The Commissioner of Taxation of the Commonwealth of Australia v Traviati

Relevant legislation 10 It is necessary to pause here to outline the legislation relevant to the Tribunal's decision. In addition to considering the penalty applied under s 226G of the 1936 Act, it considered - in the process of construing s 226G - whether a penalty could have also been applied under s 226K of the 1936 Act. 11 Part VII of the 1936 Act (now repealed) was headed "Penalty Tax". Provisions in that Part, known as "shortfall sections", applied penalties where a taxpayer incurred a tax shortfall for the relevant year. A "tax shortfall" was defined in s 222A: tax shortfall, in relation to a taxpayer and a year, means the amount, if any, by which the taxpayer's statement tax for that year at the time at which it was lowest is less than the taxpayer's proper tax for that year. 12 The meaning of "shortfall section" was also defined in s 222A: shortfall section, means section 226G, 226H, 226J, 226K, 226L or 226M. 13 The shortfall sections relevant to this proceeding are ss 226G and 226K. The additional penalty tax of 25% (reduced under s 226Z to 5%) was payable by reason of s 226G: 226G Penalty tax where shortfall caused by lack of reasonable care 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 failure of the taxpayer or of a registered tax agent to take reasonable care to comply with this Act or the regulations; the taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part. (Own emphasis). 14 The Tribunal also considered s 226K of the 1936 Act for reasons which will become clear. For now it is sufficient to note that the Tribunal considered that there was some relationship between ss 226G and 226K. Section 226K read: 226K Penalty Tax where unarguable position taken 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 taxpayer, in a taxation statement, treating an income tax law as applying in relation to a matter or identical matters in a particular way; and (c) the shortfall or part, as the case may be, so caused exceeded whichever is the higher of: (i) $10,000; (ii) 1% of the taxpayer's return tax for that year; and (d) when the statement was made, it was not reasonably arguable that the way in which the application of the law was treated was correct; the taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part. (Own emphasis). 15 "Reasonably arguable" was defined in s 222C of the 1936 Act relevantly as: 222C Reasonably arguable (1) For the purposes of this Part: (a) the correctness of the treatment of the application of a law; or (b) another matter; is reasonably arguable if, having regard to the relevant authorities and the matter in relation to which the law is applied or the other matter, it would be concluded that what is argued for is about as likely as not correct. (2) For the purposes of this Part, if the treatment of the application of a law assumed that the Commissioner would exercise a discretion in a particular way, the correctness of the treatment is reasonably arguable, in so far as it consisted of the assumption, if the exercise by the Commissioner of the discretion in that way would be reasonably arguably in accordance with law. (3) For the purposes of this Part, the exercise, or assumed exercise, by the Commissioner of a discretion is reasonably arguably in accordance with law, if having regard to the relevant authorities and the matter in relation to which the discretion is or would be exercised, it would be concluded that a Court would be about as likely as not to hold that the exercise is or would be in accordance with law. (4) In this section: authority includes: (a) an income tax law; or (b) material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901; or (c) a decision of a court (whether or not an Australian court), the Tribunal or a Board of Review; or (d) a public ruling within the meaning of Part IVAAA of the Taxation Administration Act 1953. (5) For the purposes of this section, the Commissioner exercises a discretion if the Commissioner: (a) forms an opinion; or (b) refuses or ails to form an opinion; or (c) attains a state of mind; or (d) refuses or fails to attain a state of mind; or (e) makes a determination; or (f) refuses or fails to make a determination; or (g) exercises a power; or (h) refuses or fails to exercise a power. 16 If the taxpayer is liable to pay penalty tax under two or more sections in Pt VII of the 1936 Act, s 226W prevented payment under both. The section which imposed the highest rate of penalty tax applied. 17 However, the Commissioner also had discretion in Pt VII of the 1936 Act to remit the additional penalty tax payable under s 227(3). 227 Assessment of additional tax … (3) The Commissioner may, in the Commissioner's discretion, remit the whole or any part of the additional tax payable by a person under a provision of this Part, but, for the purposes of the application of subsection 33(1) of the Acts Interpretation Act 1901 to the power of remission conferred by this subsection, nothing in this Act shall be taken to preclude the exercise of the power at a time before an assessment is made under subsection (1) of the additional tax. 18 A general interest charge ('GIC') was also imposed under Pt IIA, Div 1 of the Taxation Administration Act 1953 (Cth). The imposition of the GIC is not, and was not, reviewable by the Tribunal. However, the GIC appeared to be taken into account by the Tribunal in exercising the discretion under s 227(3) of the 1936 Act.

The Tribunal's decision 19 The Tribunal varied the Commissioner's objection decisions by reducing the penalty tax from 5% to nil. The Tribunal reached this conclusion on two alternative bases: (a) the taxpayer had a "reasonably arguable" position with respect to the deductibility of the residues, so s 226K did not impose a penalty tax. Section 226K was of a higher standard than the reasonable care standard in s 226G. Thus, "if a taxpayer had adopted such a reasonably arguable position the reasonable care standard should be accepted as having been met"; or (b) alternatively, if a tax penalty did apply, it ought have been remitted to nil under s 227(3). 20 Briefly, the Tribunal's decision covered the following points. First, the Tribunal summarised the background facts. The Tribunal considered that the facts comprising the taxpayer's case in relation to the investments were the same as in Malouf v Federal Commissioner of Taxation (2008) 68 ATR 470; [2008] FCA 497; (overturned on appeal in Federal Commissioner of Taxation v Malouf (2009) 174 FCR 581) and Shin v Federal Commissioner of Taxation [2010] AATA 1013. 21 Secondly, the Tribunal considered whether the taxpayer had demonstrated that he had taken reasonable care by comparison with the position of the taxpayer in Malouf. The Tribunal found that: (a) the taxpayer had not established, on the evidence, that he had taken the same care that the taxpayer in Malouf had taken; (b) however, given the Tribunal's conclusion that the taxpayer had a "reasonably arguable" position with respect to the deductibility of the residues, it was unnecessary to consider, as an independent question, whether the taxpayer had taken reasonable care to avoid a tax shortfall, as the former was of a higher standard than the latter. 22 Thirdly, the Tribunal went onto consider whether the taxpayer had a reasonably arguable position with respect to the deductibility of the residues. The Tribunal concluded at [15] that: …the proper conclusion is that the applicant did adopt a reasonably arguable position and that position is evident upon an analysis of the admitted facts and the law that applied to those facts at the time the position was taken, a time before the Full Court decision in Federal Commissioner of Taxation v Malouf. The applicant needs do no more than he has done to satisfy this standard. 23 As will become clear, much turns on the decision of Malouf in this proceeding. In the first instance decision by Allsop J, his Honour found that the unpaid residue was "incurred" at the time of entering into the contract for the retirement village investment and was therefore deductible under s 8-1 of the 1997 Act: Malouf per Allsop J at [79]. This was overturned by the Full Court: Federal Commissioner of Taxation v Malouf at [50], [53]-[54]. Had the Full Court decision in Malouf existed at the time when the taxpayer claimed his deduction, the position regarding the taxpayer's claim for the 1999 and 2000 years would have been clear. 24 Fourthly, the Tribunal considered the relationship between ss 226K and 226G. It relied heavily on a decision of Hill J in Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 to explain what it perceived to be the underlying policy for s 226K and its relationship to s 226G. The relevant passage in Walstern is at [106]: Section 222C was introduced in 1992 as part of a number of amendments designed to improve the system of self-assessment. Among those amendments was s 226G which imposed by way of penalty additional tax equal to 25% of the tax which should have been paid where the taxpayer failed to take reasonable care to comply with the Act. It is clear from the Second Reading Speech to the Taxation Laws Amendment (Self Assessment) Bill 1992 (Cth) which introduced the amendments that while all taxpayers would be penalised if they failed to exercise reasonable care it was thought appropriate (apparently the initiative came from a study of experiences in the United States of America where a similar system operates) for taxpayers who made large claims, generally in excess of $10,000 to exercise greater care and thus to pay a greater penalty - a further 25%. The Minister assisting the Treasurer, Mr Baldwin said, inter alia: The whole idea of the new understatement penalties is to ensure that people do not get penalised when they have made an honest and genuine attempt to correctly determine their taxable income. … The government considers it appropriate that a more rigorous standard apply where the item at issue is very large. … Where the interpretation of the law for such large items is in issue, we expect taxpayers to exercise more care; that is, the taxpayer must have a reasonably arguable position on the matter. The crux of the standard is that taxpayers should not take positions at law which, at the time taken, are not about as arguable as an alternative position. All said and done, the standard is about analysing the law and its application to the facts. If there is a strong argument to support the taxpayer's position, that may be enough. However, the Government does not want taxpayers to take positions which are not defensible or which do not have reasonable prospects of success. 25 In light of this, the Tribunal reasoned at [18] in referring to the Minister's Second Reading Speech that: The Minister did not suggest that failing to adopt a reasonably arguable position attracts an additional penalty. The Minister's explanation was that the reasonably arguable position was simply a higher standard that needs to be met when large sums are involved; the position adopted must be reasonably arguable, failing which the same level of penalty of 25% of the shortfall tax applies as would apply in cases of smaller shortfalls accompanied by a failure to take reasonable care. (Own emphasis). 26 As such, the Tribunal concluded that if a taxpayer could show that they had a reasonably arguable position with respect to their tax shortfall, it should be accepted that they had also met the standard of taking reasonable care when claiming tax deductions. That is, ss 226K and 226G were cumulative hurdles for taxpayers to overcome in avoiding penalty tax, as opposed to sequential hurdles imposing independent tests. 27 Fifthly, the Tribunal considered that even if its approach to the s 226G question was wrong, the "appropriate conclusion is that it is appropriate to remit any penalty that would otherwise be applicable" under s 227(3). The Tribunal said its reasons for doing so were the principles enunciated in Shin; although the Tribunal did not list these in its reasons.

Questions of law raised on appeal 28 The Commissioner raised the following questions of law in relation to the appeal: 1. whether the Tribunal erred in law by finding that as the taxpayer had a reasonably arguable position with respect to his substantive tax liability in each of the 1999 and 2000 years, the taxpayer therefore necessarily had demonstrated that he and his tax agent had taken reasonable care within the meaning of s 226G of the 1936 Act; and 2. whether the Tribunal erred in law by finding, as an alternative to the finding referred to in paragraph 1 above, that the penalty ought to be remitted to nil pursuant to s 227(3) of the 1936 Act on the basis that the Tribunal either took into account irrelevant considerations or failed to apply the correct test.

THE FIRST QUESTION OF LAW 29 One ground was relied on by the Commissioner in respect of the first question of law. That is, the Tribunal erred in finding that the taxpayer had necessarily satisfied the reasonable care standard on the basis that the taxpayer had a reasonably arguable position in respect of the deductions. 30 The issue essentially concerns the proper statutory construction of ss 226G and 226K, and whether there was any relationship between the two provisions.

The ordinary meaning of ss 226G and 226K in context 31 The starting point in interpreting tax legislation is to consider the text itself. That said, words cannot be considered on their own. The context in which they are placed is integral to understanding their meaning. In this regard, the Commissioner relied on a passage of the High Court in Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (Northern Territory) (2009) 239 CLR 27 at [47] where Hayne, Heydon, Crennan and Kiefel JJ said: This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the text itself. Historical considerations and extrinsic materials cannot be relied on to displace the clear meaning of the text. The language which has actually been employed in the text of legislation is the surest guide to legislative intention. The meaning of the text may require consideration of the context, which includes the general purpose and policy of a provision, in particular the mischief it is seeking to remedy. (Footnotes omitted). 32 At [57], their Honours added: …First, tax statutes do not form a class of their own to which different rules of construction apply… Secondly, the fact that a statute is a taxing Act, or contains penal provisions, is part of the context and is therefore relevant to the task of construing the Act… 33 These passages were applied in Allen v Federal Commissioner of Taxation (2011) 195 FCR 416 at [45]-[46]. 34 Sections 226G and 226K were quite different in their terms. First, s 226K outlined a threshold requirement. The shortfall (or part thereof) caused by the taxpayer treating the law as applying in a particular way must have exceeded $10,000 or 1% of the taxpayer's return tax, whichever was higher. Section 226G, by contrast, applied to all taxpayers. Secondly, s 226G applied in respect of the taxpayer or their agent. The taxpayer could be vicariously liable for a failure on the part of their registered tax agent if they failed to satisfy the reasonable care standard in s 226G (see also s 251M of the 1936 Act). 35 Thirdly, the standards which taxpayers were required to meet in order to avoid the penalty were quite different: (a) s 226G applied if the tax shortfall was caused by a failure by the taxpayer or their agent to take reasonable care to comply with the Act or the regulations; and (b) s 226K applied if the tax shortfall was caused by the taxpayer treating an income tax law, in a taxation statement, as applying in a particular way and it was not reasonably arguable that the application of the law is correct. 36 Considered as self-contained expressions, "reasonable care" and "reasonably arguable" suggest that two different - and independent - standards applied in ss 226G and 226K. Reasonable care suggests an objective test, but the particular (and subjective) circumstances relevant to the taxpayer are to be considered in applying the test. So the taxpayer must exercise the care that a reasonable person would be likely to have exercised in the circumstances of the taxpayer. 37 A reasonably arguable position, on the other hand, suggests an entirely objective test directed to the merits of the tax position put forward by the taxpayer. It is not concerned with the taxpayer's behaviour or efforts in preparing their tax return. It considers only whether they had a reasonably arguable position. As noted, s 222C supplied a lengthy definition to the term "reasonably arguable" in s 226K. However, the essential element in that definition is that the application of the law argued for by the taxpayer "is about as likely as not correct" when regard is had to "the authorities". On balance, then, the taxpayer's argument must be one which can objectively be said to be one that while wrong could be argued on rational grounds to be right: Walstern at [108]; Federal Commissioner of Taxation v R & D Holdings (2007) 160 FCR 248 at [71] per Heerey and Edmonds JJ. 38 This conclusion is reinforced in Hill and Hely JJ's judgment in Hart v Commissioner of Taxation (2003) 131 FCR 203 at [44]: …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 intentional disregard of the Act (s 226J). (Own emphasis). 39 Therefore, the phrase "reasonably arguable position" in s 226K does not concern itself with whether the taxpayer has been negligent. 40 I do not need to determine for this proceeding the exact scope of what is reasonably arguable. In Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468 at [70], Stone and Allsop JJ described the test as whether the relevant position was "open to debate in the sense of being arguable" (see also Allen at [75]-[76]). 41 The taxpayer's submissions emphasised the context in which ss 226G and 226K appeared. That is, the overall scheme of Pt VII of the 1936 Act supported a construction of ss 226G and 226K which showed them to be cumulative, and not sequential hurdles. The taxpayer submitted that the relevant provisions in Pt VII formed a "step ladder" of penalty rates that vary, depending upon the taxpayer's culpability. At the top of the hierarchy was s 226J, under which a taxpayer (or their registered tax agent) who caused a tax shortfall as a result of "intentional disregard" of the law was liable to pay a penalty of 75% of the shortfall. Under s 226H, a taxpayer's "recklessness" as to the law exposed them to a 50% penalty. Sections 226G and 226K were said to have fallen under these provisions in that order, each imposing penalties of 25%. 42 The taxpayer submitted that the descending penalties were part of a scheme, such that a taxpayer who intentionally disregarded the law could be liable under ss 226J, 226H, 226G and 226K. Section 226W operated to ensure that the taxpayer is exposed to liability for the highest penalty only. In this way, the taxpayer said that a "logical" reading of the provisions was that if the taxpayer can establish that one of these provisions is inapplicable, none of the provisions above it in the hierarchy could have applied. 43 I recognise that the passage from Hart (above) suggests some hierarchy vis-à-vis some of the provisions in Pt VII of the 1936 Act, and the taxpayer put this in oral argument. I would be prepared to entertain the proposition that there was some hierarchy between ss 226G, 226H, and 226J. They were listed in ascending order of the penalties contained in those provisions and refer to penalty tax where the shortfall was caused by lack of reasonable care, recklessness and intentional disregard of the law. All three standards are concepts well known to the law, as has been recognised by others. All of these provisions look at the taxpayer's behaviour. 44 However, s 226K appears to stand apart from this group. The penalty it contained does not ascend in order with the other provisions. It only would have applied where the shortfall is large (above $10,000 or 1% of the taxpayer's return tax). And, again, the words "reasonably arguable position" suggest that the taxpayer must have had, objectively, an argument that is as likely as not correct, or, as was said in Cameron Brae, be open to debate in the sense of being arguable. Further, this is not a case where there is textual conflict in the wording of the provisions or the obligations therein such that the Court must decide which provision prevails over another (see eg, Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355 at [70] per McHugh, Gummow, Kirby and Hayne JJ). In addition to the absence of textual conflict, s 226W operated to avoid any operational conflict.

Extrinsic materials 45 The Commissioner's submissions referred to a consultative document by the Federal Treasurer entitled A Full Self Assessment System of Taxation dated 13 December 1990, an information paper entitled Improvements to Self Assessment - Priority Tasks (also by the Treasurer) dated 20 December 1990, the Explanatory Memorandum to the Taxation Laws Amendment (Self Assessment) Bill 1992 (Cth) ('the 1992 Bill') and the Minister's Second Reading Speech to the 1992 Bill: see Commonwealth, Parliamentary Debates, House of Representatives, 26 May 1992, 2774-2779 (Peter Baldwin, Minister for Higher Education and Employment Services and Minister Assisting the Treasurer) ('the Minister's Second Reading Speech'). 46 The first two documents were part of the consultative process in developing the 1992 Bill (see the Minister's Second Reading Speech at p 2775). I am cautious to place too much reliance on these, as, in the words of Hill J in Commissioner of Taxation v Murray (1990) 21 FCR 436 at 449 (with whom Sheppard and Neaves JJ agreed): At best such material may suggest the mischief which some person had in mind when framing a bill before Parliament. But if the Parliament is not appraised of that mischief by the proponent of the bill in a second reading speech, by an explanatory memorandum or debate, it will be hard to be sure that the mischief was in truth that which the Parliament sought to overcome. A surer guide in such a case will be the words of the statute themselves… 47 Indeed, I am cautious to place too much reliance on extrinsic materials in construing the words of a statute for the reasons I discussed in Esso Australia Resources Pty Ltd v Federal Commissioner of Taxation (2011) 194 FCR 32 at [121]-[138]. Such material can often be vague and uncertain and at such a level of generality to be unhelpful. 48 The extrinsic materials that were of some relevance were the Explanatory Memorandum and the Minister's Second Reading Speech to the 1992 Bill. However, reference to extrinsic materials is not necessary to discern the relationship between ss 226G and 226K. What the Explanatory Memorandum to the 1992 Bill does confirm is that the standards in ss 226G and 226K were sequential hurdles for the taxpayer to overcome in order to avoid liability when they exceeded the threshold requirement in s 226K. 49 Before reviewing the Explanatory Memorandum, I should note that the Tribunal's reasons state that the Commissioner "heavily" relied on the Explanatory Memorandum to the 1992 Bill in its construction of the relationship between ss 226G and 226K before the Tribunal. The Tribunal then said at [16] of its reasons that "[the Explanatory Memorandum] does not refer to the explanation of the hierarchy of the penalty provisions that was given when the reasonably arguable position test was introduced". This contains the presumption that there was indeed a hierarchy. However, a closer examination of the Explanatory Memorandum to the 1992 Bill does not support the construction that ss 226G and 226K were part of a hierarchy. 50 The Explanatory Memorandum to the 1992 Bill begins by giving a general outline to the 1992 Bill. In relation to penalties relating to the understatement of tax, the Explanatory Memorandum (at p 6) states: taxpayers who have exercised reasonable care will not be, in the vast majority of cases, subject to understatement penalties. However, for large issues which involve questions of law, taxpayers will also have to satisfy the reasonably arguable position standard. 51 The Explanatory Memorandum also outlined the "key features" to the penalty provisions to be introduced into Pt VII of the 1936 Act. The first two points (at p 70) note: a. all taxpayers will be required to exercise reasonable care in conducting their tax affairs. Failure to exercise reasonable care will attract a penalty of 25% of a tax shortfall or franking tax shortfall caused by the failure; b. taxpayers with large claims (generally $10,000 or more) will, in addition, be required to ensure that the positions they adopt are reasonably arguable. Failure to have a reasonably arguable position will attract a penalty of 25% of a tax shortfall or franking tax shortfall caused by the failure… 52 These points were repeated in the Minister's Second Reading Speech. 53 At pp 74-75 of the Explanatory Memorandum to the 1992 Bill there is a section entitled "Scheme of the new penalties" followed by a flowchart which represents the operation of the new provisions. The chart clearly demonstrates that a taxpayer who exercises reasonable care will not be subject to a penalty if their shortfall is less than $10,000 or 1% of their return tax. However, taxpayers who demonstrate that they have taken reasonable care must also show that they have a reasonably arguable position if their tax shortfall exceeds these amounts. In this instance, if a taxpayer does not show that they have a reasonably arguable position, they will be subject to a penalty of 25%. However, the diagram represents the questions sequentially, as independent tests. It is clear that the reasonably arguable standard should not be considered first, on the basis that the reasonable care standard would automatically be satisfied if the first question were answered positively. 54 Pages 83 and following outline the meaning of "reasonably arguable position". It is noted that this s 226K will only be considered if the taxpayer's shortfall or return is above the relevant threshold. At pp 86-87, three examples are given of its operation. Where a taxpayer's shortfall or return is above the $10,000 or 1% threshold, it is stated they must have a reasonably arguable position. In particular, even if a taxpayer is subject to a penalty under s 226K, "the taxpayer may be subject to penalty under another shortfall section". The taxpayer conceded that this note was inconsistent with the construction for which he contended. 55 To similar effect are the comments on s 226W at p 97 of the Explanatory Memorandum to the 1992 Bill: It is possible that more than one shortfall section may apply in respect of a tax shortfall. For example, a taxpayer may be careless in making a claim for a deduction, and so be liable for a penalty under section 226G, and also be liable for penalty under section 226K for not having a reasonably arguable position in respect of the claims. In such a case the taxpayer is liable to pay only one of the penalties… 56 The proper assistance provided by the Minister's Second Reading Speech was also a point of contention. As noted, the Tribunal cited a passage from Walstern including parts of this speech to support its conclusion. The taxpayer emphasised this passage and the preceding paragraph of the Minister's Second Reading Speech p 2777: The reasonable care standard requires a taxpayer to exercise the care that an ordinary person would be likely to have exercised in the circumstances of the taxpayer. Reasonable care requires taxpayers to make a reasonable attempt to comply with their tax obligations. The effort required is commensurate with all the taxpayer's circumstances, including the taxpayer's knowledge and skill. The Government has opted to favour equity in this area by choosing a standard which has regard to the taxpayer's circumstances. However, following experience in the United States, the Government considers it appropriate that a more rigorous standard apply where the item at issue is very large, for example, generally more than $10,000 in tax. Where the interpretation of the law for such large items is in issue, we expect taxpayers to exercise more care, that is, the taxpayer must have a reasonably arguable position on the matter. 57 Following the line of reasoning found in the Tribunal's reasons at [18], the taxpayer submitted that this demonstrates that the reasonably arguable position standard was intended as a higher, "more rigorous standard", than the reasonable care standard, requiring the taxpayer to exercise "more care" than the reasonable care standard. However, the following passages of the Minister's Second Reading Speech at p 2777, clarifies Parliament's position: The reasonably arguable position standard will, because of the $10,000 threshold, apply only to relatively few taxpayers. The crux of the standard is that taxpayers should not take positions at law which, at the time taken, are not about as arguable as an alternative position. All said and done, the standard is about analysing the law and its application to the facts… 58 This paragraph is at odds with the preceding paragraph, which stated that the taxpayer must exercise "more care" if they fall above the threshold. In the latter paragraph, the standard is clearly objective. It is about "analysing the law and its application to the facts". The standard does not question whether "more care" was indeed take in fact. The latter construction confirms the construction of the language of the statute in context, and it is the construction I adopt upon reading the 1936 Act in context.

Other authority 59 The taxpayer pointed to Walstern as the main authority in support of its interpretation of the relationship between ss 226G and 226K. In Walstern, Hill J put forward seven propositions which are generally accepted to be the correct approach to the application and interpretation to s 226K at [108] (see Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 58 ATR 210; [2004] FCAFC 339 at [108]; Cameron Brae at [67]; Orica Ltd v Federal Commissioner of Taxation (2010) 78 ATR 710; [2010] FCA 197 at [224]; and Allen at [74]). Both parties agreed that this was so. However, each party's examination of proposition six brought out particular nuances as to the meaning of s 226K. Proposition six states: An argument could not be as likely as not correct if there is a failure on the part of the taxpayer to take reasonable care. Hence the argument must clearly be one where, in making it, the taxpayer has exercised reasonable care. However, mere reasonable care will not be enough for the argument of the taxpayer must be such as, objectively, to be "about as likely as not correct" when regard is to be had to the material constituting "the authorities". 60 The taxpayer submitted that the first sentence of this passage means that a taxpayer cannot have a reasonably arguable position if he has failed to take reasonable care in "returning his taxable income". Thus, this implies that if a taxpayer had adopted a reasonably arguable position, the taxpayer must have taken reasonable care. By contrast, the Commissioner seized on Hill J's passage, saying that the words "making it" did not refer to making a tax return, but making an argument. According to the Commissioner, a reasonably arguable position requires the taxpayer to take reasonable care in developing an argument, which is a different thing to taking care in preparing a tax return, and thus avoiding a penalty under s 226G. 61 I am cautious about reading too much into the words of Hill J for the purposes of this proceeding. Walstern was essentially a decision in which s 226K was interpreted. It is a strained reading of the decision to draw out significant points about the relationship between ss 226G and 226K, a matter which Hill J was not considering. 62 Both parties also relied on the Full Court's decision in North Ryde RSL Community Club Ltd v Commissioner of Taxation (2002) 121 FCR 1 to support their case. In North Ryde, the issue was whether commission received by the North Ryde RSL Community Club (as an agent for the licensees of Keno) was income. The Club did not treat the commission as income on the basis of that the commission was a "mutual receipt". It did this for several years of income. The Club became aware in mid-1996 that the Commissioner was investigating whether the mutuality principle exempted the commission from being income. In 1997, the Commissioner sought to negotiate a global settlement, on the basis that the Keno commission was indeed taxable income. The Club rejected the proposed settlement, and continued to not treat the commission as income. In early 1998, the Commissioner issued amended assessments for four years of income, imposing a 25% penalty under s 226G. 63 The Tribunal was satisfied that no penalty could have been imposed under s 226K as the proposed global settlement acknowledged that the law was difficult and the Club had a reasonably arguable case in respect of the relevant years of income. However, the Tribunal found that in the last year of income, the Club had failed to take reasonable care under s 226G on the basis that by this stage it was aware that the mutuality principle may not apply to the Keno commission, and it was imprudent not to seek a private ruling from the Tax Office about this. The Tribunal also found that the Club had obtained advice about the applicability of the mutuality principle. As that advice was not tendered, the Tribunal could infer the advice would not have assisted the Club in the proceedings before the Tribunal: at [79]-[81]. 64 The Full Court concluded that the Tribunal's finding that the failure to apply for a private ruling did not constitute a failure to take reasonable care under s 226G: at [84]. 65 Both parties in this proceeding drew different conclusions from North Ryde. The taxpayer asserted that as the Tribunal concluded that the Club had a reasonably arguable position (notwithstanding the Tribunal inferred it obtained advice contrary to the position it adopted in its tax return), that was sufficient for the Full Court to find that the taxpayer had exercised reasonable care. The Commissioner submitted that if the standard in s 226G was subsumed by that in s 226K, then the Full Court should have disposed of the matter by noting that as the Club had a reasonably arguable position, the Club must have exercised reasonable care. 66 Again, as in Walstern, the decision in North Ryde does not say anything about the relationship between ss 226G and 226K, despite the inferences that both parties drew about what was left unsaid by the Full Court on this subject. 67 The Commissioner also pointed to some obiter on s 226G in MLC Ltd v Commissioner of Taxation (2002) 126 FCR 37. Although it was strictly unnecessary to consider the provision as Hill J found that the taxpayers were not in breach of the Act, his Honour considered that the taxpayers' view, on advice, was formed in "good faith" and was "highly arguable". The taxpayers would have therefore avoided any penalty under s 226G had the question fallen for consideration: at [53]-[54]. Section 226K was not, however, considered, and the decision is not of any assistance in resolving the issue before me. 68 Therefore, I do not think that any of the authorities, including Walstern, are particularly helpful to the issue at hand.

Conclusion on the first question of law 69 The Tribunal did not approach the question of whether the taxpayer had failed to exercise reasonable care under s 226G on the correct footing. 70 The correct approach in construing the 1936 Act and the relationship between ss 226G and 226K is to first consider the text of the legislation and the context in which it is placed. The language of the two provisions reveals two independent standards. Section 226G was concerned with the taxpayer, or their registered agent, taking reasonable care. Reasonable care is a concept familiar to the law, and whilst an objective standard, it considers the subjective circumstances of the individual in question. Likewise, ss 226H and 226J refer to the concepts of "intentional disregard" and "recklessness". These, again, are familiar concepts to the law, and are objective standards with subjective elements. 71 Whether or not a taxpayer has a reasonably arguable position for the purposes of s 226K, however, is a purely objective test. That is clear from the words that the legislature has used to describe the standard that the taxpayer must meet to avoid a penalty. Put another way, ss 226G, 226H and 226J all examined the means (or process) that the taxpayer had utilised in complying with the Act. Section 226K only examined whether, as an end, the taxpayer had a reasonably arguable position. 72 Finally, I note that the approach I have taken is similar to the one adopted by Murphy J in Sent v Commissioner of Taxation [2012] FCA 382 at [219], a decision handed down after the hearing of submissions in this proceeding.

the second question of law 73 The second question of law concerns whether the Tribunal erred in law in exercising its discretion under s 227(3) to remit the additional penalty tax applied from 5% to nil. 74 The Tribunal's consideration of whether, and to what extent, it should apply its discretion was brief. At [21], the Tribunal's reasons state: If this approach [to s 226G] is wrong then the question of remission arises. The principles in Shin are equally applicable here and the appropriate conclusion is that it is appropriate to remit any penalty that would otherwise be applicable. 75 The principles relating to remission in Shin are found at [21(c)] of that decision. There, the Tribunal stated: third, the question of remission arises. For there to be a remission it is necessary to show that the penalty is harsh in the particular circumstances of the taxpayer - see Dixon as Trustee for Dixon Holdsworth Superannuation Fund v Commissioner of Taxation (2008) 167 FCR 287 at [26] per Spender, Ryan and Emmett JJ. There need to be mitigating circumstances that could be regarded as mitigating the taxpayer's behaviour while at the same time recognising the purpose and role that penalties play in a system of self assessment of tax liability - see Re Hobart Child Care Pty Ltd and Commissioner of Taxation [2005] AATA 1027 at [205] per Deputy President Forgie. In circumstances where a taxpayer adopts a position in a tax return that conforms to the outcome reached by a considered decision of a judge of the Federal Court in materially the same circumstances any level of penalty would be harsh. This is particularly so in the context of a system that includes general and shortfall interest charges that, among other things, compensate the Commonwealth for the loss of the time value of money. It is appropriate to remit any penalty that would otherwise be applicable. 76 The Commissioner submitted that the incorporation of Shin by reference indicated that the Tribunal relied on two matters to conclude that the s 226G penalty should be remitted to nil. They were: (a) the taxpayer's position with respect to the deductibility of the residues conformed to the outcome reached by a decision of a Federal Court judge (being Malouf at first instance) in materially the same circumstances; (b) the existence of the general and shortfall interest charges that, among other things, compensate the Commonwealth for the loss of time value of money. 77 Section 227(3) in its terms gave the Commissioner an unfettered discretion to remit the whole, or any part of the additional tax payable. Where discretion is so unconfined, the factors which the decision-maker can consider are similarly unconfined, except insofar that they are limited by subject-matter, scope and purpose of the statute: Minister for Aboriginal Affairs v Peko-Wallsend Ltd (1986) 162 CLR 24 at 39-40 (Mason J); and see generally Elias v Commissioner of Taxation (2002) 123 FCR 499 at [56]-[63]; and Commissioner of Taxation v Burness (2009) 77 ATR 61; [2009] FCA 1021. 78 Broadly speaking, the main consideration relevant to the discretion in s 227(3) was whether any part of the penalty should be remitted on the basis that the outcome is harsh so as to provide an unjust result, having regard to the particular circumstances of the taxpayer: Burness; and Dixon v Federal Commissioner of Taxation (2008) 167 FCR 287 at [26] (in relation to s 298-20 of sch 1 to the Taxation Administration Act, a provision with a similarly broad discretion to remit penalties). There need not be special circumstances before the discretion can be exercised: Dixon at [21]. 79 The purpose of the discretion to remit was set out in the Explanatory Memorandum to the 1992 Bill. Page 71 of the Explanatory Memorandum states: The Commissioner will however maintain a discretion to remit the penalty otherwise attracted in those cases where the penalties prescribed in the law may not provide a just result. 80 On p 98, the Explanatory Memorandum continues: While the Bill provides a set of rules and accompanying penalties which will cover all but exceptional cases, there may be cases that do not fit neatly into a category, or for which the prescribed rates of penalty are inappropriate. For this reason the discretion which the Commissioner has to remit the penalty in whole or in part (sections 227 and 160ASB of the ITAA) is not removed by this Bill, so that the Commissioner has the flexibility to deal with hard cases that may arise…

Grounds of appeal 81 Three grounds of appeal were raised in respect to the second question of law. The first two related to the Tribunal's purportedly erroneous reliance on Malouf at first instance. The third related to the general and shortfall interest charges. 82 The grounds raised were: (a) the Tribunal took into account an irrelevant consideration, namely that the taxpayer's position conformed to an outcome later reached by a Federal Court judge (being Malouf before Allsop J) in what were said to be materially the same circumstances; (b) alternatively to (a), the Tribunal failed to apply the test required by s 227(3), namely whether the outcome would be harsh having regard to the particular circumstances of the taxpayer, by treating that consideration (outlined in ground (a)) as determinative of the question without addressing or making any findings on the particular circumstances of the taxpayer; and (c) the tribunal took into account an irrelevant consideration, namely the existence of the general and shortfall interest charges, that, among other things, compensate the Commissioner for the loss of the time value of money.

Grounds (a) and (b) - the relevance of Malouf 83 As should be clear, the focus of s 227(3) was the connection between the event which brought about the penalty and the taxpayer. That is, if there were circumstances particular to the taxpayer that would render the penalty harsh so as to provide an unjust result, the penalty should be remitted in whole or in part as appropriate. On its face, Malouf at first instance contains nothing that bears on establishing this connection. Malouf was directed at the question of whether unpaid residues were, by law, outgoings in the relevant tax years. Further, Malouf did not address the particular circumstances of the taxpayer in this proceeding, and the circumstances surrounding the taxpayer and the event which brought about a penalty under Pt VII of the 1936 Act. 84 The taxpayer, however, submitted that Malouf's value lies in what it exposes about the nature of the taxpayer's error. That the error of law had also been made by a judge of the Federal Court went some way to showing that the error was reasonable, or reasonably arguable. 85 This opened up some argument as to whether the way in which the taxpayer failed to discharge the burden in relation to the shortfall sections is a potential consideration in considering whether to remit any penalty applied. That is, if the taxpayer in this proceeding failed to avoid a penalty imposed by s 226K or s 226G (or some other shortfall section), the issue is whether the taxpayer can then show that he had some degree of reasonable argument based on Malouf (per Allsop J) that would otherwise render the penalty harsh. 86 There is a difficulty with this approach. If the Court has already found that the taxpayer does not have a reasonably arguable position in relation to their tax return for the purposes of s 226K, the legislature clearly intended that they would be subject to a 25% penalty under s 226K. Likewise, if a taxpayer has failed to take reasonable care in preparing their tax return, the legislature clearly intended that they would be subject to a 25% penalty under s 226G. The point is, the taxpayer failed to reach the minimum standard to eschew the penalty, either by objective argument (s 226K) or by reason of their behaviour (s 226G). 87 The taxpayer cannot then rely the same argument, or behaviour, to show that they went some way to meeting that standard (but did not meet it) to show that the penalty should be remitted under s 227(3) The taxpayer similarly cannot rely on an argument that because they have a reasonably arguable position, they should avoid the penalty under s 226G for failing to take reasonable care on this basis would be a "harsh" circumstance. The legislature has set clear standards for taxpayers to meet when preparing their tax returns. The question of whether to remit the penalty under s 227(3) comes after the question of whether to impose a penalty under one or more of the shortfall sections, and constitutes an entirely separate enquiry. 88 The decision of Malouf at first instance was therefore an irrelevant consideration. I therefore do not need to consider whether the Commissioner would be successful in relation to ground (b). However, it appears that Malouf was the major - if not determinative -consideration in the Tribunal's decision to remit the penalty under s 227(3). Malouf bore no relevance on the particular circumstances of the taxpayer in this proceeding. Anything it indicated about the nature of the taxpayer's error was irrelevant to the exercise of the discretion under s 227(3). 89 Finally, I should also flag the taxpayer's argument that when a discretion is unfettered, such as that under s 227(3), a decision-maker is not bound to take into account particular factors. The Court will not find that the decision-maker has failed to take into account particular factors unless such an obligation is implied by the subject-matter, scope and purpose of the statute: Peko-Wallsend at [40]. 90 Whilst I endorse this statement of principle, the exercise of the Tribunal's discretion was misdirected. Section 227(3) and the scheme of Pt VII of the 1936 Act were directed to remitting a penalty in prescribed circumstances. As the payment of the penalty requires some kind of failure on the part of the taxpayer to do something, there would naturally be reasons particular to the taxpayer for this failure. By implication, then, s 227(3) is limited by considerations particular, or personal, to the taxpayer. This is supported by the conclusions in Dixon at [26]; and Burness at [27]. Whilst the decision-maker is not bound to take into account particular factors, the Tribunal in this instance placed particular reliance on Malouf which cannot be said to be relevant to the particular circumstances of the taxpayer. 91 In any event, to only focus on Malouf and not go further to consider the factors particular and personal to the taxpayer was an error on the part of the Tribunal.

Ground (c) - consideration of general and shortfall interest charges 92 The Tribunal, by reference to Shin, effectively implied that the penalty would be harsh where a taxpayer had adopted the same position as that of a Federal Court judge, and this was "particularly so in the context of a system that includes general and shortfall interest charges…". The Commissioner's third ground of appeal was that the general interest charge ('GIC') imposed on the taxpayer was a consideration that was erroneously taken into account by the Tribunal in considering the s 227(3) discretion. 93 The GIC was imposed under Div 1 of Pt IIA of the Taxation Administration Act. Section 8AAA at the relevant time stated that a person is usually subject to a GIC when the Commissioner has not been paid on time, and when an Act makes a person liable to pay the GIC. In the present case, the GIC was imposed in respect of the tax shortfall (under s 170AA of the 1936 Act) and in respect of the late payment of the tax (under s 204(3) of the 1936 Act). Under s 8AAG, the Commissioner had certain powers to remit all or part of the GIC otherwise applying. 94 The GIC was intended to replace the late payment penalties that were formerly imposed with a "commercially realistic charge" (see the Explanatory Memorandum to the General Interest Charge (Imposition) Bill (Cth) at [1.132]). In Dixon, the Full Court described the GIC as a uniform administrative penalty, to compensate the Commissioner for any loss suffered where the Commissioner has been deprived of a shortfall amount, or paid an amount that he should not have been paid: Dixon at [23]-[25]. 95 The Commissioner submitted that the imposition of the GIC was an irrelevant consideration in deciding how the discretion under s 227(3) should to be exercised. It relied on comments in Dixon at [23] and Burness at [49] and [52] in support of this. 96 The taxpayer submitted that the GIC did not affect the Tribunal's decision. It was, in that sense, an afterthought, flagged by the words "this is particularly so" in relation to the GIC regime. However, if the Court were to find that consideration of the GIC was material to the Tribunal's decision, the taxpayer submitted that it was a legitimate consideration. 97 In this proceeding, it was difficult to ascertain the extent to which the Tribunal considered the GIC a factor going to harshness, as this consideration was only incorporated by reference to Shin. However, in the context of the Tribunal's reasons, I consider it was a material consideration taken into account by the Tribunal. 98 In my view, the fact that the GIC was imposed on an individual is a matter that may well be relevant to determining whether a penalty was harsh so as to provide an unjust result, but only in conjunction with other circumstances of the taxpayer. 99 Dixon stands for the proposition that whether or not the Commissioner suffers any harm is irrelevant to the question of remission under s 298-20 of Sch 1 to the Taxation Administration Act (the present equivalent to s 227(3) of the 1936 Act). This was for two reasons. First, if the taxpayer voluntarily informs the Commissioner of a shortfall amount, the penalty is reduced under s 284-225. This occurred in the case of the taxpayer in this proceeding (though under the former, and similar s 226Z of the 1936 Act). By contrast, there is no reduction in penalty if the Commissioner detects a false statement giving rise to a shortfall before any harm is done to the revenue for which the Commissioner is responsible: Dixon at [22]. 100 The second reason cited in Dixon was that the imposition of the GIC is "inconsistent with the exercise of a discretion that would interfere with the uniformity of the application of the administrative penalties": Dixon at [23]. The payment of the GIC compensates the Commissioner for any harm that would otherwise have been done: see also Burness at [49] and [52]. 101 In Burness, Gordon J found that the Tribunal did not take the GIC into consideration in assessing the question of remission. Her Honour endorsed the comments in Dixon saying that any financial detriment suffered by the Commissioner is an irrelevant consideration in exercising the discretion under s 227(3). 102 Neither Dixon nor Burness stand for the proposition contended for by the Commissioner: that the imposition of the GIC was an irrelevant consideration in deciding how the discretion under s 227(3) should be exercised. Section 227(3) focuses on the taxpayer, and Dixon and Burness speak only of the GIC in relation to whether any harm was done to the revenue for which the Commissioner is responsible. 103 I also observe that Gordon J in Burness, by reference to the Tribunal's reasoning, said at [52] that: … If the last sentence in para [17] had sat on its own, the reference to GIC would likely have been an irrelevant consideration warranting the setting aside of the decision and remitter to the decision maker to determine the matter according to law… (Own emphasis). Her Honour was clearly contemplating that the taking into account of GIC as a sole factor supporting the exercise of the discretion to remit would be to fall into error. 104 Accepting this position (namely that the imposition of the GIC cannot be considered on its own), nevertheless the imposition of the GIC is something which forms part of the factual matrix comprising the circumstances of the taxpayer. It would be artificial if the GIC were to be ignored as it is an amount the taxpayer is obliged to pay. It may, in certain cases, go some way to show that the penalty imposed over and above the GIC is harsh in the particular circumstances of the taxpayer. This is not examine whether the Commissioner has suffered any harm, but to consider the impact that the penalty imposed has on the taxpayer in the particular circumstances, having regard to the fact that he or she must pay the GIC.

Conclusion on the second question of law 105 In light of the above, the Commissioner succeeds on the second question of law. To the extent that the Tribunal considered the penalty would be harsh on the basis of Allsop J's decision in Malouf, the Tribunal misdirected its enquiry. Malouf was not, and could not have been, directed to the circumstances particular to the taxpayer. Although objectively it may have said something about the nature of the taxpayer's error, the observation cannot be said to be particular to the taxpayer and is not relevant to s 227(3) given the scheme of Pt VII of the 1936 Act. Consideration of Malouf was, in the terms of ground (a), an "irrelevant consideration". It certainly should not have been considered in isolation, which is the basis of ground (b). 106 As to ground (c), the relevance of the GIC, without more, was also an irrelevant consideration. As an administrative charge which is uniformly applied, it cannot be harsh in itself. However, it may be considered along with other circumstances of the taxpayer, such that an accumulation of factors may make the penalty harsh so as to provide an unjust result. 107 The Tribunal should always focus on the taxpayer and his or her particular circumstances, and consider whether the whole or any part of the penalty should be remitted on that basis.

orders 108 For these reasons, the Court orders that: 1. the appeal be allowed; 2. the decision of the Administrative Appeals Tribunal dated 8 July 2011 be set aside; 3. the matter be remitted to the Administrative Appeals Tribunal to be heard and determined in accordance with law; 4. the Commissioner pay the taxpayer's costs of this appeal to be taxed on a party/party basis in default of agreement. I certify that the preceding one hundred and eight (108) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Middleton.