RIHA v FC of T
Members:G Ettinger SM
Tribunal:
Administrative Appeals Tribunal
MEDIA NEUTRAL CITATION:
[2003] AATA 768
G Ettinger (Senior Member)
The decision under review before the Administrative Appeals Tribunal (``the Tribunal''), was the decision of the Commissioner of Taxation, the Respondent in these proceedings, who decided on 10 April 2002 (T10), to disallow the objection of Mr Mirko Riha, (``the Applicant''), dated 19 March 2002 (T6), against the Assessment issued on 1 March 2002, for the year ended 30 June 2001.
2. Mr Riha appealed to this Tribunal on 20 May 2002. At the Hearing he represented himself. The Respondent was represented by Mr M Vincent and Mr Becket-Cooper.
Issue before the Tribunal
3. The Tribunal had to decide:
- • whether the amount of $13,777, claimed as a deduction by the Applicant, on the basis he was funding the business activities of Solavan Pty Ltd was incurred by him pursuant to section 8-1)(1) of the Income Tax Assessment Act 1997 (``the Act'');
- • if the amount of $13,777 was incurred by Mr Riha, whether it was incurred in gaining or producing his assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing Mr Riha's assessable income pursuant to section 8-1(1) of the Act.
Relevant legislation
4. The relevant legislation in this matter is the Income Tax Assessment Act 1997 (``the Act''), in particular section 8-1(1) which provides the regime for allowable deductions from assessable income.
``8-1 General deductions
(1) You can deduct from your assessable income any loss or outgoing to the extent that:
- (a) it is incurred in gaining or producing your assessable income; or
- (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
Note:Division 35 prevents losses from non- commercial business activities that may contribute to a tax loss being offset against other assessable income.
(2) However, you cannot deduct a loss or outgoing under this section to the extent that:
- (a) it is a loss or outgoing of capital, or of a capital nature; or
- (b) it is a loss or outgoing of a private or domestic nature; or
- (c) it is incurred in relation to gaining or producing your exempt income; or
- (d) a provision of this Act prevents you from deducting it.
...''
5. In accordance with this provision, there must be a loss or outgoing incurred by the taxpayer, Mr Riha, in this instance. There must also be a nexus between that loss or outgoing and the carrying on of a business for the purpose of gaining or producing assessable income. To qualify as a deduction, the loss or outgoing cannot be of a capital nature.
6. Section 14ZZK(b)(i) of the Taxation Administration Act 1953 also applied in relation to burden of proof. As relevant, it follows:
``14ZZK Grounds of objection and burden of proof
On an application for review of a reviewable objection decision:
- ...
- (b) the applicant has the burden of proving that:
- (i) if the taxation decision concerned is an assessment (other than a franking assessment) - the assessment is excessive;
- ...''
Evidence before the Tribunal
7. The Tribunal had before it documents lodged pursuant to the Administrative Appeals Tribunal Act 1975 the (``T-documents'') (Exhibit R1), and the following other Exhibits:
8. Mr Riha who was the only witness in this matter, gave oral evidence, and made submissions. He told me that innovators and ``small people'' needed to be encouraged in their work. He said that he had retired from the Victorian public service, and had been sick since 1986 as a result of exposure to toxic chemicals. Mr Riha told me that in 1980 he was named ``Inventor of the Year'' for his invention, a pump to treat ground water. Mr Riha explained how the big end of town reacted, and explained competition from American manufactured pumps in Australia. He explained that he could not finance the manufacture of his invention, and that he had used $20,000-$30,000 of his superannuation to do the research and development.
9. Mr Riha told me that he and his wife are directors of Solavan Pty Ltd, and that Ernst and Young Accountants (``Ernst and Young''), had in the past prepared his tax returns. He said that in order to reduce expenses, he had prepared his own tax return for the year 2001, and followed the way Ernst and Young had prepared the return. He said that the result was that his claim for deductions was disallowed for 2001. Mr Riha was dissatisfied with this, explaining how inventors had to finance themselves, and said that if he had to give his inventions up, it would be a loss for him, and the community. He referred in particular to T6, correspondence regarding safe useage of small inflatable boats, and told the Tribunal that with his equipment and advice, lives of fisherpeople could be saved.
10. Mr Riha explained that Solavan Pty Ltd was set up for a number of reasons, to protect his interests in a legal sense, and secondly, because his clients, (Alcoa, for example), preferred dealing with a company, and would not deal with an individual. Mr Riha told the Tribunal that Solavan Pty Ltd sells his inventions/products and derives the income from those sales.
11. When cross-examined, Mr Riha agreed that he was not paid by Solavan Pty Ltd, and did not expect such payment, neither that there was any agreement in place between him and the company. He added that it had all been set up by lawyers, and he did not know much about company structures.
12. When asked in cross-examination whether the $13,777 in question here had been billed to him, or to Solavan Pty Ltd, Mr Riha answered that it was a combination, as the company had a bank account, but that he paid for materials with his credit card. He said that the company had little income, so that he had to pay for materials, although he wrote some company cheques.
Submissions and conclusions
13. To come to the correct and preferable decision regarding whether the amount of $13,777 as claimed by Mr Riha, and detailed at T3/38, can be claimed as a tax deduction pursuant to section 8-1(1) of the Act, I had to take into account all the evidence, both oral and written, and the submissions of the parties, as well as relevant legislation and case law.
14. Mr Riha has the burden of proof pursuant to section 14ZZK(b)(i) of the Taxation Administration Act 1953.
15. I was mindful that Mr Riha has been a noted inventor and innovator all his working life, and has won awards for his work. In particular, he won a prize in 1980 in the ABC's Television Inventor's competition. He invented the Riha pump which has been sold to leading Australian companies since 1981.
16. The Applicant's submissions were essentially:
- • That he had prepared his return for 2001 himself for the purposes of saving costs, and followed what Ernst and Young had done for him in previous years;
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- • He was unfamiliar with legal documents, and his status as director of Solavan Pty Ltd was a technicality;
- • The company Solavan Pty Ltd was essential for his operations (a) legal protection and (b) dealing with big companies, and he did his best;
- • Solavan Pty Ltd had no funds so Mr Riha used his superannuation funds to further develop his products.
17. Mr Riha told me that he appealed the decision of the Respondent, not only on his own behalf, but because he felt that inventors were being discriminated against. His wish was for the needs of inventors and innovators to be catered for by the establishment of a special subsection in Division 35-10 of the Act which I noted stated as follows:
``35-10 Deferral of deductions from non- commercial business activities
(1) The rule in subsection (2) applies for an income year to each business activity you carried on in that year if you are an individual, either alone or in partnership (whether or not some other entity is a member of the partnership), unless:
- (a) one of the tests set out in section 35-30 (assessable income test), 35-35 (profits test), 35-40 (real property test) or 35-45 (other assets test) is satisfied for the business activity for that year; or
- (b) the Commissioner has exercised the discretion set out in section 35-55 for the business activity for that year; or
- (c) the exception in subsection (4) applies for that year.
Note:This section covers individuals carrying on a business activity as partners, but not individuals merely in receipt of income jointly. Compare the definition of partnership in subsection 995-1(1).
Rule
(2) If the amounts attributable to the *business activity for that income year that you could otherwise deduct under this Act for that year exceed your assessable income (if any) from the business activity for that year, or your share of it, this Act applies to you as if the excess:
- (a) were not incurred in that income year; and
- (b) were an amount attributable to the activity that you can deduct from assessable income from the activity for the next income year in which the activity is carried on.
Note:There are modifications of this rule if you have exempt income (see section 35-15) or you become bankrupt (see section 35-20).
Example:Jennifer has a salaried job, and she also carries on a business activity consisting of selling lingerie.
Jennifer starts that activity on 1 July 2002, and for the 2002-03 income year, the activity produces assessable income of $8,000 and deductions of $10,000. The activity does not pass any of the tests and the discretion is not exercised so the $2,000 excess is carried over to the next income year in which the activity is carried on.
For the 2003-04 income year, the activity produces assessable income of $9,000 and deductions of $10,000 (excluding the $2,000 excess from 2002-03). Again, no tests passed and no exercise of discretion.
$3,000 is carried over to the next income year (comprising the $1,000 excess for the current year, plus the previous year's $2,000 excess) when the activity is carried on.
Grouping business activities
(3) In applying this Division, you may group together *business activities of a similar kind.
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Exceptions
(4) The rule in subsection (2) does not apply to a *business activity for an income year if:
- (a) the activity is a *primary production business, or a *professional arts business; and
- (b) your assessable income for that year (except any *net capital gain) from other sources that do not relate to that activity is less than $40,000.
(5) A professional arts business is a *business you carry on as:
- (a) the author of a literary, dramatic, musical or artistic work; or
Note:The expression `author' is a technical term from copyright law. In general, the `author' of a musical work is its composer and the `author' of an artistic work is the artist, sculptor or photographer who created it.
- (b) a *performing artist; or
- (c) a *production associate.''
18. I have noted Mr Riha's submissions about the establishment of a special subsection in Division 35-10 of the Act. My duty in the Tribunal is however to apply the law as it stands, and accordingly to make the correct and preferable decision in the circumstances. Changes to legislation must be made by the Parliament.
19. As to the Respondent; I noted Mr Vincent relied on Exhibit R3, his Outline of Submissions, and supplemented these with oral submissions, restating certain facts which appear in the T-documents, and making submissions on the law.
20. The Respondent, in his Statement of Facts and Contentions (Exhibit R2), listed items which Mr Riha has been developing since his retirement in 1988. They were listed as follows: ``products for general usage, including pumps and analytical units and related technology, mobile homes, a foldable umbrella-table unit, shower massage units and inflatable rafts.''
21. It was not in dispute, and I accepted that the above-named products are distributed by the Applicant's family company, Solavan Pty Ltd, of which the Applicant is a director and shareholder.
22. However Mr Riha claimed $13,777 (T3/38) as a deduction in his individual return for the year 2001, claiming the funds as broken down at T3/38 had been used for R & D expenses for Solavan Pty Ltd. I find from the evidence before me that notwithstanding that Mr Riha claimed $13,777 in expenses in his individual income tax return for the year 2001 relating to the losses and outgoings said to have been incurred in relation to his engineering business activity, he did not declare any income from that business activity. Neither did he appear to have any substantiation for the expenditure of the $13,777.
23. Problems arose because Mr Riha confused expenses incurred by the company with those he claims to have incurred on his own behalf. I did not find that any inconsistencies in Mr Riha's evidence were given with an intention of misleading the Tribunal, or the Respondent. Rather, he simply operated as an inventor and used available funds for himself and for the company interchangeably, including his superannuation pension.
24. I was satisfied from Mr Riha's evidence and the documents before the Tribunal that he did not differentiate between his private expenditure and his company's activities.
25. I noted from the T-documents that Solavan Pty Ltd had accumulated losses of $63,099 at 30 June 2001 (T4/44), and that there was a deficiency in shareholder funds of $100,125 (T4/42), at the same date.
26. I next considered whether Mr Riha, was carrying on a business. The work that he was doing in developing products for Solavan Pty Ltd was carried out at the relevant time without payment, without expectation of payment, and there was no agreement for fees. Accordingly, as a shareholder, only dividends would be relevant, and that was only provided Solavan Pty Ltd ever becomes profitable.
27. I found accordingly that Mr Riha could not demonstrate the essential characteristics required of a business, for example to be engaged in it on a continuous and repetitive basis, and for profit. (
Ferguson v FC of T 79 ATC 4261; (1979) 26 ALR 307 and
Hope v The Council of the City of Bathurst 80 ATC 4386; (1980) 144 CLR 1). Mr Riha's activities, which is what concerned me in this application, cannot thus be characterised as carrying on a business. In coming to this decision, I accepted the submission of the Respondent that the activities of the Applicant did not constitute the carrying
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on of a business, noting that a person may incur losses in conducting a business in the hope of a subsequent profit, but that there must be a limit (Hart v FC of T 2002 ATC 5193; (2002) 51 ATR 471). I find from the evidence that in Mr Riha's case there was no expectation of profit in the medium, or even long term future which was expressed in evidence (oral and written), and find that he was unable to satisfy the indicia to demonstrate that he was carrying on a business activity at the relevant time.
28. As to Solavan Pty Ltd; it appeared that notwithstanding the company had losses, I was satisfied from the evidence before me that it could be characterised as carrying on a business of distributing products developed by Mr Riha.
29. I then moved to consider the further status of the $13,777 as claimed. Now, if indeed Mr Riha expended the $13,777 as claimed at T3/38, then the expenses would only be deductible if he meets the tests in section 8-1 of the Act, which are that the expenditure must be incurred in gaining or producing assessable income. In deciding this, I took into account the principles as enunciated in a leading case,
Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431; (1949) 78 CLR 47, where the Full Court of the High Court of Australia gave the following explanation of the words ``incurred in gaining or producing assessable income'' (in section 51(1) of the Income Tax Assessment Act 1936, the predecessor to section 8-1 of the Act). The Court in Ronpibon (supra), held as follows [at 435-436]:
``For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words `incurred in gaining or producing the assessable income' mean in the course of gaining or producing such income....
In brief substance, to come within the initial part of the subsection 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.''
30. The case of
Fletcher & Ors v FC of T 91 ATC 4950; (1991) 173 CLR 1 was also relevant in that the High Court in that case stated relevantly [at 4957]:
``The question whether an outgoing was, for the purposes of s. 51(1), wholly or partly `incurred in gaining or producing the assessable income' is a question of characterisation.... It has been pointed out on many occasions in the cases that an outgoing will not properly be characterised as having been incurred in gaining or producing assessable income unless it was `incidental and relevant to that end'...
So to say is not, however, to exclude the motive of he taxpayer in making the outgoing as a possibly relevant factor in characterisation for the purposes of the first limb of s. 51(1). At least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer has subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterisation of either the whole or part of the outgoing for the purposes of the sub-section. In that regard and in the context of the sub- section's clear contemplation of apportionment, statements in the cases to the effect that it is sufficient for the purposes of s. 51(1) that the production of the assessable income is `the occasion' of the outgoing or that the outgoing is a `cost of a step taken in the process of gaining or producing income' are to be understood as referring to a genuine and not colourable relationship between the whole of the expenditure and the production of such income.''
31. I was mindful that pursuant to section 8-1 of the Act, and the authority of Fletcher & Ors (supra), the nexus between the incurring of the expenditure and the assessable income does not necessarily have to be in the same year. Accordingly to succeed, Mr Riha would have to convince the Tribunal that there was sufficient nexus between his expenditure as claimed, and the derivation of present or future assessable income. However, I noted there was none for the relevant year 2001, and I was not satisfied on balance that that nexus into the future.
32. I was mindful that as there was no agreement as to derivation of income by Mr Riha and Solavan Pty Ltd, there was no question of future income, and all that remained was the possibility of payment of dividends, which given the history of the relationship and
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the state of affairs of Solavan Pty Ltd, was remote.33. I noted that the Respondent referred to a number of cases at paragraph 23 of Exhibit R3, cases where directors/shareholders of companies have incurred expenses on behalf of their companies, and where the nexus has been explored. The Respondent referred in particular to
Sheil v FC of T 86 ATC 4731; (1986) 17 ATR 1097, where I noted certain deductions had been allowed. In others, such as Case 26/94,
94 ATC 258;
(1994) 28 ATR 1133, the nexus between the incurring of the outgoings and the derivation of assessable income by the taxpayer, or the carrying on of a business for the purpose of deriving assessable income by the taxpayer, could not be made. I noted in Case 26/94 (supra), that the primary purpose of the taxpayer in borrowing funds and claiming a deduction for the interest, was to temporarily assist his family company which was in financial difficulties, (a situation not dissimilar to that of Mr Riha, who used his superannuation funds to assist the operation of Solavan Pty Ltd). In Case 26/94 (supra), the Tribunal held that the interest and borrowing costs incurred by the taxpayer were not incurred in gaining or producing his assessable income, notwithstanding should his company ultimately be profitable, he could be paid dividends.
34. I noted further the case of
FC of T v Total Holdings (Australia) Pty Ltd 79 ATC 4279; (1979) 9 ATR 885, where interest expenses were held to be deductible, and distinguished that case, mindful that in Mr Riha's case I have found that the nexus between the claimed expenditure and derivation of assessable income was too remote.
35. I noted that the Respondent had considered Mr Riha's situation in relation to Division 35 of the Act, which provides that losses from certain business activities may be deferred. I noted further that such loss is generally for the income year in question, the excess of a taxpayer's allowable deductions attributable to his business activity over the taxpayer's assessable income from that business activity. As I do not have evidence before me to satisfy me that Mr Riha meets the tests for conducting a business activity, and he does not come within the exception pursuant to section 35-10(4) of the Act, which concerns losses incurred in the fields of arts or primary production, Division 35 does not apply to his circumstances.
36. Accordingly the nexus between the claim for $13,777 and the gaining of assessable income pursuant to section 8-1 of the Act has not been made, and even if that amount had been expended by Mr Riha, of which I have not actual evidence, I was not satisfied that it was spent in earning his assessable income. Accordingly his claim must fail.
Decision
37. The Tribunal affirms the decision under review.
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