TKYY v FC of T
Members:BJ McCabe DP
Tribunal:
Administrative Appeals Tribunal, Sydney
MEDIA NEUTRAL CITATION:
[2023] AATA 2497
BJ McCabe (Deputy President)
1. The applicant in these proceedings, TKYY, objected to assessments and/or amended assessments issued in respect of the financial years ending 30 June 2008 to 30 June 2016. The Commissioner says TKYY should have reported a total of $6 million paid by a family company to TKYY's family trust in respect of work carried out by TKYY over the years in question. TKYY now accepts that amount is assessable in his hands, but he says is also entitled to claim deductions exceeding $18 million over the nine-year period. The claims for deductions relate to interest TKYY incurred on loan advances made to him by friends and associates in connection with a business opportunity. That opportunity turned out to be a scam. He only paid the interest on the advances in the 2008 year of income. The interest went unpaid in subsequent years after the fraud came to light, but he insists the interest was incurred and was deductible.
2. The Commissioner argues TKYY has failed to establish the interest charges were a loss or outgoing…incurred in gaining or producing assessable income within the meaning of s 8-1(1)(a) of the Income Tax Assessment Act 1997 (ITAA97). TKYY accepts he cannot claim deductions under the second limb of s 8-1(1) (ie, s 8-1(1)(b)) which refers to losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. TKYY accepts the business opportunity in question - a 'casino junket' operation promoted by TKYY's girlfriend at the time - never actually came into existence. The operation had been conjured up by his girlfriend as part of a fraudulent scheme to generate funds to feed her own gambling. In any event, TKYY emphasised in supplementary submissions lodged on his behalf that he never claimed he was carrying on a casino junket business himself; rather, he was providing money he had borrowed to his girlfriend for use in a profit-seeking venture in order to generate a return to him and the lenders.
3. TKYY also claimed capital losses in respect of the funds he contributed towards the casino junket business opportunity. The losses
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were only sought in the 2011, 2012, 2013, 2014, 2015 and 2016 years of income after the assessments and amended assessments were issued. The applicant conceded in post-hearing submissions that the claims for capital losses were not properly before the Tribunal, although he insists the capital losses may yet be claimed in subsequent years of income. In any event, the claim for capital losses is not presently before the Tribunal and will not be considered further in these proceedings.4. The Commissioner made a finding of 'fraud or evasion' pursuant to s 170 of the Income Tax Assessment Act 1936 (ITAA36) in respect of the 2007 through 2011 years of income. That finding meant the Commissioner was able to disregard the statutory time limit which otherwise applies to making amended assessments in those years. TKYY had not lodged returns with respect to the 2012-2014 years of income when the audit commenced in 2015. The finding of fraud and evasion was made in the audit report, which was finalised in September 2017.
5. TKYY says the finding of fraud or evasion should not have been made. If he is right, the Commissioner is not entitled to issue the amended assessments in respect of the 2007 through 2011 years of income. TKYY also challenged penalty assessments that were the subject of objection.
WHAT HAPPENED?
6. TKYY filed a total of four affidavits and gave evidence at the hearing.[1]
7. Ms KK had been managing a payday lending business conducted by a company in which TKYY's family trust had an interest. That business had been in operation since 2002. The business was relaunched using a new corporate vehicle in 2004 or 2005. I shall refer to the entity which operated the business as ABC.
8. I will have more to say about the money-lending business (such as it was) in due course. For now, it is appropriate to focus on the casino junket proposal Ms KK pitched to TKYY in late 2004.
9. In his first affidavit dated 23 April 2019 (exhibit one), TKYY recounted Ms KK's explanation of the proposed business as follows:
- 7. She explained to me that an operator would register with a casino as a junket operator.
- 8. In order to register as a junket operator she told me the person would need to lodge a sizeable money deposit with the casino. It could be done with more than one casino.
- 9. She said that the minimum deposit required to be lodged by a junket operator with a casino was $500,000
- 10. She explained to me that the junket operator would in turn register gamblers with the casino as part of their operation
- 11. She said that the gambling turnover of a gambler who was registered with a junket operator's activities would attract commission income (for example, 1.6%) payable by the casino to the junket operator ('Junket Income').
- 12. A casino would according to what she told me deduct from the commission income expenses incurred in providing to each registered gambler accommodation costs, food and beverage costs, entertainment costs, transport costs, etc ('Junket Expenses')
- 13. Junket Expenses would she said probably equate to 1 % of turnover.
- 14. A junket operator who demonstrated to a casino that their junket activities were being operated successfully may from time to time be invited to lodge larger money deposits in exchange for an increase in the rate of
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commission. For example, the commission rate may be increased from 1.6% to 2% of gambling turnover
10. That explanation is consistent with the Commissioner's understanding of the operation set out in the objection decision dated 20 December 2021 at [44]. I accept it is important to emphasise:
- (a) The gambler who participated in a particular junket would strike an arrangement with the operator upfront which required the gambler to deposit money with the operator or enter into a loan agreement with the operator to advance funds which could be deposited with the casino;
- (b) the operator had to deposit the funds with the casino upfront. The deposited monies would be used to buy chips for the gamblers who participated in the junket. The gamblers would use those chips in particular areas of the casino. Unused chips would be returned at the end of the junket; and
- (c) the profitability of the venture for the operator (as opposed to the casino) depended on the number of gamblers and the willingness of those individuals to gamble larger amounts.
11. TKYY recalls being told Ms KK would cultivate contacts in ethnic communities where gambling was popular. It was proposed she would then register the gamblers with the casinos. TKYY understood his role was to obtain external funding for the venture - in particular, to obtain the funds that would be deposited with the casinos: exhibit one at [18]. He says he advanced nearly $780,000 of his own cash in late 2004 or early 2005 (at [22]) and obtained loan advances from friends and associates who were interested in discreetly participating in the casino junket opportunity. He said he agreed to pay interest on the loans to the associates at up to 30% per annum. That interest rate reflected the unsecured nature of the loans: at [23]. He explained how he would service those loans and provide a return at [20]-[21] of exhibit one:
- 20. It was agreed between Ms KK and myself that we would commence the junket operation and that I would be paid interest out of the Junket Income sufficient to pay interest on the moneys I had borrowed and that I would receive in addition an amount equal to 50% of the Junket Income net of all expenses.
- 21. It was also agreed between Ms KK and myself that she would retain the other 50% of the Junket Income net of all expenses
12. TKYY was, at the time, a partner in a large accounting firm. He wanted to be discreet. He said (at [16]) he and his girlfriend:
…agreed that it would not be desirable for me to be publicly associated with such a junket operation. In principle I was willing I told her to put money in to provide the necessary deposits both from my own funds and by borrowing money from others to increase the funds available.
13. TKYY left the accounting firm in 2005 and began working full-time in an agribusiness conducted by his family trust. But he retained access to an extensive and fruitful list of business contacts from his days with the accounting firm.
14. Ms KK had referred to a friend of hers who would assist in operating the junket operation. Apparently that was attractive because it would help TKYY (and, I infer, those who provided funding) to remain at arms' length from the casino junket business. Ms KK said she and the friend would register with the junket operators and deal with the casinos. TKYY said he never met the friend: affidavit at [17]. Given how events unfolded, there must be some doubt over whether that friend ever actually existed.
15. TKYY said he obtained large loans from various friends and associates in the period 2004 through 2008. Some of the lenders made several advances. Most of the loans were unsecured although over time some of the lenders required security and restructured loans: at [23]-[33]. (I will discuss those advances and the interactions below.) The advances were mostly paid into an account held in the name of ABC, the company controlled by TKYY which separately operated the money lending business. Ms KK was able to access that account and make payments from there to casinos: at [38]. But not all the advances from the lenders were paid into the account of ABC. Some were paid into other accounts operated by TKYY himself, or to Ms KK directly, or to Star Casino. Some advances to
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TKYY were apparently delivered in cash. In any event, Ms KK told TKYY the payments she made to the casinos were made in connection with the casino junket business.16. Ms KK apparently provided a good deal of paperwork to TKYY reporting on how well the casino junket business was operating between 2004 and 2008. The paperwork included (exhibit one at [44]) statements printed on the letterhead of various casinos recording:
- a. The period of operation
- b. The names of the patron gamblers
- c. The date the patron was admitted into the junket operation
- d. The account name
- e. The account number
- f. The program type
- g. The total turnover of patrons
- h. The commission due
- i. The commission rate
- j. Junket expenses
- k. Net payment due to operator
- I. Signatures of casino manager and junket operator
17. TKYY explained in his affidavit (exhibit one at [42]):
On a daily basis I would keep a record of gamblers names and movements in and out of a casino together with records of what Junket Income had been paid in relation to the gamblers activities and at what rate…
18. The paperwork suggested the business was operating successfully. TKYY said Ms KK even approached him to provide additional funds in the expectation the casinos would pay an increased rate of commission: exhibit one at [51]. Ms KK was able to pay TKYY amounts in cash each month that he would return to lenders: at [46]. Those regular payments from Ms KK continued until early 2008 until they suddenly began to falter. TKYY said the payments from Ms KK ceased altogether in April 2008.
19. TKYY says he realised at that point that his girlfriend had scammed him and the lenders. She said as much when she was confronted in April 2008. He now concedes there never was a casino junket business. He infers Ms KK gambled all the money away. He says he (and the lenders) were the victims of a Ponzi scheme in which the 'interest payments' remitted to him were actually paid out of the capital being advanced to maintain the illusion of profitability right up until the point the money ran out: at [61]. The lenders were angry once they learned of the fraud. They wanted to recover principal and interest under the terms of the various loan agreements. Some of them sued TKYY (or sued TKYY and Ms KK on loans where they were joint borrowers) to recover the funds or took other steps to recover against him. Amounts due in respect of principal and interest on the various loans were thereafter unpaid, or not fully paid. TKYY also filed a police report against Ms KK and sought freezing orders against her in the Supreme Court of New South Wales.
20. TKYY stopped paying interest on the various loans in 2008. He said he remained liable to pay the interest, however, in the years that followed. He says he should be able to claim deductions in respect of the interest in each year that the liability accrued.
THE TAXPAYER'S RETURNS AND ASSESSMENTS IN THE RELEVANT YEARS OF INCOME
21. TKYY lodged a return in the 2008 year of income which did not disclose taxable income or a positive liability to pay tax. (To be precise, TKYY's original return in respect of that year reported a small amount of 'net non-primary production distribution income' but he subsequently sought an amended assessment disclosing gross interest income that was offset by interest and dividend expenses.) His return in the 2009 year of income reported a small amount of taxable income but recorded no tax payable because of a tax offset. He did not report as income any of the remuneration that was received in respect of the personal services he rendered through his family trust. TKYY now accepts he should have reported the amounts of personal service income in his returns. Amended assessments were subsequently issued in respect of the 2008 and 2009 years. The amended particular in each year was an increase in the taxable income derived from personal services provided to the family business.
22.
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As we shall see, TKYY reported taxable income and tax payable in his returns lodged in respect of the 2010 and 2011 years. The principal source of income in each year was 'cleaning'. He did not report all the personal services income in those years that he now accepts he should have reported. He did not claim deductions in respect of the interest accruing on the loans in respect of the casino junket business. When the Commissioner came to amend the assessments following the audit, the particulars of the amendment were referable to the increase in personal services income.23. The Commissioner concluded during the audit he was entitled to revisit the assessments in respect of the 2008-2011 financial years even though the applicable period for review in s 170 of ITAA36 had expired. He said he was entitled to do so pursuant to s 170(1)(item 5) because he formed the opinion there was fraud or evasion.
24. The Commissioner issued default assessments with respect to 2012, 2013 and 2014 years of income, and amended assessments with respect to 2015 and 2016 years following the audit. In each year of income, the Commissioner found the applicant had underreported his personal services income. The notices of assessment and amended assessment were issued on 27 September 2017.
25. The Commissioner also issued penalty assessments in respect of the 2008-2014 years of income. The 2009, 2010, 2011, 2013 and 2014 years of income were subject to a 20% uplift in the base penalty amount, and there was an additional penalty for late lodgement/failure to lodge in the 2013 and 2014 years of income.
26. The applicant lodged objections to the notices of assessment and amended assessment on 2 November 2017. The objections were determined on 23 November 2018, and the application for review with the Tribunal was lodged thereafter.
THE HISTORY OF THESE PROCEEDINGS - AND A TECHNICAL QUESTION OVER OBJECTION RIGHTS
27. The proceedings have a fraught history. It is worth recounting that history so the reader can appreciate some of the challenges associated with deciding the case, but also to bring some clarity to the way in which the questions (and to some extent the evidence) before the Tribunal evolved over time.
28. One complication arose out of the fact the Tribunal that was constituted to hear the proceedings has necessarily been reconstituted three times. When the hearing commenced on 9 February 2021, the panel was comprised of the (then) President, Thomas J, Deputy President McCabe and Senior Member (as she then was) Hespe. By that point, the proceedings had already been in gestation for some time during which TKYY had not been legally represented. I withdrew from the proceedings after the substantive hearing in light of a potential conflict, necessitating a reconstitution so the Tribunal thereafter was comprised of Thomas J and SM Hespe. The panel was reconstituted again when Thomas J resigned as President of the Tribunal. At that point, I returned to deal with the matter alongside SM Hespe after the potential conflict which I had faced (and which was disclosed to counsel) was resolved. The Tribunal was necessarily reconstituted once more after SM Hespe was elevated to the Federal Court. I have been left to deal with the proceedings.
29. Another complication arose out of the complex factual scenario that unfolded in the documents and in the testimony of the witnesses. TKYY gave evidence and was cross-examined at the hearing along with one other witness. Directions were made for the exchange of written closing submissions ahead of a resumed hearing to deal with argument.
30. Given the complex and sprawling nature of the factual material, the Tribunal had asked the parties to provide a consolidated bundle comprised of the essential documents. It turns out the consolidated bundle was close to 3000 pages. The bundle was delivered in the midst of intermittent Covid lockdowns in Victoria, New South Wales and Queensland which made it difficult for the parties to engage and confer. The Tribunal experienced the same challenges given the geographical disposition of the membership of the panel. (For context, the matter was heard remotely using Microsoft Teams. Thomas J and I were in Queensland throughout part of the hearing, although I was based in Sydney throughout a significant proportion of the proceedings while SM Hespe
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remained in Victoria throughout. The constitution of the panel was thought appropriate notwithstanding the potential inconvenience: the complexity of the facts, the legal issues and the potential sensitivity of some of the factual findings which might be required were such that it was important the Tribunal be constituted by a judicial presidential member and revenue experts.)31. At a resumed hearing to deal with submissions on 8 April 2021, Thomas J expressed the Tribunal's frustration over the consolidated bundle. His Honour also indicated the Tribunal was not adequately assisted by the written submissions that were exchanged and lodged by both parties: transcript at 186-187. That resumed hearing, it should be noted, was made more complicated by technology and connection issues. (Some of those issues may explain shortcomings in the quality of the transcript, although happily I have access to the audio recordings. That has assisted my recollection and analysis of the evidence and oral submissions that I observed, and helped me make sense of what transpired while I was absent from the proceedings.) At the conclusion of the resumed hearing, directions were made for supplementary written submissions to be filed by 5 May 2021 dealing with unresolved issues.
32. After the Tribunal received the additional submissions it had requested, the associate to Thomas J wrote to the parties on 19 May 2021. The letter enclosed the President's direction reconstituting the panel. The associate's letter went on to raise two issues which the parties were asked to address in further written submissions. One of those issues was the question of whether TKYY could claim any capital loss incurred in the 2011-2015 years of income that had not been raised in TKYY's original grounds of objection and which did not impact on his taxable income in the relevant years in any event. The second issue was articulated as follows:
The applicant's objections for the 2008, 2009, 2010 and 2011 years of income are objections against amended assessments which did not purport to deny interest deductions. Does s 14ZV of the Taxation Administration Act 1953 (Cth) preclude the applicant from raising as a ground of objection the claiming of interest deductions in those years of income and whether, by extension, precludes the Tribunal from considering such claims?
33. The Tribunal's identification of the issue under s 14ZV of the Taxation Administration Act 1953 (Cth) (the Administration Act) precipitated a lengthy but unavoidable digression in the proceedings. It would be helpful to explore the issue in some detail before returning to the factual narrative.
Putting s 14ZV in context
34. The technical question about the operation of s 14ZV of the Administration Act needs to be understood in its context. Section 14ZV forms part of the framework that surrounds the decision-making continuum in taxation. The decision-making process ordinarily commences when a taxpayer files a return as required under s 161 of ITAA36. Once a return is filed, s 166 requires the Commissioner to make an assessment of:
- • the amount of taxable income or determine that there is no taxable income;
- • the amount of tax the taxpayer is liable to pay or determine there is no tax payable; and
- • the total amount of the taxpayer's tax offset refunds or determine there are to be no such refunds.
35. Where a taxpayer is covered by the self-assessment system, s 166A provides the amounts reported in the return which are referrable to what must be included in the assessment will be deemed to be an assessment in those amounts.
36. Section 167 deals with default assessments. A default assessment can be issued where a taxpayer:
- • makes default in filing a return;
- • the Commissioner is not satisfied with the return which has been filed; or
- • the Commissioner believes a person who has not furnished a return has derived taxable income.
37. When issuing a default assessment, the Commissioner is entitled to:
make an assessment of the amount upon which in his or her judgment income tax
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ought to be levied, and that amount shall be the taxable income of that person for the purpose of section 166.
38. Section 168 permits the Commissioner to make what are, in effect, 'own motion' assessments at any point. He may at any time unilaterally issue an assessment determining the things he is required to determine in s 166. A special assessment under s 168 may also relate to a period of less than a year.
39. Sometimes the Commissioner has reason to second-guess an assessment that has already issued. He has the power to issue an amended assessment in that event under s 170(1), but there are time limits within which he must act. The applicable time limit varies depending on the kind of taxpayer and the circumstances. For individual taxpayers, the time limit is generally two years from the date on which the Commissioner gave the notice of assessment which is being amended. But the two-year limit does not apply in some situations - for example, where the individual was carrying on a business in the relevant year (although small and medium business entities are carved out of that exception).
40. Where an amended assessment issues, it is (subject to other provisions of the legislation) an assessment: s 173. More than one amended assessment can be issued, subject to the time limits set out in s 170. In some cases, the issue of an amended assessment will start the clock again on the period during which further amendments can be made.
41. Importantly, s 170(1) says (at item 5) the Commissioner may issue an amended assessment regardless of the amount of time that has elapsed "if he or she is of the opinion there has been fraud or evasion".
42. That brings us to s 175A(1), which says a taxpayer who is dissatisfied with an assessment made in relation to that taxpayer may object using the process set out in Part IVC of the Administration Act. The objection process forms part of the decision-making continuum in tax. (Section 14ZL of the Administration Act says a range of other determinations, notices, and decisions issuing from the Commissioner, including the failure to make a private ruling, are channelled through the objection process.) Where a taxpayer is dissatisfied with an assessment, including an amended assessment, they must lodge an objection to the assessment which is in the appropriate form (s 14ZU of the Administration Act) and within the time specified in s 14ZW. Where a taxpayer wishes to lodge an objection after the time for doing so has elapsed, the taxpayer may request an extension of time. Requests for an extension of time are considered under s 14ZX.
43. When viewed holistically, the decision-making framework requires taxpayers to act promptly in the event of disagreement with the Commissioner in relation to taxation decisions. There is a public interest - and usually an individual interest - in dealing with these disputes expeditiously and efficiently. That is why it is incumbent on the taxpayer to quickly identify the substance of their disagreement with the Commissioner's decision when the taxpayer lodges the objection. That obligation arises out of s 14ZU(c) which requires the taxpayer to "state in [the objection], fully and in detail , the grounds that the person relies on" [ emphasis added]. The taxpayer's obligation to identify their concerns at the outset makes sense because the taxpayer presumably knows the details of their own affairs, whereas the Commissioner has typically drawn his conclusions based on information provided to him by others. An alternative approach that permitted taxpayers to raise concerns on an ad hoc basis as the process unfolded would incentivize foot-dragging by those taxpayers who see an advantage in delay.
44. The requirement that taxpayers take the opportunity to identify their grounds of objection precisely and quickly is reinforced in the provisions which follow - most obviously, in s 14ZV. That section limits the objection rights in relation to amended assessments. If the taxpayer objects to an assessment that has been amended in any particular, the taxpayer's grounds of objection are confined to the "alterations or additions in respect of, or matters relating to, that particular". That rule prevents taxpayers from using the occasion of the amendment to call into question matters arising out of the original assessment that should have been the subject of objection at an earlier point: see
Epov v Commissioner of Taxation [2007] FCAFC 139 at [32] per Gordon J.
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45. Section 14ZY requires the Commissioner to decide whether he will allow the objection, wholly or in part, or disallow it. Time limits apply to that decision-making process. Subject to those time limits, the taxpayer may give notice requiring the Commissioner to make the objection pursuant to s 14ZYA(2) if he has not already done so. If the Commissioner does not make a decision on the objection when required to do so in accordance with s 14ZYA(2), he will be taken to have made a decision disallowing the objection under s 14ZY(1). Thereafter, if the taxpayer remains dissatisfied with the objection, they have the option of either seeking review in the Tribunal (assuming it is a reviewable objection decision) or appealing to the Federal Court: s 14ZZ.
46. The provisions that regulate the Tribunal's review under Part IVC are set out in Division 4 of the Administration Act. Division 4 includes provisions that modify the operation of provisions in the AAT Act and adapts them to Part IVC reviews. Section 14ZZK is particularly important in this regard. The provision deals with the grounds of objection and the burden of proof. The section provides:
On an application for review of a reviewable objection decision:
- (a) the applicant is, unless the Tribunal orders otherwise, limited to the grounds stated in the taxation objection to which the decision relates; and
- (b) the applicant has the burden of proving:
- (i) if the taxation decision concerned is an assessment--that the assessment is excessive or otherwise incorrect and what the assessment should have been; or
- (ii) in any other case--that the taxation decision concerned should not have been made or should have been made differently.
47. Section 14ZZK(a) and (b) are consistent with the policy evident elsewhere in the Administration Act which requires taxpayers to (i) take the initiative by identifying the issues at an early stage and (ii) use their superior knowledge of their own affairs to make out their case.
The implications of s 14ZV in this case
48. I have explained the Tribunal asked the parties for further submissions about whether the taxpayer could claim capital losses and deductions in respect of interest in the 2008-2011 years of income in light of the amended assessments and the limits on the ability to object imposed by s 14ZV of the Administration Act. TKYY formally acknowledged in brief written submissions lodged on his behalf on 2 June 2021 that he was not pressing the claim for capital losses in the 2011-2015 years of income. He conceded the claims had not been made in the returns or amended returns.
49. To answer the second question (ie, as to whether s 14ZV precluded the taxpayer from now raising the question of deductions), it is necessary to examine more closely the implications of s 14ZV. TKYY's submissions on that issue were short. He insisted the Tribunal was able to deal with the claim for interest deductions even though the deductions had not been sought in the original returns. (The assessments for the 2008 and 2009 years of income were both 'nil assessments' which did not disclose any taxable income.) He denied s 14ZV was an obstacle to dealing with the claim for deductions in these proceedings because those claims formed part of the amended assessments that issued in the wake of the audit. The deductions and the previously unreported income had been discussed during the audit. TKYY said the question of deductibility was certainly 'on the table' when the amended assessments were issued, and that ought to be enough.
50. Section 14ZV provides:
Limited objection rights in the case of certain amended taxation decisions
If the taxation objection is made against a taxation decision, being an assessment or determination that has been amended in any particular, then a person's right to object against the amended assessment or amended determination is limited to a right to object against alterations or additions in respect of, or matters relating to, that particular.
51.
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The taxpayer's argument over the implications of s 14ZV of the Administration Act was developed as follows. TKYY contends:- • The right to object does not flow from the assessments as such, but from the taxation decision(s) inherent in those assessments or amended assessments: see
Bosanac v Commissioner of Taxation [2019] HCA 41 at [12]-[16] per Nettle J. - • In this case, the Commissioner made two relevant taxation decisions which were incorporated into the amended assessment - specifically, he decided to (a) include the additional, previously unreturned income and (b) he (at least implicitly) rejected the claim for deductions which had been raised during the audit process.
- • In those circumstances, the 'particulars' for the purposes of s 14ZV included the claim for deductions, which meant the decision to that effect was properly a ground of objection and reviewable by the Tribunal in the ordinary course.
52. The Commissioner says TKYY can validly press the claims for deductions with respect to the 2008 and 2009 years of income because the original assessments in those years were 'nil assessments'. That meant TKYY was precluded from objecting to the original assessments at the time because s 175A(2) of ITAA36 says:
…a taxpayer cannot object…against an assessment ascertaining that:
- (a) the taxpayer has no taxable income; or
- (b) the taxpayer has an amount of taxable income and no tax is payable.
(Section 175A(3) includes a limited right of objection in some circumstances to a nil assessment notwithstanding s 175A(2) but those circumstances do not arise in this case. Section 175A(3) was added in 2005.)
53. In circumstances where the taxpayer could not object to the original nil assessment, the Commissioner agrees the taxpayer retains full objection rights in relation to the first subsequent amended assessment which includes a positive amount. The Commissioner justified that view in two ways.
54. First, he points out s 14ZV of the Administration Act refers to "the assessment…that has been amended" but argues that does not include a nil assessment in which there is no taxable income or no tax payable. That argument flows from observations of the High Court in
Batagol v Commissioner of Taxation [1963] HCA 51;
(1963) 109 CLR 243 and
Commissioner of Taxation v Ryan [2000] HCA 4;
(2000) 201 CLR 109 to the effect that references to a specific amount of taxable income and a determination of the precise amount the taxpayer was liable to pay were essential features of an assessment under the legislation. I summarised and analysed the authorities on this point in WLQC and Commissioner of Taxation
[2018] AATA 14. That case addressed the objection rights in the event of a nil assessment prior to amendments to s 175A of ITAA36. I concluded in that case the Tribunal had no jurisdiction to review an objection decision, or purported objection decision, in relation to a nil assessment. Once an amended assessment issues which details the amount of assessable income and a specific positive liability, the right to object arises.
55. The Commissioner's second argument about the operation of s 14ZV of the Administration Act emphasises the need to read the text of the provision in light of the text and purpose of the legislative scheme as a whole. Whereas a taxpayer has an unlimited right of objection against an original assessment within the statutory time frame, an amended assessment was not intended to confer a new and unlimited right of objection - merely a right to object to the alterations and additions that were the subject of the amendment. But the scheme of the legislation suggests the taxpayer was not intended to be disadvantaged in the objection process if they were precluded from objecting to the original assessment because that assessment disclosed no taxable income or any liability to tax. Where there is a nil assessment, the amended assessment is (or should be, if the legislation is interpreted to give effect to its purpose) the first real opportunity to object. It therefore makes sense to read the provision subject to that implied understanding. The Commissioner relied on the reasoning of the High Court in
Cooper Brooks (Wollongong) Pty Ltd v Federal Commissioner of Taxation (1981) 147 CLR 297 to argue a
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decision-maker should read into the otherwise plain language of s 14ZV a limitation to the effect that the right to object is only engaged in cases where the taxpayer has already had the right to object but did not do so (or did not object on the particular grounds in question).56. The Commissioner found further support for this approach in the dissenting judgment of Gageler and Keane JJ in
Taylor v The Owners - Strata Plan No 11564 (2014) 253 CLR 531; [2014] HCA 9 where it was said (at [65]-[66]):
65. Statutory construction involves attribution of legal meaning to statutory text, read in context. "Ordinarily, that meaning (the legal meaning) will correspond with the grammatical meaning … But not always." [
Project Blue Sky Inc v Australian Broadcasting Authority [1998] HCA 28;
(1998) 194 CLR 355 at 384 [78];
[1998] HCA 28.] Context sometimes favours an ungrammatical legal meaning. Ungrammatical legal meaning sometimes involves reading statutory text as containing implicit words. Implicit words are sometimes words of limitation. They are sometimes words of extension. But they are always words of explanation. [See for example
Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation [1981] HCA 26;
(1981) 147 CLR 297 at 310-311, 319-321] The constructional task remains throughout to expound the meaning of the statutory text, not to divine unexpressed legislative intention or to remedy perceived legislative inattention. Construction is not speculation, and it is not repair.66. Context more often reveals statutory text to be capable of a range of potential meanings, some of which may be less immediately obvious or more awkward than others, but none of which is wholly ungrammatical or unnatural. The choice between alternative meanings then turns less on linguistic fit than on evaluation of the relative coherence of the alternatives with identified statutory objects or policies.
[ Emphasis added.]
Those remarks were subsequently endorsed by the High Court in
HFM043 v Republic of Nauru [2018] HCA 37 at [24] (see footnote [6] thereto).
57. While the Commissioner agrees TKYY retains the opportunity to object to the amended assessments in the 2008 and 2009 years, the arguments set out above suggest s 14ZV precludes the taxpayer now objecting to the amended assessments to claim interest deductions in the 2010 and 2011 years. The Commissioner points out the original assessments in the 2010 and 2011 years were not nil assessments. That means TKYY could have objected to those assessments on the ground he was entitled to claim the deductions. He did not do so within the requisite time. When amended assessments issued, he was limited to objecting to the particulars of the amendment - which means he could argue about the inclusion of the additional, previously unreported income, since that was the amended particular. The Commissioner's disinclination to take up the argument over the deductibility of interest did not figure in the amendment decision. The Commissioner says the amendment was related to the taxpayer's income, not the possibility of deductions.
58. As it happens, consistent with the approach I took in WLQC, I think the Commissioner's arguments over the interpretation of s 14ZV are correct. The fact the 2008 and 2009 assessments were nil assessments meant the right and occasion to object on the grounds that interest payments were deductible did not arise until the amended assessments issued. An unfettered right of objection only arose at that point. It follows TKYY can press its objection to the amended assessments in those years (and I can give leave to amend the grounds of objection under s 14ZKK(a) to the extent that is required) in relation to the deductibility of interest on loans in those two years of income.
59. The argument about s 14ZV results in a different outcome in respect of the assessments in the 2010 and 2011 years of income. Both the original assessments in those years disclosed positive amounts for both taxable income and tax payable. TKYY therefore had full rights of objection available at the time of the original assessments. The taxpayer did not object at the time in relation to the deductibility of interest
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payments. The claim with respect to deductions only surfaced during the audit process and following the issue of the amended assessments. Since the amended assessments were amended in relation to one particular - the amount of income - the taxpayer is (subject to what follows) precluded from introducing fresh grounds of objection in these proceedings. It makes no difference that the Commissioner was aware as the audit proceeded that the taxpayer might want to argue about deductions, and it does not matter that the Commissioner may have turned his mind to those arguments during the audit. There are strict rules on the objection process, and the taxpayer has not followed them.60. I acknowledge that might seem a hard outcome for the taxpayer. The taxpayer clearly has an argument he wants to make which he believes would make a substantial difference to the outcome. But the process is clear. The only hope for the taxpayer (at least in relation to the 2010 and 2011 years of income) turned on the possibility of the Commissioner revisiting the objection to the original assessment. As it happens, the parties stumbled towards that eventuality, which I shall explain below.
THE HISTORY (CONTINUED…)
61. The Tribunal as it was then constituted did not issue a formal ruling on the s 14ZV issue following the written submissions because TKYY and the Commissioner took stock and agreed on a different course after exchanging submissions. Their joint proposal for how to proceed was set out in a letter to the Tribunal from the Commissioner dated 23 July 2021. They agreed TKYY should lodge additional notices of objection to the original assessments in the 2010 and 2011 income years in an attempt to overcome the procedural obstacle that was thought to be embodied in s 14ZV. The letter noted (a) an extension of time would be required from the Commissioner and (b) the grounds of objection would be limited to the deductibility of interest under the loans. Those objections were duly lodged on 12 July 2021 with a request for an extension of time. That request was granted.
62. At a directions hearing before Thomas J and SM Hespe on 18 August 2021 which was convened to discuss the proposal, the Tribunal was told the parties expected the objection decision would be made by late September 2021. The parties acknowledged the Commissioner would, when making his decision, take account of evidence that was adduced at the hearing. Thomas J suggested that evidence might provide a more complete understanding of what transpired in the proceedings in relation to the other years of income. His Honour made clear that a good deal of further analysis might be required before the extant proceedings came before the Tribunal and suggested "the objection decision will be a fulsome document which takes into account what's happened, and ties it together as it were": transcript at 8. It was anticipated TKYY would then commence fresh proceedings in relation to that objection decision if he were dissatisfied with the outcome in the 2010 and 2011 years, and those proceedings would be joined to the present proceedings.
63. The parties engaged in relation to the objection. As part of that process, TKYY provided a report on 6 September that was prepared by Adesso Consulting. The report was said to address "the use to which funds from the Lenders were sought". The taxpayer said the report demonstrated the monies advanced by the various lenders were not used to meet private or domestic expenses. (That was potentially an important issue because s 8-1(2)(b) of ITAA97 says one may not deduct "a loss or outgoing of a private or domestic nature".) The Commissioner reviewed the report and asked for further information. A supplementary report by Adesso was provided on 30 September 2021. That report confirmed the earlier opinion.
64. The fact the 2010 and 2011 objections would be considered with reference to additional material in the form of the Adesso reports - and perhaps other documents - had the potential to place the Tribunal in a difficult position. At a case management directions' hearing on 19 October 2021, SM Hespe pointed out it would be unfortunate if the Tribunal were unable to consider the Adesso reports in relation to the other years of income if the reports might have wider application.
65.
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In those circumstances, it was agreed the Tribunal would remit the earlier objection decisions made on 23 November 2018 (which were already before the Tribunal) to the Commissioner pursuant to s 42D of the AAT Act for reconsideration alongside the notices of objection lodged in July 2021. That would enable the Commissioner to have regard to all the material on all the objections. The parties were afforded an opportunity to make submissions as to the form of the remittal orders.66. On 26 October 2021, the parties provided consent directions. The Tribunal issued directions in the agreed form under s 42D as follows on 2 November 2021:
- 1. Remits to the respondent, to the extent it is able , each of the objection decisions of respondent, dated 23 November 2018 which are the subject of these proceedings, for reconsideration by the respondent, pursuant to s 42D of the Administrative Appeals Tribunal Act (Cth) (AAT Act).
- 2. Directs, pursuant to s 42D(5)(a) of the AAT Act, that the period within which the respondent must reconsider each of the objection decisions made by the respondent dated 23 November 2018 is the period ending on 3 December 2022.
[ Emphasis added]
The period in direction [2] was subsequently extended to 21 December 2021.
67. The qualification emphasised in direction [1] was apparently thought necessary because the question of jurisdiction arising out of the operation of s 14ZV of the Administration Act remained unresolved at that point. I shall return to that question below.
68. On 20 December 2021, the Commissioner issued a new objection decision that dealt with both the original objection decisions that had been remitted and the notices of objection lodged in July 2021. TKYY remained dissatisfied with the outcome of the (now consolidated) objection decision so the extant proceedings resumed and a fresh application for review was filed in respect of the 2010 and 2011 years of income. Both sets of proceedings came on for a directions' hearing on 15 February 2022. By that point, the Tribunal had been reconstituted after:
- • Thomas J had retired as President of the Tribunal. (His Honour remained a judge of the Federal Court but he no longer held a commission to sit in the Tribunal so he technically ceased to be a member and became unavailable within the meaning of s 19D of the AAT Act); and
- • I rejoined the panel after the potential conflict which prompted my earlier recusal had resolved. (The potential conflict and its resolution was explained to counsel for both parties following the directions hearing, and both agreed it was not an obstacle to me hearing the matter.)
69. SM Hespe remained on the panel at that point. We made directions to join both matters together into the one set of proceedings. We directed both parties to file brief supplementary submissions that would deal with the matter as a whole.
70. TKYY filed its short written supplementary submissions on 31 March 2022. The Commissioner filed reply submissions on 5 May 2022, with TKYY filing a response to those submissions on 27 May 2022.
71. The Tribunal was reconstituted again after SM Hespe was elevated to the Federal Court. I am now required to decide the case. It has been necessary for me to revisit all the evidence. I had the opportunity to observe TKYY and the other witness in the box at the hearing in February and April 2021, and I also have access to the transcripts which have been supplemented by the audio recordings. It has also been necessary to review the submissions and track the procedural twists and turns that occurred in the wake of the hearing in 2021 in the interregnum while I was absent from the panel. I have also had regard to the fresh objection decision and the submissions.
FRAMING THE DISPUTE
72. I have already explained there is no dispute as between the parties that TKYY should be assessed on his personal services' income in the relevant years. The real issue is whether he can claim deductions in respect of interest incurred (but mostly not paid) in each of those years on the funds advanced by lenders.
73.
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That being so, I should pause to say a word about the loans and the lenders. TKYY originally called a number of the lenders to give evidence at the hearing but only one appeared and was cross-examined. I had the opportunity to observe that witness in the box. He gave a straight-forward account of his dealings with TKYY (and with Ms KK, whom he met on several occasions) which I have no reason to doubt. Interestingly, he made clear the advances he made to the applicant were not specifically referrable to the casino junket business. The witness recalled the first advance was made because TKYY was seeking money in connection with a property venture of some kind: transcript at pp 173-174. The witness said he was not aware the money he advanced on that occasion made its way into Ms KK's account. He said a second advance was made in connection with another property transaction: transcript at p 175. He said his recollection of the precise details of the circumstances of the advances was hazy although he pointed out the arrangement "was all a bit loose" which I took to be a comment on the way TKYY tended to do business: transcript at p 176. The witness agreed he did receive some "ad hoc" payments from TKYY which may have been interest or a partial repayment (transcript p 176) before the loan was finally repaid out of a property settlement.74. The loan documentation prepared for other lenders was included in the hearing book. The first of those appears at pp 247ff of the first volume. It records TKYY and Ms KK as borrowers. The 'purpose' clause (at [3]) says simply: "The Borrowers shall apply the proceeds of all Loans for business and investment purposes." There is no mention of a casino junket business. The second loan document at pp 267ff, the third loan document at pp 287ff, the fourth loan document at pp 307ff, the fifth loan document at pp 327ff, the sixth loan document at pp 347ff and the seventh loan document at pp 366ff are all in similar terms. There is a mortgage document dated 14 May 2007 (at pp 386ff) which is intended to secure advances that had already been made by some of the outstanding lenders who may have become nervous about their exposure. That document does not describe the purpose of the underlying loans in any detail.
75. I have no difficulty accepting the loans were all advanced on the strength of an understanding that the advances were for use in connection with a commercial purpose, even if that purpose was not specified in the formal documentation, and that relatively high rates of interest would be paid on the loans. There is no reason to doubt the loans were made as alleged, nor is there any doubt the lenders were motivated by anything other than a desire to obtain a return. I acknowledge there may be an issue over the extent to which the interest remained due and payable on some of the loans in some of the later years of income, but - for reasons that will become apparent - I do not think I need to resolve that issue.
76. I shall focus instead on the question of deductibility which is before me. It is possible to answer the question in two ways. First, when I consider the taxpayer's case at what I take to be its highest; and second, having regard to more detailed facts which suggest the taxpayer cannot succeed in any event.
Can a taxpayer who borrows money for use in an income-producing venture conducted by someone else seek deductions in respect of interest where the venture in question never came into existence because of fraud?
77. TKYY acknowledges he was not managing or carrying on a casino junket business at any time, but he genuinely believed Ms KK was doing so when he borrowed the money from his associates that he provided to her in connection with the venture. Those loan agreements were struck before he learned the truth (ie, that Ms KK was not carrying on a casino junket business) in 2008. In his supplementary submissions dated 31 March 2022, he explained (at [35]):
The Applicant's case has never been that he was carrying on a casino junket business. His case is that he was providing borrowed money [ie, money that he had borrowed from others] for [Ms KK] to employ in a profit motivated venture under which [Ms KK] he believed had established commission arrangements with the casino which would be sufficient to generate both the necessary money to meet the Applicant's interest obligations to the various lenders and also a
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surplus which would be assessable income shared by the Applicant with [Ms KK].
78. TKYY's description of the way in which he understood Ms KK was conducting the casino junket business invites consideration of whether they were members of a partnership. TKYY expressly rejected the suggestion that he provided the funds to Ms KK by way of loan, and he expected they would split the profits from the venture between them. While the terms of their relationship was not described in any formal agreement, it sounds like a "relation which exists between persons carrying on a business in common with a view of profit". If so, the relationship prior to 2008 might satisfy the definition of a partnership at general law and in the Partnership Act 1892 (NSW). But that is not how the case was conducted before the Tribunal, not least because there was no business.
79. There is also no basis for concluding TKYY was carrying on a money-lending business which involved obtaining funds from lenders and advancing them by way of loan to Ms. KK in expectation of a return. His evidence about the provision of funds to Ms KK is inconsistent with there being a debtor-creditor relationship between them - and Ms KK was a joint borrower on a number of the loans in any event. TKYY said ABC and its predecessor had conducted a short term 'payday' lending business between 2004-2008 which was managed by Ms KK, but there is no suggestion that such a business had any connection to the monies raised under loan which are said to give rise to the deductions in question here. In his supplementary submissions, counsel for TKYY described the discussion of a money-lending business in the consolidated objection decision dated 20 December 2021 as a 'red herring'.
80. In the circumstances, TKYY cannot argue the interest on the loans was "necessarily incurred in carrying on a business for the purpose of gaining or producing [his] assessable income". There was never a casino junket business (or a money lending business apart from the payday lending activities) in existence, and TKYY never claimed to be conducting such a business in any event. It follows he cannot succeed under the second limb of s 8-1 of ITAA97. But can he satisfy the first limb by arguing the interest payable on the loans is a "loss or outgoing…incurred in gaining or producing [his] assessable income"?
Was the loss or outgoing incurred each year even though interest was only paid in the 2008 year of income?
81. TKYY says it does not matter that the interest on the loans was never actually paid after 2008. He argued the obligation to pay remained, and the existence in later years of a presently existing obligation to pay meant he had incurred the loss or outgoing during each of those years in the relevant sense: see
Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 at 506 per Dixon CJ, Webb, Fullagar, Kitto and Taylor JJ.
82. The Commissioner emphasised in his written closing submissions that interest was only incurred in a particular year if there was a presently existing obligation to pay the money in that year notwithstanding that it has not actually been paid. If the lender does not press for payment, or the liability to pay is contingent, or the debt has been forgiven or abandoned, the outgoing is not incurred. The taxpayer will only incur the outgoing in the relevant sense when he is "definitively committed in the year of income" to the obligation and has "completely subjected himself to them": see Sandbach and Commissioner of Taxation
[2015] AATA 1024 at [98] where DP Alpins summarised the leading authorities including James Flood.
83. The Commissioner queried whether, on the evidence, at least some of the debts might have been forgiven or abandoned - or whether they had become unrecoverable as a result of the operation of the Limitation Act 1969 (NSW). As will become apparent, I do not need to reach a concluded view on that issue in light of the other findings I make below. For present purposes, however, I will accept the outgoings were incurred each year.
Assuming the loss or outgoing was incurred in the relevant sense, was it "incurred…in gaining or producing assessable income"?
84. In written closing submissions, TKYY referred to
Fletcher v Federal Commissioner of Taxation [1991] HCA 42;
(1991) 173 CLR 1 to argue that determining the deductibility of a loss or outgoing involved a characterisation
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process. In Fletcher, the Court explained (at [23]):The question whether an outgoing was, for the purposes of s.51(1), wholly or partly "incurred in gaining or producing the assessable income" is a question of characterization. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. It has been pointed out on many occasions in the cases that an outgoing will not properly be characterized as having been incurred in gaining or producing assessable income unless it was "incidental and relevant to that end"…
85. TKYY went on to argue the taxpayer's intention in incurring the loss or outgoing was helpful evidence in the characterisation process - particularly where the loss or outgoing has not resulted in the generation of any assessable income. He pointed to the reasoning in Fletcher, where the Court said (at [24]-[25]):
- 24. …it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of s.51(1) without any need to refer to the taxpayer's subjective thought processes. That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income. In such a case, the characterization of the particular outgoing as wholly of a kind referred to in s.51(1) will ordinarily not be affected by considerations of the taxpayer's subjective motivation. If, for example, a particular item of assessable income can be earned by making a lesser outgoing in one of two possible ways, one of which is a loss or outgoing of the kind described in s.51(1) and the other of which is not, it will ordinarily be irrelevant that the taxpayer's choice of the method which was tax deductible was motivated by taxation considerations or that the non-deductible outgoing would have been less than the deductible one. In such a case, the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterize the whole outgoing as one which was incurred in gaining or producing assessable income. …
- 25. The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. See, e.g., Robert G. Nall Ltd v. Federal Commissioner of Taxation
[1936] HCA 79;
(1937) 57 CLR 695, at pp 699-700, 706, 708-709, 712-713. Where that is so, it is a "commonsense" or "practical" weighing of all the factors which must provide the ultimate answer. See, e.g., B.P. Australia Ltd v. Commissioner of Taxation of the Commonwealth of Australia
(1966) AC 224, at p 264; Hallstroms Pty Ltd v. Federal Commissioner of Taxation
[1946] HCA 34;
(1946) 72 CLR 634, at p 648; Federal Commissioner of Taxation v. Foxwood (Tolga) Pty Ltd
[1928] HCA 48;
(1981) 147 CLR 278, at pp 285, 293. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s.51(1) unless it is either somehow excluded by the exception of "outgoings of capital, or of a capital, private or domestic nature" or "incurred in relation to the gaining or production of exempt income". If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected
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production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.
86. The taxpayer in this case says (a) objective and subjective purpose in obtaining the loans and providing them to Ms KK is important to the characterisation process given the absence of assessable income, and (b) the nexus between loss or outgoings and (the intended generation of) assessable income is evident in the purpose of the loans advanced by the lenders and TKYY's obvious purpose in providing the monies to Ms KK. It should be said there is some doubt about the precise purpose of the lenders: the witness TKYY called to give evidence at the hearing did not appear to appreciate the monies he loaned were intended to be applied to a casino junket business, particularly one in which Ms KK played a pivotal role. The loan documentation from the other lenders also refers to business and investment purposes rather than a casino junket business in particular. But no matter what business the lenders thought they were getting into, TKYY says there is no reason to doubt on the evidence that his purpose in contracting the loans was to apply those advances towards the casino junket business that Ms KK was conducting. He says he believed that business was already in existence and operating profitably when he contracted the loans, and he notes the written loan agreements all referred to a commercial purpose. TKYY says there is no reason to assume the lenders were advancing the funds for anything other than a commercial purpose, even if the precise details of that purpose are unclear. That much was apparent from the documentation, the identity of the lenders, and the relatively high rates of interest which reflect the risky, unsecured nature of the venture. TKYY had already started to achieve a return by 2008 (although, it should be pointed out, the 'return' was actually Ms KK recycling funds that had been advanced to her, Ponzi-style). As TKYY's written supplementary submissions explained (at [50]):
The purpose of the borrowing and the application of the money by making it available to [Ms KK] on an agreed basis to utilise only in the way described [in the loan agreement] coupled with her provision to the Applicant of the documentary evidence of the use of the money in that way and her payment to the Applicant of what he clearly regarded as the fruits of the venture over an extended period provides the necessary nexus in this case.
87. In his written closing submissions, the Commissioner referred to the Full Federal Court's decision in
Spassked v Commissioner of Taxation (2003) 136 FCR 441; [2003] FCAFC 282 which discussed the relevance of objective or purpose (and subjective purpose in particular) to the characterisation process. Hill and Lander JJ explained (at [65]):
65. Ordinarily interest on money borrowed to secure capital or working capital will be deductible:
Texas Co (Australasia) Ltd v Commissioner of Taxation [1940] HCA 9;
(1940) 63 CLR 382 at 468,
Federal Commissioner of Taxation v Munro [1926] HCA 58;
(1926) 38 CLR 153 at 171, 197, 217-218;
Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 43 FLR 217,
Riverside Road (supra) and Steele v Deputy Commissioner of Taxation [1999] HCA 7;
(1999) 197 CLR 459. As was pointed out in
Hart v Federal Commissioner of Taxation [2001] FCA 1547;
(2002) 189 ALR 584 two tests may be applied when determining whether interest on a borrowing is deductible. One is to look at the use to which the borrowed funds are put. The other is to look at the purpose of the borrowing. However, normally, the purpose of the borrowing will be determined by reference to the use to which the borrowed funds are put, so that it will ordinarily be unnecessary to choose between the two tests.
88. After reviewing the authorities, Hill and Lander JJ observed it would ordinarily be unnecessary to enquire into a taxpayer's purpose or motivation to characterise the outgoing if the ultimate destination of the outgoing speaks for itself - as it might where, for example, the taxpayer acquires dividend-producing shares using monies he has borrowed: at [76]. But it was possible subjective intention was relevant in some cases. Hill and Lander JJ concluded (at [75]) the case
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before them was one where such an enquiry might be useful, not least because there was no assessable income generated. They explained:…the question of the subjective purpose of the directors will be relevant in the present case as part of the process of characterisation involved in answering whether the interest incurred by the taxpayer was incurred in gaining or producing assessable income. For that purpose, it will be relevant to consider the direct and indirect objects and advantages which the taxpayer had in mind in borrowing and thereby incurring interest in the relevant years of income. This is particularly so where one sees that in year after year (except for the two years in which dividends were declared to Spassked) the shares which Spassked acquired received no assessable income at all.
89. The Commissioner says it makes no difference in this case whether the taxpayer's subjective purpose in borrowing the funds was to use them (and thus incur the interest) "in gaining or producing assessable income". In this case, there could be no nexus between the expenditure and the earning of assessable income in circumstances where there was no money-making opportunity, just a fraud. In his objection decision, the Commissioner referred to
James Outram Anderson v Commissioner of Taxation [1989] FCA 379. In that case, the taxpayer invested in a 'film partnership' as part of a tax scheme. In return for a small investment, the taxpayer received a token amount of income and became entitled to a share in a large loss sustained by the partnership. Wilcox J concluded the real purpose of the investment was not to make money out of film production. The taxpayer conceded in his evidence that he knew little about the process and acknowledged that making films was "an extremely iffy business": at [41]. His Honour found "the whole of the expenditure incurred by the applicant as a member of [the partnership] was incurred for the purpose of earning a taxation deduction": at [44]. In other words, the investment was never about deriving assessable income. It was about obtaining a tax advantage.
90. While there must be some doubt over the wisdom of investing money in a business one does not understand, I will assume for present purposes that (a) casino junket businesses do exist and apparently generate profits for their promoters; and (b) the taxpayer in this case genuinely believed he was investing in a money-making venture, and that he convinced friends and associates to provide him with additional funds to that end. There is no suggestion the taxpayer had a different or collateral objective like the investor in James Outram. But the Commissioner suggested the observations of Wilcox J on the significance of purpose when establishing a nexus point to an obstacle for the taxpayer in any event. After reviewing the authorities, his Honour explained (at [48]):
…in doubtful cases of voluntary expenditure purpose may be relevant, even decisive, in determining whether there is the necessary nexus between a particular outgoing and the gaining or producing of assessable income. In other cases the position will be so clear that purpose is of no consequence. Thus, if particular expenditure was clearly incurred in the gaining or producing of assessable income, it is deductible notwithstanding that the money may have been spent with some other purpose in mind. Conversely, if there was no actual nexus between the expenditure and the gaining or producing of assessable income, a purpose of gaining or producing assessable income will not suffice. In the vast majority of cases, no doubt, purpose and actuality will coincide.
91. The observations of Wilcox J in James Outram suggest it does not matter if TKYY genuinely believed he was providing money to Ms KK in anticipation of gaining or producing assessable income if there were no agreements in place with the casinos or the gamblers. In the absence of those agreements, there was no income-producing structure,[2]
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apart from Ms KK herself, perhaps: transcript at p 154. I am satisfied TKYY cannot be said to be incurring outgoings "in gaining or producing assessable income" when there is no possibility of that occurring, whatever he might have intended. In truth, TKYY (unwittingly) incurred outgoings in furthering Ms KK's gambling habit.92. TKYY relied on the Tribunal's decision in Willersdorf-Greene and Commissioner of Taxation
[2009] AATA 649 to argue the fraud did not disrupt the nexus between the outgoings and the gaining or producing of assessable income. In Willersdorf-Greene, the taxpayer convinced an investor to sink money into a scheme promoted by the taxpayer's friends. The scheme involved the import and distribution of fuel. The taxpayer gave a guarantee to the investor and security over his home - only to later discover the scheme was fraudulent. The taxpayer took out a loan to pay off the investor under the terms of the guarantee. He sought to deduct interest and bank expenses associated with that loan. DP Forgie found the taxpayer did have an active arrangement with the promoters of the scheme which he expected would yield assessable income in the form of a commission over the life of the arrangement that was separately struck between the promoters and the investor.
93. The existence of an active arrangement that had been negotiated between the taxpayer and the promoter is an important and relevant difference between Willersdorf-Greene and what has transpired in this case. In Willersdorf-Greene, there was a profit-making structure in place between the taxpayer and the promoter who ultimately committed the fraud. In this case, that structure was not clearly established, so there never was a nexus. (I note the Commissioner invited me to draw an adverse inference against TKYY given his failure to call Ms KK as a witness, but I am not sure what calling her would have established. One assumes she would have invoked the privilege against self-incrimination. In the circumstances, I am not inclined to draw an adverse inference - but that does not change the fact it is unclear there was a profit-making structure established which could provide a nexus as required.)
FURTHER REASONS FOR CONCLUDING THE OUTGOINGS IN RESPECT OF INTEREST WERE NOT DEDUCTIBLE
94. Section 8-1(2) excludes a taxpayer from deducting a loss or outgoing to the extent that:
- (a) it is a loss or outgoing of capital, or of a capital nature; or
- (b) it is a loss or outgoing of a private or domestic nature; or
- (c) it is incurred in relation to gaining or producing your * exempt income or your * non-assessable non-exempt income; or
- (d) a provision of this Act prevents you from deducting it.
95. The Commissioner argues the evidence discloses instances where TKYY applied some of the loaned funds to meet personal or domestic expenses. To the extent that was so, the interest cannot be deducted.
96. I have already explained how some of the funds advanced by the lenders were deposited in the ABC account before being provided to Ms KK. Some of the funds were deposited by the lenders into other accounts maintained by TKYY, and some amounts were paid in cash or paid to Ms KK direct. This haphazard approach to the handling of the loan funds was part of a broader pattern. TKYY was unable to produce, and apparently did not maintain, reliable and intelligible records of his extensive financial transactions.
97. The Commissioner's closing submissions included examples where amounts apparently sourced from the borrowed funds were paid into an account and subsequently used to pay what are obviously personal expenses. The submissions referred in particular (at [111]-[115]) to a record of deposits from lenders into the ABC bank account on 13 March 2007 in the amount of $600,000. The following day, $100,000 was transferred from that account to an account operated by another of TKYY's companies. The bank statement for that account is found at pp 2897-2899 of the hearing book. The statement records payments from that account to:
- • David Jones, the department store;
- • TKYY's personal American Express;
- • Various phone and internet bills;
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- • Levies on properties;
- • local councils;
- • the Sydney Cricket Ground Trust; and
- • TKYY's NRMA membership.
There were also payments made to TKYYs family trust companies.
98. TKYY was asked about these payments and the destination of funds in that account more generally in cross-examination. In the following exchange (transcript at p 152), TKYY was generally dismissive of what might be regarded, at a minimum, as a leakage of borrowed funds:
Mr White: It's - those remaining moneys unaccounted for could have been allocated to your personal expenses. Correct?
TKYY: Nothing significate [sic]. Nothing significant. Minor. Yes, I accept there's some minor expenses but not anything significant. And when I mean significant, you know, I would be thinking less than $10,000.
99. When similar questions were raised later in the cross-examination in relation to what appeared to be personal expenses referred to in accounts holding loan monies, he repeated (transcript at p 155) his view that "these are small amounts of money. I mean, you know, some of the money in that calculation has gone to pay some minor bills". To similar dismissive effect, the following exchange ensued (transcript at p 158):
Mr White: In any event, there are a large number of entries, would you agree, in relation to this account which appear to be referral [sic] to your personal expenses?
TKYY: Not major. I didn't use any of that money in a significant way to cover personal costs or take any money.
100. TKYY's dismissive tone to one side, I accept he faces a challenge in trying to reconstruct and recollect transactions that occurred on his various accounts many years ago. The challenge is all the more onerous because of the complexity of his financial affairs and the inadequacy of his record-keeping. TKYY acknowledged in cross-examination that "there's money going everywhere" when questioned about transactions: transcript at p 154.
101. It turns out some of the money being deposited by lenders was also being used to repay other lenders. The Commissioner's closing submissions refer (at [117]) to a specific example where money was obtained from one lender on 30 November 2005 and payments were made from that account to, amongst others, another lender (in circumstances where the low opening balance prior to the deposit of loan monies and the low balance after the payment out were roughly the same - indicating the loan monies which had been deposited were the source of the funds for the repayment). The Commissioner refers to another example at [118] where loan monies were deposited into an account and payments were made from the account shortly after to another lender. When Mr White SC, for the Commissioner, asked TKYY about these transactions in cross-examination, the following exchange ensued (transcript at p 157):
Mr White: That money could only have been sourced from the moneys that were deposited from [one of the lenders] of $450,000 on 21 February?
TKYY: Most likely.
Mr White: Do you agree with that proposition?
TKYY: I would think that that's what happened, yes.
Mr White: You're using, to your knowledge, moneys that have been deposited by one lender to pay interest to another lender?
TKYY: I wasn't doing that as any intentional matter because in my mind, you know, there was millions with the casino.
Mr White: Doesn't that sound - - -?
TKYY: It was only ever a timing difference between the commissions coming back to pay it - you know, equalise it essentially.
Mr White: I see?
TKYY: There was always - you know, at any point in time there's a difference between when the interest is due to someone and when the commission is actually received. So that resulted in often there being a slight delay in when people were paid interest.
Mr White: Yes?
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TKYY: So sometimes you might have used that money to pay the other interest and then when the commission income was received that replenished that transaction.
102. When pressed for an explanation about the web of transactions in the cross-examination, the following exchange (transcript at p 160) ensued which speaks eloquently to the fluid nature of TKYY's financial affairs:
Mr White: What was that for?
TKYY: I don't recall but as I say I was moving money around and generally putting it into, you know, a hole if you like where it was best utilised for the time between that time and when it was needed in the operation. So for example, a lot of the rental properties they had loans on them and where money wasn't required in the casino at that time, I would move the money across to - what do they call those offset accounts - into one of the rental property loans so as to reduce interest for, you know, a week or however many number of days it was, essentially for a short term basis until that money was required and then redraw it out of those redraw accounts. So instead of just sitting here in business loans I would apply it against the rental property loan.
103. I have already decided that interest referable to the loans was not deductible because TKYY cannot satisfy either limb of s 8-1(1). If I were wrong about that, the effect of s 8-1(2) is that the outgoings could only be claimed to the extent the loans were not applied to ends of a private or domestic nature. The evidence I have referred to above makes clear that some of the money advanced by the lenders was used to fund expenses of a private or domestic nature in at least some of the years of income in question, if not all of them. The problem for the taxpayer is that the state of the records makes it difficult to be satisfied what money went where. Without more, TKYY would be unable to discharge his onus.
104. TKYY took advantage of the hiatus in the case to commission a report from an expert accountant, Mr Stephen Economides, the principal of Adesso Consulting Pty Ltd. Mr Economides is a chartered accountant and a former partner in a major accounting firm. He had previously advised TKYY in relation to his affairs over a number of years. Mr Economides was provided with the evidence and submissions in these proceedings. He was asked to analyse the transactions in the bank accounts. In his first report dated 6 September 2021, he concluded the money which had been borrowed by TKYY from seven identified lenders was not used to meet TKYY's private expenditure. The report was accompanied by an excel spreadsheet. A supplementary report dated 30 September 2021 was provided after the Commissioner asked for extra information. The reports were considered in the consolidated objection decision. In supplementary written submissions, TKYY said (at [55]):
The Adesso reports provide a convincing analysis on which the tribunal can safely act in determining the borrowed moneys were not used to pay non-deductible private or domestic expenses.
105. The Commissioner points out the Adesso report acknowledges (at [5.1]) TKYY spent $789,023 from the ABC account over the period of examination on private or domestic expenses and at least $155,897 of that amount can be traced back to loaned funds. The Commissioner called into question whether the report was sufficiently rigorous in its tracing. He suggests it would be unsafe for me to rely on it.
106. The Commissioner criticised some of the assumptions made in the Adesso report, most obviously the assumption that only Ms KK was responsible for the cash withdrawals debited against the main ABC account. TKYY's written submission says that assumption was soundly based on the evidence of TKYY who said he did not make any of the cash withdrawals. The Commissioner points out in his supplementary submissions in reply that TKYY's evidence does not go that far.
107. There are other difficulties with the Adesso reports. They focus on the transactions in the ABC account but the evidence establishes loan funds were paid into that account and several others, and to Ms KK, and to the Star casino. There is a real risk that the tracing exercise - such as it is - is too narrow. Moreover, the conclusion that there were sufficient credits in the ABC account to meet the personal expenses identified without having
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to call on loaned funds does not take account of the timing issues: even if that were true in net terms over an extended period, the Commissioner points out there were occasions (examples 5, 6 and 7 in the consolidated objection decision) where personal expenses were certainly met out of loan funds.108. TKYY relies on the Adesso reports to argue there was only a small amount of personal expenditure, and he is able to put a precise dollar value on that amount. I am not persuaded, even so. The Commissioner's criticisms of the Adesso report are well-founded. TKYY's affairs are difficult to reconstruct with confidence precisely because the records are poor, and because (as the witness who gave evidence about TKYY's behaviour demonstrates) TKYY's business processes were haphazard and unfocused.
109. TKYY must establish the outgoings he seeks to claim as deductions were not of a private or domestic nature. He has argued the bulk of the outgoing (less $155,897, or at most $789,023) were clearly business-related rather than personal. I am not satisfied he has discharged his onus.
A FINDING OF FRAUD OR EVASION
110. The Commissioner says he is permitted to ignore the time limits in s 170(1) that would otherwise prevent him from revisiting the assessments issued in respect of the 2008-2011 years because he made a finding of evasion in respect of each of those years. That finding was set out in the audit report (document T27).
111. Given the findings I have made, it is clear TKYY had significant shortfalls in the years in question. But the existence of a shortfall does not inevitably lead to a finding of fraud or evasion. A measure of culpability is required. As Dixon J explained in
Denver Chemical Manufacturing Co v Commissioner of Taxation [1949] HCA 25;
(1949) 79 CLR 296 at [19]:
I think it is unwise to attempt to define the word "evasion." The context of s. 210 (2) shows that it means more than avoid and also more than a mere withholding of information or the mere furnishing of misleading information. It is probably safe to say that some blameworthy act or omission on the part of the taxpayer or those for whom he is responsible is contemplated. An intention to withhold information lest the commissioner should consider the taxpayer liable to a greater extent than the taxpayer is prepared to concede, is conduct which if the result is to avoid tax would justify finding evasion.
112. A taxpayer bears the onus of establishing that a finding of fraud or evasion was not properly made:
Binetter v Commissioner of Taxation [2016] FCAFC 163 per Perram and Davis JJ at [93].
113. There is now no doubt that TKYY withheld information from the Commissioner in the relevant years. He failed to report the fee income that was generated in connection with his consulting to a family company. As I understand it, his explanation for that failure lay in his understanding that the income would ultimately be recorded in the returns of the family trust - but he was a trustee of that trust and it did not file returns in respect of those years. He suggested in cross-examination that there was a distribution to another family trust (which he also controlled) and the personal services income that had been received was returned by the trustee of that trust when it went into liquidation in 2014.
114. In the consolidated objection decision, the Commissioner suggested the steps taken by TKYY in relation to his tax affairs in the 2008-2011 years of income "showed a degree of artifice": at [179]. The circumstances of the withholding of information certainly invite suspicion. I am conscious TKYY was a qualified lawyer and a chartered accountant who had been a partner in a large accounting firm for 18 years at the relevant time. While I have already observed he appeared to conduct his business affairs 'by the seat of his pants', there is no reason to suppose he did not know what he was doing at the time he filed his returns. He must have appreciated a tax advantage would result if he failed to disclose his personal services income given the business structures he used. And there certainly was an advantage for him: the consolidated objection decision records TKYY enjoying the use of large amounts of money that were the product of his personal services income that he must have known were going untaxed.
115.
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There was some evidence led about interactions between Mr Economides, who represented TKYY around the time of the audit, and officers of the Commissioner. TKYY was critical of the conduct of one officer in particular, but it is difficult to see how anything the officer may have said or done in those negotiations could impact on the formation of an opinion as to evasion in the relevant years of income. I note Mr Economides was not called to give evidence so he might put meat on the bones of that submission in any event.116. I am satisfied TKYY's non-disclosure was blameworthy as opposed to being a fortuitous consequence of his idiosyncratic approach to his finances. In those circumstances, he has failed to persuade me the evasion opinion should not have been formed.
CONCLUSION ON PENALTIES
117. Having affirmed the objection decision which identified a substantial tax shortfall in all the relevant years of income, it only remains for me to deal with the question of penalties.
118. TKYY's written closing submissions did not address the penalties issue other than to assert there should be no penalties if his claim for deductions succeeded - because that would eliminate the tax shortfall.
119. The Commissioner's closing submissions were of more assistance. He dealt firstly with the administrative penalties imposed in respect of the 2008 through 2011 years of income. The penalties were imposed under s 284-75(1) of Schedule one to the Administration Act on the basis that the taxpayer had made a statement to the Commissioner and "the statement [was] false or misleading in a material particular, whether because of things in it or omitted from it…" (the false or misleading component being the underreported income). He also concluded the shortfall resulted "from intentional disregard of a taxation law… by you or your agent" within the meaning of s 284-90(1) item 1. In those circumstances, the base penalty was equal to 75% of the shortfall amount.
120. TKYY did not identify a basis for taking a different view. Indeed, the evidence about his credentials and experience in a large national firm and his experience in business points to the fact he must have been aware of his obligations. He bears the onus of establishing he did not intentionally disregard the law; he has not discharged that onus.
121. The penalties imposed in the 2012-2014 years of income were assessed at 75% pursuant to s 284-75(3) on the basis that:
- • TKYY failed to supply a return as required;
- • The return was necessary for the Commissioner to determine TKYY's liability to tax; and
- • The Commissioner proceeded to make the assessment without the assistance of the document.
122. There does not appear to be any basis for disputing this finding. TKYY did not complete his returns for those years until April 2017, long after the audit was commenced. The assessments appear to have been made with reference to what was discovered in the audit rather than the returns.
123. That leaves the questions of uplift and remission. The Commissioner originally imposed the 20% uplift in the base penalty applicable to the 2009 through 2014 years of income pursuant to s 284-220, however he agreed to remit the uplift in respect of the 2012 year. The taxpayer did not identify any basis for not imposing the uplift or explain why the uplift or the base penalty should be remitted wholly or in part under s 298-20.
CONCLUSION
124. The objection decision must be affirmed.
Footnotes
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