An “uncredible” win for the taxpayers…

ATO audits seem to be delving deeper and going longer, and there appears to be more taxpayers disputing amended and default assessments at the Administrative Appeals Tribunal (AAT). These disputes often focus on the need for the taxpayer to discharge its onus of proof that the assessments are excessive. This requires to the taxpayer to determine the correct amount of assessable income, therefore showing the Commissioner’s calculation to be excessive. Often, this includes the taxpayer justifying the source of deposits into bank accounts and why they are not assessable income.

However, the recent Federal Court decision in Liang v Commissioner of Taxation [2024] FCA 535 (Liang) has shown a commonsense approach can be used in determining whether a taxpayers’ amended assessments are excessive.

Liang is an appeal from an AAT decision from December 2023, CVMW and Commissioner of Taxation [2023] AATA 4039, which affirmed amended assessments issued by the Commissioner.

The facts of the case are not overly complicated. The taxpayers, Zhi Dong Liang and Lai Chu Yeung, are husband and wife. They operated two restaurant / takeaway businesses via discretionary trusts. Separate to these businesses, they also controlled a corporate trustee of a trust that conducted property investment activities, referred to hereafter as the Trustee and Trust respectively.

The case revolves around the nature of seven deposits totalling $735,825 made into the Trust’s bank account during 2017 and 2018. The deposits ranged from $7,475 to $220,000. The Trust had made a number of property acquisitions in those years, including 2 units in Melbourne and 2 vacant blocks in rural Victoria.

The ATO treated the deposits as income of the Property Trust under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), therefore increasing the Trust’s income under section 97. As a result, the beneficiaries’ assessable income was increased as they were presently entitled to the Trust’s income. Penalties were then imposed at 50%, based on the taxpayers’ behaviour being regarded as reckless.

The main issue was the nature of the deposits and whether or not the taxpayers had discharged their burden of proof that their assessments were excessive. According to the AAT it was up to the taxpayers to prove that the deposits were not income within the meaning of section 6-5, and the taxpayers had failed to do that.

In oral evidence given before the AAT, the details surrounding the deposits were scant or inconsistent. The taxpayers said their parents either loaned or provided equity contributions to the Property Trust to fund the acquisitions. However, cash had been provided by the parents without documentation, or confirmation whether they were equity contributions or loans. The taxpayers made no inquiries as to where their parents got the cash from, whether the funds were provided to them individually or to the Trust. There was no documentation regarding whether repayments were going to occur or any other terms of the so called “loans”. The taxpayers also declined to answer questions whether their parents entered into Australia with the cash (which would surely have required a decent sized suitcase or an oblivious border security officer!), or why their parents had left large amounts of cash sitting in the taxpayers’ house.

Not surprisingly, the AAT was not impressed with the taxpayers’ evidence.

According to paragraph 83 of the AAT decision:

While it may be generally accepted that there is no issue with taxpayers engaging in cash transactions (cash is after all a legal form of tender), it is also the case that undocumented transactions involving large amounts of cash would naturally attract the Commissioner’s interest in tax audits. The predicament for taxpayers is that, absent any independent corroboration of the alleged sources of the cash, the reliability of the evidence of the taxpayers becomes critical.

Ultimately the AAT rejected the reliability of the evidence of the taxpayers. Specifically:

… Their evidence, in the absence of any independent contemporaneous documentation or records, was not credible in all the circumstances. Even if their evidence regarding the different cultural attitudes to cash were accepted … it would carry little weight. This is because the evidence was similarly high-level and anecdotal in nature. Significantly, that evidence failed to support the position of Mr Chen and Ms Li it did not relevantly address how and where Ms Li’s mother and/or Mr Chen’s parents obtained the cash and brought it to Australia. It may be that some matters advanced by one or both of Ms Li and Mr Chen were truthful, but in the absence of sufficiently reliable evidence, the Tribunal was not satisfied to the requisite degree. It follows that the Tribunal cannot be satisfied, on the balance of probabilities, that the Deposits were cash provided by Ms Li’s mother and or Mr Chen’s parents.

The taxpayers then appealed to the Federal Court.

There were two essential issues for the Federal Court:

1. Had the AAT misunderstood the meaning and effect of section 14ZZK of the Taxation Administration Act 1953 in relation to the burden of proof; and
2. Had the AAT failed to discharge its function, notwithstanding reaching a conclusion that it could not rely upon either the oral evidence of each of the taxpayers or the descriptions given to the various deposits in the Trust’s accounts.

The Federal Court noted that it was accepted between the parties that the Trust engaged only in property investment. It did not provide services to anyone. Both parties also accepted that the deposits were not interest, dividends or a gain made with a profit-making purpose that would form part of the ordinary income of the Trust.

The taxpayers argued that the Tribunal had to consider whether:

… on the material before it and having regard to what was not at issue, the assessments had nonetheless been proved to be excessive. It was submitted that the Tribunal had failed to do this, and in so doing had thereby failed to discharge its statutory function of reviewing, on the merits, the objection decision. It was put that, on the material before the Tribunal and given what was not in dispute, that material ought to have led to a conclusion that Mr Chen and Ms Li had nonetheless proved the assessments to be excessive. (emphasis added)

In turn, the Commissioner argued that the taxpayers failed to prove the assessments were excessive.

The Federal Court judgment refers to Elsey v Commissioner of Taxation (Cth) (1969) 121 CLR 99 (Elsey). In that case, at [108], Windeyer J stated:

The taxpayer has “the burden of proving that the assessment is excessive”… But, unless it appears that there were facts on which the Commissioner could properly rely for including a particular receipt of money as part of the taxpayer’s assessable income, that burden is, I consider , discharged. I do not think the Act requires one to start with a presumption that all moneys which a taxpayer receives from any source form part of his assessable income. (emphasis added)

In another case cited in the judgment (Krew v Commissioner of Taxation (Cth) (1971) 45 ALJR 324):

I think that some of the submissions made to me failed to recognize the foregoing considerations. It was said that, where there is a surplus of assets, over those which would be explained by returned income, there is no presumption that that surplus is income, or is assessable income. In a sense that is true: cf. Elsey v. Commissioner of Taxation (Cth) (1969), 43 A.L.J.R. 415, at p. 422.

The various cases cited deal with the onus of proof and particularly whether, if a taxpayer’s evidence is not credible, other sources of evidence be taken into account when determining whether or not the onus of proof is discharged.

According to paragraph 52 of the judgment:

In my view, the Tribunal has forgotten, with respect, that a rejection of the evidence of Mr Chen and Ms Li did not inexorably lead to a conclusion that the objection decision must be affirmed. That rejection did not relieve the Tribunal from its obligation to review, on the merits and on the material before it, the objection decision in light of the issue as refined and particular concessions. The question was always whether Mr Chen and Ms Li had proved the assessments to be excessive. It remained possible, and their submissions to the Tribunal embrace this, nonetheless for the assessments to be shown to be excessive just on other material before the Tribunal and what was common ground.

Importantly, at paragraph 55 of the judgment:

In terms of the material before the Tribunal, including concessions, these Deposits were not income from services, were not interest, were not dividends, were not opportunistic profit-making gains. It is also conceded, as indeed the very amount of the Deposits would suggest, that those Deposits were not in the nature of rent in respect of the investment properties. The material before the Tribunal ought, in my view, to have led the Tribunal inexorably to a conclusion that whatever these Deposits might be, they were not, in the hands of the Property Trustee Company, income.

Based on the above, it appears that Justice Logan has taken a commonsense approach, using a process of elimination. That is, if a taxpayer only earns specific types of income and the amount does not fit within those types of income, the fact the taxpayers have not convincingly explained where the amounts have come from, or the character of those amounts such as whether they are loans or equity contributions doesn’t necessarily deem the character of the deposits to be income.

There are some additional considerations that mean this approach won’t apply in all situations:

• This case involved an amended assessment, not a default assessment. It was noted in the judgment that if there had been a default assessment, it is always for the taxpayer to show what his or her income is.
• Further, the case was confined to the deposits into the bank accounts, meaning the taxpayers only had to prove the deposits were not income, and not prove that the broader assessments were excessive.
• A process of elimination approach might not work in all situations. For example, the related businesses did not seem to form part of the dispute which would have broadened the possiblities of the types of income that the money could relate to.
• The case suggests that it’s not the taxpayer’s responsibility to justify the source of relatives’ assets or cash balances, which seems to be the correct approach (especially if you aren’t aware of your family members private details) but this might not always be appropriate particularly in family run and controlled taxpayer groups.

Although a lack of taxpayer credibility may not have hindered the taxpayers in this case, it is certainly not the recommended approach. Having better records and documentation, and being able to keep the story straight, particularly when recalling making deposits of hundreds of thousands of dollars, may have saved the taxpayers the cost and pain of a long-winded dispute with the ATO.

So, while this appears to be a good win for the taxpayer, more importantly this case may be seen as a win for all taxpayers if it affects the ATO’s position that taxpayers must document and prove the tax treatment of every last dollar!

While an AAT decision has no precedential value, the importance of this decision to the ATO is made clear given the Commissioner has now lodged an appeal to the Full Federal Court. Whether it relates to the facts of the case or the underlying principles regarding the onus of proof remains to be seen.

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