MEZRANI & ANOR v FC of T

Members:
B Tamberlin DP

Tribunal:
Administrative Appeals Tribunal, Sydney

MEDIA NEUTRAL CITATION: [2009] AATA 654

Decision date: 1 September 2009

B Tamberlin QC (Deputy President)

Basic facts

1. Applications have been made to this Tribunal to review the decisions of the Commissioner of Taxation (the Commissioner) disallowing in full objections to assessments imposing 50 percent tax penalties on the Applicants, Mr Kenneth and Mrs Nejawa Mezrani. The assessments were made on the ground that Mr and Mrs Mezrani were

ATC 3052

"reckless" in failing to disclose taxable income derived from the sale of four home units in the 2004 calendar year. The Applicants accept that the failure to disclose income arose from a failure a take reasonable care and that they are liable to pay a penalty at the rate of 25 percent.

2. The Applicants submit that the penalty amounts calculated at 25 percent should be as follows:

Applicant Income year Penalty amount Reason for penalty
Mr Mezrani 2004 $16,581.90 Failure to take reasonable care
Mr Mezrani 2005 $16,961.40 Failure to take reasonable care
  Sub-total $33,543.30  
Mrs Mezrani 2005 $31,832.10 Failure to take reasonable care
  TOTAL $65,375.40  

Issues

3. The issue is whether the Applicants, or either of them, had a tax shortfall resulting from "recklessness".

4. In respect of Mr Mezrani, the total penalty imposed by the Commissioner amounts to $67,086.40 in relation to the preparation of returns for the financial years ended 30 June 2004 and 30 June 2005. In the case of Mrs Mezrani, the penalty imposed was $63,644.05 in respect of the year ended 30 June 2005.

Background and evidence

5. Both Mr and Mrs Mezrani have filed statements of evidence and they were cross-examined in the course of the hearing. The facts emerging from that evidence are as follows:

6. Mrs Mezrani gave evidence that her husband and herself were both aware that they would probably have to pay capital gains tax at some stage in relation to the units at Allawah.

7. Subsequently, the bank required the Applicants to sell the units to reduce their overall level of mortgage and sales were completed as follows:

8. Mrs Mezrani gave evidence that, although she was unaware of the specific tax implications, she was aware that she would have to pay some kind of tax at some time.

9. In October 2004, Mr Moses the accountant for the Applicants, passed away and after his death, their nephew Mr Sammy Mezrani (Sammy) took over responsibility for looking after their financial affairs. He was extremely close to the Applicants and had lived with them for some time and helped look after their children. Sammy died in May 2006 and on the evidence, Mr Mezrani took his death very heavily to the extent that he was described as "absolutely devastated and rarely left the house". This condition prevailed for seven to eight months following Sammy's death and during that time Mr Mezrani spent his time in a disturbed state and the financial affairs were described as having fallen into disarray.

10. Mr Mezrani gave evidence that he had relied heavily on Mr Moses for the regular management of his financial affairs.

11. As a result of the combination of the deaths of both Mr Moses and Sammy Mezrani, his recording of finances was very inadequate.

12. From early 2006, Mr Mezrani said the ATO began to apply pressure on him to prepare and lodge his individual tax returns for the 2003/04 and 2004/05 financial years.

13. In 2006, Mr Mezrani engaged tax agents Gateway Partners, who had purchased the accounting practice of Mr Moses, to compile and lodge returns and these were lodged in due course. Mr Mezrani said that, in the haste of compiling the returns and the combination of the deaths of Mr Moses and Sammy, he did not recall that the financial activity in relation to the Noble Street properties needed to be advised to his tax agents, Gateway Partners, in compiling returns for himself and his wife for the tax years in question.

14. The accountants at Gateway Partners, not having been made aware of the sales of the Noble Street properties, did not include those profits in the returns.

15. Mr Mezrani states that he felt that, if Mr Moses had been alive, Mr Moses would have made sure that the information would have been disclosed to the Australian Taxation Office (ATO).

16. As soon as the Commissioner raised the issue of the proceeds of sale of the units it is common ground that there was co-operation from Mr and Mrs Mezrani in the conduct of the audit. Both Applicants accept that the proceeds should have been included in the returns for the 2004 and 2005 tax years but they emphasised that the omission did not occur deliberately.

17. Mrs Mezrani gave evidence that she relied on her husband in the preparation of financial documents in relation to the family business.

18. The Commissioner points out that Mr and Mrs Mezrani are both company directors and have experience in the business of property development and that they were both aware that sales of property at a profit resulted in taxation consequences that needed to be reported in income tax returns. The Commissioner also points out that a registered tax agent was employed to assist them, and observes that the tax agent should have enquired of them whether any property had been developed or sold in the income years in question.

19. The Commissioner submitted that a reasonable person would have foreseen that, by failing to include the sale of the four properties, which were sold for an amount in excess of $1.7 million, as directors of property development companies, they knew or ought to have known income tax obligations were highly likely to arise.

20. The Commissioner also refers to a letter dated 20 March 2006 from the tax agent for the joint venture, namely Harely, Russell & Day, that advised of the cost base for the units and submits that this should have prompted them to realise there were tax consequences related to the sale of the properties.

21. Mr and Mrs Mezrani say that they were not aware of the letter or its significance because it was sent to the accountant for the joint venture and not to their accountant.

22. The Commissioner submits that, having regard to the large size of the transactions, Mr and Mrs Mezrani should have maintained

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appropriate taxation records to ensure that such a large shortfall did not occur, and they did not. It is also pointed out that the Applicants, having been aware of a GST audit conducted by the Commissioner carried out shortly before they lodged their income tax returns, should have realised that the profits made on the sale of properties needed to be reported.

23. In summary, the Commissioner submits the Applicants' tax returns were grossly inaccurate in failing to include the sales of the two properties and that the error could only have occurred because the Applicants had inadequate record-keeping procedures or alternatively, that they knew about the transactions and failed to disclose them, and these considerations make their conduct "reckless" and not merely careless.

24. The Commissioner submits that the Applicants' evidence that they simply forgot to include the amounts in their income tax returns was insufficient to negate the imposition of a penalty for recklessness.

25. The Commissioner also submits that the discretion to remit a tax shortfall penalty should not be exercised in this case because it calls for exceptional circumstances and, as a general rule, the larger the item the greater the level of care required. The objective of the penalty regime is to promote consistent treatment in respect of the rates of penalty imposed and this would be compromised if penalties imposed at specific rates were remitted without just cause. Ignorance as to liability for tax or the fault of the entity's tax agent is insufficient to warrant a remission.

26. Moreover, the Commissioner said that Mr Mezrani had not established by any objective expert evidence that he was so affected by the deaths of his accountant and Sammy Mezrani that he was incapable of complying with with his tax obligations. The Commissioner refers to fact that he took part in two separate property developments during the time when he was lodging the relevant tax returns and sold two investment units.

27. The Commissioner also points to the date of the letter from the project accountants for the joint venture, being 20 March 2006, as sounding a warning to Mr and Mrs Mezrani that they should disclose the profit on the sale of the units in their income tax returns. The absence of appropriate record-keeping in this case was therefore so great as to amount to recklessness.

Legal principles

28. In cases of recklessness, the base penalty amount will be 50 percent of the shortfall amount if it, or part of the shortfall, resulted from recklessness by the taxpayer or their agent as to the operation of a taxation law: s 284-90 of Schedule 1 to the Taxation Administration Act 1953 (the TAA).

29. There is no substantial dispute between the parties as to what is meant by the expression "recklessness". The principles are expressed with clarity and detail in the judgment of Cooper J in
BRK (Bris) Pty Ltd v Federal Commissioner of Taxation 2001 ATC 4111; (2001) 46 ATR 347 at 364 as follows:

"…

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

…"

See also:
Hart v Commissioner of Taxation 2003 ATC 4665; (2003) 131 FCR 203;
Re Jones and Commissioner of Taxation 2003 ATC 2024; (2003) 52 ATR 1063 at 26; and Law Administration Practice Statement (PSLA) 2006/2, at paragraph 105.

30. In
Re Ajami and Commissioner of Taxation 2007 ATC 2143; (2007) 65 ATR 957 at 956, Deputy President Walker observed that the test is substantially objective, but incorporates subjective elements:

"This tribunal is bound by the majority opinion in
Hart [v Commissioner of Taxation (2003) 131 FCR 203] which

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approves the substantially objective test in BRK. Even that test incorporates significant subjective elements, though, requiring as it does that the statement must have been made 'knowing that there is a real, as opposed to fanciful, risk that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct'.

The BRK test differs from the ATO practice statement in that it requires the presence of some subjective knowledge, but on the other hand different from Spender J's view [in Hart], which depends on the taxpayer not caring whether the claim is true or false".

31. It is well settled that recklessness requires something more than an oversight or inadvertence and something less than deliberate or intentional conduct. It involves an attribution of a state of mind. It can be inferred having regard to what a reasonable person would consider to be something more blameworthy than oversight yet not amounting to intentional conduct.

32. Taxation Ruling TR 94/4, as it was at the time of the reviewable decisions, stated at paragraphs 6 and 7:

  • "6. The reasonable care test requires a taxpayer to take the care that a reasonable, ordinary person would take in all the circumstances of the taxpayer to fulfill the taxpayer's tax obligations. Provided that a taxpayer may be judged to have tried his or her best to lodge a correct return, having regard to the taxpayer's experience, education, skill and other relevant circumstances, the taxpayer will not be liable to pay penalty.
  • 7. Recklessness is gross carelessness. A taxpayer will have behaved recklessly if the taxpayer's conduct clearly shows disregard of, or indifference to, consequences that are forseeable by a reasonable person as being a likely result of the taxpayer's actions. It is not necessary for a finding of recklessness that the taxpayer intended to bring about the consequences that his or her actions caused".

Reasoning

33. Notwithstanding the submissions advanced on behalf of the Respondent, I do not consider that the decision to impose penalties based on "recklessness" in this case is the correct or preferable decision. In reaching this conclusion, I have taken into account the provisions of s 14ZZK of the TAA.

34. The Applicants have co-operated with the ATO in the conduct of the audit. Both Applicants have been cross-examined in detail before me, and I accept their evidence that the disruption to their financial affairs occasioned by the death of their accountant and the later death of their nephew Sammy had a significant impact on their state of mind and ability to manage their financial affairs in an efficient and satisfactory way. In particular, I am satisfied that Mr Mezrani, who was primarily in charge of the financial affairs of both Applicants in this matter, was deeply affected by the death of his nephew, Sammy Mezrani, to the extent of being unable to act logically for a very substantial period of time during the period when the tax returns were being compiled by Gateway Partners in 2006. I am satisfied that the Applicants did not appreciate the significance of the letter provided by Harley, Russell and Day to them in the circumstances in which they were placed at the time. Although, Mr Mezrani did carry out some business transactions after the death of Sammy Mezrani, my conclusion is that he was so affected that he "negligently", but not recklessly, overlooked the need to disclose the profit from the sale of the units to the tax agent who prepared his tax returns. Both Mr and Mrs Mezrani concede that they acted negligently and are prepared to meet the 25 percent penalty attracted by such conduct. Although their record-keeping was unsatisfactory, I have reached the conclusion that, looked at overall, their conduct amounted to negligence and did not satisfy the threshold required to make a finding of recklessness.

35. On the evidence, I do not consider that the Applicants' tax agent, Gateway Partners, demonstrated recklessness or carelessness with regard to the operation of a taxation law. As a result of the carelessness of Mr and Mrs Mezrani they were not made aware of the sales.

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Decision

36. For the above reasons, in respect of each application, the decisions of the Commissioner in relation to Mr Kenneth Mezrani for the years ended 30 June 2004 and 30 June 2005 should be set aside and, in substitution, the objections should be allowed and penalties imposed at 25 percent of the shortfall amount.

37. In relation to Mrs Najawa Mezrani, the decision of the Commissioner in respect of the year ended 30 June 2005 should be set aside and, in substitution, the objection should be allowed and a penalty imposed at 25 percent of the shortfall amount.

 

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