The Administrative Appeals Tribunal (AAT) has affirmed that two family trusts that were involved in a building and construction business with other related entities were not entitled to a deduction or a capital loss for $4.3 million. The AAT made this finding on the basis that both the documentary evidence and the oral evidence of the relevant trust controllers was not sufficiently credible to support the bona fides of the alleged guarantee arrangement.

Background

Following the audit of the applicants and their associated entities who were involved in a building business, the ATO had issued an amended assessment in relation to a unit trust for the 2007 income year. The amended assessment reflected the disallowance of a $4.3 million capital loss which the Commissioner concluded, and the applicants accepted, was not incurred by the unit trust. As a consequence, the unit trust had an additional $4.3 million available for distribution to its unitholders. That amount was distributed as 50% to one discretionary trust (controlled by the first and second applicants), and 50% to another discretionary trust (controlled by the third and fourth applicants). From those discretionary trusts, distributions flowed to each of the applicants personally.

The Commissioner then amended the applicants' assessments for the 2007 income year to take account of the additional distributions. Each of the applicants objected against their amended assessment and against the assessment of 50% shortfall penalties for recklessness. They claimed their respective discretionary trusts were entitled either to a deduction or to a capital loss equal to the amount of additional income attributed. Specifically, the applicants claimed that each of their trusts guaranteed a loan that the borrower became unable to service and that, as a result, the lender (a related entity) had called on the guarantors to meet the debt.

Decision

In affirming the Commissioner's decision to disallow the taxpayers' objections to their amended assessments, the AAT found that both the documentary evidence and the oral evidence of the relevant controllers of the trusts was not sufficiently credible to support the existence of the alleged "deeds of guarantee". Specifically, the AAT found that unusual features of the guarantee deed in evidence put into question whether the trusts were genuinely subject to a guarantee obligation. The AAT also expressed concerns about the evidence of the amount of the loan in question, but found it sufficient to decide the matter on the evidence as to the existence of the guarantee.

The AAT noted that the guarantee deed made no reference to what was involved in the guarantors "securing" the debt and did not, as would normally be expected, record an undertaking by the guarantors to perform the obligations of the debtor under the loan agreement should the debtor default. Likewise, the AAT noted that the deed said nothing about the process to be undertaken by the lender to recover from the guarantors in the event of default. The AAT stated that the only director of the debtor on the date the deed of guarantee was made (apart from another party who was not at arm's length from the applicants) said he knew nothing about a guarantee.

In these circumstances, the AAT said there was considerable doubt about whether the applicants "truly did expose themselves to any guarantee obligation under the document in question". The AAT also noted the well-settled principle that "the evidence of witnesses who have an interest in the outcome of litigation needs to be approached critically".

The AAT affirmed the 50% shortfall penalties for recklessness, saying the immediate cause of the applicants' failure to include the distributions in their assessable income was "not only an error of attribution but one of fundamental entitlement as well", and due to "extreme sloppiness … the error was caused by gross carelessness". The AAT found there were no grounds to remit the penalties in these circumstances.

Re Carioti and FCT [2017] AATA 62 AAT, File Nos: 2014/1471, 1474, 1484 and 1485, Frost DP, 25 January 2017, http://www.austlii.edu.au/au/cases/cth/AATA/2017/62.html.