PNGR and VFYF and Commissioner of Taxation
[2013] AATA 942
[2013] AATA 942
Division TAXATION APPEALS DIVISION File Numbers
2012/4668
2012/4669
2012/4670
2012/4671
2012/4673
2012/4674
2012/4675
2012/4676Re
PNGR and
VFYF
APPLICANTS
And
Commissioner of Taxation
RESPONDENT
DECISION
Tribunal Senior Member Bernard J McCabe
Date 23 December 2013 Place Brisbane The objection decisions under review are affirmed.
........................................................................
Senior Member Bernard J McCabe
CATCHWORDS
TAXATION – Income tax – Assessable income – Tobacco distribution business – Real property assets – Whether under-reporting of assessable income – Lack of evidence of source of income – Whether fraud or evasion – Imposition of penalties – Objection decisions under review affirmed.
LEGISLATION
Income Tax Assessment Act 1936 (Cth) s 170
Taxation administration Act 1953 (Cth) s14ZZK, s 284 of Schedule 1
CASES
Archibald Dixon as Trustee for the Dixon Holdsworth Superannuation Fund v Commissioner of Taxation [2008] FCAFC 54
Australasian Jam Co Pty Ltd v Federal Commissioner of Taxation (1953) 88 CLR 23
Denver Chemical Manufacturing Company v Commissioner of Taxation (NSW) (1949) 79 CLR 296
Imperial Bottleshops Pty Ltd & Edgerton v Federal Commissioner of Taxation (1991) 22 ATR 148REASONS FOR DECISION
Senior Member Bernard J McCabe
23 December 2013
The applicants in this case reported modest income in the 2001-2004 years of income from the tobacco distribution business they operated in partnership – yet they acquired a number of valuable properties during the period. The Commissioner of Taxation says this does not add up. He suspects the applicants have under-reported their assessable income in their individual returns. The Commissioner issued amended assessments and imposed administrative penalties in respect of the shortfall amounts he claims to have identified following an audit and asset betterment analysis. The applicants were unsuccessful in their objections to the amended assessments and the penalties. They have now asked the Tribunal to consider the matter.
There are two issues in this case. The first arises because the Commissioner purported to amend the assessments more than four years after the date on which he gave notice of the original assessment. He is only permitted to make an amendment in those circumstances if he is of the opinion there has been fraud or evasion: s 170, Income Tax Assessment Act 1936 (“ITAA36”). Given I step into the shoes of the Commissioner, I must satisfy myself there has been fraud or evasion within the meaning of the legislation before I can reach a final view on the second issue: whether the amended assessments are excessive and should be set aside. In reaching that view, it is not enough for me to conclude the Commissioner’s assessments are wrong. It is common in cases like this for the Commissioner’s assessment to be inaccurate. He is essentially a stranger to the applicants’ financial affairs, and his estimates are the product of guess-work based on the audit and the asset betterment methodology. Section 14ZZK(b)(i) of the Taxation Administration Act 1953 requires that I be satisfied “the assessment is excessive or otherwise incorrect and what the assessment should have been” [emphasis added].
I have decided the objection decisions must be affirmed. I explain my reasons below.
WHAT THE COMMISSIONER SAID…
While the Commissioner is not required to make a positive case, it would be useful at this point to briefly set out the concerns that emerged from the audit and asset betterment analysis which led to issue of the amended assessments. The first step is to reproduce a summary of the partnership tax returns appearing in [7] of the Commissioner’s statement of facts, issues and contentions:
Relevant tax period
2001
2002
2003
2004
Total business income
$2,709,609
$2,176,380
$2,190,159
$2,280,648
Total business expenses
($2,655,659)
($2,103,450)
($2,093,809)
($2,152,516)
Net income from business
$53,950
$72,930
$96,350
$128,132
Distribution to Mr H
$26,975
$36,465
$48,175
Not reported
Distribution to Mrs W
$26,975
$36,465
$48,175
Not reported
The Commissioner proceeded to summarise (at [9] for Mr H and [11] for Mrs W) each of the applicants’ individual tax returns during the relevant period:
Relevant tax period
2001
2002
2003
2004
Taxable income
$26,975
$32,394
$39,217
$60,210
Tax on taxable income
$4,472
$6,098
$8,145
$15,220
Relevant tax period
2001
2002
2003
2004
Taxable income
$26,975
$32,395
$39,245
$60,260
Tax on taxable income
$4,472
$6,098
$8,153
$15,241
The applicants did not report any other income in their individual returns although their assessable income was reduced in each case by losses on rental properties.
The Commissioner then explained:
[32] The applicants acquired assets during the relevant tax periods which could not have been acquired, even with finance, by people earning the amount of income declared.
[33] Bank statements for all of the accounts held by the applicants show significant expenditure using funds that were much greater than the taxable income of the applicants in that, or earlier years.
[34] It is clear the applicants had access to income that was greater than the amount declared in their income tax returns. They could not have had an honest belief that the amount of income they returned in their individual income tax returns for each of the relevant periods was their true income received in that year.
The statement of facts, issues and contentions identified six properties in which the applicants were said to have acquired an interest between 1998 and 2003. The statement also included the asset betterment schedules for each taxpayer. Those statements suggested many (if not all) of the withdrawals from various accounts should be counted as income. The applicants pointed out in their written opening submissions that there were some 10,000 bank account withdrawals during this period: at [50].
WHAT THE APPLICANTS’ WITNESSES SAID
The applicants are married to each other. I shall refer to the husband as Mr H and the wife as Mrs W. They emigrated here together from Vietnam in 1977. I mention their ethnicity because they argue their affairs will make more sense if I appreciate the impact of culture on the way in which they did business. They raised a family together in this country. They conducted a number of businesses over time. In 1983, they established a small mixed business in a Brisbane suburb that evolved into a tobacco supply business. In 1998, they established a snack bar which was located adjacent to the premises from which the firm conducted its tobacco supply business.
The central challenge for the applicants was to demonstrate how two individuals reporting relatively modest incomes could afford to pay around $3.6 million to acquire a substantial property portfolio. The applicants insist they have ready answers, although they concede the income tax returns they lodged might have understated their income in some minor respects. At [37] of the applicants’ statement of facts, issues and contentions, for example, it was acknowledged:
The applicants had withdrawn cash from the business account which is a common practice. The funds then were used to pay for daily living expenses and fund investment loan repayments. We agree that some of the funds the applicants had withdrawn from the business account should be added back in an asset betterment calculation as some funds were used for private living expenses.
The concession is made expressly in the applicants’ written opening submissions at [8]. Importantly, the applicants denied there was any fraud – which means the returns cannot now be amended – and argued the scale of the under-reporting (if that is what occurred) was much smaller than the Commissioner alleged.
Mr H acknowledged in his second statement (exhibit two) that the partnership established a snack bar that operated from the same premises as the tobacco supply business. He denied the partnership ever made much money out of the snack bar. He said it operated at either a small loss or a small profit throughout the period in question. Even so, it had turnover and expenses. Mr H said in exhibit two that the two businesses had separate business banking accounts but deposits and withdrawals relating to the tobacco supply business might be run through the snack bar account “because the [tobacco supply business] account deposit book was full or I had run out of [tobacco supply business] cheques”: exhibit two at [24]. He added he had reviewed the bank statements for the period relating to each business and concluded any transaction for an amount in excess of $500 was actually attributable to the tobacco supply business: at [25].
The evidence that funds from the snack bar and the tobacco supply businesses were intermingled muddies the waters somewhat. The evidence makes it harder to follow the financial affairs of the partnership.
The applicants say they were able to afford the properties they purchased by relying on a combination of bank borrowings and credit provided by a range of individuals, much of which was provided in cash. They also had access to cash raised through a series of syndicates called Huis. There is nothing sinister going on, they say, and certainly no evidence of fraud or evasion.
Some observations about the evidence of the applicants
I should begin with some general observations about Mr H’s evidence. The evidence was important to the applicants’ case, as Mr H acknowledged he was the “driving force” behind the tobacco supply business for much of its existence: exhibit one at [115].
Mr H is an elderly man, and seriously ill. He has been unwell for a long time: he was diagnosed with cancer in 2002 and underwent surgery and chemotherapy during the period covered by the amended assessments. His current medical problems were set out in his second statement (exhibit two at [5]). He was unable to attend the hearing on the first day because he was too sick. I was told there were questions over his competence to give evidence at the time. The proceedings were adjourned until he was cleared by his doctors. As he was still convalescing, the first day of evidence was taken at Mr H’s home, although he subsequently presented himself in the hearing room to complete his evidence and cross-examination.
Mr H spoke through an interpreter. His evidence was not always easy to follow: he was unable to answer many questions, and occasionally appeared confused. In the applicants’ written closing submissions, their lawyer suggested the cross-examination occasionally “descended into farce” when it was clear Mr H did not understand questions put to him. These submissions criticised the way in which counsel for the Commissioner cross-examined the applicant. The submissions suggested many questions were put in a confusing way. I am not inclined to criticise the Commissioner’s counsel in this regard. She had to ask Mr H about his affairs, which were not straight forward, and he was not an easy witness to deal with. His difficulties may have been the product of his age, his state of health, a desire to obfuscate or problems with the interpreter, or some combination of all of the above. I had no particular reason to question or criticise the performance of the interpreters. I note Mr H was able to answer some questions without waiting for the interpreter to translate, but he was apparently unable to understand some other questions. I am surprised Mr H’s English skills were as limited as he suggested in his second statement (exhibit two at [1]) given he has been in this country, carried on business and raised a family for over 30 years. I also note he claimed he provided advice and assistance to other members of the Vietnamese community over many years, and that he had been a leader in the Vietnamese-Australian business community: exhibit one at [7]-[10]. Those roles would presumably have required a level of familiarity with Australian practices and the local community, which would have required a level of proficiency in the English language. Even so, I note Mr Borgeaud, the applicants’ accountant, spoke of communication difficulties. In his oral evidence, he said he often had to communicate with the applicants in writing – presumably so the contents of the communication could be translated and read to them, perhaps by a member of the family.
Whatever the explanation for Mr H’s difficulties, they were such as to call into question the value of the oral evidence. Given his age, the language barriers and the apparent impact of his illness on the quality of his testimony, I was satisfied Mr H’s oral evidence should be treated with caution. His written statements (exhibits one and two) are more coherent, although the precise and confident assertions of fact in those statements are hard to reconcile with the level of impairment I observed and which I was told about at the hearing.
The shortcomings in Mr H’s direct evidence are problematic because his wife clearly did not know as much about the business as her husband, notwithstanding that she supposedly ran the business for a significant portion of the period covered by the amended assessments while her husband was ill. The paucity of documentary evidence makes the evaluative process even harder. It is understandable that documents are hard to locate in a case like this. The transactions to which the documents relate occurred around a decade ago, and the law does not require that business records be kept that long. But there is a twist: the applicants say most of the relevant records were removed by the Federal Police in the course of executing a search warrant in 2004. I was not told about the nature or purpose of the investigation. Mr Henry, for the applicants, pointed out his clients were not charged following the investigation, and the Commissioner and the applicants agreed I should not draw any adverse inferences from the police interest in the applicants’ affairs.
While I accept I should not draw any inferences from evidence about the search warrants, the simple fact the documents are no longer available makes it more difficult for the applicants to construct a superior alternative explanation of what the assessment should be. I was invited to infer some documents were misplaced by police, although there is a dispute over precisely what was removed under the terms of the search warrant, and what was returned: see the final submissions of the respondent at [38]-[39].
The applicants suggest I should draw comfort from the expert accounting evidence offered by Mr Simpson and Mr Borgeaud. Mr Borgeaud disputed the methodology used by the Commissioner in the asset betterment schedules. Mr Simpson was called to show it was entirely possible for the applicants to have acquired their property portfolio without having to treat all of the withdrawals from their accounts as private expenditure.
The evidence of Mr H about the source of the money
I turn now to deal directly with the evidence of Mr H. I have already noted he gave his evidence through an interpreter, and that he was a frail, elderly man who appeared to have difficulty understanding questions and remembering specific events. But he also provided two statements (exhibits one and two).
Mr H described the growth and operation of his business in the course of his statement (exhibit one). The partnership sold cigarettes from its retail premises but the firm also acted as a dealer in tobacco products. At first, it offered tobacco wholesaling services to retailers. Many of the early clients of the firm were from within the Vietnamese community in Brisbane and the applicants helped them reduce the administrative burden associated with tobacco sales. The business began to grow but in the late 1990s the manufacturers withdrew the bulk rebates they had previously offered to wholesalers like the applicants. The applicants changed their business model. They would buy tobacco products from other wholesalers and retailers at cheaper prices (made possible by the fact the cigarette manufacturers gave discounts and rebates to some outlets but not others) and then on-sell them to their own clients for a small profit. Mr H insisted margins on these sales were very low. Many of the transactions were conducted in cash, and many of them were quite large. In his statement (exhibit one), Mr H estimated there were several hundred cash transactions during the period relevant to the amended assessments involving amounts in excess of $10,000: at [32]. He said the partnership kept cash on hand in the safe in its office, with some additional cash in a safe at the family home. He estimated the safes contained approximately $265,000 in June 2000: at [88]. He said the money was used to fund business and personal activities. By 2007, there was only around $25,000 left: at [97].
I note there is no independent verification of the amount of cash the applicants kept, disbursed or collected (although both Mrs W and her son claimed they saw piles of cash on occasion). It is unclear how Mr H could be precise about the quantum of cash. His assertions about cash on hand must be treated with caution, given his poor memory for events.
The question of how much cash was really on hand looms larger in light of Mr H’s evidence that it would usually be necessary to withdraw money from various accounts to buy cigarettes at discounted prices when the opportunity arose (exhibit one at [30]) and cash generated from the sale of tobacco products would be deposited into the same accounts (at [31]) – but not necessarily all of the cash. Mr H pointed out (at [112]) he might put some of the proceeds of the sale of a particular batch of tobacco products into the accounts, but some of it could be used to buy other products, or pay expenses or refresh the amount of cash on hand. He also said the firm bought many products on credit from the manufacturers and other wholesalers: at [39]-[42].
Mr H explained the preference for dealing in cash in exhibit one at [43] as follows:
Throughout the period relevant to this application it must be noted that no other tobacconist would accept payment over $500.00 using a cheque. The high capital cost of tobacco products and the need to negate counterparty risk meant that none of the counterparties to secondary tobacco product transactions including other tobacconists and retailers would accept any payment method other than cash.
Mr H added that, for cultural and historical reasons, he was used to dealing in cash: exhibit one at [45], [84]-[85].
The applicants provided some paperwork evidencing transactions between their firm and some of the nominated suppliers, but the documents do not take me very far. The invoices confirm the applicants were dealing in tobacco products, but that was never really in doubt. The principal evidence about the partnership’s business and the financial transactions it conducted must come from Mr H – and from Mr H’s written statement, which offers a markedly more lucid and coherent account of what occurred than his oral evidence.
Mr H said he had other sources of cash as well. He received $90,000 from his sister in June 2002, for example. It seems that money was never deposited into a bank account. The money was not a gift, according to his sister. Their late brother had left the money to support their mother: exhibit 14 at [15]-[19]. The applicants also claimed they had extensive borrowings. Some of the money was borrowed from conventional banks to fund the purchase of their properties, but the applicants also borrowed money at various times from family members and others within the Vietnamese community. Mr H described receiving a line of credit from a business associate in the amount of $395,000 between 2001 and 2004: exhibit one at [49]-[50]. He said money was advanced to the applicants under the terms of the facility (in $30,000-50,000 amounts, he said under cross-examination) that were paid in cash. The cash was then deposited into the partnership bank accounts. About $325,000 was withdrawn from the same accounts in small amounts to repay the debt during the same period. Mr H claimed the loan diary that recorded the individual cash transactions was lost: at [51]. Mr H produced a loan agreement that he said confirmed the existence of the line of credit (exhibit one at [52] and annexure ‘A’). Mr H said the money was used to purchase tobacco products that could then be resold, but some of the money was also used to fund deposits for the acquisition of the properties acquired by the applicants: at [53].
The applicants also borrowed money from another prominent member of the Vietnamese community on an interest-free basis in 2003. Mr H says an $80,000 advance was used to fund part of the purchase price of one of the investment properties acquired by the applicants: exhibit one at [56]-[58]. The written record of the loan is annexure B to Mr H’s statement (exhibit 1). The applicants did not identify any bank statements recording a deposit in that amount around the time the loan was supposedly received.
Mr H also gave evidence of a loan from his brother-in-law in the United States (exhibit one at [61]-[63]) of $USD37,500 (about $A65,674) in June 2002. The evidence on this point was curious. The lender had previously owed Mr H money that was borrowed before the pair left Vietnam. Some of the money had already been repaid but the balance was supposedly recovered from the brother-in-law following demands issued by Mr H’s solicitor in early 2002 – not long before Mr H obtained the separate advance from the erstwhile borrower in June 2002. The substance of Mr H’s evidence on this point was confirmed in a statement provided by the other party: exhibit 21. The funds repaid to Mr H in early 2002 were paid into the business bank accounts, according to Mr H: exhibit one at [82]. There was also evidence Mr H made a series of payments totalling $53,074.27 to his brother-in-law and sister-in-law between 28 November 2002 and 1 May 2003. Mr H denied in cross-examination that the payments were repayments under the loan agreement he entered into in June 2002 (see also exhibit 1 at [63] where Mr H said the loan remained unpaid as of July 2005). He suggested in cross-examination that the payments were made for his brother, but that is inconsistent with his first statement where he said (exhibit 1 at [91]) his brother had died in 1989. (Mr H’s sister confirmed in her statement that their brother had died in 1989: exhibit 14 at [4].) Mr H noted his brother had earlier repaid a loan in cash that had been incorporated into the partnership’s cash reserves.
It is unclear why Mr H would be making payments to his late brother. This evidence makes no sense and tends to confirm my view that Mr H’s oral evidence in particular must be treated with caution. In any event, there is no suggestion from the applicants that the monies were paid to the brother-in-law in respect of a business expense, even though they were paid out of a business account. They were personal expenditure.
Mr H also spoke of two loans from Mr H’s son. One of the loans was advanced by cheque in the amount of $18,000 but the other was supposedly comprised of a series of small cash advances totalling $30,000 that were used to pay living expenses: exhibit 1 at [64]-[65]. The oral evidence of the son suggests the cash advances were not loans as such: he was living at home and any amounts paid appeared to be in respect of board. None of the money obtained from the son was repaid to him during the period although it is unclear if the amounts he contributed really amounted to anything more than a contribution towards his share of the running costs of the household: exhibit 1 at [66].
I also heard a good deal of evidence about Mr H’s participation in Huis. I was told a Hui was a traditional way of raising money in the Vietnamese business community. There might be 20 or 30 (or even more) participants in a Hui. Each participant would contribute a relatively small amount into a central pot of funds that was managed by the banker for that particular Hui, who was also one of the participants. Mr H said he usually paid his share – typically $500 or $1000 in cash – from his cash reserves, or occasionally from the partnership’s bank accounts: exhibit one at [74]. The pot would then be paid out to one of the participants selected by lottery. The following week, or month, the participants would pay the same amount into a fresh pot that would then be allocated to someone else in the group – and so on, each week or month, until everyone in the group received a payment of one round of contributions. Mr H explained (exhibit one at [68]-[72]) the Hui made it possible for participants to raise capital at no interest, although those participants who received a payout earlier in the process obviously fared better. Mr H said he participated in many Huis: he set out a list at [78] of his statement (exhibit 1). He explained he would typically deposit into his bank accounts the lump sums he received from the many Huis in which he participated: at [75].
The substance of Mr H’s evidence about the Huis and the fact he occasionally acted as banker was confirmed in evidence provided by two other regular participants. They each claimed they could recall the Huis in which Mr H participated: they both said they had met at the Buddhist temple and compared recollections in order to compile the list. Both of those witnesses confirmed in their oral evidence that the written records in relation to each Hui – most obviously the list of participants – were destroyed when that Hui concluded.
I do not think I can rely on the evidence given by Mr H or the two other witnesses who were called to discuss Huis as to the number of Huis or the precise amounts the applicant derived from each Hui. Mr H’s oral evidence must be treated with caution, as I have already explained. His recollection of matters in the witness box was poor. It is unclear how he would be in a position to recall precise details in his statement in the absence of records. The absence of documentary evidence, the passage of time and the fact the witnesses conferred in advance of the hearing in order to compile a detailed list of Huis raises serious questions about the reliability of the estimates. I will discuss the implications of this finding in due course.
All these cash transactions – many of them sourced from essentially undocumented loans (or even gifts) from friends and business associates, and still more of them relating to the Huis – washed through the partnership accounts. Or did they? The applicants (especially Mr H, who clearly controlled the applicants’ business affairs) sought to explain away the many transactions recorded in the bank accounts on the basis Mr H liked to deal in cash and his sources of cash were many – but none of them were income. The Commissioner has misunderstood what was going on, the applicants argue, and it is unfortunate (but not unreasonable) that they no longer have access to the documentation that would substantiate their claims. Mr H added for good measure that he was seriously ill from 2002 and he was for that reason unclear on what his accountants were being told about the partnership’s income. In his statement (exhibit one at [120]) he acknowledged the possibility of miscommunication between himself and his wife and their accountants owing to his illness which resulted in some under-reporting of income – but Mr Henry, the applicants’ counsel, insisted there was no fraud or evasion so that s 170 of ITAA36 was not engaged.
Mr H’s evidence about the purchase of the properties
Mr H gave evidence about the acquisition of the various properties (and interests in properties). The oral evidence related in particular to the purchase of the applicants’ home in September 2001 and the March 2002 purchase (along with their daughter) of an investment property in a neighbouring suburb. The applicants claimed they borrowed most of the purchase price for their home from the bank, with the balance coming from cash on hand and other sources of money available to them, including Huis – but not from unreported income. They then borrowed most of the purchase price for their share of the investment property and paid out the mortgage on their home shortly after in April 2002. Mr H suggested in his oral evidence that the home loan was refinanced with another financial institution. He said he did not have any documentation from a bank that would sustain that claim. He suggested the Bank of Queensland might hold relevant documents, but the documents were not produced.
The large investments in various properties during this period did rely on funds borrowed from various bankers, but there was still a requirement that the applicants contribute equity from the resources available to them. If the applicants were able to purchase the investment property in 2002 with borrowed funds while paying out the mortgage on their home using their own resources, the evidence about Huis and assistance from family and friends becomes even more significant, and the question marks over the amounts derived from the partnership business take on more significance.
The evidence of Mrs W
Mrs W gave evidence at the hearing and provided a statement. Like her husband, she gave oral evidence through an interpreter. I note she was able to respond to some questions in English, but I accept she was not proficient in English. Her oral evidence was vague. Her statement was worded more confidently but did not include much useful additional detail. It is unclear whether she wrote the statement herself, given she had difficulty reading and writing English.
The written statement (exhibit 12) is relatively short. It repeats many of the assertions of fact in Mr H’s statement about the operation of the tobacco supply business. She said she was aware of the “informal lines of credit” provided by wealthy Vietnamese business associates: at [23]. She said she thought the money made available under these arrangements was used to buy tobacco products but added some of the advances provided by one of the lenders in particular was used to fund deposits for the acquisition of properties: at [25]. She also named another wealthy businessman who provided a loan in connection with the purchase of an investment property in South Brisbane: at [27]-[28]. The statement also sets out some details of borrowings and payments received from members of the family, including an advance that has not been repaid from her son. That is all consistent with the evidence of her husband, but I do not think it adds significantly to the weight I should accord to Mr H’s evidence given the relationship between them and the fact the statements were almost certainly prepared together.
Mrs W agreed she played an active role in aspects of the business over time but – at least prior to 2002 – she left most of the management decisions to her husband: exhibit 12 at [54]. Her written and oral evidence suggests she was unaware of many aspects of the details of the partnership’s financial affairs, including the property dealings. She said in her statement (exhibit 12):
· her husband did not always consult her about property purchases: at [26] and [64]-[66];
· she was not aware whether one loan from an associate in June 2002 had been repaid. Her statement says that information would have to come from her husband: at [30];
· her husband preferred to deal in cash and held cash on hand but she was unaware of how much or where it was located: at [34]-[37].
While I accept Mrs W took on a more active role in his business after her husband became ill, it seems clear from her evidence that she still consulted her husband in relation to more important decisions.
Mrs W’s oral evidence in relation to bank transactions was of limited assistance. She was asked in cross-examination about deposits and withdrawals from bank accounts. The Commissioner suspected around $4.9 million passed through the accounts in the relevant period, and said that money should be counted as income. The applicants’ have argued through their counsel that the $4.9 million figure includes an element of double counting. Mrs W had some difficulty responding to the questions, and her senior counsel took objection on the basis that Mrs W did not understand what she was being asked in cross-examination. She conceded, in broken English, that she had withdrawn amounts for personal use but she also deposited money when she did not need it. She did not deny that a significant amount of money went through the accounts but I infer from her answer that a small portion of that money was treated as income and applied towards personal expenses while the balance of the transactions occurred in the ordinary course of the business. Her evidence was also consistent with the submission that there had been double counting, but she offered little in the way of detail that would substantiate the claim. Counsel for the applicants said the Commissioner failed to ask her about that issue, but it was a matter for the applicants to make out their claim given they are in the best position to know what was going on with their own affairs. (I note the final written submissions of the applicants criticise the Commissioner’s counsel for failing to elicit evidence from the applicants on a number of points, but I do not think that is fair. Section 14ZZK(b) of the Taxation Administration Act 1953 means it is generally the applicants who have the burden of establishing an explanation by leading appropriate evidence.)
Mrs W agreed she took over day-to-day management of the partnership’s business in 2002 when her husband became seriously ill. She agreed she was not familiar with most of the responsibilities she was required to assume: exhibit 12 at [56]. She said she had the assistance of one of her sons. She said she would prepare the paperwork for him so that he could go over it and pass it on to the accountants: at [56], [59]. She agreed she may have made innocent mistakes in relation to the paperwork which resulted in incorrect information being provided to the accountants and under-reporting of income: at [59]. She said her husband was happy to help but she did not like to bother him because of his illness: [57]. She said she struggled with the business and it closed in the latter part of 2004.
The evidence of the other lay witnesses
The eldest son of the applicants, a former police officer, gave evidence at the hearing and provided a statement (exhibit 16). He said he assisted his mother with the accounts once his father became ill in 2002. He confirmed many of the transactions were effected in cash (at [11]) and that the record-keeping was haphazard. He said his mother was struggling with the demands of the business: at [13]. He said he had no other direct role. His evidence is of limited assistance.
Mr H’s sister gave a statement: exhibit 14. She focused on the payment of $90,000 in cash to her brother in June 2002. The cash had been left with her by her other brother for the purpose of looking after their elderly mother. The money was given to Mr H, apparently for safe-keeping.
The applicants’ other son also made a statement (exhibit 15) and gave evidence. His statement included a copy of the cheque drawn in favour of his father in the amount of $18,000. The son confirmed the money was a loan which he understood was used in the business. He also spoke in his statement about further advances totalling $30,000: at [5]. He said those amounts were paid towards the living expenses of his parents, and noted in his statement the monies were loaned because his father wanted it that way. In his oral evidence, he suggested he was living with his parents at the time he advanced the monies and was not paying rent or board. He said he wanted to make money available to his parents but they were too proud to accept board. I am satisfied those monies were in substance payments in respect of board rather than advances on a loan. It is doubtful the monies were deposited in an account given they were essentially contributions towards household expenses that appeared to change hands over the kitchen table.
The Vietnamese businessman who provided a line of credit to the applicants also gave evidence. He confirmed the existence of the line of credit but had difficulty identifying how much money was owed at any given time. Apparently it was a rolling account: money came in and went out, and the balance of the account was constantly changing. He said in cross-examination that he behaved like a banker providing an overdraft, although he did recall there was a limit on the informal facility: there was never more than $150,000 owing. He had no independent recollection of how much was advanced over time. He said he had a loan diary, although that was not produced. (There was some suggestion it had been seized by the police, but that was unclear. Mr H also referred to a system of providing a letter with each advance, but said the letter was torn up when each advance was repaid.) The businessman said he had spoken with Mr H about the total he borrowed, and adopted that figure.
Curiously, Mr H was shown a copy of the loan agreement annexed to exhibit one but denied the signature on the document was his. I assume this is a further illustration of the need to treat his evidence with caution. I also note the loan agreement – if that is what it is – was dated 13 March 2013. It is not a contemporaneous record of the loan. I do not think it can be given any weight.
Given the state of the evidence, it is impossible to be sure how much (if any) money came from the businessman who supposedly provided the line of credit.
The other businessman who was said to have loaned Mr H money to buy the investment property in 2003 also gave oral evidence. There is no documentary record of that money being advanced or repaid, although the businessman recalled in his evidence that the transaction had taken place.
The applicant’s brother-in-law gave evidence from the United States by telephone. He also provided a statement (exhibit 21). His statement included documentation that purported to confirm he had paid money to Mr H in connection with the loan he had received from Mr H before they left Vietnam. He also included a document that purported to be a record of the loan to Mr H in June 2002.
WHAT CONCLUSIONS SHOULD BE DRAWN FROM THE EVIDENCE OF THE APPLICANTS AND THEIR LAY WITNESSES?
I have already indicated I regard Mr H’s oral evidence as unreliable. His written statements are also a matter of concern given they make a number of assertions – including detailed assertions as to some matters, like the amount of money invested in Huis, and the frequency with which the Huis occurred: exhibit one at [78] – that are surprising given the presentation of Mr H at the hearing. Mrs W’s evidence was also of limited value, given she did little more than endorse her husband’s evidence and claimed she really knew little of what was occurring, as she left most of the business decisions to her husband.
I am not persuaded the applicants raised the amounts of money they claimed from the Hui system. I have no reason to doubt the applicants did occasionally participate in Huis, but I do not think Mr H’s recollection of the timing and contributions is reliable. The fact his assessment was verified by two other participants does not assist: they both say they conferred in the course of preparing their evidence as to when the Huis occurred and the amounts that Mr H contributed, and there are no independent written records that would provide any sort of confirmation.
I am also unconvinced about the extent of loans obtained from various sources. It is unclear how much money was obtained from the Vietnamese business associate who provided the line of credit, for example. The businessman confirmed in his oral evidence that he did not know, and even the applicants appeared unsure of how much money came from that source even if they were in agreement as to the maximum amount that could be borrowed at any one time. I am also unimpressed by the explanation given for the monies passing between Mr H and his brother-in-law in the United States. Mr H claimed he was owed money and demanded its return before borrowing an amount – and then made payments to his brother-in-law that Mr H claimed were not repayments of a loan but were for some other purpose (he suggested they were for his brother, but he had already died). I also note the evidence of the business associate who loaned Mr H money to buy the investment property was vague and lacking in detail.
I am left in a position where I am unable to explain how much money the applicants derived from tobacco sales or from other sources. I accept there may have been money derived from family in the form of gifts and loans on favourable terms, and I accept there may have been money advanced from business associates. But the precise amounts and the timing of any payments remains a mystery. All I know for sure is that there was a lot of cash going through the accounts, and a good deal more cash was kept on hand in indeterminate amounts. There may have been some double counting, but it is unclear how much. I also accept that at least some of the money was being used to pay personal expenses, but again, it is unclear how much.
The applicants were poor witnesses. That may be at least partly due to factors beyond their control, but the fact remains their evidence – especially their oral evidence – is of limited assistance. Some of the evidence was plainly misleading or unsatisfactory: the explanations offered by Mr H for payments made to his brother-in-law, for example. The absence of documents is also a barrier to reaching a definitive view of what occurred. I accept the events in question occurred some time ago, and the parties were not obliged to keep records for this long. But it is also clear from the evidence of the parties that they never had well-developed record-keeping systems.
After hearing the applicants’ witnesses of fact, I was left without a satisfactory answer to the question posed by the Commissioner at the outset of these proceedings: how is it that two individuals who reported modest incomes in their tax returns in the relevant period could afford to purchase a number of properties, or interests in properties? The respondent says it is difficult to accept the applicants had access to sufficient equity to make these investments given their other financial commitments – including mortgage repayments, a “significant role in raising funds” for their church (referred to in exhibit 12 at [48]), meeting the cost of the credit facilities with the tobacco manufacturers, the monthly commitments to the Huis, the payments to various creditors and family members and their living expenses. I agree.
THE EXPERT WITNESSES CALLED BY THE APPLICANTS
The applicants and their lay witnesses provided the evidence upon which the accounting experts based their reports. Given my criticisms of the evidence of those lay witnesses, it will be apparent the experts’ reports are of limited value. I shall deal with them in any event for the sake of completeness.
The applicants called two expert witnesses. The first report (exhibit 18) was provided by Mr Andrew Simpson, a chartered accountant with Grant Thornton Australia Ltd. Mr Simpson also gave evidence at the hearing. He focused on the asset betterment analysis prepared by the Commissioner. He noted (at [10]-[11]) the Commissioner claimed:
·The applicants appeared to have at least twice as much stock on hand at the conclusion of each year of income; and
·Withdrawals from bank accounts were treated as expenditure on private expenses and therefore taxable income unless the withdrawals were tied to expenses incurred in relation to the business or rental properties or confirmed transfers to other accounts.
Mr Simpson said the asset betterment methodology was prejudicial to the applicants given the way they managed their financial affairs: exhibit 18 at [12]. He said the applicants told him they had a number of financial obligations – various mortgages, overdraft facilities and credit cards (and credit arrangements with suppliers, I would add). He said he understood the applicants moved money from one source of finance to another to meet their obligations as they arose. He explained (at [18]-[19]):
[18]…the applicants have told me that they may have borrowed from an associate to make a payment on their overdraft facility. Shortly thereafter they may draw down on an overdraft facility to pay a tobacco wholesaler account when it falls due.
[19] By utilising their sources of income in such a manner, it would be possible for withdrawals from bank accounts to be two or more times the amount necessary for a single purchase of tobacco.
Focusing on the withdrawals from the bank accounts (as the Commissioner had done) was misleading in those circumstances, Mr Simpson argued. He attempted to prepare a fresh analysis that took account of the information contained in the applicants’ statements. His analysis showed there appeared to be additional income that had not been reported during the relevant period but noted his instructions that there were additional sales, which meant additional cost was incurred: exhibit 18 at [32]-[33]. There were no records of those additional sales or their cost, but he used the ATO 2010 benchmark for Tobacco Retailing to establish a cost of goods sold ratio of between 92-96%: at [35]. On that analysis, he concluded the amount of unreported income was no more than $181,480 between the two applicants over the period: at [39].
The applicants also called Mr Malcolm Borgeaud to give evidence. Mr Borgeaud cannot be regarded as an independent expert. He is the applicants’ accountant. There is no evidence that he is qualified or experienced in forensic accounting. His evidence was still interesting though, in his oral evidence, he spoke of his experience in dealing with the applicants. He said he would prepare tax returns from basic documentation. The documentation did not include records; it was usually a trial balance, prepared by the applicants’ son. He said he did not see source documents. (I note Mr H claimed in cross-examination that he provided supporting paperwork when he dealt with the accountants at the end of each year for the purpose of preparing a tax return. Given the reservations I have in relation to Mr H’s recall, I prefer the evidence of Mr Borgeaud to the effect that he was provided with limited documentation.) The son became more involved in the interactions with Mr Borgeaud when Mr H became ill. Mr Borgeaud also talked about the difficulties involved in communicating with the applicants in light of their poor English skills. He said they would visit his offices but he often had to communicate with them in writing.
Like Mr Simpson, Mr Borgeaud is critical of the Commissioner’s asset betterment methodology. He said the methodology used inevitably overstates the applicants’ income because it “treats all expenditure as income and does not take account of any additional costs of sales or other legitimate business expenditure”: exhibit 17 at [25]. He complained that the methodology also occasionally mistook capital costs for expenditure and used a cash basis for recording some items and an accrual basis for others: at [26].
I acknowledge there are almost certainly flaws in the Commissioner’s methodology. Even at the best of times, an asset betterment analysis is a crude tool for estimating income. But there are also problems with the specific criticisms made by Mr Simpson and Mr Borgeaud, and with the alternative estimate of income suggested by Mr Simpson. Mr Borgeaud and Mr Simpson are operating on instructions provided by the applicants. Mr Borgeaud may be their accountant, but it was apparent from his evidence that he played a passive role throughout the period under review. He prepared returns from the limited material they provided to him, and he gave them basic advice on compliance issues. He was not across the detail of their business and he did not have access to all of the documentation. Mr Simpson has come to the matter even more recently. Given the findings I have made about the unreliability of the applicants’ evidence, and specifically about the uncertainty around the sources of income, it is difficult to give his modelling and alternative assessment any weight.
While I accept the Commissioner’s asset betterment analysis is open to criticism, I am satisfied it proceeds on a rational basis. Given the difficulties with the applicants’ accounts and records, and in light of the objective facts (namely the large flows of cash through the accounts and the acquisition of a property portfolio when the applicants reported modest assessable income), I accept the Commissioner’s analysis provides a legitimate basis for his assessments.
WERE THE AMENDED ASSESSMENTS EXCESSIVE?
The applicants say they should not be criticised for the absence of documentary evidence given the passage of time. I agree the applicants are placed at a disadvantage if they are unable to access records. That is one reason why there is a general rule preventing the Commissioner from issuing an amended assessment more than four years after the original assessment in the absence of evidence of fraud or evasion. If I am satisfied fraud or evasion has occurred, the applicants’ complaints carry rather less weight. In those circumstances, they must contend with the reality discussed in Imperial Bottleshops Pty Ltd & Edgerton v Federal Commissioner of Taxation (1991) 22 ATR 148. In that case, Hill J pointed out uncorroborated evidence of a taxpayer should be treated with caution given the obvious conflict of interest they (and their friends and relatives) face: at page 155 [31]. The shortcomings in the applicants’ own evidence (and that of their other lay witnesses) make the absence of documentary evidence a serious obstacle to establishing a more accurate assessment.
As I explained at the outset of these reasons, the applicants bear the burden of establishing that the (amended) assessments are excessive or incorrect, but they must go further than that. They must also establish what the assessments should have been: s 14ZZK(b)(i) of the Taxation Administration Act 1953. Even if I accept the amended assessments were excessive, the applicants’ case leaves me uncertain as to the correct amounts that should be assessed. It follows the applicants have not discharged their obligation under s 14ZZK(b) of the Taxation Administration Act 1953.
WAS THERE FRAUD OR EVASION?
The Commissioner is not able to amend the assessments more than four years after the date of the original assessment except in the circumstances identified in s 170 of ITAA36. It follows the apparent underreporting of income I have identified in the original returns will remain undisturbed unless I am satisfied there was fraud or evasion.
The expression “fraud or evasion” is not a technical one. I do not need to exhaustively define it. Indeed, it would be undesirable to do so, for the reasons explained in Denver Chemical Manufacturing Company v Commissioner of Taxation (NSW) (1949) 79 CLR 296 at 313 per Dixon J. But the expression certainly refers to a situation in which a taxpayer consciously withholds information from the Commissioner or deliberately misstates other information in order to reduce the amount of tax which he or she is liable to pay: see, for example, Australasian Jam Co Pty Ltd v Federal Commissioner of Taxation (1953) 88 CLR 23 at 40 per Fullagar J.
The applicants say there was no intentional misstatement or conscious withholding of information in their dealings with the Commissioner. They acknowledge mistakes might have been made, but they were innocent errors attributable to poor record-keeping and inexperience (especially once Mrs W assumed a more central role in the business following her husband’s illness).
The Commissioner argued I could infer the applicants engaged in fraud or evasion from the circumstances – in particular, from the scale of the underreporting. He argued the applicants must have known they were not accurately reporting their income at the time, and that they were paying less tax as a result.
I agree with the Commissioner. The applicants – both of them – must have known they were not reporting their income accurately, and the explanations they have given in respect of their affairs reek of artifice. While there are a number of aspects of the evidence provided by the applicants that call into question their intentions, I am particularly struck by the inherent improbability of the applicants’ account of their business model during the bulk of the period under review. They claim they acted, in effect, as arbitrageurs. They would rush to buy cigarettes from retailers or dealers who enjoyed temporary rebates or discounts from wholesalers. Those purchases could then be resold at a higher price to other retailers. That is not inherently unbelievable, but to run a business on the scale claimed by the applicants would have required an extensive intelligence network that enabled them to identify opportunities for arbitrage. The applicants – Mr H, in particular – would need to know precisely where the bargains were available, and where they were not, and someone would have to be despatched from one location to another to pick up, transport and deliver stock – and handle the money. Yet Mr H was ill during much of this period, and by his own admission his English skills were poor. He would have had some real difficulty maintaining an intelligence network or negotiating the many extra sales that he said would explain the flow of cash through the applicants’ accounts. Mrs W, who also claimed to have poor English, was in an even worse position in this regard. She did not have the knowledge or experience to obtain and assess the intelligence about arbitrage opportunities on a large scale.
I am satisfied the applicants must have engaged in fraud or evasion in their dealings with the Commissioner. They did not misinform the Commissioner about their taxable income through accident or oversight. I am satisfied they actively and deliberately misinformed the Commissioner about their income. Mr H was clearly involved in the affairs of the business after he fell ill, even though he was not as active in day-to-day operations. He cannot avoid responsibility for what was said in the latter years in the period. Mrs W, while less involved early on, was still present in the business and able to observe what was going on. Once her husband fell ill, she actively ran the business and dealt with the accountant, so she must have been aware the returns furnished by the accountant were misleading.
It follows the Commissioner is entitled to issue the amended assessments.
PENALTIES
The Commissioner is entitled to levy administrative penalties on the tax shortfalls in each year of income that resulted from the misleading statements in the returns: s 284-70(1) of Schedule one of the Taxation Administration Act 1953. The Commissioner says the taxation shortfalls in this case arose as a result of intentional disregard of taxation laws, which attracts a base penalty of 75%: s 284-90(1). There was an uplift of 20% in respect of the 2002, 2003 and 2004 years in light of the penalty in the year ended 30 June 2001.
The applicants must establish those penalties are excessive. My findings of fact make it clear I am satisfied the applicants knew they were underreporting their income. They provided incorrect and inadequate information to their accountant who completed their returns showing modest taxable income when they must have known they should have been reporting more income and paying more tax. They were not simply negligent or even reckless. They have concealed the true situation in order to pay less tax.
I am satisfied the applicants have not demonstrated the penalties were excessive. They have also not demonstrated a basis for remitting the penalties. A penalty may be remitted pursuant to s 298-20 of the Taxation Administration Act 1953 if I am satisfied the outcome (that is, the imposition of the penalty) would be “harsh, having regard to the particular circumstances of the taxpayer”: see Archibald Dixon as Trustee for the Dixon Holdsworth Superannuation Fund v Commissioner of Taxation [2008] FCAFC 54 at [26] per Spender, Ryan and Emmett JJ. I accept the applicants are elderly people, and that Mr H in particular is in poor health. I also accept that affirming the assessments as to penalties will cause them financial hardship. But penalties are calculated with reference to the taxation shortfall, so the size of the penalties is to be expected given the scale of the underreporting. The applicants have not pointed me to any evidence that persuades me their circumstances are such that they should be relieved from the burden of the penalties.
CONCLUSION
The objection decisions under review must be affirmed.
I certify that the preceding 80 (eighty) paragraphs are a true copy of the reasons for the decision herein of Senior Member Bernard J McCabe. ........................................................................
Associate
Dated 23 December 2013
Dates of hearing 30 May 2013,
20 & 21 June 2013,
3 September 2013Date final submissions received 17 September 2013 Counsel for the Applicant Mr C Sweeney QC and Mr M Henry Advocate for the Applicant Grant Thornton (Qld) Pty Ltd Counsel for the Respondent Ms L Allen Solicitors for the Respondent ATO
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