Case K35

Members: MB Hogan Ch
P Gerber M

GW Beck M

Tribunal:
No. 3 Board of Review

Decision date: 21 June 1978.

Dr. G.W. Beck (Member):

References B. 113-117/1977

I shall designate the participants in this reference in the same manner as that adopted by my colleague, Dr. Gerber. There is a significant number of related corporations involved in the business activities of the brothers B and C but only three of them require specific designation - B & C

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Investments Pty. Limited, which is the taxpayer and here designated ``B & C Investments'', B. Investments Pty. Limited, designated ``B Investments'' and C. Pty. Limited, designated ``C Investments''.

2. The facts are complicated and have been largely set down by my colleague and I shall repeat no more than an outline to establish the background against which the decision may be appraised. Two brothers, B and C, established a trading partnership in 1965 when B was only a year or so out of his apprenticeship as a carpenter. B was younger than C but seemed to emerge as the main decision maker. Their capital was, according to evidence, £ 985 cash provided by B and a utility provided by C. This partnership converted to B and C Constructions Pty. Limited in May, 1965 and by the end of 1965 a number of other companies had been incorporated, all controlled by B and C, including the three indicated above.

3. Throughout 1965 the partnership and later the construction company (B & C Constructions Pty. Limited) were busy on a number of contracts and had presumably generated considerable profit. One of the larger contracts was completed in March, 1966 and involved a contractee who was not financially strong and in order to obtain payment of the final claim the construction company accepted, in December, 1966, after nine months of pressing for payment, two strate title units (nos. 8 and 13) in the building dubbed by my colleague ``Norseman Towers'' in lieu of cash. According to evidence these units were acquired by B & C Investments at the beginning of April, 1967, by means of a loan from the construction company apparently. B had occupied unit 13 for about nine months prior to December 1966 and the following exchange between the Chairman of the Board and that brother is illuminating: -

``Chairman: So about March, 1967 you moved out?

Answer: Moved out.

Chairman: You had that on the market at the same time as the first unit?

Answer: When we decided to quit Norseman Towers it meant Norseman Towers not just unit 8, but unit 13 as well.

Chairman: You were out of unit 13 as well?

Answer: I moved out and it was for rental.

Chairman: So in fact what happened is from about April, 1967 both units were on the market?

Answer: Yes Sir.''

It can be seen that units transferred to the taxpayer B & C Investments with the intention, according to the evidence of B, of holding them for letting, were put on the market within a month of being acquired. However, by April, 1967, a liquidity crisis was looming for the brothers and their companies and presumably something had to be sold, but unless it is accepted that there was a sudden realisation of an unforeseen liquidity problem there must at least be sec. 26(a) implications in the acquisition followed by almost immediate listing for sale.

4. Had the two units in Norseman Towers been retained by the construction company, and disposed of as a means of realising the cash due for the construction debt, the profit could not be considered assessable in the hands of that company and its being caught for tax in the hands of B & C Investments by the principle in
Salomon v. Salomon & Co. Ltd. (1897) would have been somewhat ironic. But the evidence was convincing that by April, 1967 at least B was aware that they had fallen on difficult times and it was going to be necessary to sell off assets to weather the financial storm. This aspect, which results in a favourable outcome for the taxpayer insofar as assessability of the profit on the sale of units 8 and 13 in Norseman Towers is concerned, will be referred to again in the cases of B Investments and C Investments.

5. Whilst building Norseman Towers the brothers were approached to participate in a multi-storey development by contributing one quarter of the equity funds. Their construction company was to carry out the erection and a capital contribution was made by B & C Investments, the company jointly owned and controlled by B & C. Construction started in February, 1966 and the building was finished in March, 1967. The four shareholders of the development company specifically incorporated to handle the development (B & C Investments was one of the four) were to receive strata title units in equal shares after sufficient units were sold to pay out all external creditors. As a result of this arrangement by April, 1967 B & C Investments had five strata title units available

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in what Dr. Gerber has called ``Garden Towers''.

6. In evidence B maintained that late in 1965 following a short but signally successful period of contracting (barely twelve months since the total available capital was £ 980 and a utility) both he and C felt they wanted income earning investments and sought them via the equity contribution made by B & C Investments in the company formed to erect Garden Towers. It appears doubtful whether even spectacular profits flowing from their construction company could have generated the funds necessary to hold investments in seven units (two in Norseman Towers and five in Garden Towers), but B asserted that there was an expectation that the construction company would remain busy and profitable and that the cash flow would be sufficient. In fact, this state seems to have prevailed for the period that the construction company was building Garden Towers, February, 1966 to the end of April, 1967. At the time the decision was made to participate in Garden Towers there was no doubt valid cause for optimism and I believe that both B and C, the minds responsible for the actions of B & C Investments did intend to achieve profit from the construction job and income producing investment by way of units in Garden Towers.

7. Shortly after completion of Garden Towers the brothers confronted their moment of financial truth. By April, 1967, the problem was looming and obvious; by May-June, there was extreme liquidity shortage and no contracts, and there was only one minor contract from that time until the the end of the year. Several quotations from B's evidence paint the picture:

8. During this period of serious liquidity problems two of the five units in Garden Towers were sold and one mortgaged and an option to purchase given immediately to the mortgagee. Three units were thus effectively disposed of within five months of the completion of the building. C lived in one unit until it was sold in April, 1971 after his departure overseas, and the remaining unit was let until sold also in April, 1971.

9. In evidence both B and C emphasised the emergence of dissention between them that finally led to a decision to split their affairs and cease contracting together; in the words of B ``to liquidate the assets and wind the show up.'' By ``show'' it is clear that he meant all arrangements in which he and his brother were in association. C departed Australia in August, or September, 1970 and within seven months thereafter the unit still owned in Norseman Towers and the remaining two units in Garden Towers were sold. Although the conflict between the brothers may have been overstated, I believe it was such as to cause a split, but it does not in itself explain the sale of the two Garden Towers units in 1971. One each of these units could have been transferred to the individual companies of B and C but the decision was to dispose of them elsewhere. Dissention between the brothers scarcely explains this, but, in the event, I do not think that it matters.

10. Regardless of the feasibility of financing the retention of units in Norseman Towers and Garden Towers I was persuaded by the evidence of B and C that their company B & C Investments, the taxpayer in this reference, did intend to hold them as income generating property at the times the decisions were made to acquire the units. However, the taxpayer's actions did have characteristics that at least imply a sec. 26(a) purpose and only the consistent evidence as to the intention of the brothers at the time the decisions were made to enter the Garden Towers arrangement and to buy the Norseman Towers units from their construction company, reinforced by evidence of a liquidity crisis in the period April to September, 1967, causes me to exclude that purpose. This same consistent evidence leads me to conclude that the acquisitions were not

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sec. 26(a) second limb transactions for they were not per se part of a profit making scheme. Having accepted that the brothers set out on a plan to acquire property for letting it is not possible to see the subsequent acquisitions as part of a profit making scheme which would be consummated by the sale of the property. The profit on disposal clearly falls outside sec. 25(1) for the taxpayer company had no previous transactions involving the purchase and sale of units and no subsequent transactions of this nature.

11. For these reasons I concur with the findings of my colleagues and direct that the profits on the sale of units assessed in the years 1967, 1968, 1969, 1970 and 1972 (as set out in para. 23 of Dr. Gerber's decision) be deleted from the amended assessments.

Reference B. 120/1977

At the time of incorporation of the company B & C Investments Pty. Limited in 1965 there was, as explained in para. 1 and 2 of the previous decision, also incorporated B Investments Pty. Limited (here designated B Investments). B in evidence claimed that his tax adviser recommended the incorporation, and B was not clear as to the reasons for the advice. He claimed he eventually found a use for the company to separate the property that was to represent his investments from that of his brother C. His brother's property was to be held by C Pty. Limited (C Investments).

2. Towards the end of the contract drought and financial stringency experienced in 1967 after the completion of Garden Towers, and referred to in the previous decision, the construction company controlled by B and C was invited to tender for the erection of a high-rise building of strata title units and it was claimed in evidence that B and C were invited to participate in the scheme by way of taking an equity interest in the company formed to handle the development. B and C agreed to participate and their respective companies B Investments and C Investments provided in equal amounts some of the capital of the development company. The first formal steps in the new venture were taken in September, 1967 when a block of land was acquired jointly by B Investments and C Investments apparently after negotiations by B. The deposit on this land, paid equally by B Investments and C Investments, was refunded subsequently by the development company and the land transferred to that company.

3. There were five shareholders in the development company, three of which had a one fourth interest and B Investments and C Investments each had a one eighth interest. The modus operandi of the company was precisely the same as that adopted by the company responsible for the construction of Garden Towers and after the equity contributions of the shareholders had been expended substantial borrowings were made from a finance house. Sufficient strata title units were sold as soon as possible to repay these borrowings and to meet other creditors' claims and the remaining units were distributed to the shareholders. As a result of this distribution B Investments and C Investments each received two units and jointly received another unit in a building dubbed by my colleague ``Leaning Towers''. All units obtained by B Investments and C Investments were eventually disposed of at a profit and the profits were assessed by the Commissioner. The assessability of the profit on the unit jointly owned was not before the Board and the matter at issue is the assessability of the profit on one of the units owned by B Investments and the two units owned by C Investments. This decision is concerned only with a profit of $8,089 derived by B Investments in the year ended 30th June, 1970.

4. The mind of B Investments reposed in the shareholder/director B. B's change of status over a short period was quite dramatic - apprentice carpenter in 1963, busy and seemingly successful contractor by the end of 1966, and joint owner with his brother C of company B & C Investments which by early 1967 stood possessed of seven strata title units. However, by April, 1967 there were signs of severe liquidity problems for the brothers and B made it clear in evidence that he recognised this. He also spelt out in evidence how the shortage of funds was critical until September, 1967 by which time the company B & C Investments had sold four of the seven units (strictly speaking, one was mortgaged for almost full value and the mortgagee had a purchase option). In September, 1967, therefore, the crisis was over but, as B said, they ``weren't flush''.

5. The period that is relevant for the determination of a sec. 26(a) purpose as far as this taxpayer and the unit sold are concerned is that in which the decision to participate in the Leaning Towers venture was made. That

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decision was made at the latest in early September 1967 in circumstances described in the decision of my colleague, Dr. Gerber. The background to the decision by B to participate emerged from evidence and it is important; the construction company of B and C was desperate for work, there had been for about six months a severe financial stringency when units acquired as investments had to be sold to meet pressing creditors and, although this stringency had now been somewhat relieved, they were ``not flush''. It is obvious that if a major contract was to be embarked upon (and Leaning Towers was a major project) the construction company would need working capital until progress payments were received and the brothers must have known this after a period of contracting experience. The construction company had also started to tender for civil engineering work (according to evidence some of this work was commenced ``a little while later (than August, 1967)'') and working capital would also have been required for these contracts.

6. My impression of B after hearing him give evidence for a considerable time was that he was an aware man and a planner. He referred several times to the estimates and budgets that he prepared and mentioned the difficulty he had with these aspects and financial control in the early days of contracting. He was also a thoroughly rational man, given his espoused objective of profit making. It was clear that the financial planning and control of the activities of the various companies rested with B, and it seemed that by 1967 he had developed some expertise in these matters.

7. In September, 1967 we therefore have two brothers controlling a number of companies all centred on building construction and the results thereof. Their investment in units in Garden Towers and Norseman Towers had been largely realised to provide funds to meet the financial pressures of the previous six months. They were given an opportunity to participate in a development project and participation required a substantial contribution - at least B claimed that they were approached and invited to join the project, but it seems unusual that B and C would pay the deposit on the original land purchased (via their respective companies) if another party conceived and initiated the plan. Nothing had happened to dramatically improve the financial state of the brothers, and although no evidence was adduced regarding the exact overdraft status of the companies, B indicated that at the end of 1967 B & C Investments had a ``big overdraft'' and he thought all the other companies had some overdraft. The net capital of the entire group at this time (made up of three remaining units and whatever equipment they possessed - C said in evidence ``at that stage... there wasn't much equipment'' - reduced by these overdrafts and any other liabilities) was probably remarkably small when they were confronting the undertaking of a major construction project. Unless my assessment of B's perspicacity and thoroughness is totally in error he must have been cognisant of these matters.

8. Given these circumstances I do not consider that an aware and rational planner who, in his own words ``did his figures'', would seriously contemplate the possibility of an investment. There simply was nothing to invest. Rather, it seems B participated via his ``investment'' company in a plan, in association with the construction company controlled by his brother and his, and in association with a group of others, to erect a building and thereby acquire certain financial benefits. There was some flexibility in the way in which the benefits could be obtained and the strata title units could be let prior to advantageous disposal, although B indicated in evidence a significant disenchantment with letting at that time following damage to Norseman Towers units. In the light of his experience with the units in Garden Towers and Norseman Towers it is unlikely that B would have been concerned to sell the units sooner than he had to, for those buildings had provided grounds to expect that unit sale prices would constantly escalate.

9. The building development and disposal-of-unit pattern adopted for Garden Towers was manifestly successful and although I concluded that the inexperienced B and C believed when they entered upon the arrangement which provided units in that building that they could secure, and retain, an investment in lettable units, it is not possible to draw the same conclusion when the pattern is repeated a year or so later and after a financial storm that must have enhanced the business wisdom of a perceptive individual such as B. It seems to me that the arrangement entered into by the brothers B and C whereby their construction company secured work and their

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respective ``personal'' companies secured units, falls into the category of a profit making scheme. The mind behind the taxpayer company in this reference was that of B and it follows that B Investments embarked on a profit making scheme. Having found that the second limb of sec. 26(a) applies it is not essential that consideration be given to sec. 25(1). However, it seems to me that the Leaning Towers transactions were the first of a series of similar transactions entered into by B Investments over the years from 1967. B stated in evidence that the transactions after Leaning Towers were entered into with a profit making purpose and that profits had been assessed. It would be my conclusion that this purpose started with the Leaning Towers transactions and not after them.

10. In view of this I find that the profit on the sale of unit number 34, $8,089 sold by the taxpayer is assessable and I therefore confirm the Commissioner's amended assessment for the year ended 30th June, 1970.

References B. 110-111/1977

The background to this review has been set out in the above cases concerned with company B & C Investments (the jointly owned investment company of brothers B and C), and company B Investments (the ``personal investment'' company of B). We come now to C Investments, which was the ``personal investment'' company of C.

2. It will be recalled that the construction company controlled by B and C secured the contract to build Leaning Towers and the brothers made an equity contribution via their companies B Investments and C Investments to the company formed to handle the high-rise development. It will also be recalled that these two companies each received two strata title units and they jointly received one unit when Leaning Towers was completed. The matter at issue in this review is the assessability of the profit on the two units obtained by C Investments and subsequently sold. The jointly owned unit was also sold at a profit but the assessability of that profit was not before the Board.

3. Leaning Towers was completed in July, 1969 and the units allotted to C Investments were numbered 5 and 23. No. 5 was sold on 21st August, 1970 and no. 23 on 29th June, 1970. In the period from completion of the building to date of sale of the units no attempt was made to furnish or let them. C's evidence on this point was clear and consistent and is summed up in the following exchange during cross-examination: -

``Question: So you had no intention yourself of living in either of the units in Leaning Towers, did you?

Answer: Oh, we might have considered it briefly but there didn't seem to be much sense in going from one building to the other.

Question: Of course not. Well, at any rate you have told us that you didn't rent either of the units in Leaning Towers and you didn't furnish them?

Answer: That's correct.

Question: But you did sell them?

Answer: That's correct.

Question: We have the dates of sale, which were of course very close to the time that they were actually allotted to you, weren't they?

Answer: Oh no, they were allocated a long time before that. These units sat empty there for a year.''

Later on C was even more forthcoming when Councel for the Commissioner pressed him on the matter of leaving units unused for such a period:

``Question: Well it was no good allowing them to sit there unfurnished and unrented. was it?

Answer: No, it wasn't very bright, but selling them was even sillier, Sir.

Question Why?

Answer: I just noticed a sale price, one $22,500. One sold for $90,000 the other day. That wasn't very bright on my part at all.

Question: Were you waiting to allow the market to rise to get a better price?

Answer: Well, there was nothing wrong by getting a better price, Sir.

Question: Of course not. I don't blame you for that, but that is what you were doing, wasn't it?

Answer: I am not suggesting it was, no. But if that in fact happened then, you know, I

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could hardly sell them for less to satisfy the Commissioner.

Question: At any rate you did sell them and you sold them quickly without having furnished or rented them?

Answer: Well there was a demand for these units. That building was sold out at completion. That building had been sold out for some twelve months.''

4. As set out in para. 5 of the decision regarding B Investments, the period that is relevant for the determination of a sec. 26(a) purpose is that in which the decision to participate in the Leaning Towers venture was made. That period seemed to be the months immediately before September, 1967. The financial control and administration of the joint affairs of B and C certainly rested mainly with B, but that domination by B clearly does not prevent C having in mind a different purpose from that of B at the relevant time. For the reasons set out in the decision regarding B Investments it was my conclusion that that taxpayer embarked on a profit making scheme when it joined the equity holders of the company erecting Leaning Towers. If it is assumed that B kept his brother appraised of the dire financial straits they were in, it is difficult to come to a different conclusion in respect of C Investments from that in respect of B Investments. Although C was not questioned about his awareness of the financial difficulties in 1967, it was obvious he had considerable understanding of the financing implications of large scale contracting even at that time, and he certainly knew that there was a disastrous contract drought in the year or so up to the start of Leaning Towers. I think it is reasonable to assume that C had the same knowledge as B at that time, although this might not have been the situation some time hence when, according to evidence, disagreement occurred.

5. C impressed as almost the stereotype economic man - he was essentially a maximiser of profit who, without giving attention to figures in the way B did, weighed up alternatives carefully. If he had the same knowledge of the financial position as B (and I believe he did have) it does not seem likely that he would have seriously thought he could hold two units as an investment, and his decision to participate in the Leaning Towers project was, in my view of the balance of probabilities, part of a profit making scheme. However, I am more confident of the sec. 26(a) purpose in the case of C Investments than I was for B Investments, for C's responses to questions set out above seem to me to be consistent with a decision to hold units unoccupied, and so unmarked and undamaged, with a view to sale at a time most suitable to the taxpayer. C knew there had been great demand for units in Garden Towers and unit prices had constantly increased. It was a reasonable expectation that units in Leaning Towers (next door, and with all the same advantages) would also rise in price.

6. The alternative possibility, which is favourable to C Investments, is that C believed that the equity contribution to the company erecting Leaning Towers would provide rentable units to replace the jointly owned units in Garden Towers that had to be sold due to liquidity problems. The subsequent friction between B and C, and the resulting decision to go their separate ways (C went overseas for 15 months), were put forward as the reasons for selling assets acquired as rent-generating capital items. As no rational possessor of income producing assets willingly leaves them idle for twelve months, I must regard this possibility with doubt. My assessment of C was that his concern for profit made it unlikely that units would be left unoccupied unless he had an expectation that the eventual benefit would outweigh the rent income foregone.

7. B and C were forthright witnesses whose evidence I hesitate to reject. But the events of 1967 are now over ten years past and the recollections of the witnesses could not fail to have been influenced by subsequent events and subsequent knowledge gained. As an external observer of the state of affairs in 1967 of B and C and their joint and separate companies, and of the actions of B and C as the decision-makers, I must conclude that despite the evidence of B and C the transactions and events resulting in the obtaining and disposing of units in Leaning Towers bear all the marks of a sec. 26(a) scheme.

8. I therefore find that the profit on the sale of units numbered 5 ($7,755) and 23 ($7,322) sold by C Investments is assessable under the second limb of sec. 26(a) and confirm the amended assessments for the years 1970 and 1971.

Claims allowed in part

 

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