QUEENSLAND MAINTENANCE SERVICES PTY LTD (IN LIQ) v FC of T

Members:
IR Molloy DP

Tribunal:
Administrative Appeals Tribunal, Brisbane

MEDIA NEUTRAL CITATION: [2018] AATA 4525

Decision date: 5 December 2018

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IR Molloy (Deputy President)

1. This is an application by Queensland Maintenance Services Pty Ltd (In Liquidation) ("QMS") to review the following objection decisions of the Respondent ("the Commissioner"):

• (a) an objection decision made on 4 December 2012 ("the 2007 Objection Decision") by which the Commissioner disallowed in full an objection by QMS to a notice of amended assessment and a notice of assessment of shortfall penalty for the year ended 30 June 2007 ("2007 income year"); and
• (b) an objection decision also made on 4 December 2012 ("the 2008 Objection Decision") by which the Commissioner disallowed in full an objection by QMS to a notice of amended assessment and a notice of assessment of shortfall penalty for the year ended 30 June 2008 ("2008 income year").

2. In respect of the 2007 income year, the Commissioner disallowed an amount of $35,362,027.00 in payment of "renovation compensation invoices" claimed by QMS to be an allowable deduction under s 8-1 of the Income Tax Assessment Act 1997 (Cth) ("ITAA 1997").

3. In respect of the 2008 income year, the Commissioner disallowed an amount of $13,357,523.00 claimed by QMS (as the head company of a consolidated group), as part of "management fee expenses" as an allowable deduction under s 8-1 of ITAA 1997.

2007 INCOME YEAR

Agreed facts

4. The parties have agreed the facts set out in paragraphs 5 to 22 below, for the purposes of this application, by a Statement of Agreed Facts (2007 income year) ("2007 SAF").^[1] Exhibit 3, Agreed Statement of Facts – 2007 Income Year.

5. QMS was incorporated on 28 May 2003.

6. At all material times, the sole director of QMS was Mr Frank Zullo ("Mr Zullo").

7. On 13 February 2008, QMS lodged its income tax return for the income year ended 30 June 2007 ("the 2007 Return"),^[2] Exhibit 1, T Documents, T3, pp 52-63. which recorded:

• (a) a total income of $139,016,185.00; and
• (b) a taxable income of $7,672,890.00.

8. In the 2007 Return, QMS claimed a deduction for renovation compensation expenses totalling $35,362,027.26.

9. On 1 June 2011, the Commissioner issued, inter alia:

• (a) a notice of amended assessment ("the 2007 assessment")^[3] Exhibit 1, T Documents, T10, pp 103-106. for the 2007 income year which assessed QMS to an additional tax liability in the amount of $13,623,600.45 (comprising assessed tax in the amount of $10,608,608.10 and a shortfall interest charge of $3,014,992.35); and
• (b) a notice of assessment of shortfall penalty for the 2007 income year ("the 2007 penalty assessment")^[4] Exhibit 1, T Documents, T11, 107-108. in the amount of $7,956,456.05 (being 75% of the primary tax).

10. On 2 December 2011, Harris Black Accountants lodged on behalf of QMS, inter alia:

• (a) a notice of objection against the 2007 assessment;^[5] Exhibit 1, T Documents, T14, pp 115-130. and
• (b) a notice of objection against the 2007 penalty assessment.^[6] Exhibit 1, T Documents, T15, pp 131-139.

11. By the 2007 Objection Decision, the Commissioner disallowed the objections in full.

12. During, relevantly, the 2007 income year, ABC Learning Centres Ltd ACN 079 736 664 and ABC Developmental Learning Centres Pty Ltd ACN 010 788 502) (collectively "ABC") engaged various licensees to operate childcare centres around Australia on behalf of ABC. Those licensees were referred to as "Regional Management Companies" ("RMCs").

13. From approximately 2003 to November 2008, QMS provided various services to ABC including cleaning, maintenance, pest control and fleet management in respect of childcare centres operated by RMCs on behalf of ABC.

14. During the 2007 income year, QMS also provided renovation, maintenance and repair work ("renovation work") in respect of the childcare centres operated by RMCs on behalf of ABC.

15. During the 2007 income year, 845 renovation compensation invoices ("the renovation compensation invoices") were issued by 376 RMCs to QMS.

16. The details of the renovation compensation invoices are set out in the spreadsheet annexed to the 2007 SAF and marked "Schedule A" ("Schedule A").

17. The total value of the renovation compensation invoices (after allowance for credit notes) was $35,362,027.26 (excluding GST).

18. Each of the renovation compensation invoices listed in Schedule A was issued to QMS by the RMC named in the respective invoice.

19. QMS performed renovation work, by itself or by subcontractors engaged by it:

• (a) at the childcare centres the subject of the renovation compensation invoices; and
• (b) during the period identified in the respective renovation compensation invoices.

20. During the 2007 income year, QMS paid the amount of each of the renovation compensation invoices to the RMC that issued the corresponding renovation invoice.

21. Copies of renovation compensation invoices in respect of a sample of thirty (30) childcare centres are annexed to the agreed statement of facts and marked "Schedule B" ("Schedule B").

22. The Schedule B documents are to be treated, for the purposes of the application, as a representative sample of the renovation invoices.

Factual findings

23. From the late 1980s until about 2001 Edmund Groves acquired approximately forty childcare centres which were branded as ABC Learning Centres. In 2001 an ABC company was listed on the ASX.

24. ABC continued to expand and, in about 2003, Mr Groves approached Mr Zullo, then his brother-in-law, about starting a business to service ABC's general maintenance and essential services requirements.

25. In consequence, in 2003, Mr Zullo caused QMS to be established. To that time Mr Zullo had been a manager at a Brisbane motor vehicle dealership.

26. Commencing in 2003, as mentioned, QMS performed or engaged subcontractors to provide a range of services in relation to ABC Learning Centres including general maintenance, fleet management, plumbing and electrical work.

27. From approximately January 2004, QMS had a head office in Fortitude Valley, Brisbane. By late 2006 it employed more than thirty persons in its office alone.

28. On occasions childcare centres were disrupted by the renovation work being carried out. Sometimes this meant temporary closure of the centre. On some occasions it meant fewer children were able to attend whilst the work was underway.

29. Between 2003 and 2007 QMS was directed by ABC to perform renovation work to a significant number of childcare centres acquired by ABC. The renovation work was not the subject of a written agreement.

30. The purpose of the renovations varied but generally it was to ensure a childcare centre conformed to ABC's internal branding and standards, and met childcare safety and regulatory standards.

31. The extent of the renovations varied from minor to extensive. In general the renovations involved outdoor work, for example to playgrounds, or internal work such as internal painting or laying of floor coverings.

32. The work was commonly the subject of directions given at weekly management meetings at ABC's offices in Murrarie, Brisbane.

33. QMS was not given exclusivity in respect of the renovations required by ABC, but it did carry out the vast majority of the work. Between 1 January 2003 and 31 December 2007, QMS completed 1,102 renovations at ABC childcare centres.

34. The renovation compensation invoices were entered into MYOB software of QMS commencing on 22 December 2006. The last of the invoices for the 2007 year was entered on 29 June 2007.

35. On 3 January 2012, Peter Anthony Lucas and Glenn Michael Shannon were appointed as administrators to QMS.

36. On 18 December 2012, by order of the Federal Court, Mr Lucas and Mr Shannon were appointed joint and several liquidators of QMS in a winding-up. Mr Shannon resigned from his appointment as liquidator of QMS on 22 March 2017.

Absence of documentation

37. There no documentary evidence of any concluded agreement pursuant to which QMS was obliged to pay the renovation compensation invoices, for example, for delays and disruptions caused by renovation work.

38. The lack of such documentation for the payment of renovation compensation charges for the 2007 income year was confirmed by ABC auditors in February 2008.

39. There are no contemporaneous documents, contractual or otherwise, recording the basis upon which QMS was expected to pay the renovation compensation charges.

40. There is an absence of contemporary documentary evidence revealing any formula used to arrive at the amounts contained in the invoices. Who issued the invoices or calculated the amounts remains unclear.

41. Despite the liquidator having access to the QMS's business records, nowhere is there an internal QMS email, meeting note, diary note or memorandum that considers the occasion for the imposition of a renovation compensation charge or the basis for its calculation.

42. QMS has not produced any evidence of having had any system for the recording of agreed timeframes for renovations, or delays, or the levels of disruption said to have been caused by the renovations.

43. QMS has not produced any or sufficient documentary evidence concerning any query, check, or consideration of the renovation compensation invoices prior to payment.

Basis of the charges

44. The basis upon which the invoices were issued and the calculation of the amounts remains unclear.

45. Mr Zullo was the controlling mind of QMS at the time. He was QMS's principal witness.

46. According to a record of interview with officers of the Respondent on 20 April 2010, Mr Zullo said that compensation fees were normal practice in the construction industry and QMS had been expecting them to be levied for some years. He considered the charges were referable to the past three years of construction works that QMS had undertaken, and that ABC had forgotten to charge.^[7] Exhibit 2, Supplementary T Documents Volumes I, II and II) (“ST”), ST4 p 346.

47. Before the Tribunal, Mr Zullo's evidence was that he did not know the true basis for the charges. He does not recall speaking with Mr Groves or anyone from ABC about the basis for the charges. It also appears that Mr Zullo did not query the charges.^[8] Exhibit 5, First Statement of Mr Frank Zullo dated 18 December 2017 (“Zullo 2017”), [108].

48. Mr Zullo related the charges in general to losses sustained by reason of disruptions or delays in the renovation work. His evidence was that it was impractical for ABC to calculate the direct loss from disruption or delays, but instead made "arrangements based on averages given the size of their operations."^[9] Exhibit 5, Zullo 2017, [112].

49. I am not satisfied with Mr Zullo's evidence to the effect that he relied on the advice of QMS's accountants or employees to review the renovation compensation charges. There is no other or sufficient evidence that anyone checked the invoices. The formula, if any, for calculating the charges is not recorded. It is not apparent how anyone could have checked or verified the charges.

50. Mr Zullo said he expected that if QMS refused to make the renovation compensation payments, ABC would engage a competitor or competitors to perform the work. According to Mr Zullo he was particularly careful to do everything possible to ensure QMS continued to receive renovation work from ABC.

51. Mr Zullo considered that QMS was in a "take it or leave it" position and he considered that the renovation compensation ought to be paid by QMS (which it did). Mr Groves and ABC had significant bargaining power over its key suppliers such that directions of this nature were usually complied with unless they were completely unviable.

52. From the perspective of QMS, Mr Zullo was content to cause QMS to comply with any reasonable arrangement ABC required as long as QMS was, overall, making a net profit. Mr Zullo understood that ABC did not specifically quantify the actual losses to its centres flowing from disruptions caused by renovation works or delays in completing renovations. Instead it calculated the renovation compensation invoices based on a formula applied to all renovations.

53. As there were so many renovations occurring - often as many as 25 per week during 2005 to 2007 - Mr Zullo understood that it was likely impractical for ABC to calculate the direct losses from disruptions or delays to each centre. In his experience it was normal for ABC to make arrangements based on averages given the size of their operations.

54. According to QMS's analysis of the dates and amounts of invoices issued post December 2006, invoices dated 25, 28 and 29 June 2007 were issued totalling $24,057,579.99 inclusive of GST (approximately 63% of the total claimed).^[10] Exhibit 2, ST12, p 690, [63]. No explanation is given for what the Commissioner describes as this deluge of invoices (and payments) in late June 2007. Mr Zullo could not provide any explanation for this.

55. Mr Zullo struck me as an experienced and shrewd business person. He was actively involved in QMS. He gave evidence that he checked subcontractors' and suppliers' quotes or invoices to ensure their charges were reasonable. Mr Zullo indicated that his main involvement was on the operational side of things, but it is clear he did take an interest in QMS's accounts.

56. Yet he maintains that he simply acquiesced in and had no concern with the imposition, verification, or even it seems with the basis, of invoices that by 30 June 2007 exceeded $35 million. Mr Zullo said he was prepared to cause QMS to pay the renovation compensation payments as long as QMS was making a profit overall. All of this seems implausible in any circumstances. I am especially unable to reconcile this with my assessment of Mr Zullo.

57. I am also reminded of the care with which a taxpayer's evidence should be scrutinized in circumstances of this nature, in particular, where there is an absence of supporting contemporaneous documentation.^[11] See, for example, Imperial Bottleshops Pty Ltd v Federal Commissioner of Taxation (“FCT”) (1991) 22 ATR 148 , 155 (Hill J); Warriewood Valley Pty Limited as Trustee of the Jill Trust v FCT (1993) 26 ATR 270 , 281 (Lockhart J).

Liquidated damages

58. There is nothing to suggest that QMS's provision of renovation services to ABC and its related entities gave rise to any legal liability to pay the renovation compensation invoices.

59. Robert Winter, a legal practitioner and employee of ABC during the 2006 and 2007 income years, gives evidence of his review in October 2006 of QMS's renovation procedures. He produced a report of November 2006 where, under the heading "Other less important issues that should be considered" he stated:^[12] Exhibit 5, Zullo 2017, p 226.

"(b) Introduction of liquidated damages conditions with QMS and the contractors where a renovation is carried out at a temporarily closed centre or licence numbers are reduced to accommodate the renovation"

60. Mr Winter states that following the submission of his report he received no further direction from the risk committee or ABC with respect to the introduction of a liquidated damages provision.^[13] Exhibit 9, Statement of Mr Robert Winter dated 18 December 2017, [11]. As indicated in Mr Winter's sworn statement, there was no consideration given to any written agreement between ABC and the Applicant for the provision of compensation payable for delays or disruptions.

61. It is not unusual of course for a builder to find itself contractually liable to pay liquidated damages where its work overruns a fixed or reasonable time for completion. However that is not what is claimed here. Nor is it advanced on QMS's behalf before the Tribunal.

62. There is nothing to show the payments were referable to any legal liability on the part of QMS to pay compensation for delay or disruptions caused by the renovations or at all. I am not satisfied that QMS was under any legal liability to pay the charges. I have referred to these matters because of the various explanations which have been advanced or considered at times for the renovation compensation invoices.

63. Mr Lucas has prepared a calculation of the charges based on the sample invoices comprising Schedule B to the 2007 SAF. Save for invoice number 26151, this is said to correlate to centre licensed childcare places x $50 per day x a multiple of five days (with the number of five-day periods subject to the renovation invoices ranging from one to five) (and invoice number 26151 working out to an even number of 18 days).^[14] Exhibit 7, Statement of Peter Lucas with Annexures PL1-PL8 dated 18 December 2017, [27]-[30].

64. I do not consider Mr Lucas's formula is anything more than an attempt to make some sense of the charges. It does not establish that that was the basis, if there was one, upon which the charges were arrived at. The formula is not derived from any source documents. It was pointed out that Mr Lucas was not cross-examined and that his evidence should be accepted. So far as relevant, however, his evidence is that he has come up with a formula which may or may not (and I suspect more likely the latter) have anything to do with the charges contained in the invoices.

65. Overall I do not think the evidence from Mr Winter or Mr Lucas is of any real assistance.

66. Moreover, as I have said, my understanding is QMS does not now contend that the payments were in any way liquidated damages, or that they were paid under any contractual or other legal obligation. Nor were they payments for any particular loss suffered by ABC or the RMCs by reason of the manner in which the renovations were carried out or the time taken to perform that work.

67. The payments, it was submitted, were an en globo payment extracted by ABC based on an understanding by Mr Zullo that if the payments were not made, then QMS would or might be deprived of the renovation and perhaps other work which provided the bulk of its income. They were paid, it was submitted, as a matter of commercial expediency.

Commercial expediency

68. To reiterate, in characterising the renovation compensation charges the emphasis, at times, has been on compensating ABC or the RMCs for losses arising from disruption and delay associated with the renovation work.^[15] Exhibit 5, Zullo 2017, [121(d)].

69. Before the Tribunal, QMS contended that the renovation compensation payments were monies voluntarily expended for commercial expediency and in order to protect, or to facilitate, the carrying on of its business including, in particular, the renovation work it was carrying out at the childcare centres.

70. Mr Zullo's said that "it was necessary to comply with Mr Groves' directions in order to maintain or secure business dealings with ABC"^[16] Exhibit 5, Zullo 2017, [54(b)]. and Mr Zullo was "…particularly careful to do everything possible to ensure QMS continued to receive renovation work from ABC".^[17] Exhibit 5, Zullo 2017, [105].

71. I accept, however, the Commissioner's submission that Mr Zullo was in a strong bargaining position with Mr Groves and ABC in respect of the provision of renovation services. QMS had a national network in place. The evidence is that having a single entity capable of performing all of ABC's required work was of enormous benefit to ABC.

72. Mr Zullo had a lengthy relationship with Mr Groves with whom, during the period of ABC's operation, he was generally on good terms. Mr Zullo's evidence was that the commercial relationship was built on trust not only with Mr Groves, but also the board of ABC.

73. I am not satisfied that if QMS refused to make the renovation compensation payments ABC would engage other competitors and the QMS business of renovation services would be at risk. More to the point, I am not satisfied that Mr Zullo believed that, or that it was the reason for payment of the renovation compensation charges.

74. The notion that the renovation compensation invoices were paid through commercial expediency lacks commercial reality. Mr Zullo apparently had no knowledge of the basis upon which the invoices would be or were issued by ABC on behalf of the RMCs. He did not know precisely, or perhaps at all, the basis of the charges or how much they would be.

75. This was in circumstances in which QMS would charge cost and at times plus 10-15%, and the renovation compensation charge was approximately a 30% uplift in QMS's costs. As the Commissioner has pointed out, when this was put to Mr Zullo, his response was unsatisfactory, and he merely asserted that it had to come out of another part of the company, but did not say which part or how.

76. I have not overlooked the evidence of Mr Lucas that during the 2007 income year, the income from the renovation work comprised the bulk of the income generated by QMS being $116,259,541.00 out of a total of $139,002,331.00.^[18] Exhibit 8, Supplementary Statement of Peter Lucas dated 1 June 2018, [6]-[7] & PL-10. The renovation work returned an operating profit of $22,381,202.42. Upon Mr Lucas's analysis, absent the income, cost of sales and expenses from the renovation work, QMS would have made an operating loss of approximately $14,789,096.00.^[19] Exhibit 8, Supplementary Statement of Peter Lucas dated 1 June 2018, [7]-[9].

77. I am drawn to the conclusion, nonetheless, advanced by the Commissioner, that subjecting QMS to a liability in excess of $35 million in the last seven months of the 2007 income year is not explicable by reference to commercial expediency. There is some undisclosed purpose for the invoices and payments, especially where it does not appear that any renovation compensation charges were sought or paid in the 2008 income year.

Deductibility

78. Income tax is imposed on taxable income which is defined in s 4-15 of ITAA 1997 as assessable income less deductions. For an expense incurred by a taxpayer to be deductible there must be a connection between the expenditure and gaining assessable income.

79. The general deduction provision, s 8-1(1) of ITAA 1997, contains two positive limbs that set out the required nexus between expenses and gaining assessable income. A taxpayer may deduct from assessable income a loss or outgoing to the extent that it is:

• (a) incurred in gaining or producing assessable income; or
• (b) necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

80. These positive limbs are followed, in s 8-1(2) of ITAA 1997, by four negative limbs which deny deductions for expenses which might otherwise be considered to fall within the preceding sub-section. The Commissioner does not contend that subsection 8-1(2) of ITAA 1997 has any application in respect of the deductions claimed for the 2007 income year.

81. As a general rule a taxpayer is entitled to deduct the full amount of an expense or loss once it is determined that the requirements of s 8-1 of ITAA 1997 are satisfied. Deductibility is not dependent on the loss or outgoing being reasonable or commercially realistic.^[20] Ronpibon Tin No Liability and Tongkah Compound No Liability v FTC (1949) 78 CLR 47 , 60 (“Ronpibon”); Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276 (“Magna Alloys”).

82. The inquiry to determine the characterisation of a loss or outgoing is directed towards what the loss or outgoing was intended to achieve in respect of the taxpayer's income earning or business activities.^[21] Magna Alloys (1980) 11 ATR 276 , 283.

83. A taxpayer is able to deduct a loss or outgoing from assessable income "to the extent that" the loss or outgoing falls within one of the two positive limbs, being s 8-1(1) of ITAA 1997. This may call for an apportionment of a loss or outgoing so as to arrive at the amount properly deductible.^[22] Ronpibon (1949) 78 CLR 47 , 59 .

84. QMS contends that the assessment for the 2007 income year is excessive. It seeks a finding that renovation compensation expenses, in the amount of $35,362,027.00, are allowable deductions falling within both positive limbs in s 8-1(1) of ITAA 1997.

85. Under s 14ZZK(b) of the Taxation Administration Act 1953 (Cth) ("TAA") the onus of establishing that an assessment is excessive is borne by the Applicant. In order to discharge the onus of proof, the Applicant must prove not only that the assessment is excessive, but also prove what the true assessment should be.^[23] Commissioner of Taxation v Dalco (1990) 168 CLR 614 , 623, 625-6 and 631-4 ; Martin v FCT (1993) 93 ATC 5200 ; Trautwein v FCT (1936) 56 CLR 63, 88 ; and Palassis v Commissioner of Taxation [2011] FCA 1305 , [9].

86. QMS contends that for the purposes of subsection 8-1(1)(a) of ITAA 1997, for expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end.^[24] Ronpibon (1949) 78 CLR 47 , 56 . In determining whether an outgoing has been incurred "in" gaining or producing assessable income, the essential question is: "is the occasion of the outgoing found in whatever is productive of actual or expected income?"^[25] Spriggs v Commissioner of Taxation (2009) 239 CLR 1 , [55], citing FCT v Payne (2001) 202 CLR 93 , [11].

87. QMS contends that for the purposes of subsection 8-1(1)(b) of ITAA 1997, a loss or outgoing will be "necessarily incurred" if it is "reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business".^[26] Spriggs v Commissioner of Taxation (2009) 239 CLR 1 , [75] citing Magna Alloys (1980) 11 ATR 276 , 295-296 . Money expended, not of necessity but voluntarily, and on the grounds of commercial expediency, and in order to protect or facilitate the carrying on of the business may be incurred in gaining or producing the income arising from that business.^[27] FCT v Gordon (1930) 43 CLR 456 , 470 and 462 ; Sun Newspapers Limited v FCT (1938) 61 CLR 337 , 352 .

88. In reliance, in particular, on Magna Alloys,^[28] Magna Alloys (1980) 11 ATR 276 , especially the joint judgment of Deane & Fisher JJ. QMS contends that the requirement in s 8-1(1)(b) of ITAA 1997 that the claimed outgoing be "necessarily" incurred in carrying on the relevant business does not mean that it must be either "unavoidable" or "essentially necessary". What is required is that the relevant expenditure be appropriate and adapted for the ends of the business carried on for the purpose of earning assessable income.

89. QMS refers to the Commissioner's Public Ruling, TD 2016/14 , and to part of his Explanation:

"Losses or outgoings are incurred in gaining or producing assessable income where they are 'incidental and relevant to that end' (Ronpibon). Where a taxpayer is carrying on a business for the purpose of gaining or producing assessable income, voluntary expenditure incurred for business needs may be deductible. It is the taxpayer who decides whether the expenditure 'is dictated by the business ends to which it is directed' (Snowden & Willson)." (footnotes omitted)

90. QMS submits that if a gift made in the expectation of generating business from a client is deductible, there can be no proper basis to deny deductibility of the renovation compensation payments in the present case in circumstances where they were made to sustain the ongoing profit generating revenue received from ABC.

91. Whether a voluntary outgoing was necessarily incurred in carrying on a taxpayer's business depends upon the answer to the composite question of whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business and, if so, whether those responsible for carrying on the business so saw it.^[29] Magna Alloys (1980) 11 ATR 276 , 295.

92. There is no real issue with the broad propositions advanced on behalf of QMS. Unfortunately, I am not satisfied that the renovation compensation payments were made for the purpose of commercial expediency, or for the purpose of safeguarding QMS's business, or any of the other bases upon which QMS's case for deductibility has been framed.

93. In the absence of satisfactory documentation, in light of the varying reasons advanced over time for both the imposition and payment of the charges, and upon my assessment of the evidence of Mr Zullo, I am not satisfied as to the true basis of the payments. As the Commissioner submits, the purpose remains obscure.

94. As I have said, I am not satisfied that they were paid out of economic expediency. I am not satisfied that any of the explanations which have been offered truly discloses the basis upon which the invoices for renovation compensation charges were issued or, perhaps more to the point, why they were paid.

95. QMS has not satisfied me that the amounts paid according to the renovation compensation invoices were losses incurred in gaining or producing QMS's assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing its assessable income. It has not been demonstrated that the payments fall within either positive limb of s 8-1(1) of ITAA 1997.

96. As QMS has failed to satisfy me as to the basis on which the renovation compensation charges (or any of them) were paid, QMS has failed to discharge the onus to show not only that the assessment was wrong but what the assessment should be.

Penalty

97. Schedule 1, Part 4-24 to the TAA sets out an administrative penalty regime in respect of taxation laws. Section 284-75 of Schedule 1 deals inter alia with administrative penalties for making false or misleading statements that result in shortfall amounts.

98. In this case the objection decision imposed a penalty of 75% of the shortfall amount resulting from intentional disregard of a taxation law. QMS submits that if there is a shortfall, as I have found, then it does not result from intentional disregard of taxation law (or recklessness as to the operation of a taxation law).

99. QMS bears the burden of showing that the administrative penalty assessment was excessive.^[30] Commissioner of Taxation v White (No. 2) [2010] FCA 942 , [18]-[19] QMS does not advance any argument as to penalty for lack of reasonable care or for remission of penalty.

100. Intentional disregard of a taxation law includes deliberately omitting an amount from assessable income knowing it is assessable, or claiming a deduction knowing it is not allowable. The authorities referred to by QMS support the view that intentional disregard requires actual knowledge that a statement is false.^[31] Russell v Commissioner of Taxation [2009] FCA 1224 ; Price Street Professional Centre Pty Ltd v Commissioner of Taxation (2007) 66 ATR 1 , [43].

101. The evidence of Mr Zullo was in a number of respects unsatisfactory as I have indicated. For instance, I am not satisfied, on the basis of his evidence, as to the true nature of the renovation compensation payments. But while Mr Zullo may not have known the true nature of the payments, it does not follow that he or anyone else deliberately claimed a deduction knowing it was not allowable.

102. There are aspects of the payments that point to them being allowable deductions. The renovation compensation invoices may have been calculated, by ABC, on an unknown and perhaps arbitrary basis but, as QMS points out, the renovation work was carried out by QMS and the invoices were paid.

103. I appreciate that evidence of intention may be a matter of inference and is not necessarily dependent on direct evidence.^[32] Weyers v FCT [2006] FCA 818 . Nonetheless, and having regard to where the onus of proof lies, I am satisfied on all the evidence that neither Mr Zullo nor any other employee or agent of QMS had the requisite intention.

104. I am therefore satisfied that this is not a case of intentional disregard of a taxation law so as to attract the 75% penalty.

105. Recklessness is said to exist where the relevant conduct goes beyond mere carelessness or inadvertence. It includes conduct which shows indifference to or disregard of risks that are foreseeable by a reasonable person.

106. In the case of
Hart v Commissioner of Taxation,^[33] (2003) 131 FCR 203 , [43]-[44]. Hill and Hely JJ explained that recklessness in this context involves "more than mere negligence and must amount to gross carelessness." It means more than failure to exercise reasonable care, but less than an intentional disregard of a taxation law.

107. I am satisfied that QMS's conduct was more than mere negligence and can be rightly regarded as recklessness. In saying that I take into account the following facts and circumstances. The compensation renovation invoices were calculated on an unknown basis. The amounts involved were substantial, totalling more than $35 million.

108. There is no evidence that anyone on behalf of QMS sought to establish the precise nature of the charges or how they were calculated. If these matters were known, there is nothing to say they were recorded, so that they could be substantiated. Legal advice was not sought on whether the payments were properly deductible.

109. In consequence I find that the administrative penalty in respect of the 2007 return should be varied from 75% of the shortfall amount resulting from intentional disregard of a taxation law, to 50% of the shortfall amount resulting from recklessness as to the operation of a taxation law.

2008 INCOME YEAR

Agreed facts

110. The parties have agreed the facts set out in paragraphs 111 to 133 below, for the purposes of this application, by a Statement of Agreed Facts (2008 income year) ("2008 SAF").^[34] Exhibit 4, Agreed Statement of Facts – 2008 Income Year.

111. On 5 October 2007:

• (a) Neighbourhood Early Learning Centres Pty Ltd ("NELC") was incorporated pursuant to the Corporations Act 2001; and
• (b) NELC became a member of the consolidated tax group of which QMS was the head company.

112. At all material times, the sole director of NELC was Mr Zullo.

113. On or about 19 June 2009, the QMS consolidated tax group lodged the 2008 Return^[35] Exhibit 1, T Documents, T4, pp 64-76. which recorded:

• (a) a total income of $192,977,997.00; and
• (b) a taxable income of $17,870,009.00.

114. The 2008 Return claimed a deduction of $15,432,549.00 in relation to "management fee expenses" paid by NELC to eight parties (including ABC Developmental Learning Centres Pty Ltd ("ABC Centres")).

115. On 1 June 2011, the Commissioner issued, inter alia:

• (a) a Notice of Amended Assessment ("the 2008 assessment")^[36] Exhibit 1, T Documents, T12, pp 109-112. for the 2008 income year which assessed QMS to an additional tax liability in the amount of $4,948,716.35 (comprising assessed tax in the amount of $4,274,808.30 and a shortfall interest charge of $673,908.05); and
• (b) a Notice of Assessment of shortfall penalty for the 2008 year ("the 2008 penalty assessment")^[37] Exhibit 1, T Documents, T13, pp 113-114. in the amount of $2,137,404.15.

116. The Commissioner allowed $1,183,188.00 by way of deduction in respect of the claimed deduction of $15,432,549.00 (with the $1,183,188.00 representing 15% of what the Commissioner considered to be NELC's income (earned in connection with provision of the Management Services as defined below) for the 2008 income year of $7,887,920.00).

117. On 2 December 2011, Harris Black Accountants lodged on behalf of QMS:

• (a) the 2008 Notice of Objection;^[38] Exhibit 1, T Documents, T16, pp 140-160. and
• (b) a Notice of Objection against the 2008 penalty assessment.^[39] Exhibit 1, T Documents, T17, pp 161-168.

118. The 2008 Notice of Objection contended that the amount of $13,357,523.00 which was claimed as part of "management fee expenses" in the 2008 return was an allowable deduction under s 8-1 of ITAA 1997.

119. The amount of $13,357,523.00 represented the revised amount of $14,540,711.00 (comprising the original amount claimed ($15,432,549.00) less an amount of $891,838.00 and less the $1,183,188.00 allowed by the Commissioner).

120. By the 2008 Objection Decision, the Commissioner disallowed the objections in full.

121. A written agreement entitled "Management Agreement" dated 25 February 2008 ("the Management Agreement") was entered into between eight parties (including ABC Centres) which were each described respectively as an "Owner" ("the Owners") of the first part and NELC (described as the "Manager") of the other part. Annexure "A" to the 2008 SAF comprises a copy of the Management Agreement.

122. Pursuant to the Management Agreement, NELC provided services to the Owners in accordance with the terms set out in Schedule 1 of the Management Agreement ("Management Services").

123. In or about early to mid-December 2007, NELC commenced to manage various early childhood education centres of the Owners ("the relevant childcare centres") and NELC continued to do so throughout the balance of the 2008 income year.

124. On or about 8 January 2008, NELC received a bundle of tax invoices issued by ABC Centres, on behalf of itself and other Owners, totalling $9,607,220.22 (excluding GST) in respect of management fees for the period from 1 July 2007 up to and including 20 December 2007.

125. On or about 25 March 2008, NELC received a fresh bundle of tax invoices and also adjustment notes issued by ABC Centres, on behalf of itself and other Owners. The adjustment notes reduced the amount of the management fees by $9,607,220.22 (excluding GST). The new invoices claimed payment of management fees pursuant to the Management Agreement totalling $7,241,542.36 (excluding GST) for the period from 1 July 2007, up to and including, 20 December 2007. Annexure "B" to the 2008 SAF comprises a copy of a sample invoice from the bundle of new invoices received on or about 25 March 2008.

126. On or about 29 April 2008, NELC received two bundles of tax invoices issued by ABC Centres, on behalf of itself and other Owners, claiming payment of management fees pursuant to the Management Agreement for the period from 1 January 2008 up to and including March 2008 totalling $3,848,109.59 (excluding GST), and for April 2008 totalling $1,440,125.20 (excluding GST). Annexure "C" to the 2008 SAF comprises a copy of a sample invoice from the bundle of invoices for the period from 1 January 2008, up to and including, March 2008. Annexure "D" to the 2008 SAF comprises a copy of a sample invoice from the bundle of invoices for the period of April 2008.

127. On or about 8 June 2008, NELC received a bundle of tax invoices issued by ABC Centres, on behalf of itself and other Owners, claiming payment of management fees pursuant to the Management Agreement for May 2008 totalling $1,451,234.85 (excluding GST). Annexure "E" to the 2008 SAF comprises a copy of a sample invoice from the bundle of tax invoices received on or about 8 June 2008.

128. On or about 8 July 2008, NELC received a bundle of tax invoices issued by ABC Centres, on behalf of itself and other Owners, claiming payment of management fees pursuant to the Management Agreement for June 2008 totalling $1,451,536.45 (excluding GST). Annexure "F" to the 2008 SAF comprises a copy of a sample invoice from the bundle of new invoices received on or about 8 July 2008.

129. The total revenue of the childcare centres managed by NELC during the period from early to mid-December 2007, up to and including, 30 June 2008, broken down by centre and month, is set out in Annexure "G" to the 2008 SAF.

130. The revenue identified in Annexure "G" to the 2008 SAF comprised NELC's income from the childcare centres.

131. The management fees payable by NELC pursuant to the Management Agreement during the period from early to mid-December 2007, up to and including, 30 June 2008, calculated by applying the formula in Schedule 3 to the Management Agreement to the revenue set out in Annexure "G" to the 2008 SAF, is set out in Annexure "H" to the 2008 SAF.

132. Annexure "I" to the 2008 SAF is a schedule setting out the monthly totals of the revenue set out in Annexure "G" and the management fees set out in Annexure "H" thereto.

133. The parties agree that the invoices in Annexures "B", "C", "D", "E" and "F" to the 2008 SAF are to be treated, for the purposes of the application, as representative samples of the relevant invoices.

Further facts

134. At some time prior to October 2007, Mr Zullo was approached by a senior manager from ABC - most likely by Mr Groves or Martin Kemp - with an offer to operate some of ABC's childcare centres.

135. At the time, ABC had a number of the centres which, from a financial perspective, were underperforming. Some advantages were also seen in re-badging some of the ABC childcare centres. By this time Mr Zullo had experience and knowledge of childcare centre operations.

136. ABC was to offer Mr Zullo a batch of centres to operate commencing from 1 July 2007. The centres the subject of these arrangements were not all underperforming. Some had not even been completed.

137. From QMS/NELC's perspective, Martin Gallagher, as well as Mr Zullo, had some involvement in negotiating or settling the arrangement. Mr Gallagher was Mr Zullo's newly-appointed CFO. He had previously been a director of Harris Black Accountants, accountants for QMS and ABC.

138. Two draft management agreements were produced dated 17 November 2007 and 5 December 2007. From about 17 December 2007, NELC was operating twenty-eight of the childcare centres.

139. Schedule 2 of the Management Agreement lists 80 centres. Mr Zullo could not say how many centres NELC was operating at the time the Management Agreement was executed on 25 February 2008.

140. The Management Agreement, and the draft agreements, provided for NELC to acquire the right to operate the childcare centres independently of ABC and to receive the income and pay the expenses of those centres.

Management Agreement

141. The following summary of the contents of the Management Agreement (and where relevant the draft agreements) is taken substantially from the Commissioner's written submissions:

• (a) Pursuant to Clause 2, the various owners appointed NELC as manager to provide the broadly defined management services in Schedule 1. NELC was to operate as an independent contractor not as agent.
• (b) Clause 4.2 provided that NELC was solely responsible for its personnel while at a childcare centre.
• (c) Clause 4.4 required NELC to alter the appearance of each of the childcare centres so as to ensure that they would not be associated with ABC. NELC was not to use any trademark, logo, get up or intellectual property of ABC unless otherwise agreed.
• (d) NELC was to operate the childcare centres under its own licence. Clause 5(a) provided that if NELC did not hold a licence to operate the childcare centres on the Commencement Date, then the owner agreed to grant NELC use of its licence for 120 days.
• (e) Under Clause 7, the various owners agreed to grant NELC a Site Licence for the purposes of NELC providing the management services and NELC undertook to indemnify the owners in respect of their respective obligations as lessees of the various sites. NELC was also required to pay a licence fee, which related to the rent and outgoings of the childcare centres from the Commencement Date.

142. The term "Management Fee" was defined in clause 1.1 of the Management Agreement:

"Management Fee means the fees paid by the Manager to the Owner in consideration of the Owner granting to the Manager the right to manage the Centres in accordance with the terms of this Agreement in accordance with Schedule 3."

143. The draft agreements provided for a "Management Period" of three years subject to termination or extension. For that period a management fee was payable to the owners (collectively) charged at a then unascertained fixed rate per licensed place charged annually and payable by monthly instalments in arrears.

144. Under the executed Management Agreement, the commencement date remained the same (the day for each centre on which the Manager commences to provide management services) but the "Management Period" was the period commencing on the commencement date for each centre and ending on the date of termination of the agreement.

145. Clause 8.2(c) of the earlier draft which allowed for the Owner to terminate the management on 90 days' written notice was deleted and, following negotiations with Mr Zullo, was replaced with a provision for the Manager to terminate on the same amount of notice.

146. The draft provision enabled the Owner to enter a child care centre operated by NELC, without notice, and to undertake a compliance audit. The corresponding definition of "audit" was removed from the executed Management Agreement.

147. The management fee, based on a fixed rate per licensed place, was replaced with a revenue-based model. Schedule 3 of the Management Agreement now provided for a three-tiered percentage calculation based on a childcare centre's gross revenue. In summary, this tiered calculation was as follows:

• (a) a Management Fee calculated at 115% of the gross annual revenue of a childcare centre of up to $550,000.00; and
• (b) a Management Fee calculated at 85% of the gross annual revenue of a childcare centre between the amount of $550,000.00 and $750,000.00; and
• (c) a Management Fee calculated at 10% of the gross annual revenue of a childcare centre that exceeded $750,000.00.

148. The executed Management Agreement retained the requirement for the management fee to be paid on an annual basis though the mechanics of its calculation altered to a calculation of yearly, six monthly and monthly fee amounts with reconciliations to be carried out by the Owner. Under the Management Agreement, the management fee was set at a cap of $15,000,000.00 per annum for all centres managed by NELC.

149. QMS highlighted some of the same and other provisions in the Management Agreement as follows:

• (a) the Owner appointed NELC as the manager of the centres (and NELC accepted the appointment and agreed to provide the management services) until the agreement was terminated in accordance with its terms (clause 2.1).
• (b) NELC agreed to operate the centres as an independent contractor and accepted responsibility for the operation and management of the centres at its own risk (clauses 2.2(a) and (c)).
• (c) NELC could retain the income of the centres after the "Commencement Date" (clause 5(d)).
• (d) NELC was entitled to request assistance from the Owner to provide a suitable education program for use in the centres and to assist NELC by providing administrative support functions such as payroll (clause 6.1).
• (e) NELC was required to pay a "Management Fee" which was defined to mean the fees paid in consideration of the Owner granting to NELC the right to manage the centres in accordance with the terms of the Management Agreement in accordance with Schedule 3 (clause 3.1).
• (f) NELC was required to undertake alterations to the physical appearance of the centres so that none would be associated with the Owner (clause 4.4 (a)).
• (g) the Owner "may" grant a licence to the NELC to use the Owner's "Intellectual Property Rights" (clause 4.4(c)). If such a licence was granted, NELC could not sub-licence the right to use such intellectual property rights (clause 4.4(e)(3)).
• (h) the Owner agreed to grant to NELC a right to operate the centres under the licence held by the Owner for a period of 120 days from the Commencement Date but the Owner could, at its absolute discretion, extend the period (clauses 5(a) and (b)).
• (i) the Owner granted to NELC a "Site Licence" to have access to and use the premises at which the centre was operated for the purpose of providing the Management Services to the Owner and the parties agreed to enter into a Site Licence on the terms set out in Schedule 4 (clause 7.1(a) and (b)).
• (j) the rights conferred by the Site Licence rested in contract only and were personal to NELC; that licence did not confer any estate or interest in the premises and legal possession and control of the premises remained with the Owner; and when the Management Agreement terminated, the Site Licence also terminated (clause 7.1(c)).
• (k) NELC was obliged to pay to the Owner the "Site Licence Fees" within seven days of receipt of an invoice from the Owner (clause 7.3).
• (l) the Owner could terminate the Management Agreement with "immediate effect" by written notice in the event of the occurrence of one of the circumstances set out in sub-clause 8.1(a) with such circumstances including insolvency events, a breach of the Licence or relevant legislation, a failure to fulfil its obligations under the Management Agreement or termination of the Lease (clause 8.1).
• (m) NELC could also terminate the agreement by providing three months' written notice (clause 8.2).
• (n) upon termination under clauses 8.1 or 8.2, NELC was required (under clause 8.3), inter alia, to relinquish immediately possession of the premises of each centre and return to the Owner all property at the centres owned or provided by the Owner ((a)); (to the extent permitted by law) to transfer to the Owner (or its nominee) the Licence and any other rights, licences, permissions and authorisations held by NELC relevant to the provision of the management services at the centre ((c)); and to deliver up any and all copies of any materials embodying or recording the Owner's Intellectual Property Rights held by NELC under its control ((f)).

Management fees

150. Although the Management Agreement was stated to commence on 1 July 2007, and notwithstanding vague references by Mr Zullo to an earlier commencement date, it was not until early to mid-December 2007 that NELC commenced to manage various childcare centres (and commenced to generate revenue).

151. Mr Zullo could not say how the bundle of invoices for management fees of approximately $9.6 million, issued on 8 January 2008 for the period 1 July 2007 to 20 December 2007, had been calculated.

152. Subsequent to the executed Management Agreement, on about 25 March 2008, a fresh bundle of tax invoices and adjustment notes were issued with management fees now totalling $7,241,542.36 (excluding GST) for the period 1 July 2007 to 20 (or 31) December 2007.

153. The parties agreed that NELC received tax invoices (and adjustment notes on the one occasion) issued by ABC Centres, on behalf of itself and other Owners, claiming payment of management fees pursuant to the Management Agreement for the following periods in the following amounts (excluding GST):

• (a) for the period from 1 July 2007 up to and including 20 December 2007: $7,241,542.36;
• (b) for the period from 1 January 2008 up to and including March 2008: $3,848,109.59;
• (c) for the period of April 2008: $1,440,125.20;
• (d) for the period of May 2008: $1,451,234.85; and
• (e) for the period of June 2008: $1,451,536.45.

154. The reduction of the previous total of approximately $9.6 million on 8 January 2008, to the invoiced amount of about $7.24 million in March 2008, could not be explained by Mr Zullo, except to say that there was a good relationship with ABC and that Mr Gallagher would have attended to it.

Capital or revenue

155. Because NELC's management did not commence until December 2007, QMS says that it does not press as being deductible the management fees invoiced which relate to the period prior to early to mid-December 2007. (The Commissioner also points out that NELC was not a legal entity for much of that period, having only been incorporated in October 2007.)

156. The Commissioner submits that the executed Management Agreement, and the draft agreements, provided for NELC's acquisition of a right to operate nominated ABC centres independently of ABC and to earn the profits therefrom. The Commissioner submits that the management fees stated to be paid by NELC to ABC (including associated entities) as set out in ASF 2008, which were in excess of the amount the Commissioner allowed at audit in the amount of $1,183,188.00, were a loss or outgoing of capital or capital in nature and not deductible.

157. QMS claims that the management fees, referable to December 2007 to July 2008, are allowable deductions pursuant to s 8-1 of ITAA 1997. QMS submits that on a proper construction of the Management Agreement, the management fees were incurred on revenue account. On proper analysis, the management fees related to (and were incurred in) the use of the means of production rather than the acquisition of the means of production.

158. The first of the negative limbs in s 8-1 of ITAA 1997, subsection (2)(a), provides that a loss or outgoing that is capital or capital in nature is not deductible. In general, a capital expense is the acquisition of the means of production (related to the income-producing structure), whereas a revenue expense is related to the use of the means of production (the income-producing process).

159. In
Sun Newspapers Ltd v Federal Commissioner of Taxation^[40] (1938) 61 CLR 337 (“Sun Newspapers”) especially per Dixon J. Dixon J suggested three factors which should be considered in deciding whether an expense is a capital expense. QMS referred to these factors which may be summarised as follows:

• (a) the character of the advantage sought, and in this its lasting benefit may play a part;
• (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part; and
• (c) the means adopted to obtain the benefit; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.^[41] Sun Newspapers, 363, cited with approval in FCT v Citylink Melbourne Limited (2006) 228 CLR 1 , [147].

160. As QMS also submits, the first criterion is the chief, if not critical, factor in determining the character of what was paid.^[42] Tyco Australia Pty Ltd v Commissioner of Taxation (2007) 67 ATR 63 at [38] per Allsop J, citing, inter alia, GP International Pipecoaters Pty Ltd v Commissioner of Taxation (1990) 170 CLR 124 at p 137. None of the factors, however, is definitive. It is the substance of the payment and not its form or description which determines the nature of the expense.^[43] Jupiters Ltd v Deputy Commissioner of Taxation (2002) 50 ATR 236 ; FCT v Star City Pty Ltd (2009) 72 ATR 431 .

161. QMS submits the management fees were recurrent and did not secure a lasting asset. The payments were made pursuant to an agreement which could be terminated by ABC in the circumstances identified in clause 8.1, including in the event that the Lease expired (a matter beyond the control of NELC).

162. The Management Agreement could also be terminated by QMS, at its election, on the giving of three months' written notice. The termination provisions are not consistent with the parties treating QMS as acquiring any lasting asset. This is further demonstrated by the fact that, upon termination, the Management Agreement did not provide for NELC to acquire or retain any asset.

163. Amongst other things, QMS relies on the observations of the Full Federal Court in
Commissioner of Taxation v Raymor (NSW) Pty Ltd:^[44] (1990) 24 FCR 90 at 99 per Davies, Gummow and Hill JJ.

"It can be said of every payment pursuant to a contract that it secures to the payee the contractual rights under the contract. In that sense every payment made under a contract confers upon the payee a chose in action which can be described as an asset and which contractual right is discharged by the performance of the contract. But such an analysis is of no assistance in the resolution of whether a particular outgoing is on capital or revenue account."

164. Although QMS, before the Tribunal, has limited its claim for deductions to the period from December 2007, the fees imposed for the preceding period of the 2008 financial year are relevant. During this time QMS was not managing the childcare centres, yet it agreed to pay management fees commencing on 1 July 2007.

165. The six-monthly fees up to December 2007 were not fees for actual management of childcare centres. They were not fees occasioned in the use of management rights. Given that the Management Agreement was executed in February 2008, they were not even fees agreed to be paid in anticipation of the exercise of management rights during this period.

166. I think that what happened in the immediately succeeding financial year, under a fresh management agreement, also gives context to the Management Agreement and the management fees it imposed in the 2008 financial year. In the 2008 financial year, including for many months in which NELC was not managing any childcare centres, it was liable for management fees (albeit capped) on the scale referred to in the Management Agreement.

167. The revised management agreement, executed on 28 August 2008 with effect from 1 July 2008, replaced the tiered management fee to a cap of $15 million with a management fee of 15% of revenue earned. The agreement enabled both parties to terminate the agreement by giving of 30 days' written notice.

168. Mr Zullo said the formulation of management fees under the Management Agreement was common in the childcare industry. By this I understood him to mean that it was not unusual for operators of childcare centres to pay a management fee based on a percentage of income. If he meant it was commonly agreed to pay up to 115% of gross revenue (albeit to a maximum), there was no documentary or other evidence to support such an assertion. In the absence of such evidence I am not willing to accept that as fact.

169. The initial charging of the management fee in the first year, in terms of the Management Agreement, with a subsequent reduction of the rate to 15% per annum under the management agreement in the subsequent year, are indicative of a payment in that first year of an amount in the nature of capital.

170. This, together with the other matters referred to, leads me to conclude that the management fees in that initial financial year 2008, at least to extent that they exceeded the amount allowed as deductions by the Commissioner, were not on revenue side.

171. They are not explicable as management fees for actual management of childcare centres, but were fees for the acquisition of the right to control the centres. In my view on all of the evidence they were for the acquisition of the management rights, and explicable as a capital expenditure.

172. The factual foundation for the application of the 115% formula is unclear. QMS has not established to my satisfaction that there should be an apportionment beyond that allowed by the Commissioner, that is, that a deduction should be allowed for management fees in the 2008 financial year in excess the amount the Commissioner has allowed.

173. Consequently, QMS has failed to show that the amended assessment was excessive.

Penalty

174. In respect of the 2008 financial year the objection decision imposed a penalty of 50% of the shortfall amount resulting from recklessness as to the operation of a taxation law. QMS does not contest the penalty in so far as it concerns the amount comprising the difference between the disputed amount of the deduction and the amount the subject of the assessment.

175. QMS submits that, in the event the amount now claimed is not deductible, the shortfall amount did not result from recklessness. It submits the evidence does not support a conclusion that the claimed deduction resulted from gross carelessness. It does not advance any argument as to penalty for lack of reasonable care or for remission.

176. As I have said recklessness means more than failure to exercise reasonable care, but less than an intentional disregard of a taxation law.^[45] Hart v Commissioner of Taxation (2003) 131 FCR 203 , [43] and [44] . QMS has failed to satisfy me that the basis of the penalty imposed in the objection decision is inappropriate.

177. I take into account the following facts and circumstances. QMS originally sought to claim a deduction for management fees in excess of the cap under the Management Agreement. The original claim was also in respect of management fees from 1 July 2007 for a period in which NELC did not manage any childcare centres and for a substantial part of which NELC did not even exist.

178. The claimed deduction before the Tribunal does not include management fees for this earlier period. However, even in respect of the adjusted claim for deductions, there is no satisfactory evidence that legal advice was sought inter alia on whether the claims were revenue or capital in nature.

179. This was in circumstances in which the claimed deductions were wholly out of proportion to revenue earned, and were followed in the succeeding financial year by an agreement in which management fees were a small fraction of what was claimed for the 2008 financial year. The claimed management fees were commercially unrealistic which, if there were nothing else, should have caused Mr Zullo or others within QMS to consider their proper characterisation.

180. I am not satisfied that anyone did consider the true nature of the fees and whether a deduction for the amount as claimed (including even for the period from December 2007) could be properly made.

181. In all the circumstances I am not satisfied that the penalty based on recklessness is excessive.

DECISION

182. The penalty of 75% of the shortfall amount resulting from intentional disregard of a taxation law for the 2007 income year is set aside, and substituted with a penalty of 50% of the shortfall amount as a result of recklessness as to the operation of a taxation law.

183. Otherwise the objection decisions dated 4 December 2012 are affirmed.