The odds are stacked against the taxpayer - and the law should be reformed

Mark Molesworth, Partner, Tax |

05 April 2022

Two recent cases in which taxpayers have taken on the Australian Tax Office (ATO) have lessons for all taxpayers, but also illustrate concerns with the administrative machinery of the Australian tax system.

In the first case, a taxpayer had a rare win against the ATO in the Federal Court. Taxpayer wins are rare because the taxpayer always bears the burden of proving why the ATO’s tax assessment is excessive. In other words, the ATO can act on suspicion in assessing a tax liability and it is the taxpayer’s job to prove why the tax payable should be less. That is usually a very high bar for taxpayers to jump. We regularly have to remind taxpayers that the three “E’s” of winning a tax case are: evidence, evidence and evidence.

The bar can be even higher than it seems. A taxpayer’s own verbal evidence is generally given little weight by the court or tribunal – it is apt to be dismissed as ‘self-serving’. A taxpayer who just turns up, tells their story and says ‘Believe me?’ will often be told ‘No!’.

However, a taxpayer’s oral evidence which is supported by contemporaneous documents, including emails and records of conversations, is much more persuasive. And so it was in the Guardian AIT case, where the Federal Court referenced consistency with emails and file notes kept by the taxpayer and its advisers as a reason to accept oral testimony about their thoughts and actions. While this case is on appeal, the fundamental lesson is that taxpayers should create and keep timely documents that explain what they have done.

How long should taxpayers keep those records though? The tax law generally allows documentation of transactions to be destroyed five years after they cease to be relevant (but be careful, because some records of losses and the cost base of assets will only cease to be relevant five years after the loss is recouped or the asset sold). This aligns well with the usual limited period in which the ATO can amend a tax assessment. Depending on the complexity of a taxpayer’s affairs, this will either be a period of two or four years.

A problem arises if the ATO ever alleges a taxpayer has engaged in fraud or evasion. Such an allegation allows the ATO to amend assessments without limitation - that is, without regard to the usual two or four year amendment periods.

This was the situation in which the taxpayers in the second case found themselves. In order for a taxpayer to fight an allegation that they engaged in fraud or evasion, for all practical purposes the taxpayer has to prove one of two things.

First, they may show that there was no amount omitted from taxable income; for example, by showing that the amounts the ATO included in their assessable income were not assessable.

Alternatively, they can demonstrate that the amounts, while assessable, were not included in their return for a reason that shows that while there was a shortcoming, it was a shortcoming that fell short of a blameworthy fraudulent or evasive act. That is, they can show a reasonable excuse for omitting the amounts from their assessable income.

But here's the rub. Under either option, the taxpayer needs to lead evidence, preferably documentary, to explain what went on in those transactions. Without such evidence, a taxpayer will not be able to make good either argument.

Who is to say when the ATO will make a finding of fraud or evasion? In which case, a taxpayer may very well want their records many years down the track.

All in all, this calls into question the utility of the limited amendment periods and document retention rules, if compliance with the letter of the law can lead to effectively unchallengeable allegations of fraud or evasion. This area is overdue for reform.

This article was printed in The Sydney Morning Herald, Brisbane Times, WA Today and The Age (06/04/2022).