J Block DP

Administrative Appeals Tribunal


Decision date: 30 August 2002

J Block (Deputy President) (a) The objection decisions which are under review in this matter are decisions by the Respondent disallowing objections dated 11 January 1999 against notices of amended assessment issued on 5 January 1999 in respect of the year ended 30 June 1996 (referred to as the ``1996 year'') and the year ending 30 June 1997 (referred to as the ``1997 year''). The 1996 year and the 1997 year are collectively referred to as the ``relevant years''.

(b) In respect of the three Applicants (collectively the ``Applicants''), the applications were heard together having regard to the fact that the issues are the same in respect of all three of them. The Applicants were at all relevant times the only partners in Jade Wholesalers (``Jade''). They were also and at all relevant times the only shareholders in and directors of Allay Pty Ltd (``Allay''). At all relevant times, Allay carried on business as a retail jeweller through two jewellery stores in Albany, Western Australia, and a third retail jewellery store in Katanning, Western Australia.

2. (a) Dr H R Sorensen of Counsel instructed by Dibbs Barker Gosling (previously Barker Gosling) solicitors appeared for the Applicants, while Messrs D B McGovern and I Young of Counsel instructed by Mr Matthew Walsh of the Australian Government Solicitor appeared for the Respondent.

(b) The Tribunal had before it the T documents lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975. In respect of each of the Applicants, the T documents are for all practical purposes the same. References in these reasons should be construed as references to the T documents in respect of John Ciprian, who is one of the Applicants.

(c) The Tribunal also had before it a large number of exhibits; on the last hearing day, the Respondent furnished the Tribunal with a schedule detailing the exhibits; that schedule is annexed marked A. Annexure A has been amplified to include exhibits R15 and R16 and being a recent exchange (in June 2002) of correspondence between the representatives of the parties. That exchange of correspondence

ATC 2101

can be summarised in the following manner; having received the Applicants' written submissions the Respondent's solicitor wrote to the Applicants' solicitors drawing attention to the fact that a contention by the Applicants concerning opening stock for the 1996 year had not been raised in the objections referable to that year; the Respondent contended that that contention could not be raised without an amendment to those objections. The Applicants, through their solicitors, contended that their objections encompassed that contention, and stated that the Applicants did not intend to apply for an amendment to their 1996 year objections. Annexure A does not include a document (and being a questionnaire by the Valuation Centre of Australia dated 8 December 1997), which was marked for identification purposes only. I should also note, for the sake of completeness that the reference in annexure A to exhibit A17 has been corrected so as to reflect the fact that that letter was addressed to Mr Gibson.

3. (a) This matter was originally listed for hearing in November 2000; it was postponed that time and then re-listed before me in the first half of 2001.

(b) The matter was again postponed (for reasons not here relevant) and eventually commenced in July 2001.

(c) The first hearing took place on the following days in July 2001; 3, 4, 5, 6, 12, 13, 16, 17 and 18.

(d) The matter was then re-listed for further hearings later in 2001; it was postponed because the Applicants could not proceed without funding; at a subsequent directions hearing the Tribunal was advised that funding had been obtained and the matter was re-listed for resumed hearings in January and February 2002.

(e) The relevant dates in January and February 2002 on which hearings were held are 30 and 31 in January 2002 and 1, 4, 5, 6, 7, 11, 12 and 13 in February 2002.

(f) It was agreed, when the hearings ended in February 2002, that the parties would furnish written submissions setting out their contentions in relation inter alia to the voluminous documentation and evidence before the Tribunal, and that following written submissions the Tribunal would reconvene for three days in order to hear oral submissions. The time periods allowed in the original timetable proved to be insufficient, and written submissions were received later than had been anticipated. This resulted in yet another postponement; oral submissions were made in the result at hearings on 29 July 2002 and 1 August 2002 and 2 August 2002.

4. (a) I have previously referred to the list of exhibits which were tendered; in fact some of those exhibits proved in the result to be of minor relevance. Oral evidence was given by some, but not all, of those persons on whose behalf witness statements were tendered. In respect of Juneth Spouse (exhibit A9) it was agreed that she need not appear for cross- examination and that her statement could be accepted on the basis that it was agreed that she effected the entries referred to in that statement on instructions from the Applicants.

(b) The witness statements and other exhibits tendered were in aggregate of enormous length. The witness statement in respect of Boris Kosutic (exhibit R5) must (at least so far as I am concerned) constitute some sort of record; apart from the statement itself, it includes annexures consisting of fifteen large box files; each box file in turn contains many hundreds of pages of documents and including spread-sheets containing minute detail. The Tribunal notes that it proved necessary to set aside a specific conference room in which to house all of the documents, and in particular for the purpose of writing this decision.

(c) It is not necessary for me to refer to the large folders of documents produced in answer to summonses and which were not in the result tendered.

5. (a) It was made clear to me from the outset that the case to be heard by me should be regarded as a test case, in that the decision in this matter would affect many other jewellery businesses. (I note that I have been informed by a presiding member in Western Australia that there are matters in that state listed before him, which have been put on hold pending this decision; that presiding member has been in touch with me from time to time to inquire as to progress in this matter.)

(b) The written submissions received by me from the parties proved to be of great assistance. This was particularly so in the case of the submissions by the Respondent, more particularly because they dealt in detail with the very lengthy evidence given before the

ATC 2102

Tribunal. Given that this is a test case and that it may be significant to many other taxpayers, an appeal is a real possibility. I have accordingly decided that for this reason (but not only this reason) it is desirable for me to attach the written submissions, but as annexures. However, and particularly in relation to the Respondent's Outline of Submissions (annexure D [not reproduced]) I have found it convenient to cross-refer to parts of it; in some cases and purely in order to endeavour to ensure that the body of this decision can be read (for the most part) without reference to annexures, I have included clauses extracted from annexure D [ not reproduced] in the body of the decision. In the case of one witness and for reasons set out later, I have decided that it is sufficient for me to cross-refer to written submissions. This is so also in relation to the history of certain tax legislation of which section 29 of the Income Tax Assessment Act 1936 (the ``1936 Act'') forms a part.

(c) The Applicants' Submissions (Revised) dated 30 April 2002 are annexed as annexure B. I intend, as the Respondent did, to follow the Applicants' system in respect of the transcript and which is contained in clause 60 of annexure B [not reproduced]. This arises from the fact that the transcript for 3 July 2001 commences at page 1. So does the transcript for the 4 July 2001 but the pages in respect of that date and the remaining hearings in July 2001 were then numbered sequentially. Similarly the transcript for January and February 2002 commenced with page one and were then numbered sequentially thereafter. Accordingly ``TA'' refers to the transcript for 3 July 2001; ``TB'' refers to the transcript for all other hearing days in July 2001; ``TC'' refers to the transcript for all of the hearing days in January and February 2002.

It may be noted that annexure B is in fact a revised version of an earlier submission; it is not necessary for me to include the earlier version because it was replaced by annexure B.

(d) The Applicants also tendered a document dated 20 May 2002 entitled ``Addendum To Applicants' Submissions'' and it is annexed marked C. I draw attention in particular to clause 17 and 18 of annexure C [not reproduced] which contain a list of amendments, amplifications and deletions. Annexure C in this respect should be considered (to the extent necessary) in conjunction with similar information contained in annexure A. It is to be noted though that there did not appear to be any issues between the parties as to the extent of amendments to or deletions from witness statements.

(e) The Respondent's Outline of Submissions dated 23 July 2002 is annexed as annexure D. As I have indicated, I found annexure D [not reproduced] particularly helpful in relation to its analysis of the evidence. Having considered the annexures and in particular annexure D in relation to the transcripts I found that references contained in those submissions to transcripts were accurate.

(f) On the last hearing day the Respondent furnished me with a document entitled ``Respondent's Supplementary Submissions'' which deals in particular with Mr Kosutic's evidence; that document is annexed as annexure E [not reproduced].

(g) Similarly on the last hearing day the Respondent furnished me with a document entitled ``Summary of Results Analysis'', prepared by Mr Kosutic and which constitutes in effect a summary of his findings as given in evidence before me. That document is annexed as annexure F.

(h) I should perhaps note that both parties informed me of minor errors in their written submissions; those errors have been corrected in the manner specified. In particular minor corrections as directed by Dr Sorensen were made in respect of annexure B. Annexure D appears in the form of the corrected version supplied by the Respondent [not reproduced].

6. (a) As has already been noted, this case generated an astonishingly large quantity of oral and written evidence.

(b) Evidence was given at considerable length by each of Professor Walker and Mr S McClintock of Pricewaterhouse Coopers. That evidence related in particular to accounting concepts and the relevance of those accounting concepts to statutory provisions which are relevant in this case. However, and in the result their evidence proved to be of marginal (if any) significance; their evidence was not dealt with in any great detail in the written submissions. Neither party referred (otherwise than very briefly and in passing) to that evidence in their closing oral submissions. It is for this reason that this decision does not deal, (otherwise than briefly), with that evidence.

ATC 2103

(c) Notwithstanding the huge quantity of evidence before me this case turns in the result, and in the main, on one important question of fact. Jade's stock-in-trade was written down for income tax purposes in respect of each of the relevant years in accordance with valuations by Mr Terry Mitchell. As matters transpired the question of most significance before me, and which occupied much time in evidence before me, was as to whether Mr Mitchell's valuation methodology (referred to in these reasons as the ``Mitchell system'') was properly or soundly based.

(d) Questions of law were raised and argued and are dealt with in this decision. There is also a relevant question as to whether penalties were correctly imposed. But this case, as matters transpired, proved to be, in the main, one of fact rather than one of law.

(e) There is one other (minor) matter of a preliminary nature. At a very early stage of this matter and long before I had seen any papers I presided at a directions hearing in order to set a timetable for the filing of statements, submissions and other documents. (At that stage the presiding member does not have a member's file of relevant documents). I asked in casual fashion what the matter was about and was told that it concerned the valuation of trading stock. I, in turn mentioned that I had previously decided a case involving the valuation of trading stock and that as I recollected that matter, there could be quite complex legal issues dealt with at some length in a learned article by Professor Marks. On the strength of that entirely casual and ``off-the- cuff'' remark the Applicants approached the Respondent for funding; that request was (correctly) denied; this case does not raise any matters of important legal principle.

7. In this clause 7, I set out a brief introduction; it could usefully be considered in conjunction with clauses 1 to 21 (inclusive) of annexure D [not reproduced], which do not appear to me to be in dispute.

(a) At all relevant times the Applicants were the only partners in Jade and also the only shareholders in and directors of Allay; (the subsequent introduction of another party or parties is not relevant for the purposes of this decision).

(b) It was a common practice amongst retail jewellers (and for that matter many other retail businesses) to utilise a ``captive'' wholesaler. In respect of the Applicants, Jade was the captive wholesaler; it purchased stock from third party suppliers and manufacturers at arm's length; it then placed that stock on consignment with Allay; when Allay sold an item of stock by retail that sale triggered a sale between Jade and Allay.

(c) The advantage of the captive wholesaler arrangement was that it postponed until the last possible moment the taxing point in respect of sales tax which was imposed on the last wholesale sale.

(d) The Mitchell system, which involved substantial stock write-downs offered, (in addition to income tax advantages) significant sales tax advantages because it reduced the amounts on which sales tax was paid. There was mention during the hearings of a sales tax case concerning the Applicants which was (and as I understood Mrs Ciprian on this point, reluctantly) settled.

(e) Once sales tax was replaced by GST (Goods and Services Tax), the efficacy of utilising captive wholesalers largely disappeared. Indeed, Mr Gerrard who gave evidence on behalf of the Applicants said that it was at this time that his use of a captive wholesaler ended.

(f) The Respondent accepted the use of captive wholesalers in this manner for sales tax purposes subject to what were referred to as the ``safe harbour'' rules. In general terms the Respondent was satisfied if the charge by the wholesaler to the retailer was cost plus six per cent. A more detailed explanation of the ``safe harbour'' system can be found in clause 9 of annexure D [not reproduced].

(g) Mr Peter Gibson was at all relevant times the principal of Australian Sales Tax Consultants, which as the name suggests advised on sales tax. Mr Gibson played an important part in the events which gave rise to this case.

(h) It was at all times clear that as between the three Applicants, administration was the province of Mrs Dianne Ciprian who is one of the Applicants and is referred to in these reasons as ``Mrs Ciprian''. Mrs Ciprian has a number of relevant qualifications which are set out in clause 2 of her affidavit which is exhibit A1, dated 28 April 2000 and reading as follows:

ATC 2104

``2. I have the following qualifications:

  • • Bachelor of Science degree from the University of Western Australia.
  • • Graduate Diploma of Education from the University of Western Australia.
  • • The Teachers Higher Certificate from the Education Department Western Australia.
  • • Registered Valuers Certificate from the Jewellers Association of Australia.
  • • Diamond Grading Certificate from the Gemmological Association of Australia.
  • • Synthetic & Immitation Gemstone Certificate from the Gemmological Association of Australia.
  • • Workplace Assessor Certificate from Regional Training Services.
  • • Microsoft Word Certificate from the Department of TAFE (Great Southern Regional College).''

It may be noted that her major subject for her Bachelor of Science degree was mathematics. As a subsequent affidavit revealed, she taught mathematics for some years and was for a year the acting head of Mathematics at a high school in Albany. The activities of Mr Harry De Jonge were conducted outside the area of administration and so that his evidence was largely irrelevant to this case. This is so, but to a lesser extent also in respect of Mr John Ciprian, who although experienced in jewellery generally, left matters of administration and accounting to his wife, Mrs Ciprian.

(i) On 20 January 1993 Mrs Ciprian wrote to Mr Gibson inquiring as to whether stock could be written down for tax purposes. That letter reads as follows:

``Dear Peter,

As advised for showcase it is possible to depreciate old stock for tax calcs. Can you please advise us of

  • (i) the formula (if there is one!)
  • (ii) the method?''

(j) Mr Gibson sought valuation advice from Mr Terry Mitchell of The Valuation Centre of Australia. Mr Mitchell provided a stock assessment on 22 February 1993. That stock assessment which appears as annexure DC04 to Mrs Ciprian's affidavit dated 28 April 2000 (exhibit A1) reads as follows:


| DEPARTMENT |      DESCRIPTION       |     COST    |   ADJUSTED  |
|            |                        |             |     COST    |
| 01         | Dia rings over $500    |   27,788.56 |   12,783.00 |
| 02         | Dia rings under $500   |    6,852.32 |    2,604.00 |
| 03         | Dia & col over $500    |   17,626.56 |    8,108.00 |
| 04         | Dia & col under $500   |    9,662.85 |    3,672.00 |
| 05         | Etern rings over $500  |   11,586.19 |    5,330.00 |
| 06         | Etern rings under $500 |    2,694.10 |    1,239.00 |
| 07         | Wedders                |    4,426.70 |    2,213.00 |
| 08         | Lds gold drs rings     |   11,854.38 |    5,927.00 |
| 09         | Lds sil drs rings      |    1,589.04 |      636.00 |
| 10         | Gts drs rng            |    6,411.28 |    3,206.00 |
| 12         | Seiko                  |    2,742.78 |    1,097.00 |
| 13         | Pulsar                 |    1,235.80 |      494.00 |
| 14         | Citizen                |    1,751.28 |      700.00 |
| 15         | Classique              |      688.08 |      275.00 |
| 16         | Other                  |    6,140.61 |    2,456.00 |
| 17         | Gold jew               |   13,267.17 |    6,634.00 |
| 18         | Sil jew                |    1,160.03 |      580.00 |
| 19         | Fashion jew            |       56.78 |       23.00 |
| 20         | All opal jewellery     |    7,118.75 |    3,559.00 |
| 21         | All pearl jewellery    |   12,877.57 |   12,877.00 |
| 22         | Earrings               |   11,714.97 |    5,860.00 |
| 23         | Gold chain             |   14,285.53 |    7,143.00 |
| 24         | Silver chain           |      595.90 |      238.00 |
| 25         | Charms & ingots        |    3,314.98 |    1,657.00 |
| 27         | Bracelets & bangles    |   17,426.94 |    8,713.00 |
| 28         | Watch straps           |      772.69 |      386.00 |
| 29         | Clocks & barometers    |   10,231.85 |    4,093.00 |
| 30         | Leather & mesh         |    1,139.98 |      570.00 |
| 31         | Pens & Lighters        |      462.28 |      231.00 |
| 32         | Crystal                |    5,214.92 |    2,607.00 |
| 33         | Silverplate            |    7,719.49 |    3,860.00 |
| 35         | Chain & figurines      |   15,284.29 |    7,642.00 |
| 34         | Pewter                 |      870.71 |      435.00 |
| 37         | Misc gifts             |    1,443.74 |      722.00 |
| 38         | Trophies               |      361.26 |      181.00 |
| 39         | Loose stones & metal   |    1,189.85 |    1,189.00 |
| 40         | Repairs                |       18.87 |       18.00 |
|                                     | $239,579.08 | $119,958.00 |

NOTE: Valuation based upon information supplied.
      Goods not personally seen nor tested. (emphasis added)''

It is perhaps relevant to note that Mr Mitchell did not recommend any stock write-down in respect of, inter alia, pearls (category 21).

(k) It is convenient at this stage to note that stock was categorised for the Applicants in forty separate categories; I include clause 5 of annexure D which reads as follows:

``5. Jade purchases quantities of goods for ultimate sale by the three retail stores owned and operated by Allay. The goods fall within 40 separate categories including, inter alia, diamond rings greater than $500 (category 1), diamond rings less than $500 (category 2), eternity rings greater than $500 (category 5), eternity rings less than $500 (category 6), wedders (category 7), watches Seiko, Pulsar, Citizen, Classique (categories 12-15), gold jewellery (category 17), silver jewellery (category 18), fashion jewellery (category 19), opal jewellery (category 20), pearl jewellery (category 21), earrings (category 22), gold chains (category 23), charms and ingots (category 25), bracelets and bangles (category 27), clocks and barometers (category 29), leather (wallets) (category 30), crystal (category 32), silverplate (category 33), pewter (category 34), China and figurines (category 35), miscellaneous gifts (category 37), trophies (category 38), loose stones and metal (category 39), repairs (category 40) (see generally BK 90, 91 and 92 at folder 13 to the witness statement of Boris Kosutic).''

(l) In November 1993 Mr Gibson wrote to his clients, and including the Applicants, advising them that the Respondent ``will not accept the sale of aged stock on or after 1 November 1993

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at the revalued amount... It remains our opinion that an independent valuation is the most appropriate mechanism to establish the true arms length value of aged stock.''

(m) Notwithstanding the provisions of the preceding sub-clause Mr Gibson on 21 November 1994 wrote a letter entitled ``Its Time! Stock Revaluation''. That letter is dealt with in clause 456 of annexure D which reads:

``456. The first paragraph of the letter referred to the previous valuation on 5 February 1993 and continued as follows `As it has been some time you should now repeat the exercise. Similarly, if you stopped revaluing stock late last year you should consider restarting as there are considerable advantages'. Those advantages includes, for example, that watches were now being written down at 12 months of age and stock over three years old was now being reduced by up to 90%.''

(n) The Applicants elected to accept Mr Gibson's recommendation. This lead to the issue of a ``Stock Re-assessment'' dated 20 June 1995 by Mr Mitchell which appears at pages 73 and 74 of exhibit A1, and which reads as follows:


The following percentage write downs should apply to the computer printout.

| DEPT NO. | PRE MAY 1993 | MAY 92 -- NOVEMBER 93 |
|    01    |      61      |          54           |
|    02    |      62      |          62           |
|    03    |      61      |          54           |
|    04    |      62      |          62           |
|    05    |      62      |          54           |
|    06    |      62      |          62           |
|    07    |      68      |          50           |
|    08    |      80      |          50           |
|    09    |      92      |          60           |
|    10    |      80      |          50           |
|    12    |      80      |          60           |
|    13    |      80      |          60           |
|    14    |      80      |          60           |
|    15    |      80      |          --           |
|    16    |      80      |          60           |
|    17    |      80      |          50           |
|    18    |      92      |          60           |
|    19    |      90      |          --           |
|    20    |      50      |          50           |
|    21    |      NC      |          NC           |
|    22    |      80      |          50           |
|    23    |      72      |          50           |
|    24    |      92      |          60           |
|    25    |      80      |          50           |
|    27    |      75      |          50           |
|    28    |      90      |          50           |
|    29    |      80      |          60           |
|    30    |      90      |          50           |
|    31    |      75      |          50           |
|    32    |      50      |          50           |
|    33    |      90      |          50           |
|    34    |      90      |          50           |
|    35    |      50      |          50           |
|    37    |      80      |          50           |
|    38    |      90      |          50           |
|    39    |      NC      |          NC           |
|    40    |      NC      |          NC           |

The following is the watch analysis:

|     12     |   638.87 |     447.21     |     30%     |
|     13     |   678.13 |     474.69     |     30%     |
|     14     | 1,022.19 |     715.53     |     30%     |
|     15     |   224.38 |     157.07     |     30%     |
|     16     | 2,798.43 |   1,958.90     |     30%     |
|            | 5,362.00 |   3,753.40     |             |

NOTE: Valuation based upon information supplied.
      Goods not personally seen nor tested (emphasis added).''

8. It was common cause that the reference in the stock re-assessment to ``pre May 1993'' was mistaken and should be read as a reference ``pre May 1992''. It will again be noted that pearls (category 21) were not written down.

It should be noted also that the write-downs recommended were substantial and that in effect the Mitchell system differentiated between stock which was 18 months old and stock which was 36 months old. The recommended write-down percentage for stock aged 18 months is set out in the right hand column whereas the higher percentage in respect of stock aged 36 months appears in the middle column. (The right-hand column percentages are in accord with the figures in annexure DC04 to exhibit A1). It will be noted also that in respect of watches, a further recommendation was made and so that they could be written down by 30 per cent after 12 months. The 12 month, 18 month and 36 month anniversaries of purchase (in relation to Jade's stock-in-trade) are referred to in these reasons as ``milestones''.

9. Mr Gibson's evidence was that he was remunerated on the basis that he received a percentage of amounts written down; put in other words his fees increased as the write- down increased. Mr Mitchell's evidence was that he received a fee for service in accordance with his normal charging procedure; (the actual amounts paid to Mr Mitchell for his services were not in evidence before me). It should be noted though Mr Mitchell performed a valuation service of this nature (on instructions from Mr Gibson) for numerous jewellery businesses; the actual figure as referred to in the evidence varied but was apparently at least 40

ATC 2108

valuations and probably more. By contrast, Mr Bill Sechos who performed the same service on instructions from Mr Gibson did so on one occasion only.

10. The Mitchell system was effected by Mr Mitchell in accordance with the following broad principles;

(a) He did not ever see or view the stock, notwithstanding the provisions of the standard test as to the methodology to be used by valuators in preparing jewellery valuations (referred to in the hearings as the ``Silver Book''). The following excerpt from TC 47 to 48 is illustrative of this point:

``Mr McGovern:

  • As a registered valuer you are required to follow valuation guidelines and to comply with ethical standards, are you not?

Mr Mitchell:

  • Yes, that is correct.

Mr McGovern:

  • Those guidelines are principally the standards in the Australian Jewellery Valuers Council Manual?

Mr Mitchell:

  • Yes.

Mr McGovern:

  • That's commonly referred to as the Silver Book, is that right?

Mr Mitchell:

  • Yes.

Mr McGovern:

  • For the purposes of valuation you are also authorised to use the NCJV price guide?

Mr Mitchell:

  • Yes.

Mr McGovern:

  • But the price guide is applicable only to items of jewellery that contain gold or silver, is that not right?

Mr Mitchell:

  • Yes. Well, I am sorry, of course it does do pearls and things like that.

Mr McGovern:

  • Pearls as well, I am sorry, thank you. The recognised approach of a registered valuer to the valuation of jewellery is to arrive at a retail replacement value for the item, is it not?

Mr Mitchell:

  • That is correct.

Mr McGovern:

  • In order to embark upon that process it is necessary to conduct a physical examination of the item to be valued, is it not?

Mr Mitchell:

  • That is correct.

Mr McGovern:

  • The age of the item being valued is not addressed at all in ascertaining the retail replacement value, is it?

Mr Mitchell:

  • Not unless it is actually an antique.''

(b) The mere fact that a stock item reached a milestone resulted automatically in a write- down by the recommended percentage; the fact that that item was one of a large or larger number the remainder or some of the remainder having been sold, made no difference at all. Nor was there any qualification as to the fact that the same item might be (and indeed was) bought again before or after the relevant milestone.

(c) The Mitchell system did not have regard to demographics and geographical location; the same percentages applied regardless of the type of customers of the jeweller and the area in which the business was located.

(d) Mr Mitchell in his evidence said that he based his stock valuation methods on two fundamental principles in relation to the Applicants; in the first place he assumed that Jade and Allay were parties at arm's length and not associated with each other and in the second place that where an item was not sold within the prescribed period, it could be resold only as scrap and thus back up the distribution chain to the precious metals or precious stone dealer from which it had been bought by Jade in the first place. (Leaving aside the fact that the evidence before the Tribunal revealed that this did not ever happen, it could only have been of relevance to some only of the relevant categories, and more particularly because many of the relevant categories do not relate to precious metals or precious stones).

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11. I deal in this clause 11 with the relationship between Jade and Allay and certain other ancillary matters.

(a) It is relevant in particular that Jade had no offices or staff; it was run entirely from the premises of Allay. Apart from the fact that it had its own bank account, it could be regarded for all practical purposes as a ``post box'' entity.

(b) Jade for all intents and purposes had one customer only and that was Allay. There was one other sale to House of Fraser in the 1997 year and none at all in the 1996 year. I refer in this context to clause 7 of annexure D which reads as follows:

``7. Jade sold its goods to Allay almost exclusively. The one exception was de minimus. Notwithstanding the assertion in Mrs Ciprian's affidavit that Jade `sells predominately to Allay [however], it can, and it has previously made sales to other retail and wholesale entities' in fact, there were no such sales at all in 1996 (TB page 57.5) and one sale only to the House of Fraser occurred in the 1997 year (TB page 58.2; 58.4 and 58.9-60.1).''

(c) Jade did (as I have previously said) for some reason conduct its own bank account. Again as set out previously in these reasons, sales as between Jade and Allay occurred only as and when Allay sold at retail; this then triggered a sale between Jade and Allay but at the written down value and as will have been noted, the written down percentage was in many cases substantial. This had two relevant consequences; in the first place the sale of the written down value resulted in a sharp reduction of the sales tax paid; secondly the fact that the sale took place at so sharp a reduction resulted in Jade incurring ever-increasing losses. There was evidence before me (which I need not set out in detail) that from 1993 onwards, Jade incurred large losses and so that only a few years later it was no longer solvent. As to why Jade needed its own bank account given that it was financed in respect of all of its purchases by Allay was not clear.

(d) There was evidence before me in respect of one year as to an interest charge to Jade but the reason for that interest charge was not clarified.

(e) One concomitant of the sales between Jade and Allay at the reduced values was that because of the lower sales tax burden, Allay actually derived larger profits out of sales of the aged stock simply because the overall cost to the economic entity as a whole was reduced because of the sharp reduction in sales tax.

(f) The evidence of Mr Kosutic was that in relation to Allay, the milestones prescribed by Mr Mitchell were irrelevant, and that stock did sell even though at times after a number of years. Mr Kosutic in an exhaustive analysis found that the number of items sold below actual cost (that is cost to Jade) was very small. Mr Kosutic's evidence was that of 4,132 items of aged stock sold in the 1997 and 1998 financial years, only 18 were sold at a loss, that is, for an amount less than retail cost. Mrs Ciprian in her evidence said that the starting point was to ticket an item at what the market would stand (sometimes 300 per cent of cost) and then to discount it as time went on. Allay conventionally and in the ordinary course of its business, held sales in which it reduced the retail ticket prices. But the fact that an item was discounted in a sale did not mean that it did not thereafter sell at the retail ticket price. The evidence before me established that although some aged items were discounted below retail ticket price many of them achieved retail ticket price, and the discounts were in any event such that it was in a very few cases only that aged stock items did not achieve at least cost.

(g) Jade and Allay were of course two separate legal entities. However, and for economic purposes they could and should be regarded as one economic entity.

(h) Was Mr Mitchell, as he contended, unaware of the fact that Jade and Allay constituted one economic entity? It is not easy to accept that he did not know of the practice whereby retail businesses used captive wholesalers given that he received numerous instructions from Mr Gibson. Mr Kosutic in his analysis found that in a survey of ten businesses in which Mr Mitchell furnished valuations on instructions from Mr Gibson, and although the categories were often numbered differently, the write-down percentages across the board and regardless of location or demographics, were approximately the same.

(i) The relationship between Mr Gibson and Mr Mitchell was clearly an enduring one. Mr Gibson instructed Mr Mitchell in relation to numerous (at least 40) valuations. Given the fact that Mr Gibson was remunerated by results

ATC 2110

it may be possible to infer that Mr Gibson expected results from Mr Mitchell in the form of write-downs. It does not seem very likely that when Mr Mitchell would have received a stream of instructions from Mr Gibson if he had valued in such manner that Mr Gibson received no remuneration whatever because there were no write-downs. Nor does Mr Mitchell's task appear to have been a very onerous one given that he saw no need to inspect the stock and that his valuations across the board (having regard to the business survey by Mr Kosutic) were constant.

12. I turn in this clause 12 (and also clause 13) to deal with the evidence of Mr Mitchell.

(a) In his original affidavit dated 26 April 2000 (exhibit A5) Mr Mitchell specified that the market with which he had been concerned was the market in which a wholesaler sells to another arm's length wholesaler. In his affidavit dated 6 June 2001 (exhibit A15) he sought to amend clauses 39 and 60 of exhibit A5 by amending the reference to ``another arms length wholesaler'' so as to refer to its ``another arms length retailer''. It would seem that from the outset there was confusion in Mr Mitchell's mind as to the market which was relevant for his purpose.

(b) I note in general terms that I had originally thought that it might be desirable, and perhaps even necessary, when referring to oral evidence before me, to include numerous extracts from the transcript. I have decided on reflection that to do so is unnecessary and would indeed have the effect of lengthening an already lengthy decision; it is for this reason that this decision incorporates only two transcript extracts, one referable to Mr Mitchell and the other to Mr Kosutic. In dealing with Mr Mitchell's evidence, I propose to confine myself to some of the more important or prominent points. A detailed analysis of Mr Mitchell's evidence is contained in clauses 222 (and following) of annexure D [not reproduced]. It should be noted that the Tribunal accepts that that analysis is apposite in relation to the evidence given by Mr Mitchell in the hearing.

(c) Mr Mitchell's evidence as regard pearls was particularly contradictory. As set out previously in these reasons, his recommendations to the Applicants in 1993 and 1995 did not call for any write-down for pearls (TB 634 and 635). However, he was confronted with an analysis which indicated a reduction in values. He was asked whether there had been a drastic decline in the pearl market since 1995 and he answered in the manner specified in clause 253 of annexure D which reads as follows:

``253. Mr Mitchell, of course, twice asserted that in the case of pearls there was in fact no write down (TC page 634.31 and 635.25). He was then confronted with his own analysis writing down pearls 50% after 18 months and the same percentage again after 36 months (TC page 635.18-636.7). He allowed himself to be drawn to a point of ridicule when he agreed with the suggestion `do you say there was some rapid decline in the pearl market since 1995' to which he answered, `yes I'm afraid there has, yes, there has' (TB page 637.11-637.12).''

It may be noted that in clause 42 of exhibit A5 Mr Mitchell said:

``42. Since 1995 pricing levels in the wholesale jewellery industry have been generally static. Changes in pricing levels has occurred at the retail level and have involved a reduction in the retail selling price. Wholesale pricing levels are the same as they were in 1995 and as such the percentage mark downs being applied to particular lines of stock in 1995 continue to be relevant and applicable today.''

(d) Still on the subject of pearls, Mr Mitchell agreed that to value pearls it is necessary to know about size, lustre and match, all of which require visual examination (TB 634 and 635). That evidence was in conflict with other evidence by him to the effect that it was perfectly in order for him to value stock (which included pearl and diamond jewellery) by references to stock sheets without visual examination. The Tribunal notes that Mr Mitchell had in fact provided a stock assessment in February 1993 and a stock re- assessment in June 1995 for the Applicants without any testing or visual inspection.

(e) Mr Mitchell said that his valuations were based on surveys although it was never clear (and he was himself very uncertain) about whether he was referring to surveys in the wholesale or in the retail markets (TC 23). Despite a notice to produce he was unable to produce any records of any surveys of any nature made by him (TC 29 and TC 20).

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(f) Clause 29 of exhibit A5 reads as follows:

``29. The information obtained through our market research process was collated and considered with the figures released by the NCJV and the results consolidated into a two-page summary table which was used to calculate the write-downs. Annexed hereto and marked TM08 is a copy of that table.''

Annexed to exhibit A5 is annexure TM08 which is alleged to have been the table used to calculate the write-downs in February 1993 and June 1995 (TB 602). (TM08 is explained in verbal terms in exhibit A17).

13. (a) Mr Mitchell's evidence was that annexure TM08 to exhibit A5 was a contemporaneous record of the methodology used to calculate the discount percentages of all categories of stock. That contention was categorically impossible; annexure TM08 refers to break-up values for some categories only. It cannot possibly apply to the numerous categories (figurines, wallets, etc.) which cannot be broken up and sold back up the distribution chain. Not only was the statement untruthful but the Tribunal does not accept that Mr Mitchell ever seriously believed that jewellers (such as the Applicants) break up jewellery in order to sell the stones or the precious metal content back to the original suppliers. (It should be noted that the Applicants did not operate in the ``top end'' of the jewellery market; sales of very valuable or very costly items were the exception rather than the rule.)

(b) Clause 29 of exhibit A5 clearly suggests that exhibit TM08 was prepared contemporaneously with the write-downs in 1993 and 1995. Mr Mitchell agreed that this was not so; (TB 603) Mr Mitchell then said that TM08 must have been prepared contemporaneously with the preparation of his affidavit exhibit A5 that is in the year 2000. It was then put to him that annexure TM08 is identical to annexure D to his affidavit in the Pontifex proceedings (
Pontifex Jewellers (Wholesale) Pty Limited v FC of T 2000 ATC 4642 at 4648 clause 16 that ``... on occasion, old stock, did sell for full original retail price, but this was not usual,... In general, I am satisfied the retail sales could only have be effected at very substantial reductions.'') Mr Mitchell again asserted that it was prepared in 2000 (TB 605).

It was at this stage that it was put to Mr Mitchell that annexure TM08 must have been prepared at an earlier date; annexure TM08 contains an arithmetical error which is identical to an error appearing in annexure D to his affidavit in the Pontifex proceedings and the two annexures are clearly identical. It was suggested to him that he had used the figures extracted from the Jewellery Association Publication of June 1997. Finally and reluctantly he conceded that annexure TM08 must have been compiled in June 1997 (TB 668, TB 670, TC 27, TC 28).

(c) There is only one possible conclusion and that is that annexure TM08 was in no way contemporaneous with the write-downs in 1993 and 1995. Mr Mitchell did not remember any contemporaneous records in respect of the valuations made in those years. The manner in which he shifted ground on this important and relevant aspect must cause the Tribunal to have serious doubts as to his credibility.

(d) When hearings resumed in January 2002, Mr Mitchell was asked whether he would have effected valuations in the same way if he had known that Jade was a captive wholesaler to Allay and his answer was ``if they were one entity, sir, no'' (TC 21).

(e) He contended that he was instructed to value on the basis that Jade and Allay were at arm's length (TC14 and TC15). He said that if had known that Jade and Allay were associated he would have treated the two entities as one rather than as two. To him they would have been a ``whole different ball game'' (TC9). This was so in particular because the need of a the wholesaler to dispose of stock at a discount of 70 to 80 per cent of the retail price without incurring a loss did not arise (TC11). Mr Mitchell's evidence before the Tribunal was dotted with apologies and withdrawals referred to in some detail in clauses 222 and following of annexure D.

(f) The admissions by Mr Mitchell as to false assumptions came in January 2002. Mr McGovern suggested in argument that Mr Mitchell was glad to be given a way out after he had fared badly in cross-examination in the hearings in July 2001. The Tribunal considers that there may be merit in that contention. (The difficulty for the Applicants is that all of their contentions as to the Mitchell system are founded upon assumptions acknowledged to have been incorrectly made. Once the

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foundations were found to be fallacious, the Mitchell system could not stand).

(g) Mr Mitchell had great difficulty when giving evidence as to the alleged ``integral nexus''. Clauses 269, 270 and 271 of annexure D accurately record:

``269. Mr Mitchell referred in paragraph 59(b)(ii) to the concept of `integral nexus'. He then said that the first that he knew of integral nexus was when he read the affidavit (TC page 55.17). In fact when he was first confronted with the words `integral nexus' when they appeared in his affidavit in the statement `there's an integral nexus between retail selling price and the wholesale where goods are sold on consignment' he was asked `what do you say the nexus is' he answered (somewhat plaintively) `dear'. After a stammering utterance he then (not for the first or last time) said `I would have to refer back to - I do apologise, I am a bite vague there' (TB page 611.10 - TB 611.17)

270. It quickly emerged that he didn't have a clue what integral nexus meant (TB page 612-613.10) and it is as plain as a pike staff that this whole concept is something that infiltrated the affidavit. This is somewhat dramatically demonstrated when he was questioned about paragraph 59(b)(ii) and (iii) which forced him to admit that paragraph 59(b) was diametrically opposed to what he had been saying `a moment or two ago'. When asked to face up to it, Mr Mitchell said `it would appear to be' (TC page 616.24)

271. In terms of Mr Mitchell's expertise as a valuer, it was put to him that `integral nexus' it was not a concept that was `relevant or referred to in valuation' to which Mr Mitchell replied `No, sir' (TC page 56.13).''

(h) Dr Sorensen asked me to regard Mr Mitchell as a good valuator but as a poor witness. I do not agree; he was quite remarkably self-possessed before and even (although perhaps to a lesser extent) after his evidence was found to be so fundamentally flawed and indeed in important respects untruthful.

(i) In general terms, the Mitchell system was, as the evidence revealed, fundamentally flawed and unsound. If it was indeed based on market surveys that evidence would and should have been available; there was no such evidence. The Tribunal considers it significant that a stock item should be written down in value simply because it passed a given milestone; there must be a difference between an item which is the last of a number the remainder having been sold and an item in respect of which only one was ever bought. It was suggested during the course of the hearings, that the fact that, in relation to a given item, there was one remaining out of an original larger number, could be so because the sales of the remainder saturated the available market. Such a suggestion is contradicted by the evidence of Mr Kosutic that aged stock items were often bought again by the Applicants either before or after the relevant milestones. The Tribunal considers also that demographics and location must be relevant. A jewellery store in Albany should surely be regarded as being significantly different from a jewellery store in the eastern suburbs of Sydney (and Double Bay was mentioned in evidence as an example). The types and values (and prices) of items available for sale are likely, apart from other considerations, to differ to some extent. But the Kosutic survey of ten stores in different locations indicated that the write-down percentages (in accordance with Mr Mitchell's valuations) were very nearly the same throughout. It is unnecessary for me to go into further detail as to the unsatisfactory nature of Mr Mitchell's evidence before me. In January 2002, he in effect disavowed the Mitchell system on the basis that he had formulated it in accordance with basic and fundamental principles which were wrong. On this basis alone, the whole of the Applicants' case as to the fact that they had valued closing stock in accordance with its market selling value, based as it was on the Mitchell system, became equally flawed and unsound, and of course could not stand.

14. I turn next to deal with the Applicants' contentions that the Respondent deprived them of one of their rights under section 31(1) of the 1936 Act. It is convenient at this point to set out sections 28, 29, 31 of the Income Tax Assessment Act 1936 as follows:

``Section 28 Trading Stock to be taken into account

(1A) This section does not apply to the 1997-98 year of income or a later year of income.

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Note:Subdivision 70-C (Accounting for trading stock you hold at the start or end of the income year) of the Income Tax Assessment Act 1997 applies to those years of income.

(1) Where a taxpayer carries on any business, the value, ascertained under this subdivision, of all trading stock on hand at the beginning of the year of income, and of all trading stock on hand at the end of that year shall be taken into account in ascertaining whether or not the taxpayer has a taxable income.

(2) Where the value of all trading stock on hand at the end of the year of income exceeds the value of all trading stock on hand at the beginning of that year, the assessable income of the taxpayer shall include the amount of the excess.

(3) Where the value of all trading stock on hand at the beginning of the year of income exceeds the value of all trading stock on hand at the end of that year, the amount of the excess shall be an allowable deduction.

Section 29 Value at beginning of year of income

(1) The value of live stock and of each article of other trading stock to be taken into account at the beginning of the year of income shall be its value as ascertained under this or the previous Act at the end of the year immediately preceding the year of income.

(2) This section does not apply to the valuation of live stock or other trading stock at the beginning of the 1997-98 year of income or at the beginning of a later year of income.

Note:Section 70-40 (Value of trading stock at start of income year) of the Income Tax Assessment Act 1997 applies to the valuation of trading stock at the beginning of those years of income. Section 70-40 (Value of trading stock at the start of the 1997-98 income year) of the Income Tax (Transitional Provisions) Act 1997 is also relevant.


Section 31 Value at end of year of income

(1A) This section does not apply to the valuation of trading stock at the end of the 1997-98 year of income or at the end of a later year of income.

Note:Section 70-45 (Value of trading stock at end of income year) of the Income Tax Assessment Act 1997 deals with the valuation of trading stock at the end of those years of income. Section 70-70 (Valuing interests in FIFs) of that Act provides special rules for valuing interests in FIFs for those years of income.

(1) Subject to this section, the value of each article of trading stock (not being live stock) to be taken into account at the end of the year of income shall be, at the option of the taxpayer, its cost price or market selling value or the price at which it can be replaced.

(2) Where the Commissioner is satisfied, in relation to any trading stock of a taxpayer, that, by reason of obsolescence of, or any other special circumstances relating to, the trading stock, the value of the trading stock to be taken into account at the end of the year of income should be an amount, being less than the amount that is the lowest value that could be applicable under subsection (1), determined by the Commissioner to be the fair and reasonable value of the trading stock having regard to:

  • (a) the quantity of the trading stock on hand at the end of the year of income;
  • (b) the quantity of the trading stock sold, exchanged or used in manufacture by the taxpayer after the end of the year of income and the prospects of sale, exchange or use in manufacture of further quantities of that trading stock;
  • (c) the quantity of trading stock of the same kind sold, exchanged or used in manufacture by the taxpayer during the year of income and preceding years of income; and
  • (d) such other matters as the Commissioner considers relevant;

the value of the trading stock to be so taken into account shall, notwithstanding any exercise of the option of the taxpayer under

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that subsection, be the value so determined by the Commissioner.

(3) Subsection (2) does not apply in relation to a taxpayer unless, by written notice signed by or on behalf of the taxpayer and lodged with the Commissioner on or before the last day for the furnishing of the return of income of the taxpayer for the year of income, or within such further time as the Commissioner allows, the taxpayer notifies the Commissioner that he wishes that subsection to apply.

(4) Subject to the following provisions of this section, the value to be taken into account at the end of the 1991-92 year of income, and at the end of each later year of income, of an article of trading stock that consists of an interest in a FIF is to be its cost price.

(5) Subject to subsection (6), if the taxpayer elects that this subsection is to apply to the taxpayer in relation to all the taxpayer's interests in FIFs, the value to be taken into account at the end of the year of income of every article of trading stock that is an interest in a FIF is to be its market value.

(6) Subsection (5) does not apply to the taxpayer unless the election is made before the taxpayer furnishes a return in respect of income of the first year of income in which any notional accounting period of a FIF in which the taxpayer has an interest ends but, if the election is so made, that subsection applies to the taxpayer in respect of that first year of income and in respect of all later years of income.

(7) If:

  • (a) subsection (4) would, apart from this subsection, apply to the taxpayer in respect of the 1991-92 year of income; and
  • (b) an article of trading stock was on hand at the beginning of that year of income; and
  • (c) the value of that article of trading stock that was taken into account at the beginning of that year of income was greater or less than its cost price;


  • (d) subsection (4) does not apply in relation to that article of trading stock; and
  • (e) the value of that article of trading stock that is to be taken into account at the end of that year of income, or at the end of any later year of income to which subsection (5) does not apply, is the value referred to in paragraph (c) of this subsection.

(8) In this section:

`FIF' has the same meaning as in Part XI;

`notional accounting period' , in relation to a FIF, has the same meaning as in Part XI.''

(a) The Applicants base their arguments firstly on a statement by the Respondent appearing at page 11 of document T2 of the T documents reading as follows:

``In this case the auditor has adjusted the partnership's closing value for trading stock up to its cost price. The partnership is not entitled to write down its trading stock under any of the other valuation methods available to it. Details of other valuation methods, and reasons why the partnership is not permitted to use them to writedown its trading stock, are discussed below.''

(b) In the second place the Applicants base their contentions on an exchange between Dr Sorensen and Mr Kosutic (at TC 410) which is set out in clause 63 of annexure D as follows:

``63. The second piece of evidence particularized by the Applicants occurs in the cross examination of Mr. Kosutic on 6 February 2002 at transcript page 410 lines 25 to 35. In context, the passage from the Commissioner's section 37 statement, as set out above, was read to Mr. Kosutic and the following exchange occurred:

  • Dr Sorensen: `First of all, is this a document that you prepared?'
  • Mr. Kosutic: `No, not that I know of.'
  • Dr Sorenson: `When it refers to auditor, in this case ``the auditor has adjusted'', do you take that as a reference to yourself?'
  • Mr. Kosutic: `Yes'
  • Dr Sorenson: `Do you agree with which ever tax officer wrote this, as a summary of what you did , do you agree with what

    ATC 2115

    he or she has said there?' (Emphasis added)
  • Mr. Kosutic: `Yes'''

(c) If one examines document T2 as a whole without having regard to one phrase while disregarding the others, one can readily see that the decision-maker did not remove the right of the Applicants to value stock at market selling value where that right was exercised in a proper and bona fide manner. See generally T2 pages 10 to 14 and (as just one example) the second last clause on page 14 of T2 which reads as follows:

``The general thrust of the advice prepared by Steven Wearne of Borough Mazars dated 3 February 1994 is not in dispute. It is accepted that market selling value of an item of stock can be ascertained as a result of a genuine independent valuation of that item. It is stressed that at paragraph 2 of that advice Mr Wearne notes that the request for advice concerns the proposal that the wholesale entity (the partnership) obtain independent market valuations (emphasis added) of certain of the goods. Mr Wearne indicated in his advice that the Commissioner would be likely to accept such valuations for income tax purposes. However, in this case, as already discussed at length, the writedown values obtained by the partnership are not genuine independent market valuations, they are merely stock assessments based on a non-existent market. In other words the facts of this case are very different to the circumstances considered by Mr Wearne in the preparation of his opinion.''

Put in other words the statement referred to in sub-clause (a) has been taken out of context.

(d) Similarly to seek to rely on one exchange between Dr Sorensen and Mr Kosutic is again to take one piece of evidence out of context. It is clear from his evidence as a whole that the Respondent did not at any time seek to deny the Applicants their right to elect to value stock at market selling value. It is clear on the contrary that the Respondent came to the conclusion that the manner in which the Applicants sought to value their stock (at alleged market selling value) was in no way made in a manner which was bona fide or proper or correct.

(e) As to Mr Kosutic's evidence, the Tribunal agrees that with clause 88 of annexure D which reads as follows:

``88. The cross examination of Mr Kosutic goes no further than asking him ` as a summary of what you did , do you agree' that you adjusted partnership closing value for trading stock up to its cost price. As a shorthand, or summary statement of the practical effect of the adjustment, then that is correct.''

(f) It follows then that the Tribunal concludes that the decision-maker was altogether correct. The Tribunal finds then that there is no basis for the contention by the Applicants that the Respondent denied them a right vested in them pursuant to section 31(1) of the 1936 Act.

15. (a) The Respondent correctly contends that the onus is on the Applicants to establish that the amended assessments were excessive (
FC of T v Dalco 90 ATC 4088 at 4091; (1990) 168 CLR 614 at 621). It should be noted that the whole of the Applicants' case as to the write-downs depended on the correctness of the Mitchell system. In January 2002 Mr Mitchell conceded that it was framed on the basis of assumptions which were incorrect. In the light of those admissions, the Applicants were clearly in serious difficulties. The evidence of each of Messrs Gerrard and Sechos depended on the integrity of the Mitchell system which they had supported. I refer to clause to 278 of annexure D reading as follows:

``278. The evidence of each of Mr Gerard and Mr Sechos depends for its intellectual underpinnings on the integrity of the process undertaken by Mr Mitchell. If Mr Mitchell's process is irretrievably flawed then the evidence of Mr Gerard and Mr Sechos is similarly affected and not worth the proverbial hill of beans.''

(b) It is in these circumstances that Dr Sorensen found himself obliged to argue a ``course of conduct'' line of argument described by Mr McGovern as the ``Alice in Wonderland'' argument, I deal with it later in these reasons.

(c) I am not clear as to the relevance of Mr Gerrard's evidence. He is involved in the jewellery business; however his is an exclusive business at the top-end of the market in the central business district of Sydney and where he sees customers only by appointment. This was

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not always so, but it has been so, for some considerable time. His support of the Mitchell system was misguided, and based perhaps on an incomplete understanding as to what had been done by Mr Mitchell.

(d) Mr Sechos is a valuator who, on instructions from Mr Gibson performed one write-down valuation (TC 173). He was asked in cross-examination to present his working papers; he produced his file after the luncheon adjournment. It emerged that he had been to Brisbane to prepare a valuation. He said that he done so in consequence of a random sampling only of some stocks. However, his valuation as furnished to Nelson Parkhill indicated that a careful examination of all the stock had been made. It was put to him that that indication was a gross misrepresentation. His answer was that ``you can say so but I am sure they knew what was going on''. It was put to him that he had committed a despicable act and his answer (surprisingly) was ``thank you''.

(e) I do not think it is necessary for me to deal with the evidence of those witnesses for the Respondent to the effect that inspection is generally a pre-requisite to a stock valuation of jewellery.

(f) Strictly speaking then it is unnecessary for me to deal with the altogether monumental evidence of Mr Kosutic, an employee of the Respondent, who undertook a survey of the documentation available to him in order to calculate what happened to aged stock in the hands of Allay. The Applicants objected to Mr Kosutic's evidence both on the grounds of competence and on the grounds of relevance. Each of those objections was quite simply ludicrous.

(g) Mr Kosutic in effect performed a statistical spread-sheet analysis in exhaustive (and perhaps exhausting) detail. The Respondent plainly considered that in the light of what had occurred in the Pontifex proceedings, he should be prepared to demonstrate that aged jewellery stock should not be written-down in the manner contended for by the Applicants. When Mr Mitchell's evidence proved to be so defective, the evidence of Mr Kosutic became in some respects in the nature of ``overkill''. It is significant in the view of the Tribunal that Mr Kosutic's huge statement had been in the hands of the Applicants since January 2001. It cried out for a rebuttal; that none was available is in the highest degree significant.

(h) Once the Mitchell system was discredited and since the ``Alice in Wonderland'' argument (referred to later in these reasons) is demonstrably silly, the Applicants had as regards their stock write-down claims, no hope of discharging the onus. It is important to note that the whole write-down system depended for its integrity on the Mitchell system, which as has been shown, was flawed and disavowed by its creator.

(i) It is in these circumstances that I could have found that it was unnecessary for me to consider Mr. Kosutic's evidence and that the Applicants had failed pursuant to their own case to discharge the onus, in relation to their contentions as regards the market selling value of closing stock. I have however in any event considered his evidence, although I do not think it necessary to deal with it in these reasons, in any detail.

(j) Mr Kosutic's evidence was in the view of the Tribunal eminently fair and reasonable and given moreover in a convincing manner. Dr Sorensen's cross- examination did not reveal any faults or defects or mistakes. The Tribunal accepts the Respondent was eminently correct in T2 when he came to the conclusion that the trading stock was not worth less than cost. Not only were the milestone events identified by Mr Mitchell irrelevant but on the contrary Mr Kosutic's evidence indicated that aged stock sold at a profit to the business entity as a whole years after purchase; the average period involved was 7.43 years. Moreover, the number of aged stock items sold below actual cost was minute. And this accords with Mrs Ciprian's evidence (as referred to at clause 374 of annexure D [not reproduced]) as to sales below cost and in which she said `` Not unless we absolutely had to otherwise the door would be shut '' (TB 218 and 219).

(k) In relation to Mr Kosutic's evidence and to the extent that it is necessary or relevant for me to do so, I note that I accept this evidence both as to relevance and competence. The Tribunal accepts moreover that his evidence is accurately referred to in annexure D and in particular in clauses 315 (and following) [not reproduced].

(l) The Respondent has (correctly) identified six logically separate arguments or propositions by the Applicants. Clause 51 of annexure D is

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repeated in the body of these reasons as follows:

``The Applicants' contentions

51. The Applicants' written submissions advance six logically separate propositions or arguments as follows:

  • (i) The Commissioner has no statutory power to `proceed to assess relying on an option other than that elected by the taxpayer'. Thus it is asserted that the Commissioner made an adjustment to `cost' where the taxpayer has elected `market selling value' and it is not open to the Commissioner to deny the Applicants their choice of `market selling value' and prescribe `cost' instead: submissions paragraphs 4, and 12 to 21. The Commissioner's response to this submission appears at paragraph 53 and following, below.
  • (ii) The 1996 and 1997 returns for Jade were correct and the value of Aged Stock on hand as returned was, as a matter of fact, its market selling value: submissions paragraphs 23 to 37. The Commissioner's response to this submission appears at paragraph 222 and following, below.
  • (iii) Neither Expert accounting evidence nor the accounting standards are relevant to the determination of `market selling value': submissions paragraphs 24, 25 and 58. The Commissioner's response to this submission appears at paragraph 98 and following, below.
  • (iv) The Commissioner should be required to notionally adjust the value of opening Aged Stock on hand on 1 July 1995 to cost: submissions paragraphs 38 to 42. The Commissioner's response to this submission appears at paragraph 109 and following, below.
  • (v) No basis exits for the imposition of penalties, or alternatively such penalties are excessive and should be further remitted: submissions paragraphs 43 to 57. The Commissioner's response to this submission appears at paragraph 426 and following, below.
  • (vi) The evidence of Mr. Kosutic is neither relevant nor has a proper foundation been made out as to his qualifications or experience to attempt to give that evidence: submissions paragraph 59. The Commissioner's response to this submission appears at paragraph 281 and following, below.''

16. (a) Dealing with the first of the Applicants' contentions I have already found that the Applicants were not denied a right or option to value stock at market selling value. On the contrary, the Applicants sought to rely on the Mitchell system found to be fundamentally wrong and unsound.

(b) It is in this context (and in relation to the Applicants' second contention) that Dr Sorensen in his closing argument contended that over a period of years (from 1993 onwards) Jade sold stock to Allay at its the written down value prescribed by the Mitchell system (although in fact and set out in subclause (c) below, the Applicants wrote down stock beyond the percentages recommended by Mr Mitchell) and that this then by established practice was in fact the market selling value.

(c) In fact, the evidence revealed that Mrs Ciprian in keying in the necessary entries in 1995 made two ``mistakes''. It will be remembered that the 1995 Mitchell system called for different percentages at the 18 month and 36 month milestones; in fact Mrs Ciprian even in respect of stock aged 18 months keyed in the 36 months (or higher) write-down percentage. That was the first error and Dr Sorensen accepted that on the basis of that error the figures of the Applicants would in any event require adjustment accordingly. There was a second and equally egregious error; in respect of watches where in effect there were three milestones, watches aged 12 months were written down by the 36 months (or the highest) percentage.

(d) The inherent unsoundness of Dr Sorensen's argument in this context as to a ``course of conduct'' market selling value was illustrated by the fact that on this basis (and if taken to its logical conclusion) a sale of each and every item of stock at $1.00 would suffice. In effect, the Applicants were contending that the market selling value was what they said it was. It struck me that this line of reasoning (if ``reasoning'' is apt in this context) was akin to the manner in which the authorities re-wrote history in Orwell's ``1984''. Mr McGovern however put paid to that line of argument by a reference to
Liversidge v Sir John Anderson [1942] AC 206 where Lord Atkin said at 245:

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``I know of only one authority which might justify the suggested method of construction: `When I use a word,' Humpty Dumpty said in rather a scornful tone, `it means just what I choose it to mean, neither more nor less.' `The question is,' said Alice, `whether you can make words mean so many different things.' `The question is,' said Humpty Dumpty, `which is to be master - that's all.' (Through the Looking Glass, c. vi.) After all this long discussion the question is whether the words `If a man has' can mean `If a man thinks he has.' I am of opinion that they cannot, and that the case should be decided accordingly.''

(e) It follows then that there is no basis whatever for this ``course of conduct'' line of argument. (It was referred to throughout by reference to ``Alice in Wonderland'' although the correct book reference is ``Through the Looking Glass'').

17. (a) It is unnecessary for me to deal with the Applicants' third contention, but for completeness I confine myself to a few remarks.

(b) The Respondent cited
FC of T v St Hubert's Island Pty Ltd (in liq) 78 ATC 4104 at 4113; (1978) 138 CLR 210 at 228 and
J Rowe & Son Pty Ltd v FC of T 71 ATC 4157; (1971) 124 CLR 421.

(c) The Respondent also referred me to the decision of the Federal Court in
FC of T v Citibank Limited & Ors 93 ATC 4691 at 4698-4702; (1993) 44 FCR 434 at 443-448 and to the passage cited at ATC 4699-4700; FCR 444.8 reading as follows:

``Accounting evidence may also assist to elucidate the meaning of a commercial expression used in the Act and thereby to aid in determining an issue of characterisation. Thus accounting evidence was relevant in determining whether cars on floor plan constituted `trading stock' (citation omitted) and likewise a case could be conceived where accounting evidence could be relevant in determining whether a particular item of property was `plant' for the purposes of s 54 of the Act. So too it might be relevant in determining whether a particular receipt was on capital account (citation omitted).''

(d) Lastly in this context the Respondent referred me to a passage from a paper by Justice Hill presented to the Taxation Institute of Australia in 1997. The passage is referred to in clause 106 of annexure D as follows:

```Trading Stock.

The closer the taxation law comes to taxing trading profits the greater it might be expected that it would have regard to accounting concepts.

The very expression ` trading stock ' if requiring elucidation, is an expression used by businessmen and traders. Perhaps the reference to ` trading ' in the expression makes the point that the expression could have no meaning outside the area of trade. Evidence of the meaning of expression can thus be adduced and received as is illustrated by the decision in FC of T v Sutton Motors (Chullora) Wholesale Pty Ltd.

Where the issue is whether the work in progress is to be included in the trading account as trading stock, accounting evidence will be relevant. So, too, where the Tax Act permits trading stock to be valued at ` cost price ' accounting evidence will be accepted as to how that cost price is to be calculated: Phillip Morris Ltd v FC of T. There will be difficulty where the two conflicting views of direct versus absorption costing each has its own adherents. Duple Motor Bodies Limited v Inland Revenue Commissioners. Where the trading stock division specifies market value that too will be a matter for expert evidence .' (Emphasis added)''

(e) Dr Sorensen criticised the passage from the paper by Justice Hill on the basis that it refers to market value whereas market selling value is a different statutory concept. He pointed out that the former concept appears in the 1936 Act far more often than does the latter. My own view is that the views of Justice Hill are potentially apposite to either expression.

(f) Mr McGovern cited case authority to the effect that there may be no difference between market selling value and market value and I think there is much to be said for this proposition. I agree of course with the decision in Citibank (supra) in that accounting evidence may assist in the interpretation of a commercial expression used in the Act. But it is unnecessary for me to deal with this aspect further. In this case, the Applicants did not by

ATC 2119

any stretch of the imagination make an election in favour of market selling value; on the contrary they purported to follow the Mitchell system (and did not follow it correctly and where the mistakes favoured them) and in circumstances where they must have known having regard to its manifest artificiality, that it was altogether unsound.

18. In respect of the Applicants' fourth contention:

(a) In essence the Applicants seek to contend that if for the 1996 year (but not the 1997 year) the Respondent is entitled to reassess closing stock in such manner that it is equivalent to cost he must do the same in respect of opening stock at the beginning of that year that is on 1 July 1995.

(b) The Respondent contended that this constituted an entirely new ground of objection never raised either in the objections or any documents subsequently filed (and including the Applicants' Statement of Issues and the Applicants' Statement of Facts and Contentions) and was raised for the first time in the Applicants' Submissions furnished after all of the oral evidence had been heard. Certainly this point was not raised by Dr Sorensen in opening, or at any time during the oral evidence. In particular, it was not put by him to any of the witnesses for the Respondent.

(c) The Applicants contended that this ground of objection is encompassed by clause 1(a) of the objection by example Mr Ciprian for the 1996 year and see T11 page 64 which reads as follows:

``1(a) The amount included in the taxable income by the amended assessment as being the taxpayer's share of the net income of the Jade Wholesalers (the `partnership') (TFN 68 298 794) should be reduced to a loss of $2864 or some amount less than $52934.''

(d) Dr Sorensen contended that in any event the matter was in effect before me and that I should consider it accordingly. I did not understand him to be making a formal application for an amendment; indeed exhibits R15 and R16 established that the Applicants declined to do so. Dr Sorensen said that he did not consider it necessary to do so.

(e) Dr Sorensen said (tellingly) that the point first occurred to him when he was considering the oral evidence which had been given for the purpose of his clients' closing submissions when the discrepancy between the 1996 and 1997 amended assessments struck him as being significant.

(f) The Respondent contends that I should not consider the matter at all for the reasons set out in clauses 115 to 143 inclusive of annexure D.

(g) It is my view that it is my function to make the correct and preferable decision, standing in the shoes of the Respondent, but only in relation to the material before me. Put in other words and as a matter of jurisdiction it is not proper for me without an amendment to the objections to consider an entirely new ground. As I have said, Dr Sorensen did not apply for an amendment on the basis that clause 1(a) is wide enough to encompass this additional ground. It is my view that clause 1(a) is nothing more than an ambit claim which does not even remotely encompass this additional ground.

(h) I might add that I accept also that if there had been an application (and there was not), it would not have been fair or reasonable for me to allow it since to do so would have caused substantial prejudice to the Respondent for the reasons set out in clauses 139 to 143 inclusive of annexure D which are repeated as follows:

``139. If the issue and contention had been raised in the notice of contention or, for that matter, in opening address then the Commissioner would have presented a different case to the Tribunal.

140. Thus, for example certified copies of the notices of assessment under section 177 of the 1936 Act for the years of income from 1991 to 1995 inclusive may have been tendered to the Tribunal. Evidence may have been led as to whether the Applicants, or any of them, objected to their assessments in any of the years of income from 1991 to 1995 in respect of the particular, namely, the value of opening and closing stock in each year of income.

141. Evidence may also have been led by the Commissioner as to the precise date upon which the Commissioner became aware that the closing stock figure at 30 June 1995 contained write downs in respect of Aged Stock.

142. In particular expert accounting evidence would have been lead from Mr. McClintock as to the appropriateness of having a difference in amount between the

ATC 2120

value of closing stock for one year and opening stock for the next year. That is matter on which expert accounting evidence could and should have been adduced.

143. Because the Applicants did not raise the issue until the written submissions dated 30 April 2002, and because they did not properly make application for an amendment to their objections, the Commissioner is prejudiced because he would have run his case differently, and because he is denied the opportunity to adduce expert evidence directly on point.''

I note in the context that it is clear that the costs incurred in particular by the Respondent have been high. Leaving aside the large number of hearing days, there were numerous days vacated. Moreover, the Respondent incurred large costs in order to prepare the Kosutic evidence; his cost of preparing submissions was also high. To expect the Respondent to be party to a reopened case in order to consider the implications of what was no more than an afterthought would have been grossly unfair.

(i) I was asked at the hearing to consider whether if such an application (for an amendment of the objection) had been made, and if it had been granted, or in the alternative, if it were encompassed by clause 1(a) of the objections I would (making all of these notional assumptions) have found for the Applicants so as to require the Respondent to increase the opening stock for the 1996 year up to cost.

19. (a) The Respondent has (in clauses 145 to 231 of annexure D [not reproduced]) dealt at some length and in considerable (and indeed commendable) detail with the Applicant's fourth contention. In particular annexure D [not reproduced] can be referred to for a history for all of the relevant legislation and including section 29 of the 1936 Act and both the preceding legislation and the succeeding legislation and being in the latter case the Income Tax Assessment Act 1997 (``the 1997 Act'').

(b) In 1924 the precursor to section 29 of the 1936 Act appeared for the first time. I refer in this context to clauses 149 to 155 of annexure D [ not reproduced]; I include clause 155 only reading as follows:

``155. The following comment is made in the Report-

  • `The main principle expressed in this Division is that every trader, at the end of every income year, should bring in the value of his trading stock on hand, and that he shall have the option of bringing it in at its cost price, or the market selling price, or at its replacement price. In the following year trading stock should be brought in at the same figure as that given for the previous year .' (Emphasis added)''

(c) In relation to the 1936 Act I again refer to clauses 156 to 159 of annexure D. Dr Sorensen contended that words ``Its value as ascertained under the Act'' differ from the wording contained in both the predecessor provision and also the successor provision (in the Income Tax Assessment Act 1997) and that accordingly the value of opening stock must also be that ``ascertained''. Mr McGovern contended (in my view correctly) that the term ``ascertained'' is in effect a reference to ``assessed''.

(d) It is perfectly true that the 1997 Act Explanatory Memorandum provides in relation to section 70-40 of the 1997 Act (and see clause 160 of annexure D) that an amendment of the wording (when compared with section 29 of the 1936 Act) was to be made having regard to ``some Board of Review decisions''; the relevant passage from the Explanatory Memorandum appears in clause 161 of annexure D as follows:


  • `Section 29 of the 1936 Act says that an items opening value is the value ascertained under the Act at the end of the previous year. There are some Board of Review decisions concluding that those words mean that the opening value must be what the previous years closing value should have been. If the previous years assessment cannot be amended because of time limits, its closing value will be different from the next years opening value. This will produce either a windfall gain or an unexpected loss for the taxpayer .
  • The rewrite avoids the possible problem. If one years closing value is amended, then the next years opening value will change to reflect that amendment. If the closing value cannot be amended, the next years opening value will still be what was recorded as the closing value. Subsection 70-40(2) supports this by ensuring that an

    ATC 2121

    items opening value is nil if the items closing value in the previous year was not taken into account at all.' (Emphasis added)''

I agree with Mr McGovern's contention that the problem is referred to as possible only and I also agree with his contention that the rewrite was made as a matter of abundant caution only.

(e) Dr Sorensen relied on the decision of Mr Cotes in 14 CTBR Case 10 which was decided some fifty years ago; he referred also to two further old Board of Review cases namely (1951) 1 TBRD Case 106 and (1956) 7 TRBD Case G33. I refer in this context to clauses 40 and 41 of annexure B reading as follows:

``40. The Commissioner's 1996 adjustment calculation set out in Ex A1 p. 98 (TDoc 7 at 56) (a net adjustment calculation) shows that no adjustment was made for the Opening Stock as returned, that is, no account was taken of the difference between market selling value as returned and cost price - as was done in the 1997 adjustment. The failure to make that adjustment renders the 1996 calculation excessive: see 14 CTBR Case 10; see too (1951) 1 TBRD Case 106 at p. 451-452, (1956) 7 TBRD Case G33 at p. 191.

41. In Case 10, the Board decided that the value of the stock on hand at the beginning of the year of income must be a value ascertained in accordance with the provisions of s. 31 and that the fact that the assessment of the immediately preceding year of income was not amended to give effect to a value adjusted in this manner was immaterial. In this connection, Mr R A Cotes (Member) said, at para 11 p. 110-111-

  • `It was argued at the hearing that unless and until the assessment for ``the 1937 year'' was amended, it was not possible for the Commissioner to substitute an altered stock figure as at the beginning of ``the 1938 year'' for the purpose of making an amended assessment. In my view, s. 29 presupposes that, in determining the stock value at the beginning of a year for the purpose of making an assessment of the taxable income for that year, the value of stock at the end of the previous year would have been correctly ascertained in accordance with the provisions of s. 31. It is possible, of course, to make varying calculations of the aggregate value of stock on hand at any date, all of which would comply with the requirements of s. 31; and, in my opinion, the true purpose of s. 29 is to ensure that the particular aggregate value of stock at the close of any income year, determined in accordance with the provisions of s. 31, is to be the value of stock adopted at the beginning of the following year. If, therefore, the value of stock at 31 August 1937 was incorrectly shown in the return for the year ending at that date, and it is possible to determine a substituted value in accordance with the provisions of the Act, that substituted value is the one to be taken to account in ascertaining the amount to be included in or deducted from the assessable income of the year ended 31 August 1938, irrespective of whether or not the assessment of the previous year is amended.'''

I agree of course that Case 10 favours Dr Sorensen's contention.

(f) Mr McGovern referred me in particular to the decision (in New Zealand) of
Kirkpatrick v Commissioner of Inland Revenue [1962] 13 NZLR 49 see in particular clauses 197 to 207 of annexure D reading as follows:

``197. In the Commissioner's submission, the decision in
Kirkpatrick v CIR (1962) 13 NZLR 49 is indistinguishable and directly on point. It is the decision relied upon in Gunn's commentary for the proposition that the opening value ` must correspond ' with the value on hand at the end of the preceding year.

198. In that case the taxpayer, a sheepfarmer, adopted the simple expedient of representing to the Revenue that he had no unsold wool on hand at the end of each income year. Income was understated because part of his profit was represented in stock on hand. He had adopted the practice for ten years or more.

199. The subterfuge was discovered on his death in 1958 and the Revenue issued assessments back to the 1948 income year commencing on 1 April 1947. It seems the relevant New Zealand Act permitted amendment for ten years.

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200. The question raised was, what was the value of his stock on hand (unsold wool) at the beginning of the 1948 year of income. The taxpayer's return for the 1947 year showed the value of closing stock on 31/3/1947 as `Nil'. The taxpayer's 1948 return showed the opening value of stock as `Nil'. However, the actual wool on hand at 31 March 1947/1 April 1947 was known, as a fact, to be £1,842. The value of wool on hand at the end of the 1948 year was £2,505. The Revenue's assessing action for 1948 was to include the value of closing stock at £ 2,505 as income and subtract `Nil' as the opening stock as per the 1947 and 1948 returns (closing and opening values respectively).

201. Barrowclough CJ summarized the assessing action at page 50.7 as:

  • `the fact that the return for that year showed no wool in hand must therefore be conclusive evidence that on 31st March, 1947, the taxpayer had no wool in hand: that in other words, for the purposes of the Act, the taxpayer must be deemed to have no wool in hand on 31st March, 1947, even though we know that he had wool in hand worth £1,842.'

202. So too, in the Applicants' position. If Mr. Mitchell's write downs are inappropriate, the Applicants will have on hand as closing stock on 30 June 1995 and opening stock on hand at 1 July 1995 a higher value of Aged Stock.

203. Barrowclough CJ then set out sec 26 of the Act which corresponds to sec 177(1) of the 1936 Act. He relied upon the decision of Sir John Salmond in
Anson v IRC (1922) NZLR 330 at 338 for the proposition `the assessments of the appellant in previous years, therefore, not having been objected to in the statutory time and manner, are conclusive against him.'

204. At page 51.5 Barrowclough CJ reached the conclusion that the value of closing stock on 31 March 1947 was a particular of the taxpayer's return and was also a particular of the assessment which issued in conformity with that return. It followed by the equivalent of sec 177(1) that the taxpayer was `estopped from disputing' the assessment, for the 1947 year ending 31 March 1947, and all the particulars thereof (including the value of stock on hand valued at `Nil').

205. The learned Chief Justice then referred to sec 98(3) of the New Zealand Act (at page 52.5) which provision is relevantly indistinguishable from the terms of sec 29. It refers to `the value of trading stock... to be taken into account at the beginning of any income year shall be its value as at the end of the last preceding income year.'

206. Barrowclough CJ then concluded (at page 52.5) as follows:

  • `the Commissioner was bound by the statute to act on the basis that the value of the wool in hand at the beginning of that year was its value at the end of the preceding year i.e. as at 31st March, 1947. Its value then is conclusively deemed to be nil and I cannot see how the Commissioner could lawfully avoid taking it into account as being of no value at all on 1st April, 1947 . This is precisely what he did and I am of the opinion that he was right....
  • [The Commissioner] was required by the statute to take the wool into account at the beginning of the year at the same value as it had at the end of the preceding year and both he and the taxpayer are estopped from saying that its value at the end of the preceding year was other than nil ' (Emphasis added)

207. The decision in Kirkpatrick, and decision of the Sir John Salmond for the Court of Appeal in Anson, is correct and indistinguishable. The approach in those decisions is consistent, and in fact on all fours with, the decision of Lindgren J in Commercial Union Australia Mortgage (supra). It is true that Lindgren J does not use the expression `estopped'. But his Honour specifically refers to sec 177(1) and says the later year assessment must be `not inconsistent' with the proposition the earlier assessments have been duly made.''

(g) Dr Sorensen contends that Kirkpatrick (supra) should be distinguished because the wording in the New Zealand legislation differs from the Australian legislation and again focused on the words ``as ascertained'' in section 29.

(h) In my view the decision in Kirkpatrick (supra) is in point and the slight wording

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difference is not such as to cause me to agree with Dr Sorensen's contention that Kirkpatrick is not a valid authority.

(i) It will be noted that the New Zealand Court in Kirkpatrick (supra) specifically found that there was an estoppel in these circumstances. I agree with Mr McGovern's contention that the judgment of Lindgren J in
Commercial Union Australia Mortgage Insurance Company Limited v FC of T 96 ATC 4854; (1996) 69 FCR 331 is in point and I agree in particular with what Lindgren J said (
96 ATC 4854 at 4865) of that decision as follows:

``In any event, in accordance with the scheme of the relevant provisions of the ITAA which I attempted to explain earlier, CUAMIC's assessable and therefore taxable income for the year ended 30 June 1993 must be ascertained in a manner not inconsistent with the proposition that the assessments have been duly made in the earlier years.''

(j) Dr Sorensen argued that the mere fact that there would be a windfall gain or a loss should not affect the matter and referred in this context to
Henderson v FC of T 70 ATC 4016; (1970) 119 CLR 612. Lindgren J in Commercial Union (supra) dealt in terms with the judgment in Henderson's case
96 ATC 4854 at 4862; (1996) 69 FCR 331 at 341-342 which reads:

``The present appeal must, however, be resolved in a manner which accords full effect to the High Court's holding in
Henderson v FC of T 70 ATC 4016; (1970) 119 CLR 612 in which Barwick CJ, with whom McTiernan and Menzies JJ agreed, said this (at ATC 4019; CLR 649):

  • `... there cannot be any warrant in a scheme of annual taxation upon the income derived in each year of taxation for combining the results of more than one year in order to obtain the assessable income for a particular year of tax... Once it is decided that the partnership income derived in the year in question will be the net amount of its earnings of that year, it is, in my opinion, only the earnings of that year which can be included in the computation.'

Henderson's case was a `change of basis' case: if the cash basis is properly applied in respect of the earlier period and the accruals basis in respect of the later period, any escape of tax is explained by the change and does not falsify the earlier assessment.''

(k) The Respondent contended that the judgment of Fullagar J in
Australasian Jam Co Pty Ltd v FC of T (1953) 10 ATD 217; (1953) 88 CLR 23 should be regarded by me as being strongly persuasive even if, in this particular context, obiter. Fullagar J said at ATD 218; CLR 26-27:

``It is on s. 31 that the present cases primarily turn. The section in terms allows to the taxpayer considerable freedom of choice. He may adopt one method of valuation for one part of his stock, and another method for another part. And he is not bound to adhere from year to year to any method of valuation for any part of his stock: he may change the basis as to the whole or any part of his stock from year to year at will. On the other hand, the section is imperative in that it requires him to adopt for each article of his stock one or other of the three prescribed bases of valuation. He is not at liberty to adopt some other basis of his own. And s. 29 requires that the value at which his stock is brought into account at the beginning of a year shall be the value at which it was brought into account at the close of the preceding year: in other words, the opening figure of any year must be identical with the closing figure of the preceding year .''

(Emphasis added)

(l) Annexure D [not reproduced] then goes on to discuss the views of a number of textbook authorities. As appears from annexure D [not reproduced] an overwhelming majority holds the view for which the Respondent contends, namely that there must be a strict correlation between closing stock in one year and opening stock in the next succeeding year. The only exception is the CCH Federal Tax Reporter paragraph [17-555] which oddly enough, does not refer to Australasian Jam (supra) or Kirkpatrick (supra) or other relevant cases.

(m) It seems odd to be told that a Board of Review case of fifty years ago should be preferred to superior court authorities which are in any event more recent. Of course I cannot do so, and do not do so.

(n) I refer also to clauses 220 and 221 of annexure D which are repeated in this decision as follows:

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``220. It is instructive to note that the Applicants' written submissions, in a section other than dealing with the observations of Mr. Cotes, accepts expressly the Commissioner's contentions concerning sec 29. The Applicants have submitted in paragraph 12 as follows:

  • `Section 31(1) in terms allows the taxpayer considerable freedom of choice. In regard to the 3 available options, the taxpayer is not limited to adopting one basis only for all articles but may choose a different basis of value for different articles of trading stock. And subject to the overriding requirement of s. 29 that the value at the beginning of the year must be the same as that adopted at the end of the previous year , the taxpayer is not bound to maintain the adopted basis or mix of bases in subsequent years.' (Emphasis added)

221. Paradoxically, the authority cited in support of paragraph 12 by the Applicants is
Australasian Jam Co Pty Ltd v FC of T (1953) 88 CLR 23 at 26-27 per Fullagar J. which is the very passage set out above and relied upon by the Commissioner.''

20. I have said previously in these reasons that Mr Mitchell got into great difficulty over the integral nexus issue. I should say that in line with the judgment of Finkelstein J in
Bob Jane T-Marts Pty Ltd v FC of T 99 ATC 4437 a retail price may have a bearing in certain circumstances on the wholesale price. If a retailer is obliged to discount an item he may seek to pay a lower price to his wholesaler. This will of course generally apply in an arm's length situation. I do not think it necessary for me to deal further with this aspect, which is referred to in these brief terms, only for the sake of completeness.

(a) This brings me to a consideration of the penalties imposed under sections 226J and 226X of the 1936 Act; those sections are set out in full as follows:

``Section 226J Penalty tax where shortfall caused by intentional disregard of law

Subject to this Part, if:

  • (a) a taxpayer has a tax shortfall for a year; and
  • (b) the shortfall or part of it was caused by the intentional disregard by the taxpayer or by a registered tax agent of this Act or the regulations;

the taxpayer is liable to pay, by way of penalty, additional tax equal to 75% of the amount of the shortfall or part.


Section 226X Further penalty tax


  • (a) under a shortfall section, a taxpayer is liable to pay additional tax because of a tax shortfall or part of a tax shortfall; and
  • (b) one or more of the following applies:
    • (i) the taxpayer took steps to prevent or hinder the Commissioner from becoming aware of the shortfall or part;
    • (ii) if the shortfall or part was caused otherwise than by the taxpayer in a taxation statement treating an income tax law as applying to the taxpayer in relation to a matter or scheme in a particular way - the taxpayer became aware of the shortfall or part after a taxation statement by the taxpayer that was taken into account in working out the taxpayer's statement tax for the year and failed to tell the Commissioner about it, in writing, within a reasonable time of becoming so aware;
    • (iii) if the additional tax is payable under section 226G, 226H or 226J - the taxpayer was liable to pay additional tax under any of those sections in respect of an earlier year of income;
    • (iv) if the additional tax is payable because the taxpayer, in a taxation statement, treated a law as applying in relation to a matter or scheme in a particular way so that section 226K or 226L applied - the taxpayer was liable to pay additional tax under that section in respect of an earlier year of income in respect of which the taxpayer treated that law as applying in relation to that matter or a similar matter or that scheme or a similar scheme in that way;

    ATC 2125

the taxpayer is liable to pay, by way of penalty, further additional tax equal to 20% of the amount of the additional tax.''

(b) Mr McGovern described Mrs Ciprian as a willing participant in the Mitchell system and that description was apposite. It must be remembered that Mrs Ciprian is a trained and educated person who actively pursued tax benefits. Mrs Ciprian said in evidence before me that the Mitchell system was conservative; she cannot have made that statement with any belief in its truth. She was asked if the Applicants discounted at retail level to the same extent that they discounted at the wholesale level. Her answer was ``Not unless we absolutely had to otherwise the door would be shut''. (TB 219). She had no answer to Mr Kosutic's findings and analysis.

(c) It must be remembered that the 1993 write-down commenced with a request by Mrs Ciprian to Mr Gibson as to whether it was possible to write-down stock for tax purposes.

(d) In November 1993 Mr Gibson wrote to his clients, and including the Applicants advising them that the Respondent was not prepared to ``accept the sale of aged stock on or after 1 November 1993 at the revalued amount''. Mr Gibson then went on to recommend that it would be possible to continue with the system through an independent valuation to establish true arm's length value of above aged stock.

(e) As the Respondent contends the letter of Mr Gibson in November 1993 calls for a careful and cautious approach. The reference to an independent valuation and true arm's length values were and should have been regarded as warning signs.

(f) I have said that Mrs Ciprian is an educated person with expertise in both valuations of jewellery and mathematics. She knew perfectly well that the stock as revalued was well below value and the Mitchell system was in no way a true and independent valuation of arm's length value. The fact that Jade must of necessity lose money and did in fact incur substantial losses through the Mitchell system should have told, and perhaps did tell its own story.

(g) In November 1993 Mr Gibson obtained a legal opinion from Mr A H Slater QC. Although Mr Gibson (oddly enough) was prepared to show that opinion, he was not prepared to supply it. Why not? Perhaps the caveat which contained in Mr Slater's opinion gave him cause for concern. A part of Mr Slater's opinion appears in clause 446 of annexure D; clauses 446 and 447 of annexure D read as follows:

``446. The opinion by Mr. Slater is in evidence as Exhibit PG07 to the Affidavit of Mr. Gibson. It is worth noting, in full, the caveat to the opinion as follows:

  • `I add the cautionary note that the foregoing advice is predicated upon the value adopted being an arm's length value. The circumstance that an independent valuer, having no business connection with the wholesaler and retailer other than his engagement to provide a valuation, and having appropriate levels of expertise and experience, provides a valuation of the jewellery for the purpose of fixing the transfer price, is potent evidence that the price adopted is an arm's length price and it may, of course, be the fact that the valuer is simply wrong; in a dispute, a Court or Tribunal might adopt in preference a higher value attributed to the goods by a valuer called by the Commissioner. As the many cases in which competing valuations have been assessed by Courts and Tribunals indicate, independent valuers acting in good faith may reach different figures. However, if the valuer selected is accepted by the Taxation Office as being indeed and independent valuer, I should not expect there to be any contest over the figures adopted by him.
  • In this regard, I would point out that the consistent use by taxpayers (especially a group of taxpayers having a common advisor) of but one valuer may both lead the Taxation Office to question his independence, and indeed imperil that independence: the prospect of continued work (and revenue) may afford an incentive to make valuations which are more rather than less palatable to the client. A panel of independent valuers, amongst whom the work is spread, is likely to be both more reliable and more acceptable.'

447. Mr Slater's caveat could not be more direct, pointed and telling. There is, of

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course, no evidence that either any of the Applicants or their advisor, Mr. Harrison, actually read the Slater opinion. But nonetheless, it was, to the Applicants knowledge available on request.''

Of course Mr Gibson knew perfectly well that the Mitchell system was so arranged that it flew directly in the face of the caveat. Mr Mitchell could not, as Mr Gibson knew, be described as independent in the manner recommended by Mr Slater.

(h) In February 1994, Mr Gibson obtained advice from Borough & Partners, solicitors; I refer in this particular context to clauses 448 to 453 (inclusive) of annexure D, which relate inter alia to that advice and which read as follows:

``448. On 3 February 1994 Mr. Gibson obtained advice from Borough & Partners (Exhibit DC20 page 75). This written advice was received by the Applicants. However, that advice in turn is subject to three specific caveats which set out in paragraphs five and six of the letter as follows:

  • `It should also be mentioned that the income tax concept of ``market selling value'' has been considered upon a number of occasions by the Courts and has developed a relatively clear meaning. For example, it refers to the market selling value of the stock in the taxpayer's own selling market and not some other market. The Commissioner of Taxation also takes the view that selling expenses - i.e. costs which may be incurred in the future in effecting a sale of the goods do not come into the valuation of market selling value. You will appreciate from these comments that the Commissioner of Taxation might take issue with the amount ascribed to stock by an independent valuer upon the basis it does not reflect ``market selling value'' in an income tax context.
  • ...
  • It follows, therefore, that the adoption of the independent valuations proposed would not, subject only the above stated matters, be disputed by the Commissioner of Taxation. (We note again for completeness that the goods in question represent only certain stock lines and thus their sale at a loss should not result in an overall loss for taxation purposes being incurred by the wholesale entities. In the event such a loss were to be incurred, we understand you are aware of the various means by which this loss might be utilized).' (Emphasis in the original)

449. The Borough's advice is expressly qualified by reference to the sale in the taxpayers own selling market and not some other market, for example, a fire sale or an export market. It is also predicated on some specific items only being discounted and that no loss is disclosed at the wholesale level.

450. The Mitchell valuation is, of course, based upon a sale in markets that the Applicants do not trade in, namely, a sale back to wholesalers and a sale for scrap. The Applicants knew, or must be taken to have known, that they did not sell in those markets and that they could not satisfy the caveat. This is particularly so, given the `not' was emphasized in the Borough's letter i.e. `and not some other market'.

451. Mr. Harrison understood the expression taxpayers own selling market to mean the wholesale selling market in which the Applicants operated (TB page 152.7).

452. Mr. Harrison also agreed that if 37 out of 40 stock items were reduced then perhaps `that doesn't tie in with that spirit' of the Borough's advise that the goods represented `only certain stock lines' (TB 154.2).

453. Mr. Harrison also understood that Borough's assumed that the wholesale percentage write-down would not result in an overall loss for taxation purposes being incurred at the wholesale level (TB 154.2). Mr Harrison was aware that the occurrence of such a loss at the wholesale level was precisely what happened in the Applicants' case (TB 154.3).

454. Accordingly, Mr. Harrison was actually aware of, and understood the implications of the three caveats in the Borough's advice, namely, the taxpayer's own market, certain items only written down, and there be no tax loss at the wholesale level.''

Dr. Sorensen contended that the Borough's advice was not aptly characterised as a caveat at least so far as losses in Jade were concerned and more particularly having regard to the

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suggestion that those losses could be ``utilised''. I agree with Dr Sorensen's contention as to this aspect of the Borough's advice; it may be that Borough (although this is speculation only) had in mind that the Applicants could set off losses in Jade against their other income.

21. (a) The Borough's advice of course was obtained, many years ago, and in February 1994. In the course of Mr Harrison's evidence it was suggested to him that it would have been prudent to obtain an update. He agreed that that might have been desirable but it was not done.

(b) One can then only wonder at the fact that notwithstanding all of these cautionary developments which would have put any reasonable person upon his or her guard and despite the fact any ordinary and reasonable taxpayer would be concerned by all of the various warning signs, Mr Gibson in November 1994 wrote the ``It's Time! Stock Revaluation'' letter (referred to previously in these reasons).

(c) It will be remembered that Mr Gibson received fees directly commensurate with the level of write-down. The fact that in these circumstances he was prepared to recommend not only continued write-downs but in fact increased write-downs is truly astonishing.

(d) It was suggested to me in argument that Mrs Ciprian was doing no more than following advice from professionals and so that she and her partners should not be held responsible for following bad advice. There might be something in this contention if Mrs Ciprian was an untrained or uneducated person. She was not; she took the advice and followed it; in fact she did more than follow it; she not only originally solicited it, but even went beyond the high levels of write-down recommended by Mr Mitchell. And she did so not once, but twice. Moreover, the level of losses sustained by Jade should have been a cause of concern. Why having made these mistakes (twice) did she not seek to rectify the situation by advising the Respondent that she had erred in the level of write-downs and that amended assessments were for this reason required?

(e) In my view the Respondent has made out a strong case of intentional evasion within Taxation Ruling TR 94/4 and so that the penalty under section 226J was correctly and properly imposed.

22. (a) Section 226X(b)(i) of the Act applies if the Applicants took active steps to hinder the Respondent. The Respondent's contentions in this regard are set out in clauses 465 and following of annexure D [not reproduced].

(b) In particular the Respondent wrote to the Applicants in January 1998 advising that the practice of valuing aged stock was unacceptable. That letter advised:

``This office does not consider that the written down value of the stock on hand in the wholesale jewellers' books of account satisfied the above provisions. Therefore, if you have used the written down value for the calculation of your income, you are required to review your valuation for stock on hand as at 30 June 1996. Should you find that there has been an error or omission made in your calculation, you are requested to advise this office in writing by 27 February 1998. The disclosure of any errors or omissions should include the name and file number under which your business lodges a taxation return, and the amount of any adjustment(s) required. Also, please include a brief explanation of why the error was made.''

(c) The letter concluded with a note to the effect that voluntary disclosures would result in penalty reductions.

(d) The Applicants replied by letter dated 20th February 1998 as follows:

``Re: your letter of 29th Jan 1998. I am satisfied that no error nor omission was made in our calculation of income with regard to our stock on hand as at 30th June 1996.''

(e) The Applicants' letter dated 20th February 1998 was both unwise and disingenuous. The Respondent had put the Applicants on notice that the method was unacceptable and required the Applicants to review their valuation. The Applicants could have replied in a manner which specified that they had used the devaluation method and intended to adhere to it because they thought it correct. A suitable response could have taken the form suggested in clause 477 of annexure D [ not reproduced]. Mr Harrison thought that the reply was unwise (TB149).

(f) I note in this context that Mr Harrison's evidence did not materially affect the matter one way or another. It was suggested as I have

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said that it might have been wise to review the Borough's advice; he did not disagree. I gained the impression that he thought of himself as a small town accountant who should not contradict the views of his colleagues in the city.

(g) Mr Kosutic formed the view, that the reply by the Applicants in February 1998 constituted a statement to the effect that the Applicants were not using the write-down system and that he realised that this was not so only when he received a number of similarly worded replies; on the other hand it must be remembered that the Applicants were under no legal obligation to furnish the required information.

(h) The Respondent contends that the word ``hinder'' includes the concept of ``to obfuscate''. I can see no reason why this is so. The word ``hinder'' is not defined and so that resort must be had to its ordinary meaning.

In this context Butterworths Australian Legal Dictionary (Butterworths, Sydney, 1997) specifies that ``hinder'' means ``to interfere with for the purpose of delaying a person or thing.''

Stroud's Judicial Dictionary of Words and Phrases (6th edition, Sweet & Maxwell, London, 2000) specifies (not altogether helpfully for our purposes) that ``hinder'' means:

``A contest between rival claimants to tithes was not a `difference' whereby the making an award under the Title Act 1836 (c. 71) was `hindered' within s.45 (Shepherd v. Londonderry, 18 Q.B. 145).

Delay in loading a ship caused by the Canadian Wheat Board's decision to give priority to other ships was `hindrance beyond the charterer's control' within the terms of the charterparty (
Reardon Smith Line v. Ministry of Agriculture [1962] 1 Q.B. 42).

A circular issued by the Minister of Health forbidding the circulation of a lawful newspaper in hospitals `hindered... freedom of expression' contrary to Part II, s. 14(1) of the Malta (Constitution) Order in Council 1961 (
Olivier v. Buttigieg [1967] A.C. 115).''

(i) The Explanatory Memorandum to the Taxation Laws Amendment (Self Assessment) Bill 1992 (to which resort may be had in terms of the Acts Interpretation Act 1901) states that:

``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 (irrelevant)] 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.''

(j) It must be noted that the Respondent relies on section 226X(b)(i) and no other subsection of section 226X of the 1936 Act. The ``second situation'' which applies for the purposes of section 226X(b)(ii) where the taxpayer becomes aware of an error and fails to notify the Respondent of that error (and see page 94 of the Explanatory Memorandum) would thus not appear to be relevant. (As to when the Applicants became aware of their errors in using the Mitchell system is not clear; if the errors were deliberate they were ``aware'' when the errors were made; if not and this is possible, they might perhaps have become aware when they were preparing their case).

(k) The conduct of the Applicants although hardly to be recommended (and in some respects reprehensible) does not appear to me to fit within any of the concepts of ``prevent or hinder'' pursuant to section 226X(i) contained in the relevant Explanatory Memorandum; although the various examples given differ quite markedly in degree of culpability, they all connote something active as opposed to something passive. It seems to me that what the Applicants did might properly and at least on one view be categorised as passive rather than active, precisely because they were not legally obliged to furnish the information in question. The letter in February 1998 could in my view be categorised as ``stonewalling'' and thus passive; it is not clear to me that it was couched in terms which entitled Mr Kosutic to form the view that the Applicants were representing that they were not using the Mitchell system. This being so, I do not think that it can be said that their conduct amounts to hindrance within

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section 226X(b)(i) of the 1936 Act and accordingly the penalty under this section (but not the penalty under section 226J) should be remitted.

23. I have deliberately not dealt with the evidence of Professor Walker and Mr McClintock because it is not necessary for me to do so. I note that neither party in closing oral submissions thought it necessary to deal with their evidence. I should say though that Mr McClintock's evidence was at all times clear, concise and intelligent and would have been accepted by me had it been necessary for me to do so.

24. In summary:-

(a) On the main issue, which is of course the question of whether the Applicants validly or properly valued stock in accordance with the market selling value, the Applicants must fail because the Mitchell system was so conclusively discredited.

(b) The 1996 year opening stock contention is not encompassed by the objections, and to allow an amendment at this time after all the evidence would be prejudicial and should not (if it had been applied for, and this is not the case) be allowed.

(c) Even if the Applicants had applied for an amendment and even if it had been granted, the result would not have been different.

(d) The ``course of conduct'' market selling value argument is untenable (and indeed ridiculous).

(e) The Respondent did not remove a right of election vested in the Applicants under section 31(1) of the 1936 Act.

(f) As to penalties, the penalties under section 226J of the 1936 Act were correctly imposed; however the penalties under section 226X(b)(i) of the 1936 Act are remitted.

25. Accordingly and excepting only that the penalties imposed under section 226X(b)(i) of the 1936 Act are remitted, the objection decisions under review are affirmed in full.

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