AUSTRALASIAN FEED PTY LTD v DFC of T
Members:TE Barnett DP
RD Fayle SM
Tribunal:
Administrative Appeals Tribunal
MEDIA NEUTRAL CITATION:
[1999] AATA 980
TE Barnett OBE (Deputy President) and RD Fayle (Senior Member)
For the years of income ended 30 June 1989, 1990 and 1991, Australasian Feed Pty Ltd (``the applicant'') incurred tax losses, the quantum of which is not in dispute in these proceedings. Those losses were $531,845.00, $562,373.00 and $334,664.00 respectively. By a notice of an income tax assessment in relation to the year ended 30 June 1992, the Deputy Commissioner of Taxation (``the respondent'') disallowed the losses claimed in respect of the three preceding years, resulting in a liability to pay tax. That notice of assessment also included ``additional tax for incorrect return'' of $238,248.47. The consequence of disallowing the deduction for the tax losses also resulted in an adjustment to the taxable income of the applicant for the year ended 30 June 1993 and the issue of a notice of amended assessment for that year. It is the disallowance of the 1988/1989, 1989/1990 and 1990/1991 tax losses carried forward in each of the 1991/1992 and 1992/1993 years and the assessment of the additional tax for the 1991/1992 year which are the subject of objections lodged by the applicant. In addition to those grounds of objection, the applicant also claims that the notice of assessment in relation to the year ended 30 June 1992 is not authorised by s 170 of the Income Tax Assessment Act 1936 (``the Act''). The respondent considered the objections and disallowed them, notifying the applicant accordingly. Those decisions have been referred to this Tribunal for review pursuant to s 14ZZ of the Taxation Administration Act 1953.
2. At the hearing the applicant was represented by Mr J Pickering, solicitor of Freehill, Hollingdale & Page, whilst the respondent was represented by Mr M Corboy of counsel. The hearing proceeded on the basis of agreed facts and evidence by sworn affidavits of Mr Stephen Meerwald for the applicant and Mr Bevon Sinnott and Mr John McGrade for the respondent. Each also gave evidence in person. The Tribunal had before it documents filed pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 (``the T documents'').
3. As will be seen, the applicant is claiming the deduction of the tax losses on the basis that it satisfied, at all relevant times, the provisions of s 80E of the Act, called ``the same business test''. This obtains because there were two material changes in the beneficial ownership of shares since the losses were incurred, which is not disputed. Those changes preclude deduction of the losses under the Act pursuant to s 80 (1989 and 1990 years) and s 79E (later years' losses) by reason of s 80A, leaving only the possibility of a deduction under those provisions if the applicant can meet the tests of s 80E.
The legislation
4. The relevant provisions of the Act are set out below:
``79E(1) [Amount of loss] For the purposes of this section, a taxpayer incurs a loss in a post-1989 year of income equal to the amount (if any) by which the taxpayer's non-loss deductions for the year of income exceed the sum of the taxpayer's assessable income and net exempt income for that year.
...
79E(3) [Deduction for losses] Subject to this section, so much of a taxpayer's losses incurred in any of the post-1989 years of income before a particular year of income as has not been allowed as a deduction from the taxpayer's income of any of those years is allowable as a deduction in accordance with the following provisions:
- (a) where the taxpayer has not derived exempt income in the particular year of income, the deduction is to be made from the taxpayer's assessable income of that year;
- (b) where the taxpayer has derived exempt income in that year, the deduction is to be made successively from the taxpayer's net exempt income and from the taxpayer's assessable income of that year;
- (c) where a deduction is allowable under this section in respect of 2 or more losses, the losses are to be taken into account in the order in which they were incurred.
...
80(1AA) [Application of section] This section does not apply to a loss incurred in the year of income commencing on 1 July 1989 or any later year of income.
80(1) [Loss defined] For the purposes of this section, a loss shall be deemed to be
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incurred in any year when the allowable deductions (other than the deductions allowable under this section or section 80AAA or 80AA) from the assessable income of that year exceed the sum of that income and the net exempt income of that year, and the amount of the loss shall be deemed to be the amount of such excess....
80A(1) [Beneficial ownership of shares test] Notwithstanding sections 79E, 79F, 80, 80AAA and 80AA but subject to this section and sections 80B, 80DA and 80E, a loss incurred by a company in a year before the year of income shall not be taken into account for the purposes of section 79E, 79F, 80, 80AAA or 80AA unless-
- (a) the company satisfies the Commissioner; or
- (b) in the case of a company that is not a private company in relation to the year of income, the Commissioner considers that it is reasonable to assume,
that, at all times during the year of income, shares in the company carrying between them-
- (c) the right to exercise more than one- half of the voting power in the company;
- (d) the right to receive more than one- half of any dividends that may be paid by the company; and
- (e) the right to receive more than one- half of any distribution of capital of the company,
were beneficially owned by persons who, at all times during the year in which the loss was incurred, beneficially owned shares in the company carrying between them rights of those kinds.
...
80E(1) [Same business test] Subject to subsection (2), where-
- (a) the whole or part of a loss incurred by a taxpayer, being a company, in a year before the year of income would not, but for this section, by reason of a change that has taken place in the beneficial ownership of shares in the company or in any other company, be taken into account for the purposes of section 79E, 79F, 80, 80AAA or 80AA;
- (b) the first-mentioned company carried on at all times during the year of income the same business as it carried on immediately before the change referred to in paragraph (a) took place; and
- (c) the first-mentioned company did not, at any time during the year of income, derive income from a business of a kind that it did not carry on, or from a transaction of a kind that it had not entered into in the course of its business operations, before the change took place,
sections 80A and 80DA do not prevent the whole of the loss being so taken into account.
80E(2) [New business before ownership change] Subsection (1) does not apply in respect of a loss incurred by a taxpayer being a company in a year before the year of income if-
- (a) before the change took place, the company commenced to carry on a business that it had not previously carried on or entered into, in the course of its business operations, a transaction of a kind that it had not previously entered into; and
- (b) the company commenced to carry on that business or entered into that transaction for the purpose, or for purposes that included the purpose, of enabling the company to take into account, by virtue of subsection (1), for the purposes of section 79E, 79F, 80, 80AAA or 80AA a loss that the company had incurred in a year before the first- mentioned year or might incur in the first-mentioned year.''
The evidence
5. A company was incorporated in Western Australia on 23 June 1987. It initially allotted one ordinary share to each of two persons. It was what is known as a shelf company. In September 1987 several things effecting that company took place. It allotted 49,998 ordinary shares, of which 14,999 were registered to Bevon Sinnott and 34,999 to Austrex International Pty Ltd (``Austrex''). Six new directors were appointed, including Mr Sinnott who was also appointed principal executive officer. The two founding shareholders each transferred their one ordinary share to Mr Sinnott and Austrex respectively giving them
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15,000 and 35,000 shares, that is, 30 percent and 70 percent, respectively.6. In October 1987 the company changed its name to that of the applicant.
7. The applicant was established with a view to setting up a factory to supply high quality feed for both domestic feedlot consumption and for use in the live sheep trade from Australia and New Zealand. The feed was to be produced as pellets to be transported to ports and loaded onto ships to feed sheep during the voyage delivering them to overseas buyers. Mr Sinnott had previous experience in a similar business. Mr Sinnott's early projections of production by the proposed mill indicated that about 25% would be sold to its principal shareholder Austrex whilst the rest would be sold into the live sheep export trade. Mr Sinnott considered that at the time Austrex was about the sixth largest exporter of live sheep. The larger ones were Saudi Livestock & Trading Co, Kuwait Livestock & Trading Co, Wellard Rural Exports Pty Ltd (``Wellard''), Fares Rural & Co Pty Ltd and Van Ommeran International Trading Australia Pty Ltd.
8. The applicant entered into an agreement to purchase land at Wongan Hills in Western Australia, on which it intended building its factory. The price was $25,000.00. Initially it experienced some difficulty in obtaining clear title to the land so it was unable to give security for necessary capital borrowings. As a consequence it entered into short-term bill finance facilities to provide funding to build the factory. The factory building and mill installation was completed around March 1988 at an approximate cost of $3,350,000.00. Title to the land was obtained later. In July 1989 the applicant refinanced its borrowed funds through the Hong Kong Bank of Australia Limited which secured a first mortgage over the mill at Wongan Hills and a fixed and floating charge over the whole of the applicant's assets and undertakings (``the HKB Securities'').
9. Wongan Hills was chosen because it was considered as the centre of lupin production, the main grain used in the production of feed pellets. At all material times grain was purchased from farmers in the area.
10. On 19 July 1989 the applicant issued 1,700,000 ordinary shares to Jandabup Pty Ltd (``Jandabup'') and a further 250,000 ordinary shares to Austrex. The constitution of the board of directors also changed such that the interests of Jandabup dominated. Mr Sinnott continued as a director and manager. Also, the applicant employed a mill manager responsible for the purchase of raw materials from local farmers and for the daily operation of the mill. Six others were employed in the mill.
11. The applicant leased an office in Fremantle which it shared with Austrex. Austrex's principal office was in Queensland.
12. The applicant commenced sales in early 1988. Attachment 1 to Mr Sinnott's affidavit shows that sales were predominantly into the live sheep trade. There is no steady pattern to the total sales over the period shown in that attachment although sales fell dramatically in June 1988, picked up again in August 1988 but fell steadily from April 1989 until January 1990. No sales were made in February 1990 but relatively large sales commenced again in March 1990 through the rest of that year of income (and beyond). In early 1988 the applicant had entered into an agreement with Saudi Livestock & Trading Co to supply pellets for its shipments of live sheep to Saudi Arabia. Also, in June 1989 it entered into a contract to supply Wellard 5,000 tonnes over 6 months, but subject to price. Wellard was engaged in the export of live sheep to the Gulf. The evidence was that sales agreements of this kind do not bind the purchaser to actual quantities to be delivered over time but sales are made only if the purchaser requires the pellets during the agreed period. Clearly the contracts favour the purchaser by giving them some certainty about supply. Those conditions tend to reflect the uncertain state of the market for live sheep exports at the time.
13. The export of live sheep to Saudi Arabia was suspended on 22 August 1989 after the discovery, by the Saudi authorities, of blue tongue and sheep pox in six shipments from Australia. This adversely affected the applicant's business and it experienced liquidity problems. Toward the end of 1989 and the beginning of 1990 the applicant made arrangements with its creditors to pay out those owed less than $1,000.00 and suspend payment to the rest until December 1990.
14. The applicant sought to alleviate its financial difficulties by entering into a contract to supply Kuwait Livestock & Trading Co with pellets during the remainder of 1990, sought new domestic customers and investigated the possibility of producing heat beads for export to
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Asia. Nothing came of that and the company continued the production of pellets. But on 2 August 1990 Iraq invaded Kuwait causing a cessation of live sheep exports to that country. Whilst this adversely affected Wellard's sales to Saudi Arabia and the Gulf it was fortunate in having a market for live sheep exports to Jordan and lower Gulf States which continued, notwithstanding the problems in Saudi and Kuwait. This cessation of live sheep sales to the Saudi and Kuwait markets, the principal markets of the applicant's established customers, exacerbated the applicant's then financial difficulties. In late August 1990 the Hong Kong Bank, pursuant to its security, appointed a receiver and manager of the applicant.15. Mr Meerwald, the general manager of Wellard, gave evidence that Wellard commenced to purchase pellets from the applicant in January 1991 and the applicant has been its principal supplier since 12 February 1991. This quickly followed an option agreement made on 8 February 1991, between Waterbay Holdings Pty Ltd (``Waterbay''),[1]
16. In order to understand the reason for this rather complicated arrangement, it is necessary to understand the circumstances that preceded the agreement.
17. Mr Meerwald explained that all the shares in Wellard were held by the same shareholders as Turquoise Holdings Pty Ltd (``Turquoise''). By November 1990 Wellard had become aware of the applicant's financial difficulties and the appointment of a receiver manager by the Hong Kong Bank. Wellard was interested in securing the business of the applicant since it had an ongoing need for the kind of pellets produced by the applicant. It therefore investigated the applicant's operations. The investigator reported to Mr Meerwald that in his opinion, there were problems with the mill as short-cuts had been taken in its commissioning. However, the applicant's employees and suppliers (the farmers) thought the mill was capable of being operated to produce 50,000 to 60,000 tonnes of pellets annually, although at the time, in the opinion of the investigator, it was not capable of that level of output. Mr Meerwald, conscious of the then depressed export market for live sheep and the very low demand for and over supply of pellets, believed that the applicant could easily supply all of Wellard's needs and still have considerable excess capacity which they would need to sell into the spot market where the applicant had been directing its sales in recent times. A decision was taken by Wellard on 21 November 1990, to make a conditional offer to the receiver manager to acquire the applicant's mill, plant, equipment and other assets as then on offer by the receiver manager (T46), on a walk-in-walk-out basis, for $610,000.00 (Attachment 1 to Mr Meerwald's affidavit). That offer contains two relevant conditions:
- • being satisfied that all plant and equipment is operating within the manufacturer's specifications, department of Occupational Health Safety and Welfare guidelines and EPA limits; and
- • access to all records of the applicant to decide whether in the alternate they would purchase the Hong Kong Bank security (debt) for the same amount.
18. Six days later Wellard sent a revised offer (Attachment 2 to Mr Meerwald's affidavit). This states that Wellard has inspected and perused the engineer's report and removes the first condition mentioned above and amends the second one as follows:
- • ``During the time prior to settlement we require access to all records of the company to enable us to decide whether we may, as an alternative, purchase the debt of the first secured creditor for $610,000.00 or enter into some other scheme of arrangement with all creditors and purchase the issued capital of the company.''
19. The receiver manager accepted the revised offer albeit with a few minor changes and pointed out that any arrangement of the kind referred to above would require consent of the Hong Kong Bank. Meanwhile the mill continued to produce pellets.
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20. Then followed on 30 November 1990, an acceptance of Wellard's offer by the receiver manager and a confirmation of that by Wellard, by facsimile, the same day. Had that agreement then been consummated the dispute currently before this Tribunal would never have arisen because the business of the applicant would have disappeared at the time - having transferred all of its assets to Wellard. Mr Meerwald's evidence is that subsequent to the previous events Wellard had a change of mind and considered it preferable to acquire the applicant under a scheme of arrangement. So on 8 February 1991 Waterbay, the receiver manager and the Hong Kong Bank entered into the previously mentioned purchase option, the vendor's option and the security option. On the same day Turquoise acquired the securities from the Hong Kong Bank for $645,000.00, presumably with the full consent of Waterbay, which was a company wholly within the same group.
21. Concomitantly, the receiver manager's appointment for the Hong Kong Bank terminated and Turquoise reappointed him as their receiver manager under the securities which it now held.
22. On the evidence, the position at this time appears to be that the agreement for the sale and purchase of the assets of the applicant had lapsed through lack of performance and the loss of contractual power of the receiver manager whose original appointment had been terminated. Wellard held an option to acquire the assets of the applicant and the applicant held an option to require Wellard to purchase the assets. Both options were exercisable by payment of $645,000.00 by Wellard to the applicant. They were each exercisable any time after 30 June 1991 or a scheme of arrangement with the unsecured creditors of the applicant becoming unconditional.[2]
23. The scheme of arrangement was for Turquoise to fund $30,000.00 which would be used to pay out the unsecured creditors in full satisfaction of their debts. The arrangement also required Turquoise to subordinate the difference between the debt due under the security and the $645,000.00 paid, amounting to $1,245,577.00. It would have no future right to demand or be paid that amount.[3]
24. The scheme of arrangement was approved by the creditors of the applicant at a meeting on 11 November 1991 and by the Supreme Court on 14 January 1992.
25. Mr Meerwald told the Tribunal that Turquoise had three principal reasons for acquiring the shares in the applicant rather than having its wholly associated company Wellard acquire all of the applicant's property and assets. These reasons are set out in the scheme of arrangement document attached to Mr Meerwald's affidavit. At page 7 it states:
``[This] course of action is preferred by Turquoise for the following reasons:
- (a) The mill is very automated and neither Turquoise nor Waterbay have any previous experience in relation to the unique technology employed in the mill. Accordingly, it is very important for the owner of the mill to have the benefit of all the warranties and other rights of the [ applicant] in relation to the plant and equipment. It will be difficult for Waterbay, as purchaser of the Assets and distinct from the [applicant], to preserve the benefit of these warranties.
- (b) By maintaining the existing corporate structure, Turquoise, as the new shareholder, will obtain benefits arising from its ability to utilise the [applicant's] local and overseas trading name and contacts and its ability to access all of the [ applicant's] records, including its technical records and drawings.
- (c) There may be certain taxation advantages available to Turquoise in purchasing the [applicant] as compared to allowing Waterbay to purchase the Assets. These possible tax advantages relate to the allowable depreciation on plant and equipment and the potential to utilise the [applicant's] accumulated
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losses. The taxation advantages are, however, by no means certain and Turquoise will be unable to determine the extent of the available benefits (if any) until after it has acquired control of the [applicant]. Further, any tax benefits which may be available will only be of real benefit to the extent the [applicant] returns a profit.''
26. The applicant's mill continued in production whilst all of these negotiations proceeded. Paragraph 34 of the Statement of Agreed Facts filed by the parties in these proceedings sets out a chronology of the main events relating to the operation of the mill by the receiver-manager during the period immediately preceding the entering into of the option agreements in February 1991. These show that the mill last produced on 10 August 1990 and made its last sale on 22 August 1990, prior to the appointment of the receiver- manager on 27 August 1990. Repairs to mill plant were undertaken between 6 September 1990 till 30 September 1990 when the mill recommenced production. Sales recommenced on 5 October 1990 but these appear to have been rather sporadic-
- • 5.10.90 Sale of 125.42 tonnes to Austrex
- • 22.10.90 Sale of 219.24 tonnes to Fares Rural
- • 23.10.99 Sale of 215 tonnes to Fares Rural
- • 31.10.90 Sale of 107.78 tonnes to Fares Rural
- • 4.12.90 Sale of 300 tonnes to Fares Rural
27. Apart from plant shutdowns to enable repairs to be carried out, for 2 days in October 1990, 2 weeks in November 1990 and 2 days in December 1990, the plant continued to produce during this time. After the assignment of the securities by the Hong Kong Bank to Turquoise, a senior employee of Wellard, Mr David Jarvie, was assigned to oversee the[5]
28. Also, at the time of the appointment of the receiver-manager there were seven employed which reduced to three by mid- December 1990, assisted by outside contractors. The receiver later re-engaged some employees who had been retrenched and promoted one to manage the mill. At all material times most of the suppliers continued to do business with the mill. From mid-February 1991 to 30 June 1991 only 11,587 metric tonnes of fodder were produced. However, during the following year ended 30 June 1992 production reached 40,991 metric tonnes and in the year following ended 30 June 1993 production was 48,685 metric tonnes. Mr Meerwald's evidence is that since then production has been in excess of 50,000 metric tonnes per year.
29. Annexure A to Mr McGrade's affidavit is a cash receipts record[6]
30. The Tribunal was provided with copies of (unaudited) trading and profit and loss accounts and balance sheets for the years ended 30 June 1992 (which disclosed the previous year's figures also[9]
31. There are some observations, which should be made in relation to the so-called rental operations disclosures in the accounts referred to above. Mr Meerwald explained that because Wellard's sales had improved and therefore its demand for pellets, the applicant needed additional space to store its product. In April 1992 the applicant decided that it needed a bulk store in Perth to enable it to load ships more efficiently because prior to that date ships were loaded directly by deliveries from Wongan Hills and from short term hired storage in Perth. The applicant purchased a bulk store and offices in Canning Vale (proximate to Fremantle where the ships docked) in April 1992. The applicant used this store until June 1993. On two occasions it leased part of the space to allow third parties to store goods for a short time. That resulted in the storage and rental income of $4,600.00 (gross) shown in the accounts for the year ended 30 June 1992.
32. Mr Meerwald said that in 1993 the applicant was approached by Meadow Lea Foods to lease to them the Canning Vale property. He said that the applicant was not particularly interested in leasing the property but when the top market rent was offered they accepted. The lease agreement is dated 14 June 1993 and covers a period from 1 June 1993 until 30 May 1996. The annual rental was $115,000.00 payable monthly. Having lost their storage facility at Canning Vale the applicant purchased a property in Spearwood (also proximate to Fremantle) on 27 August 1993 to store pellets from the mill.
33. As mentioned above, storage income received for 1991/92 was $4,600.00. Storage income derived in the following year 1992/93, was: $70,267.00 from Canning Vale and $19,167.00 from Spearwood; and for 1993/94 from Canning Vale only, $118,487.00. Mr Meerwald suggested in his oral evidence that these amounts include internal charges for management purposes relating to internal storage between divisions of the applicant. However, the Tribunal is not satisfied that that is the case as no charge for storage appears in the applicant's Trading Accounts for each period as would be expected if that were the case. Following questions by Mr Corboy for the respondent, Mr Meerwald was not able to assist the Tribunal in this regard. What is clear is that prior to 1991/92 the applicant derived no income from storage or rental arrangements.[12]
The discussion
34. It is common ground that the only provision of the Act open to the applicant under which previous years' losses could be allowed as a deduction pursuant to s 80 or s 79E, is s 80E. This obtains because substantial changes in beneficial ownership of shares occurred firstly, in July 1989 when Jandabup became a controlling shareholder and later, when all issued shares were transferred to Turquoise in July 1991.[13]
35. Section 80E of the Act has, what might be called, distinctive tests. These are:
- • That the company carried on at all times during the year of income the same business as it carried on immediately before the change in beneficial ownership of shares took place (the s 80E(1)(b) test); and
- • The company did not, at any time during the year of income, derive income from a business of a kind that it did not carry on, or from a transaction of a kind that it had not entered into in the course of its business operations, before the change took place (the s 80E(1)(c) test); and
- • That the losses are not deductible:
- • if before the change in beneficial ownership of shares took place, the company commenced to carry on a business it had not previously carried on or entered into in the course of its business operations, a transaction of a kind that it had not previously entered into; and
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- • the company commenced to carry on that business or entered into that transaction for the purpose, or for purposes that included the purpose, of enabling the company to take into account (by virtue of s 80 or s 79E) a loss which the company had incurred prior to the year of income (the s 80E(2) test).
- • if before the change in beneficial ownership of shares took place, the company commenced to carry on a business it had not previously carried on or entered into in the course of its business operations, a transaction of a kind that it had not previously entered into; and
36. The evidence establishes that prior to November 1990[14]
37. Mr Corboy, for the respondent, submitted that the relevant change in business practice of the applicant, by selling almost exclusively to Wellard from about March 1991 is fatal to the claims by the applicant that it carried on the same business immediately prior to July 1989. By the applicant selling almost exclusively to Wellard it was entering into transactions of a kind that it had not entered into in the course of its business operations before July 1989. Therefore, it was submitted, the applicant has failed the s 80E(1)(c) test in that respect.
38. Clearly, if Mr Corboy's submission was accepted then the accumulated tax losses to the year of income ended 30 June 1989 could not be deducted pursuant to s 80 and that would be the end of the matter.
39. In the alternative, but without prejudice to the previous submission, Mr Corboy further submitted that in about March 1991 the applicant commenced to enter into transactions of a kind not previously entered into (that is, selling almost exclusively to Wellard). These, he submitted were for the purpose or for a purpose of enabling the applicant to take into account tax losses incurred in the years ended 30 June 1990 and 1991 in respect of the year of income ended 30 June 1992 and later years. He submitted that because Turquoise and Wellard had common owners, then the sales by the applicant to Wellard were for the requisite purpose. Therefore, it would follow, the applicant has failed the s 80E(2) test in that respect.
40. Mr Corboy further submitted that even if he is wrong in relation to the previous submission, which he does not admit, the applicant is denied the benefit of deductions pursuant to s 80 or 79E for the years of income ended 30 June 1992 and beyond because it failed the s 80E(1)(c) test anyway. This obtains, he submitted, because during the years of income ended 30 June 1992 and 1993 the applicant derived rental income for the very first time. In 1991/92 the assessable rental income was $4,600.00 and in 1992/93 it was $89,434.00.[16]
41. On the other hand Mr Pickering, on behalf of the applicant, submitted that for all intents and purposes the business of the applicant never changed during the relevant years. Its mill continued to operate albeit at fluctuating levels due to the fluctuating demand for its product. The mill shutdowns were only for the purpose of carrying out essential maintenance and were never for any length of time such as to disrupt seriously the production. The principal suppliers of raw material to the mill remained largely the same throughout the periods in question, being local producers of lupins. The product remained the same throughout - a unique pelleted stock feed. Sales were always exclusively into the same generic market, to live-sheep exporters. Admittedly the customer base changed but the conditions of sale remained the same - agreed quantities would be contracted for at prices to be determined from time to time depending on the then spot market. The price at which sales were made to Wellard, its almost exclusive customer from some time proximate to January 1991 was competitive at all relevant times. As it happened, the applicant whilst prepared to sell into the spot market did not have to do so after March 1991 because Wellard's business picked up and it was able to take the entire production which reached near capacity in 1992.
42. Mr Pickering further submitted that Turquoise had three commercial and complementary reasons for acquiring the shares in the applicant - the need to secure the
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benefit of any warranties and rights in relation to the unique plant and equipment; to obtain the benefits arising from the applicant's local and overseas trading contacts and access to its records, including technical records and drawings; and possible tax advantages associated with deductions available to the company for depreciation on its plant and equipment and its accumulated tax losses. He submitted that the subsequent developments whereby the applicant sold its product almost exclusively to Wellard was never anticipated at the time of the take-over by Turquoise. Mr Meerwald's evidence supports the contention that it was always expected that the applicant's output would be more than Wellard would require and that the plan was to sell the rest into the spot market. Therefore, Mr Pickering submitted, it is unsustainable to argue that on the facts the applicant entered into the sales transactions with Wellard for the purpose or for purposes that included the enabling of the applicant to deduct the tax losses in question. Whilst it may be a consequence of the sales to Wellard that the applicant may derive sufficient profit to absorb the tax losses it was not a purpose of those transactions. The purpose was simply to provide Wellard with sufficient feedstock to meet its demands.43. Each of those submissions is dealt with under the relevant provision of s 80E.
Was the applicant carrying on the same business - the s 80E(1)(b) test?
44. The High Court considered the question of what constitutes the ``same business'' for the purpose of s 80E in
Avondale Motors (Parts) Pty Ltd v FC of T 71 ATC 4101; (1971) 124 CLR 97. The head-note of the CLR report summarises the facts:
``Section 80E of the Income Tax Assessment Act 1936-1968 (Cth) provides that a company may deduct from its assessable income losses of prior years if, inter alia, it has carried on at all times during the year of income `the same business as it carried on immediately before' any change that has taken place in the beneficial ownership of shares.
The taxpayer company, which carried on a business of selling motor parts and accessories to motor dealers and traders and to the general public, made losses and subsequently ceased its selling activities; and, by July 1967 at the latest, it disposed of all its stock. On 29 February 1968 it assigned the only debts that remained owing to it. On 15 March 1968 the beneficial ownership of all of the issued shares passed to new shareholders. The taxpayer company then recommenced the sale of motor parts and accessories. Most of the parts and accessories, however, were different kinds from those sold previously; and the taxpayer company traded under a different name, occupied new premises, and was served by new employees.
Held: That the taxpayer company was not entitled to deduct the past losses from its assessable income, since (a) it has not been carrying on any business at all immediately before the change in the beneficial ownership of its shares took place, and (b) in any event, the business that it has once carried on was not the same as that which it carried on during the year of income.
Per Gibbs J: In the context of s 80E the words `same as' import identity and not merely similarity.''
45. Whilst it was not in issue, the facts support the conclusion that the applicant did not cease to carry on business immediately before either of the two changes in beneficial ownership of shares in question.[17]
Kirk and Randall Ltd v Dunn (1924) 8 TC 663).
46. In regard to the first change in beneficial ownership of shares, which occurred in July 1989, this did not result in or cause any significant change in the business of the applicant. There was no change in the way in which business was conducted or in the product, nor the staff or the management of the mill. The applicant did open an office in Fremantle but there is no evidence that that altered the nature of the business of the applicant although it may have impacted on the way aspects of its sales and distribution were managed. The change brought about a much- needed injection of capital by Jandabup but even that in time proved insufficient to sustain the business.
47. In regard to the second change in beneficial ownership of shares, the applicant was then suffering a down turn in expected
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business. This was due to the detection of disease in live sheep exported from Australia to the Middle East and the subsequent invasion of Saudi Arabia by Iraq, both of which caused a temporary suspension of sales. However, the applicant did maintain a level of sales and endeavoured to get business and obtain contracts to sell its pellets.48. The facts of this case are clearly distinguishable from those in Avondale Motors (Parts). In the present case the applicant continued to produce the same (or identical) product from the same mill after the changes as it had before. It obtained its supplies from the same sources. It continued to trade under the same name. It kept on a critical mass of employees and after the second change in beneficial ownership of shares, it re-employed some who had been retrenched due to the downturn in business. The applicant retained the same manager employed prior to the change by the receiver-manager. The only significant change in the business is that in about March 1991 the applicant commenced to sell its product almost exclusively to a customer with which previously it had only one large sale some time after November 1990. Notwithstanding, the market into which the applicant made its sales remained generically the same - to suppliers of live sheep for export, either to their feed-lots near the wharves or for provision of feed during the voyage.
49. Clearly, this change in customer base occurred after the first change in beneficial ownership of shares on 19 July 1989 when Jandabup acquired 85 percent of the issued share capital.
50. However, it is not a change that occurred after the second relevant changes in beneficial ownership of shares. The evidence is that the two share transfers were executed on 24 July 1991, but dated 28 January 1992 and 3 February 1992 respectively, about the time that the court approved the scheme. Presumably that too was about the time that the consideration of $11,500.00 was paid by Turquoise. So if the relevant date is the latter[18]
``... It seems to me natural to read the section as referring to the same business, in the sense of the identical business, and this view is supported by a consideration of the purpose of the section.... No injustice would, in my opinion, result from a refusal to treat an accrued loss as a tax deduction where the company after the change carried on a different business, although one of a similar kind.''
(ATC p 4106; CLR p 105)
51. In Case Y45,
91 ATC 426 Senior Member Professor Y Grbich of this Tribunal reviewed several cases in relation to the application of the ``same business'' test. The Senior Member conveniently sets out a synopsis of a series of cases where it was decided that the same business did not obtain after the relevant change in beneficial ownership of shares. It is useful to recite that passage [at 430]:
``14. The [s 80E] inquiry is basically a factual inquiry but such facts should be analysed in the framework of a principled set of guidelines and previous decisions have gone some way to structure the Tribunal's leeway of choice in the way it characterises particular changes. The following changes have been held sufficient for it to be held the business was not the same as that in the benchmark period.
- - Company sells wholesale and retail motor parts and accessories. It disposes of its stock. Eight to nine months later it commences a similar activity with different types of trading stock (
Avondale Motors (Parts) Pty Ltd v FC of T 71 ATC 4101; (1970) 124 CLR 97).- - Company was a brewer. It ceased brewing but bottled and sold beer brewed by another company (
Gordon & Blair Ltd v CIR (1962) 40 TC 358 (Scottish Court of Sessions)).- - Company manufactured, sold and installed swimming pools. After the change it merely sold and installed another company's pools. (Case K20,
78 ATC 184; No 2 Board of Review).- - Company was a business offering its land for stock agistment for a fee. After
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the change it entered into a partnership which conducted a full business of producing wool, lamb and beef (Case K36,
78 ATC 341; No 1 Board of Review).- - Company was in the business of growing clover and cereals to sell seed and grain. After the change it fattened stock with its seed and grain and became a pastoralist (
Fielder Downs (WA) Pty Ltd v FC of T 79 ATC 4019, Queensland Supreme Court).- - Before the change the company carried on the business of buying partly finished houseboats, completing construction and selling them. After the change it bought other types of boats, did not carry out construction and sold them (Case M19,
80 ATC 105; No 2 Board of Review).- - Rolls Royce Motors Ltd produced motor cars and aero engines. The aero engine division was the largest of six divisions. It caused large losses and put the company into financial difficulties. Four divisions of the company (including the ill-fated aero engine division) were hived off to a government owned company by special legislation. The company carried on with the two remaining divisions (
Rolls Royce Motors Ltd v Balmford (1976) 51 TC 319; English High Court).''
52. This array of cases indicates that the relevant focus to determine whether the same business has continued is the uniqueness of the product (or service) and the process by which it is obtained. There is no emphasis on the individual customers but the former two criteria will obviously determine the nature of the market into which the product is sold. In Case Y45 the taxpayer company, after the change, shed a significant source of gross earnings and changed the broad structure of its business which it conducted during the years of income in which it sought to deduct the past years' tax losses. In the present case the facts do not point to a change in the structure of the business in the sense that it did not alter in any significant way the source of its gross earnings. The relevant source was from the sale of its unique product produced at all material times in the very same way. No part of the operations or foundations of the applicant's business changed. The change in customer base was a mere change in process.
53. For the above reasons the Tribunal finds that the applicant carried on at all times during the years of income ended 30 June 1992 and 1993 the same business as it carried on immediately before the two relevant changes in beneficial ownership of shares.
Whether the applicant derived income from a business of a kind that it did not carry on, or from a transaction of a kind that it had not entered into in the course of its business operations before the relevant changes took place - the s 80E(1)(c) test?
54. On the basis of the evidence the first part of the question is answered in the negative - the company did not derive income from a business of a kind that it did not carry on after the changes. Its rental activities were passive in nature and not its business but at best, ancillary to its business.
55. However, the evidence is that the applicant did derive income from a transaction of a kind that it had not entered into in the course of its business operations before the relevant changes took place. That is, it first derived rental income during the year ended 30 June 1992 and continued to do so during the following year of income.
56. Mr Pickering for the applicant, submitted that this provision should be interpreted by reference to a de minimis test. He said that the legislature's clear intention to allow a deduction of past years' tax losses where the same business continued would be thwarted by a simple expedient of deriving any amount of income, no matter how small or insignificant, from a new source. He submitted that for the provision to have any operation there has to be an implied de minimis test.
57. In
J Hammond Investments Pty Limited v FC of T 77 ATC 4311 (Supreme Court of New South Wales), a case concerning a similar provision of the Act[19]
``... there remains the question of whether it is correct to say, within the meaning of para (c)[20]
A provision similarly couched to s 80E(1)(c). of the subsection, that the taxpayer did not derive income from a transaction of a kind that it had not entered into in the course of its business operations before the change took place. I confess to having had substantial difficulty in resolving this
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question, the difficulty stemming from the use in the provision of the words `in the course of its business operations'.Upon reflection I think it is correct... that the word `transaction' means `dealing'. Upon that basis one would think that what is being referred to is a transaction distinct or isolated from transactions which would arise from day to day in the conduct of the taxpayer's business. That is how I first read the provision but it seems to me that such a reading of it may not give the full effect to the words earlier referred to, `in the course of its business operations'.
...
In my opinion it is not without significance that the provisions of sec. 80E of the Act dealing with tax losses are in similar terms. One could imagine a situation where a company was taken over for the purpose of its tax losses in order to gain the benefit thereof, not for the purpose of offsetting income derived from the business against the losses of previous years, but for the purpose of offsetting against those losses an isolated or chance profit which might have been foreseen, perhaps a profit taxable by reason of the provisions of sec. 26(a) of the Act or some other income resulting in a chance or isolated profit or gain to the company.
...
... But I have come to the conclusion that there is a different type of transaction which probably does explain [the presence of the phrase `in the course of its business operations'] their presence. There are of course many receipts which are not properly described as being income from a business. There is an example of such a receipt in the present case. The partnership acquired a new building with a tenant in it, who remained in occupation for a short time after the acquisition. The sum of $160 was received by way of rental. It does not seem to me that that was income derived from the business being carried on by the partnership but it was certainly income derived from a transaction entered into in the course of the partnership's business operations. Many other transactions of this general type can be imagined.
Whilst, therefore, I do not regard the matter as free from difficulty, I have reached the conclusion that the second limb of the paragraph is not intended to refer to the daily transactions involved in carrying on a business but to transactions of an isolated and independent kind, which transactions have nevertheless arisen in the course of the taxpayer's business operations.
...
At one stage of the argument it was submitted by the Commissioner that the receipt of the rent to which I have referred was such a transaction. I think it is appropriate to regard that receipt as de minimis...''
(pp 4317-4318)
58. The Latin expression ``de minimis'' is defined as:
``smallest in quantity or amount (as in money); at the lowest price or valuation''
[21]
The Oxford Latin Dictionary, Clarendon Press, 1982.
And,
``de minimis non curat lex: the law cares not about very trifling matters.''
[22]
Wharton's Law Lexicon, 19th edition, Oxford University Press.
And,
``de minimis non curat lex: Contract Law - the law is unconcerned with insignificant matters. In the performance of contracts, the rule allows minute failures and insignificant defects in performance to be excused:
Shipton Anderson & Co v Weil Bros & Co [ 1912] 1 KB 574.''
59. Whether it is appropriate in the present circumstances to ignore the rental income for each of the two years of income in question on the basis of de minimis is a value judgement. The fact that the applicant derived only $4,600.00 gross rental income in the 1991/92 year would support a conclusion that the de minimis rule should apply (cf: J Hammond Investments Pty Ltd v FC of T discussed later). However, in terms of whether the rental incomes for the 1992/93 year operates to deny a deduction pursuant to s 80E, the Tribunal finds guidance in this respect from the respondent's Taxation Ruling TR 95/31 which states inter alia:
``12. The requirement in paragraph (c) of subsection 80E(1)... relating to a `transaction of a kind' not entered into in the course of the taxpayer's business operations is referred to in this Ruling as the `new transactions test' . The new transactions test
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is directed to preventing the injection of income into a loss company which has satisfied the same business test and the new business test. The new transactions test includes all transactions entered into in the course of the company's business operations and not merely those which are `isolated' or `independent'. However, generally speaking, the new transactions test will not be failed by transactions of a type which are usually unmotivated by tax avoidance, namely transactions which could have been entered into ordinarily and naturally in the course of the business operations carried on by the company before the change-over.... or which is extraordinary or unnatural when judged by the course of the business operations before the change-over, will usually be a transaction of a different kind to the transactions actually entered into by the company before the change-over....
15. The word `income' in paragraph (c) of sub-section 80E(1),... does not include amounts which are `de minimis'.''
60. Adopting the language of paragraph 12 of TR 95/31, the rental income of the applicant in each of the 1991/92 and 1992/93 years of income were ``new transactions'', that is, of a kind not previously engaged in by the applicant. They were, in context, isolated from and independent from the applicant's core business. However, the rent in each year arose somewhat fortuitously and could not be said to have been motivated by tax avoidance. In the opinion of the Tribunal the evidence supports the conclusion that the leasing arrangements which gave rise to the rental income were ``transactions which could have been entered into ordinarily and naturally in the course of the business operations carried on by the [ applicant] before the change-over''. That is, if before the change-over the applicant had found itself in a position where it was able to sell as much as its mill could comfortably produce, then it is more likely than not that it would have obtained premises closer to Fremantle for the purpose of storing the pellets for sale. Mr Meerwald's evidence was that at the time when the Canning Vale and Spearwood properties were acquired the mill was producing close to its 50,000 tonne annual capacity. That storage arrangement facilitated a more efficient business practice than the alternate of transporting from the mill directly to customers in Fremantle and Perth. The venture into obtaining a suitable warehouse was a natural extension of the pellet feed business. The evidence is that the lease to Meadow Lea was not initiated by the applicant and was entered into because the offer was too good to resist. None of these developments could have been foreseen when Jandabup became the controlling shareholder and even later when its shares were acquired by Turquoise. In the opinion of the Tribunal the ``new transactions'' income arose from relatively minor transactions unmotivated by tax avoidance. It makes no sense otherwise because the accounts for each of the two years of income in question show clearly that a net loss arose in relation to the rental activities - in 1991/92 that loss was $45,414.00 and in 1992/93 it was $429.00. These losses arose only because the applicant acquired the premises, which were later leased. Those losses reduced rather than increased the applicant's taxable income before deduction of prior years' losses in each year.
61. For the above reasons, in the opinion of the Tribunal, the applicant has not failed the s 80E(1)(c) test.
Has the applicant failed the s 80E(2) test?
62. This is a temporal test. It requires certain conditions to be satisfied. The first of these is that before the relevant changes in beneficial ownership of shares the applicant will have commenced to carry on a business that it had not previously carried on. The second condition, which is independent of the first, is that before the relevant changes in beneficial ownership of shares the applicant will have entered into a transaction of a kind that it had not previously entered into. The third condition is that if either of the first two conditions are met then the applicant will have done so for the purpose, or for purposes that included the purpose, of enabling the applicant to deduct its prior years' tax losses incurred before the change-over.
63. The evidence supports the conclusion that what the applicant did from inception, when the mill was first commissioned in 1988 and leading up to each of the two changes in beneficial ownership of shares and following was to conduct the same business. It did not engage in any other business at any time. For that reason the preconditions for applying s
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80E(2) to deny the prior years' tax losses do not obtain.Other matters raised by objection and at the hearing
64. On the basis of the previous findings there is no need for the Tribunal to address itself to the other two matters which were agitated before it. However for the sake of completeness the Tribunal will address each.
Whether the respondent issued a valid notice of assessment
65. The applicant argued that the respondent was out of time in issuing the notice of assessment for the year ended 30 June 1992 because it issued a notice which it, the applicant, contends is a notice of assessment and that was issued more than four years preceding the issue of the notice of assessment in question on 23 September 1997. The applicant was not able to produce this so-called original notice of assessment. It was a reference to a document at T12A of the Tribunal documents. The applicant submitted that this was a ``nil'' assessment. Mr McGrade in evidence denied the existence of any notice of assessment prior to that issued on 12 September 1997. He said that the document at T12A is a photocopy of an internal working record and would never have been issued to a taxpayer as it is a record containing details relating to many taxpayers.
66. In the Tribunal's opinion the document at T12A is not a notice of assessment as required by s 174 of the Act. Nor was there any administrative requirement or any attempt on the part of the respondent to serve a copy of that document on the applicant as would be required by s 174. The Tribunal merely notes in passing that if these grounds relied upon by the applicant refer to a year of income following the year ended 30 June 1990 then the provisions of s 166A would be relevant. Since the applicant's income tax return for the year ended 30 June 1989 disclosed a tax loss there could not then be a deemed assessment of taxable income in those circumstances.
The imposition of penalty tax for incorrect return
67. The additional tax for incorrect return is confined to a ``per annum'' component and does not include any ``culpability'' component (T2, p 28). The Tribunal has no jurisdiction to reconsider the additional tax to that extent since it is not part of the assessment: s 170AA(13) and cannot be the subject of an objection decision pursuant to s 175A of the Act and Part IVC of the Taxation Administration Act 1953. Nevertheless, Mr Pickering submitted that the imposition of the additional tax was not according to law. He maintained that the applicant made no false or misleading statement in either of its income tax returns for the years of income ended 30 June 1992 and 1993. The returns each made a claim pursuant to s 80 and s 79E for prior years' tax losses that had been disclosed in the respective prior years' returns. He further submitted that as it was as a result of a tax officer, some years later, auditing the returns for those income years that prompted the imposition of the additional tax. This he submitted was based on an interpretation of the law at the time, that the losses were not available by reason of s 80E (or possibly s 80DA, an issue abandoned by the respondent at the hearing). As the Tribunal understands Mr Pickering's submission, it is that by reason of the contentious nature of these proceedings and the submissions now made, it is apparent that the applicant always had a reasonably arguable case that the deductions claimed would be allowed. With that the Tribunal agrees, at least to the extent that the applicant relies on case law. But it does not seem to matter because as a consequence of the primary decision of this Tribunal the respondent will be required to make a consequential amendment remitting the additional tax in full.
Decision
68. Pursuant to s 43 of the Administrative Appeals Tribunal Act 1975 and for the reasons above the decision under review is set aside and the Tribunal remits the matter to the respondent with the direction that the applicant in entitled, for the years of income ended 30 June 1992 and 1993, to deduct its tax losses pursuant to s 80 and s 79E, incurred in respect of the years ended 30 June 1989, 1990 and 1991 of $531,845.00, $562,373.00 and $334,664.00 respectively.
Footnotes
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