SLEIGHT v FC of T

Judges:
RD Nicholson J

Court:
Federal Court of Australia

MEDIA NEUTRAL CITATION: [2003] FCA 896

Judgment date: 26 August 2003

RD Nicholson J

These proceedings concern a claim made by the applicant as a member of a partnership in the year of income ended 30 June 1995 (``the 1995 year'') for a deduction in the sum of $25 445 pursuant to s 51(1) of the Income Tax Assessment Act 1936 (Cth) (``the Act''), the amount being claimed as a loss by the partnership which was constituted by the applicant and his then wife. The consequential deduction claimed by the applicant as a partner pursuant to s 92(2) of the Act was in the sum of $12722. The claim relates to expenses incurred on management fees ($21000) and administration fees ($1000) for services provided to the applicant and his partner in respect of the cultivation and maintenance of a tea-tree farm from which they claimed to have expected to harvest tea-tree oil on a continuous basis until 2015 for the production and sale of tea-tree oil. The balance of the claim relates to interest on a loan used to finance participation ($3045) and indemnity fees paid in the 1995 year ($400).

Taxation history

2. In the 1995 year of income the applicant returned as assessable income the amount of $61 102. From that amount he claimed as deductions a total of $56 268 losses from primary production. That left a taxable income of $4834 upon which no tax was payable.

3. The losses of primary production as claimed included the applicant's share of the deductions claimed from participation in the project concerned with the cultivation and maintenance of tea-tree oil, known as the Northern Rivers Tea-tree Project (``the Project''). No details of that participation were included in his return as lodged and no notice was given by him in the return that his claim for a deduction was limited to a half share in a partnership through which he participated in the Project. An audit of the promoters of the Project revealed that the applicant had participated in the Project but not that he had participated as a partner in a partnership with his ex-wife.

4. On 7 October 1999 a determination (``the first determination'') was purportedly made by Mr D'Cunha under Pt IVA pursuant to s 177F of the Act that the applicant would not be allowed the whole of the tax benefit claimed by him as tax deductions from the Project in the 1995 year. It was then thought by the respondent that the deductions which had been allowed were in the sum of $25445. On 12 October 1999 the respondent issued to the applicant an amended assessment for the 1995 year to give effect to the determination (``the first amended assessment'').

5. On 7 December 1999 the applicant lodged an objection to the first amended assessment.

6. On 8 December 1999 the respondent issued to the applicant a second amended assessment (``the second amended assessment'') allowing deductions in the sum of $12722 which reduced the deductions previously disallowed by the first amended assessment to the sum of $12722. This followed advice given on 8 November 1999 from the applicant's tax agent to the respondent that the applicant's tax benefit from participation in the Project was half of the amounts disallowed, being his individual share of the partnership loss.

7. On 24 January 2000 the respondent purported to make a determination (``the second determination'') pursuant to s 177F of the Act cancelling a tax benefit in the sum of $12722. This was expressed to be made by Thomas Lund, acting Director of Small Business Executive Level Two.

8. On 21 December 2000 the respondent disallowed the applicant's objection to the first amended assessment on the basis, inter alia, that he was entitled to his share of the deductions claimed by him through the partnership and Pt IVA applied to disallow the deductions claimed by his partnership for management fees, administration fees, interest and indemnity fees. The effect of this objection decision was that it affirmed the first amended assessment to the extent that it disallowed the sum of $12722. The same objection decision of the respondent confirmed that the second amended assessment allowed deductions of $12722 of the $25445 previously disallowed by the first amended assessment.

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9. On 22 December 2000 the applicant elected to appeal the objection decision to this Court pursuant to s 14ZZ(a).

10. On 5 November 2001 the respondent served upon the applicant a new determination made under Pt IVA for the year in dispute (``the third determination''). This is substantially the same as the first determination and second determination save that it was made by Neil Mann, Deputy Commissioner. It is dated 5 November 2001. No notice of amended assessment for the 1995 year has been issued subsequent to the issue of the third determination.

Issues in the proceeding

11. There are two principal issues in this proceeding. The first is whether the amounts for management fees, administration fees, interest and loan indemnity fee (``Project fees'') are deductible pursuant to s 51(1) of the Act. The second is whether Pt IVA of the Act operates to disallow the claimed deductions.

Outline of project circumstances

12. On 14 June 1995 a prospectus (``the Prospectus'') was issued inviting participation in the Project. Applicants were invited to apply for a minimum of two parcels of 500 A class $1.00 shares in the Northern Rivers Land Company Limited (``the Land Company'') with an attached ``right to occupy'' a ``farm'' on land known as the Bungawalbin in northern New South Wales.

13. In 1994 the applicant had been informed about the establishment of the Project and invited to visit the plantation site, which he had done in October of that year. Subsequently he read the Prospectus.

14. On 30 June 1995 the applicant, along with his wife, took the following actions in relation to the Project. Firstly, they completed an application form (``the application form'') to purchase 1000 A class $1.00 shares in the Land Company. Secondly, they signed a loan application, undated. Thirdly, they entered into a Loan Agreement with Northern Rivers Finance Company Pty Limited (``the Finance Company''). Fourthly, they entered into a Loan Indemnity Agreement with the Land Company and the Finance Company.

15. Pursuant to an election in the application form the applicant and his then wife agreed to have the Land Company, as their agent, enter into a management agreement (``the Management Agreement'') with Northern Rivers Plantation Management Limited (``the Management Company''), which it did on 30 June 1995.

16. Particulars of the relevant documents now follow.

Prospectus

17. The Prospectus was issued in the name of the Land Company and the Management Company. It conveyed an invitation to subscribe for A class shares in the Land Company and, if at least two parcels of 500 A class shares were acquired, to exercise a right to enter into the management agreement with the Management Company. It provided that the shares would not be allotted unless the minimum subscription has been subscribed and the amount payable on application for shares so subscribed had been received by the Land Company.

18. Under the heading ``special rights attaching to the shares'' the Prospectus provided that a shareholder would have the following rights:

19. These special rights were said to attach to A class shares until 1 July 2015 at which time any such shares would become ordinary shares, the individual member's business would cease and the Land Company would take over the whole of the production of the operation of Bungawalbin. Individual members would then, as holders of ordinary shares, be entitled to receive dividends from profits made by the Land Company in direct proportion to the number of shares held. The Prospectus stated the accounting policy was not to recommend any dividends during the years 1995 to 1998 and thereafter to be on a director's recommendation to a general meeting.

20. Attached to the Prospectus were certain projections and opinions as well as questions and answers.

Application form

21. Pursuant to the application form the applicant and his then wife agreed to:

22. The effect of the application form expressed in financial terms was that the applicant and his then wife agreed to:

Management agreement

23. Under the Management Agreement the Management Company undertook in respect of the two farms said to have been acquired by the applicant and his then wife (being described under the agreement as ``the Grower'') by acquisition of shares in the Land Company:

``(i) select the seed and substantially establish the two farms and the Grower's business of growing tea-trees and producing tea-tree oil for domestic and overseas consumption by no later than 30 June 1995;

(ii) cause each farm to be physically constituted on specified Production Sites during period of 12 months after the date of execution of the Management Agreement;

(iii) identify the Grower's seedlings collectively with an identification mark to identify the Grower's ownership of the seedlings;

(iv) identify each of the Grower's farms by mark or number on a master plan to identify the Grower's ownership of the oil contained therein;

(v) perform the manager's duties under the Management Agreement;

(vi) prior to 30 June 1996 carry out certain specified work purportedly necessary to establish each of the Grower's farms of not less than 5000 trees per farm planted at a density of approximately 36000 seedlings per hectare;

(vii) pay to the Grower forthwith but in any case within 30 days after its receipt by the Management Company any money that under the Management Agreement was payable to the Grower.''

24. The Manager's duties were to provide the following services to the Grower:

``(a) selection, planting and propagation of tea-tree seed;

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(b) planting on each farm sufficient seedlings to yield not less than 5000 seedlings per farm at a density of approximately 36 000 seedlings per hectare;

(c) maintenance and cultivation of the Grower's farms including growing, watering, weeding, selecting, procuring and applying appropriate fertilisers, nutrients and herbicides and doing all other things reasonably necessary for the purpose of maintaining and cultivating the Grower's farm in accordance with good and proper farming practices;

(d) procure all necessary plant, equipment, machinery, goods and materials to enable the performance of the above services and procure the use at the farm site of suitable irrigation, fencing, drainage and shelter for the trees and any other necessary fixtures or improvements required for the purposes of performing such services;

(e) keep the farm free of competitive weeds, by eradicating the same and exterminating all vermin, noxious animals and insects;

(f) harvest the Grower's trees ideally at a time estimated by the Manager when oil yields from the leaf are at their highest and using facilities provided by the Manager to process the harvested leaf into tea-tree oil;

(g) market, sell and deliver the Grower's tea-tree oil;

(h) arrange insurance for the Grower's tea- trees for such amount or cover and with such insurers as may be determined from time to time by the Manager;

(i) obtain professional services and advice which the Manager may consider necessary or desirable in connection with the maintenance and cultivation of the Grower's farms or the harvesting of the Grower's trees and the marketing of the tea-tree oil produced;

(j) provide research and development into those matters which the Manager considers may benefit the Grower's business;

(k) identify each of the Grower's farms by mark or number on a master plan to identify the Grower's ownership of the tea-tree oil contained therein.''

25. Under the Management Agreement the Grower agreed to pay the Management Company as follows:

26. Pursuant to these provisions the applicant and his then wife jointly incurred an obligation to pay $10500 per farm or a total of $21000 as the Management Fee in respect of the first year.

Loan agreement

27. The applicant and his then wife were described in this agreement as ``the Borrower''. The obligations of the Borrower were to pay interest on the Principal Sum during the first and second year of the Finance Company's higher rate of interest of 18% per annum discounted by 4% if prepaid. From the third year onward, the interest rate was discounted from 18% to 4% per annum where the Borrower had entered into the Loan Indemnity Agreement.

28. The Borrower was also obliged to make a principal repayment of $7400 on or before 30

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September 1995 (which was paid by a cheque drawn from the applicant and his then wife's partnership account on 22 September 1995). Thereafter, if the Borrower entered into the Loan Indemnity Agreement, the Finance Company would accept 50% of the net profit from the business of growing and harvesting tea-trees and distilling the harvest to produce oil (described as ``the Business'') in repayment of the principal sum up to a term of 20 years. Although the agreement by a provision in the schedule authorised further principal repayments of $2050 per annum for a period of 7 years, that was subject to cl 5 of the Loan Agreement which provided that notwithstanding such provision, the Finance Company would accept as repayment of the Principal Sum an amount equal to 50% of the net profit of the Business in lieu of the scheduled amount.

29. There was also a provision whereby the Borrower authorised the Finance Company to remit the Principal Sum to the Trustee to be applied by the Trustee toward the obligation of the Borrower to make payment of the management fees pursuant to the Management Agreement and the balance to the Land Company in payment of administration fees.

30. The Borrower also authorised the Manager (unidentified in the Loan Agreement) to pay to the Finance Company from the net income of the Business the Principal Sum and interest and all other monies which may from time to time become owing to the Finance Company pursuant to the Loan Agreement.

Loan indemnity agreement

31. This agreement was entered into between the applicant and his then wife, described therein as ``the Borrower'', the Management Company as the Indemnifier and the Finance Company as the Lender. The applicant and his then wife agreed to pay to the Management Company as Indemnifier an indemnity fee of $400 and warranted to pay to the Finance Company the first year's interest and the first principal repayment in accordance with the Loan Agreement.

32. The Indemnifier agreed to guarantee to meet interest payments due from year three onwards under the Loan Agreement and to warrant to the Finance Company that at the end of the term of the Loan Agreement it would indemnify the Borrower in respect of any remaining obligations under the Loan Agreement.

Actions taken in purported reliance on project documentation

33. In purported pursuance of the above agreements, in the year ended 30 June 1995:

34. The result was that the applicant and his then wife made cash outlays of $4745 pursuant to the agreements. When the additional liability incurred on their behalf in respect of management and administration fees is taken into account, namely the sum of $21750, the total amount paid or incurred as a liability by the applicant and his then wife was $25445 (not including $1000 for the purchase of shares and $50 for the purchase of the seeds as they were expenditure of capital nature).

35. The transactions were carried out by:

Evidence

36. The applicant called these witnesses:

37. With the exception of what immediately follows, it is convenient that findings of fact based on the evidence be made principally in the course of addressing the contentions raised rather than globally in anticipation of them.

38. The evidence of Dr Nicholson and Mr Hanlon was directed towards the economic and commercial viability of the Project. Dr Nicholson testified that the yield projections in the Prospectus were yields which could be expected. He accepted in cross-examination that once the size of a plantation expanded, a drop in yields could be expected. He also accepted that in the 1995 year the tea-tree industry had been going around ten years, prices were high but it could have been predicted that prices would ultimately drop. However, in re-examination he testified that no such prediction could have been made accurately because there was considerable optimism that tea-tree oil would be registered with the US Federal Drug Administration so that new opportunities would open up. There was then no supply demand problem.

39. Mr Hanlon had provided an expert agricultural report for the Prospectus. He remained of the view that the yield projections in the Prospectus were reasonable. In cross- examination he accepted they were at the higher end of the scale. In re-examination he said that this was based on the availability of water to the Project.

40. Mr Holliday and Mr Lindhout gave evidence relating to the quality of management of the Project. Mr Holliday testified that the results being achieved from the Project were above industry standards. In cross-examination he said yields were based on variables including the size of the tree, the known product from previous harvests, the time of the year for harvesting and the weather. It was only safe to predict yield estimates for 12 months. He would have been happy with targets on the best field blocks of 250 to 280 kilos a hectare. In re- examination he stated that weed control was excellent. However, the money was not available for fertiliser when the price of the oil dropped from around $40 to $17 per kg.

41. Mr Lindhout gave evidence of work he had carried out from 1995 to 1997 and was cross-examined on it.

Deductibility of claimed losses and outgoings: s 51(1)

Expenses not necessarily incurred in the course of a business

42. The first issue raised by the respondent in support of the disallowance of the claimed deductions is that they were not losses or outgoings necessarily incurred by the applicant in the course of a business being carried on by the applicant: s 51(1) of the Act. The respondent's case accepts that a business might be conducted by the applicant although the business activities are carried out by a manager appointed by him:
FC of T v Lau 84 ATC 4929 at 4944; (1984) 6 FCR 202 at 221 per Beaumont J;
Puzey v FC of T 2002 ATC 4853 at 4864 [52]; [2002] FCA 1171 at [52]. However, it is contended that the features of the businesses identified by those cases are absent here. It is said that the applicant did not by the Project documentation establish or conduct a business of his own, growing, harvesting and selling oil from his own trees on his own land. This argument is sought to be advanced by reference to a number of specific features.

Non-identification of interest in land or trees

43. Firstly it is said the applicant had no interest in an identifiable area of land or trees he could call his own. The submission is that while the Prospectus and Articles were expressed in terms of the applicant having an

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identifiable area of land call a farm, the Board had the power under Art 4(3)(b) to relocate a member's Farm to such positions on the land as it may in its absolute discretion determine.

44. There was no evidence that the Board exercised this power. Because of the background against which it must be considered, I do not consider the existence of that power alone results in any lack of identification of the applicant's farm. The relevant background has factual and legal features.

45. The factual circumstances are that not only did the documentation provide for the identification of a member's farm, but this had occurred in the case of the applicant. The evidence of both the applicant and Mr Lindhout support this finding. Identification was in any event a necessary concomitant of the exercise of the right of any member to self-manage the farm or to appoint a contractor to do so.

46. The legal matter is that it is clear from decided authority that even if the applicant's farm could not be identified, that would not mean or support the inference that no business was being carried on: Lau at ATC 4933-4934 and 4943; FCR 207 and 220;
FC of T v Emmakell Pty Ltd 90 ATC 4319 at 4323-4325; (1990) 22 FCR 157 at 161-163. Even less so would the existence of a power of relocation, with no necessary cessation of identification, have that consequence.

Pooling of oil for sale

47. Next, the submissions for the respondent rely on provisions in the Management Agreement and the Prospectus having the effect of obliging the Manager to pool for sale oil from the applicant's trees with that of each other grower (without regard to the quantity or quality of the applicant's oil or that of other growers) and market and sell all such oil. Furthermore reliance is placed on the fact that the Trustee was obliged to distribute a pro rata portion of the proceeds of such sale depending on the number of the applicant's farms without reference to the quality, volume, prices or any other factor in relation to the applicant's oil. Based on this, it is submitted there was not any point in the applicant having land or trees of his own.

48. In Emmakell at ATC 4325-4326; FCR 164 it was recognized there that the manager's right to aggregate the produce of a plantation with that of other land in the vicinity also managed by the manager was a sensible provision to facilitate operations. Further it was said that what was really significant was that the insertion of such a clause was thought to be required, since it clearly underlined the intended proprietary right of the lessee which could not be trenched upon, even in the interests of practicality, without express provision. Here, if the yield were not pooled and each individual farmer had a separate harvest and a separate production of oil, there would be considerable practical difficulties in the Manager proceeding to market. It may be inferred that the pooling arrangement here, far from detracting from the character of the applicant's operation as a business, confirms it as recognized in Emmakell.

Absence of control or obligations

49. The case for the respondent then contends that the applicant had no control of or obligations in respect of his individual interests. This contention is based on certain provisions in the Management Agreement. Firstly it is said that the applicant's rights to terminate the Management Agreement were limited. Under cl 11.2 the applicant had the right to determine the Agreement by notice in writing if the Manager made a material default which remained unrectified after notice; if the Manager was placed in liquidation; if the Manager ceased to carry on business; or if a receiver or a receiver and manager were appointed in relation to the property of the Manager and not removed within 30 days. By cl 12 the occurrence of a force majeure could result in the release of the Manager if the Manager was permanently prevented from performing the obligation by the event of force majeure. By cl 15.2 the Manager was not liable to be removed except in the circumstances in cl 15.3. Those circumstances were the placement of the Manager in liquidation; the Manager's cessation of business; the appointment of a receiver or receiver and manager to the property of the Manager; the failure of the Manager to remedy a contravention of its obligations in a manner that adversely affects the Grower; or if required to do so by the terms of the Investment Deed.

50. The Investment Deed related only to those farmers who had exercised their right to have the Management Company manage their farms. That provided that the Manager could

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resign at any time upon giving three months written notice to the Trustee. The Manager's obligation to resign arose in circumstances akin to those in cl 15.3 of the Management Agreement. In addition, the Manager could be removed if required by persons holding 50% or more in number of the farms which are the subject of valid and current Management Agreements so resolved at a meeting. In addition it was provided that a Farmer could give the Manager notice to correct a default and if the Manager failed to do so or give reasonable excuse within a reasonable time the Farmer could terminate the Management Agreement.

51. The capacity of a Grower to deal with his or her farm, it is said, was further limited by the provision of cl 8.1 disentitling the Grower to transfer, assign, mortgage or otherwise encumber the farm or the trees or oil or any of the Farmer's rights and obligations under the Management Agreement without the prior written consent of the Manager on such terms and conditions as the Manager in its absolute discretion thought fit.

52. The respondent's case also refers to provisions said to indicate that administrative activities were to be carried out by the Manager and the Trustee subject to the Trustee's supervision. These provisions include cl 6.3 which allows the Manager to request the Trustee to establish a Grower's Account to which the Grower's Sale proceeds together with the proceeds of any insurance effected by the Manager with respect to the Grower's trees were to be credited. Reliance is also placed on cll 1, 4, 7 and 17 of the Investment Deed.

53. In these circumstances it is said the Manager was responsible for all farming activities and had an absolute and uncontrolled discretion as regards the powers, authorities and discretions vested in it subject only to instructions given by the Land Company member by special resolution: see Management Agreement cll 9 and 4.4.

54. Additionally it is contended that reporting structures established by the Project documentation focussed on the Project as a whole. This is sought to be supported by reference to a provision in cl 15.9(i) that the Manager shall provide the Grower every six months with a financial statement on the financial position of the Manager.

55. Finally the case for the respondent on this point says that the effect of the cross- examination of the applicant was that he agreed he did not have effective control over the operation carried out on his land and that control was exercisable only by the Growers as a group. In cross-examination a question was directed to the power of reallocation of the applicant's land. The applicant accepted that, depending on the option taken at commencement of the investment, he knew that whatever was on the lot allocated to him could not be used by him separately from the entire group. That was a correct understanding of the effect of his having chosen the option of entering into the Management Agreement option. The proposition which the evidence is called on to support is therefore wider than I consider the evidence justifies.

56. The case for the applicants made in response firstly directs attention to cl 11.2 of the Management Agreement. It is submitted that the right of termination there contained cannot accurately be described as a limited right of termination. I agree with that submission. The right is not unqualified but it is not a limited right. Furthermore it may be exercised by a Grower independently of any other Grower.

57. The Manager's obligations are set out in cll 3.2, 4 and 6 in particular. Clause 3.3 gives the Grower the benefit of a warranty in respect of seedlings used on the Grower's farms and cl 3.4 gives entitlements in that respect. Clause 4 describes ``management services.'' Before enumerating the services to be provided by the Manager to the Grower it is stated:

``Subject to the terms and conditions of this Agreement and subject to such instructions as it may from time to time receive from the Grower, the Manager shall provide the following services to the Grower in respect of the Grower's Farms''

I consider it to be important to the present contention for the respondent that the services so to be provided were ``subject to such instructions as it may from time to time receive from the Grower.'' In my view those words contradict the submission that the Grower had no control of his or her individual interests.

58. Furthermore, so far as the applicant's interests may be co-ordinated with the interests of other Growers who had instructed the Manager to act, the commercial reasons for

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such co-ordination were expressed in cl 4.3, namely that co-ordination was necessary in the interests of providing Management Services to the Grower in an efficient and cost effective manner.

59. In these circumstances I do not consider this contention for the respondent can be accepted.

Manager's role

60. Clause 4.4 provided that subject to the terms of the Management Agreement, the Manager would have the authority, discretion and powers of an independent contractor in the provision of Management Services. Clause 4.5 provided that all contracts or other arrangements entered into by the Manager for the purpose of providing Management Services were entered into as principal and not as an agent for the Grower and that nothing in the Agreement established or created a relationship of master and servant or principal and agent between the Grower and the Manager.

Not an independent contractor

61. For the respondent it is submitted that the Manager was not in any realistic sense an independent contractor engaged to act on the applicant's behalf so that the Manager's position here can be distinguished from that of the Manager in Lau, Puzey and
Cooke v FC of T 2002 ATC 4937; [2002] FCA 1315. This is denied for the applicant for whom it is contended that there is no significance in whether the Manager was an independent contractor or agent for it is certain that it was engaged to act and to perform duties under the Management Agreement and could be dismissed if it failed to perform its duties, so it could not be said the Manager was not acting on behalf of the applicant and the other investors appointing it to manage.

62. The respondent's case appeals to a number of circumstances said to support submission. The first is that by June 1997 the Manager had the management of at least 3000 farms. That fact, if anything, may equally support a conclusion of the commerciality of the Project as the contrary proposition. The date is in any event unrelated to the year of income in question.

Manager's rewards

63. Then it is submitted that it was the Manager and not the applicant who stood to gain from the success of the Project. In support, reliance is placed on cll 7.4, 7.5 and 7.6 of the Management Agreement. It was there provided that the management fee for the period of 13 months commencing on and including 30 June 1995 was the sum of $12 000 per farm (cl 7.1). For the period from 1 August 1996 to 30 June 1997 and 1 July 1997 to 30 June 1998 the Grower assigned to the Manager the proceeds of all trees grown and harvested and oil distilled in the preceding 13 months, subject to a rebate of 75% in respect of oil when the Grower was a holder of the first 7 000 000 A Class shares issued prior to 30 June 1995 and thereby entitled to occupy the first 1400 Farms allocated (cl 7.4 and 7.6). Thereafter the fee was to be calculated as 42.5% of the Grower's Percentage of the Gross Sale Proceeds (cl 7.5).

64. For the applicant in response it is submitted that the provision for the management fee at 75% then 42.5% was commercially explicable as providing an incentive to the Manager to perform its duties. It is not said the fee was excessive so that the significance of the argument is not apparent, so it was submitted. Likewise the reduction in the fee over time is said to have made sense when viewed against the projected yields over time as disclosed by the Prospectus and evidence that tea-trees would reach their maximum yield around the third year and then level out.

Manager's entitlement to repayment of principal

65. The submissions for the respondent additionally place reliance on the provision in cl 5 of the Loan Indemnity Agreement in which the Lender agrees it will accept as repayment of the Principal Sum an amount equal to 50% of the net profit of the Business in lieu of the payment schedule as set out in item 3.2 of Schedule A to that agreement. A feature of this was that there was no external borrowing because moneys advanced by the Finance Company to investors were in turn borrowed from the Manager or the Land Company.

66. In response, the applicant submitted that the evidence of the applicant is that he was unaware of this. Further it is said to be similar to the arrangement in Emmakell. Finally it is submitted that there is no basis for a contention that the absence of external borrowing in some way makes the arrangement less commercial.

67. In my opinion it cannot be concluded that either of these latter features relating to the Manager's rewards deprive the factual

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circumstances in which the applicant sought to be involved as lacking commercial genuineness. Each of the considerations is capable of explanation in terms of the attainment of the commercial objectives of the Project. Neither of them casts any serious doubt upon the essentially commercial character of the transactions: Lau at ATC 4942; FCR 218. Indeed, to the contrary, the presence of them is explicative of the reason why the Manager would be commercially motivated to attain the objectives of the Project.

Nature of the applicant's interest

Farms only roughly identified

68. The evidence of Mr Lindhout and Mr Holliday was that the farms are located in the area marked 1449-1452 on a section of the plantation known as Block B3. That comprised 33.6 hectares accommodating at least 1 209 600 trees and 488 farms. The applicant's farms were not identified on the ground. Rather they were identifiable from a map. The records produced by Mr Holliday are said not to connect the area marked on the map as 1449-1452 with the applicant. Mr Lindhout's evidence was if you wanted to find exactly where a farm was he could probably work this out from the scale of the map and the positioning of the farm.

69. The applicant in cross-examination said he knew roughly where his farm was, had driven within 10 metres of its location and was able to see that trees had not died and were healthy.

70. The cumulative effect of this evidence supports a finding that the farms were identifiable.

Trees not planted or managed for applicant

71. Then it is contended for the respondent that the trees were neither planted for nor managed on behalf of the applicant or his individual business. Reference is made to evidence of Mr Lindhout that he commenced plantation establishment works well before the applicant applied for an interest in the Project. Similarly Mr Hanlon had observed that trees had been planted in anticipation of the commencement of the Project

72. It is not said in the evidence of Mr Lindhout or Mr Hanlon that trees had been planted upon the area or block allocated to the applicant before the applicant invested. The evidence was to the effect that the Land Company started to establish trees on its own land which it retained and that was intended to generate income which would in turn produce franked dividends to the shareholders in the Land Company.

73. Additionally, it is said for the respondent that such plantation records as were produced showed that the plantation was not managed with regard to any trees or land which might be identified as the applicant's but rather by reference to ``field blocks.'' The submission for the applicant in response is that this made commercial sense given the extent of Block B3 over which planting had to occur. I accept this latter submission.

Limited involvement of applicant

Limited activities

74. The case for the respondent also states that only limited activities were undertaken by the applicant in respect of the Project. It is said these were the signing of initial documentation and cheques. However, I accept the submission for the applicant that there is no authority to support the proposition that a person could not carry on business unless actively engaged in it. To the contrary, it is open for management to take place through managers. That is particularly the case where, as here, there is an expertise involved. In any event there was evidence from the applicant that he visited the Project both before and after investing.

Execution of Management Agreement by others

75. It is also said for the respondent that the applicant was further distanced from the Project by the fact that the Management Agreement was executed under a power of attorney on his behalf. As the submissions for the applicant point out, there is no suggestion that the Management Agreement was not validly executed on his behalf in accordance with the Option Form. It was apparent from the evidence that he was aware of the terms of the Management Agreement although he could not recall having read it. However, it was clear he had read the Prospectus which set out the terms of the Management Agreement. Furthermore, in Cooke the same method of execution of the Manager did not lead to any adverse conclusion against the taxpayer.

Absence of communication with financier

76. For the respondent it is also said that the applicant had not communicated or negotiated further with the financier. Why he should have

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done so is not made apparent and I do not consider any adverse inference can be drawn from that fact.

Unbusinesslike treatment of income statements

77. Then the case for the respondent relies upon what is said to have been unbusinesslike treatment by the applicant of the income statements he received. They were uncertified; wrongly deducted an ``Occupation Fee'' of 17.5% rather than an ``Administration Fee'' of 12.5%; and made no provision for interest of 4% payable, under the Loan Agreement, from the applicant's net income. The response for the applicant is that this is not material to a judgement on whether the applicant treated the investment as a sham (which he considers is raised by this argument). The evidence was that he visited the plantation from time to time and took an interest in the statements showing what his share of the proceeds of the oil sales were over the years, so that it is not open to conclude he treated it as a sham.

Funds not at risk

78. The next submission for the respondent addresses the applicant's continuing financial liability. It is said that, save for one prepayment of interest by 30 September 1996, the applicant was not obliged to make further payments. Also his funds were said not to be at risk for management fees or payments of principal or interest on the Loan. This position followed, it is said, from cll 2.4 and 5 of the Loan Agreement and cll 2 and 4 of the Indemnity Agreement. The effect was that (1) as has been seen above, management fees were a percentage of the applicant's proportionate share of the gross proceeds of the oil pooled for sale; (2) interest on the Loan was 4% and paid from the applicant's share of the net proceeds of the oil pooled for sale; (3) of the remaining balance of the applicant's share of the net proceeds, 50% was to be applied in repayment of the Loan principal; and (4) in the event the applicant's obligations under the Loan Agreement could not be met from his share of the proceeds of oil sales, he and his funds were protected by the Indemnity Agreement by which the Manager undertook the applicant's obligations under the Loan Agreement.

79. The applicant's case sees a major fallacy in the preceding submission for the respondent. It accepts the submissions that the applicant's funds were not at risk for management fees or payments of principal and interest on the Loan. However the applicant remained at risk because his net cash outlay, after allowing for the value to him of the tax deduction, was approximately $3500 and those funds were at risk at all times. Further this is not a case where the tax saving exceeded the net cash outlay. The position was that the partnership of the applicant and his wife outlaid cash payments of $12 145 (including the payment of $1000 in respect of the purchase of shares in the Land Company) of which the applicant's proportion was $6072.50. For that he obtained after tax benefits of $2542 and hence suffered a cash loss of $3531 as a result of the arrangements. In response to the argument concerning the manner management fees were to be met, it is again submitted this is a sensible commercial arrangement, the same as applied in Lau, Emmakell and Cooke. I accept those authorities are against the view that loan arrangements of the type there sought to be questioned result in a lack of commerciality in the project in question.

Expenses as outgoings of capital

80. The case for the respondent then turns to the application of the exception to s 51, namely that the losses and outgoings in issue were capital or of a capital nature. It is submitted that examination of the Project documentation reveals that the applicant's initial cash outlay was not in substance for management fees and interest but for the right to a proportionate share of the overall proceeds of the sale of oil produced by the Project. Three features in particular are relied upon in support. The first is the fact that the oil produced from the Project was to be pooled. The second is that the applicant had a right to a pro rata share of the proceeds of sale according to the number of his farms and the respective rights of the Manager and the Finance Company to a share of the proceeds, his statements of income being expressed in terms of 'share of sale of oil.' The third is that the applicant had no further payment obligations in respect of the Project after his initial cash outlay. These propositions are said to find support in
Vincent v FC of T 2002 ATC 4742 at 4755-4756 [62-67], 4757 [ 72]; [2002] FCAFC 291 at [62]-[67], [72];
Clowes v FC of T (1954) 10 ATD 316 at 318-319; (1954) 91 CLR 209 at 218;
Milne v FC of T 76 ATC 4001 at 4005;
Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 36 ACSR 762 at 775.

ATC 4814

81. The circumstances in Clowes are clearly distinguishable from the present. There the investor acquired a right to an aliquot share in nine-tenths of the net proceeds of marketing; the investor did not acquire ownership of the land or the trees; the company to which the payments were made was not the agent of the taxpayer; and the company performed the contract independently: at ATD 318; CLR 217. Milne involved facts found by the High Court to be indistinguishable from Clowes' case. Enviro Systems concerned the characterisation of an arrangement as a franchise or a managed investment scheme and did not involve the application of the Act.

82. In Vincent, the reasoning of the Full Court (Hill, Tamberlin and Hely JJ) and the authorities there cited recognized that it is necessary to examine the circumstances of each agreement which nominates a consideration for services to be performed to determine whether, as may ordinarily be the case, the payments are on revenue account. This requires consideration of what, as a practical, commercial matter, the expenditure was calculated to achieve:
Hallstroms Pty Ltd v FC of T (1946) 8 ATD 190 at 195; (1946) 72 CLR 634 at 648 per Dixon J. It is necessary in that context to consider the character of the advantage sought; the manner in which it is to be used; and the means adopted to obtain it:
Sun Newspapers Limited and Associated Newspapers Limited v FC of T (1938) 61 CLR 337 at 363 per Dixon J. Applying those principles to the circumstances previously set out and having in mind the decisions in Lau, Emmakell,
FC of T v Brand 95 ATC 4633 and
Merchant v FC of T 99 ATC 4221 in particular, I do not consider the moneys outlaid here can be properly characterised as capital in nature. There is no contention the payments were a sham. On their face and in substance they were to secure ongoing services to be provided by the Manager and to advance the business. I therefore do not accept the submission they were capital or capital in nature.

Disproportionality between outgoings and income

83. The case for the respondent then contends that the disproportion between the applicant's outgoings and assessable income is to be explained by the pursuit by the applicant of a taxation advantage. It is said this establishes there was little commercial advantage in the applicant's investment in the Project. Support for the submission is sought from the reference in the reasons of the High Court in
Fletcher & Ors v FC of T 91 ATC 4950 at 4957-4958; (1991) 173 CLR 1 at 18 where the Court accepted that it is ordinarily the case that where the outgoing gives rise to the receipt of a larger amount of assessable income it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of s 51(1) without any need to refer to the taxpayer's subjective thought processes.

84. In
Ure v FC of T 81 ATC 4100 at 4109-4110; (1981) 34 ALR 237 at 249-250 the relevance of the proportion was also recognised, although Deane and Sheppard JJ accepted that no rigid principle can be applied to the weight to be given to indirect objects which a taxpayer had in mind in incurring the outgoing. This must be the case given that subsequent failure of a business cannot universally support a conclusion that it was entered into as a genuine commercial enterprise.

85. In the present case the evidence of Mr Holliday was that after the first year of the Project the price of tea-tree oil dropped from $40 plus to $17. That does not have the consequence that the Project was not founded on reasonable assumptions. The evidence of Dr Nicholson has already been referred to. It was that a person in 1995 could not have predicted accurately that prices would drop because at the time there was considerable optimism that tea- tree oil would have attained registration with the US Federal Drug Administration so that supply-demand problem was not thought to be likely.

86. Furthermore, the presence of an indirect object of the taxpayer to derive a tax advantage from the investment is as consistent with a proper commercial approach as with the contention that such an object was dominant. The applicant's evidence was that his purpose for the investment in the Project was to secure an income stream for the future. He had lost money in the share market crash in 1987 and was wary of the superannuation as a result of numerous changes to the superannuation legislation from 1983 through to the early 1990s.

87. In the submissions for the respondent it is stated that the total projected after-tax return to the applicant from the 20-year Project would

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have been approximately $5542. However, that calculation is based on an assumed tax rate of 48.4% for which there is no foundation and which does not provide for any deductions.

88. Then it is submitted for the respondent that the applicant had no prospect of securing an income stream for the future even on the Project's own budgeted projections. Reference is made to independent material which the applicant said he had read that indicated that the projected 250 kg per hectare yield in the third year and the projected price of $65 per kg were high and could be expected to decline. Mr Hanlon gave evidence that that yield was a reasonable projection. In cross-examination he confirmed his affidavit evidence that the figure of 250 kgs per hectare was set at the high end of the scale. He denied that the achievability of the figure was different from the likely outcome which would be arrived at. In his affidavit Mr Hanlon referred to the Main Camp Tea-tree Oil Project report. This was a report to which the applicant had had regard in making his investment in the Project. There the first harvest had yielded 140 kgs per hectare against a projection of 130 kgs. It was also stated in that report that the manager believed an average yield of 250 to 300 kgs per hectare is achievable from healthy trees on a well- managed plantation. This was in contrast with the estimates in the Prospectus of 38 kgs for year 1; 175 kgs for year 2 and 250 kgs for year 3. The evidence is therefore against the respondent's proposition that the applicant must have understood there was no prospect of the yield being achieved.

89. Finally the submissions for the respondent on this issue contend that the amount of the deductions ($12722 in the case of the applicant alone in the 1995 year and $1005 in the 1996 year) far exceeded the cash outlay and resulted in a tax saving which funded the cash contribution required of the applicant. This is supported by the statement that the applicant did not use his after-tax funds and they were never at risk. Therefore it is said the only aspect of the investment which gave it any prospect of providing a return was that the money which would otherwise have been paid in tax was utilised to make the required cash outlays.

90. For the applicant it is submitted that it is the value rather than the amount of the deductions which is significant. The evidence of the applicant in re-examination was that his total claimed deductions in respect of three investments (including the Project) was around $56000. This left a total taxable income of around $4800. Without the deductions the tax payable would be around $20 000. His cash outlay in respect of the three investments was about $23500. The consequence was that his total cash outlay had exceeded his deductions by around $3500. The applicant also gave evidence that if the Project deductions had been excluded from his return his taxable income would have been around $17500 with tax payable of around $2500. His cash outlay for the Project was just over $6000. He said that consequently without the expectation of a commercial benefit from the Project, he would not have gone into it. Against this evidence the assertions in the submissions for the respondent cannot be accepted.

91. A further relevant aspect is that the applicant's investment in the Project involved him taking up shares in the Land Company from which dividends were to be expected. It reinforces the commerciality of the investment. In addition to the possibility of tax deductibility, the Project offered investment in what then appeared to be a growth industry as well as shareholding in the Land Company which owned the land and the tea-trees and from which it was expected that there would be derived franked benefits after year six continuing to 2015.

92. For these reasons I do not consider the submissions for the respondent on disproportionality can be accepted. The ``commonsense'' or ``practical'' weighing of all the factors establish that the whole outgoing is properly characterized as genuinely and not colourably incurred in gaining or producing assessable income: Fletcher at ATC 4958-4958; CLR 18-19.

Whether scheme to reduce income tax: Part IVA

Statutory provisions

93. Part IVA of the Act permits the respondent to cancel a tax benefit, including to disallow otherwise deductible expenditures, where there is a scheme in connection with which the taxpayer derives a benefit and, having regard to the eight criteria set out in s 177D(b), it can be concluded that the purpose of the person who entered into the scheme was to obtain a tax benefit.

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94. The relevant sections in Part IVA are as follows:

``177A(1) In this Part, unless the contrary intention appears:

...

`scheme' means:

  • (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
  • (b) any scheme, plan, proposal, action, course of action or course of conduct;
  • ...

177C(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

  • ...
  • (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
  • ...

and for the purposes of this Part, the amount of the tax benefit shall be taken to be:

  • ...
  • (d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph;
  • ...

177D This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:

  • (a) a taxpayer (in this section referred to as the relevant taxpayer) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
  • (b) having regard to:
    • (i) the manner in which the scheme was entered into or carried out;
    • (ii) the form and substance of the scheme;
    • (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
    • (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
    • (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
    • (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
    • (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
    • (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),

    ATC 4817

    it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).

...

177F(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may:

  • ...
  • (c) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
  • ...''

Approach to s 177D

95. It is common ground that the test established by s 177D is objective. That is, in concluding whether ``the purpose'' of the applicant in entering into the Project was to obtain a tax benefit, the circumstances in the section have to be considered objectively and not with regard to the subjective purpose or state of mind of the applicant:
FC of T v Spotless Services Limited & Anor 96 ATC 5201 at 5209-5210; (1996) 186 CLR 404 at 421-422;
Eastern Nitrogen Ltd v FC of T 2001 ATC 4164 at 4177-4178 [81-82], 4178 [87-88]; (2001) 108 FCR 27 at [81]-[82] and [87]-[88] per Carr J with whom Sundberg J agreed. In Spotless at ATC 5206; CLR 416 the majority of the High Court referred to ``the purpose'' as a dominant purpose, being one ``which was the ruling, prevailing or most influential purpose.''

96. In determining the applicant's purpose in this sense regard may be had to the evidence concerning not only the applicant but also a promoter or legal or accounting adviser: Vincent at ATC 4761 [100]; FCAFC par 100; Puzey at ATC 4871 [105]; FCA [105]. In determining the purpose from that evidence regard must be had to the each and every one of the matters referred to in s 177D(b) and it is the evaluation of them alone and in combination which leads to a conclusion:
Peabody v FC of T 93 ATC 4104 at 4113-4114; (1993) 40 FCR 531 at 543 per Hill J (with whom Ryan and Cooper JJ agreed). However, in applying the section ``it is important not to elide the question posed by Part IVA, namely, what was the dominant purpose of a relevant party in entering into the transaction (or scheme), with the inquiry, would the transaction (or scheme) have been entered into `but for' the tax benefit?'': Eastern Nitrogen at ATC 4168; FCR 32 per Lee J.

The scheme

97. The respondent's submission was that the scheme in this case was the making and implementation of the various agreements that comprised the Project. The parties to the scheme are said to have included the applicant and his wife, Mr B Hooker of the Management Company, the Land Company, the Finance Company, the Manager, Inteq Custodians Ltd (``Inteq''), Warwick Young and Prospectus and Project Management Services Pty Ltd. The submissions for the applicant did not challenge this formulation.

Tax benefit

98. The tax benefit relied upon is the applicant's proportion of the deduction of $25 445 claimed by the partners in the 1995 year.

Application of s 177D

Marketing of the scheme

99. As a preliminary to the application of the specific provisions of s 177D, the submissions for the respondent contend that the scheme in the present case was conceived and marketed for its tax effectiveness rather than the investment returns. In particular it is said that the information brochure and the Prospectus spelt out the tax effectiveness and the net cash position as a result of tax deductions available to participants in the Project regardless of the expected returns performance of the Project.

100. Examination of the information brochure belies the respondent's submission. It promotes ownership of a tea-tree plantation, investment in an environmentally friendly and profitable operation and a fast growing Australian export industry together with tax advantages. Tax advantage is the eighth of the features promoted inside the brochure, the others being ownership, asset building and income production, capital gain, strong forecasted returns, established marketing infrastructure with over 90% export, environmental aspects and early investor advantage.

101. The submission for the respondent is also said to be supported by a letter from the Land Company to the applicant and his wife. I

ATC 4818

accept the submission for the applicant that this letter does not support the respondent's submission and rather is indicative of the establishment of an operation on a long-term basis of a commercial tea-tree farming venture.

102. The other document relied upon in support of the respondent's submission is the Prospectus which addresses possible tax implications of investment in the Project. Reference to the Prospectus shows that it commenced with an introduction in which the interests available being offered were identified, tea-tree oil was explained, the industry was examined, the land explained, and the Land Company and its directorship identified. The Prospectus then moved to set out matters under the heading ``Structure and Business operations.'' It considered the offer of shares, special rights attaching to the shares, the right to occupy, the management of member's business, the role of the trustee and financial implications of accepting the offer. The third division addressed ``Financial implications.'' It stated that the decision to invest should be considered speculative but that the risks may be offset in part by the taxation benefits. It advised ``while tax deductions are available in the early years, the profits of the member's business will constitute taxable income in the hands of the member and any distribution of profits from [ the Land Company] will be by way of franked dividends.'' Attention was then drawn to the advice of Mr Thomas of a firm of chartered accountants ``but each applicant is urged to seek his own advice as to the taxation consequences of a decision to invest.'' A table then followed illustrating the position of an investor purchasing a minimum parcel of 1000 A Class $1 shares on the basis of various assumptions. These are later carried into projections. Questions and answers follow which focus on various aspects of an investment and conduct of the business. The attached advice of Mr Thomas commenced by emphasising that the taxation consequences could vary depending upon the particular circumstances of each individual participant so that it was essential that independent taxation advice be obtained. The opinion stated a view on the general income tax consequences, including the effect in the circumstances of s 51(1) and Part IVA. I do not read this material as supporting a conclusion that the Prospectus was promoting the Project on the basis that it was being marketed dominantly for its tax effectiveness. To the contrary, a reading of it draws attention to critical matters of commercial significance. When it addresses the tax implications it does so in cautious terms advising close consideration of the position of each investor and stating only a position which may generally pertain if the assumptions in it were apposite to an investor. It was not predominantly promoting the Project for tax reasons. The argument for the respondent on this issue reads the Prospectus selectively.

The manner in which the scheme was entered into or carried out: s 177D(b)(i)

103. The submissions for the respondent commence by stating that all the applicant did was to execute the application form, the loan application, the loan agreement and the option form, and to pay certain amounts by cheque. It is said that no further activity or involvement was required from him yet he was able to assert that he was actively engaged in business, as principal, of growing the trees for the production of oil and was entitled to certain tax deductions.

104. Additionally it is said that approximately 82.53% of the amounts claimed as a deduction in the 1995 year came, not from the applicant, but from borrowing from a party, the Finance Company, associated with the person to whom the amounts were said to be payable, namely the Management Company and the Land Company. The consequences, it is submitted, were that the applicant was only required to use a small amount of his own funds and could obtain in the 1995 year a deduction well in excess of his contribution in that year. For the applicant it is contended that it would be contrary to the operability of normal commercial experience for a borrowing made to meet an investment cost to be said to give rise to a scheme under Pt IVA. Thus, it is said, in Cooke's case virtually all of the investment monies came from borrowed funds. How, it is asked for the applicant, can this affect the commerciality of an investment?

105. The respondent's submissions on this issue also contend that an investor in the Project was able to use any tax refund or tax savings in the subsequent year (the 1996 year) to repay the amount borrowed, pay for annual interest and have a small amount remaining. This submission is based on figures in the Prospectus. The general conclusion is then

ATC 4819

sought to be drawn that the funding arrangements for the scheme did and were intended to secure the result that the tax deductions or tax saving to an investor paid for the investment and were the source of the funds invested. This submission is based on the transcript of a taxation briefing given by Mr Devine, a senior tax partner with a firm of chartered accountants, to 40 accountants and other persons. Examination of the transcript makes apparent that despite the character of the speaker and the audience, from which interest in the tax aspects of the Project could be anticipated, the presentation also addressed commercial matters and the need for business acumen to be applied to the proposal. The applicant's submissions also make the point that there is no evidence that the applicant used his funds in the way stated. It is asked for the applicant if he had so used his funds, what significance would that have had in determining the essential question of whether his dominant purpose was to invest in the tea-tree plantation project with long-term benefits?

106. A further aspect to which the submissions for the respondent turn under this issue is the effect of the Indemnity Agreement. It is said the agreement secured the result that an investor would not be at risk for any more funds than those advanced in the first two years. It was an option to an investor to take up the indemnity and a fee was payable for it. However, as the submissions for the applicant contend, the existence of the indemnity was as consistent with the commercial character of the Project as with the end that the case for the respondent seeks to establish. This is because the existence of the indemnity equally demonstrates the promoter's confidence that there would be a return from tea-tree oil sales to fund the indemnification.

107. The next feature relied upon in the submissions for the respondent is the fact that the moneys advanced by the Finance Company were in turn borrowed from the Management Company or the Land Company so that there was no external borrowing. That feature, however, was present in the circumstances of both Lau and Emmakell.

108. Then it is claimed for the respondent that before investing in the Project the applicant did not assess the Project predictions as a genuine investor risking money or make inquiries about them. Rather he is said to have visited the site in conjunction with Mr Hooker of the Management Company. His affidavit evidence establishes that he took into account his experience in viewing the nearby Main Camp Project and developed confidence in Mr Hooker and the proposed contractor because of their involvement in that other project. He discussed proposed infrastructure and the details of the Project on his visits. He took into account information supplied to him. In the absence of cross-examination of this evidence, this submission for the respondent cannot be accepted.

109. The submissions for the respondent then return to the contention that the applicant was not required to and did not take any further part in the operation of the Project and the associated point that all he was required to do was execute documents. The point is sought to be taken further by the addition of matters to which it is said Mr Hooker carried out without regard to the applicant. These were the harvesting and selling of oil; the absence of a separate record of how the applicant's fees were used; the absence of separate records concerning oil harvested and sold from the applicant's Farms; the absence of recording of work beyond field blocks; the apportionment of oil sale proceeds with regard to the particular investments of each farmer; and the making of decisions in relation to the plantation as a whole and not necessarily for the best advantage of the applicant's farms. These have been previously considered in relation to s 51(1). The issue is what difference do they make to the commerciality of the investment? Reference to the halving of farm size was a later event and it is not suggested it affected the commercial viability of the Project.

110. Next the respondent's case returns again to the proposition that the Project was marketed actively and widely for its tax effectiveness. The contention is supported by factors not established as applicable to the applicant. It also refers to his role in securing the minimum number of subscriptions and procuring the assistance of others to market and sell the investments but those factors are as consistent with his acceptance of the commerciality of the Project as with the respondent's contention.

111. Then follows reliance upon the existence of round robin payments and the absence of external borrowing. Those matters do not affect the genuineness of the

ATC 4820

transactions: Lau at ATC 4933-4934; FCR 207 and Emmakell.

112. A further submission is that the high level of debt in the Project structure permitted high claims for tax deductions but substantially reduced the possible economic returns to the investors from the Project. Support for this is sought in an analysis of a model farm carried out in 1998 which cannot have relevance to the position of the applicant in the 1995 year.

113. Finally it is submitted the applicant was paid commissions to secure investors (a fact not volunteered in evidence) and the money to pay him was provided for in the financing structure of the Project (a fact not revealed in the Prospectus). I agree with the submission for the applicant that this has no consequence for the proposition that a commercial enterprise was being conducted.

114. The case for the applicant is that the arrangements were neither complex nor artificial. The agreements were entered into on an arm's length basis and were entirely commercial.

115. In
Hart & Anor v FC of T 2002 ATC 4608 at 4623; (2002) 121 FCR 206 at 226 (Hill J with whom Hely and Conti JJ agreed adding additional reasons of their own) said that the manner in which the scheme there in issue was formulated, entered into and carried out was explicable only by the taxation consequences. There the borrowed monies which might have been seen commercially as one advance were split into two separate advances with interest on the income producing advance being permitted to remain unpaid, to be capitalised and the capitalised amount then attracting compound interest with the amount which would otherwise have gone towards payment of that interest being directed towards the repayment of the capital outstanding on the private advance. To state that formulation is to distinguish that case from the present. Here the manner in which the scheme was entered into and carried out is equally explicable by commercial reasons in which tax benefit played a significant but not dominating part.

The form and substance of the scheme: s 177D(b)(ii)

116. Many of the features previously relied upon for the respondent again appear here. They are that, contrary to form, the substance of things was that the applicant was a passive investor; the moneys came from internal book entries; the debt beyond year two was never to be paid from the applicant's own funds and may never be repaid; his only economic and legal interest was to a pro rata payment from the pooled proceeds of sales of oil from all trees; the returns upon the investment were not likely to be high. For this latter point reliance was placed upon after tax distribution and the negative cash inflow compared to cash outflow so that, it is submitted, it can be said in real terms the returns on investments were not high.

117. To this the case for the applicant responds that these characterisations are based on proposition which are artificial, namely, treating inputs as not deductible but the returns as assessable. Furthermore, it is submitted that the absence of high returns does not have the consequence that the enterprise cannot be said not to be a business. The reality, it is submitted, is that the form and substance are the same. I agree with each of these latter two submissions as they accord best with the evidence.

118. Again the position here contrasts with that in Hart at ATC 4623; FCR 226-227 where in substance there was one advance but in form two.

The time at which the scheme was entered into and the length of the period during which it was carried out: s 177D(b)(iii)

119. Here it is submitted for the respondent that the scheme commenced with the issue of the Prospectus on 14 June 1995. The applicant entered into the scheme on 30 June 1995 before the end of the 1995 year and at a time when he was marketing it on the basis of its tax advantages. It is said the timing was critical to obtaining the tax deduction benefits necessary to ensure a cash surplus on the investment outlays. This timing is said to have been consistent with the promoted tax effective purpose of the scheme: Puzey at ATC 4870 [ 97]; FCA [97].

120. Additionally it is submitted the applicant was conscious that the timing was critical, as evidenced by him having secured a $200000 investment in order to ensure the minimum subscription for the Project was reached by 30 June 1995, the signature of the documents on that date and the occurrence of the round robin of cheques on that date.

121. Further it is submitted that the timing of the payments by the investors was designed to

ATC 4821

secure a tax refund or saving from the 1995 year paid or saved from liabilities that would otherwise arise in the 1996 year. It is said that refund could then be used to reduce a loan made by the promoters within only three months of entering into the transaction. In response the case for the applicant points to the absence of evidence that such was the position of the applicant.

122. Then it is submitted that the purported loan of $21750 on 30 June 1995 was to be partially repaid as to $7400 within 90 days of the borrowing. As to that portion of the loan it is said there is no commercial justification proffered other than its effect in securing a deduction in the 1995 year for an amount which was $7400 more than if an investor had borrowed only $14350 in the first place. For the applicant it is asserted that the commercial justification for the loan was to enable the management fees to be paid and later repayment does not detract from that commercial reality.

123. Finally under this item the submissions for the respondent say that the active participation of the participants generally ceased in July 1996 when the final prepayments of interest were made pursuant to the loan agreements. On this issue, however, I accept the applicant's submissions that there is no evidence to support this proposition and in his case his active involvement did not cease in 1996 because he visited the Project.

124. For the applicant it is also submitted that the time at which the arrangements were entered into was determined by the moment at which the applicant and his wife entered into the Project. That submission does not assist the applicant. The evidence shows that this is a case where the scheme involved ``a flurry of activity around the end of the tax year directed at obtaining a deduction in that year'': Hart at ATC 4623; FCR 227. Why the issue of the Prospectus did not take place until a date in June in the 1995 year is unexplained by the evidence. Against that is the fact that the applicant's interest in the Project had long pre- dated the issue of the Prospectus so that the Project was not one commenced in a flurry at the end of the tax year. In my view the evidence on this item nevertheless results in it pointing against the applicant: Peabody at ATC 4113-4114; FCR 543.

The result in relation to the operation of the Act that, but for Part IVA, would be achieved by the scheme

125. Here it is common ground that but for Pt IVA, the result of the scheme was that the applicant became entitled in the 1995 year to deductions totalling $12722 in respect of management, administration and indemnity fees and interest and in the 1996 year to deductions totalling $2009 in respect of interest.

Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme: s 177D(b)(v)

126. For the respondent it is said that the result of the applicant entering into the scheme was that he reduced his taxable income for the 1995 year by $12722. Further, the partners were able to recoup all the cash outlay from the consequent reductions in taxable income generated by the entitlement to deductions. The tax savings from the 1995 deduction are said to have covered the interest and principal payments in the 1996 year and enabled the partners to retain a total surplus. For the applicant it is submitted the evidence shows this not to be the case.

127. Then it is said for the respondent that the partners did not have to contribute any more money to the Project, all further payments required under the agreements being met from oil sale proceeds. Additionally the Indemnity Agreement ensured the balance not met from oil sale proceeds would not be called in from the partners. Such a feature, states the case for the applicant, is akin to share farming arrangement and hence not uncommercial.

128. Next the respondent's case submits that the applicant obtained an interest in the Project by expending moneys that were saved by reducing the incidence of income tax that would have been paid on taxable income but for the entitlement to a scheme deduction. The case for the applicant says this is not supported by the evidence.

129. Reference is made to the smallness of the receipts by the applicant of distributions of income in 1999 and 2000 from the Project, being his share of the proportion of oil sale proceeds allocated by the promoters to participants in the No 1 project. Here the case for the applicant relies on Cooke, submitting that the smallness of distributions does not

ATC 4822

result in the project not being commercial. Rather, it is said, the issues are whether the projected returns were reasonable and commercial.

130. Finally under this item it is submitted for the respondent that the partnership obtained commissions from the moneys paid by investors. The significance of this remains unexplained.

131. For the applicant the financial result is said to be that he stood to make a profit (see the expert evidence of Mr Hanlon and Dr Nicholson) and suffered a cash loss of $3531 so that he could only profit if the Project was a commercial success.

132. It does not seem to me that these alleged features relied upon for the respondent point definitively one way or the other. Reduction in taxable income, utilisation of oil sale proceeds, acquisition of an interest from the arrangements and the smallness of income distributions are as consistent with the commerciality of the Project as with any dominant purpose of acquiring a tax benefit. The feature of the recoupment of the cash outlay and payment of interest and principal in the 1996 year is one which could potentially point against the applicant but it cannot do so in the absence of evidence on the application of those features to the particular case of the applicant.

Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result from the scheme: s 177D(b)(vi)

133. Here attention is drawn on behalf of the respondent to the fact that the Land Company and Mr Hooker and associated companies were able to raise funds from investors which met their requirement for funds to exercise an option over the Bungawalbin land, purchase that land and establish a tea-tree plantation. It is said they were able to do so because of the immediate attraction to investors of the tax deductions which funded their initial cash outlays whilst leaving investors with a cash surplus. Reference is also made to the payment of brokerage or commissions paid to promoters and their agents out of the money contributed by the Project investors.

134. As far as the applicant's case is concerned, there was no relevant change in the financial position of any relevant person.

135. References to utilisation of the funds raised for the commercial purposes of the Project and to assist its establishment cannot be assumed to have been made possible because of the attractiveness of the tax deductions to investors. The change in the position of the Land Company and the promoters or their agents is consistent with the advancement of a commercial project as with a project to attain a tax benefit.

136. In relation to the promoter companies, the submissions for the respondent are that the financial obligations of investors were structured on the basis of a loan the promoter companies knew would never be made but which would generate a tax deduction sufficient for investors to fund the cash component of those obligations. Also those tax deductions, it is said, were used as an inducement to attract funds to the plantation which was conducted without regard to their obligations to individual investors. In response it is said for the applicant the agreed facts accept the loan was made by round robin and there is no evidence to support the latter assertion. Furthermore, reliance is placed for the applicant on the evidence of both Mr Lindhout and Mr Holliday to the effect that the plantation was being conducted in a very businesslike way and best efforts were being used to achieve maximum yields from the plantation in the interests of the investors. These latter submissions for the applicant accord with the evidence and I therefore accept them.

Any other consequences for the relevant taxpayer, or any person referred to in subparagraph (vi), of the scheme having been entered into or carried out: s 177D(b)(vii)

137. It is said under this item that the applicant did not have to pay anything further and was not at risk in the investment or the loan he took out. Additionally it is said the Finance Company could not meet the loan obligations it had ostensibly undertaken and both it and the Land and Management Companies had no entitlement to receive further contributions from the investors other than by way of a proportion of oil sale proceeds. It is submitted the poor cash flow position led to the termination of the Project prior to its projected

ATC 4823

termination date in 2015. The relevance of this latter item can only be considered in the light of the evidence that concerning the dramatic drop in the fall of the price of tea-tree oil.

138. Again the submissions for the applicant rely on his cash deficit of $3500 for which he remained at risk. A further incidental consequence was that the applicant stood to gain financially from sales commissions as a result of his participation in the Project, thus earning additional assessable income.

139. The result is that this item is neutral.

The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi): s 177D(b)(viii)

140. Under this item the submission for the respondent is that there was no substantive legal connection other than the contractual relationships created by the Project documents and the applicant's agreement to market the Project. However, it is said for the applicant the promoter Mr Hooker had more extensive business connections as a result of the applicant's group agency agreement to market other projects.

Resolution of application of Part IVA

141. The result of these considerations as put for the respondent is that the dominant purpose of the applicant on the one hand and the promoter companies on the other was that the applicant gained a tax benefit in the form of the deduction of the fees and interest payable pursuant to the agreements. The applicant's case disputes this could objectively be concluded when the value of the tax deduction fell short of the cash outlay. In any event, if that were not the case, it is said all the indicia should be seen as pointing to a genuine commercial investment in a tea-tree plantation expected to run for a long term with clear commercial benefits, including but not limited to the tea-tree oil yields, because in addition to that there was the prospect of the derivation of benefits from the shareholding.

142. It is also submitted for the respondent that entry into the agreements gave the applicant an immediate tax deduction sufficient to fund his participation in the scheme. Also more than 80% of the partner's financial obligations which generated the tax deduction was funded by a limited recourse loan repayable only from the net proceeds of the scheme. The former proposition is said for the applicant to simply not be the case.

143. The overall submission for the respondent is that objectively determined, the dominant purpose of the applicant in entering into or carrying out the scheme was to obtain a tax benefit of sufficient magnitude to provide tax savings to underwrite participation in the Project. Furthermore, it is said a reasonable person considering the circumstances objectively, would conclude that the dominant purpose of the promoter in entering into and implementing the scheme was to achieve a result whereby the applicant would obtain tax deductions that might reasonably be expected not to have been allowable to the applicant if the scheme had not been entered into: cf Puzey at ATC 4871 [104-105]; FCA [104]-[105]. Examination of those paragraphs, however, makes apparent that the purpose there found flowed from the evidence of overwhelming disparity between the cost of the seedlings and their reasonable value which provided the basis on which the arrangements were made there between the applicant in that case and the promoter. There is no such evidence in this case.

144. The applicant contends it is not possible to find the dominant purpose in the making of the investment was the acquisition of the tax deduction. It is said objectively determined it is clear the investment had a commercial purpose. The evidence of the only experts, Mr Hanlon and Dr Nicholson, is that the yield and the price projections were reasonable and achievable and that the tea-tree industry had a fairly confident, optimistic outlook in 1995. Further the evidence of the farm managers, Messrs Lindhout and Holliday, is said to confirm the businesslike manner in which the tea-tree operations were conducted. In those circumstances it is said to have been reasonable for any person entering into the Project in 1995 to have had an expectation of a commercial return from the Project. A structure to achieve the best tax outcome does not, it is submitted, make tax saving the dominant purpose of the transaction. Furthermore it made no sense for the applicant to participate in the Project for the dominant purpose of gaining tax benefits when his cash outlays far exceeded his tax benefits. Additionally this was not a case where the dominant purpose of the promoter was to enable the applicant to obtain a tax benefit.

ATC 4824

145. Having considered the matters raised in the application of s 177D it appears to me that, objectively viewed, the most telling item against the applicant is the flurry associated with the end of the 1995 year. The effect of that is modified by the evidence of the long term interest which the applicant had in the Project prior to the issue of the Prospectus. The assertions for the respondent based on the effect and utilisation of the tax deduction are either consistent with the applicant's purpose for being in the Project being a commercial one or are not sustained in fact. The result is that I am satisfied on a consideration of the items arising under s 177D and the applicant's case concerning them that the applicant's purpose for having entered the Project was not dominantly for the acquisition of the tax benefit. I am left in no doubt that the tax benefit was a significant element in his purpose but I am not satisfied it was the ruling, prevailing and most influential purpose. He was convinced the Project was commercial and that view formed a fundamental part of his purpose in entering into it.

Validity of determination

Applicant's contentions

146. The applicant submits that the first determination made by Mr D'Cunha was not validly made. It is said an act will not fall within the statute unless it be done by the person in whom the statute reposed the power (
Re: The Matter of a Reference Under Section 11 of the Ombudsman Act; ex parte the Director-General of Social Services (1979) 2 ALD 86 per Brennan J). Section 177F reposes the power in the Commissioner of Taxation, or his duly appointed delegates pursuant to s 8 of the Taxation Administration Act 1953 (Cth). Mr D'Cunha is not the Commissioner of Taxation, nor does be purport to be a duly appointed delegate of the Commissioner. Nor did he sign the determination in the name and on behalf of the Commissioner or a delegate of the Commissioner. He signed the determination in his own name and in his own right. In these circumstances, it is submitted the determination is invalid.

147. Alternatively, it is submitted if Mr D'Cunha was authorised to make determinations, the determinations the subject of these proceedings were not made validly. The respondent has discovered a document which appears to be an authority to make s 177F determinations given by Stephen Chapman, Deputy Commissioner of Taxation Small Business Program, to all officers from time to time holding, occupying or performing, inter alia, the duties of the position of Executive Level 2 Officers, but only ``... in the name and on behalf of the person from time to time holding, occupying or performing the duties of the Deputy Commissioner of Taxation...''. Mr D'Cunha does not purport to make the determinations in these proceedings ``in the name and on behalf of'' the Deputy Commissioner of Taxation. Accordingly, it is submitted Mr D'Cunha did not act as agent in the manner required by the instrument which ostensibly might have conferred power on him and the determination is invalid.

148. Additionally it is submitted the making of a determination under s 177F involves the exercise of discretion which can be challenged in Pt IVC proceedings. Assuming for the moment that Mr D'Cunha otherwise made a valid determination, in that he had appropriate authority, it is submitted the exercise of discretion was clearly miscarried. The submission is that the exercise of discretion in relation to the 1995 year was clearly premised on a tax benefit of $25445, not $12722, which is now accepted by both parties as the correct tax benefit. The identification of a completely different tax benefit would need to be the subject of a fresh exercise of discretion if there were to be a valid determination.

149. The second determination made by Mr Lund is also said to be invalid for the same reasons as outlined in the preceding two paragraphs.

150. Further, it is argued the second determination was made after the issue of the amended assessment but before the receipt of the applicant's objections. It is submitted that because that determination was not carried into effect by the issue of a further amended assessment, it cannot be used to defend the assessments the subject of these proceedings (
FC of T v Jackson 90 ATC 4990 at 5003; (1990) 27 FCR 1 at 17 per Hill J;
DFC of T v Richard Walter Pty Ltd 95 ATC 4067 at 4083-4084; (1995) 183 CLR 168 at 202-203 per Brennan J). It is said s 169A(3) does not apply because the second determination was not made in connection with the consideration of the objections lodged by the applicant.

ATC 4825

151. Further, the third determination was made after the issue of the amended assessment disallowing the applicant's deductions, after the receipt of the applicant's objections and after the Commissioner had mad a decision on the applicant's objection. Again it is submitted that because the determination was not carried into effect by the issue of a further amended assessment, it cannot be used to defend the assessments the subject of these proceedings (Jackson at ATC 5003; FCR 17 per Hill J; Richard Walter at ATC 4083-4084; CLR 202-203 per Brennan J). It is said s 169A(3) does not apply because the third determination was not made in connection with the consideration of the objections lodged by the applicant.

Reasoning

152. The first determination was made in the name of Mr D'Cunha, Director of Small Business Executive Level 2, although it was described as a determination made by the respondent to cancel a tax benefit. He was not a delegate or any other person to whom delegation had been made pursuant to s 8(1) of the Act. In
Mochkin v FC of T 2002 ATC 4465 at 4485 Ryan J said:

``... the nature of the powers reposed in the Commissioner by s 177F entails that those powers `were not intended to be exercised only by the Commissioner or his delegate personally but may be exercised through a properly authorized officer';
O'Reilly & Ors v Commissioners of the State Bank of Victoria & Ors 82 ATC 4671 at 4674; (1982-1983) 153 CLR 1 at 12-13 per Gibbs J, which was applied by Callinan J in Dooney v Henry (2000) 174 ALR 41.''

As appears from the affidavit of Mr Stephen Chapman, Mr D'Cunha was such a properly authorized officer. I therefore do not consider the first determination is invalid. Nor do I consider the first determination was not validly made - it was headed as a determination made by the Commissioner:
Vincent v FC of T 2002 ATC 4490 at 4517 and on appeal at 2002 ATC at [98]. The fact that the quantum of the tax benefit initially assessed was different from that actually obtained does not lead to a different result: Spotless Services Limited at ATC 5211; CLR 424.

153. The second determination is not invalid for the same reasons.

154. Further the making of the determinations is part of the process of making the assessment (see the assessment in the affidavit of Mr Beckett-Cooper) and not liable to challenge in this proceeding save in respect of matters going to substantive liability: Richard Walter at ATC 4070 and 4083-4084; CLR 178 and 203. Accordingly any deficiency is validated by s 175: Richard Walter at ATC 4072, 4075, 4078-4080, 4080, 4081, 4087-4088, 4094-4095, 4104-4105; 182; 187-188; 193-195, 196-197, 198-199; 209-211; 222-223; 240-242. No argument was made that this case was one falling within the conditions delineated in
R v Hickman (1945) 70 CLR 598.

Other issues

155. In the response to the applicant's statement of claim it is stated in the alternative for the respondent that s 51(2A), s 82KL, s 82KJ or s 82KZM of the Act operated to disallow the whole or part of the amount claimed as a deduction in the 1995 year. The submissions for the applicant were unanswered for the respondent.

156. The respondent says that by reason of s 226 or s 226L and s 170AA of the Act the applicant is liable to pay, by way of interest and penalty, the amounts of interest and additional tax included in the assessment for the 1995 year. The submissions for the applicant did not contest this assertion in the event the application was otherwise unsuccessful.

157. Likewise a contention in the response that each of the agreements referred to in par 2 of the statement of claim is a sham was not supported by any argument to that end save arguably that identified earlier in the reasons.

Conclusion

158. For the above reasons I consider the appeal should be allowed and the respondent's objection decision dated 21 December 2000 be varied by allowing the applicant's objection to the extent of excising from the applicant's taxable income for the year ended 30 June 1995 all of the amount of $12 722 claimed but disallowed as deductible business expenses.

THE COURT ORDERS THAT:

1. The appeal be allowed.

2. The respondent's objection decision dated 21 December 2000 in respect of the applicant's amended assessment issued on 12 October 1999 for the income year ended 30 June 1995 be varied in the following manner:

ATC 4826

3. The respondent pay the applicant's costs of the appeal.

 

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