Prosser v. Commissioner of Inland Revenue.

Judges:
Quilliam J

Court:
Supreme Court of New Zealand

Judgment date: Judgment handed down 21 November 1972.

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Quilliam J.: This is a case stated pursuant to sec. 32 of the Land and Income Tax Act 1954.

The objector is a chartered accountant who has been in practice in Nelson for 22 years. He has throughout his life had an interest in farming and has kept himself informed over the years as to farming methods and practices. Following the death of his first wife he remarried and for a time continued to occupy the residence in Songer Street, Nelson, which he had occupied during his first marriage. He eventually discovered that this residence was to be acquired by the Ministry of Works because of a proposal to build a motorway. His search for another home resulted in the purchase by him of a small farm of about forty acres at Richmond, about eight miles from Nelson. The purchase price of this farm was $17,300. Following the purchase he erected on the property a dwellinghouse at a cost of $16,700. This total of $34,000 was met eventually by a loan on mortgage from the Dominion Life Office of $16,000, the proceeds of sale of the Songer Street residence of $13,450, and the balance from the objector's personal resources. At the time of purchase of the farm the objector took advice as to the kind of farming he should carry on. As a result it was his intention to carry beef cattle purchased at the age of 2-2½ years, to fatten them and resell them three or four months later. From the experience of one of his advisers it appeared that this kind of farming should produce him an annual net profit of approximately $1,500. Unfortunately at about the time the objector

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purchased his farm the market for this kind of stock altered considerably, with the result that the class of cattle he required was no longer available at a price which was economic for him. He therefore changed in 1967 to purchasing weaner calves which he had to carry for nine to twelve months before selling. This soon proved a much less satisfactory proposition and resulted in losses in each year.

At the time of purchase of the farm the objector made an arrangement with the partners in his accountancy practice whereby he received a smaller share of profits than previously. This was to enable him to spend Wednesday of each week on his farm. He also devoted himself to the farm at weekends and often in the early mornings and evenings. He still, however, retained accountancy as his principal occupation and estimated that he would spend at least four-sevenths of his total time in that occupation. Of the balance much was spent in farming but some also in recreation.

In furnishing his return of income each year the objector claimed as deductions all his farm expenditure. In particular, he claimed interest on the mortgage to the Dominion Life Office, depreciation and rates on his dwelling and the running expenses and depreciation on his car. The loss resulting from his farming operations in each year was claimed by the objector as offset against the profit from his accountancy practice. For the years ended 31 July 1964 to 1969 inclusive his claims for expenditure were allowed in full by the Commissioner and the resulting losses were offset against his professional income. Upon receiving the objector's return for the year ended 31 July 1970, however, the Commissioner indicated his intention to disallow some of the farming expenses claimed and, notwithstanding objection by the objector, he added back a total of $1,396.23. This comprised a proportionate part of interest on the mortgage, depreciation on the dwelling, depreciation and loss on cars, and rates, as well as legal expenses in connection with a mortgage. An assessment was issued accordingly which reduced the objector's declared loss on his farming operations from $1,197.03 to $600.80. That reduced loss was then allowed against the objector's professional income.

While the objector's protests over his 1970 assessment were still being voiced he furnished his return for the year ended 31 July 1971, again claiming his farming expenses in full on the same basis as he had done previously. This time the Commissioner went further and disallowed the whole of the claim for loss on the farming operations upon the basis that those operations no longer amounted to a business at all. The objector required the Commissioner to state a case for the determination by this Court of his objection to the assessments so calculated for the years 1970 and 1971.

The objector's claim to deduct his farming loss from his professional income is based upon sec. 111 of the Land and Income Tax Act which is as follows -

``111. Expenditure or loss incurred in production of assessable income - In calculating the assessable income of any taxpayer, any expenditure or loss to the extent to which it -

• (a) Is incurred in gaining or producing the assessable income for any income year; or
• (b) Is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income for any income year -

may, except as otherwise provided in this Act, be deducted from the total income derived by the taxpayer in the income year in which the expenditure or loss is incurred.''

In order to establish his claim the objector had therefore to show either that his loss was incurred in gaining or producing ``the assessable income'' for the years concerned, or alternatively, that the loss was necessarily incurred in carrying on ``a business''. The term ``assessable income'' is defined in sec. 88 of the Land and Income Tax Act and that part of the section which is relevant for the present purpose is subsec. (1) (a) which is as follows -

``88. Items included in assessable income: (1) Without in any way limiting the meaning of the term, the assessable income of any person shall for the purposes of this Act be deemed to

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include, save so far as express provision is made in this Act to the contrary, -

(a) All profits or gains derived from any business (including any increase in the value of stock in hand at the time of the transfer or sale of the business, or on the reconstruction of a company);''

Under whichever limb of sec. 111 the objector is claiming therefore he must show that his farming operations were ``a business''.

What then is a business? It is defined in sec. 2 of the Act as including ``any profession, trade, manufacture or undertaking carried on for pecuniary profit''. This definition was considered by Henry J. in
Commr. of I.R. v. Watson (1960) N.Z.L.R. 259 where he said at p. 262 -

``The taxpayer and his accountant have each asserted, and books have been opened and kept on the basis, that as from 1952 the taxpayer was in business as a horse-breeder. This is not sufficient of itself. `Business' includes any undertaking carried on for pecuniary profit. It is not necessary that such a profit should be made, but it is essential, even if not sufficient, that at least an intention to gain pecuniary profit from the activities should be proved before the undertaking can be termed a business.''

Similarly, McCarthy J. in
G.v. Commr. of I.R. (1961) N.Z.L.R. 994 considered that the intention to make a profit was an essential element in the definition of ``business''. Further reference to the definition was made by the Court of Appeal in
Harley v. Commr. of I.R. (1971) N.Z.L.R. 482. That case, the facts of which are not on a parallel with those of the present case, concerned claims for deduction for expenses incurred in a small farm. At first instance Wilson J. held that the appellants were carrying on the business of farming, but that the losses claimed were not exclusively incurred in the production of the assessable income. This was a reference to sec. 111 of the Land and Income Tax Act as it existed prior to the Land and Income Tax Amendment Act 1968. It was not necessary for the Court of Appeal to make an express finding as to whether the appellants were carrying on the business of farming but each of Their Honours indicated doubt at Wilson J's finding on this. North P. at p. 486 said -

``The learned Judge in the Court below - if I have understood his judgment correctly - treated the matter as raising simply a question of fact and he appears to have formed the opinion that once he was satisfied that the appellants were not carrying on their farming operations `for fun or as a hobby' the proper view was that they were carrying on a `business' within the meaning of the Act. With respect, I think that it is at least arguable that the words in the definition clause make it necessary for the taxpayer to establish that he was carrying on his operation for pecuniary profit and, accordingly, if the enterprise had no prospect of earning a profit, it may be wrong to describe the enterprise as a business.''

Both Turner J., at p. 492 and Richmond J., at p. 496, made it clear that they shared the President's doubts. The proposition, therefore, that in order to constitute an undertaking a business it should be shown that there was both the intention to make a pecuniary profit and also the prospect of earning one had been expressed, although so far as the Court of Appeal was concerned the observations of North P. must be regarded as obiter.

Due note of the position which had been reached was taken by Speight J. in Golightly v. Commr. of I.R. (unreported), a judgment delivered on 18 August 1972. That was the case of a solicitor who lived on a property of 62 acres adjacent to the city in which he practised. His farming activities on that property were consistently unsuccessful and for a number of years he was allowed by the Commissioner to deduct his farming losses from his professional income. There came a time however when the Commissioner took a view similar to that which he has taken here, and Speight J. was called upon to decide whether the farming activities of the objector in that case comprised a business. Upon an examination of the evidence Speight J. held that there was a business, but in doing so he accepted that the test to be applied was that indicated by North P. in Harley v. Commr. of I.R., namely that both the intention to make a profit and also the prospect of doing

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so (though not necessarily in the year under review) should be established. In Golightly's case this test was accepted by both counsel as being correct. In the present case it is, contended for the objector that this may not be so, and I was referred to two Australian cases, which, it was said, showed a different principle. The first was
Scott v. Commissioner of Taxation 3 A.T.D. 142. The very unusual nature of the facts of that case make one approach it with a good deal of care. It was the case of a medical practitioner who, having attended his rooms regularly during the year, returned a total income of £3 3s. 0d., and claimed expenses of £182 0s. 9d. He had a substantial private income from investments and he sought to set off the loss from his medical practice against that income. He had practised for several years with a consistent lack of success and results similar to that in the year in question. The Commissioner took the view that the taxpayer was not in business as a medical practitioner as there was really no prospect of his making a profit. Gavan Duffy J. held, however, that it was not unreasonable that the taxpayer should continue to try and establish a practice and accepted his evidence that he was genuinely trying to do so. That case clearly depended very much on its own facts and I am not prepared to regard it as indicating any principle which might be applied to the present case. An essential point of distinction is that in Scott's case the taxpayer devoted his whole time to his endeavours to establish a medical practice. His private income required very little of his attention. The position in the present case is of course quite unlike that.

The other Australian case is
Tweddle v. Commissioner of Taxation (1942) 7 A.T.D 186. 186. That was the case of the Chairman of Directors of a soft goods company who also owned two farm properties. On one of those properties he did not intend to carry on business but was unable to sell it for some years. During that time he grazed a few stock and grew some crops but all on a somewhat nominal basis. He also incurred expense in improving the property and preparing it for sale. It was held that while his dominant purpose was to sell the property the facts were just sufficient to establish that he was carrying on the business of a farmer there. The other property was farmed on a more realistic basis, including the employment of a manager, but it consistently made losses. The taxpayer used the property in order to try and establish a particular breed of draught-horse in the hope that he could make a name for himself as a studmaster. It was argued that the fact that the property could never hope to make a profit took it out of the category of a business but the Court declined to take this view. At p. 364 Williams J. said -

``It is not suggested that it is the function of income tax Acts, or of those who administer them, to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically. The Act must operate upon the result of a taxpayer's activities as it finds them. If a taxpayer is in fact engaged in two businesses, one profitable and the other showing a loss, the Commissioner is not entitled to say he must close down the unprofitable business and cut his losses even if it might be better in his own interests and although it certainly would be better in the interests of the Commissioner if he did so (
Tooheys Ltd. v. Commissioner of Taxation (N.S.W.) 11, at pp. 440-1). If the appellant succeeds and makes a profit it will plainly be taxable, and it is difficult to see how his activities could at that moment of time be transmogrified from an indulgence in a somewhat unusual form of recreation into the carrying on of a business. I am satisfied that the appellant is seeking to establish himself at Winlaton as a recognized breeder of highclass stud stock, and that while he is prepared to make losses to achieve this ambition he has a genuine belief that he will be able eventually to make the business pay. Indeed, unless he can do so, his experience will hardly be an encouragement to others to emulate his example.''

While the facts of that case are substantially different from those here, it is difficult to reconcile the view taken by Williams J. with that appearing from the New Zealand cases I have already cited. All that I can say is that with respect I find myself unable to agree

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with the conclusions arrived at by Williams J. and I prefer the test indicated by North P. and applied by Speight J. I do not consider that our statute entitles a taxpayer to create or persist in an entirely unrealistic venture and then, because it has the outward semblance of a business, to be able to assert that it is one. If that is the principle to be derived from Tweddle's case then I respectfully decline to follow it.

Accepting then that the expression ``business'' involves both the intention of making a profit and also at least the reasonable prospect of doing so, it is necessary to consider the evidence in this case to see whether those elements are present.

At the time when the objector purchased his farm in 1964 I accept that his intention was to make a profit. The property he acquired was in a deteriorated condition and there had been no topdressing applied to it for many years. The previous owner had run a few dairy cows on the property and had also grown some tomatoes on it. His brother, who gave evidence, seemed at least doubtful that the property had shown a profit prior to the sale to the objector. It was necessary for the objector to set about immediate improvements, and, in particular, fairly heavy topdressing. He also re-fenced it and built cattle yards, a hay shed and an implement shed, and sprayed the gorse on it. Although his advice and his own farming knowledge persuaded him that he could expect to make a profit by fattening 2-2½ year old beef cattle he did not expect to do so immediately. I accept his evidence that he had, when he bought the property, a reasonable prospect of making a profit from it, even if not at once.

It was contended by the objector that, even if the test adopted in Golightly's case was correct, then so far as the prospect of a profit was concerned it was sufficient to show that that reasonable prospect was present at the time of purchase. If it was, then, it was said, this remained the position thereafter. I am unable to accept that. The liability of an undertaking to assessment and the right to claim deductions and losses in respect of it is, in my view, a matter for determination in each year having regard to the circumstances at that time. If, in a case such as the present one, the facts in any particular year disclose that the original intention to make a profit or the original prospect of doing so have ceased to exist, then I consider that it cannot be said for that year that the undertaking is still a business.

The objector soon discovered that he could not farm the property as he originally proposed. He could not buy cattle of the right age at the right price. His intention to make a profit was no doubt still present but there was no real prospect of his doing so by the methods proposed. This did not prevent the farming venture from being regarded still as a business, because the objector then embarked on a different proposal. This involved the purchase of weaner calves for fattening. The first substantial purchase of calves was made in 1967, and I accept that at that time it was still reasonable to anticipate that there could be a profit. In the result, however, it proved otherwise. There was a loss on farming in each year in addition to the losses already experienced prior to the change to calves. The losses for the years ended 31 July 1964 to 1971 inclusive were as follows -

                     $
      1964         525.20
      1965       2,202.76
      1966       3,023.06
      1967       2,347.76
      1968       2,280.50
      1969         466.42
      1970       1,997.03
      1971       1,700.25
      

The total losses for the whole period were therefore $14,542.98.

The objector adhered to his policy of fattening calves notwithstanding the concession he made in his evidence that he had proved to himself ``quite conclusively'' that he could not make a profit raising weaners. This was the case even though he applied all the expertise he possessed and although he spent long hours working on the property. He even went home to lunch each day so that he could inspect the property and could deal quickly with any problem which

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might arise. He not unnaturally gave consideration to other types of farming but he knew of nothing which he believed could produce for him any better result. He was asked whether there was no way he could think of to make his farm earn a profit and his reply was -

``There would most certainly be ways, but not ways I could do without giving more of my time, when I haven't got it to give, that is why any future thoughts of farming I envisage it as a full-time operation and not as a part-time operation.''

Two witnesses with experience in farming were called in support of the objector's case and each was asked whether he considered that there was a prospect of the objector making a profit by continuing to farm weaner calves. The answer of each was that if the prices for calves had dropped to a sufficiently suitable level then a profit was a reasonable possibility. It was only likely, however, that such a drop would occur if the price for wool and lambs improved to the point where farmers started to return to sheep. It could then be expected that there would be less demand for beef with a consequent drop in the price for stock. That trend has started to become apparent this year but it seems plain from the evidence that there was no reasonable likelihood of it in 1970 or 1971. The position in those years therefore was that the objector was resolutely carrying on with a type of farming which it must have been clear to him could not upon any reasonable basis have any prospect of yielding a profit. When asked when he was going to become tired of making such losses he said, with perhaps refreshing frankness, ``Probably when the tax department gets tired of allowing me losses, as it no doubt has been a help to allow those losses to me''. He was also asked whether he could only contemplate those losses on the basis that they were offset against his professional income and he said ``That certainly influenced by thinking''.

It may be that over the seven years involved the objector retained the intention of making a profit, although even this must be open to doubt. What is clear, however, is that there came a time when, upon the basis of known marketing conditions, he could not reasonably have retained any prospect of making a profit. He had proved this conclusively for himself and there was no evidence of any reasonable likelihood of the market changing so much as to convert his substantial losses into the chance of a profit. It seems that the objector really accepted that he could not expect a profit, because sometime during 1971 he had his farm subdivided by survey into 10 acre lots. By reason of the limitations imposed by the County Council he could not sell lots of less than 10 acres. By November 1971 he had agreed to sell one lot and he gave possession of that lot in January 1972. He contemplates the sale of the remaining lots also, and his intention is to apply the net proceeds of sale towards the acquisition of a full economic farming unit to which he would then devote his whole time. It seems clear, therefore, that he had in fact no reasonable prospect of a profit. I have no doubt that the prospect of a profit had disappeared earlier than that. It is not possible to put any precise date on this, but it was certainly not later than the 1970 year. His undertaking had therefore ceased to be a business. There seems little doubt that he would have readily accepted that himself but for the fact that he believed he could continue to offset the losses which were plainly to be anticipated against his professional income.

Although, in my view, the farming venture had ceased, at least in the years 1970 and 1971, to be a business, there is no reason why it should not regain that status if things alter so as to make a profit again a reasonable prospect. A similar view was expressed by Speight J. in Golightly's case with which I respectfully agree.

The result of the view I have formed is that the Commissioner acted correctly in disallowing all farming loss for the 1971 year. So far as 1970 is concerned the Commissioner did no more than disallow some of the farming expenditure. He had not sought to amend his assessment for that year by disallowing the whole farming loss but accepts that his assessment for that year may stand. It follows, however, from what I have said that there could be no question of

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allowing the objector the full deductions which he claimed for 1970. Just the same conclusions as I have reached in respect of 1971 would sustain the Commissioner's decision that the full deductions could not be upheld.

The question asked in the case stated is whether the Commissioner acted correctly in making the assessments he did for the years 1970 and 1971, and I hold that he did.

The Commissioner is entitled to costs which I fix at $100.