Taxing times: Robert Richards CPA looks at cases where time extensions are deemed not worthy, revenue loss versus capital gains tax loss, and looks again at winemaking issues.
Time extensions not warranted
Taxpayers could be forgiven following the decision of Justice Hill in Brown v FC of T (Federal Court, 6 May 1999) for believing that when they have failed to lodge an objection against an assessment, or an appeal against an objection decision, within the prescribed time that they should be granted extension as a matter of course.
This is because Justice Hill there concluded (in granting the taxpayer an extension of time within which to lodge an objection) that: 'What is required is the balancing of the delay; the explanation for it; the circumstances which gave rise to it and such prejudice if any as may be shown to exist to the [Tax Office] against prejudice which may arise to the taxpayer who has by reason of the failure to object in time lost the right to review of the assessment. In its balancing process the [Tax Office] on a review will be guided by what the justice of the case requires. The balancing process should be approached on the basis that while parliament has stipulated a time in which objections are required to be lodged it has entrusted to the [Tax Office] a power to extend that time in appropriate circumstances. The decision maker should not lose sight of the fact that [the extension of time provision] is an ameliorating provision designed to avoid injustices.'
However, a recent decision of the Administrative Appeals Tribunal illustrates that taxpayers should not expect such extensions as a matter of course.
In Spencer v FC of T (Administrative Appeals Tribunal, 30 March 2007), the taxpayer had been employed by Telstra and he instituted proceedings against Telstra claiming that it had unlawfully discriminated against him, and that Telstra and the taxpayer had settled the proceedings and their differences.
Telstra had agreed to pay a sum to the taxpayer by way of damages. The taxpayer, however, felt that there was no agreement and he presumably sought additional damages.
The Tax Office assessed the amounts that were paid to Spencer as an eligible termination payment. Spencer, however, claimed that the amounts should not have been included in his assessable income for the relevant year because he disputed those amounts, his solicitors had made withholdings from those amounts, and because Telstras solicitors had misdescribed the amounts.
That objection was disallowed but the taxpayer failed to refer the decision to the Administrative Appeals Tribunal within the 28-day period allowed by the Administrative Appeals Tribunal Act.
The Tribunal felt that an extension of time should not be allowed to the taxpayer, deputy president Forgie concluding: ' I do not consider that the case put forward by [the taxpayer] is one of merit. Despite the fact that I am not satisfied that there would be undue prejudice to the [taxpayer] if I were to extend time and I find [the taxpayers] delay is understandable, I do not consider that justice requires that I extend the time to permit him to lodge an application. Although [the taxpayer] would not agree, I do not consider that there are genuine issues between [the taxpayer] and the [Tax Office] that merit consideration almost five years after the [Tax Offices] assessment and after he had an opportunity to seek his review within the time allowed by the [Administrative Appeals Tribunal Act]. The matter has been settled, tax paid and the parties in Telstra made its arrangements accordingly.'
Seeking capital losses
The structure of the tax law is that while ordinary losses can be offset against both ordinary income and capital gains, capital losses can only be offset against capital gains. This is because the capital gains tax provisions are self-contained. One only brings to account ones net capital gains. In working out what is a net capital gain, someone is first allowed to offset against any capital gain made by them, any capital loss incurred either in the same-year income, or in a prior year of income. However, there is no provision in the tax law that gives a net capital loss any independent tax status.
This may present practical difficulties. Someone may incur a capital loss but unlike the case with ordinary income, they might have little ability to make a future capital gain an unfair tax law.
The decision in Price Street Professional Centre Pty Limited v FC of T (Federal Court, 14 March 2007) is an example of when a taxpayer hoped that a loss they incurred might be able to be categorised as a revenue loss rather than a capital gains tax loss.
However, the apparent facts there were weak, and one suspects that as so far as the taxpayer was concerned it was more a question of hope over substance.
Price Street Professional Centre Pty Limited was a shelf company effectively acquired by a solicitor on behalf of a Japanese businessman (the solicitor holding the shares in the company effectively for the benefit of that businessman). That company acquired a parcel of land in Rockhampton, which it claimed it acquired for the purposes of constructing student accommodation. However, at the time of acquisition of the land, the Japanese businessman foreshadowed that one day the land might be subdivided as a development project.
As part of an internal reorganisation in 1992 the company sold that land at a loss. The solicitor was then left holding an abandoned company. It appears the solicitor then caused that company to derive assessable income.
The solicitor decided that he should seek to have the capital loss incurred by the company recharacterised as a revenue loss so that it could offset that loss against that ordinary income subsequently derived by the company.
The Tax Office refused to allow the company to do this, and in the first instance the Administrative Appeals Tribunal (22 November 2005) agreed with the Tax Office. The company appealed against that decision to the Federal Court, which dismissed that appeal.
The court observed that real property is commonly regarded as a capital asset. It said that generally speaking, unless the sale of real property is made in the operation of a business, the resulting profit would not be income according to the ordinary concepts and usages of mankind.
The court agreed with the Administrative Appeals Tribunal that the land was acquired by the company simply for the purpose of providing student accommodation (notwithstanding the fact that the company felt that it might one day be sold or subdivided).
Furthermore, the court imputed the intention of the Japanese businessman to the company in determining what was the purpose of the company in acquiring the land.
I am not surprised by this decision. What I find most interesting is the fact that the Tax Office imposed a penalty equal to 75 per cent of the tax shortfall on the company as a consequence of the claim made by it.
One suspects that the Tax Office in imposing that penalty was influenced by the fact that a professional who could be expected to have some knowledge of tax law was responsible for the claim made by the company (while there it was a solicitor it could just as easily have been an accountant).
Also of interest is the fact that the tribunal rejected the taxpayers claim that the magnitude of the penalty was inappropriate because it acted on advice of senior counsel.
That advice was given orally. It may well be that had the taxpayer received written rather than oral advice, more attention would have been paid to the advice.
This suggests that before entering into arrangements that have possible adverse tax consequences, taxpayers should make certain they have contemporaneous written evidence to justify the action adopted by them.
More grape expectations
In the April 2007 edition of INTHEBLACK I remarked that the cases involving Part IVA continue to bubble along. There I referred to a case involving a taxpayer who participated in a winemaking venture (McPherson v FC of T, Administrative Appeals Tribunal 22 January 2007) who was denied a tax deduction, notwithstanding the fact that she entered into the winemaking venture for a genuine commercial purpose.
This was because notwithstanding that genuine commercial purpose, the dominant purpose of the taxpayer entering into the venture was to obtain a tax deduction.
Part IVA has formed part of the income tax law for more than 25 years now.
In spite of the fact that no competent tax adviser could with certainty determine in all instances whether or not Part IVA would apply, there are some instances where it is quite clear that it would not apply and other instances where it is quite clear that it will. But there are always borderline issues where it would be hard to determine.
To date the courts have been concerned with what are mostly borderline cases. More often than not the cases which come before the courts involve primary production 'tax shelters' (as a consequence, persons who enter into primary production arrangements looking for tax benefits should not be surprised that the Taxation Office will seek to apply Part IVA against them to deny them those tax deductions).
Such was the case in Iddles v FC of T (Federal Court, 23 March 2007). This case (as with McPhersons case) involved a winemaking venture. Here the taxpayer claimed tax deductions that were disallowed by the Tax Office, which caused the taxpayer to first refer those claims to the Administrative Appeals Tribunal.
The tribunal (17 August 2005) agreed with the Tax Office that Part IVA applied; in turn the taxpayer appealed against the Administrative Appeals Tribunal decision to the Federal Court.
The court agreed with the tribunal that the taxpayers dominant purpose in investing in the winemaking venture was to obtain a tax benefit.
One determines what a persons dominant purpose of entering into a scheme is by way of section 177D of the Income Tax Assessment Act 1936. That section lists eight factors which must be considered in determining the dominant reasons for entering into such a scheme. It is only by reference to those factors that a decision can be made as to whether or not the dominant purpose was to obtain a tax benefit.
The court reviewed the tribunals consideration of those eight factors. One should appreciate that when one appeals to the Federal Court from the Administrative Appeals Tribunal one only appeals on questions of law.
However, when one refers a matter to the Tribunal it can substitute its opinion for that of the Tax Office.
What this means in the present case was that all the Federal Court could do was to decide whether it was open to the Administrative Appeals Tribunal to come to the decision it had. It was not required to say whether or not that decision was right or wrong, and it could not substitute its view as to what the decision should have been.
Accordingly, the approach of the Federal Court was to look at each of those eight factors and decide whether it was open for the tribunal to come to the conclusion that it had in respect of each of those factors. After doing this it concluded that the tribunal was able to reach the decisions it had.
The problem with this approach is that it is not possible to determine which of those eight factors was the most important.
However, it is clear that where, as was the case here, the arrangements involved some round-robin financing arrangement without any short-term cash return to the taxpayer, one should suspect that Part IVA will apply to the arrangement.
