Vision Intelligence Pty Ltd and Commissioner of Taxation  AATA 527
Last Updated: 30 July 2013
 AATA 527
||TAXATION APPEALS DIVISION
||Vision Intelligence Pty Ltd
||Commissioner of Taxation
||Professor R Deutsch, Deputy President
||30 July 2013
The Tribunal sets aside the Respondent’s objection decision and substitutes a decision that the objection is allowed in part so as to reduce the penalty to 25% of the shortfall amount for failure to take reasonable care in the income tax year ended 30 June 2009.
Professor R Deutsch, Deputy President
TAXATION AND REVENUE – income tax – research and development offset – claim for offset disallowed on the basis the contracted expenditure had not been incurred in the year of income – penalty – whether the applicant failed to take reasonable care – whether penalty should be remitted – objection decision under review set aside
Income Tax Assessment Act 1936 ss 73B, 73J
Taxation Administration Act 1953 Sch 1, 284-15, 284-75 284-90, 298-20
Coles Myer Finance Ltd v Commissioner of Taxation  HCA 29; (1993) 176 CLR 640
Commissioner of Taxation v CityLink Melbourne Limited  HCA 35; (2006) 228 CLR 1
Commissioner of Taxation v James Flood Pty Ltd  HCA 65; (1953) 88 CLR 492
Dixon v Federal Commissioner of Taxation  FCAFC 54; (2008) 167 FCR 287
Federal Commissioner of Taxation v Burness  FCA 1021; (2009) 77 ATR 61
Hooker-Rex Pty Ltd v Commissioner of Taxation (1988) 19 ATR 1241
New Zealand Flax Investments Ltd v Commissioner of Taxation  HCA 60; (1938) 61 CLR 179
Re Johnston and Federal Commissioner of Taxation (2011) 81 ATR 908
Re Necovski and Federal Commissioner of Taxation  AATA 195; (2009) 75 ATR 152
REASONS FOR DECISION
Professor R Deutsch, Deputy President
30 July 2013
- The Applicant is, and was, at all relevant times an Australian resident company having been incorporated on 2 June 2009. Previously, the Applicant was called DataRail Pty Ltd.
- The directors of the Applicant are experienced in engineering and software development in the visual surveillance industry, and the Applicant was heavily involved in that industry broadly since its incorporation.
- In respect of the year ended 30 June 2009, the Applicant lodged its income tax return claiming a refundable Research and Development (“R&D”) tax offset for that year.
- The Applicant engaged a management and technology consultancy firm called Capital Technic Consulting Pty Ltd (“CTC”). This engagement was effected by the Applicant, on 5 June 2009, entering into what was described as an “R&D Funding Support Agreement” with CTC under which the Applicant agreed to pay to CTC:
- $11,000 (inclusive of GST) as an upfront non-refundable retainer fee; and
- 12.5% of “the total of all amounts awarded by the ATO to the applicant for the annual R&D Claim, less the Engagement Retainer” as a success fee.
- In addition, on 15 June 2009 the Applicant entered into a further agreement known as the Research and Development Services Agreement (“the R&D Agreement”), with a company called ThorSol Technologies Pty Ltd (“ThorSol”). ThorSol is, and was, at all relevant times an Australian resident company which was related to CTC. It was a Registered Research Agency which was recommended by CTC.
- Under the R&D Agreement, the Applicant appointed ThorSol as its “prime R&D contractor to undertake research and development activities” for the Applicant.
- On 30 June 2009 ThorSol issued an invoice to DataRail Pty Ltd (being the former name of the Applicant), which was expressed to be for “Research and Development Services subject to contract variation”. The project title was in respect of “Rail Network Video Records” and it indicated that the start date for the work was 1 June 2009 and the finish date was 30 June 2010. The invoice was for an amount of $916,420 which was described as the “Estimated value” plus a PMO Fee of $74,304 plus GST of $99,072.40. This gave rise to a total amount of the invoice including GST of $1,089,796.40.
- The amount of the invoice was and remains largely unpaid to date.
- On 13 July 2009 the Applicant’s R&D activities were registered under s 39J of the Industry Research and Development Act 1986.
- On 9 September 2009 the Applicant lodged its income tax return for the 2009 year through its tax agent, Mr Maurice McKinnon of Horizon Accounting.
- In that return the Applicant claimed $990,724 of “contracted expenditure” on R&D and a corresponding R&D tax concession of $1,238,405. Accordingly, a refund of $371,521.50 was sought – that amount having been calculated as 30 per cent of $1,238,405.
- In November 2009, the Respondent contacted the Applicant and asked for further information regarding the R&D expenditure, and this was followed by a series of communications between the parties.
- On 7 January 2010 the Respondent sent the Applicant a “Taxpayer Alert” relating to R&D arrangements of the type promoted in these circumstances, and provided the Applicant with an opportunity to seek voluntary disclosure of any relevant errors which may have been made in lodging its tax returns. The Applicant did not make any such voluntary disclosure of any error which may have been made in claiming the R&D offset.
- On 6 May 2011 the Respondent amended the 2009 income tax assessment by disallowing the R&D offset. At that stage, no refund had been paid by the Respondent to the Applicant.
- The Respondent took the view that the Applicant had claimed an R&D offset to which it was not entitled under the law and, in doing so, had made a false or misleading statement as referred to in s 284–75(1) of Schedule 1 of the Taxation Administration Act 1953 (TAA).
- Initially, the Respondent had sought to impose a 50% penalty under item 2 of s 284–90(1) on the shortfall on the basis that the Applicant’s behaviour had demonstrated recklessness.
- However, the Respondent has subsequently changed its position and now submits that a penalty of 25% based on a lack of reasonable care (item 3 of s 284–90(1)) or, alternatively, lack of a reasonably arguable position (item 4 of s 284–90(1)) is appropriate.
- The current position, however, is that the Objection Decision, the subject of this review, has disallowed the Applicant’s objection to the imposition of a 50% penalty based on recklessness. The Respondent’s changed position to argue for a lesser penalty of 25% based on lack of reasonable care is noted.
- The refundable R&D tax offset which is the subject of the Applicant’s case was provided for by s 73J of the Income Tax Assessment Act 1936. That section permitted an eligible company to choose the offset if it could otherwise have obtained a deduction for R&D expenditure under s 73B.
- Subsection 73B(13) provides as follows:
Subject to this section, where an eligible company incurs contracted expenditure during a year of income, the amount of that expenditure multiplied by 1.25 is an allowable deduction to the company for the year of income.
- The meaning of the word “incurs”, as it is used in that subsection, is critical to the application of the R&D offset, and is particularly relevant in this case where there is considerable argument as to whether or not certain expenditure had been incurred at the relevant time, so as to enable the Applicant to appropriately claim the allowable deduction to which this subsection refers.
- The issue as to whether a penalty should apply, and the amount of the penalty if it does apply, requires analysis of certain statutory provisions contained within Div 284 of Sch 1 to the Taxation Administration Act 1953 (“TAA”).
- Section 284–75(1) of the TAA provides:
You are liable to an administrative penalty if:
(a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under a taxation law; and
(b) the statement is false or misleading in a material particular, whether because of things in it or omitted from it; and
(c) you have a shortfall amount as a result of the statement.
- A quite separate and independent basis for a penalty is set out in s 284–75(2) in the following terms:
You are liable to an administrative penalty if:
(a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under an income tax law; and
(b in the statement, you or your agent treated an income tax law as applying to a matter or identical matters in a particular way that was not reasonably arguable; and
(c) you have a shortfall amount as a result of the statement; and
(d) item 4, 5 or 6 of the table in subsection 284–90(1) applies to you.
- If subs (1) applies and there has been a failure by the Applicant or its agent to take reasonable care to comply with a taxation law, the penalty will be 25% of the shortfall amount (item 3, s 284–90(1)). If however subs (2) applies and the relevant shortfall has resulted from the Applicant or its agent treating an income tax law as applying to a matter or identical matters in a particular way, that was not reasonably arguable, the penalty will be 25% of the shortfall amount (item 4, s 284–90(1)).
- In other words, if either of these two possibilities apply, the penalty will be 25% of the shortfall amount.
- No legislative assistance is provided in determining what amounts to a “lack of reasonable care”.
- However, “reasonably arguable” position, is defined in s 284–15(1):
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.
- Finally, s 298–20(1) provides a wide and broad ranging discretion allowing the Commissioner to remit all or any part of the penalty.
- This case raises three key issues:
<li “=””>(1) Had the Applicant incurred the relevant expenditure in respect of the relevant year?
<li “=””>(2) Was the shortfall penalty imposed pursuant to s 284–90 of Sch 1 to the TAA for the year ended 30 June 2009 excessive?<li “=””>(3) Should the shortfall penalty be remitted in part or in full?
ISSUE 1 – HAD THE APPLICANT INCURRED THE RELEVANT EXPENDITURE IN RESPECT OF THE RELEVANT YEAR?
- The Applicant continues to assert that the relevant expenditure had been incurred in the year ended 30 June 2009; the Respondent asserts that it had not been so incurred.
- The Applicant’s position is that while it is not challenging the Respondent’s assertion as a primary matter, it is nonetheless asserting that the liability to ThorSol had been incurred in the year ended 30 June 2009, and accordingly no shortfall arose for penalty purposes. In other words, the Applicant is neither conceding the point nor pressing it as a primary issue.
- This puts the Tribunal in an awkward position, since the determination of the primary issue, regarding whether or not the expenditure in question had been incurred, needs to be resolved in order to determine whether there was a shortfall. Accordingly, the Tribunal will now consider this matter in order to determine whether or not a shortfall arose.
- Clearly, it is a legal question as to whether the agreement between the Applicant and ThorSol gave rise to an existing liability at the time of execution and, accordingly, whether expenditure had been incurred in the year ended 30 June 2009.
- The Applicant contended, and it does not appear to be in dispute, that an outgoing could be incurred without it being paid in the year ended 30 June 2009. The critical issue is whether as at the conclusion of the 2009 tax year the outgoing was merely “contingent, pending, threatened or expected” as opposed to “definitively committed”: New Zealand Flax Investments Ltd v Commissioner of Taxation  HCA 60; (1938) 61 CLR 179 at 207; Commissioner of Taxation v James Flood Pty Ltd  HCA 65; (1953) 88 CLR 492 at 506; Coles Myer Finance Ltd v Commissioner of Taxation  HCA 29;(1993) 176 CLR 640; Hooker-Rex Pty Ltd v Commissioner of Taxation (1988) 19 ATR 1241 at 1249-1250; Commissioner of Taxation v CityLink Melbourne Limited  HCA 35; (2006) 228 CLR 1. If the expense is merely contingent, pending or expected as at the end of 30 June 2009, it is an expense that has not been incurred in that year. On the other hand, if it is an expense to which the Applicant is definitively committed as at the end of 30 June 2009, it is an expense that has been incurred in the year to 30 June 2009.
- There are a number of matters specifically relevant in the circumstances of this case that suggest that the payment of the amount in question was contingent on a number of matters, which would suggest that there was no definite commitment to the outgoing as at the conclusion of the 2009 tax year.
- First, the work to which the outgoing related was dealt with under cl 35 of the R&D Agreement, which indicated that the work shall be undertaken by ThorSol in accordance with the process set out in Figure 1 (subject to cl 19(c) and cl 22). Figure 1 contains a series of 12 steps as follows:
Initiation of project
1. Client enters into a 12 month contract for R&D outcomes with RRA.
2. RRA issues invoice for 12 month contract.
- RRA contracts subcontractor to undertake services for the period of the contract, in accordance with the Work Breakdown Structure.
Billing cycle management
- Client authorizes RRA to undertake services for the work period of the contract, in accordance with the Work Breakdown Structure.
- RRA authorizes subcontractor to undertake services for the work period of the contract, in accordance with the Work Breakdown Structure.
- Subcontractor issues an invoice and work progress documentation for work completed to RRA during a billing period.
- RRA verifies invoice with contract, and work done documentation. RRA secures approval of work done from Client. RRA issues progress claim to Client, including RRA Project Management Overhead (PMO) fee
- Client makes progress payment to RRA.
- RRA makes progress payment to Subcontractor.
- Subcontractor issues payment receipt advice to RRA.
- RRA issues payment receipt advice, account statement and project financial report to Client.
- Client issues varied Work Breakdown Structure to RRA.
Repeat billing cycle
- From other parts of the Agreement it is apparent that Client refers to the Applicant and RRA refers to ThorSol.
- Looking specifically at the process reflected in Figure 1, there are at least two contingencies applying to the outgoing of $990,724. First, the Applicant needed to authorise ThorSol to undertake the R&D services as per step 4. This was a matter entirely within the control of the Applicant and if it chose not to make such an authorisation, no work would be undertaken and no payment would be required. Secondly, ThorSol needed to make a progress payment claim as per step 7.
- Thus, until such time as the Applicant authorised ThorSol to carry out the work, it could not be said that the outgoing was an expense to which the Applicant was “definitively committed”. At best it was contingent, pending or expected. Certainly, before authorisation by the Applicant, it could not be said that the Applicant was definitively committed to the expenditure, as it would have no legal obligation to pay in the future for unauthorised work even if it was within the work contemplated by the parties.
- Further, the invoice that was issued by ThorSol dated 30 June 2009 refers to “Estimated value” and it appears that virtually none of the invoiced amount (with some minor exceptions) was ever paid. This suggests that no real commitment to make the payments existed as at 30 June 2009, and that the invoice in question merely reflected the estimate for work that was to be authorised by the Applicant and was to be done by ThorSol at some time in the 13 month period covered by the invoice.
- The fact that virtually nothing was paid by the Applicants and nothing was ever demanded from them would seem to support this conclusion.
- In view of the above, the Tribunal concludes that the R&D expenditure in question had not been incurred in the year ended 30 June 2009.
- Accordingly, for penalty purposes there was a shortfall amount.
ISSUE 2 – WAS THE SHORTFALL PENALTY EXCESSIVE?
- Having resolved the first issue in favour of the Respondent, it is now a question of determining whether the penalty imposed by the Respondent was excessive.
- The base penalty amount of 25% now sought by the Respondent is justified because, according to the Respondent, the Applicant’s tax return had indicated that the Applicant had incurred $990,724 of contracted R&D expenditure, and in making that statement the Applicant, and its tax agent, had failed to take reasonable care.
- Although not expressed formerly in these summary terms, it appears from the written submissions and the oral evidence of the directors of the Applicant and the tax agent for the Applicant, that the Applicant is relying on any one of the following six methods or a combination of them in claiming that it had taken reasonable care:
- The directors reviewed the ATO/AusIndustry Guide to the R&D Tax Concession;
- The directors had discussions with the ex-CFO of an Australian publicly listed company, Zylotech Ltd. He was, by all accounts, a well-respected business person who apparently had substantial experience in the R&D area, but no specific tax expertise;
- The directors discussed the issues amongst themselves;
- The directors had discussions with and took advice from CTC; and
- The directors obtained a copy of a detailed letter of advice from Deloitte which provided generic advice in relation to R&D claims without being specific to the circumstances of the Applicant itself;
- The directors secured the services of Mr Maurice MacKinnon to prepare and lodge the relevant tax returns in which the R&D offset claims were made.
- Whether reasonable care has been exercised depends on the facts and circumstances of any individual case, and will need to take into account the taxpayer’s specific circumstances, including the knowledge, education, age, health, experience and skills of the taxpayer in question or its representatives. Clearly a higher standard of care would be expected of lawyers, accountants and tax agents see Re Necovski and Federal Commissioner of Taxation  AATA 195; (2009) 75 ATR 152. It would also be the case that if a substantial amount of tax is involved a higher standard of care would be expected.
- In this case the directors of the Applicant were not lawyers, accountants or tax agents but the case involved a very substantial offset claim. Clearly, in such a case, a high standard of care is required to satisfy the requirement that reasonable care has been taken in the specific circumstances.
- Looking at the matters raised by the Applicant a number of comments are apposite.
- First, CTC is not a firm of tax agents, accountants or legal practitioners although it does have expertise in the R&D area. Its independence, however, from the Applicant is very much in question since the provision of its advice, such as it was, was based on a success fee arrangement. The advice which it provided could neither be described as independent nor expert in relation to the tax offset claim. Prudence would dictate that reasonable care could only be present if the Applicant had sought and obtained independent tax advice.
- Secondly, Mr McKinnon was and is at all relevant times a registered tax agent, but it appears both from the written evidence and the verbal evidence of Mr McKinnon himself that he did not provide the Applicant with independent tax advice, having explicitly stated that he relied entirely on CTC. At no time did Mr McKinnon enquire of the Applicant whether the Applicant had in fact incurred $990,724 of contracted R&D expenditure in order to be entitled to a payment of a significant amount (namely $371,521.50) in the form of an R&D tax offset.
- Thirdly, the Deloitte advice, which is provided in the form of a letter signed by Patrick Broughan, Director, Deloitte Touche Tohmatsu Ltd and addressed to Mr Denis Clancy, Managing Director, ThorSol Technologies Pty Ltd is dated 20 January 2010, and the Applicant filed the relevant tax return in September 2009. Thus the letter could not establish reasonable care in making the claim which was made upon lodgement of the tax return (although it could suggest that at least reasonable care was subsequently taken).
- However, the letter is generic in nature referring to clients of ThorSol in general and makes no specific reference to the Applicant. Indeed, in this context, it is important to note the third paragraph of that letter which highlights the generic nature of the advice provided:
As an overall observation, we are not aware of the specific circumstances of the Clients of ThorSol, so the considerations below are general in nature, and as such should not be relied upon by the Clients. Clients should seek specific income tax advice having regard to their particular circumstances. Further, based upon your representations to us, the discussion below is on the basis that the arrangements are bona fide and otherwise fit within the various definitions and requirements of section 73B of the ITAA36; and that none of the income tax issues raised in Tax Alert 2009/21 are applicable [to] the Client or ThorSol (that is, the arrangements are not a sham, the parties are acting at arm’s length, etc.)
- Thus, clearly the author of the Deloitte letter is indicating to persons in the position of the Applicant that they should seek specific advice in relation to their circumstances and, in particular, that they should test quite independently the satisfaction of the requirements of s 73B. One such requirement is the question as to whether or not the expenses claimed have been incurred in the manner required under that section.
- Finally, in this context it is simply worth noting that whilst the relevant agreement between ThorSol and the Applicant is identical to the agreement that was attached to the Deloitte letter, that Deloitte letter itself makes no reference to Figure 1 in the agreement which outlines the billing cycle and which specifically gives rise to the circumstances in this case that the payments in question had not been incurred in the manner required to satisfy s 73B. This significantly weakens the effect of the Deloitte letter in the context of the Applicant’s circumstances.
- In relation to discussions which the directors of the Applicant claimed to have had with the ex-CFO of Zylotech Ltd, and between themselves, very little evidence was provided either in written form or in verbal testimony as to the exact content of those discussions. It appears that those discussions may have suggested that there was no problem with making the relevant claim, but no precise detail was provided. In any event, neither of the directors nor the ex-CFO had any specific tax knowledge or expertise, although it is recognised and accepted that the ex-CFO, in particular, was a business expert who had considerable financial expertise having been the Chief Financial Officer of an Australian publicly listed company, Zylotech Ltd. This, albeit, important recognition nonetheless does not give him any real expertise in the context of R&D tax offset claims.
- Finally, the Applicant seeks to rely upon the Guide to the R&D Tax Concession published by the Australian Taxation Office and AusIndustry in June 2008 to suggest that reasonable care was taken. That guide however does little more than provide some historical context to the R&D tax concession and establishes the new rules for claiming offsets for R&D expenditure incurred by certain taxpayers. It does not, on any reasonable reading, minimise the need to independently verify that the relevant expenses have been incurred as required by the statutory formulation.
- Having regard to the above, the Tribunal concludes that none of the individual matters are sufficient to suggest that reasonable care was taken. In combination they would indicate perhaps that the Applicant was not reckless in its approach to lodgement of the relevant tax return but, even in combination, they do not, in the view of the Tribunal, demonstrate that reasonable care has been taken.
- In particular, either considering each matter separately or looking at any combination of the matters raised, the Applicant has failed to show that it, through its directors or tax agent, had taken appropriate steps to seek and obtain independent suitably qualified tax advice on whether an R&D tax offset could be claimed in the tax return for the year ended 30 June 2009, especially in circumstances where no payment had actually been made by 30 June 2009. A prudent taxpayer faced with such a situation, especially where the claim is large, would have sought such advice based on the specific circumstances of the taxpayer involved. If, having done so, that taxpayer were to obtain advice that the expenses in question had been incurred, notwithstanding the lack of payment, such that the offset was available, reasonable care would have been exercised even if that advice was subsequently found to be wrong.
- As the Tribunal has found that the Applicant or its tax agent (or both) failed to exercise reasonable care in relation to claiming the offset, it is not necessary for the Tribunal to consider whether there was a lack of a reasonably arguable position in the circumstances.
- Nonetheless, it is worth noting that the Deloitte letter does suggest that there is a reasonably arguable position but this is, as mentioned previously, a generic letter and cannot be taken to suggest that the Applicant in its specific circumstances had a reasonably arguable position. Indeed, the specific agreement in question indicated that expenditure was contingent on a number of future steps being taken, such steps including one step in particular which was entirely in the Applicant’s control. An argument to the effect that in such circumstances expenditure has been incurred in the sense required is not about as likely to be correct as incorrect. It is in the Tribunal’s view more likely to be incorrect. Accordingly, the definition of reasonably arguable position set out in s 284-15(1) is not satisfied.
ISSUE 3 – SHOULD THE PENALTY BE REMITTED?
- The Commissioner has the discretion to remit all or part of an administrative penalty under s 298–20 of Schedule 1 of the TAA and it is clear that the discretion is a broad one. The legislation is silent on the matter as to what the Commissioner is to take into account in deciding whether to exercise the discretion to remit an administrative penalty. Fundamentally, the main consideration appears to be whether the penalty resulting from the application of the legislation operates harshly so as to lead to an unjust result in any given case: Dixon v Federal Commissioner of Taxation  FCAFC 54; (2008) 167 FCR 287 at ;Federal Commissioner of Taxation v Burness  FCA 1021; (2009) 77 ATR 61 at . Whether it is unjust or not needs to be tested by reference to the specific taxpayer involved: in Re Johnston and Federal Commissioner of Taxation (2011) 81 ATR 908.
- In verbal evidence one of the directors of the Applicant indicated that the Applicant would be in financial difficulties in covering the penalty payment and while this is unfortunate financial hardship, in and of itself, is not a matter of relevance to the question of remission of the penalty question.
- In the circumstances, the Tribunal is of the view that a 25% penalty is not harsh or unjust and it appropriately reflects the Applicant’s (and its tax agent’s) failure to take reasonable care.
- The Tribunal accordingly sets aside the Respondent’s objection decision and substitutes a decision that the objection is allowed in part so as to reduce the penalty to 25% of the shortfall amount for failure to take reasonable care in the income tax year ended 30 June 2009.
|I certify that the preceding 66 (sixty six) paragraphs are a true copy of the reasons for the decision herein of Professor R Deutsch, Deputy President.
Dated 30 July 2013
|Date of hearing
||19 June 2013
|Advocates for the Applicant
||Dr M Magrabi and Mr T Dunne
|Counsel for the Respondent
||Ms C Burnett
|Solicitor for the Respondent
||ATO Review and Dispute Resolution Group
Courtesy of Austlii