SDRQ and Commissioner of Taxation (Taxation)
[2019] AATA 2003
•19 July 2019
SDRQ and Commissioner of Taxation (Taxation) [2019] AATA 2003 (19 July 2019)
Division:TAXATION AND COMMERCIAL DIVISION
File Number(s): 2015/6796; 2016/3747
Re:SDRQ
APPLICANT
AndCommissioner of Taxation
RESPONDENT
DECISION
Tribunal:Deputy President I R Molloy
Date:19 July 2019
Place:Sydney
The objection decision deemed to have been made by the Respondent on or about 22 December 2015 is varied by reducing the Applicant’s taxable income for the year ended 30 June 2011 of $4,397,992 to $3,012,275.
The objection decision deemed to have been made by the Respondent on or about 1 April 2016 is varied by reducing administrative penalties of $656,806.30 by $207,857.55 to $448,948.75.
The objection decisions are otherwise affirmed.
..............................[SGD]..........................................
Deputy President I R Molloy
CATCHWORDS
TAXATION – capital gains tax – disposal of shares in companies – whether a capital gains tax loss occurred – lack of contemporaneous evidence – carry forward capital gains loss – market value of the shares – meaning of 'market value' – transfer not at arm's length – hypothetical purchaser – remission of penalty – recklessness – decision varied
LEGISLATION
Administrative Appeals Tribunal Act 1975, ss 37, 38AA
Income Tax Assessment Act 1936 ss 160ZD, 160ZH, 160ZZN,
Income Tax Assessment Act 1997 ss 102-15, 170-115, 170-120, 170-155Taxation Administration Act 1953, ss 14ZYA, 14ZZF, 14ZZK, Schedule 1
CASES
Abrahams v Commissioner of Taxation (1944) 70 CLR 23
Commissioner of Succession Duties (South Australia) v Executor Trustee and Agency Company of South Australia Limited (1947) 74 CLR 358
Commissioner of Taxation v Dalco (1990) 168 CLR 614
Commissioner of Taxation v Miley [2017] FCA 1396
Commissioner of Taxation v White (No. 2) [2010] FCA 942
Granby Pty Limited v Federal Commissioner of Taxation (1995) 95 ATC 4240
Hart v Commissioner of Taxation (2003) 131 FCR 203
In Dixon as Trustee for the Dixon Holdsworth Superannuation Fund v FCT (2008) 69 ATR 627
Martin v Federal Commissioner of Taxation (1993) 93 ATC 5200
McCathie v Federal Commissioner of Taxation(1944) 69 CLR 1
Palassis v Commissioner of Taxation [2011] FCA 1305
Robertson v Federal Commissioner of Taxation (1952) 86 CLR 463
Sanctuary Lakes Pty Ltd v Commissioner of Taxation [2013] FCAFC 50
Spencer v Commonwealth (1907) 5 CLR 418Trautwein v Federal Commissioner of Taxation (1936) 56 CLR 63
REASONS FOR DECISION
Deputy President I R Molloy
19 July 2019
This is a review of deemed objection decisions disallowing claims by SDRQ (“the Applicant”) for capital losses in the 2011 tax year and imposing a shortfall penalty.
BACKGROUND
The Applicant was a member of a group of companies whose interests included property development. The principal and directing mind of the group was Mr P.
Mr P has qualifications and experience in engineering. He also has considerable experience related to property development.
On 31 January 1989 the Applicant acquired from Mr P and members of his family 100% of the shares in:
(a)an engineering company, “Company A”; and
(b)a property investment company, “Company B”.
The consideration provided by the Applicant for the acquisition of the Company A shares was $3,000,000.15 and for the Company B shares $3,000,000.00, a total of $6,000,000.15.
Over the next few years the group encountered financial difficulties, attributed by the Applicant to a decline in Sydney property prices and a financier taking action in respect of a loan facility.
On 20 May 1991, the Applicant transferred its shares in Company A to Mr P for a nominal amount, generating it says a capital gains tax loss in the 1991 tax year of $2,999,895.14 (“1991 loss”).
On 29 July 1991, the Applicant transferred its shares in Company B to a company, Company C, also for a nominal amount generating, it claims, a capital gains tax loss in the 1992 tax year of $2,999,998 (“1992 loss”).
Company C was the trustee of a discretionary trust of which Mr P and members of his family were the objects.
The Applicant carried forward the 1991 loss and the 1992 loss to later tax years.
In the 2003 and 2005 tax years, the Applicant applied $1,057,163 and $304,094 respectively against its capital gains, leaving an alleged carry forward loss of $4,638,636 (“the carry forward loss”).
In the 2011 tax year, the Applicant had capital gains from a Company C trust distribution and the disposal of other interests, which totalled $4,366,652.
In its tax return for the year 2011 (“2011 tax return”), the Applicant applied the carry forward loss against these capital gains[1], recording “nil” for net capital gains[2].
[1] Exhibit (“Ex”) 1, T3-141.
[2] Ex 1, T3-143.
The Commissioner rejected the carry forward loss and by amended assessment, issued on 15 April 2015, increased the Applicant’s assessable income in the 2011 tax year by the amount of $4,366,652.
In addition, the Commissioner assessed the Applicant to a shortfall penalty of $656,806.30 for recklessly making a false or misleading statement by recording the carry forward loss in its 2011 tax return.
On 25 May 2015 the Applicant lodged objections to the amended assessment and the assessment of shortfall penalty.
On 21 October 2015, the Applicant required the Commissioner, pursuant to s14ZYA of the Taxation Administration Act 1953 (Cth) (“TAA”) to determine the Applicant’s objection to the amended assessment within 60 days of that date.
By virtue of TAA s14ZYA (3) the Commissioner is taken to have disallowed the Applicant’s objection to the amended assessment on 22 December 2015 (“the Objection Decision”).
In a notice dated 25 January 2016, provided to the Commissioner on 1 February 2016, the Applicant also required the Commissioner to determine the Applicant’s objection to the assessment of shortfall penalty within 60 days.
The Commissioner is taken to have disallowed the Applicant’s objection to the assessment of shortfall penalty on 1 April 2016 (“the Penalty Objection Decision”).
On 20 July 2016, by consent, a direction was made that the Applicant’s applications to review the Objection Decision and the Penalty Objection Decision be dealt with and, if necessary, heard together.
ISSUES
There are three main issues:
(a)Was the market value of the Company A shares at least $3 million on 31 January 1989, when the Applicant acquired them?
(b)Was the market value of the Company B shares nil on 29 July 1991, when the Applicant disposed of them?
(c)Depending on the outcomes to (a) and (b), should the Applicant be liable to a penalty, and if so, what penalty? And should the penalty, if any, be remitted?
As to the first issue, the Commissioner does not dispute that the market value of the Company A shares was nominal when the Applicant disposed of them on 20 May 1991.
Essentially the Commissioner’s contention is that the Applicant has failed to show the value of the Company A shares was $3 million, or more than nominal, at the time they were acquired by the Applicant on 31 January 1989.
As to the second issue, the Commissioner has agreed that the cost base and reduced cost base of the shares in Company B was at least $3 million when they were acquired by the Applicant on 31 January 1989.
The Commissioner’s contention in respect of this issue is that the Applicant has failed to show that the market value of the Company B shares was less than $3 million when it disposed of them on 29 July 1991, or at least has failed to show what their true market value was at that time.
As to the third issue, the Commissioner contends that the Applicant has failed to show that the penalty imposed was excessive, or any reason why the penalty should be remitted in whole or in part.
Under TAA s14ZZK(b) on an application for review a taxpayer has the burden of proving that an assessment is excessive or otherwise incorrect and what the assessment should have been.[3] The Commissioner is entitled to rely upon any deficiency in proof by the taxpayer.[4]
[3]Commissioner of Taxation v Dalco (1990) 168 CLR 614, 623, 625-6 and 631-4; Martin v Federal Commissioner of Taxation (1993) 93 ATC 5200; Trautwein v Federal Commissioner of Taxation (1936) 56 CLR 63, 88; and Palassis v Commissioner of Taxation [2011] FCA 1305, [9].
[4] Commissioner of Taxation v Dalco (1990) 168 CLR 614, 624-5.
TAA Schedule 1, Part 4-24, sets out an administrative penalty regime in respect of taxation laws. Section 284-75 of Schedule 1 deals inter alia with administrative penalties for making a false or misleading statement about a tax-related matter that results in a shortfall.
An applicant for review bears the burden of showing that an administrative penalty, in this case 50% of the shortfall amount resulting from reckless disregard of a taxation law, was excessive or otherwise wrong, or why the penalty should be remitted.[5]
[5] Commissioner of Taxation v White (No. 2) [2010] FCA 942, [18]-[19].
Company A, Company B and the Applicant
On 17 July 1981, Mr P established Company A to provide consulting geotechnical and structural engineering services to the property, construction and mining industries.
The shares in Company A, as I have said, were held by Mr P and members of his family prior to their transfer to the Applicant. Mr P has been a director of Company A since 24 July 1981.
On 29 December 1981, Mr P established Company B as a property investor company.
Each of Mr P and his wife held one of the two shares in Company B, prior to the shares being transferred to the Applicant. Mr P has been a director of Company B since 22 January 1982.
On 3 June 1987 the Applicant was established also as a property investor company. Mr P has been a director of the Applicant since 15 June 1987.
The Applicant’s principal witness was Mr P. He was the controlling mind of each of Company A, Company B and the Applicant.
Mr P’s evidence was Company A provided a range of services to both the Applicant and Company B. The services provided included, he said, locating potential properties for purchase, obtaining development approvals, acting as primary builder and/or construction manager, arranging leasing, and management.
The Applicant and Company B had no employees, premises, plant or equipment. Company A at times had other employees, but the services provided to the Applicant and Company B were for the most part performed by Mr P.
Mr P on behalf of Company A was essentially providing services to himself as principal of the Applicant or Company B. He did not have Company A charge the Applicant and Company B for its services or, if he did, it was not at arm’s length rates.
Mr P said this was a commercial decision taken by him, as owner and controller of each of the Applicant, Company B and Company A, to generate as little profit as possible in Company A, thereby increasing the gains made by the Applicant and Company B who were in the financial market borrowing for development projects.
The background to the transfers in January 1989 of the Company A and Company B shares to the Applicant was this. On 7 October 1988, Mr and Mrs P had purchased a home. The Applicant had lent Mr and Mrs P the purchase price, $5,000,000, which sum the Applicant itself had borrowed from a third party.
As at 30 January 1989, Mr and Mrs P owed the Applicant in excess of $5,000,000 (for the home purchase) plus $109,914.87 (in respect of other borrowings). Mr P says that around that time he had become concerned that a Fringe Benefits Tax liability could arise on the borrowing from the Applicant (the “FBT borrowing”) and he wished to repay the full amount to the Applicant to “eliminate” that potential exposure.[6]
[6] Transcript 51, lines 40-45.
Accordingly, it is said to have been orally agreed between the Applicant and members of the P family that the shares in Company A and Company B would be transferred by the P family to the Applicant for the aggregate consideration referred to above of $6,000,000.15 (and a further amount of $300,000 for the shares in another group company, “Company D”).
The transactions were documented in minutes of a meeting of directors of the Applicant on 31 January 1989 and share transfers were dated that same date. Mr P said he asked the companies’ accountant and tax agent, Mr R, for assistance with the share transfers. He could not recall asking Mr R for assistance in valuing the Company A shares.[7]
[7] Transcript 57, lines 20-30.
Ultimately, no money appears to have changed hands in relation to these transactions (except possibly in relation to Mr P’s children). Instead certain charges were entered into between the parties (i.e. recognising that the Applicant owed members of the P family for the transfers of the Company A, Company B and Company D shares) with those debts later being “set-off” against the FBT Borrowing (owed by Mr and Mrs P to the Applicant).
The aggregate agreed consideration for the Company A, Company B and Company D shares in the total amount of $6,300,000.15 appears to have been sufficient to offset the FBT borrowing and other borrowings, totalling in excess of $5,109,914. Mr P was not able to give the exact figure.[8]
[8] Transcript 50, lines 30-45.
The manner in which the purchase price of the Company A shares was arrived at in January 1989, was the subject of considerable evidence, especially from Mr P and, to a lesser extent from the companies’ accountant and tax agent, Mr R.
The Commissioner’s submission was the prices set for the Company A shares (and the Company B shares) in January 1989, were dictated by the desire to eliminate a loan balance exceeding $5 million (and thus overcome the potential Fringe Benefits Tax liability).
Mr P[9] and Mr R[10] each acknowledged the purpose of the transactions in January 1989 was to deal with the potential Fringe Benefits Tax liability. This of course does not mean there was no proper evaluation of the shares undertaken at the time, or that the Company A shares were not transferred for market value.
[9] Ex 1: T12-364; Transcript, 51, lines 30-45.
[10] Ex 40: Statement Mr R dated 19 April 2018 (“R”) at [31].
As to how the purchase price was arrived at, Mr R said he believes Mr P had a set of calculations with him in 1989 which were discussed and debated. He recalls a robust discussion at the time. However, Mr R could not recall the content or nature of the calculations, and has not retained a copy of them.[11]
[11] Ex 40: R at [35].
There is no contemporaneous evidence of any calculations performed by Mr P (or Mr R) around the time of the transfer of the Company A shares. Mr R expressed the view there was no requirement to retain certain documents.
It is relevant, nonetheless, that no contemporaneous documents can be produced evidencing or supporting the purchase price. If there were any documents, it was obviously of some importance that they be retained especially if the Applicant was later to take advantage of tax losses.
As the Commissioner points out, the Applicant has given differing accounts of what occurred in January 1989 in respect the purchase price of the Company A shares.
During a tax audit, in two letters to the ATO dated 31 July 2013 and 13 September 2013, jointly signed by Mr R (as tax agent) and Mr P, it was stated that the price of the Company A shares at 31 January 1989 was set at $3,000,000.15 on an “earnings multiple” or a “purchase price based on multiple of earnings”.[12]
[12]Ex 2: Chronological Bundle of Documents (“CB”) 155 at Part B (page 3); 156 (page 2); and Attachment A (page 3).
In a letter to the Commissioner’s lawyers from the Applicant’s solicitors, dated 18 October 2016,[13] it was stated that:
“Although Mr P cannot precisely recall now how he calculated the purchase price…he believes he may have used two methods. One method compared the cost of services performed by Company A to the costs charged by third parties to perform these services. The other method calculated the net present value of the future earning of Company A in continuing to provide its services.”
[13] Ex 2: CB 2/177.
The letter attached spread-sheets[14] which apparently contained Mr P’s recollections in October 2016 as to the calculation he claimed to have performed in January 1989. The spreadsheets contain differences from Mr P’s evidence in these proceedings, including a different discount rate.[15]
[14] Ex 2: CB 2/176 and 175.
[15] Transcript 69, lines 7-21.
In evidence, Mr P said when he did his calculations in 1989:
“I only had – I had half a sheet of paper that I – probably something that size, A4 size, that I carried out a hand calculation using approximate numbers projected forward at the CPI rate; at this current rate I was paying interest of about 14 or 15 percent at the time. I knew what my previous history was in success and it extrapolated that into the future, so I used historical data to project into the future in order to calculate the likely income stream that [Company A] would generate from those developments, and I did an upper and a lower. I used what I thought – what I knew we could do, what I thought we would be able to attack (sic) in the near future, and I also used some hypothetical figures.”[16]
[16] Transcript 258, lines 1-14.
Mr R also said that “the calculations were based on forecasts and cash flow projections in the context of development projects that were current or being considered at the time.” This is inconsistent, however, with the letters sent to the ATO in 2013 stating, “the purchase price was based on a multiple of earnings”.
I am not satisfied that the differences can be explained on the basis that the parties, in earlier communications, were dealing with different issues from those which were the focus of the hearing.
In evidence, Mr R conceded that he made no reference in his “affidavit” (meaning his witness statement[17]) to an “earnings multiple” or to a conversation in which Mr P told him that he was applying an earnings multiple[18], notwithstanding it “was a very important part of the methodology”.[19] Mr R could not recall the “actual multiple”[20], or “the exact number or the amount.”[21]
[17] Ex 40, R.
[18] Transcript 507, lines 1-3.
[19] Transcript 507, lines 5-6.
[20] Transcript 507, lines 12-14.
[21] Transcript 507, lines 16-19.
In his evidence Mr P maintained that his various calculation methodologies (prepared for the hearing) “justified” or “would justify” the $3 million figure set as the price of the Company A shares.[22] Mr R used similar language in his witness statement.[23]
[22]Transcript 62, lines 14-17; page 65, lines 18, 32, 43, 44, 46; page 66, line 34; page 89, line 16.
[23]Ex 40, R at [32] and [36].
The evidence of Mr P of how the price for the Company A shares was arrived at was blurred, I thought, by his attempts to justify the price as market value.
Having heard and seen Mr P and Mr R, and having regard to the other aspects of the evidence to which I have referred, I have formed the view that their evidence of how the Company A shares were valued in 1989, and indeed whether there was anything which could properly be described as a calculation, is at best reconstruction.
I am not satisfied that the price was fixed by any particular methodology. I accept the Commissioner’s submission that the price paid for the Company A shares (incidentally, virtually identical to the price of the Company B shares) was dictated by the potential Fringe Benefits Tax exposure and of eliminating that risk.
I am satisfied that no proper consideration was given at the time to the “cost base” or “market value” of the Company A shares.
I should mention that in forming this, and any other view which may be seen as going to Mr P’s credibility, I have disregarded the evidence of Mr P during cross-examination on 12 December 2017, when certain documents were produced on behalf of the Commissioner which arguably should have been produced at an earlier time.[24]
[24] See Administrative Appeals Tribunal Act 1975 (Cth) ss37 & 38AA and TAA s14ZZF.
Value of Company A shares on 31 January 1989
The ascertainment of the market value of the Company A shares in January 1989 involves the application of the Income Tax Assessment Act 1936 (Cth) (“ITAA36”) s160ZH(9).
That provision, as it stood at the time, provides relevantly that in determining the cost base, the indexed cost base or the reduced cost base to a taxpayer of an asset, if:
(c) the consideration paid or given by the taxpayer in respect of the acquisition would, but for this paragraph, be greater or less than the market value of the asset at the time of the acquisition and the taxpayer and the person from whom the taxpayer acquired the asset were not dealing with each other at arm’s length in connection with the acquisition of the asset, the taxpayer shall be deemed to have paid or given as consideration in respect of the acquisition of the asset an amount equal to the market value of the asset at the time of the acquisition.
The Commissioner submits this provision applies because (a) the consideration paid or given in respect of the acquisition of the Company A shares on 31 January 1989 was more than the market value of the shares, and (b) the Applicant and the sellers were not dealing with each other at arm’s length.
The Applicant accepts it did not acquire the Company A shares dealing with Mr P and members of his family at arm’s length (but not that the amount paid was not an arm’s length figure). Either way, the question is what was the market value of the Company A shares at the time of their acquisition by the Applicant on 31 January 1989 (“the valuation date”), and was it at least the consideration of $3 million paid or given.
Each party referred to decisions concerning the assessment of market value, including the High Court decision Spencer v Commonwealth[25], and the test of what a willing purchaser would at the date in question have had to pay to a vendor not unwilling, but not anxious to sell.
[25](1907) 5 CLR 418, 432; see also Abrahams v Commissioner of Taxation (1944) 70 CLR 23, 29; Commissioner of Succession Duties (South Australia) v Executor Trustee and Agency Company of South Australia Limited (1947) 74 CLR 358, 367; Robertson v Federal Commissioner of Taxation (1952) 86 CLR 463, 476; Commissioner of Taxationv Miley [2017] FCA 1396, [80].
In Commissioner of Succession Duties (South Australia) v Executor Trustee and Agency Company of South Australia Limited, Latham CJ, Rich and Williams JJ, dealing with shares in a deceased estate, said[26]:
… “probably the most practical form in which the matter can be put is that the vendor is entitled to that which a prudent purchaser would have been willing to give for the shares sooner than fail to obtain them. …
… In order to estimate the probable future profits of a company it is necessary to examine its past history, particularly the accounts of those years which are most likely to afford a guide for this purpose…”
[26] (1947) 74 CLR 358, 362.
There are cases, of course, where past accounts of a company do not provide a reliable guide to future profits. The Applicant referred to McCathie v Federal Commissioner of Taxation[27] where, in ascertaining the market value of a private company, the court disregarded arrangements which shifted the profits of the company in favour of the directors.
[27] (1944) 69 CLR 1, 13.
As I have indicated, the services which Company A provided were performed predominately if not solely by Mr P. There is no contemporary evidence of other employees of Company A at or around the time of the sale of the Company A shares to the Applicant. The only employment agreement that has been produced is for Mr P.[28]
[28] Ex 2: CB 1/69.
Company A’s customers were the Applicant and Company B, also controlled by Mr P. There is no evidence that Company A was providing services to any third-party customers at or around the valuation date or that it was attempting to obtain any such work.
There was no contemporaneous evidence of any management or any other fixed-term agreements between Company A and the Applicant or Company B. Neither the Applicant nor Company B was bound to acquire services from Company A.
As at the valuation date, if the Applicant or Company B did engage Company A’s services, neither company was bound to pay any fixed rates, or to pay what the Applicant claimed were market or “going” rates.
The Applicant submitted that by January 1989, Company A was providing its services to the Applicant and Company B under “formalised” agreements expressing commercial rates for various services. I do not accept that.
The agreements were said to be in the form of letters exchanged “sometime in 1989”.[29] The letters could not be produced. Mr P, who gave this evidence, appears to have been referring to letters drafted by the Applicant’s financial controller who did not commence employment until about September 1989.[30]
[29] Transcript 134, lines 12-18.
[30] Transcript 218, lines 13-16 and lines 34-36.
I am satisfied there was no “formalised”, that is agreed, fee structure between Company A and either the Applicant or Company B by the valuation date. There may have been an exchange of letters between Company A and the Applicant, as Mr P says, but not before September 1989, which of course was after the valuation date. There was never any such fee structure between Company A and Company B.
Mr P also gave evidence of what he said were these agreed rates. He described these as market rates. Apart from rejecting that these rates, or any rates, were agreed in January 1989, I do not accept the evidence concerning market or “going market rates”.
I accept the evidence of John Barker, a senior quantity surveyor, called on behalf of the Commissioner.[31] There were (and are) publications, particularly Rawlinsons, which provide a guide to the rates which might be charged. Mr Barker said he used Rawlinsons “as an aide memoire. As a check and a review just to see what things are looking like.”[32]
[31] Ex 28: Report of John Barker dated 8 August 2017 (“Barker”).
[32] Transcript 335, lines 2 -4.
I accept the evidence of Mr Barker, however, that there was no “going rate” or “going market rate” for the services Company A was said to be providing, and that all such fees for the last 30 years have been heavily discounted.[33]
[33] Transcript 332, lines 39 – 40.
Peter Hammond, also an experienced quantity surveyor, called on behalf of the Applicant, described Rawlinsons as a “guide” in that the rates identified were indicative of the likely range. He acknowledged that in reality the variations could be quite significant. He said that fees were calculated on numerous bases.[34]
[34] Transcript 301, lines 36 – 40; 301, line 1.
In one of his reports, Mr Hammond described the phrase “going market rate” as equivalent to a cost indication, budget, allowance, likely cost or market rate – not necessarily the exact prices payable under the variety of contracts potentially involved in the provision of different development-related services.[35]
[35]Ex 26: Report of Peter Hammond dated 8 September 2017 (“Hammond 2”), [2.3]-[2.4], [2.19].
In the end, I did not think there was a great deal of difference between Mr Barker’s evidence, and the evidence of Mr Hammond. They seemed to be in general agreement on the use of Rawlinsons. I am satisfied that there was no generally-accepted “going rate” or “market going rate” for any of the services Company A was said to provide, particularly, services relating to property development.
Mr Hammond, by the way, did not endorse the rates that Mr P considered the Applicant and Company B would pay for Company A’s services on arm’s length terms, reflected as Mr P recalls in the letters exchanged in 1989.
Mr P’s figures appeared inflated. I am not at all satisfied that anyone would have been willing to pay the charges Mr P professed were the market rates, or what he says was agreed in the exchange of letters in 1989.[36]
[36]Ex 3: Statement of Mr P dated 12 May 1017 (“P2”), [58]; Ex 2: Tab 54, page 179; Ex 5: Statement of Mr P dated 11 September 1017 (“P3”), [6].
On or about 1 January 1989 (less than one month before the valuation date), Company A and Mr P entered into an employment agreement titled Executive’s Employment Agreement.[37]
[37] Ex 2: CB 1/69.
Pursuant to the agreement, Mr P was to serve as managing director of Company A for an initial 5 year term (cl 5.1 and item 6), terminable on one year’s notice (cl 5.1 and item 6), and thereafter from year to year until terminated (clause 5.3).
Pursuant to clause 4.2(a), Mr P was required to devote the whole of his time, attention and the whole of his skills to his duties under the employment agreement. The agreement provided for an annual salary commencing at $100,000 (clause 6.1 and item 4).
Company A’s “business” and thus its future earning potential was dependent in more ways than one on Mr P. As the controlling mind of the Applicant and Company B, he had the power to decide whether to engage Company A to provide its services to them.
The services which Company A offered were substantially dependent on Mr P providing them, and the derivation of arm’s length fees turned upon retention of the Applicant and/or Company B as customers, and ensuring through Mr P that henceforth they paid commercial rates.
The Commissioner points out that the Applicant and/or Company B could at any time sell down their existing or planned developments to other parties or hire other service providers to do the work that Company A was offering to do.
Under the employment agreement, aside from the expiry of his term of employment, Mr P was entitled to terminate the employment agreement on the happening of certain events. One such event was if Company A was taken over by another company without the consent of Company A’s board (clauses 5.2 and 2(b)).
Another event entitling Mr P to terminate the employment agreement was a change in control of Company A’s board, by reason of a transfer of shares to persons not associated with the Applicant (clauses 5.2 and 2(c)).
For the Commissioner it was submitted that a hypothetical purchaser would appreciate that if 100% of the shares in Company A were acquired, and control of the board of directors changed (which would be reasonably expected), then Mr P, the only source of any real earning potential of Company A, could terminate his employment agreement.
As to Mr P terminating his employment agreement, the Applicant submits that it was legally possible, but practically highly unlikely, that Mr P would as a shareholder in Company A consent to sell his shares to a particular company but, at the same time, as a director of Company A, withhold or refuse his consent to such transfer, entitling him to rely on clause 2(b).
As to clause 2(c), and termination in consequence of a change in the board of Company A, the Applicant submits this is confined to a transfer of shares with the consent of Company A’s board, otherwise clause 2(b) would be otiose.
The Applicant submits that in practical terms it was highly unlikely that this clause would have become operative. It was submitted there was no reason why Mr P would consent to a transfer of his shares in Company A, and also consent as a board member of Company A, but then seek to terminate the Employment Agreement.
Mr P, the Applicant points out, could not cease employment with Company A without triggering restraints under the employment agreement which, it was submitted, would have rendered him unable to operate the Applicant and Company B.
Although there were post-employment restrictions on Mr P under the employment agreement if he terminated his employment, these did not bind the Applicant or Company B to continue to engage Company A to perform services for them. Neither of these companies was bound to engage Company A in the future either on commercial rates or at all.
Mr Gower, a chartered accountant and experienced valuer, called on behalf of the Commissioner, observes that:
“Based on Mr P being able to terminate his services to the company in these circumstances, in my opinion, this is a significant impediment to the acquirer of Company A’s shares being able to effectively secure control of the business. This impediment is particularly significant because revenue is derived from entities controlled by Mr P. I am not aware of any agreement to retain Company A’s services to [the Applicant] and Company B on an on-going basis.”[38]
[38]Ex 34: Report of GCA Gower dated 20 April 2017 (“Gower 1”) at [50]. See also [72] and [75]-[76].
Mr Gower was expressing how he expected the employment agreement would be regarded in a commercial transaction.[39] From the perspective of a hypothetical purchaser, Company A’s future earnings were wholly uncertain. Mr P’s employment could be terminated. That would effectively bring to an end the services Company A supplied.
[39] Transcript, page 396, line 28 – 32.
Mr R, the companies’ long-time accountant, said “it was my expectation that persons in the market at that time would have jumped at the opportunity of acquiring the business of Company A such that I considered that it then had real value in the market-place that then existed.”[40]
[40] Ex 40: R at [34].
Perhaps Mr R did not appreciate the matters to which I have referred. In any event, I do not share Mr R’s view, or anything approaching it, notwithstanding the Applicant’s submissions which, of course, I have taken into account.
The wonder, to my way of thinking, is to what extent a hypothetical purchaser would even contemplate buying into a situation in which the viability of the business was utterly dependent on a managing director who, if he could be retained at all, had such obvious conflicts of interest.
Mr Gower’s evidence and credibility were challenged on behalf of the Applicant. However, I found Mr Gower to be credible, professional and objective. He was willing to make what I thought were appropriate concessions, without departing from the essential opinions contained in his reports.
In my view, in January 1989, a prudent purchaser would have looked at Company A in the terms suggested by Mr Gower. I accept his evidence in preference to the Applicant’s witnesses on valuation issues, including Jeffrey Hall, a valuer called on the Applicant’s behalf, Mr S (another of the Applicant’s accountants), and Mr R and Mr P.
Appreciating some of the matters I have mentioned, Mr P referred to various things that he or the Applicant would have done differently if the sale had been to a hypothetical purchaser. He suggested, for example, that Company A would have entered into a new or different employment agreement with him.[41]
[41] Transcript 229 lines 29 -32.
Similarly, Mr Hall, said that a purchaser would reasonably reduce uncertainty as to Mr P’s employment, and the derivation of arm’s length fees from the Applicant and Company B as clients.
This evidence seemed to contemplate changes to the transaction or the asset acquired.
In Granby Pty Limited v Federal Commissioner of Taxation[42] the Federal Court observed:
Paragraph s160ZH(9)(c) reflects a legislative presumption that if the consideration expressed in a transaction in which the parties have not dealt with each other at arm’s length is greater, or less, than the market value of the asset, that consideration cannot be relied upon to reflect the proper incidence of taxation payable under the Act in respect of that transaction.
[42] (1995) 95 ATC 4240 at [4243], Lee J.
The market substitution rule in ITAA36 s160ZH(9) concerns the amount “the taxpayer shall be deemed to have paid or given as consideration in respect of the acquisition of the asset” that has taken place. The asset is to be valued with its attributes and characteristics at the time it was acquired.
It is impermissible in my view to consider, for example, changes which may have been negotiated by the hypothetical purchaser affecting the asset acquired.
That is not say that in valuing an asset its possibilities or potential should be ignored.[43] A hypothetical purchaser, for example, would be entitled to consider the possibility that, having acquired the shares in Company A, it might have been able to negotiate with Mr P, in one or other of his capacities, to obtain variations to his employment agreement, or to obtain contractual commitments from the Applicant and/or Company B to use Company A’s services.
[43] Abrahams v Commissioner of Taxation (1944) 70 CLR 23 at 31
The Commissioner submits that none of this would provide much comfort to the prudent purchaser and I agree. It is all highly speculative. In my view a hypothetical purchaser would not place much value at all on these possibilities.
As I have said I consider a hypothetical purchaser would have been deterred by the uncertainties concerning Mr P’s continued employment, the absence of any obligation on the part of the Applicant or Company B to continue to engage Company A’s services, the absence of any agreement as to the rates those companies would pay if they did engage Company A, and the conflicts of interest which Mr P would somehow be expected to manage.
Additionally, as the Commissioner also points out, the financial information for Company A for the seven income years prior to 31 January 1989 indicated the company had a history of net operating losses, with the exception of net operating profits of $7,723.33 in 1983 and $21,483.38 in 1987.[44]
[44] Ex 2: CB 2/64; Exhibit 34: [37](a); and Exhibit 11.
The financial information for the years prior to the valuation date also indicated that Company A had a history of negative assets. At the valuation date the most recent balance sheet of Company A (for 30 June 1988) showed the company had negative net assets of $40,712.63.[45]
[45] Ex 2: CB 2/64; Exhibit 21, Tab 3.
I appreciate that Mr P says there were reasons why Company A did not charge the Applicant and Company B at commercial rates, or perhaps at all, for its services, and the effect this had on its profits. No doubt this would have been made known to the hypothetical purchaser who is taken to be conversant with the relevant facts and circumstances.
Yet the hypothetical purchaser could not be expected to ignore altogether the fact that the contemporaneous Company A documents indicated that Company A had a fairly consistent history of net operating losses.
And it is one thing to say that a company was not showing a profit because of a history of shifting income received to its directors[46]. It is another, I think, to satisfy a hypothetical purchaser that the company would have been profitable but for the fact that it had not been charging for its services.
[46] See McCathie v Federal Commissioner of Taxation (supra).
Company A had no customers other than the Applicant and Company B in January 1989. There was evidence that round that time Sydney, where the companies were located, was experiencing what the Applicant described as a buoyant property market. However, contrary to the Applicant’s submission, and in the absence of any relevant history of past customers, I am not satisfied that that would translate to Company A gaining third-party contracts for its services.
And, as I have said, I am not at all satisfied that Company A would have been able to negotiate fees, at what it claims were the going rates in the market, less still at the higher rates to which Mr P refers in this evidence.
It was submitted for the Applicant that the Applicant and Company B were motivated to continue to use Company A. They were said to be reliant upon Mr P’s skilled management of imminent redevelopments. I accept that motivation would have existed. I have taken it into account along with the Applicant’s other submissions but of course it must be balanced against the other considerations.
In its valuation evidence the Applicant relied, principally, on Mr P’s evidence, and on the evidence of the valuer, Mr Hall. Each of them sought to value Company A on the basis of a discounted cash flow (“DCF”) methodology.
As Mr Hall explained,[47] this method involves:
“. . . calculating the net present value of expected future cash flows. The projected cash flows are discounted to a present value using a discount rate that reflects the risks and uncertainties associated with the cash flow streams.”
[47] Ex 29: Report of Jeffrey Lewis Hall dated 1 March 2017 (“Hall 1”) at [14].
The evidence included consideration of the Applicant’s and Company B’s capacity to pay the commercial rates that Company A, it was claimed, could or would charge them.
Mr Hall said the “fair market value” of Company A shares on 31 January 1989 could not be determined as a multiple of its past earnings (above normalised expenses), i.e. by its past profits.
Mr Hall had regard to Mr P’s outlook for the business assuming that future property developments that had been specifically identified at the valuation date would be completed and no further anticipated or identified property developments took place.[48]
[48] Transcript, page 359, line 44.
Mr Hall’s first report[49] values Company A shares at $3.34-3.51 million using a DCF methodology. In his analysis he used the forecast earnings of Company A in January 1989 according to Mr P’s recollection of what the Applicant and Company B expected to pay Company A if dealing at arm’s length. As I have said, I do not accept those rates.
[49] Ex 29: Hall 1.
In his second report,[50] dated 12 May 2017, Mr Hall used forecast earnings of Company A as if in January 1989 it were charging the Applicant and Company B the “going rates” identified by Mr Hammond.[51] Again, I have said something about those rates. Mr Hall valued the Company A shares between $3.09-3.22 million using a DCF methodology.
[50] Ex 30: Report of Jeffrey Lewis Hall dated 12 May 2017 (“Hall 2”), [19].
[51] Ex 25: Report of Peter Hammond dated 11 May 2017 (“Hammond 2”).
In Mr Hall’s fourth report,[52] dated 23 April 2018, he constructs a cashflow analysis based on the evidence in Mr P’s cross-examination, contemporaneous records, and Mr Hammond’s forecast earnings of Company A, as if in January 1989 it were charging the Applicant and Company B the “going rates” identified by Mr Hammond. This achieves a valuation of $3.40-3.84 million.
[52] Ex 30: Report of Jeffrey Lewis Hall dated 23 April 2018 (“Hall 4”).
There are difficulties with Mr Hall’s reports. As I have said, I do not accept Mr P’s figures as to the rates Company A would or could have been charging the Applicant and Company B (or anyone else), and I do not accept Mr Hammond’s evidence of “going rates”.
Moreover, I do not accept the Applicant’s submission that it and Company B had the capacity to pay substantially “increased” fees – including the alleged “going rates” – for Company A’s services.
Mr Gower has performed cash-flow calculations that indicate that assumed rental income cash inflows from the group’s properties were insufficient to fund all the interest and holding cost cash outflows of the properties let alone the assumed fee cash outflows to Company A.[53]
[53]Ex 37: Report of GCA Gower dated 4 July 2018 (“Gower 4”), [83]; Transcript 478, lines 31-46; 479, lines 1-47; 480, lines 1-45; 481, lines 1-33.
I accept the evidence of Mr Gower which demonstrates that the Applicant and Company B would not have had the cash-flow to pay to Company A the assumed cash fees in the DCF calculations of Mr P and Mr Hall.[54] I did not think there was any sufficient response to Mr Gower’s cash-flow analysis,[55] including the Applicant’s submission that it could raise borrowed funds.
[54]Ex 34: Gower 1, [25](b), [82], [89]-[90], [95], [102]-[104], [104(e)], [106]; Exhibit 37: Gower 4, [69]-[83]; Transcript 478, lines 31-46.
[55] See, for example, Ex 33: Report of Jeffrey Lewis Hall dated 13 July 2018 (“Hall 5”).
The Commissioner submits, and I accept, that in the absence of the necessary “cash-flows” to Company A over the life of the model, there can be no DCF and no market value for Company A.
The Applicant submitted the Commissioner’s concession that the Company B shares were worth $3 million as at 31 January 1989 is significant. This, it was submitted, is totally at odds with Mr Gower’s opinion that Company B was “in a precarious financial position”[56] throughout the period up to 31 January 1989.
[56] Ex 35: Report of GCA Gower dated 7 August 2017 (“Gower 2”), [62].
Plainly, it was submitted, Company B was solvent and valuable as at the valuation date. I do not think so much can be read into the concession. In any event, the argument does not sufficiently address the question of cash-flow. Nor do these matters, however they are viewed, begin to cancel out the other factors I have referred to affecting the value of the shares in Company A.
A great deal of evidence was given on the viability or profitability of redevelopments or other projects which the Applicant and/or Company B were undertaking which were said, on one view, to be relevant to the value of the Company A shares. These matters, however they were assessed, would not affect my view on the issue.
The onus is on the Applicant to prove the market value of the Company A shares. It has not satisfied me that those shares on 31 January 1989 had a market value of $3,000,000, for which it contends, or any market value.
Accordingly, the Applicant has not satisfied me that the assessment was excessive. Consequently the objection decision on this aspect should be affirmed.
Value of Company B shares in 1991
On or about 29 July 1991, the Applicant sold its two shares in Company B for a nominal price to Company C. In consequence of the sale, the Applicant, in the 1992 tax year, claimed a capital net loss of $2,999,998.
The sale to Company C was as trustee of a discretionary trust of which Mr P and members of his family were the objects. It is agreed it was not an arm’s length transaction. ITAA36 s160ZD deals with the determination of the consideration in respect of the disposal of an asset. Under s160ZD (2) the consideration for the Company B shares upon their sale is deemed to be the market value of the shares at the time.
The Applicant relies on the evidence of the valuer, Mr Hall, contending that the assumptions he relies on in concluding the Company B shares had “nil” value in 1991 should be accepted.[57]
[57] Ex 29: Hall 1 [53]- [64].
The valuer called on behalf of the Commissioner, Mr Gower, did not express a view on the value of the Company B shares in 1991. As the Applicant points out, Mr Gower was only engaged to address the value of the Company A shares as at 31 January 1989.[58] As the Applicant also points out, he did not offer any criticism of Mr Hall’s evidence in regard to the value of the Company B shares in 1991.
[58] Ex 34: Gower 1, page 3, letter of instruction.
The Applicant submits that this should be accepted (a) because this evidence was unchallenged, and (b) in any event it is consistent with the commercial reality. I think that is right.
As at 29 July 1991 Company B had given a guarantee and indemnity such that it was liable for all of the debts of the group of companies of which it was a member.[59] The contemporaneous business records indicate that the group debts at that time (inclusive of selling costs and interest) were $50.3 million, with total assets at $31.9 million.[60]
[59] Ex 2: CB 2/111.
[60] Ex 2: CB 2/128.
The Applicant submits that by reason of the guarantee Company B was liable for the Applicant’s debts and the Applicant had a deficiency of net assets of $12.2 million as at 30 June 1991.
The Commissioner submits the Applicant’s assertion is inconsistent with the available financial information for Company B for the year ended 30 June 1991, which he says discloses:
(a)Total assets of $12,017,161.80, including property, plant and equipment of $6,058.876.00 and loan to the Applicant of $5,924,198.31;
(b)Total liabilities of $4,504,558.91, including a bank overdraft of $47,930.83 and unsecured liabilities of $3.4 million to Barclays Bank Australia Limited and $900,000 to ANZ Bank;
(c)Net assets of $7,512,602.89;
(d)Income of $4,457,943.07 including rent of $615,643.78 and interest received of $3,787,499.97;
(e)Operating expenses of $819,852.92 including interest expense of $682,823.37;
(f)Net profit for the year ended 30 June 1991 of $3,638,090.15;
(g)Retained profits as at 30 June 1991 in the amount of $3,741,468.81.
The Commissioner points out that the Company B accounts for 30 June 1991 disclosed no contingent liabilities. In particular, they disclosed no liability under a guarantee. And as the Commissioner also points out, the directors of Company B declared that the balance sheet reflected a true and fair view of the company as at that date. Mr P went so far as to admit the accounts were false.[61]
[61] Transcript 245, lines 6 -14.
Whether the liability arising under the guarantee was, or was not, reflected in Company B’s balance sheet or other financial records is not decisive. The hypothetical purchaser is assumed to be aware of all the relevant facts and circumstances.
I accept that Company B did give the guarantee, and by 29 July 1991 Company B had a potential liability for a $50 million debt. The risk was more than fanciful.
The Commissioner submitted there was no evidence the guarantee would be called upon. As it turned out Company B was not called upon under the guarantee. But I accept that as at 29 July 1991 it was a distinct possibility that it would be called upon and this was sufficient to render the Company B shares of no value to the hypothetical purchaser.
The Applicant makes two other points. First, aside from a certain property, Company B’s only significant asset as at 30 June 1991 was a related party loan of approximately $5.92 million to Company A,[62] which in turn was owed that sum by the Applicant.
[62]Ex 21: Statement of Mr S dated 1 March 2017 (“S 1”); Ex 2: CB 2/144, 1991 Financial Statement, Tab 2,
Given that Company A could not recover its loan from the Applicant, and Company A’s own financial position at the time, the Applicant submits, it was likely the loan could not be recovered.
Secondly, Company B’s property referred to above had materially declined in value, as appears from the evidence of Mr Kenny. In the Company B balance sheet as at 30 June 1991, the property, plant and equipment figure of $6,058,876 includes a carried forward figure for Land and Buildings from 30 June 1990 of $5,860,000 (see note 6), rather than the current market value figure for that land and those buildings of $4,700,000 (and less on a mortgagee in possession basis).
These other matters are relevant to the value of the Company B shares. However, they fall well short of satisfying me that the Company B shares were of no value as at 30 June 1991. It was still a company with significant equity. The guarantee, however, is of a different category. I do not accept the Commissioner’s submission that the Applicant needs to go so far as to prove the guarantee was likely to be called upon.
As the Applicant contended, the question is not whether it is proved the guarantee would or would not be called on. The issue is what value would a prospective purchaser have attributed to the Company B shares in the circumstances.
The Commissioner also submits that the fact of the transfer of the Company B shares from the Applicant to Company C on 29 July 1991 has not been properly explained and is inconsistent with the Company B shares having no value. Mr P was cross-examined to the effect that he must have perceived Company B to have some value at this time.
Mr P’s explanation for the Applicant transferring the shares it held in Company A and Company B for nominal value in 1991 was to enable him to continue the fight he was then having with BAC/Westpac and to put impediments in the way of the financier.[63] I accept this evidence.
[63] Ex 19: Statement of Mr P dated 2 May 2018 (“P4”) [91], [94], [95] and [98].
Having regard to the guarantee provided by Company B, and the financial position of the group at the time, I am satisfied that the Applicant has discharged the onus of proving it incurred a capital loss of $2,999,998 on the sale of the Company B shares in the 1992 income year.
The Applicant’s case on review should succeed on this issue.
PENALTY
The question of penalty is therefore only in respect of the loss claimed on the sale of the Company A shares.
The Commissioner submits the Applicant had a shortfall amount in the 2011 income year as a result of a statement in the Applicant’s income tax return for the 2011 year that was false or misleading in a material particular.
It was therefore liable to an administrative penalty at the base rate of 50% because the shortfall resulted from recklessness by the Applicant and/or the Applicant’s tax agent as to the operation of a tax law (pursuant to ss 284-75(1), s 284-80 and s 284-90 (item 2) Sch. 1 to the TAA).
The Applicant submits it took reasonable care and had a reasonably arguable position at the time of making its statement in the 2011 tax return.
Recklessness is said to exist where the relevant conduct goes beyond mere carelessness or inadvertence. It includes conduct which shows indifference to or disregard of risks that are foreseeable by a reasonable person.
In Hart v Commissioner of Taxation[64], Hill and Hely JJ explained recklessness in this context involves “more than mere negligence and must amount to gross carelessness.” It means more than failure to exercise reasonable care, but less than an intentional disregard of a taxation law.
[64] (2003) 131 FCR 203, [43] and [44].
Generally I have accepted the Commissioner’s contentions on this issue.
The Commissioner points out the Applicant accepts it did not acquire the Company A shares in 1989 in an arm’s length dealing. Despite this, neither the Applicant nor its tax agent obtained an independent or expert valuation of the Company A shares in the 1989 income year for the purpose of establishing the cost base of the shares.
Neither the Applicant nor its tax agent obtained an independent or expert valuation of the Company A shares (as at the time of their acquisition by the Applicant) at the time the Applicant sought to off-set the alleged capital loss in its income tax return for the 2011 income year.
The Applicant had the same tax agent in the 1989 and 2011 income years and throughout.
The Applicant did not obtain professional taxation advice in relation to making of the alleged capital loss on the Company A shares and the utilisation of the alleged capital loss in the 2011 tax year.
The Commissioner submits the failure to obtain both valuations and tax advice exhibits the Applicant’s disregard and indifference to the risk that the claimed capital loss did not exist in the amount claimed and could not be utilised to off-set its capital gain in the 2011 tax year.
The Commissioner also submits, to which I accept, the Applicant neglected to maintain contemporaneous records required to substantiate the alleged cost base of the Company A shares and the alleged capital proceeds on the disposal of the Company A shares including the alleged “formalised” agreements, financial information, and/or management accounts as at the valuation date.
There is no contemporaneous evidence of any valuation calculations carried out by Mr P or any other person either in 1989 or at any time up to and including when the capital losses were claimed in 2003, 2005 and, relevantly for this proceeding, in 2011.
There is no contemporaneous evidence of the use of valuation inputs or assumptions that are asserted to have been used in the calculation of the valuation of the Company A shares in 1989. Moreover, importantly, I have found that no particular methodology was employed by Mr P (or Mr R) in fixing the purchase price for the Company A shares in January 1989.
The Applicant (through Mr P) has given different and inconsistent statements over time as to the way in which the cost base or market value of the Company A shares was calculated.
As I have said, and contrary to the Applicant’s submission, I am not satisfied the $3 million price for the shares in Company A in January 1989 was ascertained by the same methodology as was applied in these proceedings by Mr Hall, or by any particular methodology.
As referred to above I consider the Applicant was indifferent as to whether or not the purchase price attributed to the Company A shares was true and correct, but instead the focus was on dealing with the Fringe Benefits Tax exposure.
I accept the Commissioner’s submission that, in respect of TAA s 284-75(5) of Sch. 1, neither the Applicant nor its tax agent took reasonable care in connection with the lodgement of the 2011 income tax return for the Applicant.
I am satisfied the Applicant’s conduct in respect of the claim for a capital loss on the acquisition by the Applicant of the Company A shares was more than mere negligence and can be rightly regarded as recklessness. I accept the safe harbour in TAA s284-75(6) of Sch. 1 does not apply.
REMISSION
Pursuant to TAA Schedule 1 s298-20 there is power to remit an administrative penalty. The question is whether having regard to the taxpayer’s particular circumstances it is appropriate to remit the penalty in whole or in part.[65]
[65] In Dixon as Trustee for the Dixon Holdsworth Superannuation Fund v FCT (2008) 69 ATR 627, [21]; Sanctuary Lakes Pty Ltd v Commissioner of Taxation [2013] FCAFC 50, [249].
The Applicant relies on the history of this matter, commencing on 2 October 2012, including but not limited to, the Applicant providing substantial documentation and information to the Commissioner in response to requests, the Applicant replying in a comprehensive way to the Commissioner’s position paper, meeting with and providing further information to representatives of the Commissioner, and its attempts to resolve the dispute, including following a deemed objection decision.
The Applicant points out there has been a narrowing of the issues (through the co-operation of both parties), and the Applicant has entered into a 50/50 arrangement with the Commissioner to pay half the tax in dispute.
In all the circumstances, it submits, it has conducted itself in the manner of a good taxpayer; there is no need for a penalty to secure improvement in compliance behaviour; and the imposition of a penalty would be harsh and unjust.
The Applicant also submits with better management on the part of the Commissioner, perhaps there would have been an objection decision, and an earlier narrowing of the issues. The Applicant submits that denying the Crown a penalty promotes the better use of Commonwealth resources for which the Commissioner is responsible.
The Commissioner points out the Applicant chose to lodge a TAA s14ZYA notice, and the issue initially was whether the Applicant had made a valid election under s 160ZZN. During the objection process and early in the proceedings the issue of the calculation of the capital losses was not the issue in primary focus due to the alleged election.
I also refer to my findings on this issue. In the course of the audit, and during the proceedings, when the issue of the capital losses arose, the Applicant gave inconsistent statements to the Commissioner’s officers as to the way in which the cost base or market value of the Company A shares was calculated.
The Commissioner submits a penalty is manifestly warranted to secure improvements in compliance behaviour of the Applicant as well as to ensure consistency in treatment of taxpayers generally.
The penalty is not harsh given the magnitude of the capital loss claimed in the 2011 income year by the Applicant, the nature of the Applicant’s business, the ability of the Applicant to access accounting, valuation and taxation advice, when desired, and the business experience of Mr P.
The narrowing of the issues is not a ground for remission. The 50/50 arrangement is a standard administrative arrangement and not a ground for remission. The Applicant deliberately decided to issue a s14ZYA notice while the respondent was considering the objection and the s160ZZN issue and in the process of making enquiries and obtaining further documentary evidence.
I have considered all of the submissions. In my view the matters raised on behalf of the Applicant do not justify remission of the penalty. Moreover, I accept the Commissioner’s arguments. I am not satisfied this is a case for remission.
CONCLUSION
The deemed objection decision should be varied so as to allow the Applicant’s claimed loss on the sale of the shares in Company B. The penalty decision so far as it relates to that claim should be set aside.
The deemed objection decision so far as it disallowed the claimed loss on the sale of the Company A shares should be affirmed. The penalty decision in respect to the claimed loss on the sale of the Company A shares, being 50% based on recklessness as to the operation of a taxation law, should be affirmed.
I will hear from the parties in respect of the appropriate orders, a course that was mentioned during final submissions. At that time, I also asked a question concerning the losses claimed by the Applicant in the 2002 and 2003 years, and whether those claims, which were allowed, related to specific losses.
On reflection I do not think that question arises. I will, however, hear the parties on that issue as well.
The Applicant should lodge and serve draft orders within fourteen days of the date of publication of these reasons based on my findings above and, if so advised, within the same time lodge and serve written submissions on the above-mentioned point.
The Respondent shall have a further fourteen days to respond.
FURTHER ISSUES
Following the publication to the parties of the above reasons on 26 April 2019, and pursuant to the directions referred to in [201] and [202] and to leave granted on 19 June 2019, the parties filed further written submissions inter alia in respect of the orders which should be made.[66]
[66]Applicant’s submissions dated 10 May 2019; Respondent’s submissions dated 24 May 209; Applicant’s reply dated 14 June 2019 (filed with leave); and Respondent’s further submissions dated 26 June 2019 (also filed with leave granted without objection).
The Applicant points out that:
(a)in the 2003 year (as amended on 28 July 2006), the Applicant transferred a net capital loss of $1,057,163 to a related company, Company D, and the Applicant’s income tax return shows capital losses carried forward of $4,942,730.
(b)in the 2005 year, the Applicant “recouped or transferred out” a further “net capital loss” of $304,094 (reducing $4,942,730 to $4,638,636); and
(c)in the 2011 year, the Applicant’s tax return claimed prior year net capital losses of $4,636,652 applied against capital gains and unapplied net capital losses carried forward to later income years of $1,984. [67]
[67] Compare paragraph [11] above.
The Applicant tendered, without objection, a number of documents inter alia supporting the above.[68] The Applicant pointed out that net capital losses in some circumstances may be applied by a taxpayer other than the taxpayer who made the net capital loss, for example where a net capital loss is transferred between related tax entities (here, the Applicant and Company D). The Applicant referred to the Income Tax Assessment Act 1997 (“ITAA97’) ss170-115(1) and 170-120(1).
[68]Copies of Company D’s 2003 year return; Company D’s amendment request date 28 July 2006 for 2003 and the Applicant’s amendment request dated 28 July 2006 for 2003; 2005 year return of the Applicant; the Applicant’s amendment request for the 2005 year; and the 2005 year notice of amended assessment of the Applicant.
The Applicant referred particularly to ITAA97, s102-15 which states:
“In working out if you have a *net capital gain, your *net capital losses are applied in the order in which you made them.”
The Applicant also referred to ITAA97 s170-155(1) (as it stood at 30 June 2003) providing that net capital losses are transferred in the order in which the transferor made them.
The Applicant submits, based on the foregoing:
(a)in 2003, [Company D] ‘utilised’ $1,057,163 of a transferred capital loss and the Applicant diminished its total carry forward net capital losses of $5,999,893 by a corresponding amount, reducing its total carry forward capital losses to $4,942,730 – thus [Company D] applied the 1991 tax loss;
(b)in 2005, the Applicant ‘utilised’ $304,094 of its remaining carry forward capital losses and diminished the total of such losses by a corresponding amount, bringing that total to $4,638,636 – thus, the Applicant applied the 1991 tax loss.
(c)In 2011, the carry forward losses of the Applicant of $4,638,636 available (if proven) to be applied by the Applicant to reduce the amount of capital gains made by the Applicant in that year ($4,366,652) (see at [11]) comprised:
(i) $1,638,741.14 in losses attributable to the 1991 tax year; and
(ii) $2,999,998 in losses attributable to the 1992 tax year.”
Thus, in reliance substantially on ITAA97 ss102-15 and s170-155, the Applicant contends that capital losses utilised by Company D in the 2003 year and by the Applicant in the 2005 year were part of the 1991 income year claimed net capital loss.[69] I do not accept these submissions. They elevate the 1991 claimed loss to the level of an actual capital loss. Neither ITAA97 s102-15 nor s170-155 applies to a net capital loss which is merely claimed.
[69]Applicant’s submissions dated 10 May 2019, [15(a)] & [7(c)-(f)], and Applicant’s reply dated 14 June 2019, [29]-[32].
The Applicant has not satisfied me that the Company A shares on 31 January 1989 had a market value of $3,000,000, as it contended, or any market value. It follows, as the Respondent contends, that:
(a)the Applicant is deemed to have paid or given no consideration for acquisition of the Company A shares: ITAA36 s160ZH(9) (as it stood);
(b)the Applicant’s cost base and reduced cost base for the Company A shares was nil: ITAA36, s160ZH(1) & (3);
(c)the Applicant is not deemed to have incurred a capital loss in the year ended 30 June 1991 on its disposal of the Company A shares: ITAA36, s160Z(1)(b);
(d)no net capital loss is taken to have been incurred by the Applicant in the year ended 30 June 1991: ITAA36 s160ZC(3).
The Applicant incurred a capital loss in the year ended 30 June 1992 on the sale of its shares in Company B in the sum of $2,999,998.
The Respondent submits, and I accept, that the only amount carried forward by the Applicant to the 2003 year of income was the 1992 net capital loss of $2,999,998.
From that net capital loss of $2,999,998:
(a)an amount of $1,057,163 was transferred by the Applicant to Company D and applied by Company D in the 2003 year, thereby leaving unapplied net capital losses of $1,942,835 available to be carried forward by the Applicant; and
(b)of that amount of $1,942,83, an amount of $304,094 was applied by the Applicant in the 2005 year to reduce a capital gain, leaving unapplied net capital losses of $1,638,741 available to be carried forward by the Applicant.
In its income tax return for the 2011 income year, the Applicant claimed:
(a)prior year net capital losses of $4,636,652 applied against capital gains made in that income year; and
(b)unapplied net capital losses carried forward to later income years of $1,984.
The Commissioner allowed a portion ($253,024) of the net capital loss of $4,636,652 claimed by the Applicant and disallowed the balance of $4,383,628.
Having regard to my findings, the Commissioner was correct to disallow $2,999,895 out of the claimed amount of $4,383,628, leaving available to the Applicant an amount of $1,383,733 plus, according to the Commissioner’s description, the asserted unapplied net capital loss carried forward of $1,984.
In other words, as submitted by the Respondent, there were unapplied net capital losses of $1,385,717 that could be applied by the Applicant in the 2011 year against capital gains.
I do not accept the Applicant’s submission that what I have said, or the orders I intend to make, involve a review of Company D’s assessment for the 2003 year, or the Applicant’s amended assessment for the 2005 year.
The material does not clearly indicate a transfer to Company D with respect to 2003 of part of the Applicant’s claimed net capital loss for the 1991 year as submitted by the Applicant.[70] Nor do I think that would be relevant.
[70]See Company D’s 2003 year return, page 6, “Capital losses transferred in [from the Applicant] … Loss year 1991/92”.
The Applicant also submitted that the Tribunal “cannot rewrite the agreement in 2003 between the companies as to what loss was transferred.”[71] I am not satisfied that there was any such agreement or, if it did exist, it would have any bearing on the matters in issue.
[71] Applicant’s reply dated 14 June 2019, [29].
ORDERS
I accept the Respondent’s submission that the following orders should be made:
1.The objection decision deemed to have been made by the Respondent on or about 22 December 2015 is varied by reducing the Applicant’s taxable income for the year ended 30 June 2011 of $4,397,992 to $3,012,275.
2.The objection decision deemed to have been made by the Respondent on or about 1 April 2016 is varied by reducing administrative penalties of $656,806.30 by $207,857.55 to $448,948.75.
3.The objection decisions are otherwise affirmed.
I certify that the preceding 221 (two hundred and twenty -one) paragraphs are a true copy of the reasons for the decision herein of Deputy President I R Molloy
.................................[SGD].......................................
Associate
Dated: 19 July 2019
Date(s) of hearing: 11-13 December 2017; 30 July - 2 August 2018; 23 August 2018
Date final submissions received: 26 June 2019 Counsel for the Applicant: Mr J Stoljar SC and Mr A Russoniello Solicitors for the Applicant: Speed and Stracey Lawyers Pty Limited Counsel for the Respondent: Mr S White SC and Ms M Hirschhorn Solicitors for the Respondent: Australian Government Solicitor
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