Case P51

Judges:
HP Stevens Ch
JR Harrowell M
BR Pape M

Court:
No. 1 Board of Review

Judgment date: 18 June 1982.

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H.P. Stevens (Chairman)

The questions at issue in this reference relate to the inclusion in the taxpayer's assessment for the year ended 30 June 1974 of an amount of $32,532 arising from the sale by contract of January 1973 of two lots of land acquired in October 1969 and March 1971 for the purpose of erecting units for resale thereon (such development not having taken place).

2. Incorporated in 1964 a first meeting of subscribers was held on 11 July 1964 at which one ``A'' class share was issued to individual X (Governing Director) and one ``B'' class share to his wife (no further shares have been issued). The minutes record that X ``reported his health was causing him concern, and he wished to ensure a continity [ sic ] of attention to his affairs, which the Company through its Secretary could provide'' - Mrs. X had been appointed Secretary. A minute of 4 November 1964 records that X suffered a coronary on 30 October 1964 and it would appear that he was frequently in ill-health from then on. He passed away in November 1981 and oral evidence was given by Mrs. X.

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3. In August 1964 the taxpayer acquired its first property for $15,500. It proposed having units built thereon by an independent company Y (Development Consultants and Project Builders), and then reselling the units. Y expressed the opinion the block was irregular and larger than necessary - it was ultimately subdivided in two blocks (the existing house on one and the other vacant land for the units). Plans were said to have been prepared but nothing eventuated and the subdivided lots were sold for a total of $26,500 (1965 year $13,000 and 1966 year $13,500). A minute of 10 October 1964 records that ``due to the ill health of'' X it was proposed the property be disposed of through Y. Further land was acquired in May 1965 for $14,500 ``for future development'' (per minute of 8 February 1965) and in due course a building of six units was erected thereon and the units sold on completion over the period September 1966 to December 1977.

4. A minute of 5 May 1965 resolved to purchase two further properties and for building plans to be submitted as soon as possible - completion of the purchases took place in June 1965 at costs of $4,450 and $20,000 respectively. The first of these properties had plans passed for a block of units thereon and in 1967 the block was sold together with the plans for $7,300. In respect of the second of these properties a building of 10 units was erected and those units sold over the period July 1967 to February 1968.

5. The taxpayer's first return of income lodged was that for the year ended 30 June 1965. The nature of its business was shown thereon as Property Developments and the trading account attached to that return contained, inter alia, on the credit side Sales $13,000 and Work in Progress $45,990 with Purchases $54,000, Building and Survey Fees $724 and Legal Expenses and Stamp Duties $1,242 on the debit side. The Balance Sheet as at 30 June 1965 showed as Current Assets Properties on Hand (Land and Work in Progress at Cost) $45,990. The purchases figure in the trading account encompasses the cost (or most thereof) of the four properties referred to in para. 3 and 4 above, the sales figure the selling price of the subdivided block sold in 1965, the work in progress figure the cost of the properties still on hand as at 30 June 1965 plus some costs, whilst the legal expenses claim represents the amounts ``paid on properties purchased for development and resale''.

6. A further property was acquired in January 1966 for $15,000 and in due course a building of six units was erected and the units sold over the period August to November 1968. The 1966 return was prepared on the same basis as for 1965, i.e. all items in the trading account and current assets section of the balance sheet.

7. During the 1967 year the company purchased for $4,700 two blocks of land in order to clear up the estate of Mrs. X's previous husband - a minute of 1 June 1966 resolved to purchase this land but did not give a reason for acquisition. The two blocks were sold in October 1966 for $6,400. In the 1967 return the $4,700 was shown in the trading account under the heading purchases and the proceeds shown as sales.

8. In the 1968 year two further parcels of land were acquired - the first for $9,200 and the second for $41,300. The first was subdivided and sold in February and March 1969 for a total of $14,000. The second was sold with plans approved (after a lot of difficulty) for units in January 1969 for $72,000. The purchases and sales of these blocks were treated the same as for all preceding blocks, i.e. amounts claimed as purchases and proceeds shown as sales in the trading account. They really require no further comment except for the treatment in the tax return for 1969 of the ``profit'' yielded by the ordinary trading account in relation to the second property sold for $72,000.

9. The trading account drawn up for the 1969 year yielded a Gross Profit of $50,054. In a reconciliation prepared to calculate the company's taxable income the ``profit'' amount applicable to the property concerned was said to be $33,700. It was then stated that $60,000 of the sale price was outstanding (apparently mortgage for balance) and using the proportion 60/72, $28,083 was claimed to be deferred profit and excluded in the 1969 taxable income calculation. $30,000 of the outstanding $60,000 was received in the 1970 year and, on the same basis $14,042 was added by the company to its taxable income for that year. The balance was received in the

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1971 year and the company added the remaining ``deferred'' profit of $14,041 to its 1971 taxable income.

10. A further property was acquired during the 1969 year for $40,000. After council ``changed the code, and would not allow the number of units the company anticipated it could build on this site'' it was resolved on 22 May 1970 to dispose of the property - disposed of in November 1970 for $60,000. The purchase and sale of this property was dealt with as for the other transactions set out above.

11. In the 1970 year three properties were acquired - one (18-20 Z Street) for $28,000 and the others (adjoining properties in another street) for $32,520. These adjoining properties were developed as a building of nine units in due course (acceptance of Y's quote for erection being resolved on 30 May 1971) which units were sold over the period October 1972 to October 1973 for $268,200. In this year's return the costs of the properties were treated in the same manner as usual.

12. 18-20 Z Street (one of the properties the subject of this reference) consisted of a building divided into three flats on one block with the adjoining block vacant land. A minute of 31 July 1969 resolved that development plans be prepared and submitted to council - ``the tenants to remain until the Company requires possession of the property''. Such plans were submitted by Y under cover of letter of 7 January 1970 but council, by advice of 27 February 1970, rejected the application on the basis that the proposed building represented ``excessive site development'' and the proposed landscaping treatment was inadequate. Further representations were made by Y on 2 April 1970 but on 4 May 1970 council advised adherence to its previous decisions. Attempts to acquire adjoining properties were initially unsuccessful but eventually 14-16 Z Street (comprising two separate houses) was acquired in February 1971 for $40,000 - such figure being treated in the usual way in the company's trading account and balance sheet.

13. In April 1971 the company acquired the family residence of Mr. and Mrs. X who were to ``continue to occupy the property as a home'' and to pay such rental as ``calculated after consultation with the company's accountants''. The cost $45,000 was not dealt with in the trading account and appeared as a fixed asset in the company's balance sheet.

14. The evidence does not reveal what, if any, approaches were made in relation to the development of the combined 14-20 Z Street after the acquisition in February 1971. There was evidently vandalism in the area causing insurance problems and by minute of 28 November 1972 it was resolved to sell 14-20 Z Street because of:

``1. Repeated acts of vandalism resulting in loss of tenants.

2. The Governing Director's general bad health.

3. The project `(referred to in para. 11)' is now six months behind completion and is completely occupying the time of the secretary and Mr.....''

By contract of sale dated 30 January 1973 14-20 Z Street was sold for $136,540, half to be paid by deposit and on completion with the remaining $68,270 ``deemed to have been paid by the Purchaser to the Vendor on the Purchaser executing a first legal mortgage over the security of the property'' to secure $68,270 repayable on 10 August 1973. Completion was on 30 March 1973 and a mortgage of same date for $68,270 was executed.

15. In the company's 1973 return there was a departure from the treatment afforded the previous properties sold without development occurring thereon. The sale price was not shown in the trading account although, since the figure of $230,153 Stock and work in progress at 30 June 1972 (which included the cost of 14-20 Z Street) was the opening figure from which the Stock and work in progress at 30 June 1973 (excluding 14-20 Z Street) was deducted, it appeared the cost thereof was effectively claimed therein. There is no detail as to the breakup of the sale figure of $129,986 shown but it would seem that this is not a true sales figure but includes a notional amount equivalent to the cost of 14-20 Z Street claimed as a result of the preceding calculation. The Balance Sheet as at 30 June 1973 showed the Purchaser

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under the heading of Current Assets ``Advance... secured'' whilst under the heading of Reserve appeared:

``Asset Realisation

  Reserve                 $32,533

Deferred Asset Real-

  isation Reserve          32,532       $65,065

                          --------''
        

An attachment to the return set out that the surplus on the sale of 14-20 Z Street was $65,065 and that, as only one half of the selling price had been paid, only one half of the surplus had been realised at 30 June 1973 - the balance would be realised on 10 August 1973 (this aspect being consistent with the treatment adopted previously as set out in para. 9 above). The ``inconsistency'' was that it was claimed that the surplus was not assessable in that the properties had been purchased as part of a profit-making undertaking which had had to be abandoned because of X's illness - the properties not being purchased for the purpose of profit-making by sale.

16. The Commissioner did not accept the contention that the surplus was not assessable but otherwise accepted the basis put forward, i.e. he included only $32,533 in the company's assessment for the year ended 30 June 1973 converting a returned loss into a taxable income of $6,926. Although objection was taken to this assessment when such was disallowed the matter was not taken further.

17. In the company's 1974 return the Deferred Asset Realisation Reserve was transferred to the profit and loss account and from there to the Asset Realisation Reserve. The Commissioner included the amount thereof $32,532 in the company's assessment for the year ended 30 June 1974 to which objection was taken claiming that the taxable income should be reduced to $13,424 upon the following grounds:

``1. Surplus received on disposal of the (Z) Street property is not assessable income under any provision of the Income Tax Assessment Act.

2. The taxpayer did not acquire the said property for the purpose of resale at a profit.

3. The property concerned did not constitute trading stock of any business carried on by the taxpayer.

4. The taxpayer is entitled to a deduction for previous year losses in terms of sec. 80 of the Income Tax Assessment Act.

As pointed out in the taxpayer's 1973 income tax return the land was initially purchased for the purpose of constructing home units for resale. A series of factors which included a heart attack suffered by the taxpayer's managing director forced the company to abdicate from its proposed course of action and subsequently the property was sold.

It is our opinion that the sale of the property had no element of a business deal as countenanced in McClelland's case; sale of the property was effectively the realisation of a capital asset which had not yet been committed to any business venture.''

18. It has been necessary to set out the objection in full because one of the submissions advanced before the Board was that, even if the surplus was assessable (which was not conceded), no part of that surplus was assessable in the 1974 year. The Commissioner's counsel objected to such submission on the basis that it was not covered by the grounds of objection. He also made submissions based on the technical point of whether the part was assessable in 1974 but it is convenient to deal initially with that relating to the scope of the grounds of objection.

19. Having regard to the authorities on the point (which include
Molloy v. F.C. of Land Tax (1938) 59 C.L.R. 608 ;
H.R. Lancey Shipping Co. Pty. Ltd. v. F.C. of T. (1951) 9 A.T.D. 267 and
A.L. Campbell & Co. Pty. Ltd. v. F.C. of T. (1951) 82 C.L.R. 452 ) it is my clear view ``that the grounds were not intended to cover the point that has been made and that they would not convey it to the Commissioner'' (per Dixon J. in A.L. Campbell & Co. Pty. Ltd. supra ). The Commissioner had, rightly or wrongly, followed the realisation basis set out by the taxpayer and there is nothing in the grounds which would alert him to a claim that such was being challenged. All the grounds do in my view is reinforce the claim made in the 1973 statement that the surplus was not assessable - not to introduce a fresh concept that, if it was assessable, then there had been no derivation of any part of it in the 1974 year.

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20. In the circumstances it is strictly unnecessary to consider whether there was any derivation in the 1974 year. I should however refer to counsel for the Commissioner's reliance on
Farmers' Trading Co. Ltd. v. C. of I.R. (N.Z.) 80 ATC 6022 ; (1980) 4 NZTC 61, 577 . That case concerned clothing sales where the customer received immediate title to the goods and agreed to pay for them over a 20 week period - no security being given. A calculation was made as to the gross profit and cost components of the sale price, the cost component being accounted for in the year of sale but the gross profit component being accounted for in the years in which the sales proceeds were received. It was held that this method was correct as ``the method of accounting adopted by the taxpayer produced a more realistic measure of real profits for a year than did the method for which the Commissioner contended''. Although the basis adopted is similar to that actually used by the company in respect of the surplus the factual position is different. In the first place no security was given whereas here there was a mortgage whilst-secondly the contract of sale specifically provided that the execution of the mortgage would result in the balance being ``deemed to have been paid by the Purchaser''. Any action to recover would be based on the mortgage and not on outstanding balances under a contract of sale. These differences seem sufficient to suggest that the New Zealand case is distinguishable.

21. Turning now to the real issue, i.e. whether the transaction gives rise to a profit in terms of either sec. 25(1) or 26(a) of the Act (irrespective of the fact the amount in issue may have been assessed in the wrong year), the claims made on behalf of the taxpayer were basically that:

• (a) the taxpayer fell to be dealt with in terms of sec. 26(a) and not 25(1); and
• (b) there having been an abandonment of the original purpose, sec. 26(a) did not operate to tax the surplus.

On the other hand counsel for the Commissioner submitted that sec. 25(1) was the appropriate section.

22. It was the submission of the taxpayer's representative that, on the facts, the company had insufficient transactions, etc. to be categorised as carrying on a business. Properly regarded it undertook a series of profit-making undertakings or schemes which had to be considered separately in terms of the second limb of sec. 26(a). I am unable to accept this submission. The facts show quite clearly, in my view, that the taxpayer was (within the limits of its capacity) an active property developer and I would regard the term ``Property Developments'' (as used in all returns from 1963 to 1973 inclusive) as correctly stating the nature of the business that I consider it to have carried on.

23. Over the period from incorporation to 30 June 1973 (nine income tax returns) the taxpayer acquired 12 properties (counting the acquisition of two adjoining properties on the same day for differing prices as one property, the two separate parcels of the subject land acquired at different times as two properties and excluding the ``family home'') at a total cost of $265,170 (excluding legal costs, etc., because these cannot on the evidence be split between those applicable to purchases and those applicable to sales). It is similarly impossible to split other expenses such as building and survey fees, management fees, wages to Mr. and Mrs. X, etc., between those properties which were fully developed as unit buildings, those for which development plans were approved but not proceeded with, those where development plans were rejected, etc. Accordingly the details in respect of the individual properties are not ascertainable and any figures set out hereunder must be viewed in that light.

24. Of the ten properties (other than the two subject properties) acquired, four (4) were fully developed (builders' contractors' charges claimed total $342,841 whilst the total selling prices of the units developed was $607,250), two (2) were ultimately sold with plans after such plans had been approved (cost $45,750 of sale price $79,300), one was sold after approval was refused (cost $40,000 sold for $60,000), one was sold after plans were prepared - no details whether approved or rejected - and block subdivided (cost $15,500 sold for $26,500) whilst the remaining two were sold without development being proposed (one though after subdivision). As indicated earlier all purchases and sales were recorded in the

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trading account and over the period a total gross profit of $209,554 was returned - some rent from the subject properties and some building and survey fees, etc., in respect thereof were included in the trading accounts but otherwise the gross profit reflects the position in relation to the above ten properties.

25. Both Mr. and Mrs. X were employed (stated to be full time in the 1970 return) by the company until the year ended 30 June 1971 - wages rising from $6,200 plus $790 allowances 1965 to $8,960 plus $1,296 allowances 1970 - whilst superannuation contributions were claimed in the 1971 year. The wages claim for 1971 declined but a management fee to a company was claimed for the first time. This fee increased in subsequent years (1973 $32,500) whilst wages and superannuation to Mr. and Mrs. X for 1972 and 1973 were nil. For the 1974 year no management fees were claimed but Mr. and Mrs. X were shown as full time employed at $10,350 plus $1,400 allowance and $9,150 plus $1,050 allowance - superannuation contributions of $8,916 also being claimed. The reasons for the introduction of the management company (said in the 1974 return to be ``an associated company'') in 1971 and its apparent withdrawal in 1974 was not given to the Board - however it would appear that the services of Mr. and Mrs. X were provided per medium thereof.

26. Having regard to the above (and the evidence as a whole) it is my clear view that the company was carrying on a business of property development and not, as submitted, merely engaged in a series of separate profit-making undertakings or schemes that did not amount to the carrying on of a business. The position on the facts is so self evident as not to require the citation of authority. The tenor of the authorities (which emphasize that the question of a business or not is basically a question of fact or degree, although not necessarily not a ``question of law'') can be gleaned from the decision of the Federal Court in
Ferguson v. F.C. of T. 79 ATC 4261 and of the Full High Court in
Hope v. The Council of the City of Bathurst 80 ATC 4386 . In the latter case Mason J. at p. 4390 accepted that the word ``business'' had

``the ordinary or popular meaning which it would be given in the expression `carrying on the business of grazing'. It denotes grazing activities undertaken as a commercial enterprise in the nature of a going concern, that is, activities engaged in for the purpose of profit on a continuous and repetitive basis.''

On the facts stated in that case his Honour concluded

``that the appellant's activities amounted to a business and that no other conclusion was reasonably open... Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit. The activity had a permanent character in that it had been carried on without interruption since 1965.''

The same can, in my view, be said in relation to the present taxpayer.

27. It is common knowledge that not all parcels of land acquired by an enterprise carrying on business as a property developer for development are in fact developed. Changes in zoning, failure to obtain council approval, etc., can result in the disposal (at a surplus over cost) of parcels of land acquired for development and such is an ordinary incident arising in the course of the business of a developer. Acceptance of the arguments put forward by the taxpayer's representative would mean such an enterprise would only be assessable in respect of those parcels actually developed - the other parcels sold not generating any assessable amount despite being sold in the ordinary course of its business. As pointed out by Barwick C.J. and Menzies J. in
Investment and Merchant Finance Corporation Ltd. v. F.C. of T. 71 ATC. 4140 at pp. 4142 and 4147; (1971) 125 C.L.R. 249 at pp. 255 and 264 respectively it is wrong in the case of a company carrying on a business to fragment its activities and look at individual dealings in terms of sec. 26(a) in lieu of the business activities as a whole being dealt with by the general provisions of the Act (see also per Gibbs C.J. in
F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at p. 4036 ).

28. The above is all that I think it is necessary to say in relation to the present case - ground 4 re previous years' losses was abandoned. It is unfortunate that the grounds of the objection are not apt to raise to time of derivation of the amount at issue and it may be (although I do not so find) that, if it had been covered, my decision would be different.

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29. For the above reasons I would uphold the Commissioner's decision on the objections and confirm the taxpayer's primary and Div. 7 assessments for the year ended 30 June 1974.