Robert Richards examines a tax assessment challenge, GST and credit claimed, and a theatrical case
When the High Court limits tax appeal rights
The traditional approach to contesting a tax assessment is by way of what are known as 'Part IVC proceedings', being Part IVC of the Taxation Administration Act 1953.
What this means is that if a taxpayer wants to challenge an assessment the taxpayer has to first object to it. If the objection is disallowed, the taxpayer has to either refer the objection decision to the Administrative Appeals Tribunal or appeal it to the Federal Court.
Part IVC proceedings are not taxpayer-friendly. As a consequence I am always looking for ways of challenging an assessment other than under Part IVC. But this is difficult, particularly if a taxpayer wants to challenge the validity of an assessment.
This is because in challenging an assessment under Part IVC the taxpayer is limited by section 175 of the Income Tax Assessment Act 1936, which says: 'The validity of an assessment shall not be affected by reason that any of the provisions of this Act have not been complied with.'
The accepted view is that if a taxpayer wishes to challenge an assessment, provided that the assessment has been made bona fide, it goes to the subject matter of the tax legislation, and does not go beyond the Tax Office's powers. Reassessment cannot be challenged other than under Part IVC. This is the so-called 'Hickman principle'. (R v Hickman, Ex parte Fox and Clinton, High Court, 5 September 1945).
In practice it is difficult to persuade a court to accept that an assessment has not been made bona fide and that the purported assessment can be challenged otherwise than pursuant to Part IVC.
Last year, however, the Federal Court allowed a taxpayer to challenge an assessment otherwise than under Part IVC (see Futuris Corporation Limited v FC of T, 2 June 2007; also see INTHEBLACK, August 2007 p. 61).
A public company, Futuris carried on several businesses through a number of divisions, one of which was its business products division. It decided to sell that business. But it first had to sell the business of one of its subsidiaries to another. It then sold the shares in the latter company.
This led to a dispute between it and the Tax Office as to the amount of the capital gain made on the sale. The Tax Office issued one amended assessment assessing Futuris one way, and a second amended assessment in which it made a Part IVA adjustment.
In doing so it assessed the same amount for tax twice; that is it made a deliberate 'doubling up' of the tax assessed.
Futuris argued before the Federal Court that the second amended assessment, which the Tax Office knew caused a 'doubling up' of the amount assessed, was not a bona fide assessment and thus should be set aside. The Full Federal Court agreed with Futuris.
However, the Tax Office appealed against the decision of the Full Federal Court to the High Court. The High Court allowed that appeal (1 July 2008).
The High Court held that a taxpayer |is limited to Part IVC appeals unless the Tax Office has made 'jurisdictional error'; that is, it issued an assessment it did not have jurisdiction to do.
It held that the Tax Office did not apply the tax law to facts it knew to be untrue, that there was no absence of known facts attaching to the second amended assessment, and that 'there was no jurisdictional error vitiating that assessment.'
It effectively ignored that part of the Hickman decision that indicated there were exceptions to the 'Hickman principle' and perhaps relegated the case to history.
Not long after the High Court decided the Futuris appeal, the Full Federal Court decided an appeal in Bonnell v FC of T (18 August 2008) although the Federal Court did not refer to the Futuris decision. This case also involved a taxpayer seeking to take advantage of one of the exceptions to the 'Hickman principle'.
Bonnell, a solicitor known for his association with 'controlling shareholder superannuation scheme arrangements' (see for example INTHEBLACK August 2008, p. 70-71) had claimed a deduction of $5 million for an amount contributed by him to a superannuation scheme.
The Tax Office disallowed the claimed deduction and assessed Bonnell to additional tax of $606,250. It refused to remit that tax. Bonnell wanted to contest the validity of the assessment under the Judiciary Act (and not Part IVC). The Full Federal Court refused to allow him to do so.
The Federal Court felt that Bonnell's pleadings were bad, as a consequence it is not possible to say whether or not the court would have been prepared to say that Bonnell could argue that the Tax Office's failure to remit the penalty was part of an assessment made in bad faith.
I have some difficulty in accepting the High Court's decision in Futuris (and I want to see what the Federal Court will make of it).
It seems to me that the High Court did not give enough attention to a fundamental question, namely, was there a valid assessment or not? It seems to be saying that an assessment is an assessment just because there is a piece of paper saying it is.
However, there is another case that I expect to be handed down in the very near future (I have responsibility for the carriage of this case) that should indicate how the Federal Court will apply the High Court's decision in Futuris.
That case, to be known as Kocic v FC of T, involved the Tax Office issuing amended assessments increasing a husband and wife's assessable income while refusing to recognise that there might also be additional offsetting deductions.
However, there is a twist to the case. The taxpayers' amended assessments were based on books the taxpayers claimed were improperly seized by the New South Wales police. As a consequence the taxpayers say that the assessments were also improperly made.
I expect to be writing about that case next month or soon after. The case was heard in June and the court promised a speedy decision.
Theatrical tax deductibility: not always black and white
The decision in De Simone v FC of T (Administrative Appeals Tribunal, 13 August 2008) involved two brothers who invested by way of participation in a partnership in a theatrical production known as Jolson:
The Musical. It was produced by lawyer Michael Brereton. A share in the partnership cost $500,000 of which $400,000 was to be borrowed by each of the partners from a nominated financier who would have recourse only to the income of the production. The De Simone brothers each acquired a half partnership interest. The production only ran for a limited season, as a consequence the partnership did not call on the borrowings.
Nevertheless, each brother claimed a deduction for the whole $250,000 both paid and committed by them to the partnership.
The Administrative Appeals Tribunal refused to allow them a deduction except for the actual amounts expended by them. This was because there was no evidence that the balance had been spent, which makes me wonder what was the point of the case? The Tribunal did not document the brothers' arguments, but they must have had some.
The Tribunal also said that Part IVA applied to disallow a deduction. The tribunal said, 'It could be readily concluded, looking objectively at the arrangement, that the promoter and the partners entered into the scheme purporting to borrow funds to increase the claim for expenditure beyond that actually incurred for the purpose of obtaining a tax benefit by inflating the amount sought to be deducted.'
The decision, which is not of great importance, is simply another example of the difficulty taxpayers have of claiming a geared deduction. A holy grail of tax planning is the allowance of deductions for amounts not actually expended.
However, the tribunal made one commonsense observation in determining the amount of penalties. While apparent to taxpayers, it is not always appreciated by the Tax Office. That is, it observed and apparently had no objection to the brothers' claim that they 'saw their tax position of simply being a cash-flow benefit by obtaining a tax deduction in the first year but having income from the production assessed in the second year, the bulk of which would not be recovered but paid to the financier.
It seems that here the tribunal recognised that a scheme should not be defeated simply because it was entered into to create some cash-flow advantage.
GST and paperwork in order
Goods and services tax is not payable unless a taxpayer makes a 'taxable supply'. Someone does not make a 'taxable supply' unless (inter alia) 'the supply is made in the courses of furtherance of an enterprise that the taxpayer carries on' (section 9-5 of A New Tax System (Goods and Services Tax) Act 1999).
An enterprise includes an activity, or a course of activities done 'in the form of a business' (section 9-20 of the Act). 'Business' is defined (section 195-1 of the Act) to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee.'
Not only is goods and services tax not payable unless a supply is made in the course or furtherance of an enterprise but no claim can be made for a goods and services tax credit unless a thing was acquired in the carrying on of an enterprise (section 11-15 of the Act).
The latter restriction is of particular significance to those taxpayers who incur losses in the course of what they believe is a business. There is no equivalent in the goods and services tax legislation to the non-commercial losses provisions contained within the Income Tax Assessment Act 1997.
In seeking credits for goods and services tax a taxpayer should ask if there is any difference between the income tax law and the goods and services tax law as to what is required for there to be the carrying on of a business (a tax deduction for losses might not be allowed unless the loss was incurred in carrying on a business).
The decision in D'Arcy v FC of T (Administrative Decisions Tribunal, 13 August 2008) would indicate that there is not.
D'Arcy was involved with others in breeding thoroughbred horses. D'Arcy claimed that he was entitled to claim goods and services tax credits in respect to shares of supplies acquired by him in the carrying out of that activity, which he said was a business. The Tax Office disagreed with him.
This lead D'Arcy to unsuccessfully appeal to the inistrative Appeals Tribunal. One reason why his appeal was unsuccessful was that D'Arcy's evidence was somewhat sparse. However, he could show that over a period of time he had an interest in up to eight mares. The Tax Office said that this was not enough for there to be a business.
One might think that the words 'in the form of' as used in the goods and services tax legislation would indicate that what needs be satisfied for goods and services tax purposes is not as strict as the carrying on a business test that might need to be satisfied for income tax purposes. That is, it is arguable that provided there is a business, a goods and services tax credit should be allowed.
However, the tribunal did not consider that nuance. It was particularly concerned that there was not much likelihood of a proft being made, although it cited no evidence to show whether this was the case or not.
Rather, in deciding that D'Arcy was not carrying on a business, the tribunal seemed to adopt what might be described as a 'bureaucratic approach' to the 'in the form of business' test.
Broadly, it seemed as much obsessed with the lack of paperwork than anything else. It seemed to be of the view that whether a business exists or not depends on whether there is a paper trail or not, quite at odds with what actually happens in small business.
The case is an example of the importance of documentation. While I tend to be cynical and can see the obvious temptation to create self-serving documents, it seems that taxpayers will be unable to prove that they carry on a business unless they can produce business plans and the other sort of documentation that public servants and laptop-wedded Generation Xs love.
Robert Richards CPA is a solicitor specialising in tax and superannuation law.
