DALTON v DFC of T

Members:
RD Fayle SM

Tribunal:
Administrative Appeals Tribunal (sitting as the Small Taxation Claims Tribunal)

Decision date: 9 January 1998

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RD Fayle (Senior Member)

This is an application by Mr Glenn Dalton (``the applicant'') to the Small Taxation Claims Tribunal to review the decisions of the Deputy Commissioner of Taxation (``the respondent'') dated 18 August 1997 to disallow a deduction for a partnership loss pursuant to s 92(2) of the Income Tax Assessment Act 1936 (``the Act''), for each of the years of income ended 30 June 1993 and 1994.

2. At the hearing the applicant was represented by Mr John Athans, an Accountant, and the respondent was represented by Mr Frank Maloney, an officer of the Australian Taxation Office.

3. Evidence was given by the applicant, his spouse (and partner, using that term in its commercial sense) Mrs Fay Dalton, Mr David Forrest, Mr George Chapman and Mr Ian Shadlow, for the applicant, and by Mr Mark Snabel-Matthews for the respondent. The Tribunal admitted into evidence the documents filed pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 (``the T Documents''), in addition to the following exhibits:

• Exhibit R1 Profit and Loss Statement and Depreciation Schedules for years ended June 1994 and June 1993.
• Exhibit R2 Information from Western Australian Department of Agriculture regarding fruit budgets.

4. It has to be said from the outset that both the applicant and his spouse were somewhat equivocal about their recollection of dates when certain events occurred. In the opinion of the Tribunal this was due to the not inconsiderable lapse of time between those events and the hearing. It was obvious that neither witness was rehearsed, something which can also be said for the others called by the applicant, and all impressed the Tribunal as truthful, if not, as it turned out in the case of some, to be of much assistance.

5. Having regard to the evidence and its probative value, the Tribunal sets out below its findings of material facts relevant to the claims.

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6. The applicant and his spouse (``the Daltons'') purchased a 7.6 hectare rural holding at Dardanup (``the property''), by contract of sale, in April 1992. At the time the applicant was employed in Bunbury, less than an hour away by car. Also, in consequence of the debt arising from the purchase and a mortgage owed on an investment property let for rent, the Daltons' income (Mrs Dalton had part-time employment) was fairly well committed to meeting those repayments and providing for the family which included their two young children.

7. Neither of the Daltons had any relevant experience in farming or in establishing an orchard. Apart from asking the vendor of the property, who ran cattle, whether it would be suitable to establish an orchard, no investigations were made prior to purchase in this respect. Subsequent to purchase the Daltons gained the friendship of Mr George Chapman, the owner of an adjacent property and an orchardist of some 50 years standing. Apparently he gave them advice from time to time for which they were most grateful.

8. Some time after purchasing the property arrangements were made to make a roadway into the property to the proposed site for their caravan and a shed and also to make a dam. The shed was duly erected and provided ablution facilities to complement the caravan which was parked alongside and became their temporary home after moving from Bunbury. There is some doubt as to just when this move occurred, however, the Tribunal finds that it probably happened in late summer of 1993. Soon after, Mrs Dalton established a nursery behind the shed, a sheltered spot which she believed lent itself to such an activity. She collected about 70 ``summer prunings'' of various fruit trees from friends and tried to propagate them for planting. Meanwhile the Daltons laboured away fencing and preparing an area for planting the propagated seedlings to begin their orchard. The preparation included clearing and removal of noxious weeds, mainly by hand.

9. Mrs Dalton admitted that she had no previous experience in propagation of cuttings but relied on her knowledge from having watched her mother, a keen gardener. Many of the cuttings in the nursery did not take. During that winter the Daltons planted, by hand, the cuttings which survived along with some seedlings which they purchased. These comprised in all, 15 apple seedlings of the Golden Delicious, Granny Smith and Pink Lady varieties, 10 peaches, 10 plums, 5 apricots, 10 nectarines and 4 nashies. These were planted initially some 6 metres apart but more recently, on advice, the plantings are about 1.8 metres apart which ought to yield more fruit sooner although the tree life is lessened. Mrs Dalton said that the reason several varieties of fruit trees and different varieties of apples were planted was to spread the risk associated with low frost levels (different plants respond differently to different chill factors), to spread the harvest period, since fruit matures at different times, and this reduces the risk of loss of crop through hail, storm or wind as well as avoiding a peak harvest time if all fruit matured at the same time. She further explained that different varieties are needed for effective cross-pollination. This evidence was supported by Mr Chapman.

10. At all relevant times Mrs Dalton continued with her part-time job at an aged care hostel, which required her to be there three days a week commencing late afternoon and staying overnight, returning home by 8.00 am in time to see Mr Dalton off to work. The eldest child attended school.

11. Mrs Dalton was responsible for most of the watering and fertilising of the seedlings, which required carting water from the dam and hand watering. Mr Dalton assisted with the weeding, spraying for pests, establishing and repairing fences and nurturing of the seedlings, usually at weekends, including Mondays as he used up his 60 days of leave entitlements and, on occasion, in the evenings.

12. Unfortunately and somewhat unexpectedly, kangaroos destroyed most of the seedlings. The Daltons discovered, much to their disappointment, that kangaroos were known to emerge from the adjacent forest in the summer months when feed became scarce. The fence which the Daltons had erected proved inadequate in this respect. During the years in question, the fence was fairly basic with a single electric strand on top of a standard fence. As time went by the fence was improved to a ringlock base, several strands of barbed wire and an electric strand on top. However, even this has proved not to be kangaroo-proof and the Daltons still experienced invasions during the summer months in particular. Mr Chapman

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confirmed that kangaroos have always been a problem in the area, especially in the summer.

13. During the two years in question the Daltons experienced considerable heartbreak, each time they appeared to be making headway in establishing their orchard, kangaroos would invade and eat the green shoots and sometimes ringbark the small trees. Photographs of the orchard, taken by Mr Snabel-Matthews, in February 1996 (20 months after the end of the latter year in question), at the time of his visit to carry out a site inspection for the respondent, show several small trees growing (the largest were about a metre in height) in a fenced area, with a polythene watering pipe running from the dam [T9]. The original dam proved to be inadequate, much of its water being lost to evaporation and therefore not able to provide sufficient summer watering. The dam has, since the period in question, been extended to overcome this deficiency.

14. In more recent times some trees have borne fruit which has either been eaten by kangaroos or by the family. At no time has sufficient fruit matured to provide a commercial harvest, although the Daltons believe that that time is now foreseeable, having learnt how to manage the kangaroo problem and provide more efficient watering from a more recently expanded dam and more efficient water supply. The evidence of both Messrs Chapman and Forrest, a senior lecturer in agriculture at the South West College in Bunbury, support the contentions of the Daltons that it is possible to establish a commercially viable orchard on less than 7.6 hectares with the number of trees and the manner of their layout as intended by the Daltons.

15. Evidence was provided of cash flow projections [T19, pp 78-79] which purport to indicate that the Daltons were involved in a viable business venture. Much was said about these in evidence. Suffice it to say that they appear to have been created after the years in question. They were not therefore used by the Daltons to make informed decisions in relation to the viability of the proposed orchard. The only evidence of such investigations relates to inquiries made by Mrs Dalton, in 1996, of the Department of Agriculture and a local business which purchases fruit for export. Further, since 1996 Mrs Dalton has been pursuing a horticultural course at TAFE where she is learning orchard management techniques which no doubt have assisted her in bringing the orchard to its present promising stage, where the hope of future commercial production is more soundly based, relative to the years of income in question.

The relevant legislation

16. At the outset of the hearing the applicant applied to have his grounds of objection extended to include relevant grounds covering section 92(2) of the Act for deduction of a partnership loss, sections 53 and 54 of the Act for deduction by the partnership between the Daltons of repairs and depreciation of plant and machinery respectively. No objection was taken by the respondent and on the authority of
Lighthouse Philatelics Pty Ltd v FC of T 91 ATC 4942 an order was made accordingly.

17. The nature of the claims made by the partnership, for each year, were the same, being for depreciation, motor vehicle expenses, repairs and maintenance and ``other''. It is understood that the respondent concedes that should the Tribunal find that the Daltons were carrying on a business of primary production during one or other or both years in question then the respective claims should be allowed. There is no dispute in relation to quantum. Therefore, the partnership claims are made in relation to s 51(1), s 53 and s 54 of the Act. The relevant sections provide as follows:

``51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.

53(1) Expenditure incurred by the taxpayer in the year of income for repairs, not being expenditure of a capital nature, to any premises, or part of premises, plant, machinery, implements, utensils, rolling stock, or articles held, occupied or used by him for the purpose of producing assessable income, or in carrying on a business for that purpose, shall be an allowable deduction.

54(1) Depreciation during the year of income of any property, being plant or articles owned by a taxpayer and used by

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him during that year for the purpose of producing assessable income, and of any property being plant or articles owned by the taxpayer which has been installed ready for use for that purpose and is during that year held in reserve by him shall, subject to this Act, be an allowable deduction.''

The submissions

18. The applicant submitted that the activities relating to the management of the orchard property carried out by the Daltons soon after they moved onto the property in early 1993 amount to activities associated with the carrying on of a primary production business. It was submitted that the business commenced once Mrs Dalton established the nursery and she and her spouse had prepared the orchard area for planting, and that the maintenance activities of attending to the seedlings, the weeding, spraying and watering of the orchard and the attempts to keep out the kangaroos were activities designed to produce assessable income. The fact that no income was produced is not fatal to the claims. Nor, it was submitted, is the fact that they were thwarted in their efforts by the invasion of kangaroos which caused them to spend considerable time and effort in replanting seedlings and repairing and improving fences.

19. The respondent, on the other hand, submitted that at best what the Daltons were doing during the years in question was firstly, carrying out trials to find out which, if any, varieties of fruit trees would best survive on the property and secondly, to prepare the property for and to establish an orchard. The activities of the Daltons did not go beyond the establishment stage of an orchard. The scale of the operations, it was submitted, having regard to the number of trees and evidence given by Messrs Chapman and Forrest, raises considerable doubt that a commercial operation could have resulted from the initial planting of 54 trees, even if they had grown to maturity and borne fruit. In this sense the applicant has not discharged his onus of proof required pursuant to s 14ZZK of the Taxation Administration Act 1953.

Discussion

20. The evidence supports the conclusion that the Daltons' intention when they purchased the property was to build thereon their family home and to establish an orchard which in due course would provide a supplement to their income. They had no definite plans beyond that. Their then financial situation precluded any rapid development and improvement of the property. They had not then devised a business plan nor a strategy of how this might eventuate. Mrs Dalton thought that propagating fruit tree seedlings from cuttings would not prove to be too difficult and was fairly confident that she would soon have sufficient seedlings to transplant for the beginnings of an orchard. That the Daltons are hard workers dedicated to their project is not doubted. The Tribunal accepts that the Daltons had sufficient faith in their own abilities to establish a successful orchard in the course of time. That they were taken unawares by the invasion of the kangaroos and were prevented by lack of funds from building an effective barrier between the orchard area and the forest is accepted. However, the evidence points to an inevitable conclusion that what the Daltons were in fact doing during the years of income in question was working toward the establishment of an orchard. All the steps taken by them in clearing away noxious weeds and readying the land for planting and the tree planting and nurturing activities were no more than preparatory to establishing an orchard. In many respects the Daltons were learning by trial and error. They had not undertaken any investigations of significance to determine what plants might best thrive in the area and how those plants might best be laid out and tended. They relied on advice freely given by friends and acquaintances, some of whom had orchard experience. They later realised that they had insufficient water in the dam to provide adequate watering during the summer and as a consequence subsequently extended the dam (as funds became available). They discovered that unless they built a less penetrable fence around the orchard they would never be able to prevent invasion and destruction by kangaroos. Steps have since been taken to do this. They also discovered that the varieties of fruit trees, including apples, were not the best suited for the area and have since planted a different variety and not replaced some of those originally planted and since lost. These years of income were something of a try and see approach.

21. During the years of income in question the Daltons' activities were merely steps preparatory to the commencement of a

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business. They were not then engaged in primary production;
Southern Estates Pty Limited v FC of T (1967) 14 ATD 543; (1967) 117 CLR 481, and hence, not carrying on business as primary producers. At best the expenditure incurred in the years of income in question was directed to bringing the property into a condition to facilitate primary production. The fact that no income was derived is not fatal to their claims;
Thomas v FC of T 72 ATC 4094; (1972) 3 ATR 165. And the fact that the orchard trees themselves are of a capital nature, since they bear the fruit (to use the crude analogy of the so-called
Eisner v Macomber (1920) 252 US 189 aphorism; or by reference to Dixon J's ``profit-yielding structure'' discussion in
Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 - whether the expenditure relates to the structure or to the process to derive income) does not rule out, in the Tribunal's opinion, that once the initial plantings have become established the relevant taxpayer may be carrying on a business even though the crop may not be imminent.

Conclusion

22. The evidence points to a conclusion that at least for the years in question the Daltons were in the process of establishing an orchard. They were not then engaged in the conduct of nor the carrying on of a business of primary production. The Tribunal rejects any intimation that the activities might be described as private and domestic as the scale and intended scale of operations, if successful, would produce a commercially marketable crop.

23. For this reason the partnership claims pursuant to s 51(1) of the Act must fail, as the expenditure claimed under that head in the year of income is of a capital nature.

Repairs

24. Claims were made by the partnership for repairs in the 30 June 1993 and 1994 years of $1,262 and $772 respectively. It is not the Tribunal's view that a finding that the partners were in the preparatory stage of establishing their business, for the purposes of s 51(1), necessarily forecloses a finding that any expenditure on repairs is therefore not deductible.^[1] A discussion of this possibility appears in Australian Tax Practice Commentary at paragraph 53/51 which admittedly is somewhat equivocal but does say, inter alia, ``There appear to be no recorded instances of claims for deduction failing under s 53 but succeeding under s 51(1) or vice versa.'' Subsection 53(1) excludes ``expenditure of a capital nature'' to premises etc occupied or used by a taxpayer ``for the purpose of producing assessable income, or in carrying on a business for that purpose''. The finding of fact is that no business was being carried on for the purpose of producing assessable income. A finding that the Daltons were occupying the property and undertaking activities for the purpose of producing assessable income, albeit some time in the future, is open. The expression ``year of income'', an expression defined in s 6(1) of the Act, merely focuses on the period in which the claimed expenditure must be incurred and has no bearing on whether any income is derived.

25. Given that the Daltons' activities were for the purposes of producing assessable income in due course, the only limitation on a claim for repairs is whether the expenditure incurred in the year of income was of a capital nature. Case law, of which there is no shortage,^[2] The Tribunal was not directed to any specific cases in support either way but merely refers in a general way to cases mentioned in the CCH Federal Tax Reporter at ¶27-015 to ¶27-065 inclusive and to Australian Tax Practice Commentary paragraphs 53/35 and 53/60 to 53/90 inclusive. establishes, in the broad, that any repair which is more appropriately categorised as an improvement (as distinct from a restoration) or a replacement of an entirety or what is called ``initial repairs'' is a repair of a capital nature. It is not apparent from the evidence, in this instance, how the Daltons could have incurred expenditure on repairs in the first two years of operations which would not be expenditure to improve the condition of structural improvements already established when they purchased the property or plant acquired since - that is, they would be ``initial repairs'' most likely. The evidence was that the fences were in need of ``repair'' and that the tractor was in a run-down state. On his own admission Mr Dalton spent a lot of time and effort in restoring the tractor and plant to a serviceable condition. Therefore, in the absence of any evidence to the contrary and indeed any submissions in this respect,^[3] It is noted that at the beginning of proceedings the applicant was prompted to amend his grounds of objection to extend to s 53 and s 54. Despite this no direct evidence or submissions were directed to these possibilities alone. it is not open to the Tribunal to find that the Daltons incurred any expenditure which would be deductible under s 53 of the Act. The applicant has not discharged the onus of proof in this respect.

Depreciation

26. Exhibit R1 is a copy of the partnership depreciation schedules for each of the years of income, 1992-93 and 1993-94 showing depreciation claims of $3,867 and $5,057 respectively. These reconcile to the T Documents at folios 20 and 24 in that the latter are claims for the applicant's half share.

27. Depreciation claims are made pursuant to a separate code, namely s 54 of the Act. In many ways what has been said above in relation to the potential scope of s 53 applies equally to

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s 54 which picks up similar language. But s 54 goes even further, it allows a deduction for depreciation for any plant or equipment ``installed ready for use... and held in reserve...''. In the Tribunal's view this is a different matter to that of the deductibility for repairs. Depreciation is an automatic deduction if the necessary prerequisite conditions are met - that is, the plant or articles in question are owned by the taxpayer^[4] A condition which can be assumed in this case — see Australian Tax Practice Commentary at paragraph 54/240. and used for the requisite purpose or held in reserve. The Tribunal did receive into evidence Exhibit R1, from the respondent, without comment. As mentioned this aligns with the T Documents which were also in evidence. That establishes the basis of the claim. No submissions were made either way in this respect. It may well be a denial of natural justice for the Tribunal to find absolutely that the depreciation claimed is allowable without hearing from both parties. The Tribunal is also mindful of the requirement in tax cases for the taxpayer to discharge the onus of proof, s 14ZZK(b) of the Taxation Administration Act 1953. In the circumstances the Tribunal will direct that the matter be remitted to the respondent to reconsider the applicant's claim for a partnership deduction for depreciation pursuant to s 54. In the event of no settlement being reached, the Tribunal will grant liberty to parties to bring this question back to it for further evidence (if needed), submissions and decision.

Decision

28. In accordance with the provisions of s 43 of the Administrative Appeals Tribunal Act 1953 the Tribunal:

• (a) Affirms the decision under review as it relates to the deductions claimed by the partnership pursuant to s 51(1) and s 53;
• (b) Sets aside the decision under review as it relates to the deductions claimed by the partnership pursuant to s 54 and remits this matter to the respondent for reconsideration in accordance with these reasons; and
• (c) In the event no settlement is reached in this respect, grants liberty to parties to bring this matter back to the Tribunal for further evidence (if needed), submissions and decision.