Case K45

Members:
HP Stevens Ch
CF Fairleigh QC
JR Harrowell M

Tribunal:
No. 1 Board of Review

Decision date: 2 August 1978.

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H.P. Stevens (Chairman); C.F. Fairleigh Q.C. and J.R. Harrowell (Members): The taxpayer is an engineer employed by a public authority. He also receives as sole owner rent from the letting of one house; and, with his wife as joint owner, receives rent from the letting of three other houses. The Commissioner adjusted the income of the taxpayer as returned for the year ended 30 June 1975 by disallowing some deductions

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claimed to be in respect of the production of assessable income.

2. The taxpayer objected thereto (with one exception which has no present relevance) and the Commissioner decided to disallow the objection. That decision was referred to a Board for review.

3. At the hearing of the reference the taxpayer adopted the grounds of his objection as set out in the notice of objection as substantially his evidence in chief. Those grounds are set out hereunder: -

• (a) Interest paid on mortgage on property at N was incurred in order to produce assessable income. The property was built for letting. Due to problems of water seepage, caused by the builder's excavation of the site in contravention to the plans... the house could not be let. I had to live in it and let the property at W instead. For the same reason borrowing expenses are also an allowable deduction.
• (b) The loan of $4,000 from the Commonwealth Bank... was invested in mining stocks in 1969/1970 for the purpose of share trading. A loss was incurred; the balance of the money as the stocks were sold was used to help purchase the properties at W and C which are income producing. This deduction was recognized as a legitimate deduction in previous years.
• (c) Fees paid for cleaning and letting of the property at C and services in connection with the collection of income from the property and for related activities are necessary and legitimate expenses in the production of assessable income, and cannot be considered as private expenditure. Fees paid for cleaning are lower than charged by commercial/trade cleaners and fees for letting and income collection etc. are lower than those charged by estate agents. To whom paid is not a valid consideration. This deduction was recognized as legitimate in previous years.
• (d) The Financial Review is a business paper and it is only useful and read in relation to business activity. It is important for me to be informed about the law concerning rented property, movements in rent, availability of properties, repair costs, trends in the investment market etc. Cost of this paper is a business expenditure and is allowable. This deduction was recognized as a legitimate deduction in previous years.
• (e) The office is a room furnished with a desk, desk-chair, two visitors' chairs, filing cabinet and cupboard for stationery etc. It is used exclusively as an office. It is solely used in the production of assessable income. Office work includes: Correspondence with local Councils, Water Board, insurance companies, repair work-men, Electricity Supply Authorities, building materials stores, people owning adjacent properties, etc. Sometimes considerable correspondence is generated; like when Council required the removal of a fence or the addition of septic trenches, or the Water Board wanted to pass a sewer through a property, or when there is a disagreement about a repair bill or when a repair job has been done unsatisfactorily. These are actual cases. Also often, tenants raise problems by causing damage through negligence or leave the premises without paying balance of rent or giving notice. Telephone calls also take a considerable amount of time in relation to above and in enquiring about for example, insurance premiums, fees for repair, availability of materials etc. Also receiving tenants or prospective tenants. Long preparation of income tax returns and land tax forms, sometimes even having to appeal an assessment. Payment of interest on mortgages and repayment of mortgages. Keeping files and records, etc. etc. It is essential to have a desk, chairs, and other items that are needed in an office. The office expenditure is a legitimate business expenditure. Please see also your letter of 31-7-74.
• (f) Since I carry out most of the repair work on the income producing properties myself, a workshop/storeroom is a necessity. As every house-owner knows there is a multitude of jobs, large and small, that need to be carried out to keep the house in good repair. Tenants are not as careful as owners, with the result that more repair is needed. The garage is used solely as a workshop and storeroom and

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  expenditure associated with it is a legitimate business expense.
• (g) Where a septic tank system is installed as a temporary measure until sewerage is available, and when the Water Board notifies that sewerage is pending, and when connection to the sewer is required by Council, then it is a depreciable item. On the installation of sewerage it is a liability rather than an asset and does not then add to the capital value of the property. (Where the property is sold before the sewerage is connected tax savings should be returned to the Commissioner of Taxation.) Since the eventual cost of connection to the sewer is considered to be a capital expense, the septic tank system must of necessity qualify as a temporary and depreciating item similar to the wall-oven, hotplate and hot-water unit.
• (h) Box... is located at Y post office. The distance makes it inconvenient to receive private correspondence there and the box is only emptied once a month. Private correspondence is received at my home address in the normal manner. I hired the box when I worked at Y (I now work in the City) and I consider that I have to continue hiring it to avoid confusion that a change of address always seems to create. The box is used only for business purposes. This deduction was recognized as legitimate in previous years.

4. The taxpayer is the sole owner of the residence in which he and his family have resided since 17 January 1975 and it is the property which is referred to in para. (a) of the grounds of objection. The other house (see para. 1 hereof) which he owns solely is referred to in para. (c) and (g) of the grounds of objection; it was tenanted by two tenants in succession during the year in issue and was vacant for a short time. His wife is the sole owner of two houses and each was rent-producing in the subject year; these plus the four rent producing properties referred to in para. 1 (making six in all) are those relevant to the expenditure claimed in para. (e) and (f) of the grounds of objection.

5. The taxpayer was closely cross-examined by the Commissioner's representative and he adduced evidence from an accountant employed by the building society which advanced the money to enable the residence (para. (a) of the grounds of objection) to be built; and also evidence from a qualified valuer who had inspected that residence in relation to the claims for home office expenses and for the workshop in the garage, and who had knowledge of the charges made by members of the Real Estate Institute for obtaining tenants and for collecting rents. The Commissioner's representative also put into evidence documents to support his contention that none of the claims should be allowed. It is convenient to set out at this juncture a summary of the principles of law which are relevant to the several claims.

6. There are two positive limbs to sec. 51(1) of the Act. One of the reasons why the second limb as an alternative was introduced is mentioned in
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 55; 8 A.T.D. 431 at p. 435; and it is then pointed out (at pp. 56-58; 435-436) that whilst in actual working the alternative can add but little to the operation of the leading words in the first limb, for those words cover almost all the ground occupied by the alternative (and, of course, the discussion is not concerned with the employee's position) there is the alternative standard by which those in business might succeed if they failed by the standard set out in the first limb.

7. The authorities are uniform that the quality of a sec. 51(1) deductibility is determined by the character of the outlay. A phrase such as ``incidental and relevant'' as used in Ronpibon is only a comment (cf.
F.C. of T. v. Finn (1961) 106 C.L.R. 60 at p. 67; 12 A.T.D. 348 at p. 350) unless used to mean the character or nature of a loss or outlay (
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344 at p. 351; 11 A.T.D. 147 at p. 149). As Mason J. said in
Lodge v. F.C. of T. 72 ATC 4174 at p. 4175; (1972) 128 C.L.R. 171 at p. 174: It was pointed out by Williams, Kitto and Taylor JJ. in
Lunney and Hayley v. F.C. of T. (1957-1958) 100 C.L.R. 478; 11 A.T.D. 404 that those statements did not constitute ``an exclusive and exhaustive test for ascertaining the extent of the operation of the section''; similarly in
F.C. of T. v. Ballesty 77 ATC 4181 at p. 4184. Whether one activity is incidental to or ancillary to

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another is one of degree (per Gibbs J. In
re Holmes, ex parte Public Service Association (N.S.W.) (1977) 52 A.L.J.R. 243 at p. 248). In respect of another such phrase Lord Donovan pointed out in
Commrs. of Customs and Excise v. Top Ten Productions Ltd. (1969) 3 All E.R. 39 at p. 93 that absurdities arise from a literal application of phrases of wide import such as ``connected with''.

8. The guideposts to determine whether or not an outlay by the employer or self-employed has the quality of sec. 51(1) deductibility (where not excluded by the statutory exceptions) are: -

• (a) To what extent the outlay was made for the purposes of the business, or other income producing activity (
  Johnson Bros. & Co. v. I.R. Commrs. (1919) 2 K.B. 717;
  Copeman v. Flood (William) & Sons Ltd. (1941) 1 K.B. 202).
• (b) To what extent the outlay was made pursuant to business considerations (
  Robert G. Nall Ltd. v. F.C. of T. (1936-1937) 57 C.L.R. 695 at p. 699).
• (c) To what extent the outlay was dictated by the business ends to which it is directed (
  F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431 at p. 437 explaining the phrase ``clearly appropriate or adapted for'' as used in Ronpibon supra).
• (d) To what extent the outlay was made in the course of the business (or other income producing activity) in the interests of efficiency (
  W. Nevill & Co. Pty. Ltd. v. F.C. of T. (1936-1937) 56 C.L.R. 290 at p. 300; 4 A.T.D. 187 at p. 193 explaining ``money expended... voluntarily... on the grounds of commercial expediency and in order directly to facilitate the carrying on of the business'' as in
  British Insulated & Helsby Cables v. Atherton (1926) A.C. 205 at p. 212).
• (e) To what extent the object of the outlay was the conduct of the business (or other income producing activity) on a profitable basis with due regard to that economy which is essential in any well conducted business (Nevill at p. 301; 193).
• (f) To what extent the outlay is unaffected by any considerations except those of profit and loss (
  Herald & Weekly Times Ltd. v. F.C. of T. (1932) 48 C.L.R. 113 at p. 119).
• (g) Whether there was merely a device to swell the apparent expenses of the business, or other income producing activity (
  Tooheys Ltd. v. C. of T. (N.S.W.) (1922) 22 S.R. (N.S.W.) 432 at p. 440).
• (h) Whether the outlay is in accordance with prudent business policy and according to a recognized practice of management (
  Hardie Investments Ltd. v. C. of T. (N.S.W.) (1946) 8 A.T.D. 43 affirmed (1946) 73 C.L.R. 490; 8 A.T.D. 238).
• (i) The bona fides of the taxpayer in making the outlay (the cases, passim).

9. The general provision in sec. 65(1) of the Act is that a payment made or liability incurred by a taxpayer to his wife (or other associated person) is allowable as a deduction only to the extent to which in the opinion of the Commissioner (or of the Board on an objection reference) it is reasonable.

10. In
F.C. of T. v. Green (1950) 81 C.L.R. 313; 9 A.T.D. 142 the income returned included director's fees paid by seven companies, rents from five properties at places distant from the residence, dividends from two companies and interest from two mortgages, and other items of income presently irrelevant. The trial judge had found that it was reasonably necessary for that taxpayer to keep books and records and to have them audited and to have a person (a relative) in attendance in the city of the taxpayer's residence to deal with matters affecting his financial affairs which arose during his absence; and that it was reasonably necessary for the taxpayer to inspect and supervise the properties from which the rents were derived. The High Court in a joint judgment (Latham C.J., McTiernan, Webb, Fullagar and Kitto JJ.) said: -

``The expenditure, a deduction of which is claimed, was incurred in relation to the management of the income-producing enterprises of the taxpayer. If this is so it is immaterial that there might be a difficulty in holding that the taxpayer was carrying on in a continuous manner and

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identifiable business of some particular description.''

11. The concept of ``business'' is widely defined in sec. 6 of the Act (cf. Ronpibon 78 C.L.R. at p. 56; 8 A.T.D. at p. 435) and matters of degree will arise (cf. re money-lending
Brown v. Brook (1971) 45 A.L.J.R. 400 at pp. 402-403). Frequency of an activity, of the relevant kind, is not synonymous with ``business'' (
London Australia Investment Co. Ltd. v. F.C. of T. 77 ATC 4398 at p. 4410; (1977) 51 A.L.J.R. 831 at p. 840 per Jacobs J.); there may be no business despite the frequency, and, on the other hand, there may be a business where the activity is an isolated one (ibid.); the scale of the activities does not itself provide an answer although it is important evidence (ibid.); see also
Esquire Nominees Ltd. v. F.C. of T. 73 ATC 4114 at pp. 4117, 4123 and 4128; (1971-1973) 129 C.L.R. 177 at pp. 212, 221 and 229. The dicta of the Full Bench of the High Court in Green load the scale against a finding that the taxpayer in the present case was carrying on a business; though curiously in Lunney and
Hayley v. F.C. of T. (1957-1958) 100 C.L.R. 478 at p. 491; 11 A.T.D. 404 at p. 408 McTiernan J. who had been a member of the Court in Green said ``But... as in Green the taxpayer carried on business at his residence.'' See also the discussion of
French v. Styring (1857) 2 C.B. (N.S.) 357 in The Law of Partnership in Australia and New Zealand (2nd Ed.) p. 56 and compare
Reg. v. Crayden (1978) 1 W.L.R. 604 at p. 608. It is best to adopt the phrase from Green, viz., expenditure incurred in carrying on an income producing enterprise.

12. The principle of
F.C. of T. v. Munro (1926) 38 C.L.R. 153 at p. 171 per Knox C.J. is that the nature of the security given for the loan is not crucial; see further
Thomas v. F.C. of T. 72 ATC 4094 at pp. 4097-4098; (1972) 46 A.L.J.R. 397 at p. 399; and
Europa Oil (N.Z.) Ltd. (No. 2) v. Commr. of I.R. (N.Z.) 76 ATC 6001 at pp. 6006-6007 as to the prohibition against looking behind the legal character of a payment made pursuant to a contract so as to take into account economic benefits which would in fact accrue to the taxpayer otherwise than as a matter of contractual right. Furthermore during the hearing of an application for special leave to appeal from the decision of Helsham J. in
F.C. of T. v. McCloy 75 ATC 4079 Barwick C.J. (as recorded in the transcript of proceedings) said that the Commissioner, if he is doing his task, will always look at interest to see whether in fact the principal is being used to earn assessable income and he will disallow interest that is not so used even though it happens to be borrowed on (say) a factory. In
Commr. of I.R. v. Port of London Authority (1923) A.C. 507 at pp. 522-523 Lord Sumner said: ``Of course, money may be capital none the less that it is borrowed money, for it is capital or not according to its employment, not according to its origin or obligations.'' (See also In Re Income Tax Acts 1924-1926 (Q'ld.) No. 11 A.T.D. 220 at pp. 228-229 and
Ben-Odeco Ltd. v. Powlson (1978) 1 W.L.R. 365.)

13. The Supreme Court of New Zealand (
Commr. of I.R. v. Banks 78 ATC 6001) adopts a more liberal approach to ``home office'' expenses than is permissible in the Australian cases, e.g., Thomas v. F.C. of T. 72 ATC 4094; (1972) 46 A.L.J.R. 397; and
Faichney v. F.C. of T. 72 ATC 4245; (1972) 47 A.L.J.R. 35. The Australian case law rules out any allowance under sec. 51(1) of a deduction in respect of any part of the interest or of mortgage expenses on a residence when a room therein is used as a study/office and falls short of the character that a doctor's surgery has when it is within his residence; so also with the use of a household garage as a workshop where a business, in the strict sense, is not carried on.

14. Halsbury, 3rd Ed., Vol. 23 Landlord and Tenant at p. 490 says that whether a chattel has been so affixed to the land or buildings as to become a fixture depends on the object and purpose of the annexation, and if the chattel can be removed without doing irreparable damage to the premises, neither the method nor the degree of annexation, nor the quantum of damage that would be done to the chattel or to the premises by the removal, affect the question save in so far as they throw a light upon the object and purpose of the annexation. Further, that if the object and purpose was for the permanent and substantial improvement of the land or building, the article will be deemed to be a fixture, but if it was attached to the premises merely for a temporary purpose or for the more complete enjoyment and use of it as a chattel, then it will not lose its chattel character and it does

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not become part of the realty. A chattel which is no further attached to the land than by its own weight (e.g., as Hals. ibid. in note (d) at p. 491 - a cistern) notwithstanding that it sinks into the ground, or rests by its own weight on foundations or in a place prepared for it in the ground, is not in general to be regarded as a fixture. Ultimately the question is whether the chattel is intended to form part of the building (
Wake v. Hall (1883) 8 App. Cas. 195 at p. 205) although the circumstances which can be relied on to show the intention of the annexation are such as exist at the time and are patent for all to see (ibid. note (h)). Large chambers and towers (used in an industrial process) resting on but not fixed to foundations prepared for them were held to be integral parts of one composite building permanently annexed to the freehold (
Pole-Carew v. Western Counties & General Manure Co. Ltd. (1920) 2 Ch. 97).

15. In several respects the taxpayer's evidence was unsatisfactory. The conclusions to be drawn from the evidence and from the authorities cited above (and taking each claim in the order given in the notice of objection) are set out in the following paragraphs.

16. There is cause to doubt that the taxpayer (at the time of borrowing money to construct his present residence) intended that it should be let to a tenant. When he applied to a building society for moneys to be advanced as progress payments to the builder he made a declaration that the house when completed would be the residence of himself, his wife and their children (four - eldest 10 - as at 30 June 1975). Consequent upon a dispute with the builder the taxpayer took up residence in the house before the builder had completed the construction. The correspondence between the taxpayer and the building society fully supports the Commissioner's submission that the property was not intended to be income producing. Although the taxpayer indicated in his return a total interest amount of $2,166.25 the evidence from the building society establishes that the correct total figure is $1,776.95. As such items as survey fees, preparation of plans, and council fees for plan approval have not been shown to be part of the expenses of borrowing (sec. 67) the amount that might otherwise have been allowable (if it had been shown to have been income producing) under this head would be $42.

17. There is no acceptable evidence that such part of the loan made by the Commonwealth Bank (certainly not intended by it to be for speculation on the Stock Exchange) as was salvaged from the share transactions was devoted to any income producing activity in the subject year. The amount $238 claimed under this head is, therefore, not allowable.

18. (a) The evidence does not prove that during the year in issue the taxpayer paid to his wife (or incurred a debt to her in respect of) two weeks' rent for interviewing and selecting a prospective tenant, and seven and one-half per cent commission on rent collected, and seventy dollars for five or six hours work in cleaning the house after a tenant had vacated; nor does the evidence establish that the above rates represent normal charges by real estate agents or by contractors as the case may be.

• (b) It seems that the taxpayer from time to time withdrew from the bank account into which his salary was paid amounts for general expenditure (he says he withdrew $700 or $1,000) including sums to be paid to his wife for household expenses; and that he included in general payments to her what he thought appropriate for her assistance in obtaining tenants for the properties which he owned solely or as joint tenant with her; and for the handling and recovery of rent payments (not always promptly made) which all came by post; and for the cleaning of the house (on one occasion in the subject year) to the extent that the tenant did not comply with the bond in that respect; any bond moneys retained were not returned as income nor, apparently, offset against expenditure in respect of which they were retained.
• (c) It is not shown that the taxpayer's wife is entitled to remuneration on the same basis as an agent who has to maintain his own office and staff, nor on the same basis for cleaning a house as a contractor would charge. Nonetheless it may be acknowledged that the taxpayer's wife would be likely to exercise greater care

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  and would devote more time than would a real estate agent's employee to the selection of a tenant (discussing the matter either at an interview or by telephone with about 15 applicants and narrowing that number to six for the taxpayer's decision).
• (d) The evidence does not support a figure in excess of $80 for the items claimed as deductions in para. (c) of the grounds of objection.

19. The taxpayer is correct in saying in para. (d) of his notice of objection that ``The Financial Review is a business paper''; though he understates the position in saying that ``it is only useful and read in relation to business activity.'' More important, on the authority of Green supra, the taxpayer was not conducting a business. The evidence does not establish that that newspaper would have any particular relevance to adopt the taxpayer's words "about the law concerning rented properties (e.g., the recent amendment re a tenant's bond money), movements in rent (i.e., of cottages), availability of properties (i.e., of cottages), repairs costs (i.e., of cottages) or trends in the investment market (i.e., of cottages). The taxpayer was not engaged in any share transactions in the year in issue, and no other ``business'' was suggested in evidence; and so he is restricted to the first positive limb of sec. 51(1) of the Act.

20. (a) The architect's plans for the construction of the residence show that the room which is used as a study/office was designated as ``study'' although it had a built-in cupboard across the width of the room, with four doors similar to a built-in wardrobe. Additional shelves have been added and it is used as a storage cupboard. A photograph of portion of the room showing one section of the cupboard was put in evidence. There are five bedrooms on the upper storey of the house.

• (b) In his initial application to the building society the taxpayer said that the proposed house is of necessity large to accommodate his large family and he adds: ``Moreover, I wish to extend my activities as a professional... engineer by giving private lessons in... and this makes a study a necessity.'' In evidence the taxpayer deposed that he has not carried out the intention of giving private lessons.
• (c) The taxpayer enlarged on the particulars in para. (e) of his grounds of objection by reference to a blockage in a septic system corrected by a contractor to whom $40 was paid; repairs to a concrete driveway carried out by a contractor to whom $120 was paid; replacing a curtain rod; repairing a window latch; replacing a switch on the septic pump; fitting of ``dead'' latch on door; grill for exhaust fan, washers for taps and ``other odds and ends'' and some painting.
• (d) The rent books and records of expenditure for all six houses (see para. 4) are kept in the study/office; and it contains personal items such as a cassette player, magazines, etc.
• (e) The taxpayer said that the study/office is kept locked during the day, and, upon returning home in the late afternoon, the first thing that he does is to unlock the door of this room. He further said that at night time and on week-ends (and perhaps taking into account also annual leave and holidays) he works on the average in the study/office for a total of about seven hours a week in respect of the six rent producing properties. During those hours when the study/office is unlocked, his wife may also be engaged therein on work related to one or more of those six properties.
• (f) The evidence does not establish that the study/office is to be characterized as different from any other room in the residence. It may be noted that the Commissioner allowed the taxpayer his claim to deduct a proportionate part of the outlay for electricity; and the taxpayer did not claim either in the return or in the notice of objection for depreciation for office furniture or furnishings, except as to curtains. The Commissioner disallowed the claim to a deduction (11¼% on $75 = $8.44) for depreciation of curtains. This is correct as curtains in a room used as a study/office in a house are not in the same category as a filing cabinet in the study/office.

21. (a) The valuer who gave evidence described the garage and its mode of access to the ``leisure'' room in the house

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where the taxpayer's children at times play; they keep some of their playthings in the garage. The valuer could see little difference between what was stored in the garage and what he would expect to find stored in any household garage where there is a family, except that the quantity of bricks and paint tins was appreciably greater. The garage was not used for housing the taxpayer's car and it was left on the concreted area outside. Whilst this is not commonplace, it is not of particular significance.

• (b) As with the study/office, the evidence does not show that the garage has any special characteristics which make it different from the garage of any household.

22. It is indisputable that the septic tank was intended to form part of the residence, though of course sited externally. The installation of the septic tank was for the normal way of living in the residence. The septic tank ceased to be a chattel when it was sited on the ground and connected up to the toilet suites in the residence.

23. The taxpayer entered into the arrangement with Australia Post for the availability of a post box at Y because he wanted the mortgagees of his properties to direct correspondence to a post box rather than to his residence. As with the claim to deduct interest on mortgages this claim for $8 fails.

24. Thus the taxpayer's objection succeeds only to the extent of an allowance of $80 as a deduction for a payment to his wife in the year in issue for her work (similar to the allowance in Green supra).

25. The assessment is to be reduced by the aforesaid amount of $80.

Claims allowed in part