The Tax Commissioner successfully contended that more than $1.6 million put in a couple’s bank account constituted taxable income, rather than a gift or loan from friends.
The case of Rusanova and the Commissioner of Taxation is enough for a television movie. The plot revolves around an Australian-resident Russian couple who were ‘given’ over $1.6 million in inexplicable bank deposits and over $67,000 in interest, the Russian father-in-law, a seafood exporter, a number of Australian firms, and a generous friend who loaned money in $20,000 increments.
The essence of the matter before the Federal Court is whether you can show the Australian Tax Office (ATO) that unexplained payments should be classified as gifts or loans, and what happens if the Tax Commissioner disagrees? If the Commissioner suspects the deposits represent income, he can issue a default tax assessment and determine how much tax should be paid. The taxpayer is then responsible for proving that the Tax Commissioner is incorrect.
The unexplained deposits
Between 2012 and 2016, an Australian husband and wife deposited an estimated $1,636,000 in their bank accounts. The ATO got concerned when neither spouse filed tax returns under the false idea that they had not earned any income.
Surprisingly, no records were produced to back up the deposits, and not a single SMS or email was sent reporting or acknowledging receipt of the funds.
In addition, a couple’s buddy made a series of $20,000 deposits into the husband’s account over the course of a week. According to the friend, these were interest-free loans with no agreed-upon terms but the expectation of repayment. The friend couldn’t recall how he was asked to make the loans, and there were no loan documentation, emails, or texts to back up the loans. Around the same time as the loans were granted, there was evidence of the husband’repaying’ amounts more than what had been lent. In addition, documents show that the husband transferred a Porsche Cayenne to a buddy in Russia as part of loan payback.
The husband possessed four directorships in Australian firms, none of which had filed tax filings, which exacerbated the situation. One of the enterprises was a seafood distributor that distributed products from his father-in-law’s American-registered Russian export company. During 2010 and 2016, the dedicated son-in-law asserted that he was simply attempting to grow his father-in-law’s business without compensation.
Can the Tax Commissioner actually decide how much tax you should pay?
The Tax Commissioner has the authority to make a ‘default assessment’ for the amount he considers is owed from unpaid tax returns or activity statements. The assessment is for the amount that the ATO believes is owed, not what has been disclosed.
The difficulty with a default assessment is not simply that the Tax Commissioner decides how much tax you should pay; it also includes the possibility of an administrative penalty of 75% of the tax-related liabilities for each default assessment issued. In certain cases, taxpayers with a habit of noncompliance may face a penalty of up to 95% of their tax amount.
But here’s the issue for the couple. While genuine monetary donations are not taxable, the taxpayer is responsible for proving that the gift is truly a gift if the ATO asks. According to the AAT, “absent any reliable evidence…, there is no proper basis to make any findings as to whether the deposits constitute part of the applicants’ taxable income or not.”
The Tax Commissioner may rely on a “deficiency of proof”.
Contesting the Tax Commissioner
In 2017, a covert tax audit utilised entries in the couple’s bank accounts to assess their income tax liability and the ATO issued a default assessment based on the unexplained deposits and expenses. The couple objected to the evaluation, which was partially allowed. A second assessment was made, to which the couple again objected before the Administrative Appeals Tribunal (AAT), claiming that it was excessive.
The AAT dismissed the couple’s claims that the deposits were either gifts from the father or loans from a friend. This is despite an affidavit and documentation from the wife’s father saying that the funds transferred to them were gifts. The couple failed to present their actual income in order to show that the Tax Commissioner’s assessment was unfair, and they were unable to verify that the gifts were indeed from a very generous parent.
The couple failed to present their actual income in order to show that the Tax Commissioner’s assessment was unfair, and they were unable to verify that the gifts were indeed from a very generous parent.
The Federal Court dismissed the couple’s appeal with costs, upholding the Tax Commissioner’s default tax assessment and penalties.
Avoiding the Gift Tax Trap
A gift of money or assets from an individual is normally not taxed if it is given voluntarily, there is no expectation of return, and the gift sender receives no material gain.
However, there are specific situations in which tax may apply.
Gifts from a Foreign Trust
If you are an Australian tax resident and a beneficiary of a foreign trust, you may be required to declare at least some of the sums paid to you (or applied for your benefit) on your tax returns. This applies even if you were not the actual beneficiary of the foreign trust; for example, if a family member got funds from a foreign trust and later gave them to you. This applies to cash, loans, real estate, stocks, and other assets.
Inheritances
Money or property inherited from a deceased estate is rarely taxed. However, capital gain tax (CGT) may apply when you sell an inherited item. For example, if you inherit your parents’ house, CGT is normally not applicable if:
- The property was their primary abode.
- Your parents are Australian residents for tax reasons.
- Sell the property within two years.
However, CGT will more likely apply if, for example:
- You sell your parents’ old main residence more than two years after inheriting it.
- The property you inherited was not your parents’ primary residence;
- Your parents were not Australian tax residents when they died.
Managing the tax implications of an inheritance can become complicated quickly and requires expert assistance.
Gifting an asset does not prevent taxes.
CGT cannot be avoided by donating or gifting an asset. If you receive nothing or less than the market value of the asset, the market value substitution rule may apply. When computing any CGT liability, you can use the market value substitution rule to assume you received the market value of the asset you donated or gifted.
For example, if Mum and Dad purchase a block of land and later transfer it to their daughter, the ATO will assess the worth of the land at the time it was gifted. If the market value of the land exceeds the amount paid for it by Mum and Dad, a CGT obligation will typically arise. It doesn’t matter that Mum and Dad didn’t get paid for the land. Mum and Dad may face a CGT bill for land they bequeathed without receiving anything in return.
Donations of cryptocurrencies may also trigger CGT. If you donate bitcoin to a charity, you could possibly be assessed based on the cryptocurrency’s market value at the time of donation. You can only claim a tax deduction for your donation if the charity is a deductible gift recipient and accepts cryptocurrency.
Don’t let unexpected tax liabilities catch you off guard. Learn from the Rusanova case and ensure your financial transactions are properly classified. Get expert tax guidance on managing gifts and loans to avoid costly tax traps.
