Kratzmann v. Federal Commissioner of Taxation.

Menzies J

High Court

Judgment date: Judgment handed down 31 July 1970.

Menzies J.: This is an appeal to the court from a decision of the Board of Review confirming the Commissioner's assessment of the taxpayer, Noel Austin Kratzmann, to income tax for the years ended 30 June 1959 to 30 June 1966 and to the disallowance of the taxpayer's objection thereto with what is now an immaterial exception in respect of the year ended 30 June 1960.

Although there were a number of objections to a number of assessments, the whole matter before the Board of Review and in the court has, perhaps irregularly, been treated as one appeal.

There are three matters to be determined-

1. Whether the taxpayer was assessable upon a profit made by buying land in Surfers Paradise in June 1958 for £19,415 and selling it in December 1959 for £25,000.

2. Whether the taxpayer was entitled to deductions from assessable income of sums of £990, £1,538 and £3,264 expended by him in legal expenses in the years ended 30 June 1964, 1965 and 1966 respectively.

3. Whether the taxpayer was entitled under sec. 63 of the Income Tax Assessment Act to a deduction of £26,219.13.11 from his assessable income for the year ended 30 June 1963 in respect of bad debts written off as such in his books in November 1963.

The Commissioner contended that the land at Surfers Paradise was bought by the taxpayer as part of an undertaking (1) to establish a company limited by shares to which the taxpayer would transfer the land in return for shares; (2) to attach to particular blocks of shares in the transferee company the right to occupy certain parts of a building to be erected on the land, i.e. to provide for units based not upon strata titles but upon shareholding in a company owning the land; (3) to arrange for the taxpayer's company, N.A. Kratzmann Pty. Ltd., to erect upon the land a building costing about £150,000 to be known

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as Kratzmann House and to comprise shops, offices and flats; (4) to obtain from some financial institution a loan to cover the major part of the expenditure involved in carrying out the project; (5) to recoup the costs of the project by the allotment or sale of blocks of shares to persons wanting units in Kratzmann House; and (6) to retain the remaining shares and the rights of occupation of units attached thereto for himself.

Had the Commissioner's contention been established I would have had no doubt that the taxpayer purchased the land in Surfers Paradise as a step in the carrying out of a profit-making scheme.

For the taxpayer, however, it was argued that, at the time of the purchase, he had not formulated what he would do with the land beyond intending that his company, N.A. Kratzmann Pty. Ltd., should build on the land a building of shops, offices and flats at cost which would constitute a rent-producing investment and that so much that was needed beyond his own resources would be borrowed from a lending institution.

I cannot find affirmatively that when he bought the land the taxpayer had formulated a scheme with the particularity that the Commissioner attributed to him, but I am by no means satisfied that the taxpayer did not buy the land to carry out a scheme of that sort. He knew of the means at the time being adopted in Queensland-in the absence of strata title legislation-to achieve the subdivision of a building into units and straight-away upon purchase he had plans prepared of a building suitable for subdivision in that way to which the architect attached estimates both of selling price and rental value. For this proposed building-Kratzmann House-building consent was sought and obtained in the local council. The Board of Review found that the taxpayer's intention was, when the development at Surfers Paradise had been completed, to sell off sufficient of the flats to cover the cost of the project and to retain the balance of the flats and the shops as an investment. The Board also found that, relying upon the evidence of admissions by the taxpayer, ``he intended to transfer units to the architect and the engineer to cover their costs''.

The architect was called at the hearing of the appeal. He said that he had brought the land in question to the notice of the taxpayer as a site for development by the erection thereon of a building comprising shops, offices and flats. The architect was not certain whether or not he had been paid for his considerable services in drawing plans and obtaining council consent and he said he did not think that he had intended to take a shop or flat in lieu of fees.

Upon the whole I have reached the conclusion that the taxpayer bought the land in question, not to sell it at a profit, but to carry out a profit-making scheme thereon involving the borrowing of money to erect a building, the realisation of units in the building to cover the repayment of loans and the cost of the project to leave him with a substantial asset which would constitute a surplus or profit. I do not accept the argument of counsel for the taxpayer that, in the circumstances, a surplus of this sort would be something different from a profit. I find affirmatively that the taxpayer did buy the land for the carrying out of a profit-making scheme.

It follows, therefore, that any profit arising from the carrying on or the carrying out of that profit-making scheme is assessable income pursuant to sec. 26(a) of the Act.

It is, however, a matter for decision whether the difference between the purchase price and the selling price of the land-less the expenses of doing what the taxpayer did towards carrying out his scheme-is to be regarded as a profit from the carrying on or the carrying out of the taxpayer's scheme. What happened was that the taxpayer, for financial reasons, gave up the idea of developing the land as had been intended and sold it, so making a profit.

For the Commissioner it was argued that, because the purchase was part of a profit-making scheme, any profit arising from the purchase was a profit from the carrying on or carrying out of that scheme. It seems to me, however, that the profit here arose not from the purchase but from the sale and because the sale was not part of the profit-making scheme the profit did not arise ``from the carrying on or carrying out'' of that scheme. Indeed, the profit in question did not arise until the scheme had been abandoned.

Accordingly, I am of the opinion that the taxpayer is entitled to have the assessment, including this profit as part of his assessable income, amended to exclude it.

The legal expenses which the taxpayer sought to deduct were incurred in the Supreme

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Court of Queensland, the High Court of Australia and the Privy Council in proceedings instituted by the taxpayer to prevent his public examination in the liquidation of N.A. Kratzmann Pty. Ltd. in relation to transactions with which that company was concerned. The taxpayer's case that the expenses were necessarily incurred in gaining his assessable income was based upon the suggestion that a public examination in the liquidation would tend to keep before the public matters which would discourage possible clients from entrusting him, or any company with which he was concerned, with building contracts and might involve him in total ruin necessitating the realisation of investments from which he was receiving income. Had this been the only matter in issue I would have acceded to the Commissioner's application and dismissed the appeal as incompetent. I do not think this part of the appeal involves any question of law. The Board decided against the taxpayer on the facts and it seems to me that the Board was incontestably right that the facts showed that the expenses were not deductible under sec. 51 of the Income Tax Assessment Act. Counsel for the taxpayer relied upon
F.C. of T. v. Snowden and Willson Pty. Ltd (1958) 99 C.L.R. 431, but that decision is not in point. There a company spent money advertising to counter press reports concerning allegations made against it in the conduct of its business and incurred legal costs in appearing before a Royal Commission to protect itself against allegations relating to the conduct of its business which, if proved, would affect it in the present and in the future conduct of its business. To allow such expenditure as deductible affords no warrant for allowing the taxpayer as a deduction expenditure to protect his company or his investment, if, indeed, it could be though that it could do either. The expenditure was not an outgoing incurred in gaining assessable income and, even upon the basis upon which the taxpayer sought to establish the expenses as deductible, they were clearly enough of a capital, or a private, nature.

The claim for a deduction under sec. 63 of the Income Tax Assessment Act depended upon proof that, at the critical time, N.A. Kratzmann Pty. Ltd. owed the taxpayer the sum of £26,290.13.11, that this debt was a bad debt, and that it was written off as such during the year of income, i.e. the year ended 30 June 1963. What happened was that in November 1963 an employee of the taxpayer's accountant made an entry in an account called ``Loan Account N.A. Kratzmann Pty. Ltd.'' kept by the accountant for the taxpayer. The entry was as follows-

``By Salary, Rents Interest
W/off as Bad Debt                   L26,219.13.11''.

The odd effect of this entry in the account was to show the debit total of the company to the taxpayer as increasing from £21,250.5.10 to £47,469.19.9, notwithstanding that there was in fact no increase in the actual indebtedness and the company's own books showed the debit total at £21,250.5.10. On the figures in the company's account it owed the taxpayer £9,598.5.10, whereas the taxpayer's figure in his altered account was £35,817.19.9. Nevertheless, on 12 December 1963, a few days after the adjustment of his own account as already stated, the taxpayer lodged a proof of debt with the company claiming £9,620.7.6 and verifying this as the amount owing to him, rather than £35,817.19.9 which his own altered account showed as owing to him.

The result of this so-called writing off upon the liability of the company suggests that what has happened was merely juggling with figures but I am, of course, concerned with the real situation between the taxpayer and the company and not with an artificial situation created by entries in accounts. In the circumstances stated, I am not satisfied that the debt which was purported to have been written off as bad was an existing debt. I take the same view as the Board expressed when it said-

``The taxpayer has not established to our satisfaction that there was any debt as between himself and the company which was subject to a writing off for the purposes of s. 63 of the Assessment Act and the taxpayer's claim for a deduction accordingly fails.''

In the foregoing circumstances it is unnecessary for me to trace through the various account in detail. It is sufficient to say that, at all times material, the taxpayer had to account to N. A. Kratzmann Pty. Ltd. for £22,003.10.11 which had been paid to him rather than the company in respect of the Chermside Chest Hospital and £13,400 which the Queensland Lawn Tennis Association had paid to him rather than to the company by an issue of debentures. The taxpayer had wrongly received these amounts prior to the sale of his shares in N. A. Kratzmann Pty. Ltd. to Reid

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Murray Holdings Ltd. and his contention was that the consideration which he ought to have received from the purchaser should have covered his liability to the company for the two sums of £22,003 and £13,400. It was never in issue that he owed these amounts to his company; what he claimed was that Reid Murray Holdings Pty. Ltd. should have paid him sufficient to discharge these debts and leave him with the net sum for which he bargained. In these circumstances the taxpayer did not bring these amounts into his account with N. A. Kratzmann Pty. Ltd. and it was simply because amounts clearly owing were not so included in a partial account that it became possible for the taxpayer to follow the course which was followed and purport to write off what was a non-existent debt. As I have said, however, in determining whether or not there was debt to be written off I am concerned with realities, not book entries, and the reality is as I have stated it, namely that on 1 July 1963 the company owed Kratzmann £9,620, not £35,817, and that, this being so, to purport to write off £26,219.13.11 as a bad debt was meaningless as the taxpayer's own proof of debt in the liquidation of the company demonstrates. To make up an incomplete account and then to write off a debt which would exist only if the account were complete, is not the way to obtain a deduction authorised by sec. 63. Taking this view it is not necessary for me to consider whether a writing off in November 1963 could give rise to a deduction in the year of income ended 30 June 1963. See
Point v. F.C. of T., 70 ATC 4021; 44 A.L.J.R. 121.

Accordingly, I allow the appeal as to the profit on the sale of the land in Cavill Avenue, Surfers Paradise, but not otherwise, and I remit the assessment for the year ended 30 June 1963 to the Commissioner for amendment in accordance with this judgment.

Because each party has succeeded in part, I will make no order for costs.


Appeal allowed in respect of assessment for the year ended 30 June 1960 to exclude therefrom as assessable income of the taxpayer any profit upon the purchase and sale of land at Cavill Avenue, Surfers Paradise. Assessment remitted to Commissioner for amendment in accordance with this order. Appeal otherwise dismissed.

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