Tag Archives: Onus

Integrity measures covering income tax deductions for payments, including salary, to relatives

Involved “associate” issues come up frequently on this blog. For instance:

In this piece I am looking at some core associate rules concerning income tax deductions: how the Income Tax Assessment Acts (ITAA) can restrict income tax deductions for payments, including salary and wages, where the person in receipt is a relative or associate.

Example – mischief to which s26-35 of the ITAA 1997 is directed

Let us say X owns a business which employs X’s son Y and daughter-in-law Z. The business is profitable and X pays tax on income from the business at a high marginal rate. Y and Z only have assessable income from their salary from working in the business and both pay income tax at a lower rate than X. To give Y and Z a helping hand and so X, Y and Z pay less income tax overall X pays Y and Z overly generous salaries taking into account the age, experience, extent and profitability of the work that Y and Z do in the business.

How s26-35 applies

Section 26-35, which operates together with section 65 of the ITAA 1936, to cover off on payments to individuals including payments routed through partnerships, trusts and companies, reduces the deduction for salary and wages X is allowed to the amount the Commissioner of Taxation (Commissioner) considers reasonable based on the nature of the duties performed by, the hours worked by and the total remuneration of the relative. The excess is not deductible.

The section is not punitive: sub-section 26-35(4) operates to treat the non-deductible part of the payment the relative receives as non-taxable (NANE income) to the relative. So in the example assessments of income of X, Y and Z are all in the frame for adjustment by the Commissioner so the reduction in the tax deduction for salary and wages to X can be effected.

Income tax return requirements

The onerous part of section 26-35 is that X must keep sufficient records to substantiate that the payments to relatives claimed as deductions are reasonable. As usual a taxpayer needs to self assess and the burden of proving a payment, such as of salary, is reasonable is on the taxpayer: see our blog The burden of proof in a tax objection

In support of a claim of a reasonable deduction for a payment paid to relative a taxpayer such as X must also return the total of all payments made to associates in their income tax return. This is a flag to the Commissioner that deductions have been claimed for payments to relatives and, for a safe harbour to support the total associate payments deducted, the Commissioner states that a taxpayer needs to keep:

  • full name of relative or other related entity
  • relationship
  • age, if under 18 years of age
  • nature of duties performed
  • hours worked
  • total remuneration
  • salaries or wages claimed as deductions
  • other amounts paid – for example, retiring gratuities, bonuses and commissions.

for the Commissioner’s inspection. In the 2022 income tax return X might complete this item is:

P16 Payments to associated persons

with amounts comprising total associate payments deducted returned at item G item P15, These records need to be kept even if, in the view of the taxpayer and his or her advisers, the payments made by the taxpayer to relatives are reasonable and say even align with award entitlements.

Exclusions

The regime catches payments to partnerships where a partner is a relative however a payment by a partnership to a partner (of the same partnership) who is a relative of another partner (of that partnership) is not caught: proviso in sub-section 26-35(3). Hence the above records are not required in the context of deductible payments made to say a wife partner by a husband and wife partnership. (Not of partnership [agreement] “salary” which is not deductible in any case.)

A payment of a deductible superannuation contribution by X as an employer for Y or Z is also not necessarily caught by this regime where the payment is not to a relative either directly or indirectly via a company, trust or partnership within the section 26-35 of the ITAA 1997 and section 65 of the ITAA 1936 regime. The relative is less likely to become entangled in this regime where the relative is not an individual trustee of the superannuation fund contributed to by X.

Self-represented perils contesting Australian tax residence

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Royalty-free 3d generated graphic

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.

The onus of proof on taxpayers and the common good

As I mention in my 2015 blog post on the onus of proof:

BurglarBag$

The burden of proof in a tax objection

the onus on a taxpayer is an outlier and “reversed” when compared to the onus in other kinds of legal disputes.

Even when compared to the civil case onus, where disputes are also resolved on a balance of probabilities, the tax onus of proof is unusual. It is unlike the civil case standard which generally requires a litigant taking civil action to prove their case. That differs from disputes over Australian tax assessments where it is the taxpayer who must prove their position taken in their tax filings.

Beginnings of onus on the taxpayer

This has long been the case with Australian income tax even before the introduction of the self-assessment system in the late 1980s. Paragraph 190(b) of the Income Tax Assessment Act (ITAA) 1936, which imposed the burden of proof on taxpayers on objections and appeals over tax assessments, was in the original 1936 legislation.

Advent of self-assessment

In a sense tax legislation caught up with paragraph 190(b) with the onset of self-assessment in the late 1980s. The self-assessment system moved responsibility to assess one’s tax viz. to get tax filings right, wholly onto the taxpayer. The Australian Taxation Office (ATO) website explains how self-assessment works:

we accept the information you give us is complete and accurate. We will review the information you provide if we have reason to think otherwise

Self-assessment and the taxpayer

Mutual reliance

It is a corollary of reliance on the taxpayer to get their tax filings right that a taxpayer can also demonstrate the completeness and accuracy of those filings when called on to do so by an ATO review, audit or investigation.

This proposition is made clearer when considered in the wider context of the body of Australian taxpayers meeting their tax obligations. Taxpayers, who can demonstrate accuracy and justify their tax filings, expect, or might be entitled to mutually expect, that other taxpayers, under the same obligations and contributing to the same pool of revenue; are also able to so demonstrate.

How the tax burden of proof can work

Let us say:

  1. a taxpayer T returns no income in an income year;
  2. the ATO reveals that T has received $1m in that period;
  3. T asserts that the $1m was a gift given to T by an overseas relative, and that is why T believes T’s income tax return was correct; and
  4. the ATO see a possibility that the $1m could have been income of T and T’s claim of a gift may not be true.

With the onus of proof on T, T must produce the information which supports T’s claim of a gift and T’s return of no income. That seems reasonable in the context of the $1m receipt being T’s own affair with which T is familiar enough to have excluded from T’s income in T’s income tax return. Having omitted to return $1m that way it follows that it should be up to T to demonstrate that the $1m is not T’s income on review.

If the onus of proof were the other way, and on the Commissioner, then where the Commissioner has scant information to demonstrate that the $1m or some part of it was income and the Commissioner may then be unable to positively prove the $1m was income of T so:

  • T would avoid tax liability on the $1m even though the $1m may have been T’s income; and
  • it would be in T’s interests to conceal information, including information about the possible income character of the $1m from the Commissioner, which is then unavailable to the Commissioner or costly to the ATO to establish with other means or from other sources, rather than to disclose information to positively show that the $1m was not T’s income which T would be compelled to do if the onus of proof is on T.

Parliamentary inquiry

A House of Representatives Standing Committee on Tax and Revenue (Committee) inquiry into tax administration has made recommendations on 26 October 2021 including for:

  • increase in transparency of and communication by the ATO of ATO compliance activities;
  • reversal of the onus of proof (from the taxpayer to the Commissioner) after a certain period where the Commissioner asserts there has been fraud or evasion;
  • introduction of a 10 year time limit on the Commissioner for amendment of assessments where there has been fraud or evasion; and
  • a moratorium on collection of tax debts by the Commissioner until a taxpayer has had the opportunity to dispute the debt.

The complexity issue

The long understood weakness with the self-assessment system, particularly with income tax collection in Australia, is the complexity of tax laws: see https://go.ly/x0MIU from the Australian Parliamentary website. This was not a significantly lesser weakness under the predecessor system where ATO resources in the ATO assessment process where sparse especially to assess activity where compliance with complex laws was in issue. Since self-assessment began income tax laws have only increased in complexity and, demonstrably, in volume. Yet, over the same period there has been:

  • improvement in the drafting, clarity and usability of tax laws epitomised by the ITAA 1997 and its style;
  • a release and expansion of public and private rulings, determinations and guidance on tax laws and guidance on the completion of tax returns; and
  • access to them over the internet.

Role of professional tax advisers

Even before these advancements under self-assessment, 97% of corporate taxpayers and 74% of individual taxpayers used tax agents to assist them with meeting their tax obligations. Clearly tax agents and other professional tax advisers continue as a vital resource to taxpayers, especially business taxpayers, albeit at cost; to help them ensure obligations to comply with tax laws, especially complex laws, are met.

When the ATO overreaches

A difficulty I have faced in tax disputes is where a client does have information or proof which adequately does demonstrate the position taken in a tax filing but the ATO does not accept that information as sufficient proof. A related difficulty is where complex law is involved leading to protracted difference with the ATO over how tax law applies to what a taxpayer has done.

Taxpayers, especially business taxpayers reliant on professional tax advisers, are up for significant inconvenience, costs and expenses while a dispute with the Commissioner continues including where disputes arise when the taxpayer has made little or no mistake. The use of extensive debt collection powers by the Commissioner before disputes resolve is rightly a matter of controversy in tax disputes where:

  • it can be established that the tax dispute is genuine; and
  • deferral of the disputed tax debt poses no or minimal risk of permanent loss to the revenue and the community.

It could well be that there needs to be greater control and oversight of the Commissioner’s use of collection powers in these cases as there appears to be unconstrained and disproportionate use of them by the ATO when risks of loss to the revenue may have been low. The recommendation for checks and further transparency about ATO use of its compliance powers thus makes sense. Unfortunately debt collection in Australia, including collection from business, frequently involves unscrupulous and globally mobile debtors and even the Commissioner is not always well placed to judge risks of loss to the revenue or not of using the range of collection powers available to the Commissioner. It seems inevitable that some uses of collection powers by the Commissioner are not always going to appear proportionate when considered in retrospect.

Limitation periods

The limitation periods imposed under section 170 of the ITAA 1936 are already a departure from the taxpayer expectation, related to the expectation described above, that other taxpayers will pay tax based on the way they have filed or demonstrably should have filed their taxes. Amendments are restricted after expiry of limitation periods which also means the expectation can no longer be met by assessment amendment. The limitation periods, or periods of review, are there to ensure that the Commissioner and taxpayers properly finalise tax liabilities broadly not only within the expectation but also expeditiously without the prejudice to the other party of delay. Veracity of tax filings get harder to prove after a longer period of time especially once records are archived or lost beyond the expiry of record-keeping obligations to keep those records. Belated moves to amend can thus be unfair on the other party for that reason and for others.

Fraud and evasion

The reversal of the onus of proof proposed by the Committee seems limited and justifiable as a narrow exception. It would only apply where the Commissioner alleges fraud or evasion and only after a “certain” period has elapsed. In other words the onus of proof would remain on the taxpayer to disprove fraud or evasion if the Commissioner makes the allegation (which the Committee proposes must be signed off by a senior executive service (SES) officer of the ATO) within that period. But after that period it is only then proposed that the onus is to move to the Commissioner to prove fraud or evasion.

Alleging it for the right reasons

I have been involved in tax disputes where the Commissioner has alleged fraud or evasion even though available facts are just as much explainable by taxpayer inadvertance without there having been fraud of evasion. It was apparent in those disputes that the Commissioner was alleging fraud or evasion because the period for amendment of assessments, which can be as little as two years under section 170, in the absence of fraud or evasion, had expired. The difficulty for a taxpayer, with the onus of proof on the taxpayer, is that if the Commissioner makes a fraud or evasion allegation it is then up to the taxpayer to disprove it under current law: Binetter v FC of T; FC of T v BAI [2016] FCAFC 163 and, it follows, to disprove it at a time which may be remote from when the taxpayer may have had access to or opportunity to obtain evidence to disprove it.

It is perverse that, under current rules, the Commissioner can use unsubstantiated fraud and evasion claims against taxpayers to overcome a limitation period bar that would otherwise block the Commissioner from amending a tax assessment. That may well justify the Committee’s recommendations that the onus of proof of fraud or evasion in these delayed cases should move to the Commissioner but that the onus of proof remain on the taxpayer with respect to disproving other aspects of an assessment.

10 year limitation period for fraud and evasion cases?

But is it also necessary to impose a 10 year limitation period where there has been fraud or evasion by a taxpayer once:

  • SES officer sign-off is required for making a fraud or evasion allegation; and
  • the onus of proof of fraud or evasion is imposed on the Commissioner;

as also recommended?

Why would or should a taxpayer whose filing is tainted by demonstrable fraud or evasion, and is thus improper, be entitled to expect that the Commissioner must move to finalise taxes within a limited period of time, especially if there has been delay in the Commissioner getting information indicating shortfall of tax due to fraud or evasion by the taxpayer?

The odd way disputes over PAYG deducted from salary are resolved

payday

A recent Federal Court case Price v. Commissioner of Taxation [2019] FCA 543 demonstrates the divergent way a taxpayer must go about contesting a dispute with the Commissioner of Taxation over pay as you go (PAYG) tax withholding amounts taken from salary or wages received by the taxpayer.

Right to object about PAYG credits not available

Although the credit for PAYG withholding amounts is notified on a notice of assessment of income tax the PAYG credit is not one of the matters that can be disputed by objection, or more specifically, an objection under Part IVC of the Taxation Administration Act (C’th) 1953 (“TAA”) as discussed on this blog in: Is an objection needed to amend a tax assessment? https://wp.me/p6T4vg-k.

To formally dispute a PAYG credit, especially where the salary and wages from which the withholding is made are not disputed, court action may need to be taken instead. The proceeding that can be taken by a taxpayer is further limited as the Commissioner’s refusal to allow PAYG credits cannot be challenged under the Administrative Decisions (Judicial Review) Act (C’th) 1977: Perdikaris v Deputy Commissioner of Taxation [2008] FCAFC 186. So in Price, the taxpayer (Robert) sought a declaration from the Federal Court of his entitlement to credit for PAYG withheld by his employers under section 39B of the Judiciary Act (C’th) 1903.

Price v. Commissioner of Taxation

In paragraphs 6 to 8 of the Federal Court decision in Price, Thawley J. outlined the legislative basis of the PAYG withholding regime including in the context of the predecessor PAYE (pay as you earn) regime which operated until 2000. In paragraph 2 Thawley J. confirmed that the taxpayer’s proceeding under section 39B of the Judiciary Act, rather than under Part IVC of the TAA, was correctly instigated.

Why the taxpayer risked heavy costs in the Federal Court

Action in the Federal Court is expensive, and an unsuccessful litigant in the court is generally liable for the legal costs of the successful litigant. Those legal costs are significantly more than the costs of lodging an objection or appealing against an objection decision with which the objector is dissatisfied in the Administrative Appeals Tribunal (AAT) which are costs risked in Part IVC of the TAA disputes. The AAT does not award legal costs.

It follows that considerable PAYG credits need to be in dispute before action against the Commissioner in the Federal Court is worth the risk of legal costs at stake.

In Price, Robert was employed as a truck driver by four entities controlled by his brother Jim from the 2001 to the 2016 income years. Robert claimed PAYG credits for the entire period so considerable PAYG credit entitlements were at stake. Robert hadn’t lodged tax returns returning his salary and wages income until 26 September 2016 when all sixteen income tax returns were lodged together. Robert sought all sixteen years’ worth of tax credits then.

The employer and not the Commissioner is tested

One would think that the Commissioner could easily ascertain PAYG credit from amounts remitted by an employer for a recipient of salary and wages. If amounts withheld from salary and wages haven’t been remitted to the Australian Taxation Office (ATO) then that would seemingly be conclusive or near conclusive.

But the point of remittance of PAYG credits to the ATO is not the point at which the TAA operates to confer a PAYG credit entitlement to a taxpayer. Sub-section 18-15(1) of Schedule 1 of the TAA allows PAYG credit to a taxpayer where there has been withholding by the party with the withholding obligation, viz. the employer in the case of an employer who pays salary and wages, of the amount withheld. Sub-section 18-15(1) necessitates an enquiry into whether or not the amounts claimed for PAYG credit were “withheld” by the employer whether or not the amounts “withheld” were ever remitted to the Commissioner. In the Federal Court, in its original (non-appellate) jurisdiction, whether amounts have been withheld is a matter of fact to be established to the court on the balance of probabilities.

In another Federal Court decision cited with approval in Price, David Cassaniti v Commissioner of Taxation [2010] FCA 641 at paragraphs 163 to 165 Edmonds J. thus focussed on the actions of the employer. Edmonds J. explained and contrasted the evidential value of an employer’s apparent withholding to a (its own) bank account which, on the one hand, “clearly demonstrates” a withholding and an employer’s apparent withholding by book entry, which may be insufficient to demonstrate withholding by the employer depending on the surrounding circumstances, on the other. It was also relevant in David Cassaniti, as it was in Price, that the employer had been a company enabling Edmonds J to accept the books of account of the company as first instance evidence of what the books of account contained in accordance with section 1305 of the Corporations Act 2001.

Employers were wound up companies

In the Cassaniti line of cases, which also included the Full Federal Court decision in Commissioner of Taxation v Cassaniti [2018] FCAFC 212, relevant company records of the employers were thus sufficient to establish to the Federal Court that amounts had been withheld by the party with the withholding obligation. As in Price, in which the Cassanitis were also involved, the relevant employer companies had been wound up but nevertheless, by virtue of section 1305 of the Corporations Act 2001, the financial records of these companies in the (earlier) Cassaniti cases were sufficient evidence to show that the companies had made the relevant withholdings despite no record of remittance to the ATO. Robert’s case in Price relied on PAYG payment summaries produced from accounting records of the employer companies being accepted as financial records of the companies.

Robert was unsuccessful. The tax returns and PAYG payment summaries were produced from MYOB in September 2016 after the employers were wound up so the court refused to accept the PAYG payment summaries as financial records of the wound up companies. Thus the PAYG payment summaries were not first instance evidence of the PAYG withholdings asserted in them. In paragraph 87 Thawley J. listed findings showing that withholdings were not made for Robert:

  • the absence of any records from the ATO to that effect or supporting inferences of withholding;
  • the absence of any contemporaneous record of any person or entity who paid Robert evidencing withholding;
  • the fact that every year or thereabouts Robert asked for but was not provided any PAYG payment summary;
  • the fact that no superannuation was paid by any of the employer companies for Robert;
  • the fact that Allyma Transport Services did prepare PAYG payment summaries for other employees; and
  • the fact that the bank records suggest a number of different entities paid the weekly amounts into Robert’s account (including NT TPT Pty Ltd, PMG Transport, CJN Transport) and that at least one of those entities (PMG Transport) probably treated the payments to Robert on the basis that he (or a partnership of which he was a partner) was a subcontractor rather than an employee.

The unremitted PAYG no man’s land

Cases such as the Cassaniti cases and Price are relatively rare.  In that context we can observe that it is precarious to be in the position of an employer, or of a director of an employer, obligated to withhold PAYG amounts from employees’ salary and wages where those amounts have not been remitted to the ATO. The employer and, in the case of a company, its directors personally where director penalty notices issue to the directors and trigger personal liability under Division 269 of Schedule 1 of the TAA, are liable to the Commissioner for these amounts. Further failure to remit PAYG withholding on salary and wages is a strict liability offence under Division 16 of Schedule 1 of the TAA.

The pursuit of unremitted salary and wage PAYG withholdings from the Commissioner can potentially be a fraud against the revenue where employers and their directors have overtly arranged their affairs so that they are not exposed to the above liabilities and prosecution for failure to remit. Confinement of salary and wage earner remedy to proceedings under section 39B of the Judiciary Act does operate as a bulwark against that type of fraud.

It is to be hoped that reporting of and liability for PAYG withholding on salary and wages can be reformed and streamlined so that employees can better monitor withholding for them in real time and opportunities for “phoenix” PAYG credit frauds on the revenue can be reduced.

Commissioner pushed too far to rule on private ruling – Hacon

Efforts by a $35 million pastoral dynasty to get tax certainty over their plans to restructure its farming holdings have come to an end with the Full Federal Court upholding the Commissioner of Taxation’s appeal and allowing the Commissioner to decline to rule on the applicants’ private ruling application.

Must the Commissioner rule on anything?

In theory, with enough information, the Commissioner can provide any private ruling on the way in which the Commissioner considers a tax law applies or would apply to any set of current or future facts and circumstances to a private ruling applicant. Does this afford scope for a determined taxpayer to base an extravagant application for a private ruling on a favourable but not necessarily realistic matrix of circumstances, which are yet to occur, particularly in an anti-avoidance context? Is this matrix really “information” which the private ruling must reflect?

Under the private ruling regime in Schedule 1 of the Taxation Administration Act 1953 (“Sch 1 TAA”) there are two competing limitations on the issue of private rulings:

  • If the Commissioner finds that further information is needed to make a private ruling then the Commissioner must request the applicant for that information – the Commissioner can only decline to rule if the applicant does not provide the information requested within a reasonable time: section 357-105 of Sch 1 TAA.
  • If correctness of a private ruling depends on an assumptions about a future event or other matter the Commissioner may either decline to rule or make assumptions that the Commissioner considers most appropriate: section 357-110 of Sch 1 TAA.

Info&Assumptions

Commissioner of Taxation v Hacon Pty. Ltd.

In Commissioner of Taxation v Hacon Pty. Ltd. [2017] FCAFC 181 the applicants sought a private ruling over whether the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 would apply to a proposed demerger of assets in their farming group which included a routing of the assets, by way of dividends on redeemable preference shares, to a new series of trusts.

The applicants asserted that the matters on which the Commissioner declined to rule, which were expressly listed as assumptions about future events, could have been satiated by information which the Commissioner could and should have sought from the applicants as required by section 357-105. The applicants successfully contended this at first instance in the Federal Court. However the Full Federal Court on appeal by the Commissioner, comprising Robertson, Pagone and Derrington JJ., took a different view. The Court, at paragraph 8 of the joint judgment, observed that:

The word “information” is an ordinary English word apt to cover a large range of facts and circumstances including events yet to occur and assumptions about future events.

and found that the matters set out in the Commissioner’s letter, although satiable by information, did indeed require assumptions about future events or other matters so that declining to rule, without seeking explanation by way of information from the applicant, was an option available to the Commissioner under section 357-110.

Assumptions give scope to the Commissioner to opt out

It follows from the decision of the Full Federal Court in Commissioner of Taxation v Hacon Pty. Ltd. that, if the Commissioner needs to make assumptions about future events in order to rule in a private ruling application, the Commissioner can opt not to rule rather than being obliged to make assumptions which are not appropriate in the Commissioner’s estimation. That view can be apposite for future events where the information an applicant provides about them may not be convincing.

Only a loan? Impugnable loans, proving them for tax and shams

Is a loan just a sum advanced to be repaid by a borrower to a lender? Accountants understand that a loan can be a nimble device to explain and show why money and value is elsewhere even when the relationship between the borrower and the lender is not arms length or clear.

Necessary elements of a loan

So a loan is recognised. It is clearly recorded in the books of account and appears as a liability in the financial statements of the “borrower”, the “lender” or frequently both. The individual, who is the controlling mind of the borrower, says yes, it is a loan, and the apparent lender, who has an established relationship with that individual, doesn’t say it is not. Will that apparent loan be accepted as a loan by all persons interested?

A number of recent tax cases in the aggressive tax planning space show that, in those kinds of cases, the Commissioner of Taxation is prepared to commit significant resource and effort into:

  1. disabusing courts that arrangements with the appearance of loans are loans in fact; and
  2. pursuing high profile tax scheme promoters and their clients using arrangements based on inpugnable loans.

A wide but demarcated construct

There is no doubt that a loan is a wide concept. In Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements, the Commissioner took a wide view of what amounts to a loan, or to what amounts to at least one or more of:

(a) an advance of money; and

(b) a provision of credit or any other form of financial accommodation; and(d) a transaction (whatever its terms or form) which in substance effects a loan of money.

(c) a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and

(d) a transaction (whatever its terms or form) which in substance effects a loan of money.

included as a loan under sub-section 109D(3) of the Income Tax Assessment Act (“ITAA”) 1936

which triggers a deemed dividend to a shareholder or an associate under Division 7A of the ITAA 1936. The “loan” regime in Division 7A is an exception though. Generally, if a taxpayer can establish that a sum received is received as an advance of a loan, that receipt can explain why that money or value is not in the nature of income that may be assessable to the taxpayer. That is a vital capability when the schema of Australian income tax recovery is “asset betterment” allowing the Commissioner to assert that money or value received is income unless the taxpayer can prove that it is otherwise.

Hart v Commissioner of Taxation (No 4)

So it was in Hart v Commissioner of Taxation (No 4) [2017] FCA 572, a decision of Bromwich J. of the Federal Court, concerning the personal tax affairs of the senior tax partner of Brisbane-based law firm and tax planning and tax scheme services provider Cleary Hoare. Mr Hart asserted that the amount in dispute in that case was a loan to him by an associated trust clearly recorded as a credit loan in the books of the trust.

The firm of Cleary Hoare was operated by a practice trust (“the Practice Trust”) in which discretionary trusts of the partners owned units in the Practice Trust which, it transpired, was not structured in accord with Queensland legal professional practice rules. The discretionary trust of Mr Hart owning units in the Practice Trust was referred to in the decision as the Outlook Trust.

Loan or benefit or both to the taxpayer (“borrower”)?

During the 1997 income year, the Outlook Trust included $220,398 in its assessable income as a distribution to it as a unitholder in the Practice Trust under section 97 of the ITAA 1936. The distribution was routed by a series of on-distributions through a network of interposed trust entities associated with Cleary Hoare, or its associates, to a company carrying significant tax losses, Retail Technology Pty. Ltd. and by the making of gifts by way of promissory notes to and through entities that were associated with Cleary Hoare or its associates, including Mr Hart. The Commissioner took issue with the last flow of the money through the arrangement back to Mr Hart. The Commissioner viewed that last flow as a distribution to Mr Hart for the benefit of Mr Hart. For his part, Mr Hart contended that the payment was a loan to him from the Outlook Trust, or alternatively from the Practice Trust, and that the payment was so recorded in the books of account of the Outlook Trust.

The Commissioner also pressed a number of alternative cases including a case that, even if the payments were not trust distributions, the application of general anti-avoidance provision in Part IVA of the ITAA 1936 meant that, in the absence of the scheme, the money would still have been paid to Mr Hart and instead been taxable, to which Mr Hart, for his part, contended that such payments would not have taken place in the absence of the scheme.

Present entitlement by benefiting trust beneficiaries

One of the alternative cases run by the Commissioner was that payments benefiting Mr Hart of at least $84,615.52 of the $220,398 were assessable directly to Mr Hart who was also a special unitholder, as trust distributions to him by the Practice Trust. In the absence of a sustainable case that the $220,398 or any part of it was a loan, the court could find that sections 95A and 101 of the ITAA 1936, which have the effect of deeming payments to or for the benefit of a beneficiary to be payments to which the beneficiary is presently entitled, applied to bring the $84,615.52 into the special unitholder’s assessable income for the 1997 income year.

Although this finding did not directly inform the character of the remaining $135,782, this application of sections 97, 95A and 101 of the ITAA 1936 to at least $84,615.52 of the amount in dispute, which the court accepted, did not assist Mr Hart to prove that the assessment of the greater $220,398 was excessive.

How Mr Hart’s loan contention failed

The court deduced from the submissions of the parties that whether the 1997 assessments of Mr. Hart were excessive or not turned on whether Mr Hart received the $220,398 as a loan. Mr Hart’s counsel contended that the evidence of Mr Hart, including the accounts of the Outlook Trust which showed the borrowing to Mr Hart, was sufficient to show that the funds had been loaned to Mr Hart. However other evidence caused this contention to unravel, viz.:

  1. there was nothing in writing to record or otherwise evidence a loan;
  2. there was no interest paid or payable under the purported loan;
  3. there were no repayments required or made under the purported loan, despite more than 19 years having elapsed since the advance of money under the purported loan (and the “creditor” trust had not traded for 15 years); and
  4. there were records of contemporaneous bank statements showing “pay” or “sol[icitor] pay” which were made on a fortnightly basis to a bank account of Mr and Mrs Hart between at least 5 July 1996 and 23 April 1997.

In addition to this evidence, which the court found, of itself, compelling, was the coup de grâce of a credit approval request by Mr. Hart to Suncorp Bank for two loans in 1999 in which Mr Hart, as an applicant providing personal details, appeared to state he had income of precisely $220,398 in 1997. The court observed that stating this, if it was nothing more than antecedent indebtedness, was hardly going to assist in securing a further loan, so it didn’t make sense as a loan.

Was the loan a sham?

Mr Hart’s counsel asserted that, as the Commissioner had not demonstrated that the purported loan was a sham, the court was obliged to accept the evidence lead by Mr Hart viz. his testimony and the accounts of the Outlook Trust, that there had been a loan. The court observed that a sham requires there to be a purported transaction which is falsely presented as being genuine. The court agreed with the Commissioner that, in this case, there was thus no sham loan, but that no loan had been proven to exist with the burden of proving that there was a loan on the taxpayer.

Loan terms in writing?

In Hart v Commissioner of Taxation (No 4), the taxpayer relied on an undocumented related party loan recorded only in the accounts of a related trust which gave the Commissioner leeway to run a case based on there being no loan at all. That leeway is reduced, of course, if the loan is reduced to writing in a loan agreement. However if that writing does not present the real arrangement then the loan can still be impugned by the Commissioner and the issue of sham will more likely arise with that false presentation.

Commissioner of Taxation v Normandy Finance and Investments Asia Pty Ltd

The taxpayer in Commissioner of Taxation v Normandy Finance and Investments Asia Pty Ltd [2016] FCAFC 180 faced that predicament.

Mr. Townsing was a client of Vanda Gould, a Sydney accountant and offshore tax scheme promoter. The taxpayer and two other companies were controlled by Mr Townsing. The taxpayer asserted that these companies were borrowers under loans from three companies controlled by Mr Gould recorded in written loan arrangements with those companies.

The Townsing controlled companies received substantial advances from the Gould controlled companies. The Commissioner asserted that payments to the Townsing controlled companies were sham borrowings used by Mr Townsing to bring assets held for his benefit into Australia and that they were thus assessable income of the companies.

The judges in this case noted the excessive length of the submissions of more than 1000 pages of submission material, ostensibly in support of oral argument at trial, to the primary judge by the taxpayer and the Commissioner.

Edmonds J. of the Federal Court, (Normandy Finance Pty Ltd v FCT [2015] FCA 1420) found for the taxpayer at first instance but did so on what was to prove a precarious basis. Edmonds J. found that the loans were not shams, even though the loan documents revealed disguises and pretences directed to demonstrating that the loans were at arms length, when the evidence was that the advances under the purported loans happened differently, and not at arm’s length. Still Edmonds J. found that, despite these irregularities, elements of the loans, including commitments to repay the loans, could be indentified in the evidence and so the loans were allowed to stand.

Appeals

The Commissioner appealed to the Full Federal Court. All three judges of the Full Federal Court closely considered the evidence that was before Edmonds J., and the majority, Jagot and Davies JJ., found that the basis on which Edmonds J. had recognised the loan arrangements as loans, distinct from the impugned purported written loan agreements, was expressly negated by the evidence of Mr Townsing under cross-examination by senior counsel for the Commissioner. The majority concluded that, in his evidence, Mr Townsing had rebuffed the facts upon which Edmonds J. had relied to find that there were loans not shams. Logan J., in the minority, disagreed with the majority and agreed with the trial judge’s approach to the evidence.

The taxpayer sought special leave to appeal from the Full Federal Court to the High Court but leave was refused by the High Court on the basis that the taxpayer did not have sufficient prospects of success of reversing the Full Federal Court majority’s findings.

Take-outs

Documenting a loan in writing reduces the scope of the Commissioner to assert there is no loan leaving the taxpayer, carrying the burden of the onus of proof, to prove the loan.

However documenting the loan may be a two-edged sword in contentious situations. Forcing the Commissioner to assert a sham will not necessarily give a taxpayer, who must disprove a sham in Part IVC of the Taxation Administration Act 1953 tax appeal proceedings, an advantage. Costs in litigation with the Commissioner to redress the consequences of a loan inadequately documented, can be significant. Poor documenting may have the adverse effect of revealing aspects of the arrangement that are not real or genuine. In other words, the pretences in the document and later compromising admissions by a taxpayer asserting the loan may irretrievably taint the believable in an asserted loan document and cause a loan to fail as a construct for a payment.

Loans not at arms length are the most likely to be challenged by the Commissioner. Trust beneficiary loan accounts may be held up to particular scrutiny. If a purported trust beneficiary loan is impugned sections 95A and 101 can trigger present entitlement to payments/advances to the beneficiary under the “loan” as assessable income.

These cases and the earlier Full Federal Court case of Millar v FCT [2016] FCAFC 94:

  1. which again involved an impugned loan devised by the Sydney accountant Vanda Gould for other clients; and
  2. where the taxpayers opted not to admit evidence from Mr Gould but relied on evidence of the relevant loan only from the lay taxpayer parties to the purported loan;

show that the Federal Court will not readily allow an appeal based on such restricted evidence as sufficient to prove the existence of a loan or to disprove a sham in the process of determining whether an assessment is excessive and that the High Court is reluctant to allow appeals to disturb these Federal Court decisions.

Are electronic records OK for tax?

They’re OK.

 

electronic paper-shredder

It’s clear on the ATO website that electronic storage of paper records is acceptable:

This article from Addisons explains the big picture:

  1. including in the context of record keeping obligations of companies under the Corporations Act 2001; and
  2. refers to the general requirement that taxpayers keep their (Commonwealth) tax related documents for five years.

ATO record keeping requirements in detail are in Practice Statement Law Administration PS LA 2005/2. PS LA 2005/2 shows that the period for keeping records referred to in the article can be longer than five years in certain cases. Records of documents going back to when an asset was acquired, even if prior to the introduction of capital gains tax in 1985, need to be kept for five years after the CGT asset is disposed of. It is also apparent under PS LA 2005/2 that the ATO can impose a range of penalties for failure to keep records including referring cases for criminal prosecution to the DPP where they perceive deliberate falsifications of records.

The article shows how ATO record keeping requirements reflect the Electronic Transactions Act (C’th) 1999. In essence, section 12 states that electronic records of paper documents required to be kept under Commonwealth law are OK if the electronic system is capable of conveniently and adequately reproducing the paper record. That section is referred to and is in line with Taxation Ruling TR 2005/9 Income tax: record keeping – electronic records.

Implementing electronic tax records

A taxpayer fails these requirements, and risks penalty, if electronic records are lost. Using a backup system is critical whatever electronic system is being used. Moreover electronic records have ease of duplication and filing advantages that make electronic records preferable to paper records.

There are other risks of loss of electronic records that should be borne in mind. Export to other formats from legacy or crippleware systems is an imperative when the records can no longer be retrieved from computer software say because the software becomes, over time, no longer licensed, no longer runs in the taxpayer’s operating system environment or the software itself has inherent restraints on its archiving capability. Many modern bookkeeping systems have easy to use export features which can be worthwhile using as a failsafe to ensure compliance with record keeping obligations.

Is a tax invoice that is only electronic OK?

The position with tax invoices is clear. In para 12 of Goods and Services Tax Ruling 2013/1 the ATO states:

Tax invoices in electronic form
  1. A document in electronic form that meets the requirements of subsection 29-70(1) (and if applicable, subsections 48-57(1) and 54-50(1)), will be in the approved form for a tax invoice. [Footnote 9 – This record must be in English or readily accessible and easily convertible to English as required by subsection 382-5(8) of Schedule 1 to the TAA 1953.]

The burden of proof in a tax objection

The onus or requirement of proof differs in different kinds of disputes in Australia. The most familiar is the burden or onus on a prosecution in a criminal court to establish a case beyond reasonable doubt. In civil court cases the burden or onus is on a claimant to prove a case on the balance of probabilities. In those kinds of cases the defendant may not need to prove anything.

Burden of proof in tax cases

In tax cases a reverse burden or onus applies. A tax assessment is taken to be right unless the taxpayer can prove otherwise.

Why is that? The answer is probably more practical than philosophical. In any case, it’s a bad idea not to return income and to wait for the commissioner to do the task because the commissioner’s findings will be hard to rebut if the commissioner is taken to be right to begin with.

Either in the case of a decision on an income tax objection:

the burden of proving that the assessment is excessive or is otherwise incorrect and of proving what the assessment should have been is on the taxpayer under the Taxation Administration Act (C’th) 1953. Similar state laws putting the burden of proof on to taxpayers apply to state taxes.

Is an objection needed to amend a tax assessment?

A tax assessment by the Australian Taxation Office is of full effect and taken to be right even if it may be wrong. The onus is on the taxpayer to show that a tax assessment is wrong.

Assertive correction of an assessment by objection

An objection is the serious and assertive way to challenge or dispute a tax assessment. Under the income tax law, for instance, an assessment is taken to be correct and conclusive except where the taxpayer takes steps to challenge the assessment under Part IVC of the Taxation Administration Act (C’th) 1953. A tax objection is the way by which a taxpayer takes or commences that challenge.

Other methods of challenge such as seeking an amendment of an assessment, including informally, from the commissioner or seeking judicial review carry major risks and disadvantages:

Unassertive requests for an amendment

A request to a commissioner of taxation to amend an assessment, including a request for alternative dispute resolution, has almost no legal standing but it is very common. If a commissioner grants a request to amend an assessment then there is no problem. If not, can a taxpayer complain about the request or the manner in which the request was denied? The starting point is that the taxpayer had a right to make an objection but, because the taxpayer didn’t use that right, the taxpayer has no standing to demand an alteration to an assessment from the commissioner.

Unusual forms of challenge

The Australian Constitution gives citizens rights to challenge actions by Commonwealth officers. That said Australian courts have found that these constitutional rights and related laws do not extend to challenges to tax assessments, except under the most limited circumstances, as taxpayers are directed to challenge under Part IVC – they must “object”.

Judicial review and similar actions are expensive, especially when compared to the costs of preparing an objection, and the decided court cases usually show failure when they are used to challenge tax assessments with the consequence that the taxpayer is require to meet the court costs of the commissioner as well as the taxpayer’s own costs.

So it is an objection that counts

Assessments and objections are thus vital steps in Australia’s tax system that rank with the significance of tax returns.