Harts Australia Limited v Commissioner of Taxation

The $750,000 transaction 4 The transaction occurred in the following circumstances. Downville Pty Ltd (Downville) as trustee for the McGowan Family Trust (the Trust) had been a shareholder in Harts Australia since its formation in 1987. The Trust operated a tyre retailing business in Goondiwindi. On 22 June 1992 Mr Hart wrote to Mr Lionel McGowan referring to a meeting of that date. The letter confirmed arrangements for the distribution of $750,000 to Harts Australia "in this financial year". The amount was to be paid at Mr Hart's call over the next ten years with $75,000 to be paid on or before 30 December 1992. In return for this distribution Mr Hart was to give "a personal guarantee to increase your net wealth by some $1,500,000 twice the amount that you are contributing to Harts". 5 On 30 June 1992 Downville as trustee for the Trust resolved to appropriate, set aside and apply $750,000 to Harts Australia and to apportion each of the balance, apart from a distribution of $416, between Mr Lionel McGowan and Mrs Jeanette McGowan. On the same day Harts Australia was appointed a beneficiary of the Trust. The effect of that distribution was that the Trust was no longer taxable in respect of the amount of $750,000, but that Harts Australia was liable to pay income tax on the distribution in the 1992 financial year.

Return 6 The Trust in its 1992 return showed a net income of $751,264 with distribution of $750,000 to Harts Australia, $424 to each of Lionel and Jeannette McGowan and $416 to Troy McGowan with the result that the Trust was not assessable in respect of any income. The tax agent shown on the return was a company in the Group. 7 On 24 November 1992 Harts Australia lodged a return for the 1992 tax year signed by Mr Hart on the previous day. The return showed a total gross income of $165,435. The $750,000 distribution was not declared. After deduction of expenses and other items the return showed a loss of $12,754.

ATO queries 8 Commencing in February 1996 correspondence and discussions took place between the Australian Tax Office (ATO) and Harts Australia about various tax matters, including the McGowan distribution of 1992. In a letter dated 16 February 1996 the ATO sought a large amount of information. The McGowan distribution was noted, as were other distributions to other trusts. The questions asked included: "Where have the distributed amounts been returned as taxable? Particularly in relation to Harts Australia Pty Ltd." 9 By letter dated 18 March 1996 Mr Hart responded. In relation to the McGowan distribution he said that the Trust "has been a shareholder in Harts Australia Ltd since 1987. On the 22 June it was agreed that McGowan would distribute $750,000 to Harts (see copy attached)".

The request to identify where the distributed amount had been returned as taxable income was ignored. 10 By letter dated 29 May 1996 the ATO requested various information including "evidence showing where the $750,000 distribution from the McGowan Family Trust , in 1992, has been returned by Harts Australia Ltd". By letter dated 21 June 1996 Mr Hart advised that "evidence concerning the $750,000 distribution from the McGowan Family Trust will be provided by 28 June". By letter dated 5 July 1996 Mr Hart advised that details of the distribution would be provided by the end of July. 11 On 9 September 1996 the Australian Federal Police (AFP) raided the Harts Group premises and took away many books of account and other documents. On 29 October 1996 a meeting was held attended by Mr Hart and ATO officers concerning the tax audit of Hart Australia. At the meeting Mr Hart said that to the best of his knowledge the information requested by the ATO had been provided. On 11 December 1996 the ATO wrote to Mr Hart discussing the matters raised at the meeting. The letter enclosed a schedule setting out outstanding requests and information. This included the request "Provide evidence where the $750,000 distribution from McGowan Family Trust in 1992 has been returned by Harts Australia Ltd". On 24 December 1996 Messrs Hawthorn, Cuppaidge and Badgery, solicitors, replied on behalf of the Group. The letter included the following: "We are instructed that the $750,000 distribution referred to was made as at 30 June 1992 from the McGowan Family Trust to Harts Australia Ltd ('HAL'). HAL sold part of the debt namely $675,000 to Mevton Pty Ltd in return for payment of $500,000. HAL declared the $500,000 as income in its 1992 tax return. The balance of $75,000 was paid by the McGowan Family Trust to HAL in 1993 and declared in that year." 12 Mevton Pty Ltd (Mevton) is a company associated with Mr Hart and Mr Ian Stevens who is also a director of Harts Australia. 13 By a letter dated 3 November 1997 to Mr Hart the ATO sought further detailed information relating to the tax treatment by Harts Australia of the McGowan distribution. Mr Hart was required to provide copies of all documents, work papers and other records which evidenced or in any way supported, inter alia, the claim that Harts Australia had included $500,000 in its 1992 assessable income and $75,000 in its 1993 assessable income. The letter also asked for the basis on which it was claimed that Harts Australia was entitled to reduce the amount of its assessable income in 1992 by (i) $175,000 upon the sale of the debt to Mevton; (ii) $75,000 unexplained but purportedly returned when received in the year 30 June 1993. The letter also asked for details of the calculation of the sale price of the $675,000 debt and the names of the persons who negotiated the sale of the debt on behalf of Harts Australia and on behalf of Mevton. 14 In a reply dated 23 December 1997 through his solicitors Mr Hart advised that the AFP currently held all the banking records of the Group for this period and the questions were answered "to the best of the ability of Harts, taking into consideration the lack of actual records involved". This appears to be the first time the seizure of records had been advanced as an excuse or qualification for lack of information provided. In response to the question about the alleged inclusion of $500,000 in the Harts Australia return for 1992, the reply was "Please be advised that the money came from Mevton Pty. Ltd. You are referred to the general ledgers of Mevton Pty Ltd for 1991, 1992 and 1993 which evidences the flow of funds." In relation to the query about including $75,000 in the 1993 year the reply stated (non-responsively): "I have been advised that the amount paid from the McGowan Family Trust was received and banked into the Harts group of companies in the period October to December 1992. The banking records of Harts will confirm this when the AFP returns them." 15 In response to a question as to why it was considered that the full amount of $750,000 was not assessable income of Harts Australia for the 1992 year it was stated: "While the full amount of $750,000 owed by the McGowan Family Trust the arrangement was similar to a factoring arrangement entered into with "a bank" whereas the debt was discounted to receive ready cash. This is the same commercial factoring arranging that if entered into with (sic), for example, the ANZ Bank, whereas the assessable income to Harts is the amount it has received and the bank therefore earns the balance as assessable income when it collects the debt." 16 In answer to a question as to what attempts had been made to recover the $675,000 owed by the Trust, the response stated: "Please be advised that the debt of $675,000 owing by the McGowan Family Trust have subsequently been paid (sic). Mevton in turn sold the debt and received shares in Epicorp Ltd for $675,000. Mr McGowan has recently been lent loan funds of $675,000 to repay the debt on behalf of the McGowan Family Trust. I am instructed that settlement took place in approximately September." 17 The balance sheet of Mevton for the year ended 30 June 1992, and in each successive year ended to 30 June 1996, records the Trust as a current asset in the sum of $500,000. 18 The trial balance of Harts Australia as at 30 June 1992 records Mevton as a current liability in the sum of $108,000. 19 The balance sheet of Mevton for the year ended 30 June 1992 records Harts Australia (under its former name Hartcorp Australia Limited) as a current liability in the sum of $338,034. 20 On 7 June 1993 a cheque drawn by the Trust in the sum of $25,000 was deposited into Harts Australia's bank account. 21 In the accounts of the Trust the debt to Harts Australia is recorded as a liability for the following amounts: Year ended 30 June 1992 $750,000 Year ended 30 June 1993 $700,000 Year ended 30 June 1994 $675,000 Year ended 30 June 1995 $675,000 Year ended 30 June 1996 $675,000 22 By fax dated 7 January 1998 addressed to Mr Hart, the ATO issued a position paper on the McGowan distribution. Mr Hart was invited to respond by 23 January 1998. 23 By fax dated 12 February 1998 Mr Alan Powrie, a solicitor acting for the Group, advised the ATO that he would provide a response to the position paper by 9 March 1998. Mr Powrie's response was duly provided as promised. It will be considered in detail below.

Assessment 24 On 21 December 1998 the Commissioner issued a notice of assessment to Harts Australia in respect of the 1992 tax year. The assessment included in the company's assessable income the amount of $750,000 and resulted in a taxable income of $567,671 ($750,000 minus $182,329 being 1992 loss returned of $12,754 plus carry forward losses of $169,575). 25 Penalty tax was imposed pursuant to s 223 of Part VII of the Act. The Commissioner exercised his discretion under s 227(3) to remit in part the penalty tax payable. The remission of penalty resulted in penalty of $256,398.20 being assessed, comprising a culpability component of $166,043.76 (75 per cent) and a per annum interest component of $90,354.44.

Objection 26 On or about 20 January 1999 Harts Australia objected in writing to the assessment. 27 In its objection Harts Australia requested the Commissioner to grant an extension of time in which to allow it to lodge a notice in writing for the purposes of s 80G of the Act. 28 Under cover of an undated letter sent by fax to the ATO on 23 March 1999 Harts Australia, through its solicitors Thompson Hannan, lodged with the Commissioner a document bearing date 22 March 1999 purporting to be a notice for the purposes of s 80G in respect of the year ended 30 June 1992. 29 By letter dated 1 June 1999 the Commissioner disallowed Harts Australia's objection and set out the reasons for his decision. The Commissioner also declined to exercise his discretion to allow an extension of time under s 80G.

Harts Australia's response to ATO position paper

(i) $75,000 paid by Trust 30 In its response dated 9 March 1998 to the ATO position paper Harts Australia stated: "Please be advised that $75,000 was paid by the McGowan Family Trust to the Harts Group in the following manner: $50,000 in 1993 and $25,000 in 1994 'Schedule A'. $25,000 banked into Harts Fidelity Limited's bank account on the 30th of April 1993. Please refer to 'Schedule B'. ...This amount in Harts Fidelity has been credited to Harts Pty Ltd with a journal entry made in the Harts Pty Ltd accounts to reflect the transaction as income. Please find attached 'Schedule C' (from the audit working papers) which shows a second $25,000 of Millard was paid into Harts Australia Limited in approximately June 1993. This amount was once again credited from Harts Australia into Harts Pty Ltd as income. You are now referred to the working papers of Mr Bryant for 1994. Please refer to 'Schedule D', which shows the third payment of $25,000 was paid and credited to the income of Harts Pty Ltd. Please refer to the code 80.90 and be advised that '90' is the income code used for Harts Pty Ltd, and '80' represents the branch, being Brisbane. As you can see, the $75,000 has been declared as taxable income in the Harts Group in 1993 and 1994. Although it may be 'an incorrect reflex' of the income of Harts Australia Limited, when viewed in the context of the Harts Group as an entirety there has been no detrimental effect on the income to the Commonwealth." 31 The Schedule A referred to is an extract, from the accounts of the Trust, which records the balances owing to Harts Australia set out above. These figures indicate that the debt owing to Harts Australia by the Trust was reduced by $50,000 during the year ended 30 June 1993 and $25,000 during the year ended 30 June 1994. The figures are at odds with Mr Hart's reply of 23 December 1997 wherein he advised that the amount of $75,000 paid by the Trust was received and banked into the Harts Group of companies in the period October to December 1992. 32 The Schedule B referred to is an extract from the general ledger of Harts Fidelity Limited as at 30 June 1993. The account titled "Loan - Harts Pty Ltd" has been credited with an amount of $25,000 and the notation recorded is "Fees for Harts from Millard Tyre". "Millard Tyres" is the trading name of the Trust. 33 No evidence was provided to show that this amount of $25,000 was returned as income by Harts Pty Ltd. Nor was any explanation provided as to why the amount was paid to Harts Fidelity Limited. The notation in the ledger seems to indicate that the payment was something other than a part payment of the distribution owing to Harts Australia by the Trust. 34 No evidence of the journal entry said to have been made in the accounts of Harts Pty Ltd recording the $25,000 as income was supplied. 35 Bank statements and deposit slips relating to a National Australia Bank account in the name of Harts Fidelity Limited reveal the following deposits: Drawer Date Amount Millard Tyre Centre 08.04.93 25,000 Harts Australia Limited 07.06.93 25,000 Millard Tyre Centre 06.12.93 25,000

36 The Schedule C referred to is an extract from Harts Australia's banking summary. On 7 June 1993 a cheque for $25,000 drawn by Millard Tyre Centre was deposited into Harts Australia's ANZ bank account. On the same day, a cheque for $25,000 was drawn and presented on the same account. The payee appears to be Harts Fidelity Limited. 37 The response from Mr Hart stated that this $25,000 amount was "once again credited from Harts Australia into Harts Pty Ltd as income." No evidence of this was provided. 38 While it may be said that the Group has received $75,000 from the Trust, there is no evidence to support the assertion that this amount has been included in its assessable income in any year or years, or more particularly, in 1992. (ii) The alleged factoring arrangement 39 The following was stated in relation to the purported factoring of the debt owed by the Trust to Harts Australia: "Reduction $675,000 balance to amount paid $500,000 You will note from 'Schedule E', which will be explained later in this communication, that $500,000 was paid and received by Harts Group from Mevton Pty Ltd as payment for the acquisition of the McGowan debt. For commercial reasons, Harts Australia Limited immediately onsold the balance of the debt of $675,000 to Mevton Pty Ltd for $500,000. This was calculated at a discount rate of 10.5% per annum for a period of three years. ...The transaction represented sound business decisions for both the Harts Group and for Mevton Pty Ltd. However the correct entry in the books of Harts Australia Limited should have been DR Discounts Given and CR Income Distribution. The net result of this entry would be to have no change to the declared taxable position of the Company." 40 Senior Counsel for the Commissioner argued that even if these assertions are accepted, it is clear that $175,000 of the distribution has not been returned. 41 The response goes on to explain how the alleged factoring arrangement was accounted for: "$500,00 (sic) paid by Mevton As per 'Schedule E', you will find that an amount $1,194,534 was paid by Mevton to the Harts Group in the years 1991 to 1994 inclusive. From these funds an amount of $222,034 was paid by the Harts Group back to Mevton. Mevton acquired assets for $857,000. These are as follows. $500,000 for the McGowan loan. ...Please note that, as at 1994 there was no loan account in any of the Harts Group of Companies to Mevton Pty Ltd. ...As can be seen by taking the $500,000 credit for the McGowan purchase in 1992, the income has been declared by the Harts Group due to the fact that, as previously stated, a nil balance occurs in the Harts Group loan accounts as at the 30th of June 1994. While it hasn't necessarily been declared in Harts Australia Limited itself (as previously stated) it has been declared in the Harts Group and probably in the accounts of Harts Pty Ltd. Please refer to the bottom of "Schedule E", the reconciliation of monies received and paid to the Harts Group, which details the fact that Mevton paid to Harts the $500,000. In the absence of any loan to Mevton by Harts, it would leave no doubt that the amount has been declared as income within the Harts Group." [emphasis added] 42 Schedule E is a working paper prepared by Mr Hart titled "Mevton/Harts Group Reconciliation". It purports to show the flow of loan funds between Mevton and the Group. It does not show the payment of $500,000 in discharge of the alleged debt. The Schedule states that $1,194,534 was received by the Group from Mevton during the period 5 September 1990 to 29 September 1994. Total cash repayments were $222,034. Errors in coding accounted for $115,500 and total assets acquired were $857,000. This amount allegedly includes the purchase of the McGowan debt for $500,000. 43 All that Schedule E shows is the movement in loan balances which includes an associated company, Paxglade Pty Ltd, which is not part of the Group. There is no explanation or evidence provided to show how the amounts have been treated in the income side of the accounts. 44 The general ledgers of Mevton have been supplied. From these the loan accounts to the Group have been extracted and summarised. The balance in Mevton for each year differs to those in the accounts of Harts Australia. 45 In his reply to the position paper Mr Hart attached a schedule titled "Adjustment Reconciliations". The McGowan distribution was accounted for as follows: 1992 1993 1994 McGowan/Mevton 488,034 (310,760) (102,274) McGowan Direct (50,000) (25,000)

46 No explanation has been provided as to how the figures were calculated. Nor has it been possible to reconcile any of the figures from Schedule E. The figure for the 1992 year would purport that $86,966, ($575,000 less $488,034), had been returned in that year. 47 In Mr Hart's reply to the position paper the further statement was made: "The total amount of the distribution, which should have been declared in 1992, was $750,000. While we acknowledge that the total distribution of $750,000 should have been declared by Harts Australia Limited in 1992, we point out that the amount has been declared as assessable income as per the reasons listed below. … whilst technically the income perhaps should have been returned in Harts Australia Limited, the Financial Controller who was responsible for the preparation of both the Income Tax Returns and the Management Accounts showed the income in the Management Accounts in the years in which it was received. The Financial Controller credited the amounts received to Harts Pty Ltd in the Management Accounts as that was Mr Hart's profit centre for the Group. The necessary adjustments were not reflected in the taxation returns when lodged." [emphasis added] 48 The Commissioner argued, and I accept, that the reply to the position paper does not provide any cogent evidence to demonstrate with any degree of certainty that the McGowan distribution of $750,000 has been returned as assessable income by Harts Australia. Mr Hart relies on a purported nil balance in the Group loan accounts as at 30 June 1994 as evidencing that: "… While it hasn't necessarily been declared in Harts Australia Limited itself (as previously stated) it has been declared in the Harts Group and probably in the accounts of Harts Pty Ltd." [emphasis added] 49 It is clear from this statement that Mr Hart cannot say positively which entity has returned the distribution as assessable income, if in fact any amount has been returned. 50 Mr Hart was originally queried on 16 February 1996, with further evidence requested on 29 May 1996. Two responses were received to say that the information would be supplied by 28 June 1996 and again by the end of July 1996. The general ledgers of the group would have been available at this stage as the AFP seizure did not happen until September 1996. If the McGowan distribution had been accounted for correctly it would have been reflected in the general ledgers of the relevant entities. It would have been a fairly simple exercise to provide these to show that the amounts had been returned. 51 The accounts of Mevton for the years 1991 to 1996 appear to have been prepared in July 1996 to reflect the position stated in the reply to the position paper. The argument of Harts Australia was that the lack of documentation "can readily be explained by the fact that Mevton and Harts Australia have had common directorship at all material times and no doubt the directors saw no need to fully document all transactions as if the parties were related". I find this argument unacceptable, and the more so by it being advanced on behalf of a public company which holds itself out as a business and financial adviser, accountant and tax agent. 52 I accept the Commissioner's submission that the response to the position paper did not satisfactorily explain that the total distribution of $750,000 had been returned as income.

Power to issue assessment 53 Section 166A as it stood in 1992 did not give rise to a deemed assessment where the taxpayer lodged a nil return. The section operated to create a deemed assessment in the amount of income tax payable according to the return furnished by the entity. The date of the deemed assessment is the date on which the specified amount of income tax is due, unless instalments already paid exceed the income tax payable: s 221AZD. Like the analogous provision of s 170(3) considered by the High Court in Federal Commissioner of Taxation v Ryan (2001) 201 CLR 109, such a provision has no point of reference when no tax is due and payable. Such a deeming provision has no operation beyond the precise circumstances to which it is expressed to apply, and is to be construed strictly: East Finchley v Federal Commissioner of Taxation (1989) 90 ALR 457 at 478. 54 In any event, there is a finding that there has been an avoidance of tax which, in the opinion of the Commissioner, is due to fraud or evasion. The grounds on which a taxpayer can challenge the formation of such an opinion by the Commissioner are limited: see Denver Chemical Manufacturing Co Ltd v Commissioner of Taxation (NSW) (1949) 79 CLR 296 at 317; Avon Downs Pty Ltd v Federal Commissioner of Taxation (1949) 78 CLR 353 at 360; Federal Commissioner of Taxation v Brian Hatch Timber Co (Sales) Pty Limited (1972) 128 CLR 28. 55 In Denver Chemical at 313 Dixon J said that, although it is universal to attempt to define the word "evasion", "It is probably safe to say that some blameworthy act or omission on the part of the taxpayer or those for whom he is responsible is contemplated. An intention to withhold information lest the Commissioner should consider the taxpayer liable to a greater extent than the taxpayer is prepared to concede, is conduct which if the result is to avoid tax would justify finding evasion". 56 The onus of proving that there has not been an avoidance of tax rests with the taxpayer: see McAndrew v Federal Commissioner of Taxation (1956) 98 CLR 263. It has not been satisfied. The initial failure by a company, controlled by a tax agent, to return a large amount of unarguably assessable income has been compounded by subsequent dilatory, non-responsive and unpersuasive attempts at explanation.

9 Omission of assessable income and remission of penalty 57 As already mentioned, it is now common ground that Harts Australia omitted $750,000 from its assessable income for the 1992 year. Such an omission falls within s 223(7) of the Act. Accordingly, Harts Australia is taken to have made a false or misleading statement for the purposes of s 223, and is liable to pay by way of penalty additional tax equal to double the amount of the excess of the tax properly payable over the amount assessed on the basis of the false or misleading statements in the return. 58 No error in the exercise of the Commissioner's discretion is identified by and none is apparent from the terms of the remission decision. The Commissioner was entitled to take the view that the omission of such a large sum of assessable income from a return showing a relatively small total income, and no assessable income, was consistent with deliberate omission or at least gross negligence. That the return was signed in November 1992 by Mr Hart himself , who apparently negotiated the distribution personally on 22 June 1992, and is a tax agent, reinforces that conclusion. The decision to remit only part of the penalty was well open to the Commissioner. No error of discretion is shown.

10. Refusal to extend time 59 Harts Australia requested that the Commissioner exercise his discretion under s 80G(6A)(b) to allow further time for the making of an agreement under that section. 60 The decision to refuse to extend time is logically anterior to the process of assessment of the taxable income of Harts Australia. It does not form part of the process of assessment as defined in s 6(1) of the Act. The only relevant right to object is against an "assessment": s 175A. The exercise of that discretion to extend time under s.80G does not form part of the determination of an objection for the purposes of the Act. Accordingly, it is not amenable to review in this Court in this proceeding. 61 In any event, no relevant error is shown. The period of the extension sought is more than six years. The non-declaration of income occurred in circumstances that the Commissioner was entitled to regard as serious. It was open to the Commissioner in the exercise of his discretion to refuse to extend time in the circumstances. 62 The extension of time sought is for a very substantial period. The 1992 return was signed by Mr Hart, himself a tax expert, who had direct personal knowledge of the then recent distribution. The sum omitted was very large relative to the taxpayer's other declared gross income. No satisfactory explanation for the omission has been supplied.

Issues 63 The Commissioner's assessment in 1998 eliminated prior losses and imposed penalties and interest. There are issues as to 1. Whether it was open to the Commissioner to make the assessment 2. Whether a loss transfer agreement was signed prior to lodgment of return and, 3. If it was, whether it complied with s 80G(6)(c) of the Act. The agreement did not specify a dollar amount but provided: "The amount to be transferred is so much of the losses required which make [the income company's] taxable income NIL" 4. Whether the Commissioner validly exercised his discretion to reduce any part penalty and interest.

Return 64 Harts Australia's return in respect of the 1993 tax year was lodged on 30 December 1993. 65 The return disclosed an operating profit for the year of $231,764. After allowing for reconciliation items including prior year losses recouped of $12,754 and losses transferred in of $190,295, the return disclosed a taxable income of nil and no amount of income tax payable.

Assessment 66 On 21 December 1998 the Commissioner issued a notice of assessment to Harts Australia for the 1993 year which disallowed prior year losses of $182,329 and resulted in a taxable income of $182,329. 67 Tax shortfall penalty of $53,331.23 was imposed on the taxpayer pursuant to s 226J of the Act. Interest of $34,229.35 was imposed pursuant to s 170AA. 68 The Commissioner declined to exercise his discretion under s 227(3) to remit the tax shortfall penalty and declined to exercise his discretion under s 170AA(11) to remit interest.

Objection 69 On or about 20 January 1999 Harts Australia objected in writing to the assessment. In its objection, it requested that the Commissioner grant an extension of time in which to allow it to lodge a notice in writing for the purposes of s 80G of the Act. 70 Under cover of an undated letter sent by fax to the ATO on 23 March 1999 Harts Australia, through its solicitors Thompson Hannan, lodged with the ATO a document bearing date 26 October 1993 purporting to be a notice for the purposes of s 80G in respect of the year ended 30 June 1993. The document was signed by Mr Hart as public officer of both Bomilsco Pty Ltd (Bomilsco) and Harts Australia. It was as follows: "BOMILSCO PTY LTD AND HARTS AUSTRALIA LIMITED 1993 FINANCIAL YEAR It has been irrevocably agreed between the Companies that the right to a deduction for some of the losses incurred by Bomilsco Pty will be transferred to Harts Australia Ltd. In accordance with S.80G of the ITAA :- a) The losses were incurred in the 1990 year. b) Bomilsco Pty Ltd and Harts Australia Limited were both resident companies for the whole year and all intervening years. c) Harts Australia Limited has a Taxable Income in 1993. d) Common ownership is satisfied at all times during the year and all intervening years. e) The amount to be transferred is so much of the losses required which make Harts Australia Limited taxable income NIL. (Signed) (Signed) Public Officer Public Officer Bomilsco Pty Ltd Harts Australia Limited 26/10/93 26/10/93" 71 By letter dated 1 June 1999 the Commissioner disallowed the objection and set out the reasons for his decision. The Commissioner declined to exercise his discretion to allow Harts Australia an extension of time in which to lodge a notice under s 80G. 72 The adjustment to Harts Australia's 1993 taxable income is a consequence of the adjustment made to its taxable income in respect of the 1992 income year by reason of the disallowance of the loss carried forward of $182,329, made up as follows Loss per 1992 return: 12,754 Prior year losses: 169,575 $182,329

Power to issue assessment 73 For the reasons already given in relation to the 1992 year, the Commissioner's assessment was valid.

Signature of loss transfer agreement before lodgment 74 Mr Hart failed to produce the agreement purportedly signed on 26 October 1993 and numerous other loss transfer agreements until the meeting with Mr Powrie in February 1998 although there had been queries from the ATO as early as 14 February 1995. Mr Stevens and other officers of the group who might be expected to know of the existence of the agreements were not called. Senior Counsel for the applicants argued that there was "no reason whatsoever for the Mr Hart to disclose these private transactions to employees" and that "there was no evidence whatsoever that anyone other than Mr and Mrs Hart had any relevant knowledge in relation to the execution of the loss transfer agreements". But if these agreements were signed before lodgment it was important in the company's own interests that they be properly recorded. There was nothing particularly confidential about them and certainly no basis in which they could be regarded as matters private to Mr and Mrs Hart. 75 As an excuse for not producing the agreements from the Group's records reliance was placed on the seizure of the Group's books and documents by the AFP in September 1996. But Mr Hart was on notice that the validity of the agreements, and in particular their date of issue was disputed. I am not persuaded that such difficulties as might have attended a search among the seized documents was truly insuperable. 76 More importantly, the bundle of loss transfer agreements tendered in evidence included one for the 1991 tax year, purportedly signed by Mr Hart on 14 November 1991 between Bomilsco and another company in the Group, Curtain Management Services Pty Ltd. It is in identical form to agreements purportedly signed in later years. It commences "It has been irrevocably agreed between the companies that the right to a deduction for some of the losses incurred by Bomilsco Pty Ltd will be transferred to Curtain Management Services Pty Ltd" 77 Yet the relevant terms of the Act in 1991 required a notice, not an agreement. Section 80G(6)(c) as it stood in the 1991 tax year required "the loss company and the income company (to) give to the Commissioner, on or before the date of the lodgment of the return of income of the income company for the income year or within such further time as the Commissioner allows, a notice in writing signed by the public officer of each of those companies." 78 In seeking to answer this point, Senior Counsel for the applicants referred to Income Tax Ruling 2465 dated 4 February 1988 dealing with s 80G which included par 8 as follows: "The public officers of companies associated with a transfer must agree to the amount of the loss deduction to be transferred; the amount may be the whole or only part of the loss available for transfer. Moreover, part of the loss incurred in a year of income may be transferred to one group company and the whole or part of the balance transferred to other group companies. As indicated earlier, an income company have received only sufficient loss deduction to extinguish its own taxable income - it cannot create a loss by way of the transferred loss deduction (subsection 80G(7))." [Emphasis added]. 79 But "agree" in this context simply meant that the public officers had to fix on an agreement amount before (as was then required) a notice was submitted. In any event, a point of this nature would only be valid if Mr Hart, in 1991, in fact considered ITR 2465, thought "agree" meant a formal agreement between the two companies, and as a consequence caused the agreement to be prepared in the form it bears. But Mr Hart did not proffer the ITR 2465 explanation in his evidence nor was it made in oral submissions at the hearing. 80 At common law it is not possible to transfer a "loss", let alone a "loss deduction". A loss is simply a figure produced after accounting for trading operations over a given period. To be a loss deduction a loss would need to meet the further requirement of satisfying the relevant provisions of the Act. So it would be remarkable if Mr Hart in November 1991 prepared and sign a formal agreement for a transaction not then known to the law. 81 There were forty seven of such loss transfer agreements in evidence. They bear purported dates between 1991 and 1996. They are all in common form and all seem to have the same typeface and layout. 82 The taxpayer bears the burden of proof: s 14ZZO, Taxation Administration Act 1953 (Cth) (the Administration Act) I am not satisfied it has been discharged. 7. Is a formula loss transfer agreement valid? 83 In a judgment handed down on 11 August 2000 Drummond J dealt with this question as a preliminary issue pursuant to O 29 r 2: Harts Australia Limited v Commission of Taxation [2000] FCA 1131. His Honour held that the agreements did not constitute an agreement for the purposes of s 80G(6)(c) insofar as none of the agreements specified the particular amount to be transferred. 84 The applicants appealed and a Full Court (Lee, Finn and Merkel JJ) held that the question was inappropriate to answer because the agreed facts were "limited and provisional" and the agreement could only be contained from the "matrix of facts in which the agreements were made": Harts Australia Limited v Commissioner of Taxation [2001] FCA 761 at [24], [27]. The Full Court decision was handed down after I had reserved judgment in the present case on 14 June 2001. 85 I then gave directions on for the filing of further evidence. In an affidavit sworn on 6 August 2001 Mr Hart deposed as follows as to cl (e) in the agreement: "9. The reason I used the term "taxable income" was because I wanted to make it clear that I intended to use so much of the available losses of Bomilsco as would be necessary to reduce the taxable income, as calculated and ascertained in accordance with the terms of the Income Tax Assessment Act 1936 ("ITAA36"), to nil. 10. I was aware at all material times that there was only one true taxable income for each taxpayer in each year of income and my desire was to transfer so much of the losses accumulated by Bomilsco in previous years of income as would be required to reduce the taxable income of Harts Consulting and HAL [Harts Australia Limited] to nil in each of the relevant years of income. 11. I was not concerned at any time as to whether there were sufficient losses to achieved that desired result. I was aware at all material times that Bomilsco had very substantial accumulated losses which were more than sufficient to reduce the taxable income of HAL and Consulting in the 1992, 1993 and 1996 years to nil. 12. I did not specify a precise amount in paragraph (e) of the aforementioned agreements because I was not sure, as at the date that the agreements were entered into, of the precise amount of taxable income earned by Consulting and HAL in the relevant financial years. 13. In addition I had experience with using similar sorts of terminology in minutes of meetings of trustees whereby the trustees resolved to appoint income to beneficiaries and I was aware that it was advisable to allow for the possibility that the Commissioner might not accept the taxable income as returned by the taxpayer or might initially accept the taxable income as returned but then change his mind and that the ascertainment of the true amount of taxable income might ultimately have to be resolved by the Court. 14. I therefore considered that the best way of protecting the interests of Consulting and HAL and ensuring that those companies had a nil taxable income for the 1992, 1993 and 1996 years of income was to use the form of words adopted by me in clause (e) of the agreements." 86 This evidence, dealing as it does with the subjective intentions and expectations of parties, is not admissible: Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 at 352 per Mason J, Cross on Evidence 6th Aust Ed par 39290. No other evidence was proffered as to the relevant matrix. 87 I shall not set out the full terms of s 80G. The critical part is subs(6) (c) which stipulates that: (c) the loss company and the income company agree that the right to an allowable deduction under subsection 79E(3), 79F(6), 80(2), 80AAA(7) or 80AA(4), as the case requires, in respect of so much of the whole or part of the loss as has not been allowed as a deduction should be transferred to the income company in the income year;" 88 The essential part of Drummond J's reasoning was as follows: "[14] The object of s 80G is to permit the transfer of a right to deduct a loss from one company's assessable income to an associated company so that it can deduct that same loss from its own assessable income. And since this right to deduct a transferred loss is a right exercisable only within this process of ascertaining the figure that expresses the income company's taxable income, it must I think be the right to deduct a figure that is identifiable as a specific dollar amount, at the latest, at the time the transfer agreement is made. [15] For these reasons I cannot accept that sub-section (6)(c) can be satisfied by an agreement for the transfer by the loss company of its right to a deduction in respect of the whole or a part of a loss available to it, the precise dollar amount of which is not fixed and identifiable at the date of the agreement, but which may thereafter change at each point in time at which the process of assessment of the income company's taxable income for a particular year may have to be undertaken and which will only finally be identifiable when the last stage of that process is complete. [16] A transfer agreement in the form adopted by Bomilsco and the two Harts companies is not one which meets the requirements of s 80G(6)(c) of the ITAA because it operates in terms to permit the transfer from Bomilsco to the relevant Harts company of an amount that is intended to change, to the extent necessary to reduce the Hart's company's taxable income to nil, each time an assessment of that taxable income may be made in accordance with the ITAA. [17] This is not to say, at least so far, that the dollar amount of the loss the subject of the transfer agreement must be recorded in the agreement if it is to satisfy s 80G(6)(c). But the amount of the loss must be fixed and identifiable at the date of the agreement. That much follows from a consideration of the wording of s 80G(6)(c) and of the fact that the right of deduction the subject of an agreement within that sub-clause can only be exercised in the process of assessment of the transferee company's taxable income. But in order to identify the proper construction of s 80G(6)(c), it is not enough to have regard only to the words of the sub-section: the relevant context in which that sub-section is found must also be taken into account." 89 I agree. On the applicants' construction of s 80G, an agreement would transfer an amount based upon the return as lodged, which might vary up or down, throughout the process of assessment, review and appeal extending over many years. I do not think s 80G contemplates agreements made on a che sera, sera basis, whatever will be, will be.

8. Tax shortfall penalty 90 The actual adjustment s 170AA(1) to the 1993 taxable income is a direct consequence of the adjustment in 1992. Accordingly, the outcome of the 1992 year will determine the 1993 year. 91 For the reasons given above in relation to the 1992 year, it is clear that the tax shortfall was caused by the intentional disregard by the taxpayer or by its tax agent Mr Hart of the Act or the regulations. 92 No error is shown in the exercise of the Commissioner's discretion not to remit penalty tax under s 227(3).

9. Section 170AA interest 93 A decision not to exercise the discretion in s 170AA(11) to remit a liability for interest imposed pursuant to s 170AA(1) is not a reviewable objection decision. 94 Section 170AA(1) provides that where an amendment of an assessment increasing the liability of a taxpayer to tax is made, the taxpayer is liable to pay interest to the Commissioner. 95 Under s 170AA(11) the Commissioner has a discretion to remit the whole or any part of the interest payable by a taxpayer under s 170AA. There has been no basis advanced for the exercise of the Commissioner's discretion to remit the interest under s170AA(11). 96 By virtue of s 170AA(13) no appeal to the Federal Court lies in relation to the failure of the Commissioner to exercise his discretion under s 170AA(11). 97 Section 170AA(13) provides that the ascertainment of an amount of interest is deemed not to be an assessment. The consequence of this provision is that no objection rights as provided for in s 175A are available in respect of a decision not to remit s 170AA interest. 98 Accordingly, even though Harts Australia's request to have the interest remitted was made in their notice of objection, this was not an objection in terms of s 175A. It was not a "taxation objection" as defined in s 14ZL of the Administration Act. The request was merely a request for the Commissioner to exercise a statutory discretion. 99 The Commissioner's failure to exercise the discretion is not an "objection decision" in terms of s 14ZY of the Administration Act, and therefore cannot be an "appealable objection decision" or a "reviewable objection decision" in terms of s 14ZQ of that Act and accordingly, there is no right of appeal under s 14ZZ.

Issues 100 It is common ground that a sum of $480,000 should have been declared. 101 Again a loss transfer agreement was relied on. My conclusion as to this will be as previously stated. The only remaining issues are penalty and interest.

Management fees 102 Harts Consulting was incorporated in Queensland as Jamlaw Pty Ltd on 18 July 1989. 103 Mr Hart was appointed a director of the company on 2 August 1989 and was a continuing director as at 4 August 1999. 104 The 1996 general ledger of Harts Consulting (bearing date 18 September 1997) records a liability for management fees of $480,000 in respect of management services provided to it by Harts Australia. The expense was claimed by journal entry with Harts Australia recorded as a trade creditor.

Return 105 The 1996 return of Harts Consulting signed by Mr Hart and dated 24 September 1997 included a deduction of $480,000 in respect of the management fee. This amount was included in the claim for "All other expenses" totalling $982,087. 106 The 1996 general ledger of Harts Australia (bearing date 14 July 1997) records total professional fees received of $712,489.88. The general ledger does not record any management fees received from Harts Consulting. 107 Harts Australia furnished a return in respect of its income for the 1996 tax year on 2 June 1997. 108 The return disclosed an operating profit for the year of $12,397. After allowing for reconciliation items, including losses transferred in of $12,290, the return disclosed a taxable income of nil and no amount of income tax payable. 109 Harts Australia failed to include the amount of $480,000 in its assessable income.

ATO Queries 110 By letter dated 3 November 1997 addressed to Mr Hart, the ATO sought information relating to the management fees claimed by Harts Consulting, the management services it received from Harts Australia and its trade creditors as at 30 June 1996. 111 By letter dated 28 November 1997 Mr Hart responded to the ATO's queries. The response confirmed that Harts Australia was included in Harts Consulting trade creditors as at 30 June 1996 in the amount of $480,000 for management fees. The response also confirmed that Harts Australia "provides all facilities" to Harts Consulting and that this includes "the provision of all staff, rent, telephone, stationery, legal advice, accounting advice, and any other service required." 112 By letter dated 7 January 1998 addressed to Mr Hart, the ATO issued a position paper on the management fee issue and Harts Australia's apparent failure to include the amount of $480,000 in its assessable income in respect of the year ended 30 June 1996. Mr Hart was invited to respond by 23 January 1998. 113 By fax dated 12 February 1998, Mr Hart, through his solicitor Mr Powrie, advised the ATO that a response to the position paper would be provided by 9 March 1998. Mr Powrie in fact provided a response on that date.

Assessment 114 On 21 December 1998 the Commissioner issued a notice of assessment to Harts Australia in respect of the year ended 30 June 1996 assessment including in its assessable income the amount of $480,000 and resulting in a taxable income of $480,000. 115 Tax shortfall penalty of $129,600 was imposed pursuant to s 226J of Part VII of the Act. Interest of $23,918.81 was imposed pursuant to s 170AA. 116 The Commissioner declined to exercise his discretions under s 227(3) of the Act to remit the tax shortfall penalty and under s 170AA(11) of the Act to remit the interest.

Objection 117 On or about 20 January 1999 Harts Australia objected in writing to the assessment. In its objection, it requested that the Commissioner grant an extension of time in which to allow it to lodge a notice in writing for the purposes of s 80G of the Act. 118 Under cover of an undated letter sent by fax to the ATO on 23 March 1999 Harts Australia, through its solicitors, Thompson Hannan, lodged a document bearing date 19 December 1996 purporting to be a notice for the purposes of s 80G in respect of the year ended 30 June 1996. 119 The document purported to be an agreement between Bomilsco and Harts Australia that the right to a deduction for "some of the losses incurred by Bomilsco" be transferred to Harts Australia. The document was signed by Mr Hart as public officer of both Bomilsco and Harts Australia. 120 By letter dated 1 June 1999 the Commissioner disallowed Harts Australia's objection and set out the reasons for his decision. The Commissioner declined to exercise his discretion to allow Harts Australia an extension of time in which to lodge a notice under s 80G.

Penalty 121 The accounts for Harts Consulting for the 1996 year were prepared by Mr Hart. He also signed the Harts Australia tax return for that year. The omission of almost $500,000 from a gross income of $714,320 is a matter that a tax agent is unlikely to have overlooked, especially since he was the principal executive officer of the company for part of that year, and for many previous years, and remained at all relevant times a director. 122 Harts Australia does not identify any error in the exercise of the Commissioner's discretion in relation to remission of penalty. The decision was open to him upon the material before him, and no error is apparent.

Interest 123 A decision not to exercise the discretion in s 170AA(11) to remit a liability for interest imposed pursuant to s 170AA(1) is not a reviewable objection decision, for the reasons given above in relation to the 1993 year.

Issues 124 It is common ground that an amount of $1,158,658 invoiced to clients as fees in the 1992 tax year, but not received in that year, should have been declared in the Harts Consulting 1992 tax return and were not so declared. 125 For the reasons already mentioned, the Commissioner in my view had power to issue an amended assessment in 1998 in respect of the 1992 tax year. A purported loss transfer agreement between Harts Consulting and Bomilico was ineffective, for the reasons already given. The only remaining issue is whether the decision to remit any part of the penalty was a correct exercise of the discretion.

Return 126 On 24 November 1992 Harts Consulting's return in respect of its income for the 1992 year, signed by Mr Hart, was lodged with the ATO. 127 The return showed gross income of $759,350 and, after deduction of expenses, an operating profit of $661,560. After allowing for reconciliation items including prior year losses of $207 and losses transferred in of $661,353 the return disclosed a taxable income of nil and no amount of income tax payable.

Consulting arrangements 128 During the 1992 tax year, forty seven clients of Harts Consulting entered into consultancy arrangements whereby Harts Consulting agreed to prepare for each client a "Business Management Report" ("business plan") for a fee ("the business plan consultancy"). 129 The following appear to be the circumstances surrounding the business plan consultancy:

· There were a total of forty seven clients, including Queensland Mushrooms Pty Ltd (Queensland Mushrooms).

· Each client was invoiced $40,000 for the preparation of a business plan, with the exception of Queensland Mushrooms which was invoiced $75,000.

· In 1992, each client only paid an amount of $16,250 or a similar amount.

· Each client claimed the invoiced amount of $40,000 in its 1992 return.

· Each client recorded in its creditors as at 30 June 1992 an amount of $23,750 or a similar amount as owing to Harts Consulting.

· In 1992 Queensland Mushrooms paid $75,000 to Harts Consulting (the invoice is noted "Paid").

· In 1992 and 1993 Hart's Consulting returned as assessable income the $16,250 received from each client.

· In its accounts for the 1992 year Harts Consulting did not record any amount as being owed by any client.

· Outstanding fees of $498,759 from twenty-one clients were received in the 1996 financial year and recorded as assessable income by Harts Consulting. In all cases, the amount of $23,750 was purportedly loaned to each client by Anjara Pty Ltd.

Discussions with ATO 130 By letter dated 4 September 1995 to ATO Mr Hart explained the background to the business plan consultancy and the basis on which fees were charged by Harts Consulting. Included with the letter were copies of: (a) A list of forty two clients involved in the consultancy arrangement indicating the fee charged and any amount outstanding. (b) A letter that was sent to each client regarding the business plan, confirming that part payment of $16,250 was to be made. (c) An invoice for $40,000 sent to clients. (d) A letter sent to clients who withdrew from the consultancy arrangement advising balance of monies due is no longer payable. (e) A "Business Plan Questionnaire" sent to clients. 131 By letter dated 14 September 1995 addressed to Harts Pty Ltd (Harts), the ATO sought further information in relation to the business plan consultancy. By letter dated 26 September 1995 Harts replied to that request. The response included a list of forty two clients who engaged Harts Consulting to prepare business plans on their behalf and who made a claim for $40,000 in their income tax returns. Among other matters, the response advised that:

(a) The "cost" of the consulting agreement was returned as income by Harts Consulting in the 1992 and 1993 tax years.

(b) Harts Consulting should have returned the total invoiced fee of $40,000 in respect of each business plan in the 1992 year.

(c) Harts Consulting should have brought to account a debtor representing the unpaid balance of invoices issued to clients prior to 30 June 1992.

(d) The failure to bring to account debtors was an oversight due to a change in personnel: amended returns would be lodged to reflect the correct accounting treatment of the consultancy fees.

(e) The person predominantly involved in attending to the consultancy work and the preparation of business plans was Mr Hart.

(f) There were seventeen clients with a debt outstanding to Harts Consulting totalling $403,750.

(g) Three former clients had been advised that they should have the outstanding balance of their consultancy fees written back.

132 By letter dated 3 November 1997 addressed to Mr Hart, the ATO sought further information relating to the business plan consultancy and the fee income it generated. Mr Hart was also requested to clarify the number of clients involved (forty two or forty six) and the amount they were invoiced. 133 By letter dated 28 November 1997 Mr Hart responded to the ATO's queries. Mr Hart advised, inter alia, that: (a) To his knowledge, all clients were invoiced $40,000. (b) Harts Consulting allowed Harts to "receive" income relating to the business plans, being outstanding fees of $498,750 received from clients in July and August 1995, as Harts did the majority of the work. 134 By facsimile dated 7 January 1998 addressed to Mr Hart, the ATO issued a position paper on the business plan consultancy. Mr Hart was invited to respond by 29 January 1998. After a number of extensions were granted Hart finally responded by a letter from Mr Powrie dated 9 March 1998. 135 By letter dated 3 August 1998 Mr Powrie, again after a number of delays and extensions, provided detailed submissions in relation to ss 80G(6A) of the Act, the Commissioner's power to amend beyond the four year period prescribed by ss 170(2) of the Act and penalties. 136 Through 1998 ATO officers conducted a number of interviews with officers of Harts Consulting and its auditor Mr Bryant.

Assessment 137 By letter dated 7 December 1998 the ATO advised Harts Consulting that its taxable income in respect of the year ended 30 June 1992 was to be amended by including an amount of $1,158,650 being undeclared income from the business plan consultancy. 138 On 9 December 1998 the Commissioner issued a notice of assessment to Harts Consulting in respect of the 1992 tax year. The assessment included an assessable income an amount of $1,158,650 and resulted in a taxable income of $1,158,650. 139 Penalty tax was imposed on pursuant to s 223 of Part VII of the Act. The Commissioner exercised his discretion under s 227(3) of the Act to remit in part the penalty tax payable. The remission of penalty resulted in penalty of $361,560.86 being assessed, comprising a culpability component of $213,993.00 (50 per cent - recklessness) and a per annum interest component of $147,567.86.

Objection 140 On or about 20 January 1999 Harts Consulting objected in writing to the assessment. 141 In its objection, Harts Consulting requested the Commissioner to grant an extension of time in which to allow it to lodge a notice in writing for the purposes of s 80G of the Act. 142 Under cover of an undated letter sent by fax to the ATO on 23 March 1999 Harts Consulting, through its solicitors, Thompson Hannan, purported to lodge with the Respondent a notice for the purposes of section 80G of the Act in respect of the year ended 30 June 1992. No such notice was attached to the facsimile. 143 By letter dated 1 June 1999 the Commissioner disallowed Harts Consulting's objection and set out the reasons for his decision. The Commissioner declined to exercise his discretion to allow Harts Consulting an extension of time in which to lodge a notice under s 80G of the Act.

Penalty tax 144 The penalty tax imposed pursuant to s 223 has been remitted under s 227(3) to the extent that a culpability component of 50 per cent and a per annum interest component have been assessed. 145 I am satisfied that there is no legal error in the Commissioner's decision as to penalty. It was open to him to find that the non declaration of a sum of $1.16 million, where the effective controller of the company was a tax agent, and no legitimate argument was available, amounted to recklessness. As Senior Counsel for the Commissioner correctly submitted, it is not to the point that such income may have been declared in subsequent years, or could have been neutralised by the transferring in of specific losses. Taxpayers have powerful incentives to defer the liability to pay tax, especially at the rates of interest prevailing in the early 1990s. The penalties regime exists to secure taxpayer compliance with obligations in the year in which they accrue, not at some future date.

VI ORDERS 146 The applications will be dismissed, with costs including reserved costs. I certify that the preceding one hundred and forty-six (146) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Heerey.

Associate: Dated: 28 August 2001 Counsel for the Applicant: D Russell QC and P Bickford

Solicitor for the Applicant: Hawthorn, Cuppaidge and Badgery

Counsel for the Respondent: W Sofronoff QC and N Williams

Solicitor for the Respondent: Australian Government Solicitor