Tax disputes and the burden of proof: Are your clients on the ATO’s radar?

Given the ATO’s increasing use of data and analytics as an administrative and law enforcement tool, there is certainly a risk of taxpayers being subject to ATO compliance activities. When challenging an assessment there is a misconception that a taxpayer’s onus of proof is discharged merely by showing that the Commissioner’s assessment is wrong. This article considers the standard of proof required in the context of default assessment.

It is a known fact that the ATO collects data from a range of government agencies and organisations, and cross-references the data collected to internal information obtained from returns/statements lodged. Through a range of data matching programs, the ATO is able to profile taxpayer risks, compliance obligations, and select tax cases for reviews. For example, the ATO lifestyle asset data matching program enables the ATO to obtain information from a range of insurance policies providers for certain ‘lifestyle’ assets. This data is used to identify discrepancies between accumulated assets and income reported, not declaring profits on assets sold, assets acquired for personal use through businesses and related entities and claiming GST credits, and not paying FBT.

The ATO can also access data from a range of government agencies including AUSTRAC to identify unreported financial transactions, international money transfers and anyone involved in tax fraud or tax evasion.

When can the ATO issue default assessments?

Where the ATO is dissatisfied with information furnished in a return lodged, or has reasons to believe that a taxpayer who has not lodged a return has derived income, they are empowered under s.167 of the Income Tax Assessment Act 1936 (ITAA 1936) to make a default assessment. The ATO may also raise default assessments to taxpayers who have overdue lodgement obligations.

Satisfying the burden of proof

When challenging an assessment whether at the objection stage, at the Administrative Appeals Tribunal (AAT) or in the Federal Court a taxpayer bears the burden of proving that the assessment is excessive or otherwise incorrect and what the assessment should have been. There is a misconception that a taxpayer’s onus of proof is discharged merely by showing that the assessment is wrong or there were errors in the ATO process to arrive at the amount assessed. Judicial decisions confirm that in order to establish an assessment as excessive, a taxpayer must proof unequivocally what their actual taxable income was and in doing so show that the tax levied exceeds the actual liability.

Unlike an ‘ordinary’ assessment under s.166 ITAA 1936, when making a default assessment, it is entirely appropriate for the ATO to form a judgement as to the amount of taxable income upon which income tax ought to be levied. Techniques that the ATO may employ as the basis for a default assessment include the use of external information, industries benchmarks, indirect audit methodologies such as asset betterment calculation.

Due to the nature of default assessments, the amount of tax levied may not accurately reflect the facts and thus would not be precisely accurate. Nonetheless, a taxpayer bears the evidential burden of proof. In the context of a default assessment based on the asset betterment method (or any other methods), that burden is discharged only when the taxpayer is able to satisfactorily explain the source or sources for their unexplained wealth and identify that those sources are not taxable.

The following recent cases with respect to default assessments highlight the burden and standard of proof required by taxpayers to show that an assessment is excessive.

Cammarano’s case

In Cammarano and Commissioner of Taxation (Taxation) [2022] AATA 3910 (21 November 2022) the taxpayers Robert and Aniello were regular gamblers at Crown Casino Melbourne. Based on information reported to AUSTRAC, the ATO conducted a covert audit. Data obtained from Crown Casino Melbourne of their membership cards showed discrepancies between the taxpayers extensive gambling activities and the income reported in their tax returns for the years under review. The ATO concluded that funds used by the taxpayers to finance their gambling loses and gaming chips purchased represented funds available in some form and that the taxpayers had received unreported and unexplained income to fund those gambling activities. The ATO issued default assessments, the effect being the taxpayers combined taxable income were increased by more than $3.7 million.

The taxpayers had the onus of satisfying the Tribunal that their gambling activity was sourced from non-income sources or after-tax income originally returned.

It was found that  in failing to establish what their actual incomes were the taxpayers had failed to establish that the default assessments were excessive. The taxpayers’ statements did not detail or explain what their actual gambling activities were, nor did they provide any evidence for the actual source of funds expended.

Le’s case

In Le v Commissioner of Taxation [2021] FCA 303 (30 March 2021)  the taxpayers, Ms Le and Mr Trieu filed returns that reported relatively modest income for the 2005 to 2012 years. Upon completion of an audit, the Commissioner adopted an asset betterment approach and issued default assessments based on the annual change in their net worth for the years under review. The default assessments were made on the basis of fraud and evasion.

In ascertaining what would be the taxpayers net worth under the asset betterment method the ATO assumed all payments (or debits from bank accounts) were expenses for which a corresponding amount of income was derived (and thus were unexplained income). The ATO also assumed gambling expenditure obtained from records maintained by Treasury Casino were sourced from income derived and not reported. In assessing Ms Le, the ATO included as unexplained income the amounts that she contributed towards ‘hui’ (an informal lending system common among Vietnamese communities).

In the first instance, the AAT decided that the taxpayers had failed to discharge their burden of proving that the assessments were excessive. The taxpayers appealed the AAT decision contending that the AAT had failed to consider key elements of their explanations of non-income sources for which the ATO considered were unexplained accumulated wealth. Evidence provided by the taxpayers to support their argument of the monies having a non-income source (which the AAT had failed to consider) include the taxpayers having derived a large windfall gain ($500K) from gambling before the periods under review, bank statements showing numerous transactions of cash withdrawals from one account and depositing of the same into another (which were not income as the ATO had assumed for the purposes of the taxpayers’ asset betterment statements), evidence of persons, where given, of loans (or ‘hui’) provided by the taxpayers to third parties (and loans/hui from third parties to the taxpayers). There was also some inherent and illogical inconsistency in the AAT’s decision between accepting on one hand that the taxpayers had derived but not declared interest income on loans/hui and on the other, not accepting that the transactions that yielded these interests payments were loans rather than income as purported by the ATO. This amounted to an error of law and his Honour Justice Logan J allowed the taxpayers’ appeal and remitted the matter to the AAT for a rehearing.

Ross case

In Commissioner of Taxation v Ross [2021] FCA 766 upon the conclusion of a covert audit, the ATO issued default assessments based on the asset betterment methodology to the taxpayers (Mr. and Mrs Ross), increasing their combined taxable income by almost $1.3 million plus significant administrative penalties.

Central to the dispute was whether the taxpayers were able to discharge their onus by giving explanations for some of the transactions and assets identified in the Asset Betterment Statements and otherwise giving an account of the transactions in their bank accounts.

It was found that the taxpayers did not satisfactorily explain from the evidence submitted what their actual taxable incomes were for the relevant years.

Are your clients on the ATO radar?

As can be seen, default assessments are not confined to taxpayers at the ‘top end of town’. The nature of default assessments and the standard of proof required means taxpayers face an uphill battle when challenging a tax assessment. As the above cases show, the only taxpayer who is likely to be successful is the one who has evidence to fully explain the relevant transactions. The evidentiary burden to successfully challenge an assessment is not confined to litigation but applies to all stages of the dispute cycle from tax review, tax audit, assessment, objection to the AAT/Federal Court. Given the ATO’s increasing use of data and analytics as an administrative and law enforcement tool, practitioners and their clients should be prepared for any ATO risk review activities and be able to discharge the burden of proving the tax position taken including where applicable the source or sources of their alleged ‘unexplained wealth’.

This article provides a general summary of the subject covered as at the date it is published. It cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

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