CASE 38/94
Members:P Gerber DP
Tribunal:
Administrative Appeals Tribunal
Dr P Gerber (Deputy President)
The taxpayer (``T'') is a property investor and developer. The issue before the Tribunal involves the fiscal consequences of two developments undertaken by T in the circumstances set out below. Since the events which occurred are such that if I were to place them in the city in which they took place, the identity of the taxpayer would become readily apparent. I have therefore set the action in a mythical city - Atlantis - and changed the names of the streets, various businesses, and numerous bit players - some of whom were called by the two protagonists.
2. In chronological order, the background to this application is as follows. T lodged his income tax return for the 1988 year of income year on 21 April 1989, claiming, inter alia, a capital loss of some $700,000, said to have been incurred as a result of the demolition of the improvements on 18 Swan Street, a property he had purchased in October 1987. An assessment issued 27 July 1989 (which assessed his taxable income for 1988 year of income as returned, save with respect to one item irrelevant to these proceedings).
3. In or about May 1990, as a result of an audit of T's affairs, the Commissioner of Taxation (``respondent'') sought a report from the Australian Valuation Office (``AVO'') with respect to the two developments which T undertook in the 1988 tax year which became the subject of this review - 18 Swan Street and 13 Station Street.
4. In reliance on the reports from the AVO, dated 7 July 1990 and prepared by a valuer (henceforth referred to as ``N''), the respondent issued an amended assessment on 6 September 1990, increasing T's taxable income by, inter alia, (i) disallowing the $700,000 ``loss'' claimed in respect of the demolition of the improvements on 18 Swan Street, (ii) adding some $69,875, said to constitute a capital gain on the sale of 13 Station Street, and (iii) imposing some $49,746 ``additional tax for incorrect return'', being 14.026% per annum simple interest (in respect of the period 27 July 1989 to 12 July 1990) on the amount of additional tax said to be payable as a result of the adjustments.
5. T objected against that amended assessment on 5 November 1990.
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6. After preparing ``Objection Reports'' with respect to the issues relating to the two abovementioned properties, the respondent advised T by letter dated 26 November 1991, that his objection had been considered and disallowed. By a separate letter, also dated 26 November 1991, the respondent explained his objection decision thus:
``In respect of the Loss on Demolition of Building 18 Swan Street $700,000:
Demolition of the building represented disposal of a part of an asset. Consideration on disposal was nil. Upon disposal of part of asset, the apportionment of cost base is governed by section 160ZI. With respect to consideration on acquisition of the relevant property, its whole amount is to be attributed to the land.
In respect of the Capital Gain of $69,875 on the sale of 13 Station Street:
Section 160P deems assets forming part of a building which are treated for the purposes of Income Tax Assessment Act 1936 as amended, as assets separate from the building. It also deems certain capital improvements to be assets separate to the asset to which the improvements were made. Consequently, the assets qualifying for depreciation and the improvements eligible for write-off under Division 10D constituted assets separate from the building. Section 160P requires that on disposal of an asset that is deemed to comprise two or more separate assets the consideration on disposal shall be apportioned between the separate assets. Subsection 160ZD(4) states that where any consideration in respect of a transaction relates in part only to the disposal of a particular asset, so much of that consideration as may reasonably be attributed to the disposal of the assets shall be taken to [be] related to the disposal of the asset.
In respect of the additional tax of $49,746:
The presence of a claim for the $700,000 capital loss on demolition of 18 Swan Street building constituted a statement misleading in a material particular. Non-inclusion of the capital gain accrued on disposal of 13 Station Street attracted the operation of subsection 223(7).
There was no culpability component imposed. Thus, the additional tax is equivalent to section 170AA interest payable on underpaid tax. The additional tax has been remitted to the `per annum' component only (calculated at 14.026% p.a.).
Pursuant to paragraph 193(2)(b), the Administrative Appeals Tribunal has no power to review the Commissioner's decision relating to the remission of the additional tax payable.''
7. By letter dated 8 January 1992, T notified the respondent that he was dissatisfied with the objection decision and requested that it be referred to this Tribunal for review. The respondent complied with that request on 23 April 1993.
8. The hearing before this Tribunal commenced in Atlantis on 15 November 1993, Mr McGill of counsel appearing for T, Mr Batch of counsel appearing on behalf of the respondent. For the convenience of the various professional witnesses and estate agents, most were called at the commencement of the hearing, and it was only after the bulk of that evidence was before the Tribunal that T was called as a witness. This procedure gave me a somewhat prismatic view of the evidence, particularly as witnesses were questioned indiscriminately with respect to the two properties, each raising very different issues, a distortion which was not assisted by the fact that several witnesses were recalled late in the proceedings. The transcript thus reads like the proverbial dog's breakfast, and to present the facts in some kind of coherent order can be likened to recreating the Old Testament from odd bits of Dead Sea scroll which these two ``shepherds'' saw fit to place before me as and when they found them. Doing the best I can with these scraps, the relevant events appear to have occurred in the following order.
9. Beginning with the property 18 Swan Street, it consisted of an area of 506m2 on which stood an old, empty and derelict concrete two storey building which had once been an Indian seafood restaurant - the Bombay Duck - owned by an elderly gentleman, Mr Sing, who had been mentally confused for some years prior to the events with which I am concerned. In March 1987, Mr Sing was declared incompetent to look after his affairs, which were thereupon taken over by the Public
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Trustee pursuant to the relevant Mental Health Services legislation. Suffice it for present purposes if I merely state that the Bombay Duck, being vermin infested, had been closed down by order of the Health Department for some considerable time prior to the sale of the property in 1987. It would appear that as early as September 1984, the Atlantis City Council had issued Mr Sing with an order to repair or demolish the outside laundry on the premises which the Council considered to be a ruin and prejudicial to the neighbourhood's inhabitants. Nothing was done. During 1985 the Council carried out various work on the premises, including securing dangerous portions of a verandah and the building's front walls, removing some rear stairs and boarding up various doors and windows to prevent access to the premises. It seems that the Council did not do a great deal further until January 1987, when it issued Mr Sing with an order to repair or demolish the entire building. It seems that on the same day, the Council erected barricades around the front of the building, fearing that parts of it could collapse.10. Mr Sing having ignored all notices, it appears that the Council demolished the verandah in May 1987, and soon thereafter requested a firm of independent engineers ``to inspect the remainder of the building and report on the state of the building generally'', which they did in a report dated 21 May 1987 (exh C), concluding:
``The building, whilst vacant and restricted for any use, is not considered to be in a dangerous state of repair at present. However, due particularly to the extent of corrosion evident in concrete framing and also some timber flooring areas being unusable, it is considered essential that repairs be carried out whilst it is still feasible and before a dangerous situation does arise.
Repairs to many areas of the building are necessary to allow any human occupation and in fact the rear northern amenities area in particular and the rear verandah are in a dangerous state if used by unauthorised persons.
The building is not watertight and is vermin ridden.
It is considered that the building can be repaired to a useable condition. However, in its present state it remains a danger to possible use by vagrants and other unauthorised persons. If not arrested, the state of disrepair will continue to worsen until the building becomes a danger to neighbouring properties and ultimately nears a state of collapse, particularly during the cyclone season when its resistance to cyclonic wind forces may be tested to the limit.
RECOMMENDATIONS
It is recommended that an order to repair the building be issued forthwith.''
11. Having received the above report, the Council wrote to the Public Trustee on 2 July 1987, advising that it intended to serve notice on him requiring the demolition or repair of the building on the site. This, in turn, prompted the Public Trustee (who had insufficient funds to institute the required repairs) to obtain a valuation from a local valuer who, on 6 July 1987, valued the property at $550,000, a valuation which, it seems, was based solely on the site, since the valuer noted that:
``The existing improvements comprise an old dilapidated concrete two storey building which adds no value to the subject site.''
12. On receipt of this valuation, the Public Trustee instructed a local firm of real estate agents to advise on the best method of selling the property. This agent forwarded a marketing proposal that same month (exh 3). It is sufficient for my purposes if I summarise the thrust of the report:
``The existing development is subject to a `Repair/Demolition Order' for the remaining Bombay Duck Restaurant building. We therefore believe that the ultimate purchaser will have no regard for the existing improvements.
To be more realistic, the property's highest and best use is as a development site, that is to say as part of a larger total development site or as a new commercial development.''
After noting that the Valuer-General's valuation was $35,200, this agent came up with the following financial analysis:
" ASSESSMENT OF MARKET VALUE AND FINANCIAL ANALYSIS
In making our assessment of the market value at which the property is likely to sell at, there are numerous specific aspects of
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this property which need to be considered, these include:-- comparable sales evidence
- redevelopment potential of site
- amalgamation potential of site
- possible owner occupier interest (as a redevelopment)
- possible property investment speculator interest
On the basis of comparable sales, it appears quite clear that a value around $1,050 per square site metre is correctly based on the current sales evidence.
Therefore: 18 Swan Street
@ $1050 per m^2
= $550,000
However, we must point out due to extreme interest through the other factors mentioned, and potential interest in this property, the possible range to an anxious purchaser could be as much as $1300 to $1500 per m2 and possibly even more.
This reflects a possible sale price as follows:-
$1300 per m2 = $660,000
$1500 per m2 = $760,000
We therefore believe the following:-
market evidence sale range $530,000 to $570,000
potential sale range to anxious purchaser $660,000 to $760,000"
13. The author of the above marketing report was called and deposed that at the time of compiling it, he knew that there was a Repair/ Demolition order against the building, but was unaware of its particulars.
14. Acting on the suggested marketing strategy, the Public Trustee sought the Supreme Court's approval to sell the property for $550,000 ``or for the best price obtainable''. In an affidavit dated 3 August 1987 which was attached to an Originating Summons (both part of exh B), the deponent (a member of the Public Trustee's Office) deposed that a local agent had valued the property at $550,000, and in a supplemental affidavit dated 17 August 1987 (also part of exh B), deposed, inter alia, that (i) Mr Sing had no funds available to effect the necessary repairs to the property ``as are required to place it in a tenantable condition''; and (ii) ``no benefit will accrue to [Mr Sing] in its present state and that, in my opinion, a sale of the property is warranted''.
15. Having obtained the Court's approval to sell the property, the Public Trustee instructed the author of the marketing report to offer the property for sale by public auction. In due course, an auction took place in October 1987. The property did not sell, albeit two parties - one a local real estate agent, the other a large developer - each independently made an offer of $750,000, an offer the Public Trustee rejected. T did not attend the auction. Soon after the auction, the auctioneer contacted T and advised him of the two ``rival'' offers, whereupon T made an offer of $800,000, which was accepted.
16. Two local agents were called who claimed to have offered the property for sale at a time when Mr Sing was mentally confused (including an offer by one agent to sell the property to T for $40,000 as a ``renovation project'') even though it became clear that neither agent had any binding instructions from Mr Sing who, in any event, as the evidence progressed, would appear to have lacked the capacity to give any such instructions. This did not prevent one of these agents from preparing a brochure, claiming that: ``I had some instructions from Mr Sing, but it wasn't - but it was a verbal thing.'' (T conjectured - probably correctly - that these agents were trying to find a benchmark price that a purchaser was prepared to offer so that one or other of them could buy it for him or herself at a fraction of its true value.)
17. After the offer of $800,000 had been accepted, T instructed his solicitors to act for him in the conveyance, and a contract of sale was drawn up, dated 29 October 1987 (exh E), which sought a deposit of $50,000, the date of completion being 27 January 1988. The contract did not seek to make any apportionment between land and improvements. A Special Condition provided that:
``The property will be sold subject to all current Council requisitions and conditions.''
18. It seems that in January 1988, a Mr Whirlpool, a partner of the firm of solicitors acting for T, applied for a property search of the records of the Council, which revealed the outstanding repair/demolition order. The building was demolished on 28 February 1988. Mr Whirlpool, who was called as a witness,
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claimed that he was not previously aware of the existence of such an order. He also claimed that he gave no thought to the Capital Gains Tax provisions when making the apportionment of land $100,000, improvements $700,000.19. It was against that background that it is solemnly maintained throughout the evidence before me that at the time T purchased the property, despite the repair/demolition order and notwithstanding the condition of the building as described in evidence, T intended to renovate the building, i.e. that he had no intention to demolish it when he made the offer to buy the property.
20. Since the respondent maintains - with considerable evidentiary support - that the building was worth nothing, whilst the applicant maintained in his objection that he suffered a ``loss on demolition of building'' of $700,000, it is critical to examine the evidence in some detail.
21. In a written statement by Mr Whirlpool, prepared for the purposes of the hearing and dated 12 November 1993 (part of exh B), he states that on 10 February 1988, he:
"caused to be lodged with the Atlantis City Council, Land Tax Office and Valuer General's Department a Notice of Change of Ownership. The apportionment of sale price shown thereon was:-
Unimproved Value of Land
(Freehold) $100,000
Fixed Improvements: $700,000''
When asked by Mr Batch how he arrived at this apportionment, the witness claimed that it was:
``my practice at the time to discuss the question of apportionment with my clients, particularly commercial clients, and whilst I don't have a particular note of it, it would appear to me that I would have discussed that with [T] and as a consequence the apportionment was written on the back of each file.
Mr Batch: But you have no actual recollection of discussing this particular apportionment with this particular client? - No, I can't recall this particular [transaction].''
(tr pp 10-11)
Later, the witness was asked:
``In making that apportionment on the form K and the VG1 - you have spoken of a practice you had - are you able to tell the Tribunal what factors you then took into account in 1988 in advising on or taking instructions on and ultimately lodging an apportionment? - Yes, I can. One of the regards was the current Valuer-General's valuation. And if I remember correctly this one was pretty low, it was about $35,000, $40,000.
I think $35,200 another document shows. Is it? - Yes. And we always, as a matter of policy in the Office - and I know other solicitors do it too - we kept the valuation which we apportioned on the appropriate documentation to go to Government Departments the same as - or fairly close to - the valuation adopted by the Valuer- General. And it's as consequences of that, you know. It means that we're adopting their value and it gives them less resistance to raise the value when they're doing a re- valuation. I think at that time [they] used to do valuations every five years, whereas nowadays they do them annually.
And those re-valuations flow through to affect rates and taxes? - Yes. If your valuation goes up your rates go up, and particularly with commercial clients the land tax is the most damaging to the pocket.
Can you say whether in about January and February 1988, in doing this professional step in the conveyancing, you had regard to or gave advice on the capital gains tax provisions of the Income Tax Assessment Act? - I did not, no, no.''
(tr p 14)
22. In cross-examination, Mr Whirlpool was shown the ``Notice of Sale or Purchase of Land'' form prepared and sent to the Land Tax Office by his firm in October 1989 when acting for T as vendor of 18 Swan Street, the property having been sold in October 1989 to a major corporation for $1.8 million (T had meanwhile erected a new two storey office building on the site), the apportionment being shown as follows:
Unimproved Value of Land $1,252,000
Value of Fixed Improvements $ 448,000
Value of Plant and Equipment $ 100,000
(The witness was not asked to enlighten me on how the value of the land had grown from $100,000 in February 1988 to $1,252,000 in less than two years.)
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23. At the end of the re-examination, I asked the witness in relation to T's purchase of the property:
``THE D. PRESIDENT: I am rather intrigued by the Valuer-General's value for rating purposes in relation to that property being at the relevant time $35,000. That seems a very high disproportion, doesn't it, the difference between that value and the sale price as calculated by you? - It certainly does. I have given it some thought, and whilst I can't say it was the case, it certainly sounded - you know, we apportioned on the base of $100,000 so - I can't remember what happened, but we thought that $35,000 may have been too low, so we put $100,000 on it. That is the only thing I can assume why we put the $100,000 on it. We have given it some thought.
That is the best you can do at this stage, is it? - That's right. See, it is five years ago.''
(tr p 19)
24. Historically, 1988 proved to be a big year for developments in Atlantis. Thus in George Street, the next street running parallel to Swan Street, a large hotel - the Metropole - was in the process of being built on a large block. The Metropole was designed so that the front entrance faced George Street, with the back of the hotel in Swan Street and adjacent to No 18. There was some dispute whether the proximity of 18 Swan Street to the Metropole was an advantage or a disadvantage. Predictably, the Commissioner's witness regarded No 18 as ``a prime site'', whilst T thought that being ``right next to the delivery and dispatch area where they take in the food and send out the rubbish... went against the site, not for it'' (tr pp 104-5). For good measure, at about the time when T acquired 18 Swan Street, he also acquired a large vacant site opposite to No 18 on which he intended to build - and did build - a large office complex which is now known as the Regal Insurance Building. T commenced construction on that site after having received some ``positive nibbles'' from several prospective corporate tenants. He was to say in evidence that as a result of the stock market crash in October 1987, i.e. just after he had bought that property, ``all my prospective tenants lost the urge to commit [themselves] and everything was in a state of indecision'', including the previously expressed intention of T's financial backer to finance the project. It is claimed that it was only after T received a firm commitment ``from a leading Australian company'' to lease three floors of the building that T decided to demolish No 18 ``and to use it - for want of a better word - as a display unit, or showcase of top quality office space in Atlantis in order to entice other tenants.'' (tr p 106).
25. Pausing here, if indeed T had not decided to build the Regal Insurance Building until February 1988, i.e. the same month he decided to demolish the Bombay Duck, it is somewhat surprising that in the four months between signing the contract for the purchase of 18 Swan Street (October 1987) and demolishing the building (February 1988, one month after settlement), he took no active steps of any kind to examine the feasibility of refurbishing the property - he consulted no builder, no architect, made no enquiries from the Council or did anything which would lend some credence to his avowed intention to refurbish the Bombay Duck. Indeed, in his evidence, it became clear that T's first contact with the Council was when he applied to demolish the Bombay. On that occasion, T claimed that the local Town Planner said to him that he was ``disappointed'' with the demolition plan (``he would have preferred the building to be refurbished like previous jobs I had done.'') (tr p 110). Nevertheless, T sought to support the ``refurbishment'' intention by tendering a number of reports, all supporting the proposition that the building was salvageable and setting out what could have been done with the building had it been refurbished. Thus, a document headed 18 SWAN STREET ASSESSMENT OF SITE POTENTIAL PRIOR TO DEVELOPMENT was tendered as part of a bundle of documents (exh B), drawn up by a leading architect (the same gentleman used by T in the construction of the office complex opposite). This document is dated November 1993 and came into being at T's request for the purpose of being used in support of his avowed intention to refurbish the building. To quote T:
``I explained to [the architect] how, if I had kept the building - the structure on 18 Swan Street - how I would have gone about refurbishing it.''
(tr p 108)
26. The above document, after stating that its author had inspected the site prior to the demolition of the building (what the purpose of
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this inspection was is not explained), and that its ``structure seemed sound at the time'', proceeded to set out the configuration of the two floors, stating that:``The ground floor provided a narrow access laneway capable of providing vehicular access for up to ten vehicles at the rear of the site.''
27. In addition, a local firm of construction cost consultants was asked by T to provide ``a replacement cost estimate report as at February 1988 tender market level'' (also part of exh B). The author of the report was unaware of the state of disrepair of the Bombay Duck, ``having observed the building from the outside only, but not being familiar in detail, to the extent at least, that I have never entered into the building''. Having been briefed by T ``as to the type of structure, and inspected drawings and photographs of the building'', the consultant was able to make a number of estimates. According to his calculation, the replacement cost of the building in February 1988 would have been $167,000, plus or minus 15%. The author of this document was called as a witness, and both counsel spent considerable time with him in the witness box, the main thrust of what was being sought from him was to ascertain what method of calculation was the most appropriate. In the end, I am satisfied that this hypothetical replacement cost estimate for the Bombay Duck in February 1988 is, on the evidence as I find it, of no evidentiary value.
28. Further, the applicant relied on a written statement (part of exh B) by the Managing Director of the local real estate agency whose firm was one of the parties which had made an offer to the Public Trustee after the auction to buy the site for $750,000. In that statement, he claimed that:
``Whilst we hadn't formed definite plans for the use of the property, one of our options was to renovate the building for use as a real estate office. Alternatively we could have found a tenant for it.
It was certainly not our intention to demolish the building as we considered it had significant value.''
Although this agent was called to confirm the correctness of his earlier statement, neither counsel saw fit to ask him any questions about his firm's plans in 1987. This prompted me to ask him:
``The D PRESIDENT: What was your intention had you been successful with the offer? - Well, it was quite possible that we would have established a real estate office there. But we hadn't come firmly to that conclusion. But that was a distinct possibility.
And what would that have involved in terms of improvements upon the property? - Well, we would have had to have substantially renovated what was there.
Did you have any idea as to what was involved in that renovation? - We didn't go that far, we didn't go to that extent. We were interested in the property. We felt the property was a good investment anyway, so we were not completely locked into using it as a real estate office. But it was a distinct possibility that we may have moved our real estate there either straight away or in a year or two.
...
Did you form any view at the time as to what would be involved in the cost of renovation? - No, we never got to that stage.
But your offer of $750,000 must have included some component, some costing? - We never got to costing it.
...
What I am trying to get at, did you make any attempt to value what the land was worth at the time? - No, I don't believe we did detailed assessments of apportionment of values. From our point of view, we were essentially looking at a property. If it had been vacant land we would not have been interested in it. We were interested in it because there was a building there.''
(tr pp 22-24)
29. Not surprisingly, there was considerable conflict between the valuations relied upon by the two sides, although there is little to choose between the two principal valuers in terms of experience, background and expertise. Dealing firstly with Mr C, the principal valuation witness for the applicant (who was ``local'' in that he has practised as a valuer in Atlantis since 1987, albeit having no familiarity with the Bombay Duck), he prepared his report dated 10 November 1993 (exh L) for purposes of this
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hearing, having been retained by T ``last Thursday''. That report stated:"We refer to... your request that we provide an assessment of the reasonable apportionment between land and buildings in the sale of the subject property for $800,000 on 29 October 1987.
...
In order to apportion the sale price we will first investigate sales of redevelopment sites on the fringe of the main business area to establish a reasonable value for the land component of the property on the basis that it was vacant at the relevant date.
Sales evidence is attached.
We consider the sales evidence suggests a value of $1,250 per square metre was appropriate for the land component of the subject property at the relevant date. This calculates to a total land component value of $632,500 and when this figure is deducted from the purchase price of $800,000, the value of the improvements is $167,500.
Obviously a value cannot be apportioned to the improvements unless they enhance the site or provide a benefit to it.
The improvements would not enhance the site if they were to be utilised in their existing condition, however they provided a two fold benefit if utilised as part of a redevelopment of the property. These benefits related to an offset against car parking contributions and the use of the existing structure as part of an extended development.
[Name] (Architects) have provided a plan [the same plan referred to in paragraph 25 above] for the refurbishment of the existing building and its extension to provide an additional 132m2 on the ground floor and 183.7m2 on the first floor.
If the site was vacant and a new building of this nature was to be constructed there upon then the car parking requirements would be calculated as follows:
203.3m2 of ground floor space at 1 park per 30m2 is 6.77 carparks. 304.8m2 of first floor space at 1 park per 50m2 is 6.09 carparks. Total carparks required is therefore 13. The plan makes provision for 6 carparks and thus the developer would have had to make contributions to the Council for 7 parks at $8,500 per park or a total of $59,500.
As per the letter from [name of the architects] the parking requirements for the building as it existed was six and council could at its discretion reduce the requirement on further development by 20%. Therefore if the building was refurbished and extended it was likely that no car parking contribution would have been required. This being the case the net benefit of retaining the existing building would have been $59,500.
We are advised that the gross floor area of the buildings on the site was 192.4m2 and Messrs Calculus, quantity surveyors, estimate the replacement cost of the building at the relevant date was in the order of $1,000 per m2. The buildings, although structurally sound, required considerable refurbishment. Therefore their value did not equate to replacement cost and we consider a depreciation factor in the order of 30% to 40% would be adequate to arrive at the ``in situ'' value of the buildings at the relevant date.
192.4m2 at $650 per m2 equates to a value of $125,060. Added to the parking benefit of $59,500, this suggests the added value of the improvements to the site was $184,560.
We believe the evidence suggests that at the date of sale (October 1987) the buildings provided a benefit to the site and had an added value of $175,000.
Thus we apportion the sale price as follows.
Land $625,000
Buildings $175,000
Total Value/Sale Price $800,000''
30. Much was sought to be made of what I shall refer to as ``the carpark situation''. As I understand this evidence, if an old building in Atlantis is demolished and replaced by a new building rather than being refurbished, the local Council insists on the provision of carpark facilities for the new building based on total available area, or else a payment of (then) some $8500 for each carpark space not provided. In the case of old buildings, according to Mr C:
``The normal rule is that they will allow for it on the basis of the use that was made of that building, and in this instance it was commercial on the ground floor, so they reduce your car-parking by the ground floor, divided by 30m2, and they reduce the first floor with two flats which would have had a
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requirement for three car-parks, one per flat and one visitor's car-park, and they also allow you a dispensation on that. So in essence there was three car-parks on the ground floor, and three car-parks on the first floor that you would not have had to - to provide in building the next building you wouldn't have had to provide or pay a contribution for. And on top of that they have - they can allow up to another 20% just as an incentive. It is really an incentive basis by council to retain old buildings, so the extra 20% comes up to an allowance that - of seven car-parks which I have allowed in my calculations.''(tr p 84)
31. In cross-examination, Mr C claimed that the Council has the discretion to dispense totally with the requirement of providing carpark facilities where existing buildings are refurbished, instancing an elderly building on the Promenade des Anglais ``which has now been refurbished - totally changed the face of the building and everything - and one of the advantages in that building was not having to provide carparks''. The witness assured me that the Bombay Duck ``could have easily fitted into this category.'' (tr p 85). On this assumption, the site was said to have an ``in-built'' value of $59,500 over and above the improvements.
32. I am satisfied that whether or not this building could be said to contain what might be called a ``carpark premium'' depends on whether there is any credible evidence of purchasers ready, willing and able to attach such a premium to the site on the basis that the building would be retained and refurbished. Mr C was carefully taken through the various sales in Atlantis in or around 1987/8 on which he relied in support of his valuation of $625,000 for the land component of 18 Swan Street (details of these 11 sales were attached to his abovementioned report). Sale numbers 1 to 8 were the same as those relied on by Mr N, the valuer called on behalf of the respondent and referred to in paragraph 4 above. At the hearing, details of a further three sales were tendered (as part of exh M) said to support Mr C's valuation. Prior to arriving at his own valuation, the witness had been made aware of Mr N's valuations and those of the local valuer (whose original valuation of $550,000 in 1987 was used by the Public Trustee in 1987 in seeking the Supreme Court's sanction for the sale of 18 Swan Street), including the view of both these two valuers that the existing improvements added no value to the subject site. When asked to comment on these valuations, the witness disagreed with those conclusions:
``The sales evidence suggests that the land was not worth that amount of money (i.e. $800,000) at the time and I believe there's logic that the improvements provided value in a redevelopment and refurbishment of the site.''
(tr pp 71-72)
33. The witness was then asked to particularise his disagreement with Mr N's methodology:
``Mr Batch: Mr N analyses the land, apparently based on his sales, at $1600m2, and his calculation then is `506m2 at $1600 = $809,600, adopt $800,000'. Now Mr N used $1600 per m2, you disagree with that? - I disagree with that, yes.
Right. You have used $1250? - That's correct.
Can you explain why you have adopted the lower figures? - Essentially I think there are a number of important things. If we just look at the sales and look at the ones which provide the best evidence of value, I think the first five sales on my list are really a totally different concept to buying a 500m2 site. If I could just go through those quickly, there is one that is 4570m2 which is sale No 1, which was bought for a major development, and it is important to understand what was happening in the market at that time. People were looking for big sites, whether it be for hotel, or office, of retail type developments. It had two street frontages and compared to a 500m2 `stand alone' site, it is really impossible to draw any comparison.
And the purchaser there was my client? - That's correct.
And the development that we refer to is the now 15 storey Regal Insurance Building, which is the premier commercial building in Atlantis? - That's correct.
Yes? - The next sale which is the Rural Bank site. Again, this is a prime feature site closer to the water. It is different in location, potential use, and all those sorts of things.
...
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You say here it is not comparable? - Well, you can't compare a site like that with an inside 500m2 site. There's just chalk and cheese.''
(tr pp 72-73)
34. Mr C, after being taken through the entire list of sales, claimed that only two of the eight sales relied on by Mr N (which this witness numbered 6 and 7) could be said to be ``comparable'' - one (No 6) on Jacaranda Street, consisting of 765m2, was acquired by T in September 1987 for $980 per m2. He built a small office complex on the site. The other (No 7) was a corner site situated on Jacaranda and Glen Streets consisting of 1012m2. It, too was acquired by T in May 1987 for $1,000,000, which converts to $988 per m2. Interestingly enough, of those eleven property dealings in the CBD to which Mr C had regard, T was involved (either as vendor or purchaser) in six of them.
35. Although much time was spent with this witness going through all the sales on which he had relied, I do not propose to detail these other than to note that I have taken them into account in arriving at what I consider to be the true valuation of 18 Swan Street at the time of its purchase by T. Mr C was adamant in his assertion that the ``highest and best use'' of the site (a phrase also used by Mr N) was ``refurbishment of the existing and extension of the existing building''. He was the only witness who was prepared to go that far. I have some difficulty, on the whole of the evidence, in taking that view seriously.
36. Turning to the evidence of Mr N, he inspected the site in May 1990, being requested to provide a valuation of the site as of 29 October 1987, the date T signed the contract. He was personally unfamiliar with the state of the Bombay Duck and relied on contemporary material for his valuation, and in particular the marketing report (exh 3) prepared for the Public Trustee. (Since neither Mr N nor Mr C had ever inspected the building prior to its demolition, I am satisfied that I am in much the same position as they are in informing myself as to its state of repair and viability to be refurbished). In his report to the respondent, dated 6 July 1990, Mr N stated:
"At the date of inspection, the improvements on the site consisted of a new two storey office building.
At the relevant date (i.e. October 1987), the improvements on the site consisted of an old two storey building known as the `Bombay Duck' building. This building prior to sale was subject to a Repair/Demolition Order from the Atlantis City Council. This building was demolished approximately March (sic) 1988 to enable the redevelopment of the site by the construction of the current building.
APPROACH TO VALUATION:
The improvements as at the relevant date were obsolete and incapable of providing an economic return to the property. They in fact constitute a liability to the redevelopment of the site. In theory a higher price would have been paid for the property had it been vacant land. Demolition costs were estimated at $8000 in the Council Application.
The highest and best use of the property at the relevant date was either as an individual site or in conjunction with the adjoining lands, namely the Metropole Hotel and the [retail shopping mall].
The valuation of the subject is approached on the basis of direct comparison with the attached schedule of sales evidence.
The sale of the subject property for $800,000 on 28 October 1989 (sic) is considered to represent a fair market value in relation to this evidence.
All sales on the schedule except `B' had the improvements demolished and a redevelopment of the site take place.
The Atlantis market along with the general real estate market was beginning to increase in value in the latter part of 1987.
The subject is assessed as follows:
37. Mr N was taken through the eight sales used by both him and Mr C in arriving at their respective valuations. Mr N ignored the six additional sales which Mr C took into account in arriving at his valuation, three of which took place between 6 January and I March 1988 (exh M), i.e. after T had bound himself contractually to the acquisition of 18 Swan Street. The reason Mr N advanced for ignoring these sales was that he was asked to ascertain land value, and therefore only used vacant land sales for his valuations. On that basis, he disregarded the other six properties because they involved ``improved property sales''. Having regard to all the factors, the witness told Mr Batch in cross-examination:
``I established what I believed was the value of the land at that date (i.e. 18 Swan Street) and I looked at what was described as the condition and the size of the improvements at that date, and I came to the conclusion that those improvements were not capable of providing a return on the value of the land, and further came to the conclusion that they would need to be either substantially enlarged, refurbished and enlarged, or completely replaced with a new project - a new building. And considering the development possible of the maximum gross floor area of in excess of 2000m2, I came to the conclusion that the added value of those improvements was nil....
MR BATCH: To build 2000m2 gross floor area on a 506m2 block, you have got to build at least four storeys? - Yes.
That means one lift? - Yes.
Which means at least hundreds and hundreds of thousands of dollars? - That's correct.
And for 2000m2, the City Council would require at least 40 carparks? - Yes.
Which you are not building on the site, obviously? - No.
So you are paying out the carparks to the Council at $8500 each, which is about $340,000? - That's what a developer would have to do, yes.
So we have just added $200,000 for a lift, perhaps more, and $340,000 for carparks. So there is straight off $540,000 on this exercise to build your 2000m2 GFA office block? It's just a nonsense, Mr N, isn't it? - No I think you would find that if you did a feasibility, you would then discard that scenario that you have just been through and would find that it would be not economically feasible.''
(tr pp 183-184)
38. Returning to the evidence of T, he claimed that far from having ``done a good deal'' on 18 Swan Street:
``I think I lost several hundred thousand dollars on the deal. It cost me some $700,000 to build it, acquisition costs and costs of purchase were in excess of $800,000. I paid agent's commission - just from memory, they would have been 2½-3 per cent - and holding cost during the process of holding the building. I would have, without doing the calculation, there would have been several hundred thousand dollars incurred.
And the sale price? - $1.8 million from memory.
So you say you really account for all that, and perhaps a bit more that $1.8 million? - Definitely.''
(Exh K, a document prepared for T by a firm of quantity surveyors, suggests that the ``all up'' costs of erecting the building on the site came to $616,825.)
He agreed that the architect report and sketch plan (exh B, referred to in paragraph 25 above) was commissioned by him for purposes of this hearing. It seems that the only surviving plans of the old Bombay Duck were contained in the marketing report prepared by the agent retained
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by the Public Trustee (exh 3). In the result, I am not prepared to attach much weight to a report prepared by an architect who (i) is retained by a valuable client for substantial projects, including the design of the Regal Insurance Building and the new building put up on 18 Swan Street, (ii) is compelled to rely for his report on the property description contained in the vendor's marketing report (who, incidentally, expressed the belief that ``that the ultimate purchaser will have no regard for the existing improvements''), (iii) is presumably made aware of the purpose of his report and (iv) is not called as a witness.39. T has a long history as a property developer, i.e. buying buildings and refurbishing them. Indeed, 18 Swan Street appears to have been his first foray into demolition. He was well aware of the ``carpark advantage'' offered by refurbishing an existing building.
40. Mr Batch took T carefully through his prepared statement (exh D). Thus, he was asked, having heard the evidence of Mr Whirlpool the day before, whether he adhered to his statement in exh D that ``I was not aware of the tax deductibility of capital losses at the time of my purchase of the property at 18 Swan Street in October 1987... To the best of my recollection I did not give Mr Whirlpool any instructions on the apportionment for the Form K as to $100,000 for land and $700,000 for the building. I believe that Mr Whirlpool did the Form K apportionment''. In reply, T claimed that he did ``not recall any conversations or any discussions on the matter.'' (tr p 111). I accept that neither T nor his adviser had contemplated the CGT implications at any time prior to the arrival of the amended assessment.
41. T's statement goes on to claim that it was his intention at the time of purchasing the property to renovate the building, as he could see much inherent value in the building because:
"• It was a solid structure;
• It lent itself to renovation similar to the building I had renovated at Leicester Court on the corner of Swan & Station Street;
• There was significant inherent value in the carparks which attached to the building;
• There was a great demand at the time for small area of both retail and office space which could easily be accommodated in the renovated building;
• I had much experience with renovation of buildings and knew how to make such a venture successful;
• The property had been presented to me much earlier than the auction date by Mr Crick who was working with McFarlane's Real Estate at the time. He approached me regarding the property prior to the Public Trustee being involved with the matter. I did not follow this up at the time as I believed the price at which the property was being offered was not fair to the owner of the building Mr Sing;
• I was aware that other people including [lb]names] and members of the Atlantis Indian community had looked at the building as a refurbishment opportunity.
...
Subsequent to me purchasing the 18 Swan Street site it was necessary for me to get pre- commitments from major tenants for the Regal Insurance Building project. This was vital in order to ensure that refinancing could be arranged for the Regal Insurance Building project and to this end I decided after having settled the purchase of 18 Swan Street that it would be of greater benefit to me in securing and warehousing tenants for the Regal Insurance Building if I demolished the building and built a modern building which would give an indication to potential tenants of the standard and quality of office accommodation that would be available in the Regal Insurance Building.
...
It is my firm personal belief that in view of the facts as outlined in this statement that the building on the 18 Swan Street site had a substantial value. My knowledge and experience supporting this conclusion included:
• My knowledge that similar land in the area was selling in the range of $500.00 to $1000.00 per m2;
• That there was inherent value in the existing building in not having to pay
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council car park contributions in the order of $51,000.00; and• The building was structurally solid and was ideal for refurbishment and I had experience in refurbishing similar buildings in the area."
42. T was asked as to the extent he had inspected the building.
``Now, did you personally do an inspection of 18 Swan Street before you bought it in `87? - Yes I did, and several times in `86.
And what was the extent of those inspections? - Well, it was just - it was walking around the site.
Inside the building? - Yes, I did inspect downstairs inside the building.
Did you go upstairs? - No, I hadn't. I could see, though, that it was in good condition, floor-wise and structure-wise. There was some surface cracking in the concrete, but I didn't see that as a problem. It was mainly at the back area. Some of the walls were rotten but that was the area that I would have taken out to extend the building anyhow.''
(tr p 111)
43. In cross-examination, T was asked what he had in mind for the building and whether it corresponded to the architect's report of November 1993:
``Now, you say at that time you had in mind renovating the building? - That's correct.
Was it the case that you had in mind renovating it along the lines of the proposal that has now been put in evidence, that you were describing earlier this morning, that is the recently drawn architect plan about extending the building and leaving six car- parking spaces in the back? - Either to go as far as that or medium range between a full refurbishment and depending on the balance of car spaces I needed.
Well, I wanted to know what you had in mind at the time. Was it either that, or something less extensive? - That's right (sic).
And did you do some calculations as to what it would cost? - Only rough calculations.
And did you do any calculations about what it would return on a low rent? - From memory, I felt that if I spent about a quarter of a million on it - or between 200 and 250,000 I would get a return of around $100,000 a year; a minimum of $100,000 a year.
And was that for the sort of set up that you have got shown in those architect plans? - Probably not quite as extensive as that, close to it though,
Did it get as far as working out the net lettable area of what you had in mind after renovations? - No, I wouldn't have gone that far.
You did not get an engineer to look at the premises to see whether it was structurally sound before you bought it? - No, I believed it was structurally sound.
But you did not get an expert to check on that for you? - I'd never got one in the past, so I didn't see the need for it in this case.
Were you aware that there was a demolition or repair order from the City Council in relation to the building at the time? - At the time I didn't, no.
Were not you aware of that before you signed the contract with the Public Trustee? - I knew there had been orders on the building, I didn't believe that they related only to demolition. I thought the building could be repaired.
I am sorry, I was not sufficiently precise about that, it was a notice to demolish or repair? - That's right.
You were aware of that notice, were you? - I was aware there was such a notice, yes.''
(tr pp 147-149)
44. T described the new building he put up on 18 Swan Street as ``a two-storey commercial office building''. He made no provision for carparks and paid the Council the appropriate carpark contribution (allegedly $119,000), explaining that he felt that ``in the future, to lease it up to longer-term tenants I'd have the advantage of being able to lease car spaces in the Regal Insurance Building just across the road''.
45. The picture that emerges from T's evidence is that in the critical period between October 1987 and February 1988, a number of significant events occurred. At the risk of repeating what I stated in paragraph 24 above, the stock market ``crashed'' in October 1987,
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which in turn impacted, albeit not immediately, on investor confidence as well as dampening the enthusiasm previously displayed by the Regal Insurance Company (and, semble, other professionals) who had given some positive ``signals'' about intending to lease office space in the projected building on completion. This, in turn, caused T's financial backer to hesitate in committing the substantial sums required on what had now become a speculative venture. In addition, T had committed himself to settle three other properties as well as 18 Swan Street just prior to the collapse of the stock market. He told Mr McGill that the nervousness of the market was such that he himself got ``cold feet'' and that he gave someone an option to purchase the site on which he proposed to build the Regal Insurance Building. It was not until 10 February 1988, when the Regal Insurance Company committed itself, albeit verbally, to lease a significant part of the building, that T's confidence in the project returned (``Up until then I thought I'd bought a lemon and I was never going to get off the ground.'' tr p 141). Five days later, T applied to the Council for a permit to demolish the Bombay Duck. On 22 February, T put in a building application for the new building. On 26 February 1988, the Regal Insurance Company confirmed its intention in writing. Two days later 18 Swan Street was demolished. The plans for the new building, albeit sketchy and preliminary, had been drawn up by T's architect - the same gentleman who provided the assessment of the site potential of the existing improvements in November 1993. Unfortunately, this gentleman was not called, so I do not know when he was first instructed to draw up plans for the replacement site for No 18 Swan Street.46. T agreed in cross-examination that when he made his offer to the Public Trustee to purchase 18 Swan Street, he not only outbid the local firm of real estate agents, but the developer who owned and developed the adjoining site, who, if he had been successful in his bid, could have consolidated ``the much larger site next door'' with No 18. T reiterated, when questioned about the apportionment between land and improvements, that he was advised by his solicitor ``that they put in on the basis of the Valuer-General's apportionment on the land, and the balance on the building.'' (tr p 149).
47. Finally, T was cross-examined on whether or not the project on 18 Swan Street was unprofitable, as alleged. When I queried the relevance of this evidence, I was informed the matter went to ``credit''. It was common ground that the land and improvements were sold for $1.8mil, and, doing all the arithmetic of construction costs, including the ``astronomic'' holding costs, Mr McGill put to the witness that he made a capital profit of ``a bit under $200,000'', on which note he sat down. I then took a hand in eliciting the evidence:
``THE D. PRESIDENT: Well, you have left us in rather an unsatisfactory state. Are you saying there is a capital profit, or there is not?
MR McGILL: Yes. I said there was a capital profit of a bit under $200,000.
THE D. PRESIDENT: (to the witness) Do you accept that? - Capital profit, less than $200,000. Yes.
Well, initially - because when you were asked about the profit, you said you were making a loss on it? - Well, I feel...
Do you wish to...? - I feel as though the whole deal I did make a loss, a substantial loss.
Well $200,000 or something less than that is not a loss is it? - Well, it's a capital profit, but for the whole exercise it was a loss because of the high interest that I was paying. If I didn't have interest to pay I would have made a small profit.
Well, surely the interest of the holding costs is something which one takes into account in calculating what the capital profit is? Have you taken it into account? - If I take that into account, I make a loss.
Well, Mr McGill, I would have thought the interest component is a feature of the calculation of whether or not there is a profit?
MR McGILL: The interest would have - should have rent set off against it.
THE D. PRESIDENT: Rents, for how long?
MR McGlLL: During the period until he sold it?
THE D. PRESIDENT: When was construction completed?
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THE WITNESS: They were only in there for four or five months, the tenants, and it was vacant - it was vacant from April `89 through to the sale in approximately October `89.
THE D. PRESIDENT: Well, if this is said to go to credit then, somebody can do the calculations at some stage.
MR BATCH: Just on that last point, you have mentioned a figure of $200,000. Was that before you took into account holding costs? - Yes, less than $200,000 without holding costs. But I'm sure with holding costs taken into account I would have made a loss on the deal.''
(tr pp 153-155)
48. What does the applicant's case amount to? On the whole of the evidence I am satisfied that the testimony of Mr C, viz that ``the highest and best use [of the site] was refurbishment - and extension - of the existing building'' (tr p 96) has not been made out. Mr Batch submitted that I should ``give great weight'' to the evidence of (i) the estate agent who offered to buy the site for $750,000, with the ``possibility'' of transferring his office to the refurbished building at some time or other, (ii) the two agents who ``offered'' the property for sale (without proper instructions), (iii) the report of the independent engineer and (iv) the agent who prepared the marketing report for the Public Trustee (who can hardly be claimed as supportive of Mr Batch's client), all of whom were said by counsel ``to support the ability and/or intention of the taxpayer to refurbish [the building], as do the taxpayer's previous activities''. Whilst I accept the evidence of the various ``bit players'' to the extent that it was possible to refurbish the Bombay Duck, it is however one thing to establish that an old building is capable of refurbishment, and quite another to prove that it was intended to refurbish it. Although T was otherwise an impressive witness, he has not persuaded me that he seriously considered a projected development of this obsolete structure, with its extensive corrosion of reinforcing bars, of the kind suggested and said to cost a mere $167,000 plus or minus 15%, including the provision of six or seven carparks. Indeed, I am satisfied that T must have been aware that no amount of refurbishment could convert the Bombay Duck into the kind of ``swan'' that would blend into the development that had been planned for the surrounding area, a development in which T intended to play a major part. Put another way, I am satisfied on the whole of the evidence that T, when offering to buy the site for $800,000, intended to demolish the ``improvements'' which, by then, had become an eyesore with little potential of commercial salvage in what had become a most desirable location. This view of the evidence is reinforced by (i) having inspected the site with both counsel during an adjournment (and all the other relevant sites), (ii) having viewed the surrounding developments, including the shopping mall adjoining it and the modern two storey office building T erected on the site, and then looking at contemporary photographs of the Bombay Duck and the state of repair in which it was said to be, (iii) having looked at the rest of the contemporary evidence, including the value placed upon the ``improvements'' by those advising the Public Trustee, and (iv) accepting the restrained evidence of Mr N in relation to this property. I consider that all of this evidence strongly suggests that the Bombay Duck, finding itself in the middle of what had become the most desirable area in Atlantis, had - literally - reached the point of no commercial return and was, if anything a liability rather than an asset. I am also satisfied that the site was worth what T paid for it, i.e. $800,000.
49. In submissions, Mr Batch put it to me that T suffered a capital loss of $700,000 (on Mr Whirlpool's apportionment); alternatively $300,000 (the taxpayer's valuation of the building as given in evidence); alternatively $175,000 (the ex post facto apportionment between land and building arrived at by Mr C; cf paragraph 29 above).
50. The relevant sections of the Income Tax Assessment Act 1936 (``the Act'') (in relation to both properties in issue) are set out below.
``160N For the purposes of this Part but subject to the other provisions of this Part-
- (a) the entire loss or destruction of an asset constitutes a disposal of the asset; and
- (b) the loss or destruction of part of an asset constitutes a disposal of that part of the asset,
whether or not any amount of money or other consideration by way of compensation or otherwise is received as a result of or in respect of the loss or destruction.
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160P(4) Where a building or other improvement of a capital nature made to land is treated for the purposes of this Act other than this Part as an asset separate from the land, the building or other improvement shall be deemed for the purposes of this Part to be a separate asset from the land.
160P(5) Where an asset forming part of a building is treated for the purposes of this Act other than this Part as an asset separate from the building, the asset shall be deemed for the purposes of this Part to be a separate asset from the building.
160P(6) Where-
- (a) an asset acquired by a taxpayer before 20 September 1985 has been disposed of on or after that date;
- (b) an improvement of a capital nature to the asset was made after the taxpayer acquired the asset;
- (c) if the improvement were a separate asset from the asset to which it was made-
- (i) the improvement would be taken for the purposes of this Part to have been acquired by the taxpayer on or after 20 September 1985; and
- (ii) subject to section 160Q, the indexed cost base to the taxpayer of the improvement would exceed $50,000; and
- (d) the amount of the indexed cost base referred to in subparagraph (c)(ii) exceeds 5% of the consideration in respect of the disposal of the asset to which the improvement was made,
the improvement shall be deemed for the purposes of this Part to be an asset separate from the asset to which the improvement was made.
160P(7) On the disposal of an asset that is, by this section, deemed for the purposes of this Part to comprise two or more separate assets, the consideration in respect of the disposal of the first-mentioned asset shall be apportioned between the separate assets.
160P(8) Except as provided by this section, land, and any building or other improvement made to the land, shall be deemed for the purposes of this Part to be a single asset.
160R For the purposes of this Part, a reference to a disposal of an asset includes, unless the contrary intention appears, a reference to a disposal of part of an asset.
160ZH(12) If, in the case of the happening of any of the following events without any change in the beneficial ownership of the asset or assets concerned, that is to say-
- (a) two or more assets having been merged or an asset having been divided into two or more assets; or
- (b) an asset having been changed in whole or in part into an asset of a different nature,
the value of an asset as it existed after the happening of the relevant event (in subsections (13) and (14) referred to as the `relevant asset') is in whole or in part derived from or otherwise attributable to an asset as it existed immediately before the happening of the relevant event (in subsections (13) and (14) referred to as the `original asset'), then subsections (13) and (14) have effect.
160ZH(13) For the purpose of determining the cost base, the indexed cost base or the reduced cost base to a taxpayer of the relevant asset on the disposal of that asset, any amount that would have been included in the cost base, the indexed cost base or the reduced cost base, as the case may be, to the taxpayer of the original asset if-
- (a) the relevant event had not happened;
- (b) the original asset had been disposed of at the time of the relevant event; and
- (c) this Part had been in force and applied in relation to the disposal,
shall, to such extent as is reasonable, be included in the cost base, the indexed cost base or the reduced cost base, as the case may be, to the taxpayer of the relevant asset.
160ZH(14) If the original asset continued in existence to any extent after the happening of the relevant event-
- (a) for the purpose of determining the cost base, the indexed cost base or the reduced cost base to the taxpayer of the original asset as so continuing in existence in the event of the disposal of that asset, the amount that would, if the relevant event had not happened, be that
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cost base, indexed cost base or reduced cost base, as the case may be, shall be reduced by any amount that, by virtue of the application of subsection (13) in relation to the original asset, is included in the cost base, indexed cost base or reduced cost base, as the case may be, to the taxpayer of the relevant asset; and- (b) to the extent (if any) to which it is necessary to apply this paragraph for the purpose of determining the cost base, the indexed cost base or the reduced cost base to the taxpayer of the original asset as so continuing in existence in the event of the disposal of that asset before the disposal of the relevant asset, the amount that would, if the relevant event had not happened, be that cost base, indexed cost base or reduced cost base shall be reduced by any amount that would have been included in the cost base, the indexed cost base or the reduced cost base, as the case may be, to the taxpayer of the relevant asset by virtue of subsection (13) if the relevant asset had been disposed of immediately before the disposal of the original asset.
160ZI(1) Where part of an asset is disposed of, each amount (in this subsection referred to as the `relevant amount') that, under section 160ZH, is attributable to the asset shall be apportioned as follows:
- (a) in respect of the part that is disposed of there shall be attributed so much of the relevant amount as bears to the relevant amount the same proportion as the amount of the consideration in respect of the disposal bears to the sum of the amount of that consideration and the market value of the part that remains undisposed of; and
- (b) the remainder of the relevant amount shall be attributed to the part that remains undisposed of.
160ZI(2) Subsection (1) shall not be taken as requiring the apportionment of an amount that, on the facts, is wholly attributable to the part of an asset that is disposed of, or is wholly attributable to the part of the asset that remains undisposed of.''
51. Mr Batch's principal submission was that the effect of sub-s 160P(8) is to exclude the provision of sec 160ZI, with the result that I must have recourse to sub-ss 160ZH(12)-(14) because of sub-s 160ZH(12).
52. If I understand his argument correctly, sub-s 160P(8) has the effect of deeming the land and any building upon it to be a single asset (the land) for the purposes of Part IIIA. From this it is said to follow, that the single asset - the land - remained intact notwithstanding the demolition of its improvements. Hence it is said there was - and could be - no disposal of part of the asset, and thus there can be no apportionment pursuant to sec 160ZI.
53. It is necessary to separately consider each element of that submission.
54. Firstly, does sub-s 160P(8) have the effect of deeming any building or other improvement to be a part of the land as is the general position at common law? At first blush, it does appear to have that effect, particularly in the context of the other subsections of s 160P, such as sub-ss 160P(1) and (2), which speak of a building being deemed to be ``an asset separate from the land'' and sub-s 160P(4), which speaks of a building or other improvement being deemed to be ``a separate asset from the land''. However, it is also equally possible to take a different view of sub- s 160P(8). That subsection speaks of ``land, and any building or other improvement made to the land'' being deemed ``to be a single asset''; it does not state that that ``asset'' is the land. It could be that, rather than the improvements being, as it were, ``subsumed'' into the land, both the land and the improvements simply form part of a composite asset. If this interpretation of sub-s 160P(8) is correct, then I consider that there would be no difficulty in s 160N applying in the circumstances of this case, that is, the demolition of the building would be ``the loss or destruction of part of an asset'', and thus constitute ``a disposal of that part of the asset''. But even if that interpretation of sub-s 160P(8) is not correct, and instead the building forms part of the land, it is, I consider, not an unduly strained reading of s 160N(b) to say that, since the building forms part of the land, the loss or destruction of the building constitutes ``the loss or destruction of part of an asset'' being the land.
55. If it is correct that s 160N(b) is applicable in the circumstances, then the disposal triggered by that section will give rise to the need to consider the other elements required to trigger
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the accruing of a capital gain or the incurring of a capital loss as a result of that disposal. If, however, it is considered that the effect of sub-s 160P(8) is that the building was ``subsumed'' into the land, and that s 160N(b) is not applicable, because it is said that there was no ``loss or destruction of part of an asset'' upon demolition because the asset - the land - was still intact, then the only disposal as a result of the building's demolition which could trigger the accrual of a capital gain or the incurrence of a capital loss would, in the circumstances, be the disposal of the remains of the building after its demolition. As the following analysis will illustrate, on the facts as found, whether s 160N(b) is applicable or not, the result is the same, i.e. no capital loss arises in the circumstances.56. If s 160N(b) is applicable in the circumstances, the combined effect of s 160ZD (particularly sub-s 160ZD(2B)) and s 160R is that the consideration in respect of the disposal of the part of the relevant asset would be nil. In addition, s 160ZI would be applicable, with the result that the cost base is nil because:
- (i) sub-s 160ZI(2) applies in the circumstances since, on the facts as found by me, the $800,000 consideration in respect of the acquisition of the asset (land with building), and any other elements of the cost base, are wholly attributable to the (at the time) undisposed of land; or
- (ii) if sub-s 160ZI(2) does not apply, sub-s 160ZI(1) applies, and the fact that there is a nil consideration on disposal means that the result of the calculation under paragraph (a) of sub-s 160ZI(1) is that, again, none of the elements of the cost base is apportioned to the part disposed of.
The result is thus neither a capital loss nor gain.
57. If s 160N(b) is not applicable in the circumstances, then the demolition of the building would not result in the disposal of the building. There would be no change in ownership (in terms of s 160M) of the remains of the building (now a chattel) until T either sold those remains to someone else, or did something which evidenced his abandonment of those remains (such as having someone remove them to a tip). I have no evidence that satisfies me that the consideration in respect of that disposal was other than nil. In terms of the cost base to T of that asset, it is necessary to consider sub-ss 160ZH(12)-(14).
58. For present purposes I have assumed (without deciding) that the necessary elements of sub-s 160ZH(12) are satisfied, that is relevantly, ``without any change in the beneficial ownership of the asset [being the land with the building forming part of it]... an asset [was]... divided into two or more assets [the land and the remains of the building]'' and ``the value of an asset as it existed after [that]... event... is in whole or in part derived from or otherwise attributable to an asset as it existed immediately before [that]... event'', and that therefore sub-ss 160ZH(13) and (14) have effect. In that case, what would be the effect of sub-s 160ZH(13) in relation to the remains of the building (``the relevant asset'')? The answer is that ``any amount that would have been included in the cost base... of the original asset... shall, to such extent as is reasonable , be included in the cost base... to the taxpayer of the relevant asset.'' (my emphasis). On the findings I have made, I would consider it is reasonable not to include any such amounts in the cost base, etc to T of the remains of the building, with the result, that pursuant to sub-s 160ZH(14), any such amounts would be included in the cost base, etc, to T of the land (to which such amounts were in fact attributable). As a result, as stated above, the result is that there is neither a capital loss nor gain in the year before me in connection with the demolition of the building.
59. I now turn to the issues involved in the refurbishment of the two storey building located at 13 Station Street. The property was purchased by T pursuant to a contract dated 10 September 1985 (i.e. pre-CGT), settlement taking place on 2 January 1986. The purchase price ($500,000) was apportioned under the contract as follows:
LAND $ 92,150
FIXED IMPROVEMENTS $396,850
FITTINGS ETC $ 11,000
--------
$500,000
--------
60. At the time of purchase by T the property was fully tenanted. The ground floor was occupied by a doctor, a firm of stockbrokers and an optometrist; the first floor was wholly leased to a firm of accountants. All except the stockbrokers remained in the building after the purchase by T and continued to pay rent. Before settlement, T had reached an agreement with the optometrist to move the latter into the area vacated by the stockbrokers after that area had
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been renovated. However, the optometrist insisted on certain special requirements for the ``new'' area, so that in November 1985, T requested his architect to draw up plans (part of exhibit O) ``to show... [the optometrist]... as to what his proposed newly refurbished space could look like and what the building could look like with the awning re-sheeted in a more modern state and new shopfronts put on the building''. It seems that the refurbishment of that part of the building (which included gutting that side of the floor, ``putting up a new partition, set in new basins for the optometrist, reglazed the shopfront on his proposed new space'' and providing him with a new independent ducted split air-conditioning system) was completed by the end of February 1986, whereupon the optometrist transferred his practice to the refurbished area as previously agreed. The doctor vacated his leased area of the building ``in early 1986''. In addition, during the ``early months'' of 1986, T arranged to ``re-sheet the awning, put new plumbing and drainage from the rear to the front gutter of the site'' and had sunshades installed over the windows on the first floor. During March 1986, T refurbished the remaining part of the ground floor (including ``filling up the openings on the left-hand wall... We stripped out the area and put a new shopfront on the left-hand side of the building''). In April/May 1986, he secured a new tenant to occupy the remaining (left hand side) part of the ground floor, albeit the new tenant required some refurbishments to their particular requirements (in relation to the installation of air-conditioning, partitioning and lighting). The new tenant moved into that refurbished ground floor area in late June 1986. The total cost to T of the refurbishments/ renovations set out above amounted to $129,788.61. Turning to the first floor, the firm of accountants indicated to T in March 1987 that they wished to break their lease and move out of the building in April 1987. T was agreeable to this. After the first floor became vacant in April 1987, he consulted his architect to see what needed to be done on the top floor to make it lettable. T asked the architect to cease work on that project in June 1987, ``because I was approached by [the new tenant]'', who was interested in leasing the whole of the first floor in addition to the part they already occupied on the ground floor. In August/September 1987, T refurbished the first floor of the building to meet the new tenant's requirements, which included a stairway linking the first floor area with the part which the new tenant occupied on the ground floor. The total cost of the refurbishments/renovations set out in this paragraph amounted to some $24,685.
62. Shortly thereafter T sold the building by contract dated 12 October 1987 (also part of exhibit O) for $1,350,000, with the new tenant and the optometrist still in occupation. The total rental amount received by T in respect of the building had risen from approximately $50,000 per annum at the time he purchased the building to approximately $120,000 per annum at the time he sold it. There was no apportionment of the purchase price under this contract between the land and the fixed improvements, although special condition 4 of that contract did provide that:
``The purchaser and vendor hereby agree that the value of any depreciable property, hereby agreed to be sold and purchased, shall be the depreciated value thereof, for income tax purposes as at the date of completion and as certified in writing by the vendor's accountants [name] of [Atlantis].''
Those certified values appear in exhibit N.
63. In his 1988 tax return, T did not disclose a capital gain on the sale of the 13 Station Street property.
64. After obtaining a valuation report from Mr N (exh A, T5, pp 60-67), which is further discussed below, the respondent concluded that either specific ``improvements'' were deemed to be separate assets from the building pursuant to sub-s 160P(5), or that the refurbishments/ renovations were one ``improvement'' which was deemed to be an asset separate from the land pursuant to sub-s 160P(6). Indeed the respondent's reluctance to point to a particular basis for the calculation of the alleged capital gain of $69,875 is evident in his letter of 26 November 1991 (set out in paragraph 6 above), which ``explained'' the objection decision under review. Indeed, the method used by the auditor in calculating that alleged capital gain (a copy of which was provided to the Tribunal) was admitted to be incorrect in that it ``erred in the taxpayer's favour in disregarding the depreciated assets for the purposes of calculating the Part IIIA taxable capital gain''. The method of calculation used by the auditor is said to be as follows:
65. Before dealing with the valuation evidence in relation to 13 Station Street it is, I consider, appropriate to deal with some of the submissions in relation to sub-s 160P(6). The respondent based his calculations of the alleged capital gain on the premise that the various ``improvements'' could be treated as one ``improvement of a capital nature'' for the purposes of considering whether the various ``tests'' contained in sub-s 160P(6) have been passed, so that that ``improvement'' is deemed to be an asset separate from the asset to which the improvement was made. Having considered the terms of that sub-section in the context in which it is found, I have come to the conclusion that sub-s 160P(6) is not to be interpreted as liberally as submitted by the respondent. The various calculation elements in sub-s 160P(6) point to a more restrictive conclusion. I am, however, not suggesting that the term ``improvement'' should be applied separately, for example, to each new tap that may be installed in the bathroom. Such an interpretation would defeat what I perceive to be Parliament's intention as discerned from the terms of the legislation. I consider that a more ``middle ground'' interpretation was intended. For example, applied to this case, having heard the evidence of T and examined the other evidence (particularly the plans drawn up by T's architects), I consider that the various ``renovations/refurbishments'' totalling $129,788 which were carried out up until late June 1986 are all part of the one improvement for the purposes of sub-s 160P(6). Notwithstanding that T could only undertake these in ``stages'', the various ``renovations/ refurbishments'' were part of one plan of improvement, and the fact that some of the work was carried out to the particular specifications of one tenant after it agreed to take a lease of part of the ground floor does not, I consider, alter that conclusion.
66. On the other hand, I have concluded that the ``renovations/refurbishments'' totalling $24,685 which T carried out after the accountants vacated the first floor in March 1987 are a separate ``improvement'' from the abovementioned ``improvement'' for the purposes of sub-s 160P(6). These works were not part of the original plans drawn up and were quite unrelated to the previous works.
67. It is also appropriate, before considering the valuation evidence in relation to 13 Station Street, to deal with the submissions relating to the question of the method of apportionment of the consideration on disposal of the land with improvements between, on the one hand, any improvement which may be considered to be a separate asset by either sub-s 160P(5) or (6), and, on the other, the remaining part of the property disposed of.
68. The problem lies in the fact that sub-s 160P(7) simply states that:
``On the disposal of an asset that is, by this section, deemed for the purposes of this Part to comprise two or more separate assets, the consideration in respect of the disposal of the first-mentioned asset shall be apportioned between the separate assets.''
That sub-section does not provide a method or basis upon which that apportionment is to be made. The respondent submitted that sub-s 160ZD(4) sets out the basis of such an apportionment. That subsection provides that:
``Where any consideration paid or given in respect of a transaction relates in part only to the disposal of a particular asset, so much of that consideration as may reasonably be attributed to the disposal of the asset shall be taken to relate to the disposal of the asset.''
With respect, I do not consider that sub-s 160ZD(4) takes the matter any further than sub- s 160P(7). The respondent points to the fact that the apportionment under sub-s 160ZD(4) ``is an objective test, not a matter for the taxpayer''. I accept that submission. However, as I read sub- s 160P(7), there is nothing to suggest that the apportionment referred to there is to be undertaken on anything other than an objective basis.
69. Mr McGill went on to submit that:
``A reasonable basis to apportion the consideration on sale is pro-rata on the basis of the relevant costs, that is as between the cost of the property prior to renovation and the cost of the renovations, with the cost of the further renovations in 1987 just prior to sale, being directly deducted from the sale price. This has the advantage that it is independent of any dispute as to the true apportionment between land and buildings.''
70. Mr Batch, on the other hand, submitted that ``common sense suggests the
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apportionment be made having regard to the values of the separate assets''.71. Having given the matter some consideration, and in the absence of any real guidance in the legislation, I have concluded that the basis suggested by Mr Batch is the more appropriate. Whilst the method adopted by the respondent does avoid the problems associated with the need to rely upon valuations, it contains elements of an artificial nature which I do not find attractive. The basis suggested by Mr Batch has the advantage that the tribunal of fact is able to obtain assistance on matters of valuation from those with particular expertise in that area. I should, however, point out that inherent in what I have said is a rejection of Mr Batch's alternative submission that the values placed upon the depreciable property in the contract of sale of the property (between the applicant as vendor and the subsequent purchasers) should be taken on their face value and utilised in any such process of apportionment by virtue of the condition of that contract which stated that the parties agreed that that property was sold at its depreciated values.
72. It transpired in T's evidence that he acquired the adjoining property which also had a two storey commercial building on it - 13A Station Street - by contract dated January 1987 (settlement taking place in April 1987), and sold it by contract dated 22 September 1987 for $1,400,000, settlement taking place on 5 October 1987. In his 1988 return, he returned a s 26AAA profit on this sale of $316,172. T's evidence on this aspect (which I have no reason to question) was that, apart from installing a new air conditioning condenser ($6,437), he effected no improvements to that property while he held it, and that 13A ``was actually in a state of repair similar to 13 Station Street when I purchased 13 Station Street'' (tr p 166). At the time T purchased No. 13A the whole building on that property was leased to a well known Building Society under what was described as a ``long'' lease with an annual rental of approximately $70,000. Having considered the evidence of Mr N, (including his two reports in relation to 13 Station Street), and that of Mr C, I am satisfied as to the following:
- (i) Mr N was unaware of the sale of 13A Station Street which took place within a matter of weeks before the sale of 13 Station Street, and did not take it into account when providing his valuation opinion. Overall, his evidence in relation to the valuation of No. 13 was unsatisfactory;
- (ii) there were only marginal differences in the land area of the two properties - 13A being 233m2, No 13 being 221m2, and lettable area some 390m2 for 13A and some 420m2 for 13;
- (iii) both properties were fully tenanted on not insubstantial leases to tenants of some substance;
- (iv) the sales of the two properties were comparable sales and the value of the improvements T made to No 13 is best discerned from a comparison with the sale of 13A which had not had such improvements made to it.
73. In the result, I agree with the conclusion reached by Mr C that as a result of spending $150,000 odd on improvements to No 13 before sale, T ``didn't achieve any great benefit out of it''. Put another way, in the circumstances that prevailed at the time, the subject improvements to No 13 did not add any real value to that property. It is, however, worth noting that it is regrettable that, although T had the contract of sale relating to the No 13A property with him, it was not made an exhibit, and no one sought to ask him what apportionment between land and improvements was made when the property was purchased and sold, albeit if local conveyancing practice was adopted, that evidence may not have been all that meaningful.
74. I have therefore concluded that an apportionment of the consideration on disposal for the No 13 Station Street property based upon the value of the respective assets which would be deemed to be separate if sub-s 160P(5) or (6) applied leads to the result that no capital gain arose in relation to the improvements to that property.
75. For the above reasons, I set aside the objection decision under review and allow the applicant's objection to the extent of reducing the amount of the net capital gain included in the applicant's taxable income for the 1988 year of income by $69,875.
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