Hart v Commissioner of Taxation

*Unlimited allegedly took over the business in early 1995

18 The primary judge said of this evidence: 'However, in the eight years for which figures are set out, total income was $6,190.00. For the same period claimed expenditure was $357,381.00. I accept that establishing such a business necessarily involved development of a reputation over time. Mr Arnott's evidence demonstrates as much. However the continuing disparity between income and outgoings is difficult to reconcile with an intention to carry on a business. Although one may incur losses in conducting a business in the hope of a subsequent profit, hope usually gives way to reality, at least where money is concerned. A prudent person, in the position of Nemesis or Unlimited, would have concluded, by 1995, that no profit was likely. By that time, the alleged business had been operating for almost ten years. There is no reason to believe that the figures for the period 1985-1990 were any more promising than those for the years 1991-1998. By late 1992 or early 1993, Mr Hart had identified the need for a new aircraft, and yet it was not ordered until late 1994. This is also inconsistent with an intention to trade at a profit. In fact, the new aircraft did not arrive until late 1995, three years after Mr Hart had identified the need for it. Mr Hart and the applicant undoubtedly share a keen interest in aviation. Although the figures may not be conclusive, they strongly suggest an expensive pastime rather than a business.' 19 An appeal to this Court is by way of rehearing: Western Australia v Ward (2002) 76 ALJR 1098. As recently confirmed by the High Court in Fox v Percy [2003] HCA 22, the correct approach by an appeal court hearing such an appeal is to be found in the judgment of the majority in Warren v Coombes (1979) 142 CLR 531 at 551: '… in general an appellate court is in as good a position as the trial judge to decide on the proper inference to be drawn from facts which are undisputed or which, having been disputed, are established by the findings of the trial judge. In deciding what is the proper inference to be drawn, the appellate court will give respect and weight to the conclusion of the trial judge, but, once having reached its own conclusion, will not shrink from giving effect to it.' 20 Having regard to those principles, I am satisfied that no error attends the conclusion of the primary judge that in the 1995-1996 tax year, the relevant outgoings were not incurred in connection with a business operated by Unlimited involving airshow activities. Denial of procedural fairness 21 The appellant contends that the respondent breached the rule in Browne v Dunn (1894) 6 R 67, and that in the premises, this amounted to a breach of the rules of procedural fairness. 22 The rule in Browne v Dunn (supra) is summarised by a Full Court of the Federal Court (Lee, Hill and Sundberg JJ) in Flower & Hart (a firm) v White Industries (Qld) Pty Ltd (1997) 87 FCR 134 at par 51: 'As a general rule, before an adverse finding is made against a witness in contradiction of sworn testimony given by that witness, a matter in issue, the subject of that finding, must be put to the witness in cross-examination to enable him or her to give an explanation. However, there can be no need to put such an issue to a witness who has notice that there is other material in the proceedings that will be relied upon to contradict the evidence of the witness: see Allied Pastoral Holdings Pty Ltd v Commissioner of Taxation (Cth) [1983] 1 NSWLR 1 at 16; R Cross, Cross on Evidence (4th ed, 1991), par 17445.' 23 In this case there can be no doubt that the appellant and Mr Hart were on notice that the respondent asserted that the activities carried on in connection with the airshow aircraft did not amount to the carrying on of a business and were, in effect, the pursuit of an expensive private hobby of Mr Hart. The reasons of the Commissioner earlier set out in these reasons make the position plain. 24 What Mrs Hart did depose to is the following: 'I believe that at all material times the abovementioned expenses were necessarily incurred in the carrying on of an aviation business for the purposes of gaining or producing assessable income by Unlimited since it took over the business on 17 February 1995.' In her other affidavit Mrs Hart said: 'We knew the training would take a long time possibly years, and that it would also take several years for our reputation to grow. I could not expect to make a profit within the first five years at least and in fact the income did not grow until after the first five years of operation. It was always my expectation that once profits were made that tax would be levied on the income. At all times as referred to later in this affidavit decisions were made regarding the operations of the business which reflected the commercial nature of the business being undertaken.' 25 It was sufficient for the trial judge, and sufficient for this Court, to find that the appellant has not established, on the balance of probabilities, that any airshow business was carried on by Unlimited in the 1996 tax year. The onus of proof on a taxpayer in these circumstances was explained by the Federal Court in Richard Walter Pty Ltd v FCT (1996) 67 FCR 243. 26 The determination of whether the airshow activities and aircraft involved the carrying on of a business or the pursuit of a pastime were the subject of express submissions by the appellant below. The determination of that question by the primary judge involved the proper legal character to be placed on the evidence and the agreed facts. It did not involve weighing contradictory evidence or making findings as to the credit of the witnesses. The belief of Mrs Hart that Unlimited was conducting such a business in the 1996 year was not the subject of any challenge, it is true. That, however, is not determinative of the question before the Court, which was whether in fact and in law a business involving airshow activities was being carried on in 1996. The finding that there was no business in the 1996 year had the consequence that the appellant's belief was mistaken; that finding does not involve the collateral finding that the assertion by the appellant of her belief was deliberately false. Penalties 27 Section 226H of the Act provides: 'Subject to this Part, if: (a) a taxpayer has a tax shortfall for a year; and (b) the shortfall or part of it was caused by the recklessness of the taxpayer or of a registered tax agent with regard to the correct operation of this Act or the regulations; the taxpayer is liable to pay, by way of penalty, additional tax equal to 50% of the amount of the shortfall or part.' 28 The primary judge rejected the claim that the contention that Unlimited was carrying on a business involving airshow activities in the 1996 tax year were "fairly arguable". His Honour commented: 'If Harts Pty Ltd had considered this matter in light of the long history of Nemesis receiving very low income for very high outgoings, it would inevitably have had serious reservations about the deductibility of the expenses in question. It is, to say the least, extremely unusual for a business persistently to incur substantial expenses for no appreciable return.' And later: 'Harts Pty Ltd should also have taken into account the suggestion that reputation was important in earning income in air show activities and the need for pilot training. These matters would have led to doubts about whether Unlimited was conducting such a business, given the absence of any activity until very later in 1995 when Mr Hart commenced training.' His Honour concluded: 'Any rational consideration of the facts would have demonstrated that by 1995, no business was being carried on in connection with air show activities.' One is left to infer, by implication, that to contend there was such a business was recklessly to make that claim. 29 So much might be accepted if the matters rested there. However, Mr Hart, who was not cross-examined, deposed: 'In a previous audit no question had been raised as to the appropriateness of the treatment adopted.' Mr Hart in his affidavit said: "I also recall that in or around late 1987 to early 1988 the ATO conducted an audit into the affairs of Nemesis. The Audit was conducted by a Mr Lawson and a Mr Smith. The period of the audit was for 19871 to 1987 to my recollection. At the time of the audit, Nemesis was conducting the business of Aerobatic air shows since 1985. While some adjustments were made to the assessable income to Nemesis for that 6 year period, to my recollection, there was no suggestion or disallowance of the aircraft expenses by stating that Nemesis was not conducting a business.' 30 His Honour said: 'In 1987-1988 it may well have been arguable that Nemesis was seeking to establish a business with a view to trading at a profit. The business had been going for less than three years. However, as I have observed, hope cannot last forever in the face of adversity. By 1996 it was patently clear that the undertaking had failed to yield a profit. That inevitably raised the question of whether or not persistence in it by Mr Hart, the applicant and associated entities was motivated by a desire to carry on business or by some other personal motivation such as interest in aviation. Harts Pty Ltd could hardly have relied on an opinion formed in 1988 in light of the subsequent trading history. For those reasons I see no reason to doubt the correctness of the finding of recklessness for the purposes of s 226H.' 31 Section 226H permits the imposition of a penalty only in circumstances of recklessness by the taxpayer or his agent. A knowingly false claim is not within the section, which was the section on which the Commissioner relied. 32 While it may have been wrong of Mr Hart to have relied on an 'opinion formed in 1988', having regard to the 'subsequent trading history' in making a claim that a business was being conducted, in my opinion it is not properly to be regarded as "reckless" to have persisted in a claim which was not the subject of any disputation at an earlier time, even accepting that the period of losses and the extent of them had not been as extensive as they were at a later time. 33 It is not reckless simply to make a claim that is erroneous. Nor, in my view, is it reckless to make a claim, "knowing there is a real risk that the claim might be wrong;" cf the observations of Cooper J in BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) ATC 411 at 4129. If a jockey knows that in a horse race there is a real, as opposed to a fanciful, risk of serious injury or death involved in participation in the race, it would not be reckless conduct on the part of the jockey according to the proper meaning of "reckless", to take part in the horse race. So, too, a driver in a Formula 1 motor vehicle race. 34 Recklessness consists in making a claim, not caring whether the claim is true or false. The character of the undertaking had not changed between the time of the audit to 30 June 1996. If the character of the undertaking might properly be characterised as a business after about three years of operation, while it was wrong to claim that it was still a business in 1996, in my view it cannot be said to be reckless within the proper meaning of that word in s 226H of the Act, to make that claim, notwithstanding that no profit had been made up until then. 35 I would allow the appeal in part, by reducing the penalties which have been imposed on the appellant in this respect by the respondent in respect of the 1995-1996 tax year, to nil. 36 As to costs, the appellant failed in its primary contention, but in my opinion is entitled to succeed on the discrete issue as to penalties. In the circumstances, a fair exercise of the discretion as to costs would be to not interfere with the costs order below, and to order that there be no order as to the costs of the appeal. I certify that the preceding thirty-six (36) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Spender

ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA

REASONS FOR JUDGMENT HILL & HELY JJ: 37 We have had the advantage of reading the judgment of Spender J in draft form. We agree that no error attends the conclusion of the primary judge that in the 1995-1996 tax year, the relevant outgoings were not incurred in connection with a business operated by Unlimited involving air show activities. We also agree that the appellant has not established a denial of procedural fairness in the conduct of the proceedings at first instance. 38 However, we take a different view from that taken by Spender J on the issue of penalty. The onus is on the appellant to prove that the assessment of additional tax by way of penalty was excessive. The taxpayer could discharge that onus by proof that the factual circumstances which are necessary preconditions to the operation of s 226H, or any other section in Part VII of the Act did not exist: BRK (Bris) Pty Ltd v Commissioner of Taxation (1999) 99 ATC 4725, at 4728. 39 The appellant attempted to discharge that onus by establishing that there was no tax shortfall for the relevant year, or if there was, it was not caused by the recklessness of the appellant or Unlimited, or of the registered tax agent, Harts Pty Ltd, who prepared the tax return. 40 The appellant failed to establish the first of those matters because the primary judge found that in the relevant year of income, Unlimited was not carrying on a business in respect of air show activities, hence the deduction claimed for aircraft expenses was not allowable. 41 The appellant failed to establish the second of those matters because the primary judge found that any rational consideration of the facts would have led to the conclusion which his Honour reached. The appellant relied upon a further matter to negate recklessness, namely that in 1987-1988, the Australian Tax Office conducted an audit into the affairs of Nemesis (whose undertaking had been acquired by Unlimited) without there being any suggestion of disallowance of aircraft expenses on the grounds that Nemesis was not conducting a business. The primary judge found that Harts Pty Ltd could hardly have relied upon an opinion formed in 1988 in the light of the subsequent trading history up to and including the year of income. 42 Section 226H is one of a group of sections which impose penalties on a taxpayer where there is a tax shortfall for a year. In very general terms, if the shortfall was caused by the failure to take reasonable care to comply with the Act then the taxpayer is liable to a penalty of 25 per cent of the amount of the shortfall (s 226G). If the shortfall was caused by recklessness with regard to the correct operation of the Act, then the penalty is 50 per cent (s 226H). If the shortfall was caused by the intentional disregard of the Act, then the penalty is 75 per cent (s 226J). The more culpable the behaviour leading to the tax shortfall, the higher the level of penalty. 43 Recklessness is a concept well known to the law, particularly in the fields of tort and criminal law. In those fields, recklessness will usually be found to have been established if the person's conduct shows disregard of, or indifference to, consequences foreseeable by a reasonable person. In some contexts a subjective test is applied, but in others the test is objective. In BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) ATC 4111 at 4129 Cooper J made the following observations in relation to recklessness in the context of s 226H; 'Recklessness in this context means to include in a tax statement material upon which the Act or regulations are to operate, knowing that there is a real, as opposed to a fanciful risk, that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct, and that a reasonable person in the position of the statement-maker would see there was a real risk that the Act and regulations may not operate correctly to lead to the assessment of the proper tax payable because of the content of the tax statement. So understood, the proscribed conduct is more than mere negligence and must amount to gross carelessness.' 44 There is a line between recklessness and dishonesty, and as the Explanatory Memorandum for the Taxation Laws Amendment (Self Assessment) Bill 1992 (at p 89) confirms, a finding of dishonesty is not necessary for a taxpayer to be subject to a s 226H penalty. Wherever a tax return includes deductions that are not allowable, a foreseeable consequence is that there will be a tax shortfall, particularly in a system of self assessment. But, in the ordinary case, the mere fact that a tax return includes a deduction which is not allowable is not of itself sufficient to expose the taxpayer to a penalty. Negligence, at least must be established although there are some sections (eg s 226K) which impose a liability in particular circumstances even if the taxpayer has not been negligent. The context makes it clear that recklessness means something more than failure to exercise reasonable care (s 226G), but less than an intentional disregard of the Act (s 226J). 45 The primary judge did not explain, in terms, why the circumstances of this case fell within s 226H, rather than, eg s 226G. However, it is implicit in his Honour's judgment that the claim to the tax deduction was so tenuous, that if not due to an intentional disregard of the Act, it was only explicable on the basis of gross negligence in propounding the claim. A finding of gross negligence may be made in appropriate circumstances without the need for any subjective enquiry. 46 We agree with the primary judge's conclusion in that respect. We also agree that the matters relied upon by the appellant arising out of the 1987-1988 audit do not indicate or require any different conclusion. Those events occurred some eight years earlier than the year of income and involved different aircraft, a different trust, a different trustee, and a much shorter time frame. More importantly, no evidence was led by the appellant as to what the auditors were told, what conclusion they came to, or why they came to the conclusion which they did. For all that is known, they may have simply acted on the assurance of whomever they spoke to that the activities then being undertaken involved the conduct of a business. The evidence did not establish either the scope of the audit or the thoroughness with which it was conducted. 47 It was not suggested that whatever happened in relation to the audit enlivened s 226V of the Act. 48 The appeal should be dismissed with costs. I certify that the preceding twelve (12) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justices Hill and Hely.

Counsel for the Applicant: Mr David Russell RFD, QC, with Mr Peter Bickford

Solicitor for the Applicant: Hawthorn Cuppaidge & Badgery

Counsel for the Respondent: Mr David Boddice SC, with Mr Mark Robertson

Solicitor for the Respondent: Australian Government Solicitor