The impact of this case on ATO policy is discussed in Decision Impact Statement: Peerless Marine Pty Ltd and Commissioner of Taxation (QT2005/79-90; 96-97; 324-327).
PEERLESS MARINE PTY LTD v FC of TJudges:
PE Hack SC DP
Administrative Appeals Tribunal
MEDIA NEUTRAL CITATION:
 AATA 765
PE Hack SC (Deputy President)
1. Mr Robert Stephenson is a successful businessman. For many years he has been the managing director of a very large dry-cleaning business that employs about 100 people. Mr Stephenson has also been interested in, and involved with, boats for almost 50 years. For the last 15 years or so he has had a particular interest in powered catamarans.
2. This case is about a powered catamaran, the White Spirit. The applicant, Peerless Marine Pty Ltd, constructed White Spirit over a period in excess of three years at a total cost in the order of $2.5 million. She was sold in May 2006 for $1.25 million.
3. Peerless Marine in its income tax returns for the 2001, 2002, 2003 and 2004 income years claimed deductions for expenses attributable to carrying on a business in connection with White Spirit. And in its Business Activity Statements lodged over the same period Peerless Marine claimed input tax credits for that business.
4. The matter is before me because the respondent, the Commissioner of Taxation, took the view that the amounts claimed by Peerless Marine as income tax deductions were not properly deductible. And the Commissioner, for somewhat similar reasons, took the view that Peerless Marine was not entitled to input tax credits.
5. It is convenient to examine first the statutory provisions that have particular application here. They are found in the Income Tax Assessment Act 1997 (ITAA 1997) and the A New Tax System (Goods and Services) Act 1999 (the GST Act).
6. The general rule regarding deductions is set out in s 8-1. It provides that a loss or outgoing may be deducted from assessable income 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."
Subsection (2) of s 8-1 contains the exemptions to that general rule. Relevant to the present case is paragraph (b) which operates to deny deductibility for a loss or outgoing to the extent that:
- "(b) it is a loss or outgoing of a private or domestic nature ..."
Also relevant is paragraph (d) which operates to deny deductibility for a loss or outgoing to the extent that:
- "(d) a provision of this Act prevents you deducting it."
7. Section 26-50(1) is a provision that denies deductibility. It reads:
- "(1) You cannot deduct under this Act a loss or outgoing to the extent you incur it:
- (a) to acquire ownership of a leisure facility or boat; or
- (b) to retain ownership of a leisure facility or boat; or
- (c) to acquire rights to use a leisure facility or boat; or
- (d) to retain rights to use a leisure facility or boat; or
- (e) to use, operate, maintain or repair a leisure facility or boat; or
- (f) in relation to any obligation associated with your ownership or a leisure facility or boat; or
- (g) in relation to any obligation associated with your rights to use a leisure facility or boat."
8. There are, however, exemptions to this prohibition. Relevantly, s 26-50(5)(d) has the effect that s 26-50(1) does not prevent a loss or outgoing for a boat from being deducted if, at all times during the income year, the boat is used "for a purpose that is essential to the efficient conduct of a business that you carry on."
9. It will suffice for present purposes to start with the central propositions in s 7-1 of the GST Act that (a) GST is payable on taxable supplies and taxable importations and (b) entitlements to input tax credits arise on creditable acquisitions and creditable importations.
10. This case concerns creditable acquisitions. By virtue of s 11-20 of the GST Act a taxpayer is entitled to input tax credits for creditable acquisitions made. A creditable acquisition is made in the circumstances set out in s 11-5. It is necessary, in the circumstances of this case, to notice only the requirement of that section that the acquisition be "solely or partly for a creditable purpose". Section 11-15 gives meaning to "creditable purpose" in these terms:
- "(1) You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise.
- (2) However, you do not acquire the thing for a creditable purpose to the extent that:
- (a) the acquisition relates to making supplies that could be input taxed; or
- (b) the acquisition is of private or domestic nature.
- (3) ..."
11. The terms "enterprise" is defined by s 9-20 in this way:
- "(1) An enterprise is an activity, or a series of activities, done:
- (a) in the form of a business; or
- (b) in the form of an adventure or concern in the nature of trade; or
- (c) ..."
But s 9-20(2) excludes from this definition:
"... an activity, or series of activities, done:
(b) as a private recreational pursuit or hobby ..."
"Business" is defined by s 195-1 as including any profession, trade, employment, vocation or calling.
12. In the circumstances of this case it is material to note that the expression "carrying on an enterprise" is defined in s 195-1 as including "doing anything in the course of the commencement or termination of the enterprise."
13. Finally it is relevant to note that by virtue of s 69-5(1) an acquisition is not a creditable acquisition to the extent that it is a non-deductible expense. Section 69-5(3)(e) makes an acquisition a non-deductible expense if, relevantly, it is not deductible under Division 8 of the ITAA 1997 because of s 26-50 of the ITAA 1997.
14. Thus the point of intersection in this case between the income tax regime and the GST regime is s 26-50 of ITAA 1997 and the exemption to it.
The returns and assessment process
15. Peerless Marine lodged its 2001 income tax return on 19 October 2001. It disclosed a taxable income of $687 after taking into account deductions of $27,658. The 2002 return disclosed a taxable income of $604 and deductions of $26,044; the 2003 return a loss of $367,319 and deductions of $380,830, and the 2004 return a loss of $377,998 and deductions of $431,364.
16. Following an investigation by the Commissioner assessments or amended assessments were undertaken as follows:
17. An administrative penalty for tax shortfall was imposed at the rate of 25 per cent on the basis of s 284-90 of Schedule 1 to the Taxation Administration Act 1953, that is, on the basis that the shortfall resulted from a failure to take reasonable care. But the Commissioner remitted all of the penalties imposed in relation to the 2001, 2002 and 2003 income years.
18. Peerless Marine lodged notices of objection by letter dated 15 September 2005. The objections were disallowed under cover of the Commissioner's letter dated 18 November 2005.
19. Peerless Marine commenced these proceedings on 2 December 2005.
20. So far as GST is concerned, Peerless Marine lodged quarterly BAS returns for each of the quarters from the September 2000 quarter to the December 2003 quarter. In each of those returns it claimed input tax credits for expenditure incurred in connection with the construction, outfitting and eventually maintenance of the White Spirit. The Commissioner accepted those returns as lodged.
21. Again as a consequence of investigation the Commissioner was dissatisfied with the returns lodged. On 11 May 2004 the Commissioner made assessments pursuant to s 22(1) of the Taxation Administration Act for each of the quarters between 1 July 2000 and 31 December 2003. These assessments resulted in a tax shortfall of $127,170. Penalties were imposed at the rate of 25 per cent but remitted in full. General interest charge became payable by operation of the Taxation Administration Act.
22. On 4 June 2004 Peerless Marine objected to the assessments. Thereafter followed a process where the Commissioner requested, and Peerless Marine provided, further information.
23. Eventually on 1 March 2005 the Commissioner made an objection decision which accepted some claims for input tax credits and allowed the objection to that extent. But in the main the Commissioner disallowed the objection on the footing that whilst Peerless Marine was carrying on an enterprise the acquisitions in question were non-deductible expenses because of s 26-50 of the ITAA 1997.
24. Peerless Marine sought a review of this decision in the Tribunal by application filed on 27 April 2005.
25. As well as a great deal of documentary evidence, evidence was given orally by a number of witnesses. I should say that I accept that all of the witnesses gave honest and reliable evidence insofar as they were giving evidence of matters of fact. I add to that, however, that there was a tendency in the witness statements relied upon by the applicant for witnesses to make conclusionary statements, some of which even came close to swearing the issue.
26. By way of example of this Mr Gary Lidgard, the designer of White Spirit, swore to this passage:
"Due to the high cost and luxury market status [of] this vessel design, I believe it was essential for Peerless to show customers a demonstrator vessel in order to secure orders for further vessels."
No other reasoning was provided for this conclusion. Other statements of the applicant's witnesses provided similar evidence. So far as evidence of this nature is concerned I regard it as being of little weight. I will place greater reliance upon evidence that demonstrates the process of logic involved, for example the evidence of Mr Ronald Barry-Cotter, elicited in the course of cross-examination, which is discussed below.
27. I should also deal briefly with two further aspects of the evidence.
28. Mr Stephenson gave evidence of a practice of recording in his diary events and details concerning the construction of White Spirit and of marketing attempts thereafter. Cross-examination of Mr Stephenson by Mr N.J. Williams SC, who led Mr Coulsen for the Commissioner, rather faintly suggested that Mr Stephenson had not, as he had said, made the entries contemporaneously with the events. I
ATC 2423am satisfied that the entries were made as Mr Stephenson said.
29. There was, as well, criticism of Mr Stephenson for making the entries. In my view that criticism is not well-founded. Before going into the venture Mr Stephenson sought legal advice on it from a solicitor, Mr Cahill. The Commissioner was keen to establish that Mr Cahill was a tax specialist. I am prepared to accept that he had such a reputation. But regardless of his particular areas of practice I would expect any competent solicitor to advise clients to maintain detailed notes of events concerning a project of this nature. That seems to me to be prudent advice not only because of the possibility of subsequent disputes with the Commissioner but also because of the potential of a dispute with the builders. This was a venture that involved dealings with people that Mr Stephenson did not know very well, it involved potential expenditure of hundreds of thousands of dollars in an area where Mr Stephenson had limited experience. It was prudent to maintain a record of events. Given that the key question is whether Peerless Marine was carrying on a business the diary entries will be of assistance in determining that question.
30. Finally I should mention that in the statements on the applicant's side there were examples where different witnesses used exactly, or almost exactly, the same words. Whilst nothing turns on that occurrence here it might, in a case where the words are critical, lead to the conclusion that the words are not those of the witness, rather they are the words of the person who prepared the statement. The practice is unhelpful in this Tribunal where the evidence in chief of witnesses is given by way of a statement.
31. There is little dispute, so far as I can discern, regarding the primary facts. Rather, the dispute concerns the secondary findings to be made from the primary facts. I will start by recounting the primary facts, assisted greatly in that regard by the chronology prepared on the Commissioner's side and agreed to by the applicant's representatives.
32. Mr Stephenson had been interested in boats, and particularly power catamarans, for a number of years. Mr Gary Lidgard is a yacht and boat designer. He has some 30 years of experience both in Australia and overseas. In 1997 Mr Lidgard had an established reputation as a designer, mainly in relation to custom boats rather than mass production or "short run" designs. During 1997 Mr Lidgard was engaged by Mr Stephenson to undertake the design of a boat.
33. Peerless Marine had not then been incorporated and the dealings for the initial period were between Mr Stephenson and Mr Lidgard. Mr Lidgard was paid for his design work on a fee for service basis, both before and after the incorporation of Peerless Marine.
34. Subsequently, and, I infer, in or about May or June 1998, Mr Stephenson met Mr Jean-Paul Austin and Mr Christopher Spriggens. They were experienced boat builders who also had established a reputation by mid 1998.
35. At around the same time Mr Stephenson compiled the document described as the Peerless Marine Business Plan. It does not resemble what I imagine a business plan to be although I profess no particular experience or expertise in that regard. Rather, I would describe it as notes made by Mr Stephenson of the matters that he had investigated concerning the project and the conclusions that he had reached. It is, I think, important to focus upon its content and what it reveals rather than the label given to it and one's perception of what a business plan might ordinarily contain.
36. Peerless Marine was not incorporated in May 1998 however Peerless was the name of Mr Stephenson's successful dry-cleaning business and he proposed to call his venture by that name when it was founded.
37. Also in May or June 1998 Mr Stephenson sought legal advice from Mr Greg Cahill, a solicitor with the firm then known as Hunt & Hunt. I do not regard the fact that Mr Cahill was a specialist in tax law as having any particular significance in determining the issues that I have to decide. Mr Stephenson also sought accounting advice from Merrotts Chartered Accountants, a firm that had acted for him in relation to other business interests.
38. There is one further event that precedes the incorporation of Peerless Marine. It relates to the involvement of Mr Nelson Raebel and his company Nustar Pty Ltd. In 1998 Nustar was an
ATC 2424established designer and constructor of catamarans and multi-hulled vessels. It carried on business from premises at Jacobs Well leased from Mr Lindsay Grantz and Mr Douglas Grantz. Mr Raebel had been known to Mr Stephenson for some time.
39. By a document bearing the date 10 July 1998 Nustar and Peerless Marine (which was not then in existence) agreed that Peerless Marine would finance the construction, at a cost of $25,000.00, of a 24m x 12m building on part of the land leased by Nustar from the Messrs Grantz. Peerless Marine was to have "exclusive use" of the building, rent-free for a period of two years "to construct a twin hull catamaran vessel".
40. In July 1998 a number of events took place.
41. First, A S Marine Pty Ltd was incorporated on 23 July 1998. It was the vehicle for Mr Austin (the A in A S Marine) and Mr Spriggens (the S) to operate a boat building business. They became directors on 23 July 1998. Mr Cahill resigned as a director on the same day. I infer that he had, in his capacity as solicitor, taken the steps necessary to incorporate the company.
42. Also on 23 July 1998 Peerless Marine was incorporated. Again it appears that Mr Cahill was responsible for its incorporation. Mr Stephenson and Mr Spriggens were its directors. Its members were A S Marine, which held 40 of its 100 issued shares, and Cinecolor Pty Ltd, which held the other 60 shares. Cinecolor was a company controlled by Mr Stephenson. It operated, at least, as the trustee of the Stephenson Family Trust.
43. On 25 July 1998 three documents, all prepared by Hunt & Hunt, were executed:
- • a shareholder agreement between Cinecolor, A S Marine, Mr Stephenson, and Mr Austin and Mr Spriggens,
- • a loan agreement between Cinecolor and Peerless Marine, and,
- • a deed of indemnity between Cinecolor, Mr Stephenson and Mr Austin and Mr Spriggens.
44. The shareholder agreement records, in its recitals, that Peerless Marine:
"intends to establish a business constructing Boats for resale generally in accordance with the dimensions and particulars contained in the Specifications, and the Plans ..."
Whilst the agreement indicated that "Plans" and "Specifications" were attached it seems unlikely that any plans or specifications were ever attached to any executed copy of the shareholder agreement. I find that they were not. The shareholder agreement also made reference to a "benchmark of achieving orders for at least 4 boats within the first 2 years" from 24 July 1998 and ongoing orders averaging a minimum of one per month thereafter.
45. In a general sense the shareholder agreement contemplated that A S Marine would undertake construction of vessels and Mr Stephenson would provide management and marketing services. Cinecolor was to provide "necessary financial accommodation" to permit construction of vessels. The agreement spoke of an "Approved Budget" - defined as meaning any budget and project feasibility approved by the shareholders with any agreed modifications - and anticipated that boats would be constructed in accordance with Approved Budgets. Mr Stephenson's evidence was that the process of approval was undertaken verbally and not recorded in the minutes. I am not satisfied that there ever was an "Approved Budget".
46. It is relevant, as well, to note that the shareholder agreement gave a right to terminate the agreement if the sales benchmarks of at least four boats in the first two years were not met. The benchmark was not met but the right was not availed of.
47. I should also mention in this regard that whilst the shareholder agreement (and the general law) made the directors (Mr Stephenson and Mr Spriggens) responsible for the administration and management of Peerless Marine it is difficult to avoid the conclusion that it was Mr Stephenson who made all relevant decisions. I will consider the significance of that conclusion in due course.
48. The loan agreement recorded that Cinecolor had agreed to lend up to $600,000 to Peerless Marine. Interest was not payable unless Cinecolor elected to make it payable by giving notice in writing of an intention to do so. According to Mr Stephenson's oral evidence no
ATC 2425interest was ever charged. And despite the agreement being one to lend up to $600,000, in fact an amount "in the region of $2.5 million" was lent by Cinecolor to Peerless Marine.
49. The loan agreement provided elaborate mechanisms for giving notice of drawdown including certification of:
- • the fact of work having been done in accordance with the Plans and Specifications,
- • the cost of completed work,
- • the cost to complete.
These provisions were disregarded, as was the requirement that the boat be insured in the names of Peerless Marine and Cinecolor "for their respective rights and interests". The interest of Cinecolor was as debenture holder. The loan agreement contemplated the giving of a registered first ranking mortgage debenture. I note that a charge in favour of Cinecolor was lodged on 6 November 1998. But despite the charge and the requirement of the loan agreement the interests of Cinecolor appear not to have been noted in the insurance of White Spirit.
50. Mr Stephenson, Cinecolor, Mr Austin and Mr Spriggens are the parties to the indemnity agreement. By its terms, Mr Stephenson and Cinecolor agreed that they would:
"... indemnify and keep indemnified Austin and Spriggens against liabilities, claims, actions, suits, proceedings, demands, losses, damages, costs, fees and expenses ... incurred in or arising out of or in connection with the Shareholders' Agreement of Loan Agreement."
51. I should observe in relation to all of these documents that it is obvious that some thought has gone into their preparation. Without, for a moment, regarding any of them as being a "sham" in popularly accepted legal sense of that word my impression from the evidence is that the parties did not pay any particular regard to them in the day to day operations of Peerless Marine. But I do not doubt that the parties would have relied upon their terms had there been disputation inter partes.
52. It is not entirely clear when construction of White Spirit started but I infer that it must have been around this time, that is, late July or early August 1998. According to Mr Stephenson the shed required by the agreement with Nustar to be constructed at Jacobs Well "was finished by late August '98, because we were in there and constructing the vessel."
53. From that point it would seem that construction of White Spirit proceeded apace. In June 1999 or thereabouts Nustar went into liquidation. Peerless Marine entered into a rental agreement dated 28 June 1999 directly with the Messrs Grantz. Eventually on 21 October 1999 the Messrs Grantz granted to Peerless Marine a lease in registrable form for a term of three years commencing on 6 September 1999.
54. By early 2000 it was apparent that construction of the White Spirit was taking much longer, and costing much more, than had been anticipated. By this time, according to Mr Stephenson, costs exceeded $1 million. Mr Stephenson requested Mr Spriggens and Mr Austin to provide a guarantee to Westpac in support of borrowings by Cinecolor to continue the venture. They were not prepared to make that commitment. In the result Hunt & Hunt prepared, and on 21 February 2000 the parties executed, two further agreements,
- • an agreement for the dissolution of the Peerless Marine shareholders' agreement;
- • a share sale agreement whereby Cinecolor acquired A S Marine's shares in Peerless Marine and Mr Spriggens resigned as a director of Peerless Marine.
55. Despite the changed circumstances Mr Spriggens and Mr Austin remained involved in the construction of White Spirit. By June 2000 Mr Stephenson was recording in his "Business Plan" update:
For a hundred different reasons or more this is taking longer and more cost that envisaged.
56. Eventually White Spirit was put into the water in May 2002 and was finally completed in October 2002. As I have said the ultimate cost was in the order of $2.5 million. The original estimate provided to Mr Stephenson by Mr Lidgard was for $850,000.
57. It remains to mention efforts made to market and sell boats generally and White Spirit in particular. The first concerted effort appears
ATC 2426to have been in the 1999 Sanctuary Cove Boat Show. By that stage a model of the White Spirit had been constructed and it was on display at the 1999 and 2000 Sanctuary Cove Boat Shows but not, so far as I can tell, the 2001 show. By the time of the 2002 Sanctuary Cove Boat Show White Spirit had been launched and the vessel, albeit in an unfinished state, was displayed. It attracted some attention.
58. Mr Stephenson described White Spirit as a "demonstrator", a description that I will need to consider further, however he also said that it "had always been for sale from the day it went in the water."
59. In that regard Mr Sisson, who operated a web-based marketing business, was engaged by Mr Stephenson "in or about the start of 2002". Mr Sisson put details of White Spirit on his website to generate interest and approached potential customers. Despite his endeavours he was not able to secure a sale.
60. Peerless Marine also had dealings with two yacht brokers - Grant Torrens International Marine Pty Ltd and Geoff Lovett International Pty Ltd. Grant Torrens was appointed, by letter dated 18 May 2000, to sell the "Lidgard 52", that is, the vessel of which the White Spirit, then being constructed, was the prototype. It was that appointment that lead to the model being displayed at the 2000 Sanctuary Cove Boat Show at the Grant Torrens stand.
61. Consistently with Mr Stephenson's evidence that White Spirit had been for sale once it had been launched, authority to sell it was given to Geoff Lovett International by a document executed by the parties on 28 January 2003. A further authority was executed on 12 October 2003. On the following day Peerless Marine gave to Geoff Lovett "sale rights for the marketing and sales of new orders form this vessel for a period of 6 months." The letter indicated a "base model" price of $1.85 million rising to $2.5 million for a vessel finished to the standard of White Spirit.
62. The evidence demonstrates that Geoff Lovett did advertise and promote the sale of White Spirit. There appears to have been promotion of the Lidgard 52 model but to a much lesser extent.
63. Eventually in May 2006 White Spirit was sold at a price of $1.25 million.
The contentions of the parties
64. Mr Logan SC who appeared for Peerless Marine advanced its case on the basis of these propositions:
- • Peerless Marine was carrying on a business,
- • the expenditure incurred, and claimed as a deduction, was necessarily incurred in carrying on that business,
- • the expenditure was not of a private or domestic nature,
- • deductibility is not defeated by s 8-1(2)(d) of ITAA 1997,
- • White Spirit was used for a purpose essential to the efficient conduct of the business carried on by Peerless Marine.
65. The case for the Commissioner, so far as the income tax assessments are concerned, is as follows:
- • Peerless Marine did not incur a loss carrying of a business,
- • alternatively, any loss or outgoing was of a private or domestic nature,
- • in any event s 26-50(1) of ITAA 1997 denies the deduction because the boat was not used for a purpose essential to the efficient conduct of the business.
66. The assessments so far as they relate to GST were defended on the basis that:
- • there was no creditable acquisition as any acquisition was a non - deductible expense as defined by s 69-5(3)(e) of the GST Act,
- • there was no enterprise because any activity was undertaken as a private recreational pursuit or hobby,
- • there was no creditable purpose and therefore no creditable acquisition.
Thus it was submitted, Peerless Marine was not entitled to input tax credits.
67. I should note that whilst there was some initial disagreement between the parties about the quantum of the applicant's claim, ultimately the Commissioner conceded that the amounts claimed in the relevant years were incurred.
The issues for determination
68. There was broad agreement between the parties that the issues for determination, and the logical sequence for them to be determined, are:
ATC 2427(1) was Peerless Marine carrying on a business?
- (2) what was the nature of the business?
- (3) was the boat used for a purpose essential to the efficient conduct of the business?
Was Peerless Marine carrying on a business
69. There was no real dispute about the legal principles involved. It was accepted on both sides that the question was one of fact. Mr Logan SC relied, in particular, upon the well-known passage from the judgement of Bowen CJ and Franki J in
Ferguson v FCT (1979) 37 FLR 310 at p 314 where their Honours said:
"There are many elements to be considered. The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on business notwithstanding his profit is small or even where he is making a loss. Repetition and regularity of the activities is also important. However, every business has to begin, and even isolated activities may in the circumstances he held to be the commencement of carrying on business. Again, organization of activities in a business-like manner, the keeping of books, records and the use of system may all serve to indicate that a business is being carried on. The fact that, concurrently with the activities in question, the taxpayer carries on the practice of a profession or another business, does not preclude a finding that his additional activities constitute the carrying on of a business. The volume of his operations and the amount of capital employed by him may be significant. However, if what he is doing is more properly described as the pursuit of a hobby or recreation or an addiction to a sport, he will not be held to be carrying on a business, even though his operations are fairly substantial."
70. Mr Logan also provided this useful summary of relevant considerations drawn from the cases:
- • it is not for the Commissioner to tell people how to conduct a business:
Tweddle v FCT (1942) 180 CLR 1, 7;
- • even an isolated transaction, which if repeated, would be a transaction in a business, proved to have been undertaken with the intent of carrying on a business can, from the moment of its commencement, be the first transaction in an existing business:
Fairway Estates Pty Ltd v FCT (1970) 123 CLR 153, 165 citing
ex parte The Board of Trade (1890) 60 LJQB 235, 237.
- • a person may carry on a business if only in a small and even inefficient or incompetent way:
Thomas v FCT (1972) 46 ALJR 397, 401;
- • when there is no discernable trading pattern, the presence of an intention to carry on business becomes relevant in characterising the nature of activities undertaken:
John v FCT (1989) 166 CLR 417, 430;
- • slimness in the prospect of making a profit (
FCT v Glennan (1999) 90 FCR 538, 555-6 ) or even non - achievement of any sales (
Pedley v FCT 2006 ATC 2064, 2091) does not prevent the conclusion that a business is being carried on. And neither does the fact that, with the benefit of hindsight, it is clear that a business venture was not viable:
Case M67 (1980) 80 ATC 479, 482.
71. Mr Williams, on behalf of the Commissioner, placed particular reliance upon the decision of Emmett J in
Ell v FCT 2006 ATC 4098 and, in particular, his Honour's observations at  - :
- "111. Although not determinative, intention is relevant where, for example, a particular activity produces no income (see John v FCT (1989) 166 CLR 417) or where the first step in a business is undertaken (see Fairwell Estates Pty Ltd v FCT (1970) 123 CLR 153). It is necessary to examine the activities engaged in, including their nature and extent (see Martin v FCT (1953) 90 CLR 470 at 474). Activities may constitute the carrying on of a business even though the activities are carried on in a small way and it is not for the Commissioner to dictate to a taxpayer in which business the taxpayer engages or how to run a business profitably or economically (see Tweedle v FCT (1952) 180 CLR 1)[sic]. Provided that an activity said to constitute carrying on business is
ATC 2428engaged in for the purpose of profit on a continuous and repetitive basis, that activity may constitute the carrying on of business (see Hope v Bathurst City Council (1980) 144 CLR 1).
- 112. If there were no real expectation of a profit from engaging in a particular activity, there will be real doubt as to whether engaging in that activity can be said to be the carrying on of a business. Where the expenses and outgoings of an activity are disproportionate to any income that might reasonably have been expected from engaging in the activity that involved incurring those expenses and outgoings, it may be legitimate to draw an inference that the expenses and outgoings were not incurred in gaining or producing the relevant assessable income but were incurred for some other purpose.
- 113. Where expenses and outgoings claimed as deductions are disproportionate to the assessable income produced, subjective factors, including the direct and indirect objects of a taxpayer, may become determinative (see Fletcher v FCT (1991) 173 CLR 1 at 17-19). Where an expense or outgoing claimed as an expense or outgoing of a business is disproportionate to any assessable income that may be gained, it will not be as easy to conclude that the expense or outgoing was incurred in gaining or producing that income (see Spassked Pty Ltd v Commissioner of Taxation (2003) 136 FCR 441 at ).
- 114. The state of mind or intention of a taxpayer may be relevant to the question of whether or not that taxpayer is carrying on a business. Even where a transaction produces no income, if the intention of the relevant taxpayer is that the transaction is the first step in a business, that subjective state of mind may be relevant. The acquisition of Athena was, the Taxpayers say, the first step in the carrying on of a business (see Fairway Estate Pty Ltd v FCT (1970) 123 CLR 153 at 166.8). Further, it is not for the Commissioner to dictate to a taxpayer in what way a business should be run. A business may be carried on even though it is not profitable or economical (see Tweedle v FCT (1952) 180 CLR 1) [sic], provided it is carried on with the purpose of making a profit (see FCT v Stone (2005) ATC 4234 at 4243). The Taxpayers say that they had a profit making purpose or intention in relation to the use of Athena."
72. This was a venture that produced no income other than some modest receipts from incidental activities. It was, with the benefit of hindsight, spectacularly unsuccessful. But that is, of course, not the test. It seems to me that I should give close attention to what motivated Mr Stephenson in setting up, and then driving, Peerless Marine. I attribute Mr Stephenson's motivation to Peerless Marine because it is plain that he was the driving force behind it despite the fact that Mr Spriggens was also a director of the company.
73. Mr Stephenson was, undoubtedly, successful in the dry-cleaning business. Peerless Dry-cleaning is almost a household name in this state. It employs about 100 people. My impression of him, and his evidence, is that he saw this venture as an opportunity to combine his undoubted business acumen with his leisure interest. But I do not mean by that that this venture was an extension of his leisure interests; rather I mean that he saw the opportunity to commence and undertake business activities in an area where he had a particular interest.
74. It is plain that he did not go into the venture merely for the purpose of providing a source of private pleasure. Were that to have been his motivation I would have expected him to have made some private use of White Spirit. He says that he did not do so and I accept that evidence.
75. It is possible, as well, to imagine a venture that fell somewhere between a business venture and a purely private pursuit, one that was not intended to be profitable but was, instead, intended to be a vehicle for the pursuit of a private interest in boats.
76. But I do not consider this venture answers that description. This was, to my mind, much more than a vehicle for the pursuit of Mr Stephenson's private interest in boats. He had such an interest, but I conclude that he went into the venture with an expectation that there was a profit to be made from constructing large powered catamarans. His interest in those vessels and the enquiries he made lead him to
ATC 2429conclude that there was, as he put it in the May 1998 "Business Plan", a "gap in the market place for a new design". That was a gap that he believed he was capable of filling, and profiting from. Unfortunately his belief was shown by events to have been overly optimistic but again that is not the test.
77. Mr Stephenson had discussions with Mr Lidgard, an established designer with an established reputation. He made enquiries to find an established boat builder with an established reputation and ended up pursuing the venture with Mr Austin and Mr Spriggens, boat builders who answered this description. He took professional advice on an appropriate business structure and Peerless Marine was formed and the various agreements entered into. It is, I think, fair to say that the shareholder agreement was overly optimistic and that the parties seem not to have paid a great deal of notice to its terms. But I do consider that it was intended to operate broadly according to those terms.
78. The optimism was, no doubt, the product of the enthusiasm and interest of Mr Stephenson. Despite the involvement of Mr Spriggens and Mr Austin, Mr Stephenson always was, and was always going to be, the driver of the project.
79. The argument for the respondent focuses, naturally enough, upon the lack of profitability and what is said to be the absence of indication of businesslike planning.
80. It is said that the funding arrangements as implemented were strongly suggestive of a private purpose. It is certainly true that funds were supplied on demand by Cinecolor and that, at least to this point, the loan has been interest free. And it is true that the original loan amount has been exceeded. But this was a venture that had to rely upon the wherewithal of Mr Stephenson and entities controlled by him. It is conceivable that entirely arms length funding might have been arranged but had that happened Mr Stephenson and his entities would, I imagine, have been required to provide guarantees supported by security. I do not regard the interest free element as detracting from the businesslike nature of the venture. It was a venture where Mr Stephenson was, in effect, risking his funds either directly of indirectly. Creating interest obligations between related corporations does not give any greater business character and the absence of those obligations does not detract from a conclusion of there being a business.
81. The next criticism is that there were no financial controls on the project. That criticism is factually valid. There was, at best, a rough estimate produced at the outset but, as it seems to me, it would be difficult to do more at that juncture. This was a new design; it had never before been built. There were, as it turned out, difficulties that were not foreseen at the outset. But once construction was started Mr Stephenson and Peerless Marine were committed. Again with the benefit of hindsight it can be said that there was a long period of time where it might have been better to abandon the project but, at the time, that could never have been regarded as being a realistic prospect.
82. That is the answer to another of the respondent's criticisms, that the business plan was not reviewed at any of the critical points such as when the costs blew out significantly, when the funding limit in the loan agreement was exceeded and when shareholder agreement was terminated. Had the business plan been of the nature that the respondent seemed to suggest was necessary it might have been expected that a revised business plan would have been prepared. But the document described by Mr Stephenson as a business plan was never of that nature; it was, in a sense, a record of events and investigations. And, as the updates show, it became a record of Mr Stephenson's feelings of frustration at the delays and cost overruns.
83. It is said by the respondent that:
"other parties were held harmless by the applicant by the indemnity, a document not put into evidence by the taxpayer but obtained on summons from Mr Spriggens."
The first part of that submission seems not to be accurate and the implied criticism in the second part is unfair.
84. It was Mr Stephenson and Cinecolor, not Peerless Marine, providing the indemnity. And if the respondent wanted to make some point about the nature of the indemnity or the fact that it had not been put into evidence by Peerless Marine I would have thought these matters ought to have been raised with Mr
ATC 2430Stephenson. No witness was asked to explain the circumstances by which the indemnity came to be required. In the absence of that evidence I conclude only that Mr Austin and Mr Spriggens wanted to avoid becoming personally liable in the venture. But as members of A S Marine they were indirectly entitled to participate in any profit made by Peerless Marine and paid to A S Marine as a dividend to the extent of 40 per cent. These matters reinforce in my mind the conclusion that this was Mr Stephenson's project but they do not detract from my conclusion that Mr Stephenson was motivated by a desire to make a profit from the venture.
85. There are other criticisms made by the respondent but they are put collectively on the footing that Peerless Marine carried on construction of the vessel without regard to financial constraints. I do not accept that proposition. I am satisfied that Mr Stephenson made appropriate enquiries and obtained information that satisfied him that the project was viable and that there was the prospect, reasonably based, of conducting a successful business. It seems to me not to matter that others may have approached the task in a more structured or disciplined way or systematic way. That fact, as the cases recognise, does not deny the conclusion of carrying on a business.
86. In considering this criticism it is interesting to have regard to the evidence of Mr Barry-Cotter, a man with vast experience over 40 years in the boat building business, about the situation when he first commenced building boats. Whilst in his statement he listed the matters that he would turn his mind to in considering whether to go into production of a new vessel he said that he had "definitely not" been as systematic when he had first commenced in business. My impression from Mr Barry-Cotter is that in boat building, as in most other areas of endeavour, experience is the best teacher.
87. I accept that Mr Stephenson, and through him, Peerless Marine, undertook the venture intending to make a profit. That profit may not have been attainable on the construction of the first vessel and, as it happens, a profit was not attained. But in circumstances where there was an expectation that the construction of the first vessel would lead to orders for more, I am satisfied that the applicant undertook the venture with a view to profit and that it was carrying on a business from the outset.
88. It follows that I am satisfied that s 8-1(1) of the ITAA 1997 is satisfied.
89. Given that the respondent advances an alternative case that the loss or outgoing incurred was of a private or domestic nature it is necessary to have regard to s 8-1(2)(b) of the ITAA 1997. The respondent emphasises that the paragraph, unlike s 8-1(1), does not carry a "use requirement" and that the use of the word "nature" denotes something different to use.
90. Whilst s 8-1 of ITAA 1997 uses slightly different words it is relevantly indistinguishable from s 51(1) of the Income Tax Assessment Act 1936. Importantly, for the purposes of this aspect of the argument, s 51(1) denied deductibility to losses or outgoings of a private or domestic nature. Thus it is appropriate to have regard to the jurisprudence regarding s 51(1).
91. Whatever view might be taken of "private" it is impossible to regard the losses in issue here as "domestic". On no view could they be regarded as;
"Losses and outgoings which relate solely to the house, home or family organization of the person incurring them. (CTBR (NS) Vol 5, Case 50 at p 332)"
92. It has been said that it will be a rare case where the same expenditure can satisfy the second link (carrying on a business) of s 51(1) and yet be an outgoing of a private nature:
Magna Alloys and Research Pty Ltd v FCT (1980) 33 ALR 213 at 228. This is not such a case.
93. The respondent advances the argument on the basis that White Spirit was built by Peerless Marine on the instructions, and to the specification, of Mr Stephenson to satisfy his own private wishes and demands. I do not agree.
94. Were that to be the case I would have expected there to be evidence of Mr Stephenson satisfying those private wishes and demands by using White Spirit for his own amusement. There is not such evidence. To the contrary his evidence is that he did not use it for his own purposes.
95. True it is that White Spirit was built on the instruction of Mr Stephenson. And it is true
ATC 2431that Mr Stephenson seems to have made all relevant design and building decisions. But I consider that he did so in his capacity as the driving force behind the applicant and not any capacity designed to satisfy his private desires. As it seems to me the respondent's argument imposes a level of detachment that the legislation does not require. The argument treats differently those, like Mr Stephenson, who have a passionate interest in the project that their business is involved in. I do not accept the respondent's argument that the losses and outgoings are of a private or domestic nature.
What was the nature of the business
96. The argument for the respondent seemed to me to involve the acceptance, first, of the proposition that there could only ever be one business and that it had to be either that the applicant was constructing White Spirit for use as a demonstrator or that it was constructing her for sale.
97. I do not regard the argument as sound.
98. In my view Peerless Marine commenced business as a boat builder, that is, a business that involved the construction, marketing and sale of luxury catamarans, and continued in that business, albeit that its focus altered as circumstances altered. Its original intention was to construct White Spirit as a demonstrator; to have it available (whether still under construction or completed) as an aid to sales, enabling potential customers to examine what Peerless Marine could offer to them. But over time the focus of the business changed. As costs increased and the time for construction became longer it became more important to sell White Spirit once completed. It is not possible, on the evidence, to determine when the point was reached when Peerless Marine determined to sell White Spirit rather than keep her as a demonstrator. But it must have been at least by May 2002 when it was launched. And even after a decision was made to sell her it seems plain that her use as a demonstrator continued.
99. I do not doubt that as time went by without any sales the prospects of Peerless Marine ever becoming a successful boat builder became less likely and, ultimately, a point was reached when boat building, as a business, was no longer being pursued. Were it necessary for me to find when that was I would fix that time as being November 2003 (or shortly prior) when Peerless Marine cancelled its GST registration.
100. In my view Peerless Marine started in business with the intention of constructing White Spirit as a demonstrator, that is, keeping her for that purpose once constructed, although no doubt if offered enough money a sale would have been agreed to. As costs increased and the time for construction blew out Peerless Marine determined to sell the vessel if possible. But until sold White Spirit was to be available as a demonstrator. Ultimately the notion of building other boats was abandoned and the efforts of Peerless Marine were devoted to the sale of White Spirit in order to recoup some of the investment.
101. The respondent argued, in reliance upon the holding of the High Court in
Steele v Deputy Commissioner of Taxation  HCA 7; (1999) 197 CLR 459, that, at best for Peerless Marine, it could deduct losses and outgoings incurred after January 2003 when White Spirit was first offered for sale. I take that to be a reference to the evidence regarding the authority to sell given to Geoff Lovett International dated 28 January 2003. I do not accept that submission.
102. Steele was an entirely different case to the present but in any event the submission seems to proceed upon a factual basis that I do not accept, namely that the business of Peerless Marine was that of constructing White Spirit for the purpose of its sale. But in any event the temporal relationship referred to in Steele is satisfied, or explained, by the length of time that construction of White Spirit took. On the facts of this case as I have found them I am satisfied that there is a sufficient connection between the incurring of the losses and outgoings and the gaining or producing of assessable income.
Was the boat used for a purpose essential to the efficient conduct of the business
103. As has been noted s 26-50(1) of the ITAA 1997 denies deductibility for losses and outgoings incurred to acquire ownership of a boat or associated purposes. It is not in issue here that the deductions claimed in the 2001 to 2004 income years were incurred to acquire ownership of White Spirit or, in the later part of that period, to maintain the vessel. There is thus
ATC 2432no dispute that s 26-50(1) would operate unless s 26-50(5)(d) exempts its operation.
104. It would operate in that way if I were to be satisfied that at all times during each of the income years Peerless Marine used the boat for a purpose that was essential to the efficient conduct of a business that it was carrying on.
105. The argument for the applicant was that the exemption is engaged where the use of the vessel was essential to the efficient conduct of a business that it was carrying on. Essential, it was submitted, focussed attention on what was truly necessary to be efficient in the business. For these purposes I accept the definition of efficient in the Macquarie Dictionary Federation Edition as meaning:
- 1. effective in the use of energy or resources.
- 2. adequate in operation or performance; having and using the requisite knowledge, skill, and industry; competent; capable.
- 3. producing an effect, as a cause; causative.
106. For the respondent two arguments were advanced as to why the exemption could not be relied upon. First, it was said that the use of the vessel as a demonstrator was not for a use that was essential. And, it was said, that in any event that use could only occur after the time the boat was finished in October 2002. It was said:
"... even if the Applicant falls within the terms of paragraph 26-50(5)(d) then the subsection can only have application after the time the boat is finished."
107. The concept of 'essential to the efficient conduct' of a business has been considered by the Taxation Board of Review in Case R63
(1984) 84 ATC 457. There the Board was concerned with the identical phrase in s 51AB of the Income Tax Assessment Act 1936. The view of the Chairman, Mr Stevens, is aptly conveyed by this passage at p 460:
"I am unable to conclude that 'the use of the boat was essential to the efficient conduct of the business of the taxpayer'. It is quite clear that the activities could be conducted quite satisfactorily without the use of the boat whilst, on the evidence, I am far from satisfied that its use has been the cause of any real increase in the volume of commissions received."
108. Mr McCarthy, at p 462, said:
"For the taxpayer to succeed it is necessary for the Board to be satisfied that in the relevant years the business conducted by the taxpayer would not have been conducted efficiently without the use of such a boat for that purpose - it is not enough that the business would not have been conducted as efficiently without a boat. In other words, as I see it, the question to be asked is whether the taxpayer's business would have been conducted inefficiently without the use of such a boat for that purpose."
Mr Roach, at p 464, emphasised that the use of the word "conduct" meant that it was the operations and performance rather than the results which must be efficient. He posed the question of essentiality in a similar manner to the other members of the Board.
109. I propose to consider the matter by considering whether the activities of Peerless Marine could have been conducted quite satisfactorily or effectively without the use of the boat.
110. In considering this question I have a number of sources of evidence of varying weight. Mr Stephenson said in his statement:
"Due to the high cost and luxury market status of a 53' powered catamaran, it was imperative to be able to show customers a demonstrator vessel to assist in securing orders for vessels of the same specifications or variations of that design."
He spoke, as well, of potential customers inspecting the partly constructed vessel "to gain a better appreciation of the final vessel and gain confidence for the product and in the applicant". His diaries record that fact of such inspections both during and after constructions. Mr Stephenson also said, and I accept, that it was not unusual for customers to display unwillingness to commence negotiations for a purchase in the absence of viewing the demonstrator vessel.
111. Mr Sisson, who prior to retirement, carried on the business of marketing boat designs, boat kits and other miscellaneous marine products, swore that, in his experience, "a demonstrator vessel is essential to any business involving construction and marketing of marine vessels. This is especially so when a business has vessels of unique design and of a
ATC 2433high quality and price." Mr Raebel who was a marine designer with more that 40 years experience in the industry spoke of the use of a demonstrator vessel as
"Essentially the normal method employed by industry players to commence operations, attract customers, and build their businesses."
That, he said was the experience of his company Nustar.
112. A slightly different emphasis was put by Mr Swan who has had some 20 years experience in the sales side of the marine industry. He spoke of a reluctance on the part of customers to place an order in the absences of a demonstrator vessel. Australians, in his experience, liked to be able to "touch and see a vessel" before buying. Mr McPherson, who had similar experience to Mr Swan, also spoke of the need for customers to "touch and feel" before buying.
113. I do not place a great deal of weight upon these witnesses' expressions of what is "essential" or "imperative" however I propose to have regard to the evidence of their experience, albeit not directly in the boat building field.
114. Evidence in that particular field came from Mr Barry-Cotter who has been in the boat building business for some 40 years. Mr Barry-Cotter founded, and operated, Mariner Cruisers which produced approximately 1,200 vessels between 1966 and 1978. Then in 1981 he established Riviera Marine Pty Ltd, a company which went on to become Australia's leading power boat manufacturer. He sold that interest in 2002 and established Maritoma Offshore, and entity that specifically focuses on limited series production vessels.
115. Mr Barry-Cotter was called by the respondent on the basis of his 40 odd years of experience in the day to day involvement with the design, production, costing, marketing and sale of luxury power boats. He was, if I may say so, a very impressive witness. He described the process of getting started in the business of boat building in this way:
"I ... started off building one boat I was sailing in a sailing club at the time ant that sort of gave me quite a few contacts. I sort of lobbied boating magazines, and the boating journalists, to get some - really make myself known with them, and did some repair work and then started to build a boat on spec. I sold a car and built the boat on spec and put a - finally, then, put one ad in the paper and sold it."
He described this first boat as "quite important".
116. His first boat was a wooden hulled vessel. Some little time after that his company turned to building fibreglass boats. He described the first of the fibreglass boats as experimental and "overbuilt". This passage in cross-examination by Mr Logan is revealing:
"Q With the first boat then, in fibreglass, important to get one then out to the market to show that your company could produce a good fibreglass one? - - Most definitely.
And then is it the case that a first sale
The transcript records, incorrectly, “sail”.of the new product is very important - - Very important. It's, you know, sometimes you know it's the whole business relies on it, you know, and a lot of people's jobs
Yes? - - So with a new model, in that way it's not that different today."
Later on, and in answer to a question from me, Mr Barry-Cotter said:
"You know, you'd have a - you know, for the custom boats, a photograph album, and you would really try and do a deal with the customer to get access to take prospective buyers and show them the boat, and then that was, sort of, early days. Today you've really got to build boats, put them in stock, and - so they're there for people to see.
'This is what we can build for you?' - - Yes, exactly, like a project house."
117. The evidence that I have recited satisfies me that being able to demonstrate what the boat builder can accomplish and the look and feel of the finished product is an important element in, the business of boat building. And, for that reason, it may be readily concluded that the use of White Spirit in this way was for a purpose that was important in the efficient conduct of the business of a boat builder. But the critical question is whether it was so important that the activities of the business could not have been conducted efficiently without White Spirit as a demonstrator. Or, to
ATC 2434adopt the language of Mr McCarthy in Case R63, would Peerless Marine's business have been conducted inefficiently without the use of White Spirit as a demonstrator.
118. On balance, I think the question must be answered favourably to the applicant.
119. Peerless Marine was unknown in the market place. Mr Stephenson, its alter ego, was, no doubt, well known in boating circles but was an unknown quantity so far as boat building was concerned. Mr Lidgard was, as the respondent points out, a well respected boat designer with a proven track record who was combining his talents with the undoubled talents, experience and reputations of Mr Austin and Mr Spriggins. And it is true to say that computers can display the final product quite graphically.
120. But it seems to me that without some visible demonstration of what the combination of Mr Lidgard's skills as a designer, and the boat building skills of Mr Austin and Mr Spriggens, and Mr Stephenson's talent as a businessman, potential customers were being asked to take too great a leap of faith. The combination of these people within Peerless Marine was untested and unknown even if the individuals had particular reputations. Bottom line, a potential customer would be contracting with Peerless Marine, not the individuals. I consider that any customer who was looking to spend in excess of $1.5 million in having Peerless Marine construct a vessel would reasonably require to "touch and feel" some tangible evidence that Peerless Marine could produce the desired result regardless of the reputation of the individuals behind the company.
121. Thus I conclude that use of White Spirit to demonstrate the capability of Peerless marine and the nature of the finished product was a use that was essential and not merely desirable, to the efficient conduct of the business of Peerless Marine in constructing and marketing luxury catamarans.
122. The question that remains is that of timing - the argument for the respondent that even, if the applicant falls within the terms of s 26-50-(5)(d) the paragraph can only have application after the time that White Spirit was completed in October 2002. This issue was the subject of supplementary submissions sought by me from the parties after the conclusion of then hearing.
123. It seems to be accepted on both sides that the losses or outgoings in issue here were "to acquire ownership of ... a boat". The exemption in s 26-50(5)(d) applies if "at all times in the income year you ... use the boat for a purpose that is essential to the efficient conduct of a business that" was being carried on. The argument for the respondent is that the applicant can only rely upon that exemption after such time that the boat is complete and useable.
124. I do not accept that argument. The evidence demonstrates that there were inspections by potential purchasers during the course of construction. I can see no reason why a boat under construction ought to be regarded as being incapable of demonstrating to potential purchasers what Peerless Marine could construct for them. Moreover, as Mr Logan submits, if the matter were viewed in such a narrow way then it seems difficult to see why s 26-50(1) ought not be viewed in a way that it has no application to the losses or outgoings incurred in constructing a boat.
125. In my view the applicant used the White Spirit, both during and after her construction, as a means of demonstrating to potential purchasers what it was capable of undertaking for those purchasers. That purpose was, as I have found, a purpose essential to the efficient conduct of its business.
126. It follows that I am satisfied:
- • that the losses and outgoings claimed by Peerless Marine in its 2001, 2002, 2003 and 2004 income tax returns,
- - were necessarily incurred by it in carrying on a business of boat builder,
- - were not of a private or domestic nature,
- - were not denied deductibility by s 26-50(1) of ITAA 1997 because they satisfied s 26-50(5)(d);
- • that the amounts claimed by Peerless Marine as input tax credits in its quarterly BAS statements in the periods from the September 2000 quarter to the December 2003 quarter were incurred in circumstances
ATC 2435where Peerless Marine made creditable acquisitions.
127. It also follows that the respondent's objection decisions with respect to both the income tax and GST matters ought be set aside and the objections allowed. I remit the matter to the respondent for the purpose of giving effect to this decision.