Case K51
Judges:AM Donovan Ch
RK Todd M
LC Voumard M
Court:
No. 2 Board of Review
A.M. Donovan (Chairman); R.K. Todd and L.C. Voumard (Members): Arising out of adjustments made by the Commissioner to the taxable income disclosed in his return of income for the year ended 30th June, 1976, the taxpayer requested three matters to be referred to the Board. The principal, and indeed the only one argued was a claim to deduct a sum of $8,833, being the taxpayer's one-third share of what appeared to be a ``once-only'' fee of $26,500 paid in respect of an arrangement to lease the services of one pure bred Simmental heifer located in New Zealand. This animal was one of nine such heifers which were leased, some by individuals and others by small groups of individuals under separate but, as we were told, identical lease agreements. That entered into by the taxpayer bound the lessor to deliver, in Australia, four progeny of the heifer, at least two of which were to be heifer calves. The process of superovulation and artificial insemination of the leased animal and ovum or embryo transplants from her to other cows involved in the production of these progeny, guaranteed to be pure bred Simmentals, need not be described for the purposes of these reasons. It suffices to say that it was all designed to overcome the embargo upon the importation of cattle into Australia other than those which had been born in New Zealand.
2. At the outset we must emphasise certain points. First, a number of exhibits, and a considerable amount of evidence related to the years subsequent to that with which the reference was concerned, and the relevance of much of it has to be considered in that light. Secondly, the dates on which certain documents that were tendered (Exhibits E, F, G and N) were executed, and indeed their authenticity, were the subject of a strong challenge by the Commissioner, as was the question whether the taxpayer's payment under the lease entered into by him was made, or the liability to make it was incurred prior to 1st July, 1976. It is fair to say that having considered the evidence there is some doubt in our minds as to the dates on which the documents concerned were executed, and when the liability to make payment under the leasing arrangement was incurred by the taxpayer. However, the conclusion we have arrived at makes it unnecessary to reach a firm decision on these points. It is enough to say that for the purposes of these reasons we have assumed, although we do not so find, that the documents were signed, and the lease fee paid or incurred, prior to 30th June, 1976. We do not think it necessary to discuss the arrangements regarding the financing of the taxpayer's payment of his share of the lease fee.
3. A grazing property (``the station'') situated in Victoria has since late 1972 been the headquarters of a project which, amongst other things, has since embarked upon a programme of breeding pure bred Simmental stock. This end can be achieved by one of
ATC 507
two methods. By the first, non-Simmental cows can be artificially inseminated with the imported semen from pure breds and the progeny of successive generations similarly inseminated until an animal of 15/16ths blood is obtained. Such an animal is regarded as a pure bred for the purposes of stud book registration in this country. It is clear enough that this process is one which requires a considerable time. By the second, by means of ovum transplants, already discussed, a pure bred may be obtained from a non-Simmental cow in a single generation. During the year ended 30th June, 1976, the business of the station was conducted by a company, L. Holdings, which leased the freehold. The taxpayer was employed as the farming controller of the station and some associated properties.4. Beginning some time about December 1975-January 1976, several discussions were held between the taxpayer, one B. (whose family company owned the station) and others (not identified by name) on the one hand, and members of an organisation (``L.M.'') experienced in the breeding of Simmental cattle, and which had facilities in New Zealand for their breeding by the use of the techniques mentioned in para. 1, on the other, about the former participating in the Simmental breeding programme. In the result, a decision so to participate was reached and the several leases referred to were entered into. That to which the taxpayer was a party bore date 29th June, 1976, although a schedule in one of the relevant income tax returns gave its date as 28th June, and reference has already been made to the problem of its true date.
5. It was made between L.M. as lessor, and the taxpayer, together with two other persons, O. and M., as lessees. By it, the lessees together gained a right to the services of a described heifer (``the Donor Heifer'') and such ``recipient cows'' as were necessary for the completion of the transplant process. The lease was expressed to expire (cl. 2(c)) ``in regard to each recipient cow when the pure bred stock so delivered (to Australia) by that cow is weaned from the cow''. The lessor guaranteed (cl. 7) that ``a total of at least four live calves will be produced'', of which two should be heifers (cl. 8). In the event that more than four live calves should be delivered, the surplus belonged to the lessor. The lessees were given no rights to control or interfere with the operations; their right was to obtain four live calves. The fee paid by the joint lessees for the lease of the heifer and the other services described in the lease agreement was $26,500, of which the taxpayer's share was $8,833.
6. In the events that happened, and for reasons of which we are not fully aware, performance of the lessor's obligations under the lease agreement was carried out by another entity, after some delay (little appears to have been done before the early part of 1977), and with some variations. A major change saw the transport of the recipient cows in calf to Victoria. Out of a large number of their progeny that were calved at the station in late 1977 and early 1978, calves were ``allocated'' to satisfy various leases entered into in 1976 and 1977, including the lease signed by the taxpayer and bearing date 29th June, 1976. The allocation of the four calves to this lease, and to some others, was made ``more or less at random'', as the taxpayer agreed in cross-examination, out of progeny remaining after those that were specifically identifiable as ``belonging'' to particular leases had been set aside. The random nature of the selection can be seen in the fact that the original donor heifer designated in the lease entered into by the taxpayer having proved unsatisfactory, there was some substitution, and of the four calves appropriated to the lease three appeared to be the progeny of one heifer and the fourth the progeny of another. The allocation was made about March or April 1978, although it was only after the progeny were weaned, that is some three or four months later, that four calves were specifically appropriated to the lease to which the taxpayer was a party. But the taxpayer expressed the view that these four calves were not solely the property of himself, O. and M.; rather were they the property of the P.S.S. Co. described in the next paragraph. He added that he could not dispose of the calves without the agreement of the other members of that association, although the source of this prohibition was not identified. So the possibilities as to the ownership of these four calves are -
- (a) That the taxpayer owned one and one-third of them.
ATC 508
- (b) That the taxpayer, O. and M. each owned a one-third interest in all four.
- (c) That the taxpayer, together with all members of P.S.S. Co., had an interest, the extent of which was not known, in these four calves and all other like calves appropriated to the leases entered into by members of the P.S.S. Co.
This last possibility is scarcely tenable, as the terms of the lease entered into by the taxpayer do not contemplate it, and there was no evidence to suggest that in some way these four calves had become the joint property of a larger number of persons. Evidence that the financial cost of the programme exceeded the capabilities of L. Holdings, and that for that reason other persons were invited to participate, does not produce this result. In our opinion the better view is that the lease conferred on the taxpayer a right, in due time, to become the owner of an equal one-third interest in four calves.
7. It is now necessary to refer to the association known as P.S.S. Co. The first income tax return lodged on behalf of that association was lodged in respect of the year ended 30th June, 1976. The return described it is ``an association of persons engaged in pure bred stud breeding'', and named a number of persons as members. These people included the taxpayer, and all of them, some individually and others jointly, had entered into the leases referred to earlier. The amount of the lease fee paid by the taxpayer (i.e. $8,833) was said to be his share of the loss incurred by the association for the year ended 30th June, 1976, and he accordingly claimed it as a deduction in his own return. It should be added that no written agreement existed, setting out the constitution of this association or any details concerning it, until 1st June, 1977 (see para. 9).
8. There are three possible bases on which the taxpayer's claim to deduct the amount of $8,833 might rest. It might be based on sec. 92 of the Income Tax Assessment Act, being his individual interest in a partnership loss incurred in the year of income, in this case treating the P.S.S. Co. as the partnership. As an alternative to this, it might again be based on sec. 92, but in this case treating the partnership as being composed of the taxpayer and the two persons, O. and M., all parties to the lease agreement referred to in para. 5. Or it might be an outgoing falling upon the taxpayer in his individual character. But whether looked at in terms of a partnership loss as that expression is defined in sec. 90, or as an outgoing affecting the taxpayer individually, the relevant payment must first be shown to be deductible in terms of sec. 51.
9. In the first instance we consider this question by reference to the second limb of sec. 51; that is, was the expenditure incurred during year ended 30th June, 1976, necessarily incurred by the partnership of P.S.S. Co., or the partnership of the taxpayer, O. and M., or by the taxpayer, in carrying on a business for the purpose of gaining or producing assessable income? We accept the fact that a substantial business had for some time been and still was being carried on at the station by L. Holdings, but that does nothing to determine the question now under consideration. The only evidence of any business in common being carried on during the relevant year by the members of P.S.S. Co. was (a) that some of them had, since the end of 1975, held informal meetings and taken part in discussions with the L.M. organisation about participating in the embryo transplant breeding programme (and it was said for the taxpayer that the business, whether of the taxpayer or of a partnership of which he was a member, commenced about the time of the first meeting); (b) that B., the managing director of L. Holdings, had regarded the members of P.S.S. Co. in 1976 as simply continuing on the breeding programme initiated by L. Holdings; and (c) that of a deed appearing on its face to have been executed on 23rd June, 1976 (although an adhesive duty stamp affixed to it was cancelled by unidentified initials and the writing on it of some date in June 1977) acknowledging that B., who had on 22nd June, 1976, become registered as the proprietor of the business name, P.S.S. Co., held it upon trust for the several persons said at that date to be its members (Exhibit G). This evidence does not in our view support the assertion that during the year ended 30th June, 1976, the members of the P.S.S. Co. were carrying on a business, nor does it support a conclusion that they were carrying on the cattle breeding business in which L. Holdings was involved. We cannot accept
ATC 509
that the discussions begun about December 1975 constituted the commencement of a partnership or any other business; they appear to have been exploratory only and more in the nature of a feasibility study (cf.Softwood Pulp and Paper Ltd. v. F.C. of T. 76 ATC 4439). Indeed, there was some evidence that no business was being conducted and also that the parties did not intend the P.S.S. Co. to constitute a partnership. As already indicated, no written agreement to constitute the association or to regulate the relations between the members existed at any time during the year ended 30th June, 1976. But the taxpayer's representative introduced, as part of Exhibit D, a copy of what was described as a ``deed of association'', made on 1st June, 1977, as an indication of the terms on which the P.S.S. Co. functioned in the earlier year. This deed recited that ``some of the members'' (who were not further identified) ``did during the year ended the 30th June, 1976, become associated and join together for the purpose of carrying on the business of producing pure-bred Simmental cattle'', and that ``the members wish to formally record the terms and conditions upon which the association is based'', and then, at the end of cl. 1, provided: ``The said association commenced on the 1st day of July, 1976''. But the taxpayer's claim related to the immediately preceding year. It is legitimate to ask the fate of the association of the same name that had allegedly been constituted earlier in the year ended the previous day.
10. Nor was any evidence given to support a view that the taxpayer, O. and M., were engaged in carrying on any relevant business in common during the year ended 30th June, 1976, or that the taxpayer was carrying on any relevant business alone. At the date of the lease agreement, because of delays that were to occur, the acquisition of the progeny contracted for was some two years in the future; at 30th June, 1976, the taxpayer had no more than a contractual right to acquire an interest, together with O. and M., in four calves (of which at least two should be heifers) in due time. His employment at the station and elsewhere, and his obvious interest in and dedication to the task of building a pure bred herd cannot obscure the fact that his actions of entering into the lease dated 29th June, 1976, and paying (or incurring a liability to pay) his one-third part of the fee, in return for an anticipated interest, to arise at some future date, in four pure bred calves fall far short of constituting a business of breeding stud cattle carried on by him either alone or in partnership with others.
11. The activities contemplated by the lease, including the selection of the donor heifer, its superovulation and artificial insemination, the ovum or embryo transplants into other animals and the care and maintenance of all the stock involved, were all the obligation of the lessor. No interest in possession in the heifer or the recipient cows was given to the taxpayer and his co-lessees. They were not entitled to interfere in the activities mentioned in any way. There is nothing in the lease document which would support a conclusion that the activities to be conducted by the lessor pursuant to the lease were on the lessees' behalf so that they became, as it were, the activities of the lessees; or given that those activities amounted to the carrying on of a business, that that business was to be conducted by the lessees through the agency of the lessor. As has already been explained, another entity altogether was responsible for carrying out the steps which resulted in the appropriation in 1978 of four calves to the taxpayer and O. and M. But again there is nothing to suggest that this entity was acting otherwise than on its own behalf or that its business was the taxpayer's.
12. It follows, therefore, and we so find, that during the year ended 30th June, 1976, the expenditure of $8,833 claimed as a deduction by the taxpayer was not necessarily incurred by him in carrying on a business, either alone or together with others, for the purpose of gaining or producing the assessable income, and the deduction claimed does not fall within the second limb of sec. 51.
13. The question then arises whether the expenditure can be said to have been incurred in gaining or producing the taxpayer's assessable income, and so to fall within the first limb of sec. 51. In response to a question from the Board as to the assessable income pointed to in this context, the taxpayer's representative said: ``The assessable income to be derived...will be from sales of culls,
ATC 510
general sales of the stud stock, the sales from progeny derived from further embryo transfer operations, sale of semen of bulls and the sale of bulls to the Hereford herd producers.'' With respect, this submission relates the outgoing to what must be regarded as the proceeds of a business. It concerns deductibility under the second limb and does nothing to advance the argument of allowability under the first limb. At the date of the hearing, over two years had elapsed since the expenditure was incurred and the income of which it was to be productive could still not be identified save in terms of some possible future prospect. We think that the first limb calls for some less vague connection between the outgoing and the income than this. Even if it be taken that the simple sale of the four calves obtained would yield assessable income in circumstances which did not amount to the carrying on of a business, there is again just no evidence that this course of action was intended so that there is no assessable income to which the outgoing can be connected. Accordingly, for these reasons, we are of the opinion that the outgoing is not deductible under the first limb.14. The views expressed in para. 12 and 13 make it unnecessary to determine whether the outgoing concerned was one of capital, or of a capital nature, and we refrain from doing so.
15. There remains the question whether the outgoing can be considered in the year under review as expenditure incurred in the purchase of trading stock. The transaction in the year was clearly not one of purchase if for no other reason than that what the taxpayer and his co-lessees ultimately got was unascertained and unascertainable at the end of June 1976. We specifically restrict this observation to the year with which we are concerned, for conceivably the question might arise in relation to a later year.
16. Two other matters were referred to the Board, namely the deductibility under sec. 51 or under sec. 69 of an amount of $49, paid by the taxpayer during the year ended 30th June, 1976, as accounting fees, and a claim for a deduction of housing loan interest. Neither of these matters was raised at the hearing, and the former may be taken to have been abandoned by the taxpayer (or alternatively should be dismissed on the ground that the taxpayer failed to discharge the onus of proof cast upon him by sec. 190(b)). As the taxpayer's claims for deductions aggregating $8,882 should in our opinion be disallowed, it follows that no part of the claim to deduct housing loan interest should succeed, as the taxpayer's adjusted net income after disallowing the deductions exceeded the statutory limit prescribed by sec. 82KC(1) of the Income Tax Assessment Act.
17. For the reasons given above, we would uphold the Commissioner's decision on the objection and confirm the assessment.
Claim disallowed
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