| Negligence Actions against Accountants, Lawyers and
Advisers Can your client or the ATO sue you?
Prepared for
The Australian Society of CPAs
Presented on 26 February 1999, Perth
Negligence of registered tax agents
There is a growing body of law suggesting that accountants, advisers and
lawyers are under an ever growing threat of being sued. Consider section 251M(1) ITAA
1936.
251M(1) [Liability of tax agent]
"If, through the negligence of a registered tax agent, or of a
person exempted under section 251L, a taxpayer becomes liable to pay a fine or other
penalty, any additional tax or any interest under section 170AA or 207A, the registered
tax agent, or the person, as the case may be, shall be liable to pay to the taxpayer the
amount of that fine or other penalty, additional tax or interest, and that amount may be
sued for and recovered by the taxpayer in any court of competent jurisdiction."
Section 251M(1) was amended by Act No 101 of 1992 to include the
reference to interest payable under section 170AA and 207A.
Is section 251M clear cut?
Section 251M is not clear cut in its application. Does the section
require the tax agent's negligence to be the sole reason for the liability to pay the
penalty, additional tax or interest? There is nothing in the legislation dealing with
apportionment. It could be argued that section 251M does not apply where the tax agent's
negligence was one only of several contributing factors giving rise to the liability.
Is section 251M an exclusive remedy?
Is section 251M an exclusive remedy? The answer is no. The adviser may
still suffer a concurrent cause of action at common law for negligence or breach of
contract or section 52 of the Trade Practices Act (and its myriad of brethren). What the
plaintiff ends up getting however may be restricted to the section 251M.
Consider Pech & Anor v Tilgals 94 ATC 4206. In this case 2 taxpayers took
action under section 251M in the NSW Supreme Court to recover $390,000 in additional tax
and interest. They argued that the loss arose from their tax agent's negligence in failing
to include deemed dividends in their returns. This was not the only claim. Damages were
also sought in a common law negligence action. The taxpayers won. However, they could only
recover once. The amount awarded under section 251M was greater than the damages assessed
under the negligence claim. Therefore they only received the section 251M amount.
Walker v Hungerfords ATC 4920 dealt with a partnership carrying on a retailing
electrical equipment business. The partnership successfully sued, for damages in both tort
and contract. The victim was a firm of accountants that for years had prepared the income
tax returns of the business. The Court held that the firm of accountants failed to take
reasonable steps to submit accurate tax returns. As a result the business suffered loss.
The loss included the overpayment of tax - the overpayment was unrecoverable.
What happens if the tax agent pays their client’s extra tax?
I have known situations were a tax agent has bitten the bullet and paid
their client’s additional tax. The additional tax is (sometimes arguably) because of
some failure on the adviser’s part. Unfairly, it is beyond doubt that such payments
are not allowable as a deduction. This was the clear message in Mayne Nickless Ltd v FC
of T 84 ATC 4458. The Board of Review in Case A32, 69 ATC 181 now appears to have been
wrongly decided.
Can the adviser be attacked directly by the Commissioner?
The Commissioner in the past has directly penalised the adviser - while
the taxpayer has been left untouched by the Commissioner. Taxation Ruling IT 2246 sets out
the taxation office prosecution policy. The exposure of the adviser to prosecution is set
out in this ruling.
Negligent tax advice from the lawyer and accountant.
We will be looking at the Tip Top case soon. However, not all cases end
in the tax agent’s favour. Consider EVBJ Pty Ltd v Greenwood 88 ATC 4977:
In this case the taxpayer desired to become a large residential property land owner.
The purchase would only proceed if tax deductions for interest payments on the loan were
available. The taxpayer had a friend. The friend was a lawyer. The lawyer had another
friend he was an accountant - a partner in a large firm of accountants. The
taxpayer’s "friends" both told him that the deduction is allowed -
providing a certain process was followed. The lawyer and the accountant knew that the
transaction sunk or swam on that deduction. The purchase was a non starter without that
deduction. You guessed it. The deduction was disallowed by the tax office. The taxpayer
had no option other than to sell the real estate. As is usually the case the forced sale
caused a substantial loss. The taxpayer sued the accountant. The accountant via a
cross-claim sued his friend the lawyer. The court held the accountant responsible for
one-third of the damages and the lawyer two-thirds.
Tip Top v Mackintosh - a win for the good guys - 3 April 1998
Tip Top sued its accountant and a lawyer on the basis of negligent tax
advice. This related to a proposal for Tip Top to obtain a deduction for the pre-purchase
of trading stock.
What happened in Tip Top v Mackintosh?
Tip Top carried on a number of businesses, including petrol retailing.
Tip Top was very loyal and used the same firm of accountants for 30 years. In May 1992,
the company's internal accountant predicted a massive increase of profit - $2.8 million in
the 1991/92 year. Something had to be done to reduce the tax.
The company's directors and the accountant Grant Mackintosh considered pre-purchasing
petrol and obtaining a deduction for the pre-purchase to reduce the company's tax
liability. The petrol was to be used in the succeeding tax year. You may recall that the
amendment to section 51 of ITAA 1936 had just been announced. The amendment intended to
limit the capacity to reduce taxable income by the pre-purchase of trading stock. A lawyer
was employed to look at ways of making the pre- purchase of trading stock deductible.
The lawyer prepared a pre-purchase proposal designed to avoid the operation of section
28 and 51(2A) (read now section 70-35 and 70-15 of ITAA 1997). Under section 28 the
assessable income of a taxpayer includes the amount by which the value of the trading
stock on hand at the end of the year exceeds the value of the trading stock on hand at the
beginning of the year. Section 51(2A) works in conjunction with section 28.
The scheme was decided. Tip Top pays for the petrol, obtains title and isolates the
purchased petrol. Tip Top is therefore able to claim control of the petrol as trading
stock on hand. Before the end of the financial year the very same petrol is blended with
other stocks of petrol held by Mobil. The petrol therefore now loses its character as
trading stock. What rights did Tip Top then have over the petrol? Now, rather than owning
trading stock, the company had a contractual right to have Mobil deliver to it a quantity
of petrol equivalent to the quantity owned by the company immediately before the blending.
The concept broke down somewhat with the third party Mobil - the holder of the petrol.
Mobil’s system did not allow for the petrol to pass to Tip Top at the beginning of
the transaction. Excise required bonding arrangements between the Department of Customs
and Excise and Mobil. Therefore it was not possible for property to pass to Tip Top as
required. The scheme was dead in the water. Being the optimist, the lawyer Campbell
Rankine stated that even with the current bonding arrangements the deduction may still get
through. Campbell also warned that if the deduction was disallowed then the deduction
would be unsustainable in front of the Commissioner.
Tip Top proceeded on with the purchase of the petrol. It is important to note here that
the purchase is now different to what Campbell originally set out.
You have to prepare those tax returns sometime
The day finally came when Tregloans had to prepare Tip Top’s
company 1991/92 tax returns. The accountant Grant Mackintosh gave Tip Top 3 options:
claim a deduction for the pre-purchase of the petrol and not make a full disclosure of
the transaction to the tax office;
not claim a deduction for the petrol at all; or
claim the deduction for pre-purchase of petrol and rely on the good will and kindness
of the tax office by making full disclosure.
Tip Top decided to claim a deduction and forget about making a full disclosure.
At first the Commissioner allowed the deduction. The nightmare then started when the
tax office arrived to conduct an audit. The tax office disallowed the deduction for the
pre-purchase of petrol. The amended assessment contained not only the recover of tax but
interest and penalties as well.
Tip Top was a little hurt by all of this and vented its frustration by commencing
proceedings in the South Australian Supreme Court against Grant Mackintosh, Campbell
Rankine and the accounting firm Tregloans. Tip Top wanted damages for:
- additional tax
- interest
- penalties
- loss of the use of its money
The action was on the basis of negligent advice in preparing the tax return.
Lawyers like using, what I call the scatter gun approach. Tip Top’s claims were
for damages:
- for breach of contract
- for professional negligence
- under section 56 of the Fair Trading Act (like section 52 of the TPA - misleading and
deception conduct)
- under section 251M of ITAA 1936
What did Tip Top decide?
Firstly, the Court clearly identified that Tip Top did not embark upon
the transaction originally devised by Campbell Rankine. Secondly, Tip Top was made aware
that its deduction was unsustainable if found out by the tax office. Finally, Grant
Mackintosh set out the 3 options for Tip Top to choose from at the time of preparing the
company’s tax returns.
Negligence requires that one person owes another person a duty of care. Quite clearly
both the accountant and the lawyer owed Tip Top a duty of care for the transaction entered
into by the company on 29 June. The accountant and lawyer never denied that they owed such
a duty. Debelle J held that both had discharged that duty. Tip Top received appropriate
advice from its professional advisers. Tip Top knew of the risks and proceeded on
regardless.
In contrast Tip Top argued that it knew virtually nothing about the intended
transaction, that it had not been informed that the transaction would not succeed and that
it had not been warned as to the potential consequences. As is so often the case, court
proceedings are fought over more the facts than the law. Debelle J gave more weight to the
evidence of Mackintosh and Rankine. Less weight was attached to the directors’
evidence.
The section 56 of the Fair Trading Act claim was founded upon the same facts as
the other claims. The court held that there was no deceptive or misleading conduct on the
part of either Mackintosh or Rankine.
Tip Top argued that the quality of advice in some respects was lacking. This was a
tenable position for Tip Top to take. However negligence requires that there be a
relationship between a negligent act and the damages. Debelle J would hear none of this as
he held that any negligent advice lead to no damages.
Both the accountant and lawyer where held not to be negligent. Section 251M therefore
also did not apply.
What can we learn from Tip Top?
- Interestingly the court held that there was no perceivable difference
between the degree of skill and care required of a chartered accountant or lawyer giving
tax advice.
- The taxpayer’s relationship with the accountant is a relevant
factor. Because of Mackintosh’s long and close relationship, Mackintosh’s duty
extended to giving advice that Tip Top seemed to need - this advice must be forthcoming
even if not requested by the taxpayer.
- Rankine as the lawyer had been specifically briefed to deal with the
taxation matters of the transaction. His duty therefore extended to all relevant issues
arising under the Tax Act and under the general law. Comprehensive advice touching on all
relevant matters was therefore required. Such a duty specifically included section 51 and
also the possible application of Part IVA of the Tax Act.
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