CASE 5/2005

Members:
BH Pascoe SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2005] AATA 300

Decision date: 23 March 2005

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BH Pascoe (Senior Member)

These are applications to review decisions of the Commissioner of Taxation (the respondent) to disallow objections by the applicants against amended assessments for the three years ended 30 June 1998 to 30 June 2000 inclusive in relation to the first applicant and the two years ended 30 June 1999 and 30 June 2000 in relation to the second applicant. The amended assessments were issued to disallow deductions of $32,692 claimed in each year by the applicants under Division 10B of the Income Tax Assessment Act 1936 (the Act). Additional tax, by way of penalty, was levied in the amended assessments at the rate of 10 per cent of the tax shortfall.

2. At the hearing the applicants were unrepresented. The respondent was represented by Mr P. Hack SC. Evidence was given by the applicants. The second applicant had objected solely to the imposition of additional tax and did not seek to contest the disallowance of the deduction claimed. In his objection and prior to the hearing, the first applicant sought to contest the disallowance of the deduction and the additional tax. However, in the course of the hearing he conceded that he could not succeed in his claim for the deduction.

3. In view of the concession by the first applicant it is appropriate to set out the background facts in brief only. The applicants are related by blood or marriage to an inventor of computer software who operates through a company (company A). A particular allegedly valuable price of software was owned by company A. In April 1998 a series of transactions took place as follows:

• (a) company A assigned the copyright in the software to a wholly owned subsidiary, company B, for $17 million;
• (b) company B formed 52 wholly owned subsidiaries, companies C;
• (c) company B assigned 1/52 of the copyright to each company C for $326,925;
• (d) each applicant acquired the issued capital of a company C for $29,500;
• (e) each applicant took an assignment of the 1/52 interest in the copyright from his company C for a consideration of $326,923 with payment to be at any time at the option of the assignee, but in any event, within 20 years;
• (f) each applicant entered into a licence and option for purchase of the copyright with company A. Under this agreement company A was granted an exclusive worldwide licence to use and exploit the copyright for a fee of $300 in year 1, $600 in year 2, $1100 in year 3, $3000 in year 4 and market value thereafter. The licensee was granted an option to purchase the 1/52 share of the

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  copyright for $29,500 within four years or for market value thereafter.

The effect of all of these transactions was that each applicant paid $27,500, being the cost of the shares in company C of $29,500 less $2000 licence fees for 3 years paid in advance. A deduction of $32,692 was then sought to be claimed in each of the next 10 years under Division 10B of the Act.

4. In a decision of this Tribunal involving another investor in the same arrangement (
Lyman v FC of T 2004 ATC 2269, it was noted that the accountant who devised the complex arrangement conceded at the hearing ``that the transactions had been a sham''. In this hearing, the first applicant was informed that Division 10B of the Act applies to the owner of a unit of industrial property who ``incurred expenditure of a capital nature on the purchase of the unit of industrial property''. He was asked whether he had incurred or intended to incur any expenditure under the purported assignment agreement for a consideration of $326,923. He conceded that there was neither an intention nor expectation of any payment being made other than for the purchase of the shares in company C. He had understood that the deduction would be available if a valuation equal to the purported consideration was in existence. The first applicant then conceded that, under the provisions of Division 10B, he could not succeed in a claim for a deduction.

5. The applicants submitted that the additional tax, by way of penalty, should be remitted to nil. It was said that company A was a genuine company, the software was genuine and potentially valuable and that they had participated in the arrangement devised by the accountant in a genuine desire to provide finance to company A for the future development of the software. They had relied on the advice of the accountant, who had been company A's accountant for many years. While aware that the arrangement was unusual, the applicants said that they believed that the accountant was competent and they had no individual ability to judge whether the advice was correct under complex tax law. They were both critical of the long delay by the respondent in retrospectively disallowing the deductions claimed and the consequent amount of penalty by way of interest in addition to the 10 per cent culpability penalty.

6. The respondent submitted that the 10 per cent additional tax was low and generous in comparison with penalties provided by Part VII of the Act where a minimum rate of 25 per cent would apply. It was noted that in Lyman's case (supra), the Tribunal accepted that a 10 per cent penalty was ``extremely generous''. In this case, while I accept that the applicants had confidence in the inventor and the software and had a genuine desire to assist financially in its development, it is difficult to accept that the complexity of the arrangement, which purported to provide them with deductions of $326,923 over 10 years for a one-off net outlay of $27,500, would not have raised some suspicion. A further matter which would have been expected to raise some doubt as to the effectiveness of the arrangement was the option granted to purchase the interest in the copyright for an amount equal to their actual investment within a period in which the market for the software would expect to have been demonstrated. They may well have relied on the advice of the accountant, but some documents were clearly backdated and no independent advice was sought. In the circumstances, I am unable to see that any reduction in the relatively low penalty, by way of additional tax of 10 per cent of the tax shortfall, is warranted.

7. It was clear that the applicants were concerned at the total penalties which included a general interest charge (GIC) in addition to the 10 per cent culpability penalty. Unfortunately, the Tribunal has no jurisdiction in relation to the imposition of GIC whilst accepting that this did contain a factor for culpability being significantly in excess of commercial interest rates. In the circumstances of these applicants and bearing in mind the respondent's relatively generous offers to participants in mass marketed tax schemes, it could be considered appropriate for the respondent to reconsider the rate of GIC or for the applicants to make application to the recently created panel established to deal with such applications. While accepting that both applicants had a relationship with the principal involved in the arrangement, I accept, also, their evidence that they relied upon the advice of the accountant and were somewhat naïve in being a party to that arrangement. It appears that the respondent took a considerable time to take action to disallow the deductions claimed under this arrangement notwithstanding knowledge of

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the detail thus leading the participants to believe that it was accepted.

8. Notwithstanding these concerns regarding the imposition of GIC, I have no option other than to affirm the decisions under review.