Case Q71
Members: Before MHP Stevens Ch
BR Pape M
TJ McCarthy M
Tribunal:
No. 1 Board of Review
T.J. McCarthy (Member)
The issue in this reference is whether the Commissioner was correct in disallowing an objection lodged on behalf of the taxpayer (Mrs. P) against the inclusion in her assessable income for the year ended 30 June 1974 of her half-share of the surplus arising on the sale of two lots of vacant land by a partnership comprising the taxpayer and her husband (P).
2. The partnership return for the year ended 30 June 1974 described P and Mrs. P as ``builders, farmers and property owners'' and a partnership loss of $21,913 was returned for tax purposes. An adjustment sheet issued on 5 July 1978 advising that the Commissioner had determined the partnership net income as $41,933 by including a profit of $63,534 arising from the sale of certain vacant land (lots 2 and 3) and by disallowing certain deductions claimed (to which no objection was taken) amounting to $312. During the hearing before the Board, counsel finally reached agreement that the partnership surplus arising on sale of lots 2 and 3 was $58,232 - the last matter in dispute, an amount of $2,000 in respect of fill, was conceded by the Commissioner (transcript p. 95). It was common ground that in determining the net income of the partnership, the profit of $58,232 should be taken into account if sec. 26(a) applied in relation to lots 2 and 3 and assessable income of $104,500 and allowable deductions of $46,268 should be taken into account if sec. 25(1) applied. Accordingly, if the taxpayer is unsuccessful in principle, a notice of amended assessment for the year ended 30 June 1974 should issue, reducing her share of the net income of the partnership by $2,650 (from $20,966 to $18,316).
3. The relevant notice of assessment was issued to the taxpayer on 23 October 1978 and an objection thereto dated 22 December 1978 was lodged on behalf of the taxpayer. The objection referred to an amount of $31,767, being one-half of the amount of $63,534 mentioned above, but did not refer to the other adjustment made. The main grounds were as follows:
``(1) The said amount of $31,767 represents one-half of the adjustment to the Partnership Income Tax Return to which the taxpayer has an interest in accordance with the Partnership Provisions.
(2) The said amount is not income on which income tax is payable under sec. 26(a), sec. 19, sec. 25, sec. 26AAA or any other section of the Income Tax Assessment Act 1936, as amended.
(3) The said gain on sale of real estate is a gain of capital.
(4) The amount of profit so assessed may be miscalculated.''
4. The Commissioner's decision to disallow the objection was referred to this Board for review. In his statement of reasons supplied to the Board pursuant to reg. 35(1), the Commissioner relied on sec. 25(1), and alternatively on sec. 26(a), to include the proceeds of sale, or the amount of profit on sale of lots 2 and 3, in the calculation of the net income of the partnership, and assessed the taxpayer pursuant to sec. 92(1) and 90.
5. The taxpayer appeared very briefly and gave evidence through an interpreter. She agreed that she was in partnership with her husband (P) who made all the business decisions, but did not appear to really understand anything else put to her. ``I need to stand behind my husband,'' she said. It was common ground, in view of the
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partnership and individual returns lodged and the grounds of objection, that it could not be contended that the relevant activities were carried out by P on behalf of himself only, even though the applications to Council and the contracts were in P's name only. Accordingly, most of the hearing was devoted to testing the evidence of P, although it is still necessary to bear in mind that other land transactions by P on behalf of himself and someone other than his wife, whilst they may go to P's credit, do not assist in establishing whether P and Mrs. P were carrying on a business of buying and selling land and, if so, whether the purchase and sale of the land in question formed part of that business.6. Early in 1972 P approached the owner of a block of land (later subdivided into lots 1, 2 and 3) in M Street with an offer to buy the land for $40,000. ``I want to buy this land to build some flats, if the Council will let me do it'', P said to the owner. According to P, his offer was immediately accepted, although written contracts were not exchanged until 29 October 1972. The land was surrounded by bush, with a large creek through the middle and an old house thereon. A real estate agent and registered valuer, M, who was called by taxpayer's counsel, testified that the land was not far from the main street of the town and the local leagues club and that it overlooked the river. It was suitably zoned for flats or units and he considered it was located in a prime position, although the necessity for piers meant that higher building costs were to be expected.
7. On 16 May 1972 P instructed his solicitor to proceed with the purchase of the land. The solicitor's file, which was tendered by the Commissioner, contained handwritten notes recording instructions as to vendor, purchase price and location of the land and the deeds (the land being under Old System title), and also noted a proposal by P to build at least 32 flats on the land. In relation to the purchase, the solicitor acted for both P and the vendor, as well as for the mortgagee, a finance company, A Limited, with whom P apparently had previous discussions. P handed his solicitor a cheque dated 19 May 1972 for the deposit of $4,000, but the cheque was subsequently returned unpaid by his bank.
8. The solicitor's file contained a curious letter dated 10 July 1972 addressed to the solicitor from a firm of real estate agents with whom P admittedly had dealings. This letter purported to record a sale from P to a named purchaser of ``unit 49, Block C'' in the same street as the land in question. When it was produced at the hearing, the letter appeared very damaging as it suggested that P was at this early stage selling off a plan. However, the date of the letter does not fit easily into the chronological pattern. Counsel for the Commissioner, whilst acknowledging that the proposed sale might refer to a different property, put it as a matter going to P's credit, P not remembering anything about it and not calling any evidence in rebuttal. It may be that the year shown on the letter was a typing error. In the circumstances, I am not prepared to give the letter any weight.
9. On 29 June 1972 application was made to the Council by P personally (but on the letterhead of P and Mrs. P, Building Contractors) for development approval to build fifty-four flats in three stages, nine two-bedroom flats and nine one-bedroom flats in each stage. I infer that subdivision of the land in lots 1, 2 and 3 was already contemplated by P around this time, with the proposed building on lot 1 being stage 1. The solicitor wrote to a surveyor on 22 August 1972 confirming P's instructions to the surveyor ``to prepare a compiled plan of subdivision to cut this land into three separate lots to accommodate the flats P proposes to construct there''. An undated, but obviously contemporary, handwritten record of instructions on the solicitor's file notes that this surveyor's report was to be ordered and also records: ``We will need a strata plan eventually'' and ``cut up lots into 1, 2 and 3''. By letter of 24 August 1972 the solicitor advised the Council that P ``would be prepared to pay the sum of $5,030 to the Council as a condition of development approval provided the Council carried out (roadworks, etc.) and also granted development approval for the subdivision of the land into three allotments, one for each block of units''.
10. On 14 September 1972 the Council notified their qualified approval to build a block of 18 residential flats on lot 1, subject to, inter alia, the existing dwelling being
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demolished, submission of a plan of subdivision and proof of registration of same. On 29 October 1972 contracts for the sale of the land were exchanged, the purchase price being shown as $40,000, with a deposit of $4,000. A special condition was inserted to enable P to rescind if the Council did not grant its consent to ``the Purchaser's application for the erection of at least 32 residential flats upon the property hereby sold within 28 days of the date of this Agreement''.11. P acknowledged that at the time he could only put up $10,000 of his own (or partnership) funds towards the cost of the land. It is readily apparent that his finances were then severely stretched. It will be recalled that P's first cheque for the deposit of $4,000 was dishonoured. With a view to obtaining finance discussions had previously taken place between P and the finance company, A Limited. When asked exactly when these discussions occurred, P said: ``I cannot remember.'' I infer that P knew well before 29 October 1972, when contracts were exchanged, that A Limited would only lend an amount in the vicinity of $150,000. P readily acknowledged that this amount was not enough to build stage 1. He needed $30,000 to complete the purchase of the land and another $200,000 to build stage 1. ``I knew straightaway I could not make it... I had to sell (lots 2 and 3).'' As to precisely when this occurred, P was vague, but the transcript of cross-examination records the following questions and answers:
``You knew before you signed the contract that you could only get $150,000? - Yes.''
``I put it to you that from the very time you acquired the land you always had in mind selling off the respective parcels of land? - Yes, enough to pay back money I owed.''
12. On 30 October 1972, A Limited formally notified the solicitor that it would lend P $30,000 at 13% p.a., reducible to 12% p.a. upon interest being paid within 14 days of the due date, the term of the loan being 12 months. On 10 November 1972, A Limited formally notified the solicitor that the loan had been increased to $150,000, the previously specified conditions being the same, except that the interest rate was 15% p.a., reducible to 12% p.a. upon prompt payment. Asked how he proposed to finance an annual interest charge of $27,600, P's answer was somewhat vague. He said he had intended to put the flats into the hands of a real estate agent and expected to receive about $21-$22 per week for the one-bedroom flats.
13. The real estate agent and valuer, M, who was called by taxpayer's counsel to give evidence in relation to the amount of rent likely to have been obtained, said he expected unfurnished one-bedroom and two-bedroom flats at the relevant time and in that locality to have returned about $28 per week and $43 per week respectively. On these figures, it is clear that the renting of flats was not a financially practical proposition for P. Indeed, P was not prepared to deny that he had previously said as much to a Taxation Office investigator. If one block of flats was expected by P to cost $200,000 to build and he could not afford to hold and rent them, it may be wondered how he could possibly have intended to build three blocks of flats for a total cost of $600,000 and to hold them for rental. Much more likely is that P intended to sell lots 2 and 3 with development approval granted and to then offer his services as a builder. As it turned out, he did eventually build on all three allotments.
14. On 14 November 1972 the solicitor wrote to the Council enclosing a linen plan of subdivision. By letter dated 21 November 1972 the solicitor advised P of the funds required to complete the purchase of the land, and took into account an expected first progress payment of $30,000 from the finance company, A Limited, as well as an amount $2,384.44 held in the solicitor's trust account from the sale of other land by P to C. Asked about this sale to C, P said ``I cannot remember''. P's finances were obviously still stretched and his cheque dated 23 November 1972 for the sum of $2,700 in favour of the solicitor was returned unpaid by his bank.
15. On 1 December 1972 the purchase of the land was completed. On 13 December 1972 P's subdivision application was approved by the Council, subject to payment of $5,030 to cover kerbing and gutters, etc., $1,280 in relation to water supply, $2,500 for sewerage and $1,080 towards public reserves.
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A building application in relation to stage 1 was lodged on 12 January 1973. In or around February 1973 filling and bulldozing activities were undertaken on the land and P negotiated with prospective purchasers of lots 2 and 3. On 6 April 1973 contracts were exchanged between P and L Pty. Limited in respect of the sale of lot 2 for $44,500. The land was converted from Old System title to registration under the Real Property Act and on 18 May 1973 the plan of subdivision was finally registered by the Registrar-General.16. A building application dated 6 July 1973 in relation to lot 3 was lodged with the Council, showing M as owner and P as builder, although contracts between P and M for the sale of lot 3 for $60,000 were not exchanged until 20 August 1973. On 13 August 1973 the sale of lot 2 was completed. Shortly thereafter, on 30 August 1973, P borrowed $180,000 from another finance company, B Limited, and on the same day repaid the amount owing to A Limited. The sale of lot 3 was completed on 21 September 1973 and the Council gave its final approval on 20 November 1973 for the building of 18 units on lot 1.
17. By February 1974 P's finances had obviously improved and on behalf of the partnership he then bought a farming property for $68,170 and livestock for $19,669. By 20 November 1974 the building of the 18 units on lot 1 was completed and a certificate of completion bearing that date was issued. On 4 May 1975 the solicitor made application for approval of a strata plan in relation to the units on lot 1. Whilst P said this application was made with a view to repaying B Limited, the note in the solicitor's file (see para. 9 above) suggests that a strata plan was envisaged as early as August 1972. It is significant that P applied to strata title the units not long after they were completed. In the year ended 30 June 1976 nine of the units were sold for $170,000, in the year ended 30 June 1981, three more units were sold for $38,500 and in the following year the remaining six units were sold for $95,150. On 9 June 1980 P repurchased lot 2 in exchange for $3,800 and a portion of the farming property, and was building thereon at the time of the hearing.
18. M testified that he had known P since 1965 and first sold houses for him in 1969/70. In relation to P's activities, M said: ``(P) was always building houses or units. He did not seem to stop.'' P himself said under cross-examination that he was a builder and he was then asked: ``In conjunction with that you buy and sell land?'' to which P's answer was ``Yes''. The Commissioner's investigations turned up some of P's (or the partners') land dealings and these were put to P in cross-examination and accepted by him. However, I am not satisfied that all of the land dealings were exposed.
19. Apart from the farming property, P's land dealings were all in the same town. Two lots in S Street were purchased by P and F, a business associate, as tenants in common in 1963, transferred to the taxpayer in 1968 (the only land in her name, so far as the evidence shows) and sold in 1973. P bought land in M Street in 1964, borrowed moneys, built a house and sold the property in January 1972. In T Street P and F bought land in 1964 and P sold his one-half share to F in 1968. (It is not clear whether this was the land associated with the company in which P and F held shares at one time.) Land in C Crescent was purchased by P and M in 1969, moneys were borrowed, M took one block and P took the other, P building a house thereon and selling the property in 1971. Two blocks in C Street were acquired in 1971, houses were built by P on each and one property was sold in June 1972 for $22,500 and the other for $24,000. Another lot in the same street was acquired in April 1974 and sold in May 1975 at a loss. Land in M Road was acquired in June 1972 for $4,400, $20,000 was borrowed, a house was built by P and the property was then sold at a profit in July 1973 (returned as income in the 1974 partnership return).
20. P also acquired a single block on the corner of H and M Streets. ``I tried to build some flats, could not get approval from Council, so I sold it'' said P (profit returned as income in the 1973 partnership return). Two lots in W Street were acquired in early 1973. One was sold as vacant land in May 1973 (profit returned as income in the 1973 partnership return). On the other lot, P built a factory and sold the property in 1979 for $48,500. The 1979 partnership return claimed associated costs, but no corresponding income was returned. This was the pattern in the 1976-1982 partnership returns, which were lodged in February 1983.
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The cost of building operations was claimed as a business expense, but there was no sign of any corresponding income. P said he left it all to his accountant, but the income returned from the concrete formwork business was obviously insufficient to include the receipts from various sales of vacant land and units in those years. Whilst the Board is not presently concerned with omitted income in other years, this aspect damaged P's credit, as it showed that P disclosed only what it suited him to disclose and also that he was quite prepared to treat the land dealings as a business so far as claims for deductions were concerned.21. Counsel for the taxpayer submitted that sec. 25(1) was inapplicable ``until February 1973 or at the point when P came to the realisation that he would have to sell the land''. I think it is clear that this realisation had come home to P by 29 October 1972 when contracts were exchanged. At least by this date, if not well before, a business of buying land for sale had commenced to be carried on, in conjunction with the building business. P was not in a financial position to be able to build flats on lots 2 and 3 and hold them as a long-term investment and furthermore, I find he did not intend to do so. Nor was this the first dealing in land, as the 1973 comparative figures in the 1974 partnership return acknowledged and as the Commissioner's investigations showed. In view of the objection lodged and the concession properly made by taxpayer's counsel that P's intentions were to be imputed to his partner, the taxpayer, I find that P and Mrs. P were carrying on business as land dealers at the relevant time, that the acquisition of the land in M Street was an integral part of that business and that the proceeds of sale of lots 2 and 3 in the year ended 30 June 1974 were correctly included in the assessable income of the partnership in that year. In view of these findings, it is unnecessary to consider other arguments put forward on behalf of the taxpayer.
22. Accordingly, the case put forward by counsel for the taxpayer fails. However, I would reduce the assessment before the Board to give effect to the agreement as to quantum (see para. 2 hereof) and would therefore reduce the taxpayer's individual interest in the net income of the partnership for the year ended 30 June 1974 from $20,966 to $18,316.
Claim allowed in part
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