Tikva Investments Pty. Ltd. v. Federal Commissioner of Taxation.

Stephen J

High Court

Judgment date: Judgment handed down 20 December 1972.

Stephen J.: In this case the appellant company, Tikva Investments Pty. Ltd. (Tikva), appeals against the inclusion in its assessable income for the year ended 30 June 1969 of a portion of the proceeds of the sale of a property at Mullaloo, some twenty miles north-west of Perth. The Commissioner relies upon sec. 25(1) or, alternatively, sec. 26(a) of the Income Tax Assessment Act as justifying the assessment but Tikva contends that no part of the proceeds of sale is assessable because they represent the proceeds of realisation of a capital asset.

The Mullaloo property comprises over 1,250 acres and was, prior to 1964, owned by a Mr. and Mrs. Glasson; in that year they sold a seven ninth share as tenants-in-common to ten persons, including a Mr. J. J. Krasnostein, retaining for themselves the remaining two ninths share. The contract of sale formed part of a document styled a syndicate agreement which also contained what was described as the constitution and rules of a syndicate, the members of which being the ten purchasers and the two Glassons. This agreement declared the ten purchasers to hold the property as tenants-in-common with the Glassons in specified shares, Mr. Krasnostein and his two brothers together holding a one ninth share which he stated in evidence to have in turn been held as to one half by his brothers and as to the other half by him. The purchase price of the seven ninths share was $70,000, equivalent to a price of about $72 per acre, payable by instalments over three years, the date for vacant possession of the property being 30 September 1964.

The land was, as to a few hundred acres, sown to pasture and used for grazing, the balance being undulating virgin bushland with a frontage to the Indian Ocean. Following the sale the land was put to no agricultural or pastoral use except that for a nominal rental of $150 per annum portion of it was leased for casual grazing purposes, principally so that the tenant might be responsible for maintaining fire breaks on the land. After some five years the land was sold by the members of the syndicate for $1,259,000 or $1,000 per acre.

Meanwhile Mr. Krasnostein had, in 1966, by a document styled a deed of gift, purported to transfer and assign to Tikva his one eighteenth interest in the property and in the syndicate and it is Tikva's share of an instalment of the sale price received by the syndicate on the sale of the property in 1969 that the Commissioner has included in its assessable income.

Tikva is a company which Mr. Krasnostein described as his family investment company;

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he is the holder of what is called the Life Governor's share in its issued capital, which carries a majority of voting power, and he is also chairman of directors; it is common ground that he has, at all times, been in complete control of the affairs of Tikva.

The evidence has, I think, sufficiently established that when, contemporaneously with the creation of the syndicate, ten of its members purchased their interests in the property from the Glassons, who thereupon became the two other members of the syndicate, the position of Mr. Krasnostein, as one of those ten, was such as to render any subsequent share in the profits on sale of the property assessable in his hands. The appropriate head of liability is, I think, to be found in one or other of the limbs of sec. 26(a).

Mr. Krasnostein said in evidence that he was unable to say anything as to the intentions of other members of the syndicate but there are sufficient undisputed facts to enable clear inferences to be drawn concerning the nature of the project as a whole. First the character of the property is itself significant; it had been a grazing property but the syndicate members turned it to no agricultural or grazing use, nor did they reside on it or otherwise enjoy it, indeed under the syndicate agreement no syndicate member was entitled to occupy any part of the property except with the authority of a resolution of the members and no such resolution is recorded; it was, instead, retained in its largely virgin state. It was situated quite close to Perth and was in the path of the northward-trending suburban growth of that city. It was good land for development for suburban or industrial use, having an ocean frontage, undulating hinterland, a road access and dry, well drained soil.

That the turning to account of these advantageous qualities was the purpose of the syndicate is suggested by the terms of the syndicate agreement. It is described in cl. 10 as constituted ``for the ownership, working and development'' of the property and not only were the syndicate members to contribute to future outgoings but were also to share ``in the proceeds of the operations of the Syndicate''. By a proviso to cl. 2 the ten purchasers became entitled to take transfers of seven ninth shares in respect of various portions of the land progressively as the instalment payments to the vendors, the Glassons, were made; in other words the concept of partial releases of the land, familiar in the case of instalment sales of land with subdivisional potential, was a feature of the transaction. Clause 22 deals with the dissolution of the syndicate and this is to occur ``when the whole of the said land has been sold and paid for in full and the proceeds thereof distributed to the Members'' or 21 years after the death of the last surviving member. A firm of Perth real estate agents, Justin Seward & Co., one of whose partners or employees was a member of the syndicate, kept the Petty Cash account of the syndicate and provided the registered address of the syndicate and, in Mr. Krasnostein's words, ``They handled the whole syndicate''.

The minutes of meetings of syndicate members are also significant. As early as the second meeting, held in August 1964 before the date for vacant possession, it was resolved that a person who was said to be interested in buying or leasing part of the land should be asked to make an offer; at the third meeting, in October 1964, it was agreed that the members be prepared to receive offers for the land but that $200 per acre, representing almost three times the price agreed to be paid by the ten purchasers some five months earlier, would not be entertained and that ``unless some offer of a very worthwhile nature came along then members would be content to sit on the land for a further twelve (12) months''. At the conclusion of the next meeting, in April 1965, it was resolved that the members would not re-convene ``unless a good offer to purchase the land was received'' or other specified events occurred. At the next meeting, in July 1965, a ``general discussion re the value of the property for possible sale'' took place and on Mr. Krasnostein's motion it was resolved that it be offered for sale at $600 per acre through a number of estate agents. At a meeting in April 1966 mention is made of it having been ``from the very inception of purchasing this land'' the policy of the syndicate to conserve any limestone and building sand ``for the future development of the property''. By February 1968 there was discussion of values of up to $1,000 per acre for the land and Mr. Krasnostein is reported as saying that the property could be worth $2,000,000 in ten years' time, the question, he

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said, being whether to sell now or look several years ahead; it was then resolved that a sale at $800 per acre be effected if that price was available. Later in that year negotiations began in earnest with purchasers at higher prices still and in early 1969 the sale was finally effected at a price of $1,000 per acre. Mr. Krasnostein aptly enough described the business at most syndicate meetings when he said, in evidence, ``there was nothing to discuss at these meetings other than `Well, you've got some land. What's it worth?' and so on''. He later said that the main business of meetings was in attending to enquiries and alleged enquiries from possible purchasers of the property.

Other evidence of Mr. Krasnostein, the only witness called by the taxpayer, is also relevant in this regard. He said that he personally regarded the proposed purchase as ``an ideal investment to develop the land, as it would lend itself to many things. I was most impressed of course that laid on our own land were such vital things as limestone, sand needed for plaster, lime, Ready-mix and so on''. He could foresee urban development reaching out towards the land and was looking ahead, he said, to development in about ten years. A feature of Mr. Krasnostein's evidence was his repeated assertion that he was not interested in any early sale of the property and he explained his own motions at meetings indicating the contrary as designed in fact to set such a high sale price as to discourage purchasers, while at the same time appeasing such of the syndicate members as wished to sell. Other syndicate members were, he said, interested in receiving offers for the property as early as August 1964. He could recall no initial discussion by syndicate members as to what might be done with the land. His own idea was, he said, that the syndicate should itself undertake the development of the property for residential or industrial use, thereafter retaining it as an income earning asset. His object, he said, was to create something by way of an income-producing investment for his children. However, whatever may have been his own wishes, I find it difficult to accept the view that he regarded this as a probable outcome. To develop this very large property as a suburban housing project or industrial estate would, of course, involve extremely large capital expenditure and, regardless of the ability of the syndicate to borrow on the security of the property, the fixing of a maximum quarterly contribution amounting in all to $9,000, fixed not only in the syndicate agreement but specifically affirmed at the first meeting of members, suggests that, whatever were Mr. Krasnostein's views, other syndicate members did not contemplate the contribution of large sums to finance wholesale development projects on the land.

Whereas Mr. Krasnostein spoke of development as something which lay well in the future when he acquired an interest in the land, nevertheless, when cross-examined as to the provision for periodical releases of part of the land upon payment of specified proportions of the total purchase price, he said this was a provision of the agreement with which he was familiar and which was inserted to enable the syndicate to ``utilise'' that portion of the property closest to existing development when only portion of the purchase price had been paid. This assumes significance when it is appreciated that the purchasers would become entitled to a release of this portion of the property in May 1964 and would in any event have only had to wait until May 1967 for their seven ninths interest in the whole property to be transferred to them. Mr. Krasnostein said that by ``utilise'' he had in mind the use of a released portion as security for borrowing money and proceeding with development of the land. No hint of such a scheme appears from the minutes of meetings, which instead concentrate upon possible sales of the property. This, I conclude, was the true reason for the insertion in the agreement of the release provisions contained in cl. 3 and this also points to the conclusion that the syndicate members contemplated from the start an early sale of part or the whole of the land.

It is in the light of the foregoing that I conclude that the acquisition by the ten purchasers of interests in the land and their subsequent holding of the land, while the syndicate received and considered ever-increasing offers and actively stimulated enquiries for its purchase, constituted a situation to which the first limb of sec. 26(a) is applicable. Alternatively it may be viewed as a scheme the features of which give it the character of a business deal falling within the

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second limb of sec. 26(a). I may say that I have not regarded the Mullaloo land as stock in trade to which sec. 36 and, in particular, sec. 36A would apply. Whether or not land may ever properly be so regarded this is not a case in which the land can, I think, be treated as stock in trade of a business.

What, then, were the fiscal consequences to Tikva of it coming into association with this syndicate as a result of the deed of gift? The answer to this question lies along a path in following which a number of subsidiary questions are encountered which may now be stated and then dealt with in turn; as I see it, they are as follow. Are the provisions of sec. 92 of the Income Tax Assessment Act, relating to the ascertainment of the assessable income of a partner, applicable to the syndicate? If so, was Tikva in the year of income a partner to which sec. 92 applied? If it was, how should the net income of that partnership of which it was a member be ascertained and, in particular, is sec. 26(a) applicable and, if so how is the profit of which it speaks to be calculated?

Section 92 of the Act applies in the ascertainment of the assessable income of a partner; ``partnership'' is defined in sec. 6(1) as meaning -

``an association of persons carrying on business as partners or in receipt of income jointly, but does not include a company.''

No doubt the reference to a ``partner'' in sec. 92 is to be understood as referring to one of the persons associated together in the manner specified in the definition of ``partnership''.

Whether or not the members of the syndicate were partners at general law it is clear that they were, together, an association of persons in receipt of income jointly; apparently some small sums by way of rental were received by the syndicate throughout its life and in the year of income in question this source of income was vastly augmented by receipt of a part of the proceeds of sale of the property. All these amounts were received, if not as the income of a partnership at general law, then as income from property which the syndicate members owned as tenants-in-common. Accordingly the members of the syndicate were, for the purposes of the Act, a partnership.

I turn next to the question whether Tikva was a partner for the purposes of sec. 92. The deed of gift purported to assign to Tikva two things, all Mr. Krasnostein's estate and interest in the syndicate land and all his estate, right, title and interest under and by virtue of the syndicate agreement. I am satisfied, upon the evidence, that at or soon after the making of the deed of gift any obstacles to the full effectiveness of these assignments, and, accordingly, to the attainment by Tikva of the status of a member of an association of persons either carrying on business as partners or in receipt of income jointly, and which may possibly have arisen from restrictions upon assignment contained in the syndicate agreement, were overcome by the acceptance by syndicate members of Tikva as standing in the shoes of Mr. Krasnostein. Accordingly, I conclude that Tikva did thus become a partner within the meaning of sec. 92.

When Mr. Krasnostein executed the deed of gift he intended, as he said in evidence, that Tikva should be bound by the terms of the syndicate agreement and thereafter participate in and be a member of the syndicate in his place; his own continued attendance at syndicate meetings he regarded as being in his capacity as the representative of Tikva. Tikva was treated by the syndicate, at least in the financial year ended on 30 June 1969, as a member of the syndicate; it was so described in the syndicate's partnership return; it participated as such in the distribution of that portion of the proceeds of sale of the syndicate property which came to hand in that year; it was a party to the contract for the sale of the property, being described as one of the vendors who, by cl. 16 of that contract, were stated to be the owners as tenants-in-common in unequal shares, it being shown as having two thirty sixth shares. All this is, of course, quite consistent with Mr. Krasnostein's continued activity at syndicate meetings as the representative of Tikva.

It is by no means clear how Tikva came to occupy this position as a member of the syndicate; the evidence is silent on this point. Quite stringent provisions regulating the disposition of interests in the syndicate and in the property were contained in cl. 16 of the syndicate agreement; it appears from Mr. Krasnostein's evidence that they were not wholly observed in the case of Tikva, which apparently failed to enter into any covenant with existing syndicate members as contemplated by cl. 16. I think it is proper from the evidence to infer that, despite non-compliance with that covenant, there was a tacit acceptance of Tikva as a member in the place of Mr. Krasnostein such as was referred

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to by Barton J. in
Hocking v. Western Australian Bank (1909), 9 C.L.R. 738, at p. 748. I was informed by Counsel for Tikva that it became registered as the proprietor of an undivided one eighteenth interest in the property as tenant-in-common when the Glassons were paid the final instalment due to them, presumably in the first half of 1967; the syndicate members, including Tikva, then becoming registered as proprietors of the land; Mr. Krasnostein was apparently shown in that transfer as a directing party. The delay in Tikva becoming so registered after the deed of gift in December 1966 was said to be due only to the fact that the Glassons remained the registered proprietors until all instalments of purchase price were paid to them. Counsel for Tikva also explained its failure to execute the deed of covenant provided for in cl. 16 of the syndicate agreement by reference to the fact that the assignee was no stranger but rather Mr. Krasnostein's family company, an explanation I find inherently probable.

It follows, then, that at all material times Tikva was, for the purposes of sec. 92 of the Act, a partner in the partnership represented by the syndicate.

As I understand both the Commissioner's basis of assessment and the argument presented on his behalf before me, he would contend that, having reached the foregoing conclusions, all else follows as of course; the net income of the partnership for the relevant year of income, calculated in accordance with sec. 90, should include profits on sale of the Mullaloo land as a result of either of the application of sec. 26(a) or of sec. 25(1); in calculating any sec. 26(a) profit there is to be deducted from the proceeds of sale of the Mullaloo land only its initial cost to the syndicate plus subsequent expenditure on it; the resultant net income of the partnership is then to be attributed as to one eighteenth to Tikva as its individual interest in that net income. This together with certain other amounts not now material will then comprise Tikva's assessable income for the relevant year of income.

Tikva's notice of objection is concerned primarily with the contention that the first limb of sec. 26(a) is inapplicable to its assessment and in argument this was said to be because of its status as a mere donee of an interest in land. The grounds of objection do extend to the mode of calculation of any profit flowing from the sale of the land and to which it might be held to be assessable but there was little argument before me on this aspect; indeed it was ultimately said by Counsel for Tikva that if it were taxable at all on such profit, which was contested, then it was taxable as to the whole of its due proportion thereof. However, since the grounds of objection do challenge the Commissioner's calculation of profit proper to be included in Tikva's assessment, I have been obliged to consider this aspect in some detail; indeed I regard it as inherent in a determination of the question of the propriety of including any part of such profits in its assessable income.

Tikva's liability to tax in respect of income derived from membership of the syndicate must, according to sec. 92 of the Act, be determined by the extent of its individual interest in the net income of that partnership for the relevant year of income. Section 90 of the Act defines ``net income'' in relation to a partnership as meaning -

``the assessable income of the partnership, calculated as if the partnership were a taxpayer, less all allowable deductions except the concessional deductions and deductions allowable under section eighty or section eighty AA of this Act in respect of losses of previous years.''

If then the syndicate be regarded as a taxpayer for purposes of calculation of assessable income how is sec. 26(a), which, rather than sec. 25(1), I regard as appropriate, to be applied in the ascertainment of its net income? In particular, what is the effect of sec. 90 and its introduction of a deemed taxpayer, the partnership, not only upon the application of sec. 26(a) but also upon the calculation of the amount of the profit which sec. 26(a) would operate to include in the assessable income of individual partners?

When sec. 92 refers to ``the partnership'' it necessarily refers to the ``association of persons'' described in the definition of ``partnership'' in sec. 6(1); with every alteration in the identity of the persons associated together, whether because of the substitution of a new partner for an old or the introduction of additional partners, a new association of persons comes into existence, the old association of persons being replaced by the new. Thus once Tikva was substituted for Mr. Krasnostein as a member of the syndicate it thereupon ceased to be the same association of persons as it had previously been because no longer were the same persons associated together. James L.J., in
Smith v. Anderson, (1880) 15 Ch.D 247, at p. 274 described the consequence of changes in the membership of an association of persons as producing -

``a constant shifting of the partnership, a determination of the old and a creation of a new partnership,''

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and see
Income Tax Commissioner for City of London v. Gibbs, (1942) A.C. 403, per Lord Wright at p. 430, and per Lord Porter at p. 432;
Rose v. F.C. of T. (1951), 84 C.L.R. 118 and
F.C. of T. v. Happ (1952), 9 A.T.D. 447. Lindley on Partnership (13th Ed.) succinctly deals with the matter at p. 388 -

``As an ordinary partnership is not distinguishable from the persons composing it, and as every change amongst those persons creates a new partnership, it follows that every time a partner transfers his share to a non-partner under such circumstances as to make the transferee a partner, the continuity of the firm is broken.''

If then, when Tikva became a member, a new association of persons came into being it is of that new association that sec. 90 speaks when it refers to assessable income of a partnership being calculated as if the partnership were a taxpayer; for the purpose of calculation of assessable income, but for that purpose only, a new taxpayer is brought into existence. For all other relevant purposes, it is with the individual members that the Act is concerned. It follows I think both from Rose v. F.C. of T. (1951), 84 C.L.R. 118, and from
F.C. of T. v. Beville (1953), 10 A.T.D. 170, that the Act effects no general departure from the ordinary position in English law according to which a partnership is not a separate legal entity, distinct from the members composing it.

I have already concluded that each of the ten original purchasers should be regarded individually as having entered into the syndicate and acquired the Mullaloo land both with the purpose referred to in sec. 26(a) and also so as to carry out a profit making scheme. The fact that for limited purposes of calculation of partnership net income a new legal entity arose upon Tikva becoming a member does not, I think, produce the consequence that the whole question of the applicability of sec. 26(a) is to be reviewed in relation to that new legal entity, treating it as having in some way acquired the partnership property from its predecessor and searching for the purpose actuating that acquisition. On the contrary it is, I think, correct to regard sec. 26(a) as still applicable, regardless of the consequences of Tikva being substituted for Mr. Krasnostein as a member. Section 90 is no more than a definition section and the deeming which it effects is to be limited to matters of calculation only. It is to be observed that when Tikva accepted the assignment to it of Mr. Krasnostein's interest in the land and syndicate Mr. Krasnostein was its controlling mind and his purpose was no different from that of the other members of the syndicate, to whose joint wills, in any event, Tikva necessarily subjected itself by its acceptance of a one eighteenth share in the syndicate. The ten original purchasers had, as I find, the purpose referred to in sec. 26(a) and were engaging in a profit making scheme and all but Tikva had remained throughout entitled to the same undivided fractional interest in the syndicate's assets, including the Mullaloo land.

Accordingly the net income of the syndicate for the relevant year of income will include that portion of the profit derived from the sale of Mullaloo and received in the relevant year of income, either because that property was acquired for the purpose of profit making by sale or because it arises from the carrying on or carrying out of a profit making undertaking or scheme.

It will follow that Tikva's assessable income will include its individual interest in that amount of net income. This is the express effect of sec. 92(1) and there appears to me to be no room for the making of any allowance, on the facts of this case, in favour of Tikva for the fact that, when it took an assignment from Mr. Krasnostein, as a retiring partner, of his interest in the partnership, it received that interest as a gift having a value in excess of its original cost to Mr. Krasnostein; this will be so despite the fact that the partnership assets included assets to the profit on the sale of which sec. 26(a) would apply. Whatever may be the position when, on a change in membership of a partnership, a new business is begun, with new current market values being assigned to assets of the new firm in a reconstituted set of accounts, that is not the case here and I therefore express no views as to the tax consequences, if any, which may flow from such a situation when those assets include property, any profit on the sale of which would attract sec. 26(a).

It follows that I uphold the Commissioner's assessment.

No question was raised, either in the notice of objection or in the hearing before me, of the propriety or otherwise of calculating the profit for the relevant year of income by deducting from proceeds received in that year the whole of the original cost of the land rather than only a proportional part of such cost, the balance being deducted in

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subsequent years as the balance of proceeds were received. Accordingly I say nothing as to this.

Before concluding I should refer briefly to what was much debated before me, namely what was said to be the status of Tikva as a mere passive recipient of a gift and the effect that this should have upon its liability to tax if, as was contended, all that it received from Mr. Krasnostein was an interest in land.

I do not regard Tikva as in the role of a passive recipient of a gift. By the deed of gift it expressly accepted the transfer and assignment of the interest in the land and in the syndicate and convenanted both to pay Mr. Krasnostein's due portion of the then unpaid balance of purchase money payable to the Glassons, amounting to $1,250 together with interest, and also to comply with the syndicate agreement, keeping Mr. Krasnostein indemnified against all claims and liabilities in respect of it. These covenants were potentially onerous; by cl. 11 of the syndicate agreement the members had agreed to contribute proportionately to -

``any further expenses or outgoings of any nature which may become payable by the Syndicate Members pursuant to this agreement or which may be required for the purposes of the Syndicate.''

These purposes are nowhere expressly stated but the agreement does describe the syndicate as having been formed ``for the ownership, working and development'' of Mullaloo and contemplates periodical contributions by members ``for expenditure on or in connection with the said land'', limited, in any one period of three months, to a total of $9,000 or $500 per one eighteenth share. By cl. 13 of the syndicate agreement all questions relating to its business are to be decided by majority vote. The agreement also provides that should a member of the syndicate ``default in compliance with his obligations under the Deed'' his share in the syndicate and in the land may be compulsorily acquired from him by other syndicate members at a price arrived at by a process of valuation, a defaulting member becoming liable to other syndicate members who make good his default, the amount of his liability being charged on his interest in the syndicate and in the land.

Not only was the subject-matter of the gift one that carried with it future financial obligations but, by the terms of the covenant and indemnity which it contained, Tikva, even if it did not become personally liable, as a member, to contribute to the syndicate did become liable to Mr. Krasnostein for the contributions he might be called upon to make in the future. Tikva was no doubt greatly benefited by the deed of gift but whatever are said to be the consequences upon the operation of the first limb of sec. 26(a) of a taxpayer having received as a mere donee the property which he later sells they appear to me to be inapplicable to the present case.

The appeal will be dismissed with costs and there will be the usual order as to exhibits.

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