Federal Commissioner of Taxation v. Emmakell Pty. Ltd. (as trustee of the W.K. Stevenson Family Trust)

Judges:
Wilcox J
Burchett J
Ryan J

Court:
Full Federal Court

Judgment date: Judgment handed down 1 May 1990.

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Wilcox, Burchett and Ryan JJ.

Shortly before 30 June 1983, the respondent became interested in a project for the leasing of land near Whiporie in northern New South Wales on which tea-trees (Melaleuca alternifolia) were to be cultivated for the production of a valuable oil known as tea-tree oil. This project was formulated by those in control of a company called Bowanna Pty. Ltd., which later changed its name and status to Austral Estates Ltd. We shall refer to it as Austral. Austral had acquired (or at any rate was able to exercise) some rights in relation to a grazing property known as Daalkoo, and was offering ``leases'' of one acre areas, forming part of Daalkoo, to persons interested in the establishment and maintenance of tea-tree plantations to be managed by Austral on their behalf. As at 30 June 1983, no substantial progress had been made towards the establishment of any tea-tree plantation on the land, but within a few months after that date the project was under way.

It was in these circumstances that the respondent paid to Austral a cheque dated 28 June 1983 for $8,000, followed by a cheque dated 30 June 1983 for $4,000, and applied for leases. In the following fiscal year, further moneys were paid and further leases applied for, the total sum involved in that year being $11,700. Documents purporting to be leases, together with agreements in writing which answer the description of management agreements, were duly entered into. All the ``leases'' were in identical form, and the same is true of the management agreements. The following are relevant details of one ``lease'' and one management agreement, each bearing the date 30 June 1983. The ``lease'' is executed under the common seals of Bowanna Pty. Ltd. and Emmakell Pty. Ltd. It contains the following recitals:

``A. At the time of Execution [sic] hereof the Lessor has a good right of possession of th[e] lands described in the Second Schedule hereto.

B. The Lessee wishes to lease the number of acres within the said land as set out in the Third Schedule hereto (hereinafter called `the plantation') on the terms and conditions hereinafter contained and the Lessor has the right to enter into this lease.

C. The plantation is to be utilised in the growing, harvesting and development of Melaleuca alternifolia commonly and hereinafter called tea-tree and the Lessee shall have the benefit of the professional management skills retained by the Lessor for the purpose.''

There is an operative provision as follows:

``The Lessor at the request of the Lessee hereby LEASES to the Lessee the plantation for the term and at the rental set forth in the Fourth Schedule hereto to be paid in the manner set forth in the said Schedule and otherwise upon the terms, convenants [sic] hereinafter contained.''

The Second Schedule contains a lengthy list of portion numbers and certificate of title references. The Third Schedule contains the following entry: ``Number of acres: ONE (1)''. The Fourth Schedule indicates that the term was five years and that a total rental of $10,000 was to be paid by annual amounts of $4,000 on 30 June 1983, and $1,500 on each of 30 June 1984, 30 June 1985, 30 June 1986 and 30 June 1987. There was nothing in the document to enable the area of one acre, specified in the Third Schedule, to be identified as any particular area of one acre comprised within the portions the numbers of which were listed in the Second Schedule.

The management agreement was executed by the same parties. It contained the following recitals:

``A. The Lessee is the Lessee of certain of the lands set forth in the Schedule hereto.

B. The Lessee is desirous of establishing a plantation of Melaleuca alternifolia commonly called `tea-tree' on one (1) acre(s) of land within the said lands which lands together with all other lands acquired by the Lessee for tea-tree production shall hereinafter be called `the plantation' and which the manager has identified and shall identify as most suitable for the purpose.

C. It is intended that the Manager will establish operate and manage a tea-tree plantation on the plantation for the production of Melaleuca Oil and provide the services hereinafter referred to on the terms and conditions hereinafter contained.''

The operative conditions of the management agreement included the following:

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``1. The Manager agrees to establish operate and manage the plantation on the terms and conditions hereinafter set forth for a period commencing on the date of this Agreement and expiring on the 1st day of July, 1998.

2. The Manager shall:

• (a) As soon as reasonably practicable, carry out the improvements and work necessary to establish the tea-tree plantation on the plantation.
• (b) Obtain all necessary technical assistance concerning the establishment of an adequate water supply.
• (c) Thereafter arrange to have the land suitably cleared, cultivated, watered, irrigated and otherwise improved sufficient for the purpose of readying for planting.
• (d) Acquire and have planted out Melaleuca alternifolia of a suitable quality sufficient to establish the plantation and in any event by planting approximately fourteen thousand (14,000) tea-trees to the acre.
• (e) Carry out the necessary cultivation, chemical spraying for weed control, and other agricultural treatments throughout the term of this agreement.
• (f) Promote in a proper and husband-like way the health safety and development of the tea-trees.
• (g) Employ sufficient labour to discharge its obligations under this agreement.
• (h) Provide all necessary plant and equipment.
• (i) Generally manage, supervise and maintain the plantation throughout the term of this agreement in a proper and workmanlike manner and consistent with the best agricultural practices in that regard.
• (j) Keep proper books and records of the plantation and furnish progress reports to the Lessee at regular intervals and as reasonably required by it but in any event not less than calendar monthly.
• (k) Harvest the crop as required throughout the term of this agreement.

3. The Lessee shall agree to the reimbursement from oil proceeds to Manager of all direct costs, without any margin of profit for the first five years of this agreement and thereafter at a margin of profit equal to fifteen per cent (15%) of such costs relating to harvesting of the trees, distillation of the oil, packaging of bulk oil and delivery to the stated delivery place but not in any circumstances exceeding twenty per cent (20%) of the gross oil proceeds payable to the Lessee in respect of a particular harvest.

4. The Manager shall be responsible to ensure that all necessary insurance cover including Workers Compensation and such insurances as may be required as a condition of any leasing arrangement that may be entered into in respect of machinery etc. from time to time, is acquired and maintained.

5. The manager shall not be obliged, in the harvesting of the crop, to keep separate and distinct the exact quantity referable to any particular area of land; but may aggregate the produce of the plantation with that of other land in the vicinity which is also managed by the Manager where to do so is in the opinion of the Manager necessary for the economical harvesting of the crop and is not prejudicial to the Lessee.

6. During the term of this agreement the Manager shall not have any interest in the harvested crop except to the extent of its entitlement to payment or reimbursement of the Manager or otherwise pursuant to Clause 3 hereof in respect of which the Manager shall have a first and paramount lien over the harvest.

...

14. This Agreement shall not be construed as constituting the Lessee and the Manager as partners with each other nor as constituting any relationship other than that of independent contractors, with the Manager providing services for the Lessee in accordance with the terms hereof. Either party may assign its interests under this Agreement provided that in case of any assignment by the Manager such assignee shall be demonstrably capable of fulfilling the Manager's functions hereunder.''

The respondent claimed a deduction under sec. 51(1) of the Income Tax Assessment Act

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1936 for the fiscal year ended 30 June 1983 in respect of the sum of $12,000, and for the fiscal year ended 30 June 1984 in respect of the sum of $11,700. These deductions were disallowed, and the respondent's objections were ultimately referred to the Administrative Appeals Tribunal [reported as Case W20,
89 ATC 233]. A Deputy President of that Tribunal confirmed the assessments, whereupon the respondent appealed to the Federal Court of Australia [reported at 89 ATC 4919]. Its appeal was heard by a judge of the Court, who allowed the appeal, set aside the decision of the Administrative Appeals Tribunal, and ordered that the matter be remitted to a differently constituted Tribunal to be heard and determined according to law. His Honour also ordered the Commissioner to pay the respondent's costs. From that decision the Commissioner appeals to this Court.

At the outset of his argument, counsel for the appellant Commissioner made it clear the Commissioner did not suggest that the transactions or documents involved any sham, or that in this case there was any scope for the application of a general tax avoidance provision of the Act. The question before the Tribunal had simply been whether the taxpayer was entitled to a deduction under sec. 51(1) of the Act, and the question for the Court was whether the Tribunal erred in law when it answered that question in favour of the Commissioner. So far was the Tribunal itself from suggesting that the transactions were not commercial in nature that it noted: ``[T]his trustee did all that could reasonably be expected of a prudent trustee determined to ensure that the proposed investment was commercially sound.''

The Tribunal rejected the respondent's claim of a deduction for the earlier year on the ground that Austral was not, by 30 June 1983, ``engaged in a business of primary production'' (original emphasis) - until then it had done no more than investigate ``the feasibility and logistics of tea-tree propagation in the neighbourhood''. It was conceded in argument before us that this was an erroneous approach, since the question was not whether Austral was at the relevant time engaged in a business of primary production, but whether the respondent's payments were made under such circumstances that, so far as it was concerned, they attracted the provisions of sec. 51(1). The Tribunal, however, did address this issue in relation to the following year, and again rejected the respondent's claim for a deduction. The Tribunal's ground for doing so raises the real question in the appeal. That ground was that ``it must... be shown... that [the respondent] had a lease over its six acres'', whereas the so-called leases were invalid.

The Tribunal referred to the absence of proof that Austral had, during either of the two fiscal years in question, obtained title to the land it purported to lease; to the ``total failure to identify any of the six acres involved in the two years now under review''; to defects in compliance with the Real Property Act 1900 (N.S.W.) and the Local Government Act 1919 (N.S.W.); and to a possible problem of illegality on grounds which apparently related to breaches of the Local Government Act. The Tribunal then referred to the fact that each lease was accompanied by a management agreement, but rejected an argument that the contractual rights conferred on the respondent by the documents, read together, supported the deductibility of the payments, saying (at p. 239):

``[D]eduction claimed as `lease payments' cannot be salvaged by recourse to contractual rights said to emerge in a management agreement not incorporated into the lease or forming part of it.''

The Tribunal added:

``Furthermore, the provision... which entitles the manager to aggregate the crop `with that of other land in the vicinity', makes it clear that, at its highest, the trust was merely a party to a profit-making scheme conducted by Austral qua manager.''

Two things should be noticed about the latter statement: first, it raises a question of construction of the agreement, and particularly of cl. 5, which is a question of law; and secondly, it acknowledges that the plantation was not conducted by Austral on its own behalf, but as manager (and if as manager, then necessarily as manager for, inter alia, the applicant upon the terms of the management agreement).

The most striking thing about the Tribunal's process of reasoning is the absence of any reference to the leading case on the possible

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effect of the invalidity of a lease upon the deductibility, under sec. 51(1), of rent paid under the lease and of management fees paid under an interlocking management agreement, namely,
F.C. of T. v. Lau 84 ATC 4929; (1984) 6 F.C.R. 202. We were assured by counsel that this case was cited, and can only assume that some unusual features of the present case distracted the Tribunal's attention from it.

In Lau, as in this case, there was an invalid lease executed in association with entry into a management agreement. As in this case, the grounds of invalidity of the lease included a failure to identify the particular area leased, and a failure to comply with legal requirements for a separate lease of any such area. Lau involved a scheme for the planting of land with pine trees, to be tended on behalf of the taxpayer and 79 other participants. Each participant was to be allocated a stated area of land for the growing of the trees, and the promoter was to manage the land and the growing of the trees for a period of years. The payments, for which deductions were claimed under sec. 51(1), included both rent and management fees, and both were allowed by the Court.

Fox and Beaumont JJ. delivered separate judgments, with each of which Jenkinson J. agreed. Fox J. (at ATC p. 4931; F.C.R. p. 204) noted that the document described as a lease ``was defective as a lease, and as an agreement for lease, because the land was not then delineated, or then capable of ascertainment''. His Honour did not regard this as denying the claim for a deduction. At ATC p. 4934; F.C.R. p. 207 he said:

``The early lack of definition of the land is not in my view of any consequence. It was intended that the subject area be defined, and this was in fact done, although not in the same taxation year. It can hardly be said that the rent was anything else but a payment for the use of land to be used for the growing of pine trees for the taxpayer. Nor can the management payments be regarded as anything but what they purported to be. The initial lack of certainty about the bounds of the land, or, for that matter, its precise area, doubtless would have created legal problems if dispute had arisen between the taxpayer and the companies, but their common purpose was clear enough, and certainty could be, and was given to the arrangements.

A further matter raised in this connection on behalf of the Commissioner is that a subdivision of the large area of land... to permit 14 acres to be leased to the taxpayer was forbidden by law.... There are many situations arising in the application of the Act [Income Tax Assessment Act 1936] where it is necessary that the legal effect of a document or dealing be determined precisely. In the application of sec. 51, as with the application of sec. 25, what is to be looked at is the nature of an outgoing, on the one hand, or the nature of a receipt, on the other. The mere fact that there was an illegality is often not critical, and would not be critical in the present case. It is necessary to see what was done, and to what end, and to relate that to the concepts being dealt with. If, as is submitted on behalf of the Commissioner, the `lease' part of the transaction rested in contract, this would not affect the fact that the moneys were paid for management services, and would not convert what was deductible into something not deductible.''

His Honour went on to point out (at ATC p. 4934; F.C.R. p. 208) that the management fees were paid ``for services to be rendered in connection with property which is, as between the parties, treated as that of the taxpayer''.

Several comments should be made about the passage we have cited. Even though the land the subject of the ``lease'' was not defined in the relevant fiscal year, Fox J. had no difficulty in regarding the ``rent'' as paid ``for the use of land to be used for the growing of pine trees for the taxpayer''. It is true he referred not only to the intention that the subject area be defined (an intention which existed in the present case also, as is shown by recital B of the management agreement), but as well to the fact that in a later taxation year it was defined. However, the fact that the area eventually was defined was not critical to his Honour's reasoning; it merely confirmed the proposition which was critical, namely, that the payment was made for the use of land for the particular purpose. As his Honour said, ``what is to be looked at is the nature of an outgoing''. If, from the point of view of a taxpayer, and having regard to how he conducts his business, an outgoing has the nature of rent deductible under sec. 51(1), it does not cease to be deductible because the lease to which it relates is invalid. The question

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must be asked - what did the taxpayer pay for? But the answer is not concluded by what he actually got. The characterisation of a payment does not depend on its effectiveness, either economically (in the sense that it really earned a profit), or legally (in the sense that its contractual setting was valid in law).

As regards the invalidity of the lease in Lau, it may be noted that at first instance Connolly J. said (see
Lau v. F.C. of T. 84 ATC 4618 at p. 4623; (1984) 54 A.L.R. 167 at p. 174):

``The Commissioner not unnaturally relies on the fact that the lease which purported to be granted... could not properly be described as a lease, the habendum being completely undefined. This is I think correct, at least so far as the 1981 tax year is concerned.''

Beaumont J. (at ATC p. 4937; F.C.R. p. 211) referred to the Commissioner's contention ``that the transactions were, in material respects, void by statute or otherwise ineffective under the general law'', and ``that the payments made were capital payments which fell outside sec. 51''. At ATC p. 4943; F.C.R. pp. 219-220 he said:

``But whatever be the precise status of any subdivision effected by the lease, the taxpayer's claim for deductions under sec. 51 cannot be rejected on that score. Even if it be assumed (and I express no view on the matter) that the lease was purportedly granted in contravention of the subdivisional requirements of the local legislation, it does not follow that any deduction on that account is to be ignored for taxation purposes any more than would income derived from that activity (see
Madad Pty. Limited v. F.C. of T. 84 ATC 4739).

Another difficulty raised by the Commissioner, already adverted to, is the parties' failure, in the first instance at least, to identify the leased premises. It is common ground that, taken alone, the lease instrument did not sufficiently identify its subject... It would seem that, at an uncertain later date, the taxpayer's area was identified as Lot 16. There can be little doubt that, considered as at 23 April 1981 and subsequently, there were vested in the taxpayer equitable proprietary rights in respect of the area to be planted or, at the least, equities, by virtue of which he could have proceeded to protect his interest in the land. Whether these rights or equities were in the nature of a leasehold interest or by way of a profit a prendre need not be pursued here... Taking the worst position from the taxpayer's standpoint, even if the moneys in question were laid out by him in connection with no more than a de facto lease, the expenditure was nonetheless incurred in what the learned Judge found to be a genuine commercial context. Given the business character of the expenditure, any failure of the taxpayer to perfect his title to the premises could not, in my view, disqualify the taxpayer from claiming the outgoings as allowable deductions.''

The written submissions of the appellant acknowledged that the ``lease'' and the management agreement must, in the present case, be read together. This concession was rightly made, for the two documents are so framed as to be interdependent. But the appellant's difficulty was then to distinguish Lau. The only distinction put forward in argument was a contention that, whereas in Lau the taxpayer carried on his own business, although through the agency of the manager, in the present case the business was carried on by the manager on its own behalf, being a business in the profits of which the respondent became entitled to share as an investor. But this argument flies in the face of the express finding by the Tribunal that the enterprise was conducted by Austral ``qua manager''. In any case, once the Tribunal accepted the documents as real and as not being shams, upon their true construction, the conclusion that Austral was carrying on the business of a manager only was a conclusion that followed as a matter of law. The documents plainly envisaged that particular areas of plantation, if not already identified, would be identified as the respondent's leased areas, and would be managed on his behalf (see, in particular, recital B and cl. 14 of the management agreement). It was expressly provided in cl. 6 of the management agreement that the manager should ``not have any interest in the harvested crop'' beyond a lien to recover expenditure and fees.

The appellant placed some reliance on cl. 5, which conferred a right on the manager to ``aggregate the produce of the plantation with that of other land in the vicinity which is also managed by the manager''; but, in the context,

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this was a sensible provision to facilitate operations, and it will be observed that it was qualified by necessity and lack of prejudice to the lessee. What is really significant is that the insertion of such a clause was thought to be required, since this clearly underlines the intended proprietary right of the lessee, which could not be trenched upon, even in the interests of practicality, without express provision. It follows that Lau is indistinguishable upon the only ground of distinction urged, both by virtue of the Tribunal's express finding, and also upon the true construction of documents which the Tribunal accepted as genuine.

This conclusion is the end of the matter, so far as the appeal is concerned, except for a contention as to the form of the relief granted below. During the hearing, a cross-appeal was brought by leave, on the ground that the Judge should not have referred the matter back to the Administrative Appeals Tribunal, but should have decided it himself. Both parties urged us, if we did not allow the appeal, to decide the matter on the footing that all the facts necessary to a decision have already been found by the Tribunal. The appellant, in the alternative, urged that, if the matter were to be remitted to the Tribunal, it should not be required to be dealt with by a Tribunal differently constituted. Reference was made to
East Finchley Pty. Ltd. v. F.C. of T. 89 ATC 5280 at p. 5298; (1989) 90 A.L.R. 457 at p. 478, where Hill J., when allowing an appeal, declined to make such an order. In the present case, the Deputy President who heard the evidence made strong comments about the conduct of the manager, but that does not mean he would not be able to hold the scales fairly as between the taxpayer (which contracted with the manager from a position of complete independence) and the Commissioner. The case is not like
Statham & Anor v. F.C. of T. 89 ATC 4070, where the Tribunal had committed itself quite emphatically to an opinion on the very matter it would have had to determine if the question had been remitted to it. However, in the view we take, the question does not arise.

In Statham, a Full Court discussed the powers of the court upon an appeal from the Administrative Appeals Tribunal, an appeal that is limited to a question of law: see
F.C. of T. v. Brixius 87 ATC 4963; (1987) 16 F.C.R. 359. The Court referred to subsec. (4) and (5) of sec. 44 of the Administrative Appeals Tribunal Act 1975, which in terms empower the Court to ``make such order as it thinks appropriate by reason of its decision'', and added (at p. 4075):

``It would obviously be wasteful of time and costs, and oppressive to witnesses, to order a rehearing if that can be avoided. It would not be appropriate to ask the Deputy President who heard the matter to reconsider an opinion he has expressed so emphatically. It would clearly be far better if this Court could properly dispose of the matter finally provided such course is within this Court's powers. In our view it is permissible and right that we adopt this course in the present case. The facts are largely undisputed and the Tribunal did make some findings of fact on material matters.

In all the circumstances we think it appropriate to review the facts as found, and proceed to consider what orders should be made to dispose of the matter finally.''

At p. 4076, the Court referred to the Tribunal's acceptance of certain evidence as enabling it to apply the appropriate principles of law ``to the evidence accepted by the Tribunal''.

In the present case, the Tribunal's reasons show that it accepted, in general terms, the evidence of the respondent's director, who gave evidence, making only the reservation that he was confused as to the dates of certain events involved in the development of Daalkoo. But those were not the dates which mattered. There was no dispute, either before the Tribunal or before the Judge below, as to the dates of the relevant payments. The legal significance, for the purposes of sec. 51(1), of those payments depends on the true construction (a matter of law) of documents which the Tribunal found were executed, and upon the circumstances under which those documents were executed, which the Tribunal found.

The Tribunal accepted the evidence of a Mr Stotter, who was clearly knowledgeable on the subject of tea-tree oil production, as at the time when he gave his evidence he was engaged in ``a very large and prosperous tea-tree oil production venture''. On his evidence, the Tribunal accepted that, in the 1984 tax year, Austral's activities ``included substantial clearing and planting'', on a sufficient scale to

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``justif[y] the characterisation of a business''. The Tribunal accepted that ``at some time before'' August 1984 ``a dam had been constructed on Daalkoo, at least 100 or so acres had been cleared and planted with tea-trees, a large machinery shed had been built and that nurseries were in situ with approximately 1 million tea-tree seedlings, ranging from early stages of development right through to being ready for transplantation''. The Tribunal was not satisfied that any of the respondent's ``leases'' gave it title to any part of the 100 acres planted. However, the reasoning in Lau makes it clear that this was not fatal to the respondent's case.

It was only because the Tribunal overlooked the decision in Lau that it confirmed the assessment. Immediately after making the findings of fact to which we have referred, the Tribunal said (at p. 237):

``Having concluded that Austral had, by June 1984, commenced in a business of primary production, the applicant would, on the case as pleaded, be entitled to succeed in that year.''

However, the Tribunal then held the applicant before it failed because of Austral's ``failure to ensure that investors obtained enforceable leasehold interests over the acreage with respect to which the lease payments were made''. This way of putting the matter, of course, involves a finding that the payments were made in the character of lease payments in respect of lands described by acreage but not otherwise defined and thus not identified. It was not because of any relevant finding of fact, or any failure to find any relevant fact, that the Tribunal rejected the respondent's application, but because of its view, which was directly contrary to Lau, of the legal effect of the invalidity of the ``leases''.

Although the Tribunal suggested that the respondent ``fail[ed] on the onus of proof'', its reasons, read as a whole, make it plain that it did find the facts necessary to support a decision in favour of the respondent, but then reached its conclusion because of its view of the law. The narrowness of the issue which was decisive against the respondent, as the Tribunal saw the case, is emphasised by its statement: ``No argument was advanced by the [Commissioner] that the payments to Austral were a capital expense and disqualified from deduction on that ground.'' Although we were told, on the hearing of the appeal, that the Commissioner disputes this statement, it is eloquent of the approach of the Tribunal.

We conclude that this, like Statham, is a case where the facts necessary to enable a decision to be made have been found, so that the Court's ruling upon the question of law involved enables the whole matter to be disposed of. The appeal should be dismissed, and the cross-appeal should be allowed to the extent that the order of remitter made below should be set aside, and it should be ordered as follows:

• 1. That the objection against each assessment be upheld.
• 2. That each assessment be reduced to the extent required by the allowance of the deductions referred to in these reasons.
• 3. That the Commissioner pay the respondent's costs of the appeal and of the cross-appeal.