House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 3 - Penalties

Outline of chapter

3.1 Schedule 2 to this Bill amends the administrative penalty regime in Schedule 1 to the Taxation Administration Act 1953 (TAA 1953), which applies where entities fail to meet various tax obligations, to:

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abolish the penalty for a tax shortfall resulting from a failure to follow a private ruling issued by the Commissioner of Taxation (Commissioner)

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require the Commissioner to provide an explanation of why an entity is liable to a penalty and why the penalty has not been remitted in full, and

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clarify the definition of when a statement by an entity about its income tax liability is 'reasonably arguable' (and therefore not subject to the penalty for a tax shortfall resulting from taking a position about a large item that is not reasonably arguable) in relation to income tax law.

Context of amendments

3.2 These provisions implement part of the Government's response to the recommendations made in the Report on Aspects of Income Tax Self Assessment (the Report). Background to this report and its recommendations are in Chapter 1 of this explanatory memorandum.

3.3 A generic administrative penalty regime applies to taxation laws administered by the Commissioner. The broad objective of the regime is to impose sanctions in the form of an administrative penalty where an entity fails to meet various obligations under the law. As the regime applies to various entities with taxation obligations, not just taxpayers, this chapter refers to 'entities', unlike Chapter 2 which discusses the introduction of the shortfall interest charge and refers to taxpayers.

3.4 Division 284 of Schedule 1 to the TAA 1953 sets out the circumstances in which administrative penalties apply for tax shortfalls resulting from making false or misleading statements, taking a position that is not reasonably arguable, entering into schemes, and for disregarding a private ruling. It also sets out how those penalties are to be calculated.

Abolishing the penalty for failing to follow a private ruling

3.5 Under the current law an entity is liable to an administrative penalty under subsection 284-75(4) of Schedule 1 to the TAA 1953 if there is a private ruling about the way a taxation law applies to the entity, and the entity does not follow the ruling and makes a statement treating the taxation law as applying in a different way, and a tax shortfall results.

3.6 This penalty has the potential to operate as an inappropriate disincentive to entities seeking Australian Taxation Office (ATO) advice and, accordingly, it is abolished.

Requiring the Commissioner to supply reasons why an entity is liable to a penalty and why the penalty is not remitted in full

3.7 The machinery provisions for the generic administrative penalties regime require the Commissioner to notify an entity that a tax shortfall penalty applies, but do not require the Commissioner to tell the entity the reasons that the penalty applies. Similarly, if the Commissioner decides not to remit a penalty in full, the provisions do not require the Commissioner to give reasons for that decision. However, the Commissioner could be required to give reasons if a taxpayer applied under the Administrative Decision (Judicial Review) Act 1977.

3.8 It is important that taxpayers who are subject to a penalty understand why they have been penalised. Accordingly, the amendments require the Commissioner to provide an explanation of why a penalty has been imposed and why a penalty has not been remitted in full.

Clarifying the definition of reasonably arguable

3.9 Subsection 284-15(1) of Schedule 1 to the TAA 1953 provides that a matter is reasonably arguable 'if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is as likely to be correct as incorrect, or is more likely to be correct than incorrect.' Under subsection 284-15(2), reasonably arguable has a corresponding meaning where the issue is how the Commissioner would exercise a discretion.

3.10 An entity is liable to an administrative penalty under subsection 284-75(2) of Schedule 1 to the TAA 1953 if the entity makes a statement to the Commissioner in which an income tax law is treated as applying to the entity for a large item in a way that is not reasonably arguable, and a tax shortfall results. For individuals and companies, an item is a large item if there is a tax shortfall exceeding the greater of $10,000 or 1 per cent of the income tax payable.

3.11 A shortfall amount arises where there is a difference between the amount of tax, credit or payment entitlement calculated on the basis of the entity's statement in a document, and the tax properly payable according to law.

3.12 The ATO has interpreted the current definition in accordance with the legislative intention that the relevant standard is about as likely to be correct as incorrect (or more likely to be correct than incorrect), not as likely to be correct as incorrect, consistent with the explanatory memorandum of the A New Tax System (Tax Administration) Act (No. 2) 2000. However, on their face, the words of the definition require a higher standard.

3.13 The definition of when a matter is 'reasonably arguable' is clarified to confirm that the relevant standard is about as likely to be correct as incorrect (or more likely to be correct than incorrect), not as likely to be correct as incorrect.

Comparison of key features of new law and current law

Detailed explanation of new law

Abolishing the penalty for failing to follow a private ruling

3.14 The provision that imposed an administrative penalty for not following a private ruling is repealed. [Schedule 2, item 7, subsection 284-75(4) of Schedule 1 to the TAA 1953]

3.15 The items relating to the shortfall penalty for not following a private ruling are also omitted. Consequently, the items in the table in section 284-80, which explain the concept of 'shortfall amount' in different situations, are also amended to remove a shortfall amount situation arising where a tax-related liability is less than what it would be if the statement had not been inconsistent with a private ruling. [Schedule 2, item 8, subsection 284-80(1) of Schedule 1 to the TAA 1953]

3.16 Similarly, the amendments omit the base penalty amount of 25 per cent of the shortfall which currently applies where an entity has a tax shortfall as a result of disregarding a private ruling. [Schedule 2, item 9, subsection 284-90(1) of Schedule 1 to the TAA 1953]

3.17 However, if an entity has a tax shortfall as a result of a statement they make (in a return or otherwise), they may still be liable to a shortfall tax penalty if, for example, they failed to take reasonable care or if they did not have a 'reasonably arguable position' on a large income tax item. If an entity obtains a private ruling on an issue but does not follow it, to satisfy the reasonable care standard they would normally need to have taken other steps, such as obtaining and following the considered advice of a tax practitioner about the issue.

Requiring the Commissioner to supply reasons why an entity is liable to a penalty and why the penalty is not remitted in full

3.18 This Bill amends the law to provide that when an administrative penalty applies and the Commissioner decides the penalty should not be remitted in full, the Commissioner will provide the entity with an explanation in writing of why the penalty applies and why it has not been remitted in full. The Commissioner is not required to give reasons if he or she decides to remit the entire penalty. [Schedule 2, items 12 and 14, section 298-10 and subsection 298-20(2) of Schedule 1 to the TAA 1953]

Example 3.1

Cecelia fails to include a significant amount of interest from her bank account with Megabank in her income tax return. The facts show that the statement was made as a result of Cecelia not taking reasonable care. This is the third time that Cecelia has been liable to a penalty for a false or misleading statement. She did not voluntarily disclose the omission, so a penalty is imposed at 30 per cent of the shortfall amount (ie 25 per cent for lack of reasonable care increased by 20 per cent for previous shortfall amounts arising from false or misleading statements).

The Commissioner will give Cecelia a notice explaining:

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that the penalty was imposed because she had not taken reasonable care

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the finding of fact (that she had omitted a material amount from her return) that grounded the conclusion that she had not taken reasonable care

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the evidence on which the finding was based (here, the statements of interest paid by Megabank)

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that the penalty was increased because the same type of penalty had been imposed on previous occasions, and

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that the penalty was not remitted because the same type of penalty had been imposed on previous occasions.

3.19 Section 25D of the Acts Interpretation Act 1901 requires that written reasons set out the findings on material questions of fact and refer to the evidence or other material on which those findings are based. Notes adverting to this provision will be inserted. [Schedule 2, items 13 and 15, section 298-10 and subsection 298-20(2) of Schedule 1 to the TAA 1953]

3.20 All penalties imposed under Part 4-25 of Schedule 1 to the TAA 1953 are subject to generic machinery provisions, which means that reasons must be supplied for all penalties within the generic penalty regime.

3.21 The law does not specify when the reasons must be supplied. However, it is intended that the Commissioner supply the reasons at the same time as, or as soon as possible after, the Commissioner notifies the entity of the penalty. In some cases, the Commissioner may supply reasons before issuing notice of the penalty.

3.22 An entity continues to have a right to object to an assessment of a tax shortfall penalty, and the Commissioner's decision on the objection will still be reviewable under Part IVC of the TAA 1953.

Amending the definition of reasonably arguable

3.23 The Report recommended that the definition of when a matter is reasonably arguable should be clarified to confirm that the relevant standard is about as likely to be correct as incorrect (or more likely to be correct than incorrect), not as likely to be correct as incorrect.

3.24 This recommendation is implemented by inserting the word 'about' in the relevant subsections of the definition of 'reasonably arguable'. [Schedule 2, items 3 and 4, subsections 284-15(1) and (2) of Schedule 1 to the TAA 1953]

Application and transitional provisions

3.25 These amendments will generally apply from the 2004-05 year, as announced by the Treasurer in Press Release No. 106 of 16 December 2004.

3.26 The abolition of the penalty for not following a private ruling will apply to:

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In the case of income tax - the 2004-05 income year and later years.

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In the case of fringe benefits tax - the year of tax starting on 1 April 2004 and later years.

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In the case of other taxes - the year starting on 1 July 2004 and later years.

[Schedule 2, subitem 16(1)]

3.27 The new requirement to give reasons why a penalty has been imposed and not remitted in full applies to notices given and decisions made after Royal Assent in relation to:

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In the case of income tax - the 2004-05 income year and later income years.

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In the case of fringe benefits tax - the year of tax starting on 1 April 2004 and later years.

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In the case of other taxes - the year starting on 1 July 2004 and later years.

[Schedule 2, subitem 16(2)]

3.28 The clarification of the meaning of reasonably arguable position applies from Royal Assent because it confirms how the law is currently administered.

Consequential amendments

3.29 As a consequence of abolishing the penalty for failing to follow a private ruling, references to that penalty in the objects clause and the guide provisions in the generic administrative penalties provisions are deleted. [Schedule 2, items 1, 2, 5, 6, 8 and 9, sections 284-10, 284-70 and 284-80 of Schedule 1 to the TAA 1953]

3.30 At present, an entity does not have a shortfall if the entity makes a statement to the Commissioner that is inconsistent with a private ruling if there is a court order or decision of the Administrative Appeals Tribunal that supports the statement that he or she made. Since the general rule against disregarding a private ruling is abolished, this consequential rule is deleted. [Schedule 2, item 10, subsection 284-215(3) of Schedule 1 to the TAA 1953]

3.31 Under the current law, there is a 20 per cent increase in the base penalty amount for failing to follow a private ruling where a penalty for failing to follow a private ruling was incurred for a previous accounting period. Since that penalty will no longer exist, the law is amended to remove this rule. [Schedule 2, item 11, paragraph 284-220(1)(d) of Schedule 1 to the TAA 1953]