Penalty tax for failure to exercise reasonable care

Whether the taxpayer, who fails to include interest income in their tax return because of an error brought about by distressing circumstances, is subject to penalty tax under section 226G of the Income Tax Assessment Act 1936 (ITAA 1936) for failing to exercise reasonable care.

The taxpayer is not subject to penalty tax under section 226G (ITAA 1936).

The taxpayer suffers from a severe medical condition, which is difficult and emotionally distressing for both the taxpayer and the taxpayer's family. As part of the taxpayer's recovery, the taxpayer decides to take an overseas trip. The taxpayer subsequently withdraws some money from the bank to fund the overseas trip. Due to a misunderstanding between the taxpayer and bank staff, the taxpayer receives incorrect and misleading advice from the bank that leads the taxpayer to believe that the interest on the account does not need to be included in the taxpayer's tax return.

The taxpayer is audited and as a result, the taxpayer's assessment is amended to include the omitted bank interest. On the basis that the tax shortfall was caused by the failure of the taxpayer to take reasonable care under section 226G (ITAA 1936), the amended assessment includes an amount of penalty tax equal to 25% of the amount of the tax shortfall.

The taxpayer objects to the penalty and states that the omission was an honest mistake caused by the distressing events that took place in the income year in question. The taxpayer produces a doctor's certificate to verify the medical condition.

Under section 226G (ITAA 1936) penalty tax is attracted where a taxpayer has a tax shortfall caused by their failure to take reasonable care. Taxation Ruling TR 94/4 provides guidelines as to what constitutes reasonable care. Paragraph 6 of Taxation Ruling TR 94/4 states that the reasonable care standard requires a taxpayer to take the care that a reasonable person would exercise, in their particular circumstances, to fulfil the taxpayer's tax obligations. Provided that a taxpayer may be judged to have tried his or her best to lodge a correct return having regard to the taxpayer's experience, education, skill and other relevant circumstances, the taxpayer will not be liable to pay penalty.

In this case, the taxpayer attempted to lodge a correct tax return in difficult and distressing circumstances. Given these distressing events, it is possible to conclude that the taxpayer used best endeavours to lodge a correct tax return in the circumstances as the taxpayer sought the advice of the bank, but the taxpayer still made a mistake. Accordingly, the taxpayer exercised reasonable care in preparing the tax return and no penalty tax should be imposed under section 226G (ITAA 1936).