A.R.M. Constructions Pty. Limited & Ors v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
These are eleven appeals which, by consent, were heard together. There are four appellants. The appeals concern assessments of the amount of income tax allegedly payable by the various appellants upon income said to be derived during the years ended 30 June 1980-30 June 1983 inclusive. The first appellant is A.R.M. Constructions Pty. Limited ("A.R.M.") whose directors and principal shareholders at all material times were Albert Metlej and his wife. That company was incorporated in 1971, and until 1976 it carried on the business of building home units for sale. In early 1977 its directors decided to build units to retain as a long-term investment, and it built 12 units at Marrickville in 1977-1978 which it retained as an investment to earn rental income. Each of the other plaintiffs are companies controlled by Emile Ghosn, first cousin to Albert Metlej. They are E. & M. Ghosn Pty. Limited, E. & M. Ghosn (Builders) Pty. Limited, and E. & M. Ghosn (Developments) Pty. Limited. In March 1971 these companies entered into partnership, under the name "Emag Properties", for the purpose of conducting "a building/investment business". One of the directors and shareholders in the various Ghosn companies were Mejid Ghosn, brother of Emile Ghosn, who between late 1978 and 1980 was in Lebanon. He, like Emile Ghosn, had played an active part in the business conducted by the companies which were in partnership whilst he was in Australia. Mr Metlej said that Mejid Ghosn "was the one that did most of the paper work". Both Albert Metlej and Emile Ghosn alleged in the present proceedings that in late 1978 (i.e. at a time when Emile Ghosn's brother was overseas) the two men had a number of discussions concerning the possibility of joining together to acquire home unit development sites, construct thereon home unit buildings, and thereafter divide or partition the units equally amongst themselves. Mr Metlej, in an affidavit, said:
"4. In or about November and December 1978 I recall discussing at various times with Emile Ghosn the prospects of making further investments in real estate. At that time I had insufficient capital or access to funds to finance the cost of construction of projects involving more than about 12 units. I believed that if more units could be built on a parcel of land the cost of land per unit would be reduced. At about this time we had many conversations concerning the best approach to take. These conversations usually took place in our homes and usually at about mealtimes as we live close to one another. We are first cousins. As best as I can recall the effect of these conversations was that we would both look for a suitable property to build units and that we would each take one half of the units for our own investments purposes. I say that our agreement was to find suitable land and to build home units."
Mr Ghosn's affidavit was to similar effect. Each denied that there was any intention to
ATC 4793carry on business, either by themselves or through their respective companies, in partnership. In cross-examination Mr Metlej, who said that the agreement between the two men was that "we would look for property" and that, by pooling their resources and their knowledge and experience they would be able to construct town houses at a lower cost than otherwise, said:
"Q. Was there anything said in those discussions about what you would do with anything you built jointly once you had built it? - A. Yes, about that was said.
Q. What was said about that? - A. Well, if we found the property that we were interested in we would purchase it together, because it would help us to retain it later on, but the purpose of this was to retain the properties, other than that we could have - we were in the business of constructing, we could have constructed on our own as well.
Q. You could have constructed and retained on your own, could you not? - A. No, we could not have done that.
Q. What was the reason for that? - A. Because of the cost that would be involved. It would be very difficult for us to get a cheap loan on just the basis of the construction.
Q. Do I correctly understand your evidence to be that you yourself had constructed buildings and held them prior to your discussions with Mr Ghosn? - A. Yes.
Q. And that Mr Ghosn, to your understanding, had done the same thing with certain buildings? - A. Yes.
Q. Can you at this stage tell the Court why it was that it was necessary for you and Mr Ghosn to come together in order to achieve such a result? - A. Because it was just earlier on in 1976/77 that we held our first block. We held our first block of investment.
Q. That was your company itself? - A. Our company itself and we took out a long term loan to do the business. If we wanted to do it on our own we would be going to the bank, we would not have sufficient funds so early in the piece after keeping the other one to do that, to keep it and to retain it, we would not have been able to retain it afterwards.
Q. Mr Ghosn had sufficient collateral to provide those funds, is that the position? - A. He had that and also he - yes, he had that.
Q. Was there any discussion between you about any advantages which might flow from building larger projects rather than ones of the size which each of you had built individually? - A. Yes, that was entered in conversation as well. Actually, that was an important part of it as well.
Q. Did that important part of the discussion occur in the same series of conversations you had with Mr Ghosn in late 1978? - A. Yes, I think it initially would have played a major part in our discussions.
Q. Are you able to say now whether it did or not? - A. Well, it did, yes."
"Q. When you had your discussions in late 1978 with Mr Emile Ghosn about working together did you at that stage have any particular project in mind? - A. When we were discussing -
Q. Yes? - A. No.
Q. The outcome of your discussions was that you both agreed to look for suitable properties? - A. For suitable property, yes.
Q. Did you have any particular type of construction in mind at that time? - A. Yes, a block of investment units.
Q. Did you have any discussions at that time as to how you would put into effect your expressed intention of holding the units on building them rather than selling them? - A. Yes.
Q. What was said about that? - A. Well, I had the property at Schwebel Street and I was able to borrow funds on that and if one was completed, if we bought a suitable one that was completed, provided we did our sums correctly in the beginning, there would be no reason why we couldn't do the same.
Q. The Schwebel Street property was available at that stage for collateral for funds, for use in the intended project, was it not? - A. It was limited - it would have been probably just enough to help buy - just to assist in the block of land.
Q. In the course of those discussions was anything said about what you would do in the event that things didn't go as well as they had at Schwebel Street? - A. No, we didn't, because we thought we had the experience and we should have been able to make sure of that.
Q. Is it right to say that you took on your relationship with Mr Ghosn and his companies because, as far as you were concerned, you held him in high regard as a builder and trusted him as a prospective venturer with you? - A. Well, yes.
Q. As far as your discussions were concerned about holding properties after construction, did they go any further than reference to what you had achieved at Schwebel Street? - A. Well, yes, the Ghosns had a number of these investments and through some discussions, through what my father was doing, etc., it seemed for us that it would be the only way to do it.
Q. The proposed investment had these differences, did it not, that both of you, through your companies, were involved? - A. I didn't think it would matter at that time. We thought it would be just like each going to a block of land in building lots, one is doing something to his block, we would do it together, it would not be any different.
Q. Can we conclude from that that in your initial discussions in late 1978 you had no particular discussions about how anything you proceeded with jointly would be divided up between you once construction had taken place? - A. Yes, each would take his own units.
Q. That was said, was it? - A. Yes.
Q. Was there any discussion about how equality would be achieved in that regard, if you were both going to put in equal contributions, I take it that was, in that conversation what was intended, was it? - A. To each take half of what is there?
Q. Yes, is that what was said? - A. Well, probably something like that.
Q. Can you recall now what was said about how the properties would be divided, in what proportions? - A. Yes, we said like if it is a block of ten he would take five units, I would take five units, or 20/20.
Q. Was there some reason for the equality? - A. I don't know what you are getting at - no, it wouldn't matter, we just would divide them. It didn't matter if he took a front one or a back one - is that what you are telling me?
Q. Was that discussion with any precision as to who would take what in the abstract or what? - A. No, it wasn't.
Q. Did any discussion take place as to the contributions to be made by each of you through your companies? The amount of money?
Q. It was clear, if I understand you correctly, that Mr Ghosn was to provide most of the collateral for building finance? - A. Yes.
Q. Were you to make some other greater contribution which would bring you back to equality, as it were? - A. I would do most of the running of the job.
Q. That was all discussed at the time? - A. Yes."
The reference to Schwebel Street was to the block of units at Marrickville which A.R.M. had built.
"Q. If I could just return to your original discussions with Mr Ghosn in late 1978, there was in those discussions no mention if I correctly understand your evidence, of any particular project as being in mind for the venture? - A. No.
Q. Was it discussed as to how long you would work together? - A. Well, his brother was overseas and while he was away we would do something; it would have helped me and helped him. When he [sic] brother came back - they had been building for 20 years - 10 years or 15 before that together.
Q. Did you ever have in mind working together on any projects other than Newtown or Bankstown? - A. No, we didn't. It could have been only one project, it just happened to be two."
Mr Ghosn, in cross-examination said:
"Q. And the intention was, was it, when you had these discussions in 1979 with Mr Metlej that you and he personally would
ATC 4795participate in the management and control of these projects on a more or less equal basis? - A. Yes.
Q. That you would bring to bear your expertise as a builder and property developer and so would he, is that right? - A. Yes.
Q. And may I take it as part and parcel of these discussions you agreed that you would, as it were, pool your resources together? - A. Yes.
Q. To obtain, to put together the necessary security to get the necessary loans from the bank and from the trustee company and so on, is that right? - A. Yes.
Q. And that was that was done? - A. Yes.
Q. Now obviously enough your overall objective as a result of these discussions with your cousin was to make money, is that right? - A. To make an investment.
Q. You wanted to make money out of it, did you not? - A. Make an investment.
Q. You wanted to make money out of it, did you not? - A. Yes.
Q. And the way you had made money up to that time was by building units and selling them, was it not? (Objected to; question rephrased) Q. One of the ways in which you personally or your companies had made money up to that time, that is early 1979, was by buying properties, building home units on them and selling them, was it not? - A. I do not think so we made money this way. We made money when I holding the property, before I holding the property which I held the property 1964 and I see the result from that, I hold the property in 1971, if I did not hold the property 1971, the boulevarde, 105 The Boulevarde."
Although the first question in the passage set out related to 1979, the principal discussions were in late 1978.
Mr Loftus, accountant for both Ghosn and Metlej and their companies, gave evidence that he recalled a number of conversations between the two men both before and after February 1979 during which he was informed by one or other of them "We have decided to build units together and take one-half each on completion".
By contract of sale dated 5 February 1979, A.R.M. purchased for $65,000 vacant land known as 128-134 Chapel Road, Bankstown. That contract, as varied in March, was conditional upon the purchaser obtaining approval to the erection of a block of 12 home units. In his affidavit Mr Metlej said that he was so impressed with the property that he gave the agent an immediate holding deposit of $500, and he said "I was of the opinion that the cost of land per unit of $5,500 together with a construction cost of roughly $18,000 per unit represented an attractive proposal for Emile Ghosn and myself to develop the site as home units". Mr Ghosn in his affidavit said that in February 1979 Metlej had told him of the inspection of the property, which at that time had developmental approval for 18 residential units, and he said that: "contracts for the purchase of the property by A.R.M. Constructions Pty. Limited as trustee for the partnership and A.R.M. were exchanged on 5 February 1979. On 8 August 1979, A.R.M. entered into a deed of trust indicating that it held the Bankstown property as to one-half for itself and as to the balance for the Ghosn companies equally. For various reasons building on this site did not start until late in 1981". Completion of the purchase took place on 14 September 1979 and a minute of a meeting of directors of A.R.M. dated 17 September 1979 noted this fact "and that work on the project would not commence until the Newtown project was completed". The heading was "Joint Venture Project - Bankstown".
On 24 April 1979 two contracts were entered into under which Messrs Metlej and Ghosn, in their own names, purchased various properties at Newtown, being 42 King Street (a shop), 24-28 Fitzroy Street (these being three semi-detached cottages) and 5-17 Queen Street. Plans had already been approved by the South Sydney Council for the construction of 48 town houses in timber and iron, and the renovation of the three terrace houses and shop. On 20 June 1979 the two men executed a deed of trust confirming that the Newtown properties were held by them in trust as to one-half for A.R.M. and as to one-sixth each for the three Ghosn companies. Messrs Ghosn and Metlej asserted that the purchase of the Newtown properties was pursuant to the arrangement they had earlier made and that their intention was to
ATC 4796construct town houses and to renovate the three existing terrace houses, and thereafter divide or partition the units equally between A.R.M. and the Ghosn companies. About two months after the date of the contract an offer to purchase the properties for $550,000 was made by a real estate agent to Mr Ghosn and rejected. In May 1979 Mr Loftus, the accountant, was asked to prepare a budget for the cost of construction of 48 two-storey town houses with parking. The development application to the South Sydney Council had been approved in October 1977 and an extension had been granted which required the work to commence before 5 October 1980. This provided for the demolition of the existing buildings on the site with the exception of the three semi-detached cottages, 24, 26 and 28 Fitzroy Street, and the shop. The budget prepared by Mr Loftus envisaged the sale of the shop at 42 King Street and estimated the cost of construction of the completed project at $700,000, the cost per town house being $13,230. On 30 April 1979 A.R.M. applied to the Perpetual Trustee Company Limited for a loan of $250,000 on the security of the property which it owned at Marrickville, and such loan was approved. It was designed to assist A.R.M. to provide its share of the estimated cost of acquisition and construction of the Newtown properties.
In late April 1979 Mr Ghosn interviewed Mr Spencer, then the loans officer at the Dulwich Hill branch of the Commonwealth Bank, of which Ghosn was an established customer. He sought increased overdraft accommodation of $800,000 to enable the Newtown project to be financed. Mr Spencer was not able to recall the precise words spoken at the interview, but on 1 May he wrote a submission to the bank's head office seeking approval for the borrowing. The submission said that "the firm has now the possibility of securing land at Queen Street, Newtown...". In fact, of course, the contracts had already been signed. He said also "the firm has obtained an investor who has had many years experience in the building game and who is willing to advance $200,000 plus his expertise towards the project to reduce the firm's borrowing and to cut down on costs. The investor (well-known in the building game but who unfortunately is heavily involved with another bank) has agreed to advance these moneys on the understanding that his return on the investment will come only after proposed bank indebtedness is cleared first". The submission said that "borrowing firm's present income is derived solely from rentals received from its assets" the current gross rents being said to be about $147,000 per annum. Under the heading "Repayment arrangements" the document said, inter alia:
"Proposed increase in accommodation is to be cleared from the sale of completed town houses. The firm is expecting a net sale price per unit of $33,000... estimated term of construction should be eight months... and the firm is confident that a further six months should see sufficient units sold to clear bank indebtedness sought (28-30 units). Proceeds of remaining units will be used towards repayment of investor's contribution plus agreed profit and the firm in the interim will pay investor wages yet to be determined during construction... There appears little doubt that project will prove a successful one with a net profit to the firm in the vicinity of $200,000. We mentioned that C/C/V costing of the project may prove higher than firm's estimate. In this regard Messrs Ghosn have pointed out that forming part of property to be purchased are three semi-detached cottages (24-28 Fitzroy Street)... which will not be pulled down to make way for construction of the town houses. These properties with a little bit of work can and will be sold individually (cottages $40,000 each and shop premises $70,000) for an estimated net return to the firm of around $160,000. These funds will be made available to cover any shortfall in original estimates to complete construction."
On 15 June 1979 Mr Stuart, the manager of the Dulwich Hill branch of the bank, wrote to "The Proprietors, Emag Properties", C/- Mr Loftus, advising that an increase of $800,000 had been approved to assist in the purchase of the land and the construction of the properties at Newtown, making total accommodation then available $918,657. Condition 5 said that a settlement fee would be charged for each unit sold. The letter also required that the contribution of $200,000 being made available by Mr Metlej and/or his company was to be promptly lodged with the bank and utilised entirely in the purchase of the land and the early stages of the work involved. Paragraph 10 said:
"In order to complete the project within the limit of the accommodation now approved, it will be necessary to pursue a sale of the property at 42 King Street, Newtown, and probably also the other properties which it is not proposed to demolish..."
Completion of the purchase of the Newtown properties took place on 25 July 1979 and thereafter excavation work commenced. Mr Metlej undertook the day to day management of this work. On 26 July the present appellants executed a mortgage in favour of the Commonwealth Bank over the Newtown property and the Ghosn companies provided collateral security over their properties at Marrickville and Dulwich Hill. At a meeting of the Directors of A.R.M. held on 26 July, under the heading "Joint Venture Project - Newtown", it was recorded that the purchase had been completed and the construction would commence immediately and further:
"IT WAS RESOLVED that the business of the joint venture be the construction of 48 town houses and the renovation of three existing terrace houses and a shop fronting King Street, Newtown. IT WAS FURTHER RESOLVED that at completion of construction the company would take its half share of the property which it would retain as a long term rent producing investment."
Prior to the commencement of the construction of the town houses, the appellants decided to alter the existing approved building fabric from timber and iron to full brick, concrete and titles. In relation to this Mr Metlej said in his affidavit:
"9. I say that demolition work at Newtown was commenced on the day of settlement. This work was carried out in a manner which would save as much of the material as possible for re-use in the new buildings and all timbers were stacked in the shop for re-sawing. Excavation work was commenced for the carpark. While this was going on Emile and I were continually discussing the plans and specifications between ourselves. I became concerned that the specifications could be in breach of Ordinance 70 of the Local Government Ordinance. I was of the opinion that if a building constructed of timber and iron was erected on top of the car park, it would, in my experience have been in breach of Ordinance 70. This fact and the availability of materials from the demolition of the existing buildings aroused my thinking on the whole project. Emile and I decided that as part of the building had to be altered from the original plan it was in both our long term interests to change the whole construction to one of brick, title and concrete so that maintenance would be lessened in future years.
10. I say it would have been to our advantage to sell the materials, (especially the bricks because they would not all have been required) and to keep to the specifications that did not contravene the ordinance. If I had not intended to keep the units for a long term investment it would have been much cheaper to build in the materials originally specified. I did an estimate of the extra cost involved to make sure we would not be over burdened at the end of the project and to be sure we would be able to service any extra cost involved. It appeared to me that the increase in cost would be minimal taking into account that the shop had to be sold and perhaps, if necessary, the three terrace houses. It appeared to me that at that stage that extra money from the bank would not be required.
11. Amended plans were lodged with the Council for full brick, concrete and tile construction. The engineer's plans were passed by South Sydney Council and we commenced operations on the foundations. The shop was put on the market. I was informed by the Council that work on the site could continue and that the amended plans would be stamped. Some time late in 1979 Emile and I asked the Commonwealth Bank for a further draw down on our loan. A valuer from the bank came out to inspect the site. I told him that the plans had been altered to accommodate the changes we had made following the non compliance of the stamped plans with Ordinance 70. A Council Inspector then visited the site for another inspection. I asked him if he would bring our stamped plans with him next time he came. He came a few more times for inspections without bringing the plans. I received more telephone calls from Mr Stuart regarding the plans and he became
ATC 4798very anxious over the delay. I went to the Council to obtain the plans but they could not find them. Later the Council's inspector came to the site and told us the plans were not approved.
12. I told the inspector that the plans had been approved. The inspector went back to the office, and returned to the site to tell me that they had not been approved and that work may have to stop on that part of the building which was not approved, which as I recall was the brick work.
13. Mr Stuart threatened to stop payment of any further cheques unless the amended approved plans were given to him. The Council at about this time issued us with a notice to stop work. The shop was full of timber which we had stored in it, to re-cut for the building, so we tried to sub-divide the terrace houses to sell them as they were. All this was in vain as the terrace houses could not be sub-divided. I also found we could not sub-divide the shop either at this stage. The bank at this point requested me to give them details of how the increased cost of construction was made up and this was given to them about March 1980.
14. I went to the South Sydney Council and had a meeting with some officers to point out that the main reason for amending the plans was due to the fact that a major part of the original plans were in breach of Ordinance 70. The Council agreed to expedite the amendments and recommend approval. Finally about March 1980 our plans were approved by Council and a copy of the plans was given to the bank. Extra costs were being added from everywhere, the delays, the rising costs in material and labour were very high. The shop could not be sold nor could the terrace houses. I knew we needed extra finance to complete the project. Exhibited hereto and marked with the letters `AM16' is a true copy of a statement of additional funds required to complete the project and given to Mr Stuart on 13 March 1980."
The "statement of additional funds" which was given to Mr Stuart on 13 March 1980 was prepared by Mr Loftus following a meeting at which, according to Loftus, Ghosn had said to him "I am worried about the increased costs of Newtown and rising interest rates. But I do not want to sell any part of my share of the Newtown property; I might however sell Wardell Road". The document in question (which was exhibit "O") showed that additional funds of $390,000 approximately would be required. Thus it was not until March 1980 that the South Sydney Council formally approved of the change in plans and by this time the cost over-runs were of the order of that mentioned, interest rates had risen significantly, and at least by April 1980 the relationship between Mr Ghosn and the bank had become strained.
Mr Metlej, in para. 15 of his affidavit, said:
"By May 1980 relations with the Bank Manager, Mr Stuart were at an all time low. The continually changing circumstances which I never envisaged would arise from the outset were causing me tremendous concern and I felt the situation was beginning to get beyond my control at this stage. Mr Stuart became very annoyed with Emile Ghosn and I and he suggested Emag Properties should approach C.B.F.C. Limited, the Bank's finance company. Their interest rates as I recall were approximately 17.5%. The Bank Manager, said words to the effect, `that the Bank would not advance any more money to us under any circumstances and to find money to complete the building elsewhere'. The loan we had from the Bank reached its peak. Our solicitor was approached by Emile and I for long term finance by Emag Properties. The solicitor was able to have one of a number of securities owned by Emag Properties released from the Bank. A loan of $400,000 from the Perpetual Trustee Co. Limited was granted. At that stage I was no longer on good speaking terms with Mr Stuart the Bank Manager."
On 26 May 1980 the Ghosn companies sought from Perpetual Trustee Company Limited a loan in the sum of $400,000, the purpose being stated as "to build town houses". That loan was approved by letter dated 9 June 1980, the security to be a first mortgage over property at The Boulevarde, Dulwich Hill.
A letter from the Commonwealth Trading Bank to Mr Ghosn dated 4 June 1980 had said:
"We confirm the advices conveyed to Mr Albert Metlej by our Mr Norris on 7 May
ATC 4799that before releasing its charges over the properties in The Boulevarde the Bank would need to be satisfied that outside finance sufficient to complete the Newtown project has been arranged. In this regard Mr Metlej informed the writer on Friday 30 May that you were holding a letter stating that a loan of $400,000 had been approved and this letter would be produced to the writer on Monday 2 June.
On the information available to the Bank and as advised by the writer on 2 May, $400,000 would seemingly not be sufficient to allow you to complete the work involved, meet accruing interest and charges, the payment of $42,900 to South Sydney Council and the various other miscellaneous charges involved in a project of this nature. Accordingly, we should be pleased if you would furnish us with details of your estimates of outgoings to complete the project and how these outgoings are to be financed together with confirmation of the finance arranged.
During our discussion with Mr Metlej we mentioned that the funds held in the account of Emag Properties and A.R.M. Constructions Pty. Limited would be exhausted in the near future with interest to be debited to that account in the next few weeks. It was therefore stressed that every endeavour should be made in your own interests to expedite the obtaining of the necessary finance and also the sale of the shop at 42 King Street as the Bank is not prepared to allow any latitude beyond the facilities already approved.
With a view to minimising any delays on the Bank's part in releasing charges over The Boulevarde properties the writer has arranged discharge of the relative mortgages and a further inspection of the Newtown work in progress.
We mention that it will be necessary for both you and Mr Metlej to call at this office and sign documents covering the release of The Boulevarde properties.
We again express our regrets that the limitations imposed on all banks' lending activities have precluded the Bank from providing you with additional funds beyond those originally approved."
Mr Metlej, in his affidavit, after referring to the problems detailed in para. 15 which I have earlier set out, said:
"Following these events I knew that some part of both interests in the projected investment would have to be sold. The cost of the project had increased beyond Emile Ghosn's and my expectations and interest rates were also increasing beyond those we had envisaged at the start of the project. By this stage the debt to the Bank was about $800,000. My $200,000 had been applied to purchase 50% of the land."
Paragraphs 17 and 18 were as as follows:
"17. I say that funds began to get low towards the finishing stages of the job. I rang the Manager at General Credits Limited and told him I required some urgent funds. The Manager, Mr Noel Martin, came out to the site and I told him we required another $175,000 to finish the job and that I would give him a second mortgage on the Newtown property plus a second mortgage on Schwebel Street, Marrickville. I was desperate for funds at this stage. General Credits Limited advanced us $170,000 at 16.0% per annum, however, $20,000 of this was to be set aside to meet interest payments. Exhibited hereto and marked with the letters `AM4' is a true copy of a letter dated 23 September 1980.
18. Before completion of the project, money was running out again and I asked General Credits Limited for another $100,000 which they advanced and interest on the $270,000 increased to 16.5%. I said to Mr Martin of General Credits Limited words to the effect that `its loan would be repaid out of proceeds of sale of part of the Newtown project as at that stage the project could not carry this additional loan'. Interest rates at this stage were very high and I was also under pressure from the Bank to repay the loan. It was difficult to have the Bank release its securities on the property to obtain alternate finance, as not only did General Credits have a second mortgage over it but also the Bank now wanted repayment from sales. I say that we had no alternative but to satisfy the Bank as quickly as possible, by selling some of the town houses. I knew A.R.M. would have to sell a greater share of its units than Emag
ATC 4800Properties would have to, as Emag had borrowed more money than A.R.M."
The letter of 23 September 1980 to which reference is made in para. 17 (and which became exhibit "P"), indicated that the loan would be granted upon the security of a second registered mortgage over A.R.M.'s property at Schwebel Street, Marrickville, a second mortgage by A.R.M. and Emag over 5-17 Queen Street, Newtown, and joint and several guarantees by Mr and Mrs Metlej.
Mr Martin, who was the manager of the Bankstown branch of General Credits Limited, said that in September 1980 he first met Messrs Ghosn and Metlej when they were seeking additional finance to complete the project at Newtown. On 12 November 1980 A.R.M. sought and obtained a further loan from General Credits Limited in the sum of $100,000, this being the amount referred to in para. 18 of the affidavit of Mr Metlej. The document signed by Mr Martin at the time said that the principal would be repaid by the end of the term (which was 12 months) through sale of the Newtown property as individual strata title town houses. It was stated also that contracts "have been issued" for 13 of the town houses at $75,000 each, and that the shop premises were the subject of a contract of sale. In evidence Mr Martin said this:
"Q. At the time. Can I take you to par 7 and in particular the second last sentence `We advise that contracts have been issued for 13 of the town houses at $75,000 each and there are three contracts in the shops at $110,000, total $1,085,000 gross. Contracts are not yet exchanged'. Do you see that? - A. Yes.
Q. Was it your understanding when that document was prepared that General Credits was intending to pay out General Credits from the proceeds of sale from those 13 town houses and three terraced houses? - A. Yes, after the first mortgagee.
Q. And it was the fact that it was from the proceeds of those sales that General Credits second mortgage was in fact paid out in full? - A. I believe so, I don't have that information. It's reasonable to assume it.
Q. Can I just take you to the document which is next attached to your affidavit, dated 12 November 1980, and there is a reference on the second page of that document, to a number of properties under the heading `To be sold on completion as follows'? - A. Yes.
Q. Of course so far as you were concerned - when I say you, so far as your company was concerned - it was looking to proceeds of sale of properties at Newtown for the reduction of its borrowing? - A. That's correct.
Q. Or its lending, and for the purposes of this application it was necessary to indicate to the company the sort of value that it was getting, is that right? - A. That's correct.
Q. Particularly as it was a second mortgage, and in order to convey to your Head Office the dimension of value which would be available to it, you asked Mr Metlej to give you his estimate of selling prices for each strata unit of the Newtown property? - A. That's correct.
Q. And when he provided that material to you, would you agree that he made it clear to you that in fact only so many units as were necessary to sell to redeem the mortgage, would in fact be sold? - A. Yes; I am afraid I cannot remember the conversation per se but certainly we would have only been interested in sufficient to quit our loan.
Q. Did Mr Metlej at some stage indicate to you that, except to the extent as was necessary to sell strata units so that your loan could be quitted, it was the proposal of himself and Mr Ghosn to lease the properties at Newtown? - A. Yes, I was aware that quite a number of the properties would be leased.
Q. You state that you were aware that the properties at Newtown were to be let, in the qualified way which my question invited you to. Is that a matter of which you were aware at the time this document of 12 November 1980 was prepared?
Q. I think you said at some stage you became aware of an intention to lease the properties at Newtown except to the extent as was necessary to sell properties? - A. Mmm hmm.
Q. To redeem the General Credits borrowing, lending, and the General Credits lending of course would not be redeemed
ATC 4801until the bank's first mortgage was redeemed. Now, what I wanted to ask you was, I think at the time this document was prepared on 12 November 1980, I think you were aware that the building was close to completion? - A. Yes, I had inspected the building.
Q. When you had inspected it, it was just a matter of tidying up and fitting out? - A. Mmm.
Q. And were you aware at the time you inspected the property that it was the intention of Mr Metlej and/or Mr Ghosn to lease so much of the property, the units at Newtown, as were not required to discharge the first and second mortgages? - A. I am sorry, memory fades [sic] me. I am reasonably certain that I did know that, yes.
Q. At what stage did you know it? - A. When we entered into negotiations to advance the funds.
Q. And that was something which had probably been indicated to you when you were making your inspection? - A. Yes."
In early December 1980 the work at Newtown was finished and a certificate of compliance issued. In the meantime, on 10 October 1980, Kelly & Sons Real Estate Pty. Limited were retained by A.R.M. and Emag to sell 15 town houses and to lease the remainder as from the date of completion. In fact only 13 units were sold, and from the proceeds the balance owing to the bank and to General Credits was discharged. On 9 March 1981 a deed of partition was entered into between A.R.M. on the one hand and the Ghosn companies on the other in relation to the 48 town houses, whereby 24 nominated dwellings were "transferred to A.R.M. Constructions Pty Limited for its own use absolutely" and the balance equally to the three Ghosn companies. It was not expressed to relate to the three terrace houses or the shop premises. All of the 13 town houses sold were the subject of contracts of sale entered into prior to the date of the deed of partition, although with one exception (lot 40) all were completed after the date of such deed. In Mr Loftus's affidavit he said:
"8. In November 1980, Mr Ghosn came into my office and we had a long discussion about difficulties encountered on the Newtown project. He said to me words to the effect: `I have decided to sell 5 of my Newtown town houses. Alternatively I would keep those 5 units and sell Wardell Road Dulwich Hill. If I sold Wardell Road, would I have a tax problem?' I said `I could not be sure, I could write to the Tax Department as we did in relation to 97 The Boulevarde Dulwich Hill, but it would take some time to get an answer'. Mr Ghosn said: `I don't think we have spare time, I will go ahead and sell the 5 units'.
9. In the upshot, A.R.M. sold 8 units (Nos. 6, 7, 16, 17, 18, 19, 29 and 30) and the Ghosn Companies sold 5 units (Nos. 40, 41, 46, 47 and 48). The proceeds of sale were applied firstly to repay General Credits and secondly to repay the Commonwealth Bank; such application of funds occurred direct, but in my accounting function, I credited the proceeds of sale of the 8 units to A.R.M. and the proceeds of sale of the 5 units to the Ghosn Companies, and the taxation returns reflected those circumstances."
Details of the four units sold jointly, and of those sold by Emag and A.R.M. individually, are set out in exhibit "AA".
Prior to the execution of the deed of partition all of the 35 units had been leased, the leases, a schedule of which is exhibit "AB", being dated between October 1980 and March 1981. Since the deed of partition each company has continued to lease such of the units as were transferred to it, and there is no evidence of any further attempted sales of individual town houses. The sales of the three terrace houses and of the shop premises were completed in 1981, and this was by the appellant companies as joint owners, in their respective proportions. Apparently the sales were not completed earlier because of unforeseen difficulties in relation to the production of separate titles.
I return to consider the Bankstown property which had been purchased in February 1979. Completion had occurred on 14 September 1979 but in the meantime in July Messrs Metlej and Ghosn had mutually decided to defer the construction of the premises at Bankstown by reason principally of their preoccupation with Newtown. I have already set out the terms of the minutes of the meeting of directors of A.R.M. held on 17 September 1979 when it was noted that work on the Bankstown project
ATC 4802would not commence until Newtown was completed. On 29 December 1981 General Credits Limited informed A.R.M. of its approval to a loan of $350,000, this being to enable the work at Bankstown to be commenced. A mortgage later entered into by A.R.M. and the Ghosn companies as mortgagors provided for the date of the first payment under the mortgage to be 30 April 1982. The term of the loan was two years. Originally the plans drawn by the architect in relation to the Bankstown project provided for 14 units, but he was instructed to reduce this to 12 by Mr Metlej "because I would be holding on to them". The building was completed about 24 June 1982 and thereafter a strata plan was registered. Of the 12 units, seven were first let by the end of July 1981, another two by the end of August, one in September and the last by the end of October. On 19 January 1983 the Ghosn companies and A.R.M. entered into a deed of partition allocating six nominated units to A.R.M. for its own use absolutely, and the other six to the Ghosn companies in equal shares as tenants-in-common for their own use. Thus partition took place after all the units had been let. Mr Martin stated in his affidavit that in January 1983 Mr Metlej spoke to him about a reduction in the interest rate, saying words to the effect "We prefer not to sell the units until the market improves, but the interest rate on our loan with General Credits Limited is excessive...". In cross-examination Mr Martin said:
"Q. Would this correctly reflect your understanding at the time the Bankstown transaction was entered into, that the primary, or the preferred intention of your customers in relation to the Bankstown property was to keep them for letting with the aid of long-term financing, but if that could not be achieved, they then would have to sell the units to quit the General Credits advance? - A. I believe that to be so. As I remember, the clients didn't really want the development site let at that stage but I think their development approval was due to expire and so they were forced to go ahead with the construction, and at that particular period of time it wasn't a good time for developing in some areas."
In relation to this Mr Metlej said:
"Q. Do you remember ever in the course of your discussions with Mr Martin saying to him anything to the effect that `We prefer not to sell the units at Bankstown until the market improved, but the interest on our General Credits loan is excessive', do you recall ever telling him that? - A. I don't recall, but that could have happened. I can't recall the exact words.
Q. If you said something to that effect to Mr Martin did that reflect some intention of yourself and Mr Ghosn to in fact sell the units when the market improved? - A. Not at all.
Q. Was there any purpose in your saying that to Mr Martin? - A. I can't recall saying that, but we were pretty friendly with Mr Martin, like we were with Mr Stuart, and things would have been discussed - not necessarily from us, they could have just come up in conversation or from him or from us and I don't know the purpose of it.
Q. Well, you may have said that, but you don't know, if you did, why you said it? - A. I can't recall, but it could have been said, yes.
Q. Do you remember ever saying to him about Bankstown that it was on the market? - A. No really, no, because it wasn't.
Q. It was never on the market? - A. No.
Q. Did you ever tell him that you might choose to sell some or more of the units to discharge the loan to General Credits, but that you would prefer to hand onto them until the market improved? - A. Not really, because from the point of view, as a completed project, we were losing money on it. We would have made money if we sold it then, we could have made a profit.
Q. At any time during the course of construction of Bankstown did you discuss with Mr Ghosn the possibility of selling? - A. No because there was no need to, it is not necessary. What we did after the loan expired we just put it in different names, we asked Mr Martin to give the Ghosns their loan on their six units and us on ours."
In 1984 A.R.M. refinanced its half interest in the loan from General Credits Limited on a longer term basis with Marrickville R.S.L. Club Limited. All of the companies still retain all of their respective units, none having been sold.
The respondent increased the taxable income of each of the appellants in relation to the years in question for the reasons appearing in letters written to their solicitors. One such letter, which is typical of the others, was in these terms:
"Your letter of 22 March 1985 requested reasons for increasing the taxpayer's taxable income by the amount in dispute during the year ended 30 June 1981 and the following comments are offered in response to that request.
A.R.M. Constructions Pty Ltd. and the Emag Properties partnership acquired, improved and subsequently disposed of certain property at Bankstown and Newtown. Firstly, the excess of consideration received or receivable over the estimated cost of acquisition and improvement of the parts of the property sold, and secondly, applying the relevant trading stock provisions of the Income Tax Assessment Act, the value of the balance of property in excess of the estimated cost of its acquisition and improvement was included as the net income of A.R.M. Constructions Pty Ltd. and Emag Properties. The taxpayer's share of the net income was calculated as set out in the attached annexures, which also explain the manner in which the taxpayer's assessable income for the years ended 30 June 1980, 1982 and 1983 was arrived at."
The principal issues which, in consequence, arise in the present appeals are, firstly, whether unsold units and town houses were trading stock of a partnership business of development and resale as at the date of the deeds of partition (9 March 1981, in the case of Newtown, 19 January 1983 in the case of Bankstown); secondly, whether at the relevant time A.R.M. and the Ghosn companies were carrying on business in partnership and whether, if so, it had as its object the making of a profit from the sale of land in the redeveloped form; thirdly, whether the net profits arising upon the sale of the town houses, the three renovated terrace houses and the shop premises were within the assessable income of the appellants by reason of the provisions of sec. 26(a) of the Income Tax Assessment Act (so far as the shop is concerned, it was conceded that the net profits were assessable, since it was the intention of the appellants from the outset to sell such shop in order to assist in funding the development at Newtown); fourthly, whether, if there was brought into existence a partnership business between the appellants of development and resale in relation to either or both the Bankstown and Newtown properties, and the unsold units or town houses were assets of that business, they ceased to have the character of trading stock before the respective partitions were duly effected by virtue of the fact that they were committed to investment by way of leasing prior to partition; and finally whether, in any event, there was any warrant for the imposition of penalties such as were imposed in the present cases. The total amount of tax and penalties disputed is of the order of $1,334,000.
The only provisions of the Income Tax Assessment Act to which it is presently necessary to refer are the following: "Partnership" is defined in sec. 6(1) to mean "an association of persons carrying on business as partners or in receipt of income jointly, but does not include a company".
By sec. 25(1) the assessable income of a resident taxpayer includes the gross income derived directly or indirectly from all sources, whether in or out of Australia. Section 26 at the relevant time provided, inter alia, that the assessable income of a taxpayer shall include profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme. Section 36(1) was as follows:
Subject to this section, where -
- (a) a taxpayer disposes by sale, gift, or otherwise of property being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale;
- (b) that property constitutes or constituted the whole or part of the assets of a business which is or was carried on by the taxpayer; and
- (c) the disposal was not in the ordinary course of carrying on that business,
the value of that property shall be included in the assessable income of the taxpayer, and the person acquiring that property shall
ATC 4804be deemed to have purchased it at a price equal to that value...
- Where, for any reason, including -
- (a) the formation or dissolution of a partnership; or
- (b) a variation in the constitution of a partnership, or in the interests of the partners,
a change has occurred in the ownership of, or in the interests of persons in, property constituting the whole or part of the assets of a business and being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale, and the person, or one or more of the persons, who owned the property before the change has or have an interest in the property after the change, section 36 applies as if the person or persons who owned the property before the change had, on the day on which the change occurred, disposed of the whole of the property to the person, or all the persons, by whom the property is owned after the change.
The first matter with which I propose to deal is whether the strata allotments at Bankstown and/or the unsold town houses at Newtown were trading stock of a partnership business of development and resale as at the date of the respective deeds of partition. The critical threshold question is to determine what the appellants intended to do with the properties at Bankstown and Newtown when they acquired them. On behalf of the Commissioner it was submitted that the evidence supported the conclusion that at that stage they planned to act as partners in the construction of home units for eventual resale, and that their later decision to retain some units was brought about by a change in circumstances, in particular the unexpected increase in the value of the Newtown units and the immediately perceived adverse income tax ramifications which would ensue were the original objective carried into effect. In support of this submission reference was made in particular to the information said to have been provided on behalf of the appellants to the Commonwealth Trading Bank at the time of the Newtown purchase; the short-term nature of the borrowings for each purchase and the basis on which the finance was provided (i.e. that the loans would be repaid from the anticipated proceeds of sale); lack of any realistic calculations regarding the viability of the projects as long-term rental investments; the statements allegedly made to the bank officers as to the likely incidence of taxation in the event of a sale during the financial year ended 30 June 1981; and the absence of any earlier agreement as to which particular units were to be taken by the participants under the partitions. The respondent submitted also that the relationship between A.R.M. and the Ghosn companies was a partnership because the companies were controlled by Messrs Metlej and Ghosn who enjoyed a mutual trust and confidence, who were to participate together in the management and control of the projects on an equal footing and were to pool their resources and expertise together for that purpose; the companies carried on business in common with a view to profit; the alleged agreement made in late 1978 was so imprecise as to amount to no more than a vague understanding that the companies would together construct the units with a view to profit; and the parties were in receipt of income jointly, both from rental and the sale of the properties.
I have come to the conclusion that I should accept the substance of the evidence given by Mr Metlej and that of Mr Loftus. Mr Ghosn was not a satisfactory witness in a number of respects and I accept his evidence to the extent that it is corroborated.
So far as the Bankstown property is concerned, although there was discussion between Messrs Metlej and Martin of the possible need to sell some of the units at Bankstown when completed in order to discharge the indebtedness of the appellants, I am satisfied that the primary intention and agreement of the latter was as reflected in the evidence of Mr Martin as to his understanding of such intention, in the passage which I have earlier set out.
In relation to the Newtown properties there is, on the face of it, conflict between the records of the Commonwealth Bank and the evidence of Messrs Metlej and Ghosn. The latter agreed that virtually from the outset they formed the intention to resell the shop premises, and they considered that it might also become necessary to resell the terrace houses,
ATC 4805all this to assist the funding of the development.
A number of matters entered in the records of the bank in relation to the application for a loan by the Ghosn companies were plainly erroneous; some were obviously included as an inducement to head office to approve the loan; and some are inconsistent with the documents brought into existence at or about the same time, and other objective facts. There is little doubt, as those records reveal, that, in view of the decision to alter the approved building fabric from timber and iron to full brick with concrete and tiles in relation to Newtown, and in view of the cost over-runs in the order of $400,000, the significant rise in interest rates, and the substantial increase generally in the cost of the whole project, the companies finally resolved irrevocably to sell some 15 town houses out of the total number of 48, as well as the three renovated terrace houses and the shop. In fact only 13 units were sold. I am satisfied that in May 1979, when Mr Spencer wrote his memorandum concerning the application for increased accommodation to head office, the expressed intention of the appellants was to sell such of the properties as would be necessary to repay the indebtedness to the bank. Although the document completed by Mr Spencer refers to 28-30 units being sold to clear such indebtedness, in fact the appellants informed the bank that they would sell such units as may be required to be sold for the purpose only of repaying the loan. In the result only 13 were sold together with the renovated terrace houses and the shop.
No challenge was made to the minutes of A.R.M. Constructions dated 26 July 1979 in which reference is made to "joint venture project - Newtown" and in which, as has previously been set out, it was resolved that on completion that company would take its half-share of the property, which it would retain as a long-term rent producing investment; or to the minutes of 17 September 1979 in which, under the heading "Joint Venture Project - Bankstown", it was said that work on such project would not commence until after the Newtown work was completed. Those unchallenged minutes show that in 1979 the intention of A.R.M. Constructions at least was to enter into a joint venture and, in relation to Bankstown (and, by inference, in relation to Newtown) it would take its half share of the property and retain it as a long-term rent-producing investment. So also the deed of partition in relation to Newtown in March 1981 was not challenged as being fraudulent. This was at a time before any contest with the respondent arose. In my view the events which in fact happened in relation to Bankstown and Newtown (in the case of the latter, leaving out of consideration the sale prior to partition) corroborate the evidence given by Messrs Metlej and Ghosn as to their original intentions, and as to their specific intentions concerning the Bankstown and Newtown properties. I find that they arranged in substance in late 1978 to join together to acquire home unit development sites, construct thereon home unit buildings, and thereafter divide or partition the units and town houses equally between themselves. The evidence of Mr Loftus, which I accept, corroborates this conclusion. It is also corroborated by the prior investment histories of the various companies.
F.C. of T. v. St. Hubert's Island Pty. Ltd. 78 ATC 4104; (1977-1978) 138 C.L.R. 210 it was held, by a majority of the High Court, that land was capable of being "trading stock" for the purposes of sec. 36(1). In the present case I am clearly of the opinion that the properties erected at Bankstown, and the unsold town houses at Newtown, were not "trading stock" because in relation to them there was merely a joint venture between the appellants to construct buildings, in contrast to an agreement to make profits for sharing, and it was the intention of the parties at all material times to retain the units and town houses so erected, except to the extent that sales might be necessary to repay moneys borrowed from lending institutions. What in fact has happened in relation to the units and town houses erected on both sites is what, in my opinion, the parties at all material times intended, subject only to the fact that in relation to Newtown it was necessary to sell more properties than had originally been contemplated, having regard to the cost over-runs, etc. In my view the parties associated together to produce a product, a building of units capable of partition between them, so that each could thereafter go their own respective ways. Their expressed intention so to do was duly manifested in what they thereafter did and achieved, and their agreement constituted in law something in the nature of a joint venture to construct a building, in contrast
ATC 4806to an agreement to make profits for sharing inter se. The only partnership for tax purposes related to such rental income as was received jointly before the date of the deed of partition, namely, 19 January 1983 (in relation to Bankstown) and hence such rental income up to that date constituted assessable income within sec. 92. The decisive factor in determining whether or not the units at Bankstown became trading stock at any time up to and including the date of partition was the primary or substantial intent or purpose of the parties, which intention or purpose was carried into execution. The fact that they may have had a secondary or subsidiary purpose in selling the units if that became necessary in order to discharge their subsequent borrowing from General Credits Limited did not stamp upon the units the character of trading stock up to the time of the date of the deed of partition. Thus I conclude that in relation to Bankstown the units never became trading stock of a partnership of property development and trading between the appellants.
In relation to Newtown I conclude that, so far as the unsold town houses are concerned, the situation is the same. I find that Messrs Ghosn and Metlej met together in early 1979 and calculated that it was feasible to retain the property on completion (except for the shop premises) in order to implement the basic partition arrangement which they had earlier made. I am of the opinion that the town houses in fact retained at Newtown, as well as the 13 sold, could not be characterised as "trading stock", a conclusion which extends to the shop and the terrace houses. But I consider that the profit arising on the sale of the Newtown properties in fact sold is assessable under the provisions of sec. 26(a). So far as the shop and the two terrace houses are concerned, I find that it was the intention of the appellants from the outset to sell them in order to assist funding the development, an intention which related with greater certainty to the shop than to the terrace houses. In relation to the latter I am satisfied that, in accordance with the principles discussed in the High Court in
Steinberg v. F.C. of T. 75 ATC 4221; (1976) 50 A.L.J.R. 43, an original intention of the appellants was to redeem purchase and development cost borrowings out of the proceeds of sale of such number of the town houses as were required for that purpose, and that there was a dominant purpose of resale for profit making, notwithstanding that initially it could not be known which particular town houses would ultimately in fact be sold.
I am also of the opinion that there is no warrant for the imposition of penalties under sec. 226(2), for the reason that sufficient details of the sales of the various properties, the purpose of the acquisition of the land, and the construction of the buildings and other relevant details, were adequately disclosed in the income tax returns.
Thus I conclude that, in relation to the Bankstown property, the appeals should succeed; in relation to the Newtown properties the appeals should succeed to the extent that, although the unsold town houses, the terrace houses and the shop should not be regarded as "trading stock", none the less the profit from the sale of the 13 town houses, the terrace houses and the shop is assessable under sec. 26(a); and the respondent is not entitled to impose any of the penalties which he has imposed. The parties should bring in short minutes of the relevant orders which should be made in each of the appeals, and those orders should provide that the respondent pay the costs of the appellants.