Intermingling of funds and evasion – some principles of tax litigation and a warning to taxpayers and their advisers

The Administrative Appeals Tribunal (AAT) has affirmed the Commissioner of Taxation’s objection decisions relating to unexplained bank deposits and loan account credits pertaining to the relevant taxpayer, Mr Buzadzic: Buzadzic & Anor v FC of T 2021 ATC ¶10-606; [2021] AATA 4820, 24 December 2021.

The case highlights the serious difficulties faced by a taxpayer seeking to discharge the burden of proof and demonstrate that assessments are excessive, where private and business sourced money are intermingled and where the records kept, and procedures adopted do not allow for an effective “unmingling” process. Mere assertions or speculation are not sufficient to satisfy the onus of proof. It is incumbent on the taxpayer to lead sufficient evidence to support its submissions.

The overall tax shortfall for Mr Buzadzic was $1.8 million, with penalties and Shortfall Interest Charges totalling $2.3 million.

The decision is instructive for taxpayers and their advisers as to some of the principles which apply in relation to tax litigation, audits, objections or other tax controversy.

The taxpayer has appealed the decision of the AAT to the Federal Court.  However, in the authors' view, the tax litigation observations referred to above remain as fundamental considerations in the area of tax controversy.

1. Burden of proof

The Taxation Administration Act 1953 (Cth) provides the taxpayer bears the onus of proving that the amended assessment is excessive.

This burden is not discharged by showing an error in the basis on which the amended assessments were issued. Rather, it is for the taxpayer to demonstrate what their actual taxable income is and that the amount determined by the objection decision is excessive.

The taxpayer must discharge the burden of demonstrating, on the balance of probabilities, the true amount of the taxpayer's taxable income and thus the amount determined by the objection decision is excessive (refer to Nettle J in Bosanac v F. C. of T. [2019] HCA 41).

The AAT [at para 128] noted that in a case where there were unexplained deposits and unexplained reduction in liabilities, it is incumbent on the taxpayer to lead evidence that explains how those distributions and dividends were paid (whether in cash or book entry), how the distributions had been reflected in their taxable income as returned and how those dividends and distributions explain decreases in personal liabilities. 

Ultimately, the AAT was not satisfied that the assessments were excessive. In part, the AAT considered Mr Buzadzic’s oral evidence concerning the deposits was, for the most part, “speculative and unreliable” [para 150].

2. Reasonableness of proof required / lack of documents

The taxpayer submitted it was not reasonable to expect a person to retain records for an indefinite period and that no adverse finding should be made merely because the taxpayer was unable to produce contemporaneous records [para 108].

The AAT noted that while that proposition might be of some influence in some cases, the obligation to retain, and expectation to retain appropriate records, depends on the nature of the transaction and whether it is of a kind that would result in retention of documents in the circumstances [para 109].

The case included 3 trusts and 16 companies with which Mr Buzadzic was associated, repeated intermingling of substantial volume and value of business transactions with private arrangements, repeated intermingling of funds of separate businesses and their owners and an apparent reluctance to do what the group’s external accountants usually ask of their clients.

The above circumstances suggested there might be expected to be a business record or trail that set out the provenance of the deposits and credits and thus threw light on whether the deposits and credits revealed, or were the produce of, an undisclosed source of income [para 109].

The AAT noted that using available funds and credit cards and intermingling of various entities’ money (including personal money) is not of itself improper and that there may be various reasons for managing money this way [para 104].

However, the AAT stated that the circumstances of the case required a degree of record keeping that ensured that amounts transferred between accounts of different entities and for different purposes were accurately accounted for and could be explained if the need arose (as it did). 

By merging his business and personal affairs in the way he did, Mr Buzadzic created a situation that made these tasks difficult, reflecting the warning made by Davidson AJ in Sabiel v FC of T [1926] ITDA 87 where his Honour said:

Although a person is not bound to keep the best of books or the best system of accounting that is available, nevertheless, if through the want of records of this kind he falls into a position which is hostile to himself, he has to put up with it unless he can establish from other facts appearing in evidence that the case he is putting forward is correct.

A failure to create and retain records can have consequences for a taxpayer seeking to discharge its onus of proof. In this case, the AAT considered the inconsistent vague recollections of Mr Buzadzic amounted to no more than speculation and was not evidence that could be accorded any weight [para 107].

3. Corporations Act s 1305 and double entry accounting

Under section 286 of the Corporations Act 2001 (Cth), all proprietary companies must keep financial records that correctly record and explain its transactions. 

The taxpayer relied upon section 1305 of the Corporations Act as supporting a contention that the final accounts of an entity are prima facie evidence of the matters recorded in them.

The AAT considered section 1305 of the Corporations Act provided very limited assistance to the taxpayer, and the section only provides that such books are prima facie, but not conclusive evidence of the matters recorded in them. 

The Commissioner was thus entitled to interrogate the accounts, with the AAT noting that the accuracy of the records depended on the accuracy and completeness of the information provided to the bookkeeper. Ultimately, the AAT was not satisfied that all information relating to Mr Buzadzic’s dealings was accurately provided to the bookkeepers.

The AAT also noted, double entry accounting system entries under which each debit must have a corresponding credit was only to be taken at face value and cannot be taken to explain the transactions giving rise to certain entries unless supported by forensic examination [paras 118 / 119].

4. Use of estimates by the Commissioner

The AAT suggested that even where the Commissioner may have relied on inexact evidence in making the assessments, any role of estimates was very limited and in any case, the Commissioner had identified particular occurrences which called for explanation that the taxpayer was not able to provide.

5. Fraud or evasion

The taxpayer submitted the amended assessments were excessive because they had been issued outside of the time limits (generally four years) provided for in section 170 of the Income Tax Assessment Act 1936 (Cth) and the Commissioner had no basis for forming an opinion that there had been fraud or evasion [ para.197].

The AAT observed the taxpayer carries the onus of showing that there was no fraud or evasion or that the Commissioner had not formed the requisite opinion. There is no onus on the Commissioner to show that the assessment was correctly made [para.198] [Refer to Binetter v F. C. of T. [2016] FCAFC 163; 249 FCR 534 at [93]; Nguyen v F. C. of T. [2018] FCA 1420; 265 FCR 355].

There being no dispute that the Commissioner had formed an opinion that there had been evasion, the issue before the Tribunal was whether it was satisfied that the taxpayer had discharged the onus of showing the opinion of evasion should not have been formed.

‘Evasion’ for these purposes means more than the mere withholding of information or the mere furnishing of misleading information. Some blameworthy act or omission on the part of the taxpayer or those he is responsible for is required [para. 200] [Refer to Denver Chemical Manufacturing Co v Commissioner of Taxation (NSW)[1949] HCA 25; 79 CLR 296 at 313].

A taxpayer may demonstrate that there was no fraud or evasion by showing no amount omitted was from taxable income; for example, by showing that the amounts were not assessable as was the case in Binetter v FC of T [2016] FCAFC 163. Alternatively, a taxpayer could demonstrate that the amounts, while assessable, were not included in assessable income returned for a reason that shows that while there was a shortcoming, it was a shortcoming that fell short of a blameworthy act in the Denver Chemical sense. For example, there will be no fraud or evasion if the taxpayer can show a reasonable excuse for omitting the amount [Wilson v Chambers & Company Pty Ltd[1926] HCA 15; 38 CLR 131].

To discharge the onus regarding fraud and evasion, Mr Buzadzic needed to provide evidence as to the sources of the amounts deposited into the bank accounts. The AAT considered that Mr Buzadzic failed to demonstrate the omission of the relevant amounts from his assessable income were not attributable to a blameworthy act.

Mr Buzadzic also contended there was no basis that he had engaged in fraud or evasion because he was a panel beater with limited education who relied upon his employees and external accountants in order to comply with his taxation obligations. He had no knowledge of the provisions of the Income Tax Assessment Act 1936 and could not have understood that unverified credit entries comprising discrepancies in loan accounts with various companies and discrepancies between closing and opening balances of some loan accounts were assessable income.

The AAT [at para 204] had a number of difficulties with this submission:

  • the submission did not lay a foundation to come to a conclusion that there was not a blameworthy act;
  • a taxpayer is responsible for the acts of his employees and agents. The blameworthy act may be that of the taxpayer personally or of those he is responsible for; and
  • a taxpayer does not discharge their onus of showing an absence of evasion based on a contention about their subjective level of understanding of the operation of the income tax legislation. To allow otherwise would be to reward fiscal naivety. 

If you would like further information or to discuss your own circumstances, please contact a member of our Taxation team

 

|By Saxon Rose & Michael Patane

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