Case U88

Members:
BJ McMahon SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 10 April 1987.

---

B.J. McMahon (Senior Member)

In 1975 the applicant was employed by a company which specialised in light engineering household products. He worked in research as a development engineer. As an executive of the company, he was entitled to participate in its executive share option plan.

2. This involved the entering into an agreement with the employer company by which the company became bound to issue shares to the applicant at a price there stated if the option was exercised at any time between three and five years after the date on which it was granted. The option was not transferable and lapsed if the holder ceased to work for the group of which the employer company formed a part.

3. At the time of entering into these arrangements, the applicant was given a reneoed document of three sheets explaining aspects of the plan. Although he did not have the original document at the hearing, he agreed with the Commissioner's representative that a blank pro forma that was shown to him and tendered in evidence was essentially the same as the document he received in 1975.

4. Under the heading "Taxation", the document states:

"As a result of changes in taxation law, made in September, 1974, all issues of options are the subject of taxation at the point they are exercised and tax is calculated on the difference between the exercise, and the market price at that date."

5. It then proceeds to set out an example. Under the heading "Hereunder is the Sequence of Events" a paragraph occurs in the following words:

"When you lodge your taxation return, following a decision to take up the options (which could either be your return for 198, 198, or 198 ), you would have to return the `benefit received' from taking up the options, as taxable income. This would be the difference between the cost of dollars and the market value assumed of dollars. You would pay taxation at your current personal rate of taxation on dollars."

6. This document, and others associated with the option plan, were kept by the applicant at his home for some five years.

---

ATC 507

7. Shortly after 18 June 1980, he received a letter from the company secretary reminding him that the options held by him for the initial number of shares and for rights to subsequent bonus issues which had accrued as a result of his entitlement would lapse on 18 August 1980. If he wished to take up these shares, he was invited to discuss the matter with staff in the company secretary's office.

8. The applicant took the matter up with a pay clerk who advised him that it was "a good idea to buy them". On 11 August 1980 he paid to the company $2,562.50, partly from money borrowed from his mother-in-law. This money represented the original option exercise price and the price of the additional shares. The shares were then worth more than the amount he paid for them.

9. He told me (and I accept) that he had worked for the company for a number of years. His object in taking up the shares was partly to assist the company against a possible takeover offer, and partly because he considered the shares were a good investment.

10. He had prepared his own income tax return annually since the age of 16 when he started work. He did not seek professional advice, nor was any given to him from non professional sources. His return for the year ended 30 June 1981 contained provision in Item 10 for disclosure of dividends. He there stated the name of the employer company and the amount he had received by way of dividends from the shares which he had recently taken up. Item 6 of the return form contains ten sub-items describing various allowances or benefits which the taxpayer may have received. In Item (e) he showed receipt of an entertainment allowance of $650, which was subsequently claimed as a deduction in Item 15. Paragraph (i) of Item 6 states:

"Value of benefit received through acquisition of employees' shares or acquisition or disposal of rights (attach details)."

There is no entry opposite this paragraph. It is therefore not apparent on the face of the applicant's return that in the year of income he exercised the option referred to above.

11. He gave evidence, which I accept, that he was not conscious that this subparagraph related to the transactions which I have described, notwithstanding the fact that he received a paper five years previously advising him of the taxation consequences of exercising his option. After he received the initial assessment in November 1981, he noted that additional tax was imposed in respect of the dividends. He remembered having a conversation with a fellow employee who received a similar assessment. Their concern was simply that the extra tax for the dividends had not been taken out of their pay packet, and that the company should have done something about that. At no time did he have any discussion concerning the taxation ramifications of the share option scheme.

12. He said that he first heard of it when he received an amended assessment shortly after 7 February 1984, the date that it bore. He said:

"I took it to the pay office, I could not believe it, I had declared all my dividends."

He spoke to the company secretary, who told him that he (the applicant) had made a "terrible mistake". The secretary pointed out to him that para. (i) was not restricted to any profits arising from disposal of rights and that he should have given full details as invited in the terms of the return. The applicant of course had not sold any shares or rights. He was aware that another employee had and was conscious that that person had been assessed to additional tax. He says that at that stage, he still did not believe that he was liable for any additional taxation. The secretary persuaded him that he was.

13. The amended assessment included an amount of additional tax to which reference will be made later. The company secretary consulted the company's accountants, and instructed them to prepare an objection to the assessment. The objection was not in form a challenge to the liability to tax of the difference between the option exercise price and the market value. The objection was firstly to the taxability of moneys paid which related to the additional shares. Secondly, the objection related to the extent of the "penalty" or additional tax which had been imposed. The applicant instructed the accountants only indirectly through the company secretary, although he did telephone the accountant on two occasions to give him certain details.

14. No explanation was given by the Commissioner showing how the amount of additional tax was calculated. No explanation

---

ATC 508

was given why it was considered that tax was payable in respect of the additional shares. There was no personal contact between any officer of the respondent and the applicant until the preliminary conference held under the auspices of this Tribunal. On that occasion the applicant attended in person and discussed the matter in detail with an officer of the department for one and a half hours. As a result of that, he understood why tax was payable on the benefit received in respect of both the original and the additional shares. However, he considered that the "penalty" was too high a price for a simple mistake. The issue before me, therefore, is confined simply to the question whether the decision to impose the additional tax was the correct and preferable decision in the circumstances.

15. At the relevant time, the legislation dealing with the imposition of additional tax and its remission was to be found in subsec. (2) and (3) of sec. 226 of the Income Tax Assessment Act 1936 which were in the following terms:

"(2) Any taxpayer who -

• (a) omits from his return any assessable income;
• (b) includes in his return as a deduction for, or as a rebate in respect of, expenditure incurred by him an amount in excess of the expenditure actually incurred by him;
• (c) in his return, whether furnished before or after the commencement of this sub-section, claims to be entitled to a rebate of tax in respect of recouped expenditure; or
• (d) in relation to a claim to be entitled to a rebate under section 23AB, 79A, 79B, 159J, 159K or 159L, includes in his return information that is false in any particular,

shall be liable to pay as additional tax an amount equal to double the difference between the tax properly payable by him and the tax that would be payable if it were assessed upon the basis of the return furnished by him, or the amount of $2, whichever is the greater.

...

(3) The Commissioner may in any case, for reasons which he thinks sufficient, and either before or after making any assessment, remit the additional tax or any part thereof."

16. It will be seen that subsec. (3) gave the Commissioner a complete discretion to remit the additional tax or any part thereof. In order to assist in the administration of the Act and to provide guidelines for his officers, the Commissioner introduced a Taxation Ruling system at the end of 1982. Ruling 1 recognises that these Rulings "cannot supplant the terms of the law", and they are not intended to do so. Ruling 1 also makes it clear that one of the progenitors of the system was the Freedom of Information Act 1982. In its words, "Indeed, the need for the taxation ruling system has been brought into focus by the Freedom of Information Act".

17. Within these limitations, Taxation Ruling IT 2012 provides guidelines for officers considering requests for remission of additional tax under sec. 226 of the Act.

18. In the present circumstances, it has been assumed that disclosure by the applicant has been non-voluntary. I will deal with this concept later, but it is useful to note at the outset the guidelines which the Commissioner applies in non-voluntary cases. They are set out in para. 8 of Taxation Ruling IT 2012 in the following terms:

"Non-voluntary Cases, i.e. all other adjustments to which sec. 226(2) applies (Note 2) -

• a basic penalty of -
  • • 10% per annum of the tax avoided for the period up to and including 13 February 1983 and 20% per annum thereafter (see Note 3), plus
  • • 40% of the tax avoided

subject to increase by a further percentage of the tax avoided (as indicated below), depending on the seriousness of the offence, for each of the following circumstances that exists (Note 4).

• (a) Deliberate steps have been taken, either before or after commencement of official enquiries, to conceal omitted income or support a false claim (Note 5) - 10% to 50%.

  ---

  ATC 509

• (b) The above steps have involved corruption of employees or collusion (Note 6) - 10% to 50%.
• (c) There has been previous tax evasion by or on behalf of the taxpayer (Note 7) - 10% to 50%.
• (d) The degree of co-operation has been less than `reasonable' or such as to cause excessive delay in the completion of the official enquiries, and/or there has been positive obstruction (Note 8) - 10% to 50%.
• (e) There is other tax evasion, not subject to additional tax under sec. 226(2), by or on behalf of the taxpayer (Note 9) - 10% to 50%.

The basic rate of penalty (10% or 20% per annum plus 40% flat), subject to increase as indicated above, is to be applied to all items penalisable under sec. 226(2) except in certain limited situations where the statutory penalty may be further reduced (Note 10). Care should, of course, be exercised to ensure that the penalty calculated in accordance with the above guidelines does not exceed the statutory maximum of 200% of the tax avoided."

19. It will be noted from the above that the penalty is expressed as a percentage per annum of 10% for a period from the original assessment up to and including 13 February 1983. There seems to be no significance in the choice of this date, except that the Ruling was dated 25 January 1983 and was expressed to be operative on and from 14 February 1983. It is merely a date arbitrarily chosen. From that date the rate per annum doubled to 20%. In addition to the basic penalty expressed as a rate per centum per annum of the tax avoided, there is a further sum (referred to as the culpability factor) of a flat percentage of 40% of the tax avoided. It is clear from the Ruling that this is to be a norm rather than an inflexible amount.

20. Five examples are given above of the sort of conduct which would result in an increase of the culpability factor. There is no suggestion in the present circumstances that the applicant has engaged in any of this conduct.

21. There are, however, in the guidelines, circumstances set out where the normative rate of 40% may be decreased. These are to be found in para. 29 in the following terms:

"29. Subject to these comments, circumstances of the kind warranting further remission would include cases where you are satisfied that -

• (i) the taxpayer's offence was occasioned by carelessness of a less serious nature and there are other mitigating factors, e.g. advanced age or serious illness, which excuse that carelessness to a substantial extent;
• (ii) the taxpayer's offence was occasioned by ignorance of the law in the sense that, in the particular exceptional circumstances, he could not reasonably be expected to have been aware of the requirements in question;
• (iii) the taxpayer has made a genuine and, in the particular exceptional circumstances, excusable mistake in interpreting the law. (Both this and the preceding kind of case could probably only occur where the return was not prepared by an agent);
• (iv) the office adjustment is clearly contentious. This does not mean that there should be a further remission of penalty merely because the precise quantum of the adjustment cannot be proved. A lower penalty should be considered only where the quantum or legality of the adjustment is open to serious and genuine dispute; or
• (v) the effect of the penalty, having regard to the taxpayer's net assets and his potential earning capacity, would be such as to amount to a `ruinous imposition', i.e. leave the taxpayer with little or no remaining assets."

22. It is clear that these guidelines are not binding on this Tribunal. The extent to which similar guidelines should be taken into account by this Tribunal has been discussed in many cases during the Tribunal's life. A broad view is given in Sharpe: "The Administrative Appeals Tribunal and Policy Review". It is not necessary for the purposes of the present decision to canvass the whole field. It will be useful however to point to certain areas where policy has been followed and where it has been disregarded. A distinction has always been drawn between ministerial and departmental policy. The former is departed from less readily

---

ATC 510

than the latter, particularly if it has been scrutinised and approved by Parliament. The basic approach of this Tribunal is that enunciated by Brennan J. in
Re Drake (No. 2) (1978-1980) 2 ALD 634 at p. 644.

23. "Income Tax Rulings" are similar to guidelines that are to be found in many Government departments as aids to officers in administering various Acts of Parliament which grant administrative discretion. Sometimes policies are administrative glosses, either limiting or, sometimes, extending the scope of a discretionary power according to the perception of the administrator as to what the Act was intended to mean (see
Re Woods and Collector of Customs (N.S.W.) (1985) 8 ALN N82). Policy guidelines are sometimes quoted by advocates for the Department of Social Security, but have not been pressed as aids to proper decision making processes by this Tribunal. However, the Tribunal has in some cases had regard to, but has not considered itself bound by, those guidelines. Examples may be found in
Re Te Velde 3 ALN N111 and
Re Watts 6 ALN N201. On the other hand the Department's assets test policy was disregarded in
Re Henry Decision No. 2739 and
Re Williamson 5 AAR 41. Guidelines have had some relevance in relation to medical standards for public service and superannuation purposes. Medical guidelines used by Commonwealth medical officers for the dual purposes of assessing the medical fitness of a person for employment in the public service and for acceptance as an eligible employee under the Superannuation Act 1976, have been referred to in a number of cases. An example may be seen in
Re RM 6 ALD 272. On the other hand, medical guidelines adopted by the Repatriation Commission were expressly rejected by the president of this Tribunal in
Re McPherson 8 ALD 484 as an aid in assessing an appropriate rate of disability pension.

24. Whilst it is clear that guidelines are not binding, they can be useful, both as a guide to what has been considered appropriate in the past, and as a structure for analysis of the discretionary problem under review. However, at all times it should be remembered that they are guidelines. The Commissioner prefers to use the term "ruling". This, however, does not give any additional validity to what is, in effect, a series of recommendations and departmental instructions. Guidelines are to be applied flexibly within their own terms if they are to be of any assistance, and if they are to operate fairly. Above all, it should be remembered that the circumstances of the particular case must be considered. This has been emphasised many times. The need was illustrated in
Re Barbaro (1980-1981) 3 ALD 1 at p. 14.

25. The question of the principles to be applied where additional tax is to be assessed was considered at length in Case U36,
87 ATC 266. With respect, I adopt and agree with all the observations made by the Senior Member in that case. It is instructive to examine some of the relevant factors there outlined against the facts of the present application.

26. At para. 3.9 the Tribunal pointed out that when the Parliament in 1922 adopted the 200% limit, the maximum marginal rate of tax was 25%. For reasons which are set out in detail, the Tribunal concluded that this no doubt explained why there is no record in recent times indicating that the Commissioner has levied additional tax at any rate close to 200% of the tax avoided. The learned Senior Member personally could not recall any imposition exceeding 100% of tax avoided, except in the extreme case of
F.C. of T. v. Smith 72 ATC 4251. If that be so, then the extent of the remission can be expressed in a misleading way.

27. The amount in question in the present application is $1,676.39. The amount of tax avoided by the non disclosure was $2,357.04. The additional tax is calculated in the following manner:

                                                  $
      10% p.a. from 21 December 1981
      (the due date of the original
      assessment) until 13 February 1983
      (the date when new guidelines were
      adopted)                                 269.68
      20% p.a. from 14 February 1983 to
      7 February 1984 (date of amended
      assessment)                              464.73
                                              -------
      TOTAL                                   $734.41
                                              -------
          

By rounding out the dollars and cents, the computers arrived at a total of $733.59 for the percentum per annum penalty.

---

ATC 511

28. To this was added a culpability component of 40% of the tax avoided, namely $942.80, giving a total of $1,676.39.

29. The Commissioner's representative pointed out that the permitted additional tax under sec. 226 was therefore $4,714. The fact that only $1,676 had been imposed meant that the taxpayer was being asked only for 35% of the maximum penalty. He submitted that the penalty should not be reduced any further.

30. However, looked at from the taxpayer's point of view, $1,676.39 represents 71% of the tax avoided, namely $2,357.04 - a much more severe penalty when expressed in those percentage terms. Furthermore, if, as was pointed out in Case U36, the practical (as distinct from the legal) limit is 100% of the tax avoided, then the amount assessed against the applicant would appear to be very severe indeed. It would indicate circumstances of gravity warranting the imposition of a comparatively heavy penalty.

31. One of the factors to be considered, as set out in para. 4.7 of Case U36, is whether the error was made honestly. This circumstance is not recognised by the Commissioner explicitly as a mitigating factor. It is, however, implicit in subpara. (i), (ii) and (iii) of para. 29 of the Ruling quoted above. Whilst I agree that an honest error is no answer to an assessment of additional tax, it is most material when it comes to determining the appropriate remission. Having observed the applicant in the witness box and having heard his version of events, I am readily prepared to infer that he had no intention to deceive when he completed his return of income. I accept that he had been told five years previously what he should do, but he was given no reminder by the company (unlike the taxpayer in Case U36) when his option was exercised some five years later.

32. The extent of the applicant's understanding of the issues involved is referred to in para. 4.16 of Case U36 in these terms:

"Some matters in relation to tax are more difficult to understand than others. For example, it is hard to understand why all employees in the community should be expected to know that in some circumstances to buy shares in the company which employs them may create a liability to income tax. That would have been relevant to the situation of F - the employee shareholder - if it had not been for the circumstance that he received notice from his employer warning him of his income tax liability. As appears from the passages quoted earlier from Trautwein's case, such problems of understanding are matters to be taken into account in mitigation."

33. I accept the applicant's evidence that he had not discussed the taxability of benefits received with any other person in the company, or with any professional adviser. I accept that he had only the haziest notion of what was involved even in 1975, and that by 1980 it did not exercise his mind at all. The non disclosure relates to matters that are taxable only by virtue of special statutory provisions. If one hides interest on a bank account or hides a second cash income, this is clearly understood in the community to be taxable and punishable. Having regard to the issues which could appear complex to the present applicant, I consider that this should be taken into account as a factor in remission of part of the additional tax.

34. The Tribunal also pointed out in para. 4.17:

"Regard, too, needs to be had to relevant personal attributes and characteristics of the taxpayer. If a taxpayer is learned in matters of accountancy and tax law, or has substantial commercial experience, his culpability in relation to his own taxation affairs is greater than that of a person substantially lacking in the skills of literacy and numeracy and awareness as to income tax law and financial techniques - the truck driver is an example. On the other hand, some issues are sufficiently simple so that no special qualifications are needed to understand them. Understatement of the gross takings of a business by setting moneys aside so that they are not disclosed in ordinary business bankings is an example. Non disclosure of interest from investments is another."

35. The applicant is a reasonably intelligent man, but has had no training in commerce or finance. He obtained the Leaving Certificate before leaving school at the age of 16. He then did a short engineering course at a TAFE college. He is presently employed as a service engineer by the same company in which he holds shares. He has worked for it for many

---

ATC 512

years in a minor engineering capacity. He has always prepared his own income tax returns and has not received professional advice, nor has he felt the need to obtain professional advice in relation to his taxation affairs until the events outlined above. It seems to me that he must be regarded in a different light from, for example, an executive in the finance sector who would be expected to have a working knowledge of tax, particularly as it related to his own personal income.

36. The guidelines referred to above are applicable in the case of non-voluntary disclosure. In the sense that the applicant did not react to the respondent until after the amended assessment had been issued, these circumstances may be classified as non-voluntary disclosure. However, the use of the word "voluntary" implies a knowledge and understanding upon which to base a voluntary act. Voluntary disclosure is one that is brought about by one's own choice or deliberate action. If one is not aware of whatever it is that is to be disclosed, then voluntary disclosure is simply not possible. This I consider to be another factor to be taken into account.

37. Above all, it should be emphasised that if the guidelines are to be applied as signposts rather than fences, the computations inherent in them must be tempered by an exercise of discretion. To insist on a blind application of a culpability factor of 40% is not to exercise the discretion which the Commissioner is bound to exercise under subsec. (3) quoted above. He cannot abrogate his responsibility. Whilst the exercise of discretion in every individual case is obviously a practical impossibility, in the long run it is the duty of any administrator to regard each case as an individual case when the facts are put before him. The application of an inflexible formula to those facts without considering other elements is not a proper exercise of discretion. As the Tribunal put it in para. 5.3 of Case U36:

"That being so, it would appear that no matter how well planned and executed, no matter how deliberate or flagrant the course of conduct giving rise to the under-assessment of income, and no matter how personally culpable the offending taxpayer may have been, so long as he has avoided the aggravating factors specified, the `maximum' penalty to be expected of him by way of a culpability factor will be 40% of tax avoided, just as it will be for those - such as all the applicants before me - who are less culpable. I do not accept that as being reasonable; but if the `maximum' is 40%, that becomes an important factor in assessing the penalties to be exacted of each of the applicants whose causes now fall for consideration."

38. In considering additional tax, attention should not be focused exclusively on the culpability factor. The imposition of additional tax at a rate per annum (to compensate for the loss of revenue over a period - subject to the statutory maximum), is in itself a severe penalty. At para. 5.9 in Case U36, the Tribunal said:

"However, whether the matter be viewed as a particular or general deterrent, the notion of being liable to compensatory interest of 20% p.a. - non-deductible - without any additional penalty at all by way of a culpability factor, is likely to be sufficient deterrent to all whose commitment to honesty needs the stimulus of a deterrent and who will respond to it. On the other hand, even a more substantial sanction is not likely to be a deterrent to those who consciously elect to understate income, taking the optimistic view that their understatements will not be detected."

39. With these observations in mind, the fate of the various applicants in Case U36 can be contrasted with the fate of the present applicant. The employee shareholder in Case U36 (who was given a reminder by his company at the time he exercised his option), was found to be not deserving of suffering any culpability factor because of the (incomplete) disclosure that was made in his return of income. In the present case the applicant gave no indication in his return of income that he was in a tax liability situation. On the other hand, he received no reminder from his employer and no intention to deceive has been established. The salesman in Case U36, who was regarded as clever enough to understand his liability, had the culpability factor reduced to 15%. The truck driver who was not, had his reduced to 10%. The colonial pensioner suffered a culpability factor of 10% and the husband, who wrongly claimed a spouse rebate, that of 5%.

40. To the extent that additional tax is intended to serve as a deterrent, its imposition

---

ATC 513

would be pointless in the present circumstances. I have come to the conclusion that the applicant is the sort of person who would not, in the future, as he has not in the past, understate his income, having regard to these events.

41. I would also add another factor that occurs to me as being relevant in considering the extent of the proper culpability factor. In criminal matters, the fact that the defendant pleads guilty has been held to be a fact properly taken into account in imposing a lighter sentence. It constitutes an acknowledgment of wrongdoing, it indicates remorse, it foreshadows good conduct in the future. At the same time, it eliminates the need and expense of proof. In the present circumstances the applicant at the preliminary conference stage (the first time the basis of the assessment had been explained to him), agreed to admit his liability for the basic additional tax. I consider that some credit should be given for this attitude of co-operation.

42. Having regard to all these facts, these principles, and the decisions made in relation to other taxpayers in comparable situations, I consider that the guidelines for non-voluntary disclosure may be usefully applied in coming to a correct and preferable decision, provided that the extent of the culpability factor is reduced to 10%.

43. The amended assessment under review is therefore set aside and the matter is remitted to the respondent with the direction that the additional tax payable pursuant to sec. 226 of the Act should be fixed at $969.29 rather than the original amount of $1,676.39.