HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

GRIEVE v INLAND REVENUE COMMISSIONER (NZ)

SINCLAIR J

21 May 1982 -

Sinclair J This is a case stated brought by the two objectors against the assessment of the Commissioner of Inland Revenue in respect of the tax liability of the two objectors for the years ended 31 March 1976 and 31 March 1977.

The first objector appeared in person to represent himself and his wife and prior to the commencement of the hearing I enquired from Mr Grieve whether, having regard to the implications which were involved in the case stated, it would not be better for him to be represented by a legal practitioner. However, he indicated very firmly indeed that he had given that matter full consideration and that he felt competent to deal with all matters which might arise and did not consider, in the circumstances, that it was necessary for the objectors to be represented by a practitioner. Accordingly the matter proceeded.

Mr Grieve himself, as is disclosed by the case stated, carried on business as a chartered secretary and also had an interest in a land agency business known as Eastern Real Estate Ltd. His wife at all times material to the matters in issue carried on her profession as a medical practitioner.

In 1969 the objectors acquired an area of land near Maraetai and commenced a farming partnership. For the years ended 31 March 1972 to 1977 inclusive a net farming loss was shown in each year, the losses being as follows:

1972 ...	$3,577	1975 ...	$9,023
1973 ...	$1,443	1976 ...	$9,367
1974 ...	$5,373	1977 ...	$10,699

For the years ended 31 March 1972 to 1975 inclusive the Commissioner allowed the above farming losses sustained by the partnership to be offset against income derived by the objectors from other sources in each of the years under consideration. However, for the years ended 31 March 1976 and 1977 the Commissioner declined to allow the partnership losses to be offset against the income derived by the objectors from other sources on the basis that the farming activities were not such as to constitute a business within the meaning of the term "business" in s 2 of the Land and Income Tax Act 1954. In consequence, for those two years the objectors' liability for tax was increased and the Commissioner's assessments for two years under consideration appear in para 7 of the case stated.

The objectors made separate objections to the above assessments and upon their objections being disallowed the Commissioner was required to state a case.

The objectors continued to insist that their farming activities constituted a business within the meaning of that term as contained in s 2 of the statute whilst the Commissioner contended that for the purposes of s 111 of the same statute the losses incurred by the partnership in each of the stated years did not constitute a loss that was necessarily incurred by the partnership in carrying on a business for the purpose of gaining or producing the assessable income of the partnership for that particular income year or years.

The question posed by the case stated was whether the Commissioner, in making the assessment for the two years of 1976 and 1977, had acted correctly in disallowing the farming losses sustained by the partnership to be deducted from the incomes for those years.

The case stated necessarily involves what is meant by a "business" which was defined in the statute as "including any profession, trade, manufacture or undertaking carried on for pecuniary profit". A number of cases having a bearing on the meaning of the above term were referred to the Court, both by the objectors and by the Commissioner. I have given consideration to all of the cases which were quoted, but I intend to refer to but three which seem to me to be truly definitive of the position in this country. I do not overlook, however, the decisions in such cases as IRC v Duke of Westminster [1936] AC 1; J & R O'Kane & Co v IRC (1922) 55 ILTR 75; 126 LT 707 and IRC v Livingstone [1927] SC 251.

During the course of his submissions Mr Grieve relied strongly on two Australian cases: Tweddle v FCT (1942) 2 AITR 360, and Scott v FCT (1939) 1 AITR 495. It is not my intention to examine those two cases in the course of this judgment with any great particularity because they have both been considered by Quilliam J in Prosser v IRC (NZ) (1972) 3 ATR 371 and as I have come to the same conclusion as did Quilliam J in relation to those two cases I am content for the purposes of this judgment to adopt that which he said about the two Australian cases just referred to.

So far as New Zealand is concerned, I begin by quoting from a portion of the judgment of McCarthy J in Graham v IRC (NZ) (1961) 8 AITR 309; [1961] NZLR 994 and I quote from 998:

"Up to this stage I have been discussing the term business in its general sense, disregarding any particular connotation which it may bear in our taxing statute. It is now necessary to turn to s 2 of the Land and Income Tax Act 1954, the interpretation section. There it is enacted that 'business' 'includes any profession, trade, manufacture or undertaking carried on for pecuniary profit'. The use of the word 'includes' will be noted, and as the word 'means' is also used in the same section in the definition of other terms, prima facie this definition of business should be treated as an extending one and not an exclusive one: Haynes v McKillop (1905) 24 NZLR 833; 7 GLR 478. But, on the other hand, a study of the definition itself forces the view that it does not add anything to the common meaning of the word; does not catch anything which would not otherwise be caught; and so, for myself, I am not prepared to say that the use of the word 'business' in s 88, particularly having in mind the taxing nature of the section and bearing in mind, too, the definition in s 2, is intended to embrace a profession, trade, manufacture or calling, unless there is shown to exist an intention to carry on the particular activity under consideration for pecuniary profit. But the word 'for' does not point to motive. Motive as distinct from intention is generally not the concern of the law. 'For' points to intention. I agree with the authors of Gunn's Commonwealth Income Tax Law and Practice, 6th ed, that the essential test as to whether a business exists is the intention of the taxpayer as evidenced by his conduct and that the various tests discussed in the decided cases are merely tests to ascertain the existence of that intention. I think that it conforms with this approach to construe the word 'for', when considering a phrase such as 'carried on for pecuniary profit' used in relation to an occupation, as importing intention. Henry J took a like view in IRC (NZ) v Watson (1960) 7 AITR 629; [1960] NZLR 259 at 262, though not necessarily for the same reasons. The question then in this case, as I see it, is whether the conduct of the appellant can fairly be said to disclose an intention to carry out his evangelistic activities in the material years with the intention of making a profit."

This quotation has reference to the decision in IRC (NZ) v Watson (1960) 7 AITR 629; [1960] NZLR 259 which was another case referred to by Mr Grieve.

The portion of the judgment I have just quoted draws attention to the fact that whether a business exists, it is the intention of the taxpayer as evidenced by his conduct which is all important. An extension of this concept appears from the judgment of North P in Harley v IRC (NZ) [1971] NZLR 482 and it is referred to with admirable clarity in the judgment of Speight J in Golightly v IRC (NZ) (1972) 1 TRNZ 135 at 137. I quote from the judgment as follows:

"Both counsel are agreed that the test is simply stated by examining the definition of a 'business' in s 2, namely 'includes profession, trade, manufacture or undertaking carried on for pecuniary profit'. Again both counsel agreed that the correct interpretation is as posed by North P in Harley v IRC (NZ) (1971) 2 ATR 103; [1971] NZLR 482. The learned President at 486 and 487 posed the test as being whether or not the taxpayer had the intention and prospect of making a profit. Although different matters were at issue Harley's case contains helpful guidelines in examining an enterprise of this nature. The objector must show in relation to the farm that he has carried it on with the intention of making a profit, and even this does not suffice unless there was also a prospect of making a profit though not necessarily in the year under review. Doubtless what interested the Commissioner was the fact that by the end of the financial year 1970, for the fifth year in succession, there had been net losses and in particular, included the outgoings with large interest payments which themselves were greater than the gross profits being achieved in those years. Further, if such interest payments continued to be made and the other expenses incurred at the same rates, and if the gross profit on stock dealing remained as low, there did not on the face of it appear to be any prospect of a farming profit in the foreseeable future."

That decision makes it clear that not only must there exist the intention of making a profit, but there must also be existing a prospect of making a profit although not necessarily in the year or years under review.

Finally, the problem received extensive consideration by Quilliam J in Prosser's case, supra, and he brings together a summary of all the cases which I feel have a bearing on the problem in hand. I adopt in total the following extracts from his judgment commencing at 373:

"What then is a business? It is defined in s 2 of the Act as including 'any profession, trade, manufacture or undertaking carried on for pecuniary profit'. This definition was considered by Henry J in IRC (NZ) v Watson [1960] NZLR 259 where he said at 262: 'The taxpayer and his accountant have each asserted, and books have been opened and kept on the basis, that as from 1952 the taxpayer was in business as a horse-breeder. This is not sufficient of itself. "Business" includes any undertaking carried on for pecuniary profit. It is not necessary that such a profit should be made, but it is essential, even if not sufficient, that at least an intention to gain pecuniary profit from the activities should be proved before the undertaking can be termed a business'. Similarly, McCarthy J, in G v IRC (NZ) [1961] NZLR 994 considered that the intention to make a profit was an essential element in the definition of 'business'. Further reference to the definition was made by the Court of Appeal in Harley v IRC (NZ) [1971] NZLR 482. That case, the facts of which are not on a parallel with those of the present case, concerned claims for deduction for expenses incurred in a small farm. At first instance Wilson J, held that the appellants were carrying on the business of farming, but that the losses claimed were not exclusively incurred in the production of the assessable income. This was a reference to s 111 of the Land and Income Tax Act as it existed prior to the Land and Income Tax Amendment Act 1968. It was not necessary for the Court of Appeal to make an express finding as to whether the appellants were carrying on the business of farming but each of their Honours indicated doubt at Wilson J's, finding on this. North P, at 486, said: 'The learned Judge in the Court below - if I have understood his judgment correctly - treated the matter as raising simply a question of fact and he appears to have formed the opinion that once he was satisfied that the appellants were not carrying on their farming operations "for fun or as a hobby" the proper view was that they were carrying on a "business" within the meaning of the Act. With respect, I think that it is at least arguable that the words in the definition clause make it necessary for the taxpayer to establish that he was carrying on his operation for pecuniary profit and, accordingly, if the enterprise had no prospect of earning a profit, it may be wrong to describe the enterprise as a business.' Both Turner J, at 492 and Richmond J, at 496, made it clear that they shared the President's doubts. The proposition, therefore, that in order to constitute an undertaking a business it should be shown that there was both the intention to make a pecuniary profit and also the prospect of earning one had been expressed, although so far as the Court of Appeal was concerned the observations of North P, must be regarded as obiter.

"Due note of the position which had been reached was taken by Speight J, in Golightly v IRC (NZ) [(1972) 1 TRNZ 135], a judgment delivered on 18 August 1972. That was the case of a solicitor who lived on a property of 62 acres adjacent to the city in which he practised. His farming activities on that property were consistently unsuccessful and for a number of years he was allowed by the Commissioner to deduct his farming losses from his professional income. There came a time however when the Commissioner took a view similar to that which he has taken here, and Speight J, was called upon to decide whether the farming activities of the objector in that case comprised a business. Upon an examination of the evidence Speight J, held that there was a business, but in doing so he accepted that the test to be applied was that indicated by North P, in Harley v IRC (NZ) [supra], namely that both the intention to make a profit and also the prospect of doing so (though not necessarily in the year under review) should be established. In Golightly's case this test was accepted by both counsel as being correct. In the present case it is contended for the objector that this may not be so, and I was referred to two Australian cases, which it was said, showed a different principle. The first was Scott v FCT (1939) 1 AITR 495. The very unusual nature of the facts of that case make one approach it with a good deal of care. It was the case of a medical practitioner who, having attended his rooms regularly during the year, returned a total income of £3 3s 0d and claimed expenses of £182 0s 9d. He had a substantial private income from investments and he sought to set off the loss from his medical practice against that income. He had practised for several years with a consequent lack of success and results similar to that in the year in question. The Commissioner took the view that the taxpayer was not in business as a medical practitioner as there was really no prospect of his making a profit. Gavan Duffy J, held, however, that it was not unreasonable that the taxpayer should continue to try and establish a practice and accepted his evidence that he was genuinely trying to do so. That case clearly depended very much on its own facts and I am not prepared to regard it as indicating any principle which might be applied to the present case. An essential point of distinction is that in Scott's case the taxpayer devoted his whole time to his endeavours to establish a medical practice. His private income required very little of his attention. The position in the present case is of course quite unlike that.

"The other Australian case is Tweddle v FCT (1942) 2 AITR 360. That was the case of the Chairman of Directors of a soft goods company who also owned two farm properties. On one of those properties he did not intend to carry on business but was unable to sell it for some years. During that time he grazed a few stock and grew some crops but all on a somewhat nominal basis. He also incurred expenses in improving the property and preparing it for sale. It was held that while his dominant purpose was to sell the property the facts were just sufficient to establish that he was carrying on the business of a farmer there. The other property was farmed on a more realistic basis including the employment of a manager, but it consistently made losses. The taxpayer used the property in order to try and establish a particular breed of draught-horse in the hope that he could make a name for himself as a studmaster. It was argued that the fact that the property could never hope to make a profit took it out of the category of a business but the Court declined to take this view. At 364 Williams J, said: 'It is not suggested that it is the function of income tax Acts, or of those who administer them, to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically. The Act must operate upon the result of a taxpayer's activities as it finds them. If a taxpayer is in fact engaged in two businesses, one profitable and the other showing a loss, the Commissioner is not entitled to say he must close down the unprofitable business and cut his losses even if it might be better in his own interests and although it certainly would be better in the interests of the Commissioner if he did so. (Tooheys Ltd v DCT (NSW) (1922) 22 SR (NSW) 432, at 440-441). If the appellant succeeds and makes a profit it will plainly be taxable, and it is difficult to see how his activities could at that moment of time be transmogrified from an indulgence in a somewhat unusual form of recreation into the carrying on of a business. I am satisfied that the appellant is seeking to establish himself at Winlaton as a recognised breeder of high-class stud stock, and that while he is prepared to make losses to achieve this ambition he has a genuine belief that he will be able eventually to make the business pay. Indeed, unless he can do so, his experience will hardly be an encouragement to others to emulate his example.' While the facts of that case are substantially different from those here, it is difficult to reconcile the view taken by Williams J, with that appearing from the New Zealand cases I have already cited. All that I can say is that with respect I find myself unable to agree with the conclusions arrived at by Williams J, and I prefer the test indicated by North P and applied by Speight J. I do not consider that our statute entitles a taxpayer to create or persist in an entirely unrealistic venture and then, because it has the outward semblance of a business, to be able to assert that it is one. If that is the principle to be derived from Tweddle's case [supra] then I respectfully decline to follow it.

"Accepting then that the expression 'business' involves both the intention of making a profit and also at least the reasonable prospect of doing so, it is necessary to consider the evidence in this case to see whether those elements are present."

I draw particular attention to the statement of Quilliam J that the taxing statute in New Zealand does not entitle a taxpayer to create or persist in an entirely unrealistic venture and then, because it has the outward semblance of a business, to be able to assert that it is one.

I now proceed to do as Quilliam J did, namely to consider the evidence to see whether in this particular farming venture there was both the intention of making a profit and at least the reasonable prospect of doing so.

As has already been demonstrated, for each of the income years up to 31 March 1977 there had been a loss. In each of the years after 1977, namely from 1978 to 1981 inclusive, losses had also been sustained. In other words, for the whole of the period of the farming partnership losses had been incurred in every income year and not in one year had a profit resulted.

From the evidence which was tendered I am satisfied that the property which the objectors took over in 1969 was considerably run down. Portion of it was freehold and a portion was leasehold and a small island was occupied pursuant to a licence to occupy. The land was heavily infested with gorse, the pastures had deteriorated, the fencing was practically non-existent and there were difficulties in development in that adjoining a portion of the farm was a forestry area owned by Henderson & Pollard Ltd. The existence of this forest made the development of the land probably more difficult by reason of the fact that it was not possible to burn the grass and scrub without endangering the forestry area. It was necessary to spray using due care because of the nearness of vineyards and resort was also had to the more difficult method of clearance such as the use of machinery.

It is evident that at the time the objectors took over the property a small amount of dairying was carried on on the property and that for a period the objectors carried dry stock hoping in the long run to be able to establish a stud on the property. To that end their son went through a course for artificial insemination and, indeed, in 1977 I am satisfied that the objectors were taking steps to try and establish if they could a stud on the property.

Mr Grieve claims that he was beset by many problems which caused considerable difficulties and he instanced the collapse of the beef market in the 1973-4 period, droughts, the inability to borrow except on the open market with a consequent drain on finances in meeting the interest payments and the difficulties which were created by their not being able to get title for quite a considerable period to a portion of road which was to be closed.

From the photographs which were produced it is evident that the gorse infestation is extremely heavy and that clearing and eradicating the gorse would be a mammoth task, particularly having regard to the manner in which that menace so quickly and easily regenerates. The evidence produced satisfies me that the soil is of low fertility with the result that considerable manure would be required to be applied.

If one examines the farm accounts one finds that the ground rental payable in respect of the leased portion is now quite considerable and it must be a considerable drain upon the finances of the objectors. That increase did not occur until 1978, but in terms of the lease apparently was operative from 1 April 1977.

For the year ended 31 March 1974 the gross profit was $2,136 while the fixed charges in relation to interest and ground rent alone amounted to $3,218; in 1975 the gross profit was $444 while the interest and ground rent totalled $4,182; in the following year, 1976, there was no gross profit, but a gross loss of $403 with interest and ground rent totalling over $5,700. In 1977 the gross profit was $6,201 and in that year the interest, ground rent and rates totalled $5,818. In that year there was a small gross profit after payment of the fixed charges, but in that year the objectors' son received wages and that item alone totalled $2,754, once again producing a loss having regard but to those items and disregarding all the other expenses. In 1978 a gross profit was produced of $4,909 while interest, ground rent and rates exceeded $10,400. In 1979 the gross profit was $2,192 while the interest, ground rent and rates exceeded $9,400. In 1980 there was a gross profit of $6,018 while the interest, ground rent and rates exceeded $9,900, but in that year sheep were introduced so that there was some change in method of farming. In 1981 the gross profit on the sheep and cattle amounted to $4,916 while wool worth $4,247 was sold, but the interest, ground rent and rates exceeded $11,200.

I was informed by Mr Grieve that for the years ended 1978, 1979 and 1980 the partnership losses had been allowed as a deduction as against other income earned, but just why this should be so I do not know. It may well be that by reason of there having been some change in the method of farming that may have influenced the Commissioner, or it may have been an administrative error. However, I am not concerned with those particular years, but only to look at them from the point of view as to ascertaining whether or not there was a prospect of a profit being earned.

Mr Grieve maintained that he had been engaged full-time in the management of the farming operations, but accepting that, there has been no charge made for his wages and had that charge been made the actual loss would have been increased by the amount of those wages. He contended that having been engaged full-time on the farming operations he ought to be treated as being in a different position from the objector in Prosser's case because in that decision it is shown quite clearly that Prosser was engaged but part-time. However, full-time or part-time engagement to my mind is not the test. The test is, as has been laid down in the earlier cases, was there an intention to make a profit and a reasonable prospect of one being earned?

With this particular farming venture I have come to the conclusion that, having regard to the nature and quality of the land, it is impossible to come to a conclusion that there is any reasonable prospect of this land ever producing a profit if the present system of farming is continued. It may well be that a profit can be obtained from the land if it is used in a different way, but having regard to past experiences to my mind it is simply quite unreal to suggest that within the foreseeable future there is any reasonable prospect of this particular partnership making a profit from this land.

In those circumstances there is no justifiable reason for the losses of the partnership being allowed as a set off as against the other income earned by the objectors and there is no justifiable reason why the general run of taxpayer ought, in these circumstances, to in reality subsidise the objectors in what I term an unrealistic venture.

Accordingly I hold that the Commissioner was correct in disallowing the farm losses sustained by the partnership to be deducted from the objectors' incomes for the two years under consideration.

The Commissioner is entitled to costs which I fix at $500.