KP Brady Ch
JE Stewart M
DJ Trowse M
No. 2 Board of Review
K.P. Brady (Chairman), J.E. Stewart and D.J. Trowse (Members)
These references relate to the years of income ended 30 June 1981 and 1982, and by consent they were heard concurrently. The matter in issue is whether a partnership of which the taxpayer was a member carried on a business of primary production in each of the years in issue. It is the Commissioner's contention that no such business activity existed and that, consequentially, the taxpayer is not entitled to offset his share of the losses incurred in those years against his other income.
2. It appears that the partnership came into existence when the taxpayer, together with his mother and brother (hereinafter referred to as B), purchased a partly developed grazing property of some 41 hectares for a consideration of $35,000. The acquisition occurred in November 1980, and was funded by a trading bank loan to the extent of $25,000. The property is located in hilly country and it was the intention of the new owners that it (or rather selected portions) be used for the growing of blueberries. A partnership agreement setting out the terms of the arrangement was executed by the three members of the family, and it seems that one of the clauses contained therein provided that all profits and losses were to be shared equally. At about the same time, a joint cheque account was opened with a trading bank and it seems that such account was used for the settlement of all outstandings associated with the venture.
3. It is appropriate at this stage to observe that B, a self-employed landscape gardener and also the holder of a diploma in horticulture, had for some time been attracted to the notion of being involved in a farming activity, and that such an aspiration was instrumental in the decision to purchase the property for the purpose of growing blueberries. It appears that he was the partner selected to oversee the project and that he spent approximately 50% of his time in the discharge of that responsibility. There was no dispute that B possessed the ability to carry out the functions attaching to the position. Furthermore, it seems that the taxpayer, a course co-ordinator at an institute of technology, was to apply portion of his salary to meet the mortgage repayments on the jointly owned property and that their mother would provide working capital as required.
4. It appears that the decision to engage in this particular type of activity was taken only after considerable research and enquiry, and on that issue it seems that assistance was sought and received from the Australian Blueberry Society. Whilst the purchase of land sufficient for the economic growing of crops such as wheat and barley or the grazing of livestock was beyond their financial means, the partners shared the view that, given the small area of land required to grow blueberries commercially, such a venture was within their budget. Additionally, it was thought that the likely high yield on their contributions warranted such an investment. Having decided that matter and with the guidance and assistance of W, a friend and fellow graduate of B, they proceeded to purchase the property which was located about 150 kilometres from a capital city where all of the partners resided. It is relevant to observe that, at the time, W was conducting a nursery activity on a neighbouring property and that he was engaged in research and experimentation pertaining to the establishment of a blueberry farm. According to the explanations given at the hearing, the subject property was well suited for the cultivation of blueberries, inasmuch as it possessed certain natural advantages such as an area of about eight hectares of free draining sandy soils which could be developed for that purpose. Location in a high annual rainfall area with suitable catchment sites for water storage, and freedom from frosts, represented additional attractions. It seems that all of those factors played a part in the decision to acquire the property.
5. Apparently the growing of blueberries within Australia on a commercial basis was, at that stage, a comparatively new concept and, having regard to the variations in conditions as compared with those existing in other countries producing that fruit, some of the knowledge required to ensure a successful operation could only be gained by experience at first hand. It should also be appreciated that the initial production period, i.e. from first planting to harvesting, is four to five years and that the picking of the berry prior to the expiration of that term would have the effect of retarding the growth of the bush. Notwithstanding those difficulties, the taxpayer and his partners were confident of receiving a more than adequate return on their investment, and no doubt that expectation stemmed from the fact that, given the right conditions, one hectare of suitable land had the capacity to carry 1,000 bushes, which in turn could produce about 12,000 kilograms of blueberries. At that time, the market value of such a crop would have been in the vicinity of $30,000. It will be recalled that the property contained approximately eight hectares of land possessing the attributes required for the intended use, and it is notable that, of the remainder, 16 hectares were under native pastures and suitable for cattle grazing, whilst the balance of yet another 17 hectares consisted of heavily timbered and hilly country of no appreciable commercial worth.
6. It seems that it was the intention of the partners to develop the proposed planting area in stages and that, as part of the plan, a section of land of just over 0.5 of a hectare (i.e. about 1½ acres) had been selected for initial improvement. It is appropriate to mention that the growing of blueberries necessitates a constant supply of water and, in recognition of that requirement, it seems that the partners sank a catchment dam using their own labour as well as contract labour and equipment, and that the work on that improvement was commenced some time in the 1982 fiscal year. It is of interest to observe that a 45 kilolitre concrete storage tank to be used in the proposed irrigation system was purchased and installed in the 1983 year. Also included in the first stage was the procurement of a sufficient stock of blueberry seedlings to enable the ultimate planting out of the selected area. It appears that such a volume of stock could have been obtained by either a direct purchase of the total requirement or the slower and yet less expensive approach of acquiring a parent stock and the propagation therefrom of new stock by way of cuttings. Notwithstanding the resultant extension to the production period, the partners decided in favour of the latter course of action, and it was their anticipation that the processes of propagation would generate a stock of 10,000 plants by the end of the fourth year. Furthermore, it seems that the adoption of that alternative would not only ensure the availability of plants as and when required, but additionally such a course would facilitate the choice of plant varieties most suitable to the district.
7. In order to better understand the activities undertaken on behalf of the partnership in each of the two years under review, it is necessary to elaborate on some of the aspects associated with the generation of new stock from cuttings. It appears that the chances of survival for those cuttings are quite low and that, in order to improve their prospects, they are kept in a protected environment for at least an initial period of four years. They are potted and then placed for two years in structures which provide controlled temperature and humidity. At the conclusion of that time, they are then moved outside into an enclosure which affords some protection from the elements, and there they remain for another two years. It is only after the expiration of that period that the bushes are ready for planting out.
8. It is appropriate that we now turn to a consideration of the activities engaged in during the 1981 and 1982 years and these are set out in the following summary of events:
- • Purchase of parent stock and commencement of propagation procedures.
- • The mandatory slashing and spraying of blackberry bushes which, in terms of the Vermin and Noxious Weeds Act, are included in the definition of a noxious weed.
- • Replacement of existing fences, which at time of purchase were in a very poor condition, and erection of new fencing on portion of boundary as well as internal fences separating the timbered land from the grazing area.
- • Finalisation of weed spraying program.
- • Purchase of additional stock and expansion of existing propagation procedures.
- • Completion of fencing.
- • Agistment of cattle on grazing area and sale of ferns dug from property.
- • Commencement of the sinking of catchment dam using bulldozer leased by the partnership.
- • Levelling of area to be used for growing the blueberries.
The activities appertaining to the generation of new stock were carried out on the nursery property owned by W, that being regarded as being more suitable for that purpose than the partners' own property. It seems that B, with the assistance of W, constructed two igloo shaped polythene covered hot-houses, and that those structures were used to accommodate the cuttings throughout the period of their infancy. Notwithstanding the application of those precautionary measures, it appears that the degree of losses suffered during that stage was high and that the program was further set back by the presence of an unknown bacterial disease. Cuttings on hand at the end of the two year period numbered somewhere between 300 and 400.
9. The profit and loss statements prepared on behalf of the partnership for the years under review, and which were tendered as part of the Commissioner's file, revealed the following items of income and expenditure:
1981 1982 Income $ $ $ $ Agistment -- 507 Fern sales -- 270 -- --- Gross income: -- 777 Less expenses Accountancy -- 425 Bank charges 11 17 Borrowing expenses 213 213 Depreciation 105 324 Hire of equipment 55 -- Fencing -- 270 Fertilizers -- 36 Freight -- 320 Insurance -- 212 Interest paid to bank 915 1,570 Leasing of bulldozer -- 4,656 Light and power -- 5 Plants -- parent stock 106 137 Protective clothing 92 -- Printing and stationery -- 12 Shire rates 128 171 Repairs to bulldozer and equipment 121 1,068 Salaries 2,796 -- Spraying weeds 502 596 Subscription -- Australian Blueberry Growers Association -- 20 Telephone 279 503 Tool replacement 92 5,415 252 10,807 ---- ----- --- ------ Net loss: $5,415 $10,030 ------ -------
The following additional comments are made in an effort to expand upon some of the above outgoings:
- • The borrowing expenses relate to the original raising of funds for the purchase of the property.
- • The interest outgoing stems from that same borrowing.
- • Depreciation was calculated on sundry items of plant used in the development of the property.
- • Salaries of $2,796 claimed in 1981 year refer to payments made in connection with the spraying of weeds, the effecting of the fencing improvements and also the costs of having part of the property surveyed. The taxpayer was not able to suggest any meaningful dissection of this item of expenditure.
- • The amounts shown under the heading of telephone represent an estimate of the cost of calls made from the house of the taxpayer's mother and which were said to relate to matters pertaining to the venture. Whilst such estimates were evidently made by the tax agent acting for the partnership, the method so applied remains unknown.
10. In processing the partnership returns for the two years in issue, the Commissioner formed the opinion that the activities undertaken during those times were not sufficient to constitute the carrying on of a business of primary production and that, in any event, the work engaged in was of a preliminary or experimental nature. In accordance with those views, the Commissioner adjusted the taxpayer's taxable incomes by the total disallowance of the amounts claimed as representing a share of the losses incurred by the partnership. The taxpayer objected to such action and submitted that the partnership had been engaged in the business of primary production during 1981 and 1982 and that the expenses claimed in its returns for those years were deductible in terms of the provisions contained in sec. 51, 53, 54, 59, 67, 72, 75, 75A and 90 of the Income Tax Assessment Act 1936.
11. In the light of the above facts, can it be said that the partnership of which the taxpayer was a member had been carrying on a business of primary production in the years under review? We begin with the observations that there was no dispute that the growing of blueberries is capable of coming within the definition of primary production as set out in sec. 6(1) of the Income Tax Assessment Act 1936, and that the only matter requiring resolution is whether at those times such a business had in fact commenced.
12. This same question has been considered by the courts on many occasions, and whilst it has been acknowledged that the final determination should only be based on the large or general impression gained (see
Martin v. F.C. of T. (1952-1953) 90 C.L.R. 470 at p. 474), certain guidelines have been suggested. The criteria to be applied in cases of this kind was succinctly outlined by Bowen C.J. and Franki J. in
Ferguson v. F.C. of T. 79 ATC 4261 at pp. 4264 and 4265 in the following terms:
``There are many elements to be considered. The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on business notwithstanding his profit is small or even where he is making a loss. Repetition and regularity of the activities is also important. However, every business has to begin and even isolated activities may in the circumstances be held to be the commencement of carrying on business. Again, organization of activities in a business-like manner, the keeping of books, records and the use of system may all serve to indicate that a business is being carried on. The fact that, concurrently with the activities in question, the taxpayer carries on the practice of a profession or another business, does not preclude a finding that his additional activities constitute the carrying on of a business. The volume of his operations and the amount of capital employed by him may be significant. However, if what he is doing is more properly described as the pursuit of a hobby or recreation or an addiction to a sport, he will not be held to be carrying on a business even though his operations are fairly substantial.''
The application of that indicia to the facts present in these references provides, in our opinion, the following conclusions:
- • Notwithstanding that losses were incurred in both years (and on that point one must recognise as a matter of course the lengthy lead time to final production), the activities were undertaken for the purpose of profit making.
- • The activities were undertaken on a repetitive and regular basis throughout the period under review.
- • Inasmuch as the partners sought professional assistance from the Australian Blueberry Growers Association and W, they adopted a business-like approach.
- • The degree of activity and the amount of capital employed in the venture were significant.
- • The activities engaged in do not appear to fit the description of those normally associated with a hobby, recreation or sport.
Whilst those results, of themselves, tend to create the initial impression that the partnership had been involved in the conduct of a business of primary production in both of the years in question, we are required to direct our attention to the Commissioner's submission that the work performed on behalf of the partnership during those times had been of an experimental nature and that such tasks had occurred at a stage preparatory to the commencement of a business. It was on that line of reasoning that the Commissioner took the view that no deduction should be allowed for any of the items of expenditure claimed in the 1981 and 1982 partnership returns.
13. The question of whether a business had been conducted, and the deductibility of expenditure incurred in the preliminary stage of a two-tiered plan, were considered at some length by the Full Federal Court in Ferguson v. F.C. of T. (supra) and, in our view, the reasoning applied in that matter is of particular relevance to the matters now under consideration. In that case, the taxpayer, a naval officer, intended to buy a grazing property and raise beef cattle upon his retirement. Some years prior to that anticipated time, he entered into transactions whereby he agreed to sub-lease five identified half-cross Charolais cows on the basis that he became entitled to their progeny, and for the management of such livestock on a property owned by an entity closely associated with the cattle leasing company. It appears that Commander Ferguson saw the arrangement as a feasible way of building up a herd which he could eventually move to his own property where he could then engage in the production of cattle on a full scale. It was held that the activities engaged in during the leasing period, i.e. the preparatory stage, constituted the carrying on of a business by Commander Ferguson and that, accordingly, he was entitled to claim the costs relevant to the leasing arrangement as a deduction in terms of the second limb of sec. 51(1). We consider that the following excerpt taken from the judgment of Fisher J. (see p. 4269) is directly to the point raised by the Commissioner in the present matter:
``The trial Judge in this matter was not prepared to find that the taxpayer was carrying on a business during the relevant years. He accepted the contentions of the Commissioner that there were `two steps in the taxpayer's proposals'. The first step was the entry of the taxpayer into the two agreements pursuant to which the taxpayer acquired stock. The second step was the commencement of a cattle-raising business upon a property to be purchased by the taxpayer. It followed, the trial judge found, that the taxpayer was in reality acquiring stock at a cheap price against the day when he would commence business with that stock on his own property.
Stated in this way I am quite prepared to accept these findings as far as they go. But it seems to me necessary to give more detailed consideration to the activities of the taxpayer at the first stage. The fact that he ultimately intended to carry on the business of cattle raising or primary production on his own property with the stock acquired during the first stage does not necessarily preclude the finding that the taxpayer was also carrying on business during the first stage. A person may conduct a business, albeit of a limited nature, the activities of which business are preparatory to or in preparation for the conduct of another business on a larger scale. The question is whether the more limited activities at the
ATC 185earlier stage, standing alone, constitute a business.''
14. Whilst we are prepared to accept that the nature of the activities undertaken during the years in issue may be seen as preparatory to the operation as planned, we do not consider that such an acceptance is necessarily fatal to the taxpayer's claim. It seems to us that the partnership had embarked upon a commercial undertaking designed to create stock as cheaply as possible and which ultimately was to be used in the derivation of assessable income by the sale of its produce. The evidence taken as a whole leads to the conclusion that the venture had at that stage a commercial flavour and that it had been conducted in a systematic and businesslike manner. For those reasons, we consider that those activities, when taken alone, constitute the carrying on of a business.
15. In the course of proceedings, the Commissioner's representative expressed the view that the decision of the High Court in
Southern Estates Pty. Ltd. v. F.C. of T. (1966-1967) 117 C.L.R. 481, stood in the path of the taxpayer's claim, and with such a possibility in mind we now turn to consider that contention. In that case, a partnership of which the taxpayer company was a member had acquired for resale at a profit an area of scrub country at Naracoorte, South Australia. The plan was to realise upon the property once it had been developed to the stage of being capable of the carriage of livestock. Prior to the attainment of that intended condition the property was sold, and the company contended that, as a consequence of the activities undertaken by it and associated with the reclamation and improvement of the land, it had been engaged in primary production and therefore entitled to claim the costs related to those works under the provisions contained in sec. 75(1). In deciding against the taxpayer, all four judges concluded that the company had not been engaged in primary production and it seems that, in the formation of that opinion, Barwick C.J., Taylor J. and Owen J. shared the view that the activities pertaining to the conversion of land unsuitable for primary production to land so suitable did not, of themselves, constitute such an involvement.
16. In the present matter, we agree that the activities carried out in connection with the development of the property belonging to the partnership are of the same general description as those performed by or on behalf of Southern Estates Pty. Ltd., and yet there still remains the fundamental difference that, in conjunction with the making of those improvements, the partnership had purchased parent stock and was involved in the generation of new stock, albeit on a neighbouring property. It is that extra activity that takes the matter beyond the reach of the Southern Estates decision. Furthermore, in our opinion, it is the existence of that same factor which tilts the scales in favour of the taxpayer.
17. Having regard to our finding that the partnership was conducting a business in both the 1981 and 1982 years of income, it will be appreciated that both limbs of sec. 51(1) are available to the taxpayer in respect of outgoings falling for consideration under that section. It is also well established that losses and outgoings may be allowable deductions in terms of sec. 51(1), although incurred in a year in which no assessable income is actually gained or produced by the activities in relation to which the losses or outgoings are incurred (see
C. of T. v. Finn (1961) 106 C.L.R. 60 at p. 68 and
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057 at p. 4071). Additionally, it is interesting to observe that Walsh J., in
Thomas v. F.C. of T. 72 ATC 4094, expressed the opinion that in certain circumstances a similar view may be taken on the operations of sec. 54 and 57AA. that is to say, depreciation in accordance with those sections may be allowed with respect to a year of income although the carrying out of the purpose for which the depreciated property is used does not produce income received in that year.
18. Before embarking on a detailed testing of the various kinds of expenditure incurred during the relevant periods, we are of the opinion that in respect of the outgoings included under the headings of salaries and telephone the taxpayer has not discharged the onus of proof imposed on him by sec. 190(b). The evidence establishes that the amount claimed for salaries includes some unquantified amount for surveying portion of the property and, as there is no doubt in our minds that no deduction is permitted for that unknown portion, the taxpayer's claim must fail in its totality for want of information. The apparent lack of a clear basis in calculating the claims for telephone leads us to a similar conclusion. For that reason, the question of the
ATC 186deductibility of those outgoings is taken no further.
19. In examining that part of the taxpayer's claim which falls for consideration under the second limb of sec. 51(1), we commence with the observation that deductibility is generally decided on the basis of whether, according to the ordinary conduct of affairs, the expenditure incurred was incidental to the conduct of a business activity. The use of the word ``necessarily'' places an additional qualification upon the degree of connection between the expenditure and the carrying on of the business inasmuch as the outgoings must be dictated by the business ends to which it is directed, those ends forming part of or being truly incidental to the business (see Dixon C.J.
F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431 at pp. 436 and 437). On this same point, it seems to us that where a taxpayer who is conducting a business incurs expenditure which is incidental to or connected with the operations or activities regularly carried on for the production of income, then such expenditure is an allowable deduction. The following extract taken from the judgment of Dixon J. (as he then was) in
Texas Co. (Australasia) Ltd. v. F.C. of T. (1939-1940) 63 C.L.R. 382 at p. 468, is of particular relevance as it refers to certain types of outgoings which are similar to some of those present in the current references:
``Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant.''
20. In our opinion, the following items of expenditure were incidental to or connected with the operations being conducted by the partnership and none of those outgoings were of a capital nature, and on that basis they qualify for deduction in terms of the second limb of sec. 51(1):
1981 1982 $ $ Accountancy -- 425 Bank charges 11 17 Hire of equipment 55 -- Fertilizers -- 36 Freight -- 320 Insurance -- 212 Interest 915 1,570 Leasing of bulldozer -- 4,656 Light and power -- 5 Plants --parent stock 106 137 Protective clothing 92 -- Printing and stationery -- 12 Shire rates 128 171 Subscription -- 20 Tool replacement 92 252 ----- ----- $1,399 $7,833 ----- -----
In view of this determination, it is not necessary to concern ourselves with the position under the first limb, but we consider it appropriate to briefly refer to the recent decision of the National Court of Papua New Guinea in
Travelodge Papua New Guinea Ltd. v. Chief Collector of Taxes 85 ATC 4432. In that case it was held that, in terms of sec. 68(1) of the Income Tax Assessment Act (P.N.G.) (identical to our sec. 51(1)), interest, rates and rent incurred prior to the opening of a hotel and thus before commencement of business were incidental and relevant to the production of assessable income and that those outgoings were not of a capital nature. On that interpretation it seems that the expenses relative to the partnership property could also come within the first limb.
21. For the same reasons referred to in the previous paragraph, we hold that the amounts expended on repairs (1981 - $121 1982 - $1,068) are allowable deductions in terms of sec. 53. Additionally, we consider that the moneys borrowed by the partners and applied to the purchase of the property were used for the purpose of producing assessable income and that, in terms of sec. 67(1), the partnership is entitled to claim the expenses associated with that borrowing as a deduction and that the calculations made in terms of subsec. (2) have been correctly made.
22. On our understanding of the evidence, the amount of $270 expended in the 1982 year of income and shown under the classification of ``Fencing'' related either to the erection of new fencing or the replacement of existing fencing which was said to be in a state of near total disrepair at the time of the original acquisition, and with that interpretation in mind we hold that the amount so outlaid was of a capital nature and that the complete write-off of same in the one year is not authorised by any section
ATC 187of the Act. However, it is noted that fences on land which is used for the purposes of agricultural or pastoral pursuits come within the definition of plant referred to in sec. 54, and thus it seems appropriate that this matter be considered in conjunction with the claims for depreciation.
23. The relevant provisions of sec. 54 are as follows:
``(1) Depreciation during the year of income of any property, being plant or articles owned by a taxpayer and used by him during that year for the purpose of producing assessable income, and of any property being plant or articles owned by the taxpayer which has been installed ready for use for that purpose and is during that year held in reserve by him shall, subject to this Act, be an allowable deduction.
(2) In this section, `plant' includes -
- (b) fences, dams and other structural improvements on land which is used for the purposes of agricultural or pastoral pursuits...''
In our opinion, the items listed in the depreciation schedules annexed to the partnership returns, together with the fences, are correctly described as ``plant'' and all of those articles were used by the partnership during the years under review for the purpose of producing assessable income. Not only do we allow the amounts claimed, but we increase the 1982 figure by $12, i.e. $270, being the cost of fencing at 4½% per annum.
24. We also take the view that the expenditure incurred on the spraying and destruction of the blackberry bushes located on the property was of a capital nature, and therefore no deduction is permitted in terms of sec. 51(1). However, it should be recognised that the deductibility of certain items of expenditure on land used for primary production is raised in sec. 75A and, at first glance, the type of outgoing now under focus appears to come within the meaning of ``expenditure incurred in the destruction of undergrowth indigenous to the land''. Notwithstanding that apparent compliance, the section imposes the additional requirement that the expenditure must be directed to the land upon which the business of primary production is conducted, and it is because of that condition that the taxpayer's submission fails. Unlike the provisions of sec. 54, which refer to improvements on land used for the purposes of agricultural pursuits, sec. 75A stipulates that the expenditure must relate to the land upon which the taxpayer is carrying on a business of primary production. In that sense, it appears to us that the application of sec. 75A is more restrictive than sec. 54. Whilst we have previously held that the partnership was carrying on a business of primary production and that the expenses pertaining to the property were relevant and incidental to that activity, it is not to be assumed that such findings lead automatically to the conclusion that the partnership was carrying on a business of that description on the particular land in question. To the contrary, we consider that no such business was being conducted on that land at those stages, and for that reason the partnership fails to meet the tests prescribed in terms of sec. 75A.
25. In summary, we would calculate the losses incurred by the partnership and the taxpayer's share of those losses in the following manner:
1981 1982 Assessable income $ $ Agistment Nil 507 Fern sales Nil 270 --- ---- Nil $777 --- ---- Less allowable deductions Section 51(1) expenditure 1,399 7,833 Repairs 121 1,068 Borrowing expenses 213 213 Depreciation 105 336 ------ ------ $1,838 $9,450 ------ ------ Net losses $1,838 $8,673 ------ ------ Taxpayer's one-third share: $613 $2,891 --- -----
26. For the reasons detailed above, we uphold the taxpayer's objections to the extent set out in the previous paragraph and order that his assessments for the 1981 and 1982 years of income be amended to give effect to those partial allowances.
Claims allowed in part