• The impact of this case on ATO policy is discussed in Decision Impact Statement: Mold and Commissioner of Taxation (Published 16 February 2012).

MOLD v FC of T

Members:
F O'Loughlin SM

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2011] AATA 823

Decision date: 18 November 2011

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Frank O'Loughlin (Senior Member)

1. In partnership with his wife, the applicant conducted a cabinet making business. In the lead up to and during the Goods and Services Tax periods from 1 April 2003 to 31 December 2005, and the income tax years ended 30 June 2003 and 2004, the applicant experienced difficulties that affected the business such that it was not as profitable as it might have been. Those difficulties include two serious medical conditions, one requiring surgery and the other requiring lengthy recuperation, that at times prevented the applicant from working and completing jobs he had contracted for. The surgery was required in 2002. The non-surgical condition occurred in August 2003, from which the applicant took a year to recover. There was a repeat episode of this condition in late 2006. Those conditions affected the applicant's business activities and his memory, and possibly his dealings with the Commissioner's officers that led to the current dispute.

2. Following an audit of the partnership business and the applicant's income tax affairs, the Commissioner assessed GST shortfalls associated with what the Commissioner contended were over claimed Input Tax Credits, GST shortfall penalties, Income Tax shortfalls associated with what the Commissioner contended were claims for deductions for business expenses which were not allowable, and Income Tax shortfall penalties.

3. The applicant claims that he has provided substantiation of the amounts claimed to the Commissioner. The Commissioner, having made searches, says it was not received. Limited substitute evidence of the amounts claimed is now available to the applicant.

4. There is no dispute as to the amounts of taxable supplies on which GST was imposed or the applicant's assessable income.

Issues for determination

GST and related penalties

5. Following the Commissioner's objection decisions, the disputed amounts of GST and penalty related thereto were as set out in Table 1 below.

Table 1

Table 1

GST and related penalty in dispute after objection
Quarter ended	Disclosed in applicant's BAS	ITCs accepted	Shortfall	Penalty %	Penalty
	GST on Sales	ITCs on purchases
30-Jun-03	$887.00	$1,966.00	$110.00	$1856.00	25	$464.00
30-Sep-03	$255.00	$1,417.00	$285.00	$1132.00	25	$283.00
31-Dec-03	$409.00	$2,041.00	$80.00	$1961.00	25	$490.25
31-Mar-04	$160.00	$1,272.00	$0	$1,272.00	25	$318.00
30-Jun-04	$603.00	$5,114.00	$0	$5,114.00	25	$1,278.50
30-Sep-04	$528.00	$2,829.00	$0	$2,829.00	25	$707.25
31-Dec-04	$576.00	$2,038.00	$0	$2,038.00	25	$509.50
31-Mar-05	$384.00	$1,689.00	$18.00	$1,671.00	25	$417.75
30-Jun-05	$420.00	$6,049.00	$282.00	$5,767.00	25	$1,441.75
30-Sep-05	$435.00	$2,614.00	$194.00	$2,420.00	25	$605.65
31-Dec-05	$530.00	$2,258.00	$258.00	$2,000.00	25	$500.00
	$5,187.00	$35,000.00		$35,000.00	50	$14,000.00
Totals		$64,287.00	$1,225.00	$63,060.00		$21,015.00

6. The $14,000 penalty for the December 2005 quarter BAS is the amount remaining after applying the 50 per cent rate to the shortfall amount and allowing a 20 per cent reduction because the Commissioner accepted that the applicant had made a voluntary disclosure after an audit had started.

7. After the applicant provided such substitute substantiation materials as became available to him, the Commissioner reconsidered his GST assessments. The question remaining in dispute is whether the applicant has demonstrated the shortfalls and penalties in Table 2 to be excessive, in the required sense.

Table 2

Table 2

GST And related penalty in dispute
Quarter ended	Disclosed in applicant's BAS	ITCs accepted	Shortfall	Penalty %	Penalty
	GST on Sales	ITCs on purchases
30-Jun-03	$887.00	$1,966.00	$390.28	$1,575.72	25	$393.93
30-Sep-03	$255.00	$1,417.00	$112.20	$1,304.80	25	$326.20
31-Dec-03	$409.00	$2,041.00	$179.96	$1,861.04	25	$465.26
31-Mar-04	$160.00	$1,272.00	$70.40	$1,201.60	25	$300.40
30-Jun-04	$603.00	$5,114.00	$265.32	$4,848.68	25	$1,212.17
30-Sep-04	$528.00	$2,829.00	$232.32	$2,596.68	25	$649.17
31-Dec-04	$576.00	$2,038.00	$253.44	$1,784.56	25	$446.14
31-Mar-05	$384.00	$1,689.00	$168.96	$1,520.04	25	$380.01
30-Jun-05	$420.00	$6,049.00	$184.80	$5,864.20	25	$1,466.05
30-Sep-05	$435.00	$2,614.00	$191.40	$2,422.60	25	$605.65
31-Dec-05	$1,501.00	$2,258.00	$660.44	$1,597.56	25	$399.39
		$35,000.00		$35,000.00	50	$14,000.00
Totals		$64,287.00	$2,709.52	$61,577.48		$20,644.37

8. The Commissioner has accepted the GST on sales amounts disclosed by the applicant. The Commissioner concedes that ITCs are allowable but only to the extent indicated, which is based on the industry standard for cabinet makers and at the upper end of the 28 per cent - 44 per cent range for costs of goods sold for a business in the $75,000 to $110,000 annual turnover bracket. For the December 2005 quarter, the shortfall is separated into two components because there was a particular claim for ITCs of $35,000 associated with a purchase of a factory from a related party that did not take place.

Income Tax and related penalties

9. The Commissioner has not altered his position concerning the income tax assessments as a consequence of the substitute substantiation materials provided by the applicant. The question in dispute is whether the applicant has demonstrated that the shortfalls and penalties in Table 3 are excessive, in the required sense.

Table 3

Table 3

Income tax and related penalty in dispute
	Year ended 30 June 2003	Year ended 30 June 2004
	applicant's tax return	FC of T's assessment	applicant's tax return	FC of T's assessment
Wages	$2,688.00	$2,688.00	$3,584.00	$3,584.00
Business income	$93,409.00	$84,917.00	$15,697.00	$14,270.00
Business expenses	$128,900.00	$61,876.00	$109,134.00	$29,856.00
Net income/ -Loss	$32,803.00	$25,729.00	-$89,853.00	-$12,002.00
Carried forward loss from prior year		$15,294.00		Nil
Taxable income	Nil	$10,435.00	Nil	Nil
Tax payable	Nil	$753.95	Nil	Nil
Tax shortfall		$753.95		Nil
Tax shortfall penalty		$188.49
Business income calculated as total supplies reported by applicant in BAS less GST
2003 year: $93,409 − $8,492 = $84,917
2004 year: $15,697 − $1,427 = $14,270

10. The business expenses allowed as deductions by the Commissioner were the amounts of the net bank statement withdrawals less an assumed cost of personal or private living drawn from the account. The assumed cost of personal or private living drawn from the account adopted by the Commissioner was the amount of the Australian Bureau of Statistics poverty line net cost of living less family non business income. The Commissioner concedes that, for the 2003 year, the deductions represent 72.9 per cent of business income. For the 2004 year they represent 209 per cent of business income.

GST matters

11. During the periods in dispute, the applicant's reported expenses comfortably exceed his sales. The explanation he offered entailed jobs done for free and losing money on jobs because his illnesses forced him to hire contractors to finish work for him.

12. The applicant has included in various months' claims the GST component of the purchase prices of materials used in the provision of free cabinet ware provided to related and unrelated people and the applicant has also included the GST included in the price of renovations to his residence - which he contends was not private work but rather work done for a non-profit organisation called "Stephen Mold, Supporters Voice". The applicant has not established the requisite nexus between the renovations on his residence and carrying on his enterprise to allow ITCs for these expenditures. Accordingly, on no view is the applicant entitled to all of the ITCs he has claimed. The quantum of all of the ITCs associated with the free supplies and home renovations and the periods to which they relate has not been ascertained on the evidence led.

13. During the course of his audit, the Commissioner sought substantiation of the ITCs claimed. The applicant insists that he provided his copies of tax invoices to the Commissioner by post and that is the reason he cannot provide them to the Tribunal in the present application. Those documents were not received by the Commissioner. I accept that the applicant did have a significant amount of documentation of the expenditures associated with his business and that he no longer has it as a consequence of at least attempting to provide it to the Commissioner.

14. As a surrogate, the applicant has provided only limited substitute substantiation of the ITCs claimed. This substantiation does not, without more and certain assumptions being made, support ITCs of the amount claimed.

15. The applicant contends that he is now at a disadvantage. He states that he is able to supply tax invoices for earlier periods, which would not be available now had they been asked for by the Commissioner's officers. The applicant contends that the tax invoices and BAS records for the earlier period throw light on what the applicant had for the periods in dispute before the records went missing.

16. The Commissioner accepts that the presence of invoices from earlier periods suggests that at the time the applicant lodged his BAS for the GST periods in dispute he did in fact hold some invoices. Moreover, the Commissioner concedes, correctly, that cabinet makers incur costs of goods manufactured and installed.

17. Where the primary or usual documents required to validate an ITC claim, i.e. tax invoices, have been lost, taxpayers can rely on alternative substantiation. The applicant's bank statements provide an incomplete coverage of the period relevant to these applications. The bank statements do not indicate what was being purchased or from whom. Further, the $139,301 total of withdrawals (net of reversals) falls materially short of the $322,157 total of purchases implied from the $29,287 ITCs on non-capital purchases claimed in BAS shown in Table 1. Acknowledging that he has had difficulty in securing assistance from suppliers who no longer have records that relate to the period under review, the applicant has provided limited statements from suppliers that do not account for the ITCs claimed. These documents do not demonstrate that the applicant is entitled to the ITCs he has claimed.

18. The applicant has provided records from earlier periods that he contends show his BAS for earlier periods were in order and show that but for providing the records to the Commissioner he would have the records for the period under review. The records of the earlier periods do not show that the applicant's business traded as unprofitably as it did for the review period; nor do these records show that the applicant traded within the usual industry profit margin norms.

19. For the most recent period where the applicant has not claimed that his invoices were lost in transit to the Commissioner's offices, the quarter ended 30 June 2002, the BAS disclosures, the records provided by the applicant and the Commissioner's review are as set out in Table 4.

Table 4

Table 4

Total sales implied from GST payable in BAS: ($GST*11)	Total purchases implied from ITCs claimed in BAS: ($ITC*11)	Total purchases reflected in invoices asserted by applicant	Total purchases reflected in invoices asserted by applicant upon review by the Commissioner
$29,931.00	$32,065.00	$28,622.57	$25,465.00

20. There are various problems with the invoices supplied by the applicant in corroboration of the total of purchases in earlier periods that his ITC claims imply. Some of the invoices supplied are for incorrect periods. One document is a statement of account not an invoice. Some invoices were issued to a company and not the applicant. Without any verification that the sales revenue and GST on sales is accurately stated (sales revenue being accepted by the Commissioner for present purposes), the 30 June 2002 quarter records reveal that before he suffered his illnesses the purchases made as part of the applicant's business were approximately 85 per cent of sales revenue. This percentage is somewhat less than the equivalent proportions disclosed by other BAS filed by the applicant as set out in Table 5.

Table 5

Table 5

Quarter ended	GST payable as per BAS	Total sales implied from GST payable in BAS: ($GST*11)	ITCs per BAS	Total purchases implied from ITCs claimed in Base: ($ITC*11)	Implied purchases as a % of implied sales
30-Jun-01	$1,090.00	$11,990.00	$1,272.00	$13,992.00	117%
30-Sep-01	$3,084.00	$33,924.00	$2,610.00	$28,710.00	85%
31-Dec-01	$2,848.00	$31,328.00	$2,986.00	$32,846.00	105%
31-Mar-02	$1,543.00	$16,973.00	$2,184.00	$24,024.00	142%
30-Jun-02	$2,721.00	$29,931.00	$2,915.00	$32,065.00	107%
30-Sep-02	$2,862.00	$31,482.00	$3,253.00	$35,783.00	114%
31-Dec-02	$3,272.00	$35,992.00	$3,426.00	$37,686.00	105%
31-Mar-03	$1,469.00	$16,159.00	$3,073.00	$33,803.00	209%

21. The Commissioner agrees that the presence of the invoices from earlier periods does suggest that at the time the applicant lodged his BAS for the GST periods in dispute he held some tax invoices. The Commissioner also agrees that the applicant should be allowed ITCs for purchases up to the maximum of the range set out in the document tendered entitled Cabinet Makers Industry Overview Performance Benchmarks for a business in the $75,000 to $110,000 annual turnover bracket - and that 44 per cent of sales revenue should be recognised as purchases. The Commissioner recognises an alternative approach consistent with the proportions of purchases to sales revenue for the June 2002 quarter - 85 per cent. However, this approach is not advanced by the Commissioner as it may reflect the outcome of expenditures on non-creditable acquisitions such as private expenditures and jobs done for free for family and friends.

Income tax

22. The Commissioner accepts the applicant's reported business income of $84,917 (GST exclusive) for the income year ended 30 June 2003. The Commissioner also accepts the applicant's reported business income of $14,270 (GST exclusive) for the income year ended 30 June 2004.

23. The applicant has not provided sufficient documentation to allow deductions as claimed in either the 2003 or 2004 year. For both years the applicant suffers the same problem as he does for his GST liabilities.

24. The Commissioner's assessments allow what he asserts is a reasonable amount for deductions for business.

25. For the 2003 year, the Commissioner has allowed $61,876. He determined this sum by calculating the total net bank statement withdrawals (less reversals) less the net cost of living (ABS poverty line less net family non business income). Consequently, the tax payable for 2003 is $753.95, after applying the carried forward losses from the previous year. It will be observed that $61,876 is 72.87 per cent of the sales revenue of $84,917.

26. For the 2004 year, the Commissioner has allowed $29,856, calculated on the same basis. Consequently, the tax payable for this year is nil with a carried forward loss of $12,002 to the following year.

27. The Commissioner also contends that the contention in support of the applicant's ITC position, namely that ITCs based on an industry average cost of goods sold of 44 per cent, could also be applied to determine the income tax deduction. However, the Commissioner does not propose that that happen.

GST and income tax conclusions

28. In this matter the applicant bears the onus of proving his assessments are excessive. However, a balance needs to be struck in circumstances where the applicant experiences difficulties because his attempts to do just that rendered him unable to do so.

29. Notwithstanding the applicant's assertions that all the amounts he claimed were legitimately expended and properly claimable, it is clear that the applicant cannot be entitled to the extent of the claims he has made. He has made claims that are not connected with furtherance of a business or enterprise.

30. Equally the applicant has produced enough documentation to show that he is entitled to ITCs and deductions for some of the amounts he has claimed, and a surrogate for tax invoices is to be used to determine an appropriate amount.

31. Is the industry range an appropriate surrogate? In circumstances where the applicant has suffered serious illness that has had undoubted impact on his business activities and capabilities, and in a relatively low turnover business, it can be readily concluded that he may not be within industry norms; and a relatively small variance in costs can have a significant impact on cost of goods sold as a percentage of sales revenue. Therefore, an allowance of something more than the industry average is appropriate.

32. The proportion of cost of goods sold to sales revenue for the June 2002 quarter might be too high, if it takes into account free jobs done for friends and family that are not connected with the furtherance of the applicant's enterprise and are essentially private matters.

33. Is consistency in approach between the two taxing systems desirable? Where the subject matter is common, as in this case it is for ITCs and deductions associated with the same business expenditures, consistency in approach is desirable. For the 2003 year, the approach that the Commissioner accepts is appropriate for deductions for business expenses would allow deductions of business expenses of 72.87 per cent of the sales revenue of $84,917. The applicant has not provided any basis for disturbing this allowance.

34. Given the link between business expense deductions and ITCs, the conclusion to be reached is that the same 72.87 per cent proportion of GST on sales revenue, across all GST periods, is to be allowed as ITCs. The results of such an allowance, including the recalculated shortfall, are as set out in Table 6.

Table 6

Table 6

GST in dispute
Quarter ended	Disclosed in applicant's BAS	ITCs to be allowed	Shortfall
	GST on Sales	ITCs on purchases
30-Jun-03	$887.00	$1,966.00	$646.36	$1,319.64
30-Sep-03	$255.00	$1,417.00	$185.82	$1,231.18
31-Dec-03	$409.00	$2,041.00	$298.04	$1,742.96
31-Mar-04	$160.00	$1,272.00	$116.59	$1,155.41
30-Jun-04	$603.00	$5,114.00	$439.41	$4,674.59
30-Sep-04	$528.00	$2,829.00	$384.75	$2,444.25
31-Dec-04	$576.00	$2,038.00	$419.73	$1,618.27
31-Mar-05	$384.00	$1,689.00	$279.82	$1,409.18
30-Jun-05	$420.00	$6,049.00	$306.05	$5,742.95
30-Sep-05	$435.00	$2,614.00	$316.98	$2,297.02
31-Dec-05	$1,501.00	$2,258.00	$1,093.78	$1,164.22
		$35,000.00		$35,000.00
Totals		$64,287.00	$4,487.33	$59,799.67

Penalties

GST (Non-capital acquisition ITCS) shortfalls

35. The Commissioner imposed an administrative penalty of 25 percent on the GST shortfall amounts in relation to the non-capital acquisitions, for the quarterly tax periods from 1 April 2003 to 31 December 2005. The applicant has not put forward any reason why that penalty, on that basis, ought not be imposed on the adjusted shortfall. He has not substantiated his claims and has not led any evidence that shows he has taken reasonable care in filing his BAS. The applicant has made claims for private expenditures. The applicant has also made claims that are inordinate when compared with income levels and has not substantiated them, notwithstanding that he has been provided with ample opportunity to do so. The 25 per cent penalty is to remain payable on the adjusted shortfall set out in Table 6 above.

GST (Capital acquisition ITCS) shortfalls

36. The Commissioner imposed an administrative penalty at the recklessness or gross carelessness 50 per cent rate on the GST shortfall amount in relation to the capital acquisitions for the December 2005 quarter. This was on the basis that the applicant knew the sale did not take place. The Commissioner reduced this penalty by $3,500 as the applicant made a voluntary disclosure after the audit process commenced.

37. A critical aspect of the test for recklessness is gross carelessness. Gross carelessness is the appropriate characterisation of statements upon which a tax liability or an entitlement to a refund will be determined made by someone grossly indifferent as to whether there is a risk of its correctness and a reasonable person in the position of the statement maker would appreciate that risk.^[1] See in BRK (Bris) Pty Ltd v Commissioner of Taxation 2001 ATC 4111 ; [2001] FCA 164 at [77] per Cooper J and its endorsement by the Full Federal Court in Hart v Commissioner of Taxation 2003 ATC 4665 ; (2003) 131 FCR 2003 at paragraphs 33 and 43.

38. Notwithstanding the applicant's contentions that:

• (a) he had advice that he could reorganise his affairs and purchase the factory and raise debt finance for the purchase which would become available to him given the related party nature of the transaction;
• (b) he contacted the ATO to obtain advice as to how he should account for the GST on the purchase and that he acted in accordance with that advice; and
• (c) when telephoned by one of the Commissioner's officers about the claim made, or the size of the refund that would have issued if not stopped, he immediately withdrew the claim and offered to file another BAS;

it is clear that the applicant knew that the claim was made in circumstances where the purchase had not been made. That is sufficient to be regarded as being reckless in making a claim. It does not matter that the Commissioner detects a false statement before a taxpayer enjoys either a reduced tax burden or a tax refund that would otherwise arise in the absence of detection. The Commissioner's early detection is not a relevant consideration in these matters.^[2] See Dixon v Federal Commissioner of Taxation 2008 ATC ¶10-047 ; (2008) 167 FCR 287 at [21] per Spender, Ryan and Emmett JJ. Recklessness is the proper basis on which the penalty ought be calculated in the circumstances.

39. The Commissioner contends that the penalty ought only be remitted by 20 per cent under s 284-225 of Schedule 1 to the Taxation Administration Act 1953 (C'th).

40. On other occasions, the Commissioner has remitted the penalties by 80 per cent, recognising that a voluntary disclosure after notification of the audit, which is considered to save the Commissioner significant time and resources in the audit, warrants this treatment.^[3] See Intevox Pty Ltd and Commissioner of Taxation 2010 ATC ¶10-121 ; [2010] AATA 57 Moreover, at the time of the applicant's voluntary disclosure the Commissioner had a ruling (MT 2008/3) in which he said that a balance is to be drawn between taxpayers who sit back and wait until detection is inevitable and then disclose, and those who disclose before that time; with the greater concession extended to the latter group. However, the Commissioner also said that as a general rule a taxpayer will be treated as having disclosed voluntarily before being informed that an audit is to be conducted where, during the initial notification of the audit, the tax officer invites the taxpayer to make a voluntary disclosure within a specified period or by a specified date, and the taxpayer makes a full disclosure within that period or by that date. In these circumstances, the penalty in excess of $1,000 otherwise attracted will be reduced by 80 per cent.

41. The relevant sequence of events is that the initial auditor contacted the applicant on 12 January 2006 and offered the opportunity to make a voluntary disclosure of any problems with the December 2005 quarter BAS. Observing what is said to be normal practice, the auditor informed the applicant that this BAS had been selected for an audit and advised him to re-check the amounts reported on the BAS. The auditor asked the applicant to advise the ATO of any errors either before or with provision of any requested documents. It was made clear that if he did so, any applicable penalties may be reduced due to a voluntary disclosure made at the start of the audit.

42. On 17 January 2006 the applicant made a request to amend his BAS, as payments had come through which should have been attributed to the period ended 31 December 2005. On 23 January 2006 the applicant advised the Commissioner that the BAS amounts should be changed to reflect the fact that the factory sale had not happened.

43. This is a marginal case. It is not entirely clear what would have happened had a refund of the magnitude claimed been paid. Nor is it clear whether the applicant was sitting back, hoping not to be detected. Absent the ruling referred to above, it is unclear whether the applicant should be treated as having made his disclosure before the audit was notified. With the ruling, on balance, he should be so treated and an 80 per cent reduction in penalty allowed.

44. The 50 per cent penalty for the capital acquisition ITC shortfall is to be remitted by 80 per cent, such that the penalty payable is to be 10 per cent of the shortfall.

Income tax shortfalls

45. For the same reasons as penalty is properly imposed on GST shortfall amounts in relation to the non-capital acquisitions for the quarterly tax periods from 1 April 2003 to 31 December 2005, the administrative penalty at the rate of 25 per cent imposed on the income tax shortfall amount for the income year 2002/03 is not excessive. Further, that level of penalty should not be further reduced or remitted.

46. The objection decision in relation to this penalty is confirmed.

Decision

47. For the reasons set out above, the decisions under review are set aside to the extent set out above and the objections are to be allowed to the extent set out above.