Macionis and Commissioner of Taxation

[2004] AATA 926

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2004] AATA 926

ADMINISTRATIVE APPEALS TRIBUNAL      )

)QT2003/107

)QT2003/122-124

TAXATION APPEALS  DIVISION		)
Re		STANLEY MIROSLAW MACIONIS

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Deputy President Don Muller

Date3 September 2004

PlaceBrisbane

Decision

The Tribunal:

1.  Sets aside the objection decision in relation to the income tax year ending 30 June 1997.

2.  Affirms the objection decisions for the income tax years ending 30 June 1998, 30 June 1999 and 30 June 2000, including the understatement penalty rate of 10%.

................SIGNED..............................

D.W. MULLER

DEPUTY PRESIDENT

CATCHWORDS

TAXATION – attempt to take advantage of Division 10B by series of sham transactions – decisions to disallow claimed deductions affirmed – penalty affirmed

Income Tax Assessment Act 1936 – Division 10B, ss.124K, 124L, 124M, 124R, 226F, 226H

Income Tax Assessment Act 1997 – Division 373

REASONS FOR DECISION

Deputy President Don Muller        

1.      This review relates to objection decisions covering income tax years ending 30 June 1997, 30 June 1998, 30 June 1999 and 30 June 2000.  In each of the four tax years Stanley Miroslaw Macionis claimed as a deduction an amount of just under $40,000 representing amortisation of $500,000, claimed to be the cost of his share of a patent, over the remaining years of the patent.

2.      The claims for deductions were rejected on the grounds that the true value of the patent to Mr. Macionis was significantly less than $500,000.

3.      At the hearing Mr. Macionis was represented by his accountant, William Schoch.  The Respondent was represented by Mr. Hack SC and Mr. McQuade.

4. Mr. Macionis, in common with many other applicants for review at the AAT was a participant in an arrangement, devised and promoted by Mr. Schoch, that sought to take advantage of Division 10B of the Income Tax Assessment Act 1936 (the 1936 Act) and, with effect from the 1999 income year, Division 373 of the Income Tax Assessment Act 1997 (the 1997 Act).  Broadly, those provisions permit accelerated deduction of capital expenditure on industrial property.

5. It is not necessary for present purposes to consider separately Division 373 of the 1997 Act, the elements of that Division being relevantly identical to those that operate in Division 10B of the 1936 Act.

6. The operative part of Division 10B is s.124M. It permits the owner of a “unit of industrial property to which this Division applies” to deduct annually an amount based upon the amortised value of the property.  The term “unit of industrial property” is defined by s.124K(1) as meaning, relevantly,

“(a)     rights possessed by a person under a law of Australia as:

(i)        the grantee or proprietor of a patent for an invention

….

(iv)      a licensee under such a patent

….

and includes equitable rights in respect of such a patent … or in respect of a licence under such a patent.”

The Division applies, relevantly, by virtue of s.124L(1)(b) to the owner of a unit of industrial property who “incurred expenditure of a capital nature on the purchase of the unit of industrial property”.

7.      It is important, in the context of this case, to note s.124R which governs the manner in which the cost to the owner of the unit of industrial property is to be determined.  Sub-section 124R(1)(b) has the effect that whilst, ordinarily, the cost is the expenditure referred to in s.124L(1)(b), that does not apply in the circumstances set out in s.124R(3).  That sub-section provides:

“(3)     Where, in the case of an owner referred to in paragraph 124L(1)(b):

(a)the Commissioner is satisfied, having regard to any connection between the owner and the person from whom the unit of industrial property concerned was purchased or to any other relevant circumstances, that the owner and that person were not dealing with each other at arm’s length in relation to the purchase;  and

(b)the expenditure of a capital nature incurred by the owner on the purchase of the unit of industrial property:

(i)exceeds the amount that was the cost of the unit to the last preceding owner of the unit;  or

(ii)does not exceed the amount that was the cost of the unit to the last preceding owner of the unit but exceeds the value of the unit at the time of the purchase;

the cost of the unit to the owner for the purposes of this Division shall be taken to be the cost of the unit to the last preceding owner of the unit or the value of the unit at the time of the purchase, which ever is the less.”

8.      The steps in the scheme devised by Mr. Schoch were as follows:

i.In 1996 Mr. Schoch contacted an inventor, Darcy Lester Flynn, who was seeking to raise funds to manufacture and market his invention.

ii.Mr. Flynn had invented a “reversible drill” for use in the mining and oil industry.  He invented the drill in about 1988 but he had been having trouble exploiting it commercially.  He or one of his companies were issued with a patent on 10 April 1991 for a term of 16 years commencing on 31 October 1988.

iii.Mr. Flynn estimated that he needed about $600,000 to begin to manufacture and market his invention.

iv.Mr. Schoch devised a scheme whereby it was to appear that 32 investors would each buy a 1/32 share in Mr. Flynn’s patent.

v.Each investor paid $27,500 to Mr. Schoch.  That is, a total of $880,000.

vi.Mr. Schoch paid approximately $600,000 to Mr. Flynn.

vii.Mr. Flynn purported to transfer 1/32 of the right to his patent to each of the investors by means of a number of complicated transactions from company to company.

viii.During the course of one of the transactions, Mr. Schoch assigned a total value of $16M to the patent.

ix.Each investor therefore became the proud owner of 1/32 of a patent said to be worth $16M.  That is, $500,000 each.

x.There was also a final contract in which each investor agreed to sell the 1/32 share, “worth” $500,000, back to Mr. Flynn at any time within four years for $27,500, and thereafter for a slightly higher price.

9.      Mr. Macionis was one of the investors.

10.     The attraction of the scheme from the point of view of the investors was that for an outlay of $27,500 they could claim a deduction of about $38,500 per year for over ten years, representing amortisation of the $500,000.

11.     The attraction for Mr. Flynn was that he received $600,000 to manufacture his invention and he could buy it back any time he liked for or near the original price of $27,500.

12.     The attraction for Mr. Schoch was the fee for providing the service.

13.     The claims for deductions for the years 1997, 1998, 1999 and 2000 were eventually investigated and disallowed.  An understatement penalty of 50% was initially imposed on Mr. Macionis, and the other investors, later reduced to 10% in the case of Mr. Macionis and most of the other investors.

14.     The Tribunal heard several days of evidence, followed by extensive written submissions by Mr. Hack.

15.     Mr. Schoch was called upon to respond to Mr. Hack’s submissions.  He thereupon conceded on behalf of Mr. Macionis that the transactions had been a sham.

16.     Mr. Schoch went on to submit that the Tribunal should reduce the 10% penalty.  He said that he had sought from the Commissioner on behalf of the investors a private ruling.  This had been refused.  He said that if he had received a ruling that his scheme was not approved he would never have embarked upon it.

17.     The material shows that the Commissioner not only refused to give a private ruling but also pointed out that the “valuation” of $16M was not accepted, and that more information was needed about the parties to the contracts.

18.     The Tribunal takes the view that the Commissioner’s reply could in no way amount to encouragement to embark on the scheme.

19.     The Tribunal also takes the view that an investor would have to be highly suspicious of a scheme in which for a one-off outlay of $27,500, a deduction of $38,500 could be claimed each year for at least the next ten years.

20.     The Respondent ultimately imposed understatement penalty pursuant to Part VII of the 1936 Act at the rate of 10%.  By way of comparison,

·     S.226F, “lack of reasonable care” imposes a penalty of 25%;

·     S.226H, “recklessness” imposes a penalty of 50%.

21.     The Tribunal takes the view that the Respondent has been extremely generous on the question of penalty.

22.     The Respondent conceded that in relation to the 1997 objection the decision ought be set aside on the footing that the amended assessment had not been issued within the ordinary period of four years.

23.     The Tribunal affirms the objection decision in relation to the tax years ending in 1998, 1999 and 2000, including the understatement penalty rate of 10%.

I certify that the 23 preceding paragraphs are a true copy of the reasons for the decision herein of Deputy President Don Muller

Signed:         .....................................................................................
           C. O’Donovan, Associate

Date/s of Hearing  26-29.7.04, 2-3.8.04       
Date of Decision  3 September 2004
Applicant   Mr. W. Schoch
Counsel for the Respondent     Mr. Hack SC and Mr. McQuade
Solicitor for the Respondent      Australian Government Solicitor