HART v FC of TJudges:
MEDIA NEUTRAL CITATION:
 FCA 1559
This is an appeal by the applicant pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) (the ``Administration Act'') against a decision of the respondent concerning the applicant's assessment to income tax for the year ended 30 June 1996. The respondent increased the amount of the applicant's taxable income as returned by an amount of $108,580.00 and penalties. The increase reflected the disallowance by the respondent of deductions claimed by Unlimited Aerobatics Pty Ltd (``Unlimited'') as trustee of the Unlimited Aerobatics Discretionary Trust (the ``Unlimited Trust''). Unlimited subsequently changed its name to Harts Flying Fighters Pty Ltd and then to Flying Fighters Pty Ltd. The applicant is a beneficiary under the terms of the Unlimited Trust. Unlimited resolved that she should receive all of the trust income for the 1995-1996 tax year. The respondent's disallowance of the relevant deductions therefore led to a consequential increase in the applicant's assessable income. It is now conceded that the respondent was correct in disallowing the amount of $50,000.00. This appeal concerns the balance of $58,580.00 and penalties.
2. Unlimited was incorporated in January 1995. The Unlimited Trust was established by deed of settlement dated 17 February 1995, with Unlimited as trustee. Shortly thereafter, it allegedly took over an existing aviation business which had previously been operated by another company, Steve Hart Family Holdings Pty Ltd as trustee for the Steve Hart Family Trust. That company is now known as Nemesis Australia Pty Ltd. I will refer to it as ``Nemesis''. The applicant claims that Unlimited took over that business in its capacity as trustee of the Unlimited Trust, in which capacity Unlimited was also a beneficiary under the terms of two family trusts, including the Steve Hart Family Trust. The applicant's 1995-1996 income included income received from those trusts through the Unlimited Trust. It seems that the parties to this appeal have proceeded upon the basis that outgoings totalling $58,581.00 were deductible if incurred by Unlimited in carrying on an aviation business. This factual question is the only matter in dispute in these proceedings, other than the question of penalty.
3. The applicant is married to Steven Irvine Hart, an accountant. Since the mid-1980s Mr Hart has also been actively involved in aviation. He is a licensed pilot. The applicant shares his interest. In about September 1985 the directors of Nemesis, as trustee for the Steve Hart Family Trust, decided to enter the aviation industry. At that time Mr Hart, the applicant and Ms Shirley-Ann Petersen were directors of Nemesis. Although it is not entirely clear from the affidavits, it seems that the proposed business involved performing aerobatics and demonstrating aircraft at air shows. Mr Hart was to act as pilot. It was hoped that income would eventually be generated from those sources and from offering joy rides. These activities are hereinafter collectively described as ``air show activities''. The capacity to earn income from such activities no doubt depended to some extent upon the type of aircraft and its relative rarity and also upon the skills of the
ATC 5195pilot, particularly in the area of aerobatics. The evidence suggests that as the reputation of a pilot and that of his or her aircraft increase, the capacity to demand fees and the level of such fees are also likely to increase. The applicant said that Nemesis always expected that it would be some considerable time before any substantial financial return was derived from its air show activities.
4. In October 1985 Nemesis purchased a Pitts Special aircraft for about $36,000.00. A business name, ``Rufus Splice Aero Services'', was registered. Mr Hart undertook training with a leading aerobatic pilot. In May 1986 he was first paid for attending an air show. In late 1987 Nemesis decided to purchase another aircraft. In early 1988 it purchased a Laser aircraft for $90,000.00. The Pitts aircraft was retained. Mr Hart claims to have continued appearing at air shows during ``the balance of the 1980's''. However there is little available detail of such activities. In 1991 Nemesis acquired a Beechcraft Baron aircraft. It was not for use in air show activities. I will discuss it further at a later stage. Mr Hart said that:
``... it became apparent in late 1992 early 1993 that the aircraft that we were using were no longer appropriate for the type of performances required by Airshow Organizers.''
5. Nemesis became interested in the ``Sukhoi 26'' aircraft and in two competing aircraft, the CAP 232 and the Extra 300S. Mr Hart saw the Sukhoi 26 flown in Australia and concluded that air show organizers would be interested in it. He tested one such aircraft owned by Mr Nigel Arnott who has also sworn an affidavit in these proceedings. In August 1993 Mr Hart and the applicant visited Russia to inspect the Sukhoi factory and in order that the former could undertake training on the aircraft in question. They were there for about three weeks, during which time Mr Hart flew over fifty hours on the aircraft. They returned home via America to inspect other competing aircraft but did not think that they were as suitable as the Sukhoi 26. Upon return to Australia they decided to defer any decision until after a forthcoming event in Hungary. After attending that event, the applicant and Mr Hart went to France to test-fly the CAP aircraft. In October 1994 Nemesis ordered a CAP 232 aircraft, expecting that it would be delivered in April 1995. In December 1994 Nemesis disposed of its aircraft other than the Beechcraft Baron, in order to fund the acquisition of the CAP 232.
6. As I have observed, Unlimited was incorporated in January 1995 and became trustee of the Unlimited Trust by deed of settlement dated 17 February 1995. According to the applicant, at about that time, Unlimited took over the ``existing aviation business'' previously conducted by Nemesis. In April 1995 Mr Hart and the applicant visited the CAP factory in France, expecting that the former would there undertake training on the aircraft which Unlimited was to acquire. However they found that the aircraft was unfinished. It was not delivered until late November 1995. As a matter of business prudence I find it surprising that they should have gone to France expecting the aircraft to be available, without first ensuring that such was the case. Whilst there, Mr Hart trained on another aircraft. The new aircraft arrived in Australia in late November. Assembly took about two weeks. Mr Hart then commenced training. He found that he needed much more training than he had initially expected in order to become sufficiently proficient to perform at air shows. Mr Hart said that in February 1996 Nemesis brought a leading air show pilot to Australia to train him and other pilots. The applicant asserted that ``we had arranged'' for this visit.
7. In about October 1995 Unlimited decided to acquire military aircraft of Second World War vintage. In about January 1996 Mr Hart negotiated for the acquisition from Mr Malcolm Rolph-Smith of a half-share in a North American Trojan T 28 aircraft for $130,000.00. This acquisition is evidenced by a contract dated 29 April 1996, pursuant to which Unlimited is the purchaser. The contract was to be completed within thirty days of that date. The agreement contemplated that the aircraft would be operated by Mr Rolph-Smith and Unlimited and that Mr Rolph-Smith and Mr Hart would be the pilots. Apparently the parties subsequently agreed that the aircraft would be operated by a company, Wings & Wheels (Aust) Pty Ltd as trustee of another discretionary trust, the Wings & Wheels (Aust) Discretionary Trust, of which Unlimited and Mr Rolph-Smith were the beneficiaries. The deed of trust is dated 1 July 1996. In about August 1996 Unlimited acquired another aircraft in partnership with Mr Rolph-Smith. As a matter of policy, neither Nemesis nor Unlimited has
ATC 5196claimed deductions for depreciation of aircraft acquired for air show activities. It is thought that they do not depreciate. In the Unlimited Trust tax return for 1995-1996, the main business of the trust is said to be ``Beneficiary''. In the 1996-1997, 1997-1998, 1998-1999 and 1999-2000 returns, its main business activity is said to be ``Aircraft leasing''. In the 2001-2001 return, it is said to be ``Aircraft charter''.
8. As I have observed, in 1991 Nemesis acquired a Beechcraft Baron aircraft. It was transferred to Unlimited in early 1995 and disposed of by that company in September 2001. This matter caused some confusion at the hearing, at least part of which was caused by me. In the respondent's reasons for disallowing the relevant deductions, it is said that:
``The Baron is used in the business of Harts Accountants and all expenses associated with this aircraft are not in question.''
The applicant did not challenge this as a matter of fact. These proceedings have been conducted upon the basis that the expenses with which I am presently concerned were not incurred in connection with the Beechcraft Baron aircraft. The applicant has submitted that the justification for the claimed deduction is that they were incurred by Unlimited in the 1995-1996 tax year in carrying on the business of providing air show activities. Should the applicant fail to establish that proposition, then the appeal must fail. The Beechcraft Baron was not used for that purpose and is largely irrelevant for present purposes.
9. From the reasons given by the respondent for disallowing the deduction, it appears that the following income was received and deductions claimed in connection with aircraft other than the Beechcraft Baron in the tax years, 1990-1991 to 1997-1998:
+----------------------------------------------+ | Year Ended | Income | Expenditure Claimed | | 30 June | | | |----------------------------------------------| | By Steve Hart Family Trust | |----------------------------------------------| | 1991 | $1,000.00 | $28,046.00 | |----------------------------------------------| | 1992 | $940.00 | $20,966.00 | |----------------------------------------------| | 1993 | $1,000.00 | $35,943.00 | |----------------------------------------------| | 1994 | $1,000.00 | $12,028.00 | |----------------------------------------------| | 1995* | $0.00 | $11,274.00 | |----------------------------------------------| | By Unlimited Trust | |----------------------------------------------| | 1996 | $0.00 | $58,581.00 | |----------------------------------------------| | 1997 | $2,450.00 | $111,052.00 | |----------------------------------------------| | 1998 | $700.00 | $79,491.00 | +----------------------------------------------+ * Unlimited allegedly took over the business in early 1995.
10. According to the applicant and Mr Hart they became active in aviation with a view to making a profit in 1985. The above table does not deal with the income and outgoings for years prior to 1990-1991. However in the eight years for which figures are set out, total income was $6,190.00. For the same period claimed expenditure was $357,381.00. I accept that establishing such a business necessarily involved development of a reputation over time. Mr Arnott's evidence demonstrates as much. However the continuing disparity between income and outgoings is difficult to reconcile with an intention to carry on a business. Although one may incur losses in conducting a business in the hope of a subsequent profit, hope usually gives way to reality, at least where money is concerned. A prudent person, in the position of Nemesis or Unlimited, would have concluded, by 1995, that no profit was likely. By that time, the alleged business had been operating for almost ten years. There is no reason to believe that the figures for the period 1985-1990 were any more promising than those
ATC 5197for the years 1991-1998. By late 1992 or early 1993, Mr Hart had identified the need for a new aircraft, and yet it was not ordered until late 1994. This is also inconsistent with an intention to trade at a profit. In fact, the new aircraft did not arrive until late 1995, three years after Mr Hart had identified the need for it. Mr Hart and the applicant undoubtedly share a keen interest in aviation. Although the figures may not be conclusive, they strongly suggest an expensive pastime rather than a business.
11. Figures for the Unlimited Trust in the years 1998-1999, 1999-2000 and 2000-2001 are also available. The profit and loss account for 1998-1999 discloses a distribution from Nemesis of $60,000.00, income described as ``hiring charges'' in the amount of $33,456.73 and sundry income of $66,270.52. Total income was therefore $159,727.25, no doubt including income associated with the Beechcraft Baron. Expenses totalled $158,811.66 showing net income of less than $1,000.00. The expenses were presumably incurred, virtually entirely, in aviation, including operation of the Beechcraft Baron. No other source of income is demonstrated apart from Nemesis. It is a reasonable inference that income from Nemesis was from the family trusts and that no significant outgoings were incurred in connection with such receipt.
12. In 1999-2000 the distribution from Nemesis was $30,000.00. Other income included:
air show income $4,850.00 hiring charges $3,063.65 rent $2,000.00
Total income was $39,913.65. Expenses totalled $38,899.29, yielding a net ordinary income of slightly over $1,000.00. Hiring charges presumably related to the Beechcraft Baron. Some of the outgoings would also have been attributable to it.
13. In 2000-2001 income included:
air show income $24,895.32 profit on share trading $37,691.85 hiring charges $19,713.81 entry fee $259.45 rent $525.00 profit on sale of aircraft $13,045.34 merchandise $409.10 ---------- Total $96,539.87 ----------
Expenses totalled $158,678.85, presumably primarily attributable to aviation activities and share trading.
14. The available inference most favourable to the applicant is that some significant sums were derived from air show activities in the years 1998-1999 and 2000-2001 but again, little detail has been supplied. In 1999-2000, air show income totalled only $4,850.00. In cross- examination, the applicant said that large amounts would have been made from air shows in 2001-2002 had it not been for the adverse effects of the New York terrorist attack in September 2001.
15. Considerable care should be used in connection with evidence of trading results after the end of the 1995-1996 tax year. The more removed in time from that tax year, the less relevant such material will be for present purposes. As far as I can see, the only relevance of such material from the applicant's point of view is that it demonstrates that they continued to participate in the aviation industry and in particular, in air show activities, and that some significant amounts have been derived from such activities in more recent years. However it is clear from the evidence, in particular the ``time line'' which is exhibit LEH 2 to the applicant's second affidavit, that there have been substantial changes in the nature of the operation since mid-1996. Other aircraft have been purchased, and staff have been employed. The applicant conceded that Unlimited had not employed any employees prior to the end of the 1995-1996 tax year. The only persons working in the business were the applicant and Mr Hart. There was no suggestion that either was paid wages. It may be argued that changes in the operation were responses to business success. Alternatively, success may have been brought about by changes in the nature of the operation. It is really not possible to draw any firm conclusions about such matters.
16. Of the fact that Unlimited derived no income from air show activities in the 1994-1995 and 1995-1996 tax years, the applicant said:
``Unlimited was without aerobatic aircraft from December 1994 to December 1995 because while the CAP 232 was ordered in January 1995, it did not arrive in Australia until November 1995. That is the main reason why the income and expenses for the
ATC 5198company were relatively low for the 1996 financial year.
I recall also that my husband was away from December 1995 to January 1996 for approximately one (1) month overseas and when he returned he spent sixty (60) hours as aforesaid to be proficient at the new aircraft, the Cap 232 aircraft.
No income was generated until my husband reached the required level of proficiency in flying the Cap 232 aircraft. The expenses incurred by Unlimited in connection with the business during the period 1 July 1995 to 30 June 1996 were incurred in earning assessable income.''
17. It will be recalled that all aircraft other than the Beechcraft Baron were sold in late 1994. From early 1995 until 30 June 1996, Unlimited did very little in connection with air show activities. The CAP aircraft was ordered before Unlimited was incorporated. Although delivery had been expected in April 1995, it did not arrive until November 1995. The applicant and Mr Hart attended at the CAP factory in France in April 1995 so that Mr Hart could undergo training. When the aircraft eventually arrived in Australia Mr Hart underwent further training. An instructor was brought to Australia. Mr Hart was not a director, shareholder or employee of Unlimited. The applicant was a director and shareholder. Late in the 1995-1996 year, Unlimited acquired a half interest in the Trojan T28 aircraft. There is no evidence that it was used by Unlimited in any aviation business in that year. It was utilized by Wings & Wheels (Aust) Pty Ltd, presumably, with the consent of Unlimited. The date of the Wings & Wheels (Aust) trust deed suggests that such operations commenced on or after 1 July 1996.
18. If these facts stood alone as the only evidence of Unlimited's involvement in air show activities, it would be difficult to argue that it was, during the 1995-1996 tax year, conducting a business in that industry. However the applicant submits that these matters should not be taken in isolation and that I should consider her pre-1995 involvement in aviation and that of Mr Hart and entities associated with them. I am also invited to consider Unlimited's subsequent involvement in the industry. Obviously, the pre-1995 history does not demonstrate that Unlimited was then engaged in a business connected with air show activities. It was not incorporated until January 1995. Rather, the applicant submits that such evidence demonstrates that those responsible for the activities of Unlimited, its directors, shareholders and, perhaps, Mr Hart had long been involved in an aviation business and that it is reasonable to infer that from the beginning of 1995, Unlimited, in effect, became the vehicle through which that business was conducted.
19. Mr Hart was not cross-examined. The applicant argues that it was not put to him that the involvement of Nemesis and Unlimited in air show activities was simply a manifestation of his aviation hobby. Whilst this is true, it must be seen in light of the fact that Mr Hart has never been a director or shareholder of Unlimited. Although one might suspect that he has influenced decisions made by the board, any such influence was quite informal. Speaking technically, it would not have been appropriate for him to give evidence as to board decisions.
20. It seems that Unlimited kept appropriate books of account concerning its activities. In many circumstances that may be an appropriate ``badge of business''. However in this case, it is hardly conclusive. Conducting activities in a business-like way is not necessarily carrying on a business. The absence of employees prior to the end of 1996 may be of some significance. There is no evidence as to the amount of time invested in the business by the applicant, and only a little evidence as to Mr Hart's involvement which, as far as I know, was voluntary. Utilization of substantial assets and funds is often consistent with conduct of a business. No doubt substantial assets were owned and utilized by Nemesis in air show activities prior to the end of 1994. Substantial assets were acquired by Unlimited in the course of the 1995-1996 tax year. The CAP 232 was delivered in late 1995 and the Trojan T28 was acquired in April or May, 1996. It was not argued that the acquisition of the latter aircraft itself constituted the commencement of a new business. No income was derived from it in the course of the 1995-1996 tax year, and no attempt was made to identify expenses which may have been attributable to it. As I have said, the date of the Wings and Wheels Aust trust deed suggests that activities may have commenced on 1 July 1996. The Beechcraft Baron appears to have been operated quite separately from any other activities undertaken
ATC 5199by Unlimited. Nonetheless, the acquisition of the Trojan T28 and the continued operation of the Beechcraft Baron indicate that during the 1995-1996 tax year, Unlimited was involved in business-like activities in the aviation industry. However, as I have said, the question is whether the relevant outgoings were incurred in connection with a business involving air show activities.
21. I am not satisfied that Unlimited operated such a business during the 1995-1996 tax year. I am also not satisfied that Nemesis operated any such business prior to the end of 1994. My primary reason for that conclusion is simply the unlikelihood that anybody running a business would continue to incur such heavy losses for so long. As I have said, I accept the proposition that it may take some time to become established in a business of that kind, but there must be a limit. Further, if establishment of a reputation is so important, then one would not have expected the applicant or Mr Hart to have permitted loss of the benefit of years spent in the establishment of such a reputation by an extended suspension of operations as occurred between the end of 1994 and June 1996. It also seems likely that Mr Hart's skill would have been adversely affected by the lay-off from the end of 1994 until the end of 1995 when the new aircraft arrived. Perhaps he trained on another aircraft, but nothing was said about it. The three year delay in replacing unsuitable aircraft is also inconsistent with Unlimited carrying on a business. To this might be added the curious behaviour of the applicant and Mr Hart in travelling to France to fly an aircraft which, as it turned out, was not available for months thereafter.
22. In my view the operations in connection with air show activities undertaken by Nemesis prior to the end of 1994 and by Unlimited thereafter and until the end of the 1995-1996 tax year were in connection with Mr Hart's hobby. No business was being conducted.
23. I turn to the question of penalty. I have previously observed that Mr Hart is an accountant. Section 226H of the Income Tax Assessment Act 1936 (Cth) provides:
``Subject to this Part, if:
- (a) a taxpayer has a tax shortfall for a year; and
- (b) the shortfall or part of it was caused by the recklessness of the taxpayer or of a registered tax agent with regard to the correct operation of this Act or the regulations;
the taxpayer is liable to pay, by way of penalty, additional tax equal to 50 % of the amount of the shortfall or part.''
24. The return for the Unlimited trust and the applicant's return were both completed by Harts Pty Ltd, a tax agent. There seems to be little doubt that it was part of Mr Hart's accounting operations. In the respondent's reasons concerning the penalty, it was observed that:
``It is considered that the operation of the aircraft is an indulgence in a particular passion of Steve Hart's. It is further consider that Mr Hart taking into account his expertise, education, experience, etc would have been aware that a business is not being conducted.''
25. It seems likely that Harts Pty Ltd was aware of all of the relevant circumstances surrounding the conduct of the aviation business, at least in the 1995-1996 year. The respondent concluded that:
``The claiming of such expenditure is similar to actions envisaged by the explanatory memorandum in describing recklessness, in that the conduct `shows disregard of, or indifference to, consequences foreseeable by a reasonable person'. This behaviour is also consistent with reckless behaviour described in Stones case.
The standard of care required by a tax agent is higher than that expected of an ordinary taxpayer due to his knowledge, education, skill and experience that has been obtained from continual exposure as an accounting professional.
The Commissioner considers that the above actions constitute recklessness and penalty would be imposed under section 226H at 50%. The circumstances do not warrant the Commissioner to exercise his discretion to remit any of the additional tax pursuant to subsection 227(3).''
26. The applicant submits that the respondent erred in two respects. Firstly, she submits that the tax agent was entitled to claim the deduction because arguments such as those advanced in this case were ``fairly arguable''. I have considerable difficulty in accepting that
ATC 5200submission. Air show activities up to, and including 1996 and in particular, between late 1994 and 30 June 1996 were very limited. It is difficult to avoid the conclusion that any reasonably well-informed tax agent would have addressed the possibility that Unlimited had not commenced to carry on any such activities following its incorporation in early 1995. It may have contemplated doing so in the future, but very little had been done prior to the end of the relevant tax year. If Harts Pty Ltd had considered this matter in light of the long history of Nemesis receiving very low income for very high outgoings, it would inevitably have had serious reservations about the deductibility of the expenses in question. It is, to say the least, extremely unusual for a business persistently to incur substantial expenses for no appreciable return. Nemesis certainly did so from 1990-1991 until the end of 1994 and probably did so from 1985 until 1990. Harts Pty Ltd should also have taken into account the suggestion that reputation was important in earning income in air show activities and the need for pilot training. These matters would have led to doubts about whether Unlimited was conducting such a business, given the absence of any activity until very late in 1995 when Mr Hart commenced training. Even then there was no air show activity until after the end of the 1995-1996 tax year. Any rational consideration of the facts would have demonstrated that by 1995, no business was being carried on in connection with air show activities.
27. Secondly the applicant submits that Harts Pty Ltd was entitled to rely upon the fact that:
``In a previous audit, no question had been raised as to the appropriateness of the treatment adopted.''
28. This is presumably a reference to the treatment of deductions related to air show activities. The relevant evidence as to this matter appears from the affidavit of Mr Hart. He said:
``I also recall that in or around late 1987 to early 1988 the ATO conducted an audit into the affairs of Nemesis. The Audit was conducted by a Mr Lawson and a Mr Smith. The period of the audit was for 1981 to 1987 to my recollection. At the time of the audit, Nemesis was conducting the business of Aerobatic air shows since 1985. While some adjustments were made to the assessable income to Nemesis for that 6 year period, to my recollection, there was no suggestion or disallowance of the aircraft expenses by stating that Nemesis was not conducting a business.''
29. In 1987-1988 it may well have been arguable that Nemesis was seeking to establish a business with a view to trading at a profit. The business had been going for less than three years. However, as I have observed, hope cannot last forever in the face of adversity. By 1996 it was patently clear that the undertaking had failed to yield a profit. That inevitably raised the question of whether or not persistence in it by Mr Hart, the applicant and associated entities was motivated by a desire to carry on business or by some other personal motivation such as interest in aviation. Harts Pty Ltd could hardly have relied on an opinion formed in 1988 in light of the subsequent trading history. For those reasons I see no reason to doubt the correctness of the finding of recklessness for the purposes of s 226H. The appeal must be dismissed with costs.
THE COURT ORDERS THAT:
1. The appeal be dismissed.
2. The applicant pay the respondent's costs of the appeal.