayer will not have to meet the legal costs of the commissioner. Although the AAT is not a court and the AAT is not bound by the rules of evidence, the AAT is essentially a quasi-court in tax appeals and appellants will be at a disadvantage if the implications of the rules of evidence are not understood.

To commence an appeal in the AAT a fee of $861 usually applies. The AAT offers alternative dispute resolution services before a case moves to a hearing in the AAT. If a case in the AAT does not resolve and it proceeds to hearing a barrister will usually be required for the taxpayer. Legal costs will exceed $50,000 in many cases that reach the full hearing stage.

Federal Court

The Federal Court option is a more expensive alternative and, if the taxpayer loses, an order to meet the costs of the commissioner usually follows. Running a case in the Federal Court usually involves six figure legal costs.

Try to win at the objection stage

In that context making the most of the objection stage to a dispute a tax assessment before it reaches the pressing and expensive appeal stage does make sense.