Case X28

Members:
IR Thompson DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 16 February 1990.

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I.R. Thompson (Deputy President)

The applicant in these proceedings is a family company which I shall refer to as Famco. The principal shareholders in the company are John and a family trust of which his brother and family are the beneficiaries. John resides in Sydney and is a senior executive of a major company. His brother resides in the United States of America, where he is also a senior executive of a major company. They were, however, born in Australia of a family which apparently had considerable farming interests. The directors of Famco at all relevant times were John, his brother and, until her death, their mother. Famco owns over 4,000 hectares of grazing land in New South Wales adjacent to 8,575 hectares of similar land owned by John and family trusts of his brother and sister. The

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land owned by Famco is leased by it to John and the two family trusts; in partnership they engage, through a manager, in farming activities on the whole of the two areas of land.

2. Since 1978 one of the activities of Famco has been the breeding and racing of racehorses. In each of the taxation years which ended respectively on 30 June 1979, 1980, 1981, 1982, 1983 and 1984 Famco incurred expenditure on those activities. In each of the 1981, 1982, 1983 and 1984 years it also derived income from them. Overall, however, in every year the expenditure exceeded the income. When Famco lodged its returns of income to the respondent in respect of each of the six years, it claimed a deduction for the expenses; in each of four years in which it derived income, it entered that income in the return as assessable income. However, when the respondent assessed Famco's income tax liability for each of the years, he treated the income as not having been derived from the carrying on of a business and therefore as not being assessable income; for the same reason he treated the expenditure as not giving rise to an allowable deduction.

3. Famco objected to all the assessments. The respondent disallowed the objections. Famco then requested the respondent to refer his decisions on those objections to the Administrative Appeals Tribunal for review in accordance with sec. 187 of the Income Tax Assessment Act 1936 (``the Act''). The decisions having been referred, applications are deemed to have been made to the Tribunal by Famco for review of them (Taxation Administration Act 1953, sec. 14HD(2)).

4. At the hearing of those deemed applications, the applicant was represented by Mr J.W. de Wijn, of counsel, and the respondent by a departmental officer, P. Oral evidence was given by John, by a former professional trainer of racehorses (``Trainer'') and by an accountant (``Accountant''). In addition many documents were tendered in evidence relating to the activities of Famco in respect of breeding horses and racing them and also in respect of John's involvement as a director of Famco in managing those activities. P did not suggest that the expenditure shown in Famco's income tax returns as having been incurred in carrying on the activities of breeding and racing horses was not in fact incurred or that the amount of that expenditure was otherwise than as entered in those returns. Having had regard to the documents tendered in evidence, I am satisfied that the expenditure incurred by Famco in carrying on those activities was as shown in its income tax returns. The only issue in these proceedings is, therefore, whether that expenditure constituted outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income (sec. 51(1) of the Act).

5. P referred the Tribunal to a number of decisions of courts, Taxation Boards of Review and this Tribunal in which it was held that a taxpayer's engagement in activities of breeding and racing horses did not constitute the carrying on of a business for the purpose of gaining or producing assessable income. Mr de Wijn referred to other cases in which such activities had been held to constitute carrying on such a business. No useful purpose would, in my view, be served by discussing at length all of the many cases to which P and Mr de Wijn referred. What is important is to note that it is clear from an examination of them that each case was decided on the basis of its own facts. There is no general presumption either that the engagement in such activities constitutes the carrying on of a business for the purpose of gaining or producing assessable income; nor is there any rule that it cannot constitute such a business (see
Martin v. F.C. of T. (1952-1953) 90 C.L.R. 470 at p. 479).

6. In Martin's case, Webb J. at first instance suggested a test to be applied in order to come to a conclusion whether or not a taxpayer's activities are a pastime or a business carried on for the purpose of gaining assessable income. Although his decision in that case was overturned by the Full Court of the High Court, it did not disapprove of the test he postulated. He expressed it as follows at p. 474:

``The test is both subjective and objective: it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.''

7. In
Tweddle v. F.C. of T. (1942) 7 A.T.D. 186 at p. 188 Williams J. referred with approval to a passage from the judgment of the

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Lord President in
I.R. Commrs v. Livingston (11 Tax. Cas. 538 at p. 542) that a taxpayer is engaged in trade if ``the operations involved in it are of the same kind, and carried on in the same way as those which are characteristic of ordinary trade in the line of business in which the venture was made''. His Honour regarded as significant the fact that the taxpayer in the proceedings before him had kept proper accounts of all transactions. He pointed out that in the early years of many businesses net losses are anticipated without that derogating from the fact that the businesses are carried on for the purpose of gaining assessable income.

8. That view was reaffirmed by the Full Court of the Federal Court in
Ferguson v. F.C. of T. 79 ATC 4261 per Bowen C.J. and Franki J. at p. 4264. At. p. 4270 of that case Fisher J. referred to tests suggested by the courts from time to time, including whether the activities had ``a significant commercial purpose or character'' (
Thomas v. F.C. of T. 72 ATC 4094) and whether they had ``a commercial purpose, i.e. pursuit of profit or gain rather than pleasure or recreation'' (
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 at p. 49). His Honour then suggested that the test suggested by the Lord President in Livingston's case, set out in para. 7 above, indicated how it might be determined whether activities had a commercial character. He considered that ``if the transactions which go to make up the activity or operations of the taxpayer have an element of regularity or repetitiveness this factor assists in concluding that the taxpayer is carrying on a business rather than indulging in a recreational or hobby activity''.

9. In Case W122,
89 ATC 967, Deputy President McMahon suggested that decisions of the courts indicated that four principal factors might be used as guides in deciding whether business was being carried on for the purpose of gaining assessable income. They were, he said at p. 970, ``firstly, the scale of operations, secondly, the elements of repetition and system, thirdly, whether a significant commercial purpose exists or whether the activity represents a hobby and, fourthly, whether there is a profit purpose''.

10. In the present case Famco bought in 1978 two breeding mares, one of them in foal. In 1981 it bought a one forty-second share in a stallion which was standing at stud. One of the mares died in 1987 but one of the foals to which that mare gave birth in 1979 was retained and has been used by Famco as a breeding mare since 1987. It caused each of the mares to be served in each of the years with which we are concerned in these proceedings, except for 1983 in the case of the mare that died in 1987 and except for 1981 in the case of the other mare. In 1982 the part-owned stallion was used to serve one of the mares and in 1984 to serve both of them. In 1979 Famco had the original two mares and the foal, a colt. In 1980 it had five horses, in 1981 five, in 1982 four, in 1983 four and in 1984 six. Since then the numbers have fluctuated between six and eight. Horses had been sold in 1981, 1982, 1986, 1987 and 1988.

11. John gave evidence that he managed the affairs of Famco from day to day. However, he kept his brother, who was now the only other director of the company, fully informed of all matters of significance before decisions in respect of them were taken. He tendered in evidence copies of messages which he had sent to his brother regarding the company's affairs. In addition to obtaining income each year from renting its land to the partnership, Famco also derived income from various investments, of which some were interest-bearing and others resulted in the receipt of dividends.

12. John gave an account of the circumstances in which Famco commenced its horse breeding and racing activities. He said that his father had bred and raced horses in partnership with another person. His father had died in 1975 and his partner shortly afterwards. When the property of the partnership was being disposed of and both estates wound up, Famco entered into negotiations with those who were administering the estate of John's father's partner with a view to buying the two mares which it considered had the best potential for breeding purposes. They were valued by an independent valuer and bought at that price.

13. John gave evidence that the purpose of the directors of Famco when it bought the mares was to establish a horse breeding business. With that aim in view he sought the advice of Trainer, who had been a close friend of his father; thenceforth he acted on Trainer's expert advice in carrying on the breeding activities. Because Famco intended to carry on a breeding business rather than a racing

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business, the directors decided to sell the colt born in 1978 at the yearling sales. However, the highest price bid for it was slightly below what Trainer had advised it was likely to fetch. John's mother, who was the only director at the sale, then withdrew it from sale. Subsequently, it was raced by Famco in the hope that it would do well and could then be sold for a substantial price. Unfortunately it did not race well and was later sold at a very low price, about one-tenth of what had been offered for it at the yearling sale. Had it been sold for the price which was offered at the yearling sale Famco would have made a substantial profit in 1980.

14. John gave evidence that Famco was principally concerned to increase the number of its breeding mares. Consequently its policy was to sell colts but to retain any mares which appeared to have good breeding potential. In the event the one filly which had a successful racing career was sold as a three-year-old because she was too small to use as a breeding mare and her racing potential was not foreseen. Had she been retained and raced by Famco, the net result of its breeding and racing activities over the years would have been an overall profit instead of the loss which has actually been sustained. However, John gave evidence that during all the years with which we are concerned Famco acted on the advice of Trainer, who himself gave evidence of a distinguished professional career as a trainer. I am satisfied that decisions were taken by John and his co-director on the advice of Trainer and that they were entitled to regard him as an expert on racehorses and racing. John gave evidence that, when the horses were not at stud, under training or necessarily agisted elsewhere, they were kept on Famco's land.

15. When decisions had been taken, other than that a horse should be trained by Trainer for racing, the responsibility for ensuring that proper action was taken to give effect to the decision rested with Accountant. He gave evidence that he was the chief officer of a service company which provided services to a family group engaged in rural businesses, of which John's father and his children were one branch. The services provided were not only accounting but also administration. As is apparent from the documents tendered in evidence in these proceedings, Accountant maintained meticulous records of all activities relating to Famco's horse breeding and racing activities. He gave evidence that he also took action as required from time to time to give effect to decisions of the directors as to those activities, e.g. arranging for the transportation of horses. It is significant, I consider, that the records were maintained by Accountant in a professional manner characteristic of an efficiently run business but extremely rare where activities are engaged in as a mere pastime.

16. Although the scale of Famco's horse breeding and racing activities has never been very great, they have been carried on continuously since 1978 in a thoroughly business-like manner. In terms of the four factors identified by Deputy President McMahon as guides in cases such as this, I find that the situation is as follows. The scale of operations was small but not insignificant. They were carried on throughout the whole of the period to which the objection decisions under review relate - and have continued to be carried on ever since - in a thoroughly systematic manner. I accept John's evidence that Famco engaged in them in the manner in which it did with the intention of developing the horse-breeding activities and that the racing was undertaken to further that purpose. The Tribunal did not receive any evidence as to the manner in which the business of breeding racehorses is ordinarily carried on but the operations involved in Famco's activities were of the kind which one would expect of ``ordinary trade in that line of business''. I am satisfied that there was a significant commercial purpose and that the activities did not represent only a pastime of those who controlled Famco. Finally, I accept John's evidence that it was the intention of the shareholders of Famco that the activities should be pursued with the purpose of making a profit from them. Although expenditure has exceeded income to date, that is not unusual or unexpected in the early years of a business of that type. In that regard I note in particular comments of Williams J. in Tweddle referred to in para. 7 above and those of Bowen C.J. and Franki J. in Ferguson's case at p. 4264.

17. Having had regard to all the facts of the present case I have come to the conclusion that during each of the years to which the objection decisions in these proceedings relate Famco was carrying on a business of horse breeding and, ancillary to that, a business of racing the

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horses bred. I am satisfied that that business was carried on for the purpose of gaining assessable income. For that reason the objection decisions under review must be set aside and in substitution for them a decision made to allow in full the objections in respect of all six years.