Case V133

Members:
BJ McMahon SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 26 August 1988.

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B.J. McMahon (Senior Member)

In the years ended 30 June 1983 and 1984, the applicants, husband and wife, included in their income tax returns a claim for one-half each of a loss brought about by what was described as a joint venture. Income received from the joint venture was by way of rental on a home in the Port Stephens area and expenditure was said to be incurred in gaining that rental. The loss was the excess of expenditure over income. The extent of the expenditure and the quantum of the loss has not been in issue. In 1983, the whole of the loss claimed was disallowed for the stated reason that the applicants were not considered to be engaged in carrying on a business. In 1984, the loss claimed by the husband was disallowed in full but a different assessor came to the conclusion that part of the loss claimed by the wife should be allowed. This application is brought to review all decisions on their objections to the extent that they affirmed the assessments.

2. In both returns for both years it was acknowledged that the parties had used the house on a number of nights. In 1984 for example, it was agreed that they had used the house for 70 nights. It was then alleged in the return that for the balance of the year, the house was available for letting. The return assessed private usage therefore at 19.1 per cent and as the house was let or available for letting for 80.9 per cent of year, expenses associated with the house were apportioned accordingly.

3. The wife gave evidence that she purchased the land on which the house was later erected before she married the husband. At the time that she bought it, she had no idea what form her investment would take although she was adamant that the property was bought as an investment and not as a site for a future home.

4. It was not until after she married that her husband conceived the idea of building a house on the land for, as he said, investment purposes. He had a history of building and renovating real estate for rental purposes and considered that this was the best use to be made of the property at the time.

5. The husband gave evidence that he had built a house similar in style and finish to the subject house and had successfully let it for quite some time. It was, however, located in Maitland, a much more accessible area than the subject house which was in a sparsely populated area around Port Stephens. He was also a 50 per cent shareholder in a company that had purchased derelict houses in areas which, at the time, were unpromising, had renovated the houses and had successfully let them. Both husband and wife also had units in Sydney which they let through agents. They lived in a company house on a property in western New South Wales where the husband was manager of a stockfeed lot for a public company.

6. After their marriage, the land was transferred into the joint names of the husband and wife. The husband sold his Maitland house and both borrowed in order to build the subject house. The total cost of the house was $142,000. The husband gave evidence that he had anticipated a 7½ per cent per annum return (a reasonable return for that time) if he could average out a rental of $200 per week throughout the year. He believed that on a long term basis, he would have been able to achieve this. It should be said that at the time, there was a good deal of local speculation about development in the area. There had been plans for the construction of an aluminium smelter and a new power plant nearby. The husband gave evidence that through talking with others in the neighbourhood and through his own knowledge, he had come to the conclusion that there would be a demand for good quality housing in the area for executives of these companies associated with these developments. The house would also have potential for holiday letting.

7. Before the house was finished, he had it inspected by a local agent and commenced to advertise it extensively for letting. A selection of advertisements and promotions was tendered in evidence. These included display advertisements inserted in newspapers, such as The Land and Open Road, as well as in the daily newspapers and in specialised journals, such as Qantas News. There were also tendered letters which the husband had written to companies associated with the proposed aluminium and power developments in an endeavour to interest those companies in taking block bookings for their employees. The property was also listed with several real estate agents, including the agent in Sydney that managed the wife's unit. Over the period of two years after the house was built, evidence

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was given that approximately $2,000 had been spent in advertising.

8. The applicants had no trouble letting the house over Christmas and New Year. There was, however, only limited interest at other times of the year. It was a high quality house and fetched good rents in the high season. At Christmas, it would let for $500 per week with ease. Rents were set by the agent after consultation with the husband. The husband gave evidence that the lowest rent he could remember being paid was of the order of $300 per week. He said that although he would have been interested in letting the property on a long term basis in order to obtain more money from the investment, he was not approached for any such letting and accordingly the question of what he would have charged, or what the agent would have recommended, did not arise. He also gave evidence that he had never refused a short term letting. On one occasion, the property had been let for five days. On another occasion, an agent had suggested that a lower rent should be accepted and he agreed with the suggestion.

9. At no time was the property let to relatives. On two occasions, it was let to business contacts but it was done through an agent and they paid the full rental. Although there were acknowledged family holidays at the house, the husband gave evidence that his family also went to other places for their holidays. He denied that he came to the house to escape unpleasant working conditions at the feedlot. Both he and his wife insisted that they enjoyed the life style on the rural property.

10. An attempt was made by the applicant's representative during the hearing to show that the number of nights already acknowledged to have been occupied by the applicants should be reduced for the purpose of apportionment because some of these visits were in the course of inspecting and maintaining the property. In my view, that attempt was not successful. The wife kept a detailed diary and from that record, a schedule was prepared showing the dates of the visits and the wife's purposes attributed to them. However, nearly all of the visits occurred on weekends. Some of them were for dealing with matters that could not have any connection with the gaining of assessable income. For example, in August 1983, the schedule shows that two nights were spent on the property and the reason given was ``boat delivery''. The wife gave evidence that this referred to a cabin cruiser that they had acquired but which was not available to tenants for letting. On another occasion the reason given was ``oyster farmers''. This was explained by the fact that the husband was negotiating with local oyster farmers to begin his own separate business at some time in the future. The number of occasions, the fact that they occurred on weekends, the very minor nature of the repairs and inspections referred to in the schedule and the irrelevant reasons given for some of the visits, lead me to reject the proposition that any of the nights already acknowledged as private should be reduced for apportionment purposes if any apportionment is, in fact, called for. In any event, there was evidence given by the local real estate agent that it was part of his function to arrange for cleaning, to arrange for inspection after cleaning, to arrange for repair jobs and garden maintenance. In response to this the wife said that agents ``could only do so much. They only do what you ask them to do''. That certainly did not seem to be the view of their agent who gave evidence on the hearing of this application.

11. Despite all the efforts to obtain tenants, and despite constant contact with the agents, encouraging and urging them to greater efforts, the husband and wife were unable to make a profit out of the lettings in either year. Shortly before the end of the second financial year under consideration, the husband and wife moved into the property to live there. Evidence was given that the company for which the husband worked had been taken over by another public company. Because some of the assets for which he was previously responsible had been sold off by the new owners in a rationalisation process, he felt ill at ease about his future. He was only 45 at that time and had no former intention of retiring. Nevertheless, he resigned and they were therefore obliged to move out of the company house. He gave evidence that he and his wife decided to move to the subject house as all the others were rented out and this one was not making a profit. Since moving to the house, he has become self-employed through an investment in an oyster farm and through carrying on a consultancy business in the industry with which he was formerly associated.

12. The property itself is a superior dwelling in brick and timber. The husband denied that it

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was extravagant to build such a house simply for rental purposes. As he put it: ``When I build a rental property I do it properly.'' I accept that evidence, particularly in the light of the evidence that his previous house at Maitland was in the same style and had been successfully let. I am also conscious of the general optimism about the economy in the area at the time when the house was built and the prospects of prosperity thought to be around the corner for all local residents. When it became apparent that this aluminium and associated power development was not to be, there was, according to the agent who gave evidence, a recession from the end of 1982 and throughout 1983. One could, he said, feel the effects of lack of demand in everything. The previous high level of activity in 1978 and 1979 in the area simply disappeared.

13. The same agent gave evidence of the efforts put in by his firm to let the property. He was continually approached by the husband (``He was always after as much money as possible''). For one reason or another, the agent was not as successful at he would have wished. He did not consider that the tariffs charged or asked were excessive. There were no complaints about this from tenants who did accept them. He agreed that the rents charged were top of the range, but he considered that the house was of such a quality that it was reasonable to expect it to command such rentals. He pointed out that there were many other houses in the area that could be let only during school holidays. Although the subject property was better placed than most others, he said that he had two other homes for letting of a similar style in the area.

14. Evidence was given for the respondent by a valuer from the Australian Valuation Office. In his view, the property was superior to most other accommodation in that area but it was unlikely that the applicants would obtain any long term tenant. If there were any prospects of such a tenant, he thought that the asking rate of $250 per week was excessive and that a more realistic rate would have been $125 per week. He agreed, however, that he arrived at this figure by talking to agents in the area and looking at the very scattered and poor evidence available of the nearest thing to comparable lettings. In fact, there was no evidence of any comparable letting of a house of this quality on a long term basis. He had arrived at the figure of $125 per week as a theoretical exercise and as an extrapolation of figures obtained for rental properties of lower quality. In discussing the subject property with agents, he was not of course at liberty to disclose its exact address. Their views as given to him and as relayed by him to this Tribunal must therefore be taken to be only abstract propositions and not considered valuation opinions. The valuer could not comment on whether the site had been over-capitalised, as his instructions did not extend to valuing the land over the period under consideration. He agreed that the rentals charged for peak period lettings for the subject property were in line with other comparable rentals in the area.

15. The respondent's advocate sought to support the assessments with three arguments. Firstly, it was argued that the gaining of assessable income was very much a subordinate purpose of the applicants. It followed, he said, that the principles in
F.C. of T. v. Groser 82 ATC 4478 at p. 4479 and
Ure v. F.C. of T. 81 ATC 4100 should be followed and that the allowable deductions should be limited to the extent of the income derived. He submitted that even though the pursuit of rentals was ``aggressive'' it was only in order to defray expenses. In support of this ``purpose'' argument, he relied on two factors. In their 1982 income tax returns, the applicants had included this sentence: ``The taxpayers purchased land on Port Stephens for the purpose of building a holiday home for letting and for their own use.'' I do not read that sentence to mean that the applicants admit building a holiday home for their own use as their primary purpose. That is not the ordinary meaning of the sentence. Furthermore, such a meaning would be inconsistent with the weight of the evidence already described concerning the priorities that they adopted for letting the house. At no time did either of the applicants take their holidays during the peak letting seasons nor, apart from those periods when they occupied it, was the house ever let at less than market rates.

16. The second submission put by the respondent on the question of purpose was in relation to the rates charged. It was submitted that the tariff of $250 asked for long term lettings showed ``mala fides''. It showed, according to the submission, that active and bona fide efforts to let the property at a

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commercial rental were not being made. I do not accept this submission. Firstly, I am not convinced that there is any evidence that the tariff asked was unusually high. There was evidence that there was no demand for long term letting. Any evidence as to what an appropriate tariff should have been is therefore mere speculation. Secondly, the submission is quite inconsistent with the overwhelming evidence of the commercially real approach adopted by the applicants in their search for tenants. I should say at this point that I accept the evidence of the husband and the wife without reservation. The husband is clearly an astute but straightforward businessman and the wife is a careful recorder of events. Their evidence can be accepted not only because of their natural honesty, but also because it was corroborated by substantial written records. The facts of these applications are quite different from the artificial family arrangement described in Groser and the clear tax avoidance arrangement described in Ure. I have no reason to reject evidence that the enterprise was conceived as a profit-making undertaking, but that because of changes in interest rates, poor demand, and lack of development in the area, the forecasts were not realised.

17. The second submission of the respondent was that in the alternative, the expenses claimed in relation to the property should be apportioned, having regard to the actual time that the property was let as distinct from the time that the property was available for letting. In support of this approach, the respondent relied upon Case P116,
82 ATC 590 and Case R118,
84 ATC 773. In both of those cases, however, the evidence of efforts made to realise the full letting potential of the subject property was vague and unsatisfactory. In Case P116 there was a notable absence of ``active and bona fide efforts to let the property''. This phrase is reflected in para. 25 of the Commissioner's Taxation Ruling IT 2167 dealing, inter alia, with holiday homes. In Case R118 the evidence of the taxpayer led Dr Beck (with whom the majority agreed) to the view that the way in which the taxpayer went about earning income from her investment showed that income earning was a ``relatively minor or incidental object''. In my view, the present facts call for the opposite conclusion. I accept the evidence that the primary purpose of both applicants was the gaining of assessable income and the gaining of an appropriate return on their investment. The fact that they were unsuccessful is, by itself alone, no evidence that this purpose did not exist.

18. This is one of those exceptional cases where strong and verifiable evidence is presented for a definite purpose. It is a case where the applicants are believable and where their evidence is supported and corroborated in all relevant details by objective evidence. The Ruling to which I have referred recognises that individual cases will give results different from those in the mainstream. In my view, this is one of those individual cases. By all the tests that have been evolved for judging whether expenditure falls within the first limb of sec. 51, I consider that the applicants ought to succeed. I also consider that the correct way of apportioning these expenses is by reference to the number of nights occupied by the applicant or his wife against the remainder of the year when the property was available for letting. The deductions, in other words, should be allowed in terms claimed in the original income tax returns.

19. The objection decisions are therefore set aside and the matters are remitted to the respondent with the direction that the losses as originally claimed in the returns should be allowed as deductions against the income of both applicants.