Use of the small business capital gains tax (SB CGT) concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) is a commonly audited and appealed area of the income tax law.
In the recent case of The Executors of the Estate of the late Peter Fowler and Commissioner of Taxation (Taxation) [2016] AATA 416 (22 June 2016)the taxpayer’s representative was unsuccessful in proving that the taxpayer was carrying on a business meaning that the taxpayer wasn’t able to access the SB CGT concessions.
The significance of the decision was not that the taxpayer wasn’t able to claim the SB CGT concessions. Rather, more notable was the tribunal’s decision to set aside the administrative penalty for failing to take reasonable care (equal to 25% of the shortfall amount) because the safe harbour conditions were satisfied by the taxpayer. There are lessons in this for all taxpayers and their tax agents.
Background
The taxpayer acquired a property (a block comprised of 10 residential units) with his wife in 1986. He became the sole owner of it in 1994 when his wife died. The property was sold in the 2012 income year and a gross capital gain of approximately $3.4 million was realised, however the net capital gain was reduced to nil by application of the general CGT discount (approximately $1.7 million) and SB CGT concessions. The Commissioner issued an amended assessment that allowed the use of the general CGT discount but denied the SB CGT concessions resulting in an increase in the taxable income of the taxpayer of approximately $1.7 million. After unsuccessfully objecting to the amended assessment, the taxpayer applied to the Administrative Appeals Tribunal (AAT) for a review of the Commissioner’s decision.
No business being carried on
The evidence surrounding the degree of the taxpayer’s involvement in the use of the property was patchy, due largely to the fact that he had died prior to the matter coming before the AAT. Most of the evidence came from his son who stated that his father conducted a number of day to day activities such as advertising, interviewing prospective tenants, supervising tenant inspections, cleaning units, etc. and also undertaking refurbishments. Deputy President Frost was ultimately unconvinced that the degree of the taxpayer’s involvement was sufficient to draw the conclusion that a business was being carried on. As such, the tribunal affirmed the $1.7 million increase in the taxpayer’s amended assessment due to not being able to use the SB CGT concessions. That is, only the general CGT discount could be applied to the gross capital gain.
Penalty for failing to take reasonable care set aside as safe harbour rule applied
In the amended assessment, the taxpayer received an administrative penalty for failing to take reasonable care when making a statement to the Commissioner.
Although the argument that the taxpayer exercised reasonable care was unsuccessful, Deputy President Frost was satisfied that the conditions to rely on the safe harbour rule in s 284-75(6) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) were met. Consequently, the administrative penalty equal to 25% of the shortfall amount was set aside.
Given the amount of the capital gain, the remission of the penalty was a significant victory for the taxpayer’s estate, effectively allowing them to escape punishment despite incorrectly claiming the SB CGT concessions.
The safe harbour provision in s 284-75(6) of Schedule 1 to the TAA 1953 provides as follows:
“You are not liable to an administrative penalty under subsection (1) or (4) if: (a) you engage a *registered tax agent or BAS agent; and (b) you give the registered tax agent or BAS agent all relevant taxation information; and (c) the registered tax agent or BAS agent makes the statement; and (d) the false or misleading nature of the statement did not result from: (i) intentional disregard by the registered tax agent or BAS agent of a *taxation law (other than the *Excise Acts); or (ii) recklessness by the agent as to the operation of a taxation law (other than the Excise Acts).”
At paragraph 40 of the decision, Deputy President Frost was satisfied that the taxpayer engaged a registered tax agent (satisfying (a)), the tax agent made the statement (satisfying (c)), and there was no assertion by the Commissioner that the statement resulted from either intentional disregard of the law or recklessness (satisfying (d)).
The relevant question that came under consideration was whether the taxpayer gave their tax agent all the relevant taxation information as required by (b).
As the following excerpt from within paragraph 44 of the decision shows, Deputy President Frost was satisfied that the taxpayer gave their tax agent all relevant information.
“The question instead is, did Greg Fowler [the taxpayer’s son] provide to Mr Bertram [the taxpayer’s registered tax agent] ‘all relevant taxation information’? And the answer to that, in my view, is yes. Greg Fowler’s initial outline of the circumstances led to Mr Bertram’s preliminary opinion that the exemption was not available because he considered that Mr Fowler had not been carrying on a business. But by the end of the first meeting he had reached at least a tentative view that the exemption may be available [24]. That evolution in his thinking can only have come about as he listened to Greg Fowler’s explanation of his understanding of his father’s activities. The explanation of the activities – which necessarily included a reference to the fact that the units were tenanted – together with the undisputed fact that Mr Fowler had owned the property for over 15 years, was the relevant taxation information that needed to be provided so that Mr Bertram could form a view on the CGT position and then lodge the return. Mr Bertram may have got the answer wrong, but provided there was neither recklessness nor an intentional disregard of the law, the ‘safe harbour’ in s 284-75(6) applies.”
Footnote 24 in the above extract that noted that the tax agent had formed a tentative view that the exemption may be available stated as follows:
“(24)Supported by the contemporaneous email sent by Greg Fowler to his sister on 30 March 2012, the day after the first meeting, in which he said ‘The fact that we believe it is correct [that is, “Dad being an active investor until he was placed into a home”] and by all accounts from what we have read is correct, including preliminary assessment by the accountant’: Exhibit A3 [200]”
Conclusion
Tax agents and their clients should take note of the above comments and contemporaneously document their discussions with each other to prove the tax agent was given all relevant information necessary to make the statement. Although the onus of proof is on the taxpayer to demonstrate that they provided their tax agent with all the relevant information, practically, it is incumbent on the tax agent to request as much information as possible from their client and document this one way or another as their client will often not know what to give to their tax agent. This will allow the tax agent to show that they have all information necessary to form a view of how the law operates to the relevant matter prior to making any statements (such as lodging a tax return) to the Commissioner. In turn, this will give their clients the best chance of successfully arguing that the safe harbour rule applies in the event that that the taxpayer has understated their tax liability.
Had the ATO also sought to impose a penalty for failing to have a reasonably arguable position, as they often do, it would have been interesting to see whether this also would have been set aside. Such a penalty also carries a base penalty of 25% of the tax shortfall amount. When penalties for failing to have a reasonably arguable position and failing to take reasonable care are applied, the penalty is only applied once pursuant to s 284-90(2) of Schedule 1 to the TAA 1953. A reasonably arguable position would have required the position taken to have been as likely to be correct as incorrect. There was scarce evidence of a business being carried on, and even if that argument had been successful, the CGT asset may also have been excluded from being an active asset under the mainly used to derive rent exclusion. It seems likely that the position taken by the taxpayer in relation to satisfying the basic conditions to gain access to the SB CGT concessions would not have been reasonably arguable, with the consequence that the 25% shortfall penalty would have stood for this reason. This seems to have been an oversight by the Commissioner.
Accordingly, even though the conditions to rely on the safe harbour rule should relatively easily be met with contemporaneous documentation, tax agents need also to be confident of the accuracy of their position under the law prior to making statements to the Commissioner (i.e. lodging returns). If there is uncertainty in the law, or difficulty applying it, a private binding ruling request may well be the path to go down. Chances are the claim for the SB CGT concessions will be reviewed anyway.
