Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)
Chapter 4 Penalties
This chapter sets out the operation of the new penalty provisions which govern the behaviour required of self assessing taxpayers. The key features are:
- all taxpayers will be required to exercise reasonable care in conducting their tax affairs. Failure to exercise reasonable care will attract a penalty of 25% of a tax shortfall or franking tax shortfall caused by the failure;
- taxpayers with large claims (generally $10 000 tax or more) will, in addition, be required to ensure that the positions they adopt are reasonably arguable. Failure to have a reasonably arguable position will attract a penalty of 25% of a tax shortfall or franking tax shortfall caused by the failure;
- a taxpayer who has received a Private Ruling from the Commissioner on a matter (see Chapter 1) but does not follow the ruling when preparing its return will also be liable to pay a penalty of 25% of a tax shortfall or franking tax shortfall caused by not following the ruling;
- taxpayers who behave recklessly with regard to their tax affairs, or who set out to deliberately evade tax will also be penalised (at 50% and 75% respectively) in respect of any tax shortfall or franking tax shortfall caused by their behaviour;
- taxpayers who enter into schemes for the sole or dominant purpose of avoiding tax will be liable to pay penalty of 50% of the tax sought to be avoided by the scheme, reduced to 25% if the position taken by the taxpayer is reasonably arguable. This will be so, irrespective of the provision of the ITAA used by the Commissioner to defeat the scheme;
- penalties may be increased by 20% of the penalty if a taxpayer hinders the Commissioner's enquiries, or decreased by 20% of the penalty if the taxpayer discloses a tax shortfall or scheme to the Commissioner during an audit;
- taxpayers who voluntarily disclose a tax shortfall or scheme to the Commissioner before the Commissioner enquires into the taxpayer's affairs will have the penalty reduced by 80%;
- all penalties will be subject to the Commissioner's discretion to remit the penalty in whole or in part;
- the penalties mentioned above will be subject to full review rights.
The Bill gives effect to changes announced in section 2 of the August 1991 information paper entitled 'Improvements to Self Assessment - Priority Tasks'.
The Bill will remove the present administrative penalty standard of 'false or misleading statements' contained in section 223 of the ITAA and replace it with a series of provisions which outline the circumstances when taxpayers may be penalised in respect of shortfalls in the assessment of their tax liability. Each of the shortfall sections prescribe the penalty attracted where the provision is breached, instead of the present approach of penalty being attracted at 200% in all cases subject to the Commissioner's discretion to remit. The Commissioner will however maintain a discretion to remit the penalty otherwise attracted in those cases where the penalties prescribed in the law may not provide a just result.
The changes to the penalty provisions should be read in conjunction with the changes to the interest system also introduced by this Bill. See Chapter 5. The penalties described in this chapter are flat percentage amounts which relate to the degree of culpability in understating taxable income. Interest under the interest system will be payable in addition to any penalty.
The changes to the penalty provisions are necessary because the current penalty standard no longer reflects what is required of taxpayers. Rather than making a full and true disclosure of all material facts to the Commissioner so that the Commissioner can actively assess a taxpayer's liability, taxpayers are now effectively required to determine their own taxable income. The new penalties set out the standards that taxpayers should meet in fulfilling their tax obligations in a self assessment environment. Similar changes are made in respect of company taxpayers who self assess their liability to franking deficit tax.
Generally, where taxpayers exercise reasonable care, and, for large items, have a reasonably arguable position, they will not be subject to penalties.
The Bill will amend Part VII of the ITAA to repeal section 223 and to insert a number of new provisions to reflect the circumstances where taxpayers will be subject to penalty, the rates of penalty and the circumstances in which the rates may vary (eg., aggravating factors and voluntary disclosures). Sections 224, 225 and 226 which apply where specific anti-tax avoidance provisions apply, will be amended to change the rates of penalty attracted under those provisions and to insert the circumstances under which the penalty may be reduced.
In addition, the Bill will amend Division 11 of Part IIIAA of the ITAA to make corresponding changes in respect of company taxpayers which are required to self assess their liability to franking deficit tax.
Finally, the Bill will amend section 14ZS of the Administration Act to ensure that the penalties mentioned above are subject to full review rights.
The chart opposite summarises the rates of penalty. All rates are expressed as a percentage of the tax shortfall caused by the culpable behaviour, or of the tax sought to be avoided through participation in a tax avoidance scheme, and are subject to the Commissioner's discretion to remit the penalty in whole or in part. Interest applies whether or not the penalty provisions apply.
Who the changes affect and when
The amendments to the penalty provisions introduced by the Bill apply to all taxpayers. The shortfall sections (sections 226G, 226H, 226J, 226K, 226L and 226M, and 160ARZA, 160ARZB, 160ARZC, 160ARZD and 160ARZE) apply to:
- tax shortfalls for the 1992-93 year of income and all subsequent years (but excluding substituted accounting periods that are in lieu of the 1992-93 year of income that commence before 1 July 1992); and
- franking tax shortfalls for the franking years that commence on or after 1 July 1992;
that are caused by acts or omissions that occur after the Bill receives Royal Assent. [subsection 34(2) of the Self Assessment Act - Subclause 34(2)]
|Culpable behaviour||Primary penalty||Primary penalty increased or decreased to:|||||if hindrance||if disclosure|||||during audit||before audit|
|Profit shifting (no dominant tax avoidance purpose)||25(10)*||30(12)*||20(8)*||5(2)*|
|No reasonable care||25||30||20||5|
|No reasonably arguable case||25||30||20||5|
|Private Ruling disregarded||25||30||20||5|
|* Bracket rates of penalty apply if the position adopted by the taxpayer is reasonably arguable|
The scheme sections (sections 224, 225 and 226), as amended by this Bill, apply in relation to assessments in respect of the 1992-93 year of income and all subsequent years, but excluding substituted accounting periods that are in lieu of the 1992-93 year of income that commence before 1 July 1992. [subsection 34(8) of the Self Assessment Act - Subclause 34(8)]
While sections 223 and 160AS of the ITAA are repealed by the Bill, they continue to apply in respect of the 1991-92 year of income and earlier years, and substituted accounting periods adopted in lieu of the 1992-93 year of income that commence before 1 July 1992, and franking years that commence before 1 July 1992. [subsections 34(3) and (7) of the Self Assessment Act - Subclauses 34(3) and (7)]
Scheme of the new penalties
The scheme of the new penalties is as shown in the diagram opposite.
A tax shortfall is the difference between the tax that is payable by a taxpayer for a year in accordance with the law (the 'proper tax') and the tax that would have been payable by the taxpayer for that year if it were assessed on the basis of statements made by the taxpayer (the 'statement tax'). [section 222A - Clause 26]
taxpayer's proper tax
taxpayer's statement tax
taxpayer's tax shortfall
A franking tax shortfall is calculated on a similar basis. It is the difference between the franking deficit tax properly payable by a company for a year (the 'proper franking tax') and the franking deficit tax that would have been payable by the company for that year if it were assessed on the basis of statements made by the company (the 'statement franking tax'). [section 160ARXA -Clause 17]
While the explanation below is principally in respect of income tax shortfalls, similar considerations apply in respect of franking tax shortfalls. The references to clauses of the Bill include the references to the equivalent franking tax shortfall provisions, and additional comments are provided where appropriate.
It may be noted that a tax shortfall or franking tax shortfall is the gross amount by which a taxpayer has understated its tax liability. The shortfall sections operate to impose penalty in respect of the whole or a part of a shortfall, depending on how much of the shortfall was caused by culpable behaviour.
A taxpayer's 'proper tax' is the tax properly payable by the taxpayer in accordance with the income tax law [section 222A - Clause 26]. While in theory there is only one proper tax, in practice the figure may vary as a matter moves through the dispute process. The new ruling provisions (see Chapter 1) will also have an impact on proper tax.
Thus, where there is a Public Ruling which is relevant to a taxpayer's circumstances, or the taxpayer has received a Private Ruling, the proper tax would be the tax that would be assessed on the basis of that ruling. If there has been an objection decision in respect of the Private Ruling and no decision has been made on a review of that objection decision, the proper tax at that time would be the lesser of the tax that would be assessed on the basis of the ruling and the tax that would be assessed on the basis of the objection decision. If there is a decision of the AAT or court in respect of the Private Ruling, the proper tax at that time would be the tax that would be assessed on the basis of the AAT or court decision.
These considerations are relevant for the purpose of determining the amount of a tax shortfall for the purpose of the penalty imposed for disregarding a Private Ruling, or where a taxpayer self assesses on a basis inconsistent with a decision of the AAT or court on a Private Ruling. See 'Disregarding a Private Ruling' below.
A taxpayer's 'statement tax' is the tax that would have been payable if it were assessed on the basis of 'taxation statements' made by the taxpayer [section 222A - Clause 26]. The definition of a 'taxation statement' corresponds with the present definition of a 'statement' in subsections 223(8) and (9) of the ITAA, and includes statements made to persons other than taxation officers [section 222A]. The special circumstances presently covered by subsections 223(9A) to (9F) of the ITAA in respect of statements about qualifying securities are also covered by the definition. [section 222B - Clause 26]
For the purpose of franking tax shortfalls, the definition of 'taxation statement' corresponds with the present definition of a 'statement' in subsection 160AS(2) of the ITAA. [section 160ARXA - Clause 17]
In practice the relevant statements will usually be those made in returns, amendment requests and objections, as well as statements of fact made to a taxation officer in the course of an audit of the taxpayer's affairs. Statements on the operation of the law made to a taxation officer during an audit or in response to a questionnaire sent by the ATO would not normally give rise to tax shortfalls.
The definition of 'taxation statement' is limited in one very important respect, in that it does not include a statement of a taxpayer's view of the operation of the law made in an objection against an assessment or against a determination of a credit or an offset. A taxpayer is therefore able to dispute, if the taxpayer so wishes, an area of the law which may appear on the face of the relevant authorities to be fairly settled, without the risk of being penalised. The taxpayer could do this by either 'self assessing' on a basis consistent with the settled treatment and objecting against the assessment, or by seeking a Private Ruling on the matter and objecting against the ruling.
In a similar vein, penalties do not apply in respect of statements made in an appeal against a decision of the AAT or court. Such statements are not 'taxation statements' and so cannot give rise to a tax shortfall.
In most cases, the statements affecting how a taxpayer may be assessed in respect of a particular year will be made in a taxpayer's tax return, so that the taxpayer's 'statement tax' will be the tax that would be assessed on the basis of the return. This will usually be the figure shown on a taxpayer's notice of assessment, although there may be cases where the Commissioner detects an error prior to issuing the assessment. In these cases the 'statement tax' is the tax that would have been assessed if the Commissioner relied on the statement in the return as allowed under section 169A of the ITAA.
Statements may, however, be made elsewhere than in the taxpayer's return, for example, in an amendment request or during an audit. At any particular time, the statement tax in relation to a year of income is the tax that would be assessed on the basis of the statements made at or before that time. Where, because of statements made at a number of different times, statement tax is calculated more than once in relation to a year of income, the taxpayer's tax shortfall for the year is calculated by reference to the smallest statement tax (ie., the statement tax that produces the largest shortfall for that year of income).
A statement may give rise to a shortfall in more than one year of income [sections 222E and 160ARXC - Clauses 26 and 17]. For example, if a taxpayer makes a statement giving rise to a loss in one year which is carried forward to the next year there may be a shortfall both for the year in respect of which the statement was originally made and for the subsequent year. The shortfall in the subsequent year may be subject to penalty because of the statement made in the earlier year, depending on the circumstances which gave rise to that statement.
Two or more statements, each taken on their own, may give rise to the same tax shortfall, or the same part of a tax shortfall, but whether that shortfall or part attracts penalty depends on the operation of the shortfall sections. A shortfall section can apply only once in respect of a given shortfall or part.
Where a person omits from a return an amount of assessable income, the person is taken to have made a statement in the return that the income had not been derived [section 222F - Clause 26]. This makes clear that a taxpayer's statement tax is calculated on a basis which excludes the omitted income.
Certain shortfalls not shortfalls
Certain tax shortfalls are taken to not be tax shortfalls for the purposes of the shortfall sections and so cannot be subject to penalty [sections 226U and 226V, and 160ARZF and 160ARZG - Clauses 31 and 18]. A tax shortfall caused by a taxpayer adopting a favourable basis in respect of an arrangement will not be subject to penalty if the taxpayer has sought a Private Ruling on the arrangement prior to, or at the time of lodging the return which deals with the arrangement, and the Private Ruling has not been made by the Commissioner at the time the taxpayer lodges the return (provided the application is one the Commissioner is required to comply with) [sections 226U and 160ARZF]. A similar rule applies where a taxpayer seeks a Private Ruling in relation to a tax avoidance scheme. [section 226A - Clause 31]
If a Private Ruling, when made, is unfavourable to the taxpayer the Commissioner will amend the taxpayer's assessment and charge interest, as necessary. The protection provided by section 226U and 226A is only available if the arrangement set out in the ruling application is not materially different from the actual arrangement which was dealt with in the taxpayer's return.
A tax shortfall will also be taken not to be a tax shortfall if it was caused by a taxpayer treating the law as applying in a particular way, if the treatment agreed with advice given to the taxpayer by a taxation officer or a general administrative practice under the ITAA [sections 226V and 160ARZG]. A similar rule applies where a taxpayer's treatment of a tax avoidance scheme agrees with advice given or a general administrative practice. [section 226B -Clause 31]
A taxpayer will be liable to pay a penalty of 25% of a tax shortfall or franking tax shortfall caused by a failure by the taxpayer to take reasonable care to comply with the ITAA or regulations. [sections 226A and 160ARZA - Clauses 31 and 18]
The reasonable care test requires a taxpayer to exercise the care that a reasonable ordinary person would be likely to have exercised in the circumstances of the taxpayer to fulfil the taxpayer's tax obligations. Taxpayers must take reasonable care not only in the preparation of their return, but throughout the year on matters that may impact on their return, for example, record keeping. A tax shortfall may be caused not only by the taxpayer being careless in making (or not making) taxation statements, but also by the careless acts or omissions of the taxpayer which lie behind the statements that are (or are not) made. Whether a taxpayer has behaved reasonably will depend on all the facts of each case.
The test looks to whether an ordinary person, in all the circumstances of the taxpayer, would have foreseen as a reasonable probability or likelihood the prospect that the act or failure to act would result in a shortfall. It is not a question of whether the taxpayer actually foresaw the probable impact of the act or failure to act, but whether an ordinary person in all the circumstances would have foreseen it. The test does not depend on the actual intentions of the taxpayer.
Reasonable care requires a taxpayer to make a reasonable attempt to comply with the provisions of the ITAA and regulations. The effort required is one commensurate with all the taxpayer's circumstances, including the taxpayer's knowledge, education, experience and skill.
The reasonable care test is not intended to be overly onerous for ordinary taxpayers. For most ordinary taxpayers, an earnest effort to follow TaxPack instructions would usually be sufficient to pass the test. For example, if a taxpayer made a claim for a deduction without being able to substantiate the deduction in accordance with the substantiation provisions, then this would tend to indicate that the taxpayer had not taken reasonable care about the claim, since TaxPack makes plain the need to be able to substantiate work related expenses.
Similarly, a failure by a taxpayer to respond to a notice from the Commissioner under subsection 82KZA(2) to provide receipts required by the substantiation provisions would tend to lead to a presumption that the taxpayer had not exercised reasonable care in claiming the relevant deductions.
On the other hand, if a taxpayer who could not meet the substantiation requirements was able to show that he/she did not know and could not reasonably be expected to have known of the substantiation requirements, and had in fact incurred the relevant expenditure which would be deductible but for the substantiation requirements, the taxpayer would not be liable for penalty. Whether penalty is attracted will depend on the circumstances of the case.
For business taxpayers, reasonable care would require the putting into place of an appropriate record keeping system and other procedures to ensure that the income and expenditure of the business is properly recorded and classified for tax purposes. The fact that an employee of the business makes a careless error would not necessarily mean that the taxpayer is subject to penalty, provided that the taxpayer can show that its procedures are reasonably designed to prevent such errors from occurring. What is reasonable will depend, among other things, on the nature and size of the business, but could include, for example, internal audits, sample checks of claims made, adequate training of accounting staff and instruction manuals for staff.
On questions of interpretation, reasonable care requires a taxpayer to come to conclusions that would be reasonable for an ordinary person to come to in the circumstances of the taxpayer. If the taxpayer is uncertain about the correct tax treatment of an item, reasonable care requires the taxpayer to make reasonable enquiries to resolve the issue. Reasonable enquiry would include the taxpayer consulting someone or some text like an ATO publication or other reference in an effort to satisfy the taxpayer about the proper tax treatment of the item. The taxpayer would need to have reasonable grounds for believing the source consulted reflected the true tax position in respect of the item. A mere reading of a provision of the ITAA which the taxpayer believed to be the relevant one might not constitute a reasonable enquiry unless the taxpayer had reasonable grounds for believing that he/she had understood the requirements of the law. For example, a wrong interpretation of a statutory provision that is clear and unambiguous would tend to suggest that the taxpayer did not exercise reasonable care. The ultimate consideration would be the honest efforts of the taxpayer, as displayed by the actions of the taxpayer in the context of the taxpayer's circumstances, to ascertain the proper tax position.
The taking of a position with respect to an item that is frivolous, or which lacks a reasonable basis, would be a strong indication of a lack of reasonable care.
A taxpayer who prepares his/her own return would usually be taken to have exercised reasonable care if in doing so the taxpayer relies upon the advice of an accountant or lawyer or other person whom the taxpayer could reasonably expect to provide competent advice on the relevant matter. On the other hand, where such advice is not followed this would usually mean that the taxpayer did not exercise reasonable care.
If a taxpayer seeks to rely upon wrong advice, and the taxpayer's skill and education was such that the taxpayer could reasonably be expected to have known or suspected that the advice was wrong, the taxpayer would risk penalty. A taxpayer would also risk penalty if the taxpayer was careless in presenting all of the relevant facts to the advisor, and this had materially affected the advice on which the taxpayer sought to rely.
A taxpayer who relies upon advice from a third party of a fact that is material to the preparation of the taxpayer's return (eg., a bank providing a statement of the amount of interest earned by the taxpayer) will not usually be liable for penalty if the advice is wrong - taxpayers are ordinarily entitled to rely on such advice. However, if the taxpayer knew, or could reasonably be expected to have known or suspected that the advice was wrong, the taxpayer would risk penalty. For example, a group company may not have exercised reasonable care in claiming a deduction for a group loss transferred to it, if the company could reasonably be expected to have known or suspected (eg., because of common management and control of the transferor and transferee companies) that the deduction giving rise to the loss was not properly allowable to be transferor company.
For an explanation of the situation where a taxpayer uses a tax agent, see 'Taxpayer's who use tax agents' below.
Arithmetic errors may indicate a failure to take reasonable care but are not conclusive. For business taxpayers, as indicated above, it would depend on the procedures the taxpayer has in place to detect such errors. In other cases it may depend on the size, nature and frequency of the error, or the circumstances of the taxpayer in making the error, for example, if the taxpayer was under extreme stress at the time of preparing the return. If, notwithstanding that an arithmetic error was carelessly made, the Commissioner is convinced that the error was made honestly or inadvertently, the Commissioner may remit the penalty (section 227).
Reasonably arguable position
A taxpayer may be liable to pay a penalty of 25% of a tax shortfall or franking tax shortfall that is caused by the taxpayer taking a position on a question of interpretation (including a conclusion of fact, for example, whether the taxpayer is carrying on a business) that is not reasonably arguable at the time the position is taken [sections 226K and 160ARZD - Clauses 31 and 18]. The application of this penalty is subject to a threshold test (see below).
A position taken by a taxpayer will be reasonably arguable if, on an objective analysis of the law and the application of the law to the relevant facts, it would be concluded that the taxpayer's position was about as likely as not correct [sections 222C and 160ARZD - Clauses 26 and 18]. In other words the position must involve a clearly contentious area of the law, that is, one where the relevant law is unsettled or where, although the principles of law are settled, there is a serious question about the application of those principles to the circumstances of the particular case.
The test does not require the taxpayer's position to be the 'better view'; the standard is 'about as likely as not' and not 'more likely than not'. However, the reasonably arguable position standard would not be satisfied if a taxpayer takes a position which is not defensible, or that is fairly unlikely to prevail in court. On the contrary, the strength of the taxpayer's argument should be sufficient to support a reasonable expectation that the taxpayer could win in court. The taxpayer's argument should be cogent, well grounded and considerable in its persuasiveness.
For the purposes of determining whether a taxpayer has a reasonably arguable position for the tax treatment of an item, relevant authorities include the following [subsections 222C(4) and 160ARZD(4)]:
- an income tax law, for example a provision of the ITAA;
- material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901, such as explanatory memoranda and second reading speeches;
- a decision of a court, the AAT or a Board of Review;
- a Public Ruling issued by the Commissioner under the new ruling system introduced by this Bill. See Chapter 1.
This list is not intended to be exhaustive, and a wider range of authorities may be taken into account in weighing up the merits of the competing arguments. For example, authorities relating to other areas of the law (eg., contract law) may provide support for a particular treatment of an item. Taxation rulings issued by the Commissioner prior to the new arrangements introduced by this Bill may also be considered.
A taxpayer may have a reasonably arguable position for the tax treatment of an item despite the absence of authorities other than the law itself. What is required in such cases is that the taxpayer has a well-reasoned construction of the applicable statutory provision which it could be concluded was about as likely as not the correct interpretation.
An opinion expressed by an accountant, lawyer or other advisor is not an authority. However, the authorities used to support or reach the view expressed by the advisor, including a well-reasoned construction of the relevant statutory provisions, may support the position taken by a taxpayer.
The relevance of any authority is a matter to be weighed against other authorities, including the applicable statutory provisions, and the facts of the case. An authority that has some facts in common with the tax treatment at issue is not particularly relevant if the authority is materially distinguishable on its facts, or is otherwise inapplicable to the tax treatment at issue. An authority that merely states a conclusion is ordinarily less persuasive than one that reaches its conclusion by cogently relating the applicable law to the pertinent facts. It will be relevant, however, to consider the source of an authority. For example, a High Court decision on all fours with the tax treatment in question will be accorded more weight than a Federal Court decision, which in turn would be accorded more weight than a decision of the AAT.
Pending the progressive removal of Commissioner discretions from the law and their replacement with objective criteria, there will be cases where a taxpayer, in applying the tax law to the facts, will need to make an assumption about the way in which the Commissioner would act. In these cases, a taxpayer will have a reasonably arguable position to the extent that the assumption is in the range of positions which, if decided by the Commissioner in the circumstances of the case, a court would be about as likely as not to conclude was decided according to law. This approach effectively puts the taxpayer in the shoes of the Commissioner, and looks to whether the taxpayer, in making the assumption, has taken into account all relevant considerations, and not taken into account any irrelevant considerations, that bear materially on the decision reached. [subsections 222C(2) and 160ARZD(3) - Clauses 26 and 18]
Where a taxpayer is uncertain of whether the position the taxpayer wishes to adopt is reasonably arguable, the taxpayer can seek a Private Ruling on the matter. See Chapter 1.
A taxpayer will only be liable for penalty for not having a reasonably arguable position where the shortfall caused by the position is greater than the higher of $10 000 or 1% of the tax that would have been payable on the basis of the taxpayer's return [paragraphs 226K(c) and 160ARZD(1)(c) - Clauses 31 and 18]. The use of the threshold ensures that the reasonably arguable position standard applies to only a relatively small number of taxpayers.
1. Tax shortfall less than the threshold:
- a taxpayer's return tax is $10m;
- the taxpayer has omitted income from the sale of property resulting in a tax shortfall of $500 000;
- 1% of the return tax ($100 000) is higher than $10 000;
- because the tax shortfall is greater than $100 000 the taxpayer must have a reasonably arguable position to support the non-inclusion of the income from the sale of the property to avoid being penalised under section 226K. (Note: even if the taxpayer has a reasonably arguable position, the taxpayer may be subject to penalty under another shortfall section.)
Where a position taken by a taxpayer results in a shortfall in 2 or more years of income, each shortfall is tested against the return tax for the year of income to which it relates, to determine whether the reasonably arguable position test must be satisfied in respect of that shortfall.
Where a tax shortfall is caused by the taxpayer treating the law as applying in a particular way in respect of a number of different matters, the taxpayer will only need to have a reasonably arguable position in respect of the treatment of those matters that cause a part of the shortfall to exceed the threshold. However, if any of the matters are identical, for example, 2 separate lease payments for the same item of plant, the parts of a shortfall caused by the treatment of the 2 payments will be amalgamated for the purposes of testing that part of the shortfall against the threshold. This rule is designed primarily to prevent taxpayers seeking to split single matters up so as to come under the threshold. It is not intended, for example, that many small repairs to many substantially similar but discrete items of plant would be treated as a single matter. [paragraphs 226K(b) and 160ARZD(1)(b) - Clauses 31 and 18]
Treating law as not applying
The term 'treating an income tax law as applying in relation to a matter in a particular way' is used in section 226K to focus on a tax shortfall or part of a tax shortfall brought about because of a position taken by a taxpayer on a question of interpretation [paragraph 226K(b)]. The term, or variations of it, is also used in a number of other penalty provisions, for example, sections 226A, 226B, 226L, 226P and 226S and sections 160ARZD, 160ARZF and 160ARZG. For the purposes of the penalty provisions a taxpayer will be taken to have treated an income tax law as applying in a particular way even where the taxpayer treats a provision as not applying to a matter, for example, where the taxpayer treats a provision as not applying to include an amount in assessable income, or as not applying to disallow a deduction. [sections 222D and 160ARXB - Clauses 26 and 17]
Disregarding a Private Ruling
A taxpayer who applies for and receives a Private Ruling on an arrangement is required to follow the ruling when determining his/her taxable income for assessment purposes. If the taxpayer does not follow the ruling and as a result there is a tax shortfall or franking tax shortfall, the taxpayer will be liable to pay a penalty of 25% of the shortfall. [sections 226M and 160ARZE - Clauses 31 and 18]
For an explanation of how the shortfall would be calculated for the purposes of this penalty, refer to the explanation of 'proper tax' under the heading 'tax shortfalls' above.
This penalty does not apply if there has been a decision of the AAT or of a court that applies to the ruling [subsections 226M(2) and 160ARZE(2)]. In such a case the taxpayer would be expected to follow the decision of the AAT or court when determining taxable income, even if the taxpayer has appealed against the decision. Failure to self assess in accordance with the decision of the AAT or court would ordinarily amount to a failure to take reasonable care under section 226G or 160ARZA.
Where a taxpayer seeks a ruling after lodging the relevant return of income, this penalty does not apply. If the Commissioner rules against the taxpayer, the Commissioner will amend the taxpayer's assessment to give effect to the ruling. The application for a ruling after the return has been lodged may, however, qualify as a voluntary disclosure, and so affect the rate of penalty that may be applicable to a shortfall.
A taxpayer will be liable to pay a penalty of 50% of a tax shortfall or franking tax shortfall caused by the taxpayer behaving recklessly with regard to the operation of the tax law. [sections 226H and 160ARZB - Clauses 31 and 18]
A taxpayer would be behaving recklessly if the taxpayer's conduct shows disregard of, or indifference to, consequences forseeable by a reasonable person. A finding of dishonesty is not necessary for a taxpayer to be subject to this penalty.
For example, a taxpayer who purchases shares in a company, but who makes no attempt to find out the tax consequences of receiving dividends, and who destroys letters from the company (after banking the dividend cheque) without reading them would be penalised 50% of any tax shortfall which results from the taxpayer failing to return the dividends as income. The concept of recklessness for the purposes of this penalty covers behaviour which could be described as gross negligence.
For an explanation of the situation where a taxpayer uses a tax agent, see 'Taxpayers who use tax agents' below.
Where a taxpayer excludes from its assessable income an amount knowing it to be assessable, or claims a deduction, rebate, credit or offset knowing that it is not allowable, the taxpayer will be liable to a penalty of 75% of a tax shortfall or franking tax shortfall so caused. [sections 226J and 160ARZC - Clauses 31 and 18]
For an explanation of the situation where a taxpayer uses a tax agent, see 'Taxpayers who use tax agents' below.
Where a taxpayer enters into a tax scheme with the sole or dominant purpose of avoiding tax, the taxpayer will be liable to pay a penalty equal to 50% of the tax sought to be avoided. The penalty will be reduced to 25% if the correctness of the treatment of the scheme by the taxpayer was reasonably arguable [amended sections 224, 225 and 226, and section 226L - Clauses 28, 29, 30 and 31]. There are no equivalent provisions that relate to franking deficit tax.
Tax avoidance caught by Division 13 and comparable provisions in Australia's double tax agreements (eg., through the use of 'non arm's length' prices in international dealings), but which cannot be characterised as having been caused by a scheme entered into for the sole or dominant purpose of avoiding tax, will attract a penalty of 25%, reduced to 10% where the treatment of the transaction or arrangement was at the time of lodging the return about as likely as not the correct treatment. [amended section 225 - Clause 29]
Sections 224, 225 and 226 of the ITAA are amended by the Bill to reflect the new rates of penalty and the circumstances where the penalty may be reduced. The sections are otherwise unchanged by the Bill. Because these sections contemplate action by the Commissioner in applying a discretionary anti-avoidance provision against a taxpayer, the 'reasonably arguable' test looks at whether it is about as likely as not that the anti-avoidance provisions do not apply. This would be the case, for example, in relation to a scheme to which Part IVA had been applied, if there was a sound case for concluding that either:
- one of the pre-conditions to the operation of the Part had not been satisfied (eg., the scheme did not have the relevant dominant purpose); or
- the Commissioner had erred in law in making the determination (eg., had taken into account irrelevant considerations in exercising his discretion to make the determination). [paragraph 226(2)(b) and subsection 222C(3) - Clauses 30 and 26]
In a case to which Division 13 of the ITAA applied a taxpayer would need to demonstrate that, for example, the price the taxpayer had used was about as likely as not the 'arm's length price' [subsection 225(1A) - Clause 29]. A taxpayer would be best placed to show that its prices were 'arm's length' if it maintained documents that were brought into existence as part of the process of determining the prices.
Section 226L penalises at the same rates of penalty as sections 224, 225 and 226, schemes entered into for the sole or dominant purpose of avoiding tax, but in respect of which the Commissioner has not applied any of the anti-avoidance provisions covered by sections 224, 225 and 226 [Clause 31]. This recognises that most schemes are found to be ineffective under the ordinary provisions of the ITAA (eg., sections 25 and 51) without recourse to the anti-avoidance provisions. Schemes defeated under the ordinary provisions face the same penalties as if an anti-avoidance provision had been invoked, if it can be concluded that the scheme was entered into for the sole or dominant purpose of avoiding tax.
Taxpayers who use tax agents
The ATO, in conjunction with taxpayer and tax professional representative bodies, is looking at whether tax agent penalties or some other form of regulation of tax agents is appropriate, and if so, the level of those penalties or the form of regulation.
Pending that review, and as an interim measure designed to protect the Revenue, the Bill maintains the current position that a taxpayer is liable to penalties for shortfalls caused by the culpable conduct of a tax agent in dealing with the taxpayer's affairs. Thus, where a taxpayer has a tax shortfall or a franking tax shortfall that is caused by a registered tax agent either failing to take reasonable care, behaving recklessly or intentionally disregarding the provisions of the ITAA, the taxpayer will be liable to pay penalty at the relevant prescribed rate [sections 226G, 226H and 226J, and 160ARZA, 160ARZB and 160ARZC - Clauses 31 and 18]. Penalties attracted under the other shortfall sections or under the scheme sections fall on the taxpayer irrespective of whether the taxpayer uses a tax agent, since those penalties do not depend on a taxpayer's behaviour for their application.
It may be noted that just because a taxpayer goes to a tax agent this is not conclusive as to whether the taxpayer has, for example, exercised reasonable care in carrying out his/her tax obligations. If the taxpayer does not provide a full and true disclosure of all the relevant facts to the tax agent, and that gives rise to a tax shortfall, the taxpayer would not have exercised reasonable care. Similarly, there may not have been reasonable care on the part of the taxpayer if the taxpayer could reasonably have been expected to pick up errors of fact or law when signing the return. Nevertheless, there will be cases where penalty is attracted solely because of culpable behaviour on the part of the tax agent.
A taxpayer who is liable to pay penalty because of the negligence of the taxpayer's tax agent is able to sue the tax agent for recovery of the penalty under section 251M of the ITAA. Section 251M is amended by the Bill to also provide for a taxpayer to recover from a negligent tax agent any interest payable under sections 170AA or 207A. [Clause 32]
Where both the tax agent and the taxpayer have exercised reasonable care but there is nevertheless a shortfall, then the shortfall will not attract penalty. For example, where the shortfall arose through an inadvertent error or honest mistake of the tax agent in circumstances where reasonable care had been exercised (eg., a transposition error by a staff member), that shortfall would not attract penalty.
Partners and trustees
Special rules outline how the penalty imposed by sections 226G, 226H, 226J, 226K and 226L apply in the case of partners and trustees [sections 226N to 226T - Clause 31]. The special rules basically mirror the approach of subsections 223(2), (4) and (5) of the ITAA. The other penalty sections operate according to their terms to all taxpayers, including partners and trustees.
A defaulting partner, that is, one who makes a statement relating to the net income or partnership loss of the partnership (a 'partnership taxation statement' - section 222A), the effect of which is to understate the net income of the partnership, or to overstate the partnership loss, may be liable to pay penalty in respect of each partner's 'partnership shortfall excess' that arises because of the statement. The defaulting partner will be so liable if the statement made by the defaulting partner:
- was caused by carelessness, recklessness, or intentional disregard of the ITAA or the regulations by the defaulting partner; [section 226N]
- treats an income tax law as applying in relation to a matter in a particular way that is not reasonably arguably correct, where the impact of the treatment on the net income or partnership loss of the partnership would have exceeded the higher of $20 000 or 2% of the net income of the partnership as returned; [section 226P]
- treats an income tax law as applying in relation to a scheme in a particular way, where the scheme was entered into for the sole or dominant purpose of avoiding tax. [section 226Q]
A 'partnership shortfall excess' [section 222A - Clause 26], in relation to a partner, is the difference between:
- what would have been the partner's tax shortfall if the partner had returned what would have been his/her share of the net income, or partnership loss, of the partnership if the net income (or loss) were calculated on the basis of the defaulting partner's partnership taxation statement; and
- what would have been the partner's tax shortfall (if any) if the partner had returned his/her share of the correct partnership net income.
The rules in respect of trustees are basically the same as for partners. Thus, a trustee may be liable to pay penalty in respect of each beneficiary's 'estate shortfall excess' that arises because of a statement by the trustee relating to the net income of the trust estate (an 'estate taxation statement' - section 222A). The trustee will be so liable if the trustee's statement:
- was caused by carelessness, recklessness, or intentional disregard of the ITAA or the regulations by the trustee; [section 226R]
- treats an income tax law as applying in relation to a matter in a particular way that is not reasonably arguable where the impact of the treatment on the net income or loss of the trust would have exceeded the higher of $20 000 or 2% of the net income of the trust as returned; [section 226S]
- treats an income tax law as applying in relation to a scheme in a particular way, where the scheme was entered into for the sole or dominant purpose of avoiding tax. [section 226T]
An 'estate shortfall excess' [section 222A - Clause 26], in relation to a beneficiary, is the difference between:
- what would have been the beneficiary's tax shortfall if the beneficiary had returned what would have been his/her share of the net income of the trust estate if the net income were calculated on the basis of the trustee's trust estate taxation statement; and
- what would have been the beneficiary's tax shortfall (if any) if the beneficiary had returned his/her share of the correct trust estate net income.
The definitions of 'partnership shortfall excess' and 'estate shortfall excess' work on the basis of the effect each statement made by the defaulting partner or trustee would have on the net income of the partnership or trust, and the consequence for each partner or beneficiary. To cover cases where an amount of assessable income is omitted from the partnership or trust return, section 222F provides that the person who omitted the income is taken to have made a statement that the income had not been derived. [Clause 26]
Nothing in the special rules relating to trustees is to be taken to mean that a trustee may not be liable (as a taxpayer) under any of the shortfall sections in respect of the trustee's own tax shortfall. [subsections 226R(2), 226S(2) and 226T(2)]
Hindering the Commissioner etc.
There are three situations where a taxpayer liable to pay penalty may be liable to pay a further penalty of 20% (eg., a taxpayer liable to pay a penalty of 25% may have that penalty increased to 30%). [sections 226X and 160ARZI - Clauses 31 and 18]
The first situation is where a taxpayer takes steps to prevent or hinder the Commissioner from discovering part or all of the tax shortfall [subparagraphs 226X(b)(i) and 160ARZI(b)(i)]. This would include, for example, unreasonable delay by the taxpayer in responding to enquiries by taxation officers, or the taxpayer failing to attend an interview at a time previously agreed without a reasonable excuse. It would also include instances where the taxpayer destroyed relevant records, or colluded with other persons (after the relevant statement had been made) to conceal part or all of the shortfall.
The second situation is where a taxpayer becomes aware of an error in calculation or fact that has caused a tax shortfall and fails within a reasonable time to notify the Commissioner of the error [subparagraphs 226X(b)(ii) and 160ARZI(b)(ii)]. This covers situations such as where a taxpayer relies upon factual information from a third party in preparing the taxpayer's return, and subsequently finds that the information supplied was inaccurate (eg., the separate net income of the taxpayer's spouse). This rule does not require a taxpayer to monitor developments in the law, but rather looks solely at errors of a factual nature.
The third situation where a taxpayer may be liable to further penalty is where the taxpayer has been penalised in an earlier year. If a taxpayer is liable to penalty for carelessness, recklessness or deliberate evasion (sections 226G, 226H or 226J, or 160ARZA, 160ARZB or160ARZC), and has been penalised in a prior year for one of those reasons, the further penalty is attracted [subparagraphs 226X(b)(iii) and 160ARZI(b)(iii)]. However, if a taxpayer is liable to penalty because of the way in which the taxpayer treated the law as applying to a matter (sections 226K or 226L, or 160ARZD) the taxpayer will only be liable to the further additional tax if in an earlier year the taxpayer had treated the law as applying to that matter or a similar matter in the same way. [subparagraphs 226X(b)(iv) and 160ARZI(b)(iv)]
Similar rules apply to impose further penalty where penalty has initially been attracted under a scheme section. [section 226C - Clause 31]
Voluntary disclosures during an audit
Where a taxpayer voluntarily discloses to the Commissioner part or all of a tax shortfall and an audit has commenced or advice of an impending audit has been given, the penalty otherwise attracted will be reduced by 20%. For example, where the shortfall was due to a failure to take reasonable care, and the taxpayer brings the shortfall to the auditor's attention, the penalty will be discounted from 25% to 20%. [sections 226Y and 160ARZJ - Clauses 31 and 18]
The taxpayer's disclosure must be in writing, and must bring all the relevant facts and other information to the attention of the auditor that will allow the auditor to readily identify the amount and nature of the shortfall. The disclosure should be such that it could reasonably be estimated to have saved the auditor a significant amount of time or resources in looking into the matter disclosed.
A taxpayer need not admit liability in respect of the shortfall disclosed. A taxpayer is eligible for the discounted penalty whether or not the taxpayer maintains an opinion contrary to that of the auditor, or disputes the adjustment the auditor makes to the taxpayer's assessment.
Similar rules apply where a taxpayer makes a voluntary disclosure during an audit of a matter in respect of which the taxpayer is liable to pay penalty under a scheme section. [section 226D - Clause 31]
Voluntary disclosures before an audit
Where a taxpayer voluntarily discloses to the Commissioner part or all of a tax shortfall that is greater than $1 000 before any audit action has commenced, the penalty otherwise attracted in respect of the shortfall will be reduced by 80%. For example, where the tax shortfall is due to a failure to exercise reasonable care, and a voluntary disclosure is made, the penalty is discounted from 25% to 5%. [sections 226Z and 160ARZK - Clauses 31 and 18]
If a shortfall voluntarily notified to the Commissioner before an audit has commenced is less than $1 000, no penalty is attracted. [paragraphs 226Z(d) and 160ARZK(d)]
As with disclosures during an audit, disclosures before an audit must be in writing. Also, the disclosure must contain all the relevant facts and other information, including the amount of the shortfall, to enable the Commissioner to make an adjustment of the taxpayer's assessment. An application for a Private Ruling in relation to a completed transaction, made after the taxpayers relevant return has been lodged, would usually qualify as a voluntary disclosure.
A taxpayer need not admit liability in respect of the shortfall disclosed to qualify for the discounted penalty, provided there is full disclosure of the relevant facts and the other conditions of the section are satisfied.
Similar rules apply where a taxpayer makes a voluntary disclosure before an audit of a matter in respect of which the taxpayer is liable to pay penalty under a scheme section, except that the discount is 80% in all such cases. [section 226E - Clause 31]
Commissioner's discretion regarding when a disclosure is made
In some instances, even where an audit has commenced or the commencement of an audit has been advised to a taxpayer, it may be appropriate to grant the taxpayer the higher penalty discount of 80% in respect of disclosures. This may be the case, for example, where an audit of a group of companies has commenced and a company which is a part of the group, but not the focus of the audit, discloses a matter which was unlikely to have been detected by the audit.
To enable the Commissioner to grant this concession in the appropriate circumstances, the Commissioner has a discretion to deem a disclosure to have been made prior to the taxpayer being informed of an audit. [sections 226F, 226ZA and 160ARZL - Clauses 31 and 18]
Where more than one shortfall section applies
It is possible that more than one shortfall section may apply in respect of a tax shortfall. For example, a taxpayer may be careless in making a claim for a deduction, and so be liable for penalty under section 226G, and also be liable for penalty under section 226K for not having a reasonably arguable position in respect of the claim. In such a case the taxpayer is liable to pay only one of the penalties. If one penalty is higher than the other (eg., if sections 226H and 226J both apply), the taxpayer is liable to pay the highest one. [sections 226W and 160ARZH - Clauses 31 and 18]
The purpose of the new penalty provisions is to reduce the risk of penalties for taxpayers who have not been culpable and to provide standards for taxpayers in carrying out their taxation obligations. With this end in mind the Bill prescribes specific penalties for breaches of the standards set by the Bill, which means that taxpayers will know what penalties will be attracted for delinquent behaviour. This replaces the previous system where penalty was automatically attracted at a rate of 200%, and remitted at the discretion of the Commissioner.
While the Bill provides a set of rules and accompanying penalties which will cover all but exceptional cases, there may be cases that do not fit neatly into a category, or for which the prescribed rates of penalty are inappropriate. For this reason the discretion which the Commissioner has to remit penalty in whole or in part (sections 227 and 160ASB of the ITAA) is not removed by this Bill, so that the Commissioner has the flexibility to deal with hard cases that may arise. The AAT is able to exercise this power of remission in appropriate cases when reviewing decisions of the Commissioner, and the courts are able to adjudicate on whether the discretion was exercised in accordance with the law.
Some examples of where it may be appropriate for the Commissioner to exercise the discretion to remit penalties are:
- where an authority that is material to whether a taxpayer has a reasonably arguable position is published immediately before a taxpayer lodges its return of income, in circumstances where the taxpayer could not reasonably be expected to have been aware of the authority's existence;
- where a taxpayer, because of an extraordinary transaction, exceeds the threshold beyond which the reasonably arguable position test applies, and the circumstances of the case are such that it would be unjust to penalise the taxpayer solely by reason of failing that test;
- where the application of the special rules in respect of partners and trustees imposes an overly burdensome penalty on the defaulting partner or trustee.
The August 1991 information paper 'Improvements to Self Assessment - Priority Tasks' outlined how certain 'good faith' considerations would be taken into account for the purposes of the new penalties. These are covered by the Bill in a number of areas. For example, a taxpayer who has been misguided by advice from the ATO or by an ATO administrative practice will not be subject to penalty on a shortfall caused by relying on the advice or practice [sections 226V and 160ARZG - Clauses 31 and 18]. Also, for the purpose of determining whether a taxpayer has exercised reasonable care, it will be relevant to consider whether:
- the taxpayer has genuinely misunderstood the requirements or the application of the law;
- the taxpayer has made an isolated arithmetic or transposition error that was honestly made;
- the taxpayer did not know and could not reasonably be expected to have known or suspected that a statement misrepresented the true position.
Finally, the retention of the Commissioner's discretion to remit the penalties otherwise attracted covers any 'good faith' considerations not specifically picked up by the Bill.
Liability and review
Penalties covered in this chapter will be assessed by the Commissioner and the taxpayer notified accordingly (sections 227, 160ARL and 160ARM). The Bill amends section 14ZS of the Administration Act so that all penalties imposed under the shortfall sections or the scheme sections will be subject to full review rights, including a right to review by the AAT irrespective of the amount. [Clause 6]
Where an amount of penalty would otherwise be less than $20, the amount is increased to $20. [section 226ZB - Clause 31]