Case S62
Judges: HP Stevens ChTJ McCarthy M
PM Roach M
Court:
No. 1 Board of Review
T.J. McCarthy (Member)
During the year ended 30 June 1981 the taxpayers, G, his wife, M, and their son, N, carried on a supermarket and delicatessen business in partnership. Pursuant to sec. 92 and 161 of the Income Tax Assessment Act each taxpayer was required to return as assessable income his or her individual interest in the partnership net income (if any). In their 1981 partnership tax return the net income was disclosed as $11,567 and in their individual 1981 returns each taxpayer included as assessable income a sum of $3,855, being one-third of $11,567, disregarding fractions. However, it is not disputed by the taxpayers' representatives that the net income of the partnership for the year ended 30 June 1981 was actually $23,614, so that each taxpayer should have included an amount of $7,871 as assessable income in relation to the partnership. Thus each taxpayer omitted assessable income of $4,016 in his or her return.
2. The omitted income was discovered as a result of an audit by the Commissioner. By amended assessments in the cases of G and M (notices issued 2 December 1983, with tax payable 4 January 1984; original assessment notice had issued to G on 8 January 1982 with tax payable 13 April 1982 and to M on 5 January 1982, with tax payable 2 April 1982) and by original assessment in the case of N (notice issued 2 December 1983 with tax payable 4 January 1984), the Commissioner included the omitted income in the assessable income of each taxpayer for the year ended 30 June 1981. Additional tax was also imposed. The amount of additional tax prescribed by Parliament in (the former) sec. 226(2) was $2,570 in the case of G, $2,570 in the case of M, and $2,451 in the case of N, being double the difference between the tax properly payable and the tax that would be payable if it were assessed upon the basis of the return furnished in each case. After remission by the Commissioner, pursuant to sec. 226(3), of almost 70% of those amounts, the additional tax ultimately levied was $788 for each of G and M, and $750 for N. Objections in identical form, which were lodged on behalf of G, M
ATC 447
and N, claimed (a) that sec. 226(2) did not apply to particular adjustments which were made to the partnership net income by the Commissioner and (b) that the additional tax was excessive having regard to the circumstances surrounding certain incorrect claims in the 1981 partnership return in connection with outstanding cheques as at 30 June 1980. The first ground was abandoned at the hearing and only the second ground was pursued.3. So far I have only mentioned the additional tax which was imposed in respect of the year ended 30 June 1981. It seems that the Commissioner's audit discovered that the partnership net income was also understated for the year ended 30 June 1982 and additional tax was imposed in respect of that year as well. The objections lodged by the taxpayers covered both years and the Commissioner's decisions thereon were all referred to the Board. However, at the beginning of the hearing, the taxpayer's representatives abandoned the objections in relation to the year ended 30 June 1982. Accordingly, the taxpayers' assessments for the year ended 30 June 1982 should be confirmed and the only issue is whether additional tax in respect of the year ended 30 June 1981 should be further remitted for any of the taxpayers.
4. The adjustment of $12,047 which was made to the 1981 partnership net income as returned was calculated as follows:
$
Goods applied to own use 2,080
Rates and taxes - private 501
Car depreciation - private 36
Car running - private 345
-----
2,962
Outstanding cheques
as at 30.6.80
Payee Amount
A 290.00
B 192.00
C 1,277.30
D 310.00
E 7,015.65
--------
9,084.95
-------- 9,085
-------
$12,047
-------
5. The first witness called on behalf of the taxpayers was the taxpayer, N. I accept his evidence. The supermarket and delicatessen business commenced on 1 May 1980 and N managed the business on behalf of a partnership comprising N and his parents. The partnership return and the individual returns for the relevant period ending 30 June 1980 were lodged by X & Co., a firm of accountants. N was not happy with these accountants and he changed to Y & Co. after the end of June 1980. Y & Co. prepared the partnership accounts for the year ended 30 June 1981 and lodged the partnership return and the individual returns for that year. (I note in passing that the firm of accountants which represented the taxpayer at the hearing was Z & Co.). N asked Y & Co. what information they required, and he gave them the partnership bank statements and cheque butts and no doubt some other details. N glanced over the 1981 tax returns which had been prepared by Y & Co., but he said that he had no real knowledge of whether they were correct. The problem in relation to the outstanding partnership cheques as at 30 June 1980 only came to N's attention after the audit by the Taxation Office. N said that neither he nor his parents had any intention of avoiding tax.
6. The next witness called on behalf of the taxpayers was W, an employee (since June 1980) of Y & Co. I accept her evidence. W prepared monthly trading accounts for the partnership as well as the final accounts for the year ended 30 June 1981. In September 1980 W began coding the bank statements (as from 1 July 1980) using the notations on the cheque butts (from 1 July 1980) and the details were entered in an in-house computer. Initially W did not ask X & Co. for any information, but later she asked for and received copies of the 1980 tax returns and the 1980 partnership financial statements. W never received the working papers of X & Co. who, she said, were ``not very co-operative''.
7. In looking at the balance sheet for the partners as at 30 June 1980, which had been prepared by X & Co., W discovered a curious feature. That balance sheet was in the following form:
ATC 448
``Proprietorship G M N
$ $ $
Capital at start 8,990.17 8,990.17 8,990.17
Add Share of profits 514.78 514.77 514.77
-------- -------- --------
9,504.95 9,504.94 9,504.94
Less Drawings 822.95 822.94 822.94
-------- -------- --------
8,682.00 8,682.00 8,682.00
-------- -------- ---------
Total Partnership Funds 26,046.00
---------
These funds are represented by:
Non Current Assets
Plant
&
equipment (at cost) 24,385.00
Less Provision for depreciation 552.00 23,833.00
---------
[other assets] 1,180.00
Current Assets
Stock on hand 24,500.00
Intangible Assets
Goodwill and preliminary expenses 45,683.70
---------
Total Assets 94,196.70
Less Liabilities
Bank Account [1] 48,660.80
Bank Account [2] 17,603.26
Sundry Trade Creditors 2,886.64
---------
Total Liabilities 69,150.70
Net Assets 26,046.00
---------''
8. W discovered that the bank overdraft amount of $17,603.26 which was shown in the balance sheet was identical to the debit balance which was shown in the bank statement for Account No. 2 as at 30 June 1980, yet cheques drawn prior to 30 June 1980 in favour of creditors were debited to that bank account early in July 1980, for example, outstanding cheques for $1,277.30 and $7,015.65 were debited on 1 July 1980. W asked a partner for instructions and was told that she should expense the total amount of the outstanding cheques, i.e. $9,084.85, by way of journal entry, as it appeared that X & Co. had not taken these expenses into account in preparing the accounts for the year ended 30 June 1980. No communication was made with X & Co. because W regarded them as unco-operative. In fact, as the Commissioner's audit subsequently discovered, X & Co. had claimed the expenses of $9,084.85 and W accepted that this amount had been wrongly claimed in the year ended 30 June 1981.
9. The next witness called on behalf of the taxpayers was a leading chartered accountant, J. I accept his evidence except as indicated below. J testified that it would have been normal accounting practice for the balance sheet to have incorporated a reconciled figure in respect of the bank account rather than the overdraft balance shown as at 30 June 1980 on the bank statement. Also, in view of the amount of $2,886.64 shown for sundry creditors in the balance sheet, J was intrigued as to how the accounts balanced if X & Co. had taken into account the amount of $9,084.95. Upon the undisputed basis that X & Co. did in fact take that amount into account, he speculated that some adjustment might have been made to the capital accounts. Asked what he would have done if he had been in the position of Y & Co., J said that his first reaction would be that the 1980 accounts had been prepared on a cash basis and he would therefore expense the outstanding cheques in the 1981 year; his next reaction would be to go back to the previous accountants, X & Co., and
ATC 449
ask for a copy of the bank reconciliation and if this were not forthcoming he would ``enquire further''; and his more considered reaction would be to conclude that the accounts prepared by X & Co. were not correct. This last conclusion would presumably have led him to properly prepare the financial statements for the period of two months ended 30 June 1980. The crux of the argument presented on behalf of the taxpayers was that Y & Co. had acted reasonably in assuming that the amount of $9,084.85 had not been expensed in the 1980 year, whereas J said that he would have made further enquiries. However, in any view, the stated assumption that was made by Y & Co. was not unreasonable in the circumstances. The reservation that I have about J's evidence does not go to his truthfulness or to his expertise in accounting matters, but rather to the basis upon which he was asked to proceed. Y & Co. were not conducting an audit; they were engaged to prepare monthly trading accounts for management purposes as well as annual financial statements for management and tax purposes. The previous accountants, X & Co., were not particularly co-operative, and did not supply their working papers. It seems to me that it was quite reasonable for Y & Co. to have assumed that the 1980 profit and loss account was prepared by X & Co. on a cash basis. Presumably X & Co. isolated the tax deductible items and ultimately calculated the amount of drawings by way of a balancing figure.10. No evidence was led about the circumstances surrounding the other adjustments which were made by the Commissioner to the 1981 partnership net income as returned. Those adjustments were not disputed by the taxpayers' representatives. On behalf of the taxpayers a document was produced to the Board and this appeared to contain the calculations made by the Commissioner's officers in determining the amount of additional tax ultimately levied. I do not know whether this information was obtained under the Freedom of Information Act. These calculations were as follows:
``N
Income adjustments penalised Share Income
Adjustment Penalty
$ $ $ $
Goods own use 693 134
Rates
&
taxes - private 167 32
Outstanding cheques 3,028 3,888 584 750
Income adjustments not penalised
Car depreciation - private 12
Car running - private 115
Fraction 1 128 nil
----- ------ ----
Adjustment to taxable income and penalty $4,016 $750
------ ----''
ATC 450
``G and M
Income adjustments penalised Share Income
Adjustment Penalty
$ $ $ $
Goods own use 693 140
Rates and taxes - private 167 34
Outstanding cheques 3,028 3,888 614 788
Income adjustments not penalised
Car depreciation - private 12
Car running - private 115
Fraction 1 128 nil
------ ------ ----
$4,016 $788
------ ----''
11. The case presented on behalf of the taxpayers was that additional tax of $584 in the case of N, and $614 in the cases of G and M, which was said to be the amount of additional tax attributable to the outstanding cheques incorrectly claimed in the 1981 year, should be further remitted and that no penalty other than an interest factor should have been imposed in relation to that item.
12. A highlight of this case was the submission presented by the taxpayers' second representative, presumably the taxpayers' solicitor. That submission contained many interesting insights, as well as references to overseas authorities. During his address the taxpayers' solicitor referred to the following cases:
Molloy
v.
F.C. of T.
(1937) 4 A.T.D. 570
at p. 571
;
Archer Bros Pty. Ltd.
v.
F.C. of T.
(1953) 10 A.T.D. 192
at pp. 197-198
;
H.R. Lancey Shipping Co. Pty. Ltd.
v.
F.C. of T.
(1951) 9 A.T.D. 267
at p. 273
;
F.C. of T.
v.
McClelland
69 ATC 4001
at p. 4006
;
A.L. Campbell
&
Company Pty. Ltd.
v.
F.C. of T.
(1951) 82 C.L.R. 452
at p. 461
;
Case
42
(1966) 13 C.T.B.R. (N.S.) 263
at p. 265;
New Zealand Flax Investments Ltd.
v.
F.C. of T.
(1938) 5 A.T.D. 36
at p. 47
;
D.
v.
C. of T. (Qld)
(1940) 6 A.T.D. 25
at p. 39
;
Lancaster
v.
I.R. Commrs
(1969) 1 A.T.R. 109
at p. 116
;
Glausiuss
v.
I.R. Commrs
(1970) 1 A.T.R. 588
at p. 591
;
Case
D44
(1980) 4 NZTC 60, 759
;
Poole and
Dight
v.
F.C. of T.
70 ATC 4047
at p. 4055
;
Lurie
v.
Lurie
(1938) 107 L.R. Ch.D. 289
;
In
re Egan
(1915) 154 N.W. 521
at p. 522
;
Case
R53,
84 ATC 404
at pp. 406-407;
Case
57 (1947) 13 C.T.B.R. 307
;
Case
104
(1945) 12 C.T.B.R. 689
at p. 691;
Case
Q124,
83 ATC 737
;
Case
R57,
84 ATC 430
at pp. 435-436;
Case
S20,
85 ATC 232
;
Case
P121,
82 ATC 611
;
Case
53
(1945) 14 C.T.B.R. 64
;
Case
35
(1950) 1 C.T.B.R. (N.S.) 145
at p. 146;
Case
Q50,
83 ATC 241
at p. 263;
F.C. of T.
v.
Trautwein (No. 3)
(1936) 4 A.T.D. 92
;
A.-G.
v.
Till
(1909) 5 T.C. 440
at p. 453
;
Case
E91
(1982) 5 NZTC 59, 477
;
Case
N58,
81 ATC 298
;
Case
No.
1331 (1981) 43 S.A.T.C. 76
at p. 87;
Case
F52
(1983) 6 NZTC 59, 830
;
Case
F80
(1983) 6 NZTC 59, 961
; and
Case
F115
(1983) 6 NZTC 60, 118
. He also referred to sec. 185, 190(a), 226 and 251M of the Act and sec. 15AA, of the
Acts Interpretation Act
as well as to
Income Tax Ruling
IT 2012. I note that in the course of his address the taxpayers' solicitor quite correctly pointed out that a remedy in negligence by a taxpayer against his accounting or legal adviser did not bear on the amount of additional tax which should be levied in a particular case.
13. Nevertheless, and with great respect, I am of the opinion that the case presented on behalf of the taxpayers has two major defects. The first defect arises from a failure to distinguish between the internal workings of the Taxation Office and the statutory jurisdiction of the Board, an independent tribunal. If the Board further remitted the additional tax for any of the taxpayers in the manner sought, then it seems to me that the Board would be acting unlawfully and that on appeal the Commissioner could attack such a decision in the following way: In so far as the Board purported to exercise a discretion in relation to the remission of part only of the additional tax by reference to only one of a number of items involved in the omission of partnership income by each taxpayer, the Board exercised a discretion which is not entrusted to it by sec. 193 and 226(3), because the discretion to remit in sec. 226(3) in relation to any taxpayer in the present case is a discretion to remit the amount prescribed by sec. 226(2) and it is not a combination of individual discretions; and in so far as the Board purported to exercise the discretion in sec. 226(3) by reference to only one such item, but without any evidence of the surrounding circumstances in relation to the other items involved in the omission of partnership income by each taxpayer, then the Board acted arbitrarily, without proper regard to the provisions of sec. 190(b), and therefore unlawfully because it failed to discharge its exact function according to law, cf.
Avon Downs Pty. Ltd.
v.
F.C. of T.
(1949) 78 C.L.R. 353
per
Dixon
J. at p. 360;
Brian Hatch Timber Co. (Sales) Pty. Ltd.
v.
F.C. of T.
71 ATC 4093
per
Walsh
J. at p. 4095; 72 ATC 4001, per
Menzies
J. at p. 4007 and per
Owen
J. at p. 4013;
Kolotex Hosiery (Australia) Pty. Ltd.
v.
F.C. of T.
75 ATC 4028
per
Gibbs
J. at p. 4055.
14. Where the evidence permits, the Board, unlike a court, exercises a discretion afresh, see
B.O.A. Pty. Ltd.
v.
F.C. of T.
81 ATC 4492
and the cases there cited. But where the evidence does not so permit, it would require a special case, such as an error of law being necessarily involved in the Commissioner's assessment (see, for example,
Case
Q70,
83 ATC 354
),
ATC 451
before the Board could properly upset the exercise by the Commissioner of his discretion; otherwise, as it seems to me, the Board would be acting arbitrarily and therefore unlawfully. By virtue of sec. 190(b), which applies to proceedings before a Board of Review as well as to legal proceedings before a court, the onus is on the taxpayer to show that the assessment is excessive. Thus there must be sufficient material before the Board to enable a discretionary judgment to be made. How could the Board in this case possibly know whether the additional tax levied against any of the taxpayers is excessive when it is merely supplied with a list of the other partnership errors which were made and knows nothing of the surrounding circumstances in which such errors occurred? Furthermore, as the Commissioner's representative correctly submitted, this case involves an omission of income by each taxpayer, seeBenwerrin Developments Pty. Ltd. v. F.C. of T. 81 ATC 4524 , and not a claim for a share in a partnership loss (not involving an omission of income), see
F.C. of T. v. Sahhar 85 ATC 4072 , nor a claim for a deduction in such circumstances as occurred in
F.C. of T. v. Rabinov & Anor 83 ATC 4437 .
15. I have another major difficulty with the argument presented on behalf of the taxpayers. Assuming that the Board could properly further remit so much of the additional tax as is said to relate to the outstanding cheques, the taxpayers' argument completely fails to take into account the aspect of disclosure. That aspect was given emphasis by the Federal Court in F.C. of T. v. Rabinov . In the present case the outgoings represented by the outstanding cheques discharged liabilities which arose in the year ended 30 June 1980, and at least some if not all of the outgoings were paid in that year when cheques for valuable consideration were received by the payees. The taxpayers' solicitor did not suggest otherwise. Accordingly, Y & Co., on behalf of the taxpayers, claimed outgoings in respect of the year ended 30 June 1981 which were not deductible in that year, irrespective of whether those outgoings had been claimed in the previous year. The justification advanced on behalf of the taxpayers is that their accountants, Y & Co., reasonably believed that the outgoings had not been claimed in the previous year. I accept that this belief was reasonably based on the information available to Y & Co., but I am unable to accept that this provides any justification for claiming outgoings in the year ended 30 June 1981 which, on any view, were not deductible in that year, when - and this is the important point - no disclosure of the circumstances was made to the Commissioner.
16. In fact, the belief which Y & Co. entertained was wrong and the relevant outgoings were claimed twice. To my mind that is a situation which should be viewed with considerable concern. Moreover, the error would never have been discovered without the diligence of the Commissioner. Should the Commissioner be required to audit a business whenever there is a change of accountants? Surely not. In the present case the important difference which disclosure of the circumstances would have made never seems to have occurred to Y & Co. or to the taxpayers' representatives at the hearing. Such a disclosure would have alerted the Commissioner to what had been assumed and he could have sought appropriate information from X & Co. Those accountants may have been unco-operative as far as Y & Co. were concerned, but it would no doubt have been different if the information had been sought by the Commissioner who, of course, has certain statutory powers to require information to be furnished to him. Accordingly, even if it were permissible for the Board to isolate so much of the additional tax as relates to the outstanding cheques, I consider that the circumstances do not warrant a further remission.
17. For these reasons I am of the opinion that the Commissioner's decisions on the taxpayers' objections should be upheld and that the assessments of the taxpayers for the years ended 1981 and 1982 should be confirmed.
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