Carioti and Commissioner of Taxation (Taxation)

Carioti and Commissioner of Taxation (Taxation) [2017] AATA 62 (25 January 2017)
Division:TAXATION & COMMERCIAL DIVISION
File Number(s): 2014/1471
Re:Francesco Carioti
APPLICANT

AndCommissioner of Taxation
RESPONDENT

File Number(s): 2014/1474
Re:Marisa Carioti
APPLICANT

AndCommissioner of Taxation
RESPONDENT

File Number(s): 2014/1484
Re:Roy Spagnolo
APPLICANT

AndCommissioner of Taxation
RESPONDENT

File Number(s): 2014/1485
Re:Amanda Spagnolo
APPLICANT

AndCommissioner of Taxation
RESPONDENT

DECISION
Tribunal:Deputy President S E Frost
Date:25 January 2017
Place:Sydney

Objection decisions affirmed.
..........................[sgd]..............................................
Deputy President S E Frost
Catchwords
TAXATION AND REVENUE – loss – characterisation of ‘loan agreement’ – characterisation of ‘acknowledgement of debt’ – whether obligations as guarantors satisfied – whether notice of claim presented to guarantors – administrative penalty – whether Applicants’ conduct reckless or a failure to take reasonable care – objection decisions affirmed
Legislation
Taxation Administration Act 1953 (Cth) ss 14ZZK, 284-90(1), 298-20
Cases
BRK (Bris) Pty Ltd v Commissioner of Taxation [2001] FCA 164
Federal Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149
REASONS FOR DECISION
Deputy President S E Frost
25 January 2017
INTRODUCTION

Following the Commissioner’s audit of the tax affairs of the Applicants and their associated entities, an amended assessment was made in relation to one of those entities, a unit trust known as the Percival Road Unit Trust (PRUT), for the 2007 income year. The amended assessment reflected the disallowance of a $4.3 million capital loss which the Commissioner concluded, and the Applicants accept, was not incurred by the PRUT.
As a consequence, the PRUT had an additional $4.3 million available for distribution to its unit holders. That amount was distributed as to 50 per cent to a discretionary trust controlled by Mr and Mrs Carioti (the first and second Applicants in these reviews), and as to 50 per cent to a discretionary trust controlled by Mr and Mrs Spagnolo (the third and fourth Applicants). From those discretionary trusts, distributions flowed to each of the Applicants personally.
The Commissioner then amended the Applicants’ assessments for the 2007 income year to take account of those additional distributions. Furthermore, administrative penalty equal to 50 per cent of the tax shortfall was imposed in each case, on the ground that the tax shortfall resulted from recklessness as to the operation of a taxation law.
Each of the Applicants objected against their amended assessment and against the assessment of penalty. They claim their respective discretionary trusts are entitled either to a deduction, or to a capital loss, equal to the amount of additional income attributed to it. The Applicants claim that each of their trusts guaranteed a loan which the borrower became unable to service, and that the lender called on the guarantors to cover the outstanding loan amount. The Commissioner did not accept the Applicants’ claims and disallowed each of the objections. The Applicants have now applied to the Tribunal for review of the objection decisions.
THE RELEVANT ENTITIES
It is convenient to start by listing a number of the entities involved in the arrangements that led to the dispute:
·The Percival Road Unit Trust – the trustee of which, in the 2007 income year, was Brenex Nominees Pty Ltd;
·The St Ives Trust – in the 2007 income year:
othe St Ives Trust was a unit holder of the PRUT; and
othe trustee of the St Ives Trust was M & F Carioti Pty Ltd;
·The Eels Trust – in the 2007 income year:
othe Eels Trust was a unit holder of the PRUT; and
othe trustee of the Eels Trust was R & A Spagnolo Pty Ltd;
·The Sine Trust – in the 2007 income year:
othe trustee of the Sine Trust was Sine Two Pty Ltd;
oeach of the Applicants was a director and shareholder of Sine Two;
othe St Ives Trust and the Eels Trust were unit holders of the Sine Trust;
·Roy Spagnolo & Associates (RSA):
oThe registered tax agent for the PRUT, the St Ives Trust, the Eels Trust and the Sine Trust;
oLodged the 2007 tax returns for each of the Applicants, the PRUT, the St Ives Trust, the Eels Trust and the Sine Trust;
·Flurrie Pty Ltd:
oThe trustee of the Darling Street Balmain Unit Trust.
THE ISSUES
The dispute between the Applicants and the Commissioner is centred on the following questions:
·Did Sine Two lend money to Flurrie between 2003 and 2007, and if so, how much did it lend?
·Did R & A Spagnolo and M & F Carioti guarantee any debt owed by Flurrie to Sine Two?
·Was Flurrie unable to repay the debt, and if so, did Sine Two write off the debt and call on the guarantee by R & A Spagnolo and M & F Carioti?
·If so, did R & A Spagnolo and M & F Carioti satisfy their obligations as guarantors?
·What, if any, are the tax implications?
The Applicants bear the burden of proof: s 14ZZK of the Taxation Administration Act 1953 (Cth) (TAA).
THE FACTUAL BACKGROUND
Mr Carioti and Mr Spagnolo have known each other since their school days.
Mr Carioti has worked in the building industry for over 40 years. He is a qualified architectural draftsman but started out operating a concreting business in the early 1970s. In 1986 he expanded his operations to more general building activities and then did some work as a project manager. He became a business partner of Mr Spagnolo in 1993 for the purpose of undertaking property development projects.
Mr Spagnolo’s background is as an accountant and tax agent. He obtained his accounting qualifications in 1977. He started his working life as a trainee accountant but in late 1984 he set up his own accounting practice, RSA. Initially he operated that practice part-time but in 1986 he left his main employment and started operating RSA full-time. The firm continues to operate but Mr Spagnolo himself no longer practises. The firm has virtually no ‘outside clients’; the work it does is for Mr Carioti and Mr Spagnolo and their associated entities and the various unit trusts they have set up to conduct their property development activities.
Since Mr Carioti and Mr Spagnolo started working together they have been jointly involved in about 25 property investment and development projects, either on their own account or with other investors. They generally adopt the practice of establishing a new unit trust for each new project and, usually, incorporating a company to act as the trustee for each new project. They refer to their companies collectively as the ‘Brenex Group’.
The Brenex Group’s financial arrangements
In the late 1990s Mr Spagnolo started borrowing money from family members and close family friends to help finance some of the projects he and Mr Carioti were involved in. The amounts he borrowed would generally range between $100,000 and $300,000 at a time. According to Mr Spagnolo the borrowings were generally at interest but the arrangements were rarely in writing.
Eventually the total amount borrowed became quite significant. Mr Spagnolo decided to establish a company, Clientele Investments Pty Ltd, as an ‘internal finance company’ for the Brenex Group. As he explained in his affidavit, Exhibit A2:
[18]     … [Clientele Investments] received amounts and made payments on behalf of members of the Group but did not itself undertake other business activity. Nor was it a party to any transactions. Thus, for example, if a company needed to make a mortgage repayment to the bank, the payment would be made by Clientele Investments on its behalf, with appropriate entries made in the accounts maintained by Clientele Investments.
[19]     This change also meant that rental income generated by members of the Group, as well as additional borrowings by members, were deposited with Clientele Investments. Thus, for example, if the company was able to increase its borrowing because a property had increased in value, the additional funds would be deposited with Clientele Investments. Often funds were transferred directly to Clientele Investments’ bank account, with appropriate entries made in the accounts maintained by Clientele Investments.
[20]     The entries in the accounts of Clientele Investments were made by employees of RSA. Effectively, these entries established a running account between Clientele Investments and each other member of the Group. Thus, for example, the deposit with Clientele Investments of additional borrowings obtained by a company gave rise to a credit entry in favour of the company, whilst a payment made on behalf of a company gave rise to a debit entry.
[21]     Where there was a transaction between members of the Group, for example, a payment from one member to another, the respective running accounts of the two members would be adjusted to reflect the transaction between them.
In this way Clientele Investments effectively became a ‘clearing house’ for the Group generally. Some companies in the Group would have a credit balance with Clientele Investments and some would have a debit balance, but the overall net position for Clientele Investments was always a nil balance.[1]
[1] Exhibit A3 at [19]
In May 2003 a new company, Clientele Investments Australia Pty Ltd, took over the ‘clearing house’ activity of Clientele Investments.[2] However, by mid-2005 there were still some intercompany loans between various Group members which had not been consolidated in the Clientele Investments Australia running accounts. Therefore, to achieve the full streamlining that had originally been intended, a further company, Secured Capital Pty Ltd, was registered in June 2005.[3] Secured Capital has acted as the clearing house for the Group since then.[4]
[2] Exhibit A3 at [24]; Tab 38 of Exhibit A6
[3] Tab 39 of Exhibit A6
[4] Exhibit A3 at [28]
The Balmain development
George Gaitanos is a property developer who has had dealings with Mr Carioti and Mr Spagnolo since the late 1990s.
In late 2001 Mr Gaitanos was looking to undertake a mixed residential and commercial development in Balmain. Mr Spagnolo agreed to provide some short-term financing for the project and to have RSA help with ‘setting everything up’.[5] Xavier Lo, an employee of RSA, arranged for the establishment of the Darling Street Balmain Unit Trust, with Flurrie as its trustee. Stephen Bartrop and another participant, Agy Dassakis, were the directors of Flurrie from 11 December 2001, with Mr Dassakis resigning his directorship on 15 March 2002. On that date Patrick Agostino, Mr Spagnolo’s brother-in-law, became a director. Mr Lo became a director on 13 November 2002 at Mr Bartrop’s request when Mr Bartrop and Mr Gaitanos were about to travel overseas for a few weeks.
[5] Exhibit A2 at [76]; Exhibit A3 at [53]
Despite his apparently heavy involvement in the project from the very beginning, and despite his ‘remain[ing] in charge of managing Flurrie’ with Mr Bartrop and providing Mr Lo with instructions during his time overseas with Mr Bartrop,[6] Mr Gaitanos did not become a director of Flurrie until 8 March 2004, when Mr Lo resigned his directorship.[7]
[6] Exhibit A3 at [63]-[64]
[7] Tab 42 of Exhibit A6
Around late 2001 Mr Lo set up an account for Flurrie with Clientele Investments. He operated that account in the same way as other accounts in the name of the various corporate trustees undertaking the Group’s projects: if money was paid to or on behalf of Flurrie, a debit entry was made, and if money was received from Flurrie, a credit entry was made.[8]
[8] Exhibit A3 at [55]
In December 2001 Flurrie entered into a contract to purchase four of the five lots on which the Balmain development was to be undertaken. The fifth lot was purchased in September 2002. Nevertheless, by June 2003 Flurrie had not obtained construction finance. Mr Carioti and Mr Spagnolo once again agreed to provide financial assistance. Mr Spagnolo thought Flurrie needed about $5 million ‘to get the project off the ground’. He considered the project would be profitable and would provide a return on the investment.[9]
[9] Exhibit A2 at [83]
Mr Spagnolo claims to have decided that the company in the best position to lend money to Flurrie was Sine Two.[10] Nevertheless, he identified that Sine Two’s own financial position would be at risk if Flurrie could not repay the loan in full. Accordingly, as he described the position:[11]
I therefore decided that the best way to avoid that was for Frank [that is, Mr Carioti] and me to take on this risk by us guaranteeing the repayment of the loan. This could be achieved by our respective family trusts guaranteeing Sine Two in respect of the money it would lend to Flurrie.
[10] Exhibit A2 at [87]-[88]
[11] Exhibit A2 at [88]
The project was not as successful as everyone had hoped. The prices achieved were well below expectations, with the proceeds not even covering the full amount that was owed by Flurrie to the builders and the principal lender, Perpetual.
The Applicants claim that by the time the last units in the development were sold, in June 2007, Sine Two had advanced about $4.3 million to Flurrie and there was no prospect that any of that amount would be recovered.
Mr Spagnolo formed the view that a loss would be available for the amount written off and he was keen to have everything finalised by the end of the 2007 financial year. He spoke to Mr Lo who indicated that Sine Two already owed M & F Carioti and R & A Spagnolo about $2.4 million each. Mr Lo said both companies could accept a reduction in those loans and Sine Two could accept that adjustment as payment of the guarantee. Mr Lo says that Mr Spagnolo told him:[12]
There is not much time so I need you to prepare all the relevant documentation for these transactions as soon as possible. Make sure you get both George [Gaitanos] and Steve [Bartrop] to sign a loan acknowledgment by Flurrie.
[12] Exhibit A3 at [100]
Mr Lo’s evidence is that he prepared:
·a loan acknowledgment which he had Mr Gaitanos and Mr Bartrop sign;
·board minutes for Sine Two, M & F Carioti and R & A Spagnolo which he had Mr Carioti and Mr Spagnolo sign where appropriate.[13]
[13] Exhibit A3 at [102]
Mr Lo also says that he, ‘or another employee of RSA at [his] direction, subsequently recorded these transactions in the accounts of the companies involved’.[14] But he adds:[15]
At the time the guarantee was recorded erroneously as a loss made by Brenex Nominees, the unitholders of which were R & A Spagnolo and M & F Carioti in equal proportions. In fact, it should have been separately recorded in the accounts of R & A Spagnolo and M & F Carioti.
[14] Exhibit A3 at [104]
[15] Exhibit A3 at [105]
That error caused the lodgment of an incorrect return for the PRUT, but that has since been corrected by the Commissioner (see [1] of these reasons).
CONSIDERATION OF THE ISSUES
To support their claim that Sine Two lent money to Flurrie, the Applicants rely on a Loan Agreement dated 30 June 2003 recording the agreement of Sine Two to advance to Flurrie a sum not exceeding $5 million, for three years, at an interest rate of 10 per cent per annum.[16]
[16] Tab 29 of Exhibit A6
The Loan Agreement is a single-page document which was prepared by Xavier Lo. Although the Brenex Group did not normally prepare written agreements for transactions occurring within the Group, Mr Lo had come across many different types of written agreements during his professional life. He extracted one such document from the client files maintained by RSA and he used that document as a template for the Loan Agreement.
The Loan Agreement commences with the following words in typescript:
THIS AGREEMENT made this day of , Two Thousand & Three
The words ‘30^th’ and ‘June’ are handwritten in the gaps.
The Loan Agreement is signed by Mr Carioti and Mr Spagnolo on behalf of Sine Two. This is despite the fact that as at 30 June 2003, only Mr Spagnolo was a director of that company. Mr Carioti did not become a director until 12 June 2004.[17]
[17] Tab 10 of Exhibit A6
The execution block at the foot of the Loan Agreement says that, on behalf of Flurrie, it is ‘SIGNED AND DELIVERED by the said S. Bartrop & G. Gaitanos in the presence of Xavier Lo’ but the only signature on Flurrie’s behalf is that of Mr Bartrop. As already noted in these reasons, Mr Gaitanos was not a director of Flurrie as at 30 June 2003.
The references to Mr Carioti and Mr Gaitanos in the Loan Agreement, even though neither of them was a director of the relevant company as at 30 June 2003, caused the Commissioner to doubt whether the Loan Agreement had been signed at that date, or at some later date – perhaps only after the Commissioner made the amended assessments that are now the subject of these reviews.
Ms Bishop, counsel for the Commissioner, asked each of the witnesses questions about the timing of their having signed the Loan Agreement (and other critical documentation as well). The Applicants submit[18] that this amounted to an unwarranted allegation by the Commissioner of fraud and, moreover, an allegation made too late since no such contention had been made by the Commissioner prior to the hearing. However, Ms Bishop emphasised during the hearing that fraud was not being alleged[19]; only the timing of the signing of the document was being called into question. In the circumstances I consider that Ms Bishop was entitled to pursue that line of questioning. Nevertheless, based on an overall assessment of the answers provided by the witnesses (Mr Lo’s evidence[20] was more convincing, Mr Carioti’s[21] and Mr Spagnolo’s[22] quite vague and in some respects evasive), I am satisfied that the Loan Agreement was signed on 30 June 2003.
[18] Applicants’ Submissions at [53]
[19] Transcript 141:17
[20] Transcript 113:15-114:18
[21] Transcript 93:46-94:21 (Loan Agreement); 96:12-97:18 (Deed of Guarantee – see [44] below)
[22] Transcript 73:10-22 (Loan Agreement); 72:26-73:1 (Deed of Guarantee – see [44] below)
The next question is, if Sine Two actually lent money to Flurrie, how much did it lend?
The Applicants claim the amount lent between 2003 and 2007 totalled $4,302,682. This is the amount recorded in a document dated 26 June 2007[23] and which the Applicants claim is an Acknowledgment of Debt even though it is identical in form to the Loan Agreement dated 30 June 2003 and it appears to be exactly that – a loan agreement.
[23] Tab 34 of Exhibit A6
This 2007 document (styled an ‘Agreement’) was also prepared by Mr Lo and it appears to be a ‘copy-and-paste’ from the 2003 document, with very little change except for the substitution of the $4,302,682 figure for the earlier words ‘a sum not exceeding FIVE MILLION DOLLARS’. Even the opening line of the document has the same typed content as the 2003 Loan Agreement:
THIS AGREEMENT made this day of , Two Thousand & Three
The words ‘26^th’ and ‘June’ have been inserted in the gaps. The word ‘Three’ has been crossed out and the word ‘Seven’ handwritten in its place.
After identifying the parties to the Agreement as Sine Two (the Lender) and Flurrie (the Borrower), the document provides as follows:
WHEREAS:
a)The Lender has advanced to the Borrower the sum of FOUR MILLION THREE HUNDRED AND TWO THOUSAND SIX HUNDRED AND EIGHTY TWO DOLLARS ($4,302,682.00)
b)The Borrower acknowledges his (sic) indebtedness to the Lender in the sum of FOUR MILLION THREE HUNDRED AND TWO THOUSAND SIX HUNDRED AND EIGHTY TWO DOLLARS ($4,302,682.00).
NOW THIS DEED WITNESSETH:
1)That the Borrower covenants and agrees with the Lender to pay to the Lender the said sum of FOUR MILLION THREE HUNDRED AND TWO THOUSAND SIX HUNDRED AND EIGHTY TWO DOLLARS ($4,302,682.00).
2)The Borrower agrees with the Lender to pay to the Lender interest at the rate of 10% per annum.
3)The loan agreement shall be for a period of THREE YEARS.
4)The principal amount of FOUR MILLION THREE HUNDRED AND TWO THOUSAND SIX HUNDRED AND EIGHTY TWO DOLLARS ($4,302,682.00) shall be repaid to the Lender within one month(s) written notice given to the Borrower by the lender, together with any calculated interest.

The document is signed by Mr Carioti and Mr Spagnolo on behalf of Sine Two, and by Mr Gaitanos and Mr Bartrop on behalf of Flurrie.
It is quite remarkable that the people involved in creating or signing two virtually identical documents (the first dated 30 June 2003 and the second dated 26 June 2007) now say that the documents are fundamentally different in effect. If what they now say is correct then the only explanation is that none of them paid the slightest attention to the content of the second document. Perhaps surprisingly, that is a much more likely explanation than the alternative – which is that Sine Two advanced a further $4.3 million to Flurrie at a time when it was probably incapable of repaying it. On balance, I accept that the 2007 document is indeed an acknowledgment of Flurrie’s debt to Sine Two as at 26 June 2007 and not a new loan agreement for a further advance of $4.3 million.
But that is not to say that the $4.3 million figure is accurate. Confirmation of that figure is a complicated exercise, requiring a comparison of ledger statements of Clientele Investments, Clientele Investments Australia and Secured Capital, as the case may be, with bank statements (where available) and the evidence of Mr Lo, who appears to have been responsible for keeping track of the relevant accounts. For the time being, quantification can be put to one side; it is more productive to focus on the remaining documents that the Applicants say support their case.
Next, the Applicants rely on a Deed of Guarantee, dated 30 June 2003 (the same date as the Loan Agreement). Under this deed, R & A Spagnolo and M & F Carioti, identified as the Guarantors, ‘agreed to secure the debt owed to Sine Two Pty Ltd by the Debtor [that is, Flurrie] from time to time’, and also ‘acknowledge that they have secured the debt owed by Sine Two Pty Ltd by the Debtor’.[24] The document is executed ‘for and on behalf of R & A Spagnolo’ by Mr & Mrs Spagnolo, and ‘for and on behalf of M & F Carioti’ by Mr & Mrs Carioti. No-one signed the document on behalf of the Debtor, Flurrie, or on behalf of the Lender, Sine Two.
[24] Tab 30 of Exhibit A6
This document, like the others, was created by Mr Lo from examples he held in RSA’s files. It makes no reference to what is involved in the Guarantors’ ‘securing’ the debt. It does not, as would normally be expected in a guarantee, record an undertaking by the Guarantors to perform the obligations of the Debtor under the Loan Agreement in the event of default by the Debtor. It says nothing about the process to be undertaken by the Lender to recover from the Guarantors in the event of default. Furthermore, Mr Bartrop, the only director of Flurrie on the date the Deed of Guarantee was made (apart from Mr Lo, who is hardly at arm’s length from the Applicants), said he knew nothing about a guarantee.[25]
[25] Transcript 56:24
There must be considerable doubt as to whether R & A Spagnolo and M & F Carioti truly did expose themselves to any obligation under this document to repay Sine Two in the event of Flurrie’s default.
In any event, by around the middle of 2007 the construction of the Balmain development was complete, and the finance provided by Perpetual and Sine Two had been exhausted.[26]
[26] Transcript 56:28; 57:2-5
On 26 June 2007, the date on which the Acknowledgment of Debt was made, separate meetings of the directors of Sine Two, R & A Spagnolo and M & F Carioti took place at the premises of RSA in Fairfield.[27] The minutes of the meeting of the directors of Sine Two as the Trustees for the Sine Trust record the following:
The Draft Financial Reports of the Trust for the year ending 30^th June 2007 was tabled.
It was noted that although numerous attempts were made to Flurrie Pty Ltd for the repayment of the outstanding loan of $4,302,682.37, the loan remained unpaid.
It is the opinion of the Directors that this loan is irrecoverable and should be written off and recovered from the guarantors under the terms of the guarantee.
IT WAS RESOLVED that the loan of $4,302,682.37 to Flurrie Pty Ltd be written off.
IT WAS FURTHER RESOLVED that the guarantee to the loan of Flurrie Pty Ltd be exercised and the monies be recovered from the guarantors.
IT WAS RESOLVED that the draft Financial Report should incorporate the write-off and claim from the guarantors.
[27] Tabs 35, 36 and 37 respectively of Exhibit A6
The minutes of the meeting of the directors of R & A Spagnolo as the Trustees for the Eels Trust, and of M & F Carioti as the Trustees for the St Ives Trust, are relevantly identical, recording the following:
A Notice of Claim on our guarantee to Sine Two Pty Ltd securing their loan to Flurrie Pty Ltd for the sum of $2,151,341.18 was tabled.
IT WAS RESOLVED that the claim be approved and duly recorded in our financial accounts for the year.
Contrary to what is recorded in the Sine Two minutes, Mr Bartrop said he did not recall Sine Two ever taking any action to recover any of the money it had lent to Flurrie. He said Flurrie never received a notice of claim from Sine Two, and never received any letters pursuing the debt.[28]
[28] Transcript 57:18-25
Mr Spagnolo agreed that there was never any formal document sent to Flurrie requiring the debt to be repaid.[29] Ms Bishop asked him to elaborate:[30]
[29] Transcript 75:2
[30] Transcript 75:9-36
Did you have conversations with them where they said they were not able to meet their debts any longer?---I would have to say yes. They said they weren’t - they didn’t have any money. Bartrop said he had no money. George said he had no money. So - - -
Mr Bartrop said that to you?---Yes, he did.
So you had conversations with him?---Yes, I did.
Could you go to tab 36?---Yes.
Another minute of meeting on the same day?---Yes.
Where you acknowledge that a notice of claim on your guarantee has been tabled?---M’mm.
So what was that notice of claim?---Well, it was obviously the total amount that was outstanding and owing to us.
Who prepared a notice of claim? Where is the notice of claim?---I don’t have it, sorry.
There is no notice of claim, is there?---Sorry?
There was no notice of claim?---I’m not sure. As I say, it - - -
Well, you were at the meeting?---Yes, well, I can’t recall. The answer is I can’t recall. There is or there isn’t.
Mr Carioti’s evidence on this point was equally vague and unhelpful.[31]
[31] Transcript 99:44- 100:29
This is where the Applicants’ case is particularly unconvincing.
I do not accept that a notice of claim was ever presented to either of the meetings of the directors of R & A Spagnolo and M & F Carioti. If a notice of claim had been tabled then it surely would have been filed in the records of each of the companies and retained for production to the Commissioner and, in due course, to the Tribunal. On the basis that no such document has been produced, I find that no such document was ever created. In the absence of such a document, I find that Sine Two did not at any stage formally require the guarantors to perform whatever obligations were thought to have been created by the Deed of Guarantee.
It is not to the point that the guarantors may have paid – I do not say they did – $4.3 million to Sine Two at around this time. Unless a payment (or an equivalent adjustment to the loan accounts between Sine Two and the guarantors) can be linked to the guarantors’ obligations under the Deed of Guarantee, and a specific requirement by Sine Two that the guarantors fulfil those obligations, I cannot conclude that that is what any such payment (if one was made) represented. And the Applicants’ case – whether put on the basis of a capital loss, or a deduction under s 8-1 of the Income Tax Assessment Act 1997 (Cth) – is based squarely on the proposition that the payments, if made, were made in response to a call on the guarantee by Sine Two.
Sine Two was not at arm’s length from either of the guarantors. With the same directing minds on both sides of the guarantee, it is not enough that Mr Carioti and Mr Spagnolo make the assertion that one of their emanations, Sine Two, called on other emanations of theirs, M & F Carioti or R & A Spagnolo, as the case may be, to honour obligations that each of the latter entities is said to have had to the former. They need to be able to establish, on the basis of objective evidence, that this is what actually happened. That is especially so where the guarantee arrangement itself was so unusual, with the Guarantors in the lender’s camp, so to speak, rather than in the borrower’s. And in addition to that, it is entirely unclear what the obligations of the guarantors were in the first place.
Nor is the Applicants’ case fortified by the fact that the payments that are said to have been made in response to the call on the guarantee were recorded at the time (incorrectly, the Applicants now say) as a loss by Brenex Nominees. There is no adequate explanation of that alleged error. Making such a fundamental error with respect to an amount of such magnitude cannot simply be explained away as an oversight. Instead, it bespeaks either outright confusion about the true nature of the arrangements or extreme sloppiness.
Although there is a measure of plausibility to some of the elements of the Applicants’ case, there is none to the whole. The approach from the beginning was to cut corners – as is evident from the documents on which the Applicants rely so heavily, but which barely reflect the intentions of the parties (and one of them, the Acknowledgment of Debt, not doing so at all). The Deed of Guarantee says virtually nothing about the relationship it created between Sine Two and the Guarantors.
Some of the evidence of Mr Carioti and Mr Spagnolo was also difficult to accept. They both claimed to have a clear recollection of conversations that took place ten or more years ago. On the other hand, when asked if they could recall signing the critical documents within the same timeframe (in circumstances where documentation was rare), they either said they did not recall, or they evaded the question. Here is the exchange between Ms Bishop and Mr Spagnolo dealing with his signing the Deed of Guarantee:[32]
Do you recall signing it?---That’s my signature.
Do you recall signing it?---That’s my signature.
Do you recall signing it in 2003?---That’s the date on there, yes, that’s right.
But you don’t actually recall signing it in 2003, do you?---Well, I - you know, that’s the date on there, yes, I recall on that particular date.
DEPUTY PRESIDENT: Well, just listen carefully to the question?---Yes.
Put it again, Ms Bishop.
MS BISHOP: You don’t recall signing that document in 2003, do you?---Well, that is the date that’s on there, and that’s the date I would have signed it.
[32] Transcript 72:26-41
Mr Spagnolo’s responses in relation to the Loan Agreement were equally unsatisfactory:[33]
MS BISHOP: If we could go to tab 29. There’s an agreement there dated 30 June 2003. Now, you’ve signed that document?---That’s my signature, yes. Frank and I have signed it.
Do you recall signing it in 2003?---I would suggest, yes, it’s the same date.
I just want to remind you that you’ve acknowledged already that you didn’t ordinarily have written loan documentation. So this is an extraordinary document from your usual practice?---And it’s an extraordinary amount.
That’s right, and you don’t recall signing it in 2003?---Well, that’s the date that’s on there and that’s the date I suggest I signed it. I don’t suggest that it’s any other date.
[33] Transcript 73:10-22
When Mr Carioti was asked about his signing the Deed of Guarantee, this is what he said:[34]
MS BISHOP: And do you recall signing that document?---Well, it has got my signature here. Of course.
But do you recall signing it?---Yes, obviously. It’s my signature, I had to sign. Nobody else - - -
Where were you when you signed this?---I don’t recall.
And who were you with when you signed the document?---Well, there’s my wife’s signature too and the secretary and director.
So all four of you were there at once signing the document. And do you recall that?---Well, again, you’re talking about 2003. We’re not talking about yesterday. It’s 13 years ago.
DEPUTY PRESIDENT: Does that mean you do recall or you don’t recall?---I don’t - I don’t recall it.
You don’t recall?---Yes, sir. I signed it, my signature is there, that’s all I can say. I can confirm I was there because I’ve signed it.
[34] Transcript 96:12-31
I had the impression they were both closely following a script, with Mr Spagnolo in particular not being entirely open with his responses.
In Federal Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149 the Full Federal Court referred at [82] to the well-settled principle that ‘the evidence of witnesses who have an interest in the outcome of litigation needs to be approached critically’. In applying that principle, I find myself unable to resolve in the Applicants’ favour the shortcomings in their case.
The objection decisions in relation to the amended assessments for each of the Applicants must therefore be affirmed.
ADMINISTRATIVE PENALTY
Penalty was imposed at the rate of 50 per cent for recklessness: table item 2 in s 284-90(1) in Schedule 1 to the TAA.
Recklessness in the context of the administrative penalty regime means ‘to include in a tax statement material upon which the [relevant] 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: BRK (Bris) Pty Ltd v Commissioner of Taxation [2001] FCA 164 at [77] (Cooper J).
The level of penalty depends on the characterisation of the actions of Mr Spagnolo and Mr Lo[35] in failing to include the respective distributions from the St Ives Trust and the Eels Trust in the Applicants’ tax returns for 2007. The failure to include the distributions has led to the tax shortfall in each case, given my conclusion that the equivalent losses to which the Applicants claimed they were entitled were not available to them.
[35] Mr Spagnolo was the primary decision-maker and Mr Lo either prepared the tax returns or supervised their preparation
The immediate cause of the failure to include the distributions is that it was initially thought that the loss arising from the payment under the guarantee was attributable to Brenex Nominees. That was not only an error of attribution but one of fundamental entitlement as well. Faced with the alternatives of ‘outright confusion about the true nature of the arrangements’, on the one hand, and ‘extreme sloppiness’ on the other[36], I put the error of attribution down to extreme sloppiness.
[36] See [57] of these reasons
Now, putting aside the attribution error and focusing on the question of fundamental entitlement (in other words, was anyone entitled to claim a loss on the basis asserted?), I think the error was caused by gross carelessness. No doubt Mr Spagnolo held a genuine belief that a loss was available, but no reasonable person with his training and experience could have held that belief in reliance on such inadequate documentation. Penalty at the rate of 50 per cent of the shortfall applies.
The Applicants submitted that if the Tribunal should conclude that penalty applies, it should nevertheless remit the penalty either in part or in full. I do not see grounds for remission in this case and decline to exercise the discretion under s 298-20 in Schedule 1 to the TAA.

I certify that the preceding 70 (seventy) paragraphs are a true copy of the reasons for the decision herein of Deputy President S E Frost

..........................[sgd]..............................................
Associate
Dated: 25 January 2017

Date(s) of hearing: 17-18 May, 23 June 2016

Counsel for the Applicant: Mr P Fraser & Mr N Kulkarni, instructed by Mr T Rooney

Counsel for the Respondent: Ms E Bishop

Solicitors for the Respondent: ATO Review and Dispute Resolution Group

[2017] AATA 62

25 January 2017

Key Legal Topics

Areas of Law

Tax Law

Statutory Interpretation

Administrative Law

Legal Concepts

Statutory Construction

Appeal

Procedural Fairness

Judicial Review

Standing

Intention

Date(s) of hearing:	17-18 May, 23 June 2016
Counsel for the Applicant:	Mr P Fraser & Mr N Kulkarni, instructed by Mr T Rooney
Counsel for the Respondent:	Ms E Bishop
Solicitors for the Respondent:	ATO Review and Dispute Resolution Group