• The impact of this case on ATO policy is discussed in Decision Impact Statement: Drysdale and Commissioner of Taxation (Published 24 July 2008).

DRYSDALE v FC of T

Members:
J Handley SM

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2008] AATA 393

Decision date: 14 May 2008

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J Handley (Senior Member)

1. The applicant applies to review a decision made by the respondent on 29 August 2006 which denied a claim he made for an input tax credit arising out of the purchase, by him, in the 2005 income year of a Dufour 40 foot yacht with 55 horsepower motor manufactured in France and assembled in Australia. The respondent contends that the purchase of the vessel was not a creditable acquisition within the meaning of the A New Tax System (Goods and Services Tax) Act 1999 (the Act).

The legislation

2. Section 7-1 and s 11-20 provide that an entitlement to an input tax credit will arise if there has been a creditable acquisition. A creditable acquisition occurs if all of the circumstances recorded in s 11-5 of the Act occur. In the present application the respondent only disputes ss 11-5 (a) namely, the acquisition for which credit is sought was not solely or partly for a creditable purpose. A creditable purpose for the purposes of s 11-15 is the acquisition of a thing for the purposes of carrying on your enterprise and ss 11-15 (2) (b) provides that the thing is not a creditable purpose if its acquisition is of a private or domestic nature.

3. Section 9-20 of the Act records that an enterprise is an activity or a series of activities done in the form of a business (ss 9-20 (1) (a)) however an enterprise excludes activity (ss 9-20 (2) (b) and (c)) done as a private recreational pursuit or hobby or without a reasonable expectation of profit or gain.

4. Section 69-5 (1) of the Act provides that an acquisition is not a creditable acquisition if it is a non deductable expense. Such an expense is not deductable if it falls within s 26-50 of the Income Tax Assessment Act 1997 (the ITAA). For reasons which will follow I am not satisfied that the acquisition of the vessel by the applicant is a creditable acquisition and it will not be necessary to consider the provisions of the ITAA.

5. Whilst this review is obliged to decide whether the purchase of the vessel is a creditable acquisition, the real focus is whether the acquisition of the vessel was done either for a private recreational pursuit or hobby or without a reasonable expectation of profit or gain. In reaching the conclusions which appear later, regard was had to the evidence of the applicant and a number of letters written by him, the documents lodged and the written submissions of the parties.

The facts

6. The applicant is a self-employed mussel farmer trading in Geelong, in partnership with his wife, under the registered business name of Marrose Cultured Mussels. He has an extensive history in fishing and boating.

7. In October 2004, the applicant agreed to purchase Dufour 40 yacht in the sum of $398,587. When it was delivered there was a dispute concerning items fitted. He eventually paid $389,000 for it. Later, he spent approximately $25,000 in fitting additional equipment and safety items. $3177.90 was also paid to insure the vessel. $44,165 was claimed as the input tax credit with respect to the purchase of the vessel. (The respondent allowed $186.00 with respect to the farming lands leased by the applicant. His agricultural pursuits and that claim is not relevant to these proceedings).

8. The applicant said that prior to purchase of the vessel, it was understood that he would become a sub-dealer and in consideration of making his boat available for demonstration purposes and promoting the Dufour brand, he would recover a commission of $5000.00 for each Dufour vessel sold. He understood that he would sell either two, three or four Dufour vessels per annum which would entitle him to an income from commission sales of between $10,000 and $20,000 per annum. In the period under review, and subsequently, no such vessels have been sold.

9. The applicant entered into a sub-dealer's agreement with Vicsail Melbourne (Vicsail) where it was agreed that the applicant would be a dealer of Dufour 40 yachts and for which Vicsail would have exclusive distributor rights in Victoria. The agreement provides that the dealer (the applicant) agreed to promote the sales and the image of Dufour 40 and by any common marketing and service manners and the distributor (Vicsail) shall be allowed to do sales within the territory. In consideration of sales, a commission of $5000.00 would be paid to the applicant being $2500.00 from Vicsail and $2500.00 from MPM Marine (refer summonsed documents at p45).

10. The applicant agreed that he was not involved in sales of the vessel but rather promoted it by participating in the Sandringham Boat Show in 2005 and 2006, leaving it moored at the Docklands Marina and the Royal Geelong Yacht Club where it could be observed and inspected by persons, participating in some ocean racing and sailing the vessel with other persons who were potential purchasers.

11. The vessel purchased by the applicant was valued on 25 October 2007 by Mr Peter Southwell the Managing Director of Navatair which is engaged in the business of marine survey and consulting. Mr Southwell is a master mariner. He valued the vessel at $285,000 plus or minus five per cent based on a wharf side inspection. The applicant said that Mr Southwell did not inspect the inside of the vessel and it wasn't a proper valuation, but he did not challenge the valuation and did not require Mr Southwell for cross-examination.

Conclusion and reasons for decision

12. For reasons which follow I am not satisfied that the acquisition of the vessel was for a creditable purpose. In making the findings as follows I am not satisfied that it was acquired for the purposes of carrying on your enterprise. I am also satisfied that the vessel was used either as a private recreational pursuit or hobby and or purchased without any reasonable expectation of profit or gain.

13. The subjective your before the word enterprise in s11-15 (1) of the Act clearly points to an intention on the part of the Parliament to confine eligibility for an input tax credit to a creditable acquisition being a creditable purpose acquired for an enterprise of an applicant, that is an activity or series of activities done in the form of a business (refer s9-20). The business of the applicant was mussel farming. It was a full time six day per week activity. It was subject to weather (as demonstration of a yacht would be) and it was an activity the applicant acknowledged actively engaged him (refer Trans. p36).

14. The applicant acknowledged in evidence that he did not try to promote or market the vessel but rather made it available to Vicsail to advertise and sell Dufour yachts (refer Trans. p36 and letter to ATO 27 July 2007).

15. He also submitted that the vessel was moored at Docklands to expose it to a greater number of people than elsewhere - but its effect must have been to isolate the applicant from it. That is, he was located in Geelong, 70kms away, mussel farming six days per week. Even if his business was to demonstrate, sail it and refer people to Vicsail, he could not readily or practically do it. The business, as he described, involved a principal (him) who was mainly absent. He did entrust Vicsail to sell Dufour yachts but their role must not be confused with his role. I am not satisfied that the activities of the applicant concerning the yacht permit a finding of any business. His commitment to mussel farming caused him to be mainly absent from marketing and promoting the vessel. The absence of any or any adequate or reasonable planning, control, revenue projection or expectation point to the applicant not being engaged in activities done in the form of a business (concerning the yacht) (refer s 9-20 of the Act and
Fergusen v Federal Commissioner of Taxation 79 ATC 4261; (1979) 26 ALR 307;
Ell and Anor v Federal Commissioner of Taxation 2006 ATC 4098; [2006] FCA 71) (Ell).

16. In 2006 two decisions of note were decided by both the Administrative Appeals Tribunal and the Federal Court which are illustrative of activity being undertaken sufficient to amount to a finding of an enterprise or business.

17. In both decisions -
Peerless Marine Pty Ltd and Commissioner of Taxation 2006 ATC 2419; [2006] AATA 765 (Peerless Marine) and
Hostess Marine Pty Ltd v Commissioner of Taxation [2006] FCA 1651 (Hostess Marine) - each applicant, as was the applicant in these proceedings, engaged in another business but became involved in yachting.

18. In Peerless Marine the applicant arranged to have a vessel constructed - with the intention of it being a demonstrator vessel - in order to secure other orders. He expended $2.5M in construction. Having regard to the size of the vessel, he negotiated with the owner of land to construct - at his expense - a 24 metre by 12 metre building in which the vessel would be constructed. The Tribunal found that the applicant did have an intention to carry on the business of boat building and although the applicant's expenses were disproportionate to assessable income, he did have an expectation of profit which was found by the Tribunal to be reasonable. The Tribunal also found that the applicant was not engaged in an activity which was of a private or domestic nature.

19. In Hostess Marine the applicant was also involved in another business but as a boating or yachting enthusiast he incorporated the corporation Hostess Marine as a prelude to acquiring a particular type of motor yacht and approaching the overseas manufacturer of it to secure the position as an Australian agent or distributor. In pursuit of that intention and by regard also to the applicant's contacts and reputation within the boating industry, he was confident that he would earn a profit and that was his intention. He devised and published a marketing and public relations campaign which comprised three chapter headings of objectives, strategies and tactics. The promotional strategies involved advertising and promotion by television, newspaper and yachting magazines. The objectives were recorded as achieving a defined number of sales or a defined amount of revenue for each year and to personally show the vessel to between 30 and 50 eminent potential customers per year. The strategies involved the appointment of a high profile personality/opinion leader to endorse the product and the tactics involved public relation type activities of personal invitations being sent to 32 journalists to observe or be entertained onboard the vessel (including provision of media kits and the distribution of merchandise being shirts, windcheaters, caps, stubbie holders and business cards) bearing the Hostess Marine logo at boating shows. A promotional budget was also devised. The Federal Court was satisfied that the principle intention of Hostess Marine was to use the vessel otherwise than for providing pleasure, sport or recreation, private transport or accommodation or a combination of these facilities.

20. The applicant was not involved actively or at all in the sale of Dufour yachts. Consistent with the sub-dealer's agreement (refer earlier), the role of the applicant was to promote the sales and the image of the vessels, whereas Vicsail was allowed to do sales. The applicant agreed with that arrangement and said that the vessel was to be regarded as an advertising billboard and was intended to attract potential purchasers by it being viewed whilst moored at Docklands Marina, the Royal Geelong Yacht Club, at the Sandringham Boat Show and during occasions where it was engaged in racing and on other occasions when persons, whom the applicant believed were potential purchasers, were onboard the vessel. None of those persons were called to give evidence, The applicant could recall the name of one person only but a statement of the evidence of that person was not lodged. There was no evidence of any interest expressed by any person in the vessel during the occasion that it was on display at the Sandringham Yacht Club in 2005 and 2006 or elsewhere. There was documented evidence in materials received by summons of enquiries made of Vicsail from some persons who apparently observed the vessel at the Sandringham Boat Show and/or enquiries generally. The documents, under the heading Vicsail Melbourne - Prospective Purchasers mainly refer to enquiries made of persons expressing a purchase budget less than the probable cost of a Dufour 40 yacht and do not express any apparent effort on the part of Vicsail to sell the vessel. For example, the comments made under Follow Up include references to forwarding brochures and invitations to the 2005 Sydney Boat Show. Two persons expressed an interest in wanting to sail a Dufour 40 yacht but there is nothing which indicates whether those persons ever had their wishes fulfilled.

21. Allied to an argument raised by the respondent of the absence of any reasonable expectation of profit or gain (s 9 (2) (c)) was the depreciation value of the vessel. The applicant agreed at October 2004 the vessel was valued at $415,000. At October 2007 it was valued at $285,000. I am satisfied in the absence of any evidence to the contrary that it is a true valuation. Accordingly the vessel has depreciated in value by $130,000 which would average an annual depreciation in excess of $40,000. In the first year after acquisition, the applicant spent $9595.00 in mooring fees at Docklands (summonsed documents p72) and in the second year spent $2600.00 in mooring fees at the Royal Geelong Yacht Club. Insurance was paid over the vessel in the first year at $3177.90. Even if the applicant had received commission from sales - and he did not receive any commissions - he would not have achieved any profits indeed he would have operated at a loss. The applicant said that he did not regard depreciation as an out of pocket expense and accordingly did not take it into account when deciding whether he would earn assessable income or profit from sales of similar vessels. Operating at a loss will not necessarily defeat a finding of an intention to earn profit, but such an intention although subjective must be realistic and not illusury. The income projections (of $20,000 maximum per annum - refer paragraph 8 earlier) would have been overwhelmed by the depreciation of the vessel. Where losses are disproportionate or in excess of income it is difficult to find that the expense was incurred in achieving income (
Spassked v Commissioner of Taxation 2003 ATC 5099; [2003] FCAFC 282 at paragraph 64; Ell at paragraph 111).

22. In the Spanish Prospecting Company Limited (1911) 1CH 92 (Spanish Prospecting) a decision of the Chancery Division of the Court of Appeal it was decided that in order to calculate profits the assets of a business must be valued. A depreciation in value whether from physical or commercial causes which affects their realisable value is in truth a business loss (p99). To render the ascertainment of the profits for business of practical use it is evident that the assets of whatever nature they may be must be represented by their money value (p100). A company may wisely write-off liberally under the head of depreciation but they will be only allowed to deduct the sum representing actual depreciation for the purpose of calculating the profits for income tax (p101).

23. That decision has been followed on many occasions by Courts in Australia especially the High Court in
Commissioner of Taxation v Slater Holdings Limited 84 ATC 4883; [1984] HCA 78 where at paragraph 16 Gibbs C J decided that the definition of profit as decided in Spanish Prospecting should be treated as a guide. Nonetheless the Tax Office regards taking account of depreciated value in assessing profits by its Income Tax Ruling 2003/4 at paragraph 17. I am satisfied that regard to the depreciated value of the vessel is a legitimate manner of deciding profit or loss.

24. The applicant did not have a business plan nor did he ever consider preparing such a plan. A corporation or business was never commenced or acquired for the purposes of promoting the sales and the image of the vessel (and in turn therefore earning income from commission sales) nor was there any evidence of any marketing or advertising by the applicant in print, audio, visual or electronic means.

25. The applicant was also taken to copies of a ledger or balance sheet found within the T-documents which contain some entries with respect to purchases of items which by their description would indicate a relationship to the vessel but other items clearly were not. For example, the ledgers referred to payment of expenses for municipal rates, water charges and a telephone account. The absence of ledgers or books of account distinguishing the expenses in relation to the vessel from those expenses of a private or domestic nature, tend to support the contention of the respondent that the Dufour 40 yacht was acquired not with a reasonable expectation of profit but rather was in the nature of a private recreational pursuit.

26. The circumstances of the applicant are vastly different from those discerned from the decisions in Peerless Marine and Hostess Marine. Of course the ventures evident from those decisions involved outlays of considerably greater amounts of money but that is not determinative of whether a business is being undertaken. The level of investment, involvement, planning, commitment, time, effort, promotion, marketing and enthusiasm all point to Peerless Marine and Hostess Marine undertaking a business. Few of those features, if any, exist in the case of the applicant.

27. The applicant may well have had an intention to make a profit when he purchased it but when his circumstances are considered and in the absence of features readily apparent from the Peerless Marine and Hostess Marine decisions, it could not be found as a fact that the applicant had any reasonable expectation of profit or gain. I think the use of the vessel was also in the nature of a private recreational pursuit or hobby, as evident particularly by the ledgers recording domestic and yachting expenses and the absence of a business like commitment to promotion of the yacht.

28. In the circumstances the acquisition of the vessel was not a creditable acquisition within the meaning of the Act. The decision under review must therefore be affirmed.