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Asset betterment: operation, obligation and onus

The recent decision in Le v Commissioner of Taxation has renewed attention on the ATO’s use of assessment betterment statements. This article explains the operation of the process, taxpayers' obligations and where the onus lays. It’s not where you may think.

Insights Robyn Jacobson, The Tax Institute 29 April 2021
— 8 minute read

What is asset betterment?

‘Asset betterment’ refers to an approach adopted by the Commissioner of Taxation in determining the amount of taxable income of a taxpayer.

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Broadly, under asset betterment, the net worth of an individual at the end of an income year is compared with their net worth at the start of that year (this may be applied to multiple years). This produces an estimate of the annual growth in the individual’s assets. Prima facie, this is treated as assessable income. Non-deductible expenditure is then added to this estimate and liabilities and exemptions are subtracted. The result is determined to be the individual’s total taxable income and forms the basis of the issue of a default assessment to the individual.

Examples of non-deductible expenditure include the payment of private school fees, the purchase of property or lifestyle assets such as luxury cars and boats, and frequent overseas travel (although not in the past 12 months!).

How can the Commissioner simply deem an amount to be the taxable income of a person?

The Commissioner is given the power to issue a default assessment under s 167 of the ITAA 1936.

To paraphrase s 167, the Commissioner may issue an assessment (a default assessment) of the amount upon which, in the Commissioner’s opinion, income tax ought to be levied if:

  • a person fails to lodge an income tax return;
  • the Commissioner is not satisfied with the information reported in an income tax return lodged by a person; or
  • the Commissioner has reason to believe that any person who has not lodged an income tax return has derived taxable income.

The amount shown in the default assessment is taken to be the taxable income of that person. Separate provisions provide for the imposition of an administrative penalty, up to the hefty rate of 75 per cent, which can accompany a default assessment. The penalty can be uplifted by 20 per cent to 90 per cent if the taxpayer hinders the Commissioner, for example, by obstructing information. The general interest charge is also generally imposed.

Taxpayers have expressed concerns that the ATO’s use of benchmarks for a default assessment is unreasonable since the benchmark is a generalised statistic and may not resemble a taxpayer’s reality, and that the ATO can effectively ‘make up’ or ‘create’ income that doesn’t exist.

When a default assessment is issued, ATO officers are required to follow Law Administration Practice Statement PS LA 2007/24 — Making default assessments: section 167 of the Income Tax Assessment Act 1936 and similar provisions.

Paragraph 8 of the Practice Statement explains that:

  • ATO officers must ensure that their decisions are fair;
  • they are made on reasonable grounds;
  • there is sufficient information available to them to make a genuine judgment; and
  • they consider the relevant individual circumstances in accordance with the law, the commitments made in the taxpayers’ charter and the principles of the compliance model.

Paragraph 9 of the Practice Statement lists the following as being reasonable grounds:

  • information provided by third parties;
  • any internal or external data matching information;
  • indirect audit methodologies (such as sources and application of funds, ‘T’ accounts or asset betterment assessments);
  • relevant economic statistics; or
  • extrapolation from previous years’ returns.

The Inspector-General of Taxation’s 2012 Review into the Australian Taxation Office’s use of benchmarking to target the cash economy identified that, of the 228 default assessments issued from July 2010 to April 2012, 223 arose from ATO audit activity.

Where a taxpayer is dissatisfied with an assessment, including a default assessment, they may lodge an objection against it. A decision on objection by the ATO may be reviewed by the Administrative Appeals Tribunal (AAT) or appealed to the Federal Court.

Where does the onus lay?

In the criminal justice system, the legal burden of proof rests on the prosecution to prove beyond reasonable doubt that the defendant committed the offence and disprove beyond reasonable doubt any defence against the charge. We’ve all heard the truism: defendants are guilty until proven innocent.

However, in the tax system, the onus rests on the taxpayer. It is not enough to be right; the taxpayer must prove they’re right. Rather, they must prove that an assessment (including a default assessment) or amended assessment is excessive. The Commissioner is not required to prove the assessment is correct.

That the Commissioner is given the power by the law to issue a default assessment acknowledges a taxpayer is best placed to determine their taxable income — they know how much they have earned in the year. In the absence of a lodged income tax return, the Commissioner may make an ‘informed guess’ by reasonably estimating the amount of a taxpayer’s taxable income.

A common thread through many of the AAT cases in which taxpayers have been unable to prove default assessments were excessive is their failure to produce independent and verifiable evidence to support their claims, by failing to keep adequate corroborating records. They are invariably self-represented, and their evidence lacks plausibility and credibility. This conclusion can be drawn from the notable absence of contemporaneous documentary evidence supporting their claims or the absence of evidence given by those with whom the taxpayer has dealt.

Claims that their receipts are not assessable often include that the funds were sourced from loans or gifts from family members, gambling winnings or existing savings transferred from overseas or other bank accounts in Australia. A failure by the taxpayer to call witnesses, such as their accountant/tax agent or family members, can also lead the AAT to infer that their appearance would have been detrimental to, or at least would not have assisted, the taxpayer’s case.

Recent decision in Le v Commissioner of Taxation

In most cases, the taxpayer does not dispute the default assessment or reaches a settlement with the ATO. In a handful of cases, the taxpayer seeks a review of the Commissioner’s decision before the AAT or appeals the decision to the Federal Court.

The use of asset betterment was recently examined in the Federal Court decision in Le v Commissioner of Taxation [2021] FCA 303. The taxpayers, a de facto couple, each lodged tax returns for the 2004–05 to 2011–12 income years, disclosing modest taxable incomes (less than $50,000 each per year). The Commissioner formed the opinion that there had been an avoidance of tax by virtue of fraud or evasion (which allows the Commissioner to issue assessments out of time).

The starting point of the tax dispute was a conventional, asset betterment. The ATO then:

  1. identified assets — bank account balances, real estate and motor vehicles;
  2. identified liabilities — bank loans and credit card balances;
  3. deducted liabilities from the assets so as to derive net assets; and
  4. identified the annual change in net assets.

That change then became a component of the Commissioner’s assessment of the taxable income of the taxpayers. Their combined taxable incomes were increased by more than $5.5 million and penalties of nearly $850,000 were imposed.

Other components of the Commissioner’s assessing approach was to identify amounts:

  • paid from bank accounts (both amounts particular to expenditures and cash withdrawals);
  • contributed by one of the taxpayers to various ‘hui’ (‘hui’ is an informal money lending system, common among Vietnamese communities, where a group of people collectively make contributions to form a pool of cash; each contributor is then entitled to collect the pool of cash based on their share); and
  • spent at the Treasury Casino, Brisbane, based on records maintained by the casino.

The Commissioner assumed that, for the taxpayers to make such payments, a corresponding amount of income must have been derived by them.

Adjustments in the taxpayers’ favour were made by the Commissioner in the form of a credit for income that had already been declared, deductible expenses and for other non-assessable receipts by the taxpayers, which included certain gambling winnings that were substantiated by documentation and a loan that the Commissioner was satisfied had been made.

The opening paragraph of the Tribunal’s decision in NGFZ and Commissioner of Taxation (Taxation) [2019] AATA 5410 states:

Where did the money come from? That is the key question in a case like this where the taxpayers appeared to have lots of cash flowing through their hands during the years of income under review — more than one would expect having regard to the amounts they returned as assessable income.

In this first instance decision, the AAT decided that the taxpayers had failed to discharge their burden of proving the assessments were excessive. The Tribunal went on to decide that the taxpayers did not demonstrate any good reason for disturbing the objection decision with respect to penalties. The rate of penalty should not be reduced, and the penalties should not otherwise be remitted. In arriving at its decision, the AAT explained its difficulty in dealing with statements provided by witnesses who were not made available for cross-examination in a case which turns on credibility.

The taxpayers appealed the AAT’s decision to the Federal Court who noted that the submissions in support of the taxpayers’ case ‘were advanced with consummate skill by their counsel’. The key argument was that an error of law was to be found in a failure by the AAT to ‘respond to a substantial, clearly articulated argument relying upon established facts’.

The taxpayers’ primary argument was that it was wrong to assume every cash withdrawal from a bank account constituted ‘expenditure’ because such withdrawals were equally consistent with transferring funds by withdrawing cash from one account and depositing it into another. Logan J accepted the taxpayers’ contention that the AAT was bound as a matter of law to consider and deal with their explanation as to why the amended assessments were excessive. The explanation offered by the taxpayers, would, had it been addressed by the AAT, have forced consideration of whether there was double counting, or more, of the amounts, and at least to this extent resultant, excessive assessments. Accordingly, the AAT erred in not considering the taxpayers’ explanation as to why the debits in the bank account statements should not be equated with income.

The remittance by Logan J of the matter to the AAT for rehearing has provided the taxpayers with a second opportunity before the AAT to show the tribunal that the assessments were excessive or incorrect to some extent.

The case serves as a timely reminder of the power of the Commissioner to issue default or amended assessments in the absence of full disclosures by taxpayers, based on increases in their net worth and their expenditures. The ATO has access to massive amounts of data through their data-matching programs, Tax Information Exchange Agreements with nearly 40 non-OECD participating countries, and mandatory or compelled reporting by the asset ownership registries (e.g. land titles offices, and motor vehicle and boat registration). Errant taxpayers who think that their non-compliant behaviour will remain undetected underestimate the ATO’s ability to use a wide range of tools in identifying tax avoidance and evasion, including utilising asset betterment.

Robyn Jacobson, senior advocate, The Tax Institute

Asset betterment: operation, obligation and onus
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