Case X46

Members:
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 1 May 1990.

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K.L. Beddoe (Senior Member)

The question to be decided is whether a profit amounting to $13,888 realised by the applicant company in respect of the sale of a cotton picker during the year ended 30 June 1983 is assessable income.

2. Section 26AAA of the Income Tax Assessment Act 1936 (``the Act'') is the only statutory provision in dispute. Section 26AAA(2) provides that a profit arising where property is sold before the expiration of the period of 12 months from the date of purchase of that property shall be included in assessable income. That subsection is subject to sec. 26AAA(5) which provides that sec. 26AAA(2) does not apply in relation to a sale of property if sec. 54 of the Act applied in relation to that property and, as a result of the sale, sec. 59 of the Act applies in relation to the property.

3. Section 54 of the Act provides for depreciation, as an allowable deduction, of any property being plant or articles, owned by the taxpayer which has been installed ready for use for the purpose of producing assessable income and is, during the year of income, held in reserve by the taxpayer. Section 59(2) relevantly provides that where property on which depreciation is allowable is disposed of, any excess of consideration over depreciated value, to the extent of amounts allowable, is assessable income.

4. In its income tax return for the year ended 30 June 1983 (ex. A) the applicant company described its business as ``contractor and manufacturer''. It is apparent on the evidence that it was not a farmer at the relevant time. A director of the company, in evidence before the Tribunal, stated that a wholly-owned subsidiary carried on business as farmers and owned 1,000 acres of land suitable for growing cotton. The director gave evidence that the applicant company, although not currently engaged in growing cotton, had the necessary expertise in cotton growing. As it transpired, the land owned by the subsidiary was too far from a cotton gin and the directors of the applicant company therefore changed the proposal and decided to acquire suitable broad acres in the vicinity of a cotton gin.

5. That plan did not come to fruition because the search for suitable land necessarily took time. Meanwhile the world price for cotton had collapsed to 50% of the prices applying when the applicant's directors decided to grow cotton. In the result the applicant did not go ahead with its intention to acquire suitable broad acres for cotton growing.

6. However, while the applicant company was still intending to enter cotton growing, the company purchased a second-hand cotton picker for $14,672 on 28 January 1983. The evidence of the director of the applicant company supported the contention that the cotton picker was purchased as part of the overall scheme to diversify into cotton growing. It must be inferred from the oral evidence that the subject cotton picker was thought to be an excellent purchase because of its price - an opportunity too good to miss!

7. At a meeting of the directors of the applicant held on 3 March 1983 the directors decided to sell the cotton picker and defer the cotton growing project for at least 12-16 months (T4).

8. The depreciation schedule which forms part of ex. A reveals that the cotton picker was depreciated by an amount of $432 during the period January 1983 to March 1983. That represents depreciation for a period of two months from January 1983. The amount of $432 was also shown as an assessable amount pursuant to sec. 59 of the Act.

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ATC 380

9. There was no evidence before the Tribunal to the effect that the cotton picker had been acquired other than for the purpose of using the cotton picker for producing assessable income in the applicant's proposed cotton growing venture. Furthermore the respondent's representative did not contend any other purpose in acquisition by the applicant. Nor was it contended that the cotton picker had been used by the applicant.

10. It will be apparent that, although the profit on disposal has been assessed under sec. 26AAA, the first question to be answered is whether sec. 54 operated to allow deductible depreciation on the cotton picker for the period of approximately two months that the applicant owned the picker. Furthermore as the cotton picker was not used during those two months the question is whether it had been installed ready for use for the relevant purpose but held in reserve.

11. The applicant's representative in an able and well-thought-out argument contended that the question was whether the cotton picker had been acquired for the purpose of the applicant's planned entry into cotton farming. It was not relevant to ask whether the cotton picker had actually been used for picking cotton. It was sufficient that the company intended to use the picker on its own cotton and that the picker was on the subsidiary company's property ready for use for this purpose. It was not necessary to show actual use by the applicant for cotton picking. This was consistent with the ordinary meaning of the word ``reserve''. He sought to support this submission by reference to a decision of this Tribunal reported as Case X14,
90 ATC 171. That decision concerned a factual question of whether or not the taxpayer was carrying on a business. It does not assist the applicant in these proceedings.

12. Neither, with respect, does the decision of the Federal Court in
Inglis v. F.C. of T. 80 ATC 4001, where once again the Court was concerned to determine whether a business was being carried on and in the alternative whether plant had been installed ready for use for the purpose of producing assessable income and held in reserve. The Court gave a negative answer to those issues. On the facts of the case the Court held that the plant was not installed ready for the relevant use or as Davies J. held was simply not held in reserve (per Brennan J. at p. 4005 and Davies J. at p. 4012)

13. The respondent's case, also very ably argued, erred in its emphasis on whether or not the applicant was carrying on a business of growing cotton. Section 54 does not pose such a test. It looks to use for the purpose of producing assessable income, words different in effect to the positive limbs of sec. 51(1). It is now well established in relation to sec. 51(1) that where no assessable income has been derived in the subject year of income the outgoings must be relevantly connected to operations which are expected to produce assessable income in the future. In
Ronpibon Tin N.L. & Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 the Court said at p. 57:

``In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.''

The relevant connection depends upon the ``essential character'' of the outgoings in question - not whether the outgoings were incurred for the purpose of producing assessable income (
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at p. 497).

14. In
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057 at p. 4071; (1975) 132 C.L.R. 175 at p. 197, Mason J. said:

``It is inconceivable that Parliament intended to confine deductions to losses and outgoings incurred in connection with the production of income in the year in question and to exclude losses and outgoings incurred in connection with the production of income in preceding or succeeding years.''

15. Unlike sec. 51, and in stark contrast, sec. 54 refers to use for the purpose of producing assessable income. It does not in any way suggest that the assessable income must be derived in the year of income and in the light of the decisions of the High Court in relation to the operation of sec. 51(1) there is no basis for implying such a limitation on the operation of sec. 54. Depreciation is a concept depending upon there being capital expenditure which is to be matched with income over the effective life of the plant. It is neither a loss nor outgoing incurred in the year of income but rather an allowable deduction generated by force of the

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ATC 381

Act in relation to plant falling within the terms of sec. 54.

16. For the section to allow a deduction for depreciation the plant must have been used by the taxpayer during the year of income for the purpose of producing assessable income or been installed ready for use for that purpose. It is of course the latter concept that is relevant in this case. This latter part of sec. 54(1) requires that:

• (a) the plant is owned by the taxpayer;
• (b) the plant is installed;
• (c) the plant is ready for use;
• (d) the use is for the purpose of producing assessable income; and
• (e) the plant is held in reserve.

To the extent that the decision of Taxation Board of Review No. 3 in Case L52,
79 ATC 384 suggests a different set of criteria, I respectfully disagree with the decision. As I have already explained it cannot be consistent with the Act to infer that Parliament intended that the purpose of producing assessable income was restricted to assessable income actually produced in the year of income.

17. It is beyond argument, on the evidence, that the plant was owned by the applicant and that it was ready for use for the purpose of producing assessable income. The evidence before the Tribunal does not admit of any other finding.

18. As to whether the plant was installed; in the context of the cotton picker which, on the evidence, only needed to be fuelled and operated by an operator for it to perform its function, the test must be whether the cotton picker was on hand and in such a state that it was ready to perform its function. In fact the plant was held on the property originally intended to be used for growing the cotton. Therefore, the cotton picker was installed and also ready for use. The fact that there was no cotton does not reflect upon the readiness for use of the plant.

19. Whether the cotton picker was held in reserve is more difficult to answer. Something being held in reserve usually connotes that its use is contingent upon some future event. That future event may be the mechanical failure of other plant, the advent of famine, fire, flood or pestilence or the example given by Dr Gerber in Case L52 in relation to provision of an auxiliary power supply. On the other hand, that future event may be an upturn in market conditions to be taken advantage of by use of plant installed ready for use but held in reserve. The concept is not a narrow one and would have many examples in productive industries.

20. However, the concept is not so wide as to embrace income-producing operations which may be undertaken at some future time. Certainly, on the evidence, the cotton picker was acquired for future expected operations and its use was contingent upon those operations resulting in a cotton crop. However, that contingency is not one of a kind embraced by the words ``held in reserve''. The sense in which those words are used in the section is to set aside for future use, upon the happening of some contingency occurring, in the taxpayer's existing income-producing activities. In other words to keep back or save for future use in those present income-producing operations.

21. The sense in which the word is used in sec. 54(1) does not therefore include plant being held in reserve for income-producing operations yet to be entered upon by the taxpayer. To adopt such a view would be to give the second limb of the subsection a far wider field of operation than the first limb and could result in absurdity. On that basis I have come to the conclusion that the cotton picker was not held in reserve and was not therefore within the terms of the second limb of sec. 54(1).

22. As sec. 54 (and therefore sec. 59) does not apply to the cotton picker, para. 26AAA(5)(b) does not operate to deny the operation of sec. 26AAA(2). It was not suggested that any other basis existed for denying the operation of that subsection. It follows that the applicant's claim must fail.

23. The objection decision under review will be affirmed.