Penalty tax for failure to exercise reasonable care

Whether the taxpayer, who makes a simple arithmetic error in the preparation of the taxpayer's tax return, is subject to penalty tax under section 226G of the Income Tax Assessment Act 1936 (ITAA 1936) for failing to take reasonable care.

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

The taxpayer, a self preparer, uses TaxPack and claims a substantial interest deduction against interest and dividend income in the tax return lodged by the taxpayer. Subsequently, the taxpayer is audited. The taxpayer re-checks the tax return and discovers that an arithmetic error was made when the taxpayer added together amounts in the tax return. The error resulted in an over claimed deduction, which represented approximately 5% of the total claim.

The taxpayer's assessment is amended and the taxpayer is made liable to pay penalty tax equal to 25% of the amount of the tax shortfall caused by the taxpayer's failure to take reasonable care.

The taxpayer objects to the penalty tax imposed, claiming it is the result of an honest mistake. Accordingly, the taxpayer believes that the Commissioner's Guarantee in TaxPack applies. The Commissioner's Guarantee states, amongst other things, that if a taxpayer uses TaxPack properly and makes an honest mistake, then the taxpayer will not be liable to pay penalty tax.

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 showed reasonable care but made a simple mistake when calculating the amount of the deduction allowable. The arithmetic error occurred only once and was not sizeable enough in relation to the overall claim to alert the taxpayer to the mistake. Having regard to the quantum of the error in relation to the total claim for interest, the taxpayer exercised reasonable care in the preparation of the income tax return. Therefore, no penalty tax should be imposed.