My paper recently published in the Australian Tax Forum, centres on the implications of Farah Custodians Pty Limited v Commissioner of Taxation (No 2), an interlocutory hearing in which the Federal Court of Australia refused to strike out a taxpayer negligence claim against the Commissioner of Taxation.
Why is Farah significant?
Farah stands out as a novel interlocutory finding in favour of a taxpayer claiming negligence by Australian tax officials. The last reported case that examined negligence (Harris v Deputy Commissioner of Taxation) was decided almost 2 decades ago – and the taxpayer’s claim was cursorily dismissed. More specifically, Farah also provides new judicial insights into the question of whether the Commissioner owes any private law duties to taxpayers alongside their statutory duties to the Crown. The case is also instructive in providing some guidance concerning duties potentially owed to taxpayers by tax officials engaged in tax audits or other tax investigation activities.
My paper examines the reasoning in Farah and its potential implications. It also assesses the key judicial challenges likely to be encountered in determining future taxpayer negligence claims against tax officials. This assessment is based on the judicial reasoning in Farah and the approach to similar issues in Canada – the jurisdiction with the most mature and extensive body of case law involving taxpayer negligence claims against tax officials in the common law world.
The Farah Case in Context
Essentially, Farah was the victim of the fraudulent actions of its former tax agent (‘Strathfield Tax’) and the principal of Strathfield Tax, Mr. Kennedy. Kennedy prepared and lodged Business Activity Statements, purportedly on behalf of Farah, which generated substantial tax refunds due to Farah. However, unknown to Farah, Kennedy nominated a bank account held by a company Kennedy controlled (‘Viaus’) into which the refunds due to Farah were paid, effectively fraudulently misappropriating the tax refunds. There was some suggestion Farah had consented to the payments being made. However, this was on the basis of an apparently forged document produced by Kennedy purporting to show the signature of the wife of one of the principals of Farah, evidencing a loan to Kennedy of the refund amounts due to Farah.
The genesis of the specific allegations of negligence against the Commissioner stemmed from the fact that tax officers had been auditing both Strathfield Tax and the plaintiff during much of the period in which the refunds were being paid into the Viaus bank account (2012-2014). The plaintiff asserted these payments continued notwithstanding knowledge acquired by the tax officers during the audit of Strathfield Tax, putting them on notice of the misuse or possible misuse of that account. Justice Michael Wigney of the Federal Court ruled in favour of the taxpayer, rejecting the Commissioner’s strike out application and concluding that the plaintiff’s case was ‘at least arguable.’
The Commissioner had contended that common law duties are completely incompatible with the Commissioner’s statutory duties, precluding the possibility of any duty of care in negligence being recognised. This is consistent with the approach taken in earlier cases, with no Australian court ever having recognised a tortious duty of care to taxpayers alongside the statutory duties of tax officials. However, in Farah, Justice Wigney reasoned there were insufficient grounds to conclude that the existence of a duty of care in the specific circumstances of the Farah case was ‘…necessarily inconsistent or incompatible with the statutory scheme, or would impose impossible or prohibitive burdens on the Commissioner in the context of the statutory scheme.’
Future Directions in light of Farah
The Court in Farah was prepared to entertain the possibility that specific interactions between taxpayers and tax officials might create a narrow exception to the general principle that tax auditors are under no duty to warn taxpayers of harm identified as part of an audit. This reasoning closely parallels the Canadian reasoning in Leroux v Canada Revenue Authority (Leroux). In that case, the British Columbia Supreme Court similarly reasoned that although revenue authority auditors do not owe a general common law duty of care to taxpayers in carrying out audits, specific interactions between the taxpayer and the tax officials can create an exceptional situation where a duty can arise. For example, in Leroux, as Humphries J put it ‘the audit was a focussed and intensive one taking place over many years, covering three years of statute barred taxes, involving three auditors, many face to face meetings and phone calls’.
If this reasoning is applied in any future Australian taxpayer negligence claim, the question will likely be resolved by a close examination of the extent and nature of interactions between the taxpayer and the tax officials, and the relative knowledge and control of the likely risk of harm possessed by the taxpayer and the tax officials. In Canada, courts conducting a similar analysis have considered the intensity and duration of the audit process, the number of tax officials involved, the volume and nature of meetings, phone calls and other interactions between the taxpayer and the tax officials, and the degree of awareness of the harm and gravity of consequences of that harm on the taxpayer in the event of it materialising.
It is obviously very difficult to predict how this factual weighing up process might play out in future Australian cases, however in Farah, the length of the audit, the relatively large number of tax officials involved, and the intensity of the interactions between the taxpayer and the tax officials involved may all weigh in favour of the taxpayer. Weighing against these factors is the difficulty of arguing that tax officers generally have any significant degree of control over the risk posed by unscrupulous tax agents, and evidentiary uncertainty concerning the degree of actual knowledge the tax auditors had of the fraud being perpetrated on the taxpayer by its tax agent.
What is clear from Farah, and from Canadian authorities such as Leroux, is that the usual audit relationship will be insufficient to support any contention that tax auditors owe a duty of care to taxpayers. More will be required. Whether a common law duty arises will depend on the nature of the relationship established by specific interactions between the relevant tax officials and the taxpayer. These interactions will need to extend well beyond the routine both in terms of their volume and their nature, but little more specific judicial guidance is presently available.
Unresolved Matters in the Wake of Farah
The focus in any future substantive hearing of the Farah negligence claim will almost certainly centre on finding the answer to the question of whether a duty of care is owed by tax officials to taxpayers. Given the absence of any superior court recognition in Australia of any duty in any other case, the odds weigh heavily against the plaintiff. However, even if there is a favourable result on the duty of care question, the plaintiff (along with any other future taxpayer litigant) faces many other hurdles which are yet to receive Australian judicial attention. Prime among these is the question of the standard of care expected of tax officials to satisfy any duty of care. This is completely unexplored territory in Australia. Similarly, there are significant unknowns concerning the application in a taxpayer negligence claim of principles of causation and mitigation of loss. Given the incremental nature of the development of tort law in novel circumstances, these issues are unlikely to be settled in the short or medium term – but are likely to gain increasing prominence in the longer term if more cases like Farah come before the courts. My article warns that the early indications from Canada are that these issues will also pose significant challenges for prospective taxpayer litigants.
This article is based on Bevacqua, J 2020, ‘Suing negligent Australian tax officials – Recent judicial developments & possible future directions’, Australian Tax Forum, vol. 35, vol. 2, pp. 191-212.
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