HEANEY v FC of T

Members:
E Fice SM

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2013] AATA 331

Decision date: 23 May 2013

Egon Fice (Senior Member)

23 May 2013

1. Dr Thomas Heaney is a medical practitioner. He operates a medical practice in Red Hill, Rosebud and Wagga Wagga. He also described himself as having a second occupation, which is primary producer.

2. Dr Heaney had incurred losses from his primary production activities which he wished to set off against income from his medical practice.

3. On 2 September 2010 Dr Heaney applied for a private ruling, requesting the Commissioner of Taxation (the Commissioner) allow him to claim losses incurred in the 2010 to 2013 income years in respect of his primary production activities, cattle and sheep farming. This was because Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) prevents losses of individuals from non-commercial business activities being offset against other assessable income in the year the loss was incurred. However, Division 35 also contains discretionary provisions which allow the Commissioner to offset losses against other income if the income requirement and one of the other tests are satisfied. Dr Heaney submitted that he satisfied the requirements for the exercise of the Commissioner's discretion.

4. The Commissioner issued a private ruling on 20 September 2010 in which he refused to exercise the discretion in s. 35-55 (1)(a) and s. 35-55 (1)(c) of ITAA 1997.

5. Notwithstanding the Commissioner's decision on Dr Heaney's private ruling application, on 2 June 2011 Dr Heaney lodged his income tax return for the 2010 income year disclosing a loss of $179,187; the loss being attributable to his cattle breeding and sheep farming activities. The Commissioner issued a notice of assessment for the 2010 income year on 10 June 2011 disallowing Dr Heaney's offset claim due to losses from primary production.

6. Dr Heaney lodged an objection pursuant to Part IVC of the Taxation Administration Act 1953 (the Administration Act) to the 2010 income year assessment on 20 July 2011. On 22 November 2011 the Commissioner issued a Notice of objection decision disallowing Dr Heaney's objection. On 20 January 2012 Dr Heaney lodged an application pursuant to s. 14ZZ of the Administration Act with the Tribunal seeking review of the objection decision.

7. I am required to determine whether:

ONUS OF PROOF

8. As Dr Philip Bender of counsel, who appeared on behalf of the Commissioner, correctly submitted, Dr Heaney bears the onus of proving that his tax assessment is excessive. Section 14ZZK of the Administration Act provides:

14ZZK Grounds of objection and burden of proof

On an application for review of a reviewable objection decision:

  • (a) the applicant is, unless the Tribunal orders otherwise, limited to the grounds

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    stated in the taxation objection to which the decision relates; and
  • (b) the applicant has the burden of proving that:
    • (i) if the taxation decision concerned is an assessment (other than a franking assessment) - the assessment is excessive; or
    • (ii) if the taxation decision concerned is a franking assessment - the assessment is incorrect; or
    • (iii) in any other case - the taxation decision concerned should not have been made or should have been made differently.

9. The High Court of Australia (Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ) in
Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614, when dealing with s. 190 (b) of the Income Tax Assessment Act 1936 (ITAA 1936) which provided that the burden of proving that the assessment was excessive lies on the taxpayer, made that abundantly clear. Toohey J said, at 631:

I agree with Wilcox J. in the Federal Court that "the task for the taxpayer, upon an appeal or review under Pt V of the Act, is to show that the amount of money for which tax is levied by a particular notice of assessment exceeds the actual substantive liability of the taxpayer". As his Honour points out, a taxpayer will generally discharge that onus by satisfying the court or tribunal that his or her true taxable income is less than that appearing in the assessment. He or she may do so by pointing to some error of computation or, as suggested by McAndrew, by showing non-compliance with statutory conditions precedent to the imposition of liability, in that case arising by reason of an amended assessment. A taxpayer does not necessarily discharge the onus of showing that an assessment is excessive, merely by showing that moneys treated by the Commissioner as income are in truth not the income of the taxpayer, though that may be a step in demonstrating his or her taxable income to be less than the assessment.

10. Brennan J described how a taxpayer might discharge the burden of proof. He said, at 624:

The manner in which a taxpayer can discharge that burden varies with the circumstances. If the Commissioner and a taxpayer agreed to confine an appeal to a specific point of law or fact on which the amount of the assessment depends, it will suffice for the taxpayer to show that he is entitled to succeed on that point. Absent such a confining of the issues for determination, the Commissioner is entitled to rely upon any deficiency in proof of the excessiveness of the amount assessed to uphold the assessment, though the taxpayer is limited to the grounds of his objection.

11. Dr Bender also submitted that a taxpayer must go further than showing that the assessment is wrong. He submitted the taxpayer must show what the correct assessment should be, and what corrections should be made in order to make the assessment right, or more nearly right. He referred to the High Court decision in
Trautwein v The Federal Commissioner of Taxation (1936) 56 CLR 63, where Latham CJ said, at 88:

It [the assessment] is prima facie right - and remains right until the appellant shows that it is wrong. If it were necessary to decide the point I would, as at present advised, be prepared to hold that the taxpayer must, at least as a general rule, go further and show, not only negatively that the assessment is wrong, but also positively what correction should be made in order to make it right or more nearly right. I say "as a general rule" because, conceivably, there might be a case where it appeared that the assessment had been made upon no intelligible basis even as an approximation, and the court would then set aside the assessment and remit it to the commissioner for further consideration.

12. Dr Bender also submitted that evidence by or on behalf of Dr Heaney was essential because, in the absence of evidence, I could not infer facts in his favour. He referred to the High Court decision in
McCormack v Federal Commissioner of Taxation (1979) 143 CLR 284 at 303, where Gibbs J said:

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The burden may be discharged by drawing inferences from the evidence. In some cases in which all the relevant facts are known, and there is no material upon which it might properly be concluded that the property was acquired for the relevant purpose, the inference may properly be drawn that the property was not acquired for the relevant purpose. But it is not enough, even when all the facts are known, that there is no material upon which it may be concluded that the property was acquired for the purpose mentioned in s. 26 (a). If a taxpayer can succeed, simply because there is no evidence from which it can be concluded that the relevant purpose existed, that must mean that the burden of proving the existence of that purpose lies on the Commissioner. That in my respectful opinion would be to invert the onus of proof. The taxpayer will succeed if the proper inference from the evidence is that the property was not acquired for the relevant purpose, but if there is no evidence as to the purpose for which the taxpayer acquired the property the appeal must fail.

13. Finally on this topic, Dr Bender submitted that there was no onus on the Commissioner to show that the assessment was correctly made. He referred me to the High Court decision in
Gauci v Federal Commissioner of Taxation (1975) 135 CLR 81 where Mason J said, at 89:

The Act does not place any onus on the Commissioner to show that the assessments were correctly made. Nor is there any statutory requirement that the assessments should be sustained or supported by evidence. The implication of such a requirement would be inconsistent with s. 190 (b) for it is a consequence of that provision that unless the appellant shows by evidence that the assessment is incorrect, it will prevail.

14. According to Dr Bender, there are a number of respects in which Dr Heaney's evidence was deficient. I have dealt with this submission below where the contention arises.

DEFERRAL OF LOSSES FROM NON-COMMERCIAL BUSINESS ACTIVITIES

15. Division 35 of the ITAA 1997 deals with losses from non-commercial business activities. Section 35-1 describes the function of this Division in the following way:

This Division prevents losses of individuals from non-commercial business activities being offset against other assessable income in the year the loss is incurred. The loss is deferred.

It sets out an income requirement and a series of tests to determine whether a business activity is treated as being non-commercial.

The deferred losses may be offset in later years against profits from the activity. They may also be offset against other income if the income requirement and one of the other tests are satisfied, or if the Commissioner exercises a discretion.

16. The object of the Division is set out in s. 35-5. This is of some relevance to this matter because I am required to interpret the rather broad discretionary provisions set out in s. 35-55. Section 35-5 provides:

17. The general rule which applies to taxpayers who have secondary sources of income from other business activities is set out in s. 35-10 (2) which provides:

18. In other words, where a business activity makes a loss in an income year, that loss cannot be deducted from other assessable income in that income year until such time as the business activity makes a profit. It may then be deducted against income from the business activity. The losses accumulate and are deferred. The business activity losses can only be deducted against other assessable income if the income requirements and one of the other tests (set out in s. 35-10 (1)) are satisfied, or if the Commissioner exercises his discretion under s. 35-55 of ITAA 1997.

19. It appears that a taxpayer may treat business activities of a similar kind as part of the same business activity. Section 35-10 (3) provides:

20. The exceptions to the rule in s. 35-10 (2) are set out in s. 35-10 (1) which provides:

21. Section 35-30 provides that the rules in s. 35-10 do not apply to a business activity for an income year if the amount of the assessable income from the business activity for the year is at least $20,000. The Commissioner accepted that Dr Heaney satisfied the assessable income test having returned total business income from primary production in the amount of $64,425 for the 2010 income year. However, Dr Heaney did not satisfy s. 35-10 (2E).

22. Section 35-10 (2E) provides:

You satisfy this subsection for an income year if the sum of the following is less than $250,000:

  • (a) your taxable income for that year;
  • (b) your *reportable fringe benefits total for that year;
  • (c) your *reportable superannuation contributions for that year;
  • (d) your *total net investment losses for that year.

    For the purposes of paragraph (a), when working out your taxable income, disregard any excess mentioned in subsection (2) for any *business activity for that year that you could otherwise deduct under this Act for that year.

23. Dr Heaney did not satisfy s. 35-10 (2E) because his taxable income for the 2010 income year as disclosed on his income tax return, disregarding the losses made on his business activities, was $516,522.

24. The rule in s. 35-10 (2) does not apply to an activity described as a primary production business if the assessable income for that year from other sources not relating to the business activity is less than $40,000 (s. 35-10 (4)). It clearly does not apply to Dr Heaney.

25. Therefore, it is only the discretionary provisions set out in s. 35-55, if exercised in Dr Heaney's favour, which would permit the offsets he has claimed in respect of his primary production business activity.

26.

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The relevant discretionary provisions are as follows:

35-55 Commissioner's discretion

  • (1) The Commissioner may, on application, decide that the rule in subsection 35-10 (2) does not apply to a *business activity for one or more income years (the excluded years ) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:
    • (a) the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disasters; or

      Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

    • (b) for an applicant who carries on the business activity who satisfies subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:
      • (i) because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45; and
      • (ii) there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will either meet one of those tests or will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)); or
    • (c) For an applicant who carries on the business activity who does not satisfy subsection 35-10 (2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:
      • (i) because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and
      • (ii) there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

      Note: Paragraphs (b) and (c) are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example an activity involving the planting of hardwood trees for harvest, when many years would pass before the activity could reasonably be expected to produce income.

DID DR HEANEY CONDUCT A SINGLE FARMING BUSINESS

27. There was a dispute between the parties as to whether Dr Heaney conducted a single farming business at two discrete locations, with some differences in the nature of activities conducted at each location, or whether the farming activities at each location should be described as a business activity in its own right for the purposes of Division 35 of ITAA 1997. Dr Heaney contended that the two farms, known as Big Springs and Humula, are two separate business activities. He submitted that Big Springs was affected by special circumstances outside his control in the 2010 income year. Therefore, the Commissioner should have exercised his discretion under s. 35-55 (1)(a) in respect of the losses incurred in farming that property. As for the Humula property, Dr Heaney contended that the Commissioner should have exercised the discretion in s. 35-55 (1)(c) because the business conducted on that property was newly commenced primary production and, because of

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its nature, had not produced a profit for the 2010 income year.

28. It will assist if I briefly explain the history of Dr Heaney's farming activities which I understood was not in dispute. The history is taken from a witness statement made by Dr Heaney which was taken into evidence.

29. Dr Heaney purchased 100 acres of land and a house at Big Springs, which is near Wagga Wagga, in 1995. This plot of land is called Woodridge. In 1997 he purchased an additional 450 acres (called Stokes) which was across the road from Woodridge. He commenced farming activities at Stokes after purchasing 10 Murray Grey cows and an Angus bull. Woodridge and Stokes are collectively described by Dr Heaney as the Big Springs farm. Dr Heaney constructed dams, cattle yards, sheds and purchased machinery to be used on Stokes and Woodridge. After acquiring the Stokes property, he purchased additional calves and also started sheep breeding in 2002 by purchasing a herd of 300 Merino ewes and 4 Poll Dorset rams.

30. By 2011 Dr Heaney said he had some 550 sheep, about 50 lambs and 11 rams on the property at Big Springs. He said the Woodridge land is no longer used as part of that farm. In addition to cattle and sheep, he planted oats, triticale and lupins each year at Big Springs. He said that in most years he would bale the crops for hay or graze the crops for stock feed.

31. On 28 July 2009 he contracted to purchase a 760 acre farm at Humula, which he described as being on the edge of the Snowy Mountains. Dr Heaney explained that the reason for purchasing the Humula farm was to allow him to run a significant number of cattle, freeing up the Big Springs farm to primarily stock sheep. He said that in March 2010 he moved 45 cows and 1 bull from the Big Springs farm to Humula. He also bought another 92 heifers for the Humula farm at about that time.

32. In cross-examination Dr Heaney was asked to explain the level of interaction between the two farming properties. He said that effectively, they were two separate farms. The equipment used for the Humula farm stays on that property and is not used at the Stokes farm. He said that the people who worked on the Humula farm and the equipment used there was all in respect of the cattle run on that property and that it is completely separate to the cropping and sheep-work done at Big Springs. He said there was no overlap between the two farms. He also explained that the distance between Big Springs and Humula was roughly 30 or 40 km.

33. Mr Andrew Wright, a solicitor who appeared on behalf of Dr Heaney, referred me to Taxation Ruling TR 2001/14 which deals with Division 35 non-commercial business losses.

34. TR 2001/14 is described as a public ruling for the purposes of Part IVAAA of the Administration Act. Although Part IVAAA was repealed in 2005, Division 358, which appears in Schedule 1 of the Administration Act, now deals with public rulings. Schedule 2 of the amending act, No 161 of 2005, contained transitional provisions including Item 29 which dealt with the status of existing rulings. Item 29 (1) provided that a public ruling in force immediately before the commencement day (1 January 2006) had effect on and after that day as if it were a public ruling made under Division 358 in Schedule 1 to the Administration Act. As is set out in s. 357-60 (1) of Schedule 1 of the Administration Act, where a taxpayer relies on a ruling which applies to him or her, the ruling binds the Commissioner.

35. Mr Wright submitted that the Division 35 uses a composite phrase, business activity, as opposed to simply business. While the word business is defined in s. 995-1 (1) of ITAA 1997, the expression business activity is not defined. The word business is defined as: includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. However, the expression business activity is defined in TR 2001/14 at paragraph 34 in the following way:

'*business activity' means an activity which may be a complete *business in itself, or part of a larger *business, and may include, applying subsection 35-10 (3), "… *business activities of a similar kind" (see paragraphs 36 to 39 following);

36. In the Ruling section of TR 2001/14, the Commissioner, in explaining what is meant by the term business activity, said at paragraph 38:

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However, while a *business may be subdivided into a number of different *business activities this cannot be carried out to the point where the composite term in Division 35, "*business activity", is deprived practical meaning. An activity that forms part of a taxpayer's overall *business will not be a separate "*business activity" for the purposes of Division 35 unless it is capable of standing alone as an autonomous commercial undertaking of some sort (see further paragraphs 40 to 46 on identifying separate and distinct *business activities for the purposes of Division 35).

37. Taxation ruling TR 2001/14 refers to the Federal Court of Australia decision in
Allied Mills Industries Pty Ltd v Commissioner of Taxation (1989) 20 FCR 288 where Gummow J said, at 304:

Viewed in the light of the conduct of business of the taxpayer as a whole, one cannot sensibly say that the taxpayer went out of business, that the taxpayer never parted with a substantial part of its business undertaking, or that its profit making apparatus was materially crippled.

It may be that the activities of a taxpayer are so disparate in character and so discrete in the manner they are conducted, that one properly asks questions of the type posed by the facts of this case by reference to some but not the whole of those activities; examples of several distinct businesses conducted by the one taxpayer may be provided by the Board of Review decisions
Case 52, 6 CTBR (NS) 328 (retail jeweller and real estate letting agent), and
Case 2, 11 CTBR (NS) 7 (printer and seller of goods on commission). But, in my view, for the reasons I have given, the present is not such a case.

38. TR 2001/14 then goes on to suggest that a similar approach may be taken in respect of Division 35 regarding an individual taxpayer carrying on the one business.

39. With respect, in my opinion, the use of the Allied Mills case to establish that argument by analogy is not convincing. This is particularly so when one examines the facts of the case. The taxpayer, Allied Mills, received compensation for the termination of an agreement under which it was the sole distributor and a del credere agent for a company in respect of the distribution of particular products. In effect, the taxpayer had given up the right to exploit the distributorship under the agreement and thus to pursue profits. The question which Gummow J was required to resolve was whether that compensation bore the character of a capital receipt or income. His Honour found that the termination agreement did not involve the taxpayer parting with a substantial part of its business undertaking presented in the course of carrying on its business. It was therefore of an income character. Gummow J referred to the taxpayer conducting its business activities in several divisions. He then said, at 304:

But that does not have the consequence that when asking the questions thrown up by this case, one looks to a plurality of frameworks, capital structures, profit making apparatus and the like, to see whether they or any of them are mortally wounded, destroyed, crippled, maimed, or, on the contrary, quite uninjured.

40. The Allied Mills case needs to be understood in this context. Despite that, TR 2001/14 states, at paragraph 41:

In certain situations their *business activities may be so discrete in character and in the manner they are conducted that the question arises whether they are carrying on separate and distinct *business activities for Division 35 purposes. Whether this is so is clearly a question of fact an overall impression, like the question of whether they are carrying on a *business.

41. Paragraph 42 of TR 2001/14 goes on to state that given the purpose and context in which the expression business activity appears in Division 35, separate business activities are those which are each capable in their own right of producing assessable income and having attributed to them amounts which would otherwise be deductible. The taxation ruling then states at paragraph 43 that to be identified as a separate business activity for the purposes of Division 35, the activity or set of activities need to exhibit the following:

42. In my opinion, this somewhat prescriptive approach, which is overly rigid, appears to arise out of reliance on the Allied Mills case. While that approach most certainly was appropriate when attempting to establish whether the receipt of compensation by Allied Mills was of a capital or income nature, Division 35 is concerned more broadly with the nature of business activities. That much is clear from the insertion of s. 35-10 (3) which permits a taxpayer to group business activities together for the purposes in Division 35 if they are of a similar kind. The use of the words of a similar kind makes it clear that the activities need not be discrete.

43. While I accept that s. 35-10 (3) has a different function and that the taxpayer may choose to group those activities, undoubtedly if it is to their advantage, the very fact of its existence in Division 35 provides a contextual basis for determining what is meant by the expression business activity. In fact, s. 35-10 (3) commences with the words: In applying this Division,…. In my opinion, this strongly suggests that even though business activities may be related, they may nevertheless be treated as discrete business activities.

44. It is also of some significance that Division 35 refers to a business activity rather than simply a business. The word business is a defined term in s. 995-1 of ITAA 1997 and it has a broad general meaning. It seems to me that the expression business activity is used in Division 35 for the reason that, as is set out in s. 35-10 (2), amounts sought to be deducted as a consequence of that activity need to be deductible under ITAA 1997. In particular, the general deductions provisions as set out in s. 8-1 (1)(b) refer specifically to losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. In fact the Explanatory Memorandum to the New Business Tax System (Integrity Measures) Bill 2000 provides, at paragraph 1.17:

Division 35 only operates in a framework where an individual (including an individual in partnership) is considered to be carrying on a business activity. Business deductions relating to that activity and to which Division 35 would apply, must be otherwise deductible under the ITAA 1936 or the ITAA 1997 before Division 35 can have any application….

45. The Explanatory Memorandum acknowledges that a business activity may consist of several parts (paragraph 1.18). It then states, at paragraph 1.19:

If the activity is not a part of another business activity it should be viewed in isolation and treated as a separate business activity. Whether or not an activity is simply a part of a particular business activity, or a separate business activity in its own right, will depend on the circumstances of each case.

46. The Explanatory Memorandum sets out an example where a taxpayer conducts a business activity as an olive farmer producing olive oil. More recently, the taxpayer started producing bottled olives in an attempt to expand her business. The new activity was sustained independently from the olive oil market activity. The Explanatory Memorandum states that Division 35 will treat the taxpayer's bottling activity as part of her primary business activity of producing olive oil. That is on the application of the activity of a similar kind provision. While the example goes on to state that the taxpayer in those circumstances could aggregate her activities for the purposes of Division 35, the choice to do so remains with the taxpayer. Clearly, the taxpayer in that example need not do so and those two activities might be properly described as discrete business activities. That is even though this is clearly a primary production business which involves the growing of olive trees. The fruit so produced is processed differently under each activity and, no doubt, is directed at different markets. So

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while there are similarities and some overlap of activities, there are also significant differences.

47. In my opinion, in order to determine whether a taxpayer conducts discrete business activities or whether those activities should be described as a single business activity remains to be determined by examining the circumstances of each activity on a case-by-case basis. Quite clearly, that does not involve an artificial distinction between those activities.

48. Dr Bender referred me to the case
The Taxpayer and Commissioner of Taxation [2012] AATA 695 as a case in which the Tribunal accepted that the question was one of fact and overall impression as to whether the activities were sufficiently distinct and discrete to demonstrate that they were separate business activities. In that case, which also involved a primary production business, the Tribunal set out the characteristics of each operation, but only as described by the Commissioner. With respect to the Tribunal, the reasons for decision do not explain why the Tribunal arrived at its decision. It simply said, after setting out the various characteristics of the activities as described by the Commissioner, at paragraph 28:

I see the Commissioner's point: it is unclear from the description of the scheme whether the two aspects of the operation are "discrete in the manner they are conducted": see
Allied Mills Industries Pty Ltd v Federal Commissioner of Taxation (1988) 20 FCR 288 at 304, referred to in the Commissioner's statement of facts, issues and contentions at [79].

There was neither analysis of the taxpayer's claimed nature of the discrete activities nor any reason why the Commissioner's view of the activities should simply be accepted without question. Frankly, it is unhelpful.

49. Dr Heaney's evidence was, essentially, uncontroversial. His evidence was that in the 2010 income year, there were two farms, Big Springs which is a 450 acre property and Humula which is a 780 acre property. Big Springs was primarily used for sheep and crops and Humula for cattle production. The Big Springs property, which originally comprised two properties, Woodridge and Stokes, had been used for cattle farming, sheep farming and cropping prior to the income year in question. In cross-examination Dr Heaney said that cattle yards were built at Woodridge before he acquired the land at Stokes. Stokes was bare land when purchased, having been cleared of its trees. There were no improvements in terms of dams or internal fences or laneways. He said that he built machinery sheds there and put in the dams. With some other helpers, other improvements were built on Stokes including fencing and stockyards. The purpose of putting in many extra dams at Stokes was in an attempt to mitigate the effects of drought. He also explained that a second line of fencing was put in and trees and shrubs planted between the fences.

50. Dr Heaney testified that prior to the purchase of Humula, he started out with some Murray Grey cattle at the Woodridge property. After purchasing the land referred to as Stokes, he attempted to increase the number of cattle, buying steers in lots of 100, bringing them back to fatten them up over a short period of time and then selling them off.

51. In around 2002 Dr Heaney said that he commenced farming sheep almost entirely at Stokes. He built sheep yards, machinery sheds and shearing sheds at Stokes. Although Dr Heaney also testified that he purchased another property at O'Brien's Creek Road near Wagga Wagga in 2000, which was also used to graze sheep, that property was subsequently sold. In 2009, he purchased the Humula property. That property was purchased without stock and the cattle from Big Springs were moved onto the Humula property. In cross-examination Dr Heaney said this occurred in about December 2009 when he settled the purchase of Humula. Dr Heaney testified that there had only ever been cattle at Humula, never any sheep.

52. Dr Heaney was also taken to the financial reports prepared by his accountants for the year ended 30 June 2010. I had in evidence a livestock trading account relating to cattle and a livestock trading account relating to sheep. Those accounts indicate that at the year ended 30 June 2010, Dr Heaney had a total of 206 head of cattle and 672 head of sheep. In cross-examination Dr Heaney confirmed that all of the cattle at that time were on the Humula property and that all of the sheep were at the

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Big Springs property. Dr Heaney also confirmed that there were 97 head of cattle at the Big Springs farm at the start of that financial year but that they were moved to Humula when that property was purchased.

53. Dr Heaney was also taken to a document described as Divisional Profit and Loss Statement for the year ended 30 June 2010. That document discloses a gross profit from cattle trading of $20,324.64 and from sheep trading $17,734.86. Other sources of income were from agistment, $3834.00 and sales of wool $3336.91. However, the expenditures relating to that financial year appear to be grouped together and no distinction is made between the Big Springs and the Humula properties.

54. Dr Bender submitted that in reality, Dr Heaney conducted a single farming activity, which was carried on over a number of years, and included cattle, sheep and crops. Over the years Dr Heaney simply purchased more land onto which some of the stock was subsequently moved in an activity which was already being carried on, at Big Springs. On the other hand, Mr Wright submitted that a business activity does not necessarily have to constitute the entire business. He submitted that while it was correct to say that Dr Heaney carried on a primary production business, for the purposes of Division 35, the Tribunal is required to determine the nature of each business activity rather than simply determining the nature of the business Dr Heaney conducted. In my opinion, Mr Wright's submission is correct.

55. I have come to that conclusion because the evidence in this case points to two discrete business activities in the course of primary production. While it is correct to say that Dr Heaney commenced cattle production at Big Springs, following the purchase of the Humula property, the cattle at Big Springs were moved to that property and Dr Heaney acquired a substantially greater number of cattle. His evidence was that he then ceased any cattle production activities at Big Springs, focusing solely on sheep and cropping on that property. While I accept that there are similarities and possibly overlap between the activities conducted on each property, the activities themselves and the expenses incurred in each of those business activities is not necessarily the same. For example, Dr Heaney referred to shearing sheep at Big Springs. The rearing of beef cattle at the Humula property obviously involves no such activity. Nor does it require the equipment or expenditure to conduct that business activity. Cropping on the Big Springs property also requires different equipment and no doubt expenditure for that particular activity. Furthermore, in the 2010 income year, the properties themselves were at very different stages of development. Much of the infrastructure for the conduct of the business activities at Big Springs was already in place while Humula required substantial capital investment to enable the cattle breeding activities to take place. Dr Heaney's evidence was that the fencing at Humula was damaged when he purchased the property and the pasture was of poor quality due to overstocking by the previous owner. He testified that there was drought in the years prior to his purchase of the property and that he was required to establish the farm at Humula from bare paddocks caused by the drought.

56. The balance sheet as at 30 June 2010 records that the value of the asset, cattle on hand, increased from $19,074.00 to $46,371.53 in the financial year. While the combined profit and loss statement does not distribute expenses between the two properties, logically, the different nature of the business activities on each property would result in different expenditure at each property. It cannot be properly said that the business activity conducted at Humula is part of the business activity conducted at Big Springs. Although they are different activities with different expenditures, they do nevertheless form part of an overall business which can be described as primary production business. However, for the purposes of Division 35, unless Dr Heaney chose to group those two business activities, he is at liberty to treat them as discrete because that is their inherent nature.

THE SPECIAL CIRCUMSTANCES DISCRETION - s. 35-55 (1)(a)

57. Mr Wright submitted that the business activity conducted at the Big Springs farm was subject to special circumstances outside Dr Heaney's control, namely, the effect of drought.

58.

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In his witness statement, which was taken into evidence, Dr Heaney said that the Big Springs farm had been affected by poor rainfall during the year ended 30 June 2010 and much of the preceding decade. He said that the drought in the area where the Big Springs farm is located had been documented.

59. Dr Heaney testified that the drought resulted in additional costs being incurred to maintain stock because it had negated the growth of pastures and sufficient feed had to be purchased and brought in from other locations. He said the drought also had the effect of causing green slime and algae to grow in the dams which inflicted disease upon the stock. Poor returns were realised on those stock which were sold and the drought also contributed to poor stock levels and falling cattle and lamb prices. Dr Heaney also testified that in late 2010 Big Springs was subjected to floods which resulted in many kilometres of fencing washed away, pumping equipment being damaged or lost and stock being drowned. There was also a large inundation of weed seeds creating a problem and causing an increased use of expensive selective herbicides. As a result of the floods, the paddocks were too wet to harvest and were instead grazed off over the summer as feed.

60. I had in evidence drought maps and declarations from the New South Wales Department of Primary industries. Those maps disclose that in the year in question, where the Big Springs farm is located was declared a drought area between July 2009 and September 2009 inclusive; a marginal/drought area in January 2010; a drought area in February and March 2010; and a marginal area between April and June 2010. There were flooding rains in October 2010, which of course is in the following income year.

61. Dr Bender submitted that Dr Heaney had not discharged his onus of proving that a tax profit would have been made by the Big Springs farm as a separate business in the 2010 income year but for any special circumstances that were outside his control as the operator of the farm. In fact, Dr Bender submitted that on a stand-alone basis, Big Springs would have made a tax loss simply on the interest expenses even if all other costs were not accounted for.

62. According to the Commissioner, it would only be reasonable to exercise the discretion if the business activity in question would have made a tax profit but for the special circumstances outside the control of the operators; and one of the four tests described in s. 35-10 (1)(a) of ITAA 1997 was met or would have been met but for the special circumstances. In fact Dr Bender referred me to paragraph 13A of TR 2007/6 which states:

For those individuals who do not satisfy the income requirement in subsection 35-10(2E) special circumstances are those which have materially affected the business activity, causing it to make a loss. For these individuals the Commissioner's discretion in paragraph 35-55(1)(a) may be exercised for the income year(s) in question where:

  • • but for the special circumstances, the business activity would have made a tax profit; and
  • • the activity passes at least one of the four tests or, but for the special circumstances, would have passed at least one of the four tests.

63. As best I am able to determine, the pre-requisite requiring the business activity to pass at least one of the four tests set out in s. 35-10 (2A) of ITAA 1997 arises from the Note set out immediately beneath s. 35-55 (1)(a). However, I disagree with the Commissioner's submission regarding the making of a tax profit and one of the four tests described in s. 35-10 (1)(a) being satisfied. That is because, as I explain below, following amendments made to Division 35 in 2009, a taxpayer earning in excess of $250,000 per annum no longer had access to the four objective tests in order to establish that the business activity was commercial in nature.

64. The discretionary provisions set out in s. 35-55 of ITAA 1997 need to be examined with some care where the taxpayer seeks to rely on the special circumstances provision set out in s. 35-55 (1)(a). The first point to observe is that the Note which applies to s. 35-55 (1)(a) forms part of ITAA 1997 (see s. 2-45). While this may, at first glance, appear to contradict the Acts Interpretation Act 1901 (the Interpretation Act) given that s. 13, which deals with material which forms part of an Act, does not include

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Notes, that is subject to what is set out in s. 2 (2) of the Interpretation Act which provides:

Clearly, a contrary intention is set out in s. 2-45 of ITAA 1997.

65. The second point is that the Note to s. 35-55 (1)(a) refers to one of the tests, which is clearly a reference to ss. 35-30, 35-35, 35-40 and 35-45. However, unlike s. 35-55 (1) (b) and (c), there is no reference to satisfying s. 35-10 (2E), the $250,000 income limit. Therefore, at least on its face, one might understand s. 35-55 (1)(a) to apply to a taxpayer irrespective of whether he or she meets the income limit requirement in s. 35-10 (2E).

66. The question which then arises is whether the special circumstances discretion is enlivened in circumstances where the taxpayer, despite not satisfying the income requirement in s. 35-10 (2E), has nevertheless met one of the tests. That is because the Note appears to indicate that the purpose of the discretion in this subsection appears to permit a taxpayer to set off business activity losses against other income where, but for the special circumstances claimed, the taxpayer would have satisfied one of the four tests. In order to answer that question, I need to examine more closely all of the provisions in Division 35 and the context in which the Commissioner's discretion is intended to be exercised having regard to the objects of that Division.

67. The basic principles involved were recently clearly restated by the High Court of Australia (French CJ, Hayne, Crennan, Kiefel and Bell JJ) in
Certain Lloyd's Underwriters Subscribing to Contract No IHOOAAQS v Cross (2012) 293 ALR 412. French CJ and Hayne J said, at 417 - 419:

It is as well to begin consideration of this issue by re-stating some basic principles. It is convenient to do that by reference to the reasons of the plurality in
Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (at [47]):

[47] This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the text itself. Historical considerations and extrinsic materials cannot be relied on to displace the clear meaning of the text. The language which has actually been employed in the text of legislation is the surest guide to legislative intention. The meaning of the text may require consideration of the context, which includes the general purpose and policy of a provision, in particular the mischief it is seeking to remedy.

The context and purpose of a provision are important to its proper construction because, as the plurality said in Project Blue Sky, "[t]he primary object of statutory construction is to construe the relevant provisions so that it is consistent with the language and purpose of all the provisions of the statute". That is, statutory construction requires deciding what is the legal meaning of the relevant provision "by reference to the language of the instrument viewed as a whole", and "the context, the general purpose and policy of a provision and its consistency and fairness are surer guides to its meaning than the logic with which it is constructed".

Determination of the purpose of the statute or of particular provisions in a statute may be based upon an express statement of purpose in the statute itself, inference from its text and structure and, where appropriate, reference to extrinsic materials. The purpose of a statute resides in its text and structure. Determination of a statutory purpose neither permits nor requires some search for what those who promoted or passed the legislation may have had in mind when it was enacted. It is important in this respect, as in others, to recognise that to speak of legislative "intention" is to use a metaphor. Use of that metaphor must not mislead. "[T]he duty of a court is to give the words of a statutory provision the meaning that the legislature is taken to have intended them to have".

…

The search for legal meaning involves application of the processes of statutory

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construction. The identification of statutory purpose and legislative intention is the product of those processes, not the discovery of some subjective purpose or intention.

68. Kiefel J also described the approaches to statutory construction in the following way, at 436:

…The starting point for this process of construction is the words of the provision in question read in the context of the statute. Context is also spoken of in a broader sense as including the general purpose and policy of the legislation, in particular the mischief to which the statute is directed at which the legislature is intended to remedy.

It is legitimate to resort to materials outside the statute, but it is necessary to bear in mind the purpose of doing so and the process of construction to which it is directed. That purpose is, generally speaking, to identify the policy of the statute in order to better understand the language and intended operation of the statute. An understanding of legislative policy by these means does not provide a warrant for departing from the process of statutory construction and attributing a wider operation to a statute than its language and evident operation permit.

69. It is clear that Division 35 is concerned to prevent taxpayers who conduct non-commercial business activities from claiming losses from those activities and setting them off against other assessable income in a particular income year. Hence the introduction of the rules under s. 35-10. However, the reason for the introduction of the income requirement under s. 35-10 (2E) is not clear from a reading of the provisions in Division 35 or having regard to its objects. Its function is reasonably clear, because to obtain the benefit of setting off losses from business activities against other assessable income, a taxpayer, generally, must satisfy the income requirement and pass one of four tests set out in s. 35-10 (1)(a). However, as s. 35-10 (1)(b) provides, the benefit of setting off losses from business activities against other assessable income may also be available to a taxpayer where the Commissioner has exercised the discretion as set out in s. 35-55 for the business activity in a particular year. That subsection is not subject to a taxpayer satisfying the income requirement in s. 35-10 (2E).

70. In these circumstances, in my opinion it is permissible to resort to extrinsic materials in order to better understand the purpose of the tests referred to in s. 35-10 (1)(a) and the income requirement which is found in s. 35-10 (2E). This is in accordance with s. 15AB of the Interpretation Act.

71. Section 35-10 (2E) was introduced by Tax Laws Amendment (2009 Budget Measures No. 2) Act 2009 (No. 133, 2009). The Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 explained, at paragraphs 2.13 and 2.14:

These amendments recognise that the current non-commercial loss rules apply in a discriminatory way, because taxpayers with high incomes are more able to meet one of the four objective tests. These amendments limit access to the four objective tests to individuals who meet an income requirement.

These amendments also provide the Commissioner with a new discretion in cases where an individual does not meet the income requirement, but can nonetheless independently demonstrate that their business is genuinely commercial.

72. In the table set out under paragraph 2.14 of the Explanatory Memorandum, the purpose of the objective tests is stated as follows:

Four objective tests are used to work out if a business activity is commercial in nature.

73. The 2009 amending Act also introduced another subsection to the discretionary provisions set out in s. 35-55. In effect, the new provision is identical to the existing s. 35-55 (1)(b) in that it deals with a start-up business activity and an objective expectation of producing assessable income for an income year greater than the deductions attributable to it for that year, thus indicating the business activity is commercially viable. However the difference between the two subsections is that (b) refers to the inability to satisfy the four objective tests while (c) simply refers to the business activity not having produced or which will not produce assessable income greater than the deductions attributable to it. Furthermore,

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the new provision (s. 35-55 (1)(c)) expressly applies to a taxpayer who does not satisfy s. 35-10 (2E) in that his or her income exceeds $250,000 for the income year in question. Quite clearly, the reference in subsection (c) to the business activity not having produced or which will not produce assessable income greater than the deductions attributable to it is substituted for the commerciality test set out in each of the four objective tests. That simply follows because, as the Explanatory Memorandum explains, the four objective tests cannot be accessed by a taxpayer who does not meet the income requirement. Nevertheless, a taxpayer who does not meet the income requirement is not excluded from the exercise of the Commissioner's discretion in s. 35-55, at least in respect of a start-up business activity.

74. The problem, if it is in fact a problem, is that subsection (a) of the discretionary provisions appears, because of what is stated in the Note, to allow a taxpayer to demonstrate that but for the special circumstances claimed, he or she would have satisfied one of the four objective tests. As I have explained, a taxpayer who does not meet the income requirement cannot have access to the four objective tests. The question then is whether a taxpayer who does not meet the income requirement can nevertheless seek to have the Commissioner exercise his discretion under the special circumstances provision and, if so, whether the taxpayer must nevertheless demonstrate the commercial viability of the business activity by proving, on the balance of probabilities, that but for the special circumstances, the business activity would have been commercially viable in the income year in question.

75. Dr Bender submitted that in this case, it is paramount whether or not, but for the special circumstances, the business activity would have derived a tax profit. I understand the expression tax profit to mean that the business activity will produce assessable income greater than the deductions attributable to it. He submitted it would be unreasonable to allow a tax loss to be deducted in circumstances where a taxpayer did not meet the income requirement and the business activity would not have made a tax profit but for the special circumstances. Dr Bender further submitted that a discretionary power, such as that set out in s. 35-55, should not be exercised where to do so would defeat the policy of the relevant statute. He referred to the Tribunal decision in
Delandro and Commission of Taxation [2006] AATA 859 where the Tribunal purportedly relied on the Federal Court decision in
Federal Commissioner of Taxation v G.M. Swift & Ors (1989) 89 ATC 5101 at 5118.

76. Although it is correct to say, as does Dr Bender, that the Tribunal made the statement he referred to above, French J in the Swift case said precisely the opposite. What his Honour said, at 5118 was:

It may be said that the Tribunal's exercise of its discretion has undermined the objectives of the Act. If that be so, then it is for the legislature to consider confining the dispensing power.

77. Although I disagree with Dr Bender's reasoning regarding the exercise of discretion in subsection (a), I am of the view that the discretion is available to be exercised where a taxpayer does not meet the income requirement in s. 35-10 (2E) provided that the taxpayer is able to prove, on the balance of probabilities, that but for the special circumstances claimed, he or she would have produced assessable income greater than the deductions attributable to the business activity. That is because the Note to subparagraph (a), which was left unchanged following the 2009 amendments to s. 35-55, indicates that the discretion was intended to be exercised in circumstances where the taxpayer would have satisfied one of the four tests which establish commercial viability but for the special circumstances. Upon the introduction of the 2009 amendments, although subsection (c) was introduced so as to, effectively, maintain the discretionary provisions in subsection (b) where a taxpayer did not meet the income requirement and did not have recourse to the objective tests, the commerciality test became that which is now found in subsection (c). It would be inconsistent to accept that the discretions which deal with a start-up business activity can apply to a taxpayer who does not meet the income requirement but who can satisfy the objective expectation of producing assessable income greater than deductions attributable to it, and not apply the same test to the discretion in (a).

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This is particularly so when the object of the Division is to prevent losses from non-commercial activities being offset against other assessable income.

78. Accordingly, I find that the Commissioner's discretion set down in s. 35-55 (1)(a) will be enlivened in Dr Heaney's case if he is able to prove, on the balance of probabilities, that but for the special circumstances (drought and floods) which he claims, his primary production activities at Big Springs would have produced assessable income greater than the deductions attributable to them.

79. In essence, Dr Heaney's claim regarding the business activities at Big Springs is that it was affected by drought and flood in the 2010 income year, being circumstances outside of his control. It was those circumstances which resulted in the deductions attributable to the business activities conducted at Big Springs exceeding the assessable income produced from that property.

80. Therefore, I need to examine the evidence to determine whether the Big Springs property was affected by drought and flood in the 2010 income year and, if I were to find that was the case, whether one or both of those events was the cause of the loss incurred from those business activities. In other words, I need to determine whether, but for the claimed drought and flood in the 2010 income year, the business activity conducted at the Big Springs property would have been commercial in that it would have produced assessable income greater than deductions attributable to it.

81. Although Mr Wright, in his closing submissions, said that he believed it was not disputed that Dr Heaney satisfied one of the four tests referred to in Division 35 which would ordinarily indicate that the activity was commercial, for the reasons I have set out above, because Dr Heaney's other income exceeded $250,000 in the 2010 income year, he cannot rely on those tests to establish a commercially viable business activity.

82. I should also say at the outset that, having heard Dr Heaney's evidence, I have no doubt whatsoever that he has worked extremely hard at farming activities about which he is clearly passionate. However, that in itself, does not necessarily result in a business activity which can be described as commercial, and which would have produced assessable income in excess of deductions save for the drought and flood he said he experienced in 2010 income year.

83. In cross-examination, Dr Heaney was asked about when he first commenced his farming activities. He agreed that he first purchased a 100 acre property at Gerogery West in 1991 where he originally farmed emus. That farming venture failed and the land was then used to grow plantation timber. That property was sold in about 2005. He also purchased another small lot, about five acres, in 1992 at Wirlinga the near Albury in New South Wales. That property was subsequently sold as well in about 1994.

84. He testified that he purchased the house and land (100 acres) at Big Springs in 1995. That was the property known as Woodridge. He commenced a cattle breeding operation on that property. That property was sold in around 2006. Dr Heaney purchased another portion of land in 1997, directly adjacent to Woodridge, known as Stokes. That property comprised some 450 acres. In cross-examination Dr Heaney explained that Stokes was basically bare land which had no improvements such as dams and internal fences or laneways. He said that property was extensively improved by putting in dams, building cattle yards, machinery sheds and fencing. Dr Heaney said that he had been putting roughly two dams a year on that property to alleviate the effects of drought.

85. In his witness statement Dr Heaney said that after purchasing Stokes, he bought an additional 87 calves and started sheep breeding in 2002 by purchasing a herd of 300 Merino ewes and four Poll Dorset rams.

86. Dr Heaney testified that the Stokes property and the Humula farm were financed by bank loans. In cross-examination Dr Heaney said that in 2010, his family also held land at Red Hill in Victoria. He said that was a small acreage which was held basically as a home where he had some trees and chooks and stuff. Dr Heaney also testified that he was hoping to sell the Red Hill property in order to pay out one of the mortgages on the other properties in

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full and decrease the other loan or to pay off part of both loans.

87. In cross-examination Dr Bender put to Dr Heaney that since commencing his farming activities in 1994, he made losses on those activities in every year. Dr Heaney answered: Obviously that is not the intent, but so far we have, yes. He agreed that he had made tax losses in every year since 1994 on his farming activities. That evidence in itself gives rise to serious concern about the commerciality of Dr Heaney's farming ventures. However, despite that, I need to look carefully at all the circumstances in the 2010 income year in order to determine whether the farming activities were of a commercial nature and, if that was the case, the cause of the losses from the Big Springs farm in that year.

88. I had in evidence financial reports for the 2010 income year which included comparative figures for the 2009 income year. The Big Springs farm was used essentially for sheep farming and some cropping. Although Dr Heaney had 97 head of beef cattle on that property at the commencement of the 2010 income year, and those numbers apparently came down to about 45 cows and 1 bull at the time the Humula farm was purchased, those cattle were moved to the Humula property when that was acquired. In his evidence in chief, Dr Heaney said that the 2010 income year was about the eighth year of the drought and the stock were in a relatively poor condition. He said that because buyers knew farmers had stock they had to unload because they couldn't afford to feed them, prices were greatly depressed. Despite this evidence, the financial statements dealing with livestock trading concerning sheep indicates a gross profit of $17,734.86. That is reflected in the profit and loss statement prepared specifically for the Big Springs property. In addition to that income, wool sales were said to have earned $3337. If one then goes to the divisional profit and loss statement for the year ended 30 June 2010 which also discloses comparative figures for 2009, it can be seen that in the 2009 income year, the gross profit from sheep trading was $0 although sales from wool was comparable with the 2010 income year, being $3881.51. It appears there was no income from cropping in either year. Clearly, although Dr Heaney claimed that income from the Big Springs farm was significantly reduced in the 2010 income year due to drought and subsequent floods, the income statement does not reflect that.

89. In addition to the drought charts prepared by the New South Wales Department of Primary Industry, I had in evidence average rainfall figures for the calendar years 1942 to 2010 produced by the Bureau of Meteorology. As one would expect, there is a wide divergence between the upper range (in excess of 900 mm) and the lower range (between 200 - 300 mm). However, it is significant that the mode (the typical or most common case) is between 400 - 500 mm. The next most frequently occurring score is between 500 - 600 mm followed by 600 - 700 mm. In the 2010 income year, the total rainfall was 633.6 mm. While I accept what Dr Heaney said in evidence about the timing of that rainfall being significant, it cannot be said that the total rainfall in the 2010 income year was atypical. In fact, it was better than most years since 1942.

90. Dr Heaney participated in an Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) survey for the 2010 income year. Dr Heaney was asked about the survey in cross-examination and he explained that a person from ABARES came out to do an interview with him and he gave that person, off the top of my head, the numbers as best he could remember at the time. The problem with those numbers is that they cannot be reconciled with what is produced in the financial reports. The figures provided by Dr Heaney are also from the combined operations at Big Springs and Humula. The ABARES survey discloses total cash receipts from his farming activities of $84,261 (I note that the precise nature of this figure does not accord with Dr Heaney's evidence that he provided off the top of his head figures). According to the financial reports, the total value of sales of cattle and sheep was $57,252. While that did not include sales from wool, that would add some $3834. The total of cash receipts recorded in the financial reports of the 2010 income year is $61,086. It appears that Dr Heaney has overstated the total cash receipts figure given to ABARES by some $23,175. When the cash receipts figure from his farming activities (Humula and Big Springs) is compared with

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other farms in his region, although those other farms are approximately 24% larger, they produced almost 4 times the amount of total cash receipts. In addition to that, Dr Heaney's total cash costs exceeded the average in his region by $89,413. Of course I accept that there would be additional expenditure incurred in establishing the Humula farm in that income year although the costs are, nevertheless, grossly disproportionate.

91. Perhaps the most significant figure on the ABARES survey relates to farm capital, debt and equity as at 30 June 2010. The capital value of livestock, other tradeable stocks, plant and equipment and the capital value of land and improvements are almost identical to the other farms in his region, being only some 9% less. However, the farm debt which Dr Heaney said was $2,000,000 is compared with the average in the region of $619,153, being some 3.2 times larger.

92. While I accept what Dr Heaney said about the figures provided to ABARES being off the top of his head, they are nevertheless significant in disclosing under-production on Dr Heaney's properties which are also burdened with a very significant amount of debt. Dr Heaney's debt to equity ratio is approximately 70.07% while that of farms in his region was 19.8%. In fact, if one were to calculate the debt to equity ratio based on the financial reports, and in particular the balance sheet as at 30 June 2010, it exceeds 100%. In my opinion, that is clearly significant and it discloses the major impediment to Dr Heaney conducting his primary production business activities at a tax profit. These are highly negatively geared operations. It suggests that the income from all of the primary production activities plus an additional source of income is required to service the two mortgages on the properties which, at the relevant time, stood at $460,297.67 and $875,000.00. In addition, Dr Heaney also had an overdraft account with the National Australia Bank in the sum of $100,000. In fact, a profit and loss statement prepared for the Big Springs farm for the year ended 30 June 2010 discloses income from sheep trading and all sales of $21,072 against interest on the Flexiplus Mortgage of $29,930. The additional expenses for that income year which amount to $86,039, except for two depreciation amounts totalling $9496, are cash expenses and required funding in that particular income year.

93. Even if Dr Heaney were to increase the rate of production at the Big Springs farm to the level of comparative farms in his region, he would not have made a tax profit in the 2010 income year. Assuming the ABARES figures are representative, if Dr Heaney earned comparative additional income for sheep and lamb sales, wool sales and sales of other crops, it would only have added about $48,608 to his income. And that figure is calculated without attributing any additional variable costs to the additional production.

94. Among the documents produced by the Commissioner under s. 37 of the Administrative Appeals Tribunal Act 1975 (the AAT Act) was a document from Elders described as a 2009/2010 Plan Tom Heaney (the Elders document). Dr Bender submitted that should this document be admitted to evidence, I should attach little, if any, weight to it in respect of the Big Springs farm. Dr Bender pointed to a number of problems including:

95. I agree with Dr Bender's submissions regarding problems with the Elders document. At best, the document appears to be a plan, as described on its cover sheet. Without questioning the author of that document, it is impossible to come to any sound conclusions regarding the reasons why Dr Heaney was not able to achieve the production figures suggested. I have attached little weight to it.

96. Mr Richard Reid, who described himself as a qualified farm adviser from Wagga who provides financial and rural management services and advice to commercial businesses, provided the statement which was taken into evidence. Dr Bender objected to Mr Reid's statement being taken into evidence.

97. In essence, Dr Bender submitted that Mr Reid's statement did not meet the requirements generally understood to apply to expert evidence. He referred to the Federal Court of Australia decision (Robertson J) in
King v Jetstar Airways Pty Ltd [2011] FCA 1259 (2 November 2011). His Honour said that he followed and applied the decision of the High Court in
Dasreef Pty Ltd v Hawchar (2011) 277 ALR 611. Robertson J addressed the following questions, at [4]: what precisely is the relevance of the materials; to what fact in issue does it go; and what is the putative expert's specialised knowledge. Secondly and independently of that is whether the opinion is wholly or substantially based on that knowledge and how.

98. In answering those questions, his Honour said, at [6] - [9]:

I do not regard it as determinative by any means that Mr Miller has not worked at Jetstar itself. Indeed, I did not understand that to be at the forefront of the respondent's submissions. No doubt, in the same vein, Mr Miller has some specialised knowledge of the airline industry. I also accept that there are questions of judgement and degree involved.

But in my opinion the criteria for admissibility have not been satisfied by this report. The proposed opinion does not explain or articulate what is the field of specialised knowledge or how it applies to the facts. Further the proposed opinion does not identify what the facts are with any or sufficient precision.

Alternatively, and there is some overlap between what I have just said and what follows, there is no identification of the factual basis of the conclusions or of the reasoning process by which the facts (not identified) or assumptions (not identified) inform the conclusion. The identification, such as it is, is no more than global. Perhaps one of the reasons for and indications of the global nature of the report is that the author does not in terms provide answers to the specific questions he was asked.

The second group of matters to which I have referred are relevant to my discretion, which I exercise, to exclude the material under s 135(c) of the Act [Evidence Act 1995 (Cth)]. That is, if the material has any probative value there is a danger that the evidence might result in undue waste of time. Not only does that form of the document lead to the prospect of undue waste of time, there is also unfairness in the opposing party being put in a position of having to explore in cross-examination material at this level of generality.

99. On the fundamental question regarding the admissibility of opinion evidence, Dr Bender referred me to the New South Wales Court of Appeal (Priestley JA, Powell JA and Heydon JA) decision in
Makita (Australia) Pty Ltd v Sprowles (2001) 52 NSWLR 705. Heydon JA said, at 731-732:

The basal principle is that what an expert gives is an opinion based on facts. Because of that, the expert must either prove by admissible means the facts on which the opinion is based, or state explicitly the assumptions as to fact on which the opinion is based. If other admissible evidence establishes that the matters assumed are

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"sufficiently like" the matters established "to render the opinion of the expert of any value", even though they may not correspond "with complete precision", the opinion will be admissible and material: see
generally Paric v John Holland Constructions Pty Ltd [1984] 2 NSWLR 505 at 509 - 510;
Paric v John Holland (Constructions) Pty Ltd (at 846; 87). One of the reasons why the facts proved must correlate to some degree with those assumed is that the expert's conclusion must have some rational relationship with the facts proved.

100. Dr Bender also referred to the decision of Austin J in
Australian Securities and Investments Commission v Rich [2005] NSWSC 149. His Honour explained the need by the expert to identify and articulate the assumed or accepted facts upon which his or her report proceeded. He said, at [297]:

Thus, if the expert fails to identify and articulate the assumed, accepted and observed facts upon which he or she proceeded, the court may well be unable to identify those facts, with consequences of several kinds. First, if the court is uncertain about the factual basis used by the expert, it may be unable to comprehend the opinion so as to decide how much weight or probative value to give it. Secondly, if the factual basis is not articulated, the court may be unable to determine whether the facts assumed or accepted by the expert correspond to the facts proved or admitted at the hearing:… This difficulty goes to the weight or value of the evidence, on any view, and may go to strict admissibility, if the "basis rule" discussed at 6.7 is correct. Thirdly, in extreme cases the consequence of failure to articulate the factual basis may even be inadmissibility for irrelevancy.

101. While it is correct to say that the Tribunal is not bound by the rules of evidence (AAT Act s. 33 (1)(c)), it has published Guidelines for Persons Giving Expert and Opinion Evidence (9 November 2011). Those guidelines state, at paragraph 8, that documents provided to the Tribunal under s. 37 of the AAT Act may include reports which fall within the scope of the guidelines. If a party wishes to place particular reliance on such a report but the report does not include information of the kind referred to in paragraphs 10 and 11 of the guidelines, the party should consider whether any additional information should be sought from the expert and provided to the AAT. Among the matters referred to in paragraphs 10 and 11 of the guidelines are the letter of instruction or details of the questions or issues the person was asked to address in the report and details of any facts and assumptions that inform the report and the sources for the factual information in the report. The reasons for these guidelines are to accord procedural fairness to both parties before the Tribunal on a hearing. As the guidelines state, and in accordance with notions of procedural fairness, failure to comply with the guidelines may be relevant to determining the weight which will be given to that evidence.

102. I allowed Mr Reid's statement to be taken into evidence subject to the concerns raised by Dr Bender being put to Mr Reid in the course of his examination in chief.

103. In his written report Mr Reid explained that he interviewed Dr Heaney in relation to his management techniques, his farming practices and specifically, his farming program. He also said he had reviewed Dr Heaney's historic data including, stocking rates, farm nutrient regimes and more broadly, his marketing strategies. He said he considered his (Dr Heaney's) previous advisers' opinions and the material which was presented to the Tribunal to date. Dr Bender's objection centred on the fact that Mr Reid did not attach to his report the data to which he referred. Nor had he attached the opinions and material to which he referred. On that basis, Dr Bender submitted that it was not possible for the Tribunal to properly assess the validity of his calculations as there was no way of testing the assumptions on which they were based. In my opinion, Dr Bender's submission is correct. It is not possible to assess the validity of an opinion unless the factual assumptions upon which it is based can be properly tested. Unless those assumptions are sufficiently like the facts as found, they are valueless.

104. In the introduction to his report, Mr Reid said he considered the Elders document and that in broad terms, he agreed with the

ATC 5629

assumptions of the plan. He said he considered the areas, stocking rates, yields and prices to be within general acceptance for a long term average based mainly on historic evidence of district yields and prices. However Mr Reid then said: I had restated all assumptions as which I consider achievable (please see attached gross margins, enterprise summary and cash flow).

105. In his evidence in chief Mr Reid was asked to explain the basis for the calculations referred to in his report. He said: my budget's essentially been worked up on the back of the Department of Primary Industries - New South Wales Department of Primary Industries' gross margins, which as you all know only give you the variable costs, so those costs specific to the enterprise as opposed to overhead costs which cannot be allocated to the enterprise in question. The Department of Primary Industries figures referred to by Mr Reid were not in evidence. Nor was anyone from that Department called to give evidence. Mr Reid also said that the Department of Primary Industries' gross margins were those which he used except that he had downgraded or lowered the income. As Dr Bender submitted, that makes my task impossible because I do not know the provenance of the figures Mr Reid used or the assumptions on which they are based.

106. As to the expense figures used by Mr Reid, he said that the variable costs which he used were adopted from the New South Wales Department of Primary Industries projection for the period in question. As for the overhead costs, he said he went through the past three years' financial statements prepared for the ATO and took out or mitigated anything that was extraordinary. He mentioned property sales resulting in a decreasing asset base and increasing costs in some instances but that in the end, by averaging the last three years' overheads and further questioning Dr Heaney, he came up with his own set of projected overhead costs. Again, as Dr Bender submitted, the financial statements for the three years prior to the 2010 income year were not in evidence. Mr Reid also said he relied on Dr Heaney regarding the number of cattle and sheep which he had.

107. Mr Reid also said he noted that Dr Heaney was in the process of selling some non-farm real estate (the Red Hill property) in order to reduce the current farm debt, which was stated to be $1,359,000, by $1,000,000. However, in cross-examination Dr Heaney said this about the Red Hill property: They - they [Big Springs and Humula] both have mortgages over them still, which is what I am hoping to - when we got our property in Red Hill, in Melbourne, for sale, and the intent is that we'll either pay out one fully, and decrease the other, or pay off part of both loans, depending on what - with one of the loans there is a time at which we can't pay it out early so we were aiming to sell both - hoping to pay out one loan fully and pay out the majority of the second loan once we sell the property in Red Hill. Therefore, despite what Mr Reid said about Dr Heaney being in the process of selling the Red Hill property, Dr Heaney's evidence was simply expressed in terms of a hope rather than being in the process.

108. In his concluding paragraph, Mr Reid said that both the Big Springs farm and the Humula farm were: already appropriately stocked with sheep and cattle and with the resumption of average seasons and continuance current prices that the farms are long-term viable on a stand-alone basis. However, as Dr Bender submitted, Mr Reid did not explain what was meant by the expression long-term viable. Furthermore, he submitted that the relevant question is not whether the farming business was viable, but rather whether there would have been tax profit in the 2010 income year but for special circumstances. He submitted that Mr Reid's statement and the accompanying calculations did not provide any evidence that assists in resolving this issue.

109. I must say that it is not clear to me that Mr Reid's detailed calculations regarding forecast income and forecast expenditure can be of any assistance at all in determining whether, but for the claimed drought, the Big Springs farm would have produced assessable income in excess of deductions attributable to earning that income. It should also be reasonably obvious to tax practitioners that deductions are not restricted simply to cash outgoings, or as Mr Reid described those expenditures, the variable costs. When asked in cross-examination what

ATC 5630

his instructions were for the purposes of preparing his report, he answered: the hearing would be interested to know about his [Dr Heaney's] viability prospects, given that the 2009/2010 be the year I was told specifically in question, Dr Heaney told me that he felt that he had to mitigate the circumstances as to why there were losses, and wanted to know my opinion. That - so my instruction was that if all things were equal in terms of pricing and yield and climate for that year, and if the - so production base was where it should be, then would he be viable. So I thought I was being asked for a viability statement.

110. It should be apparent that Mr Reid understood his instructions to be much broader than the question which is required to be answered for the purposes of the exercise of the Commissioner's discretion under s. 35-55 of ITAA 1997. That probably explains why the figures Mr Reid used when referring to the numbers of various stock on each of the properties substantially exceed those used in the Elders document. For example, the Elders document assumes the Big Springs to be stocked with 1120 head of sheep. That number is made up of 20 rams, 550 ewes and an average of 550 lambs. By way of contrast, Mr Reid used a figure of 2236 head of sheep, made up of 1200 ewes, 500 1st crossed ewe lambs, 500 1st crossed wether lambs and 36 rams. In cross-examination Mr Reid confirmed that these numbers came from Dr Heaney. He also confirmed that the numbers of cattle which he used in his calculation and the hectares of crop sown came from what he was told by Dr Heaney. It appears that Mr Reid based his numbers of stock and hectares of crop on the maximum possible carrying capacity of the land given good climate conditions and prices for produce. Given the many variables involved in primary production (Mr Reid suggested his figures were based on 1000 assumptions), I cannot understand how the calculations made by Mr Reid can disclose that, but for drought or flood in the 2010 income year, Dr Heaney's assessable income from primary production would have exceeded the deductions involved in producing that income.

111. Regardless of what Mr Reid said in cross-examination, in his evidence in chief he said that he calculated that the Big Springs property carried 2752 dry sheep equivalent (DSE). As I understood Mr Reid he said that the figures he used were for average seasonal conditions and average prices. Mr Reid explained that DSE is a unit or a common denominator in terms of the grazing industry to refer to a dry sheep equivalent. He said this was opposed to a lactating animal, so it is an animal which is not giving milk. He said the unit was used to assess, depending on the size of the animal, the amount of pasture it would consume. The unit is applied to any animal and he gave the example that a year old steer would be rated at 10 DSE, a lactating cow at 14 DSE and with a calf at foot at 20 DSE. He did stress that it was only a rough rule of thumb.

112. Mr Reid did not describe what he understood average seasonal conditions for the particular area might be. It seems to me that because much of New South Wales was declared to be in drought for three months in the latter half of 2009 and marginal or in drought for two months in 2010, both Dr Heaney and Mr Reid have simply accepted that the entire year was a drought year. However, as I have already said above, the rainfall for the Wagga area between the end of June 2009 and the end of June 2010 was 633.6 mm, which is in fact higher than the mode (400 mm - 500 mm) when rainfall patterns are taken into account since 1942. It was, in fact, slightly better than a typical year. Furthermore, when one looks at the Bureau of Meteorology rainfall figures between 2000 and 2008, the record discloses that except for the 2002 and 2006 years, the rainfall was in the range 376 mm - 513 mm or above in those years. Although Mr Reid said nothing about the rainfall upon which he based the maximum stock carrying capacity for the Big Springs farm, in his evidence in chief he referred to 700 mm of annual rainfall when discussing the Humula property. Therefore, it seems to me that Mr Reid probably calculated the Big Springs property carrying capacity at 2752 DSE on a better than typical rainfall year. If that was in fact the case, then the question which remains unanswered is why the maximum number of sheep recorded in the accounts for the Big Springs property was 900. In fact 228 of those were sold in the year so that the average stock level was something less than 900. The figures used by Mr Reid also do not

ATC 5631

accord with what Dr Heaney said in answer to questions raised by the ATO in a letter dated 16 September 2011 where, when referring to the current stock levels of sheep at the Big Springs farm, he said it was carrying close to the goal level.

113. No explanation was provided by Mr Reid for using a sale price for sheep of $60 per head. The actual sales price figure achieved by Dr Heaney in 2010 income year was substantially higher than that. In fact, 228 sheep were sold for $20,635 which equates to something slightly over $90 per head.

114. Mr Reid estimated the total income from the sale of wool to be $26,360. That of course is based on the stock level of 2236 sheep. In fact Dr Heaney has recorded in his profit and loss statement for the year ending 30 June 2010 sales from wool in the amount of $3336.91. The Elders document is based on wool sales at $17.85 per head while Mr Reid's calculation is based on $11.78 per head. As Dr Bender submitted, there was no source data supporting the wool prices used in Mr Reid's statement nor the amount of wool upon which the Elders document figure is based. There was no explanation for the very significantly lower wool sales recorded by Dr Heaney in the financial records.

115. Mr Reid recorded income from crop sales in the total amount of $48,915. However, as Dr Heaney explained, he was not able to harvest any crop in the 2010 income year and the livestock were permitted to graze those crops. The figures used by Mr Reid are identical to those in the Elders document. As Dr Bender submitted, there was no supporting data for this forecast income and the maker of the Elders document was not available for cross-examination. Dr Bender also submitted that even in some of the years in which there was rainfall close to the median annual rainfall for Wagga Wagga, crops from the Big Springs farm were not sold to derive income. From the rainfall data which was in evidence over a 68 year period, the median rainfall is 561 mm. In other words, there were as many years with rainfall above this figure as there were below. Dr Bender referred specifically to the years 2000 and 2005 in which the annual rainfall recorded was 653.4 mm and 513 mm respectively.

116. However, Dr Heaney explained in his witness statement that he rarely harvested each year he planted crops because of the poor rainfall in the essential period of August to October. However, the rainfall figures for the Wagga Wagga area disclose that the dry years between August and October were 2002 and 2006 - 2009. Other than those years, there is no obvious reason from a rainfall perspective why crops could not have been sown and harvested. The evidence before me does not support Dr Heaney's claim that poor rainfall was the cause of not harvesting crops. Although Dr Heaney in his witness statement said that in late 2010 Big Springs was subjected to floods resulting in the paddocks being too wet to harvest, accepting what he said about the essential growing period being between August to October, with harvesting taking place some time after those months, that of course could not have affected the 2010 income year which ended on 30 June 2010.

117. Furthermore, as Dr Bender submitted, the overhead expenses or costs referred to by Mr Reid in his table of forecast expenditure for the 2010 income year do not correspond with the financial report for that year. For example, Mr Reid described an overhead cost relating to Administration in the amount of $48,000, whereas the divisional profit and loss statement which refers to his primary production activities has no such expenditure. Mr Reid's forecast records expenditure for an item described as farm supplies in the amount of $9600 whereas the profit and loss statement records farm supplies at $16,782.74. How this could be so when Dr Heaney's expenditure is based on a maximum number of 281 head of cattle and 900 head of sheep compared with Mr Reid's assumption of 2236 head of sheep and 376 head of cattle was not explained. In addition to that, Mr Reid has based his forecast expenditure on planting some 271.81 acres with crop to which he has allocated about $26,000 by way of variable costs whereas the profit and loss statement has an expense for crop planting in the amount of $4459.14. On their face, the numbers appear illogical. Despite that, there was no explanation given by either Mr Reid or Dr Heaney for the apparent disparities.

118.

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In my opinion, the most significant aspect of Mr Reid's analysis is his failure to include non-cash expenditure such as depreciation, and the true financing costs associated with both properties. These costs plainly impact on whether the production base was where it would have been but for the weather conditions. It should be obvious that stocking both properties at the maximum sustainable level would result in significant additional variable costs and possibly further overhead costs being incurred. In fact, as Dr Heaney said in cross-examination, he was required to obtain a $100,000 overdraft from the bank when he bought his first load of cattle for the Humula farm. Although Mr Reid recognised this when including Dr Heaney's financial commitments, he assumed a restructured debt of $359,000 financed at 6%. Dr Heaney's balance sheet as at 30 June 2010 disclosed non-current liabilities of $1,371,695.97. Plainly, unless the servicing of the non-current liabilities is taken into account, there is no point in estimating returns from stock or crops at a maximum sustainable level unless the ability to service the debt is such that it does not impact on the ability to stock the farms or to sow crops at the maximum sustainable level.

119. Given that Dr Heaney had income from professional fees of $380,724.21 in the 2010 income year, from which was withheld $69,044 for tax, Dr Heaney had some $311,680 available from his professional practice to meet all expenditures. The divisional profit and loss statement for the year ending 30 June 2010 relating to his medical practice shows expenses in the amount of $72,298.11. That left Dr Heaney with some $239,382 which could be put towards his farming activities as well as maintaining his property at Red Hill and meeting living expenses. The divisional profit and loss statement for the year ended 30 June 2010 in respect of his farming activities discloses expenditure in the amount of $224,417.19. While that expenditure includes $13,581 in depreciation which needs to be added back to determine the amount of excess cash he had available to spend on farming activities in that income year, the resultant, some $28,545, discloses that without another source of income, Dr Heaney must necessarily have been limited by his finances regarding the additional number of stock he was able to purchase or crops he could plant in the 2010 income year. In fact this is borne out by Dr Heaney's evidence. In cross-examination he was taken to a letter written to the ATO answering a number of queries put to him. When referring to the stock at the Humula farm, Dr Heaney said: The northern paddocks are being agisted out as stock are too expensive to allow me to achieve the stocking goal … The plan is to build up the ideal stock numbers with good young breeders as listed but stock are asking exorbitant prices as all other farmers are also trying to restock after the drought.… Hence while the aim is to get ideal stock numbers it would be financially unwise to do this at the current prices.

120. When asked about stock numbers in cross-examination, Dr Heaney said:

Well, no, it's just a mixture of - you know, I'd like to buy another 100 cows but if I buy 100 cows you've got to - to buy - to borrow that money to buy them, you're effectively losing a cow a week in interest. Now - so to me it seems more logical to breed up your own stock where you're not outlaying money. It just seems more - of the two options seems more financially viable to breed your stock than to buy a large number of stock and carry a heavy loan.

121. In other words, the evidence does not disclose that Dr Heaney was financially able to stock both properties and to plant crops at the levels suggested by Mr Reid even if the rainfall would have permitted it. It follows that I must find Mr Reid's evidence, even if admissible, to be of little or no assistance in this matter.

122. I find that Dr Heaney has not proved, on the balance of probabilities, that but for the claimed special circumstances outside of his control, he would have produced assessable income greater than the deductions attributable to the farming activities at Big Springs. I find that it is not unreasonable in those circumstances for the Commissioner to apply the rule in s. 35-10 (2) to the business activity conducted at Big Springs.

THE LEAD-TIME DISCRETION - s. 35-55 (1)(c)

123.

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Mr Wright submitted that in respect of the Humula business farming activity, the Commissioner should exercise the discretion in s. 33-55 (1)(c). That is because the business activity at Humula had only been started in the 2010 income year and because of its nature, it has not produced or will not produce assessable income greater than the deductions attributable to it until a later time. Furthermore, there was an objective expectation, based on evidence from independent sources, that within a period which is commercially viable for the beef cattle industry, the activity would produce assessable income for an income year greater than the deductions attributable to it for that year.

124. On the other hand, Dr Bender submitted that Dr Heaney's beef cattle production activities commenced in 1995 at Big Springs. He submitted that Dr Heaney did not commence a new business when he purchased the Humula farm. He simply carried on the same activity which he had conducted since 1995. Dr Bender referred to the Federal Court decision in
Lilyvale Hotel Pty Ltd v Federal Commissioner of Taxation (2009) 175 FCR 491. That case involved Division 165 of ITAA 1997 dealing with income tax consequences of changing ownership or control of a company. Where a company did not meet the test regarding maintaining the same owners, it was required to meet what is described as the same business test.

125. With respect to Dr Bender, the decision in the Lilyvale Hotel case was concerned with the change of management of a hotel business and whether that change of management should have been regarded when considering the same business test. Edmonds and Graham JJ held that the primary judge fell into error in concluding that in answering the same business test one had to have regard to the management of the business. Their Honours referred to the High Court decision in
Avondale Motors (Parts) Pty Ltd v Federal Commissioner of Taxation (1971) 124 CLR 97 where Gibbs J, when dealing with a similar provision in ITAA 1936, explained why the business in that case carried on immediately before the change of ownership in shares could not be the same kind of business prior to the change. His Honour explained that after the change in the ownership of shares, it carried on the same kind of business but under a different name, at different places, with different directors and employees, with different stock and plant and in conjunction with a motor dealer having different franchises. In coming to their conclusion, Edmonds and Graham JJ said:

In the instant case, the appellant did not move to a different location or locations to conduct its hotel business. It did not, so it would seem, introduce gaming machines or otherwise change the character of the hotel business.

126. It should be immediately apparent that the Lilyvale Hotel case is distinguishable on its facts. We are not concerned here with change of ownership or management. Furthermore, we are not concerned with the change of business test which has much broader considerations than the examination of a business activity which may form part of an overall business. It does not assist the Commissioner's case.

127. Dr Bender also referred to the High Court of Australia decision in
AGC (Advances) Ltd v Federal Commissioner of Taxation (1975) 132 CLR 175. That case involved a taxpayer who was carrying on a business as a financier lending money and financing the purchase of goods under hire-purchase agreements. The taxpayer entered into a scheme of compromise and arrangement under which a special manager was appointed for five years to act as agent of the company, to take possession of its assets and to wind up its affairs. The taxpayer wrote off a number of bad debts which it had not been able to recover. It claimed to be entitled to deductions in the amounts of those debts. One of the issues for the Court to determine was whether it was necessary that the taxpayer should have been carrying on, in the year the losses were incurred, the business it had previously carried on. The Court held that despite the appointment of a special manager, it nevertheless continued to carry on the same business. Barwick CJ said, at 188:

The fact that the company changed its name in the circumstances of this case can have no possible bearing, in my opinion, upon the nature or continuing nature of the business which the company was carrying on: nor does it matter, in my opinion, that the addressed from which it conducted its affairs was changed. The nature of the

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company's business, both before and at the conclusion of the scheme when the company resumed activities, was that of a financier, lending directly to borrowers and also servicing higher-purchase agreements. There was no change in the nature of the business at all.

128. Once again, in my opinion, this case is distinguishable from the matter before me. The business of a financier financing hire-purchase agreements is plainly different from that of primary production. The dependence of primary production on suitable land is plainly paramount. It is not so in the case of conducting a business as a financier. The process of commencing beef production on a newly acquired property will, in any event, require the acquisition of cattle, whether from an existing herd or by way of new purchases. Simply because the cattle come from an existing herd does not, in my opinion, alter the fact that this is the commencement of a new business activity. The fact that some of the cows from an existing herd may be with calves simply goes to decreasing the length of time for that new business activity to become commercially viable. It remains dependent to a large extent on conditions existing on the new property.

129. I find that the beef production activity which Dr Heaney commenced upon the acquisition of the Humula property constitutes the start-up of a new business activity. Accordingly, s. 35-55 (1)(c) may have application in this case.

130. Dr Heaney's evidence was that settlement on the purchase of the Humula farm took place on 4 December 2009. He testified that the Humula farm pasture was of poor quality when purchased. The fencing was also damaged. This was due partly to the farm being overstocked by the previous owner and the quality of the pasture was poor as a result of the effects of drought in the area in years preceding his purchase. He said he incurred additional costs when starting the business at Humula due to repairs necessary to rectify damage to the property and the fact that he was required to establish the farm from bare paddocks caused by the drought. He commenced the farming activity in March 2010 by moving the 45 cows and 1 bull from the Big Springs farm to Humula. He also said he bought 92 heifers for the Humula farm. Dr Heaney also testified that the Humula farm was affected by the floods in late 2010 and early 2011 resulting in many kilometres of fencing being washed away which affected his ability to stock the farm during this period.

131. Mr Wright directed my attention to the Federal Court of Australia decision in
Federal Commissioner of Taxation v Eskandari (2004) ATC 4042. In that case, Stone J was required to deal with the expression because of its nature as it then appeared in Division 35 of ITAA 1997. Her Honour said, at [28]:

This brings me to consider the correct interpretation of the phrase "because of its nature".… The reference to the "nature" of the business indicates that the failure must be a result of some inherent feature of the business. The difference between the interpretations of the Commissioner and the respondent is the level of generality at which the relevant business activity is viewed: on the former view the nature of migration consultancies in general must be considered but on the latter view the nature of the respondent's particular business activity is the correct criterion.

132. Stone J examined the Explanatory Memorandum to the New Business Tax System (Integrity Measures) Bill 2000 and noted that in making the amendments, the legislature was concerned with the common features of business activities, not with features that are peculiar to the way in which the individual taxpayer runs his business ([29]). Her Honour referred to an example given in the Explanatory Memorandum and then said, at [31]:

The example in the Explanatory Memorandum is consistent with the note to s 35-55 which refers to the kind of business activity which the section is intended to cover and mentions, by way of example, the planting of hardwood trees for harvest. Such activities have an inherent characteristic that cannot be overcome by conducting the business activity in a different way but only by changing the nature of the business.

133. When referring to the expression objective expectation, Stone J said: at [45]:

ATC 5635

In determining whether there is the requisite 'objective expectation' as to the matters mentioned in the subsection, including the period that is commercially viable for the industry, the Tribunal, standing in the Commissioner's shoes, (see [18] above) must consider the facts and circumstances of each case. The words used in this subsection are not used in any special technical or legal sense and I see no reason to go beyond their ordinary meaning.

134. Her Honour then said this about established industries, at [46]:

In some cases it may be a straightforward exercise to identify the industry in which the business activity takes place. Some industries are well-established and the basis for an 'objective expectation' can readily be based on a comparison between the taxpayer's business and other businesses within that industry, particularly where businesses or business associations within the industry produce material such as annual reports or industry papers.

135. There can be no argument about the fact that the beef cattle industry is long established. Therefore, a comparison between Dr Heaney's beef production activities at Humula and other beef producing businesses should provide a reliable estimate of the lead time question. The comparison may also be affected by the particular circumstances which apply to beef production activities on the Humula property, but not by the way in which those activities have been conducted.

136. I did not understand it to be disputed that if the production of beef cattle at the Humula farm was a start-up business activity, it plainly required a lead-time before that activity could begin to produce a tax profit. This was despite the fact that a small number of cows and one bull were moved from Big Springs to Humula in March 2010. What was in issue was the second limb of s. 35-55 (1)(c) which requires the taxpayer to prove, on the balance of probabilities, that there existed an objective expectation based on evidence from independent sources disclosing that his beef cattle production activities at Humula would produce assessable income greater than the deductions attributable to it within a period that was commercially viable for that industry.

137. As Dr Bender submitted, Dr Heaney, when seeking a private ruling, claimed that a commercially viable period in the beef cattle industry was three years. Dr Bender also noted that in the applicant's statement of facts issues and contentions lodged for the purposes of this proceeding, Dr Heaney claimed that the commercially viable period would be at least three - four years.

138. Mr Wright referred me to the Commissioner's objection decision where he said:

The Commissioner considers that for the sheep and cattle industry the commercially viable period begins from the commencement of the business activity and includes time in which the following activities are completed:

  • • raising females to breeding age;
  • • allowing for the gestation period of those animals to finish; and
  • • raising the progeny to a saleable age.

Generally the above activities are completed within three yeas [sic] from the commencement.

139. Mr Wright also referred me to TR 2007/6 which states, at paragraph 23:

Not all business activities will commence immediately at the start of an income year. In practice, determination of the period referred to in subparagraphs 35-55 (1)(b)(ii) and (c)(ii) as the period that is commercially viable for the industry concerned should allow for this. A tolerance of at least one year beyond the income year otherwise identified from the relevant material as the end of this period will be applied.

140. Given that Dr Heaney's cattle production activities commenced in March 2010, if the objective evidence indicated a three-year lead-time period for commercial production, the expectation would be that his beef production activities at Humula should produce a tax profit by 2014.

141. Dr Bender submitted that the legislature was concerned with common features of

ATC 5636

business activities rather than with features which may be peculiar to the way in which an individual taxpayer runs his business. Nevertheless, Dr Bender conceded that although managerial decision-making was not always mutually exclusive with an inherent feature of a particular activity, not every managerial decision reaction to events encountered in conducting a business activity should be regarded as having occurred because of the nature of the activity. I agree with that submission. However, it seems to me that some caution must be exercised in reading the provision too narrowly. Section 35-55 (1)(c) uses the definite article throughout. For example, it refers to the business activity; its nature; and the activity will produce assessable income. Logically, it is difficult to see how one can separate beef cattle production activities from the environment in which those activities are carried out. They are, to a large extent, dependent upon that environment. For example, the number of cattle which can be reared is plainly dependent upon the capacity of the land to successfully permit breeding. Every farm has a carrying capacity limit. In my opinion, that should be taken into account when determining whether the activity conducted by a taxpayer will produce assessable income within a period commercially viable for that activity.

142. Mr Wright directed my attention to paragraph 86 of TR 2007/6 which states:

Whether the required objective expectation exists can be affected by decisions about how a particular activity is operated. For example, the extent of debt finance used (and as a result the level of allowable deductions for interest attributable to the business activity) can affect the time within which the activity can produce a tax profit or satisfy the Profits test.

143. The problem with what is set out in paragraph 86 is that it falls within the section which is described as not legally binding. It forms an appendix to the tax ruling itself and is designed to provide information to help understand how the Commissioner's view has been reached. It does not form part of the binding public ruling.

144. With respect to Mr Wright, I disagree with what is set out in paragraph 86 of TR 2007/6. The level of debt financing of such a business operation is not a factor which goes to its nature. It is not an inherent feature of a taxpayer's business activity and will depend entirely upon the way in which the taxpayer goes about conducting the business. Also, it is contrary to what Stone J said in Eskandari where she said, at [32]:

In my view, to adopt the construction advocated by the respondent would be very close to allowing the exception to supplant the basic position set out in s 35-10. In my view, the phrase 'because of its nature' in s 35-55 indicates that the failure must be a result of some inherent feature that the taxpayer's business activity has in common with business activities of that type.

145. I do however agree with Mr Wright's submission that the condition of the property at the time Dr Heaney commenced cattle producing activities may play a part in determining the commercially viable period for that industry conducted on Humula.

146. Dr Bender submitted that there was no objective evidence before me regarding the period within which Dr Heaney's beef cattle production activities at Humula should become commercially viable. With respect to Dr Bender, that is not quite correct. In his examination in chief Mr Reid said this:

At 700 mm of annual rainfall with the current pastures, I estimated that to be in the order of 15 DSE per hectare. I believe that could be increased to 20 DSE per hectare given a three to five-year emphasis on - on balance of pastures, legumes and the very nature of his breeding herd [of] cattle. He's only just got up to his critical cow number now to 200 cows. And just the breeding cycle alone, it's 283 days to produce a calf. It's 12 months to produce a vealer and then typically these cattle are sold, you know, in excess of sort of 400 kilos, at around 200 cents a kilo is about $800.

147. Furthermore, when Mr Reid was asked in cross-examination what he meant when he said the properties on which Dr Heaney conducted his farming businesses were appropriately stocked with sheep and cattle, he replied: the 1200 ewes and followers and 200

ATC 5637

cows and followers, meaning progeny. I understood Mr Reid to mean that appropriately stocked, the Humula property would carry 375 head of cattle which included 200 cows, 85 vealer steers, 84 vealer heifers and 6 bulls. As at 30 June 2010, Dr Heaney had a total of 206 cattle on that property. That is significantly less than the number used by Mr Reid to make his calculations regarding the viability of the Humula business activity. Nevertheless, based on Mr Reid's evidence, it seems reasonable to conclude that an objective expectation for commercial viability of beef cattle farming at Humula is between three and five years from the time that activity is commenced.

148. However, the underlying problem with the Humula farm business activity is, as I have found in relation to Big Springs, the level of debt carried by Dr Heaney in the form of mortgages over both of those properties. As at 30 June 2010 the mortgage over Humula stood at $875,000. The only objective assessment which I had in evidence regarding the Humula property was that of Mr Reid. Although it may also be said that the Elders document also discloses an objective expectation that the Humula farm can operate at a tax profit, it contains no timeframe within which that expectation might be met. Furthermore, it is predicated on the Humula property carrying 484 head of cattle, which is significantly larger than the number suggested by Mr Reid. Both the Elders document and Mr Reid's report do not take into account the debt constraints on the ability of Dr Heaney to expand the herd on the Humula farm to the size at which it will become commercially viable. I have already referred to some of the difficulties with Mr Reid's analysis. Furthermore, as Dr Bender submitted, because Mr Reid's calculations regarding the viability or profitability of Dr Heaney's farming activities treat the Big Springs farm and Humula farm as a single entity, it is not possible from his calculation to determine whether the Humula farm, as a single entity, will become profitable within the three to five years he suggested.

149. Dr Bender also submitted that Dr Heaney's income tax return for the 2011 income year disclosed a net primary production loss of $268,136. This is a significant increase from the tax loss recorded by Dr Heaney for the 2010 income year. In fact, Dr Bender submitted that the farm surveys for the 2011 and 2012 income years disclose improving conditions in New South Wales. The Australian Farm Survey Results for 2008 - 2009 to 2010 - 2011 years published by ABARES states, in respect of New South Wales: Farm cash incomes for livestock farms are projected to increase in most regions, with higher sheep, lamb, wool and beef prices combined with higher sale weights for livestock and despite an expected reduction in the number of cattle sold. The ABARES Australian Farm Survey Results for the following income year state, for New South Wales: Farm cash incomes for beef cattle and sheep farms are projected to increase, with higher wool and beef prices as well is an increase in numbers of lambs sold and higher sale weights for livestock. On average, farm cash income of broadacre farms in New South Wales is projected to average $100,000 for a farm in 2011 - 12, which is around 68 per cent above the average farm cash income recorded for the 10 years to 2010 - 11.

150. In my opinion, the reason why Dr Heaney was unable to produce assessable income in excess of deductions attributable to that income is the overall level of debt both on the Humula property and the Big Springs property. Although Dr Heaney quite clearly recognised this and said that he hoped to sell the Red Hill property in order to reduce the level of his debt funding in respect of the two farming properties, as at the date of hearing this matter, he had not done so. In those circumstances, it cannot be said that there is an objective expectation that within three to five years from commencing beef production activities at the Humula farm, that business activity will produce assessable income greater than the deductions attributable to it. Accordingly, I find that it would not be unreasonable to apply the rule in s. 35-10 (2) to the business activity conducted on the Humula farm in the 2010 income year. Dr Heaney does not meet the conditions for the exercise of the Commissioner's discretion under s. 35-55 (1)(c).

CONCLUSIONS

151. Dr Heaney, a medical practitioner, conducted farming activities at Big Springs and Humula in the 2010 income year. Despite his

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very high level of commitment to those farming activities, they did not operate at a profit. Dr Heaney sought to set off his losses against income from his medical practice. In order to be able to do that, he required the Commissioner to exercise discretion, due to drought which he claimed affected operations at Big Springs and the fact that the farming activities on the Humula property were commenced in that financial year.

152. Although the Commissioner contended that the two farming operations should be regarded as a single farming business, I have found that the activities conducted on each property was sufficiently discrete to warrant individual consideration. Division 35 of ITAA 1997 is concerned with losses from non-commercial business activities, not simply losses from a non-commercial business. The Big Springs farming activities involved the rearing of sheep and the planting of some crops while the Humula farming activities were solely the production of beef cattle. Although some cattle were maintained at the Big Springs farm in the early part of the 2010 income year, those cattle were later moved to the Humula property. I have found that the income and expenditures on each of those properties were able to be identified to the extent that it was possible to determine, in each case, whether the activities were conducted at a tax profit. They are appropriately described as autonomous commercial undertakings. I have found that it was open to Dr Heaney to treat the activities on each farm as discrete business activities for the purposes of Division 35.

153. Dr Heaney sought that the Commissioner exercise the special circumstances discretion in s. 35-55 (1)(a) in respect of the Big Springs farming activities; and the start-up discretion in s. 35-55 (1)(c) in respect of the Humula farm activities.

154. Standing in the Commissioner's shoes for the purposes of this application for review, in order to exercise the Commissioner's discretion in s. 35-55 (1)(a), I needed to find that Dr Heaney had proved, on the balance of probabilities, that but for the special circumstances which he claimed affected the Big Springs property in the 2010 income year, his primary production activities at Big Springs would have produced assessable income greater than the deductions attributable to them.

155. I have found that Dr Heaney has not discharged the onus of proving, on the balance of probabilities, that but for the special circumstances outside of his control, he would have produced assessable income greater than the deductions attributable to the farming activities at Big Springs. In my opinion, the evidence disclosed that the principal reason why the farming activities at Big Springs did not produce a tax profit was the level of debt carried by Dr Heaney by way of mortgages over both properties. They are both highly negatively geared. Unless and until Dr Heaney can reduce the level of debt he has in respect of those properties, the evidence discloses that he does not have sufficient disposable income to stock and operate the Big Springs property at a tax profit.

156. Although I have found that Dr Heaney is entitled to rely on the fact that the farming activities on the Humula property should be regarded as start-up activities for the 2010 income year, he has not discharged the onus of proving that within a commercially viable period for the beef cattle industry, the beef production activities conducted on the Humula property would produce assessable income for an income year greater than the deductions attributable to it for that year. This was due to the level of debt carried by Dr Heaney and the limited financial resources he had available after servicing that debt. He needed to substantially increase the number of cattle carried on that property and there was no evidence that he had the financial resources to do that without incurring further borrowing. This activity, like the farming activity on the Big Springs property, is highly negatively geared. Accordingly, I have found that Dr Heaney does not meet the conditions for the exercise of discretion under s. 35-55 (1)(c) of ITAA 1997.

157. Given the findings I have made regarding the business activities on the Big Springs and Humula properties, it follows that the rule in s. 35-10 (2) must be applied to those business activities. The tax losses Dr Heaney incurred in the 2010 income year must be deferred until such time as those activities

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produce assessable income in excess of deductions attributable to the activities.

158. I find that the decision made by the Commissioner on 22 November 2011 disallowing Dr Heaney's objection was correct. I affirm the decision.

 

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