Federal Commissioner of Taxation v. McDonald.
Judges:Beaumont J
Court:
Federal Court
Beaumont J.
In his return of income for the year ended 30 June 1978, the respondent claimed a deduction in the sum of $1,941 in respect of a loss said to be incurred by him in connection with a "property business". The Commissioner allowed the deduction claimed as to one-half thereof only, i.e. $971 and assessed the respondent accordingly. The respondent objected to the assessment but his objection was disallowed by the Commissioner. The Administrative Appeals Tribunal upheld the respondent's objection and set aside the Commissioner's decision [reported as Case T81,
86 ATC 1109]. The Commissioner now appeals to this Court pursuant to sec. 44(1) of the Administrative Appeals Tribunal Act 1975. The appeal raises a number of important, and difficult, questions of law.
There is no dispute that, in the year in question, a deductible loss of $1,941 was incurred by the respondent and his wife in their investment. The question for determination is whether, as the respondent claims, the whole of that loss was incurred by him or, as the Commissioner claims, one-half of the loss was
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incurred by each of the respondent and his wife.In his return of income, the respondent disclosed a substantial gross income by way of salary as a company manager employed by a company. He also disclosed gross rent in respect of the following premises:
"Gross Rent, premiums etc. Date property Gross
became income Amount
producing $
Unit 5 Strata Plan 6964
24 Campbell Crescent TERRIGAL 2.7.77 3,633
Unit 2 Strata Plan 5793
5-7 Barrhill Road, TERRIGAL 18.11.77 2,039
------
$5,672
------"
He claimed, as deductions from investment and property income, the sum of $7,613 made up as follows:
"Item Amounts
No. Claimed
$
21 Rates and land taxes on income-producing properties........ 381
22 Repairs to income-producing properties..................... 190
23 Insurance premiums on income-producing properties.......... 52
24 Interest on borrowed money used to produce investment
and property income........................................ 2483
25 Commission for collection of investment and property income... 229
26 Other deductions relating to production of investment
and property income........................................ 278
-----
$7613
-----"
By way of explanation of these claims, the respondent supplied the following information in his return:
"Acquisition of income producing property background information
During the calender year 1977 my wife and I decided to invest in income producing properties. To achieve this objective, it was necessary to borrow initial funds under mortgage to finance the purchase of the respective properties.
It was agreed that the net income from this activity would be shared by my wife and I in the following proportions:
My wife 75% Self 25%This principle was adopted to allow my wife to build up a separate income in the event of something happening to me as the only income producer in the household at present.
However, it was further understood that in the event of outgoings in any one year exceeding the gross income, I would bear the full amount of such net loss, on account of my wife's present lack of income to any extent.
A budget taken out in respect of the two properties subsequently purchased, indicated that such a loss would be incurred in the first 18 months/2 years until some repayments of the loan monies could be effected to reduce the high interest charges.
Details of the properties purchased, finance obtained and letting arrangements are listed hereunder:
1. Unit 5 Strata Plan 6964
- 24 Campbell Crescent
- Terrigal NSW
- (hereinafter referred to as Property A)
Date purchased 16th June 1977 - becoming income producing from week ending 2nd July 1977.
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Financed by means of overdraft arrangement of $10,000 from Bank of Adelaide Ltd., Sydney. Rate of interest - 10½%.
As a result of this ownership, I was appointed the Secretary/Treasurer of the Strata Plan, due to my accounting qualifications, by the other owners to not only maintain proper records of the Body Corporate, but to ensure a proper accounting of the expenses incurred and income received in the letting arrangements detailed below.
Letting of Unit -
As a number of unit owners in the Strata Plan desired to let their units continuously for holiday bookings, it was decided by these owners to appoint a part time on-site manager to handle the letting of the respective units, rather than place them individually in the hands of separate local Real Estate Agents. Furniture and equipment were acquired for an on-site office.
It was agreed that the expenses of so doing, including advertising and depreciation on the furniture and equipment purchased would be apportioned among the owners on an equitable basis. Separate accounts of this activity, which was conducted under the control of the Council of the Body Corporate, were maintained and a statement of our share is appended to this return to substantiate the deduction claimed.
2. Unit 2 Strata Plan 5793
- 5-7 Barrhill Road
- Terrigal NSW
- (hereafter referred to as Property B)
Date purchased - 18th November 1977, becoming income producing immediately.
Financed by loan funds of $30,000 arranged through solicitor, from John E. Hilton Esq. 1/5 Military Road, Dover Heights at an interest rate of 13%.
Letting arranged through local agent, Havenview Real Estate of 62 Terrigal Esplanade, Terrigal. Casual holiday bookings were taken in the period after purchase till early February '78, when a permanent tenancy was established.
Both of the above properties were purchased fully furnished and separate values agreed for contents."
The respondent gave further details in his return of the deductions claimed. Item 26 described as "Other Deductions relating to production of investment and property income - $4278" was particularised as follows:
"Item 26 Other Deductions Property A Property B $ $ Levies paid to strata plan for maintenance, effluent removal etc. 1,323.00 448.41 Cleaning after tenant occupancy (incl. item 25) 40.00 Electricity - Brisbane Water County Council 76.39 29.80 Depreciation on contents (refer separate schedule) 146.00 154.00 Procurement of loan funds - paid to (a) Bank of Adelaide - establishment fee, stamp duty on mortgage, land titles office fee 98.50 (b) Geoffrey D. Schroder & Co., Solicitors Fees in connection with mortgage 295.00 Registration fee on mortgage 22.00 Bank Service charge on documents 30.00 Service fee on overdraft 40.00 Quarterly fees - pro rata 4.00 1.00 Stamp duty on cheques 1.50 1.60 Telephone calls to Terrigal 1.40 0.60 Postage and Stationery 4.20 3.00 Travelling expenses (see note page 5) 183.12 52.32 Use of home on income producing affairs (see note page 5) 25.00
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General expenses Development of photos for advantage. purposes 5.00 Purchase book `Strata Title Management' 10.00 Christmas present for agent 8.99 --------- --------- $1,948.11 $1,056.72 --------- ---------"
The reference to travelling expenses is a reference to a claim for expenses incurred by the respondent in travelling from his home in Beecroft to Terrigal where the units were situated. The claim for "use of home on income producing affairs" was explained as follows in the return:
"Use of home - as a result of the income producing activities, and particularly in conjunction with my position as Secretary/Treasurer of Strata Plan 6964, it became necessary to set aside a small alcove of my home - not used now for other purposes - and provide a desk top for use as an office area. I am, therefore, claiming a nominal deduction for the space used and electricity etc. entailed."
In his return, the respondent claimed a rebate of $485 in respect of his wife, disclosing that she had a separate income during the year of $468.
In his objection, the respondent relied upon a document executed by his wife and himself as follows:
"RECORD OF DISCUSSION held this Fourteenth day of February, 1977 between BARRY DONALD McDONALD, Company Manager, and JILL McDONALD, his wife, both of 6 Benrhyn Avenue, Beecroft, New South Wales.
Concern was expressed by the said JILL McDONALD that, having committed herself entirely to the welfare and upbringing of a family, she was not in receipt of any regular separate income and in the event of the untimely death or accident induced disability of her husband, the said BARRY McDONALD who was the sole income earner of the family, both she and the family may find themselves in difficult circumstances.
It was therefore decided that investment in income producing property should take place on the following basis:
- 1. Requisite funds were to be borrowed from existing bankers or any other recognised avenue of finance.
- 2. Properties were to be purchased in the names of both parties as joint tenants.
- 3. The present joint bank accounts conducted at the Bank of N.S.W. Eastwood branch and the Bank of Adelaide, Sydney branch, were to be used for the purpose of recording the incoming and outgoing of funds.
- 4. Separate accounting records were to be kept of the income and expenditure incurred in respect of the ownership of such properties.
- As soon as practicable after the 30th June each year, a summary of the year's activities was to be prepared, showing the total receipts and total expenditure.
- In the event of a net profit, that is, income exceeding expenses, in any one year, it was to be apportioned
- 75% to JILL McDONALD
- 25% to BARRY McDONALD
and the amounts so calculated withdrawn from the joint bank accounts and paid to the individuals concerned. JILL McDONALD was also given the ability to withdraw at any time, such sums as were estimated to be equivalent to her share of the profits up to the date of withdrawal with a balancing adjustment to her share, if found necessary, at year end.
- In the event of a net loss, that is, expenses exceeding income, in any one year, the whole of the loss was to be absorbed by BARRY McDONALD.
In witness hereof, the two parties concerned have prepared this record of their discussions as to their intentions and have appended their signatures hereto, this twenty first day of February, 1977.
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- Signed by the said
- BARRY DONALD McDONALD
- in the presence of: (SGD) B.D. McDonald
- (SGD) W.L. BROWN
- Signed by the said
- JILL McDONALD
- in the presence of: (SGD) Jill McDonald
- (SGD) W.L. BROWN"
The circumstances in which this document came into existence were explained by the respondent in his evidence before the Tribunal as follows:
"The acquisition of the income producing property came about from discussions my wife and I held in late - commencing in late 1976, whereby she was expressing concern that she had no income of her own. She was housebound and an above average house to look after, three children who were then 14, 11 and 7. Who enjoyed, unfortunately less than average health and she was dependent on me completely, from a financial point of view. Perhaps like a lot of women in the community today, she found it a bit de-humanising or demoralising to have to ask for money to buy an outfit or a frock. She wanted to have something of her own. So after many discussions we decided that a part-time job or something of that nature was out of the question because of the family situation and we decided that we should enter into an arrangement whereby we invested in something. Following further discussions we decided that income producing property was perhaps the best source of investment, rather than the stock market or something of that nature. We did a budget beforehand to indicate that if we proceeded in that direction that we would have to borrow money. In the first year there would have been a definite loss but the second year, with perhaps capital payments being reduced that we would be getting near to a break-square situation and in the third and subsequent years there would be a profit from this - this arrangement. We agreed at that stage that the income therefrom should be divided in the ratio that I have set out there, 75 percent for my wife and 25 percent to myself. However, I did agree as the sole income earner that in the first year, where a loss was budgeted, that I would absorb that loss. Subsequent events - sorry - may I just make one further comment that in that arrangement it was agreed that we would purchase the properties as joint tenants purely for the benefits that arose from the survivorship tradition.
So you purchased Strata Plan 6964 on 16 June 1977? - Yes, and subsequent unit in November 1977.
That is Unit 2, Strata Plan 5793 purchased on 18 November 1977? - That is correct.
And they were purchased as joint tenants? - And they were purchased as joint tenants which was the arrangement made initially in February 77 when we reached this overall arrangement between us, purely from the point of view of survivorship. That well - you know, if something happened to us obviously the property went directly to the other."
The subsequent history was summarised by the Tribunal as follows [at pp. 1110-1111]:
"2 In the result, the parties purchased several properties as joint tenants. The properties were let and, as predicted, there was a loss in the first year (1978), in the second year the parties broke even and have shown a profit ever since. These properties are still held by them. The rent was paid by cheque made out to the husband and wife. In substance, what the parties sought to achieve, and did achieve, was that the applicant would receive 25% of any surplus, the wife 75%; in the event of any losses, these would be borne wholly by the applicant."
According to the evidence before the Tribunal, one unit was let on a short-term basis to holiday makers. The caretaker collected the rent and after deducting his commission forwarded the net amount by cheque to the respondent and his wife. The cheques were then banked in a joint bank account. The other unit was leased through an agent who collected the rent and forwarded monthly statements. The agent paid the net rent into a joint bank account of the respondent and his wife.
The respondent claims that there is a partnership between his wife and himself; that the two home units are partnership property, and that, pursuant to the provisions of the partnership agreement, he is liable for the
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whole of the partnership losses. Thus, he says, in the year ended 30 June 1978, the partnership made a loss of $1,941 for which he is totally responsible and for which he is entitled to be allowed a deduction for income tax purposes. The Commissioner, on the other hand, disputes that there was any partnership. He says that the only relevant relationship between the parties was that of co-ownership. According to the Commissioner's argument, since the parties were joint tenants at law and in equity, the losses incurred in letting the premises were to be shared equally with the consequence that the respondent was entitled to a deduction for one-half only of those losses.Before turning to the legal arguments which were advanced, it is necessary to say something more about the course of proceedings before the Tribunal. The respondent's explanation of the circumstances in which the record of discussion came into existence was given in his evidence in chief. The respondent was cross-examined briefly by the Commissioner's representative. The cross-examination was limited to establishing that the rents from the premises were paid by cheques drawn in favour of the respondent and his wife and paid into their joint bank accounts; and that the expenses incurred in connection with the premises were paid out of those accounts. The respondent called no other evidence. The Commissioner called no evidence.
Before the Tribunal, it was submitted on behalf of the Commissioner that, by reason of the provisions of sec. 92 of the Income Tax Assessment Act 1936 ("the Act"), only $971 was allowable to the respondent as a deduction being his share of the loss of the partnership as defined by sec. 6(1) of the Act. It was further submitted that the purported transfer by the respondent of a right to receive income was ineffective by reason of the provisions of sec. 102B of the Act, a point no longer pressed. Thirdly, it was contended that only $971 was an allowable deduction under sec. 92(2) because (a) the transaction between the respondent and his wife was a sham; (b) sec. 260 applied and (c) the transaction should be disregarded as a "fiscal nullity".
The transcript of argument then records the following:
"The Chairman: Well, that last submission are you going to pursue that or are you just putting that as a formality?
Mr Bellew: I guess as a formality.
Dr Gerber: Well, is not sham a formality as well? Did you cross-examine on that?
Mr Bellew: No, Mr...
Dr Gerber: Well, sham is a fraud, is not it?
Mr Bellew: Well, on that basis I withdraw that.
The Chairman: So you are not pursuing sham or fiscal nullity?
Mr Bellew: No, Mr Chairman.
Dr Gerber: You would have a difficult job anyway, I think."
The Commissioner's representative then submitted to the Tribunal that the present case was on all fours with the decision of a Board of Review in Case Q35,
83 ATC 154. In that case, the taxpayer and his wife rented out a house which they owned as joint tenants. Expenses exceeded rental income and a loss resulted. The taxpayer claimed that as he was the sole income earner in the family and had in fact paid the expenses, he was entitled to deduct the full amount of the loss. The Board held that, in the absence of any evidence which might provide a basis for dividing profits and losses in other than equal shares, the taxpayer and his wife, by virtue of their co-ownership shared profits and losses equally.
The respondent then addressed the Tribunal, submitting, by reference to a number of authorities, that his arrangement with his wife governed the position to the exclusion of what might have been the situation in a case of bare co-ownership.
The transcript of argument shows that the following discussion then took place:
"The Chairman: Thank you, Mr McDonald. Mr Bellew, you addressed on a basis that did not include the concept of a partnership at law. Do you want to say anything further?
Mr Bellew: No, only that I think in this situation here Mr Chairman, the taxpayers were in receipt of income jointly for the purposes of...
The Chairman: Well, that is one of the attributes of a partnership, it is very broad.
Mr Bellew: They say it has got a definition in section 6.
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The Chairman: Yes. Well, clearly that is right but it is also one of the attributes of a partnership at law income.
Dr Gerber: The thrust... is that a joint tenancy is one and indivisable effectively. Is not that the thrust of - you cannot split a joint tenancy other than...
Mr Bellew: The joint tenancy probably leads to the receipt of income jointly, having received the income jointly. They then satisfy the definition in section 6, so you have a partnership.
The Chairman: A partnership for taxation purposes?
Mr Bellew: Yes.
The Chairman: But that is not a partnership at law is it?
Dr Beck: You would not dispute, I take it, that a partnership at law under the Partnership Act, the partners can determine full proportions that they are going to share profits.
Mr Bellew: I realize Dr Beck that there is a difference between partnership at law and a partnership for taxation purposes.
Dr Beck: No, I was not testing on you.
Dr Gerber...
Mr Bellew: Yes, I am aware of that Dr Gerber."
In its reasons for decision, the Tribunal accepted the respondent's explanation for entry into the arrangement with his wife. It said [at p. 1110]:
"The applicant in this case is a company manager, his wife is solely engaged in domestic duties. In order to give the wife a greater sense of independence and security, the couple decided that they would enter into an arrangement whereby they would invest in income-earning properties as joint tenants. An oral agreement was reached and reduced to writing."
The Tribunal then referred to the record of discussion. After reciting the history of the renting out of the premises and stating the respective submissions of the parties, the Tribunal said [at p. 1111]:
"5. When the Tribunal pointed out to the Commissioner's representative that he had not cross-examined the applicant on the issue of `sham' - an allegation tantamount to fraud - and that the issue of `fiscal nullity' had been held in
Oakey Abattoir Pty. Ltd. v. F.C. of T. 84 ATC 4718, not to apply in this country, the submissions both with respect to `sham' and `fiscal nullity' were abandoned."
The Tribunal then referred to Case Q35, 83 ATC 154 and quoted the following passage from the Board's reasoning in that case (at p. 155):
"8. Unfortunately for the taxpayer, the legal consequences which flow from owning the residence jointly with his wife are not affected by their private arrangement for claiming deduction of its operating losses. Each of them is as much entitled to any part of the house property as the other. Neither of them can point to any part of the property as his or her own to the exclusion of the other. Similarly, either one of them cannot take the whole of the profits (or losses) to the exclusion of the other. (See Megarry and Wade, The Law of Real Property 2nd ed., pp. 392 and 393.) [p. 405 3rd ed.] In the instant case we have seen that the couple owned their residence jointly and thus they were in receipt of the rental income jointly. The taxpayer did not seek to contend that his wife in any way alienated her right to receive her share of the income from the property."
The Tribunal then observed [at 86 ATC 1109 at pp. 1111-1112]:
"If the above statement is intended to convey that it is not competent for partners to vary the distribution of their profits and losses, or that, whilst profits may be shared rateably, all losses may be borne by one of them exclusively, we respectfully disagree with that view. We hold that it is always open to one partner to agree to indemnify the other(s) against loss without removing from the agreement its character as a contract of partnership. The question in this case is: Have the parties achieved the desired result, and, if so, is it void as against the Commissioner by virtue of sec. 260 of the Income Tax Assessment Act.
7. As to the first proposition, it seems to us that the agreement, although inelegantly drafted, none the less clearly records the
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intention of the parties - the applicant was to `absorb' all losses incurred by the partnership.8. In view of the fact that this was an informal arrangement, we think it would be wrong to demand too great a formalism and to search in the agreement for such phrases as `the party of the first part hereby undertakes to indemnify the party of the second part against all losses that may be incurred by the partnership.' We therefore find that the agreement is adequate to achieve its desired object."
Finally, the Tribunal considered and rejected the Commissioner's argument based on sec. 260. The Commissioner no longer pressed this argument.
In this Court, it was submitted on behalf of the Commissioner that the Tribunal should have held that there was no partnership here under the general law; and that the private arrangement arrived at between the respondent and his wife as to the sharing of profits and losses could not alter their respective entitlements for income tax purposes.
It was argued for the Commissioner that the present case was one merely of co-ownership rather than partnership. He relied, in this connection, upon the well-known dictum of Willes J. in the early case of
French v. Styring (1857) 2 C.B. (N.S.) 357 at p. 366:
"It in truth amounts to no more than a contract between two tenants in common, whereby the one agrees, in consideration of certain things to be done by the other, to abstain from exercising his rights in respect of the chattel held by them in common. It is no more a partnership than if two tenants in common of a house agreed that one of them should have the general management, and provide funds for necessary repairs, so as to render the house fit for the habitation of a tenant, and that the net rent should be divided between them equally."
The Commissioner also relied upon the following observations made by Thurlow J. in the Exchequer Court of Canada in
Wertman v. Minister of National Revenue 64 DTC 5158 at p. 5167:
"On the evidence in the present case the sum received as rentals from the Park Strand should I think be regarded as having accrued to the appellant and his wife and son predominantly, if not entirely, in their capacity as owners of the property rather than as traders, and I also think that the rentals should be regarded as having accrued predominantly, if not entirely, from the use by tenants of the property in the sense that they represent payments for the tenants' occupation thereof rather than payments arising from the process of letting apartments and providing certain limited services such as heat of which the tenants have the benefit. To my mind while there is a sense in which the rentals can be said to be revenues from a business of letting apartments or operating an apartment building for the purpose of securing rentals, it is a fanciful and unrealistic way of describing them for it puts the emphasis of the description of their source where it does not belong viz., on the mere sine qua non or conduit pipe of the letting activity rather than on the fact that they arise from the use or exercise of the owners' right of occupation of the property by tenants who pay not for the letting but for the use of the property."
On behalf of the respondent it was submitted that the relevant relationship for present purposes was not that of co-ownership; rather the relationship was that of partnership both under the general law and under the Act. It was further submitted, in the alternative, that even if no partnership exists, the agreement between the respondent and his wife bound the Commissioner as a lawful contract which conclusively governed the relevant legal relations between those parties.
In my opinion, although the case is a difficult one, the Commissioner's arguments are, on the whole, valid. For this purpose, I accept the findings of primary fact made by the Tribunal. I also accept that in the course of the conduct of the proceedings before the Tribunal, the Commissioner's representative withdrew any suggestion that the arrangement made between the respondent and his wife was a sham. I have already noted that sec. 260 and the doctrine of "fiscal nullity" are no longer pursued. But, in my view, the respondent was entitled to deduct only one-half of the loss claimed.
It is true that, for the purposes of the Act, "persons in receipt of income jointly" as well as persons carrying on business as partners, are
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deemed to be "partners" (see the definition in sec. 6(1)). Thus, if co-owners, who might not be partners under the general law, receive income jointly, they are treated as "partners" for the purposes of the Act. In the present case, the respondent and his wife were joint tenants, legally and beneficially, of the subject premises. They were in receipt of income jointly from the lettings. By reason of the extended partnership definition, they were deemed to be "partners" for the purposes of the statute.This circumstance does not, however, advance the respondent's case: "Taxation law recognises the schizoid nature of the partnership as both a distinct firm or profit centre in accounting and economic theory and as a non-entity in general legal theory." (See Fletcher, The Law of Partnership in Australia and New Zealand, 5th ed. at p. 307.) As Professor Fletcher notes, the Act requires that the accounts of the business (or, in the case of co-owners, notional business) be prepared on the basis that the partnership is a distinct commercial operation; yet no tax is levied on the earnings of the partnership and its income is credited to partners in the appropriate shares and taxed in their hands as part of their income (sec. 90, 91 and 92). In the same way, the Act, as it stood at material times, allowed a partner, or a notional "partner", a deduction in respect of "his individual interest in a partnership loss" (sec. 92(1)). "Carrying on business in partnership or being a partner confers no special rights or entitlements for taxation purposes" (Fletcher, op. cit.). As I followed the argument, the respondent acknowledged this. He accepted that if no more appeared in the case than that he and his wife were joint tenants, that is to say, that for the purposes of the general law, they were merely co-owners and not partners carrying on a business in common with a view of profit (see Partnership Act 1892 (N.S.W.) sec. (1)), then although their receipt of income jointly would deem them to be "partners" for taxation purposes, the respondent would, by virtue of sec. 92(1), be allowed a deduction of only one-half of the losses incurred. The respondent's concession was, I think, rightly made. It is common ground that the respondent and his wife were beneficially entitled to the premises as joint tenants. As joint tenants, they were entitled in equal shares to the rents and profits (see Helmore, The Law of Real Property in New South Wales, 2nd ed. at p. 274). For taxation purposes, the Act takes the taxpayer's income as it finds it, that is to say, subject to the general law in all its aspects. This will pick up the position at law and inequity modified by any relevant legislation, including the provisions of the Act itself (see
MacFarlane v. F.C. of T. 86 ATC 4477; (1986) 67 A.L.R. 624 at p. 636). What is relied on by the respondent in claiming to be allowed a deduction for the whole of the losses is his assertion that he and his wife were also partners under the general law (i.e. they were "true" partners (see
F.C. of T. v. Walsh & Anor 83 ATC 4415 per Fitzgerald J. at p. 4430)); and that it was a term of the partnership agreement that he be liable for the whole of the losses of the venture. Alternatively, the respondent says, even if a general law partnership did not subsist, it was a term of the agreement between the respondent and his wife that he be liable for all the losses and his contractual liability was itself sufficient to entitle him to deduct the total amount claimed.
In my opinion, no partnership under the general law subsisted between the respondent and his wife. Their relationship was one of co-ownership, and even if they were deemed to be partners by reason of sec. 6(1) of the Act, this circumstance is immaterial for our purposes. As has been noted, their notional "partnership" will carry with it the consequence that they are to be treated as a "partnership" for some purposes. It does not follow that the respondent can deduct the whole of the losses. He may only deduct his individual interest in the "partnership" loss. His "individual interest" is the interest to which a "partner" is solely entitled, as contrasted with his joint interest in the whole (see
F.C. of T. v. Whiting (1942-1943) 68 C.L.R. 199 at p. 204). It is necessary therefore to determine whether the respondent and Mrs McDonald were merely notional "partners" for the purposes of the Act (i.e. merely co-owners) or were "true" partners under the general law.
Partnership is the relationship which subsists "between persons carrying on a business in common with a view of profit" (Partnership Act, sec. 1). The reference to "business", defined in the statute as including every trade occupation or profession (Partnership Act, sec. 45), indicates "a commercial enterprise as a
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going concern" (seeHope v. The Council of the City of Bathurst 80 ATC 4386; (1980) 144 C.L.R. 1 per Mason J. at ATC pp. 4389-4390; C.L.R. p. 8). Purely domestic transactions are thus excluded from the definition (see Fletcher, op. cit. at p. 28). The "business" must be "carried on". This suggests some active occupation or profession (see
I.R. Commrs v. The Marine Steam Turbine Co. Ltd. (1919) 12 T.C. 174 per Rowlatt J. at p. 179). It also suggests an element of continuity although it has been recognised that it is possible that a single joint venture will suffice (see
Canny Gabriel Castle Jackson Advertising Pty. Ltd. v. Volume Sales (Finance) Pty. Ltd. (1974) 131 C.L.R. 321;
United Dominions Corporation Ltd. v. Brian Pty. Ltd. (1984-1985) 157 C.L.R. 1 at p. 15; Fletcher, op. cit. at pp. 31-33). On the other hand, in the case of a private individual as distinct from a company, "it may well be that the mere receipt of rents from properties that he owns raises no presumption that he is carrying on a business" (see
American Leaf Blending Co. Sdn. Bhd. v. Director-General of Inland Revenue (1979) A.C. 676 per Lord Diplock at p. 684).
The well-known statutory rules for determining the existence of a partnership (see the Partnership Act, sec. 2) are introduced by Professor Fletcher (op. cit. at p. 43) in this way:
"The partnership relation is basically contractual (
Pooley v. Driver (1876) 5 Ch.D. 458 at 472 per Jessel M.R.). Whether it exists in a particular case is determined by assessment of what the parties must be taken to have intended, as evidenced not only by the terms of their express agreement but by their conduct towards one another during the course of carrying on the business. No one factor of itself is conclusive. All the facts and relevant circumstances of the relationship between the parties must be considered (
Re Ruddock (1879) 5 V.L.R. (1 P. & M.) 51). The statutory rules... qualify the terms of the definition and provide guidance for persons interested in separating partnership from non partnership joint ventures and other relationships... which may exhibit similar characteristics."
One of these statutory rules is that co-ownership of property, including joint tenancy, does not of itself create a partnership as to anything so owned, whether the co-owners do or do not share any profits made by the use thereof (Rule 1). Of co-owners sharing profits, Lindley on Partnership, 15th ed. says (at p. 81):
"When, however, co-owners of property employ it with a view to profit, and divide the profit obtained by its employment, the difference, if any, between them and the partners becomes very obscure. The point to be determined is whether, from all the circumstances of the case, an agreement for a partnership ought to be inferred; but this is often an extremely difficult question.
If each owner does nothing more than take his share of the gross returns obtained by the use of the common property, partnership is not the result. On the other hand, if the owners convert those returns into money, bring that money into a common stock, defray out of it the expenses of obtaining the returns, and then divide the net profits, partnership is created in the profits, if not also in the property which yields them."
Fletcher (op. cit. at p. 44), after referring to French v. Styring, supra, says (at p. 44):
"However it seems probable that the extent of this concession [i.e., that `bare' co-ownership does not, of itself, constitute a partnership] has been eroded by changes in the legal appreciation of what constitutes a business. Whereas a century ago most single venture operations would not have been regarded as business, it is submitted that few gain making activities will now avoid that designation. To remain within the ambit of the rule, it is probable that the joint activity should require minimal involvement by the co-owners, such as a decision to lease a house property for a term of years rather than operating it as a boarding house, and be designed to cover costs rather than to return profits to the participants."
This approach is consistent with the approach taken in Wertman, supra.
It is true that the record of discussion referred to the relationship in terms of an "investments" rather than that of a partnership. This is inconclusive. It is well established that the parties' description of their relationship as a partnership or as not a partnership does not determine the legal question to be addressed by
ATC 4552
the Court. (See, e.g.,Fenston v. Johnstone (1940) 23 T.C. 29 per Wrottesley J. at pp. 35-36.)
In the present case, a number of indications point to the conclusion that the parties were not carrying on a business, with the consequence that their relationship was that of co-ownership rather than partnership. Their investment involved little, if any, active participation from either party. This was inevitable because the respondent was apparently in full-time employment, and Mrs McDonald was fully committed at home. On the few occasions on which the owners needed to be involved, the respondent and not Mrs McDonald attended to the matter. This was not a case of the active joint participation by the parties in a business activity. Rather, it was a case of a renting out of premises without the provision of other services of the kind discussed in Wertman, supra. In my view, there was here a mere investment in property rather than a partnership in the properties or their profits. This is not, of course, to say that it is not possible for husband and wife to enter into a partnership under the general law with respect to land dealings - see, e.g.,
Spence v. F.C. of T. (1967) 121 C.L.R. 273.
Given the respondent's minor participation in the affair and given Mrs McDonald's apparent lack of commercial expertise and her passive role, it is, I think, more accurate to describe them as co-owners in investments rather than as partners in a business operation.
This is not to say that the respondent and his wife were not each entitled to claim one-half of the losses under sec. 51(1) of the Act. That provision is not limited to deductions from income derived as being the proceeds of a business. It is "a general provision relating to deductions claimable in relation to expenses, losses or outgoings incurred in gaining or producing any income whatever and not merely in relation to income derived from a business". (See
F.C. of T. v. Green (1950) 81 C.L.R. 313 per Latham C.J. at p. 319.)
As has been noted, the respondent put an alternative submission that, even if a partnership under the general law did not exist, he could deduct the whole of the losses by virtue of his agreement to indemnify his wife. But sec. 51 does not permit a deduction merely by virtue of that agreement. In truth, it was a term of the agreement that the respondent actually give income away to his wife. That involves none of the features required as a condition of deductibility under sec. 51(1). In fact, the transaction, so far as concerned the respondent, involved two significant detriments. In the first place, he gave away one-quarter of his income entitlement; secondly, he indemnified his wife against any loss from the investments. It cannot be said, as the language of sec. 51 requires, that a payment made pursuant to such an indemnity is a loss incurred in gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing such income. Rather, the assumption of liability for the losses, voluntarily made by the respondent, was a purely domestic arrangement in which the respondent sought to advance his wife's finances (cf.
Ure v. F.C. of T. 81 ATC 4100 at p. 4108;
Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at p. 4549;
F.C. of T. v. Ilbery 81 ATC 4661 at p. 4668). In any event, there is expressly excluded from deductions allowable under sec. 51(1) losses of a private or domestic nature and the wife's half share of the losses now claimed by the respondent may be so described (see Parsons, Income Tax in Australia, "Principles of Income Tax, Deductibility and Tax Accounting" at pp. 452-453).
The appeal will be allowed with costs.
THE COURT ORDERS:
1. Appeal allowed.
2. Set aside the decision of the Administrative Appeals Tribunal; in lieu thereof order that the decision under review by the Tribunal and the assessment be confirmed.
3. The respondent pays the Commissioner's costs.
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