Faigenbaum and Ors and Commissioner of Taxation

[2008] AATA 946

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2008] AATA 946

ADMINISTRATIVE APPEALS TRIBUNAL      ) No WT200100254-256

) No WT200100429

TAXATION APPEALS DIVISION

) No WT200100379-380

Re

FREDERICK FAIGENBAUM
  and

WAYNE HENRY LEGGETT

  and

GARY KEITH WATSON

Applicants

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Mr A Sweidan, Senior Member

Date17 October 2008

PlacePerth

Decision The Tribunal affirms the decisions of the respondent under review in relation to the imposition of penalties.  

.....(sgd) Mr A Sweidan.........

Senior Member

CATCHWORDS

Income Tax - penalties where claimed deductions not allowable - decision under review affirmed

LEGISLATION

Income Tax Assessment Act 1936, ss226L, 226E, 51(1)

CASES

Commissioner of Taxation v Faigenbaum [2008] FCA 510
Commissioner of Taxation v Starr (2007) 164 FCR 436
Fletcher v Commissioner of Taxation (1991) 173 CLR 1
Hopkins v Commissioner of Taxation (2007) 65 ATR 86
Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 213 ALR 450
Starr v Commissioner of Taxation [2007] FCA 23
Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1

REASONS FOR DECISION

17 OCTOBER 2008	Mr A Sweidan, Senior Member
BACKGROUND

1.      The Tribunal originally handed down its decisions in the above matters on 31 July 2007. The Tribunal affirmed the decisions under review in respect of each of the above applicants except in relation to the imposition of penalties.

2.      The Commissioner appealed to the Federal Court in respect of that part of the Tribunal decision not to affirm the imposition of penalties.

3.      The Federal Court in a decision handed down on 18 April 2008 (Commissioner of Taxation v Faigenbaum [2008] FCA 510 allowed the appeal, set aside that part of the Tribunal decision by which the Tribunal concluded that no penalties should be imposed and remitted the matter to the Tribunal to reconsider the question according to law.

4.      In the case of each applicant, the respondent imposed penalty by way of additional tax pursuant to section 226L, alternatively pursuant to section 226 of the Income Tax Assessment Act 1936 ("the Act"), at the rate of 50% of the amount of the tax shortfall arising from the deductions claimed in respect of his participation in the Satcom Financial Services Project.  In the case of the applicants Faigenbaum and Leggett that penalty was reduced, for voluntary disclosure, to 10% of the tax shortfall in accordance with section 226E of the 1936 Act.

THE TRIBUNAL’S FINDINGS ON RE-CONSIDERATION

5.      The Tribunal has, in accordance with the direction of the Federal Court, re-considered it’s decision of 31 July 2008 after taking into account further submissions from the parties on the question of penalties.

6.      The Tribunal has concluded that the additional tax is not excessive because the penalties were properly imposed under section 226L in light of the Tribunal’s findings in it’s decision namely that:

6.1the claimed deductions were not allowable under section 51(1) of the Act; and

6.2on the whole of the evidence before the Tribunal that "the occasion of the applicants' outgoings was not the production of assessable income but the income tax deductions which facilitated their participation", (Tribunal decision [116], [191] and [197]).  In so finding, the Tribunal rejected the applicants' evidence that their purpose in entering the Satcom Financial Services Project was to gain income.

7. Furthermore, the Tribunal is of the view for the reasons set out in paragraph 16 below that it is not reasonably arguable that the applicants’ treatment of the claimed deductions in their income tax returns as allowable under section 51(1) of the Act was correct.

APPLICATION OF SECTION 226L

8.        The application of section 226L depends upon consideration and application of each separate element set out in the section itself.  Section 226L provides:

Subject to this Part, if:

(a)a taxpayer has a tax shortfall for a year; and

(b)the shortfall or part of it was caused by the taxpayer in a taxation statement treating an income tax law as applying in relation to a scheme in a particular way; and

(c)the scheme was a tax avoidance scheme within the meaning of subsection 224(1); and

(d)none of the scheme sections applies in relation to the scheme;

the taxpayer is liable to pay, by way of penalty, additional tax equal to:

(e)if, when the statement was made, it was reasonably arguable that the way in which the application of the law was treated was correct – 25% of the amount of the shortfall or part; or

(f)       in any other case – 50% of the amount of the shortfall or part.

9. The requirement of paragraph (a) is clearly met in this case. The Tribunal found that the claimed deductions are not allowable under section 51(1) of the 1936 Act. Accordingly:

(a)Faigenbaum had a tax shortfall in each of the years ended 30 June 1995, 30 June 1996 and 30 June 1997;

(b)Leggett had a tax shortfall in the year ended 30 June 1996; and

(c)Watson had a tax shortfall in each of the years ended 30 June 1996 and 30 June 1997.

10. The requirements of paragraph (b) are also met. The shortfall was caused by each applicant, in each of his tax returns for the 1995, 1996 and 1997 years (as appropriate), treating section 51(1) as applying to outgoings in relation to the Satcom Financial Services Project as allowable. Scheme, as used in paragraph (b) is not defined there. It takes its meaning from the first part of paragraph (c), (and, ultimately, section 224(2)). As set out below, the Satcom Financial Services Project is clearly a scheme in the sense used in section 177A of the Act, that is:

(a)     any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b)any scheme, plan, proposal, action, course of action or course of conduct.

11.      The requirements of paragraph (c) are met.  The Tribunal finds that the Satcom Financial Services Project was a tax avoidance scheme within the meaning of subsection 224(1).

12.      Section 224(2) relevantly defines tax avoidance scheme. Section 224(2) states:

In subsection (1), “tax avoidance scheme” means a scheme within the meaning of Part IVA that was entered into or carried out for the sole or dominant purpose of enabling a person to pay no tax or less tax.

13.      It is clear that the initial phrase in section 224(2), scheme within the meaning of Part IVA, refers to the meaning given to scheme in Part IVA, specifically by section 177A. See Starr v Commissioner of Taxation; Hopkins v Commissioner of Taxation (2007) 65 ATR 86; [2007] FCA 23 at [47] and see on appeal Commissioner of Taxation v Starr (2007) 164 FCR 436, [2007] FCAFC 204 at [9]. The Satcom Financial Services Project readily falls within the meaning of scheme so defined.

14.      The second part of the definition requires consideration of the taxpayer’s purpose in entering into or carrying out the scheme: Starr v Commissioner of Taxation; Hopkins v Commissioner of Taxation at [49]-[50] and is clearly not based solely on the evidence of the taxpayer see [29], [38] and [52]; also see the reasons for judgment of the Full Federal Court on the appeal at [30]-[31], [66] and [65], [67] respectively. As noted above, based on the evidence as a whole the Tribunal found (at Tribunal decision, [116], [191] and [197]) that the purpose of each applicant was to obtain the tax savings which permitted participation in the Satcom Financial Services Project without risk of loss.  It follows, for the purposes of section 226L(c) and in the words of the definition of tax avoidance scheme in section 224(2), that the Satcom Financial Services Project was entered into or carried out for the sole or dominant purpose of enabling a person to pay no tax or less tax.

15.      The requirements of paragraph (d) are also met.  Section 222A(1) defines the scheme sections as section 224, 225, 226 and 226AA of the 1936 Act. They are those penalty sections which impose penalty by way of additional tax when the Commissioner has applied an anti-avoidance section to, relevantly, disallow a deduction otherwise allowable. Owing to the Tribunal’s finding that the claimed deductions were not allowable under section 51(1) of the 1936 Act, none of the scheme sections as defined applies.

16. In the result, the Tribunal on reconsideration in light of the submissions is of the view that the Commissioner correctly applied penalty at the rate of 50% of the amount of the tax shortfalls. In the Tribunal’s opinion as was noted above it was not reasonably arguable that the deductions claimed were allowable under section 51(1) of the Act in view of the several, independent bases upon which the Tribunal found section 51(1) not to be applicable namely:

16.1the Tribunal found that each applicant’s claimed deductions were outgoings of capital or of a capital nature (Tribunal decision, [104]‑[106], [119]‑[128]);

16.2the Tribunal also found that the applicants’ claimed deductions were not referable to any business activities carried on by the applicants (Tribunal decision, [107]‑[114], [129]-[186]);

16.3furthermore the Tribunal found that the gaining of assessable income was not the advantage that the outgoings sought to achieve (Tribunal decision, [116], [191]‑[197]).

17.      The applicants contend that the Tribunal “determined that the applicants had the actual purpose of investing in the Project to receive income”.

18.      However, as set out at [105], [138] and [187] of its Reasons for   Decision, the Tribunal held that the applicants had not established that they were carrying on a business and in any event the claimed deductions were outgoings of capital because the applicants were passive investors in a project from which they hoped to derive a return.

19.      The Tribunal is of the view that the contention of the applicants that for the purposes of section 226L(c) and in the words of the definition of ‘tax avoidance scheme’ in section 224(2), their sole or dominant purpose of entering into the scheme was to obtain a return from the scheme, is not established by:-

19.1      their statements that they expected a return from the scheme; and

19.2      the reference to those statements, among other evidence, by the Tribunal in determining that the applicants were passive investors and not carrying on a business.  

20. The applicants’ contention that their actual purpose was to obtain a return does not stand up when weighed against the findings of the Tribunal as to their purpose. To give proper consideration to the application of section 51(1) the Tribunal had to make findings on whether the outgoings were incurred for the purpose of gaining or producing assessable income. On weighing the applicants’ subjective motives in incurring the outgoings (as required by Fletcher v Commissioner of Taxation (1991) 173 CLR 1 at 17-19), the Tribunal found on the evidence that the applicants incurred the scheme outgoings (and thereby entered into the scheme) to obtain the more certain and immediate income tax deductions which those outgoings secured and which facilitated their participation in the scheme: see the Tribunal’s reasons for decision at [115]-[116], [191] and [197] and at [15] to [48] regarding the scheme documentation and the applicants entry into the scheme.

21.      The Tribunal notes that the applicants have not been able to point to any evidence before the Tribunal which compels the conclusion that the Tribunal’s finding was incorrect, and that contrary to that finding, the scheme was entered into for the sole or dominant purpose of deriving assessable income.

22. As indicated above the Tribunal also finds that it cannot objectively be said that, while wrong, the applicants’ argument could be argued on rational grounds to be right: see s 222C of the Act and Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 213 ALR 450 at 477 [108]; Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 at 26 [108].

DECISION

23.      The Tribunal is of the view that the decision of the Commissioner with regard to penalty should, in each case, be affirmed.

I certify that the 23 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member

Signed: ...(sgd) T Freeman...................
  Associate

Date/s of Hearing  Heard on the papers
Date of Final Submissions       3 October 2008
Date of Decision  17 October 2008
Counsel for the Applicant         Mr D Romano
Solicitor for the Applicant          Wilson and Atkinson
Counsel for the Respondent     Ms L B Price
Solicitor for the Respondent     Australian Government Solicitor