ATO

Decision in asset betterment case sent back to AAT: Le v FCT

The Federal Court has held that the AAT should hear again a case involving assets betterment assessments, as one of the taxpayers’ central arguments as to why the assessments in question were excessive was not considered by the AAT: Le v FCT [2021] FCA 303 (Federal Court, Logan J, 30 March 2021).

Background

The taxpayers (Ms L and Mr T) were a de facto couple. They were Vietnamese emigres who had lived in Australia for decades. They carried on in partnership various businesses that often dealt in cash, including a fishing business and a clothing shop. Each may also have conducted business activities on their own account. They owned a number of rental properties and a fishing trawler and large amounts of cash flowed through their bank accounts. However, the clothing shop reportedly generated only modest income and a significant portion of Mr T’s regular catch was sold for cash which he kept at home.

For the 2005 to 2012 income years, the taxpayers both reported relatively modest income. Following an audit, the ATO concluded that the taxpayers must have had access to significant unreported income.

Accordingly, the ATO issued amended assessments increasing substantially their taxable income (by almost $3.4m in Ms L’s case and by just over $1.15m in Mr T’s case). The ATO also imposed significant administrative penalties based on the taxpayers having intentionally disregarded the law.

The ATO adopted a conventional, asset betterment approach. Thus, assets (in particular bank account balances, real estate and vehicles) and liabilities (in particular bank loans and credit card balances) were identified and the annual change in net assets became a component of the taxpayers’ taxable income. The ATO also identified amounts paid from bank accounts and then assumed that, in order to make such payments, a corresponding amount of income must have been derived.

However, the taxpayers contended that amounts deposited in the bank accounts were either repayments of loans (18 in total) made by the taxpayers to third parties or loans (17 in total) made by third parties to the taxpayers (all debtors and lenders were members of the Vietnamese community). The taxpayers admitted that they had earned interest income on various loans.

The ATO also included in the taxpayers’ assessable income expenditure at a casino, on the assumption that the expenditure must have been sourced in income derived by the taxpayers. The taxpayers contended that they had won significant sums at the casino.

The ATO also assessed Ms L on the footing that amounts said to be contributions by her to various “hui” were sourced in equivalent income derived by her (but not what she said she had withdrawn). A “hui” is an informal money lending system, common among Vietnamese communities (see below). It was accepted that Ms L was heavily involved in various hui.

Before finalising the amended assessments for the years in question, the ATO made a number of adjustments in favour of the taxpayers, such as giving credit for income that had already been declared and deductible expenses that had been paid in the course of earning that income. The ATO accepted that some receipts were not assessable, including gambling winnings that were proved by documents and a loan that the ATO was satisfied was made.

In NGFZ and FCT [2019] AATA 5410, the AAT largely upheld the amended assessments, stating that the evidence provided at the hearing “often hinted at alternative explanations for the cash that tended to tantalise rather than persuade or clarify”. The AAT based its decision on: adverse findings as to the credit of the taxpayers and some other witnesses; the fact that most of the loans were undocumented and there were no other relevant records (as a result, the AAT was not satisfied that most financial relationships between the taxpayers and third parties constituted creditor-debtor relationships); and the taxpayers’ failure to show how much they had won at the casino (the AAT also accepted that the taxpayers’ gambling patterns were evidence of unreported income). The taxpayers appealed.

Decision

Logan J allowed the taxpayers’ appeal and remitted the matter to the AAT for a rehearing in accordance with the law.

His Honour held that the AAT had failed to consider one of the taxpayers’ central arguments as to why the assessments were excessive. “The flow of funds into and out of bank accounts was in evidence, as was an explanation as to why outgoings from accounts were not income. The [taxpayers] gave precision in their tabulations as to the resultant excess in the amount of each assessment. A failure to consider that explanation is, truly, a failure to undertake the statutory review function.” Logan J added that the impact of that failure was not explicable by findings as to credit, because those findings themselves were made without considering the explanation.

Another reason for setting aside the AAT’s decision was its failure to decide the review “by a logical process of reasoning”. Logan J said there was “an internal inconsistency” between accepting Ms L’s confessed derivation of interest from a particular, identified loan and rejecting that same transaction as a loan. It was also illogical for the AAT to accept Ms L’s acknowledgment that transactions with identified persons were loans from which confessed interest was derived, while rejecting the evidence of these persons, where given, that they had entered into loans. However, submissions that the AAT’s decision involved a failure to afford procedural fairness to the taxpayers and to witnesses were rejected.

What is a “hui”?

A “hui” is a syndicated arrangement (or game, depending on how it is described) where participants make periodic contributions of an agreed amount into a common pool, or pot. Each contributor thereby becomes a member of the hui and each member has a certain number of “shares”. At regular intervals, typically monthly, the members would “bid” for the right to take the pot. The “winner” would have access to the pot, but they would be required to continue making regular contributions so that other participants might enjoy a win in turn.

A member’s “bid” is effectively the interest amount the member is willing to pay to the other members. Typically, the member who is ready to pay the highest interest will receive the pot, with the interest amount being evenly disbursed among the other members. The higher the bid, the less money the member gets (reflecting the urgency of that member’s capital requirement).

Thomson Reuters comment

Although the taxpayers haven’t yet succeeded in showing the assessments in question were excessive or otherwise incorrect (as they are required to do by s 14ZZK of the TAA), at least they get a second chance before the AAT; and it seems they can thank their counsel (Mr MJ May).

Logan J observed that, in view of the requirement for the taxpayers to show that the assessments in question were excessive or otherwise incorrect and the adverse findings by the AAT as to the credit of the taxpayers and some other witnesses (the AAT has “the singular advantage” of observing witnesses when they gave oral evidence), it would have been difficult for the taxpayers to succeed in an appeal on a question of law.

However, to quote Logan J, “the submissions in support of the [taxpayers’] case were advanced with consummate skill by their counsel … on the hearing of the appeal and in related written submissions”. His Honour added that that “was all the more so skilful, given that the then prevailing public health restrictions dictated that the hearing be conducted by the impersonalising, technologically capricious, audio-visual medium of Microsoft Teams, rather than by the superior means of an appearance in person in the courtroom”.

This article was first published in Thomson Reuters’ Weekly Tax Bulletin.

Ian has worked at Thomson Reuters for over 15 years as a senior tax analyst with expertise in income tax and GST. He has been involved in tax publishing for over 25 years.

Prior to his tax writing career, Ian worked as a manager for a Big 4 accountancy firm and then with a firm which provided specialist tax advice for the music and recording industry.

Ian holds a Bachelor of Economics degree, is a Chartered Accountant and a registered tax agent. Among other things, Ian is the author of the Australian GST Handbook, the GST Commentary Service, the Australian Financial Planning Handbook and the specialist income tax commentary services, as well as being a regular contributor to the news services.

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