Walker v. Federal Commissioner of Taxation.
Judges:Lusher J
Court:
Supreme Court of New South Wales
Lusher J.
This is an appeal to this Court under Div. 2 of Pt. V of the Income Tax Assessment Act 1936, as amended, by Dr. Michael John Walker, a medical practitioner residing at Lisarow near Gosford, New South Wales (herein called the appellant) and a taxpayer dissatisfied with the disallowance by the Commissioner of Taxation (called the Commissioner) of objections by the taxpayer to the Commissioner's assessment of income for the years ending 30th June 1976 and 1977 and referred to this Court pursuant to the statute. The objections relate to the disallowance of certain deductions claimed by the taxpayer as losses and other outgoings arising out of his participation as a member of two partnerships during the years of income ended 30th June 1976 and 1977 respectively. By consent the two matters were heard together, similar considerations and principles applying to each.
The onus of proof is on the appellant and this is kept in mind although for convenience and clarity in many of the submissions the contentions of the Commissioner may be first considered and examined.
The findings I make follow. The matters arise out of the application of a technique of ovum transplant as applied to cattle and which appears to have been introduced into Australia during the last decade. The advantage of the technique is that firstly it enables animals of valuable exotic European breed not otherwise able to be brought into Australia to be developed in this country and secondly it accelerates to a marked extent the natural breeding process which may be expected from one female animal. At the relevant time quarantine regulations in this country had placed an embargo upon the import of live animals into Australia. A modification permitted imports from New Zealand provided they were born there. Thus the progeny of animals imported into New Zealand and born there could be imported into Australia. The first of such imports were in 1971-1972. Because of the breeding and scarcity the animals are of considerable value.
The technique of ovum transplant in short terms involves the removal of eggs produced by the female animal by operative process at the time of ovulation and the transplanting.
In the ordinary breeding process, whether by natural or artificial insemination of the ovum or egg, a calf can be expected after a gestation period of 9-10 months. The female, however, produces a considerable number of eggs capable of fertilisation. The technique of ovum transfer in short terms seeks to
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utilise this capacity by removing by operative treatment the eggs produced by the female at the time of ovulation. These are then separately transplanted into available recipient females of local breeding who then in due course produce a calf. As many as 17 eggs can be so recovered and transplanted into as many recipients, although such a number is not necessarily to be an average. It is obvious that in this way a pure bred exotic herd of value can be produced much more quickly and in far greater numbers than by conventional breeding. There are factors involved in the timing of the procedure of the technique from acceptance by the female into the transplant centre to the calf drop. These include the age and time at which the female cycles, which vary from the age of four months to fourteen months depending on the animal. It is desirable that the female should have three or four normal oestrus cycles before operation. The season of the year and availability of pasture to avoid the expense of hand feeding leads to a preference to commence operative procedures at the end of winter. There was no dispute between the parties as to the technique and its procedures.As previously stated, inherent in the process is that the animals are of considerable value. The breeds involved are Charolais, Limousin and Simmental. The first sale of Charolais in Australia in 1972 saw heifers bring $36,000 and one bull $48,000. In 1974-1975 Charolais were bringing between $5,000-$10,000 for both sexes. In 1975 French heifers averaged $6,458. In 1976 top price for heifers was $8,750 and the average $6,438. In March 1977 heifers averaged $6,500.
At the first Simmental sale, heifers sold at $43,000 and bulls at $25,000. In 1975 heifers made $11,500 down to $6,500. In April 1976 heifers brought from $10,500 to $16,000 and bulls $2,100-$5,500. In April 1978 heifers sold at $7,250 and two bulls for $4,000 and $4,500 respectively.
The first Limousin appear to have come to Australia in 1975-1976. In 1976 there were less than 100 head, today 500. The first sale was in 1977 or 1978 and since then prices for both heifers and bulls are around $2,500. Again there was no real dispute on these matters and I accept these figures.
Presumably in the light of the value and the scarcity of type of the donor animal and the nature of the technique to which it was subject and which was capable of repetition, a method adopted in principle was for the owner to lease the donor to those desirous of utilising the procedures for breeding and building a herd for a period sufficient to enable two such operations to be performed with guarantees as to numbers of eggs to be obtained, provision for substitution in the event of failure and other related provisions. The lessor arranged for the necessary veterinary operations and care of the animal and provided recipient cows. The rental under the lease was substantial, $45,000 per animal leased. As will appear later a purchase of the cattle was adopted in one partnership, this being the distinction between the two partnerships apart from the membership.
The appellant was a member of two partnerships which in 1976 and 1977 respectively acquired interests in donor animals brought into Australia from New Zealand and subjected them here to transplant operations. It is the appellant's share of the losses sustained by the partnerships in the relevant years and other related moneys claimed by him in his personal return as deductions, and which have been disallowed by the Commissioner, that form the subject matters of these appeals. The partnerships are not identical in their membership or arrangements but substantially they raise the same problem.
The complexities of the arrangements are not to be lost sight of: there were other parties, major and minor partners and their repective rights, arrangement for loans by others to the individual members of whom the appellant was one, and for the management of cattle. It is the totality of these arrangements and the events leading up to them that the Commissioner relies upon to oppose the appeal and these will emerge in due course. At no stage was it submitted as suggested by the Commissioner that any sham transactions were involved, or that the transactions were other than is indicated by their tenor. At the outset it is important however to keep in mind that it is the disallowance of the appellant's claim to his share of the partnership's losses that is substantially the subject of the appeal, not
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deduction or loss incurred personally by the appellant. Furthermore, a body of evidentiary material was developed during the hearing both by way of history and background and development not all of which necessarily touched the appellant or partnership members personally. It should also be said that there were other partnerships at or about the relevant time, of which some members of the major partners were members but not the appellant and in one instance a witness was a member not of the partnerships to which the appellant belonged but of another.The broad background which led to the formation of the partnership as disclosed by the evidence and which I accept was as follows.
In 1974, Mr. Busquet who gave evidence, a cattle expert in this State, visited New Zealand with a Mr. Brian Maher, described as ``a breeder of stud cattle and a property developer'', for the purpose of inspecting and evaluating and advising on a herd of European stud cattle there which had been assembled in the United Kingdom, and on which he reported in highly favourable terms. In 1975, quite independently, Mr. Loneragan, a veterinary surgeon in practice here, visited the U.S.A. with particular regard to ovum transplant techniques then being developed. In 1975 there were meetings, discussions and seminars on the subject of European cattle and transplants held in this State and attended by persons interested. At one of such meetings, Mr. Egan, a chartered accountant and then a member of the firm of Egan, McIntyre and Holman, Chartered Accountants in Gosford, met Maher. Egan also attended a seminar conducted by Sir William Gunn. At these meetings there were discussions as to both cattle transplant techniques and taxation aspects. In November 1975 there was a meeting at Mr. McIntyre's home at Gosford, New South Wales (he was also a chartered accountant and a partner in the firm with Egan) attended by a number of persons some of whom joined subsequent partnerships and at which meeting Maher also attended. Maher spoke on the cattle and taxation and explained sec. 36A of the Income Tax Act. Busquet spoke on the cattle and prices and gave ruling prices between $7,000-$10,000 as average for both heifers and bulls. The appellant did not attend this meeting. He was a medical practitioner in practice in Gosford with a high personal income. He had first heard of this type of venture earlier from a separate source and also from his accountant, a Mr. Reid, also in practice in Gosford, who in turn was told of it by Egan in about November-December 1975. At about the same time, but after he had heard of the venture from Reid, the appellant met Egan socially at a party in Gosford and some casual reference relating to it passed between them and the appellant said he would be interested.
In discussion, Egan explained to him a project that six heifers be leased by a partnership for $45,000 each - $270,000 - that two operations with four calves resulting from each heifer would result in 48 calves worth $6,000 on maturity or a total of $288,000. It was developed as a viable commercial enterprise with confidence in its success. It was put that a capital contribution of $65,000 would give Walker a 25% interest approximately. The intention was that the bulls be sold, the heifers kept for further breeding unless they were unsuitable. He explained that he had had advice from cattle experts as to feasibility and that after McIntyre's visit to New Zealand to confirm the existence and availability of the cattle he was confident the proposal was a viable business proposition. Egan also had detailed discussions with Reid as to the financial and taxation aspects of the proposal. He told Reid that documentation was being prepared and legal advice sought. These meetings are dealt with subsequently.
It is convenient to interpose here that the appellant was a medical practitioner in the Gosford area who had an interest in rural matters and ran a few head of breeding cattle on a few acres in that district as a hobby and sometimes thought he could put some pure breeds on as well. He had previously learned of the ovum transplant concept and knew something of it before it was ever mentioned to him initially by Egan, and the discussions with Egan at the time were that there was a terrific breeding programme that was available which he had heard of over the past year and there was being promoted a facility to carry out that type of project. There was mentioned lease arrangements and that lease costs would be a tax deduction. The emphasis at the beginning was on the
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breeding programme, a method of getting a number of exotic cattle very quickly. He was told that opinions were being sought as to the documentation which he took to mean that they were legally technically correct documents and he understood that Egan was getting opinions whether tax deductions would be authentic or not and as to their availability. He left the business arrangements with the accountants who had approached him and no details were discussed other than the overall concept, the tax consequences were certainly taken into account. He knew of other people who were interested in the type of project and apart from Egan he knew McLelland (a pharmacist), Tonkin (a solicitor) and O'Malley (an orthopaedic surgeon), Dr. Schweitzer and Gosper (a lawyer), of the members of the Wintara membership, and to his knowledge none of them were actively engaged in cattle breeding but that a management firm would manage the cattle breeding for the partnership, and he relied upon the advice of the accountants and McIntyre who was mostly concerned with the administration management side of things and who reported mostly to him.On 8th January 1976 a Mr. Malone of Egan's firm wrote a letter (Exhibit 1) to Yarwood Vane & Co., a firm of Chartered Accountants in Sydney, referring to a conversation between himself and Mr. Tosi of the latter firm outlining ``the general features of a tax plan involving the leasing of purebred European Cattle'' and setting out ``features of the scheme in more detail'' and requesting a written opinion as to aspects of it. The opinion was forwarded and is contained in a letter dated 15th January 1976 (Exhibit 2). This is more fully dealt with subsequently. The letters were in general terms and were not specifically with reference to Wintara or Columba, neither of which were in existence at this time. I find that the firm was equipping itself and its members with such opinion as to the legal position as part of its own expertise in such matters. It is recalled that Egan later became a member of the Wintara major partners and McIntyre did likewise in Columba.
In January 1976 McIntyre visited New Zealand with Busquet. Egan had told McIntyre that Maher had invited someone from the firm to go to New Zealand to look at the ovum transplant operations and it was under those circumstances that he had gone. He was provided with an air ticket by the Cord organisation, the phrase used in evidence to loosely describe the interests of those connected with the leasing of cattle as lessors or as vendors. There he inspected cattle and witnessed ovum operations and met people expert in the field and generally familiarised himself with all that was involved from the cattle point of view.
In February 1976 Egan received the cattle leasing and management documents from International Genetics Pty. Ltd. (called International Genetics). He obtained the appellant's signature to the partnership agreement (Wintara Lodge Cattle Breeders, herein called the Wintara partnership and registered on 16th May 1976 under the Business Names Act). The partnership comprised 10 individuals as major partners of whom the appellant was one and a minor partner, International Genetics (supra). Egan, but not McIntyre, was a member of this partnership although McIntyre was a member of the other partnership, Columba, of which the appellant was also a member (infra). A lease and management agreement, deed of loan, charge, guarantee and other documents were also signed. These documents will be considered later. At the same time he received a cheque from the appellant for $68,319, in favour of Egan's firm. This cheque comprised $64,800 which the appellant had borrowed under the deed of loan from Cattle Genetics Finance Pty. Ltd. (called Cattle Genetics Finance), plus $3,519 of the appellant's other personal funds. This was disbursed in full by Egan, as to partnership capital $247.50, partnership contribution $62,221.50, guarantee fees $1,350, interest to Cattle Genetics Finance $1,800, and the first loan repayment $2,700.
Settlement was effected on 25th May 1976, the date of the documentation. The detail of the settlement is dealt with later. At this stage it is mentioned that Cattle Genetics Finance made separate individual loans to all the major partners personally and not as partners (supra) including the appellant. The telegraphic transfer from this company for this total ($259,200) was paid to Egan's firm trust account from which appropriate cheques were drawn payable to the relevant partners including the appellant and
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deposited in their individual accounts. Thereafter these partners drew their own cheques for their proportionate contributions which were deposited on behalf of the partnership in the above trust account, as was an amount from the minor partner International Genetics for its contribution. The trust account was also used to pay the amount of partnership capital ($1,000) into the partnership's bank account, and to pay on behalf of Wintara partnership $251,400 for the lease of and guarantee costs for the cattle to Cattle Genetics Leaseco Pty. Ltd. (called Cattle Genetics Leaseco), and on behalf of the major partners payment of guarantee fees, first loan instalment and interest to Cattle Genetics Finance. Thus, at this stage, the appellant had borrowed funds, used them and some of his own additional funds to make his capital and other contribution to the partnership, and the partnership had from those contributions and those from others paid the lease rental, guarantee costs and other costs. In addition Egan's firm's trust account had paid the loan repayment first instalment and interest on the appellant's behalf.The settlement arrangements in relation to Wintara were as follows:
At the time that the appellant signed the Wintara documents, he gave a cheque in favour of Egan Holman and McIntyre Trust Account for $68,319 which was made up as follows:
$
Loan from Cattle Genetics
Finance Pty. Ltd. ..............64,800.00
Own funds ........................ 3,519.00
----------
$68,319.00
----------
Funds were paid as follows:
$
Partnership capital .............. 247.50
Partnership contribution .........62,221.50
Guarantee fees ................... 1,350.00
Interest paid (Cattle Genetics
Finance) ....................... 1,800.00
1st loan repayment ............... 2,700.00
----------
$68,319.00
----------
Settlement was effected on 25th May 1976 as follows:
- (a) Telegraphic transfer received from Cattle Genetics Finance Pty. Ltd. for $259,200 being loans to major partners (including $64,800 for appellant) - credited to Egan Holman and McIntyre Trust Account.
- (b) Cheques drawn on Egan Holman and McIntyre Trust Account payable to individual partners for above loan (including $64,800 for appellant) - cheques deposited to individual partners' bank accounts.
- (c) Cheques totalling $269,076 deposited to credit of Egan Holman and McIntyre Trust Account being funds required for settlement - cheques were from individual partners (including cheque from appellant for $68,319).
- (d) Telegraphic transfer from International Genetics for $2,524 credited to Egan Holman and McIntyre Trust Account for their partnership contribution.
- (e) Cheque drawn on Egan Holman and McIntyre Trust Account for $1,000 being partnership capital and paid into bank account of Wintara (appellant $247.50).
- (f) The following cheques were drawn on Egan Holman and McIntyre Trust Account to acquire bank cheques for settlement on behalf of Wintara and its partners:
$ (i) Cattle Genetics Leaseco Pty. Ltd. ..................... 251,400 lease and guarantee costs - for Wintara (ii) Cattle Genetics Finance Pty. Ltd. ..................... 5,400 guarantee fee - for major partners (iii) Cattle Genetics Finance Pty. Ltd. ..................... 7,200 interest - for major partners (iv) Cattle Genetics Finance Pty. Ltd. ..................... 6,600 part of first loan instalment - for major partners.
Continuing the chronology on 25th May 1976 some commercial poll shorthorn cattle were acquired in Western Australia by
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Wintara, and in the same month four heifers of the six from New Zealand arrived for Wintara at Loneragan's Transplant Centre at Mudgee and a further two from New Zealand in September 1976. The poll shorthorns were never put to any business purpose. These twelve head were ordinary commercial cattle valued at around $750 per head and were in Western Australia. Mr. McIntyre, whom I accept as a witness, explained that it was understood at the time that the Cord interests were building an ovum transplant centre in Western Australia and it was a possibility that these animals would become part of a recipient deal over there, from which I understand them to have been females which would be used as recipient cows in that State. McIntyre also gave evidence that as he understood it, the Cord organisation hoped in addition to the transplant centre to have a very large pastoral complex in that State with pure bred cattle and pastoral properties there. He made inquiries about them and their condition from time to time and was finally informed that they must have died. Nothing ever came apparently of the Western Australia venture. In answer to a suggestion in cross-examination that these cattle were brought forward by Maher to make the tax position a bit stronger, he said that he would say that was the motive behind it, from which I infer that he meant that the wider the spread of interests, the more advantageous it was to the acceptability for tax purposes.At this point it is convenient to break off the narrative and to consider the nature of the documentation and its provisions.
The formal documentation concerning Wintara, all dated 26th April 1976 and in some respects related to each other by respective recitals were as follows:
1. A deed of partnership between the ten individuals being the major partners, and the minor partner International Genetics Pty. Ltd. (having an address in Queensland). Its object was to carry on the business of cattle breeders and pastoralists and for a term of five years unless previously determined and commencing on the date it bore. The initial capital was $1,000 to be borne as to 1% by the minor partner and as to 99% by the major partner in proportions, amongst the individuals, varying from 2.75% to 24.75% thereof, the latter being Walker's proportion (cl. 3 and third schedule). The partners were entitled to share profits and bear losses in accordance with their contribution. There was provision for notice of variation by any partner requiring the proportion to be varied from that in the third schedule to that in the fifth. The effect of this variation would give the minor partner a 50% interest in the partnership (cl. 11). By cl. 12 in the event of such a notice the minor partner was to pay the others according to a formula in the fourth schedule. This was as follows:
``An amount equal to the difference between one half of the capital up to the relevant date contributed by the partners to the partnership and that part of the capital up to that time contributed by the minor partner to the partnership but in any event the sum so payable by the minor partner shall not be less than one hundred and twenty-nine thousand six hundred dollars ($129,600).''
Thereafter the minor partner was entitled to and bore 50% of the profits and losses respectively with the major partners similarly being entitled to 50%. Subclause (iii) provided for the partners to lodge with the Commissioner of Taxation, before 31st August next succeeding the financial year in which the relevant date occurred, fixed as the 1st July next following the date of giving the variation notice, a notice that the partners had agreed that sec. 36A(2) of the Income Tax Assessment Act 1936, as amended, shall apply in respect of partnership property in connection with the change of ownership arising in consequence of the variation.
2. A deed of lease between Wintara as lessee and Cattle Genetics Leaseco Pty. Ltd. (also of Queensland) as lessor for the lease of six heifers for transplant purposes, commencing on the date signed and expiring two months after the last ovum transplant operation to be performed thereunder and also agreeing to lease such number of recipient cows as required. The partnership was entitled to two transplant operations from each animal, as I construe the document, and a guarantee of 48 progeny, which means that with the two operations on each of the six animals there was an expectation of a minimum of four fertile eggs. It follows that there would be a minimum of 48 recipient cows required for
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transplant. This assumes that every recipient cow bore a live calf, so that it would be reasonable to contemplate a considerably larger herd of recipient cows being required under the lease, not only to support the guarantee but also when it is borne in mind the partnership was not limited to the minimum guarantee but was entitled to any excess by way of recoverable eggs for transplant to recipient cows.The rental for heifers and recipients was $246,800. The lessor covenanted and warranted to register the donors as pure bred females with the appropriate Breed Society and to have the lessee's interests endorsed and to cause the donors to be super-ovulated and artificially inseminated with pure bred serum of the same breed.
3. A deed of loan. Under this deed the borrowers are the ten individuals as such who, however, are those who comprised the major partners and the lender is Cattle Genetics Finance Pty. Ltd., also of Queensland. It recites the partnership and the lease and the obligation to make contributions thereunder and a request for the loan. The borrowers severally agreed, each respectively, to repay the amount advanced to each respectively, total for all being $259,200. The loans were of different amounts, the appellant's being $65,800. Repayments were to be by 12 instalments monthly totalling, for all, $10,800, in the appellant's case by $2,700 each month. The total of such 12 monthly repayments was $129,600 leaving a balance remaining of $129,600. This balance of $129,600 was repayable as to the individual loans on 31st December 1978 or in the event of a variation notice (under the partnership deed) having been given on that date or the relevant date as defined in the partnership deed, whichever first occurs. The interest payments were dealt with quite separately (seventh schedule). The similarity will be observed between this amount of $129,600 loan moneys repayable to the lender company by the members of the major partners in the partnership as individuals and the amount of $129,600 payable by the lessor company (a different company) to the major partners in the partnership in the event of a variation of that partnership consequent upon the giving of a variation notice.
Clause 5 makes it plain in terms that the loans are to the respective several borrowers and each is only severally responsible for his own loan and is not responsible for the repayment of the loans of other borrowers. International Genetics and Cattle Genetics Leaseco are parties to this deed but are not touched by it other than the recitals.
4. A deed of charge entered into between each of the major partners individually with the lender, Cattle Genetics Finance Pty. Ltd., pursuant to the deed of loan, reciting the partnership lease and charging the individuals interest in the lease and the heifers, the progeny and the goodwill and book debits of the partnership. Again International Genetics is a party.
5. Deed of guarantee between Cattle Genetics Finance Pty. Ltd. (guarantor), Cattle Genetics Leaseco Pty. Ltd. (lessor) and the lessees, Wintara, whereby the guarantor guarantees the lessor's performance of its obligations under the lease to the lessees. It recites that the guarantor and lessor are wholly owned subsidiaries of Cattle Genetics Pty. Ltd.
6. A management agreement between Westralian Pastoral Corporation Pty. Ltd. and Wintara for the management of 15 poll shorthorn cows. These, presumably, are the Western Australian cattle previously mentioned.
7. An option from Cattle Genetics Leaseco Pty. Ltd. to Wintara to purchase the recipient cows for $200 each. I understand these to be the recipients used following the transplants in New South Wales.
It is appropriate to recall some of the overall features. The Wintara partnership comprised the major partners (the ten individuals) and the minor partner, International Genetics Pty. Ltd., with 99% and 1% interest respectively. It will be recalled that the amount of the rental for the lease of the heifers by the partnership from Cattle Genetics Leaseco was $246,800. The contribution of the major partners, with 99% interest in the partnership to the capital of $1,000 was $990, the minor partner $10. The amount of the total of the loans to the major partners from Cattle Genetics Finance was $259,200. The monthly repayment by the individuals under the loan deed would repay half of that amount, viz. $129,600, and the balance of their loans then remaining also
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$129,600 was repayable on 31st December 1978 or the date of the notice of the variation under the partnership deed of interests in the partnership (if given), whichever first occurred. The provision for variation under the partnership deed which was optional and available to either major or minor partner, required a minimum payment in that event by the minor partner, International Genetics, to the major partners of not less than $129,600, an amount which corresponds with the amount mentioned above in the loan deed as repayable. If a notice of variation was given it was to be followed by a notice under sec. 36A(2) of the Act (infra). Assuming a notice of variation was so given, the balance of the individual loans ($129,600) became payable from the respective borrowers, who were also the major partners, to the lender, Cattle Genetics Finance. At the same time, under the partnership agreement, again assuming a notice of variation having been given, the major partners, who were also the individual borrowers, were entitled to a minimum payment of $129,600 from the minor partner International Genetics Pty. Ltd., in consequence of which International Genetics increased its share of the partnership from 1% to 50% with a corresponding alteration of the interest of the major partners from 99% to 50%. This latter fact is not insignificant as will appear later. Cattle Genetics Leaseco and Cattle Genetics Finance are wholly owned subsidiaries of Cattle Genetics Pty. Ltd., the latter being not otherwise mentioned in these Wintara transactions but which is mentioned in the subsequent transactions involving the Columba partnership as a vendor of the particular cattle there mentioned as the subject of the sale. The effect of the sec. 36A(2) notice would be that the value of the property in the partnership for the purpose of sec. 36, expressed shortly, would be that which would be taken into account at the end of the year of income as if no disposal had taken place and no tax would be paid under sec. 36. Section 36 deals with the disposal of trading stock and its value for tax purposes.Reverting to the sequence of events following the arrival of the donors at Mudgee in May and September 1976 respectively, there was a further meeting in October 1976 of various persons interested in such matters and described as enthusiastic as to transplants and at which the appellant was present and which addresses were given and at which Maher and others spoke.
By letter of 21st September 1976 Wintara was advised by Cattle Genetics Leaseco of the schedule of transplant operations. The major partners had expected these to commence some time before 30th June 1976. McIntyre and the appellant had hoped they would start as soon as possible, and this impression had been given by the Cord interests.
On 25th November 1976 Loneragan began pre-treatment of the donors and in December 1976, operations in respect of ovum transplants commenced. By way of example, an operation on a donor on 5th December proved it to be infertile, but in respect of this the abovementioned documents provided for an entitlement to a substitute donor. On 14th December three eggs were recovered and on 28th December 14 eggs. Thus two heifers averaged eight fertile eggs. Fourteen eggs were transplanted to recipient cows. These various operations continued into 1978. On 27th January 1978 a newsletter from the Cattle Genetics Group was circulated to clients, including Wintara, referring to the results of various activities in this field, described as outstanding, giving numbers, percentages of pregnancies, birth weights and results of sales, and other information. By letter 29th March 1978 Wintara was advised that 47 recipients had been proved pregnant and to that date 17 calves had been born alive. Pregnancy tests on animals were carried out. The Wintara major partners, including the appellant, flew to Mudgee at their own expense in December 1976, to witness transplant operations being performed. McLellan, a member, took many photographs of the animals, including photographs of transplant procedures and incorporated and recorded them with other information in an album. At some stage consideration was given to the purchase of a pastoral property for the project and its ultimate herd but this was not pursued.
At about the time of the first operations, i.e. December 1976, the appellant was approached by Egan to join another partnership which he later did. Although at this time a number of the proposed operations had been performed, and there
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were yet to be pregnancy tests before commercial viability of this type of project could be fully determined, the operations results were consistent with expectations. On 4th January 1977 he gave his cheque to Egan for this purpose and this partnership, of individual major partners and a minor partner, named Columba Park Charolais Breeding Partnership, and herein called Columba, was documented on 16th March 1977. It was somewhat similar to Wintara, but not with identical members although some were common. McIntyre for instance was a member of Columba, Egan was not. In this partnership the minor partner was Cord Securities Pty. Ltd. The transaction differed in substance from Wintara in that instead of a lease of the donor cattle, there was a purchase of the cattle by the partnership. The Columba partnership name was registered under the Business Names Act on 19th April 1977.It is appropriate to interpose here that McIntyre was asked in cross-examination as to financial benefits flowing to his firm in relation to the transactions and apart from fees and services to clients he said that later on, commission was received by family trusts associated with a member or members of his firm shortly before the Columba partnership was formed or about that time, but it was not related to the Wintara partnership. The commission was based upon the number of head of cattle involved, by which I understood sold, and he believed that it was based on a formula of $4,000 per head. Columba involved a sale not a lease of cattle. He was asked whether it was for introducing clients into proposals and although his answer was, ``For introducing clients - well it was based on the number of head of cattle involved in each agreement I believe'', at the time I took it that the first three words were a repetition of the words in the question rather than an assent to them. The reference to ``each agreement'' did not include Wintara and it will be remembered that there were partnerships other than Wintara and Columba.
The Columba documentation comprised the following, all dated 16th March 1977.
1. The deed of partnership between the major partners, consisting of eight individuals (including the appellant and McIntyre) and the minor partner Cord Securities Ltd., a company incorporated in Western Australia. It is in similar terms to the Wintara deed and similar shares as between the partners. The formula under the fourth schedule in the event of a notice of variation shows an amount not exceeding $96,000 as becoming payable by the minor partner.
2. The deed of management between the manager Corlease Pty. Ltd., a Western Australian company, and the stock owner being all the partners excepting one of the major partners Alan Grant who however signed the document in the appropriate place so that the omission of his name from the second schedule naming the parties would appear to be by error. It recites that the stock owner has agreed to purchase six identified heifers.
The dates of delivery are omitted from the third schedule (cf. cl. B) of recital. It further recites the owners wish to have the cattle super-ovulated and artificially inseminated on two separate occasions, that the manager will make recipient cows available for transplant. There is provision for the manager to agist and depasture the cattle and to cause them to be super-ovulated and inseminated twice and to effect the transplants. The manager is to provide recipients and generally manage the project for the charges set out totalling $200,400 (cl. 4 and fourth schedule). The manager warranted that if 48 calves did not result from the two operations, to cause a third operation to make good the deficiency or at his option to otherwise make good the numbers (cl. 4(2)).
3. The deed of loan, the borrowers being the eight individuals as such being the above major partners, and Cord Investments Pty. Ltd., a Western Australian company as the lender, the minor partner Cord Securities Pty. Ltd., being joined in. The borrowers, as in the Wintara document, respectively borrowed several sums amounting to $192,000, Walker's loan being $58,000. The rest of the document is similar to that in Wintara, the monthly repayments in this case totalling $96,000 and the balance, being the same amount, being payable in the same way as in Wintara. This sum of $96,000 corresponds with the amount of $96,000
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referred to in the partnership variation in the partnership deed.4. The deed of charge in favour of Cord Investments Pty. Ltd. This is in similar terms to that in Wintara.
5. The deed of guarantee. The guarantor is Cord Investments Pty. Ltd. The major partners are described as the vendors (sic). The guarantor is recited to be a wholly owned subsidiary of Cord Holdings Pty. Ltd. The guarantee is in similar terms to Wintara.
6. The deed whereby Cattle Genetics Pty. Ltd., a Queensland company, agreed to sell to the partnership (Grant's name is again omitted from the second schedule although he signed) six heifers for the price of $27,000.
7. The deed of loan, for the purchase of the donors, between the major partners (the borrowers), the partner Cord Securities Pty. Ltd., and the lender, again Cord Investments Pty. Ltd. It recites the partnership, that the partners have entered into a deed to purchase cattle, and the borrowers' request to borrow severally the amounts totalling $27,000, and provides for loans and interest thereon to each of the major partners respectively and severally, Walker's loan being $8,156. As in Wintara's document, each is only severally responsible for repayment of his own loan and not responsible for that of any other borrower. The manner of repayment is set out in the sixth schedule, viz. on 30th June 1979 with a proviso that if all or any of the cattle die beforehand then the repayments are to be in accordance with the formula there set out.
The settlement in relation to Columba was as follows:
On 4th January 1977 the appellant gave Egan a cheque in favour of Egan Holman and McIntyre Trust Account for $8,754.62 as a deposit. The total contribution was to be $74,910.62 made up as follows:
$
Loan from Cord Investments Pty. Ltd. .............. 8,156.25
re: purchase of donors
Loan from Cord Investments Pty. Ltd. .............. 58,000.00
re: management, etc. ----------
66,156.25
Own funds ........................................ 8,754.37
----------
$74,910.62
----------
Funds were paid as follows:
$
Partnership capital ............................... 145.00
Partnership contribution .......................... 68,686.50
Guarantee fee (re minor partner) .................. 302.09
Interest - Cord Investments Pty. Ltd............... 1,178.13
loan for purchase
Interest - Cord Investments Pty. Ltd............... 2,628.12
loan for management -------- 3,806.25
Additional loan to partnership .................... 145.00
Accountancy fees .................................. 1,359.37
Stamp duty ........................................ 466.41
----------
$74,910.62
----------
Egan had told the appellant that rather than have the loan moneys paid direct to the appellant and have him draw a cheque in favour of Egan Holman and McIntyre, Egan would collect the moneys in the firm's trust account on his behalf, which was agreed to and carried out. Settlement was effected on 15th March 1977, in Columba, as follows:
- (a) Bank cheque for $219,000 deposited in Egan Holman and McIntyre Trust Account being loans from Cord
ATC 4180
Investments Pty. Ltd. to major partners (including $66,156.25 for the appellant). - (b) Individual cheques drawn on Egan Holman and McIntyre Trust Account on behalf of the major partners for a total of $227,856 (including $68,831.50 for the appellant) being partnership capital and equity contribution, such cheques being banked to credit of Columba at Bank of N.S.W., Woy Woy.
- (c) Bank cheque for $2,301.53 deposited in Columba account being capital and equity contribution from minor partners, Cord Securities Pty. Ltd.
- (d) Cheque drawn on Egan Holman and McIntyre Trust Account for $12,600 being interest paid to Cord Investments Pty. Ltd. on behalf of the major partners (including $3,806.25 for the appellant).
- (e) Cheque drawn on Egan Holman and McIntyre Trust Account for $1,000 being guarantee fee paid to Cord Investments Pty. Ltd. on behalf of the major partners (including $302.09 for the appellant).
- (f) Cheque drawn on Egan Holman and McIntyre Trust Account for $480 being sundry loans from the major partners paid to and banked in Columba. This amount was paid in error originally as it was to have been the initial capital of the major partners (including $145 for the appellant). As the initial capital was contributed on settlement (see (b)) the amount has been treated in the accounts as a sundry loan from the major partners.
- (g) The following cheques were drawn on the Columba account:
$ Bank cheques for Corlease Pty. Ltd. ..........200,400 agistment, management, etc. Bank cheque for Cord Investments Pty. Ltd. . 2,000 guarantee fees. Bank cheque for Cord Leasing Pty. Ltd....... 27,000 purchase of six Charolais.
A second series of Wintara transplant operations commenced on 4th April 1977. These were completed on 26th May 1978. No operation was performed on the animal substituted for the donor found to be infertile in December 1976.
Something has already been said as to the timing of the ovum transplant so far as concerns the animal itself. The Wintara donors were progeny born in New Zealand of the herds originally imported into that country and on arrival here as it transpired seem to have been too young to be operated upon before June 1976. Other reasons such as the onset of the winter season were also relevant. There were no plans by Loneragan to operate on these donors before August 1976 and it seems later that Egan's understanding was that no operations would be performed until October 1976, although as I find he and the appellant, if not others, had expected operations earlier and before June 1976. A letter from McIntyre on 1st October 1976 to a breeding association regarding membership referred to the transplant operations as being anticipated to take place in November 1976, subject to veterinary advice. The appellant himself does not seem to have had any expressed view as to this particular programme.
In May 1977 the first round of operations for Columba commenced when one donor was operated upon and four eggs transferred resulting in two pregnancies reported in February 1978 as due to calve in March 1978 and which then occurred. Other operations were programmed for February-May 1978 and continued into June 1978, including a second operation on the abovementioned donor that had calved.
On 1st October 1978 the respective interests of the major and minor partners in Wintara were varied by notice from 99 per cent and one per cent, respectively, to 50 per cent each. Pursuant to the partnership deed the minor partner paid the major partner paid the sum of $129,600 to Cattle Genetics Finance in discharge of the balance of the loans outstanding by each of them individually in accordance with the deed of loan.
On 30th November 1978 there was a dissolution of the interests in the Wintara partnership as between the major and minor partners following upon dissatisfaction, as I find, the major partners continuing in partnership. At this time there were thirty-seven living calves and on the dissolution the major partners received twenty-four. This
ATC 4181
was not in accordance with the interests of the respective partners at the time but I find it was a compromise settlement between them (and gave the major partners fifty per cent of the number initially guaranteed).Turning to Columba, the alterations of the interests of the major and minor partners took place on 14th May 1979 and payments pursuant to the documentation were made in similar fashion as in the case of Wintara. This partnership was dissolved on 5th June 1979. The major partners again received twenty-four calves, this time from thirty-one calves then living.
The Commissioner placed emphasis on a letter of 8th January 1976 (Exhibit 1) from Mr. Malone of Egan's firm to Yarwood Vane and Co., which sought advice concerning the subject of income tax and the reply, Exhibit 2, from Mr. Tosi of that firm. This was prior to the formation of the Wintara and Columba partnerships and the correspondence was not on their behalf. I accept evidence as to how these came into existence. The letter of inquiry referred to a tax plan or scheme concerning the leasing of purchased European cattle and set out a number of details similar in broad terms to what took place here. The reply is an appreciation of the facts and law relating thereto. The letters are detailed and lengthy and cannot be reproduced here.
The appellant submits that Mr. Tosi was asked to make assumptions on the commercial aspects which were however still under investigation. There was, however, an expectation of sale under commercial conditions and retention for breeding. Assumptions were made that only four progeny would be involved and a value of $5,000 which would have a result quite different to the actual facts as they emerged when the undertaking was entered into and the commercial prospects were quite different.
In his references to sec. 51(1), ``Deductions'', Mr. Tosi, on p. 6, dealing with the loss under sec. 90 being available to the client, is clearly referring to the nett loss pursuant to that section. He also contemplates the partnership continuing to trade and derive assessable income.
The view I have is that I do not get the assistance from these letters that is submitted by the Commissioner. I should have thought that any arrangement of any sizeable proportions would require some consideration of what the tax position was likely to be, and whether what was being suggested as the way it be done would be likely to have the results put forward for it. The tax position was far from certain as the Commissioner submits; the fact that it was submitted to Yarwood Vane and Co., and that some partners, not the appellant, thought of the question of legal costs if a Court case resulted shows uncertainty. Actually, Mr. Reid, who was the appellant's accountant, also raised the question with Egan with the consequence that Maher said he would bear the costs if it got to that point. Nor was the fact that the business side may have been uncertain a telling factor. Much of business activity, particularly in a new field, has a degree of uncertainty and risk depending on many factors and elements that give an atmosphere sometimes of a gamble to it but nevertheless the reality is that a business is being carried on. It is a necessity for businessmen and others entering upon business enterprises to assess such matters and to make decisions upon them and back their judgment financially.
I accordingly do not accept the submission that the tax side was certain and determined, whereas the business side was not a matter that really was of significance, or commercial reality or interest. The submission emphasises these letters but sets to one side the expertise and advice availed of in relation to the cattle, the trip to New Zealand to inspect them and the other aspects on the cattle side, including the covenants obtained, the interest in the cattle and the techniques involved and the meetings.
I find that neither Egan nor McIntyre were tax experts, although both believed the leasing charges to be deductible. The appellant did not personally seek tax advice and the evidence of both Egan and McIntyre was enthusiasm and interest in the cattle activity with the tax aspect certainly part of it in McIntyre's case, and as important but not to the forefront in Egan's case. McLennan saw advantages in the commercial use of the technology and the tax was not stressed from his point of view, nor was it the primary reason.
ATC 4182
Another aspect relied upon by the Commissioner was exhibits 6, 7 and 8, comprising notes made by Egan and given to the appellant's accountant, Reid. It is true that there were meetings between Reid and Egan where the tax aspects of the proposed transactions were obviously discussed.
I accept that Egan prepared a summary cash flow, taking into account tax consequences. This was not given to the appellant but was discussed between Egan and Reid. I find this was based on a conservative price for each progeny at $4,171 at the end of breeding programme and was for use as a guideline. In fact, in Exhibit 8, figures discussed ranged from $5,000 to $11,000 for heifers and $4,500 for bulls, which leads to an average of well over $6,000. In short, the discussions centred not solely on tax but also on commercial matters which accord with Egan's recollection which I accept. I also accept Egan's evidence that the contemplation that the commencement of the partnership would be April was based on practical considerations and was not related to tax considerations as was suggested. It is also observed that the proposal is in accord with a document tendered from Reid's file, not from a document given by Egan to Reid.
Here again I find nothing sinister or adverse to the appellant in these documents. It is to be expected that such a matter would involve discussions with his accountant and that taxation and working out of the proposal and its results would be obvious considerations. In my opinion, it would be strange on a taxpayer's part if some such discussions and examinations did not take place.
Correspondence between Egan and the appellant as to the contributions were also relied upon. I find that there was nothing conclusive to be found or inferred in this correspondence adverse to the appellant. It was an appreciation of the financial and taxation aspects and dealt with it as such. It was also submitted that the documents do not suggest that the appellant should pay anything towards the cost of advice relating to cattle. It is put that the absence of this advice and the presence of payments for advice regarding legal and accountancy advice demonstrate that the appellant's real and prime purpose lay in securing the tax advantage. There are a number of answers to this submitted on behalf of the appellant. First, the submission confuses the partnership which incurred the outgoings and the appellant who obtained consequential losses as a result of partnership activities. Secondly, the payments related to more than tax aspects. Some related to legal and accountancy advice as to the protection available to the individuals as such and as partners under the various documents and some of which by inference reimbursed Egan, McIntyre and Holman for investigating commercial aspects of the cattle project generally. Thirdly, such payments or lack of them tell nothing concerning, let alone demonstrate, the appellant's purpose. I do not accept this submission from the Commissioner. It was never suggested on behalf of the appellant that the deductions for outgoings were irrelevant or that the advantages conferred by sec. 36A were disregarded. To emphasise the tax aspect as the submission does is to overlook what I find to be the reality of a commercial undertaking for the purpose of gaining or producing assessable income involving substantial financial investment and the application of comparatively new scientific procedures on which the advice of acceptable experts, both in this country and in New Zealand, was availed of.
An early submission of the Commissioner was that Busquet, who was a grazier and stud cattle breeder interested in exotic European breeds, had meetings with Maher, described in the submission as a real estate developer and a marketer of tax avoidance schemes. I accept that Maher was such a developer but the evidence before me does not enable me to find and I do not find or accept that he was properly described as a marketer of tax avoidance schemes at the relevant period. The Commissioner's submission is based on one piece of evidence put to Egan in relation to the period when the proposals were under discussion.
The questions were put to Egan in cross-examination by the senior counsel for the Commissioner:
``Q. Of course, when you first met Mr. Maher, you knew that he had been involved in first of all selling cars? A. I
ATC 4183
didn't know when I first met him that he was selling cars, no.Q. You knew he had been involved in selling real estate? A. He was introduced to me as a property developer and cattle breeder.
Q. Did you, shortly, find out that Mr. Maher was also in the business of marketing tax avoidance schemes? A. I didn't know that until quite some time after.''
That was where the evidence was left first as to Maher's suggested activity and, secondly, as to Egan's knowledge. The suggestion was not put or accepted by Egan at any relevant period. It was not pursued. In my opinion that evidence before me was insufficient to ground a submission from the Commissioner's counsel containing an assertion that Maher was a marketer of tax avoidance schemes and I reject any suggestion that Egan knew that at any relevant time. There was no other evidence acceptable to me to warrant such a finding concerning Maher.
I have already mentioned the broad nature of the various meetings. I find that at the November meeting at McIntyre's at which the appellant was not present, the numbers present are uncertain since Busquet's figure was a guess and I could not rely on it. They were described by Busquet as professional people, but the question following:
``Q. People by and large with high taxable incomes? (Objected to; allowed.) A. Yes, that would be fair to say.''
The question was allowed on a subject to objection approach as I recall, thinking further evidence would link it up. Busquet's evidence on this could not be of any assistance and I place no reliance on it and reject it. I accept that Maher spoke concerning tax consequences expected to result from leasing the cattle and I find that he also spoke of the cattle. The latter matter was given by McIntyre in response to a question by senior counsel for the Commissioner:
``Q. He [i.e. Maher] spoke about cattle? A. Yes.''
The general issues to be determined in these appeals emerge as follows:
- 1. whether the partnership styled Wintara Lodge Cattle Breeders incurred outgoings of $251,412 which are deductible in terms of sec. 51(1) of the Act in determining its profit or loss for the year of income ended 30th June 1976, and whether accordingly the appellant is entitled to deduct from his income an amount of $62,224 being his share of the partnership loss for that year;
- 2. whether the appellant is personally entitled to a deduction in terms of sec. 51(1) for an amount of $1,800 paid as interest on moneys borrowed to permit his participation in the Wintara Partnership for the year of income ended 30th June 1976;
- 3. whether the partnership styled Columba Park Charolais Cattle Breeders incurred outgoings of $202,433 which are deductible in terms of sec. 51(1) of the Act in determining its profit or loss for the year of income ended 30th June 1977 and whether, accordingly, the appellant is entitled to deduct from his income for that year an amount of $60,540 being his share of the outgoings of the partnership;
- 4. whether the partnership styled Wintara Lodge Cattle Breeders incurred outgoings of $316 which are deductible in terms of sec. 51(1) of the Act in determining its profit or loss for the year of income ended 30th June 1977 and whether, accordingly, the appellant is entitled to deduct from his income for the year ended 30th June 1977, an amount of $78 being his share of the partnership loss for that year; and
- 5. whether the appellant is entitled to a deduction pursuant to sec. 51(1) of the Act in respect of an amount of $3,806 paid by the appellant to Cord Investments Pty. Limited during the year of income ended 30th June 1977, and expenses of $302 incurred in respect of a guarantee arrangement in that year of income.
At this stage, the broad contentions of the parties can be stated briefly and in principle are applicable to both partnerships. It is to be remembered from the outset that there has been no challenge to the partnership return as such, but only indirectly: the challenge made is to the personal return of the appellant which claims as a deduction a loss by reference to the partnership return.
The appellant's submission is that the
ATC 4184
amounts claimed as outgoings in the partnership returns in each partnership were outgoings properly so called and were incurred in gaining or producing assessable income or, alternatively, were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income and were deductions pursuant to sec. 51(1). It is further claimed that the appellant as a partner in partnership is entitled under the Act to the benefit of his proportionate share of the results of the partnership as a deduction in his personal return.These two submissions are challenged by the Commissioner.
In making the challenge it should be stated clearly, as I have mentioned earlier, that at no stage did the Commissioner submit or suggest that any sham transactions were involved. It is conceded that the documents evidence real transactions (cf.
Mullens & Ors. v. F.C. of T. 76 ATC 4288 at p. 4302; (1975-1976) 135 C.L.R. 290 at p. 317, per Stephen J.). The submissions (for the Commissioner) begin with the proposition that an overall scheme or arrangement was involved with appeal to persons such as the appellant with high personal income and probably subject to high personal income tax, that overall it provided means of obtaining for a small financial outlay large partnership losses which would be available as personal deductions to offset against personal income, thereby considerably reducing the amount of income tax payable. There is, of course, no doubt that losses were incurred which in turn resulted in substantial deductions to the taxpayer and, if proper, would reduce any income subject to tax. The Commissioner points to material to support this proposition such as, without being exhaustive, the formulation of the scheme, the subjecting of it for critical accountant and legal analysis, the propagating of such a scheme [and] the quantifying of its financial advantages by way of taxation reduction. This is said to disclose a scheme, participation in which is said to be for the purpose of tax reduction. An alleged lack of interest in the animals and managerial laxity is pointed to as giving support to this view.
The submission of the Commissioner is faced broadly by the taxpayer's submission that it ignores the central object of the partnership, viz. its interest in the imported donor cattle and the accelerated development of a valuable exotic herd new to Australia with the expectation of substantial financial rewards after the initial stages. Further, the Commissioner's submission is said to ignore the obligations under the documentation and the fact that much of the matters urged as essential were in truth optional.
As to tax, although there be an initial deduction there is in reality a deferral since liability for tax will arise in later years when the project is looked at overall and in the long term, without the benefit of deductions spread over that income earning period.
In approaching the Commissioner's submission the distinction is to be kept steadily in mind, between the partnership, which is claimed to have incurred the deductions and incurred losses, and the individual partner, the appellant, who obtained the benefit of his proportion of those losses for his personal return.
It will be seen also that although the proposition is stated in relation to an overall situation with an ultimate result of deductions for the appellant, that result is achieved through the business activities and outgoings of a partnership which in turn is funded by the appellant and others substantially with funds borrowed by another company different to that from which the partnerships obtained the cattle, whether by lease or purchase. Thus, the Commissioner's attack is to be directed initially at the partnership's activities and its alleged losses. The deductions claimed by the appellant in respect of his own non-loan funds really follow the result and can be left until later. The attack begins with the partnership returns. No issue arises as to the amounts therein and thereafter claimed by the appellant in his personal return.
The substantial issue in Wintara is whether moneys paid by the partnership pursuant to the lease in the years 1976-1977 were allowable deductions under sec. 51(1). Looking at the question under sec. 90 of the Act and the definitions of the nett income and partnership loss of the partnership it would seem to follow that there is an allowable deduction under sec. 92(2) to the appellant of his individual interest in the partnership loss. Section 90 provides that the
ATC 4185
nett income or loss in relation to a partnership is to be determined on the basis of treating the partnership as if it were a taxpayer, in effect, a hypothetical taxpayer.In respect of the appellant's claim for interest in each year, the matter falls to be decided as applied to the appellant personally under sec. 51(1) and this aspect will be deferred for the time being. In relation to Wintara, the loss of $316 and the amounts of $3,806 and $303 disallowed in 1977 raises similar questions to the other matters concerned in the partnership.
Section 51(1) provides, so far as presently relevant:
``51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.
(2) Expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock shall be deemed not to be an outgoing of capital or of a capital nature.''
It is established that there is no dichotomy between the first and second limbs of sec. 51(1) and most outgoings deductible under the second limb of the subsection would also be deductible under the first. I would find under the first limb that the expenditure was outgoings fully incurred in the gaining and/or producing of assessable income.
Dealing with the second limb as an alternative, I pass by ``necessarily'' as being ``clearly appropriate or adapted for'' the carrying on of operations and observe ``assessable income'' refers not to assessable income of the accounting period or the particular year in question in which the outgoing is incurred, but to assessable income generally (
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057; (1975) 132 C.L.R. 175).
Business is defined in a non-exclusive fashion in sec. 6(1) to include, inter alia, ``trade''. It has been held to include activities of a holding company existing to hold shares in a subsidiary company (see
F.C. of T. v. Total Holdings (Australia) Pty. Ltd. 79 ATC 4279).
It is, of course, necessary before any entitlement can arise under sec. 51(1) that there be a business, that the business be identified and it has commenced, accepting that any business must necessarily have a first transaction or activity (
Fairway Estates Pty. Ltd. v. F.C. of T. 70 ATC 4061 at p. 4068; (1970) 123 C.L.R. 153 at p. 165). Here the business is referred to in the partnership as that of ``cattle breeders and pastoralists''. A consideration of activities is a determinant of the effect of the business, and also whether they were undertaken as a commercial enterprise in the nature of a going concern, i.e. activities engaged in for the purpose of profit on a continuous and repetitive basis (per Mason J. in Hope v. The Council of the City of Bathurst 80 ATC 4386). At the same time, little activity may be sufficient for the carrying on of a business (
Thomas v. F.C. of T. 72 ATC 4094; (1972) 46 A.L.J.R. 397;
Ferguson v. F.C. of T. 79 ATC 4261). Ultimately, whether a business is carried on is a question of fact and it has been said ``there is not any principle of law which lays down what carrying on trade is; there are a multitude of things which together make up carrying on a trade''. (
Erichsen v. Last (1881) 8 Q.B.D. 414; and see the criteria considered in Ferguson's case, supra.)
It is appropriate to deal first with the question of carrying on a business by the partnership since this is a threshold challenge by the Commissioner. I am quite satisfied as a matter of fact on the material and documentation before me that the partnership intended to carry on the activities and programme of breeding valuable, pure bred animals and establish a substantial herd and breed therefrom and intended to sell and breed from progeny from time to time. I have no doubt that this was intended as a long term activity and I have no doubt that it is properly described as a business.
I am also satisfied that the business was carried on during the years in question, that it commenced and carried on business
ATC 4186
thereafter following upon the documentation and in both years. Prior to its commencement there was considerable exploratory activity and meetings of those who ultimately became members of the partnership and others.As I have said, I accept that the herd was seen by McIntyre in New Zealand in company with experts in the field, including Busquet, and that it had been assembled in the United Kingdom and exported to New Zealand and comprised some one hundred head of females and was properly regarded as the finest herd of cattle in Australasia. The animals were seen in New Zealand by McIntyre who made a special visit for that purpose and they were highly recommended to him and the best females identified for selection. The ultimate selection was made by Egan for these particular partnerships upon opinion provided by McIntyre and no doubt following discussion with him. The management and care of the animals were part of the leasing arrangement and were the subject of contractual obligations on the part of the managers. Whether the individual partners themselves personally participated from day to day in my opinion is irrelevant. McIntyre was the more active on behalf of the major partners and as it were was the point of contact for them and he and Egan were the professional advisers and in contact with the managers. The administrative side was organised adequately and was thus in the hands of a reputable firm of accountants who were known to the major partners and were themselves involved in some partnerships, an indication of their belief and faith in the projects and their viability.
The managers were relied upon and believed to be competent, expert and experienced, as I find they were and, as I have indicated, there is a contract relating to it. Whether or not they prove so to be in the long term is beside the point. The animals had arrived from New Zealand for the partnership in May 1976. I accept that McIntyre and the appellant and others hoped and expected that some operations would be started before June of 1976. When operations were delayed he or Egan complained to the managers and were given explanations and the programme that resulted was a lot slower than was anticipated. Meantime, the animals were in Australia, being managed and cared for by the managers for the partnership.
It is beyond dispute that operations were performed and reported to the partners and that calves resulted and were the subject of agistment, notwithstanding delays. It is also the fact that applications were made to the Breed Societies for the registration of the progeny. I think it is beside the point that the full expectations and scope of the transplant operations were not immediately carried out. The fact is that a substantial number were. It was not put or suggested to any witness for cross-examination that the arrangements were a sham or that it was never intended that transplant operations be performed, or that there would necessarily be a termination of the partnership before all the operations were performed.
The question of the registration of some of the cattle is raised by the Commissioner and no inference is drawn by me adverse to the partnership on this aspect. I am satisfied any failures were inadvertent; I am also satisfied that the evidence of Mr. Richard from the Charolais Society shows that the records of the Society were in some confusion. In any event, the obligation concerning registration under the lease was on the managers, and the partnership was entitled to rely upon that.
A further matter is the very substantial investment and expenditure involved in the partnership in the cattle breeding project, irrespective of how it may have been funded. It was obviously, in my opinion, a business activity and far removed from a hobby or a sham. It involved a guarantee of the production of a minimum of forty-eight animals to each partnership, they having a then value of some hundreds of thousands of dollars. Forty-eight was a minimum figure and I am satisfied that the transplant expectations, and which were confirmed in some instances, were such that far more than forty-eight could reasonably be expected. I accept that it was contemplated and expected that the matter would not stop with the production of the minimum forty-eight pure bred animals or whatever the number may have been in excess thereof, following upon the transplants. I accept that there would be subsequent breeding, culling, sales and the like with all the necessary elements that that would involve, and with the intention of
ATC 4187
profits being distributed amongst the partners. This was not challenged in cross-examination. It is consistent with the above that notwithstanding the circumstance that the minor partner is no longer a member of the partnership, the major partners have continued the partnership, breeding, developing, showing and selling cattle and generally performing the activities of cattle breeders up to the present.If the matter is viewed objectively from a feasibility point of view as at the time of the commencement of the partnership or shortly before, there were forty-eight animals guaranteed by way of progeny. At a value of $6,000 each, which I find on the evidence was within the range, these would achieve a value of $288,000, which, less the leasing and other charges reaching $251,412, leaves an excess of $36,588, or is 14.5 per cent of the initial expenditure. If this is spread over a three year period, and there was evidence to that effect, it involves a return of 4.58 per cent per annum. These figures of course are only approximate and obviously there is a margin either way but, nevertheless, they offer some guide. The foregoing assumes forty-eight animals, that being the guaranteed minimum. The average transplant in effect achieved was 4.5 ovum, so that on the same values the figures would reach $324,000, an excess of $72,588, i.e. 28.7 per cent or, again over a three year period, 9.6 per cent per annum. Bearing in mind that some transplants reached seventeen and that the 4.5 average is so close to the guarantee of four, these figures can properly be said to be quite conservative. I accept evidence that a realistic average of 5.5 can be expected. Thus an increase in the number of progeny beyond the above numbers or in prices would add much to the feasibility and attraction of the programme. Beyond this, and assuming some retained progeny portion from these animals during the three year period, there were further accelerating prospects, particularly with the use of the transplant technique. In my opinion, it was plainly a viable and attractive commercial business viewed long term.
The amount of rental paid under the lease is another factor. It was $246,800 for six animals for the term, and a right to two operations each. If the twelve transplants alone are considered in that sense, the figure of $20,566 could be placed on each. However, quite apart from the transplants and their costs, which were considerable, the lessor was obliged to provide qualified pure bred semen, recipient females for at least forty-eight progeny, agistment, care and management, and transport and the like for the recipients and the calves during the weaning stages, together with value of the guarantee given and the risk of liability in the event of the guarantee not being performed. In addition, and still from the lessor's point of view, it lost the benefit of its animals during the lease term and possible transplants during that period for its own purposes or other use, together with the risk of loss or injury to the valuable donor animals during the term. There is also the cost of confirmed pregnancy tests. I accept that the rental had a commercial reality and was fairly comparable to that of other organisations and opportunities in this field.
On the question of duration of the business, irrespective of whether it was contemplated that a notice of variation would be given so that the major partners and the minor partners would have an equal share in the partnership respectively - a matter which will be dealt with more fully subsequently herein - the fact that this may have been contemplated does not mean that it was inevitable on the documentation. There was no contractual obligation for such a notice to be given and so long as it was not, the shares would remain as they originally were, with the consequent obligation on the respective parties under the other documents. Depending upon the results of the transplants, the progeny resulting, prices, seasonal conditions, market factors and demands and the popularity of the breeds and other imponderables may or may not have the influenced the giving of the notice. Even assuming that the notice was given, it does not follow that the partnership itself would be determined, indeed the document contemplated its continuance because the consequence was a change in the shares of the respective partners. It was not put to any witness that the intention was that the partnership would be determined at that point, nor was it put that the partnership would be determined by a distribution in:specie, nor was it a provision. As I find, the dissolution did not occur consequent upon
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the exercise of any provision in the partnership agreements, but as the result of a continuing dispute between the two interests in the partnership. The dissolutions were I find brought about following dissatisfaction mainly between McIntyre and the minor partners' interests concerning operation delays, high agistment fees for weaned animals, poor condition of animals, and the frequent moving of animals and the consequences of very adverse seasonal and drought conditions. It was following upon that dissolution that the distribution in specie took place and I find that the distribution was done on the advice of Mr. Ross, who was involved in this aspect and whose efforts ensured that the major partners received the best of the animals. A further fact is, as I find, that the major partners have continued to carry on throughout as Wintara and still do so.Whilst on this subject, although what follows is not by any means determinate of the question, it is interesting to consider the consequence had the prices of cattle remained as anticipated or increased had the seasons been more favourable and had the ovum transplants been more prolific than 4.5 and the activities had developed along the lines contemplated, whether the increases in the margin of excess previously mentioned, since undoubtedly they would have been far higher, could properly have been regarded by the partnership and its advisers and the Commissioner as profits resulting from the carrying on of business. Actually it would raise not so much the question of profits but whether the gross proceeds of the sale of the animals were properly to be regarded as being assessable income by the partnership under the provisions of sec. 25(1) of the Act.
It is obvious that a person may have two businesses and further that activities and conduct effected by him through managers does not deny the character of an activity as being a business. Similarly, the manner in which the business is carried out, given that it is a business, is beside the point. It is no doubt a question not only of fact but of degree but when one compares the investment and size of the transactions entered upon here with the position in
Hanlon v. F.C. of T. 81 ATC 4617, where a lease of one animal only for similar purposes to those embarked upon here could be the commencement of a business activity by a syndicate of nine, it confirms the conclusion and finding reached.
I make a similar finding under the first limb of sec. 51(1) and under the second limb as to the existence and carrying on of the business by Columba in the relevant period, the circumstances and principle being similar, and involving the same submission and approach by counsel for both parties.
I come now to a consideration of ``purpose'' in sec. 51(1), relied upon by the Commissioner to defeat the appellant. Purpose does not appear in the first limb of the subsection; it does appear in the second limb in the context of ``carrying on a business for the purpose of gaining or producing income''. As I understand the decisions it is the business which has the purpose, a concept simple enough in the case of a business carried on by an individual but somewhat more elusive where it is the business of a partnership, albeit the partnership comprises individuals who subjectively may have quite different purposes, although in the instant case the partnership included a corporation as well.
Whilst a factor of an individual partner may well have been also to hope to obtain ultimately a tax benefit and, as I find, it was in the appellant's case, but no such finding can be made in respect of all other partners, even so in his case I find it was not the only or predominant hope or motivation. Be that as it may, that is not the concern of the joint operation of sec. 90 and 51(1). By the operation of sec. 90 it is the losses or expenditure of the partnerships that is the matter for consideration.
The question is not whether a person or partnership incurred losses or outgoings for the purpose, sole or otherwise, of obtaining a deduction so that a taxpayer succeeds or fails to qualify for the deduction. The question is whether the losses or outgoings are necessarily incurred in carrying on business for the purpose of producing assessable income. The quantum of assessable income is not quantified by the subsection, nor need it be obtained in the year of expenditure.
The introduction of purpose as a matter for subjective or objective examination in relation to the taxpayer as distinct from his business is interesting as a concept, quite
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apart from whether it be sole, dominant or incidental. In a simple illustration, the shopkeeper taxpayer, having embarked on business and who had decided to rent shop premises necessary and appropriate for the purpose of carrying it on for profit, would have a deduction for the rent. Should he decide to move the business to more expensive premises he would equally be entitled to a deduction. However, so runs the argument, should he say that his purpose, or even his sole purpose, in paying the higher rent is to get a bigger deduction, the proposition is that he thereby loses or at least imperils the allowance of the deduction. Should he on the other hand decide to rent the premises rather than purchase them outright by the use of his available capital, again should he say and mean, as he honestly could, that obtaining the deduction for rent was his sole purpose in renting rather than buying, the same result follows.Purpose, motive and intention and the distinction between them nevertheless have been the subject of judicial consideration in tax cases.
The Commissioner's written submissions begin with the acceptance of the proposition that for a deduction to be allowed under the first limb of sec. 51(1), it is necessary for there to be a finding of a connection between the incurring of the respective outgoings and the operations and activities which are expected to gain or produce assessable income. It is accepted that the proper test is as submitted, and is to be found in
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 57, viz.:
``In brief substance, to come within the initial part of the subsection it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.''
It is to be observed that the passage refers to the first limb of the subsection.
The next step in the argument is [in] two parts, first, the relevant connection is shown by reference to ``the essential character of the expenditure itself'' (
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at p. 497). This seems to be obvious since, e.g. if the essential character of the expenditure is rent and it is paid for premises where an income producing business is carried on, the connection between the essential character of the expenditure, viz. rent, and the gaining or producing of the assessable income is established.
The second part of the submission proceeds, however, that additionally to the above the relevant connection may be shown by reference to the purpose for which the relevant expenditure is made. I should have thought that, having already established the first part, it followed that the section was satisfied and the deduction established. This observation, for the purpose of this point, leaves to one side the exceptions of outgoings of a capital and private and domestic nature and exempt income. The submission is not expressed alternatively to the first, no doubt because if it did it would, if found, result in the exclusion of the first principle which stems from Ronpibon Tin. Thus, there is to be engrafted on to that principle a consideration of purpose. It is said that a purpose related to a business activity or operation will not defeat the deduction otherwise within the first part, but that a purpose unrelated to such business activity, e.g. to save or reduce the incidence of tax liability that might otherwise be payable were the claimed deduction not a deduction, would operate to defeat the finding of a connection between the incurring of the outgoing and the business operations which were producing or expected to produce assessable income. In the instant case the purpose is said to be the purpose of incurring expenditure in the partnership so as to secure as part of an overall scheme the tax advantages, inherent in the use of sec. 36A. The submission does not say in whom or where the purpose is to be found, nor does it distinguish between the individuals or corporation as such who comprise the partnership and the partnership itself which incurred the expenditure. This may be left to one side but it is a criticism relied on by the appellant.
In relation to the notion of purpose, the submission then proceeds to rely on the observations of Brennan J. in
Magna Alloys and Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at p. 4547:
ATC 4190
``Thought purpose is not the test of deductibility not even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer's undertaking or business is affected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-earning kind.''
Based on this passage the Commissioner by his counsel developed an argument that the purpose in the appellant in the case before me had a relationship to tax deductions and it was by a voluntary act on his part that the expenditure was incurred.
The submission can be answered by saying that the expenditure was not that of the appellant but was expenditure of the partnership. Nor was the expenditure a voluntary act of the appellant. On the contrary, it was an act of the partnership and to the extent that it was made pursuant to the relevant contractual obligation to do so it was not a voluntary payment but on the contrary an obligatory or involuntary payment. In this sense, the present case is removed from anything in Magna Alloys, it is more like Cecil Bros. (infra). However, it was an argument that was put on the cases and I therefore dealt with it.
His Honour, however, makes it clear he is dealing with a business. In the first portion of the sentence, as I read it, he is referring to a loss involuntarily incurred where purpose is irrelevant; in the second part he is not referring to a loss but to a connection between an outgoing and the business itself being affected by a voluntary act of the taxpayer. However, the passage says two things, that purpose is not the test of deductibility (presumably of an outgoing since it is that which is deductible), or even relevant to an outgoing involuntarily incurred, as opposed to an outgoing which is voluntary or manufactured or contrived. If this be so, and in my opinion it is, this part of the passage offers no support for the submission, rather the submission is contrary to the expression that ``it may'' so constitute an element. The second portion of the passage with respect does not indicate the manner in which the connection may be affected or the type of voluntary act that may so affect it, or in what way the purpose (of incurring the expenditure) may constitute an element of its (i.e. the expenditure's) essential character, other than that the purpose, if it does become an element of the expenditure's essential character, may stamp it as expenditure of the required kind.
Brennan J., at p. 4553, after a review of the decisions touching the present question, said that:
``In the circumstances of the present case, the expenditure bears the character of expenditure necessarily incurred in the carrying on of Magna's business. This conclusion is a conclusion of fact, but it does no violence to the findings of fact made by the learned trial judge, nor does it set aside any inference actually drawn by him. The character of the expenditure is not lost because the expenditure was apt to serve both the business purpose and the purpose of defending the directors, nor is that character lost because the principal or dominant reason for incurring the expenditure was to defend the directors.''
Earlier, at p. 4549 in particular, Brennan J. limits the evidence of the taxpayer's subjective purpose to that which goes to the character of the business or undertaking or, as I read it, whether the expenditure is voluntary. In the same case, Deane and Fisher JJ., at pp. 4560-4561 put the matter as follows:
``In our view, however, the identification of the dominant motive of the directors in deciding to incur the expenditure was not the essential question which arose for determination. There is no necessary dichotomy between what can properly be regarded as incidental and relevant to the business ends of a business and that which advances the personal interests of those persons who are employed or otherwise involved in that business... It is not essential, for the purposes of sec. 51(1) of the Act, that such outgoings be shown to have been incurred with a dominant motive characterised by lack of self-interest or generosity before they can be said to have been necessarily incurred in carrying on the particular business... An outgoing can, in the relevant sense, be necessarily incurred in carrying on a
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business notwithstanding that it flows from a sense of moral obligation to those involved in the business... Whether a voluntary outgoing was so incurred depends upon the answer to the composite question... namely, whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business and, if so, whether those responsible for carrying on the business so saw it.''
Having regard to all these observations, any subjective examination is not an examination of how the appellant in this case or the partnership or its members individually or some of them, saw the tax advantages of their respective involvement in the partnership but, and it would seem this is the essence of the matter, whether the expenditure by the partnership bore the character of expenditure necessarily incurred in the carrying on of the partnership business or if it was regarded as in any way voluntary, that it was at least capable of being seen as desirable or appropriate by them from the point of view of the pursuit of the business ends of their business of cattle breeders.
I reject the submission of the Commissioner based on the passage mentioned.
The submission, still maintaining the introduction of purpose, relies upon the observation of Toohey J. in
F.C. of T. v. Ilbery 81 ATC 4661 at p. 4667, in reference to the passage in Magna Alloys (supra), that:
``Conversely, I would add, purpose may stamp the outgoing as one having no relevant connection with the gaining or producing of assessable income.''
With respect, whether this is so, the inquiry, of course, is whether the outgoing was incurred in gaining or producing assessable income. The case was decided on the ground that there was no relevant income-earning business in existence nor had any such activity begun.
A further step in the submission is that the above quotations relating to the notion of purpose are equally applicable to a determination of deductibility in terms of sec. 51(1) because of the presence of the express words ``for the purpose of'' in the second limb of the subsection.
There is, in my opinion, with respect, some misunderstanding here. The passage from Brennan J. (supra) refers to ``the taxpayer's undertaking or business''. As to the words in the subsection, they are specifically ``for the purpose of gaining or producing income'' and the words ``for the purpose of'' cannot be removed from that context and used to support a concept of a purpose constituting an element of the character of the outgoing as is expressed in Magna Alloys or, as is more specifically argued here, a purpose in the taxpayer or partnership in incurring the expenditure was tax advantage. The use and concept of the word ``purpose'' in the two situations are different and I reject this particular submission. Should it be accepted, the result is that the submission applies to the second limb but not the first. Brennan J. made no such distinction; the reality is that it is the purpose of carrying on the business that is referred to in the section, viz., the purpose of gaining or producing assessable income, as distinct from capital or private or domestic expenditure or exempt income. In any event, the particular submission is effectively answered to the contrary by a passage from Menzies J. in
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 at p. 49, repeated later by Brennan J. in Magna Alloys (supra) at p. 4545 to the effect that, in relation to the subsection:
``... there must, if an outgoing is to fall within its terms, be found (i) that it was necessarily incurred in carrying on a business; and (ii) that the carrying on of the business was for the purpose of gaining assessable income.''
A further submission is that the use of the words ``to the extent'' in sec. 51(1) demonstrate that a Court may apportion an outgoing between that portion thereof which comes within the subsection and that which does not in circumstances where it is possible to discern a duality of purpose in the incurring of the outgoing. I accept that an outgoing can be apportioned, and the presence of the words mentioned makes it clear, but it is not so much because of the duality or multiplicity of purpose as it is because the subsection itself says the outgoing is allowable ``to the extent'' that it
ATC 4192
is incurred in gaining or producing assessable income and as provided by the second limb, and this is so in my opinion irrespective of and independent of purpose however expressed.The submission concludes with the subsidiary submission that the appellant, through his participation in partnerships, obtained for a consideration which is identifiable and quantifiable, an additional advantage unconnected with the business undertaken by the respective partnership and this proportion of the overall expenditure is not deductible in terms of sec. 51(1). It is then submitted that the identifiable and quantifiable advantage (in the preceding sentence of the submission it was the consideration that was identifiable and by the expenditure was the anticipated assumption by the minor partner of the liability for 50 per cent of the borrowings by the major partners arising out of the variation of the interests of the minor partner in each partnership from one per cent to 50 per cent in both instances. Accordingly, 50 per cent of the original outlay says the submission must be seen as not having been expended for the purposes of gaining or producing assessable income.
There are two points here, apportionment and purpose. As to apportionment, the reality is that there was no assumption by the minor partner of the liability for 50 per cent of the borrowing. Furthermore, the liability of the individual borrowers remained constant and the right of the lender company was unaffected. The minor partner received an additional 49 per cent interest in the partnership and the appellant lost his proportion of the 49 per cent correspondingly lost by the major partners. The question of apportionment does not arise in any event. Under the section it has application in respect of an outgoing, in this case an outgoing in the partnership. The Commissioner's submission is an attempt to effect a conglomerate view of a number of transactions involving different parties and to assert a final result in the appellant as a consequence.
The question of purpose on this submission is a different approach to that previously submitted. There the purpose referred to is for the purpose of gaining or producing assessable income which I accept as correct as I have already stated. The submission has no relevance to purpose in this sense.
The fact that, consequential to losses made by the partnership that an individual member of the partnership included in his respective personal return has nothing to do with the relationship or connection between the outgoing of the partnership and its business. The effect of the profit or loss distribution on the individual member bears no connection or relationship between the partnership outgoing and its gaining or producing of assessable income. With a number of members in the partnership, the submission becomes that because one, the appellant in this case, gains some ultimate advantage, the outgoing in the partnership thereby ceases to be an outgoing. By reason of this consequence it is also said that the outgoings take on non-business characteristics. In truth, the outgoings were for the lease of animals for a term, for the performance of operations, management and care of animals and progeny pursuant to a contract which is admitted not to be a sham or a subterfuge. It is also said that there were advantages flowing from the variation which were certain. I have already indicated that the variation was not certain.
The submission of the Commissioner as to ``purpose'' really involves the proposition that a taxpayer personally or as a partnership who or which embarks upon the course of incurring an admitted outgoing incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, and he does that being desirous of obtaining that deduction and for the purpose of having the benefit of that deduction, e.g. because it may reduce his income from that business, does not in law obtain the deduction, even though the deduction, but for the desire or purpose, would otherwise be a proper deduction. In my opinion, this is not so under the subsection in the context of a commercial world where many business decisions and their efficacy of necessity must be made with a clear consciousness and awareness of the consequences of income tax upon the available options and the ultimate decision.
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As will have emerged by now, in my opinion the Commissioner's submissions are not to be accepted. Rather than leave the matter with the criticism which has been made of the submissions as developed, I will state further my reasons on the question of purpose which may overlap in some respects what has already been said.
The Income Tax Act, 1922, which preceded this Act as it presently stands, was construed as to sec. 21(1)(a) and 25(e) thereof, the forerunner of the present sec. 51(1) though different in terms, as involving purpose as a factor when considering deductibility. This is seen in
W. Nevill & Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. 290, per Latham C.J. at pp. 300-301, Rich J. at p. 303, Dixon J. at p. 207, McTiernan J. at p. 309. Under the same Act in
R.G. Nall Ltd. v. F.C. of T. (1937) 57 C.L.R. 695, Rich J. at first instance put the test, as being: was the expenditure laid out for the production of income or some other reason; and on appeal it was held his decision was supported by the evidence. Latham C.J., at p. 705, said that the word ``for'' in the phrase:
``... expended for the production of assessable income'... suggests that regard should be had to the purpose for which the expenditure is made. The existence of a purpose in the mind of some person cannot always be taken as a test... The provision must be applied in the case of corporations, and it is impossible to limit the ascertainment of purpose in the case of a corporation to the ascertainment of the actual mental state of some natural person. The words... must... be given an interpretation which does not necessarily depend upon the object which some person or persons desire to achieve, though, in a case where natural persons are concerned, the object which they naturally have in their minds may properly be taken into consideration...''
His Honour put the question as being whether there was a real connection between the expenditure and the income produced. Starke J. said the expenditure was open to two interpretation on the facts and the Rich J., at p. 709, was entitled to take the view he did. Dixon J., at p. 711, referred to the purposes of the payment, and said:
``The nature of the connection [between the expenditure and earning income] is vaguely stated by the word `for', and this is commonly paraphrased by means of words expressing purpose. But, in matters of income tax, purpose is an elusive and indefinite criterion. The purpose of a payment when a deduction is claimed for it becomes an attribute of the transaction rather than a state of mind of some actual person.''
His Honour went on to say (at p. 712):
``... that gaining or producing assessable income must be the purpose of the expenditure... no more can be meant than that the circumstances of the transaction must give it the complexion of money laid out in furtherance of a purpose of gaining income. If in the common course of affairs the expenditure is considered to conduce to or to be required by the purpose, to be referable or attributable to it, the condition prescribed by sec. 25(e) will be presumptively satisfied.''
The purpose last referred to is, as I understand it, to be taken in the sense used by his Honour earlier, viz. that the circumstances of the transaction gave it the complexion mentioned. Evatt J. referred to the purpose of the payment and said that no income getting purpose characterised the expenditure and that it was purely family or personal reasons. McTiernan J., at p. 714, said it was a matter of fact whether the payment was for services.
In
Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382 at p. 468 Dixon J. points out, for example, that:
``Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant.''
The use of ``purpose'' here is obvious.
Reference may then be made to Ronpibon Tin (supra).
In
F.C. of T. v. The Midland Railway Co. of Western Australia Ltd. (1951-1952) 85 C.L.R. 306, Dixon J., at p. 312, makes it quite plain that:
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``... from beginning to end the issue is whether the payment of any part of it was an outgoing incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income...''
With respect, I regard this not only as a timely reminder but a percept to be kept constantly in mind when dealing with this subsection. He went on to say (at p. 313) that:
``The second consideration is that what governs the issue is the business purposes for which the outgoing was incurred from the point of view of the taxpayer...''
Business purpose in this sense can only be the identification of the particular business activity, dealing or transaction that the expenditure is matched with within the ambit of the business itself viewed as a whole. This is made clear in the sentence following:
``The controlling factors are those which arise from the character of the business or undertaking and the relation which the expenditure or the liability to make it bore to the carrying on of the business or the gaining of assessable income.''
This is an objective inquiry and is not concerned with the taxpayer's state of mind or his desires or purposes devious or otherwise. It goes to an identifiable transaction or dealing in the context of the given or established parameters of the business.
Assistance is obtained from
Cecil Bros. Pty. Ltd. v. F.C. of T. (1962-1964) 111 C.L.R. 430 where, in the case of expenditure made pursuant to a contract in the business area, purpose or motive is irrelevant to the determination of deductibility. The question of what the expenditure is directed to or for in the business is considered in the light of the contract and its relation to the business. In Cecil Bros. it was shoes; in the instant case the partnership expenditure was for the use of the cattle for the term and the transplants and other matter mentioned in the contract. In
Europa Oil (N.Z.) Ltd. v. Commr. of I.R. 76 ATC 6001, where the activity was related to minimisation of tax, the majority rejected a test which would permit investigation into subjective matters where the expenditure was incurred under a contract.
A similar approach is seen in
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412; (1977-1978) 140 C.L.R. 645. There the rental was payable under a lease to a company. There was also an option granted to the company or its nominee. The company assigned the lease to the taxpayer. The option was exercised in favour of the company at a price fixed in the option which decreased in a formula related to the rent. It was an advantage to have a high rental under the agreement (assuming it to be deductible) and it operated to reduce the purchase price under the option. In response to a claim by the Federal Commissioner of Taxation that the rent was in part outgoings of a capital nature and thus apportionable, the majority found the rent to be deductible. Gibbs A.C.J. (as he then was) at ATC p. 4416; C.L.R. p. 653, said:
``There can... be no doubt that the payments made... under the lease were outgoings incurred in gaining or producing assessable income, or alternatively were necessarily incurred in carrying on a business for the purposes of gaining or producing such income... it is impossible to suggest that the lease was a sham. The taxpayer carried on its business in the factory on the leased land and the payments were those required... to be made as the price for the right to possession of that land... it would not be relevant... that the taxpayer might have leased the same or other premises at a lower rental...''
At ATC pp. 4417-4418; C.L.R. p. 656 his Honour said, significantly enough, and this was in the context of whether capital was involved:
``However it is abundantly clear that those who managed the affairs of the taxpayer knew that the grant of the lease was part of a wider scheme designed to benefit another or other companies in the group. They knew that part of the payments made as rent would in effect be credited against the purchase price of the land... it seems right to say that the payments were made not only with the knowledge, but also with the purpose,
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that part might be treated as part of the price of a capital asset...''
At ATC p. 4420; C.L.R. p. 660 he said:
``No doubt at first sight the transaction appears to have the flavour of a scheme or device to reduce taxation. However it was not a sham, and the Commissioner, no doubt rightly, made no attempt to rely on sec. 260...''
Magna Alloys (supra) dealt with the legal costs of defending criminal proceedings against the taxpayer company's directors and agents and these were allowed as a deduction, notwithstanding the motive or purpose in incurring the outgoing included both the taxpayer company's interests and those of the directors' own position. The learned trial judge considered that the relevant issue was to determine the dominant motive involved and concluded that the directors' dominant motive was to protect their own position and rejected the outgoings as deductions. The view taken on appeal was that the dominant motive was not the essential question and the fact that the needs of the directors and benefits to them was a dominant motive did not preclude the outgoing from being within the second limb of the section. Brennan J., in a long judgment and consideration of the authorities, concluded (at p. 4549) that:
``In that step towards characterisation [i.e. of the expenditure], the taxpayer's state of mind has no part to play. His purpose or motive is not a controlling factors for the purpose to be attributed to the incurring of the expenditure.''
(My brackets.)
This was said in relation to the considerations laid down by Dixon J. in Midland Railway Co. (supra). Brennan J. went on to say the taxpayer's state of mind (as distinguished from objective purpose of the expenditure) whether intention or purpose or motive, was evidentiary only in ascertaining the controlling factors of the business purpose which arise from the nature of the business and the relationship which the expenditure bore to the carrying on of the business or the gaining of assessable income. In a case where the protection and the preservation of the business and the protection of the directors are entwined, such considerations are apposite. His Honour, however, said (at p. 4552) that in that case:
``... the character and scope of the taxpayer's business is known without reference to its state of mind. Equally, it is objectively certain that the... expenditure was incurred to defray... costs of the directors and agents... The connection between the legal services thus acquired and the taxpayer's business neither requires nor permits reference to the taxpayer's state of mind. The... connection is to be found in the objective facts found...''
If this be so, and it is my opinion, the more so is there no requirement to look at the partnership's state of mind if this were possible in considering expenditure in its business, and how much more irrelevant is the appellant's state of mind in that respect.
From the foregoing line of authorities as I understand it the principle emerges that an expenditure, particularly if it is made pursuant to a contractual obligation, is within sec. 51(1) if it is incurred as a matter of fact in gaining or producing assessable income, or by means of which the taxpayer made income (per Starke J. in
Munro's case (1926) 38 C.L.R. 153 at p. 218, Infra), or is necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income, subject always to the exceptions mentioned in the subsection.
In the case of an expenditure incurred or made in carrying on a business where the business is for the purpose of gaining or producing such income, the nature or ambit of the business having been determined, it is a question of fact whether there is a match of the expenditure with an acceptable business purpose within that ambit. This is an objective examination and has nothing to do with the taxpayer's state of mind, motivation or purpose other than it may be relevant as an evidentiary matter to the determination of the parameters of the business or its nature. This is illustrated where, e.g. rent was paid by a taxpayer for premises which objectively were found to be outside the ambit of the then given business. Evidence of his intention or purpose to extend the activities, and that the new premises were for the business purpose of extending that business, would be
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relevant and admissible and, if accepted, to extend the area of activities of the business and stamp the payment as an outgoing. These observations are made as the context of a business existence. If that is a threshold question, it is a question of fact to be determined and I have already dealt with this issue in favour of the appellant.Where the expenditure is incurred in the ordinary course of business there is no problem, likewise where it is incurred pursuant to some contractual obligation entered into as a business matter touching the business. Where the expenditure is touched by a quality of voluntariness, even if contractual, a challenge to the expenditure may result and depending on the material may be successful. This is not so much because it is incurred voluntarily but first, either because it is not ``necessarily'' incurred within the section or also because there may be difficulty in showing a connection between the expenditure and the business. The emphasis of approach seems to have been on the latter rather than the former. If the approach is focused on the latter and there is no ready commercial or business explanation, it becomes a matter of a commonsense appreciation of all the guiding features which must provide the ultimate answer, as was put in
B.P. Australia Ltd. v. F.C. of T. (1965) 112 C.L.R. 386 at p. 397.
If the expenditure is not wholly incurred in the business but only partially so, as a result of the phrase ``to the extent'' in the submission the expenditure may be apportioned so as to reflect the connection of the amount actually so incurred, in which event it is then properly characterised as an outgoing.
Two cases on which reliance was placed by the Commissioner were
Ure v. F.C. of T. 81 ATC 4100 and
F.C. of T. v. Ilbery 81 ATC 466. The former was not a case of a business and the decision flowed from a finding of fact that the expenditure of the interest on the money borrowed was not incurred in gaining or producing assessable income but was of a private and domestic nature. However, had the appellant succeeded in obtaining a finding of fact that the borrowing at a high rate was incurred in gaining the one per cent income, and as to the latter it did, the result, so it would seem, would have been an expenditure within the subsection. The findings of fact made were that the outgoing of high interest was incurred to achieve other results which were ulterior to the earning of an income of one per cent. Even so this case contains observations relied on by the Commissioner and I shall deal with them. Ilbery's case ultimately went as it did because the expenditure was incurred at a time when there was no relevant income earning business in existence, nor had any such activity begun; the finding was [that] it was not outlaid to gain income. In my opinion, neither of these cases are of application to the present matter.
Ure v. F.C. of T. involves some discussion of purpose. It was a borrowing case, under the first limb of sec. 51(1) and was not a business case. It was seen by all the Judges as a somewhat special case.
Reliance was placed by the Commissioner on the passage per Deane and Sheppard JJ., at p. 4110:
``The incurring of the outgoing can only be explained by reference also to less direct objects and advantages which the taxpayer sought to achieve and which plainly were of paramount importance. These indirect objects or advantages were, insofar as the taxpayer was concerned, not of an income-earning character in that they involved the provision of accommodation for the taxpayer and his family, the financial benefit of the taxpayer's wife and a family trust and a reduction in the taxpayer's personal liability to pay income tax.''
This passage accepts that there was an outgoing and, as I read it, that, as a matter of fact, the outgoings were not incurred in earning or gaining income but for other purposes there enumerated not being the gaining or production of assessable income. So understood, the passage does not assist the Commissioner's submission. It is true that Brennan J. said at p. 4104 in relation to the question whether the incurring of interest at the rates mentioned was incidental to the gaining of income by way of a higher rate:
``The answer to that question does not turn directly upon the disparity in interest
ATC 4197
rates, but upon an examination of the purposes for which the money was laid out. The disparity in interest rates is itself eloquent to suggest the existence of purposes ulterior to the earning of interest at the rate of 1% per annum, and the evidence confirms the existence of further purposes. The loans of the borrowed moneys made by Mr. Ure were calculated to achieve the further purposes of providing some income to Mrs. Ure, of enhancing the profits of Listohan, of providing Mr. Ure and his family with the Epping residence at a nominal rental, and of enabling the Joan Honeybourne Trust to take the benefit of any increment in the capital value of the Epping property and to enjoy the rents and profits of that property when it became available for letting at a commercial rental.''
It is clear that Brennan J. to this point also saw the expenditure as in fact not only incurred in the gaining of assessable income, but in fact incurred for other purposes in the sense of other objects. The passage continues:
``Of course, the achievement of these further purposes required the co-operative action of Mrs. Ure, Listohan and Weston, but where a question arises as to the purpose for which the money is laid out by a taxpayer, it is erroneous to exclude as irrelevant evidence of the use of the money albeit by others, in conformity with arrangements made by the taxpayer. That is not to deny the separate identity of those who use the borrowed money, nor to attribute vicariously to the taxpayer the activities of others.''
His Honour then proceeded:
``It is simply to take some relevant factors into account in determining purposes for which money is laid out. Those purposes do not depend upon the state of the taxpayer's mind but upon what the taxpayer in the circumstances of the case is ascertained to have done in using and arranging for the use of the borrowed moneys.''
This latter sentence clearly states that ``those purposes'' had not been dependent upon the state of the taxpayer's mind, but rather that those purposes are discoverable and ascertainable from what it is decided that he has done in fact in using the money and arranging for its use. In the initial quotation of his Honour (supra) it is observed that, ``the loans... were calculated to achieve the further purposes'' there mentioned, not that what was done by the taxpayer or done in using the money or arranging for its use.
Put shortly, the proposition that the answer depends upon the purposes for which the money was laid out appearing in the first sentence of the earlier quotation becomes as to purpose, expressed in terms that the purpose is to be found in what is in fact later determined to have been done in using the money and, if it be so, in arranging for its use. If this be so, and the taxpayer had borrowed, as he did, at rates of interest up to 12½ per cent and that if the fact then found had been that what he had done in fact in using the money was to make a loan to another at one per cent thereby gaining assessable income, it would seem to follow that the purpose of gaining income was established and that the money laid out was a proper deduction. However, the fact that what was done with the money was to use it to make a loan to another was apparently not itself sufficient as a fact to determine that the expenditure incurred entitled the taxpayer to the outgoing since there was a finding of fact that he had also arranged for the use of the moneys so lent. This latter finding was that the arranged use was not for gaining assessable income, since what was also expressly said was that the loan having been so made it was to consider what the use the borrower and others would then make of the loan money and the effect of the result that the loan achieved to the borrower, to Listohan and others and in different ways, was in that respect not for the gaining of assessable income.
So far as purpose is concerned, the question in that case was whether in the terms of sec. 51(1) the moneys laid out were an outgoing to the extent to which they were incurred in gaining or producing assessable income. If purpose in the context discussed is accepted as the factual objective purpose in the subsection, i.e. of gaining assessable income for which the outgoing was incurred, in the sense of being actually so used and not
ATC 4198
for a variety of other non-assessable income gaining purposes, such as a private or domestic purpose or nature, and the inquiry is directed to that purpose, so as to determine as a matter of fact whether the expenditure was an outgoing incurred in gaining or producing that income, then purpose presents no difficulty. Under the section the deduction is allowance ``to the extent to which [it is] incurred'', i.e. in gaining or producing assessable income, so that an apportionment of expenditure or outgoing can be apportioned in order to reach the amount of outgoings can be apportioned in order to reach the amount of outgoings which are incurred in gaining or producing assessable income. The effect of the decision as I understand it is that portion only of the interest expended (the outgoing) was incurred in obtaining the total funds which were used as the loan and which gained or produced the assessable income being the one per cent interest on the loan. The question whether funds could have been obtained by the taxpayer at an apportionated rate so as to enable him to then obtain the funds in the first place and to then lend them and earn the assessable income was not explored and was presumably not relevant.At p. 4104, Brennan J. said:
``The purposes of which money is laid out is an issue of fact, turning upon the objective circumstances which human experience would judge to be relevant to the issue (cf.
Magna Alloys and Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at p. 4549). In the present case, there is an air of unreality about the proposition that the borrowed moneys were laid out wholly for the purpose of earning a return of 1% per annum. Rather is it right to say that the purpose for which the borrowed moneys were laid out included all the purposes earlier mentioned, only one of which was to earn a return of 1% per annum.''
The latter part of the above quote regards the approach as being not only for the purpose of earning the stated amount of interest, but that it should be wholly for that purpose, so that, as I understand it, if some other purpose is involved additional to that of earning income which is not itself related to the earning of assessable income, then the expenditure is apportioned as required under sec. 51(1). This clearly follows from the next following paragraph, namely:
``If the borrowed moneys had been laid out solely for the purpose of gaining assessable income, the interest would be wholly deductible; but as they were laid out in part for that purpose, and in part for other purposes, the interest charges must be apportioned.''
Deane and Sheppard JJ.'s view was that it would be misleading half truth to say that the objective which the taxpayer had in mind or the advantage which he sought in incurring liability for interest was to derive interest at the lower rate by re-lending it. Their Honours said no doubt it was an object or advantage but that in the circumstances the characterisation could not be affected by reference to that object or advantage alone and that the incurring of the outgoing could only be explained by reference also to less direct objectives and advantages, and which were of paramount importance. Their Honours said, at p. 4110, that:
``In the result, the outlays of interest can be seen as servicing a number of objects indifferently. The predominant, though indirect, objects were not concerned with earning assessable income... but were, for the purpose of sec. 51(1), of a private and domestic nature.''
Their Honours said further that:
``If... apportionment were not possible and it were necessary to give a single characterisation to the whole of the interest which was paid, we would conclude that the interest could not be characterised as having been incurred in earning assessable income and that its primary characterisation was as being of a private or domestic character. It is however established that apportionment is, in those circumstances not only permissible, but required.''
With respect, the above would be consistent with the judgment of Brennan J. and his reliance initially on
F.C. of T. v. Munro (1926) 38 C.L.R. 153 at pp. 170, 171 and 197 where he says, at p. 4104:
``An outgoing of interest may be incidental and relevant to the gaining of assessable income where the borrowed money is laid out for the purpose of gaining that income.''
ATC 4199
In Munro's case, at p. 171, Knox J. said:
``The interest was paid, not for the purpose of gaining or producing assessable income of the taxpayer, but for the purpose of satisfying pro tanto a debt which the taxpayer, had incurred with a view, not to the production of his assessable income, but to the production of income by the company for the benefit of its shareholders. The debt having been incurred for a purpose wholly unconnected with the production of assessable income of the respondent, I think it impossible to say that the interest paid on the amount of the debt was money wholly and exclusively laid out or expended for the production of his assessable income.''
At pp. 197-198,Isaacs J. said:
``In short, the interest paid to the bank was not paid to create any of the assessable income in question...''
Later, on p. 198, his Honour said:
``Clearly the production of `assessable income' was not the only purpose of the loan.''
Higgins J. said, at p. 204, concerning the interest paid:
``The position is, to my mind, so obvious that I should serve no useful purpose by amplifying my reasons.''
In the judgment of Starke J. it is put at pp. 217-218:
``The interest paid... was on moneys borrowed for the purpose of contributing capital on the part of the taxpayer and his son to a newly formed company. It was not an outgoing by means of which the taxpayer procured the use of money whereby he made any income...''
In my opinion,Ure's case can be seen as one of an expenditure or outgoing directed to two objects, one being the gaining of assessable income and thereby to that extent within sec. 51(1), and the other to other objects set out and which were not objects directed to the gaining of assessable income objects, but were of a private or domestic nature. Thus an apportionment was called for under the subsection and this is what was done. The case depended on its particular factual findings. Ultimately the question, with respect, may any turn rather on the subject matter to which the expenditure is directed than so much on purpose. In Ure's case the expenditure was money paid by way of interest paid for borrowed money which was itself (as was said in the joint judgment at p. 4109) likely to be of its nature neutral. Where the subject matter of the expenditure is not so colourless but plainly takes on the character of rent or hire of necessary plant or equipment or the like the difficulty is not so likely to arise. Once the expenditure matches an appropriate business subject matter, the fact that the taxpayer had some purpose in mind in obtaining thereby tax deductions or benefit (to which on the premise he was entitled) the additional purpose, not directed to some subject matter of expenditure, is irrelevant and, with respect, Ure's case says nothing to the contrary and does not in my opinion support the Commissioner's submission. Here the expenditure in Wintara was wholly and solely directed to the subject matter of outgoings under the lease, and in Columba to corresponding outgoings.
This leaves the question whether the expenditure or outgoings so found were of capital or of a capital nature and so excluded from sec. 51(1).
The appellant's submission is that the outgoings are on revenue account. From a practical business point of view, the expenditure affected the use of the animals and the acquisition of progeny, being trading stock for use and sale and breeding purposes.
Looked at from the tests applied, and which are descriptive rather than definitive and are to be seen in
Sun Newspapers Ltd. & Anor. v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-363, further explored and elaborated in
B.P. Australia Ltd. v. F.C. of T. (1966) A.C. 224 at p. 261 ff., and South Australian Battery Makers Pty. Ltd. (supra) at ATC p. 4419; C.L.R. p. 659 the character of the advantage sought is the production of trading stock, with no lasting or permanent qualities, not a capital asset in the accepted practical and business sense. The manner of the use of enjoyment is not as in that of a capital asset and the means employed in obtaining it, although a matter of degree, is a factor. Advance payments for periods, particularly where short, has been said to be
ATC 4200
not unusual in revenue matters. It is further put for the appellant, and in my opinion correctly, that sec. 51(2) is not a code for deductibility, that deductibility comes under sec. 51(1), and (2) is really concerned to negate trading stock as being capital, that ``used'' is not to be construed as used in the given year of income.Further, there are historical reasons for the presence of sec. 51(2). The earlier legislation had no equivalent to sec. 51(2). There was a prohibition against capital deductions in sec. 23(1)(a) and 25(e) of the 1922 Act, and trading stock as defined in sec. 4 did not include livestock. Before the 1936 legislation there was no case where purchase or acquisition of trading stock, whether initial or later purchases, were held to be of a capital nature. In 1936 ``livestock'' was introduced into the definition of trading stock. There was some discussion of this in
F.C. of T. v. Wade (1951) 84 C.L.R. 105 at pp. 113 and 115 and John Fairfax & Sons Pty. Ltd. v. F.C. of T. (supra) at p. 35. There is also a discussion of circulating capital in
F.C. of T. v. AVCO Financial Services Ltd. 82 ATC 4246 where sec. 51(2) could not be relied on, livestock not being involved.
It is also to be said that it is not essential that outgoings on trading stock under sec. 51(1) are to be deducted only if the stock is sold during the year or is represented by stock on hand at the end of the year. In
Farnsworth v. F.C. of T. (1949) 78 C.L.R. 504 the deduction was allowed in a year where no income was derived and had no stock at the end of the year. Outgoings on stock in transit at the end of the year are deductible under sec. 51(1).
The Commissioner submits that the payment was for the progeny and nothing else and was a once and for all payment. I do not accept the initial part of that submission. It is also submitted that when the payments were made there was a sure knowledge that the two partnership would be wound up and the guaranteed progeny distributed to the major partners. I do not accept this and find to the contrary. However, from this the point is made that the expenditure is to be seen as the acquisition of means of production or as establishment costs in setting up a business as distinct from carrying it on. I have dealt earlier with this and have found to the contrary. An alternative submission was that as dissolution and distribution in specie was anticipated there was no intention that the progeny would be traded in by the partnerships. I reject this submission on the facts. I do not find that it was so anticipated.
The final submission was that outgoings for stock were not involved but the outgoings were in respect of prospective purchase of stock which might subsequently be used as trading stock, that really purchase agreements were involved for prospective acquisition of stock. I cannot construe the agreements in this fashion.
In my opinion, the Commissioner's submissions are to be rejected, and for the reasons offered in respect to the appellant's submission, I accept and find that the outgoings were not outgoings of capital or of a capital nature.
The submission made on behalf of the appellant as to stock was in the context that the outgoings were not excepted as being outgoings of capital or of a capital nature. The Commissioner's written submissions on this point were directed not so much to that situation as to whether they were outgoings but as to whether under the lease agreement the taxpayer incurred an outgoing in respect of trading stock, and authorities such as
F.C. of T. v. St. Hubert's Island Pty. Ltd. 78 ATC 4104; (1977-1978) 138 C.L.R. 210 were relied on. If the taxpayer is regarded as the partnership, which presents some problems, I understand the point. Even so, I did not understand the appellant's argument that the partnership outgoings were expended on stock in the sense of stock in hand.
It was also submitted that the outgoings were of a capital nature as the partners did not seek to acquire cows for resale (see sec. 6(1) but that at some remote stage they only hoped to acquire ``donor cows'' for breeding and not resale. This was not so on the facts. Sales were, as I have found, a factor and, furthermore, the submission ignores the male progeny and the culling process.
A considerable amount of argument was directed towards sec. 36A and the provision for an election thereunder pursuant to subsec. (2) thereof and its consequential effect. The section seems plain enough,
ATC 4201
bearing in mind the reasons for its insertion followingRose v. F.C. of T. (1951) 84 C.L.R. 118 and the decisions subsequent thereto, including
F.C. of T. v. Westraders Pty. Ltd. 80 ATC 4357. Section 36A provides, so far as is presently relevant:
``36A(1) Where, for any reason, including -
- (a) the formation or dissolution of a partnership; or
- (b) a variation in the constitution of a partnership, or in the interests of the partners,
a change has occurred in the ownership of, or in the interests of persons in, property constituting the whole or part of the assets of a business and being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale, and the person, or one or more of the persons, who owned the property before the change has or have an interest in the property after the change, section 36 applies as if the person or persons who owned the property before the change had, on the day on which the change occurred, disposed of the whole of the property to the person, or all the persons, by whom the property is owned after the change.
(2) Where -
- (a) property in relation to which sub-section (1) applies has become, upon the change in ownership or interests, an asset of a business carried on by the person or persons by whom the property is owned after the change;
- (b) the person or persons by whom the property was owned before the change holds or hold, after the change, an interest or interests in the property of a value equal to not less than one-quarter of the value of the property;
- (c) the value of the property as ascertained in accordance with paragraph 36(8)(a) is greater than the value (if any) that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change; and
- (d) the person or persons by whom the property was owned before the change together with the person or persons by whom the property is owned after the change give notice to the Commissioner, in accordance with this section, that they have agreed that this sub-section shall apply in respect of the property,
the value of the property, for the purposes of section 36, shall be, instead of the value specified in paragraph 36(8)(a), the value (if any) that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change.
(3) A notice in pursuance of sub-section (2) shall be in writing, signed by all the persons giving it, and lodged with the Commissioner on or before 31 August next succeeding the end of the financial year in which the change in ownership or interests occurred or on or before such later date as the Commissioner determines.''
In Westraders, the Chief Justice Sir Garfield Barwick at p. 4359, endorsed the reasons of Deane J. in the Court below as to policy and possible unfairness which were in the following terms:
``If there be, in truth, such contrariety or unfairness, the fault lies with the form of the legislation at the relevant time and not with the Courts whose duty it is to apply the words which the Parliament has enacted. For a Court to arrogate to itself, without legislative warrant, the function of overriding the plain words of the Act in any case where it considers that overall considerations of fairness or some general policy of the Act would be best served by a decision against the taxpayer would be to substitute arbitrary taxation for taxation under the rule of law and, indeed, to subvert the rule of law itself (see
Ransom v. Higgs (1974) 1 W.L.R. 1594 at p. 1617;
I.R.C. v. Duke of Westminster (1936) A.C. 1 at p. 19).''
The Chief Justice then made the following observations:
``The principle to which his Honour calls
ATC 4202
attention is basic to the maintenance of a free society.Parliament having prescribed the circumstances which will attract tax, or provide occasion for its reduction or elimination, the citizen has every right to mould the transaction into which he is about to enter into a form which satisfies the requirements of the statute. It is nothing to the point that he might have attained the same or a similar result as that achieved by the transaction into which he in fact entered by some other transaction, which, if he had entered into it, would or might have involved him in a liability to tax, or to more tax than that attracted by the transaction into which he in fact entered. Nor can it matter that his choice of transaction was influenced wholly or in part by its effect upon his obligation to pay tax. Of course, the transaction must not be a pretence obscuring or attempting to supplant some other transaction into which in fact the taxpayer had earlier entered. Again, the freedom to choose the form of transaction into which he shall enter is basic to the maintenance of a free society.''
The latter four sentences of this passage are particularly apposite here and as has been pointed out elsewhere herein it is specifically stated by senior counsel for the Commissioner that there is no suggestion by the Commissioner that the transactions here were any pretence, obscuring or attempting to supplant some other transaction, or sham. On the contrary, the arguments of the Commissioner proceed on the basis that the documentation does in fact reflect the transactions and it is sought to argue from them that the very provisions relied upon, including that relating to the election under sec. 36A(2), demonstrate that the expenditure is not within sec. 51(1). In Westraders both the Chief Justice and Mason and Aickin JJ. were of the view that once the terms of the section were complied with, the section providing its own criteria, then it operated according to its tenor. It is noted that there is reference to the active promotion of sec. 36A partnerships in the judgments and also in the judgment of the learned trial Judge. Throughout his submissions to me the Commissioner, through his counsel, frequently referred to promotion in this context.
With respect, the section being in plain enough terms and in the light of the above decision, it is difficult to see how the benefit of the section is not available to the partnerships. It was never disputed by the appellant's submissions, but that sec. 36A was an important part of the documentation. The section's opening words are extremely wide and no doubt to be interpreted as meaning what they say, short, no doubt, of something unlawful. Here the fact that there was a provision in the deed of partnership relating to the possibility that an election under sec. 36A could be made would be within the meaning in the section of the phrase ``for any reason''. All the criteria available in sec. 36A to enable the effect of an election to eventuates as to value have been complied with, as a matter of fact, indeed, there is really no dispute concerning it. There are two other points to be made in relation to the use of this section. First, and this has been mentioned earlier, there was no covenant or agreement that the section would be availed of, and in this sense it is possible but not necessary or inevitable, although its very presence in the deed, apart from any other evidence, shows that its possible use was within the contemplation of all concerned. The second point is, and it is not to be overlooked, that upon the exercise of the election and the giving of the requisite notice, the interest of the major and minor partners in the partnership and its assets changed substantially. The minor partner moved from a one per cent to a fifty per cent interest, whereas the major partners thereupon suffered the loss of a forty-nine per cent interest in the partnership and its assets. On any view, this was a substantial diminution in their interests and this was associated with the payment to them pursuant to the deed of the amount mentioned. This was the bargain that the parties made; although an examination of the respective values may produce interesting results, it is not a function of the Court to make such an examination, particularly when it is not suggested that there is any sham or unreal transaction involved.
It can be argued if the minor partner did not make an election the major partner could itself force the election. This is so, but it
ATC 4203
assumes unanimity or, if not, some degree of agreement among the members of the major partners, an assumption that cannot be made with complete confidence. The argument that the appellant as an individual member of the major partners was personally entitled to a large deduction for tax purposes consequent upon partnership losses for a very small outlay, even if that be relevant, and in my opinion it is not, assumes that the election necessarily must be made and that the consequent payment to him of the amount under the loan, which is geared to that election, will be then paid and thus be available to reduce the amount of the individual loan.Independently of there being no obligation on either party to give notice of variation, whether in fact it would be given would ultimately be a decision made on the facts at the time. On the assumption that each operation in Wintara produced thirteen animals as could eventuate, then the result would be 156 progeny. Whether the major partners would give notice in such circumstances and in consequence lose forty-nine per cent of the partnership would at least be doubtful. Whether the minor partner in any circumstances would give notice would depend upon its financial capacity to find the required amount to buy in the forty-nine per cent from the major partners and its solvency otherwise. The lender under the loan deed was a separate legal entity. In addition the minor party was entitled to charge agistment fees for which its own liability was only very minor (one per cent). If the notice were not given, its liability increased to fifty per cent upon giving notice. The highest that it can be put is that it was open to the parties to give notice of variation, and each had good reason for so doing, other things remaining equal, in that sense it was contemplated and anticipated, neither party was under any obligation to do so. In this regard the remarks in Mullens & Ors. v. F.C. of T. (supra) per Stephen J., at ATC p. 4303; C.L.R. p. 317, are apposite, where he referred, in not wholly dissimilar circumstances, to the fact that there was ``the strongest commercial probability that the... shareholders would exercise their options, but it remained but a probability. Such a transaction is precisely what the documents record and the existence of this probability goes no way towards establishing a sham.''
The Commissioner made a submission that an overall view of the totality of the transactions entered into concerning each partnership and their overall effect with the result that by application of the principles to be gleaned from
W.T. Ramsay v. I.R. Commrs. (1981) I All E.R. 865, the conclusion would be reached to the extent that the major partners, including the appellant, effectively recouped their initial outlay, that initial outlay should be regarded as being of no effect for fiscal purposes, i.e. a fiscal nullity. The recoupment, it is said, was achieved by arrangements whereby amounts were ``paid'' to the major partners by the minor partner to increase its interest in the partnership by an amount equal to fifty per cent of the initial outlay made by the major partners.
The submission faces an initial problem in that the outgoing in question here is not the initial payment by the appellant or others, it is a payment made by the partnership pursuant to a contractual obligation, and the fact that the appellant outside the partnership made some financial arrangement to fund his contribution is separate and external to the partnership. The submission also is insistent that the variation of the partnership interests was inevitable and pre-arranged, whereas I have found that though variation was a possibility and within contemplation, nevertheless it was not inevitable. The further point is that it ignores the fact that there were other members of the partnership.
Although the submission has been stated barely and without full argument other than in the written submissions, it is enough to enable me to express my views on it since in my opinion it is to be rejected, not only on a factual basis, but also for the reasons following.
The legislation in Ramsay's case was different to that under consideration here. The United Kingdom Finance Act 1965 imposed tax upon gains in certain areas less losses. It had no relation to business outgoings or commercial dealings. The scheme considered was to cancel out gains by losses. It is not the task of a judge at first
ATC 4204
instance to reconcile Ramsay's case in the context of losses with High Court decisions such asCurran v. F.C. of T. 74 ATC 4296; (1974) 131 C.L.R. 409, and Westraders v. F.C. of T. (supra). It is true that in Ilbery v. F.C. of T. (supra) there is reference to Ramsay's case in the judgment of Northrop and Sheppard JJ., by way of dicta. The High Court of Australia there refused leave to appeal. Ramsay has not been the ratio of an Australian decision.
There are fundamental aspects as well. In Ramsay's case, the speech of Lord Wilberforce (at p. 873), relied on here by the Commissioner refers to:
``... an indivisible process... which is intended to be and is cancelled out by a later stage, so that at the end of what was brought as, and planned as, a single continuous operation, is not such a loss (or gain) as the legislation is dealing with...''
It dealt with a closely integrated situation, a rapid timetable, and a result at the end precisely as it was at the beginning, except for promoter's fees, and no funds were provided from Ramsay's resources.
This is to be compared with the position here. The transactions and business commenced in 1976, they are still in fact being carried on by all the original partners other than the company. The time factor between commencement and dissolution was over two years in the case of Wintara and eighteen months with Columba. Ramsay's time span was a few days. Ramsay's case involved no commercial or business dealing and it was conceded there was no profit element or prospect. In the instant case, tax was a factor considered but it was not as I find the sole or dominant purpose or motive or reason for joining the partnership and this is quite apart from the incurring of the outgoing by the partnership which was a contractual obligation of undoubted validity.
In Ramsay's case Lord Wilberforce said, at p. 870, that there were other significant features which are normally found in schemes of the character with which the House was dealing:
``First, it is the clear and stated intention that once started each scheme shall proceed through the various steps to the end; they are not intended to be arrested halfway... This intention may be expressed either as a firm contractual obligation... or... as an expectation without contractual force.''
His Lordship continued:
``Second, although sums of money, sometimes considerable, are supposed to be involved in individual transactions, the taxpayer does not have to put his hand in his pocket...''
and later:
``Finally, in each of the present cases it is candidly; if inevitably, admitted that the whole and only purpose of each scheme was the avoidance of tax.''
In the instant case, none of those observations apply to the partnerships. It was not the clear and stated intention, as indicated above, nor was the intention expressed as a firm contractual obligation or, as I find, as an expectation without contractual force. As to the second, the appellant personally and independently of the partnership in fact not only incurred expense involving a sum in excess of $30,000 at least, but also, assumed substantial contractual liabilities. As to the third, it was never so admitted, and indeed the findings I have made negate that requirement. Finally, the appellant's position was not the same after dissolution between the major and minor partners as it was before he entered the partnership (even if that be a relevant date which I do not accept since the dissolution was a consequence of genuine dispute). It cannot be and it is not disputed that in Wintara, for example, the appellant committed $34,909 of his own funds which were not recoverable and could not be so. Prior to the variation he had actually paid $99,709 including $29,700 in repayment of monthly loan instalments. He was also liable under the deed of loan to repay the totality of the loan of $64,800 should the variation not take place. In addition, he contributed further sums amounting in all to $9,809 towards the financing of the partnership activity. Following upon the variation he in fact and in law lost his proportionate share of the minor partners in forty-nine per cent of the partnership. The same comments with an appropriate adjustment of figures and
ATC 4205
liabilities assumed apply to the Columba partnership, the sum of his own funds actually paid being $37,754. The results of the enterprise were real, substantial, and in no way imaginary. The progeny were available and were ultimately distributed in specie following the dispute between the major and minor partners which led to the dissolution and thereafter the Wintara partnership continued to operate with the major partners and their share of the progeny and does so up to the present.Based on the same authority, it was submitted by the Commissioner that there was a preordained scheme to be effected and to proceed through various steps to an end, and there was an expectation that the transactions would occur in the way they did. It is submitted that the results were to leave the appellant's financial position exactly as it was before he entered into the linked series of transactions. This latter submission is not in accordance with the factual results as has been demonstrated above. As to the expectations, the fact is undisputed that all the documentation took place on the one day and spoke according to its tenor. The submission does not come to grips with the circumstance that the variation was permissive, not mandatory, and if it were exercised it resulted in a loss to the major partners of forty-nine per cent of the partnership. Neither does it deal with the possibility that the partnership might be dissolved leaving the partners to their remedies at law.
I reject this further submission for reasons earlier given and also because on the facts I find that there was no such inevitable preordained intention, or expectation in the sense as submitted, nor any contractual obligation that expressed any such intention in any relevant sense.
A final submission made by counsel for the Commissioner was a written submission relying on sec. 260 of the Act. It was not argued as such and, so far as I can see from my notes taken, the appellant did not deal with it. As the submission accepted, the recent decisions of the High Court, subject to one qualification, appear to read sec. 260 out of existence in which event it is submitted there is full scope for the principle in Ramsay's case to apply. I have already stated my conclusions on the application of Ramsay's case in this case and have rejected the Commissioner's submissions. The qualification abovementioned is said to be found in
Cridland v. F.C. of T. 77 ATC 4538 and is grounded on the approach that it was not said there that
Newton v. F.C. of T. (1957) 96 C.L.R. 577 was in any respects wrongly decided, nor has it been held that
Bell v. F.C. of T. (1953) 87 C.L.R. 548,
Hancock v. F.C. of T. (1961) 108 C.L.R. 258 or
Peate v. F.C. of T. (1966) 116 C.L.R. 38 were wrongly decided.
Since Newton's case, limitations to the application of sec. 260 have been established. The choice principle postulates that a taxpayer may properly create a situation by entry into a transaction which involved tax results for which the Act provides and is unaffected by sec. 260 because the tax results are more advantageous to the taxpayer, and he enters upon the transaction with the specific intention of gaining that advantage
W.P. Keighery Pty. Ltd. v. F.C. of T. (1957) 100 C.L.R. 66;
F.C. of T. v. Casuarina Pty. Ltd. 71 ATC 4068, Mullens & Ors. v. F.C. of T. (supra); Brambles Holdings v. F.C. of T. 77 ATC 4481).
It is also established that sec. 260 does not operate to enable a reconstruction to be effected so as to involve different liabilities (Cecil Bros. v. F.C. of T. (supra);
Kareena Hospital Pty. Ltd. v. F.C. of T. 79 ATC 4667), nor, so it would seem, does it apply to an arrangement where there was no pre-existing liability or antecedent transaction as is the case before me (Mullens & Ors. v. F.C. of T. (supra)).
The submission made here, in so many terms, is that the scheme arrangements involved the appellant entering into a leasing arrangement without regard to its commercial viability and with the tax advantage as the only motive or purpose and with the preconceived agreement to achieve that end result by exploiting sec. 36 and 36A for a purpose other than they are intended for. It is said that the section strikes down the entire arrangement between Maher and the appellant so that there would be no relevant lease payments and charges by the appellant and, accordingly, no deduction under sec. 51(1).
ATC 4206
The submission in its initial form does not state with whom the arrangements were; later it refers to arrangements between Maher and the appellant. There is no evidence of any arrangement or scheme existing between Maher and the appellant that I can see and none was referred to as having evidentiary support. In any event, I find there was no arrangement between them. I also find that the appellant did have regard to the commercial viability and that tax advantage was not the only motive or purpose. I do not understand what purpose sec. 36 and 36A had other than what they provide (see Westraders Pty. Ltd. (supra)). As to any exploitation of sec. 36 and 36A or intention so to do I refer back to my earlier remarks and findings on sec. 36A (supra). Finally, there were no lease arrangements or lease payments made by the appellant personally.
In dealing with the formulation of the submission, it is not to be taken that I accept that the formulation is necessarily correct or relevant to the consideration of sec. 260. In so dealing with the submission, in my opinion, an effective answer is provided. As to Newton's case, with great respect to that authority, it is for me to follow the subsequent decisions of the High Court.
At the time of the inception of these partnerships, the fundamental basis of the whole project as I find was to utilise the development of scientific veterinary techniques of ovum transplant development overseas and to do so in two ways - first to enable them to bring into Australia from New Zealand valuable pure bred European cattle for breeding and other purposes which otherwise could not be brought into this country; secondly, by the same techniques more recently developed in this country following overseas visits and research by local veterinarians, to build up valuable pure bred herds far more rapidly than could ever be achieved in this country by conventional breeding methods. It was the use of these techniques and enormous reduction in the time spent with consequent reduction and with obvious saving in running and other costs that made the projects attractive and exciting to those whose interests were in these areas. It was also novel and adventurous and participated in breaking new ground in cattle breeding in this country. Apart from the building of the individual herds, there was the capacity to use the animals to improve cattle herds in this country. The project's appeal to individuals of some standing and with professional backgrounds, particularly medical men or those related to that profession such as chemists, is understandable and it provided them not only with a substantial business activity and interest of considerable proportions, but also a relationship with the country itself and the image of a cattle breeder.
From this basis it is clear that the market for any suppliers of such cattle, and suppliers also possessed of or having control of or access to such cattle expertise and techniques, was obviously limited and it is not unreasonable to suppose that to some extent at least, the basis or terms on which cattle of this type would be leased or sold might be expected to be largely within their control. This is not unusual with most lessors and vendors. Since more than one transaction of this type seems to have been contemplated by the suppliers, some degree of uniformity and control in the transaction could well be expected, particularly as their animals were the very subject of the transactions. The funds required and the possible liabilities and obligations were substantial and in the cases of individuals might be expected to be beyond the means of a single individual. The leasing or sale of a single animal may well have been unattractive to a supplier. Accordingly, an association, corporate or unincorporated, could be expected and there are the usual advantages and disadvantages with either. Partnerships or syndicates or joint ventures are acceptable and common vehicles for business enterprises.
I am prepared to make a finding of fact favourable to the bona fides of the appellant and the members of these partnerships who came before me. The appellant and the other members of the partnerships who gave evidence all impressed me as being truthful, honest and acceptable witnesses, as indeed were all witnesses who came before me. I should mention Mr. McLellan, a chemist, who gave evidence and impressed me, was not only a member of one of the subject partnerships but was also a member of others, as was his wife, and whose evidence, which I accept, was that in relation to a
ATC 4207
partnership involving one cow the venture had proved successful and a very excellent arrangement. A third prize had been won at the Sydney Royal Easter Show and they had topped the sales at Orange against cattle submitted by Busquet, the expert who had advised and initially inspected the New Zealand herd, and all this was achieved from one cow.I find that the expenditure claimed by the partnerships bears the character of expenditure and outgoings incurred in the carrying on of the partnership business for the purpose of gaining or producing assessable income in the case of each partnership under the provisions of the second limb of sec. 51(1).
In respect of the first limb of sec. 51(1), there is some degree of overlapping with the second. Here, as under the second limb, it is not essential that the assessable income be income in the year in question. Similar considerations as to purpose apply to this limb also.
I find that the expenditure claimed by the partnerships was expenditure or outgoings incurred under both limbs of sec. 51(1).
The further findings of fact that I make are that the partnerships were formed and in fact carried on business as cattle breeders and pastoralists at all relevant times, that pursuant to a contract entered into for the leasing of cattle for a term in the case of Wintara and for the purchase of cattle in the case of Columba, in each case together with the other rights and advantages under the respective contracts, the subject payments were made; the payments were expenditure and outgoings properly incurred by the respective partnerships in the carrying on of the respective businesses for the gaining and production of assessable income and were not outgoings of a private or domestic nature, nor were they incurred in relation to the gaining or producing of exempt income.
The Columba partnership was documented on 16th March, 1976, and differed from Wintara in that the cattle were purchased instead of being leased. If anything, therefore, this is a stronger case than Wintara. The appellant and McIntyre were members of this partnership. The substantial outgoing payments here are the payments under the managerial agreement. Forty-eight calves were guaranteed and as at dissolution on 5th June, 1979, thirty-one calves had been born. The variation of interests in the partnership as between the major and minor partners occurred on 14th May, 1979. On dissolution the major partners received twenty-four calves. I make similar findings in this case as were made in the Wintara partnership and the parties approached both matters as being in effect the same in principle. It is accepted in both cases that notices of variation were given and that subsequently the provisions of the partnership deeds and other documents were followed until the dissolutions. The loans were duly repaid by the borrowers. In the case of Columba, the repayment of the loan for the purpose of the purchase of cattle was repaid from proceeds of subsequent sales of donors to Cord Cattle Genetics and Cord Securities.
The payments referred to in the issues being Nos. 2, 4 and 5 of the issues as formulated are all moneys expended or incurred by the appellant as outgoings to the two partnerships and in accordance with my findings are consequential thereto and allowable deductions.
Order in matter No. 603 of 1980, the appeals are upheld. Order that the matter be remitted to the Commissioner and that the objection against assessment for the year ended 30th June 1977 be allowed. Order that the respondent pay the appellant's costs.
In matter No. 604 of 1980, the appeals are upheld. Order that the matter be remitted to the Commissioner and that the objection against assessment for the year ended 30th June, 1976 be allowed. Order the respondent to pay the appellant's costs. The Exhibits may be returned.
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