PETERSEN & ANOR v FC of T

Members:
A Sweidan SM

Tribunal:
Administrative Appeals Tribunal, Perth

MEDIA NEUTRAL CITATION: [2007] AATA 1896

Decision date: 26 October 2007

A Sweidan (Senior Member)

Background

1. The applicants claimed to be entitled to income tax deductions in the year ending 30 June 1999 for expenses they incurred as participants in the Banalasta Natural Oil Joint Venture Project No. 1 (JV Project), as follows: -

(a) Leake $7,966;
(b) Petersen $15,932 (in respect of 2 Participation Interests).

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Each applicant claimed that the outgoings were incurred in the payment of management fees, research fees, loan administration fees, and in the payment of interest and a loan indemnity fee. The claimed deductions were disallowed as were subsequent objections. The applicants now seek a review of the objection decisions.

2. It should be noted that the applicants did not claim deductions in relation to the JV Project in the year ending 30 June 2000, although such deductions were said to be available in the prospectus for the JV Project. In July 2000, the respondent issued a position paper in which it advised those involved in the JV Project that deductions would not be allowed.

Issues

3. The issues in these applications are:

Tribunal's decision

4. The Tribunal is of the view, for the reasons which follow, that the claimed deductions are not allowable under s 8-1 of the 1997 Act. It is accordingly not necessary for the Tribunal to consider the application of Part IVA of the 1936 Act.

Evidence

5. The following evidence is before the Tribunal: -

All of the above witnesses also gave oral evidence.

6. The Tribunal summarizes below: -

The Prospectus:

7. Banalasta Oil Plantation Limited (BOPL) issued a Prospectus dated 29 May 1998 for the JV Project.

8. The entities concerned in the JV Project were:

9. BOPL, Armidale and ANORI were all companies effectively under the control of Rolf Blickling. The Prospectus disclosed that Rolf Blickling was a director of each of BOPL, Armidale and ANORI. The ASIC historical company extract for each of the companies involved in the project, shows further that: -

10. 

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In 2000, BOPL became the single responsible entity for the JV Project.

11. The initial section of the Prospectus was headed "Introduction":-

"The offer contained in this Prospectus is an offer to apply for Participation Interests in a joint venture known as the [JV Project]. Participants share the profits and assets of the Joint Venture in proportion to the number of Participation Interests held compared with the total number issued. There will be a total of about 2,500 Participation Interests available in the Joint Venture……..

The purpose of the Joint Venture is to research and develop technical know-how, intellectual property, formulations and product development and to then Commercialise the results of that research.

Specifically, research will be carried out in the penetration abilities of Eucalyptus Oil particularly in skin care products. New products would be developed by using several of the most active and accepted herbals in combination with Eucalyptus oil. The Joint Venture will then benefit from the Research Results by developing eucalyptus oil based products for sale ……."

12. The "Introduction" further explained that: -

13. In the following section, headed "Background", it was explained that Armidale had acquired the rights to certain Core Technology. "It is the purpose of this Joint Venture Project to further research this Core Technology and develop specific products from the Research Results…. . The Joint Venture will concentrate on the development and marketing of two base products; a face and body moisturizer and a summer cream."

14. Similarly, in the next section, headed "Key Data", the purpose of the Joint Venture was stated as follows: -

"The Joint Venture will carry out Research and Development of the Core Technology to produce Research Results for the purposes of commercializing those results (the 'Joint Venture Business') comprising: -

  • a) Undertaking Research and Development in relation to the Core Technology;
  • b) purchasing or licensing necessary technology or rights for that purpose;
  • c) commercialisation of the Research Results; and
  • d) derivation of Gross Income and profits from the above activities."

15. The "Key Data" also included: -

16. 

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The next section of the Prospectus was headed "Joint Venture Business". That section, first, outlined the "Contractual Structure" as follows:-

17. The section headed "Joint Venture Business" contained a further section headed "Operational Structure" which explained:-

18. The third section under the heading "Joint Venture Business" was "Joint Venture Income". Here it was explained that the Joint Venture would be entitled to the income from all sales of the products, to be paid to ARG as trustee.

19. This section contained income projections based on achieving a market share of 0.67% for the face and body moisturizer and 0.3% for the summer cream at full production and projected wholesale prices for those products. It was, further, explained here: "The Manager anticipates that Research and Development will be conducted over the first two years and production will commence toward the end of year 2." As a result, product sales and income were projected from year 3. All projections were based solely on the production and sale of the two specified products.

20. The income projections were supported by a market report dated 16 May 1996 by Dr Caspar Sieger of Pharma Service. The report indicated its purpose as "to provide an overview of the market for the products that the Joint Venture Project intends to develop" and referred to the commercialisation plan "to develop specific products on the base of Eucalyptus radiata oils". It explained that the two products to be developed were a day and night all purpose face and body cream (moisturizer) and a summer cream (sun care product). In respect of the former, it was observed: "The Joint Venture product, once the formula is identified, may take the form of a

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cream, gel, oil, foam and/or lotion to cater to a range of markets."

21. The final section under the heading "Joint Venture Business" contained a "Forecast of Expenditure" for fees contributed by participants for each of years 1 and 2, showing budgeted percentages of those contributions against expenditure items in the Research and Development Budget and the Marketing and Management Budget.

22. Under "Finance Options" the Prospectus offered finance to participants through a company associated with the manager, Plantation Equity. It is not necessary to consider issues relating to the financing arrangements in any detail here except to say that the terms of the loans were on a "limited recourse" basis and that they were effected by "round robins" of bills of exchange and book entries so that no funds were actually made available in cash, apart from those amounts paid by the participants.

23. Under the heading "Possible Tax Implications" the Prospectus included a table detailing the tax/cash position of a participant taxed at the highest marginal rate of 48.5% at the end of each of 30 June 1998 and 30 June 1999. According to the tables, as a result of deductible items available in each year, such a participant's net position at 30 June, 1999, would be +$958. An Independent Tax Expert's Report followed. (at V1/135ff).

24. There followed a summary of the Investment Deed, the Joint Venture Agreement and an Application Form and Power of Attorney.

First supplementary Prospectus

25. On 22 March 1999 BOPL issued a first supplementary Prospectus amending the date to which applications for interests would be accepted from 28 May 1999 to 30 June 1999.

Applications for JV Project

26. An applicant applied to participate in the Project: -

27. The agreements governing the applicants' participation in the JV Project were:-

28. It is only necessary to consider here the Investment Deed and the Joint Venture Agreement. The terms of those agreements are, relevantly, set out below.

The Investment Deed

29. A copy of the Investment Deed is in the Supplementary s37 documents at S1. The Prospectus did not include a copy of the Investment Deed, but summarised its key terms as follows.

30. The parties to the Investment Deed were:

31. The deed provided for matters including:

The Joint Venture Agreement

32. The Joint Venture Agreement was between: -

Separate Joint Venture Agreements were executed for individual Participants under power of attorney.

33. Relevantly terms defined in the Joint Venture Agreement were as follows (all in clause 1.1.

34. Clause 2 provided for the formation of the Joint Venture for a term of 10 years (clause 2.4 ). In particular, it provided:

35. Clause 3 (at 181-182) provided for the grant by Armidale to the Joint Venture Participants of a non-exclusive licence to use the Core Technology throughout the world for the term of the Joint Venture Agreement. It included:

36. By clause 4 (at 182-183), the Joint Venture Participant appointed BOPL manager of "the Joint Venture and the Project" (clause 4.1). BOPL was appointed to do all things as may be necessary to carry out the project on behalf of the Joint Venture, subject to the proviso that it could not pledge the credit of the Joint Venture Participant or incur any liability on behalf of a Joint Venture Participant in excess of the proportion of the Joint Venture Participant's interest in the Joint Venture (clause 4.2).

37. By clause 4.3, BOPL agreed with the JV Participant and the Joint Venture to perform the Management Services and do all things necessary or incidental thereto, including:

The Management Services were defined in clause 1.1 as the services BOPL was to provide for the Joint Venture with respect to the Joint Venture under the Investment Deed and the Joint Venture Agreement, including the services in clauses 4 and 7 of the Agreement.

38. BOPL was also required, to arrange the carrying out of Research and Development. It could engage a researcher (clause 5.1). In

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setting out BOPL's obligations, clause 5.2 referred in particular, to:

39. Clause 5 further dealt with the preparation of research budgets and programs (clause 5.3), provision of necessary resources and personnel (clause 5.5), and keeping of separate records and accounts "sufficient to enable a complete understanding of all payments made and all incomes received and all steps taken in the Project" (clause 5.6). During the first 2 years, the Manager was required to report 6 monthly to the Joint Venture Participants on work performed with respect to Research and Development, any research results arising therefrom and any intended future Commercialisation of those results (clauses 5.13 and 5.14).

40. By clause 5.15 and 5.16, BOPL was appointed to carry out the Commercialisation of the Research Results on behalf of the Joint Venture, with a view to producing sustainable profits for the term of the Joint Venture.

41. Clause 5.17 specifically provided that BOPL gave no warranty that there would be any Research Results, or that they could be successfully Commercialised.

42. By clause 6, BOPL was to receive Manager's Remuneration under the agreement:

43. BOPL was to receive Research Fees in the first 2 years of the Joint Venture, in consideration of carrying out the Research and Development. The Research Fees were payable by the Joint Venture Participant as follows:

44. Further provision for expenses was made in clauses 6.5 to 6.7 as follows:

45. The Net Income of the Joint Venture in each year (being Gross Commercialisation Income after deduction of Annual Management Fees and other amounts provided for by the Investment Deed: definition clause 1.1) was to be shared between the Joint Venture Participants in proportion to their participations (clause 7).

46. Clause 8 of the Agreement, dealing with Administrative and Financial Matters, included the obligation on BOPL to: -

The participation of the applicants

47. Each applicant's evidence is directed to the following: -

48. In respect of their entry into the JV Project, the applicants' evidence is as follows:

  Leake Petersen
  Dated 12 May 1999 Dated 30 June 1999
Application Form and Power of Attorney [16] - no copy retained Annexure CIP10 (2 participations)
Joint Venture Agreement (executed under the power of attorney) Annexure JNKL7 Annexure CIP11
Loan Application Form and Power of Attorney Annexure JNKL8 Annexure CIP9
Loan Deed Annexure JNKL8 Annexure CIP9
Loan Deed - Interest Borrowing Annexure JNKL8 Annexure CIP9

49. For the year ended 30 June, 1999, each applicant claimed a deduction of $7,966 for each interest they held (a total of $15,932 in the case of Petersen who applied for 2 participation interests). Each applicant also claimed a deduction of $7,966 per interest in his or her notice of objection. That deduction was made up as follows: -

Fee Amount Agreement Source of funds
Management fees (including Annual IP Licence fee of $300)1 $3,500 Joint Venture Agreement Borrowed from Plantation Equity
Research and Development fees $3,000 Joint Venture Agreement Borrowed from Plantation Equity
Indemnity fee $813 Indemnity Agreement with Armidale Borrowed from Plantation Equity, repayable by 30/09/99
Interest $553 Loan Agreement with Plantation Equity Borrowed from Armidale, repayable by 31/10/99
Loan application fee $100 Loan Agreement with Plantation Equity Paid in cash with application

Notices of Objection Petersen T10 at 32, Leake T8 at 28

50. The applicants' evidence as to cash payments they made is as follows: -

51. The applicants did not claim deductions for the year ended 30 June, 2000. In July 2000, the respondent issued a position paper on the Joint Venture Project, to the effect that deductions claimed for investment in the project would be disallowed: BOPL informed investors of the ATO position by its July 2000 newsletter.

Applicants' contentions

Section 8-1 of the 1997 Act

52. The applicants asserted that their purpose in investing in the Project was to carry on a business of researching, developing and improving health products to be sold on the world market by utilising the Core Technology. The applicants also said that they elected to appoint the Manager as their manager to undertake their business to derive assessable income there from. The Manager was employed as an independent contractor to the applicants and Joint Venture and was remunerated for its services to the applicants and Joint Venture. It asserted that the applicants were not investing in the Manager's business.

53. It was also asserted that pursuant to the Joint Venture Agreement, the applicants had clearly incurred the obligation to make the payment of the relevant fees, such as the management fees in the amount of $3,500.00 per participation and research fees in the amount of $3,000.00 per participation on or before 30 June 1999 for the purposes of carrying on their business, and that the evidence supports the view that the applicants had at 30 June 1999 commenced to carry on a business via the Manager.

54. The applicants pointed out that by clauses 4.3 and 4.4 of the Joint Venture Agreement, the Manager was to perform its duties on behalf of the Participants, including the applicants, exercising reasonable care and in a professional manner. Moreover, if the Participants including the applicants were not satisfied with the Manager's or the Trustee's performance, by clauses 11.1 of the Joint Venture Agreement and clauses 16 and 17 of the Investment Deed the Participants including the applicants were empowered to terminate the Agreement and remove the Manager and Trustee. The Participants including the applicants also had the power to appoint another manager or trustee (see clauses 13 and 16 of the Investment Deed). The Manager and Trustee were obligated to conduct the Joint Venture in the best interests of the Participants.

55. The applicants contended that the fees paid by the applicants were incurred in the gaining or production of assessable income, or necessarily incurred in carrying on a business for the purpose of gaining income. The expenditure incurred was claimed to be incidental to and relevant to the income to be derived from the Project. The income in this case was so it was claimed to be derived from the sale of cosmetic products, being a moisturizer and/or sun cream, or derived from the sub-licensing of the rights to Core Technology and improvements thereon.

56. In characterising the applicants' payment of the relevant fees in the 1999 year it is necessary to identify what the expenditure was for (
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation 80 ATC 4542; (1980) 33 ALR 213). Upon a consideration of the evidence and agreements the applicants contended that the expenditure was incurred to retain a Manager to conduct the day to day operations of the applicants' business to sell, research, develop and improve the health products or to sell the rights to the improvements on the Core Technology.

57. The applicants relied on authority that expenditure incurred on management fees, marketing fees and annual license fees is revenue in nature rather than capital where the taxpayer is carrying on a business and has employed a manager (over which the investor had control) or has incurred the relevant fees in the course of deriving assessable income (see
Sleight v Commissioner of Taxation 2004 ATC 4477; (2004) 136 FCR 211,
Commissioner of Taxation v Cooke 2004 ATC 4268; (2004) 55 ATR 183,
Commissioner of Taxation v Lau 84 ATC 4618; (1984) 6 FCR 202 at 221 per Beaumont J,
Commissioner of Taxation v Emmakell Pty Ltd 90 ATC 4319; (1990) 22 FCR 157

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,
Puzey v Commissioner of Taxation 2002 ATC 4853; (2002) 50 ATR 595; (2003) 53 ATR 614,
Commissioner of Taxation v Brand 95 ATC 4633; (1995) 31 ATR 326,
Commissioner of Taxation v Walker (1984) 84 ATC 4553,
Australian Trade Commission v Disktravel [1999] FCA 1399,
Madison Pacific Property Management and Ors v Australian Securities Commissioner 30 ACSR 218,
Merchant v Commissioner of Taxation 99 ATC 4221).

58. It was contended by the applicants that the facts of this case can be distinguished from the facts in
Softwood Pulp and Paper Ltd v Federal Commissioner of Taxation 76 ATC 4439. They claimed that the Agreements in this case demonstrate that the applicants had committed themselves to the Project and to the expenditure incurred and to the activities necessary to produce assessable income. The element of commitment to the activities to generate income and the Project was said to be not lacking in this case. They asserted that they were not undertaking feasibility studies to determine whether the activities of research and development would provide a commercial outcome and that the applicants' expenditure can be said to be, in the words of Menzies J in
John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1956) 11 ATD 510, "part of the costs of trading operations".

59. The applicants argued that the facts of this case can be distinguished from the facts in
Goodman Fielder Wattie Ltd v Federal Commissioner of Taxation 91 ATC 4438. The applicants contended that they not engaging in activities of a provisional kind and the activities committed to by the applicants and the Joint Venture were not dependant nor reliant on the outcome of the research and development, like the taxpayer in Goodman. The Joint Venture had the legal right to use the Core Technology to either generate products or to use to improve products which it was claimed were capable of being sold at the time that the applicants committed themselves to the activities to generate the income of the Project.

60. Applicants contended that irrespective of the outcomes of the research and development of the Core Technology there was something for the applicants and the Joint Venture to commercialise to generate income. The applicants and the Joint Venture had the right to sub-license the Core Technology and any improvements thereon (if any) at the date of commencement of the Project.

61. The applicants claimed that unlike in
Howland Rose and ors v Commissioner of Taxation 2002 ATC 4200; 49 ATR 206, the commercialisation of the Core Technology was capable of beginning at the commencement of the Project and not only following a successful research and development phase leading to a feasible manufacturing process. They said that the expenditure was not removed from the activities which were capable of deriving assessable income and was not directed to the establishment of the commercial viability of the venture. In Howland Rose, research and development was an essential step in the derivation of income. There was a real risk in that case that the research and development would be a barrier to the ability of the taxpayer in that case from earning any income. It was asserted that unlike in Howland Rose the facts of this case demonstrate that the applicants and Joint Venture had always been capable of carrying on the business activities.

62. Further the applicants contended that this is not a case where the development being undertaken by the taxpayer can not be attributable to an existing and identifiable business of the taxpayer. They said that this was not an entirely new project which might at some time be an income producing venture (cf
AAT Case 4595 19 ATR 3847 at 3853-49 and 2854-28). The Core Technology which was central to the Project was not so it was claimed such that it was a novel and scientifically challenging prospect, like it was in the Goodman case. The evidence of Sieger they claimed confirmed that the Core Technology was already in existence, had been previously researched and did not involve procedures or activities which were capable of being protected by a patent. They said that this is a significant and relevant distinction to the "typical" research and development ventures undertaken (see bottom of page 3 of prospectus).

63. According to the applicants to the extent that the applicants' subjective purpose is relevant to the characterisation of these outgoings (
Fletcher v Federal Commissioner of Taxation 91 ATC 4950; (1991) 173 CLR 1), it

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does not differ from this purpose. They asserted that this is not a case where it can be said objectively that at the time of the investment there was no prospect of obtaining a sum of assessable income greater than the outgoings (see forecast projections in the Prospectus). Nor they claimed is this a case where it can be said that at the time of the outlay it was not expected that the Project would run its course. They argued that the evidence demonstrates that it was reasonable for the applicants to expect that they would earn assessable income for the duration of the Project.

64. The applicants further contended that if the Tribunal does not conclude that the applicants were carrying on a business, then the expenditure incurred by the applicants on the Project is deductible under the first limb of section 8-1 of the 1997 Act, being necessarily incurred in gaining or producing assessable income.

65. The applicants relied on the decision in
Commissioner of Taxation v Brand 95 ATC 4633; (1995) 31 ATR 326 which determined that expenditure incurred can be deductible under section 8-1 of the 1997 Act despite the fact that the participant is not carrying on a business. The case of
Commissioner of Taxation v Emmakell Pty Ltd 90 ATC 4319; (1990) 22 FCR 157 was also advanced as authority for this view.

66. They submitted that by virtue of the execution of the Agreements, there is a clear connection between the expenditure incurred by the applicants under the agreements and the gaining of assessable income by the applicants from or in connection with the Project. This submission they claim is supported by
Merchant v Commissioner of Taxation 99 ATC 4221 where Nicholson J confirmed that rent and management fees were incurred upon execution of those agreements. Accordingly, the applicant was definitely committed to incurring the expenditure in the year of income. In paragraph 62 His Honour stated:

"The occasion of the payment of the liabilities is therefore to be found in what would be expected to produce assessable income. In my opinion it follows there was "sufficient connection" between the occasion of the liabilities and the operations expected to be productive of assessable income".

67. They also claimed that the majority in the Full Federal Court decision in
Madison Pacific Property Management and Ors v Australian Securities Commissioner 30 ACSR 218 adopted the same view that, in the absence of a sham, the legal documentation must be relied upon in order to determine the rights and obligations of the parties.

68. The applicants argued that the Merchant and Madison Pacific decisions indicate that in determining whether there is a sufficient connection between incurring expenditure and the future production of assessable income, the respondent must consider the rights and obligations of the parties involved and the capacity to identify the services rendered by any party as detailed in the legal documentation involved in a project. They said that in the absence of strong evidence to the contrary, the respondent ought to acknowledge that an investor's expenditure is sufficiently connected to the future production of assessable income for it to be deductible under the "first limb" where there exists a properly executed and legally binding agreements and a sound commercial reason for entering into those agreements.

69. The applicants claimed that the existence of the required nexus between the outlays and the gaining of income is confirmed by the Prospectus and the Project Agreements. It was said that there was a reasonable basis to expect to derive income from their participation in the Project.

70. Further it was argued that the fact that the applicants prepaid fees for management services as a lump sum in advance is not sufficient to displace the presumption that monies outlaid in return for recurrent services which are provided periodically are paid on revenue account (
Commissioner of Taxation v Lau 84 ATC 4618; (1984) 6 FCR 202). Upon the execution of the Agreements the Applicants became liable to pay a management fee for the performance of the management services (Merchant).

71. The applicants asserted that the prepayment of the fees by the applicants during each year of the Project does not alter the nature of the benefit provided in consideration for

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these prepayments which is recurrent and periodic in nature. These prepayments, they said, are directed towards the process of operating the Applicants' activities and they are therefore revenue and not capital in nature.

72. Unlike in Clowes and Milne the Participants including the applicants appointed a manager to undertake their business to derive assessable income there from over a 10 year period, as opposed to the applicants participating by investing a sum of money on the expectation of a capital increment at the conclusion of the Project. Furthermore, the applicants and all other Participants had the power to terminate the manager's services, unlike in Clowes and Milne.

73. Applicants pointed out that In Puzey on appeal, Hill and Carr J at [58] concluded that "there is no doubt that a contractual payment to a manager to manage such a scheme [managed investment scheme] would be deductible" notwithstanding that the taxpayer in Puzey was found not to be carrying on a business due to the restructuring of the scheme imposed by the Australian Securities and Investment Commission and the establishment of a trust to operate the business. Unlike in Puzey the participants of the Project including the applicants were not unit holders in a unit trust entitled to a share of the profits (if any) of the trust. The trust in that case being the entity which was carrying on the activities of the project, engaging the manager and undertaking the sale of the harvested produce. The structure of this Project involves each Participant including the applicants carrying on a joint venture business, engaging a manager and trustee to undertake activities on their behalf in order to research, develop and improve health products to sell on the world market.

74. It was asserted that the facts in the case of
Vincent v Federal Commissioner of Taxation 2002 ATC 4742; [2002] FCAFC 291 are dissimilar to the facts of this case. Neither in form nor in substance did the applicants acquire a capital asset in connection with the payment of the relevant fees. In both form and substance the Applicant sought and obtained the relevant services, such as management and marketing services, in relation to the research, development, improvement and sale of health products for a period of 10 years. Like the management fee in Lau, Brand, Merchant, Puzey, Sleight, Cooke and Emmakell the fees in this case were claimed to be revenue in nature for a service period of 12 months. No enduring benefit would have been obtained by the applicant in relation to the payment of the relevant fees (cf with
Sun Newspapers Ltd and Associated Newspapers Ltd v Commissioner of Taxation (1938) 61 CLR 337).

75. Further, it was said that the research and development activities undertaken by the applicants and the Joint Venture were not removed from the day to day obligations and necessary activities to derive the income and it cannot be said that a significant or permanent asset was created. The research and development was envisaged to improve and expand "the products" to ensure that it was well positioned to be a front runner in the world cosmetics market.

76. There was also argument as to whether the JV Project offered a commercial return based on the income projections contained in the Prospectus. The Tribunal does not find it necessary to determine that issue having regard to the Tribunal's findings as set out below.

77. Finally, the applicants argued that the amount of $553.00 per participation being prepaid interest paid by the applicants is deductible under section 8-1 of the 1997 Act as it was necessarily incurred in the course of earning income, or necessarily incurred in carrying on a business (
Steele v Deputy Commissioner of Taxation 99 ATC 4242; (1999) 197 CLR 459, Sleight, Cooke).

Evidence

Affidavit of Caspar Sieger made 9 February 2006 (Sieger's affidavit) and oral evidence

78. Dr Sieger purports to comment on the reasonableness of: -

79. In the Tribunal's view Dr Sieger's evidence carries very little weight. He was an integral part of the development and conduct of the JV Project and, at the time he made the Independent Market Report, entitled to receive significant payments calculated according to the number of Participant Interests sold: -

80. Quite apart from his obvious lack of independence, Dr Sieger's opinions are of little or no use to the Tribunal. First, the affidavit and report do not disclose the facts on which the opinions expressed are based. At paragraph [5], he says that he has been provided only with a copy of the Prospectus. He says that he has made all enquiries which he believes to be desirable and appropriate, but does not identify those inquiries, or any other documents or facts on which his opinions are based. Sieger's knowledge obviously extends beyond the document he deposes to being given, because of his extensive involvement with the JV Project. Without a proved factual basis, the opinions Sieger expresses on the three questions on which he was asked to comment can have little weight.

81. Second, facts have been assumed by Sieger which are, in any event, inconsistent with documents otherwise before the Tribunal. For example,

82. Further, the opinions themselves are so general that they are useless. For example: -

83. In the result, as the agreements at RPB 3 and RPB4, show, at the time of the Marketing Report, the ingredients of the products to be developed had not yet been decided. Dr Sieger purports to comment upon an assumed retail price and wholesale price (see Prospectus at T103, page 151; and report attached to Sieger's affidavit at 3) for a product which had not yet

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been formulated and in respect of which costs of manufacture and marketing had not yet been considered. As Dr Sieger said in cross-examination, his opinion was based only on his conviction that a quality product can be successful worldwide without even a product upon which to form any judgment. As the evidence shows, his conviction had no foundation as far as the summer cream was concerned. It was rejected because eucalyptus oil was not suitable for this type of product (see Banalasta newsletter at CIP 22, at 174).

Witness statement of Martin Langridge dated 8 September, 2006 with report

84. In addition to his comments on Mr Simpson's evidence (to which no further reference need be made here), Mr Langridge reports on: -

Mr Langridge's evidence as to the above matters is uncontested.

85. In particular, Mr Langridge has analysed the available financial records of the Project entities and comments on matters including:

86. Mr Langridge further notes the accounting treatment of the acquisition by entities associated with the JV Project of 245 participation interests in the year ended 30 June 1998, which were cancelled on 29 June 1999 - see at 35-37).

87. For the year ended 30 June 1999 (the year in which each applicant invested in the Project) Mr Langridge notes:

88. The cash flow of the Project shows:

89. Based on the Prospectus and the Joint Venture Agreement, Research and Development fees of $3,000 for each Participation Interest were payable for each of the first 2 years. The total Research and Development fees payable for 4,852 Participation Interests purchased in 1998 and 1999 is $29,112,000, (Table 25 at 57). Table 26, at page 58, shows, however, that in the accounts of ANORI to 30 April 2000, only $3,650,000 is recorded as Research Fees. Expenditure recorded on research and development is $3,991,932 which includes:

90. That is, the accounts examined by Mr Langridge demonstrate that while the purpose of the JV Project was to research and develop technical know how and commercialise the results of that research, only a small part of cash flow (about $750 for each Participation Interest, compared with $6,000 provided for in the agreements) was directed to ANORI as research and development fees.

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Evidence of the applicants

91. Mrs Petersen testified that:

92. Mr Leake testified that:

Summary of Tribunal's findings

93. The Tribunal is of the view for the reasons which follow that the applicants' claimed deductions are not allowable under

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section 8-1. Similarly to the position in
Howland-Rose & Ors v FCT 2002 ATC 4200; (2002) 118 FCR 61 at 102 the JV project agreements show:-

  • "(a) [T]he contractual quid pro quo for each Applicant's expenditure was in substance and reality the undertaking of research and expenditure [sic] which would not necessarily lead to any assessable income ever being derived from products which might subsequently be manufactured upon the basis of the results therefrom. Whilst it may be said that a successful outcome to the undertaking of the research and expenditure may well have led ultimately to the viable manufacture and sale of … products … based upon or arising out of the same, it would not be conceptually correct to categorise such consequences as the contractual quid pro quo for what was in truth research and development expenditure."

94. Hence, the applicants' claimed deductions were in respect of fees which were specifically referable to research and development activities to be conducted over the first two years of their participation. Any commercial activities were to commence only in year 3, in respect of which further fees were payable.

95. In the alternative the Tribunal finds that each applicant's claimed deductions were outgoings of capital or of a capital nature because the applicants entered into a joint venture and the outgoings were incurred in respect of the acquisition of each applicant's interest in the business of the joint venture. There is no basis in the project documents for concluding that the applicants were, in any way, in business on their own account.

96. The Tribunal further finds on the evidence as a whole that in any event on the application of the principles set out in
Fletcher v Commissioner of Taxation 91 ATC 4950; (1991) 173 CLR 1, the gaining of assessable income was not the advantage that the outgoings sought to achieve.

Section 8-1

97. Section 8-1 of the Income Tax Assessment Act 1997 provides:

  • "(1) You can deduct from your assessable income any loss or outgoing to the extent that:
    • (a) it is incurred in gaining or producing your assessable income; or
    • (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
  • (2) However, you cannot deduct a loss or outgoing under this section to the extent that:
    • (a) it is a loss or outgoing of capital, or of a capital nature; or
    • (b) it is a loss or outgoing of a private or domestic nature; or
    • (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or
    • (d) a provision of this Act prevents you from deducting it."

98. Section 8-1 is not materially different from section 51(1) of the Income Tax Assessment Act 1936, and the principles governing the application of both sections are the same:
Federal Commissioner of Taxation v Citylink Melbourne Ltd 2006 ATC 4404; (2006) 228 ALR 301 at 331[90]; Income Tax Assessment Act 1997, section 1-3.

The applicants' claimed deductions were incurred for research and development and not in the gaining or producing of assessable income, in carrying on a business or otherwise

99. The Tribunal's primary finding is that the applicants' claimed deductions were incurred for research and development and not in the gaining or producing of assessable income, in carrying on a business or otherwise. In the Tribunal's opinion the evidence supports findings as follows.

100. First, the Prospectus and the Joint Venture Agreement clearly contemplated: -

Without successful research and the production of Research Results, there could be no Commercialisation, as it was the Research

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Results which were to be Commercialised. The expenditure claimed by the applicants was, thus incurred as a prelude to business. The contemplated research and development activities, in respect of which the expenditure claimed by the applicants was incurred, would not produce assessable income. That was hoped for only from the third year of the JV Project when products might be available for sale.

101. Second, no Research Results were guaranteed. See Joint Venture Agreement, clause 5.17 and Prospectus.

102. Third, the JV Project as established by the Joint Venture Agreement is in respect of research for the development of products. There is nothing in the language of the Joint Venture Agreement or the Prospectus or any other evidence to suggest the existence of products as at the time those documents were made or at the time the applicants entered into the Joint Venture Agreement. In particular, neither the Joint Venture Agreement nor the Prospectus offered any rights to use, market or distribute any existing products. Rights given to the Joint Venture were limited to the further development and exploitation of the Core Technology (Joint Venture Agreement, clause 3.3). See also Joint Venture Updates referring to "long awaiting products" and their subsequent launch.

103. Further in this respect, Gross Commercialisation Income was to be derived only from exploitation of any Research Results. Research Results could be derived only by the conduct of Research and Development activities with respect to the Core Technology. Accordingly, participants in the JV Project acquired no rights to income earned from the sale of eucalyptus oil produced by the First Project or by products developed by activities not related to the Core Technology. See Joint Venture Agreement, clause 1.1, definitions and clause 7.

104. The above findings in the Tribunal's view warrant the same conclusion here as that reached by Conti, J. in Howland-Rose set out above. Comparison of the project documents in Howland-Rose and the JV Project documents shows the language and structure of the JV Project documents to be substantially similar to the language of the documents which provided the basis for Conti, J.'s conclusion. In the Tribunal's opinion the language of the JV Project documents clearly supports that conclusion. The Tribunal notes the Court's further specific findings in Howland-Rose as follows: -

105. The evidence of Mr Langridge shows that on any view, the prepaid interest of $553 was never incurred. The lender, Plantation Equity never made the loan for such interest. Accordingly, the applicants were never provided with the means by which they could honour their obligation to pay interest. See
Vincent v Commissioner of Taxation [2002] ATC 4490 (at first instance) at [106]-[107] and the report of Mr Langridge cf 16 and 50 where he reports that:-

Each applicant was a passive investor and the project outgoings were capital outgoings

106. The Tribunal finds in the alternative that if the Management Fee and Research and Development Fees were outgoings incurred in gaining or producing assessable income, they were outgoings of capital or of a capital nature and were, as such, not deductible.

107. The Joint Venture participants did not themselves carry on a business of Research and Development of the Core Technology and Commercialisation of the Research Results. Although styled Management Fees and Research and Development Fees, the applicant's outgoings represented in the Tribunal's opinion nothing more than their capital contribution to the business of the Joint Venture.

108. The fact that the outgoings were called Management Fees and Research and Development Fees, does not determine the proper characterisation of the payments. What the parties call a payment may have some relevance, depending on the circumstances of the case, but is not determinative:
Vincent v Commissioner of Taxation 2002 ATC 4490; (2002) 124 FCR 350, at [62]-[67];
Commissioner of Taxation v Broken Hill Pty Company Ltd 2000 ATC 4659; (2000) 179 ALR 593 at [36];
Radaich v Smith (1959) 101 CLR 209;
Commissioner of Taxation v Krakos Investments Pty Ltd 96 ATC 4063; (1995) 61 FCR 489 at 495-6.

109. Whether or not the labels are accurate, the issue is whether, properly characterized, the amounts are on capital or revenue account. The characterisation of an outgoing as capital or revenue "depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any,

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secured, employed or exhausted in the process":
Hallstroms Pty Ltd v FCT (1947) 72 CLR 634 at 648;
Cliffs International Inc v FCT 79 ATC 4059; (1979) 142 CLR 410;
FCT v South Australian Battery Makers Pty Ltd 78 ATC 4412; (1978) 140 CLR 645 at 655, 657, 659, 660, 662.

110. The Tribunal is of the view that from a practical and business point of view, as the Joint Venture Agreement makes clear, each applicant's outgoings were for the purchase of a right to share in the proceeds of a joint venture business conducted by BOPL for the joint venture as a whole:-

111. Consistently with the Joint Venture Agreement: -

112. In substance therefore, the Tribunal finds that amounts styled Management Fees and Research and Development Fees constituted each individual participant's contribution to the funds available to the Manager for the conduct of the Joint Venture. The advantage secured for the participants was the obtaining of a right to a share in the distribution of the gross income of the Joint Venture. The sums paid by participants were the cost to them of obtaining that interest, and were in the Tribunal's view outgoings of capital or of a capital nature.

113. Looked at from an alternative point of view, the Tribunal finds no business of an individual participant beyond the business of the joint venture as a whole. This is in contrast with
Puzey v Commissioner of Taxation 2003 ATC 4782; (2003) 131 FCR 244 and
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 (which, in turn, relied upon principles expressed in
Commissioner of Taxation v Lau 84 ATC 4618; (1984) 6 FCR 202 and
Commissioner of Taxation v Emmakell 90 ATC 4319; (1990) 22 FCR 157). In those cases, the Court, relying on the reasoning in
Commissioner of Taxation v

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Lau 84 ATC 4618; (1984) 6 FCR 202, found a business of the investor, growing and harvesting tree products. That business was a distinct business of the investor because the investor was granted a specific area of land and so an identifiable interest in specific trees. See
Commissioner of Taxation v Sleight per Hill, J. (with whom Hely, J. agreed) at [51]-[61] and per Carr, J. at [164]-[188];
Puzey v Commissioner of Taxation at [51]-[54]; and see Lee, J. at first instance,
Puzey v Commissioner of Taxation 2002 ATC 4853; (2002) 194 ALR 615 at [51]-[54]. The applicants can point to nothing like their own "identifiable trees on an identifiable plot". No part of the joint venture business can be identified with any of its individual participants. The only obligation of BOPL as Manager is to conduct the business of the joint venture as a whole and the only right of individual participants is to a proportionate share of the Joint Venture's expenses and income.

114. Conceptually, the businesses found in Puzey and Sleight are quite different from any business which might be found here. As Hill and Carr, JJ. pointed out in
Puzey v Commissioner of Taxation at [50]: "It is not possible to argue from the decision in a particular case that a person is carrying on business unless there is a complete identity of facts and that is seldom the case." And see
Commissioner of Taxation v Sleight at [51], per Hill, J. (with whom Healy, J. agreed).

115. If the so-called Management Fees and Research and Development Fees are capital outgoings as found by the Tribunal it follows that the loan application fee, indemnity fee and interest are also capital expenses, being incurred in connection with the acquisition of a capital sum obtained by way of loan.

Each applicant incurred the claimed deductions for the purpose of obtaining the tax deductions which facilitated his or her investment in the JV Project

116. The Tribunal further finds that each applicant incurred the claimed deductions for the purpose of obtaining the tax deductions which facilitated his or her investment in the JV Project. The question whether an outgoing is wholly or partly incurred in gaining or producing assessable income is one of characterisation by reference to the advantage the outgoing seeks to achieve. The relationship between the outgoing and assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. The outgoing must be incidental and relevant to gaining or producing assessable income. Put another way, the production of assessable income must be the occasion of the outgoing:
Amalgamated Zinc (de Bavay's) Ltd v FCT (1935) 54 CLR 295 at 309 and
Ronpibon Tin NL v FCT (1949) 78 CLR 47.

117. Here, having regard to the principles set out in
Fletcher v Commissioner of Taxation 91 ATC 4950; (1991) 173 CLR 1, at 17-19 and
Ure v Commissioner of Taxation 81 ATC 4100; (1981) 34 ALR 237 at 241, 248-250, the Tribunal finds that the claimed deductions were primarily incurred by the applicants for the purpose of obtaining the tax deductions offered by the JV Project in relation to their investment.

118. In Fletcher, at 18 - 19, the Court said:

"The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterisation of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. Where that is so, it is a "commonsense" or "practical" weighing of all the factors which must provide the ultimate answer. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterised as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s51(1) unless it is either somehow excluded by the exception of "outgoings of capital, or of a capital, private or domestic nature" or "incurred in relation to the gaining or production of exempt income".

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If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterised by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary."

119. The Tribunal is of the opinion that the occasion of the outgoings incurred in the first two years of the JV Project is to be explained by reference to the independent pursuit by each applicant of a tax advantage.

120. The Prospectus advised that production of any product for sale was only expected towards the end of the second year. No income was projected for the first two years of the Project.

121. The only evidence of "income" derived by any of the applicants from the project after the first two years is as follows:

  1999 2000 2001 2002 2003
Petersen   $0.00   $43.28 $4.18
Leake   $0.00 $16.13 $21.64  
           

These amounts were credited to Management Fees and interest, resulting in no distribution to any of the applicants.

122. It is clear that the applicants could expect little in the way of income because:-

123. By contrast, the Prospectus offered tax savings as a result of participation in the JV Project which more than covered initial cash outlays. In each applicant's case, the projected net cash benefit was as follows:

  Petersen Leake
Total cash contribution to 30/6/01 $11,650 $5,825
     
Total projected tax savings to 30/6/01 $11,650.00 $5,825.00 or $5,825.00
Total projected net cash benefit $3,061.14 362.35 or $255.61

124. As Mr Langridge concludes (at page 85) of his report:

"… the overall financial impact of the investment in the Project would have been positive if deductions were claimed by the Applicants in each year. I therefore conclude that for each of these scenarios, on an after tax basis, the investment would have yielded a net benefit to the investor irrespective of the performance of the Project."

125. The terms of the loans, and the tax savings, meant that the applicants could enter the JV Project with little if any risk of being out of pocket if the projected tax savings were in

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fact available. The Tribunal finds that the projected tax savings were what the outgoings were really for notwithstanding the applicants' protestations to the contrary. As they demonstrated in cross-examination, the applicants apparently had little regard to:

the payments required of them. It can hardly be said that the applicants were concerned with making income from the project. Because they did not expect to be out of pocket in relation to their investments, they were in the Tribunal's view not genuinely concerned with making a return at all. Their assertions to the contrary are not accepted by the Tribunal particularly when the JV Project structure permitted the applicants' participation without risk of loss. As both indicated in cross-examination, they were concerned with the risk of losing money on the investment. Mrs Petersen was concerned with the precise nature of the loan indemnity. Mr Leake, by his affidavit, was conscious of the protection offered him by the terms of the loan which he was able to clearly articulate. It is, therefore not accepted by the Tribunal that the tax savings, which similarly protected the applicants from loss were not similarly understood and relied upon by them, notwithstanding their claims to the contrary.

126. In the circumstances, on a commonsense or practical weighing of all the factors, the Tribunal finds that the applicant's outgoings were only colourably incurred in gaining or producing assessable income. In the Tribunal's view those outgoings are not explained by the claimed commercial advantages of participation in the JV Project, but rather by reference to pursuit of the tax advantages offered by the Prospectus.

127. There is no basis for allowing the claimed deductions as the applicants' shares in a net loss of the joint venture. The applicants' objections claimed the outgoings as outgoings of their own businesses. Their claimed deductions are based on their own outgoings and not any net loss of the joint venture as a whole or its distribution to them, of which there is no evidence whatsoever.

128. After the hearing the applicants' solicitors drew the Tribunal's attention to the recent decision of French J in
Lenzo v Commissioner of Taxation 2007 ATC 5016; (2007) FCA 1402 which they asserted is relevant to this matter. In the Tribunal's view the facts of that case are very different to the facts here and the decision in Lenzo has no relevance to this case.

Penalties

129. Finally there remains the question of penalties by way of additional tax. The respondent at the conclusion of the hearing submitted that the precise application of the additional tax provisions in Part VII of the Income Tax Assessment Act 1936 is a matter which depends on the Tribunal's findings of fact in its reasons for decision. The respondent proposed that further submissions on the issue of penalties be made after the delivering of the Tribunal's reasons. The parties will be afforded an opportunity to make submissions in that regard.

Decision

130. The Tribunal affirms the decision under review save in relation to additional tax in respect of which the Tribunal reserves it's decision pending further submissions by the parties.

 

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