Unexplained loans and income tax assessment
In Hourigan and Commissioner of Taxation (Taxation)  AATA 3369 an individual taxpayer was partially successful in proving amended assessments were excessive, having contended that various unexplained bank deposits were predominantly received as loans from his father.
The Taxpayer successfully contended that one deposit was not assessable income, as there was sufficient indirect evidence establishing the transfer of money and its purpose. However, due to discrepancies in the evidence provided, and significant gaps in that evidence, the Administrative Appeals Tribunal (Tribunal) held that the Taxpayer had failed to discharge his onus of establishing that the majority of the amounts were anything other than assessable income.
This case serves as a reminder of the importance of accurate and complete contemporaneous records, and the need to be consistent in the evidence put to the Commissioner (and later, to the Tribunal or a Court).
In this case, amended income tax assessments were issued to the Taxpayer for the 2010 to 2014 income years on the basis that the Taxpayer’s private expenditure (established by his bank accounts) far exceeded, and could not possibly be supported by, his reported income.
Following an asset betterment test, the taxpayer’s taxable income was raised by just over $562,000 to reflect a number of unexplained deposits into his bank accounts. The Commissioner concluded that these deposits were received by the Taxpayer as assessable income and he had therefore significantly underreported his taxable income for the relevant years.
The main issues to be determined by the Tribunal in this case were as follows:
- Were the assessments excessive or otherwise incorrect, and what should the assessment have been?
- In relation to the years in which the Commissioner formed the opinion that the Taxpayer had engaged in fraud or evasion, should that decision not have been made or should it have been made differently?
Pursuant to section 14ZZO of the Taxation Administration Act 1953 (Cth) the civil burden of proof with respect to the above, rests with the Taxpayer.
Were the assessments excessive?
The taxpayer contended that the deposits in question mostly constituted undocumented loans from his father, or repayments of loans from various friends and relatives. These included substantial deposits that the Taxpayer asserted were received as compensation for the sale of a motor vehicle and undocumented loans from the Taxpayer’s father and partner.
The Tribunal accepted that an unexplained deposit of $13,000 related to the sale of the Taxpayer’s car to his partner. This was supported by bank account records, a Vehicle Registration Renewal Notice and a letter from the Queensland Department of Transport and Main Roads confirming that the vehicle was transferred out of the Taxpayer’s name in 2011. Despite there being no written agreement for the sale of the vehicle, the Tribunal accepted that there was sufficient evidence to conclude that the deposit was received pursuant to the sale of the Taxpayer’s car and adjusted the Taxpayer’s 2010 assessment to reflect this.
Conversely, the scant written and oral evidence put to the Tribunal by the Taxpayer was found to be inconsistent, and at times conflicted with statements previously made by the Taxpayer and his accountants. In light of the various discrepancies and lack of evidence (namely, documents that were subpoenaed but not tendered as evidence, and the fact that various key persons were not called to give oral evidence) the Tribunal held that the Taxpayer had failed to discharge his onus of establishing that the amounts were anything other than assessable income.
Was there fraud or evasion?
The Commissioner may amend a taxpayer’s income tax assessment for a year of income, subject to certain statutory time limits. However, if the Commissioner forms the opinion that there has been fraud or evasion by a taxpayer, the Commissioner may amend that taxpayer’s income tax assessment for any prior year of income. The concepts of fraud and evasion in relation to tax law are set out in Practice Statement Law Administration 2008/6 (recently updated on 17 May 2018).
While the Commissioner was within time to amend the Taxpayer’s income tax assessment for the 2014 income year, he fell outside the applicable 2-year time limit for the 2010 to 2013 income years. The Commissioner determined that by falsely reporting his income (i.e. not returning the above amounts as assessable income) the Taxpayer had engaged in fraud or evasion in the relevant income years, and the Commissioner was therefore empowered to issue amended assessments for those years.
The Tribunal noted that in discharging his civil onus of proof, the Taxpayer must demonstrate that, on the balance of probabilities, there was no fraud or evasion and therefore that the Commissioner’s decision in this respect is wrong. The onus is not discharged by identifying a mere error by the Commissioner.
As the Taxpayer had failed to establish that the amounts received were not assessable income, the Tribunal concluded that the Commissioner was correct in determining that the Taxpayer had failed to return amounts of assessable income. On this basis, the Tribunal refused to overturn the Commissioner’s finding of fraud or evasion with respect to the relevant years.
Moreton Resources Ltd and Innovation and Science Australia  AATA 3378
In Moreton Resources Ltd and Innovation and Science Australia  AATA 3378 the Administrative Appeals Tribunal (Tribunal) upheld the decision of Innovation and Science Australia, finding that the activities of the Taxpayer were not research ‘R&D activities’ as defined in s 355-20 of the Income Tax Assessment Act 1997 (ITAA 1997).
The Taxpayer in this case was an Australian resources company that sought to demonstrate that some of its activities carried out in connection with certain projects should be registered as R&D activities and consequently, that it should be able to access the R&D concessions provided by Division 355 of the ITAA 1997. The projects included:
- Designing and developing an underground coal gasification generated (UCG) syngas cleaning and power generation pilot plant. This involved the integration of known technologies for the first time.
- Designing and developing a second UCG syngas processing plant based on the outcomes of the first project, and determining the most appropriate economical uses for syngas.
- Developing a conceptual water model and rehabilitation plan following the first project.
Division 355 of the ITAA 1997 provides taxpayers with access to certain tax concessions in respect of R&D activities they carry out. R&D activities are defined to include both core R&D activities and supporting R&D activities.
Core R&D activities are defined by section 322-25 of the ITAA 1997 to be ‘experimental activities whose outcome cannot be known or determined in advance on the basis of current knowledge, information or experience, but can only be determined by applying a systematic progression of work…that are conducted for the purpose of generating new knowledge.’ Supporting R&D activities, as the name may suggest, are defined by section 355-30 of the ITAA 1997 to be activities that are directly related to core R&D activities or are certain prescribed activities that are undertaken for the dominant purpose of supporting core R&D activities.
Innovation and Science Australia initially determined that the Taxpayer’s activities were not sufficient to be deemed R&D activities. This decision was upheld by the Tribunal, which concluded that:
- none of the activities were core R&D activities within the meaning of that term; and
- as a consequence of the finding there were no core R&D activities, none of the Taxpayer’s activities could then be found to be supporting R&D activities (as this relies on the existence of core R&D activities).
In coming to this decision the Tribunal noted the following relevant points:
- Activities associated with complying with the conditions of a Mineral Development Licence under the Mineral Resources Act 1989 (QLD) or an Environmental Authority issued under the under the Environmental Protection Act 1994 (QLD), are activities associated with complying with a statutory requirement, which are expressly excluded from the definition of core R&D activities by section 355-25(2)(f) of the ITAA 1997.
- Certain activities claimed to be ‘experimental’ were not, because:
- they did not involve testing a principle or discovering whether a particular outcome would flow from the Taxpayer’s activities. The potential outcomes of the Taxpayer’s activities could not be said to be unknown, as they could be determined in advance on the basis of existing knowledge or experience; and
- they were not a progression of work that proceeded from that hypothesis to experiment, observation and evaluation and on to logical conclusions. The process that the Taxpayer undertook suggested a random approach that was not underpinned by an ordered or planned system of trial and error.
Historically, operators of mines have been successful with R&D concession claims where the whole of a mining operation came within the definition of R&D activities. Recently we have seen that these claims are now being challenged, and this case is merely another example of Innovation and Science Australia challenging R&D claims that would historically have been accepted.
High Court refuses taxpayer’s appeal due to low prospects of success
The High Court has refused to allow the Taxpayer’s application for special leave to appeal from the decision of the Full Federal Court in Hart v FCT  FCAFC 61. In its decision, the High Court said the application for special leave to appeal from the decision did not have sufficient prospects of success to warrant a grant of special leave.
The Full Federal Court decision, which now stands, has dismissed the taxpayer’s appeal against a decision upholding Pt IVA determinations that included a portion of a law firm’s earnings in the assessable income of one of the practising solicitors.
ATO confirms view on the Commissioner being entitled to decline to make private ruling
On 14 September 2018, the ATO released a Decision Impact Statement regarding the decision of the Full Federal Court in FCT v Hacon Pty Ltd  FCAFC 181 (Hacon). The ATO states that the Hacon decision confirms the Commissioner’s view that:
- the Commissioner is entitled to decline to make a private ruling where the correctness of the ruling would depend on the assumptions about future events or other matters, and
- the Commissioner is not obligated to first request that information from the taxpayer in those circumstances.
In Hacon, the Court held that the Commissioner was entitled to refuse to make a private ruling, overturning the decision at first instance in which Justice Logan of the Federal Court ruled that the Commissioner had unlawfully declined to make a private ruling. For a more detailed case update on the Hacon decision, please refer to Talking Tax issue 105.
The Decision Impact Statement notes that the ATO intends to publish further guidance for ATO officers about the Commissioner’s discretion to decline to make a private ruling.
Time for a simpler tax system
Following the conclusion of its inquiry into taxpayer engagement with the tax system, the House Committee on Tax and Revenue (Committee) presented its report Taxpayer Engagement with the Tax System (Report) to the House of Representatives. In presenting the Report, Committee Chair Mr Jason Falinski MP said that the Committee’s 13 recommendations are aimed at making tax obligations in Australia easier to administer and comply with.
The inquiry involved a comprehensive assessment of tax administration in Australia and in comparable nations overseas. The Committee found that while the ATO’s goal of creating a modern tax administration service is well underway, Australia’s complex tax system is presenting some hurdles to full automation.
The Report makes the following recommendations:
- A review of Australia’s tax system should be undertaken before 2022, with the purpose of making recommendations on how to simplify the present tax system.
- The ATO should continue to deploy behavioural insights approaches to increase taxpayer engagement.
- The ATO should make greater use of behavioural insights techniques, such as randomised controlled trials, before full implementation of new initiatives to determine if such changes are better than current practices.
- The ATO should consider adopting a Regulatory Philosophy to codify the principles on which it will administer tax laws and engage with taxpayers.
- The ATO should continue to expand availability of technical initiatives such as pre-filing, simplified electronic lodgement systems for business and individuals, and online assessment tools to facilitate Australia’s transition to a ‘push return’ tax system.
- The Treasury should consider an ABN withholding tax system at source for all industries with the potential for the rates to be industry specific.
- The ATO should review the functionality of the contractor assessment tool for accuracy and utility to taxpayers.
- Work-related deductions scheme should be reformed by introducing the standard reduction concept as proposed by the Australia’s Future Tax System Review.
- The ATO should adopt a roadmap for the abolition of paper-based returns.
- The ATO should work to develop a framework which clearly outlines the rights and obligations of both parties in the tax engagement process.
- The ATO should include a service level agreement with end users, particularly tax agents, that includes consideration of payments to end users for poor delivery outcomes.
- The ATO should engage with all services providers, allowing taxpayers the ultimate choice of which channel of access or service to use.
Increased scrutiny of employees working from home
The ATO has updated its website to provide information on claiming expenses when working from home. The ATO states that a high level of mistakes, errors and questionable claims has prompted them to increase attention on home office expenses.
Last year, 67 million taxpayers claimed $7.9 billion in deductions for ‘other work-related expenses’, which includes expenses related to working from home. While taxpayers can legitimately claim additional costs incurred as a direct result of working from home, they need to be careful not to claim private expenses as well. According to the ATO, one of the biggest issues is taxpayers claiming the entire amount of expenses such as internet or phone use, not just a portion for work-related use.
This update from the ATO is a timely reminder of the importance of accurate record keeping for work-related expenses and, when apportioning expenses, maintaining a record of how the work-related proportion is calculated.
Legislation and government policy
Parliament backs small business
On 12 September 2018, the Senate passed the Treasury Laws Amendment (Accelerated Depreciation for Small Business Entities) Bill 2018. This Bill amends the Income Tax Assessment Act 1997 to extend the $20,000 instant asset write-off (as part of the broader suite of accelerated depreciation rules) by a further 12 months to 30 June 2019.
The decision to extend the instant asset write-off was announced in the 2018-19 Federal Budget.
The instant asset write-off is a simplified depreciation rule provided to businesses with an aggregated annual turnover (post budget announcement) of less than $10 million. If the business purchases an asset that costs less than $20,000 it can choose to immediately deduct the value of the asset in the year it was purchased.
However, the write-off is only available for the ‘taxable purpose proportion’ of the cost of the asset. The taxable purpose proportion of a depreciating asset represents the proportion of an asset’s use in an income year that is for the purposes of producing assessable income.
Broadly, the cost of the asset is what you have paid for it, including any GST paid if you are not registered for GST, and additional amounts spent on transporting, installing and improving the asset. For motor vehicles, amounts paid for CTP, registration and extended warranty are not included in the asset’s cost.
The instant asset write-off applies on a ‘per asset basis’. This means that there is no limit on how many times a business can apply the instant asset write-off in a year. For example, if a business buys four cars to be used entirely for business purposes at a cost $18,000 per car, they may choose to deduct the entire cost of each car in that income year.
The instant asset write-off was initially available to businesses in respect of assets that cost $1,000 or less. In the 2015-16 Federal Budget this threshold was raised to $20,000, but was to revert to $1,000 on 30 June 2017. The $20,000 threshold was then extended to 30 June 2018 and now we’ve seen a further proposed extension to 30 June 2019, but unfortunately it has not yet been made permanent.
More support for farmers
On 13 September 2018, the Treasury Laws Amendment (Supporting Australian Farmers) Bill 2018 was introduced in the House of Representatives. This Bill proposes to amend the Income Tax Assessment Act 1997 to allow primary producers to immediately deduct (rather than depreciate over 3 years) the cost of fodder storage assets, such as silos and hay sheds, used to store grain and other animal feed.
This Bill is designed to assist primary producers by making it easier to invest in and stockpile fodder. The measure will apply to fodder storage assets first used or installed ready for use on or after 19 August 2018.