When negligent is better than reckless

The Administrative Appeals Tribunal (AAT) has recently found that a husband and wife were not “reckless”, but were merely “negligent”, in failing to disclose taxable income derived from the sale of four home units.

This might sound like splitting hairs to many, but under the tax law, the degree or scale of the offence influences the size of the penalty that may be applied. The case also highlights that the results often depend on the facts and circumstances of each case.

In this case, while the taxpayers were at fault in not declaring the capital gains on the sale of the home units, the downgrading of the offence from “reckless” to “negligence” meant the penalty imposed was reduced from 50% to 25% of the shortfall amount. The husband and wife acknowledged that their failure to disclose the income arose from a failure to take reasonable care, but they disputed the 50% penalty.

The taxpayers were involved in a property development, and formed a family company to undertake the development. They obviously intended to sell the properties for a profit. The husband was primarily responsible for the financial affairs of the couple.

Their accountant, with whom they had had a close relationship as a family friend and trusted adviser, died in 2004. After his death, the taxpayers’ nephew took over responsibility for looking after their financial affairs. The Tribunal heard he was extremely close to the taxpayers and had lived with them for some time and helped look after their children. Unfortunately, the nephew died in 2006.

In the haste of compiling their outstanding tax returns with a new accountant, and following the deaths of their original accountant and adviser, the husband forgot to advise their new tax agents about the proceeds from the sale of the properties.

The AAT heard that the husband took his nephew’s death in 2006 very heavily to the extent that he was described as “absolutely devastated and rarely left the house”. This condition prevailed for seven to eight months following the death and, during that time, the AAT said the husband spent his time in a disturbed state and the financial affairs were described as having fallen into disarray.

Following an audit by the Tax Office, the Commissioner formed the opinion that the taxpayers were “reckless” in failing to include the proceeds from the sale of the properties. Therefore, he imposed on each taxpayer a shortfall penalty of 50%, amounting to around $130,000 in total for both of them.

Before the AAT, the wife gave evidence that her husband and herself were both aware that they would probably have to pay capital gains tax at some stage in relation to the units in question. Although she said she was unaware of the specific tax implications, she was aware that she would have to pay some kind of tax at some time.

Broadly, the Commissioner contended the omission of the proceeds was the result of the taxpayers’ inadequate record-keeping procedures. Alternatively, he contended the taxpayers knew about the transactions and failed to disclose them. Therefore, the Commissioner submitted that these considerations made the taxpayers’ conduct “reckless” and not merely careless.

The Commissioner also contended that the discretion under the law to remit the shortfall penalties imposed should not be exercised because there were no exceptional circumstances. In addition, he submitted that “ignorance as to liability for tax or the fault of the entity’s tax agent is insufficient to warrant a remission”.

In reaching its decision, the Tribunal considered the operation of provisions of the Taxation Administration Act 1953 and the evidence presented by the taxpayers. It noted that the taxpayers had cooperated with the Tax Office in the conduct of the audit. The AAT said it was satisfied that the husband was “deeply affected” by the deaths of their accountants “to the extent of being unable to act logically for a very substantial period of time during the period when the tax returns were compiled by [the new tax agents]”.

The Tribunal’s view was that the husband “was so affected that he ‘negligently’, but not recklessly, overlooked the need to disclose the profit form the sale of the units to the tax agent”. While the Tribunal acknowledged that the taxpayers’ record-keeping was unsatisfactory, it said their conduct amounted to negligence rather than recklessness.

In conclusion, the Tribunal set aside penalties imposed by the Commissioner and, in substitution, imposed penalties at 25% of the shortfall amount.

Of course, it is better not be negligent or reckless, but it is important to understand that the tax law does recognise individual circumstances when tax penalties are imposed. A penalty in this case could not be avoided, but its magnitude was certainly influenced by the circumstances of the case.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.