Case U39

Members:
P Gerber SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 30 January 1987.

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Dr P. Gerber (Senior Member)

The material facts of this application can be put in short compass. Barkis Pty. Ltd. began life humbly as a shelf company. It was acquired in 1980, lock, stock and barrel (i.e. with its articles of association) by the Copperfield family, consisting, for present purposes, of Mr and Mrs Copperfield and their two adult sons, all engaged in a farming partnership on three properties - Blackacre, Whiteacre and Blenheim. Blenheim was owned by one of the sons, and was, by common consent, of a poorer quality than the other two properties. The family therefore decided to sell Blenheim and acquire another farm - Waterloo - which had much better soil. Enter McTavish, the family's accountant and tax adviser, who suggested that for purposes of "estate planning and consequent tax advantages", Waterloo should be acquired by a corporate trustee, to be held for the duration of the permitted perpetuity period (80 years) and leased to the partnership; hence Barkis Pty. Ltd., the vehicle to be used for that purpose. Why the son who owned Blenheim outright should consent to an arrangement which appears to me to have had the effect of depriving him of ownership was never made clear and explicable - like much

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of the rest of this estate planning - only in terms of the looseness one frequently finds in family arrangements. Waterloo was acquired by the Trust in October 1980 for $302,250 after Blenheim had been sold. For commercial reasons which I unhesitatingly accept, Waterloo did not prove viable and was sold in August 1981, resulting in a net profit of $61,354. Another property, Salonica, of more suitable size was subsequently acquired by the Trust. However, this is a matter which does not concern me. I find that Waterloo was not acquired with an intention to resell at a profit. The respondent, whilst not abandoning the sec. 26(a) argument, properly did not press it.

2. The sole issue before me is whether the profit from the sale of Waterloo is assessable income pursuant to sec. 26AAA, subsec. (2) of which having the effect - subject to subsec. (5) - of treating as assessable income the profit from the sale of any property sold within 12 months from the date of acquisition. Subsection (5) provides that subsec. (2) does not apply in relation to a sale of property if:

"(a) the property was included in the assets of a business carried on by the taxpayer and, as a result of the sale, an amount will be included in the assessable income of the taxpayer of the year of income under a provision of this Act other than this section;

(b) section 54 applied in relation to the property and, as a result of the sale, section 59 applies in relation to the property;"

Section 54(1) states "Depreciation during the year of income of any property, being plant or articles owned by a taxpayer and used by him during that year for the purpose of producing assessable income... shall, subject to this Act, be an allowable deduction." ("Plant" is defined to include, inter alia, fences and other structural improvements on land which is used for the purposes of agricultural or pastoral pursuits.)

Section 59(1) provides that "Where any property of a taxpayer, in respect of which depreciation has been allowed or is allowable under this or the previous Act, is disposed of, lost or destroyed at any time in the year of income, the depreciated value of the property at that time, less the amount of any consideration receivable in respect of the disposal, loss or destruction, shall be an allowable deduction."

3. To complete the factual narrative, no rental income for Waterloo is shown in the Trust Estate's first return in 1981 and a modest distribution of two equal amounts is shown as having been paid to two infant grandchildren, such income having been received from an interest-bearing deposit. The failure to charge rent was explained by Mr McTavish as an error of judgment "in that I considered that there was sufficient income in the Trust that year and did not raise a rental charge. In retrospect, I regret having made that judgment". In the 1982 tax year the Trust received as "rent" an amount of $13,230 which, after paying interest owing and other expenses, left a net profit of $3,120 which was distributed in three equal amounts of $1,040 to the (by now) three grandchildren. In parentheses, it is worth noting that $1,040 was the threshold of tax-free income in that financial year. In other words, it is clear that the "rent" charged was quite artificial and calculated after the end of the financial year by Mr McTavish without consultation with the directors of the Trust or other members of the family, who presumably were quite unversed in estate planning. All this was cheerfully admitted by Mr McTavish in cross-examination, who was to add that the rent of $13,230 raised in that year was in no sense a commercial rent when compared with other properties in the area. In the end, I am not persuaded that much turns on this other than to highlight the extreme looseness of this family's arrangement. For good measure, no written lease existed between the Trust and the family partnership and at no time, semble, was any rent negotiated or even mentioned between the parties when it was decided that the Trust should acquire Waterloo and lease it to the partnership. Was the corporate Trust carrying on a business? Unassisted by authority I would have concluded that the lack of activity by the Trust did not amount to the carrying on of a business. However, much reliance was placed by counsel on the decision in
American Leaf Blending Co. v. Director-General of I.R. (1978) 3 All E.R. 1185 where their Lordships of the Privy Council observed:

"In the case of a private individual it may well be that the mere receipt of rents from property that he owns raises no presumption that he is carrying on a business. In contrast, in their Lordships' view, in the case of a company incorporated for the

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purpose of making profits for its shareholders any gainful use to which it puts any of its assets prima facie amounts to the carrying on of a business. Where the gainful use to which a company's property is put is letting it out for rent, their Lordships do not find it easy to envisage circumstances that are likely to arise in practice which would displace the prima facie inference that in doing so it was carrying on business."

(at p. 1189)

Their Lordships concluded that, in this case, "the evidence serves only to reinforce that prima facie inference", there being continuous activity by the company in and about its letting operations. But their Lordships noted that:

"The carrying on of `business', no doubt, usually calls for some activity on the part of whoever carries it on, though, depending on the nature of the business, the activity may be intermittent with long intervals of quiescence in between."

(at p. 1189)

I had occasion to review that case in Case M3,
80 ATC 28 at pp. 36-38. I concluded there that the decision of the Privy Council, based as it was on the Malaysian Tax Act, was only of marginal relevance to the Australian Tax Act. I remain unrepentant of the view I expressed on that occasion, the more so since our courts have provided ample guidelines for determining whether or not a business is being carried on. I am not persuaded that mere incorporation necessarily involves the conception of a business. Whether or not an entity is engaged in a business turns on the investigation into the nature of the operations and activities carried on rather than on the identity of the persona who is in receipt of income. And when one observes the activity of this applicant in the 1981 and 1982 tax years, such movement as there was lay somewhere between that of Galapagos turtles and drying paint. To the extent, therefore, that subsec. (5)(a) of sec. 26AAA demands the carrying on of a business before the exclusionary provision applies, I am satisfied that this applicant is disqualified from taking advantage of that provision. As pointed out before, I am satisfied that the mere receipt of rent - whether by a corporate trustee or an individual - does not by itself constitute the carrying on of a business.

4. Different considerations apply with respect to subsec. (5)(b) of sec. 26AAA. This subsection excludes from the ambit of subsec. (2) a sale of property if sec. 54 applies and, as a result of such sale, sec. 59 applies in relation to the property. This takes me to the fences for which depreciation was claimed - and allowed - in both 1981 and 1982. I find as a fact that it was only at or about the time of the sale of Waterloo that the possibility of utilising the result of the decision in
F.C. of T. v. Mullins (81 ATC 4643) affected the thinking of McTavish and the directors of the Trust company. The following was elicited in cross-examination of Mr McTavish.

"Did any of the Copperfields approach you concerning their proposal to sell? - Yes.

What was the content of the conversation then? - First of all there were several of the Copperfields came in. I cannot remember how many but I do recollect there was more than one. They came in and told me of the decision they had made regarding the land and were there any problems in relation to a disposal, having in mind the twelve months period. I told them that there was. I know that I examined the CCH references on section 26AAA and I asked their permission to telephone lawyers in Cairns to discuss the problem with them, which I did. I spoke to Mr Ted Jarndyce of Jarndyce & Jarndyce. Out of that I came to the conclusion whilst still on the telephone that the advice I gave was of such importance that I wanted it in writing. I informed Mr Jarndyce of that fact and he asked me to send to him a brief of what I wanted. I then conveyed to the Copperfields the outline of what Mr Jarndyce had said to me; that is to say that, providing we could use section 54 and 59, then there was no reason why the property sale could not then proceed. At the same time I did inform the Copperfields that I would be sending a brief off to Jarndyce & Jarndyce and that a written opinion would be coming back and for them not to do anything until we had that written opinion."

It transpired that at the instigation of McTavish, Mr Copperfield snr approached the vendor of Waterloo - well after the purchase date and exchange of contracts - and obtained from him a signed statement which put a value of $100 on the boundary fences on Waterloo. This, in turn, became an attachment to the Trust Estate's return for 1981 and a claim for $1 was made for depreciation. In addition -

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and this was not challenged - the Copperfield family had effected improvements to the boundary fences on Waterloo during the period in which they farmed it and expended an amount of $900 on such improvement. A further amount of $10 was therefore deducted for depreciation in that year. The written down value of these fences was again claimed for depreciation in the 1982 tax year. Is this sufficient to satisfy the requirements of either subsec. (5)(a) or (5)(b) of sec. 26AAA, the latter merely demanding that sec. 54 apply in relation to the property and, as a result of the sale, sec. 59 applies in relation to the property so as to exclude the application of subsec. (2) of sec. 26AAA?

5. This point was considered - albeit obiter - in Mullins (supra). The facts, taken from the headnote at pp. 4643-4644, were:

"By contract dated 26 June 1975, the taxpayer and his wife purchased an area of approximately eight acres of land on which they carried on, in partnership, a business of pig farming. They sold the land on 23 April 1976, i.e., within 12 months of their purchase of it, at a profit. At the time of the purchase of the land, there were some badly damaged fences on it which the taxpayer repaired.

The Commissioner, relying on sec. 26AAA, assessed the taxpayer on his share of the profit and the taxpayer objected claiming that, in the circumstances, sec. 26AAA(5)(a) or (b) excluded the operation of sec. 26AAA(2). It was common ground that, following the sale of the land, a small amount was included in the assessable income of the taxpayer pursuant to sec. 59(2) representing recoupment, upon the sale, of depreciation allowable in respect of the fences.

On review, the No. 3 Board of Review allowed the taxpayer's objection (Case L20, 79 ATC 101) and the Supreme Court dismissed an appeal by the Commissioner from this decision. Leave to appeal from the Supreme Court's decision was given to the Commissioner by the Federal Court subject to certain conditions, one of which was that the finding by the Supreme Court that at all material times the taxpayer and his wife carried on the business of pig farming on the land, remained undisturbed."

The majority, consisting of Deane and Lockhart JJ., held that the profit from the sale was excluded from assessability under sec. 26AAA(5)(a). Integral to the majority's conclusion was the (imposed) finding that the taxpayers were engaged in the business of farming and had used the land (with improvements) as part of the assets of the business.

6. Having concluded that in the instant case this taxpayer was not engaged in the business of farming - or indeed any business - it follows that the decision in Mullins can have no direct bearing on the outcome of this application. However, there are some observations by two of their Honours with respect to subsec. (5)(b) which cannot be lightly ignored. Thus McGregor J. (dissenting) stated (at p. 4653):

"In my opinion, sec. 54 does not apply in relation to the estate or land though it does apply in relation to fences. It cannot be said, I consider, that if sec. 54 applies to a depreciable asset (fences) on land, it applies thereby `in relation to the land'. Indeed, sec. 54(1) of the Act, if extended by including `fences' as the relevant `plant' would read -

• `Depreciation during the year... of any fences... on land which is used...'

i.e. specifically distinguishing fences from land. Their depreciation is unaffected by the quality, the situation or the area of the land. Section 59 is designed to protect the revenue as well as the taxpayer on disposal of depreciable assets and does not, I consider, apply in relation to the disposal of an estate or land merely because on it are to be found depreciable assets. This would appear to be in harmony with the references made by Taylor J. referred to earlier."

The references to Taylor J. relate to a decision of the High Court in
Ferling v. F.C. of T. (1966) 115 C.L.R. 603. In that case some of their Honours expressed opinions, albeit by way of obiter dicta, as to whether sec. 59 of the Tax Act can be applied where there is a sale of land together with improvements which are an inseparable part of the land.

In Ferling (supra) the appellant claimed to be entitled to a deduction under sec. 51(1) on certain depreciable items which constituted

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improvements within the definition of "plant" in sec. 54. It was submitted that the improvements were disposed of at the time the appellant disposed of his interest in the land, that those items of property were sold with other assets but, because separate values were allocated to them in the contract of sale, the Commissioner was not empowered to determine the values pursuant to sec. 59(3)(c). In dealing with this submission, Taylor J. noted (at pp. 630-631):

"With these observations in mind it is necessary to point out that what s. 59 deals with is `property' of the taxpayer, upon which depreciation has been allowed or allowable, which is disposed of, lost or destroyed, at any time during the year of income. This, of course, raises the initial difficulty in the way of the appellant for it is difficult to regard improvements upon land which, although they add to the value of the land, do not in themselves constitute property and have no value independently of the land itself. The next difficulty is that, in spite of the apportionment of the purchase money which each agreement purported to make, the purchase price specified in each agreement was the consideration receivable in respect of the land in the condition in which it stood at the time of each sale. No part of it was the consideration receivable for the improvements which could not be, and therefore were not, made, independently, the subject of a sale. In these circumstances there is, in my view, much to be said for the proposition that the provisions of s. 59 have no application to a case such as the present. I appreciate the difficulties which would flow from such a view but it is one to which, as at present advised, I would be prepared to subscribe since it seems to me to follow inevitably from the language of the section."

7. Deane J. tentatively agreed with the view expressed by McGregor J. Thus, his Honour observed (at p. 4645):

"As at present advised, I agree with McGregor J. that cl. (b) does not, in the circumstances, exclude the application of sec. 26AAA(2) in relation to the sale for the reason that it cannot properly be said that either sec. 54 or 59 of the Act applies in relation to the `property' the subject of the relevant sale regardless of whether that `property' be the taxpayer's estate in the relevant land or the land itself. With due respect to those who see the matter differently, it seems to me that sec. 54 and 59, in their application to an item of plant, structure or structural improvement, apply to, or in relation to, the item, structure or structural improvement itself. They do not apply to, or in relation to, the whole area of land, however vast or small, to which that item of plant, structure or structural improvement may happen to be affixed or on which it may happen to be found. I am, in indicating this tentative view, conscious of the difficulty posed by structural improvements which consist of the shaping of the land itself, such as dams (see sec. 54(2)(b)). It seems to me, however, that sec. 54 and 59, in the application, effect, even in such cases, a notional isolation of the relevant item of plant, structure or structural improvement with the result that it cannot properly be said that either sec. 54 or 59 applies in relation to the overall area of land. it is, however, unnecessary that I form or express any concluded view on that question since I have come to the view that the application of the provisions of sec. 25AAA(2) is excluded by reason of the operation of the provisions of cl. (a) of sec. 26AAA(5)."

8. I find these observations to be compelling and must conclude that on the evidence in the instant case, subsec. (5)(b) does not exclude the application of subsec. (2) of sec. 26AAA, and since I have concluded that subsec. (5)(a) has no application to a taxpayer of whom no more can be said than that its activity consists exclusively of collecting "rent" as and when it feels like it, calculated according to no normal yardstick known to man, this taxpayer fails on the two grounds which have been advanced on its behalf.

9. The decision under review is affirmed.