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This article was originally published in CCH Australian Tax Week Issue 34 (26 August 2022).
With audits and reviews now in full-swing after COVID-19, we are seeing more and more clients who have had shortfall penalties imposed. As tax practitioners, we have the job of objecting to shortfall penalties that have been imposed – by explaining the taxpayer’s unique (subjective) circumstances and hoping that they fit into the objective test applied by the ATO decision makers.
With audits and reviews now in full-swing after COVID-19, we are seeing more and more clients who have had shortfall penalties imposed. As tax practitioners, we have the job of objecting to shortfall penalties that have been imposed – by explaining the taxpayer’s unique (subjective) circumstances and hoping that they fit into the objective test applied by the ATO decision makers.
To determine if there will be shortfall penalties, you need to first determine if there has been a tax shortfall – where there has been a change in the tax liability.
Once the Taxation Administration Act 1953 (TAA 1953) Sch 1 s 284-75(1) imposes administrative penalties, including shortfall penalties, for making a false or misleading statement, the table in the TAA 1953 Sch 1 s 284-90(1) is the starting point for calculating the level and amount of that penalty. The following reproduces items 1, 2 and 3 from that table where there is a tax shortfall which creates a shortfall penalty.
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What is a false or misleading statement?
Shortfall penalties are imposed where the taxpayer has made a false or misleading statement. A false or misleading statement is one that is wrong, contrary to fact or contains omissions of fact. Importantly, the statement must have been false at the time it was made, meaning that if it later becomes correct due to subsequent events, the penalties can still apply to the making of the [false] statement before those events changed the facts.
The statement needs to be made to the Commissioner (or delegate), either in writing or orally. The statement can be made in any correspondence, registration form or return/statement provided to the Commissioner. Importantly, failing to include information in a document or form where there is a requirement to do so, is also treated as being a statement (as an omission from that statement).
Severity of shortfall penalties
For most income tax and indirect taxes, there are 3 different levels of shortfall penalty, based upon the perceived severity (or culpability) of the taxpayer’s conduct in making such false or misleading statements under s 284-90(1):
Reasonable care is not defined and as a result just takes its ordinary meaning. The “test” is objective and requires an entity’s conduct to be compared with the same level of care that would be expected of a reasonable ordinary person in the same position (ie this requires considering the particular circumstances of the person making the statement).
Similar to reasonable care, recklessness is not defined and takes its ordinary meaning. It is clearly “something” more than a lack of reasonable care but “something” less than intentional disregard. Again, this is an objective “test”, where a person will be reckless if they disregard or show indifference to the consequences flowing from their action [in making the statement] that could have been foreseen by a reasonable person (in their circumstances).
Once again, intentional disregard is not defined, and takes its ordinary meaning. What is clear, is that conduct is more serious than lack of reasonable care and recklessness. Importantly, unlike the others, this test is subjective and involves determining the person’s intent in making the [false] statement. This does not require an express admission, but may be inferred from context and the actions the person took – again considering their particular circumstances. The central concept is that the person must know and understand that the statement was false and the relevant consequences that would flow under the relevant legislation – often involving dishonesty or concealment of “true” circumstances that are contrary to what the statement said.
Subjective circumstances applied to an objective test
A difficulty that taxpayers and tax practitioners face on shortfall penalty cases is proving to the satisfaction of ATO decision makers that the unique and subjective circumstances of the taxpayer mean that the expected level of conduct for them would not require them to meet the “perfect” or “ideal” standard of a taxpayer with greater knowledge and understanding of tax law or the relevant and material facts behind the statement. As tax experts, ATO officers may at times have an understandable tendency to assume greater knowledge of tax law by taxpayers than is reasonable for non-experts, even when they may be advised by tax agents or tax lawyers.
For example, consider a taxpayer who operates a small business in a small regional town, who has mental health issues that have taken them away from their business over the last few years. During this time, they have forgotten to lodge their tax returns for the last few years. The small business just scraped through each financial each year, just making payments to their employees. In addition, the small business has had 4 different contracts liquidate after services were provided, leaving them in the lurch. Finally, they were impacted by the floods and lost many of their paper-only records. When they finally lodged their returns in 2021, they were audited, and it was found that there were a number of omissions of material facts and transactions.
The most significant risk on the shortfall penalty front for that taxpayer is that the ATO is likely to apply the objective test by comparing their conduct with what an “ideal” small business operator would have done, rather than looking at what a reasonable person would have done in the taxpayer’s “true” circumstances. In that sense, one of the most important roles for tax and legal practitioners supporting such a taxpayer is to effectively communicate those “true” circumstances to the ATO early and often during the process of reviews, audits, objections and even litigation. Otherwise, the ATO will not be able to properly consider the taxpayer’s unique personal context in assessing their liability to potential shortfall penalties. However, ATO staff may be cautious in reviewing such evidence of those circumstances and determining whether they should accept it as being “true”. This often requires the advisor to present corroborative evidence from health providers or other “independent” third parties.
There is a considerable amount of case law to assist tax practitioners and taxpayers to determine what severity of penalty may be applicable based on conduct, including:
To join the discussion about the shortfall penalty regime, register for the CCH Learning session with Bruce Collins from Tax Controversy Partners Pty Limited “ATO Tax Shortfall Penalties” that will be held on Tuesday, 30 August 2022 at 10.30am. You can also register for the recording from 31 August 2022.