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LITTLE v FC of T

Members:
J Block DP

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2006] AATA 949

Decision date: 9 November 2006

J Block (Deputy President)

Part A - introduction and background

1. The objection decision which is under review in this matter is the disallowance by the Respondent of an objection dated 14 July 2005 by the Applicant against an assessment dated 23 June 2005 in respect of the year ended 30 June 2003 ("the Relevant Year").

2. The Applicant was represented by Mr Ian Holland of Sylvania Taxation Services Pty Limited, an accountant, while the Respondent was represented by Mr Roger Quinn of counsel instructed by Mr Andrew Tran of the ATO Legal Practice.

3. The Tribunal had before it the T documents lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 together with Exhibits as follows:

Exhibit R1: A search (contained under tab 5 in a bundle of documents furnished to the Tribunal by the Respondent) made in respect of I R Little Pty Ltd ("the Company");
  It is convenient at this point to note that the bundle of documents ("the Bundle") referred to above includes both documents procured by the Respondent in response to summons and also the reports of relevant decided cases.
Exhibit R2: (Tab 1 of the Bundle) is an agreement dated 18 November 2001 entitled Franchise Hose Doctor Agreement made between Parker Enzed Technology Pty Limited ("Enzed"), Willcam Pty Ltd TRADING AS Enzed Newcastle ("Service Centre Franchisee") and the Company, referred to therein as the "Hose Doctor";
Exhibit R3: (Tab 2 of the Bundle) is an "Equipment Lease" dated 7 January 2002 made between Willcam Pty Limited as the lessor and the Company as lessee;
Exhibit R4: A set of accounts, and including a trial balance, in respect of the Company and referable to the Relevant Year;
Exhibit R5: (Tab 3 of the Bundle) is the Company's tax return for the Relevant Year;
Exhibit R6: (Tab 6 of the Bundle) consists of a number of BAS returns made by the Company in respect of the Relevant Year; and
Exhibit R7: (Tab 4 of the Bundle) is a lengthy letter dated 30 April 2003 by the Applicant to Mr Dennis Johnson of Parker Enzed Pty Limited.

4. It is convenient to include by way of commencement, the content of the Respondent's Statement of Facts and Contentions dated 6 October 2005 under the head of Facts; clauses 1 to 23 read as follows:

"…

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FACTS

  • 1. In around July and August 2002 the Applicant, who at the time was employed by the Department of Defence, became interested in purchasing a franchise from Parker Enzed Technology Pty Ltd ('Enzed').
  • 2. The franchise permitted the franchisee to offer for sale hydraulic and flexible hose, fittings and accessories to customers under the franchisor's trade marks within a designated area.
  • 3. It was a condition of entry into a franchise Agreement with Enzed that the franchisee be incorporated.
  • 4. On 19 August 2002 the Applicant incorporated a private company I R Little Pty Ltd ('the Company'). The Applicant was a sole director of the Company.
  • 5. On 30 October 2002 the Company executed a franchise agreement with Enzed. Under the franchise agreement the franchisee had the title of a Hose Doctor.
  • 6. Pursuant to clause 6.1 the franchisee was required to lease or purchase a vehicle for the conduct of the franchise.
  • 7. On or about 31 October 2002 the Applicant purchased a new Isuzu cab chassis (Registration NZD 062) from Suttons Arncliffe. The vehicle was purchased by way of a finance lease agreement between Suttons Motor Finance Pty Ltd and the Applicant.
  • 8. On 8 November 2002, the Applicant ceased employment with the Department of Defence.
  • 9. Around December 2002 the Company commenced conducting a business under the franchise Agreement. The business was not a success.
  • 10. On 30 April 2003 the Company wrote to Enzed advising that it wished to terminate the franchise agreement.
  • 11. The only income returned by the Applicant from his involvement with the Company for the year ended 30 June 2003 ('the relevant year'), was an amount of $50 by way of a director's fee. (T4-30)
  • 12. The Applicant's income tax return for the relevant year was prepared by a tax agent.
  • 13. The Applicant claimed a number of expenses in his income tax return for the relevant year which were said to be incurred in earning the Applicant's assessable income.
  • 14. As to the use of the Isuzu vehicle (Registration NZD 062) the Applicant claimed the following as work related travel expenses:
    Truck Parts $887.00
    Insurance $575.00
    Lease Payments $8,940.00
    Fuel $339.00
    Loss on sale $1,000.00
    TOTAL $11,741.00
  • 15. The Applicant also claimed an amount of $7,367 as other work related expenses (T4-30)
  • 16. On 18 August 2004 the Commissioner notified the Applicant that his tax return for the relevant year was to be subject to an audit in relation to the work related expenses prior to issue of the assessment. (T5-34)
  • 17. The Applicant provided a number of receipts and invoices to the Commissioner in relation to the above expenses (T7-39 to T7-78). The documentation showed that the expenses were either incurred in the name of the Applicant, the company or as cash sales.
  • 18. On 27 May 2005, as a result of the audit, the Commissioner disallowed the travel expenses totalling $11,741 and the other work related expenses amounting to $7,367 (T10-96) on the basis that the expenses were not incurred by the Applicant in earning his assessable income for the purposes of sec 8-1 of the Income Tax Assessment Act 1997 ('ITAA1997').
  • 19. By reason of the above the Applicant had a tax shortfall. On 22 June 2005 the Respondent imposed, and gave notice of

    ATC 2491

    a tax shortfall penalty pursuant to section 284-75 of Schedule 1 to the Taxation Administration Act 1953 at the rate of 25% amounting to $2,520.05 for failure to take reasonable care.
  • 20. On 23 June 2005 the Commissioner issued a Notice of Assessment for the relevant year to the Applicant including adjustments reflecting the audit decision. (T12-114).
  • 21. On 14 July 2005, the Applicant lodged an objection to the assessment for the relevant year (T13-115). In his objection the Applicant indicated that he would accept a disallowance of bank fees of $120 but wished to claim an additional amount of $175 for a storage bin, with the result that the net effect on the total amount claimed for other work related expenses was $7,422.
  • 22. On 14 July 2005 the Applicant's tax agent lodged an objection to the tax shortfall penalty imposed for the relevant year (T14-120).
  • 23. On 24 March 2006 the Respondent issued to the Applicant a notice of decision on the objection (T15-123). The Commissioner's decision on the objection allowed travel expenses only to the extent of $50. The Commissioner remitted in full the tax shortfall penalty.

…"

Words and phrases defined in the Respondent's Statement of Facts and Contentions as quoted above have the same meanings when used in these reasons.

Part B - the evidence of the applicant; evidence in chief

5. A written statement of the evidence to be given by the Applicant was not produced; however Mr Quinn agreed to dispense with this requirement.

6. The Applicant is currently a technical adviser to the Royal Australian Navy ("RAN"). After 22 years with RAN (the last five as a chief petty officer) the Applicant resigned from RAN. His resignation occurred at the end of a period of deployment in the Persian Gulf. He said that he had been overseas for extended periods and in consequence of which saw little of his family and friends. As to whether his resignation from RAN occurred in 2001 or 2002 was at the time when his evidence commenced not altogether clear but the latter would appear to be far more likely.

7. At or about the time of his deployment in the Persian Gulf, the Applicant saw an advertisement in the Navy News by Enzed offering franchises in respect of Hose Doctors. A Hose Doctor put in brief terms, furnishes a mobile service repairing hydraulic hoses (forming part of heavy machinery) on site.

8. The Applicant expressed interest and an exchange of emails resulted. In particular the Applicant was contacted by the Enzed franchisee in Newcastle; this company, which is not Enzed, is referred to as "Enzed Newcastle"; (it is the Service Centre Franchisee referred to in Exhibit R2).

9. Enzed Newcastle informed the Applicant that a franchise in the Gosford area was available. The Applicant while in the Persian Gulf "did homework" and obtained information as to what he could earn from such a franchise. After returning to Australia in 2002, the Applicant obtained advice from Mr Holland to the effect that the proposition appeared to be viable. Having received a lump sum on his resignation from RAN the Applicant used part of it to purchase a franchise from Enzed; he said that the consideration paid for the franchise was $24,000.

10. T7-47 indicates that the Applicant (and not the Company) contracted to acquire an Isuzu vehicle ("the Vehicle") for a total price of $35,419; it indicates that a lease by Suttons Finance would be provided. T7-48 is the Finance Lease Agreement and being an agreement between Suttons Motors Finance Pty Limited and the Applicant in respect of the Vehicle for a period of five years commencing 31 October 2002. In fact T7-48 is a summary of the essential terms, to be read with a booklet entitled "Suttons Motors Finance Pty Limited Lease Agreement" ("the Booklet"). The Booklet was not in evidence before the Tribunal; however there was no dispute as to the fact that the lease referred to in this clause 10 of these reasons was a finance lease. The lessor under the finance lease is referred to in these reasons as "Suttons" and the finance lease of the Vehicle is referred to as the "Vehicle Lease".

11. 

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The Vehicle Lease must be distinguished from Exhibit R3, which is the Equipment Lease. The Equipment Lease in contrast with the Vehicle Lease was entered into between Willcam Pty Limited as the lessor thereunder and the Company as lessee. That it was connected with the Franchise Agreement appears from Schedule One to the Equipment Lease; Schedule One to the Equipment Lease (Exhibit R3) reads as follows:

"Schedule One


Item Term Definition
1. Lessor Willcam Pty Ltd
44 Industrial Drive Mayfield NSW
2. Lessee IR Little Pty Ltd
8 Pine Ridge Close Litharow NSW
3. Guarantor Iain Little
8 Pine Ridge Close Litharow
4. Franchise Deed The Enzed Hose Doctor Franchise Deed between the Lessor, the Lessee and Parker Enzed Technology Pty Limited dated [date]
5. Leased Equipment 1 09FF Nokia Mobile Phone - serial no. 0505786
1 Truck Body - ENZED 0407713544 to fit Isuzu truck
1 Cut off saw =- serial no. WILLCAM 2
1 DS8 Crimping Machine - serial no. WILLCAM 1
1 complete die set
Bins, racking and lights fit within Truck Body
6. Commencing Date The Commencing Date of the Franchise Deed
7. Expiry Date The Terminating Date of the Franchise Deed
8. Further Term As provided in the Enzed Hose Doctor Franchise Deed
9. Rent $275.00 per month plus 50% of all Assembly Charges as calculated by the Monthly Commission Report in the form provided in Schedule Two, as amended from time to time by agreement of the parties.
10. Permitted Use To carry out the Services provided in the Franchise Deed."

12. It is to be noted that the Equipment Lease is related to the Leased Equipment consisting in the main but not entirely of attachments (and particularly the Truck Body) which was attached to the Vehicle. Although the Truck Body was attached to the Vehicle the lessors in respect of the Vehicle alone and (inter alia) the Truck Body were Suttons and Enzed Newcastle respectively while the lessees were the Applicant and the Company respectively.

13. As a part of the overall transaction, a customer list was furnished by Enzed. The Applicant said that the customer list was bogus in particular in that potential customers referred to in it had closed down. He contacted another Hose Doctor and was told that the latter was earning less than $20,000 per annum.

14. The Applicant said that after six months of canvassing as much as he could the enterprise was closed down. (It is probable that the relevant period was less than six months). He said that Enzed required the return of the stock which it had provided and he returned it (replacing stock sold) in March 2003. That date was then amended so as to refer to May 2003. The Franchise Agreement indicates that stock was provided on consignment.

15. When the enterprise failed Enzed purchased the Vehicle from Suttons. The Applicant said that he was unemployed from May 2003 and recommenced service with RAN in June 2003 first as a reservist (until July 2003) then on a full-time basis as a chief petty officer

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and thereafter in the same capacity and on the same terms, but as a civilian.

16. The Applicant said that he used his RAN payment not only to pay for the franchise but also to pay for tools and also various insurances. He said that he paid for all of these amounts himself and did not borrow.

17. The Applicant said that he thought that there were breaches of contract by Enzed but that he did not take action after obtaining legal advice that the costs involved would be too high.

18. The Applicant insisted that as a simple sailor he knew nothing about business and simply "signed on the dotted line" having relied on Mr Holland. He explained that in respect of sales (and sales consisted of both the supply of goods and the provision of services) the Hose Doctor received 33 percent of sales proceeds. Payments were made by customers (in response to invoices issued to them) to Enzed Newcastle. In the time between November 2002 and May 2003, only two payments were received; the larger payment was $185. When asked whether payments were made to him or to the Company he said that he was not sure.

Part C - the evidence of the applicant: cross-examination

19. It may be noted in general terms that throughout his cross-examination the Applicant indicated a lack of awareness of (in general terms) financial and tax matters. Many questions were answered simply on the basis that he did not know the answer but had relied on Mr Holland or could not remember and in particular after the lapse of the years that have ensued. The Applicant was referred to Exhibit R1 which is the search in respect of the Company. He agreed that he was a director and that the capital consisted of 10 shares of $1 each, two of which were owned by him and the other eight by his wife.

20. The Applicant was next referred to Exhibit R2 which is the Franchise Agreement (prepared by Corrs Chambers Westgarth) and which was executed by the Company as the Hose Doctor (represented by the Applicant) on 18 November 2002. The terms "Enzed Hose Doctor Franchise" and "Enzed System" are referred to on page two of the lengthy and comprehensive Franchise Agreement as follows:

"…

  • 1.7 In this Deed, the following definitions shall apply:

    …

    'Enzed Hose Doctor Franchise' means a retail business utilising mobile van units which provide on-site sales and servicing of hydraulic hose fittings and accessories to customers and which operates from the Service Centre Franchisee's Enzed Service Centre which supplies the Hose Doctor with inventory, commissions, customer lists, marketing services and other services and information in conjunction with Enzed. The Hose Doctor services the immediate needs of customers located within the Territory on behalf of the Service Centre Franchisee. The Hose Doctor also will utilise in the operation of its franchised business certain equipment which has been developed and manufactured by Enzed or its affiliates for the preparation of customised hydraulic hose fittings and related products to suit specific requirements of the customers serviced by the Hose Doctor.

    …

    'Enzed System' means a business system developed by Enzed its affiliates and principals for the establishment development and operation world wide of retail businesses of Enzed Service Centre franchises, hose doctor franchises and includes without limitation physical layout for sales and service centre premises, a programme for the administration and operation of Enzed hose doctors and hose doctors franchises, mobile van units, franchisee and hose doctor training, promotional activities and advice and assistance in methods of marketing,, business administration, customer dealings and other related matters, and the use of the Business Names and the Marks in connection with such retail business.

    …"

21. 

ATC 2494

The Applicant agreed that he knew that the franchise would be given only to a limited company and the Company was incorporated for this reason. He knew that unless granted to a limited company the franchise would not be granted at all. He personally attended training in Albury-Wodonga in October 2002 after his return from the Persian Gulf. The Applicant was next referred in particular to clause 11(f)(i) of the Franchise Agreement reading as follows:
  • "11. DUTIES OF THE HOSE DOCTOR

  • In addition to the Hose Doctor's other obligations and duties set out in this Deed the Hose Doctor shall comply with the following terms and conditions:

  • …

  • (f) during the Term, the Hose Doctor shall …
    • (i) submit to the Service Centre Franchisee, no later than the tenth (10th) day of each month during the Term a report in the form prescribed by the Service Centre Franchisee, accurately reflecting all Gross Sales for the immediately preceding month …
    • (ii) …"

22. The Applicant agreed that the Service Centre Franchisee was Enzed Newcastle to whom accounts were sent and by whom invoices were sent and who received payments from customers.

23. The Applicant was also referred to clause 8 of the Franchise Agreement reading (in part) as follows: …

  • "8. SALE OF INVENTORY AND PAYMENT OF COMMISSIONS
  • 8.1
    • (a) …
    • (b) Each week in the manner determined by the Service Centre Franchisee the Hose Doctor shall forward all invoices and related records to the Franchisee reflecting On-Site Sales for the previous week. The Hose Doctor shall be paid commissions on all products sold at the rates described in the Manuals and on the terms described at Clause 8.3 below

    • …"

  • It is of course clear that the Hose Doctor was the Company and not the Applicant. …

24. The Applicant said also that the Vehicle was decorated with Enzed's reference and phone number and in accordance with its colour scheme. Enzed supplied stationery and invoices. Possible customers could phone the number indicated and their enquiries would be directed to the nearest Hose Doctor. He, the Applicant, wore shirts supplied by Enzed and denoting his connection with Enzed.

25. The Applicant said that the Company operated the franchise until March 2003 when Enzed required the return of the stock and equipment. He said that this occurred because "I wasn't making any money for them".

26. The Applicant was next referred to the Company's tax return for the Relevant Year; he agreed that the Company reflected sales totalling $187. He agreed also that the Company claimed that it incurred expenses (referred to as "all other expenses") of $7,889 and said that his amount included substantial insurance costs in respect of income protection, stock, the Vehicle and public liability.

27. The Applicant was referred to the fact that the tax return reflected a loss for the Relevant Year of $7,702. He agreed that this amount corresponded (almost exactly) with the entry in the Company's balance sheet (Exhibit R4) reflecting a director's loan of $7,702.38 and said that the lender director was in fact himself.

28. The Applicant was referred to the Franchise Agreement which reflected an amount of $5,500 paid for the franchise and asked whether he wished to alter his previous statement that he paid $24,000, he said that he did not know where the other $20,000 had gone but was satisfied that he paid $24,000. He agreed also that the balance sheet reflected an insurance liability of $1,359 which he said was for public liability. The Applicant said that Exhibit R4 was prepared by Mr Holland as his accountant. As to his director's loan account of $7,702.38, he said when asked whether he had vouchers, that his accountant would have them.

29. The Applicant's attention was drawn to the fact that there was no provision in the tax return under the head of Expenses, for salaries and wages. It was also put to him that in his

ATC 2495

own return he reflected a director's fee of $50 received from the Company and asked where in relation to the Company this was reflected. He replied that he did not know what a director's fee was for and when asked the source, said "no idea". He was asked whether his accountant told him to reflect $50 and he replied "I believe so". He said also that the amount of $50 was paid by him personally.

30. The Applicant answered "I don't remember" to various questions as to the amount of $50 and in particular as to whether his accountant told him to include it. He said though that $50 was very little for six months' work.

31. Next referred to the Company's BAS returns (Exhibit R6) the Applicant agreed that they were returns by the Company, the ABN corresponding with that reflected in the search paper previously referred to; he agreed also that no amounts were reflected in the BAS returns in respect of sales and moreover no amounts were reflected in respect of any payments to employees. When asked about the amount of $187 previously referred to he said that he did not remember if it was paid to the Company.

32. The Applicant confirmed that he personally has no ABN and that the ABN reflected in Exhibit R6 relates to the Company.

33. Exhibit R7 is a letter dated 30 April 2003 addressed by the Applicant to Mr Johnson. It reads as follows:

"…

RE: TERMINATION OF FRANCHISE FOR IR LITTLE PTY LTD

Dear Dennis;

As a result of IR Little Pty Ltd becoming insolvent it is my unfortunate duty to request the termination of my contract with Parker Enzed Pty Ltd as per article 18, paragraphs 18.1 (B) and 18.5 (A) of the franchise hose doctor agreement.

In November 2002 I started canvassing some 120 potential customers (average of 10 per day) from the yellow pages from Brooklyn in the south to Doyalson in the north in the hope of securing some permanent clientele without any success, I did realise that the Christmas holiday period was always going to prove an up hill battle bit it is nearly May and nothing has improved.

I was so disappointed and surprised at the lack of customers that I contacted the Newcastle service centre in February and requested assistance from a seasoned representative in canvassing potential clients as I felt that I might have been doing something wrong in my presentation.

It was fortunate at the time that Brendon O'Loghlan was visiting the service centre and he told me that he would organise to visit the Central Coast and assist me, I never heard from Brendon again.

As I explained to you on the phone I had the opportunity to secure a very lucrative and lengthy contract with the Department of Marine Services (DMS) at Garden Island Dockyard which supports the Royal Australian Navy (RAN) with some 300 water craft is [sic] Sydney alone, unfortunately this meant working in another service centres [sic] territory.

I informed Danny Ward and Jim Harman of this opportunity and the 'technical glitch' that incumbered [sic] the deal and asked them to contact the Mascot service centre in an attempt to work out a compromise between service centres as the contract was offered to Enzed on the proviso that I would be the main player as I had the contacts in DMS management, 'Nothing was done' and the contract has been awarded to a rival hose company.

On Friday the 21st of March I requested a crisis meeting with Danny Ward and Jim Harman to ask if there was anything that could be done to same my franchise and keep me going, Danny did not attend the meeting preferring to fit hoses in the workshop so it was up to Jim Harman and once again Brendon 'who just happened to be there' to try to sort something out before it was to [sic] late. Once again Brendon said that he would allocate time to visit the Coast and attempt to source clients and once again nothing happened.

Jim Harman produced a Hose Doctor Franchise Agreement Addendum that would put me on guaranteed income for a six month period and I was more than happy to

ATC 2496

fore go [sic] commission to trial the offer as I believe that would have kept me going until I could secure permanent customers. The following week I was contacted by Jim informing me that the offer had been revoked and I was on my own.

On the 1st of April I contacted Jim Harman and informed him that I had ceased canvassing clients and had become insolvent as a company, I have also begun negotiations with the Newcastle service centre to return un used [sic] stock and the cargo/work area of the truck. It is my opinion that the Newcastle service centre had not thoroughly investigated the Central Coast market before offering me the opportunity to start trading as a hose doctor, I was only introduced to the other hose doctor after I had signed the agreement and he informed me of some home truths that I was not aware of.

During my short time with Enzed I was supplied with two ancient mobile phones in succession that failed repeatedly, which put me behind the 8 ball from the start.

In closing Dennis, I am extremely disappointed in the way I have been treated by the Newcastle service centre and feel humiliated that I allowed myself to be persuaded from a very rewarding and prosperous Naval career into a franchise that was doomed from the start, I asked for assistance on many occasions by following the guide lines laid out in the franchise agreement but was ignored. The Enzed name will remain forever in my mind as a company that does not care about its employees unless they are earning top dollar.

Please inform me at your convenience if there is anything else that I am required to do with regard to closing down the franchise.

Regards"

Exhibit R7 indicates that the enterprise had closed by the end of March 2003 and so that this being so, it could not have continued into May 2003. It follows also that at most the enterprise endured for about four months.

34. The Applicant was asked when he formed the view that the Company was insolvent. He explained that the Company was active; when his attention was drawn to the fact that he used the term "insolvent" he said that that was a mistake. He agreed though the Company had capital of $10 only.

35. The Applicant himself for the Relevant Year claimed work-related deductions of $11,741 and including $887 for truck parts. He was referred to T4-33 and asked why he claimed for truck parts in respect of the Vehicle, which was purchased new and would have been under warranty. He answered that this amount would have had something to do with a water tank.

36. Again referred to the director's fee of $50 (and referred in particular to T7-48) the Applicant (or to be more exact Mr Holland on his behalf) answered that it was reflected in the trial balance and that as to vehicle costs there was no legal obligation to keep a logbook because the Vehicle was used for commercial purposes.

37. The Applicant was cross-examined as to some of his deduction claims. T7-39 is his logbook for the Vehicle; the opening entry notes that the first trip took place on 29 November 2002 when he picked up the Vehicle in Sydney and drove it to Gosford; the distance reflected is 500 kilometres. The Applicant agreed that this could not be correct.

38. In respect of home office expenses the Applicant said that he had a home office in his garage in which he kept a table and a computer and other items. The computer was purchased, according to the evidence, some three months after the business had terminated. A claim for internet fees at the rate of $25 per month for 12 months was sought to be justified on the basis that although the business ran for a much lesser period he was employed by RAN both before and after the business commenced and terminated and that when employed by RAN he had required internet access. There was no answer to a question as to the period immediately before the business commenced and when the Applicant was in the Persian Gulf and when he could not possibly have required internet access at any rate in respect of the business, or for that matter at all.

39. The deductions claimed included items of a capital nature (such as Slimline) and referable to attachments to the Vehicle. They

ATC 2497

included depreciation on a digital camera and other items. A loss on the sale of the Vehicle was claimed. The amounts sought to be deducted suffer from a general lack of substantiation in accordance with Division 900 of the Income Tax Assessment Act 1997 ("the Tax Act"). I do not think it necessary for me to deal further or in detail with the cross-examination of the Applicant in respect of his claimed deductions for the reasons set out later in this decision.

Part D - the issues

40. There are only two issues. The first question is as to whether the Applicant is entitled to deductions for amounts expended by him in respect of the business of the Company. The second question is as to whether if deductions are available at all whether the deductions claimed are valid and/or have been properly substantiated.

41. Mr Holland commenced the hearing by noting that he was unclear as to why the matter was before the Tribunal at all and felt that any difficulties could and should have been resolved prior to the hearing. He was in fact (it would seem) referring to questions of substantiation of amounts claimed as deductions.

42. Mr Holland was altogether firm about one aspect and he repeated it on numerous occasions. The Applicant himself entered into the Vehicle Lease. This being so, he was entitled, so Mr Holland contended, to deductions related to the Vehicle, and also other deductions related to the business. He put it on this basis; a sales representative who is obliged by his terms of employment to provide a motor vehicle as a condition of employment is entitled to deductions referable to that motor vehicle. Put on this basis, so Mr Holland claimed, the Applicant incurred expenses in the hope that the Company's business would be successful and so that it would be able to pay him a return. As Mr Holland saw it, the position of the Applicant and the position of a sales representative obliged to provide his own car are no different and the fact that this particular business endeavour was so unsuccessful was not in any way relevant. (There was no evidence before the Tribunal as to any terms of employment as between the Applicant and the Company)

43. I do not think that I better demonstrate the fallacies in the Applicant's case than quote the first seven paragraphs of Mr Holland's letter to the Respondent dated 21 April 2005 which appears at T9-93/94 as follows:

"Reference is made to your letter dated 14 April 2005 concerning the Income Tax Audit - Work Related Expenses for the year ended 30 June 2003 for the above mentioned Taxpayer.

You appear to have missed the major point of the Taxpayer's employment. The Taxpayer ceased full-time employment with the Department of Defence - Navy on 8 November 2002. Subsequently he commenced full-time employment with the private company I R Little Pty Ltd of which he was a director.

In his capacity of director/employee of the company he was required to:-

  • (a) Market and deliver services of the company to businesses within a specified geographic area;
  • (b) To provide a suitable commercial vehicle and mobile workshop to carry out the company's business;
  • (c) To provide appropriate insurance, tools and phone expenses to carry out his duties;
  • (d) As a one-director company he was required to do all things necessary to ensure the company business is carried out.

The company entered into a franchise agreement with Parker Enzed Pty Ltd to operate an Enzed Hose franchise. The company's enterprises did not prove profitable and the company could not afford to pay more than $50 remuneration to the taxpayer for his full time activities on the company's behalf.

That the company's activities were not profitable is unfortunate but that this does not negate the activities were a legitimate business venture and that the Taxpayer was employed full time on behalf of the company.

The work related travel expenses of $11,471 were incurred by the Taxpayer in providing his own truck fitted with a [sic] Enzed mobile work shop to carry out his duties of employment for the company.

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The other work related expenses claimed were either incurred in fulfilling the Taxpayer's employment duties as a Naval Engineer with the Department of Defence or as an employee/director of I R Little Pty Ltd. Both occupations were full time positions.

…"

44. Mr Holland argued in the alternative that in fact the Applicant was in reality a sole trader on the basis that the Company was merely an interposed entity. This claim too was repeated although in the end it was abandoned. Mr Holland accepted that the Applicant did not himself have an ABN and could not himself obtain the franchise, and thus could not have been in business on this or any other basis.

45. The Applicant, as I have said, did not file a witness statement and in addition did not file written submissions. Mr Holland said that the Applicant relied on his Statement of Facts and Contentions which is somewhat sparse in relation to relevant case law. The Respondent's written submissions by contrast deal extensively with case law and I have drawn on them to some considerable extent for the purpose of these reasons.

46. The test of deductibility requires that the expenditure be incidental and relevant in the sense of having the essential character of expenditure incurred in the course of gaining or producing assessable income (first limb) or the carrying on of a business for the purpose of producing assessable income (second limb). Expenditure will be deductible if there is a connection between the loss or outgoing on the one hand and the assessable income or business operations on the other, if it is "incidental and relevant" (
Ronpibon Tin N.L. v FC of T (1949) 78 CLR 47 at 56) to that end. It is necessary to identify (by this approach) the essential character of the expenditure. This case is not concerned with the second limb since clearly the Applicant was not carrying on a business.

47. It has long been established that "incurred in gaining or producing" is to be understood as meaning incurred "in the course of" gaining or producing the assessable income:
FCT v Payne 2001 ATC 4027; 46 ATR 228 at 232. To come within the initial part of the subsection it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income: Payne (supra); Ronpibon (supra).

48. Conversely the principle underlying section 8-1 is also one which will exclude outgoings which although incurred for the purpose of deriving assessable income or in the carrying on of a business, are not incurred "in the course of" doing so:
FC of T v Payne 2001 ATC 4027; 46 ATR 228 at 230. It is not sufficient that the purpose of the expenditure is incidental or relevant to the derivation of assessable income but it must be of a character incidental or relevant to such derivation:
Lunney & Anor v FC of T 11 ATD 404.

49. The task of characterisation will involve enquiring what the loss or outgoing was for:
Colonial Mutual Life Assurance Society v FC of T (1953) 89 CLR 428 at 454;
Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634. The relevant question to be asked is: "is the occasion of the outgoing found in whatever is productive of actual or expected income": Payne (supra).

50. One of the leading case in respect of which an expense was voluntarily occurred is
Fletcher & Ors v FCT 91 ATC 4950; (1991) 173 CLR 1; the High Court said:

"…

The question whether an outgoing was, for the purposes of s 51(1) , wholly or partly 'incurred in gaining or producing the assessable income' is a question of characterisation … It has been pointed out on many occasions in the cases that an outgoing will not properly be characterised as having been incurred in gaining or producing assessable income unless it was 'incidental and relevant to that end' … So to say is not, however, to exclude the motive of the taxpayer in making the outgoing as a possibly relevant factor in characterisation for the purposes of the first limb of s 51(1) . At least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer has subjectively had in view in incurring it may, depending on the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterisation of either the whole or part of the outgoing for the purposes of the sub-section. In that regard and in the context of the

ATC 2499

sub-section's clear contemplation of apportionment, statements in the cases to the effect that it is sufficient for the purposes of s 51(1) that the production of the assessable income is 'the occasion' of the outgoing or that the outgoing is a 'cost of a step taken in the process of gaining or producing income' are to be understood as referring to a genuine and not colourable relationship between the whole of the expenditure and the production of such income.

…"

The High Court went on to elaborate the reasoning set out previously at page 18 as follows:

"…

Nonetheless, it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of s 51(1) without any need to refer to the taxpayer's subjective thought processes. That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income … The position may, however, 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 … where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer.

…"

51. It cannot be doubted that the wording of section 8-1 is such that a deduction is permitted only where it is incurred in the derivation of the taxpayer's income. In this case the Applicant conducted no business at all; the business was conducted by the Company. That any income derived in respect of the business what that of the Company is clear from the terms of the Franchise Agreement; see in particular the following provisions of that agreement:

  • (a) The Company held the rights to conduct the franchise business (Recital D and definition of Enzed Hose Doctor Franchise in clause 1.7 of the Franchise Agreement);
  • (b) The Company was supplied with the business system developed by the Franchisor (see definition of Enzed System in clause 1.7 of the Franchise Agreement and also clause 11(e));
  • (c) The Company leased Equipment from the Franchisor including a truck body (see Equipment Lease).
  • (d) The Company was supplied with a list of potential customers (clause 4.1 of the FA);
  • (e) The Company was supplied with all necessary Enzed products and inventory on consignment by the Franchisor (clause 6.2 of the Franchise Agreement);
  • (f) The Company was required to submit invoices each week to the Franchisor for all products sold (clause 8.1(b) of the Franchise Agreement) and to account monthly for all gross sales (clause 11(f)(i) of the Franchise Agreement).

52. Although pursuant to the Franchise Agreement the Applicant was the Nominee Agent of the Company is altogether clear that he was acting as such on behalf of the Hose Doctor which was of course the Company. This being so all of the relevant expenses were and could only be incidental to the business of the Company. According to the Company's tax return for the Relevant Year, and also the BAS returns (which recorded that no salary and wages were paid) the Company had no employees. In any event clause 11(f) of the Franchise Agreement provided that only the Applicant could be an employee of the Company.

53. As the Company was not profitable in the Relevant Year the only remuneration which was paid to him (and even this is altogether doubtful) was the $50 director's fee. That a company is an entity separate from its shareholders is so trite that it hardly need elaboration. See in particular Salomon & Salomon & Co [1897] AC 22. See also
North Australian Pastoral Co Ltd v FCT (1944) 71 CLR 623 where one of the issues was as to whether rebates on dividends received from subsidiaries should be based on the net amount of dividends after deducting allowable deductions attributable to the dividends. Dixon J said at page 635:

"…

[T]he companies paying the dividends are independent entities taxable as such and no deduction would be allowed in the

ATC 2500

appellant's assessment for expenses incurred by the appellant for the purpose of the earning of profits for those companies.

…

54. If the Applicant is to succeed in respect of this issue he must establish that he falls within either FCT v Total Holdings (Aust) Pty Ltd( 1979) 9 ATR 885 and/or FCT v E A Marr & Sons (Sales) Ltd (1984) 15 ATR 879.

55. In Total Holdings (supra) the Full Federal Court held that the generation of profits by a taxpayer company was a sufficient connection to enable it to claim as a deduction, interest on borrowings which were on-lent, interest free, to a wholly owned subsidiary. The principal reason given by the court, relying on Ronpibon Tin (supra), was that the interest expense was "incidental and relevant" to the gaining of assessable income. As the court said at page 893:

"…

The activities of the taxpayer were designed to render TAL profitable as soon as commercially feasible and to promote the generation of income by TAL and its subsequent derivation by the taxpayer and thence CFP.

…"

56. And at page 890:

"…

In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income-producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under [the general deduction provision].

…"

57. In Marr & Sons (supra) the taxpayer company's business consisted of leasing land, buildings, plant and equipment, which it owned, as well as providing management and administration services to its several operating subsidiaries. It also arranged for the leasing of plant and equipment from third parties as lessee and making these items available principally to one particular subsidiary. That subsidiary company remitted the monthly lease rents direct to the lessor company and the taxpayer which merely facilitated the arrangement derived no assessable income. Upon the liquidation of that subsidiary in 1972 the taxpayer paid $396,289 to the lessor finance companies being the difference between the unpaid lease rents and the realised value of the hired plant and equipment. The court held that the payment was deductible under the second limb of the general deduction provision as, taken as a whole, the activities of the taxpayer constituted the business of the taxpayer. As such the outgoings were deductible despite the fact that no income was derived nor was potentially derivable from the leasing arrangements. It was found that the taxpayer, at the material times, had controlled the subsidiary's activities and was in a position to channel its resources in whatever direction it wished. Due to the arrangements, the subsidiaries may generate profits which the taxpayer could, if it wished, direct to itself by way of dividend.

58. Total Holdings (supra) is distinguishable for two reasons in particular; in the first instance it dealt with a holding company-wholly owned subsidiary situation and where there was a close connection between the two companies. In the second instance, the subsidiary was indeed wholly owned. In this case the Company did not have a holding company and moreover the Applicant held 20 percent only of the issued shares in the Company. Marr & Sons (supra) cannot apply if only because it cannot be said that taken as a whole, the activities of the Company constituted the business of the Applicant.

59. Referring further to Total Holdings (supra), the "prospective income" referred to at page 890 related to possible future dividends or interest from the subsidiary or even possible future assessable income from the sale of the subsidiary's shares at a profit, being "incidental and relevant to the derivation of income by the taxpayer and … part of its business activities" (at page 892). It was important that the company taxpayer was carrying on business and the interest free loans were merely part of the totality of carrying on its business. The principle in Total Holdings (supra) is one based on the second limb of subsection 51(1) of the Income Tax Assessment Act 1936 ("the ITAA36") (now sec 8-1 of the ITAA97) and

ATC 2501

would appear to be confined to cases where a taxpayer is carrying on a business and where there is a parent company/ wholly owned subsidiary company relationship. There have been a number of cases in which it has been held that expenses incurred by an individual taxpayer on behalf of a company of which the taxpayer was a shareholder and/or director are not deductible: see
Case U134 87 ATC 780; 18 ATR 3646;
Case 26/94 94 ATC 258; 28 ATR 1133;
Case 48/97 97 ATC 500; 37 ATR 1208,
Riha v Commissioner of Taxation [2003] AATA 768; 2003 ATC 2160; 53 ATR 1108.

60. In Case U134 (supra) the Tribunal considered the deductibility of certain expenses incurred by the taxpayer in relation to his duties as a director of a family company. The expenses were not reimbursed by the company. The applicant claimed that the expenses were incurred to enable him to carry out the company business, and that the purpose of the payment personally of the director's expenses was to reduce the annual expenses of the company and thereby to increase the annual income distributable and assessable to shareholders. The Tribunal took the view at p 3649 that the expenses were incurred in his capacity as a director and were not sufficiently related to the carrying on of the business of being a shareholder. While the applicant had relied upon Total Holdings (supra) the Tribunal held that Total Holdings (supra) was a case in which, given the existence of a not uncomplicated corporate and business structure, with interlocking company loans, the court was able to discern the existence of the required nexus.

61. Similarly in Case 48/97 (supra) an applicant submitted that the purpose of loans made by a director to a family company was to generate future income in the form of dividends from the company. In holding that interest on loans was not deductible, I held:

"…

The requirement remains for the taxpayer to adduce evidence which suggests that, given the use of the borrowed moneys and the other circumstances surrounding the loan and the incurring of the relevant expenses, the required nexus for deductibility exists such that the statutory criterion, namely that the expenditure be incurred in gaining or producing assessable income, is satisfied.

In the present case the tribunal is of the opinion that the applicant has failed to adequately demonstrate that the circumstances surrounding the loans were such as to give rise to the conclusion of a sufficient nexus between the outgoings and the derivation of income.

The following words of Member McCarthy in Case 86; Case S83 apply equally to the present case (at CTBR 64; ATC 616):

…

This case is not like Total Holdings where the carrying on of a relevant business by the taxpayer enabled various activities to be linked and considered together, under the umbrella of one income-producing activity, such that in all the circumstances the outgoing could be said to have the requisite connection with the operations which more directly gain or produce the assessable income.

…"

62. Case 26/94 (supra) was again a case where a director and shareholder of a family company had incurred an interest expense in relation to loans made to the company. The director had submitted that the purpose of the loan was to generate future income in the form of dividends. This was not accepted by the Tribunal which took the view that the loans were to assist the company to avoid liquidation by providing a short-term rescue package..

63. In (1954) 5 CTBR (NS) Case 75 469 a director incurred travel expenses to ensure continuity of trade with certain overseas companies and sought to claim a deduction. The Taxation Board of Review held at 472 as follows:

"…

We think that, except insofar as the expenditure may be said to have relation to the receipt of future dividends, it was incurred by the taxpayer, not in the production of his assessable income, but rather in the production of the assessable income of company A … If it can be said that the expenditure was incurred partly with the object of ensuring the maintenance of

ATC 2502

future dividends from company A at previously existing levels, thus benefiting the taxpayer, we think that, to the extent that it was so incurred, it was of a capital nature. It could be said, in that event, that that the expenditure was to safeguard the dividend-paying capacity of company A - and, hence, the value of his share investment in that company.

…"

64. In Riha (supra) a director claimed a deduction for an amount of $13,777 on the basis he was funding the business activities of a family company. The evidence showed that the amount in question had been invoiced indifferently to either the director or the company, (as in the present case) but the director had paid the expenses with his credit card. The Tribunal (per Senior Member Ettinger) found that the director had confused expenses incurred by the company with those he claimed to have incurred on his own behalf. The Tribunal also rejected the contention that the taxpayer was carrying on a business:

" …

  • [26] I next considered whether Mr Riha, was carrying on a business. The work that he was doing in developing products for Solavan Pty Ltd was carried out at the relevant time without payment, without expectation of payment, and there was no agreement for fees. Accordingly, as a shareholder, only dividends would be relevant, and that was only provided Solavan Pty Ltd ever becomes profitable.
  • [27] I found accordingly that Mr Riha could not demonstrate the essential characteristics required of a business, for example to be engaged in it on a continuous and repetitive basis, and for profit. (
    Ferguson v FCT (1979) 9 ATR 873; 79 ATC 4261 and
    Hope v Council of the City of Bathurst (1980) 144 CLR 1; 12 ATR 231; 80 ATC 4386). Mr Riha's activities, which is what concerned me in this application, cannot thus be characterised as carrying on a business. In coming to this decision, I accepted the submission of the respondent that the activities of the applicant did not constitute the carrying on of a business, noting that a person may incur losses in conducting a business in the hope of a subsequent profit, but that there must be a limit (
    Hart v FCT (2002) 51 ATR 471; 2002 ATC 5193). I find from the evidence that in Mr Riha's case there was no expectation of profit in the medium, or even long term future which was expressed in evidence (oral and written), and find that he was unable to satisfy the indicia to demonstrate that he was carrying on a business activity at the relevant time.

…"

65. This case is in many respects similar to Case 26/94 (supra). The present facts are not dissimilar and where the incurrence of the expense by the director was to assist a company, which had no capacity to meet certain expenses and to also defray possible insolvency. It is clear from the Company's BAS returns and the return for the year of income ended 30 June 2003 that expenses were incurred in a situation where the Company did not have sufficient capital or any income to pay the expenses itself. The Company was also not in a position to reimburse the Applicant. The assets of the company comprised $10 being the initial shareholding. On 30 April 2003 (and see clause 33 above) the Applicant advised that the Company wished to terminate the franchise because the Company had become insolvent.

66. There are other cases in the same vein and with which I need not deal in detail. In AAT Case 9460; 28 ATR 1133 the taxpayer was a shareholder and director of a family company and had borrowed money which he on-lent to the company. At that time, the company had no capacity to borrow in its own name. The taxpayer submitted that he had lent the money to the company to shore up its debts and ensure its future profitability, which would enable him to derive assessable dividends in the future. The AAT held that the connection between the lending and the dividends was too remote.

67. In AAT Case; 12,386 37 ATR 1208 also a case involving similar facts, the taxpayer was a director and shareholder of a company and sought to claim a deduction for interest paid on borrowed monies he had on-lent to the company on the basis that the moneys were borrowed to enable the first company to

ATC 2503

continue in business. Again, the Tribunal found that the relevant outgoing was not sufficiently connected to the activities, which produced or were expected to produce the taxpayer's income.

68. I find as a matter of fact that the Applicant did incur certain expenses on behalf of the Company (although not to the extent claimed, and not in any event referable to the extent claimed to the business of the Company) in order to furnish the Company with the moneys required by it to either commence or continue its business. From the outset, the business was a failure and without that financial assistance the Company would have been unable to commence business or having commenced would not have been able to continue. The Applicant in respect of some amounts so paid recorded them to the credit of his loan account (giving rise to a loan account in his favour of $7,702) and he could have done so in respect of the other amounts expended, which would have had the effect that his loan account was thereby increased; similarly of course, the loss sustained by the Company would have increased correspondingly. He chose the alternative in respect of some but not all expense items of seeking deductions for himself. That he was motivated by considerations of tax cannot on the evidence be doubted; the Company was in liquidation and losses sustained by it were of little if any value. The director's fee of $50 was conceived in the hope that it would strengthen the Applicant's case under this head. To the extent if any, that this is material there was no real evidence that that amount was ever paid.

69. I hold as a matter of law that the Applicant cannot contend that he falls within the authorities in Total Holdings (supra) or Marr & Sons (supra) and that he cannot succeed in respect of the deductions claimed in accordance with section 8-1 if the Tax Act.

Part E - the second issue; the deductions

70. Having found that the Applicant fails under the first issue it is not necessary for me to deal with the second issue and I do not intend to do so. I note merely that in respect of the amounts claimed there are a number of distinctly dubious features leaving aside the fact that there was a remarkable lack of substantiation. Amounts appear to have been concocted at random and sometimes on a basis that was decidedly weak. I referred earlier to the opening entry in the Vehicle logbook, which was incorrect, but it was one only of a number of instances. The same is so of course in respect of the internet expenses. Some of the deductions claimed were of a capital nature. How then did these deductions come to be claimed? The Applicant said that as "a simple sailor" he relied entirely on his accountant. It is not necessary or desirable for me to delve into these aspects further.

Part F - conclusion

71. I said earlier that the Applicant did not file a statement of evidence. Nor for that matter did he file written submissions. The Applicant did file a Statement of Facts and Contentions but curiously enough it referred only to three cases and being cases which, per the Applicant, were not relevant to the Applicant's situation. Clause 2 of the Applicant's Statement of Facts and Contentions reads as follows:

"…

  • 2. Cases quoted by the ATO to support their decision but are not relevant to Mr Little's situation
    • (a) Case U134 87 ATC 780; (1987) 18 ATR 3646 (Case 134)

    • The taxpayer failed in his claim for expenses he incurred as he incurred them in his capacity as a director but did not receive any assessable income in that capacity. This is not the case of Mr Little. He did receive income in his capacity as director / employee. Although the income was limited due to the non profitability of the company the expenses were actually incurred and paid by him. The travelling [sic] expenses paid had no private component and in the other expenses he paid any private component has been excluded.

    • (b) Case 26/94 94 ATC 258; (1994) 28 ATR 1133 also does not apply to the circumstances of Mr Little. The expenses Mr Little actually incurred were not to support the company with a view to future dividends but to fulfil [sic] his duties in his capacity of

      ATC 2504

      employee / director in which position he did receive income.
    • (c) Case 48/97 97 ATC 500; (1997) 37 ATR 1208 - the expenses were not incurred in producing immediate income but possible future income. This is not Mr Little's situation as actual assessable income was produced.

    • …"

72. Oddly enough and in closing submissions, Mr. Holland did not refer to either Total Holdings (supra) or to Marr & Sons (supra). After the hearing had been completed and the decision had been reserved, the Applicant sent the Tribunal a further submission (and including certain documents) entitled "Submissions Further Information". The Applicant did not at the hearing seek permission to furnish additional submissions or evidence after the hearing had been completed; I do not know whether that additional material was copied to the Respondent but in any event it is clear enough that I cannot take account of material submitted after the hearing in this manner. I would note however that the additional material in question would not in any event affect this decision in any way.

73. It would seem that the assessment included a penalty amount. Not one word, throughout the hearing, was said in respect of penalty. In any event, the circumstances are such that I do not consider that any reduction in penalty would be appropriate. This is a case where the Applicant sought without any justification or legal basis to claim expenses which were in fact expenses of the Company because from a tax point of view it suited him to do so. The fact that one only of a number of relevant documents was entered into by the Applicant personally cannot lead, as Mr Holland contended that expenses were thereby deductible to the Applicant.

74. Accordingly, the decision under review is affirmed.


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