Gallie & Anor v. Federal Commissioner of Taxation.
Judges:Lusher J
Court:
Supreme Court of New South Wales
Lusher J.
These two matters involve appeals to this Court under Div. 2 Pt V of the Income Tax Assessment Act 1936 (as amended) by Mr B.P. Gallie in the one case and Davidson Motors Pty. Ltd., in the other in each case (hereinafter separately referred to as the taxpayer) each being a taxpayer dissatisfied with the decision of the Commissioner of Taxation (called the Commissioner) upon objection to an assessment of income tax derived in the year 1976, and subsequently referred in each case to this Court pursuant to that statute.
As a matter of convenience the two matters were heard together, because of the circumstance that many of the issues raised are common to each case as will subsequently appear. However, although there are common features regarding the two cases, and although there are aspects of evidence which are common to each and it has been agreed that in such matters the evidence is available in both cases, there are nevertheless, certain separate and distinguishing aspects of evidence which relate to the particular cases in question.
The onus of proof in each case of course is on the taxpayer. The items involve losses and expenditure incurred by partnerships of which each of the appellants respectively was a member. The amounts are not in dispute.
It is appropriate here to mention the circumstances under which the two cases are by consent of all parties heard together. The first taxpayer, Mr Gallie, is an accountant carrying on his profession in a suburb of Sydney in partnership with certain other gentlemen. The second taxpayer, Davidson Motors Pty. Ltd., is a client of Mr Gallie who looks after the general accountancy work for that company and has done so over a considerable period of years. The events which gave rise to the appeals in both cases emerge from partnerships formed in June of 1976 in which in the one case, Mr Gallie was a member and in another and similar case, Davidson Motors Pty. Ltd., was a member and the subsequent entering into by the respective partnerships of leases wherein female Simmental cattle were leased from the owner thereof for the purposes of enabling the female to be subjected to a process known as super ovulation and the recovery of ova from the animal as a consequence, the subsequent ovulation of that ova with appropriate male sperm and the impregnation of recipient female cattle with such ovum with the view to producing in a comparatively short period of time considerable numbers of such cattle. The arrangements for the ventures were, to some extent at least promulgated by Mr Gallie and/or his firm and it was in this way that Davidson Motors, through its director, Mr Davidson, came to be involved in the partnership with which that company was a member. From this brief summary, it will be readily seen that to some extent at least, there will be some common evidentiary material.
It is also appropriate to make some brief reference to the nature of the type of ventures and the explanation for interest in them. Under normal circumstances, the progeny of the female animal under natural conditions involves a considerable period of pregnancy involving some months so that in general terms, one calf per year may be expected from the coupling of the two animals. The technique or process of super ovulation of the donor animal which has been perfected to a considerable extent means that the production of eggs within the female can be stimulated to a considerable extent. Surgical treatment thereafter enables the ova or eggs to be then removed from the donor female and then by artificial means the same may be fertilised by male sperm and then the fertilised ovum is transplanted to another recipient female. In this way, it will be readily seen that, depending on the number of ova which are available, and this
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may be very many, the result can be that by means of the transplant to the recipient cows, the same number of calves can be produced simultaneously. When it is borne in mind that the super ovulation process may be carried out on the donor on more than one occasion during the year and the above process repeated, it can readily be seen that substantial numbers of offspring can be produced within a very short time when compared with the natural process of joining and consequent calving. The financial value and efficacy of these processes is of substantial importance when applied to expensive exotic breeds of cattle and to this I now turn.Because of the inherent dangers touching the introduction of exotic breeds of cattle from European sources into Australia, quarantine regulations of considerable severity render it almost impossible to build up herds of such cattle in Australia so that the benefit to be derived from their introduction and these benefits are indeed considerable, is lost. New Zealand, however, by supervisory and cautionary processes which for the purposes of this judgment need not be explored, has permitted introduction of certain of these breeds into that country. It has become possible under existing quarantine laws in Australia to import cattle into Australia of such imported breeds which have been born in New Zealand. Because of the initial expenses of the animals and their scarcity, the effect of quarantine and import restrictions and prohibitions, together with other relevant factors in the years immediately preceding 1976, cattle of these breeds command very high prices in Australia, particularly for breeding purposes. In the result, in short terms, market conditions were such that females suitable for breeding command very high prices in this country compared with local stock. Accordingly, situations developed within the pastoral industry and beyond it whereby the purchase of young heifers from New Zealand by Australian interests, their importation into Australia and thereafter the leasing of the animal for a period to enable the process above described to be performed during the period of the lease, enables lessees to obtain within a short period of time anything from six to eight or more animals within the ordinary period of gestation from one process performed on the one female. When one bears in mind the prices then available in respect of animals of this breed in Australia, the possible profitability was substantial or if the animal was not sold the opportunity of developing a herd of first rate exotic breed could quickly be achieved. This type of activity took place substantially in relation to three exotic breeds, Simmental, Charolais and Limousin. The cases before me involve Simmental cattle. The benefits to be derived from such cattle from the point of breeding and imparting of beneficial characteristics to existing local herds was developed in the evidence and is not disputed.
It is against such background that various suggestions or schemes were promulgated in about those years for these purposes. In respect of one such method, advice was sought from the Commissioner of Taxation as to the feasibility of such an arrangement from a taxation point of view [and] so far as the participants were concerned, received a favourable response from the Commissioner and more will appear concerning this later in this judgment. It is at this period and against the above broad background that the two taxpayers entered into their respective partnerships. The broad picture as set out above is not in dispute.
I come now to consider the more detailed evidentiary material concerning the first taxpayer, Mr Gallie. Mr Gallie, Mr Hales, Mr de Maria and Mr Nielson were partners in an accountancy practice, Hales & Co. Those four partners, which I will refer to as the Hales partners, with equal shares therein, entered into a further partnership on 10 June 1976 which I shall call the cattle partnership with Baker Estates Pty. Ltd., to carry on business as cattle breeders, dealers and graziers. The accountancy partnership subscribed $40,000 to the capital of the cattle partnership and Baker Estates Pty. Ltd., contributed $400. The respective interests of the cattle partners were that the accountancy partners had a 99% interest and Baker Estates Pty. Ltd., a 1% interest. The cattle partnership agreement contained a cl. 13 which entitled either partner to give notice to the other, the effect of which would be to require Baker Estates Pty. Ltd., to increase its interest in the capital of the partnership from 1% to 50% with a consequent diminution in the capital of the accountancy partners from 99% to 50%. In such event Baker Estates Pty. Ltd., was obliged to pay consideration for the increase in its share in the
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capital and share in the partnership an amount equal to one-half of the difference between the respective capital amounts contributed, i.e., $40,000 and $400, less $5,000, namely, $14,800. Such a notice was subsequently served and that sum was paid accordingly.On 15 June 1976 a loan agreement was entered into whereby the accountancy partners borrowed from Bamala Pty. Ltd., a sum of $30,000, so that their contribution to the capital of $40,000 was financed as to $10,000 from their own personal funds and as to $30,000 from moneys borrowed by them from Bamala. The Baker Estates contribution was from its own funds. Thereafter, the accountancy partners paid the sum of $15,000 off their debt to Bamala under the above loan agreement and upon the exercise of the option by Baker Estates to adjust the capital interests, they directed Baker Estates to pay the sum of $15,800 which was payable by Baker Estates to them to Bamala in further partial satisfaction of the balance of the debt due to Bamala, leaving some few hundred dollars outstanding.
On 15 June 1976 a lease agreement was entered into between Mr F.J. Baker as lessor and the cattle partnership as lessee whereby that partnership leased or agreed to lease a Simmental heifer known as Canterbury Caroline from the lessor, it being a term of the lease that the subject female would be super ovulated, then the ova artificially inseminated. The lessor at the lessor's expense on at least two occasions was to cause the heifer to be super ovulated and subsequently artificially inseminated and to cause the fertile ova produced by the heifer to be implanted in recipient cows provided by the lessees. The lease and the obligation to provide those services were for a term of two years from the date thereof or for the period which shall expire two months after the second ovulation, whichever shall be the longer, so that there was the opportunity for the lessee to obtain more than two ova transplant from the heifer during the currency of the lease, and there was a further provision for a minimum number of calves to be produced, namely eight and if not so produced, then such number to be made up by similar stock.
The heifer in question was subject to three attempts to ova transplantation, the first in March 1977 by Mr Loneragan, veterinarian at Kaloodibar Stud at Mudgee, which resulted in the production of five calves in December 1977. An attempt in early 1978 by Dr Baker of Queensland of a further transplant was unsuccessful. Shortly after, a further successful transplant was effected by the Australian Transplant Breeders Pty. Ltd., of Mittagong, with the result that in January/February 1979 a further six calves were born, a total of eleven in all.
On 19 June 1978 notice of exercise of the option contained in the Cattle Partnership Agreement requiring Baker Estates to increase its interest to 50% was given. The partnership was dissolved as from 30 June 1978. On dissolution the progeny was divided and the accountancy partnership received five, being the more mature animals from the first drop and the other partner, Baker Estates, received the remaining six. The partnership made provision for distribution in specie between the partners in the event of dissolution.
Thereafter the accountancy partnership disposed of four of the five calves in April 1980 for a net consideration of $2,808.20. A bull calf was leased for two years for $600 a year and then sold for $300.
It is appropriate to consider some of the earlier history leading up to the interest in these cattle. The first of such cattle was imported into Australia in 1973. Thereafter, pure bred heifers sold at very substantial prices, as high as $40,000. The Australian Simmental Breeders Association was formed in 1972 and the ova transplant procedure was available and had attracted the interest of academics, professors and veterinarians. In 1975 the taxpayer visited a property of Baker Estates at Moss Vale where a company interested in the transplant breeding was operating. Baker had been a client of Gallie since 1972. Gallie decided to interest himself in what was regarded as an exciting development in cattle breeding. There was literature both locally and from Europe and experts in the field such as Professor Geddes, Mr Alan Roe of Elders and Mr Loneragan a veterinarian who performed such transplants. At about that time a letter from the Commissioner to a firm of solicitors, Messrs Allen Allen and Hemsley was available, which dealt with taxation aspects of another particular cattle leasing proposal and indicating approval. The letter dated 17 March 1976 was in terms as follows:
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``We refer to your letter of 17 March 1976 and to the discussion this morning between yourself, Mr. T. Magney and Mr. W.C. Matthews of this office concerning the proposed leasing arrangements to be made between the company and its clients. It is understood that the company proposes to lease its cattle and provide management services to its clients if requested. A further proposal is that the company may agree to enter into partnership arrangements with its clients regarding the cattle.
You will of course understand that where advice is sought concerning proposed transactions such advice can only be given in the form of an opinion not binding on the Commissioner. When the time comes for making an assessment the Commissioner is obliged to have regard to the facts as they finally emerge and to the law as then enacted. The advice given in this letter would be read as subject to this qualification.
Consideration has been given to the matter and on the information available it can be said that payments under the lease agreements will be allowable as deductions for income tax purposes to the lessees and the amount of the deduction allowable will be determined with relation to the payments made each year. The deductions allowable will include payments made in terms of the lease, management fees and agistment.
It is understood that the lessees may have to resort to outside borrowings in order to finance the leases, in which case the interest on such borrowings will also qualify for deduction.
If partnerships are entered into between the company and its clients and elections are made in terms of section 36A the owner of the calf will not be assessed for tax on the proceeds of the sale to the partnership of his three-quarter interest in the calf.
I trust the above opinion will be satisfactory for your purposes.''
Interest developed to the point that Roe addressed a meeting at the Rockdale Businessmen's Club on 1 June 1976 at which Baker and Gallie were present. The subject was possible investment in these cattle and assessment of their prospects and the use of the transplant technology. In the same month Roe and Baker went to New Zealand where Baker purchased 14 pure bred heifers and had them shipped to Australia. Information regarding New Zealand quarantine was received by Gallie's firm and on 10 June 1976 the sale note for the subject heifer was prepared and on the same day the loan agreement and lease were entered into. On 16 June the Hales partnership received $30,000 under the loan agreement and the same day $200 and $40,200 was deposited with the cattle partnership account. On 17 June $40,000 was paid by the cattle partnership pursuant to the lease for the subject animal and $115 to the association for membership. Some legal fees and stamp duty was also paid.
No dispute arises as to the detail, outgoings or receipts incurred by the two partnerships. The taxpayer claims his share of the Hales partnership loss in the year ended 30 June 1976, a sum in the vicinity of $10,000.
The evidence also discloses material such as minutes of the partnership, the interest of the partners, visits to field days where lectures were given by eminent experts in this area, efforts and visits by the taxpayer to a country centre with a view to the partnership purchasing a property and Simmental herd in October 1976, material as to the birth of the calves and reports as to progress on the venture and the like. I accept the whole of this and other material presented by the taxpayer, including his own evidence.
In the result, the position in this matter on the accepted factual findings is not dissimilar in principle to the situation dealt with in
Walker v. F.C. of T. 83 ATC 4168 affirmed on appeal in the Federal Court of Australia (84 ATC 4553), and in which special leave to appeal to the High Court of Australia was refused (7 December 1984).
The principles applicable are fully set out in those decisions. Applying those principles, it is plain and I find that the expenditures incurred qualified for deduction under both limbs of sec. 51(1) of the Income Tax Assessment Act. I find that the outgoings were incurred in gaining or producing assessable income. I find that the activities involved the carrying on of business of cattle breeders and the outgoings, necessarily incurred were outgoings in the carrying on of their business for the purpose of gaining or producing assessable income and were not of a capital nature.
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In the light of that decision, the submission of the counsel for the Commissioner can be dealt with shortly. Walker's case, of course, was accepted. The question was raised whether there was in fact a carrying on of business. I find that there was. It was put that rather it was a tax venture with business activities. I do not accept that appreciation of it. It was a business, at the time with feasible chances of success, supported by expert opinions. That it failed is little to the point. Many businesses do. On the figures, it can be shown that even with the benefit of the deductions for tax purposes, considerable losses were incurred. The argument was that it was all really to avoid tax, not to carry on business, that there was no real rural interest, that most of those involved were suburban business men. These arguments were not accepted.
Gallie's evidence as to his interest and expectations to develop a herd of some substance and to fulfil an ambition were not challenged in cross-examination nor were the business activities. This continued after the dissolution and the sale of the progeny was explained to my satisfaction by conditions of drought and the decision, not his, that the Moss Vale property be sold by the owners. One of the cattle sold was later shown at the Royal Easter Show. He has himself purchased a further two Simmental cattle in 1981. None of this evidence was challenged. I find that the contemplation and expectation was that the business would not have been stopped with the initial animal but would have continued with further breeding as a business with the profits shared among the partners. Mr Gallie and the other witnesses impressed me and I accept their evidence.
A final point made was that a deed is not completed until delivery and there was no evidence of delivery before 30 June 1976 and hence no business.
True it is that a deed takes effect from its delivery, and not from its date but delivery is presumed to have taken place on its date (Norton on Deeds, 2nd ed. p. 189 and authorities therein cited and see sec. 38 of the Conveyancing Act 1919 as amended and Stuckey on the Conveyancing Act, p. 8, para. 246). In addition, the parties clearly acted on the documentation and the documents were in the possession of the taxpayer. The taxpayer's (Gallie) affidavit refers to payments made pursuant to the documents and Bamala paid over funds in pursuance thereof. In these circumstances, I reject the submission. In my opinion, this submission fails. Accordingly, the plaintiff succeeds on the appeal.
I turn now to the appeal of Davidson Motors Pty. Ltd., which was heard together with the appeal of Gallie. It is based upon almost an identical situation. If anything it is a stronger case for the taxpayer company (called the company) if only because of the fact that I accept that Mr Davidson had some prior and continuing rural interests culminating in the purchase of a property and the use thereon of cattle for breeding purposes including some of this breed. I accept his evidence. He was a director of a company and a distributor of Nissan motor vehicles. The company was formed in 1971, the principal shareholder being his father until his death in January 1979. Since the inception he has been the manager and primarily responsible for the company's management. He is an accountant by profession but also has an interest in cattle and horses which followed his father's interest in racehorses and shares in them, and he himself has owned shares in racehorses since 1975. In 1973 he became friendly with one Stokes a meat inspector and part-time farmer at Mudgee. There was dealing in cattle and consideration to building up a herd. There were discussions as to whether they would enter into partnership.
In 1976 Gallie was then and still is the company's accountant. Davidson learned of the procedures of breeding Simmental cattle from him and that Gallie himself was becoming interested and the detail of information was passed on to him. Davidson was attracted to this scheme as he had already been looking towards a possible venture in cattle and the manner of building up a herd with such a venture gave appeal to him and it would be an avenue for his father to control. He and his father decided to participate in such a venture and it was seen as an opportunity to get into another business and diversify the company's interests. His interest in it was on the basis of it being a reasonably profitable venture with appeal to him and not on the basis of saving tax. After their decision to participate in such a venture, his father attended the meeting referred to earlier in this judgment at the Rockdale Businessmen's Club where the venture was discussed, the purpose of which
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was to be informed as to how the venture was to be organized and to give them further information as to the breeding program.Thereafter, and following discussions by and with his father, a series of documents were entered into similar to those in the Gallie case. They were a partnership agreement dated 10 June 1976 between Baker Estates Pty. Ltd., and Davidson Motors. This agreement was executed on behalf of the company by his father and himself and the seal was affixed. I only mention this to show his father's interest in the scheme. On 15 June 1976 an agreement for loan was entered into by the company. On the same day a deed of lease dated 15 June 1976 was entered into in respect of a Simmental animal. All those documents were based on a similar structure to those referred to in the Gallie case. Subsequently, on 18 March 1977 a further lease was entered into by the company.
The records relating to the partnership and the various transactions as to the contributions made by the company to these transactions were kept by L.N. Hales & Co., the accountants, of which firm of course, Gallie was a member.
The sums of money payable under the terms of the various documents were duly paid, including the sum of $10,000 contributed by the company pursuant to the lease.
The company became a member of the Simmental Association and Davidson himself visited the property at Moss Vale where cows and calves and recipient cows in calf were seen. This was a field day activity and some of the calves on the ground at that stage belonged to this partnership and there was disappointment that the anticipated number had not been produced. There were discussions as to the failures in the transplanting of eggs and a new procedure of flushing had been adopted. The laboratory facilities were inspected. The expectation of obtaining from six to ten calves from the operation did not seem to be a reality although there were hopes that the new procedure would bring greater success. In fact, the first transplant brought a drop of four calves, and a second group of calves was subsequently born. The company exercised the option contained in the partnership agreement to require Baker Estates to take a greater share in the capital, substantially because the venture had not been as successful as expected.
On 30 June 1978, this partnership was dissolved by oral agreement. There had been no prior intention of winding up the partnership but due to poor results and the drop in prices, the company was not prepared to contribute any further. The cattle which belonged to the company subsequent to dissolution, remained on the property for which there were to be agistment charges. Davidson decided to investigate the possibility of removing the cattle then owned by Stokes at Mudgee. In the meantime, Gallie informed him that the Moss Vale property was to be sold and cattle dispersed at a sale in April 1980. Davidson saw Stokes to see whether it would be better to transfer the cattle to Mudgee or allow them to be sold at dispersal sale. Stokes was interested in taking the cows and a bull calf but thought it better to sell a bull which the partnership had. Stokes was not so much interested in developing the Simmental herd but thought the Simmetal cows would be useful for cross-breeding. Stokes purchased a property in the Mudgee area about June 1979. In 1980 Davidson entered into the partnership with Stokes on the cattle breeding and also acquired a half-interest in the property. The bull above-mentioned owned by the company was sold at a sale at Moss Vale for $1,550. At the same sale Davidson and Stokes purchased three three-quarter cross-bred Simmental cows which were taken to the Mudgee property together with two pure bred heifers and a pure bred bull calf which were retained from the Moss Vale property.
Davidson continues in partnership with Stokes at Mudgee, the formalities of this partnership being between Davidson Motors Pty. Ltd., and W. & J. Stokes. Davidson has also entered into a further venture operated by Derowen Pastoral Co. Pty. Ltd., in which company he holds shares. The initial property at Mudgee has since been converted to wheat and wool sheep production. The property operated by Derowen Pastoral Company of 2,200 acres carries approximately 300 head of cattle and 2,000 head of sheep. Davidson himself says he was never personally actively involved in the Moss Vale venture with the cattle since he relied upon Gallie and the experts and the advice of the pastoral company, and subsequently he relied upon the management provided by Baker. In the same way, he has not been actively involved in the
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partnership at Mudgee relying very much upon the knowledge and expertise of Stokes. I accept the above factual summary and the appeal was supported by expert evidence which I accept as to the procedures relevant to the cattle and their expectations. These included an agricultural consultant, Mr Geddes, a former associate professor of Animal Husbandry at the University of Sydney and a former director of the Sydney University Animal Husbandry farms, a M/s Olsen, an experienced farm-hand who had worked on various cattle properties and stations who later assumed responsibility for the care of the cattle, and detailed the nature of the property and its capacity, including the surgery, calving and recovery pens and details of the treatment and the procedures and the care and routine required of the animals, and Mr Alan William Roe, a company branch manager, employed with Elders for a large number of years and who detailed the nature of the breed and the processes. At the relevant time he had been for 12 years the New South Wales stud stock manager for Elders and was particularly involved with the acquisition of several clients in all States of Australia. He had made numerous trips to New Zealand and interstate for the purpose of assisting Australian breeders in the selection of these cattle and maintained a close contact with overseas agencies so as to be able to advise thereon and on the best bulls and semen for use in artificial insemination. He had met Baker and with him addressed a meeting at the club mentioned and informed that meeting that many of the range of prices then being received for pure-bred bull calves ($8,000 to $15,000) and heifer calves ($10,000 to $15,000). The evidence contained details of the prices received for such cattle in Australia between 1974 to 1976 with prices as high as $43,000 for heifer calves in 1974. He accompanied Baker to New Zealand and there selected what he believed to be the best available heifers and Baker purchased 14 as far as he could recall.I accepted the evidence of these three witnesses.
From the totality of all this evidence, and it is to be borne in mind that the two matters were heard together and the evidence of each was available to the other, I find that the partnership genuinely carried on business and continued to do so until dissolution. I also find that the items in question being the amounts let out in connection with the partnership loan agreement were outgoings incurred in the production and gaining of income and also that they were outgoings incurred for the production of income and the carrying on of the business, in other words, in this appeal as in the other appeal, I am satisfied and find that the outgoings concerned came within both limbs of sec. 51(1) and were not items of a capital nature.
As in the Gallie matter, I accept the evidence of Mr Davidson as to his interest and expectation to develop a herd of some substance and to fulfil a desire to have such a business for the company and particularly for his father. None of this or the business activities was challenged in cross-examination. His interest has continued after the dissolution in a genuine and bona fide fashion and in this case also I am satisfied as to the explanation for the failure of the business which evidence was also not challenged. I am quite satisfied and find that the contemplation and expectation was that the business would have continued and not ceased with the purchase of the single animal but would have continued with further breeding as a business with the profits to be shared amongst the partners.
In the result, in both cases, the appeals succeed and the matter will be remitted to the Commissioner with indication that the objection against the assessment for the year in question be allowed.
The formal orders of the Court are as follows:
- In matter No. 643 of 1984 the appeal is upheld. Order that the matter be remitted to the Commissioner and that the objection against assessment for the year ended 30 June 1976 be allowed. Order that the respondent pay the appellant's costs.
- In matter No. 654 of 1984 the appeal is upheld. Order that the matter be remitted to the Commissioner and that the objection against assessment for the year ended 30 June 1976 be allowed. Order that the respondent pay the appellant's costs.
- The exhibits in both cases may be returned.
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