• The impact of this case on ATO policy is discussed in Decision Impact Statement: The Employed Accountant and Commissioner of Taxation (Published 18 April 2013).

CASE 9/2012

Members:
SE Frost DP

Tribunal:
Administrative Appeals Tribunal, Sydney

MEDIA NEUTRAL CITATION: [2012] AATA 770

Decision date: 6 November 2012

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Deputy President S E Frost

INTRODUCTION

1. The taxpayer is disputing tax assessments made by the Commissioner for the income years 2001 to 2005 inclusive. For the 2001 to 2003 income years the Commissioner made amended assessments because the original assessments were considered insufficient. For 2004 and 2005 the assessments in issue are default assessments, made by the Commissioner because the taxpayer had not lodged tax returns for those years.

2. During the relevant years the taxpayer worked as an employee in a suburban professional taxation and accounting practice ("the accounting practice"). For at least part of that period he also derived rental income from investment properties. Working out his taxable income in those circumstances would not normally present any real difficulties.

3. But the complicating factor here is that reasonably regular deposits were being made into the taxpayer's bank account - deposits which the Commissioner says represent additional income amounts to the taxpayer. The taxpayer says that the amounts deposited do not represent income attributable to him or, if they do, that they are completely (or almost completely) negated by deductions allowable against them.

4. This is the main, but not the only, area of dispute between the parties. Other areas will become apparent later in these reasons. Interest deductibility on the investment properties is one; the other major one is administrative penalty.

THE TAXPAYER'S BURDEN OF PROOF

5. The taxpayer's burden, under s 14ZZK of the Taxation Administration Act 1953 (TAA), of proving the tax assessments "excessive" is an important issue in this case.

6. It is well known that a taxpayer does not prove an assessment excessive by establishing some error on the part of the Commissioner in the formation of a judgment as to the amount on which tax ought to be levied:
Federal Commissioner of Taxation v Dalco [1990] HCA 3; (1990) 168 CLR 614 at 623. That is because it is possible that, even if there was such an error, the amount assessed is still not excessive.

7. Rather than establishing an error in the approach, a taxpayer must establish:

… affirmatively that the amount of taxable income for which he has been assessed exceeds the actual taxable income which he has derived during the year of income …^[1] George v Federal Commissioner of Taxation [1952] HCA 21 ; (1952) 86 CLR 183 at 201

8. As Brennan J noted in Dalco at 624:

The manner in which a taxpayer can discharge that burden varies with the circumstances. If the Commissioner and a taxpayer agree to confine an appeal to a specific point of law or fact on which the amount of the assessment depends, it will suffice for the taxpayer to show that he is entitled to succeed on that point…

9. I will return to this aspect later.

THE DEPOSITS TO THE TAXPAYER'S BANK ACCOUNT

10. The deposits to the taxpayer's bank account comprise cheques originally drawn in favour of the Australian Taxation Office by clients of the accounting practice. They were able to be deposited to the taxpayer's account because the name of the payee, as shown on the cheque, was improperly altered, from ATO to the taxpayer.

11. This practice started, the taxpayer explained, because his employer at the accounting practice told him that the accounting practice's trust account was not in order. The employer asked if he could pass the client money through the taxpayer's account instead. Whether willingly or not (the taxpayer's evidence on this point is confusing and inconsistent), the taxpayer allowed the practice to commence, and then to continue for a period of several years.

12. The taxpayer claims that a cheque would originally be drawn by the client for the amount of money calculated as owing to the Tax Office by the client in relation to its monthly or quarterly business activity. The cheque would be delivered to the accounting practice. The cheque would then be altered to show the taxpayer's name as the payee, and would be deposited to his account. The client's business activity statement (BAS) would be altered, without the knowledge of the client, to show a lower liability. The taxpayer would arrange a bank cheque for the lower amount and deliver the bank cheque to his employer. The doctored BAS, together with the bank cheque, would be lodged with the ATO. The clients knew nothing of what was happening.

13. The taxpayer says that it was his employer who was responsible for these improper activities. It was the employer who altered the BASs, or caused them to be altered. It was the employer who told the taxpayer how much the bank cheques should be drawn for, and when they should be drawn. And it was the employer who told the taxpayer what to do with the money that was left over - the difference between the amount deposited to the taxpayer's account in the first place, and the amount shown on the bank cheque. Invariably, according to the taxpayer, the employer instructed the taxpayer to hand over the balance to the employer as cash.

14. There is some evidence to support the assertions that the lower amounts were paid to the ATO. There is no evidence to support the taxpayer's assertions that the balance was paid to the employer in cash.

15. Against this background, the Commissioner says that the taxpayer is liable to income tax.

16. Originally the Commissioner took the position that the total of the amounts deposited to the taxpayer's account represented assessable income to him. That position was encouraged by the taxpayer's statements (now exposed, and accepted by the Commissioner, as false) to the ATO auditors that the deposits represented income that the taxpayer had earned from a bookkeeping business that he carried on. That was a story, the taxpayer says, that was concocted by the employer to conceal the improper dealings with client money. As the Commissioner now accepts, the taxpayer never carried on a bookkeeping business. That was an utter lie.

17. Over time, as the facts have gradually emerged, the Commissioner has moved away from a position that seeks to treat the entirety of the deposits as the taxpayer's income. The Commissioner now accepts that the amounts that the taxpayer can prove to have found their way to the ATO, or to the employer, are not assessable to the taxpayer. The Commissioner described it this way in his Outline of Closing Submissions^[2] At paragraph 2 :

Absent evidence establishing that the Applicant parted with those misappropriated funds, following his withdrawing them from his bank account, the Respondent included the amounts in his assessable income and imposed penalties …

18. During the hearing there was a significant focus on the taxpayer's cash withdrawals from his bank account, and what happened to the money after it was withdrawn. Bearing in mind that the taxpayer had sole control over the account, in that he was the only one who could make withdrawals from it, the Commissioner considered it important that he should be able to demonstrate that the money went where he said it went - to the employer - and that it had not simply been withdrawn as cash to meet the taxpayer's normal living expenses.

19. The taxpayer was asked whether any of the cash withdrawn had not gone to his employer. He said that, while he "used to try not to use cash from that account for [his] personal use", "between eight to ten" per cent of the cash withdrawals were "personally used" ^[3] Transcript, 5 March 2012, p. 59.4-.22 . But shortly after making those statements, he was asked by his own counsel^[4] Transcript, 5 March 2012, p. 60.8-.9 :

MR HYDE PAGE: Now, during any of this period, did you personally spend any of the money that you were aware was not yours?

THE WITNESS: No, I did not.

20. He also maintained that, although he had not tracked the deposits and withdrawals^[5] Transcript, 8 March 2012, p. 268.37-.43 , and had not ever sought to reconcile the credits and debits to his account (including, apparently, overlooking entirely the multiple charges imposed on him by the bank for the many bank cheques he drew^[6] Transcript, 8 March 2012, p. 266.36-267.14 ), he did not retain any of the amounts deposited into his bank account^[7] Transcript, 8 March 2012, p. 218.31-.33 . He had to retreat from that position when it was pointed out to him that he had reimbursed a client, in June 2006, in relation to an altered cheque dated February 2005, in circumstances where it seems that no part of the original deposit to the taxpayer's bank account was ever passed on to the ATO^[8] Exhibits R1-4, R1-5 .

21. Plainly enough, the taxpayer cannot account for all the money that was deposited into his bank account. He says, and I accept, that some of it was forwarded to the ATO in payment of the clients' liabilities (although, as explained above, the liabilities as disclosed to the ATO were lower than they should have been). However, it is impossible to put a reliable number on the proportion of the funds deposited into his account that eventually found their way to the ATO. Furthermore, there is no reliable basis on which I could find that the remainder (or any identified proportion of the remainder) was paid as cash to the employer, or was used to fund the taxpayer's personal expenses.

22. The Commissioner seized upon this shortcoming in the evidence and submitted^[9] Respondent’s Outline of Closing Submissions [77] :

The Applicant needs to satisfy the Tribunal that he has on-paid all of the deposited money. Failing to satisfy the Tribunal of this fact will fall short of the test so clearly set out by Latham CJ.

23. The test referred to was formulated in
Danmark Pty Ltd v Federal Commissioner of Taxation (1944) 7 ATD 333 at 337:

… the onus rests upon the taxpayer of establishing the facts upon which he relies and if it is necessary for him to establish a particular fact in order to displace the assessment he must satisfy the court with respect to that fact . [emphasis added by the Commissioner]

24. That principle, of course, is unimpeachable.

25. But I do not agree with the Commissioner that the taxpayer must establish that he has on-paid all of the deposited money to prove that the assessments are excessive. That seems to me to be asking the wrong question - Did he dispose of all the money to others? - rather than the right question - Are the amounts assessable to him in the first place?

26. The taxpayer's primary submission is that he was not beneficially entitled to the amounts, and so they cannot be assessable to him as income. He relies on the decision of Burchett J in
Zobory v Commissioner of Taxation (1995) 64 FCR 86, a case involving an employee who fraudulently misappropriated his employer's money, invested it in his own name, and then received interest which the Commissioner sought to assess. Burchett J held that the interest earned from the embezzled funds was not assessable to the embezzler, basing his conclusion on an argument that had as its starting point the "fundamental principle" that what is taxed is "income to which a taxpayer is beneficially entitled": 64 FCR at 89D.

27. Zobory is factually slightly different from this case. In Zobory the question was whether the interest earned on the embezzled funds was assessable to the embezzler; the case did not concern itself with the embezzled funds themselves.

28. A case that did concern stolen funds, and on which the taxpayer also relies, is the New Zealand Court of Appeal case
A Taxpayer v Commissioner of Inland Revenue [1997] NZCA 135; (1997) 18 NZTC 13,350. There, the taxpayer had traded in the futures market using money stolen from his employer. He repaid some of the stolen money to the employer, and the Commissioner assessed him to tax on what had not been repaid. (As in Zobory, it seems, the Commissioner did not seek to tax the entire amount stolen.) The plurality (Richardson P, Keith and Elias JJ, with whose decision Tipping J agreed, but for different reasons) discussed the different approaches taken in the US and Canada to the taxing of embezzled funds, and then noted:

The crucial point, however, is whether the misappropriations in this case had the character of "income derived" within the meaning of s 38(2) and paras (a), (e) and (l) of s 65(2). Two questions arise: the meaning to be given to "income" and the meaning to be given to "derived". As to the latter, the term derived is not defined and the deemed derivation provision (s 75) provides no immediate guidance. But in
Commissioner of Inland Revenue v N V Philips' Gloeilampenfabrieken [1955] NZLR 868, 884 Gresson J said of it:

The word "derived" means more than received; it connotes the source or origin, rather than the fund or place, from which the income was taken. It means flowing, springing, emanating from, or, as was said in
Commissioners of Taxation v Kirk (
[1900] AC 588, 592), arising from or accruing.

The same view has been taken in Australia. In
Federal Commissioner of Taxation v Clarke (1927) 40 CLR 246 , 261 Isaacs ACJ said: "All income is derived from something and by someone". See, too,
Harding v Federal Commissioner of Taxation (1917) 23 CLR 119, 131;
Evans v Deputy Federal Commissioner of Taxation (South Australia) (1936) 55 CLR 80, 101; and
Brent v Federal Commissioner of Taxation [1971] 71 ATC 4195, 4200.

29. Their Honours went on to say:

The embezzler does not have any claim of right to the stolen property. In the absence of a specific statutory provision allowing for a recharacterisation or different characterisation of the misappropriation receipt for tax purposes, the ordinary rules apply. Legal rights and obligations cannot be ignored. There is no gain to a taxpayer unless the receipt is derived beneficially by the taxpayer. Taxation by economic equivalence is impermissible (
Commissioner of Inland Revenue v Europa Oil (NZ) Ltd [1971] 1 NZLR 641, 648;
Europa Oil (NZ) Ltd v Commissioner of Inland Revenue (No 2) [1976] 1 NZLR 546, 552).

30. On the "beneficial entitlement" point, the Commissioner cites the comments of Dixon J in a case concerning trust distributions to a mother for advancement of an infant daughter,
Countess of Bective v Federal Commissioner of Taxation(1932) 47 CLR 417 at 424:

On the other hand, if she is not an object intended to be benefited at all by the provision for maintenance, the payments ought not, in my opinion, to be included as assessable income of the taxpayer, although, if it appeared that she had appropriated to her own use an unexpended surplus after discharging her duty of maintaining her daughter, that surplus would be taxable as part of her income . [emphasis added by the Commissioner]

31. That case is, with respect, a long way from this one.

32. The money that went into the taxpayer's bank account is not his, and it never was his. I am comfortably satisfied that it originated from the accounting practice's clients, who intended it for payment to the ATO. Through the intervention of the taxpayer's employer, it was deposited to the taxpayer's bank account to enable it to be misappropriated, to the financial detriment of the ATO and the clients. While the taxpayer's evidence is in many respects unsatisfactory or at least unclear (for example, he could not adequately explain the circumstances of the cash withdrawals for payment to his employer), he has established what he needed to establish - that he was not beneficially entitled to the amounts to which he has been assessed.

33. It follows from the principles that underpin Zobory and the New Zealand case, A Taxpayer, that, to the extent that the deposits have been included in his assessable income, they should not have been. I say that despite the obvious factual differences between both those cases and this one. I do not agree with the Commissioner's submission that the principles differ according to the number of persons who are the subject of the misappropriations, whether criminal sanctions have followed, whether the victims know what happened, whether or not they have been reimbursed and whether or not the embezzler has applied the funds to his own use^[10] Transcript, 21 May 2012, p. 6.12-.31 . Either the money is beneficially derived or it is not; in my view it is not, just as much in this case as in Zobory and A Taxpayer.

34. In accordance with the authorities, and in particular the excerpt from Dalco cited in [8] of these reasons, the taxpayer has discharged his burden under s 14ZZK of the TAA in relation to the amounts deposited to his bank account. This is because the income on which he has been assessed is made up of various identified components, one of which is the total amount (or some part of the total amount) of the deposits to his account. Once he proves that that particular component has been incorrectly included, he has shown the assessment "excessive" in that respect.

THE CLAIM FOR DEDUCTIONS FOR INTEREST PAYMENTS

35. During the relevant years the taxpayer owned rental properties. He purchased a property in 2002 and borrowed the entire purchase price. He sold that property in 2004 and used the proceeds towards the purchase of a second property.

36. Both properties have been income producing. The rental income has been included in the assessments made by the Commissioner.

37. Some deductions have been allowed against the rental income but the taxpayer says that he is entitled to further deductions representing the interest charged to him by the lending institutions. The respective proportions of the borrowed amounts in respect of which the taxpayer seeks deductions are summarised in tables at pages 3 and 4 of his Closing Submissions.

38. The Commissioner formally puts these claims in issue by noting at [95] of his Outline of Closing Submissions that he "disagrees with" various contentions made by the taxpayer, including the contention that he is "entitled to various interest deductions on loan accounts throughout the relevant period". However, apart from that statement, the Commissioner does not address the issue elsewhere in his written submissions.

39. The question was touched on only briefly by the Commissioner's counsel in oral submissions, as follows^[11] Transcript, 21 May 2012, p. 9.19-.23 :

If the tribunal came to the view that there was - that the loan deductions relating to the investment properties were paid, and the schedule to my friend's submissions detail what those amounts are, those amounts would be properly deductible, as any loan on an investment property would to a taxpayer.

40. In principle, in respect of the loans that relate to the investment properties, I accept the summary prepared by the taxpayer's counsel and included in the table at pages 3 and 4 of the Applicant's Closing Submissions. The principles, and the explanations for them, can be summarised as follows:

• • 100% of the interest paid in respect of Loan Account 4037 is deductible - this loan funded the purchase of the first property;
• • 57/67 of the interest paid in respect of Loan Account 7721 is deductible - this loan was for a total of $335,000, to refinance Loan 4037 ($285,000) and an additional loan of $50,000; 57/67 is the fraction representing the relationship between $285,000 and $335,000;
• • 100% of the interest paid in respect of Loan 0856 is deductible - this loan funded the purchase of the second property.

41. The "interest" amounts referred to in the preceding paragraph must be confined to those that have been identified and put before the Tribunal.

42. The taxpayer presses an additional deduction claim for interest in relation to money borrowed and lent to his employer. He claims that he was pressured into lending this money to the employer - essentially, that his continued employment depended on handing the money over - and draws a nexus between the borrowing and his income-generating activity as an employee. I am not satisfied that the employer threatened the taxpayer in the way that he claims; the evidence on this point is simply unconvincing. As a result, the nexus has not been established, and the interest paid on that loan is therefore not deductible.

43. In fact, the entire course of dealings in the money borrowed, including lending it to the employer, and the repayment of only part of it by the employer in the form of payment to the ATO in part satisfaction of the taxpayer's tax debts, gives rise to no taxation consequences for the taxpayer. Bad debt relief under s 25-35 of the Income Tax Assessment Act 1997 ("the 1997 Act") is not available because:

• • there is no evidence that the amount not recouped has been written off as a bad debt;
• • the debt was not included in the taxpayer's assessable income; and
• • the taxpayer is not in the business of lending money.

44. Section 25-45 of the 1997 Act ("Loss by theft etc") plainly does not apply, and nor does s 8-1. Furthermore, the repayment to the taxpayer by the employer is not assessable.

ADMINISTRATIVE PENALTY

45. Administrative penalty was imposed in respect of the 2001, 2002 and 2003 years at 75% of the "shortfall amount" on the basis of what the Commissioner considered to be the taxpayer's "intentional disregard" of the taxation law: s 284-75(1), and item 1 in the table in s 284-90, in Schedule 1 to the TAA. In respect of the 2004 and 2005 years, penalty was imposed at 75% for failure to lodge the returns for those years: s 284-75(3) in that Schedule.

46. At objection, the penalty for 2004 and 2005 was remitted in full, but the penalty for the earlier years was left undisturbed.

47. As a result of my conclusion that the taxpayer is not assessable on the client funds deposited to his bank account, the shortfall amount originally identified by the Commissioner is significantly reduced. But there still remains a question whether the 75% penalty imposed for intentional disregard is appropriate, and then there is the question whether the penalty should be remitted to any extent under s 298-20 in Schedule 1 to the TAA.

48. Before dealing with those two questions, I need to address a threshold issue concerning the method of calculation of the penalty amount. This issue arises because for each of the 2001 and 2002 income years, there were two tax returns lodged for the taxpayer - an original return, and an amended return. The question is whether the penalty should be calculated by reference to the shortfall amount that results from the lodgment of the original returns, or the one that results from the lodgment of the amended returns.

49. The circumstances surrounding the lodgment of the original tax returns for 2001 and 2002 are set out in the taxpayer's revised witness statement, Exhibit A1. The taxpayer explains, and I accept, that it was his employer, and not the taxpayer himself, who lodged the original tax returns. It was done without the taxpayer's knowledge. He did not know what details were included in the returns. He did not even know that the returns were being lodged. (The employer was a registered tax agent who had the ability to lodge tax returns electronically through the tax agents' portal without obtaining the signature of the taxpayer.) The original returns understated the taxpayer's salary and wage income, a fact not in dispute in these proceedings.

50. It is clear from the terms of s 284-75(1) and the table items in s 284-90 that the administrative penalty is triggered whenever:

• • "you or your agent" makes a false statement to the Commissioner (such as, for example, in a tax return) that leads to a shortfall amount; and
• • the resulting shortfall amount arises from the specified level of culpable behaviour on the part of "you or your agent".

51. It is also clear (assuming that the taxpayer's employer is properly regarded as his "agent" for the purposes of those provisions) that these elements were present when the original tax returns for 2001 and 2002 were lodged. There was a false statement made, it was made with intentional disregard of the taxation law (since the employer knew the salary and wage figures were wrong), and the false statement led to a shortfall amount. In those circumstances, penalty is automatically imposed by Division 284.

52. Then the amended returns were lodged. Amended returns normally represent an attempt by a taxpayer to rectify errors made in returns lodged earlier. That is not the case here. These amended returns, lodged with the knowledge of the taxpayer and containing figures which he himself was now asserting were correct, reported exactly the same salary and wage income as the original returns. He knew they were wrong, but he reported those figures anyway.

53. What was different about the amended returns was that they reported, as additional "income", the amounts of the deposits into the taxpayer's bank account. They did this so as to provide support for the concocted story about the non-existent bookkeeping business. In other words, instead of seeking to rectify errors (which is what amended returns normally do), these amended returns actually continued to deceive the Commissioner by representing a state of affairs that was known to be untrue.

54. At least in theory, the amended returns triggered a second imposition of administrative penalty under Division 284. But that is not to say that both penalty amounts, if they were imposed, should stand. The multiple imposition of penalties for the same income year appears to conflict with general notions of fairness and reasonableness, and may even discourage taxpayers from trying to report their affairs truthfully and accurately once they realise they have made an error. Imagine a taxpayer who makes a reckless error in her tax return, but who tries to correct it by lodging an amended return. Although genuinely attempting to get things right, she understates her income a second time (but this time, to a lesser extent than before, and because of a failure to take reasonable care, rather than recklessness). Should it really be the case that she must pay penalty equal to 50% of the first shortfall amount, plus 25% of the second? Of course not.

55. In practical terms, the Commissioner would be unlikely to make multiple penalty assessments. If he had already assessed penalty in relation to the original return, he may well consider that it should be reduced (remitted) to take account of the taxpayer's later behaviour represented by the lodgment of an amended return. Alternatively, he may not consider the question of penalty until after the amended return has been lodged. In that case he would be expected to take the revised disclosures into account in determining the appropriate level of penalty.

56. In the current case, I consider the following matters relevant:

• • the taxpayer did not know the original returns were being lodged, and he did not know what their contents were;
• • he did know the contents of the amended returns, and he asserted they were correct even though he knew they were not.

57. Bearing those matters in mind, I consider that the penalty amount should be calculated by reference to the shortfall amount that results from the lodgment of the amended returns, not the original returns (although it is unlikely to make a difference, since the main impact arises from the salary and wage disclosures, which, as I have already indicated, do not change from one to the other). The appropriate rate of penalty is 75% of the shortfall amount, since the shortfall amount resulted from intentional disregard of the tax law. There are no grounds for remission.

58. In relation to the 2003 year, the taxpayer once again lodged a return declaring salary and wage income that he knew was understated. He blamed this on his employer's having given him an understated PAYG summary, but that is an inadequate explanation. A diligent taxpayer (especially one working in a taxation and accounting practice) would have put the full story to the Commissioner, by way of a covering letter and perhaps a statutory declaration. Once again, the appropriate penalty rate is 75% of the shortfall amount, and no remission is warranted.

DECISION

59. I set aside the objection decisions and remit the matters to the Commissioner for reconsideration, in accordance with the following directions:

• (a) The amounts of client funds deposited to the taxpayer's bank account are not included in his assessable income;
• (b) Deductions are allowable in respect of interest paid on loans relating to investment properties, as outlined in [40] of these reasons;
• (c) For the 2001 and 2002 income years, administrative penalty is set at a figure equal to 75% of the shortfall amount as calculated by reference to the figures disclosed in the amended tax returns for those years;
• (d) For the 2003 income year, administrative penalty is set at a figure equal to 75% of the shortfall amount.