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CASE 5/2012

Members:
RW Dunne SM

Tribunal:
Administrative Appeals Tribunal, Adelaide

MEDIA NEUTRAL CITATION: [2012] AATA 348

Decision date: 12 June 2012

RW Dunne (Senior Member)

INTRODUCTION

1. JCZC is the applicant in this case. It is the corporate trustee of the B Trust. During the 1999-2003 tax years, the B Trust was a beneficiary of three related trusts ("Related Trusts"). During the 1999-2003 tax years, the Related Trusts were beneficiaries of another trust, the M Trust. The corporate trustee of the M Trust was SCM. Mr X is (and was) the sole director and shareholder of the applicant and SCM.

2. During the 1999-2003 tax years, the M Trust owned a motor yacht ("Yacht"). The purchase of the Yacht was negotiated by Mr X. Expenditure in relation to the Yacht was claimed by the M Trust in the 1999-2003 tax years to be deductible under s 8-1 of the Income Tax Assessment Act 1997 ("1997 Act"). The expenditure claimed was disallowed as a deduction. For tax purposes and for the 2003 tax year, the net income of the M Trust was increased to $2,925,658 and, because of the structuring of the Related Trusts as beneficiaries of the M Trust, the net income of the applicant was correspondingly increased. The respondent issued a notice of assessment to the applicant for the 2003 tax year, pursuant to s 99A of the Income Tax Assessment Act 1936.

3. The 2003 assessment gave rise to a shortfall amount of tax and a notice issued to the applicant assessing a 25 per cent base penalty of $550,501.25 in respect of the shortfall amount for treating an income tax law as applying in a particular way that was not reasonably arguable ("First Penalty Assessment"). The applicant lodged a notice of objection against the First Penalty Assessment, which was disallowed. The respondent issued a notice to the applicant assessing a further base penalty amount of $550,501.25, uplifting the base penalty to 50 per cent of the shortfall amount ("Second Penalty Assessment"). The applicant objected against the Second Penalty Assessment, which the respondent disallowed. The applicant has applied to this Tribunal for review of the objection decisions.

4. At the hearing, the applicant was represented by Mr B Jones (of counsel) and the respondent was represented by Ms L Price (of counsel). I received into evidence the T documents (Exhibit R1 and Exhibit R2) and the Supplementary T documents (Exhibit R3 [excluding page 289], Exhibit R4 and Exhibit R5 [excluding pages 576, 578-580 and 582-589]) lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975, together with the following exhibits:

  • • affidavit of Mr X sworn on 14 April 2011, with annexures (Exhibit A1);
  • • photograph of the Yacht dated on or around 1999/2000 (Exhibit A2);
  • • respondents extract of lodgement of 2002 taxation return for SCM (Exhibit R6);
  • • respondents extract of lodgement of 2003 taxation return for SCM (Exhibit R7);
  • • affidavit of Mr B C Shepherd dated 2 June 2011 (Exhibit R8); and
  • • folder of documents produced to the Tribunal by KPMG pursuant to a summons dated 12 July 2011 (Exhibit R9).

ISSUES FOR THE TRIBUNAL

5. The following are the issues before me:

  • ATC 479

    (a) Whether claiming expenditure in relation to the Yacht as allowable deductions, with a consequential omission from the net income of the B Trust for the 2003 tax year, was or was not a reasonably arguable matter within the meaning of s 284-15 of Schedule 1 of the Taxation Administration Act 1953 (TA Act)?
  • (b) If the claiming of expenditure in relation to the Yacht was not a reasonably arguable matter such that the applicant is liable under s 282-75 of Schedule 1 of the TA Act to an administrative penalty in respect of a shortfall amount, should the base penalty amount worked out under s 284-90 of Schedule 1 of the TA Act be:
    • (i) 25 per cent of the shortfall amount because the shortfall amount (or part thereof) resulted from the applicant or its agent treating an income tax law as applying in a particular way that was not reasonably arguable; or
    • (ii) 50 per cent of the shortfall amount because the shortfall amount (or part thereof) resulted from recklessness by the applicant or its agent as to the operation of a taxation law?

LEGISLATION

6. Under Schedule 1, Division 284 of the TA Act a penalty may apply if a taxpayer (or tax agent) makes a statement (or fails to make a statement) to the respondent about a taxation law that results in a "shortfall amount" of tax to the taxpayer. The relevant provisions in Division 284 read:

" 284-15 When a matter is reasonably arguable

  • (1) A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.
  • (2) To the extent that a matter involves an assumption about the way in which the Commissioner will exercise a discretion, the matter is only reasonably arguable if, had the Commissioner exercised the discretion in the way assumed, a court would be about as likely as not to decide that the exercise of the discretion was in accordance with law.
  • (3) Without limiting subsection (1), these authorities are relevant:
    • (a) a *taxation law;
    • (b) material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901;
    • (c) a decision of a court (whether or not an Australian court), the *AAT or a Board of Review;
    • (d) a *public ruling."

" 284-30 Application of Division to trusts

If you are a trustee of a trust and:

  • (a) you make a statement to the Commissioner or to an officer who is exercising powers or performing functions under a *taxation law about the trust; and
  • (b) the statement:
    • (i) is false or misleading in a material particular, whether because of things in it or omitted from it; or
    • (ii) treated an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable; or
    • (iii) treated a taxation law as applying in a particular way to a *scheme:

    this Division applies to you as if any *shortfall amount or *scheme shortfall amount of a beneficiary of the trust as a result of the statement were your shortfall amount or scheme shortfall amount

    ."

" 284-75 Liability to penalty

  • (1) You are liable to an administrative penalty if:
    • (a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under a *taxation law; and
    • (b) the statement is false or misleading in a material particular, whether because of things in it or omitted from it; and
    • (c) you have a *shortfall amount as a result of the statement.

      ATC 480

    Note: Subsection 2(2) specifies laws that are not taxation laws for the purposes of this Subdivision.

  • (2) You are liable to an administrative penalty if:
    • (a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under an *income tax law; and
    • (b) in the statement, you or your agent treated an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable; and
    • (c) you have a *shortfall amount as a result of the statement; and
    • (d) item 4, 5 or 6 of the table in subsection 284-90(1) applies to you.
    • …"

" 284-80 Shortfall amounts

  • (1) You have a shortfall amount if an item in this table applies to you. That amount is the amount by which the relevant liability, or the payment or credit, is less than or more than it would otherwise have been.
    Shortfall amounts
    Item You have a shortfall amount in this situation :
    1 A *tax-related liability of yours for an accounting period, or for a *taxable importation, worked out on the basis of the statement is less than it would be if the statement were not false or misleading
    … …
    3 A *tax-related liability of yours for an accounting period worked out on the basis of the statement is less than it would be if the statement did not treat an *income tax law as applying in a way that was not *reasonably arguable

    …"

" 284-90 Base penalty amount

  • (1) The base penalty amount under this Subdivision is worked out using this table:
    Base penalty amount
    Item In this situation : The base penalty amount is :
      …  
    2 Your *shortfall amount or part of it resulted from recklessness by you or your agent as to the operation of a *taxation law 50% of your *shortfall amount or part

    ATC 481

    3    		 Your *shortfall amount or part of it resulted from a failure by you or your agent to take reasonable care to comply with a *taxation law 25% of your *shortfall amount or part
    4 Your *shortfall amount or part of it resulted from you or your agent treating an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable, and that amount is more than the greater of $10,000 or 1% of the income tax payable by you for the income year, worked out on the basis of your *income tax return 25% of your *shortfall amount or part
    5 You have a *shortfall amount because of section 284-30 (about trusts) and: 25% of your *shortfall amount or part
      (a) your shortfall amount or part of it resulted from you or your agent treating an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable; and  
      (b) because of that treatment, the trust's net income would have been reduced, or the trust's *tax loss would have been increased, for the income year by more than the greater of $20,000 or 2% of the trust's net income (if any) for that year worked out on the basis of the trust's *income tax return  

    …"

Reasonably Arguable Matter

7. At the commencement of the hearing of this matter, Mr Jones informed me that the sole issue for consideration was whether or not the appropriate penalty rate was one of 25 per cent for a failure to take a reasonably arguable position, or whether it was due to the recklessness of the applicant. In response to a question I put to him, Mr Jones confirmed that the objection decision relating to the Second Penalty Assessment was in issue and that "if the tribunal accepts the applicant's case, then the first penalty assessment would stand and the second penalty assessment would be set aside" (see page 10/35 of the transcript). Mr Jones' confirmation, which was accepted by the respondent and the Tribunal, effectively meant the applicant conceded it did not have a reasonably arguable position and the First Penalty Assessment was not excessive (see page 22/10 of the transcript). Earlier, Mr Jones had accepted this when he said (at page 19/15-20 and 25-35 of the transcript):

"All of the administrative penalty provisions are now, of course, found in subdivision 284 of the Administration Act, and relevantly, 284-75 imposes the liability to penalty if you or your tax agent makes a statement regarding the - statement to a Commissioner or to an entity that is exercising powers and performing functions under income tax law, and the statement treated income tax law as applying to a matter or identical matters in a particular way that was not reasonably arguable, and you have a shortfall amount. We accept all of those matters. And items 4, 5, and 6 in the table at 284-90 apply.

…

And then item 4 is - shortfall amount was due to you treatment [sic] matters in a particular way that was not reasonably arguable, which we say is the appropriate factual situation, and the base penalty amount then is 25 per cent. The Commissioner contends that it's item 2 of that table that's more correct, in that it

ATC 482

resulted from recklessness of the applicant or its agent, KPMG. And then subsection (2) provides that if more than one item in the table applies, then you applied the item imposing the higher penalty.…"

8. The issue before me thus became whether the Second Penalty Assessment was excessive, by imposing a further penalty of 25 per cent to increase the base penalty to 50 per cent of the shortfall amount, because the shortfall amount resulted from recklessness by the applicant or its agent as to the operation of a taxation law.

9. At the end of the hearing, at the request of counsel for both the applicant and the respondent, I agreed to accept closing submissions in writing and a timeline for filing the submissions was set. In his closing submissions dated 9 December 2011, Mr Jones sought to re-state the issues for the Tribunal's consideration. He said (relevantly at paragraphs 3 and 4):

  • "3. At the opening of the hearing the Applicant accepted, given the evidence filed by the parties, that its position was not reasonably arguable. However, in light of the fact that the evidence given by the Respondent's witness Mr Shepherd, in the witness box considerably departed from the affidavit filed by the Respondent's solicitor, that concession is withdrawn.…"
  • 4. Accordingly, there are two issues. First, whether the Applicant had a reasonably arguable position. Second, if the Applicant did not have a reasonably arguable position whether its tax shortfall was caused as a consequence of the taxpayer taking a position that was not reasonable arguable or by recklessness."

10. By way of background, Mr B C Shepherd (through his company, International Yacht Imports Pty Ltd) was the sole Australian selling agent of yachts manufactured by Dyna Craft Ltd in Taiwan.

11. In her closing submissions, Ms Price referred to the decision of the Full Tribunal in
Re Marks and Secretary, Department of Defence (1987) 11 ALD 456 which related to a concession that had been made there by the applicant at the hearing of the matter. At paragraph (7) of its decision, the Tribunal said:

"We are satisfied that he correctly conceded his liability to pay the amount of the loss, subject to any reduction in that liability resulting from the application of reg 126D. However, as the Tribunal cannot simply accept such concessions (See Kuswardana and Minister for Immigration and Ethnic Affairs (1981) 3 ALN N66) we shall state in due course why we are satisfied that the concessions were properly made."

12. In relation to the withdrawal of the concession that the applicant did not have a reasonably arguable position, I sought further written submissions from the parties. In his further submissions, Mr Jones argued that the concession was only made at the opening of the hearing and the respondent's counsel was, as a courtesy, informed that that would occur on the previous day. Consequently, the situation was quite unlike an attempt to withdraw a concession made at trial on appeal. Given the circumstances of the case and his argument that Mr Shepherd's oral evidence considerably departed from his affidavit, Mr Jones submitted that the Tribunal ought to grant leave to the applicant to withdraw its concession and contend that it had a reasonably arguable position.

13. Having considered the question, I am of the view that Mr Shepherd's evidence was not complex. It is covered in five short paragraphs of his affidavit and in less than two pages of transcript. More importantly, there is no compelling explanation in Mr Jones' submissions why the matter could not have been properly raised with the Tribunal during the hearing (after Mr Shepherd had given his evidence) or leave sought to examine the matter before the hearing closed. Mr Jones has argued that he did not have an opportunity to read the transcript until after the hearing and it would have been premature to make an application for leave to withdraw the concession without carefully checking the transcript. However, Mr Jones impressed me as an experienced tax counsel. He was obviously familiar with the applicant's case and, having cross-examined Mr Shepherd on his affidavit and listened to his oral evidence, there would have been ample opportunity to question him further or to recall him to clarify what he had said in giving his evidence. It seems Mr Jones may have

ATC 483

considered doing this when he said (at page 112/20-25 of the transcript):

"Yes. Well, it's obviously self-evidently hearsay and in light of the evidence that the witness gave in cross-examination, he's somewhat - you will see, the effect of paragraph 15 and 18 and I will be addressing this in written submissions but you will see the effect of his evidence there was that it was - he only gave a discount just to avoid sales tax. His evidence in cross-examination was to the opposite effect but that's really a more material point as opposed to the objection on the hearsay.…"

14. In
Re Martin and Commonwealth of Australia (1983) 5 ALD 277, Deputy President Hall remarked that, in the ordinary course of events, the Tribunal would rely on a concession by the parties. At paragraph 29 of his reasons, he said:

"However, in the exercise of its wide discretion over its own procedures (see s 33 of the Administrative Appeals Tribunal Act 1975), the Tribunal may accept concessions by the parties of particular facts or issues that would otherwise require determination by the Tribunal [see
Kuswardana v Minister for Immigration and Ethnic Affairs (1981) 35 ALR 186]. The decision under review in this case is the Commissioner's determination in relation to the applicant's claim for compensation. As neither party had called into question the determination as to the liability of the Commonwealth, and as there was evidence to support a finding of liability, I would have been content, in the ordinary course of events, to act upon that concession. But where the evidence adduced before the Tribunal by the applicant raises a serious doubt as to the correctness of the conceded issue, the Tribunal may well be obliged to reject the concession (cf Kuswardana) and to open up the whole of the determination under review for consideration."

15. Later, in
Tuite v Administrative Appeals Tribunal and Another (1993) 40 FCR 483, Davies J in the Federal Court considered the question of concessions made in the course of Tribunal proceedings. At page 489, he said:

"In such a circumstance, where the tribunal's procedures encourage the representatives of the parties to agree upon limited issues and thereby maximise the efficiency and reduce the cost of review by the Administrative Appeals Tribunal, it is obviously desirable that a concession made by the representative of one of the parties, be accepted unless there exist good reasons to the contrary. To do otherwise would be disruptive of the procedures of the Administrative Appeals Tribunal, which seeks to achieve resolution or limitation of disputes through its process of pre-trial mediation. Moreover, if a concession agreed to before a hearing is not accepted by the tribunal at the hearing, then the result will usually be, as in this case, that the hearing ought to be adjourned so that the parties may deal with the issue which they had understood to have been resolved."

16. In my opinion, the material and evidence before me does not raise a serious doubt as to the correctness of the conceded issue that the applicant did not have a reasonably arguable position. I find that the concession made by the applicant has been properly made and may not be withdrawn.

BACKGROUND AND EVIDENCE

17. Mr X was born in Greece. In addition to the applicant and SCM, he is (or was) a shareholder and director of a number of companies making up what is known as the X Group. The X Group is a property developer which, among other things, is involved in the acquisition, redevelopment and operation of shopping centres. In December 1998, the M Trust acquired the Yacht, which was a Dyna Craft Signature Series 75 foot motor yacht, from International Yacht Imports Pty Ltd ("IYI"). Under the terms of the sale agreement, the sale price was expressed to be $2,500,000. However, it appears that a reduced sale price of $2,300,000 was eventually negotiated.

18. The M Trust also entered into an agreement with Dyna Craft Ltd, the manufacturer of Dyna Craft vessels, and IYI under which the M Trust was appointed as a commission sub-agent in South Australia for the sale of Dyna Craft vessels. Under the

ATC 484

agreement, the M Trust had the right to canvas orders from buyers (or potential buyers) of the vessels, both inside and outside South Australia.

19. The expenditure incurred by the M Trust in the 1999-2003 tax years in relation to the ownership and use of the Yacht totalled $3,064,106 and comprised the following:

Income Year 1999 2000 2001 2002 2003
Expenses $418,542 $743,218 $742,503 $615,052 $544,791

20. A specific issue audit was undertaken in respect of the claimed expenditure in the taxation return of the M Trust, with the outcome that the accumulated deductions in relation to the Yacht were denied in the 2003 tax year. This resulted in an increase in distributions of income from the M Trust. These increased distributions flowed through to the B Trust via the Related Trusts.

21. During the 1998-2003 tax years, KPMG acted as the accountants and tax agents of the applicant, the B Trust, SCM, the M Trust and the Related Trusts. During each of these years, KPMG was engaged to prepare financial statements and taxation returns and to provide general tax and accounting advice.

Evidence of Mr X

22. Mr X gave evidence in his affidavit dated 14 April 2011 (Exhibit A1), and orally. In his affidavit he said he had thought about operating a boat charter business in Greece to transport wealthy tourists from Athens to many of the Greek islands. He believed that such a business would be very profitable. However, after speaking with Mr Grant Torrens of Mitchell T Marine Pty Ltd on the Gold Coast, he had been advised that there was significant money to be made from buying and selling a new range of motor cruisers which had come to Australia and were manufactured by a company known as Dyna. Mr Torrens informed Mr X that he had a demonstrator Dyna 75 for sale. He advised him that he could make money from buying and selling luxury motor cruisers and far more than operating an expensive charter business. He said the Dyna 75 was manufactured in Taiwan and resold for considerably less than other motor cruisers that were of a similar standard manufactured in Europe. He informed Mr X that the Yacht was a demonstrator and was available for sale for approximately $2,500,000, but if marketed properly, he believed it could fetch as much as $3,800.00. If Mr X (or the applicant) went ahead, Mr Torrens said that he would look after the Yacht, he would advertise it and do everything else, including arranging for a captain to operate it.

23. Mr X said that he met Mr Shepherd in Sydney in 1998. He had a discussion with Mr Shepherd and Mr Torrens about a sub-agency agreement for the sale of the Dyna range of vessels. Mr Shepherd said he had agents in all the States, except for South Australia. Mr X said that he could sell boats and get commission and he would leave everything with KPMG to organise what had to be done. He sought advice from KPMG regarding the tax issues associated with the purchase. KPMG advised him that the depreciation and running costs of the Yacht would be tax deductible as long as he had a properly drafted agency agreement with the manufacturer, which would allow him to sell to buyers outside South Australia, and if he kept any private use of the Yacht to a bare minimum. He was also advised that, if he did not have a written agency agreement and if he used the Yacht for private purposes or brought the Yacht to Adelaide, then the respondent would not allow the tax deductions.

24. Mr X said he later received a written opinion from KPMG dated 1 December 1998 (Exhibit A1, Annexure CM3). He said he could not recall having received any other written advice from KPMG. In relation to the purchase of the Yacht, Mr X said that Mr Shepherd had made no mention of any sales tax that would be involved in the purchase.

25. When asked by Mr Jones about the use of the Yacht, he said that he and his wife used it about 12 or 15 times, other than when used with prospective purchasers. He used it more during the 2000 Olympics because he and his wife could not obtain accommodation in Sydney at

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that time. The Yacht was not used any further than those times because his wife was "terrified about water".

26. As a result of the advice that Mr X received from Mr Torrens and KPMG, the applicant proceeded with the purchase of the Yacht and arranged for a sale agreement to be entered into between the applicant and IYI and a sub-agency agreement to be entered into between Dyna Craft Ltd, the applicant and IYI. Mr X said he left the marketing activities required by the agency agreement to Mr Torrens, who said that he would do everything that he considered necessary to sell the Yacht and to make sales of Dyna vessels. He kept in regular contact with Mr Torrens and he understood that, in relation to the marketing of the vessel, there would be advertisements, involvement in boat shows, sea trials with prospective purchasers and a virtual tour on a CD. He said he had decided to refurbish the interior of the Yacht, which Mr Torrens advised was necessary to maximise the prospect of sale. To maximise possible sale, the Yacht was always available and there was never a time when it was not available as a demonstrator for prospective purchasers, or for sale.

27. Mr X said that he met regularly with KPMG personnel to discuss his own tax affairs and the tax affairs of the entities in which he was interested. He confirmed that KPMG did not give him any advice in 1998 or at any time prior to lodging the 2003 taxation returns to prepare a business plan in relation to the Yacht, to keep records of marketing activities, to maintain log books or to maintain other business records with respect to the conduct of the sub-agency. During the 2003 tax year, KPMG prepared financial statements and taxation returns for the applicant. Mr X understood that those returns claimed certain depreciation and operating deductions relating to the Yacht and that those deductions were allowable because of the advice he had received from KPMG. He had not been advised by anyone from KPMG that the deductions were not properly claimable.

28. In cross examination by Ms Price, Mr X denied that Mr Shepherd would not reduce the price of the Yacht, but would instead arrange to enter into an agency agreement with him. Mr X said that Mr Shepherd had simply offered the sub-agency to him like sub-agencies existing in other States. Mr Shepherd had given him the discount and the sub-agency for South Australia was to sell boats and make a lot of money. As to due diligence in relation to the sub-agency, he said he had left all that with KPMG and his solicitors. He believed what he had been told by Mr Shepherd and Mr Torrens when he acquired the Yacht. The advice he had received from KPMG dated 1 December 1998 was the only advice he had received before purchasing the Yacht and entering into the sub-agency agreement. When asked to confirm this, he said that he could not recall whether the advice of 1 December 1998 was the only advice. He said he could not remember. In relation to the Yacht itself, Mr X said that a number of the accessories in the Yacht were second-hand and eventually had to be replaced. They had to be replaced because the intention was to present the Yacht as a demonstrator and not only to upgrade it. He said KPMG did not discuss with him the monies he was expending on upgrading the Yacht, after having purchased the cruiser. He was trying to improve the Yacht to enable more vessels to be sold and to make more money.

29. When asked about the agency agreement and the requirement that the applicant must prepare a marketing plan for the initial term of the sub-agency, Mr X said that he left the Yacht with Mr Torrens as he had the experience to attend to a marketing plan. When asked about the financial statements relating to the Yacht, he said the statements were not prepared by someone in his office, but by KPMG. He said he was concerned that outgoings were being incurred in relation to the Yacht every year, without any income coming in. He said:

"Look, this agency is not deriving nothing for me and I am just spending money". What do you suggest? Well, that's why I said to the agent. "Try to sell it," and eventually I gave it to another two agents, you know, no… I just spoke to them and said, "Try to sell it at any price," and this guy from Queensland brought this buyer, 2.1, and we sold the boat and I had to pay 200,000 GST because it was a company, it

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wasn't on my name, simple as that." (page 66/15-20 of the transcript)

30. In response to further questioning by Ms Price about the use of business cards and polo shirts for the Yacht, Mr X said that all matters relating to the marketing and sale of the Yacht were conducted by Mr Torrens. He was "running the business" and was responsible for those activities. When various propositions were put to him by Ms Price, Mr X denied that the applicant had entered into the agency arrangement simply to obtain a discount on the purchase price of the Yacht. He said it was not simply a dormant, inactive arrangement and that he never intended to carry it on as a sub-agency. He also denied that the Yacht had been purchased principally for him and his family to use for personal purposes, to entertain guests and to just enjoy having a luxury boat.

31. Mr X was then referred to paragraph 49 of his affidavit, in which he said:

"I relied heavily on KPMG and just provided general directions under their recommendations as required."

When asked what he meant by "general directions", Mr X said that he relied heavily on the advice he received from KPMG and he denied that he gave a general direction to them to the effect that he wanted to get a tax deduction for all the expenses he had incurred in relation to the Yacht. He said that, when he signed the 2003 taxation returns relating to the Yacht expenditure, after the commencement of the audit of the applicant's affairs, there had been no discussion with KPMG about the risk that deductions for the expenditure might not be allowable.

Evidence of Mr Shepherd

32. Mr Shepherd, who was a witness for the respondent, gave evidence in his affidavit dated 2 June 2011 (Exhibit R8). He gave no evidence in chief, but merely confirmed what he said in his affidavit. He was cross-examined by Mr Jones. In his affidavit he said he imported Dyna Craft yachts through his company, IYI, which was the sole Australian selling agent for the yachts. He said he first met Mr X at a boat show in Sydney in about 1998, where Mr Torrens was trying to sell the Dyna Craft 75 Signature Series motor yacht. Mr Torrens told him that Mr X was interested in the Yacht, but he wanted a discount in the purchase price. Mr Shepherd told him that he would not give a straight discount, but would reduce the purchase price by the amount of the sales tax if Mr X agreed to become a sub-agent in South Australia for two years. Mr X agreed to take up a sub-agency in South Australia from 8 December 1998 for an initial period of two years and the sale price for the Yacht was reduced by the amount of the sales tax.

33. In cross examination, Mr Shepherd said that, instead of asking for a discount in relation to the purchase price of the Yacht, Mr X put a counter offer to him for a lesser amount, which was $2,300,000. He said that:

"… I left the boat with my broker and he negotiated with [Mr X] and I have no understand [sic] exactly of what they talked about but they came to me with a project or a proposal for an amount of money, which I accepted on the proviso that [Mr X] would sign an understanding that he would be a sole agent for the State of South Australia. And by doing that he would then - if he sold the boat, through me, through me being the sole importer, he would then be in a position to …get a receipt - receive a substantial commission." (page 109/25-35 of the transcript)

Mr Shepherd said he intended there to be a real sub-agency and that Mr X would act as his sub-agent, and this wasn't done for any sales tax avoidance reasons. From his meeting with Mr Torrens and Mr X, he understood that Mr Torrens would be undertaking the marketing activities on behalf of Mr X in respect of Dyna Craft. In relation to the agency agreement with the applicant, Mr Shepherd accepted that there was no need to agree to extend the term of the agreement. He agreed that there was to be an automatic renewal of the term.

CONSIDERATION

Was claiming expenditure in relation to the Yacht as allowable deductions, with a consequential omission from the net income of the B Trust for the 2003 tax year, a reasonably arguable matter within the meaning of s 284-15 of Schedule 1 of the Taxation Administration Act 1953?

34. In view of the finding I have made in paragraph 16 of these reasons, claiming

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expenditure in relation to the Yacht as allowable deductions was not a reasonably arguable matter within the meaning of s 284-15 of Schedule 1 of the TA Act.

As the claiming of expenditure in relation to the Yacht was not a reasonably arguable matter, should the base penalty amount worked out under s 284-90 of Schedule 1 of the Taxation Administration Act 1953 be :

  • (i) 25 per cent of the shortfall amount because the shortfall amount resulted from the applicant or its agent treating an income tax law as applying in a particular way that was not reasonably arguable; or
  • (ii) 50 per cent of the shortfall amount because the shortfall amount resulted from recklessness by the applicant or its agent as to the operation of a taxation law?

35. Mr Jones submitted that, if the applicant did not have a reasonably arguable position, the shortfall amount was the result of that and not recklessness. On the other hand, Ms Price submitted that the shortfall amount resulted from recklessness by the applicant or its agent as to the operation of a taxation law. Thus, the Tribunal's task is to decide whether, on the material before it, the respondent's decision to impose a penalty of 50 per cent of the shortfall amount for recklessness was the correct or preferable decision:
Drake v Minister for Immigration and Ethnic Affairs (1979) 2 ALD 60. More particularly, should the Tribunal find that the applicant has failed to discharge the onus placed upon it pursuant to s 14ZZK of the TA Act of establishing that the assessment by the respondent of a 50 per cent administrative penalty for recklessness, is excessive?

36. Section 14ZZK of the TA Act relevantly provides:

"On an application for review of a reviewable objection decision;

  • …
  • (b) the applicant has the burden of proving that;
    • (i) if the taxation decision concerned is an assessment (other than a franking assessment) - the assessment is excessive;
    • …"

Consistently, with this provision, the authorities provide that the applicant bears the onus of showing that a penalty imposed by the respondent is excessive:
Hart v Federal Commissioner of Taxation 2003 ATC 4665; (2003) 131 FCR 203 at [38] per Hill and Hely JJ.

37. Section 284-75(1) of Schedule 1 of the TA Act provides that a taxpayer is liable to an administrative penalty for a false or misleading statement where a shortfall amount results from the statement. Section 284-75(2) of Schedule 1 of the TA Act provides that a taxpayer is liable to an administrative penalty for a statement that treated an income tax law as applying to a matter that was not reasonably arguable. Item 2 in the table to s 284-90(1) of Schedule 1 of the TA Act sets out how the base penalty amount for recklessness is calculated. It relevantly provides that the base penalty of 50 per cent of the shortfall amount applies if the "… shortfall amount or part of it resulted from recklessness by you or your agent as to the operation of a taxation law" (emphasis added). Applying what was said recently by Murphy J in the Federal Court in
Sent v Commissioner of Taxation 2012 ATC 20-318[2012] FCA 382 (at paragraph 161), under the TA Act, s 284-75(1) and s 284-90(1) of Schedule 1 and s 14ZZK operate so that for the applicant to succeed before the Tribunal it is required to show that:

  • (a) it did not act recklessly; and
  • (b) its tax agent did not act recklessly.

38. The dispute in these proceedings came about as a result of the purchase of the Yacht by the M Trust in 1998 and the claiming of tax deductions in relation to its use during the 1999-2003 tax years. The deductions were disallowed in the M Trust, the net income of the M Trust was increased and ultimately the net income of the B Trust was correspondingly increased. Mr X was the sole director and shareholder of the applicant (as the trustee of the B Trust) and the trustee of the M Trust. The evidence of Mr X was that he had thought about operating a boat charter business in Greece for wealthy tourists and he believed that such a business would be very profitable. He was then advised by a broker (Mr Torrens) on the Gold Coast that he could make money from buying

ATC 488

and selling a new range of motor cruisers which had come to Australia and were manufactured by a company in Taiwan known as Dyna. The broker informed him that he had the Yacht, which was a Dyna 75 demonstrator, available for sale.

39. Mr X knew nothing about boats and was persuaded by the broker and the Australian distributor of Dyna cruisers (Mr Shepherd) to purchase the Yacht. Through Mr Torrens, he offered to purchase the Yacht for about $2,300,000 and Mr Shepherd accepted that amount, provided Mr X agreed to be the sole sub-agent for Dyna vessels in South Australia. Mr Torrens offered to undertake all the marketing and operational activities for the Dyna range of boats in return for a commission on sale, and he would also put the Yacht back on the market for a profit of $1,000,000. It was put to Mr X that the sub-agency was simply a means of obtaining a discount on the purchase price of the Yacht and that he never intended to carry out the sub-agency. Mr X denied this and his evidence was supported by Mr Shepherd in cross-examination. He admitted that the sub-agency was a genuine agreement, not done for any sales tax avoidance reasons.

40. Before purchasing the Yacht, Mr X sought advice from KPMG regarding the tax issues associated with the purchase. During the 1998-2003 tax years, KPMG were the accountants and tax agents for the applicant as well as the B Trust, the M Trust and SCM. Mr X was not familiar with taxation law and relied heavily on his legal and accounting advisors. KPMG provided a written advice to Mr X on 1 December 1998. Mr X said that he could not recall receiving any other written advice from KPMG. The KPMG advice read in part (Exhibit A1, Annexure CM3, page 4):

"The yacht will generate substantial income tax deductions by way of depreciation, interest charges and running costs, to the extent that the boat is used as a demonstrator. Even if the boat was used 55% as a demonstrator and 45% for entertainment or other non-business purposes, the depreciation in the first full year would appear to be $254,000. It would be advisable to hold the yacht in an entity which was likely to generate substantial profits.

Based on our knowledge of your operations we suggest the yacht be held in the name of SCM, as trustee for the M Trust.

Income tax deductions will not be available for the period in which the yacht is used for entertainment, even where the entertainment of clients might be important for your business.

Where the yacht is being demonstrated and entertainment takes place, income tax deductions would not be available for the entertainment, however, income tax deductions for depreciation, interest charges and running costs in respect of the demonstration activities should be available."

41. It was Mr X's evidence that he intended to use the Yacht for business and not for private purposes. However, he acknowledged that he and his wife had used the Yacht on about 12 to 15 occasions, other than with prospective purchasers. Most of that use was during the Olympics in 2000 when accommodation could not be obtained in Sydney.

42. On the material before the Tribunal, it appears that a specific issue audit was commenced by the respondent in relation to the claims for deduction relating to the maintenance and use of the Yacht during the 1999 to 2003 tax years and the audit was finalised in May 2008. The respondent issued the First Penalty Assessment on 11 June 2008 and an administrative penalty was imposed at the rate of 25 per cent of the shortfall amount, where the position taken was not reasonably arguable, pursuant to s 284-75(2) and s 284-90(1) of Schedule 1 of the TA Act. The applicant's objection was disallowed in full. In reviewing the facts giving rise to the imposition of the penalty, the respondent determined that a higher penalty of 50 per cent for recklessness should be imposed under s 284-75(1) of Schedule 1 of the TA Act. In its Reasons for Decision in disallowing the objection, the respondent said at page 5 of its Reasons (Exhibit R1, T2, page 7):

"…The imposition of the higher penalty is made in response to conduct that goes beyond mere carelessness or inadvertence

ATC 489

by displaying a high degree of carelessness. In making this decision reference is made to the following paragraphs of Miscellaneous Taxation Ruling MT 2008/1:
  • 100. Like the test for determining whether reasonable care has been shown, a finding of recklessness depends on the application of an essentially objective test. There must be the presence of conduct that falls short of the standard of a reasonable person in the position of the entity. Similar to the position with a failure to take reasonable care, dishonesty is not an element of establishing recklessness. The actual intention of the entity is of no relevance.
  • 101. Behaviour will indicate recklessness where it falls significantly short of the standard of care expected of a reasonable person in the same circumstances as the entity. Although the test for determining whether recklessness is shown is the same as that applied for testing a want of reasonable care, it is the extent or degree to which the conduct of the entity falls below that required of a reasonable person that underscores a finding of recklessness.
  • 102. Recklessness assumes that the behaviour in question shows disregard of or indifference to a risk that is foreseeable by a reasonable person. The Full Federal Court in
    Hart v FC of T 2003 ATC 4665(2003) 131 FCR 203; [2003] FCAFC 105 (Hart) at paragraphs 33 and 43 endorsed the following comments of Cooper J in
    BRK (Bris) Pty Ltd v Federal Commissioner of Taxation 2001 ATC 4111; [2001] FCA 164; ; (2001) 46 ATR 347 at paragraph 77:

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

…"

It seems to me that, in the process of determining the applicant's objection against the First Penalty Assessment, the respondent had a rethink about the conduct of the applicant (or Mr X) and decided that a higher penalty was necessary or appropriate. The Second Penalty Assessment was issued on 19 February 2009. It is somewhat strange that the respondent adopted this approach. It might have been more appropriate for the First Penalty Assessment (with the penalty of 25 per cent) to have been withdrawn and a fresh penalty assessment (with the penalty of 50 per cent) issued. The result, from a penalty perspective, would have been the same but there might have been an opportunity for the respondent to explain, in its Reasons, how the "high degree of carelessness" in the applicant's case had been displayed.

Was the M Trust or the B Trust reckless?

43. Whether the M Trust or the B Trust was reckless necessarily raises the issue of whether Mr X, as the guiding mind of both the M Trust and/or the B Trust, acted recklessly. The expenditure relating to the Yacht claimed in the 1999-2003 taxation returns of the M Trust was disallowed in full. Mr Jones contended that there were rational grounds to argue that the M Trust was carrying on a business and consequently the expenditure was deductible. In the applicant's written submissions, Mr Jones sought to support this contention by maintaining that:

  • (a) Mr X genuinely intended to make profits on the sale of Dyna Craft boats and the sale of the Yacht - a belief shared by Mr Shepherd and Mr Torrens;
  • (b) Consistent with this intention there was a bona fide agency agreement under which the M Trust was entitled to receive commissions on the sale of Dyna Craft vessels. Moreover, the terms of the agreement were amended by Mr X to allow him to also receive commissions on vessels sold outside South Australia;

    ATC 490

  • (c) an experienced agent (Mr Torrens) was appointed who was responsible for all marketing activities;
  • (d) the Yacht was persistently advertised and available for inspection as a demonstrator at Mr Torrens' marina (and other marinas);
  • (e) the boat was presented at boat shows by Mr Torrens;
  • (f) a crew was employed (at considerable expense) who took the boat out on sea trials with prospective purchasers; and
  • (g) any private use was de minimus.

Further, Mr Jones submitted that each of the foregoing factors militated in favour of a conclusion that Mr X (and through him the M Trust) held a profit-making purpose in relation to the Yacht and that sufficient activity was taking place for the M Trust to be considered to be carrying on a business as a demonstrator.

44. In following on, Mr Jones submitted that the shortfall amount in the Second Penalty Assessment did not arise as a consequence of recklessness on the part of Mr X or the applicant, as trustee of the M Trust. He too referred to the reasoning of Cooper J in BRK (Bris) (supra), which is set out in paragraph 42 above.

45. As to the issue of deductions which are found to be non-deductible, in Hart (supra) at paragraph [44], Hill and Hely JJ commented:

"… But, in the ordinary case, the mere fact that a tax return includes a deduction which is not allowable is not of itself sufficient to expose the taxpayer to a penalty. Negligence, at least must be established although there are some sections (e.g. s 226K) which impose a liability in particular circumstances even if the taxpayer has not been negligent.…"

46. In BRK (Bris) (supra), I note that Cooper J also considered recklessness and the position of taxpayers who lacked an income tax and accounting background to understand whether statements in the taxation returns prepared by their tax agents were correct. At paragraph [78], he said:

"The applicant relied upon Harts to act as professional accountants, tax agents and investment advisers in its interests in relation to the joint ventures and in relation to the preparation and lodgment of its income tax returns seeking assessment by the respondent on the basis of the material contained in those returns. To rely on Harts in those circumstances, when it did not have the knowledge and experience to understand what was proposed and the effect of the documentation which it signed, was not unreasonable, and in the circumstances the lodgment of the income tax returns by the applicant by its tax agent Harts was not reckless conduct on the part of the applicant for the purposes of s 226H. However, reliance in this way on the tax agent carries with it the risk that the tax agent may be 'reckless' within the meaning of s 226H and that the tax consequences of such recklessness will be borne by the taxpayer as s 226H in fact provides."

47. In Mr X's case, he only had a primary school education and arrived in Australia not able to speak English. It was therefore reasonable for him to rely on KPMG for tax advice. KPMG did not identify any risk that the claims for expenditure might not be deductible. Thus, Mr X (and through him, the M Trust) was unaware that there was any real risk that the claims for deduction might not be allowable.

48. In my view and on the authorities, it could not be said that Mr X (and through him the M Trust) acted recklessly.

Was KPMG reckless?

49. On the balance of the evidence, it is clear in my view that Mr X (and hence the M Trust) had the intention of generating a profit from the sub-agency and the ownership, use and ultimate sale of the Yacht. It seems clear that, during the 1999-2003 tax years, KPMG personnel met regularly with Mr X in relation to his accounting and taxation affairs. Although the conclusion reached by KPMG was erroneous, it was not "grossly careless". In my view, it was reached having regard to the relevant information, and involved a reasonable professional judgment:
Forrest v FCT 2010 ATC 20-163; (2010) 78 ATR 417 at [152]. As Mr Jones submitted, at the highest, the advice to Mr X by KPMG was careless in failing to address the possibility that the deductions would not be available. But, it could not be said that KPMG was indifferent to the correctness of

ATC 491

the taxation returns of the M Trust, or that the advice given was so self-evidently wrong or tenuous that it could be said to be "grossly negligent". I agree with those submissions. KPMG is a large and well-established accounting and tax firm and, given Mr X's background and the ongoing discussions it had with the respondent during the course of the audit, it was open to the firm to provide the reasonable advice that it did.

50. In my view and again on the authorities, it could not be said that KPMG acted recklessly.

Ms Price's Submissions

51. Ms Price referred to various instances where the use of the Yacht was not for business purposes or where the expenditure was not of a business nature. The Tribunal is unable to draw from Mr X's evidence or the instances that Ms Price referred to that the Yacht was a personal yacht for Mr X and his family.

52. Ms Price argued that there were no contemporaneous records from Mr Torrens, from Mr X or from KPMG recording the use of the Yacht as a demonstrator yacht for Dyna craft over the 1999-2003 tax years. Although such records were absent, it can be inferred from Mr X's evidence that he was satisfied with what Mr Torrens was doing to market the Dyna boats and the Yacht and if he required reports he would speak to Mr Torrens on the telephone. When questioned by Mr Jones, he said:

"…Graham Torrens, he said, that he is going to look after the boat. He is going to advertise, he is going to do everything. He is going to get a captain and, you know, all those things." (page 24/20 of the transcript)

And in paragraph 39 of his affidavit, Mr X said:

"Because I trusted Mr Torrens ability to do what was need [sic] to make sales of the Dyna75, I considered that I did not need to prepare a formal marketing or business plan."

53. Ms Price was critical of the manner adopted by Mr X in giving his evidence. She said the evidence lacked definition as to the timing of the events and, in cross-examination, his answers were self-serving and inconsistent with contemporaneous documentation. She said Mr X was evasive and defensive in answering when questions ventured into areas he did not want to explore. In relation to timing, a number of years have passed since the events taking place had occurred. For this reason, one can understand how Mr X's evidence might appear evasive and defensive with the passage of time. This deficiency could not, however, amount to recklessness.

54. Ms Price further submitted that the evidence supported a reasonable finding that the sub-agency was largely dormant and inactive for the relevant years, and also a finding that the Yacht was a private luxury yacht for the use of Mr X and his wife and their family and friends. Although the sub-agency was not producing an income it could not be suggested that Mr X was aware that it was not being actively and commercially pursued and did not inform KPMG. On the evidence available, Mr Torrens was seeking to market both the sub-agency and the sale of the Yacht, and there was no reason to suggest that everything possible was not being undertaken to conduct the business activities. Mr X had engaged KPMG to advise him on the taxation considerations relating to the purchase of the Yacht and on the ongoing conduct of the sub-agency and the ownership of the Yacht.

55. Ms Price was critical of the fact that KPMG made no inquiries about the actual usage of the Yacht and the sub-agency in preparing the income tax returns of the applicant in each year. She argued that a reasonably well-informed agent would have addressed, by inquiry, the possibility in each year that circumstances had changed and that no sub-agency business was being carried on using the Yacht, and that the vessel was being held as a private asset for leisure. She also argued that there was no evidence that KPMG positively engaged with the issue of income tax deductibility of the Yacht expenditure. However, Mr X's evidence is that he met with KPMG regularly and, during the latter part of the 1999-2003 tax years, a KPMG representative was in his office overseeing the business activities carried out in relation to the sub-agency and the sale of the Yacht.

CONCLUSION

56. Given the findings I have made in paragraphs 48 and 50 above, I conclude that the

ATC 492

base penalty amount for the applicant worked out under s 284-90(1) of Schedule 1 of the TA Act (when read with s 284-75(2)) should be 25 per cent of the shortfall amount because the shortfall amount resulted from the applicant or its agent treating an income tax law as applying in a particular way that was not reasonably arguable.

DECISION

57. The Tribunal varies or affirms the objection decisions under review:

  • (a) by setting aside the objection decision imposing an administrative penalty of 50 per cent of the shortfall amount in the Second Penalty Assessment; and
  • (b) by affirming the objection decision imposing an administrative penalty of 25 per cent of the shortfall amount in the First Penalty Assessment.


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