Decision impact statement
Kocic and Federal Commissioner of Taxation
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Court Citation(s):
[2011] AATA 47
[2011] ATC 10-174
8 2ATR 211
Venue: Administrative Appeals Tribunal
Venue Reference No: 3191-3208 & 4601-4604 of 2007, 1406-1409 of 2008
Judge Name: Tamberlin DP; Redfern SM
Judgment date: 1 February 2011
Appeals on foot: No.
Decision Outcome: Partially adverse
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Distributable Surplus
Division 7A
General Interest Charge
Present Legal Obligation
Précis
Outlines the ATO's response to this case which concerns undisclosed income, penalties and whether the distributable surplus of a company for an income year is reduced by taking into consideration a general interest charge on pre-existing taxation debts.
Brief summary of facts
Steven and Savko Kocic were the directors and shareholders of Ansetat Pty Ltd (Ansetat) which owned and operated cafes in Darlinghurst and Paddington from 1991 to 2007.
In September 2005, the NSW Crime Commission seized handwritten sales books written by Mr Kocic. The sales books revealed income for the cafes far above what was recorded in the income tax returns.
After conducting an audit, the Commissioner concluded that the 'second set of books' more accurately represented gross sales for Ansetat for the income years 1995 to 2006. Amended assessments were issued to Mr and Mrs Kocic for the income years 1995 to 2006. Undisclosed sales above income declared in tax returns appearing in the Ansetat handwritten books were deemed to be dividends to the shareholders (Mr and Mrs Kocic) under Division 7A of the Income Tax Assessment Act 1936 ('The 1936 Act'). In calculating the distributable surplus of Ansetat for the years 1998-2006 as required by s 109Y on the Act, the Commissioner did not take into consideration Ansetat's liability to interest on accumulated unpaid tax as a present legal obligation. In calculating the distributable surplus of Ansetat, the Commissioner also did not take into consideration a loan recorded in the handwritten accounts from Mr Kocic as a present legal obligation.
Administrative penalties of between 75 to 90 percent were imposed for the years 1995 to 2006 on the amended assessments of Mr and Mrs Kocic. A penalty of 25 percent was also imposed on Mr Kocic for an undisclosed capital gain in the 2003 income year.
Mr and Mrs Kocic objected to all of the assessments and penalties. The Commissioner disallowed the objections in full. Proceedings were initiated in the AAT after the objection decision.
Issues decided by the tribunal
1 ) Do the seized set of books sufficiently record the net income for Ansetat for the income years 1995 to 2006 ?
The Tribunal concluded that the seized books do not accurately reflect the net income for Ansetat for the years in question. Rather, they represented gross takings for Ansetat. The Tribunal rejected the Commissioner's argument that the gross income of Ansetat was in excess of what appeared in the second set of books. Furthermore, the Tribunal concluded that the net income for Ansetat must be calculated after wages paid by cash is deducted from gross income amounts. Wage records were maintained in separate handwritten books which the Commissioner did not to take into consideration when calculating profit/distributable surplus for the company.
2 ) What were the ' profits' of Ansetat for 1995 to 1997 out of which a dividend could deemed to be paid to the Applicants pursuant to s 108 of the 1936 Act ?
The Tribunal found that the profits from 1995 to 1997 as calculated by the Commissioner should be reduced to take into account wages paid in cash by Ansetat. The amended assessments were excessive as the deemed dividends calculated by the Commissioner exceeded the adjusted profit. This determination was only relevant for the income years 1995 to 1997, where under s 108(1) of the 1936 Act, deemed dividends can be paid by the company if an amount credited to a shareholder represents a distribution of 'profits.'
3 ) Should the undisclosed sales be ' added back' when determining the net assets of Ansetat for the purposes of determining distributable surplus, calculated under s 109Y of the 1936 Act, for the income years 1998 to 2006 ?
The Tribunal agreed with this submission. Under s 109Y, the net assets component shall be calculated in accordance with the company's accounting records. Yet this proposition can be displaced if the company's accounting records significantly undervalue or overvalue its assets. This reinforced what the Tribunal had concluded in the case of Re Waffles and anor v Commissioner of Taxation [2010] AATA 78 ('Waffles'). The Tribunal concluded that in the present case, the undisclosed sales of Ansetat less cash payments for wages were assets of the company in the relevant period and were improperly excluded from the accounting records. In such circumstances, the Commissioner may add back such amounts when determining net assets.
4 ) Was interest on the unpaid tax liability of Ansetat was a ' present legal obligation' of Ansetat, thus requiring it to be taken into consideration when calculating distributable surplus for the income years 1998 to 2006 ?
The Tribunal found that Ansetat's liability for interest on unpaid tax was a 'present legal obligation' for the income years 1998 to 2006 and must be taken into account when calculating distributable surplus for each particular year. The Tribunal noted that this followed the precedent set in Waffles and then affirmed in the full Federal Court in Commissioner of Taxation v H [2010] FCAFC 128 ('Commissioner v H').
5 ) Was a loan from Mr Kocic to Ansetat, recorded in the accounts, considered a ' present legal obligation' for the purposes of calculating distributable surplus for the income years 1998 to 2006 ?
The Tribunal agreed this loan was a 'present legal obligation.' The Commissioner should have included this loan amount when calculating distributable surplus. Specific attention was drawn to the testimony of Mr Tesanovic, the accountant of Mr and Mrs Kocic. Mr Tesanovic prepared financial statements for Ansetat recording loans from "S Kocic" that could be substantiated through source documents and loan account ledgers.
6 ) Can the Commissioner, in the circumstances of the AAT proceedings, claim new grounds for the assessments ?
The Tribunal rejected the submission that the Commissioner should be able to claim new grounds for the assessments in AAT proceedings. The Commissioner submitted that if money paid to Mr and Mrs Kocic is not assessable as deemed dividends as the money is not part of distributable surplus, the monies should still be treated as ordinary dividends under s 44 of the 1936 Act or ordinary income under s 25(1) of the 1936 Act. In rejecting the submission, the Tribunal highlighted the denial of procedural fairness of introducing new grounds during the proceedings. Mr and Mrs Kocic may have run their case differently had they known of the new grounds prior to proceedings. Regardless of this argument, the Tribunal stated the new grounds had not been established.
7 ) Were any deemed dividends paid made wholly for the benefit of Mr Kocic, rather than shared by Mr Kocic and Mrs Kocic ?
The Tribunal rejected this argument. The Applicants argued that payments for the purposes of ss 108(1) and 109C(1) of the 1936 Act were only made to Mr Kocic as there was no agreement to split the cash equally while Mrs Kocic was unaware that sales were being made but not declared in the Ansetat tax returns. However, the Tribunal found that the fact that Mrs Kocic was unaware of the separate set of books is irrelevant if the funds were in fact paid into joint accounts or were paid towards any joint assets and expenditure. Evidence suggested funds were used in such a way.
8 ) Were the penalties imposed on Mr and Mrs Kocic properly applied ?
The Tribunal concluded that in respect of Mr Kocic, the penalties were correctly imposed. The Tribunal agreed that Mr Kocic showed 'intentional disregard' by deliberately keeping a second set of books for 12 years without disclosing them to the accountant for Ansetat, the Commissioner or his wife. The Tribunal also upheld the 25 percent penalty for an undisclosed capital gain in 2003, as Mr Kocic should have realised the gain needed to be disclosed and failed to take reasonable care when lodging his tax return.
The Tribunal concluded in respect of Mrs Kocic that the penalty should be reduced to 25% for carelessness, with the entire additional uplift factor remitted. Mrs Kocic was not aware of the second set of books. While statements about her income for the years 1997 to 2003 were false, albeit not intentionally so, the Tribunal concluded that it would be unjust to penalise Mrs Kocic for the actions of her husband beyond the penalty for failure to take reasonable care.
Tax Office view of Decision
The decision applied the following principles regarding calculating distributable surplus for the purposes of s 109Y(2) of the 1936 Act.
General Interest Charge
Section 170AA of the 1936 Act provides that a liability for a General Interest Charge ('GIC') arises from the due date of the tax payable under the original assessment. The Tribunal in this matter applied the decision of the Full Federal Court in Commissioner of Taxation v H, when finding that because GIC accrues (daily) as a consequence of a tax debt remaining unpaid past a due date, GIC can be seen as a present legal obligation on each income year it remains unpaid. GIC that becomes payable as a result of an amended assessment is treated as a present legal obligation in the year it accrues, rather than the year in which the amended assessment was made.
Quantum of Distributable Surplus/Penalties
The remaining conclusions of the Tribunal, related to the quantum of distributable surplus and penalties, were based on particular findings of fact. It was open to the Tribunal to make these findings based on the evidence adduced at the hearing. Accordingly these aspects are confined to this case.
Administrative Treatment
Implications for ATO precedential documents (Public Rulings & Determinations etc)
The ATO is reviewing TD 2007/28 and TD 2008/28 following the decision of the AAT in this matter and the decision of the Full Federal Court in Commissioner and Taxation v H [2010] FCAFC 128.
Implications for Law Administration Practice Statements
Legislative References:
Income Tax Assessment Act 1936 (CTH)
25(1)
44
108(1)
109C
109Y
170AA
226G-226H
Taxation Administration Act 1953 (CTH)
Division 284, Schedule 1
Case References:
Re Waffles and anor v Commissioner of Taxation
[2010] AATA 78
2010 ATC 1-020
75 ATR 376
Commissioner of Taxation v H
[2010] FCAFC 128
2010 ATC 20-218