//
[2021] AATA 4070
General information, not legal advice.
Administrative Appeals Tribunal of Australia
2021-11-05
Original judgment source is linked above.
The decision under review is varied such that the shortfall penalty of 25% payable by the Applicant is reduced to 15% for the income tax years ended 30 June 2012 and 30 June 2013.
...[SGD].....................................................................
TAXATION - review of a decision of the Commissioner to disallow the Applicant's objection to amended assessments - whether Applicant entitled to claim notional deduction pursuant to ITAA 97 div 355 - R&D expenditure - whether Applicant incurred expenditure on R&D for the purposes of ITAA 97 s 355-205 - whether Applicant owns IP of R&D - whether level of penalty appropriate under TAA s 284-90 - whether penalty should be remitted in full or in part under TAA s 298-20 - reviewable decision varied
Copyright Act 1968 (Cth) ss 35(2), 196
Income Tax Assessment Act 1936 (Cth) s 102T(9), 227(3), 262A(1D)(a)
Industrial Research and Development Act 1986 (Cth) s 27A
Bosanac and Commissioner of Taxation [2019] AATA 1240
Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640; [1993] HCA 29
Commissioner of Taxation v Desalination Technology Pty Ltd (2015) 66 AAR 553; [2015] FCAFC 96
Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492; [1953] HCA 65
Desalination Technology Pty Ltd and Commissioner of Taxation [2013] AATA 846
Federal Commissioner of Taxation v CityLink Melbourne Ltd (2006) 228 CLR 1; [2006] HCA 35
Frugtniet v Australian Securities and Investment Commission (2019) 266 CLR 250; [2019] HCA 16
New Zealand Flax Investments Limited v Commissioner of Taxation [1938] HCA 60; (1938) 61 CLR 179; [1939] ALR 1
Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616; [1981] HCA 6
Sanctuary Lakes Pty Ltd v Commissioner of Taxation (2013) 212 FCR 483; [2013] FCAFC 50
Sands & McDougall Pty Ltd v Robinson (1917) 23 CLR 49; [1917] HCA 14
Vestas - Australian Wind Technology Pty Limited and Comptroller-General of Customs [2017] AATA 791
Australian Taxation Office, Penalty relating to statements: meaning of reasonable care, recklessness and intentional disregard (MT 2008/1, 1 April 2015)
Australian Taxation Office, Practice Statement Law Administration (PS LA 2012/5, 25 June 2020)
Australian Taxation Office, Shortfall penalties: voluntary disclosures (MT 2008/3, 12 November 2008)
Explanatory Memorandum, Tax Laws Amendment (Research and Development) Bill 2013 (Cth)
2. By the amended assessments, the Commissioner had disallowed claims for notional deductions for research and development (R&D) expenditure claimed under s 355-205 of the Income Tax Assessment Act 1997 (Cth) (ITAA 97). The Applicant claimed refundable tax offsets of $624,805.65 in the 2012 year and $548,338.05 in the 2013 year.
3. Section 14ZZ(1) of the Taxation Administration Act 1953 (Cth) (TAA) relevantly provides that:
(1) If the person is dissatisfied with the Commissioner's objection decision ... the person may:
(a) if the decision is a reviewable objection decision - either:
(i) apply to the Tribunal for review of the decision; ...
4. Section 14ZY(2) of the TAA defines an "objection decision" as, amongst other things, a decision made by the Commissioner in respect of an objection lodged with the Commissioner. The Commissioner's decision to disallow the Applicant's objection referred to in [1] above is an "objection decision" as that term is defined in s 14ZY(2) of the TAA.
5. Section 14ZQ of the TAA defines a "reviewable objection decision" as one "that is not an ineligible income tax remission decision". That latter term is defined in s 14ZS(1) of the TAA. The decision to disallow the Applicant's objection is not an "ineligible income tax remission decision" as that term is defined and is, therefore, a "reviewable objection decision" for the purposes of s 14ZZ(1) of the TAA.
6. I am satisfied that the Tribunal has jurisdiction to hear the application.
Identification of the Applicant - s 14ZZJ(2D) of the TAA
7. The Applicant made a request under s 14ZZE of the TAA that the hearing be in private. In drafting these reasons for decision I have been mindful of the requirements of s 14ZZJ(2D) of the TAA and have, as far as it is practicable, framed these reasons so as not to be likely to enable the identification of the Applicant.
8. The Application was heard on 10 and 11 June 2021.
9. The Applicant was represented by Ms C Lyford instructed by Sceales Lawyers and the Commissioner was represented by Mr A Willinge. The following documents were admitted into evidence:
(a) Report of Martin Paul Langridge dated 29 March 2021, as amended in the witness box (A1);
(b) Statement by James Reginald Loaring made 24 March 2021 (A2);
(c) Statement of LMB made 17 March 2021 (A3); and
10. In addition to the above documents, I had before me the documents filed by the Commissioner pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 (Cth) (T documents), as well as a bundle of supplementary T documents, further supplementary T documents and the parties' submissions being:
(a) Applicant's Statement of Facts, Issues and Contentions including annexures dated 19 July 2019;
(b) The Commissioner's Statement of Facts, Issues and Contentions dated 14 February 2020;
(c) Applicant's amended Statement of Facts, Issues and Contentions dated 31 March 2021 (ASFIC);
(d) The Commissioner's amended Statement of Facts, Issues and Contentions dated 19 May 2021 (CSFIC); and
(e) A joint bundle of authorities filed on 9 June 2021.
11. The following witnesses were called by the Applicant:
13. The Commissioner identifies the issues for determination as follows:
(a) Whether the Applicant has proved that the assessments issued by the Commissioner and the penalties imposed were excessive and, if so, what the assessments should have been.
(b) Determination of [13(a)] will require determination of whether the Applicant was entitled to claim a notional deduction of $624,805.65 and $548,338.05 pursuant to div 355 of ITAA 97 so as to validly claim a tax offset under s 355-100 of ITAA 97 in the 2012 and 2013 income tax years.
(c) Determination of [13(b)] will require determination of whether, in each of the relevant years, the amount claimed was incurred by the Applicant in undertaking eligible R&D activity conducted "for" the Applicant.
(d) Whether the Penalties of $156,201.40 and $137,084.50 for the 2012 and 2013 years were excessive and, if so, what the assessments should have been which will require consideration of:
(i) the Applicant's conduct for the purpose of calculating the base penalty amount under s284-90 of Schedule 1 to the TAA;
(ii) whether the Applicant treated the tax law in a way that was not reasonably arguable; and
(iii) whether the Applicant's circumstances warrant a remission of the penalties.[4]
14. Although expressed differently, the Applicant, in effect, identifies the same issues for determination.[5]
15. The Applicant was incorporated on 16 July 2007 with CJB as the sole director and shareholder. The Applicant, in its capacity as a company, is the registered holder of an Australian Business Number (ABN).
16. On the same day, the Trust was settled. The Trust operates as a discretionary trust, of which the Applicant is the trustee and has been so since settlement. The Applicant, in its capacity as trustee of the Trust, is the registered holder of a separate ABN.
17. JB, CJB's father, commenced and carried on the business through a company as trustee of the B Family Trust.
18. On 31 December 2008, the Applicant, as trustee of the Trust, acquired the business.
19. LMB (CJB's wife) is the administration manager of the Applicant.
20. Mr James Loaring is the proprietor of Loaring Consulting, a specialist consulting practice. He was engaged by the Applicant to assist with the preparation and lodgement of the Applicant's application for registration of R&D activities and the determination of its R&D tax claims for the 2010, 2011, 2012 and 2013 years.
21. In its income tax returns for the years ended 30 June 2012 and 30 June 2013, the Applicant, in its capacity as a company, claimed notional deductions for R&D expenses connected with production of façade sun shading solutions for residential and commercial buildings for the general public, architects, designers and builders. This resulted in the Applicant, in its capacity as a company, claiming refundable tax offsets of:
22. The Commissioner issued the Applicant assessments for the 2012 and 2013 income years in accordance with the tax returns filed by the Applicant.
24. As a result of the outcome of the Audit, on 26 July 2016, the Commissioner:
(a) issued the Applicant with Notices of Amended Assessment for the 2012 and 2013 years;[8] and
25. On 23 September 2016 the Applicant objected to the Amended Assessments and the Penalty Assessments (Objection).[11]
26. On 19 December 2018, after considering further information provided by the Applicant, the Commissioner disallowed the Objection in full and provided reasons for the Objection Decision.[12]
27. On 8 February 2019, the Applicant applied to the Tribunal for review of the Objection Decision.
28. The following facts are taken largely from the ASFIC and are, as far as I am aware, not materially in dispute.
29. In its capacity as trustee of the Trust, the Applicant carries on the business which is developing and manufacturing various commercial and residential shade solutions, including awnings, external venetians, glazing and weather shades (i.e. "off the shelf" products) that are sold to the public at large, architects, designers and builders.
30. Customers are able to request custom façade shading solutions tailored to their specific needs. These products are not "off the shelf" products and, according to the Applicant, required R&D.
31. CJB and LMB determined which contracts entered into by the Trust included R&D. In making the assessment they employed the guidelines established by Mr Loaring.
32. All employees or contractors who worked on the R&D projects were engaged by the Trust to perform other (non-R&D) activities of the business.
33. The Applicant did not have a bank account its own right in the relevant income years. Payments by clients were made to the Trust's bank account.
34. The Applicant asserts that "the execution page of the leases ... evidence that the Applicant, in its own capacity, ... executed/entered into the lease of the business premises, and not the Applicant in its capacity as Trustee of the Trust".[13] While the ASFIC refers to "leases", as far as I am aware, there is only one lease which appears as T170[14] and T171.[15]
36. Payments of rent for the business premises came from the bank account.
37. The Applicant prepared and lodged income tax returns in its own capacity and in its capacity as trustee of the Trust.
38. The Applicant, in its own right, and the Trust were grouped for GST purposes, which required the filing of a single Business Activity Statement (BAS) and not separate BASs.
39. For the 2012 and 2013 years, the Applicant did not lodge a BAS. The Trust did lodge BASs in the 2012 and 2013 years, returning all sales, including the R&D jobs, and purchases, including all the materials and other expenses in relation to R&D jobs.
40. Section 355-5 of the ITAA 97 describes the object of div 355 of that act in the following terms:
(1) The object of this Division is to encourage industry to conduct research and development activities that might otherwise not be conducted because of an uncertain return from the activities, in cases where the knowledge gained is likely to benefit the wider Australian economy.
(2) This object is to be achieved by providing a tax incentive for industry to conduct, in a scientific way, experimental activities for the purpose of generating new knowledge or information in either a general or applied form (including new knowledge in the form of new or improved materials, products, devices, processes or services).
42. Section 355-35 of the ITAA 97 relevantly defines an R&D entity as follows:
(a) a body corporate incorporated under an * Australian law;
(b) a body corporate incorporated under a * foreign law that is an Australian resident.
Note: Each of the above paragraphs extends to a body corporate acting in its capacity as trustee of a public trading trust (see subsection 102T(9) of the Income Tax Assessment Act 1936).
43. Section 102T(9) of the Income Tax Assessment Act 1936 (Cth) (ITAA 36) provides:
A reference in section 355-35 of the Income Tax Assessment Act 1997 to a body corporate is to be read as including a reference to a body corporate acting in its capacity as trustee of a public trading trust.
44. Section 355-100 of the ITAA 97 relevantly provides:
355-100 Entitlement to tax offset
If notional deductions are between $20,000 and $150 million
(1) An * R&D entity is entitled to a * tax offset for an income year equal to the percentage, set out in the table, of the total of the amounts (if any) that the entity can deduct for the income year under any or all of the following provisions...
(Original emphasis.)
45. Section 355-205 of the ITAA 97 relevantly provides:
(1) An * R&D entity can deduct for an income year (the present year) expenditure it incurs during that year to the extent that the expenditure:
(a) is incurred on one or more * R&D activities:
(i) for which the R&D entity is registered under section 27A of the Industry Research and Development Act 1986 for an income year; and
(ii) that are activities to which section 355-210 (conditions for R&D activities) applies; and
(b) if the expenditure is incurred to the R&D entity's * associate - is paid to that associate during the present year.
46. Section 355-210 of the ITAA 97 relevantly provides:
355-210 Conditions for R&D activities
(1) An *R&D activity covered by one or more of the following paragraphs is an activity to which this section applies:
(a) the R&D activity is conducted for the * R&D entity solely within Australia;
...
(Original emphasis.)
47. Section 284-75 of the TAA (sch 1) relevantly provides as follows:
(1) You are liable to an administrative penalty if:
(a) you make a statement to the Commissioner or to an entity that is exercising powers or performing functions under a *taxation law (other than the *Excise Acts); and
(b) the statement is false or misleading in a material particular, whether because of things in it or omitted from it.
...
(5) You are not liable to an administrative penalty under subsection (1) ... for a statement that is false or misleading in a material particular if you, ... took reasonable care in connection with the making of the statement.
(Original emphasis.)
48. Section 284-80 of the TAA relevantly provides:
284-80 Shortfall amounts
(1) (1) You have a shortfall amount if an item in this table applies to you. That amount is the amount by which the relevant liability, or the payment or credit, is less than or more than it would otherwise have been.
(Original emphasis.)
49. Section 284-90 of the TAA relevantly provides:
You have a *shortfall amount as a result of a statement described in subsection 284‑75(1) or (4) and the amount, or part of the amount, resulted from intentional disregard of a *taxation law (other than the *Excise Acts) by you or your agent
You have a *shortfall amount as a result of a statement described in subsection 284‑75(1) or (4) and the amount, or part of the amount, resulted from recklessness by you or your agent as to the operation of a *taxation law (other than the *Excise Acts)
You have a *shortfall amount as a result of a statement described in subsection 284‑75(1) or (4) and the amount, or part of the amount, resulted from a failure by you or your agent to take reasonable care to comply with a *taxation law (other than the *Excise Acts)
(1) The base penalty amount under this Subdivision is worked out using this table and subsections (1A) to (2), and section 284-224 if relevant:
(Original emphasis and formatting.)
50. Section 298-20 of sch 1 the TAA relevantly provides:
(1) The Commissioner may remit all or a part of the penalty.
(2) If the Commissioner decides:
the Commissioner must give written notice of the decision and the reasons for the decision to the entity.
...
51. Mr Langridge describes himself as specialist principal in the forensic practice of Deloitte Financial Advisory Pty Ltd, Australia. He is a chartered accountant, having been admitted as a member of the Institute of Chartered Accountants of Scotland and as a Fellow of Chartered Accountants Australia and New Zealand. He has 37 years' experience in public practice.[18]
52. Mr Langridge's report described itself as an "expert report". In evidence-in-chief, counsel for the Applicant referred to the report as an expert report and sought its tender as an "expert report".[19]
53. It is not clear, to me at least, whether Mr Langridge's report can properly be described as an expert report. There is no doubting Mr Langridge's qualifications and experience in his field. The question, however, is whether, by his report, Mr Langridge expresses views on relevant technical issues which require his particular qualifications, knowledge or experience to form an opinion which would assist the Tribunal. Much of the content of the report goes more to his understanding of the facts, a description of the accounts created by the Applicant, or probably more correctly, the Trust, and how the entries made in the accounts were explained to him by CJB and LMB. Looking at Deputy President Forgie's very useful explanation of the role of expert reports in Tribunal proceedings in Vestas - Australian Wind Technology Pty Limited and Comptroller-General of Customs[20] at [38]-[49], much of Mr Langridge's report could not be considered to be an expert report. That is not to say, however, that the report is not helpful as a guide to the accounts and the identification of the relevant entries and ledgers. I also note that the Commissioner accepts and relies on certain of the conclusions reached and statements made by Mr Langridge, for instance, those expressed at paras 4.13 and 4.26 of the report.[21]
54. Mr Langridge provides a summary of his conclusions at paras 2.1 to 2.5 of his report. The thrust of those conclusions was:
(a) While "the Business" chose to record accounting transactions in a single general ledger, there were systems in place to identify transactions which were undertaken by the Trust on behalf of the Applicant in its own right to enable separate financial statements to be prepared for both the Applicant in its own right and the Applicant as the Trust at each year end.
(b) Due to the nature of the business and the use of common suppliers and employees to undertake both R&D and non-R&D activities, the use of a single general ledger was more efficient.
(c) The system as employed was capable of meeting the record keeping requirements of s 286(1) of the Corporations Act 2001 (Cth) and s 262A(1D)(a) of the ITAA 36.
(d) The system of recording transactions in a single general ledger, identifying those that related to the Applicant undertaking R&D and reallocating these by journal entry at year end was consistently applied in 2012 and 2013.
(e) The use of a single bank account was consistent with the conduct of the business and did not prevent the recognition of expenditure in the relevant entity.
(f) The system of accounting employed has resulted in the build-up of a significant loan due by the Applicant to the Trust. Partial repayments of this loan were made using the tax refunds relating to the R&D claims, however a significant balance still remains with no formal agreement in place to determine the method of repayment of the balance of this loan.
(g) The ultimate repayment of the loan is dependent upon a future sale or licencing of the IP to the Trust or a third party.
(h) In his opinion, from an accounting perspective, the undertaking of R&D activities has been properly recorded as such in the Applicant's financial statements notwithstanding the existence of a loan due to the Trust, the repayment of which has been deferred in that it is dependent upon:
(i) future tax refunds being received by the Applicant; and
55. Mr Langridge noted that he had relied on the statements of CJB and LMB for the facts upon which he made the above findings.[22]
56. By his statement,[23] Mr Loaring advised that he provided guidance to the Applicant to assist in determining which of the activities qualified as eligible R&D.
57. When it was determined that a new contract involved R&D, the new job had the suffix RD added to the job number. Expenditure incurred by the Applicant in its own right on R&D activities was recorded contemporaneously by the Applicant in its job costing system. At the end of each year Mr Loaring would review the records kept so that he could determine the various elements of R&D tax claims to ensure that only eligible costs were claimed.
58. The costs of R&D activities which were claimed were incurred by the Applicant on its own account. Overhead costs, salaries and wages, and some on-costs were apportioned between the Applicant and the Trust and were reimbursed to the Trust.
59. Mr Loaring's statement commented on and was critical of aspects of the conduct of the Australian Taxation Office (ATO). The ATO's conduct and Mr Loaring's opinion of their conduct are not relevant to the exercise that I undertake, which is to make my own decision on the issues identified in [13] above based on the evidence before me.[24]
60. LMB's statement[25] was to the following effect:
(a) In December 2008 the Applicant in its capacity as trustee of the Trust purchased the business as a going concern.
(b) All R&D activities are conducted by the Applicant in its own right.
(c) The Applicant in its own right and as the Trust operates a MYOB accounting system covering off-the-shelf contracts and R&D activities.
(d) Invoices for all works are issued to the customer by the Applicant in its capacity as trustee of the Trust.
(e) The Applicant prepares and lodges tax returns on its own account and for the Trust.
(f) The Applicant in its own right and as trustee of the Trust are grouped for GST purposes which results in the filing of a single BAS statement.
(g) Jobs involving R&D are given the suffix RD added to the job number which is shown in the accounting system. Expenditure incurred by the Applicant on R&D activities is contemporaneously recorded as such in the job costing system.
(i) R&D activities are conducted by the Applicant in its own right and recorded contemporaneously.
(j) In 2012 there were 191 jobs 12 of which required R&D. In 2013 there were 110 jobs of which five entailed R&D.
(k) Expenditure incurred by the Trust including salaries and wages of its employees and some overheads which relate to R&D activities are apportioned in the tax accounting records between the Applicant in its own right and the Trust.
(l) The Applicant reimburses the Trust for expenditure incurred in respect of staff and overhead costs properly attributable to R&D activities by means of a loan account set up for that purpose. The R&D offsets to which the Applicant became entitled were accounted for via the loan account being credited by way of set off.
(m) At para 5.17 of her statement, LMB says "Funds received from claims made by the Applicant for R&D tax offset constitute a source of funds for the payment of the Applicant's expenses including its proportionate share of costs. At the present time that does not occur, because until such time as the current matters with the Respondent are resolved no offsets have arisen."
(n) The Applicant as trustee of the Trust issued invoices to customers for the manufacture, design and installation of work including that which had been classified as R&D.[26] The clients' contracts were with the Applicant in its own right.
(o) There have been no issues with AusIndustry as to the nature of the Applicant's core activities and the supporting activities.
(p) In carrying out R&D activities that Applicant engaged subcontractors to undertake work under its direction and control. It also engaged employees of the Trust as were required to undertake such work which is accounted for as a cost of the R&D activity. It would not be commercially practical to maintain two separate sets of staff.
(q) Common employees, contractors and suppliers are used for both R&D activities undertaken by the Applicant and also non-R&D activities undertaken by the Trust. These costs are simultaneously tracked by the accounting system allowing for accurate and live costings of all projects.
61. CJB's statement[27] was to the following effect:
(a) He is a director of the Applicant. In 2008 the Applicant, in its capacity as trustee of the Trust, purchased the business as a going concern. The business had been owned and run by a company controlled by his father which also carried on the business under a trust.
(b) The business name under which the business operates is registered in the Applicant's name. In its capacity as the trustee of the Trust, the Applicant carries on the development and manufacture of commercial and residential shade solutions, including awnings, external venetian blinds, glazing and weather shades sold to the public.
(c) In 2014 the Commissioner undertook an audit relating to the Applicant's R&D tax offset claim for the year ended 30 June 2013. The audit was then expanded to cover the tax offset claims for the year ended 30 June 2012.
(d) The claims made by the Applicant for tax offsets relate only to R&D activities carried out by the Applicant in its own right, not as trustee for the Trust.
(e) CJB summarised the single accounting system in the same terms as LMB as set out in [57] above.
(f) When a new contract/order came in, CJB would determine whether R&D for the order was required. This involved the use of computer assisted drafting by the in-house design team. Depending on the needs of the job sometimes outside design contractors were used. This design process would sometimes involve the design and fabrication of a prototype to test whether the product would meet the client's performance requirements.
(g) At para 28 of his statement, CJB says that in the 2012 and 2013 financial years, the Applicant undertook R&D on 17 projects. At para 29 of his statement, CJB says that "In the 2013 income year 17 jobs were completed which gave rise to R&D activities which represented 25.4% of the Trust's income". This apparent inconsistency is not material as CJB's statement then proceeds to outline each of the 17 projects and the need for R&D in relation to each project[28] as well as setting out what he says are the factors which drive the need for specialist design and experimentation.[29]
(h) In relation to the ownership of the intellectual property (IP) in the resultant design and product, CJB says that the Applicant does not bring to account the value of the IP in its books and that "It will only be when the Applicant sells its business that it will be able to negotiate for a price representing the market value of the intellectual property, know-how and goodwill".[30]
(i) The Applicant separates its R&D activities from the Trust to "protect the know-how and intellectual property rights the Applicant has developed and continues to develop through R&D activities in case of insolvency of the Applicant acting in its capacity as [t]rustee of the Trust, and to provide the Applicant as an R&D entity with the ability to claim R&D tax concessions and tax offsets".[31]
(k) Suppliers are reluctant to deal with trusts so the contracts with suppliers are with the Applicant in its own right not as trustee of the Trust. Invoices from suppliers are addressed to the Applicant, not the Applicant as trustee of the Trust.
(m) The Applicant in its own right has provided security to suppliers as disclosed by the Personal Property Securities Register (PPSR).[36] The Applicant has also provided security as trustee of the Trust as disclosed by the PPSR.[37] The suppliers to whom the Applicant has provided PPS security in its own name are suppliers of goods and services related to the design, testing, manufacture and installation of louvres and systems. The creditors to whom the Applicant has provided security as the trustee of the Trust are suppliers of rental equipment usually needed for installation and building sites as well as Toyota finance to secure the lease on a Toyota LandCruiser under a business vehicle loan.
(n) The Applicant in its own right has also concluded a number of other arrangements relating to funding, insurance and the provision of services.[38]
62. The Applicant says that the determination of the primary issue ultimately turns on whether the Applicant, carrying on the business, being an "R&D entity" as defined in s 355-35 of the ITAA 97, satisfies the condition for R&D activities stated in s 355-210(1)(a), which requires that "the R&D activity is conducted for the *R&D entity solely within Australia..."
63. The Applicant agrees that it bears the burden of proving, on the balance of probabilities, that the Amended Assessments and the Penalty Assessments issued are excessive or otherwise incorrect, and what those assessments should have been.[39]
64. The ASFIC sets out the Applicant's case as follows:
(i) the Applicant was an "R&D entity" (as defined in s 355-25 of the ITAA 97);
(ii) it incurred expenditure on "R&D activities" (as defined in a 355-20 of the ITAA 97):
Was the R&D expenditure "incurred" by the Applicant on R&D activities in the 2012 and 2013 years (ITAA 97 s 355-205(1)(a))?
(b) An amount is "incurred" if a taxpayer has a presently existing liability to which the taxpayer is definitively committed and completely subjected.[40]
(c) This does not include a loss or expenditure which is no more than impending, threatened or expected or an obligation which is contingent.[41]
(d) The evidence before the Tribunal establishes that the Applicant incurred the relevant expenditure in the 2012 and 2013 years. That is, the evidence establishes that the R&D expenditure charged to the Applicant, in its own right, by the Applicant in its capacity as trustee of the Trust, in the 2012 and 2013 years was a presently existing liability to which the Applicant, in its own right, was definitively committed and completely subjected.[42]
Was the R&D expenditure incurred by the Applicant on R&D activities for which the Applicant was registered under IRDA in the 2012 and 2013 years (ITAA 97 s 355-205(1)(a)(i))?
(e) The evidence establishes that in the 2012 and 2013 years the Applicant incurred expenditure on R&D activities for which it was registered under s 27A of the IRDA.
Was the R&D activity conducted "for" the Applicant (ITAA 97 s 355-205(1)(a)(ii))?
(f) Whether the Applicant, in its own right, is the true benefactor of the relevant R&D activities is a question of fact which requires consideration of all the circumstances surrounding the conduct of the activities, the ownership and control of, and ability to use, the intellectual property or other results obtained from the expenditure on the R&D activities concerned.[43]
(g) The following three factors indicate whether an entity is the benefactor of the R&D activities (for the purpose of s 355-210(1)(a) of the ITAA 97 and, it follows, for the purpose of s 355-205(1)(a)(ii) of the ITAA 97):
(i) the R&D entity "effectively owns" the know-how, intellectual property or other similar results arising from the R&D entity's expenditure on the R&D activities;
(ii) the R&D entity has appropriate control over the conduct of the R&D activities; and
(iii) the R&D entity bears the financial burden of carrying out the R&D activities.[44]
(h) The evidence establishes that the Applicant, in its own right, was the true benefactor of the R&D activities concerned, and that they were conducted "for" the Applicant for the purpose of s 355-210(1)(a) of the ITAA 97 and, it follows, for the purpose of s 355-205(1)(a)(ii) of the ITAA 97.[45]
(i) Where in a statement the taxpayer or its agent treats an income tax law as applying in a particular way, but the position taken is not "reasonably arguable", the penalty is 25% of the shortfall amount.[46]
(j) In the Penalty Assessments, the Commissioner determined that the shortfall amounts in the 2012 and 2013 years were caused by the Applicant's (or its agent's) failure to take reasonable care and that the Applicant was liable to a penalty of 25% of the amount of the shortfalls in the 2012 and 2013 years.
(k) The "reasonable care" test requires a taxpayer to take the same care in fulfilling their tax obligations as could be expected of a reasonable ordinary person in their shoes. Australian Taxation Office, Penalty relating to statements: meaning of reasonable care, recklessness and intentional disregard (MT 2008/1, 1 April 2015) provides some guidance in relation to this test.
(l) The Commissioner has a discretion to remit penalties in whole or in part.[47] The relevant question for the Commissioner in deciding whether to exercise his discretion to remit, is whether he is satisfied, having regard to the taxpayer's particular circumstances, that it is appropriate to remit the penalties.[48]
(m) Based on the evidence before the Tribunal, the Applicant contends that:
(i) the Applicant did exercise reasonable care in claiming the R&D tax offsets that it did (in its own capacity) in the 2012 and 2013 income years under Division 355 of the ITAA 97;
(ii) on the balance of probabilities, the Penalty Assessments are excessive; and
(iii) having regard to the Applicant's particular circumstances, the Commissioner should be satisfied that it is appropriate to wholly remit the penalties imposed on the Applicant (in the Penalty Assessments) under s 298-20 of Schedule 1 of the TAA.
65. The CSFIC sets out the Commissioner's case as follows:
(a) Contractors and suppliers generally include the Trust's ABN on their invoices for the services performed or the goods provided.
(b) Neither the Applicant nor the Trust holds any patents or trademarks in relation to the results from the R&D activities.
(c) The Applicant did not generate any income in its own right and no feedstock adjustments had been made to include an amount in the Applicant's assessable income in either the 2012 or 2013 income year.[49]
(d) The Applicant did not lodge BAS for the relevant years. The Commissioner agrees that the Applicant and the Trust are grouped for GST purposes and the Trust is the "representative" of the group so only it is required to report GST.
(e) The Trust receives payment from the customers for any R&D job done.
(f) The Applicant did not declare any income for the relevant income years.
(g) The Applicant stated on 21 November 2014 that the value to the Applicant "for the R&D conducted and expenditure incurred will be reflected in whatever it can obtain for the IP (know-how, etc) when and if the business is sold".[50]
(h) There are increasing loan balances at the end of the income years with respect to the loan from the Trust to the Applicant:
(i) The threshold condition for an amount to form part of a notional deduction under s 355-205 of the ITAA 97 is that it must have been "incurred" by the Applicant during the relevant income year.
(j) An amount is "incurred" if a taxpayer has a presently existing liability[51] to which the taxpayer is definitely committed and completely subjected.[52] This does not include a loss or expenditure which is no more than impending, threatened or expected[53] or an obligation which is contingent.[54]
(k) It is for the Applicant to establish that it incurred the necessary expenditure in the 2012 and 2013 years including, where relevant, by establishing that it had a presently existing liability to which the Applicant was definitively committed and completely subjected at the end of the 2012 and 2013 years respectively.
Was the notional expenditure incurred on one or more eligible R&D activities?
(l) The fact that AusIndustry registered the Applicant as an R&D Entity in relation to certain R&D projects for the 2012 and 2013 income years does not mean that the Applicant will automatically be eligible for a div 355 tax offset. The Applicant must still satisfy all the relevant statutory criteria.
Was the eligible R&D activity conducted "for" the Applicant?
(m) Section 355-210(1)(a) of the ITAA 97 requires that the R&D activity must be carried on for the "R&D entity", that is, for the Applicant.
(n) Whether or not the Applicant is the true benefactor of the R&D activities is a question of fact that requires consideration of all the circumstances. These circumstances include the conduct of the activities and the ownership and control of, and ability to use, the intellectual property or other results obtained from the expenditure on the R&D activities.[55]
(o) The following three matters indicate that an entity is the benefactor of R&D activities:[56]
(i) The entity "effectively owns" the know-how, intellectual property or other similar results arising from the R&D entity's expenditure on the R&D activities;
(ii) The entity has appropriate control over the conduct of the R&D activities; and
(iii) The entity bears the financial burden of carrying out the R&D activities.
(p) The Applicant was conducting R&D activities in its capacity as trustee of the Trust. It is the Trust that was incurring the expenditure on the R&D activities. The Trust is not an eligible entity to claim R&D tax offsets. The Applicant cannot notionally deduct the expenditure under s 355-205 of the ITAA 97 because it did not incur the expenditure in its own right.
(q) In the alternative, if the Applicant was conducting R&D activities in its own right, those activities were conducted for the Trust. Accordingly, the Applicant cannot notionally deduct the expenditure because of s 355-210(1)(a) of the ITAA 97 because the R&D activity was not conducted "for" the Applicant.
(r) The evidence overwhelmingly shows the R&D activities were undertaken for the Trust. The R&D activities were conducted to assist the business. The business is owned by the Trust. The Trust received all the income from the business in the relevant years. The Applicant did not declare any income for the relevant years. The Trust and not the Applicant is the major benefactor from the R&D activities.
(i) the invoices in relation to expenditure were made out to the Trust's ABN;
(ii) the Trust receives the payment from the customer for any R&D job done;
(v) despite funding the R&D activities, the Trust had no expectation of receiving anything but a partial reimbursement from the Applicant and even this was contingent on the Applicant receiving a R&D tax offset.
(t) The Applicant's non-current liability loan balance does not evidence that the amounts were incurred by the Applicant. On the contrary, the loan evidences that it was the Trust and not the Applicant that funded the R&D activities;
(u) In any case, the Applicant admits that repayment of the purported loan was contingent on the Applicant receiving R&D refunds. A contingent repayment is not an incurred amount.
(v) In addition, the amounts claimed by the Applicant were not repaid by it in the relevant income years and have still not been paid by it- hence the increasing loan balance. The Applicant's loan from the Trust is increasing not decreasing. This does not support a conclusion that there was any obligation of payment in the relevant income years if the amounts were "loaned" by the Trust to the Applicant.
(w) With no expectation of the amounts being paid the loans are considered contingent. In any case, it cannot be said that the Applicant incurred the expenditure. The Trust has paid the relevant amounts and as the Applicant's obligation to repay the Trust is dependent on it determining it has sufficient funds to do so, the liability for the unpaid amounts is contingent.[57]
(i) made statements to the Respondent when its tax agent lodge the tax returns for the 2012 and 2013 income year respectively; and
(ii) the statements were false or misleading as it claimed R&D tax offsets of $624,805.65 and $548,338.05 for respective income years.
(y) The Applicant treated the tax law in a way that was not reasonably arguable. A matter is "reasonably arguable" if, having regard to the relevant authorities it is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.[58]
(z) By claiming the tax offsets without having incurred the expenditure the Applicant took a position that was not defensible. It follows that the Applicant was properly subject to a penalty under s 284-75(2) of sch 1 to the TAA. In addition, by the claiming the tax offsets in circumstances where they were not claimable because of any one or more of ss 355-205(1), 355-210(1)(a) and 355-210(2) of the ITAA 97, the Applicant took a position that was not defensible.
(aa) There was a partial remission of penalty at the audit stage. There is nothing in the evidence before the Tribunal that points to any further remission being appropriate. Any further remission of the Penalties would be inappropriate when considering the Applicant's conduct and the policy intent of the administrative penalty regime.
66. In opening, Mr Willinge for the Commissioner identified four "problems" with the Applicant's case for being entitled to notional deductions for R&D:
... the four problems that we say face the [A]pplicant in relation to duty, we say the first problem is the applicant did not incur the expenditure. The second problem is that the [A]pplicant also did not incur the relevant expenditure during the relevant years. In other words, even if the [A]pplicant did incur expenditure, it wasn't in the relevant years. The third and fourth problems are related. The third problem is that the R&D activities were not for the [A]pplicant, they were for the trust. The fourth problem is that the R&D activities were for the significant benefit of the trust.[59]
67. Those four problems, which I think encapsulate the issues to be determined by the Tribunal identified in [13] above, became the focus of the hearing and the parties' respective submissions.
68. In closing, Ms Lyford sought to address the four claimed problems. She, correctly in my view, identified the first two problems as arising from the wording of s 355-205(1) of ITAA 97 which refer to the R&D entity having to (1) incur the expenditure and (2) incur the expenditure in the relevant year for which the notional deduction is claimed.[60]
69. In relation to the issue of the expenditure being "incurred", Ms Lyford cited the cases referred to in the Applicant's Amended SFIC as set out at [64(b)] and [63(c)] above. These cases are also relied on by the Commissioner (see [65(j)] above). Ms Lyford also referred to the Tribunal's decision in Desalination Technology Pty Ltd and Commissioner of Taxation[61] (Desalination AAT) in which Deputy President Frost (at [17]-[20]) set out what Ms Lyford describes as "quite a good summary ... of the law on the meaning of 'incurred.'"[62]
70. The relevant facts in Desalination AAT were that IDTG, a company related to the taxpayer, was specifically established to coordinate, subcontract and fund R&D work on behalf of the taxpayer.[63] IDTG would render monthly invoices for that R&D work to the taxpayer. Only a fraction of those invoices were paid. The balance of the unpaid invoices was debited to an inter-company loan account between IDTG and the taxpayer. That loan account grew over time. Pursuant to an agreement between the taxpayer and IDTG (initially oral/arising by conduct and subsequently reduced to writing) the taxpayer would make such reductions of the amount of the inter-company loan account "as funds received from investors, loan funds received and any amounts [the taxpayer] may receive from other sources will prudently allow".[64] The Tribunal in that case found that the expenditure had been incurred in the relevant year "... notwithstanding the fact that there were conditions affecting the timing of the discharge of that liability".[65]
71. That finding of the Tribunal was, however, in effect, overturned on appeal which was then confirmed by the Full Court in Desalination Technology. The Full Court observed that:
43. ... It is common ground that that "come and go loan account" was subject to the contingencies which the learned primary judge found (JR [38] and [39] - see [26] above), contrary to the finding of the Tribunal (TR [26]), went not to timing of payment but to the very existence of the obligation itself.
...
45. No obligation of the taxpayer to IDTG came into existence on the rendering of each invoice because of the contingencies attaching to the come and go loan account to which the amount of the invoice was debited; and if, contrary to that conclusion, some obligation did come into existence, it was so infected by those contingencies that it was not open to the Tribunal to conclude that the taxpayer was definitively committed to the obligation. On either view, the taxpayer did not incur the relevant expenditure in the year of income for the purposes of s 73B(14) of the 1936 Act.
72. Ms Lyford referred to the following passage from the judgment of Dixon J in New Zealand Flax cited by Deputy President Frost in Desalination AAT:
Incurred" does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected.[66]
and submitted that the Commissioner's argument, that due to the way the inter-entity loan account worked, and the fact that the Applicant had a loan balance owing to the Trust, the expenditure was no more than impending, threatened or expected, was not correct.[67]
73. Ms Lyford further submitted that the leading case on the meaning of "incurred" in this context is the High Court decision in Coles Myer Finance Ltd v Federal Commissioner of Taxation.[68] She cited the following passage from the decision of Deane J (at 670):
It does not follow from those cases, however, that the fact that jurisprudential analysis discloses that a particular liability to make a future payment of money is contingent necessarily means that such a contingent liability cannot constitute or found a "loss or outgoing" which has been "incurred" for the purposes of s. 51(1). To the contrary, the weight of authority supports the conclusion that, depending upon the circumstances, a liability to pay money can constitute, or give rise to, a "loss or outgoing" which is "incurred" within the meaning of that sub-section notwithstanding that the money is not payable until a future time ((61) See, e.g., Federal Commissioner of Taxation v James Flood Pty. Ltd. (1953) 88 CLR, at p 506.) and that the obligation to pay it is theoretically defeasible ((62) ibid) or contingent ((63) See, e.g., Commercial Union Assurance Co. of Australia Ltd. v. Federal Commissioner of Taxation (1977) 14 ALR 651, at p 661; Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation [1940] HCA 9; (1940) 63 CLR 382.) in that it is subject to a condition which remains unfulfilled.
74. Ms Lyford also referred to the following passage of Crennan J's judgment in Federal Commissioner of Taxation v CityLink Melbourne Ltd,[69] in which, referring to the above passage from the judgment of Deane J in Coles Myer, her Honour said (at [125]):
Deane J considered that the critical question was whether the taxpayer was, as a practical matter, definitively committed or completely subjected to discharge of the liability in the future. His Honour recognised that on some facts it would be apparent that a condition giving rise to a theoretical contingency could be treated, for practical purposes, as certain to be satisfied.
(Footnotes omitted.)
75. Ms Lyford then submitted that the factual matrix underlying the decision in Desalination AAT (and therefore Desalination Technology) can be distinguished from the present case because in the former cases there was a service agreement in place and the issuing of the invoices in that case was "a reasonably contrived arrangement."[70] That, according to Ms Lyford, was distinguishable from the present case because "in this case, the money was transferred between entities into a company loan account and was, in fact, incurred."[71]
76. In the present case, according to Ms Lyford, there was money being lent and that "money was transferred between entities". In response to that submission I pointed out to Ms Lyford that there was no actual transfer of funds but rather the "transfer of funds" was affected by an entry in a loan account; in effect the same factual scenario that applied in the Desalination cases. Ms Lyford's response was that the difference was that in the Desalination cases "the money did not come out of the company to which the money was transferred to incur the expenditure, it was done through - it was actually done by the transferral company. It paid the expenditure and sent an invoice to the other company which it couldn't repay, so it's slightly different".[72] That, in my view is not a basis upon which to distinguish the Desalination cases. The fact that the arrangement in that case involved the use of an "intermediary" was not material to the decisions in the Desalination cases, in particular the Full Court's decision in Desalination Technology.
77. In closing Ms Lyford posited that incurring the expenditure by an entry in a loan account between the Applicant in its own right and the Applicant as trustee of the Trust was no different to the Applicant borrowing the money from a bank to pay for the R&D. She submitted:
But, as I suggested yesterday, I don't believe that whether the money comes from within one loan account between two different entities is any different, say, from borrowing money from a bank and owing that money to the bank. That's still going and actually incurring the expenditure and still owing the bank the money. As I said, these sort of intercompany loan accounts occur frequently in the commercial world. A client I'm dealing with at the moment, a big corporate group, they do it all the time and they owe money back to - - -[73]
TRIBUNAL: Yes. But in the present case, as the witnesses say, the money was lent by the trust to the company for the company to pay for the R&D. But there was - that was effected, supposedly, or that was effected via the balance in the loan account, for the loan accounts.
MS LYFORD: Yes.
TRIBUNAL: So it's just a balancing exercise, after reconciliation of R&D costs, at the end of an accounting period?
MS LYFORD: Yes.
79. In closing Mr Willinge, for the Commissioner, responded to Ms Lyford's argument that the debiting of a loan account between two related entities (in this case the Applicant in its own right and the Applicant as the Trust) was no different to the money spent in the R&D being borrowed from a bank as follows:
I understand that the argument being advanced by the [A]pplicant is that you can draw some comfort or make some comparison between the position of the trust and the company and by comparing the situation where an external bank had loaned the funds to the company. That argument seems to proceed in these steps: first, the loan from the trust to the [A]pplicant is like a loan from a bank, and secondly, if a bank loaned money to the [A]pplicant company, and the [A]pplicant had spent it on R&D activities, the [A]pplicant would have incurred the expenditure. In our respectful submission, that argument doesn't assist the [A]pplicant in the circumstances of this case, and the reason is it fails at the premise, which is trying to compare a loan from the [A]pplicant to the trust to a loan from a bank. If a bank had loaned money to the [A]pplicant, then in all likelihood there would have been a formal loan agreement, a requirement to make regular repayments, a requirement also to pay interest, the giving of security from the [A]pplicant to the bank, and defined events of default which could lead to immediate repayment of the entirety of the outstanding loan or other consequences. None of those features are present here between the [A]pplicant and the trust. But in our respectful submission, there is also a more fundamental problem. If a bank had loaned money to the [A]pplicant company, the funds would have been provided from a third party outside the business, namely, the bank. Any money here was provided by the trust. The trust owns the business. The trust paid for the R&D. It funded the R&D. It incurred the expenditure.[74]
80. I agree with Mr Willinge's analysis. The circumstances of the present case are materially legally different to the Applicant having borrowed money from a bank to fund R&D. The starting point of the bank scenario posited by Ms Lyford would be the borrowing of the money by the Applicant (the Applicant thereby incurring a liability to bank in respect of the borrowed funds) and then the payment of that money to the Trust for the Trust to undertake the R&D. That legal character of the steps in that transaction, and the legal consequences flowing from those steps, are fundamentally different to what occurred. The starting point of the actual sequence in this case was the R&D work being undertaken by the Trust and paid for by the Trust. It was the Trust, through the business which it owned and operated, which undertook the R&D work. It paid for the R&D work irrespective of whether an entry was subsequently made in the loan account. That had to be the case as it is the Trust that owned and ran the business, contracted with customers and it is only the Trust that generated any income.[75] The money in the bank account from which the costs of the R&D were met was the Trust's money. A "subsequent balancing exercise, after reconciliation of R&D costs, at the end of an accounting period" (see [78] above) does not change the relevant legal characterisation of what occurred to equate to the Applicant borrowing funds from a bank and expending that money on R&D.
81. The lack of any definite obligation to pay also undermines a comparison of what occurred to money being borrowed from a bank. None of the obligations which would attach to borrowing from a bank exists in the present case. There is no interest accruing on the balance of the loan account, there is no security and there is not even the most fundamental obligation that would attach to a loan from a bank, namely, the obligation to repay. The total lack of any documentation recording obligations attaching to the supposed loan and its repayment differentiate this "transaction" from borrowing money from a bank. The usual characteristics of a commercial transaction by which an obligation to pay (or repay) could be implied are absent. CJB's claim that the dealings between the Applicant and the Trust are carried out "on an arm's length basis" (see [61(j)] above) is clearly not correct.
82. The Applicant sought to distinguish the present case from Desalination Technology on the basis set out in [75] above. The fact that the invoices in that case were a contrived arrangement was not material to the decision made. As the Full Court found at [45], independently of the contrived nature of the invoices, if some obligation did come into existence as a result entries made in the account between the companies, "it was so infected by those contingencies that it was not open to the Tribunal to conclude that the taxpayer was definitively committed to the obligation." The Full Court found that in either case (i.e. invoices or entries into the loan account), the taxpayer did not incur the relevant expenditure in the year of income (see [71] above).
83. The Applicant identified two "contingencies" which would trigger an obligation on the part of the Applicant to pay anything towards reducing the amount of the loan account. They were receipt of tax refunds relating to R&D[76] and final payout of the balance being "dependent upon a future sale or licensing of the IP to the Trust or a third party."[77]
84. One issue with the first of the above contingencies is that, in relation to each claim, the liability to reduce the amount of the loan account is triggered by an event which occurs after the claim is made for the deduction and is dependent on the claim for the deduction being successful. However, the ability to claim the deduction in the first place is dependent upon the expense having been incurred which, in the circumstances of credit or a loan account requires the Applicant being "definitively committed to the obligation to pay."[78] If the obligation to pay is contingent on receipt of a tax refund (which is only properly claimable for expenditure incurred at the time of the claim), then at the time that the claim for the deduction was made the expense had not been incurred as the Applicant was not, at that point, "definitively committed to the obligation to pay." That contingency for liability to pay, in effect, puts the cart before the horse.
85. There are a number of issues with the second contingency identified by the Applicant for an obligation to pay out the loan account, namely the sale of the IP. Firstly, the enforceability of such an obligation is questionable given the vagueness of its terms and the lack of any agreement (written or otherwise) reflecting that obligation.
86. Secondly, the contingency is dependent on the Applicant having the legal rights to the IP. In re-examination CJB conceded that there was no agreement between the Applicant and the Trust by which ownership of IP is vested in the Applicant.[79] When I asked CJB why then the Applicant asserts that the IP resulting from the R&D is owned by the Applicant, the following exchange occurred:
TRIBUNAL: When you make those statements that the company in its own right owns the intellectual property, what are you relying on?
CJB: Well, it's the company that uses the designs and the manpower materials that forms part of that R&D requirement. And I see that as under the umbrella of the company.
TRIBUNAL: But it is the trust, isn't it, that carries on the business which includes trading and dealing with customers and undertaking the design and the actual work is done by, as I understand it, the trust, isn't it? There may be an accounting for R&D by virtue of the loan account, but it's the trust that actually does the work?
CJB: I've always seen the trust and the company as XQDX, so just trading under the name, XQDX, which is the company. I haven't differentiated from one or the other. It's been set up like that for a while and that's how we've run the business.[80]
87. While the above evidence may represent CJB's view, that view does not represent the law. The facts are that the Trust purchased, owned and ran the business, and its employees (i.e. the Trust) undertook the R&D work. Those facts, absent an agreement to the contrary (the Applicant admits that the is no such agreement) point to the Trust, not the Applicant, having the rights over any IP created by the R&D process.[81] Insofar as the Applicant may claim ownership of IP arising under the Copyright Act, s 35(2) of that act vests ownership of the copyright in the author of the subject matter which, in this case, would be the Trust.[82] Other than the views of CJB and the assumptions of Mr Langridge as to ownership of IP, which do not represent the legal position, there is no evidence that the Applicant owned or owns whatever IP there may be arising out of the R&D activities. On the contrary, the evidence indicates that the Trust holds any such IP.
88. Thirdly, while the Applicant's witnesses referred to IP, there was no evidence to which I was taken to establish the existence of any IP, the nature of any such IP, what the IP covers, the value of the IP or even whether the IP (whatever it is) has any commercial or saleable value. The second contingency for an obligation to pay arising, that is the sale of the IP, appears to be illusory.
89. The contingencies that give rise to an obligation on the Applicant to pay in the present case, namely the Applicant receiving R&D refunds or selling IP, have the same contaminating effect as the contingencies in Desalination Technology (see [71] above). The Tribunal cannot conclude that the Applicant is "definitively committed to the obligation" to pay those funds. It has not incurred the expenditure.
90. The Applicant falls at the hurdle of the first of the four problems identified by the Commissioner. The Applicant did not incur the expenditure for R&D.
91. Given the finding that the Applicant did not incur the expenditure for R&D, the question of whether the expenditure was incurred in the relevant years falls away. My answer to the first question also renders the third and the fourth problems identified by the Commissioner (see [66] above) academic.
92. I therefore find that the Applicant was not entitled to the notional deductions that it claimed for the years ended 30 June 2012 and 30 June 2013. Accordingly, the Applicant has not proved that the Amended Assessments issued by the Commissioner were excessive.
93. The Applicant says that the claims that it made were based on professional advice. It followed the advice of its accountant and its R&D consultant. The claims that it made which are the subject of these proceedings, were no different to claims that had been made in previous years. There was no reason to question the correctness of the claims.[83] I note that in closing, Mr Willinge did make the submission (correctly in my view) that the Applicant had led little or no evidence that that was the case and that, in any event, the relevant law had changed in 2010.[84]
94. The Commissioner submits that deductions claimed were false or misleading because the Applicant was not eligible for the deductions under div 355 of the ITAA 97. The Commissioner says that the term false or misleading in this context is not used in a pejorative sense or to suggest any moral opprobrium. If the information provided in the returns and the claims was incorrect, then it is relevantly false and misleading.
95. Insofar as the Applicant seeks to rely on it having taken appropriate professional advice, the Commissioner says that little, if any, evidence was led about the advice that the Applicant received or the basis for that advice. That was so, according to the Commissioner, notwithstanding that there were opportunities, including in the Tribunal proceedings, for the Applicant to do that.
96. In relation to the present claims being the same as claims for notional deductions previously made (and apparently accepted) and in relation to relying on advice, Mr Willinge in closing submitted that:
There was some suggestion in the evidence yesterday and in closing today about the business being structured in the same way as previously, but there was little evidence about what occurred in relation to R&D offsets previously or why. In any case the law changed from 1 July 2010... We say it was incumbent on the [A]pplicant or its advisers to check the position and satisfy themselves. Mr Loaring gave evidence yesterday that he had considered the explanatory memorandum, although I should say it was not entirely clear whether that was before or after the 2010 and 2011 R&D claims were made. The R&D offsets were also not correctly claimed for multiple reasons. Even leaving aside issues in relation to which entity incurred the expenditure and any arguments about the loan, the trust is not an R&D entity. The trust was funding the R&D activities, and the R&D activities were for the benefit of the business, and so the trust and not the [A]pplicant. The onus of course is on the [A]pplicant. In our respectful submission the [A]pplicant has not put on evidence that discharges that onus in relation to penalty.[85]
97. The operation of the penalty provisions of the TAA, including those dealing with the remission of penalties, were canvassed in detail by the Full Court of the Federal Court in Sanctuary Lakes. The Australian Taxation Office, Shortfall penalties: voluntary disclosures (MT 2008/3, 12 November 2008) also provides guidance at to the interpretation of s 284-75(2) of the TAA.
A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.
(Original emphasis.)
99. At [180] of Sanctuary Lakes, Greenwood J summarises the operation of s 284-75(2) of the TAA as follows:
If the shortfall amount (or the relevant part) results from the taxpayer or the taxpayer's agent treating an income tax law as applying to a matter in a particular way that was not reasonably arguable and the amount is more than the statutory threshold as earlier mentioned at [170] of these reasons, the base penalty amount is 25% of the shortfall amount or the relevant part (Item 4 of the table).
100. As Greenwood J noted at [181], item 4 in s 284-90(1) of the TAA, by which the base penalty amount is calculated, has the same effect. If the shortfall results from the taxpayer or their agent treating a tax law in a particular way which is not reasonably arguable, then a base penalty of 25% applies.
...The purpose of that statutory method is to discourage a taxpayer (either by itself or its agents) from engaging in an intentional disregard of a taxation law, recklessness and a failure to take reasonable care in the making of statements to the Commissioner about the material particulars. The Administration Act has not created an exception from liability to penalty in circumstances where a taxpayer has failed to take reasonable care but has nevertheless made a claim which is reasonably arguable. Nor has the Act effected a reduction in the amount of such penalty on such a basis. Nor has the Act released a taxpayer from a penalty on the footing that notwithstanding that it engaged in a failure to take reasonable care, the taxpayer nevertheless made a claim which was reasonably arguable.
103. At [150] of Sanctuary Lakes, Edmonds J observed:
I reject Lakes' contention that it necessarily follows that, a finding that its position was reasonably arguable, Lakes (and its tax agent) must have taken reasonable care in filing the relevant return. Similar arguments have been rejected in a number of recent decisions which have held that having a reasonably arguable position and taking reasonable care are independent standards: Federal Commissioner of Taxation v Traviati [2012] FCA 546; (2012) 205 FCR 136 at [10]-[22]; Pratt Holdings Ltd v Federal Commissioner of Taxation [2012] FCA 1075 at [167].
... the two standards of failing to take reasonable care and taking a position which is not reasonably arguable are different and independent standards (at least for the purposes of imposing liability to administrative penalty, as to which see Traviati at [36] to [39] per Middleton J; Sent v Federal Commissioner of Taxation [2012] FCA 382; (2012) 57 AAR 27 at [219] per Murphy J; Fowler v Commissioner of Taxation [2012] FCA 1040 at [135] per Kenny J and Pratt Holdings Pty Ltd v Commissioner of Taxation [2012] FCA 1075 at [167] per Gordon J)...
105. The decision being reviewed by the Full Court in Sanctuary Lakes had found a base penalty of 25% applied because the taxpayer had not taken reasonable care, although the position taken by the taxpayer was still reasonably arguable.
106. In the present case, I am not satisfied that the claims for notional deductions made by the Applicant were reasonably arguable having regard to the relevant authorities because:
(a) the Trust purchased, owned and operated the business;
(b) the Trust employed and supervised the personnel who undertook the R&D work; and
(c) all of the funds actually used for the R&D work came from the Trust (the Trust being the only entity that had funds).
I do not accept that it was reasonably arguable that, by creating an inter-entity loan account between the Applicant in its own right and the Applicant as the Trust by which costs for R&D were nominally allocated (after the costs were incurred) to the Applicant in its own right, the Applicant could be treated as having incurred the expenditure for the purposes of s 355-205 of the ITAA 97. This is particularly the case where the contingencies which would give rise to any obligation to pay the amount owed by the Applicant were at best vague, or at worst illusory.
107. While the decision of the Full Court in Desalination Technology was delivered after the Applicant had lodged the tax returns, the earlier cases to which the Full Court referred in its decision (including Coles Myer, CityLink, New Zealand Flax, Nilsen, James Flood) were an indication that the use of the inter-entity loan account in the factual scenario applying to the present case would not be a legitimate basis upon which to claim that the Applicant incurred the R&D expenditure in its own right. Ms Lyford sought to distinguish the present case from the "reasonably contrived arrangement" (see [75] above) involving invoices and an inter-company loan account used in the Desalination cases. The use of an inter-entity loan account against which expenditure was allocated after the event, in relation to which there was no agreement and the repayment terms of which were vague or illusory is, in my view, just as, if not more, contrived. In that regard, the following exchange that I had with Ms Lyford in closing is illuminating:
TRIBUNAL: I suppose in that sense one comment might be that whilst there weren't invoices - contrived invoices here, it's almost - not conceded is the wrong word, but it doesn't seem to be disputed that the need for the loan account in the first place was really in order for the company, which is the R&D entity, to be able to claim.
MS LYFORD: Yes.
TRIBUNAL: So in that sense the whole arrangement is contrived, isn't it?
MS LYFORD: Well, coming back to what you said earlier, Deputy President, there had to be a company put in place in order to register its activities and carry out the expenditure, because the trust couldn't do it.
TRIBUNAL: No - that's correct, but that sort of answers the point, doesn't it? So it is contrived in that sense. The whole point of the exercise is to create - now it may well be effective as a matter of law, but insofar as you're looking at the issuing of invoices or the raising of loan accounts, it is contrived in the sense that it is done for an ulterior purpose, which is purely in order to qualify for R&D?[86]
108. While the commercial reasons for setting up the contrived structure of an inter-entity loan account are understandable, it was done to get around the "problem" that, because the business was owned and operated by the Trust which undertook all of the activities relating to the business, including R&D, the business could not claim the R&D expenditure. That inability of the business to claim deductions for R&D expenditure, however, was the result of the choice of the Applicant to purchase and operate the business through a trust structure, presumably, because there are or were taxation or liability advantages in doing so. That choice to take advantage of a trust structure for tax or other purposes, was presumably one made on relevant professional accounting advice. The Applicant seems to have been happy to take the tax and liability advantages of operating the business through a trust structure, however, wanted also to get the tax benefits of supposedly operating part of the business through the Applicant in its own right.
109. By making the claims for the R&D deductions in the circumstances that it did, the Applicant failed to take reasonable care to ensure that it had a proper basis for doing so. Its failure to do so resulted in the statement made to the Commissioner being false or misleading in a material particular.
110. I am therefore not satisfied that the Applicant has discharged the onus of proof under s 14ZZK of the TAA that the penalties were excessive.
111. At [192] of Sanctuary Lakes, Greenwood J described the discretion to remit penalty under s 298-20 of the TAA as follows:
Section 298-20 addresses the topic of "Remission of Penalty". It applies to each penalty arising under each of the penalty regimes under Part 4-25. In order to provide the Commissioner with the flexibility necessary to determine the circumstances informing the exercise of the discretion to remit a penalty imposed under a Division of Part 4-25, s 298-20(1) simply provides that the Commissioner "may remit all or a part of the penalty". Section 298-20 does not provide for any considerations that must be taken into account in the exercise of the discretion to remit all or a part of the penalty.
112. His Honour at [193] further described the discretion under s 298-20 of the TAA in the following terms:
The discretion conferred by s 298-20(1) is unconstrained, according to its terms. It must, however, be exercised for a proper purpose; in accordance with the objects of the Administration Act; and according to law.
113. At [206]-[209] of Sanctuary Lakes, Greenwood J described the basis for the exercise of the discretion to remit as follows:
206. Upon a proper exercise of the discretion, the Tribunal might or might not conclude that the penalty imposed by the Administration Act on the taxpayer in failing to take reasonable care is to be remitted to zero. That is entirely a matter of merits assessment in the exercise of the discretion for the Tribunal in determining where the balance of factors lies. However, the exercise of the discretion must take account of the statutory scheme, the foundation upon which the Administration Act imposes the penalty and the questions that need to be examined in exercising the discretionary power to remit the penalty.
207. The Tribunal must be taken to have asked itself the question, does the object of the penalty regime justify the exercise of the discretion conferred by s 298-20(1) of Sch 1 so as to remit the penalty imposed upon the taxpayer by operation of s 284-75(1), s 284-80, s 284-85 and s 284-90 of Sch 1, to nil because the statement made to the Commissioner in the absence of reasonable care nevertheless gave rise to a reasonably arguable claim for a deduction.
...
209. In exercising the discretion under s 298-20(1) to remit, the Tribunal was required to ask itself, having regard to the evidence, what were the circumstances surrounding the failure on the part of the taxpayer or its agent to exercise reasonable care in making the statement to the Commissioner that might explain the conduct the subject of the penalty and what circumstances, on the evidence, ought to be taken into account in determining, as a matter of discretion, that notwithstanding the imposition of a penalty on the taxpayer by the Administration Act on the footing of a failure to take reasonable care in making the statement, the penalty ought nevertheless be reduced either in whole or in part, and as in this case, to nothing.
114. Justice Griffiths in Sanctuary Lakes, having reviewed the language of s 227(3) of the ITAA 36 dealing with the discretion under that act to remit penalties (which refers remission where the outcome would otherwise be harsh), observed at [247]:
In my view, there is no warrant for reading into the broad discretion conferred by s 298-20 of the TAA 1953 (or, indeed, former s 227(3) of the ITAA 1936) a requirement that the decision-maker must be satisfied that the outcome is "harsh" for the particular taxpayer in his or her individual circumstances unless penalty is remitted. One rhetorically asks what is the basis for reading into s 298-20 a term which is simply not there?
In my opinion, the correct question which arises under s 298-20 should not be expressed in terms of "harshness". Rather, the question is simply whether the decision-maker is satisfied having regard to the taxpayer's particular circumstances that it is appropriate to remit penalty in whole or in part. For example, a decision-maker might determine that it is appropriate to remit penalty in whole or in part because otherwise the outcome for a particular taxpayer would be unreasonable or unjust (and therefore inappropriate), as opposed to harsh (see the observations of McHugh and Gummow JJ in Byrne v Australian Airlines Ltd (1995) 185 CLR 410 at 465 on the different meanings of the individual words "harsh", "unjust" and "unreasonable" in a different context concerning unfair dismissal and the collocation of those words in both legislation and an industrial award).
115. In Bosanac and Commissioner of Taxation,[87] I described the exercise of the discretion under s 298-20 of the TAA as follows:
33. The Tribunal is bound and guided by the principles spelt out by the Court in Sanctuary Lakes. On that point the parties seem to be agreed. The correct question for the Tribunal as identified by the Court in Sanctuary Lakes is whether it is satisfied, having regard to the "taxpayer's personal circumstances", that it is "appropriate" to remit the penalty in whole or in part. The judgment in Sanctuary Lakes, as applied in subsequent cases, also makes it clear that the discretion in s 298-20 of Schedule 1 is broad.
116. The extent of the Applicant's submissions in the ASFIC on the issue of remission were as set out in [64(m)] above. Those submissions are, in effect, bare, conclusory assertions rather than identification of relevant facts or circumstances on which to exercise the discretion under s 298-20.
117. Ms Lyford did, however, expand on this issue in her closing submissions. She referred to Bosanac, in which I decided to partially remit the penalty (in effect reducing the penalty from 75% to 60%), and submitted that:
... given the history of the matter and the fact that throughout the entire process, from at least 2010 until 2013, there was an accountant advising them. They also had an R&D consultant, whom we heard from yesterday. They carried on without incident, until these two income years, with no reason to think that anything they were doing was wrong and I say that they did not fail to take reasonable care, in such circumstances.[88]
118. In relation to harshness, Ms Lyford in closing submitted:
... in terms of harshness, if the [A]pplicant company, and this need not be taken into account if you consider it irrelevant, I'm simply stating the fact it's likely that this company will go into liquidation and it's also likely that [CJB], himself, may become bankrupt, because he has director penalty notices issued against him. At the moment, as at 3 May, roughly, the outstanding balance, in XQDX's tax account with the ATO is $1.527570 million, comprising primary tax, shortfall interest charges, shortfall penalty, general interest charge, and penalty for non-lodgement of tax returns.
As at the end of May the outstanding balance of XQDX's - so we're looking at the whole group now, XQDX Trust PAYG BAS account is $4.2614646 million, comprising PAYG goods and services tax, general interest charges and penalties. Neither XQDX, the [A]pplicant company, nor the XQDX [T]rust is in a position to repay the ATO any of the tax liabilities or, indeed, to borrow funds from a bank or other financial institution to do so. There has been a payment arrangement in place, in relation to BAS and - PAYG, BAS and super, with the [T]rust, which has been complied with by the [T]rust. But, essentially, I'm saying that failure to remit these penalties on the basis that they didn't take reasonable care, when I say they have, will result in a very harsh outcome.
119. Mr Willinge referred to the Commissioner's practice statement PS LA 2012/5[89] that guides the exercise of that discretion which, at para 10G, provides:
Even if an entity uses a registered tax agent or BAS agent, they are still expected to take a prudent attitude to their tax affairs.
120. Mr Willinge then made the submission referred to above at [94] that, notwithstanding the opportunity to do so, the Applicant, which bears the onus under s 14ZZK of the TAA, had lead "little if any evidence ... about the advice it received or the basis for that advice."[90] He further submitted that:
... the [A]pplicant hasn't put forward a reasonably arguable position, and upholding the penalty in the circumstances of this case would not be unreasonable or unfair.
121. While it is the case, as Mr Willinge submits, that there was little evidence led by the Applicant as to the tax or legal advice it received, I am satisfied that the Applicant, or probably more accurately, CJB and LMB, acted on and put in place structures based on relevant professional advice. Mr Loaring's and Mr Langridge's statements and the evidence at the hearing made that clear.
122. The amount to which the penalties and interest have grown are, for a company of the size of the Applicant (based on its turnover/profit as indicated in the documents filed in the proceedings) very substantial. I accept that the Applicant may struggle to survive if it were required to pay the full amount of the tax shortfalls, the penalties and the interest.
123. Because of the matters identified in [121] and [122], I find that in the present case I should adopt the same approach as I did in Bosanac. I think that a partial remission of the penalties is appropriate. The reason that I think that only a partial remission is appropriate is because the Applicant chose the structure of a trust to operate its business for taxation reasons and it is not unreasonable that if it is to get the benefit of such a structure, it must also take the disadvantages of such a structure, which in this case, is not being able to claim R&D tax deductions. Balancing those factors, I conclude that a remission by reducing the effective level of the penalty from 25% to 15% is appropriate.
124. For the reasons set out above, the decision under review is varied such that the shortfall penalty of 25% payable by the Applicant is reduced to 15% for the income tax years ended 30 June 2012 and 30 June 2013.
I certify that the preceding 124 (one hundred and twenty-four) paragraphs are a true copy of the reasons for the decision herein of Deputy President Boyle
...[SGD].....................................................................
[24] Frugtniet v Australian Securities and Investment Commission (2019) 266 CLR 250; [2019] HCA 16 per Kiefel CJ, Keane and Nettle JJ at [14] and Bell, Gageler, Gordon and Edelman JJ at [51]-[53].
[26] A3, para 5.18; transcript at 26-7.
[40] Citing Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation [1981] HCA 6; (1981) 144 CLR 616 at 627; Commissioner of Taxation v James Flood Pty Ltd [1953] HCA 65; (1953) 88 CLR 492 at 506.
[41] Citing New Zealand Flax Investments Limited v Commissioner of Taxation [1938] HCA 60; (1938) 61 CLR 179 at 207; Commissioner of Taxation v Desalination Technology Pty Ltd [2015] FCAFC 96 at [45].
[43] Citing Explanatory Memorandum, Tax Laws Amendment (Research and Development) Bill 2010 (Cth) [3.55] (EM).
[45] Citing EM at [3.54] and [3.55].
[46] Citing TAA item 4, s 284-90, sch 1.
[48] Citing Sanctuary Lakes Pty Ltd v Commissioner of Taxation [2013] FCAFC 50; (2013) 212 FCR 483 at 534-5.
[50] Citing the Applicant's accountant's email exchange with ATO in December 2014 (T179).
[54] Citing Desalination Technology at [45].
[56] Citing EM at [3.54] and ITAA 97 s 355-210, noting "also known as 'on own behalf' requirement".
[75] A1, paras 3.17, 4.8(b); Evidence of CJB, transcript at 33.
[78] Desalination Technology at [45]; see [71] above.
[81] See Copyright Act 1968 (Cth) s 196.
[82] See Sands & McDougall Pty Ltd v Robinson (1917) 23 CLR 49; [1917] HCA 14 at 55 (Isaacs J).
[89] Australian Taxation Office, Practice Statement Law Administration (PS LA 2012/5, 25 June 2020).
(1993) 176 CLR 640
(1981) 144 CLR 616
(2013) 212 FCR 483
(1917) 23 CLR 49
(1977) 14 ALR 651
(1940) 63 CLR 382
(2012) 205 FCR 136
(1995) 185 CLR 410
(1953) 88 CLR 492
(2006) 228 CLR 1
(2019) 266 CLR 250
(1938) 61 CLR 179