Case W79

Members:
PM Roach SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 10 August 1989.

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P.M. Roach (Senior Member)

I shall refer to the applicant in this reference by the name of ``Clancy''; a name appropriate to events set in the Snowy Mountains. Clancy married in 1965 and with his wife bought a parcel of land with a home on it in the Snowy Mountains. There the couple reared three children to adulthood. To provide for the daily needs of his family, Clancy worked for wages. He was still doing so during the year of income 30 June 1984. The land that the couple had purchased comprised 399 hectares (nearly 1,000 acres). It was timbered throughout, but poorly timbered. There was no sawlog and if there was any

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ATC 706

useful pulp-wood very little of it was capable of being marketed economically.

2. Clancy and his bride followed the practice of many generations who had preceded them - they set about clearing the land. As they cleared it they were able to establish some pasture and growing crops. They introduced stock as development and finances permitted. In doing so they faced a hazard not known to the early white settlers of the district: the provisions of the Income Tax Assessment Act 1936 (``the Act''). But the provisions of the income tax laws were not wholly unfavourable to the interests of the family for, as conventional understanding of the law would have it, having reached the point of clearing sufficient land to run enough stock to be considered to be in business, they could proceed to develop their capital asset (the land) by clearing it while at the same time claiming the costs of that development as a revenue expense to be set off against such other income as they might have. As joint owners of the freehold it was clear that any increase in its capital value would pass to them equally independently of the proportions in which they might make contributions to, or to the cost of, that development. There were several possibilities open to them as to the manner in which they would bear the costs of that development, including a number of possibilities which would maximise the benefits to the couple by confining their contributions to the revenue. One possibility was for Clancy alone to carry on the business of primary production, at least while it was generating losses. A second possibility was to carry on business as a partnership, but on the terms that the losses to be borne in the early years would be borne by Clancy to the exclusion of his wife. Both of those possibilities were borne out of the circumstance that Clancy had an income from employment against which to offset the losses, whereas his wife had no such independent income. In the event the couple chose a third course which was intended by those advising them and which, but for the Commissioner's submissions in these proceedings, would have had the same effect. In 1979 they took the first step and entered into a partnership on the basis that, unless they would otherwise determine, they would share equally in the profits and losses of the partnership. The partnership agreement also made provision that:

``13. Any partner may with the consent of the other partner be paid or credited out of the gross profits of the partnership business, such sum by way of salary as may be commensurate to the special duties carried out by such partner.''

3. The subtleties of difference between the many alternatives available were lost upon Clancy and his wife. That is not to their discredit. Although Clancy's formal education was limited, he impressed - as did Mrs Clancy - as a person worthy of great respect. Further, I am satisfied that they were trusting people who placed themselves and their financial affairs in the hands of their then accountant. He was to prove worthy of that trust so far as his concern to advance their interests was concerned. Whether his advice would prove to be effective was another matter.

4. From at least 1981 the couple had run stock on the property and it is common ground that they were carrying on business - albeit doing so at a loss. Both husband and wife were active in the affairs of the farm. They worked together at weekends clearing, burning, slashing, sowing crops, treating stock, repairing fences and attending to all the many other things involved in the management of the property. However, during the week the whole burden of farm management fell on the shoulders of Mrs Clancy. It is not disputed that she spent substantial periods of each and every day attending to matters of farm management, including the simple but sufficient management of accounts. In particular, there were prolonged periods when she was intensely engaged in caring for stock. Hand-feeding both flocks of sheep in winter was an onerous task. It was said that she worked of the order of 40 hours per week. As it was not disputed, I accept it. It was said that she worked 52 weeks per year. Apart from the circumstance that I find there were vacations of up to a week at intervals of several years, I accept that. Clancy on the other hand worked only at weekends being principally concerned with the heavier work and works of clearing. I find that for him too the working weeks were 51 to 52 weeks in each year.

5. The result of their endeavours was that, excluding from account distributions to partners by ``salary'', the results of their activities in those years were as follows:

        
Year ended   1982*    1983*   1984*    1985      1986   1987   1988
30 June        $        $       $        $**       $**    $**    $**

Cattle                        1,666
Sheep        (425)           (1,540)   (393)
Wool        2,621             3,161   4,483
Timber                          528
Gravel                                  434***
           ------   ------   ------  ------     ------ ------ ------
            2,195    2,148    6,190   9,451     12,691 17,232 32,974
Expenses   10,220   12,641   21,362  14,081     17,812 15,856 35,054
           ------   ------   ------  ------     ------ ------ ------
           (8,035) (10,493) (15,172) (4,630)    (5,121) 1,376 (2,080)


*Figures are based on these returns. They have not been reconciled
to the unchallenged summaries prepared for the Commissioner.

**Some details were not provided.

***Not included as assessable income.
      

6. However, those results were not known until assessed and calculated by the accountant following the close of the financial year. During the course of each year of income the financial relationship between the spouses as partners was determined by the terms of the partnership agreement. There was an expectation that the accountant would make a recommendation such as he perceived to be in their best interests; and an expectation that they would accept recommendations so made, although having no obligation to do so. But it is equally clear that such recommendations would neither be made nor accepted until after the close of the financial year. That being so, as at 30 June in each year the relationship between the parties stood to be determined upon the basis of an equal division of profits and losses. I am satisfied that there had not been any agreement to vary the provisions of the partnership agreement.

7. Following the close of each financial year Mrs Clancy attended, together with all records, on the accountant and discussed with him everything which was considered to be relevant by either of them. The accountant then prepared accounts and returns of income and forwarded them to the couple for their perusal and, if approved, for execution. In preparing those accounts for the year of income ended 30 June 1984 - the only year of assessment under review in these proceedings - he made provision for ``salary'' to Mrs Clancy as he had done in at least the two preceding years and was to do in the years following. In doing so, he also presented for their adoption in relation to the 1984 year a resolution as follows:

``Partners Resolution

We the undersigned being all the partners of the partnership hereby resolve that a salary be paid to (Mrs Clancy) out of the gross profits of the partnership for the extra services performed by her during the year.

The salary is to be paid at the following rate:

$6.55 x 40 hrs x 52 wks = $13,624.''

The resolution so drafted was signed by both partners and presented to the Commissioner with the return of income to 30 June 1984.

8. The calculation was so presented as if the figure of $13,624 was deduced as a figure determined by the other factors. As the case was presented before me I find nothing excessive or unreasonable about the notion that $13,624 was an appropriate remuneration for a person with the skills of Mrs Clancy rendering the services she rendered. I accept $6.55 per hour as a reasonable rate to pay to persons dealing at arm's length with a paying authority. But reasonable though it might have been in that sense, I am anything but persuaded that the figure was so calculated.

9. The evidence presented before me shows that the ``salary'' so paid to Mrs Clancy over the years was as follows:

        
Year ended      1983     1984     1985     1986     1987     1988
30 June           $        $        $        $        $        $

Salary          9,360   13,624    4,628    5,100    1,300    3,900
      

10. When that ``salary'' was taken into account in addition to the other expenses previously referred to the net profit (loss) of the partnership came to be shown in the profit and loss accounts as follows:

Year ended       1983     1984     1985     1986     1987     1988
30 June            $        $        $        $        $        $
Loss before
"salary"      ( 9,866) (13,625)  (4,630)  (5,121)   1,376   (2,080)
Salary          9,360   13,624    4,628    5,100    1,300    3,900
              -------- --------  ------- --------   -----   -------
Gross loss    (19,226) (27,249)  (9,258) (10,221)      76   (5,980)
      

For Clancy the result was a return of losses (or in 1987 a profit of $38) to be offset against his income from employment; those losses being as follows:

Year ended       1983     1984     1985     1986     1987     1988
30 June            $        $        $        $        $        $
               (9,613) (13,624)  (4,629)  (5,110)      38   (2,990)
    

For Mrs Clancy the same losses were returned but with ``salary'' off-sets to create the following result:

Share profit   (9,613) (13,625)  (4,629)  (5,110)      38   (2,990)
Salary          9,360   13,624    4,628    5,100    1,300    3,900
                ------  -------   ------   ------    -----   ------
Total salary and
distribution     (253)      (1)      (1)     (10)   1,338      910
    

Figures in this table are based on the Commissioner's unchallenged summary. No reconciliation to the figures in the table on p. 4 was provided. The differences are not material to present purposes.

11. In face of those figures I am compelled to the conclusion that the determinant of the ``salary'' attributed to Mrs Clancy was not the value of her services but a desire to so distribute the financial result of partnership activities as to have Clancy bear the whole, or nearly the whole, of the net loss and entitle him to set that loss off against his other income liable to tax.

12. The result claimed to have been achieved by the action taken is of the same effect as the result which might have been achieved by following other courses of action. But the problem is not to be resolved by reference to any doctrine or concept of ``economic equivalence'' (
Europa Oil (N.Z.) Ltd. v. Commr of I.R. (N.Z.) 76 ATC 6001). The law necessarily analyses human conduct and classifies and categorises human action. By the standards of the law the ``partnership'' which arose between this couple at their marriage is thereby not a ``partnership'' for the purposes of commercial law. For the individuals that means that neither is financially responsible for the actions of the other by reason only of marriage. But, conversely, they

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ATC 709

are not taxed to income tax as a family unit either. Income generated in their common interest or by their joint efforts is not to be automatically assessed against them equally, or as they nominate. Rather it is to be assessed against them as individuals in accordance with concepts of ``derivation''. How the farm income would be derived or the losses incurred was a matter which they were largely at liberty to organise so that they could determine who would ``derive'' income and who would ``incur'' losses. But those arrangements had to be in place before the income was derived or the losses were incurred (as the case might be). It could not be achieved after the event so as to alter the incidence of derivation of income or of losses incurred. For those reasons, as was illustrated in decisions such as Case R59
(1966) 16 T.B.R.D. 271, Case T69
(1968) 18 T.B.R.D. 353, decisions such as the decision in this case after the close of the year of income to pay a ``salary'' really constitute an attempt to re-distribute the partnership income. As such they came too late in point of time to alter what has been derived or incurred at the close of the year of income.

13. In reaching the conclusions I have, I have not overlooked the circumstance that for at least some few years there had been a practice whereby a ``salary'' was paid to the wife sufficient to have the effect of causing Clancy to bear the entirety for the loss for the years. Such course of conduct in some circumstances might be considered to have effected a modification to the contractual relationships subsisting between the parties as expressed by the terms of the partnership agreement. But in the circumstances of this case I am not persuaded that the action adopted in relation to any one year was indicative of a consensual commitment to adopt and be bound by the same principles in relation to any later year.

14. The Commissioner's representative, in his argument, also relied upon the provisions of Pt IVA of the Act. His intention to do so was not referred to in the Commissioner's reasons expressed in defence of the assessments at the time of submitting the reference to the Tribunal. The Commissioner properly gave notice to the applicant and the Tribunal in advance of the hearing of his intention to rely upon such arguments (
Fletcher & Ors v. F.C. of T. 88 ATC 4834 at p. 4846). In view of the findings I have made it is not necessary to consider whether the extensive, intricate and complex provisions in Pt IVA of the Act need to be invoked in order to render ineffective against the Commissioner arrangements so simple as these: arrangements the desired effect of which might have been simply and effectively achieved by other means.

15. The determination of the Commissioner upon the objection under review will be affirmed.