STEELE v FC of T
Members:Nicholson J
Tribunal:
Federal Court
Nicholson J
This is an ``appeal'' from the whole of a decision of the Administrative Appeals Tribunal constituted by Dr P Gerber (Deputy President) and Messrs RD Fayle and SD Hotop (Senior Members) given on 4 March 1994, whereby the decision under review was set aside and the matter remitted to the respondent to deal with in accordance with the reasons of the Tribunal.
The decision under review disallowed an objection dated 7 July 1989 to an assessment issued on 8 May 1989 in respect of income derived during the year ended 30 June 1987. The effect of the disallowance was to deny to the applicant a claim for deduction of losses of $909,649 against her income for the relevant year. Her claim was that the whole of the losses were properly deductible as being losses or outgoings incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income, pursuant to s 51(1) of the Income Tax Assessment Act 1936 (``the Act'') and that they were not losses or outgoings of capital or of a capital private or domestic nature. The losses were comprised principally of interest but also of what the notice of objection described as rates and rent. The losses were claimed to have been accumulated over the 1981-1987 years.
The Administrative Appeals Tribunal first reached a decision in relation to this matter on 15 September 1992 (``the first AAT decision''). The Tribunal decided that the decision under review should be set aside and the matter remitted to the respondent for reconsideration in accordance with the reasons of the Tribunal.
An appeal from the first AAT decision was listed before the Federal Court (Sweeney J) on 20 April 1993. However, he adjourned the appeal indefinitely on the ground that the parties would be seeking liberty to apply to the Tribunal in relation to the question of apportionment of expenses incurred. That occurred and the Tribunal heard new evidence and reached its second decision (``the second AAT decision'') on 4 March 1994. That was a decision by majority in that the two Members of the Tribunal reached a different decision in relation to the new evidence than did the Deputy President, although the majority agreed with the Deputy President on the manner in which apportionment should occur.
The grounds of appeal include all of the grounds relied upon in relation to the appeal from the first AAT decision. It is necessary therefore to examine each of the AAT decisions.
The first AAT decision
The reasons of the Tribunal for the first AAT decision commence by recounting the evidence of the applicant. She was a person with experience as a manager and owner principally in the catering and hospitality industry, including 6 weeks as manager of an hotel which was part of an equestrian complex. Looking for
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an investment, she entered into a contract on 18 December 1980 to purchase Tibradden, a 7.4ha racehorse training and agistment centre. After purchase, the applicant made arrangements for management and supervision of agistment of horses on the property.The applicant also assumed the lease of an adjoining property from 1 January 1981.
The Tribunal recounted the evidence of the dealings of the applicant with architects, a partner and others concerning the possible use and development of the property. It then proceeded to make the following findings:
``50. We accept that in 1979, [the applicant], having sold her business, was looking round for an investment which would provide her a good income. However, we reject [the applicant's] assertion that her equestrian interests played any role in her initial search. Indeed, we are satisfied that when she discovered that Tibradden was on the market, her interests were focused on its commercial possibilities as a motel site, and the fact that the property was presently used for agisting horses was merely fortuitous. We therefore accept as accurate - and accurately reflecting [the applicant's] intention - the answer she gave to Mr T as to how she intended to use Tibradden, viz: `my intention was to build a motel and operate it by myself. It was my belief that another motel business in that area would be profitable, given the proximity to the airport and the city'. The fact that Tibradden was used for agistment purposes was thus a lucky coincidence - lucky in the sense that it coincided both with her own interests, as well as contributing, however modestly, to the holding costs whilst the motel plans were being developed. It also provided accommodation and an occupation for [the applicant's] sister.''
The Tribunal continued:
``52. Putting the most benevolent - indeed charitable - construction on her evidence, we find that the acquisition of Tibradden had, as far as [the applicant] was concerned, a dual purpose. We are satisfied that her main or dominant purpose in the acquisition of this property was to erect a motel upon the site and that any activity involving horses was subsidiary to her main purpose.
...
We are satisfied that after Williams joined the project as a partner in January 1982, the `horse business' ceased to play any part in the development of the project. Thereafter, scheme after scheme is floated, architects are sacked and re-engaged and potential equity partners for different projects come onto the scene only to disappear again. Against that background, we are unable to find that equestrian activities, although mentioned occasionally in one or other schematic design, can be said to be a purpose of holding the property after January 1982. To the extent that there is here a single outlay which serves two objects indifferently, the matter may ultimately become one of apportionment. We will come back to this at the end of our decision.''
As the Tribunal viewed the applicant's case, she relied on two separate operations said to relate to the derivation of assessable income. The first was the revenue to be derived from the hotel/motel if and when it became operational. The second was revenue derived from agistment.
In relation to the first, the Tribunal referred to the reliance placed by the applicant upon
Travelodge Papua New Guinea Ltd v Chief Collector of Taxes 85 ATC 4432. The Tribunal said:
``55. We are satisfied that the decision in the Travelodge case can have no bearing on the case before us. When Tibradden was purchased by [the applicant], she could hardly be said to be in business of the building and management of the hotel/ motels. In any event, any motel development was no more than a fond hope, if only because the zoning of the land did not permit the kind of development contemplated by its purchaser, [the applicant] having no more than a statement from someone on the Council that `there probably would not be a problem in getting it rezoned'. Furthermore, such future development would require road closure and sewerage connection. The fact that some of these obstacles were subsequently overcome cannot assist the applicant.''
The Tribunal then said in relation to the holding costs:
``57. We are satisfied that, to the extent that [the applicant] relies on any future income
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to be derived from any motel complex, the nexus - to use a hallowed concept from the law of tort - is too remote. It is, in our view, not enough to come within sub-sec 51(1) to buy some land and announce to the world `I have a dream'. Nor is the case assisted by the fact that this dream turned into a nightmare. We have therefore concluded that to the extent that the holding costs of Tibradden relate to the motel project - the first `limb' of the applicant's argument - they are not an allowable deduction.''
In relation to the second limb of the applicant's case, the Tribunal held:
``59. Having concluded that Tibradden was purchased by [the applicant], at the highest, for the dual purpose of (i) deriving income from agistment and (ii) developing a motel complex upon the land, we are satisfied that whatever `horse' purpose may be said to have played a part in the acquisition of the property, ceased to play any part after Williams became a partner in January 1982. Thereafter, any `horse' income derived from Tibradden is a windfall in the sense that it is unconnected with the purpose for which the property is being held. It is a nice question whether, on that finding, [the applicant] can set off any part of the claimed deductions thereafter.''
Referring to
Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 8 ATD 431; (1949) 78 CLR 47 and
Fletcher & Ors v FC of T 91 ATC 4950 at 4957-4958 and 4958; (1991) 173 CLR 1 at 17-18 and 18-19, the Tribunal said that what represents an appropriate apportionment in each case is a question of fact. Having been advised on behalf of the respondent that the Commissioner had allowed some deductions on this aspect, the Tribunal found merely that the applicant had acquired Tibradden with a twofold purpose, one of which - the equestrian component - was properly characterised as incurred in producing assessable income, thus entitling her to a deduction under the first limb of subs 51(1), at least in part.
On the aspect of rates the Tribunal referred to the provisions of s 72 of the Act and concluded that since Tibradden was used for a purpose of deriving income between the time of acquisition until the year ended 30 June 1986, the applicant's share of the rates paid with respect to the property were allowable in part.
On the issue of penalties, the Tribunal said that the 1987 return and earlier returns show the income from Tibradden had been returned as ``rent and interest received''. It was satisfied that to return the income as ``rent'', being income predominantly derived from agistment, could not have alerted the Commissioner to the nature of the business being carried on and that the use of the word ``rent'' was at best misleading.
The decision under review was set aside and the matter remitted to the respondent for reconsideration with liberty to apply on questions of quantum.
The second AAT decision
At the resumed hearing, the Tribunal accepted into evidence a schedule setting out a statement of income and expenses relevant to the activities of Tibradden for the years ending 30 June 1981 to 1987 inclusive. This was in effect an amendment to a schedule previously tendered. The parties reached agreement as to the amended details regarding expenses but disputed the disclosure of income for the three years to 30 June 1987, the matter which became the subject of the new evidence.
The new evidence was given by Ms S O'Shannessy, sister of the applicant who had come to reside at Tibradden. The majority in their reasons said that her evidence had the " unusual purpose of seeking to increase the applicant's disclosed assessable income".
The majority was unconvinced concerning the accuracy of the amounts of income disclosed in the new schedule. They nevertheless found that the partnership derived assessable income from its Tibradden agistment business in each of the 1985-1986-1987 tax years and that such income was greater than the amounts disclosed in the original schedule. The majority found that the amounts disclosed in the new schedule reflected approximate estimates of the income derived for each of the 1985 to 1987 tax years and should be accepted as the applicant's share of the assessable income so derived. They found that in the year ended 30 June 1983 an indeterminate amount of income of similar magnitude to that derived in the other years in question was derived but not returned.
The majority re-considered the previous findings in the light of the fresh evidence. They
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did not resile from the finding in par 50 to the effect that ``the fact that Tibradden was used for agistment purposes was thus a lucky coincidence - lucky in the sense that it coincided both with her own interest, as well as contributing, however modestly, to the holding costs whilst the motel plans were being developed, it also provided accommodation and an occupation for [the applicant's] sister''. The majority also confirmed their findings at par 52 concerning dual purpose. They reaffirmed the statement that "after Williams joined the project as a partner in January 1982, the `horse business' ceased to play any part in the development of the project". However, the majority then accepted that in the light of the fresh evidence there was a business activity being carried on at Tibradden including the adjacent leased land. They therefore modified the statement at par 59 and reached the preferred conclusion that:``17. On the basis of the fresh evidence, a preferred conclusion is that whilst the main or dominant purpose for which `Tibradden' was held was its redevelopment, nonetheless, at all material times accessible [sic] income was derived from a business being carried on. That business had no other objective than to derive assessable income which, subjectively, helped to defray the expenses of running that business and of holding the property. It is on this basis that the issue of apportionment is to be determined.''
In relation to the interest expense, the majority said that this was a case where there was a considerable disproportion between the amount of assessable income and the allowable deductions claimed: Fletcher v FC of T (supra) at ATC 4957-4958; CLR 17-18. The majority continued:
``20.... However, there is no suggestion that in the case at hand there was not a genuine business relationship between the applicant (and her arm's length partner) and the lending institution to which the liability to pay interest was incurred as a consequence of a commercial agreement to borrow and lend money in the ordinary course of business. There is no suggestion that the mortgage loan in question was other than genuine. There is no question here of a colourable arrangement designed to disguise other purposes lying behind the applicant's dominant purpose of redevelopment and the subsidiary purpose of deriving income from the `horse' business.''
After reviewing various authorities the majority said:
``26. The evidence in the present case indicates that the applicant, in purchasing `Tibradden', had a dual objective, the dominant one of which was capital redevelopment. Therefore, for losses or outgoings to qualify for deductions under s 51(1), dissection or apportionment must occur. The applicant's evidence was that she acquired `Tibradden' as an investment for development. Her evidence makes it clear that she did not have any specific plan in mind as to how this investment might be made profitable; all that she had was an idea, at best, to develop a motel to be managed by herself. Her idea was that what she developed would produce income under her management. Whilst the idea was far from crystallised, the evidence indicates that there was no thought on her part, nor later to her partner Williams, to sell the property for profit. Sale of the property was imperative when, towards the end it became economically impossible to proceed with a development. The idea to develop the investment was not incompatible with the fact that there existed on the property an agistment business which, with virtually no effort on her part, could be continued at least until redevelopment commenced and would provide income. The purpose of the applicant in acquiring the property was therefore twofold - to obtain income from `Tibradden' so long as that was convenient (the subsidiary purpose) and to develop the property (the main purpose), an activity which would not of itself amount to a present purpose of gaining assessable income. There were too many contingencies to say with any certainty that income would ever be derived from the dominant purpose. The evidence is that this was never more than an idea or hope - plans were never finalised nor finance ever secured.''
After further examination of the authorities the majority accepted, in the absence of any ``arithmetical or rateable'' basis for apportionment in the case, the Deputy President's approach to apportionment.
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The Deputy President, in the minority, was satisfied from the evidence at the resumed hearing that Tibradden continued to be used for agistment in the 1983 tax year. However, he found the evidence so vague as to make it impossible for him to reach any conclusion as to how much income was derived in that year. He also considered that the effect of the evidence during the resumed hearing was such that he could not come to a different conclusion to that which the Tribunal had reached in par 52 of the first AAT decision.
He continued:
``27. It must be said in fairness to the applicant that she always readily conceded that the borrowed moneys were not wholly laid out to earn fees from agistment. Indeed, when one looks at the paltry income derived from Tibradden in 1980 (or, indeed, the potential income which the property could generate from `horse' activities), it is clear that the predominant purpose which persuaded her to pay $1,000,000 for the property was for its future potential as a motel complex. In all the circumstances, I am satisfied that only a relatively insignificant proportion of the interest expense, `insurance', `bank fees' and `General & Misc', incurred in the years 1982 to 1987 inclusive (set out in exh `J'), are to be characterised as deductible pursuant to sub-s 51(1) of the Income Tax Assessment Act 1936 (`the Act').''
As the basis of assessment, the Deputy President was attracted to the method of apportionment used by Lee J at first instance in
Ure v FC of T 80 ATC 4264 and also by the Full Federal Court on Appeal 81 ATC 4100; (1981) 34 ALR 237, in which, for each of the relevant years, a total amount of deductions for interest expense, rates and land tax, insurance, bank fees and ``general and miscellaneous'' was allowed equal to the amount of the taxpayer's share of the non-development income, in this case the applicant's share of the agistment income.
Grounds
The case for the applicant is grounded on two principal arguments: firstly, that the finding of the Tribunal that apportionment was appropriate because the applicant had a fond hope of future development is wrong in law; secondly, the Tribunal was wrong in law in distinguishing the present case from the decision in Travelodge (supra). Before coming to those grounds it is appropriate to address a number of other issues arising either in grounds not abandoned or in support of the principal grounds and relating to questions of fact.
Misconception of case
Grounds 1 and 2 contend the Tribunal was in error of law in perceiving a real difference between the case of the applicant as it was presented to the Tribunal and as it appeared in the grounds of appeal and objection. In its reasons for the first AAT decision the Tribunal said:
``45. Given the sole basis upon which [the applicant] objected against the assessment, viz. the intention to build a motel complex on Tibradden, we cannot refrain from expressing some surprise at the way her case was conducted, particularly as no attempt was made to explain the substantial discrepancy between the grounds of the objection - in which horses, agisting and equestrian activities can hardly be said to have loomed large - and the basis upon which it was sought to justify the claimed deduction, namely that [the applicant] purchased Tibradden and obtained the lease of the adjoining... land to continue the existing business of agistment and horse training.''
In her objection the applicant stated that her intention was to build a motel on the property and to operate the motel for the purpose of producing assessable income while in the interim deriving assessable income from agistment fees. In the outline of submissions before the Tribunal the applicant's case was that she purchased Tibradden and took the adjacent lease to continue the existing business of agistment and horse training. In my opinion the case for the applicant does not establish that the Tribunal misconstrued the grounds of objection or made an error of law. The findings it made were open to it. In any event I am unpersuaded that the findings affected the decision of the Tribunal which accepted the continuity and income earning role of the agistment business. The oral submissions for the applicant appear to indicate that the real concern for the applicant in these matters is that they may have led the Tribunal to wrongly characterise the dominant purpose of the applicant. These grounds do not so contend and that effect is not apparent.
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Failure to make findings
Ground 3 contends that the Tribunal erred in law to the extent it failed to make findings upon uncontradicted evidence to the following effect, namely that (1) at the time of purchase Tibradden was a property on which there was a well established agistment business producing income; (2) the intention of the applicant on purchase was to derive income from that business; (3) during the years in which outgoings were incurred the property was used only for the business of producing income from agistment; (4) the conduct of the agistment business required the incurring of the outgoings. In my opinion the modification to par 59 of the reasons of the first AAT decision by the decision of the majority in the second AAT decision establishes that the Tribunal did not fail to make these findings or findings substantially to that effect. So far as the Tribunal did not accept any of the evidence of the applicant it was open for it to do so. No error of law is established.
Characterisation of purpose
As part of the case for the applicant in relation to the appropriateness of apportionment, emphasis was placed on the description given to the purpose of the applicant to achieve a motel development in the reasons of the first AAT decision at par 55 as a ``fond hope''. I accept the submissions for the respondent that, when the reasons of the Tribunal are read as a whole and in context, the relevant finding was that the applicant had the dominant intention on purchase of Tibradden to undertake a redevelopment. That remained her dominant intention and one which she attempted to implement. It is reflected in the conclusion of the majority at par 17. In any event the decision of the majority in par 17 of their reasons in the second AAT decision makes abundantly apparent that, however the redevelopment intention was characterised, there was a finding of a dual purpose in the terms there described.
Type of development intended
In the submissions for the applicant reference was made to the type of development intended by the applicant as a ``motel-equestrian complex''. I accept the submission for the respondent that the findings of the Tribunal were that what was intended by the applicant as her dominant purpose was redevelopment as a motel complex (although the precise content of such a complex was indeterminate and, as will appear, varied to include hotel and other accommodation). The evidence before the Tribunal supported a finding that the development in this way was not a further development of the agistment business but the demolition of the existing improvements and the erection on the site of something which would be inconsistent with the running of an agistment business.
The motel redevelopment argument
Ground 6 contends that the Tribunal erred in law in par 55 of its reasons when it distinguished the Travelodge case. In that case the taxpayer company was incorporated in 1971 to construct and operate a hotel in Papua New Guinea. The construction of the hotel was completed in 1978. In returns for the years ended 31 December 1981 and 1982, the taxpayer claimed the interest, rates and rent incurred in the years prior to the hotel earning income as deductions under s 68(1) of Income Tax Assessment Act (PNG) which was in identical terms to s 51(1) of the Act. The amounts claimed were held to be incidental and relevant to the production of the assessable income from the hotel and so deductible. The interest was not so integrally connected with the creation of the capital asset that it amounted to a payment of a capital nature. Bredmeyer J found that the taxpayer company intended throughout the relevant period 1974-77 to build and operate a hotel and the time lapse was not inordinately long. He concluded that the payments of interest were payments for the use of money to build the hotel and that the payments of rent and rates were paid for the use of the land.
The Tribunal did not misconceive the effect of the decision. In par 54 of its reasons in the first AAT decision the Tribunal said "... it was clearly part of the res decisa of that case (i) that the taxpayer was engaged in the business of running hotels, and (ii) that after it had obtained the lease over the land, it was irrevocably committed to building and running the hotel". It then proceeded to reach the view expressed in par 55 of its reasons.
For the applicant it is contended that the factors referred to in that paragraph are not points of distinction in principle. In particular, it is contended that the fact that the applicant was not engaged in the business of running motels
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or that ultimately the motel was not built are not proper points of distinction.In Travelodge (supra) Bredmeyer J relied upon the statement of Lockhart J in
FC of T v Total Holdings (Australia) Pty Ltd 79 ATC 4279 at 4282-3 to the effect that the first limb of s 51(1) is directed to expenditure incurred in the actual course of producing assessable income. He also relied upon the dicta of Toohey J in
FC of T v Ilbery 81 ATC 4661 at 4667; 38 ALR 172 at 180 that ``[t]he laying out of the borrowed money for the purpose of gaining assessable income furnishes the required connection between the interest paid upon it by the taxpayer and the income derived by him from its use''. For the applicant it is contended that even if the agistment business were taken out of the equation so that the only purpose of the outgoing was the motel development, it would nevertheless be the case that all of the outgoings were for the purpose of deriving assessable income. In short, it is said it is enough that the applicant had an intention, however described, to develop Tibradden to a point where assessable income would be derived of a much greater amount than from the agistment business.
For the respondent it is accepted that there must be a connection or nexus between the outgoings and the derivation of assessable income, or the carrying on of a business for that purpose, and that there must be a sufficient connection of that nature in order for the outgoing to have the necessary character. In my opinion, what the Tribunal was doing in par 55 was simply to find that there was not a sufficiency of connection on the authority of the Travelodge case where the applicant was not in the same position as the res decisa of that case. The Tribunal was not, as the argument for the applicant maintains, relying upon the ultimate non-appearance of the motel in the case of the applicant. There were important distinctions between Travelodge and the present case and the Tribunal was not in error of law in finding that Travelodge did not require it to reach a different decision.
The ground addresses the wider issue of whether the Tribunal was in error of law in finding that no holding costs relating to the proposed motel business were allowable as outgoings for the purpose of gaining assessable income even though that business had not yet commenced. In support, the case for the applicant relies upon evidence to the effect that the applicant proceeded to do things to further her intention that Tibradden could be developed as a motel complex.
The case for the respondent points to evidence to support the Tribunal's implicit finding in its rejection of the applicability of Travelodge that the outgoings were not sufficiently proximate to the earning of assessable income to give them the requisite character. Like the facts addressed by Menhennitt J in
Softwood Pulp and Paper Ltd v FC of T 76 ATC 4439 at 4450-1, it is contended for the respondent that the evidence disclosed to the Tribunal that what was done by the applicant was entirely preliminary and anterior to the course of gaining or producing income from motel development. An outgoing may be precluded from deductibility if it is incurred at a point too soon before the commencement of the business or income producing activity:
FC of T v Riverside Road Lodge Pty Ltd (In Liq) 90 ATC 4567 at 4575; (1990) 23 FCR 305 at 313 citing
FC of T v Maddalena 71 ATC 4161; (1971) 45 ALJR 426 and
Lodge v FC of T 72 ATC 4174; (1972) 128 CLR 171. These authorities were considered by Lee and Lindgren JJ in
FC of T v Brand 95 ATC 4633 at 4646 where they said:
``The circumstances and extent of any lapse of time between the incurring of a loss or outgoing and the commencement of the relevant activity directed to the gaining or producing of assessable income constitute a factor relevant to the question whether the statutory description is met. The cogency of that factor will vary from case to case, and depends on more than a mere measuring of the period. The temporal hiatus may suggest that the outgoing was incurred for some purpose other than the gaining or producing of assessable income. The test of deductibility is to be found in, relevantly, the language of the first limb of sub-s 51(1). Statements in the cases that a loss or outgoing was incurred `too soon' for it to satisfy the statute are not intended to lay down a further test but to refer to a factor which, in the circumstances of a particular case, has led to a conclusion that the statutory test is not satisfied.''
(Emphasis added.)
Cf
Griffin Coal Mining Company Limited v FC of T 90 ATC 4870 at 4887-8.
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The evidence showed that existing zoning did not permit the motel complex development. The applicant had made informal and preliminary enquiries about zoning, road closure and sewerage connection. The identity of the project varied. Initially town-house units were included as strata units for investor purchase. A half interest was acquired in the property on 8 January 1982. In October 1982 the applicant approached Southern Pacific Hotels to take an equity interest in the project but the agreement was not carried through. On 1 November 1983 the applicant and her partner entered into a memorandum of intentions with Malaysian investors for acquisition of the property and the construction of a 208 room hotel, but again nothing came of it. After the partner failed to sell his half interest to the applicant, the property was auctioned on 15 March 1984 without a buyer being found. The applicant and her partner agreed upon a division of the property around 9 October 1984 and 5 January 1985 but none was effected. During 1985/86 the applicant approached persons to buy the property. In December 1986 the applicant purchased the partner's interest in the property at auction and immediately sold a divided half of the property. Subsequently he entered negotiations to sell the portion which she retained and which was unsuitable for development. After April 1984 no proposed development was progressed. No final plans for development of a motel complex were ever settled. The road reserves were not acquired by the applicant. Finance for the motel complex, as distinguished from the purchase of the land, was never obtained. In my opinion the evidence relied upon for the respondent in this respect fully entitled the Tribunal to conclude that there was an insufficiency of connection, so that it did not err in law in reaching that conclusion.
Apportionment argument
In grounds 4 and 5 and in grounds 2 and 3 of the notice of further appeal (effectively grounds 8 and 9) the case for the applicant contends that even though the motel purpose was not a deductible purpose, it is sufficient that one of the purposes found by the Tribunal, albeit the subsidiary purpose, is a deductible purpose and the whole of the interest payments qualify as deductible. In other words, the contention is that all of the outgoings claimed by the applicant were properly deductible as having been necessarily incurred to enable her to derive assessable income from agistment on Tibradden, there being no dispute that she had conducted the business of agistment on the property during the years of income in question. The thrust of these grounds is that apportionment between the purposes found by the Tribunal is inappropriate. The submission is that, as a matter of law, if a taxpayer purchases property which yields assessable income and the cost of deriving that assessable income is principally interest paid on borrowings, then the interest is deductible even though it may exceed the income from the property unless it can be shown that there is another use to which the property is put apart from the derivation of assessable income. It is not enough to support apportionment, so the submission runs, that the taxpayer had a possible redevelopment in mind at the time of purchase of the property.
There are two preliminary propositions in the case for the applicant on this issue which can be accepted as indisputable. The first is that there is no question that the agistment business of the applicant was bona fide and so was genuine and not colourable: Fletcher (supra) at ATC 4958; CLR 18. The Tribunal so found. Secondly, the disparity which appears when the relevant assessable income is less than the amount of the outgoing does not preclude the outgoing being deductible for it is not for the Court or the Commissioner to say how much a taxpayer ought to spend in obtaining income: Fletcher (supra) at ATC 4958; CLR 18; Ronpibon (supra) at ATD 437-438; CLR 60;
FC of T v Kowal 84 ATC 4001 at 4007. Nor does it alone justify apportionment:
FC of T v Janmor Nominees Pty Ltd 87 ATC 4813 at 4820-4821; (1987) 75 ALR 15 at 24. It is not even necessary that an outgoing produce any income in the year in which the expenditure was incurred for it to qualify for deductibility: Kowal (supra) at 4007; Fletcher (supra) at ATC 4958; CLR 18.
It is not in dispute between the parties that the critical task which faced the Tribunal was to characterise the outgoings - that is, to decide whether the interest and other payments were wholly or partly incurred in gaining or producing the assessable income yielded by the agistment business: Fletcher (supra) at ATC 4957; CLR 17; Ure (supra) at ATC 4108-4109; ALR 248 (Full Court). The manner in which the Tribunal was bound to carry out that characterisation is set out in Fletcher (supra) at
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ATC 4958; CLR 18-9. Where the outgoing gives rise to the receipt of a larger amount of assessable income it will ordinarily be the case that it can be characterized without any need to refer to the taxpayer's subjective thought processes. However:``[t]he position may... well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterisation of the outgoing for the purposes of the sub- section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. [See, e.g.,
Robert G. Nall Ltd. v. F.C. of T. (1936) 4 ATD 335 at pp. 338, 340, 342-343; (1936-1937) 57 C.L.R. 695, at pp. 699-700, 706, 708-709, 712-713.] Where that is so, it is a `commonsense' or `practical' weighing of all the factors which must provide the ultimate answer. [See, e.g.,
B.P. Australia Ltd. v. F.C. of T. (1966) A.C. 224, at p. 264;
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 8 ATD 190 at p. 195; (1946) 72 C.L.R. 634, at p. 648;
F.C. of T. v. Foxwood (Tolga) Pty. Ltd. 81 ATC 4261 at pp. 4264, 4268-4269; (1981) 147 C.L.R. 278, at pp. 285, 293.] If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterised as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s. 51(1) unless it is either somehow excluded by the exception of `outgoings of capital, or of a capital, private or domestic nature' or `incurred in relation to the gaining or production of exempt income'. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterised by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.''(Emphasis added.)
The Court in Fletcher went on to say that ``[t]o the extent that the outgoings of interest incurred in the borrowing can properly be characterised as of a kind referred to in the first limb of s. 51(1), they must draw their character from the use of the borrowed funds''. That statement is supported by reference to Ure (supra) at ATC 4109-4110; ALR 249 where Deane and Sheppard JJ said:
``In a case such as the present where the outgoing claimed as a deduction is interest paid on borrowed money, one cannot ordinarily look to the direct object or advantage which the outgoing was intended to achieve for the reason that that will ordinarily be the receipt of the borrowed money which is likely to be neutral in character. One must, of necessity, look more to the objects or advantages which the application and use of the borrowed money were intended to gain (
F.C. of T. v. Munro (1926) 38 C.L.R. 153 at p. 197).''
In that statement their Honours refer both to the role of ``intention'' and ``use'' in the characterization process and draw attention to their interrelationship.
In FC of T v Munro (1926) 38 CLR 153 the taxpayer had borrowed money and secured it on a previously acquired rent-producing property to the full extent so that nothing more was necessary for him to gain or produce that income. Deductibility of the interest on the borrowing against that income was disallowed because it was for a purpose quite alien to the property (and, as the majority in the Tribunal state, the decision was made before provision for apportionment). Here, it is contended ``the borrowed moneys were directed entirely to the acquisition of a property on which a business was conducted in the relevant years the sole objective of which was the derivation of assessable income'' which was in fact derived.
That submission directs attention to what the Tribunal found. The majority firstly arrived at the conclusion that Tibradden was held mainly or dominantly for the purpose of its redevelopment but also for the derivation of the agistment income. I accept the submission for the respondent that this was a finding of two
ATC 4141
present purposes, not of a present purpose to derive agistment income and a future intention to carry out the development of a motel complex. They appreciated that the determination of the deductibility of interest required a further inquiry concerning the use to which the borrowed funds had been put. They concluded that, because there was a dual objective of the applicant in purchasing Tibradden apportionment of the outgoings must occur. In its reasoning the majority relied upon appropriate authorities, most of which have been referred to in these reasons. I am unable to detect any error of law in principle in the reasoning of the majority. Nor is this a case where it could be successfully contended that the finding of dual purpose was without appropriate evidentiary foundation.The view that there was no error of principle by the Tribunal may be tested by reference to the first principles set out above in Fletcher. It was clearly the task of the majority to weigh ``the whole set of circumstances'' which included ``direct and indirect objects and advantages which the taxpayer sought in making the outgoing''. It was not therefore open to the Tribunal to consider only the circumstance that one objective was the derivation of agistment income. In a ``commonsense'' or ``practical'' way it could not be said that the outgoing was for the purpose of securing the agistment income. That appears to have been conceded: see par 27 of the reasons of the Deputy President in the second AAT decision. The finding of dual purpose establishes the existence of ``the independent pursuit of some other objective'' than the derivation of agistment income. As in Ure (supra), the Tribunal was of necessity required to look more to ``the objects or advantages which the application and use of the borrowed money were intended to gain''. It could not look only to one of those objects or advantages and it was required to have regard to intention as well as use. Use alone could not be determinative and fell to be evaluated in the context of intention.
For the applicant it is also submitted that if apportionment occurs it leads to an extraordinary result because, if a taxpayer purchases a property on which an existing business is being conducted, borrows money for the purchase, pays interest on the loan and has no purpose other than that, the outgoings of interest will be fully deductible. However, if the taxpayer has a purpose at the time of incurring the outgoing of ultimately improving the property and so deriving more assessable income, it is said that the interest is either not deductible or is only partly deductible. In my view, the answer to that submission is that the law requires that regard be had to the direct and indirect objects and advantages sought by a taxpayer in making an outgoing where there is a relevant disproportion between outgoings and income and, in the case of an outgoing being payments of interest, to the objects or advantages which the application and use of the borrowed money were intended to gain. If the taxpayer makes an outgoing in circumstances where the subjective thoughts of the taxpayer are relevant to the issue of characterization, the presence of objectives other than the derivation of assessable income will be a factor relevant to the characterization process. Consideration of what was said by members of the High Court in
Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542; (1980) 33 ALR 213 does not lead me to the conclusion that, contrary to the authorities to which I have previously referred, the question of the taxpayer's state of mind is not relevant at all (as was submitted for the applicant). Indeed in Fletcher (supra) at ATC 4957; CLR 17 a passage from Magna Alloys (supra) relied upon in the case for the applicant on this point is cited in support of the proposition that ``at least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterization of either the whole or part of the outgoing for the purposes of'' subs 51(1). It is the presence of the disproportion which necessitates resort to the subjective thoughts of the taxpayer. There is no apparent inequity between the application of that law and the absence of resort to those subjective thoughts where a taxpayer purchases a property on which an existing business is being conducted with no other purpose in mind because, in those latter circumstances, it would be the case that the taxpayer would have tailored the outgoing to the income (and so no disproportion would appear).
In reaching these views I accept the submission for the applicant that the
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characterisation of the purpose of redevelopment as ``dominant'' is of no particular significance to the resolution of these arguments.It should also be noted that the majority also concluded that the derivation of assessable income from the agistment activities was an affair of revenue and that the other purpose (``to develop a profit-yielding structure of a future business enterprise'') was an affair of capital. For the applicant it is contended that, at the time the outgoings were made, they were not ``related to the development of a motel''. In my view the finding of the majority of the Tribunal concerning the dual purpose of the outgoings precludes that argument.
Penalty
Ground 7 is that the Tribunal erred in law in holding that the description of the income from agistment in the applicant's returns as ``rent and interest received'' justified the imposition of a penalty under s 223(1) of the Act on the ground that the applicant had made a false or misleading statement in a material particular. The ground is supported by reference to two considerations namely, that the respondent did not contend in his reasons for imposing the penalty that the description of the agistment income in the returns as ``rental'' was misleading in any relevant sense; nor was it so as a matter of law.
In its reasons the Tribunal accepted that, although the penalty was struck in an amount below the amount reviewable by the Tribunal, it was open to the Tribunal to review the penalty on the basis of the contention that there was no legal foundation for it. The Tribunal concluded in the reasons of the first AAT decision:
``67... We are satisfied that to return the income from Tibradden - predominantly derived from agistment - as `rent' cannot be said to have alerted the Commissioner to the nature of the business being carried on. In other words, the use of the word `rent' is at best misleading.''
It is the description of the income received which the Tribunal found to be misleading.
For the applicant it is contended the reasons of the Tribunal fail to disclose how the misdescription was misleading ``in a material particular'': s 223(1) of the Act. For the respondent it is contended that had the income received been described as agistment income the Commissioner would have known that the applicant remained in possession of the property and, because of the disproportion between the interest outgoing and the agistment income, might have been alerted that there was another purpose for which the property was being used.
The issue to which the description of the income received was material, on the respondent's contention, is whether the interest payments were fully deductible or deductible only upon apportionment. What might have alerted the Commissioner to this issue was the disproportion previously referred to, irrespective of the description of the income received. Given the quantum of such income, neither description would necessarily have carried with it the conclusion that the applicant did not retain possession of the property.
For the respondent it was also contended that the description is misleading because it did not state expressly that the property was being held for the purpose of development of a motel complex. This was not a matter relied upon by the Tribunal.
While the Tribunal was correct in concluding that the description in issue was misleading in the sense that it was a wrong or inadequate description of the income received, it was in error of law in concluding that the misdescription was misleading ``in a material particular''. In my opinion, the applicant is entitled to succeed on this ground.
Conclusion
For these reasons I conclude that the ``appeal'' should be allowed in relation to the issue of penalty but otherwise dismissed.
The Court orders that:
1. The decision of the Administrative Appeals Tribunal made on 4 March 1994 be affirmed save and except that it be set aside so far as it requires the decision-maker to reconsider the question of penalty pursuant to s 223(1) of the Income Tax Assessment Act 1936 in accordance with the reasons of the Tribunal and in lieu thereof the decision-maker be required to reconsider that matter in accordance with the reasons for judgment of this Court.
2. The applicant pay the respondent's costs of the ``appeal''.
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