FC of T v SLEIGHTJudges:
Full Federal Court
MEDIA NEUTRAL CITATION:
 FCAFC 94
The appellant, the Commissioner of Taxation (``the Commissioner'') appeals against the judgment of a Judge of this Court allowing to the respondent, Mr Sleight (``Mr Sleight'') an appeal against the objection decision of the Commissioner disallowing his objection to an assessment of income tax made in respect of the year of income ended 30 June 1995 [reported at
2003 ATC 4801]. Mr Sleight has also filed a notice of contention dealing with the validity of determinations made under s 177F of the Income Tax Assessment Act 1936 (Cth) (``the Act'').
2. Mr Sleight claimed to be a partner with his wife, carrying on the business of cultivating and maintaining a tea tree farm on two blocks of land. As such the partnership claimed to be entitled to a deduction for amounts incurred as prepaid management fees (for the management of the farm) ($21,000) and administration fees ($1,000). The balance of the deduction claimed by him related to interest prepaid on a loan that was used to finance the partnership participation in the project ($3,045) and an indemnity fee ($400), which will be more fully described later in these reasons. Mr Sleight's share of the partnership loss for the year (no income was expected to be received from the harvest of the tea trees for approximately 3 years) was claimed to be $12,722 (i.e half the partnership loss).
3. Ultimately the Commissioner made three determinations purporting to act under s 177F of the Act. The circumstances in which these determinations were issued will be recounted later. The first determination purported to cancel the tax benefit Mr Sleight was said to have gained in the sum of $25,444, that being the total of the deductions claimed by Mr Sleight and his wife. In the second and third of these determinations there was a decision to cancel the tax benefit of $12,722, that is to say,
ATC 4480a benefit of the amount of the deductions Mr Sleight claimed.
4. An assessment originally issued to Mr Sleight on 12 October 1999 disallowing to him a deduction for $25, 444, being the whole of the outlay of the partnership consisting of his wife and himself. That followed upon the first determination which purported to cancel a tax benefit of the amount subsequently disallowed. Following upon Mr Sleight's objection against this assessment, an amended assessment issued on 8 December 1999 disallowing the amount of $12,722 only as a deduction. A second determination was made on 24 January 2000 that purported to cancel the tax benefit of that amount.
5. A third determination was made on 5 November 2001. It referred to the tax benefit to Mr Sleight as being $12,722. The difference between the second and third determinations is that the second determination was expressed to be made by a Thomas Lund, acting Director of Small Business Executive Level Two, while the third determination was expressed to be made by a Mr Neil Mann, Deputy Commissioner of Taxation. No amended assessment was issued after either the second or the third determination.
6. Two substantive issues arose before the learned Primary Judge. The first was whether the amounts incurred by Mr Sleight and his wife in the year of income and claimed by Mr Sleight to be allowable deductions in calculating the net income of the partnership (so that Mr Sleight's partnership share was $12,722 as claimed), were in fact allowable. The second, which arose only if the first issue was decided favourably to the taxpayer was whether the general anti-avoidance provisions of Part IVA of the Act operated to disallow to him the share of the deductions which he had claimed. In addition his Honour was required to consider the validity of the determinations referred to above so far as they supported the disallowance of the deductions claimed under Part IVA.
The legal structure of the tea tree oil project
7. Mr Sleight was an investment adviser. Not much was asked in cross-examination as to his activities. However it would seem that, at least among other products, he sold what may neutrally be described as tax effective income tax schemes. That is to say investment schemes carrying with them tax advantages. It would seem that Mr Sleight also invested in at least some of the schemes he offered for sale, including what may be referred to as the Northern Rivers Tea Tree scheme (the subject of the present assessments), a similar scheme which was concerned with cotton growing, and a scheme apparently if not identical, then very similar to that discussed by a full Court of this Court in
Vincent v FC of T 2002 ATC 4742; (2002) 193 ALR 686.
8. On 14 June 1995 there was lodged with the Australian Securities and Investments Commission a prospectus inviting applicants to apply for a minimum of two parcels of 500 A class $1.00 shares in Northern Rivers Land Company Limited (``the Land Company''). There was attached to each of the two parcels of shares a right to occupy a farm on land known as Bungawalbin in northern New South Wales. Acceptance of the invitation required completion of an application to purchase 1000 A class $1.00 shares. It was also required that the acceptor apply for a loan and thereafter enter into a loan agreement with Northern Rivers Finance Company Pty Ltd (``the Finance Company''). Finally, although this was optional, signature was required of a Loan Indemnity Agreement with the Land Company and the Finance Company. The application form gave, as will be seen, to the applicant among other options, the option to enter into a management agreement with Northern Rivers Plantation Management Ltd (``the Management Company'') for the management of the two parcels.
9. On 30 June 1995 Mr Sleight and his wife signed the share application form, signed a loan application and loan agreement, and having exercised their option to do so, entered into the management agreement. On the same day they paid $250 to the Land Company (the balance of the administration fee), $400 to the Management Company (being the purported Indemnity Fee), $3,045 to the Finance Company (being a purported prepayment of the first year's interest on the loan applied for pursuant to the Loan Agreement), $50 for the purchase of tea-tree seeds and $1,000 for the purchase of the 1000 A class $1.00 shares in the Land Company. Other steps were taken on their behalf to complete the payments required under the agreements which had been signed. It is now necessary to describe in some detail precisely what the agreements required of the parties to them. There was no suggestion that
ATC 4481any agreement entered into was a sham. Each of the agreements took effect and was intended to take effect in accordance with its tenor.
10. The prospectus was ``an invitation to subscribe for A class shares in Northern Rivers Land Company Limited (`the Land Company') and if you acquire at least 2 parcels of 500 A class acres, to exercise a right to enter into a management agreement with Northern Rivers Plantation Management Limited.'' The document noted that the ``investments'' were considered ``speculative'' and advised that ``independent financial advice should be obtained''. The issuer of the prospectus was Mobandilla Cotton Management Limited said to be agent for the Management Company. The minimum subscription was 350,000 ``A'' class shares of $1 each fully paid. In addition to the right to occupy the two farms one attached to each parcel of shares (ie a minimum of two ``farms''), the subscriber had the right, but not the obligation, to have the Management Company manage the farms on the terms of a management agreement which was included in the articles of association of the Land Company.
11. A subscriber who elected to have the Management Company manage the farms was obliged to have oil produced from these farms pooled for marketing and sale with the oil of other farmers on the Land. The pooled proceeds were to be allocated amongst such of the farmers who had management agreements in proportion to the number of farms held as a proportion of all the farms participating in the pooling. This distribution was to be made without regard to the quantity or quality of oil produced from a particular farm. There was also a trust deed which was designed to protect the interests of farmers under the management agreements.
12. The land in question was, at the time the prospectus was lodged, the subject of a lease of 20 years from the then owner of the land to the Land Company. The lease contained an option for the Land Company to acquire the freehold subject to the lease. That option was proposed to be exercised (and was in fact exercised), once the minimum subscription was reached. The purchase price was, in part, to be satisfied by the allotment of 900,000 non participating redeemable preference shares in the Land Company to the vendor which were to be redeemed in 1999. There was a second parcel of land which was to be acquired in the event that more than 700 minimum parcels of 1000 A class shares were applied for under the prospectus (as was in fact the case).
13. The Land Company was said to be obliged to ensure that ``identifiable portions'' of the land were to be made available to holders of the A class shares who, by reason of their right to occupy, were to ``engage in their own business of commercially cultivating and maintaining the tea trees planted thereon and to harvest them and process the harvest into tea tree oil''. In consideration of the right to occupy that attached to the A class shares, the Management Company was to receive from each holder of 1000 shares an annual administration fee, which in the first year was $1,000 for each 1000 A class shares issued to the holder. In years two and three the administration fee was to be $800 for the minimum 2 farms, and thereafter until 2015 the annual administration fee was to be 12.5% of the gross farm income.
14. The ``identifiable portion'' was to be of ``sufficient size'' to enable the planting, growing and harvesting of 5000 tea trees at a planting density of 36,000 trees per hectare (ie.139 of a hectare or just over.343 of an acre). The prospectus contained no plan showing the relevant portions. However, there was no requirement that lots be contiguous and most had no access save through another lot on which another investor was likewise growing tea trees. The prospectus required that the so- called farms were to be separately identified on a master plan (they were) but any particular portion could be relocated by the Board of Directors of the Land Company from time to time. Subscribers were to have no interest in the land itself. Their rights were said to be limited to the right to access the lot (although how they might do that legally is unclear) and to take away the tea tree when harvested. A farmer not electing to enter into a management agreement would have no right to participate in the pooling of the oil.
15. So far as the evidence revealed, none of the investors did other than enter into a management agreement. That is not surprising, as it would seem to have been difficult, if not legally impossible, to attempt to farm the particular portions which were allocated to the investor under the agreements. However, it
ATC 4482must be said that the evidence only extended to 25 participants out of a total 95.
16. The management agreement imposed upon the Management Company the following obligations in respect of the two portions allocated to an investor (referred to in the agreement as ``the Grower''), namely that the Management Company would:
- ``(i) select the seed and substantially establish the two farms and the Grower's business of growing tea-trees and producing tea-tree oil for domestic and overseas consumption by no later than 30 June 1995;
- (ii) cause each farm to be physically constituted on specified Production Sites during period of 12 months after the date of execution of the Management Agreement;
- (iii) identify the Grower's seedlings collectively with an identification mark to identify the Grower's ownership of the seedlings;
- (iv) identify each of the Grower's farms by mark or number on a master plan to identify the Grower's ownership of the oil contained therein;
- (v) perform the manager's duties under the Management Agreement;
- (vi) prior to 30 June 1996 carry out certain specified work purportedly necessary to establish each of the Grower's farms of not less than 5000 trees per farm planted at a density of approximately 36 000 seedlings per hectare;
- (vii) pay to the Grower forthwith but in any case within 30 days after its receipt by the Management Company any money that under the Management Agreement was payable to the Grower.''
17. The management agreement also imposed the following duties upon the Manager:
- ``(a) selection, planting and propagation of tea-tree seed;
- (b) planting on each farm sufficient seedlings to yield not less than 5000 seedlings per farm at a density of approximately 36 000 seedlings per hectare;
- (c) maintenance and cultivation of the Grower's farms including growing, watering, weeding, selecting, procuring and applying appropriate fertilisers, nutrients and herbicides and doing all other things reasonably necessary for the purpose of maintaining and cultivating the Grower's farm in accordance with good and proper farming practices;
- (d) procure all necessary plant, equipment, machinery, goods and materials to enable the performance of the above services and procure the use at the farm site of suitable irrigation, fencing, drainage and shelter for the trees and any other necessary fixtures or improvements required for the purposes of performing such services;
- (e) keep the farm free of competitive weeds, by eradicating the same and exterminating all vermin, noxious animals and insects;
- (f) harvest the Grower's trees ideally at a time estimated by the Manager when oil yields from the leaf are at their highest and using facilities provided by the Manager to process the harvested leaf into tea-tree oil;
- (g) market, sell and deliver the Grower's tea-tree oil;
- (h) arrange insurance for the Grower's tea- trees for such amount or cover and with such insurers as may be determined from time to time by the Manager;
- (i) obtain professional services and advice which the Manager may consider necessary or desirable in connection with the maintenance and cultivation of the Grower's farms or the harvesting of the Grower's trees and the marketing of the tea-tree oil produced;
- (j) provide research and development into those matters which the Manager considers may benefit the Grower's business;
- (k) identify each of the Grower's farms by mark or number on a master plan to identify the Grower's ownership of the tea-tree oil contained therein.''
18. The A class shares were to convert to ordinary shares on 1 July 2015. The consequence would then be that the rights to occupy the individual lots would on that day cease and the land on which the ``farms'' had been established would belong to the Land Company which would then be able to take over the whole plantation and run it for the benefit of the shareholders/investors.
19. If a member entered into a management agreement with the Management Company certain rights, including the right to terminate the management agreement, were to require a special resolution of the shareholders in the
ATC 4483Land Company. A farmer who had elected to have the Management Company manage his farm was required to pay initially the first years' management fee of $24000 per two farms by equal monthly amounts in advance, or prepay the first year management fee at a reduced rate of $21,000. There was also a requirement to pay the Management Company $50 ($25 per farm for the minimum two farms) for the purchase of seed for germination as tea tree seedlings.
20. The member was to be introduced to a financier (the Finance Company) which was to advance to the member 100% of the Year one prepaid management fee ($21,000 for the two parcels of shares) and 75% of the Year one administration fee (this amounted to $750 for the minimum 2 farms). Interest was to be 18% payable monthly in advance unless the borrower should prepay the first year's interest in full on application (an amount of $3,045) in which case the interest rate would be 16% per annum. The rate for the second year was to be 18% per annum payable monthly in advance but to be reduced to 14% if prepaid on or before 30 June 1996. From year 3 onwards the interest rate was to be 4%. The first principal repayment was to be made by a borrower on or before 30 September 1995 or 90 days after the granting of the loan which ever was the later. The amount of the payment was to be approximately 34% of the principal sum or $7,400 for each loan of $21,750. Further principal repayments were to be made by 7 annual instalments of $2,050 unless the borrower entered into an indemnity agreement.
21. Under the indemnity agreement the Management Company agreed to indemnify borrowers against personal liability under their Loan Agreement. The indemnity meant that if the borrower chose to prepay the first years' interest under the loan agreement, he then had the right (for a ``once off'' cost of $400) to full indemnity for the major portion of his principal and interest payments under the loan agreement. He or she would thus only be liable to pay the first principal repayment ($7,400) and the prepayment of the year two interest ($2,009) when, under the indemnity agreement the interest would be discounted from year two onwards to 4%. Repayment of the balance of the principal sum advanced (after the first principal repayment) was to be made by way of 50% of the ``net profits of the Member's business until repaid.'' Likewise interest was to be payable out of the ``income of the Member's business'' without recourse to the investor for personal repayment of either principal or interest. If any amount of principal was outstanding as at 1 July 2015 it was to be paid by the Management Company which indemnified the investor accordingly. The lender was to look only to the Management Company and not to the investor for repayment of the balance of principal and interest.
22. The Prospectus noted the ``Possible Tax Implications'' of ``a Member Engaging in Business'' in a table which indicated what was said to be the position of an investor who purchased the minimum parcel of 1000 A Class $1 shares, exercised the right to occupy the two portions of land, exercised the right to appoint the Management Company to manage the farm business, exercised all options available in borrowing 100% of the Year one management fees and 75% of the Year one administration fees and entered into the Indemnity Agreement. The table assumes that the investor has a tax rate of 48.4%. The table shows the following calculation:
BUSINESS EXPENSES INVESTOR FUNDS BORROWED DEDUCTIBLE ------------------------------------------------------------------------- PAYABLE DAY 1 Year 1 Management Fees $21,000 $21,000 Year 1 Administration Fee $250 $750 $1,000 Year 1 Interest $3,045 $3,045 Loan Indemnity Fee $400 $400 Seed Purchase $50 PAYABLE 90 DAYS Principal Repayment $7,400 ($7,400) PAYABLE 30 JUNE 1996 Year 2 Interest $2,009 $2,009 ------- ------- TOTALS $13,154 $14,350 $27,454 Tax Refund/Saving ($27,454 x 48.4%) $13,288 Less Investor Cash $13,154 ------- Investor's Net Position (Not Including purchase of Shares) + $134
23. There was included in the prospectus a letter from Hudson Croft Thomas, Chartered Accountants and Business Advisors. This letter gave a favourable tax view of the arrangement, although it did note that the taxation consequences could vary depending upon the particular circumstances of the individual participants and urged prospective investors to obtain independent taxation advice.
24. The prospectus also contained projections of what the promoters thought the results should be (including tax) on certain assumptions. There was a note to the projections to the effect that agriculture was subject to risk factors which could affect the accuracy of the projections. The projections assumed inflation of 3% per annum, oil yield of 250 kg per hectare, sales revenue calculated on the price of oil being $65 per kg in the years 1996 and 1997 (which was said to be expected to rise by approximately $3 in subsequent years), and costs of oil production of $1,396 per farm in 1998 with an expected rise of 3% thereafter. It noted that a plus or minus 4% variation in the seedling price per kg or to the yield per farm would be approximately plus or minus $279,187 assuming 1200 units subscribed and $48,896 assuming 350 units subscribed in the year ending 30 June 1998. An increase or decrease of 5% in operating and overhead expenses would affect taxable income by plus or minus $167,512 based on 1200 units subscribed and $48,896 based on 350 units subscribed in the year ending 30 June 1998. The projections showed before tax cash distribution to growers of nothing for the years ended June 95, 96 and 97 and thereafter $645 in the 98 year, $685 in the 99 year, $727 in the year 2000 with a total projected through to the year 2015 of $24,201 on the assumption that there were 350 units subscribed for. There were slightly lower figures in the event that 1200 units were subscribed for.
The implementation of the proposal
25. Perhaps unusually for this kind of proposal not only were the agreements entered into but they appear to have been implemented.
26. The Finance Company remitted the sum of $21,750 per investor with two ``farms'' to the Trustee. The Trustee then remitted on behalf of each investor the sum of $21,000 to the Management Company and the sum of $750 to the Land Company, thereby satisfying the obligation of the investor to pay the management fee and 75% of the administration fee. Mr Sleight and his wife paid the sum of $250 to the Land Company being the balance of the administration fee, the sum of $400 to the Management Company for the purported Indemnity Fee, the sum of $3,045 to the Finance Company being the prepayment of the year one interest obligation, $50 for the purchase of tea tree seeds and $1,000 for the purchase of the 1000 A class shares in the Land Company. The transactions, other than the cash payments by Mr Sleight and his wife, were carried out by entries in the books of account of the various companies and a round robin type exchange of cheques between the Finance Company and the Trustee. In the result, as his Honour found, Mr Sleight and his wife outlaid in cash $4,745. However, when amounts paid on their account pursuant to the borrowings are taken into account they had paid $21,750 for management and administration fees and had incurred a liability of $25,445 (not including $1,000 for the purchase of the shares and $50 for the purchase of seeds). It was common ground that these last two amounts were on capital account and not deductible.
27. His Honour made no findings as to the actual activity undertaken after the documents were signed and the payments were made, save that his Honour noted that Mr Sleight ``knew roughly where his farm was, had driven within 10 metres of its location and was able to see that the trees had not died and were healthy''. Certainly the case proceeded on the basis that
ATC 4485the Management Company had complied with its obligations, in that it had allocated two portions of land to Mr Sleight and his wife, had planted seeds on those portions, presumably at the requisite density, which had grown into trees and had looked after the trees to the extent that they needed to be looked after. Such plantation records as were produced showed that the plantation that had been established in the area where the partnership portions had been allocated was managed by reference to ``field blocks'' that is to say, by reference to identified large blocks containing many smaller allocated blocks.
28. It can be added that events which took place after the end of the year of income in dispute could not be relevant save so far as they cast light on what the parties intended as at the end of the year of income.
The Judgment appealed from
29. The learned Primary Judge held that Mr Sleight and his wife were carrying on the business of planting, cultivating and harvesting tea trees on the two parcels of land allocated to them. His Honour found that the fact that they had no interest in any identifiable land did not affect this conclusion, nor did the fact that the Land Company might relocate a farm. The fact that oil was to be pooled did not affect the conclusion. Nor did the fact that the applicant had little control in respect of the particular farms. They did, his Honour said, have a right to terminate the agreement with the Manager, a right which his Honour said was ``not unqualified, but it is not a limited right''. The right could be exercised by a grower independently of any other grower. The services provided by the Manager were subject to such instructions as the grower might give. Also, the fact that these services might be co- ordinated with the interests of other participants merely meant that the management was to proceed in ``an efficient and cost effective manner''.
30. The conclusion his Honour reached on the issue of business was, his Honour said, not affected by the role of the Manager under the arrangements, and nor was it affected by whether the Manager was an independent contractor, or that the Manager stood to gain from the success of the project. It was also not affected by the location of the farms being only ``roughly identified'', because they were identifiable. The fact that Mr Sleight and his wife did not personally plant trees or cultivate the land, other than under the contract with the Manager and had only a limited personal involvement was, likewise, irrelevant. In arriving at the conclusion that Mr Sleight and his wife carried on business his Honour paid particular attention (amongst others) to the cases of
FC of T v Lau 84 ATC 4929 at 4944; (1984) 6 FCR 202 at 221 per Beaumont J,
FC of T v Emmakell Pty Ltd 90 ATC 4319 at 4323-4325; (1990) 22 FCR 157 at 161-163, the decision at first instance in
Puzey v FC of T 2002 ATC 4853;  FCA 1171, reversed on appeal in respect of one year of income, but not in respect of the general conclusion that in the first year the taxpayer carried on a business and
Cooke & Anor v FC of T 2002 ATC 4937;  FCA 1315, again a decision at first instance. An appeal on this last mentioned case has been heard and judgment has been delivered and discussed at para .
31. His Honour held also that the amounts claimed were, in consequence of the finding that a business was carried on, not denied deductibility as being outgoings of capital. In this part of his Honour's judgment his Honour considered and rejected a submission on behalf of the Commissioner that the initial cash outlay was not in substance for management fees and interest ``but for the right to a proportionate share of the overall proceeds of the sale of oil produced by the Project''. In so doing his Honour noted that there was no contention that the payments were a sham. Such a submission was bound to fail, unless they were a sham.
32. His Honour found, finally on this part of the case, that there was no disproportionality between the outgoings made by Mr Sleight and his wife under the agreements and the income to be generated by them from the sale of tea tree oil in the future. Had his Honour found such disproportionality, this might bring into operation considerations of the kind referred to by the High Court in
Fletcher & Ors v FC of T 91 ATC 4950 at 4957-4958; (1991) 173 CLR 1 at 18. The argument was not repeated on the appeal.
33. His Honour then turned to consider whether Part IVA would have application on the assumption that there had been a valid determination.
34. The ``scheme'' which the Commissioner advanced before his Honour extended to the ``making and implementation of the various
ATC 4486agreements that comprised the Project''. No other scheme was suggested by the parties. The tax benefit relied upon was Mr Sleight's proportion of the deduction of $25445 claimed by the partners in the 1995 year of income.
35. His Honour then proceeded to consider the eight factors to which regard must be had in reaching the conclusion as to dominant purpose required if a scheme was to fall within Part IVA. The tax advantage was but one of the various features (his Honour found there to be eight features in all) which were promoted in promotional brochures. In his Honour's view, Mr Sleight and his wife had invested in and conducted ``a commercial enterprise''. His Honour's conclusion as to the first of the eight factors, viz ``the manner in which the scheme was entered into or carried out'' is to be found in the following sentence which was the subject of some criticism on the appeal [ATC at 4820 [ 115]]:
``... Here the manner in which the scheme was entered into and carried out is equally explicable by commercial reasons in which tax benefit played a significant but not dominating part.''
(¶115 at 33)
36. Form and substance (s 177D(b)(ii)) were, his Honour held, neutral. Timing, on the other hand favoured a conclusion as to a dominant purpose of tax avoidance having regard to the fact that the arrangement was entered into on the last day of the year of income. However, his Honour noted that the applicant had had an interest in tea trees before the issue of the prospectus. Nevertheless, in his Honour's view this factor pointed against Mr Sleight.
37. His Honour discussed the remaining factors in some detail. Suffice it to say here that his Honour appears to have regarded each of the other factors as neutral or at least not detracting from ``commerciality''.
38. His Honour briefly considered not only the conclusion relevant to Mr Sleight but also that relevant to the promoter companies. This was the subject of some attack and it is therefore useful to set out in full what his Honour had to say on this matter [ATC at 4822 [ 136]]:
``In relation to the promoter companies, the submissions for the respondent are that the financial obligations of investors were structured on the basis of a loan the promoter companies knew would never be made but which would generate a tax deduction sufficient for investors to fund the cash component of those obligations. Also those tax deductions, it is said, were used as an inducement to attract funds to the plantation which was conducted without regard to their obligations to individual investors. In response it is said for the applicant the agreed facts accept the loan was made by round robin and there is no evidence to support the latter assertion. Furthermore, reliance is placed for the applicant on the evidence of both Mr Lindhout and Mr Holliday to the effect that the plantation was being conducted in a very businesslike way and best efforts were being used to achieve maximum yields from the plantation in the interests of the investors. These latter submissions for the applicant accord with the evidence and I therefore accept them.''
(¶136 at 37)
39. The present case was, his Honour felt, distinguishable from that considered at first instance in Puzey. Rather, his Honour held, objectively viewed, the only matter which was a ``telling item'' against Mr Sleight was what his Honour referred to as ``the flurry associated with the end of the 1995 tax year'', when the prospectus was registered and the documentation entered into and cheques passed. However, his Honour said, the effect of that was modified by ``the evidence of the long term interest which the applicant had in the Project prior to the issue of the Prospectus.'' His Honour said [ATC at 4824 ]:
``... The result is that I am satisfied on a consideration of the items arising under s 177D and the applicant's case concerning them that the applicant's purpose for having entered the Project was not dominantly for the acquisition of the tax benefit. I am left in no doubt that the tax benefit was a significant element in his purpose but I am not satisfied it was the ruling, prevailing and most influential purpose. He was convinced the Project was commercial and that view formed a fundamental part of his purpose in entering into it.''
(¶145 at 40)
The validity of the Part IVA determinations
40. Finally his Honour considered the arguments advanced concerning the validity of the respective determinations.
41. The first determination was, it may be remembered, made by a Mr D'Cunha, Director
ATC 4487of Small Business Executive Level 2, who was not a delegate or a person to whom a delegation had been made pursuant to s 8(1) of the Act. However, his Honour followed Ryan J in
Mochkin v FC of T 2002 ATC 4465 at 4485 in holding that the power reposed in the Commissioner by s 177F could be exercised through a properly authorised officer and Mr D'Cunha was such an officer. Although the determination was made in Mr D'Cunha's name, it was headed as a determination made by the Commissioner. The fact that the quantum of the tax benefit was wrong did not lead to the result that the first determination was invalid.
42. Likewise the second determination was not invalid. It was accordingly not necessary for his Honour to consider the validity of the third determination.
43. His Honour held, further, that the making of the s 177F determination was part of the process of making the assessment and so could not be challenged in proceedings under the Taxation Administration Act 195 (Cth). Any deficiency in the making of it was saved by s 175 of the Act:
DFC of T v Richard Walter Pty Ltd 95 ATC 4067; (1995) 183 CLR 168.
The submissions made on the appeal
44. For the Commissioner it was submitted:
- 1. The learned Primary Judge erred in holding that Mr Sleight and his wife were carrying on a business and accordingly it followed that the amounts incurred by them were not allowable deductions.
- 2. In the alternative, if the amounts incurred were allowable deductions, the Primary Judge should have held that the provisions of Part IVA operated to disallow a deduction for the amounts otherwise allowable.
- 3. Alternatively leave should be granted to the Commissioner to rely in the appeal on the application of Part IVA to two schemes differently formulated from that considered below. The first alternative scheme was a course of conduct, or plan or course of action constituted by the following:
- (a) the terms of the Management Agreement by which the respondent was obliged to prepay the first year's management fee of $21,000,
- (b) the terms of the Loan Agreement by which Mr Sleight and his wife borrowed $21,750 comprising, inter alia the whole of the first year's management fee, pursuant to which the first year's interest of $3045 was prepaid and pursuant to which the principal repayment of $7400 was made on 22 September 1995,
- (c) the terms of the Indemnity Agreement by which by the payment of $400 Mr Sleight and his wife were relieved of further repaying the loan but save to the extent that it might be repaid from the share of the proceeds of the sale of oil, and
- (d) the ``round robin'' exchange of cheques by which, inter alia, the prepayment of the first year's management fee of $21,000 and the obligation of the Finance Company under the loan agreement to remit the management fee on behalf of Mr and Mrs Sleight were satisfied without any actual exchange of cash.
- The second alternative scheme omitted the step in paragraph (a) above.
45. For Mr Sleight it was contended in a Notice of Contention that his Honour had erred in finding that the determinations were valid. It was also contended that the first determinations were invalid for another reason, namely that the person making the determination, Mr D'Cunha had not taken into account the individual circumstances of Mr Sleight and particularly that his tax rate in the year of income was considerably less than the maximum rate of tax and, in fact, in the order of 20%. In evidence Mr D'Cunha had, it was said, confirmed that prior to exercising the discretion he had not taken into account any facts and circumstances concerning Mr Sleight and his participation in the Project and that he could not specifically recall reading the ATO position paper concerning the Project.
Was the partnership carrying on a business on 30 June 1995
46. It was common ground in the appeal that, subject to the operation of Part IVA, if the partnership was, as at 30 June 1995, carrying on a business of planting, tending and harvesting tea trees for the purpose of profit then the amounts paid for management fees and the other disbursements, such as the administration fee, interest and the indemnity fee would be allowable deductions. It was also common ground that the amount paid for the shares and
ATC 4488the amount paid for seeds would be of a capital nature and not deductible.
47. Whether a business is carried on is, ultimately, a conclusion of fact. Furthermore, it is common sense to say that every business must have a first transaction, so long as it is at least part of a plan, intended to be carried out, to undertake the activity which is the intended business:
Fairway Estates Pty Ltd v FC of T 70 ATC 4061 at 4068; (1970) 123 CLR 153 at 165 per Barwick CJ (quoting Lord Esher in
Re Griffen, Ex parte The Board of Trade (1890) 60 LJ QB 235 at 237). In the case before us, the Respondent's incurring of various amounts claimed as deductions on 30 June 1995 could be that first transaction:
Steele v DFC of T 99 ATC 4242; (1999) 197 CLR 459, citing with approval the decision in
Travelodge Papua New Guinea Ltd v Chief Collector of Taxes 85 ATC 4432; (1985) 16 ATR 867.
48. There is no one test of what constitutes a business. In some contexts, repetition and continuity have been seen to be necessary: Fairway Estates Pty Ltd (supra at ATC 4067; CLR 164). However, the place which repetition may play will depend upon the activities undertaken. For example, establishing and maintaining a timber plantation would continue over a relatively long period of time, whereas other activities, such as, for example, the planting, tending and ultimate sale of a short term crop may continue but a short time. In the former there may be significant times of inactivity, and yet such inactivity will not necessarily result in a finding that no business is carried on. ``Business'' does not equate with being busy.
49. Mason J in
Hope v The Council of the City of Bathurst 80 ATC 4386 at 4390; (1980) 144 CLR 1 at 8-9 spoke of ``activities engaged in for the purpose of profit on a continuous and repetitive basis''. His Honour spoke also (at ATC 4390; CLR 9) of the activity in that case having a ``permanent character'', (meaning perhaps ``indefinite''). This, however, is not to say that a share farmer cannot be carrying on a business notwithstanding an apparent lack of permanency. A business may be carried on in a small way, yet still have the commercial purpose or character that would be significant in finding there to be a business:
Thomas v FC of T (1972) 46 ALJR 397.
Puzey v FC of T 2003 ATC 4782 at 4791-4792 Hill & Carr JJ set out various propositions derived from the case law. Their Honours, after dealing with some of the matters set out above, said:
``... A person may carry on a business, notwithstanding that the person had some other activity, such as full time employment. It is not necessary, in concluding that a business is carried on, that the acts to be undertaken are acts of the person seeking to establish he or she is carrying on a business. So a person may appoint another to take the steps which constitute the business activity:
Ferguson v FC of T 79 ATC 4261 at 4270; (1979) 26 ALR 307 at 319 and, at least if the facts in
FC of T v Lau 84 ATC 4929 at 4942; (1984) 6 FCR 202 at 218 involved a business, that case is another example.
In deciding whether or not a business is carried on courts have pointed to what have been called in the United Kingdom the `badges of trade,' indicia which, while no one of them will be determinative of whether a business is carried on, collectively will demonstrate a business. These include the profit motive (although a non profit company may still carry on a business), acting in a business like way, (although many businesses may be found which operate in a non-business like way), the keeping of books of account and records, (although the fact that there are none will not necessitate the conclusion that a business is not carried on) and repetition (although a fixed term project may still be a business).''
51. In Puzey it was also pointed out that reliance can seldom be placed on a particular decided case to conclude that a business is, or is not, carried on, unless there is a complete identity of fact between that case and the circumstances under consideration. However in this case, some guidance can nevertheless be obtained from the decisions to which counsel for both parties referred.
52. Lau was the subject of some analysis in Puzey. It is unnecessary to repeat that analysis here. It is sufficient to say that the case concerned an afforestation scheme involving pine trees. A feature that was common with the present facts was the relatively small area of land leased as part of the scheme to the taxpayer (there, no less than 14 hectares were to be leased on which a minimum of ten hectares
ATC 4489of trees were to be planted). Planting, tending and the ultimate felling of the trees was to be carried out under a management agreement. Not much attention was given in the judgment to the question whether a business was carried on. None-the-less, it is perhaps implicit in the judgment of Fox J, with whom Jenkinson J agreed, that there was a business (see at ATC 4936-4937; FCR 211). However, Beaumont J (at ATC 4944; FCR 221) did refer specifically to the business of the taxpayer. It may be noted that an argument that there was difficulty identifying the land leased to the taxpayer did not result in the deduction claimed being disallowed.
Clowes & Anor v FC of T (1954) 10 ATD 316; (1953-1954) 91 CLR 209, on the other hand, concerned the purchase by a taxpayer of two parcels of land, one of one acre and the other of two acres. These parcels of land were to be planted, tended and in due course harvested together with other parcels belonging to other taxpayers. The taxpayer was entitled to a percentage interest in 90% of the ultimate proceeds from the sale of the timber, pro rata to the total number of lots in the scheme. The remaining 10% interest went to the promoter. The High Court held that the taxpayer was a ``passive investor'' (see per Dixon CJ at ATD 317; CLR 215). He had made an investment of capital in the hope that at the end of many years he would receive a greater sum. Accordingly he did not carry on any business.
54. Puzey involved a taxpayer who, in the first year under consideration, was held to be carrying on a business of planting and developing a sandalwood plantation. The area of land which the taxpayer leased was approximately one hectare. There were to be 115 similar lots leased to other investors, and through the agency of the promoter and a plantation manager, seedlings were to be planted on the lots, tended and ultimately harvested. The harvested timber from all leased areas was to be pooled and the proceeds divided among the lessees of the lots. The conclusion that a business was being carried on was reached, and notwithstanding that all work on the leased land was undertaken other than by the taxpayer, who relied on the expertise of the promoter or plantation manage; notwithstanding the small size of the block, and notwithstanding that harvesting would involve pooling the timber grown on the taxpayer's block with timber grown on other blocks. By the second year however, the situation had changed following the intervention of the Australian Securities and Investment Commissioner. Thereafter the plantation activity was carried on by a trustee and not the taxpayer.
Enviro Systems Renewable Resources Pty Ltd v Australian Securities and Investment Commission (2001) 80 SASR 1 was a case where it was held, although not in the context of income tax, that there was a managed investment scheme in which the investors were passive and did not carry on a business.
FC of T v Emmakell Pty Ltd 90 ATC 4319; (1990) 22 FCR 157 was another tea tree plantation scheme involving what were said to be ``leases'' of areas of one acre (the so-called leases were invalid in law). The land leased was to be managed by a manager who was to clear the land, plant tea trees at a density of approximately 14,000 trees to an acre, tend the trees, harvest them, and distil and sell the oil from them. The manager had the right to aggregate the produce of the particular plantation with that of other land in the vicinity where to do so was, in the opinion of the manager, necessary for the economical harvesting of the crop and was not prejudicial to the lessee. It was held that the fact that the leases were defective in law did not operate to disallow the deduction, a matter in fact decided in Lau. The pooling arrangement was, it was said, a ``sensible provision to facilitate operations'' and clearly underlined the intended proprietary right of the lessee. The conclusion of the Administrative Appeals Tribunal that the taxpayer carried on business involved no error of law by the Tribunal.
FC of T v Brand 95 ATC 4633 was concerned with prawn farming in Northern Queensland. A pond area was licensed to the taxpayer who could in accordance with the documents signed, elect to run a prawn farm on the licensed area or join with others. Again the activity was to be carried on by a manager. The question debated in the case was not whether a business was carried on, but rather whether the fees paid were incurred prior to the business having commenced. The taxpayer was successful.
58. Finally reference may be made to the decision of another Full Court of this Court in
Vincent v FC of T 2002 ATC 4742; (2002) 193 ALR 686. Vincent involved a cattle breeding
ATC 4490program where participants were to lease a specified number of cows to participate in embryo transplant operations under which fertilised eggs were to be transplanted from stud cattle to the leased cows. The taxpayer had entered into a lease of three cows for a term of two years and expected there to be produced six progeny. There was a management agreement which was held to oblige the manager to deliver six calves irrespective of the outcome of the operations. In the circumstances of the case it was held that the taxpayer was not carrying on the business of breeding and selling cattle, and the outgoings she incurred were held to be on capital account.
59. Before the Primary Judge and before us, Queen's Counsel for the Commissioner relied on various factors said to lead to the conclusion that Mr Sleight and his wife were not carrying on business on the blocks leased. These included:
- • The power of relocation
- • The difficulty in identifying the farm
- • The pooling of oil for sale and the overall ``substance'' of the agreements which showed, it was submitted, that Mr and Mrs Sleight were really participating in an investment proposal from which they were to receive a proportion of the sale proceeds from the sale of oil
- • The lack of control by Mr and Mrs Sleight in respect of their interest said to result from the difficulty in controlling or removing the manager under the Management Agreement and having regard to the provisions of the Articles of Association of the Land Company. Mr and Mrs Sleight's role was, it was submitted, such that they were denied any ``operational or determinative role'' in the project.
- • The fact that all work on the relevant blocks was to be done not by Mr and Mrs Sleight, or persons employed by them, but under the terms of the Management Agreement. Rather they were merely passive investors in an activity conducted by the project companies, where the trustee for investors was a ``third party guardian'' of the investors' interests in the project.
- • Despite the terms of the Management Agreement, and apparent right of Mr and Mrs Sleight to elect to carry on business on their own without appointing a manager, or pooling oil proceeds, it was practically impossible for them to elect to manage themselves the farm or to appoint an alternative manager
60. In summary, it was submitted that here there was no organised commercial activity intended to be carried on by the project investors other than that, in return for the initial cash outlay, they were to receive the promised share of proceeds from the sale of the tea tree oil produced from the project plantation over the 15 year period before ownership of the plantation passed to the Land Company. It followed that the learned Primary Judge erred it was said, in finding that Mr and Mrs Sleight carried on a business. They were mere passive investors, and the amounts they paid were thus outgoings of capital.
61. In my view the Commissioner's submissions can not, on the facts, be accepted. Mr and Mrs Sleight commenced on the last day of the year of income to carry on a business of tea-tree farming on the land. As the cases, to which reference has been made in some detail above demonstrate, none of the features which the Commissioner seeks to emphasise necessitate the conclusion that a business is not being carried on. Indeed they point generally to a contrary conclusion. Difficulties of identification of the land (and it should be noted that those difficulties were here practical, rather than legal), the fact that the manager may substitute one block for another, the employment of a manager as contractor to carry on the activity of tea tree farming, and the pooling of oil produced from tea trees harvested and grown on the relevant leased area with oil from other farms, - none of these matters require the conclusion that no business was commenced to be carried on by Mr and Mrs Sleight on 30 June 1995. The learned Primary Judge was, therefore, not in error in concluding, as he did, that Mr and Mrs Sleight did commence business on that day and in consequence that, but for Part IVA of the Act, the amounts they incurred were deductible to them and were not of a capital nature.
62. If Mr Sleight entered into or carried out a scheme to which Part IVA applied then the Commissioner was entitled to make a determination under s 177F to cancel any ``tax benefit'' which he obtained in connection with that scheme. As already noted, the
ATC 4491Commissioner in fact made three determinations. I shall defer until later the question of the validity of these determinations.
63. Before the Primary Judge, as already noted, the Commissioner particularised the scheme to which, he submitted, the provisions of Part IVA applied as being the entering into by Mr Sleight and his wife of the various documents signed by or on his behalf together with the drawing of the various cheques contemplated by them. As also noted earlier it was submitted on behalf of the Commissioner, by way of an alternative submission raised for the first time in the Appeal that the relevant scheme was something less than the entering into of the whole of the documentation. However, it is convenient first to consider whether the whole of the transaction entered into by Mr Sleight and his wife is a scheme to which Part IVA applies. Only if it is not will it be necessary to consider the alternative scheme proposed.
64. The first requirement of a scheme to which the provisions of Part IVA will apply is that there be obtained by the taxpayer a tax benefit in connection with the scheme. There will be relevantly a tax benefit obtained in connection with a scheme where there is a deduction allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out. Here there is no contest. The deductions totalling $12,722 being one half of the total amounts incurred by Mr Sleight and his wife on 30 June 1995 other than the amount of $1,000 paid to subscribe for 1000 ``A'' class shares in the Land Company, and $50 for the purchase of tea tree seeds thus represented the tax benefit obtained in connection with the scheme by him.
65. The question then is whether, having regard to the eight matters set out in s 177D(b) ``it would be concluded that (a person) who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling... (Mr Sleight) to obtain a tax benefit in connection with the scheme or of enabling... Mr Sleight and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme...''. The words ``the purpose'' include ``the dominant purpose'' (see s 177A(5)).
66. While the case was argued on the basis that the relevant purpose to be considered was that of enabling Mr Sleight, or Mr Sleight and his wife each to obtain a tax benefit in connection with the scheme, the relevant purpose to be considered might alternatively extend to the purpose of enabling not only Mr Sleight and his wife, but also all the other persons who entered into similar arrangements with the Land Company each to obtain tax benefits in connection with the scheme. However, that would require the scheme to be more widely defined than it was before the Primary Judge to encompass the involvement of other investors.
67. There have by now been a number of cases, both in the High Court and in this Court where the provisions of Part IVA have been considered. The propositions which may now be taken as decided may be summarised as follows:
- 1 Part IVA does not authorise consideration of evidence of the subjective purpose or motivation of a particular person. The subjective state of mind of a person is not a matter listed in s 177D(b) to which regard may be had. Rather the section requires consideration of the eight matters listed in s 177D(b) and no other matters. The subjective state of mind of a person is not such a matter. Hence the section seeks to establish the conclusion which would be reached by reference to what may be referred to as objective factors, that conclusion being however, a conclusion as to the purpose of a person who entered into or carried out the scheme:
FC of T v Zoffanies Pty Ltd 2003 ATC 4942 at 4954 [ 53-54] per Hill J, with whom, on this point, Hely and Gyles JJ agreed,
Eastern Nitrogen Ltd v FC of T 2001 ATC 4164 at 4177; (2001) 108 FCR 27 at 44 per Carr J, with whom Sundberg J agreed.
- 2 The reference to dominant purpose in a case where more than one purpose is present is a reference to the ``ruling, prevailing or most influential'' purpose:
FC of T v Spotless Services Limited & Anor 96 ATC 5201 at 5210; (1996) 186 CLR 404 at 423.
- 3 The conclusion as to dominant purpose may be reached not only with respect to the dominant purpose of the taxpayer, it may be
ATC 4492reached by reference to the dominant purpose of any other person or persons so long as they are persons who entered into or carried out the scheme or any part of it: Spotless (at ATC 5207; CLR 418). Likewise, the purpose of an adviser may be attributed to the taxpayer in an appropriate case:
FC of T v Consolidated Press Holdings Ltd & Anor 2001 ATC 4343 at 4360; (2001) 207 CLR 235 at 264.
- 4 It is possible to arrive at the conclusion as to purpose by making a global assessment of the facts, so long as it is clear that the relevant eight factors are taken into account: Consolidated Press Holdings at ATC 4359-4360; CLR 263.
- 5 Some of the eight factors (there is clearly some overlap among them) may point one way, others may point in the opposite direction, and some may be neutral: it is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers: per Hill J in
Peabody v FC of T 93 ATC 4104 at 4113-4114. Nothing said on the appeal at
94 ATC 4663; (1994) 181 CLR 359 would cast doubt on this proposition
- 6 There is no inconsistency between a finding that the purpose of a person lay in the pursuit of commercial gain in the course of carrying on a business and a finding that the dominant purpose was to enable the relevant taxpayer to obtain a tax benefit: per Gleeson CJ, Gaudron, Gummow, Hayne and Callinan JJ in Consolidated Press Holdings Ltd at ATC 4360 ; CLR .
68. In the circumstances of the present case there were two persons whose purpose might be tested, namely Mr Sleight (and/or his wife) on the one hand, and the promoter of the scheme on the other. Indeed the judgment below was criticised upon the basis that the Primary Judge had not really considered the purpose of the promoter. I shall return to that question later. It is more convenient to consider first the purpose of Mr Sleight having regard to the eight factors. I shall consider each separately, but in so doing I am aware of the need, ultimately to consider them together as well as separately.
The manner in which the scheme was entered into or carried out
69. The present is not a case where a taxpayer is introduced to a mass marketed tax scheme by a salesman and, in the result, enters into the scheme. Rather it is the case of the salesman himself entering into a mass marketed scheme with both tax and commercial consequences.
70. Mr Sleight was, as has been noted, an investment adviser. It appears from his return of income for the year of income that he sold this particular scheme to some of his clients. The evidence is silent whether he did so for the purpose of selling a scheme to clients seeking a tax deduction, clients seeking an investment opportunity or both. It seems that Mr Sleight's interest in tea trees was brought about by a visit to the Main Camp Tea Tree plantation site in Rappville New South Wales where, on a number of occasions he spoke to the directors. There was no cross-examination about these visits and indeed there is nothing in the evidence concerning the Main Camp Tea Tree plantation itself. Perhaps the judgment of Conti J in
Howland-Rose & Ors v FC of T 2002 ATC 4200 may have provided fertile ground for such cross-examination. However, for whatever reasons the matter was not pursued and hence it must be accepted that the evidence was that Mr Sleight had some interest in tea tree production.
71. In favour of what may be referred to as the non tax purpose, Mr Sleight's visit on a number of occasions to the Northern Rivers property may also be mentioned.
72. The scheme was the subject of a prospectus, filed in June 1995 which contained both financial and taxation information. Tax, while it occupied some pages, can not be said to have been given any overemphasis in the prospectus which was a lengthy document. Mr Sleight, despite his occupation had little training in financial matters. He had attended an investment training centre in Sydney for some five or six weeks undertaking an investment course while he was employed by the Commercial Bank of Australia. He subsequently worked with that bank for some time and later with another bank and an insurance company before commencing business on his own behalf. He appears to have collected from various sources prospectuses on tea tree projects and some information from product marketing companies as to what they
ATC 4493were willing to pay for tea tree oil. Some, although he said not all, of this information was annexed to his affidavit. Some of the material annexed appeared to postdate his entering into the scheme. Such information as there was in his hands at the end of June 1995 hardly suggests a great deal of interest in the commercial side of the operation other than such as was disclosed in the prospectuses. At any event, Mr Sleight said in evidence that he considered the profit projections contained in the prospectus, which he saw (at least in final form) for the first time on or after 14 June 1995, that being the date of registration of the prospectus for the issue, were realistic.
73. In marketing the scheme to his clients Mr Sleight used a document that had been prepared by the management team of the Northern Rivers project for the purpose of supplying basic information to interested persons before the prospectus was registered. That document, Mr Sleight agreed, emphasised the tax effectiveness of an investment in the project. The document, in describing the features of the project, referred to one as ``Tax effective, tax effective, tax effective.'' The emphasis is telling. A table in that document showing the tax consequences (there is a similar table in the prospectus) revealed that an investor on the top rate of tax, after taking into account the tax deductions thought to be available, actually was ahead on cash flow, other than for the investment in shares in the Land Company. On the other hand, as the Primary Judge observed, the information brochure promoted eight advantages of investment. Tax was but one of these. Other advantages promoted were ownership, asset building, income production, capital gain, strong forecasted returns, established marketing infrastructure, environmental aspects and early investor advantage.
74. Nor was the particular investment the only investment of its kind undertaken by Mr Sleight. Mr Sleight's tax return showed that he claimed deductions in the year of income for a very similar scheme with similar tax advantages, but this time involving cotton. Mr Sleight's interest in cotton as well as tea trees was not the subject of any exploration in cross- examination. It seems that some of the documents in the cotton scheme had been used in the present scheme with ``cotton seed'' crossed out and ``tea tree seed'' substituted. Mr Sleight was also involved in an investment involving cattle breeding being, as he agreed, ``the transaction involved in the Vincent case''. Indeed, it would seem that Mrs Vincent was a client of Mr Sleight. Given the basis of the claim for deductions in the latter scheme it may be thought not surprising that Mr Sleight might want to invest in another scheme, to ``cover his bets''.
75. The commercial investment in tea trees was, as the prospectus pointed out, attendant with risk. Without the tax benefits which the opinions in the prospectus suggested should be available, the commercial returns were far from encouraging. This was even on the assumptions that were made in the prospectus which saw oil prices expected to rise by 3% a year with cost rising at the same rate and inflation expected to be at the same rate. These projections took no account of any possible fall in the price of tea tree oil brought about by the increased investment in that oil from not only the present scheme, but from others like Main Camp, assuming they were to be successful.
76. Without taking tax into account an investor would outlay $ 3,745.00 in cash on 30 June 1995 and a further amount of $9,409.00 in the next year. No cash return was expected to be received in hand until the 1998 tax year when a return was forecast of $645.00 and the cash return according to the figures in the prospectus at the end of five years was $1,333.00 (ie sum of return for 1998 and 1999). These figures take no account of inflation. The evidence on the commercial viability of the project was somewhat mixed. One expert called on behalf of Mr Sleight accepted in cross- examination that a drop in yields could be expected as the size of the plantation expanded. He said that prices in the 1995 tax year for oil were high and it could have been predicted that the prices would ultimately drop. On the other hand there was optimism that tea tree oil would be registered with the US Federal Drug Administration so that new opportunities could open up. Another expert who had given evidence that the yields in the prospectus were reasonable, in cross-examination accepted that they were at the higher end of the scale. The availability of water was a relevant factor. Yet another expert gave evidence that it was only safe to predict yields for 12 months.
77. One other matter relating to the manner in which the scheme was entered into may be
ATC 4494noted. Although Mr Sleight and his wife did sign the application form pursuant to which they agreed inter alia to, pre-pay the management fee and subscribe for shares in the Land Company, and they did sign the loan application, the loan agreement and the loan indemnity agreement; the management agreement was executed under powers of attorney, the attorney being, it would seem, someone connected with the promoters. Further, a number of the cheque transactions involved exchanges of cheques generally called ``round robins''. It was said that Mr Sleight was not aware of this, but there is evidence which suggests the contrary. While a round robin is perfectly legally effective to create real relationships between parties, it must be said that it is a feature of many tax avoidance schemes where no real money is involved and may point to a tax avoidance purpose. On the other hand it can not be said that the round robin strongly points to what may be called here the tax avoidance purpose. Likewise a loan agreement with prepaid interest operating to ``gear up'' an investment is a mark of tax avoidance schemes which likewise involve investment opportunities.
78. The Primary Judge rejected consideration of the lack of external funding as pointing to tax avoidance relying on Lau and Emmakell to support that rejection. However, it must be noted that neither case involved Part IVA at all (Lau predated Part IVA; Emmakell does not refer to Part IVA). It is true, as his Honour observed, that the ``round robin'' did not affect the ``genuineness of the transactions''. That may be accepted. But the question is not whether the transactions were genuine, but what, if anything, they tell concerning the purpose of the taxpayer.
79. Another factor pointing to the tax purpose predominating over the commercial purpose is that it does not seem that Mr Sleight attempted, before entering into the agreement to identify the two lots which would be allocated to him. One might expect that a person interested in growing tea trees might be particularly interested in the blocks to be allocated, if only because he or she might want at some time to farm the blocks otherwise than through the services of the Management company. Of course the pooling arrangement, which had the consequence that the owner of a block producing no tea trees at all would nevertheless participate in the pooled oil proceeds, made the location and condition of the blocks irrelevant as long as the blocks were to be farmed by the Management Company.
80. Finally, it should be noted that the financial structure that the management agreement, loan agreement and indemnity agreement created was not necessary to the success of a tea tree project. Presumably the promoters, for example, could have still received the same amount of return by limiting the first year management fee to the actual cash outlay of the investor, and then adjusting the management fee in subsequent years to achieve this result. Arguably, an investor would thus have a legitimate, albeit significantly reduced, tax deduction for his cash outlay because it was actually a necessary cost of the project. This fact points towards a dominant tax incentive purpose because it could be objectively determined or concluded that an investor, who had a dominant commercial purpose, would prefer the project with a normal structure, rather than one which was so structured that it maximised the deductions available by the use of a somewhat artificial structure.
Form and substance
81. There is a difference between the form and the substance of the present scheme. In form there is an option whether to farm alone or to employ the management company. There is a management agreement and financing and interest payments. The form, involving pre- payment of management fee and interest is, it may be concluded readily, designed to increase the taxation deductions available to an investor. The substance is, however, quite different. As Senior Counsel for the Commissioner put it, in substance the investor is a mere passive investor in what, once the tax features are removed, is a managed fund where no deduction would be available, or perhaps an alternative characterisation of the substance of the scheme is an investment in shares in the Land Company which at the expiration of 15 years is to own the tea tree plantation.
82. With respect to the learned Primary Judge it is not correct to say that form and substance are the same. Rather the particular shape the investment took was clearly fashioned in a way that would maximise the tax deductions. They were geared up by the loan agreement with up front interest payments. But for the tax deductions the form the investment might be
ATC 4495expected to take would clearly relate more to the substance of what happened. Rather than a loan with prepaid interest where the loan was to be repaid out of the investor's profit share without recourse (achieved through the indemnity agreement) the substance is that the investor was to receive only a lesser share of profit over the term of the loan agreement. The loan allowed, also, the prepayment of the management fee and the deduction which emanated from that.
The time at which the scheme was entered into and length of the period during which the scheme was carried out
83. This factor clearly points to taxation as a predominating purpose. The scheme was entered into on the last day of the year of income. This was not accidental as it was necessary for a large portion of the deductions to be incurred in the 1995 year of income. If what may be called the tea tree or investment purpose predominated, then there would be no need for a ``flurry of activity'' to occur, as it did, at the end of the year of income. The investment could be entered into at any time.
84. As his Honour points out the reason why the issue of the Prospectus did not take place until a date in June 1995 is unexplained by the evidence. It is true, as his Honour says that Mr Sleight's interest in the project had long predated the issue of the prospectus. However, it is clear that the evidence relating to the need to document the transaction before the end of the year of income does, as his Honour accepted, point against Mr Sleight.
85. The length of the scheme is a neutral factor, or perhaps marginally may support Mr Sleight. This is not a case of a scheme which starts and finishes in the year of income once the deduction is availed of. It is a scheme which, on its face, contemplates an activity over some 15 years before the management agreements terminate and the farms revert to the Land Company.
The result in relation to the operation of the Act apart from Part IVA
86. Apart from Part IVA the scheme operates to provide to Mr Sleight deductions in the 1995 and 1996 years of income considerably in excess of the funds he contributes with his wife, namely deductions totalling $12722 in respect of the management, administration and indemnity fees and interest and in the 1996 year of income a deduction of $2009 in respect of interest. This point to taxation as a predominant purpose.
Change in financial position of Mr Sleight resulting from the scheme
87. Mr Sleight outlayed in cash together with his wife the sum of $4,745 in the 1995 year and $9,409 in the 1996 year. For this they obtained tax deductions, amounting to $25,445 in the year of income and $2009 in respect of interest in the 1996 year of income. They also obtained an investment in the tea trees to be planted and tended and harvested. The value to Mr Sleight of his share of the tax deductions was the subject of some controversy. It was said that given the deductions he had claimed for the cotton scheme and the Vincent scheme he had hardly any tax to pay so that the deductions were virtually valueless. That assumes that both those deductions from the other schemes were allowable. So far as the Vincent deduction is concerned that can be seen now to be unlikely to be available. The cotton scheme deduction claim is more difficult to assess but given that the scheme has similar features to the present scheme it would stand or fall with the present scheme.
88. The deductions, which investment in the scheme made available to Mr Sleight, may not have been such as to have covered the interest and principal payments in the 1996 year as was suggested by counsel for the Commissioner, but they clearly had a considerable value to Mr Sleight, particularly if the other deductions claimed by him were not allowable. The commercial interest in tea trees which the outlays obtained was considerably less certain than the tax benefit. If the investment lived up to the projected figures in the prospectus many years were likely to pass before Mr Sleight and his wife would see their cash returned to them. In fact the prospectus indicated that in the 1999 and 2000 years their share of the proceeds of the sale of oil was only to be $685 and $727 respectively. The prospectus presents detailed calculation of predicted revenue for the first six years of the project, however, continuing these calculations into the future reveals that it would only be at the end of the 17th year that the investor would have earned, in case, the amount that was initially outlaid (excluding the $1000 for the purchase of the shares) but subject to any dividend from the separate share purchase.
Change in the financial position of others with a connection to Mr Sleight
89. This is not a case where a taxpayer received a tax benefit and a person associated with him or her received some collateral capital payment. No doubt the promoter companies made money out of the scheme, but they would hardly seem to be entities having any real connection of a business nature with Mr Sleight as that expression is used in s 177D(b)(vi).
Any other consequences for Mr Sleight or other person referred to in s 177D(b)(vi)
90. It is difficult to see any relevant matter under this heading pointing one way or the other.
The nature of any connection between Mr Sleight and any person referred to in s 177D(b)(viii)
91. This factor is likewise neutral.
The conclusion under s 177D in respect of Mr Sleight
92. It is obvious, as the above analysis shows, that such of the eight matters to be considered as are relevant make it clear that Mr Sleight had two purposes in entering into or carrying out the scheme; a tax purpose and an investment purpose. It may be accepted that the investment had a commercial purpose. The real question is which of the two purposes, tax or investment, predominated.
93. It was submitted before his Honour, and before us, that it could not objectively be concluded that Mr Sleight entered into or carried out the scheme for the dominant purpose of obtaining the tax deductions available where the value of the tax deduction fell short of the cash outlay. As already noted, the difficulty of valuing the tax deduction lies in determining what tax rate should be taken as applicable to Mr Sleight's taxable income. For the reasons already given, the deductions claimed for the cotton scheme and the Vincent scheme would, necessarily need to be heavily discounted. With respect to his Honour the projected yields from the tea tree project itself were far from as encouraging as his Honour appears to suggest. And that is before taking into account any difficulties which the project might in fact encounter.
94. While the conclusion is one where minds might differ, I think that it is more likely than not that a reasonable person faced with having to draw the conclusion which s 177D requires would conclude that Mr Sleight entered into or carried out the scheme with the dominant purpose of obtaining the tax benefits available to him given the uncertainty attendant on the other deductions he had claimed and the uncertainty of the investment yields which the project might realise.
The conclusion regarding the promoter
95. Counsel for the Commissioner submitted that his Honour had erred in failing to consider whether it would be concluded, having regard to the eight factors that the Promoter or the promoter's company entered into or carried out the scheme for the dominant purpose of obtaining for Mr Sleight a tax benefit.
96. It is arguable whether his Honour did fail to consider the promoter (or the promoter's companies) in this context. But it is unnecessary to decide whether this was so. With respect to the submission of counsel for the Commissioner it is difficult to see why, having regard to the relevant eight factors, the conclusion would be drawn that the promoter entered into or carried out the scheme for the dominant purpose of providing to Mr Sleight a tax deduction. The promoter no doubt was motivated by the profit which the promoter and his or her entities would make. That profit was no doubt dependant upon Mr Sleight and others entering into the scheme. That in turn no doubt depended upon Mr Sleight forming the view that a tax benefit was available to him. However, I do not think that it would be concluded that the promoter or associated entities entered into or carried out the scheme for the dominant purpose of Mr Sleight obtaining tax deductions.
Should the Commissioner be allowed on the appeal to formulate a different scheme
97. It is unnecessary for me to reach a decided view on this matter. However, as presently advised I would refuse leave to the Commissioner at this late stage to argue on the appeal a matter not raised at the hearing at first instance.
98. Senior Counsel for Mr Sleight submitted that his client would or could be prejudiced if leave was given. Had it been known at the hearing below that the Commissioner would rely upon an alternative scheme counsel for Mr Sleight might, it was submitted, have called evidence to counteract the submissions of the
ATC 4497Commissioner. It followed, it was said, that to permit the Commissioner to rely now on the alternative scheme would be prejudicial to Mr Sleight.
99. It is not clear to me what evidence might have been called on behalf of Mr Sleight that would not have been called in any event in the consideration of the wider scheme. No indication was given by counsel for Mr Sleight what this evidence might have been. There is, in any event, another difficulty in allowing the Commissioner now to argue in favour of an alternative and narrower scheme. It is a prerequisite of a scheme being a scheme to which Part IVA applies that there be a tax benefit obtained in connection with the scheme. Yet it seems to me that the narrower scheme which the Commissioner now seeks leave to rely upon would require the question in the appeal to be considered by reference to a different tax benefit than was considered at first instance. This may cause prejudice to Mr Sleight and, in my view, the Commissioner should not be granted leave now to rely not only upon a different scheme, but also upon a different tax benefit obtained in connexion with that different scheme.
The validity of the first determination
100. It is convenient under this heading to deal with two issues arising in the appeal from the Notice of Contention filed on behalf of Mr Sleight. First there is the more general question whether the first determination was valid because it was made by Mr D'Cunha. Secondly there is a matter dealt with only briefly in the judgment under appeal, namely that the determination was invalid and the discretion to make it miscarried because the person who made it failed to consider the personal circumstances of Mr Sleight.
101. As to the first of these matters the learned Primary Judge was of the view that the first determination was not invalid because it was made in the name of Mr D'Cunha, Director of Small Business Executive Level 2, albeit expressed to be a determination made by the Commissioner to cancel a tax benefit.
102. His Honour referred to the judgment of Ryan J in
Mochkin v FC of T 2002 ATC 4465 at 4485 where his Honour had noted that the nature of the powers conferred upon the Commissioner by s 177F were such that they were not intended to be exercised only by the Commissioner or his delegate but through a properly authorised officer:
O'Reilly & Ors v Commr of the State Bank of Victoria & Ors 82 ATC 4671 at 4674-4675; (1983) 153 CLR 1 at 12-13 per Gibbs J. The evidence showed that Mr D'Cunha was a properly authorised officer in this sense. The determination on its face purported to be a determination of the Commissioner, notwithstanding that it was signed by Mr D'Cunha in his own name. His Honour referred to the decision in
Vincent v FC of T 2002 ATC 4742 at 4760 . Accordingly in his Honour's view, the Determination was not invalid. And this was so notwithstanding that the determination showed a tax benefit greater than the actual tax benefit Mr Sleight could have obtained in connexion with the scheme because it adopted the partnership figure rather than Mr Sleight's share of the partnership loss. In support, his Honour cited Spotless Services Ltd (at ATC 5211; CLR 424) as authority for the proposition that the fact that the quantum of the tax benefit initially assessed was different from that actually obtained did not lead to invalidity. With respect, I agree with his Honour and for the reasons his Honour gave.
103. The second question is whether Mr Sleight could challenge the determination on the basis that the exercise of discretion by Mr D'Cunha miscarried in that he had failed in making the determination to take into account matters personal to Mr Sleight, for example, the fact that his taxable income after allowance of deductions claimed was quite small.
104. The answer to the submission lies, as his Honour noted in the provisions of ss 175 and 177 of the Act. Section 177(1) provides that production of a notice of assessment or copy, even in proceedings in this Court challenging an assessment brought under part IVC of the Taxation Administration Act 1953 will be conclusive evidence ``of the due making of the assessment''. The subsection allows there to be an issue on the appeal relating to the assessment whether the assessment is excessive. Section 175 ensures that the validity of an assessment is not to be affected by reason that any provision of the Act is not complied with.
``... `due making of the assessment' was intended to cover all procedural steps, other
ATC 4498than those if any going to substantive liability and so contributing to the excessiveness of the assessment, the thing which is put in contest by an appeal.''
DFC of T v Richard Walter Pty Ltd 95 ATC 4067 at 4073; (1995) 183 CLR 168 at 184, Mason CJ said that the making of a determination under s 177F:
``... is a determination going to substantive liability and, in conformity with the interpretation of s 177F(1) adopted in George, McAndrew, FJ Bloemen and Dalco, is put in issue by an appeal which challenges the assessment on the ground that it is excessive.''
107. In other words, it is not open to a taxpayer to challenge an assessment under Part IVA by showing some error in the making of that determination.
108. Although the reasoning of the members of the Court in Richard Walter differed, the result did not. Brennan J, for example, applied the principle in
R v Hickman; ex parte Fox and Clinton (1945) 70 CLR 598 and concluded that it was necessary to read ss 175 and 177(1) together to reconcile what is a prima facie inconsistency between the two provisions. The present, as the Primary Judge observed, was not a case where the exceptions referred to in Hickman operated and in consequence any deficiency in the determination was validated by s 175.
109. Richard Walter is consistent with what the High Court later said in
FC of T v Peabody 94 ATC 4663; (1993-1994) 181 CLR 359. It had been argued that the Commissioner, having made a determination in respect of a particular scheme was confined in proceedings under Part IVC of the Taxation Administration Act, to supporting the assessment by reference to that scheme. The argument was rejected. Their Honours said at ATC 4669-4670; CLR 382:
``Under s 177F(1), the Commissioner's discretion to cancel a tax benefit extends only to a tax benefit obtained in connection with a scheme to which Part IVA applies. The existence of the discretion is not made to depend upon the Commissioner's opinion or satisfaction that there is a tax benefit or that, if there is a tax benefit, it was obtained in connection with a part IVA scheme. Those are posited as objective facts. The erroneous identification by the Commissioner of a scheme as being one to which Pt IVA applies or a misconception on his part as to the connection of a tax benefit with such a scheme will result in the wrongful exercise of the discretion conferred by s 177F(1) only if in the event the tax benefit which the Commissioner purports to cancel is not a tax benefit within the meaning of Pt IVA.... the question in every case must be whether a tax benefit which the Commissioner has purported to cancel is in fact a tax benefit obtained in connection with a Pt IVA scheme and so susceptible to cancellation at the discretion of the Commissioner.''
110. The question whether the Commissioner's discretion as to whether there was a scheme to which Part IVA applied miscarried is thus not an issue in an appeal. Rather the issue will be, relevant to the present appeal, whether, the determination having been made, there was a scheme to which the provisions of Part IVA applied and if so, whether there was a tax benefit obtained in connection with that scheme. These will be matters of fact and the burden will lie on the taxpayer to show that objectively there was no scheme in connection with which the taxpayer obtained a tax benefit. If the taxpayer satisfies that burden he or she will have shown the assessment was excessive. That will not be shown by the taxpayer demonstrating that the person who made the determination in some way erred in making it so that the discretion conferred upon the Commissioner miscarried.
The decision in FC of T v Cooke  FCAFC 75
111. After the hearing of this appeal another Full Court decided FC of T v Cooke [
2004 ATC 4268]. Properly, the solicitor for Mr Sleight referred the Court to this decision which was favourable to the taxpayers. However, it must be said that decisions on Part IVA will, inevitably, turn upon the particular facts of the case. The facts in Cooke differ substantially from those in the present case. Indeed, the figures in the prospectus, if accepted, showed a very substantial return on cash invested even if the tax consequences were not taken into account.
The orders to be made
112. At the close of the hearing Senior Counsel for the Commissioner indicated that
ATC 4499the Court might consider that the tax benefit should be cancelled only to the extent of the deductions not reflected in the cash outlays actually made by Mr Sleight and his wife, but excluding such outlays as were of a capital nature such as the subscription for shares and the cost of seeds. However, it had not been argued on behalf of Mr Sleight that a deduction should be allowed of the actual cash outlaid. Rather the case was argued on what may be called an ``all or nothing'' basis, that is to say that either the whole amounts claimed were deductible or none of them were.
113. There is much to be said for the view that in cancelling the tax benefit under Part IVA, the Commissioner in a case such as the present, where a taxpayer is carrying on a business and it is found (by reference to the objective matters set out in s 177D(b) and these matters only) that it would be concluded that the taxpayer has entered into or carried out a scheme for two purposes, the one a business purpose and the other and predominant purpose being a tax purpose, the Commissioner should give consideration to allowing as deductions amounts actually outlaid by the taxpayer which are not inflated by features of the scheme which point to tax avoidance. In the present case, if there had there been no gearing of the management fees, for example, it would have been unlikely that the conclusion of dominant purpose required under s 177D could have been reached and likewise the cash actually expended, to the extent it was of a revenue nature would have been clearly deductible.
114. Section 177F(1)(b) permits the Commissioner in his discretion to determine that part only of a deduction which is the tax benefit obtained by the taxpayer under the scheme may be disallowed by the Commissioner. Arguably the making of a compensatory adjustment under s 177F(3) would likewise permit the Commissioner if he considered it fair and reasonable, to allow part of a deduction. There are no reasons why the ``relevant taxpayer'' referred to in that subsection could not be the ``relevant taxpayer'' referred to in s 177D if it was thought that s 177F(1) did not confer the power.
115. The appropriate orders to ensure the making of such an amendment to the assessment were not the subject of any debate. Unless the amendment were to be ordered by the Court the Commissioner might now no longer have power to amend the assessment by reducing the tax payable under it. In these circumstances it seems to me that the Court should defer making orders disposing of the appeal until the parties have had the opportunity of discussing what orders might be necessary to ensure that the assessment could be amended to permit the taxpayer to obtain deductions for amounts actually outlaid and not of a capital nature. It may suffice that the Court while allowing the appeal direct that the assessment be remitted to the Commissioner to consider whether some part of the deductions disallowed to Mr Sleight might be allowed under either s 177F(1) or s 177F(3). It is for that reasons that I would order only that the parties file short minutes of order in draft form setting out the orders which the Court should make in allowing the Appeal within 7 days of the delivery of the reasons of the Court.
116. Otherwise, the orders made by the learned primary Judge will be set aside and the appeal will be allowed. Mr Sleight must pay the costs of the Commissioner both at first instance and on appeal.