Tax litigation: you cannot win a tax case without good evidence on your side. Andrew O'Bryan and Sally Scott define 'evidence', explain how the courts use it and provide tips for running a good case.
The role of an accountant in the success of tax litigation cannot be underestimated. Obviously the advice given to a client by an accountant before any legal proceedings are important in helping a client follow the law. However, the evidence that is created and retained by an accountant at that time can have consequences should a client end up in court appealing an ATO decision.
Judges can only work with what they are given. While your legal arguments and allegations may be the skeleton of your case, the evidence is the meat and the muscles that hold everything together and will determine whether you walk confidently or stumble.
The evidence you give to the court to show you are legally right is essential to your case. You cannot win without good evidence on your side even if you have the better legal argument.
In our previous article, 'To appeal or not to appeal' (INTHEBLACK, June 2008), we stressed the importance of the strength of your evidence when deciding whether to run an appeal. In this article, we continue our exploration of defining evidence and how the courts use it, and give you some practical tips to ensure you put your best foot forward when running a case.
Court cases are determined by reference to the law and facts, both of which are often in dispute.
During a court case, lawyers representing each party will present evidence in an effort to establish their client's version of the facts (unless facts are agreed upon) and make submissions to establish how the relevant law is to be interpreted and applied to the facts.
The judge (or member in AAT cases) will then make a decision in relation to both the facts (unless facts are agreed) and the law, leading to the result in the case.
Facts: the importance of evidence
Truth and justice always prevail. Well, we would all like to think so. In fact, this is an idealistic myth. It is the strength of the evidence that is available to prove a particular version of the facts that prevails. Not as sexy, but accurate.
Put simply, a case can be won or lost based on the evidence that is available to prove facts. Your client might tell you that a version of facts is true, such as the client's reason for being involved in a certain transaction. You may believe your client is honest and genuine and that their version must be right.
You may also know (or at least believe) that this version is true if you were involved in advising on the transaction at the time. However, this does not necessarily mean a court will accept the true version of the facts.
A court can only make a decision based on available evidence.
If: there is no documentary evidence to support a version of the facts; there is documentary evidence that supports another version of the facts; or the oral evidence given in court is discounted because of a poor performance in the witness box (caused by, say, nerves) then a case can be lost, regardless of the true facts.
Give your client the best shot at winning a case (and protect yourself from liability)
Keep proper records and assume every file note, letter or memo you write will be produced in court.
Good evidence is essential to success in a court case and a client's professional adviser (whether a legal or accounting adviser) plays an important part in providing it. Too many cases are lost in circumstances where legal arguments are good but the supporting evidence is poor.
Evidence can be documentary or oral. Documentary evidence can include letters, file notes, memos, balance sheets, financial reports and your files as a whole.
Further, Australian courts have, in recent years, expanded the definition of 'documentary evidence' to include electronic documents such as emails, spreadsheets and even video and picture files. This opens up new sources of evidence such as computer hard drives and computer system back-up tapes.
Tip 1: Make and retain records of communications Good evidence is essential to success in a court case, and a client's professional adviser plays a major role with this. Making and retaining accurate documentary records (including file notes and source documents) is imperative. Don't let a case be determined on oral evidence alone. Documentary evidence is critical.
If a client told you of, say, the reason for entering into a transaction and you made an accurate file note of this conversation at the time and then some six or so years later your client needed to prove this fact in court, your file note could be critical evidence. On the other hand, if you did not make a file note at the time, the only evidence available may be oral (your client's evidence and your evidence if you have an extremely good memory).
Further, in relation to accounting documents, it is common for an accountant who prepared the document to give evidence that, from the accountant's own knowledge, the accounting document sought to be relied on was prepared by him or her and is accurate (often the accountant is then being cross-examined by the other side on issues such as a document's accuracy). Relying on memory alone is generally far from ideal.
Merely relying on oral evidence in a court case involves considerable risk. The strength of oral evidence normally goes hand in hand with a judge's impressions of a witness. Was the witness believable? Did the witness sound confident in their evidence? What impression did the witness make on the judge overall?
The judge's impression of a witness could be influenced by nerves in the witness box, credibility, memory, ability to stay calm and not get frazzled during cross-examination, intellect and ability to listen carefully to, and not misinterpret, a line of questioning. Going into a court case with only oral evidence of a critical disputed fact is fraught with danger and highly unpredictable.
The evidence-creation process begins once you shake your client's hand for the first time. A file that is complete and well maintained will not only help your client but may also avoid a negligence claim against you if a client is advised that certain evidence critical to their success has been lost or destroyed by you, or even not created.
It is often too late to start thinking about what evidence might exist once litigation is contemplated. Usually by this time email folders have been emptied and the 'trash' deleted, and physical files may have been lost (or destroyed). The very brief and unreadable file notes you took, believing at the time that no one would ever look at them again, suddenly become critical to your client's prospects of success.
Some accounting firms and other organisations are starting to keep electronic files only. While this can be adequate for evidentiary purposes, systems are necessary to ensure electronic files are adequately maintained.
It is important that your files (whether electronic or hard copy) be complete and well maintained. To assist your client in the event that they are sued (or decide to sue someone else), you should always:
ensure that all correspondence is reviewed and kept
back up your email folders to a CD / DVD (this is particularly important given the exponential growth in the use of emails and the court's acceptance of emails as documents capable of constituting good evidence)
take a few minutes after a telephone conversation with your client to review your file note and supplement any notes that others may not understand in the future
ensure that all physical files are kept for at least seven years
organise your documents (a key document that cannot be located because it is wedged between thousands of pages of rubbish, is in the back of someone's car or is in the wrong file is of no use)
Tip 2: Make sure your records of communications are accurate Even worse than failing to make a file note could be making a file note that either contradicts the true facts or casts doubt on them. Accurate file notes are a must.
Tip 3: Always assume your notes and correspondence could end up in court Not only is it important to maintain notes, it is also important to realise that your notes and correspondence in any matter could end up in court.
No one likes to think that their files will one day become the subject of intense public scrutiny. However, operating as if they might be from the outset will help you if the worst-case scenario eventuates.
Although it is a given that you would not be advising a client to engage in, say, a Part IV arrangement, a file note that is ambiguous, inaccurate or incomplete might be interpreted in the wrong way.
This may, in some circumstances, leave both you and your client exposed.
There have been cases where file notes containing racist comments or comments degrading a client have been required to be produced in court because of other information contained in the documents.
The golden rule is to assume that all communications may be seen by the public.
Tip 4: Don't assume certain documents will be privileged Another trap is to assume that all documents containing advice (whether given by accountants or lawyers), communications with lawyers or communications relating to legal issues or legislative interpretation, are always privileged. This is dangerous.
Deciding whether or not a document is privileged can involve complex analysis, so an assumption without adequate legal consideration can be risky. Further, even if a document was at one point privileged, privilege may be lost at a later time due to, say, disclosure of a related document.
Tip 5: Don't assume that deleted computer records can't be retrieved Another trap is to assume a deleted email or document can't be retrieved and later produced in court. Deleted computer communications and records can be retrieved.
Tip 6: Be wary of destroying documents You are no doubt aware of the legislative requirement to keep tax and other particular records for five years under the Income Tax Assessment Act 1997 and seven years under the Corporations Act 2001. But did you know that in Victoria destroying a document, even after more than seven years, that is likely to be required as evidence in a legal proceeding could result in significant penalties (including imprisonment and hefty fines)?
Tip 7: Legal professional privilege. Don't count on it Legal professional privilege can prevent a protected document from being produced in court. This could be important.
Consider written advice that states that a tax objection is not likely to succeed. Keeping this document from being produced in court would be important.
There are two problems for accountants in relation to privilege. Firstly, they do not enjoy the same privilege that applies to lawyers. Secondly, and this applies to lawyers as well, even where a document is privileged, that protection can be lost.
Broadly, legal professional privilege protects the following communications:
lawyer / client: communications between a lawyer and client for the dominant purpose of providing legal advice or preparing for existing or anticipated litigation
lawyer / client's agent: communications between a lawyer and a client's agent for the dominant purpose of providing legal advice or for the purpose of obtaining information necessary for existing or anticipated litigation
lawyer / third party: communications between a lawyer and a third party made for the dominant purpose of obtaining information necessary for existing or anticipated litigation
client / third party: communications between a client (or the client's agent) and a third party for the dominant purpose of obtaining information for the client's lawyer to enable advice on existing or anticipated litigation
Currently, there is no equivalent privilege for accountants. Unless communications involving accountants fit within one of the above categories, communications will not be protected by privilege.
Even if a communication is privileged, the protection can be lost. The most common instance when privilege is lost is where it has been waived. This extends to situations where there is an express / intentional waiver by a client and also where there is an implied/inadvertent waiver. Examples of the latter include where there has been disclosure of the same subject matter or associated material.
Although lawyers and accountants have no power to expressly waive privilege, they can inadvertently waive privilege by, for example, forwarding or discussing privileged documentation, subject matter or associated material to another entity. Such a waiver of privilege could not only result in a client losing a court case, but could also leave the lawyer / accountant exposed to a claim by a client.
It is also worth noting that privilege will not extend to communications in furtherance of a crime or fraud, even if they would otherwise fall within a protected category of privilege. This could include communications in furtherance of a Part IV offence.
The Australian Law Reform Commission report (number 107) Privilege in Perspective: Client Legal Privilege in Federal Investigations (December 2007) recommended the creation of a 'tax advice privilege' to protect the confidentiality of tax advice given by independent professional accounting advisers from the information-gathering powers of the commissioner of taxation.
While nothing has been formally decided, the first step has been taken and we will be watching the government closely to see how it deals with this recommendation.
So where to from here?
Knowledge and awareness of the importance of evidence and your involvement (including how you can help and what traps to avoid) are the first steps. Next, extend that knowledge and awareness to your colleagues. Discuss the issues among yourselves. Create systems to help. Then, educate your clients.
Finally, put all of your knowledge, awareness and systems into action and create and maintain those files.
Sally Scott and Andrew O'Bryan are partners of law firm Hall & Wilcox. Together with Keith James, they head the firm's tax litigation practice, which incorporates both the tax and litigation expertise at the firm. They have handled many prominent tax litigation cases.
