In both cases, the ATO issued assessments on the basis that payments that had been made to the taxpayers were income. In the first case, the amounts paid to the taxpayer, Mr Rowntree, totalled more than $4 million over four years: in the second case involving Mr Hart, the total was approximately $500,000 in one year. In addition to income tax on the amounts paid, the ATO imposed shortfall penalties of 50% of the additional tax on the basis that the taxpayers’ behaviour with respect to the tax treatment of the payments had been reckless. In the case of Mr Rowntree, the penalty was increased to 70% for the last three of the four years involved.
In both cases, the taxpayers argued that the payments were loans. While Mr Rowntree produced some documents (Division 7A loan agreements), the terms of the documents and dates they were executed were inconsistent with his argument (for example, as the loan documents only applied from a certain date and not to transactions before that date). Mr Hart offered no documents to support his argument. Further, the ATO had discovered material that Mr Hart had provided his bank in support of a loan application which supported the ATO case that the amounts were income.
These cases highlight the importance of documentation and (equally) the importance of the timing of documentation.
To the extent that loans are to be made by a company or trust, it is better to have those documents in place before the loans are made. It is also important to ensure that the documents (in fact) cover the relevant transactions and that the documents are consistent with the substance of the arrangement. The consequences for getting this wrong can be quite substantial.