Case S41

Members: MB Hogan Ch
P Gerber M

GW Beck M

Tribunal:
No. 3 Board of Review

Decision date: 7 June 1985.

Dr G.W. Beck (Member)

The same matters are in issue in both these references, the taxpayers, B and L, being husband and wife and partners in a partnership which claimed certain deductions under sec. 51 and investment allowance under Subdiv. B of Div. 3 of Pt III of the Act. The claims were disallowed, an amount of $2,125 returned as income by the partnership was excised and a penalty under sec. 226(2) imposed. The taxpayers objected against their respective assessments which reflected the effects of these actions, by the Commissioner. At the hearing counsel for the Commissioner said he had been instructed that there were errors in both assessments caused by overcalculation of penalty tax, and the assessments were to be reduced by $935.83 in respect of each taxpayer. The deductions disallowed to the partnership were made up as under:

                                                 $

      Site rental in respect of caravans       4,000

      Management (service) fees of

        caravans                              16,000

      Lease rental fees of caravans              781

      Interest on borrowings                     663

      Investment allowance on caravans         6,680

2. For some time prior to 1978 (and, indeed, up to the time of the hearing in September 1984) the taxpayers derived income from a business of concrete contracting. During the tax year involved in this reference, 1978, the concreting business operations were transferred from a husband and wife partnership to an operating trust, the beneficiaries shown in the trust distribution statement at 30 June 1978 being the taxpayers as to 40% of net income each and the remaining 20% in equal shares to their three children. It seems from the date on accounting statements that the transfer from partnership to the corporate trustee took place on 12 October 1977, but the partnership tax return covers the full 1978 tax year and all of the transactions involved here appear in the partnership return. Whether the partnership actually carried on business after 12 October 1977 is a matter for subsequent consideration,

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but the events which caused the claims in dispute in this reference all occurred well after the partnership had ceased to conduct a concreting business. The events began on the night of 29 March 1978 although the contacts that led up to them were made at least several months before. Both taxpayers said that B had a knee injury that caused them to believe that he would not be able to work as a concretor for very long and they were therefore on the lookout for alternative sources of income. Since 1978 they have embarked on other business ventures in their search for alternative sources.

3. The husband had carried out concreting work late in 1977 or early in 1978 on a building that he believed was being erected for one X. The head contractor on the building told B that X was was a good investment adviser and both B and L were impressed when X negotiated a sizeable loan on their behalf at a time when, as L said, ``large sums of money were fairly hard to get''. Early in 1978 X told them of a project by a company, here called ``Holiday'', owned by a man here designated Z, to develop a caravan park with many attractive facilities such as a waterslide, restaurant, children's playground, tennis courts and swimming pool. The land on which the development was to take place was known to B and L who regarded it as especially suitable by reason of its topography and location near major tourist resorts. X advised B and L that financial participation in the project would be beneficial and told them of a means whereby they could be involved. L summarised the overall plan for participation in answer to a question from her counsel by saying: ``Well, we were going to borrow some money and we were going to lease some land and lease some caravans and pay for services to the sites''. She said she discussed the proposed investment ``with our friends and I rang our accountant about it... and also our bank manager'' and ``they, like us, were quite excited about the caravan park''. In cross-examination, it became clear that L had no worthwhile analytical discussion with anyone and B took no steps to discuss the proposed investment with anyone other than X, saying that he left such matters to his wife and, in any case, he trusted X. It was clear that he trusted both X's integrity and business judgement.

4. It seems that Z, through his company Holiday, wanted to lease for five years sites in the caravan park to investors who would lease caravans which would be placed on the sites and offered for rent. The maintenance of the park, the provision of services to the caravans and all matters relating to rent collections, cleaning and so on, were to be looked after by Z. The plan was for investors to simply pay for a leased site and provide a caravan. As it eventually turned out, the site lease agreement and a service agreement were with Holiday, but there was also a management agreement between each investor and another of Z's companies, here called ``Tourist''.

5. On the night of 29 March 1978, X's business partner (Y) took certain documents to the home of B and L and Y witnessed their signatures to the documents, collected cheques drawn on the bank account of the trustee company that had taken over the concreting business formerly run by B and L in partnership, and immediately delivered both cheques and documents to Z, apparently despite the lateness of the hour. For clarity I set out hereunder the documents that were signed and summarise the relevant contents.

  • ``The taxayers would grant to Tourist the right to grant to others the right to use the caravan, and in exchange for that Tourist would pay the taxpayers a

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    guaranteed minimum sum each year, a specific minimum sum each year, whether Tourist let the caravans or not.
  • ... there was an obligation upon Tourist, at least implied in the agreement, to let them because there was a provision that, when the income from the letting of those caravans exceeded the guaranteed minimum, it would in fact be divided between Tourist and the taxpayers in the proportions set out in that agreement, that is, 10 per cent was to go to Tourist.
  • Tourist really did not earn any fee - it did not earn any sum of money from the joint venture, if I can put it that way - if the income from the hiring of the caravans did not exceed the minimum sum, and it did not in the relevant income year, and, notwithstanding that, Tourist was obliged to and did pay to the taxpayers a sum of money in that year.''

One clause of this agreement gave Tourist an option, exercisable after three years from the date of the agreement, to acquire the site leases and all rights under the service agreement for a consideration of $3,330. Both B and L said they knew at the time of signing that there was an option clause, but believed the option was theirs, i.e. after three years they could decide to carry on or get out by selling to Tourist for the designated sum. I accept this evidence of the taxpayers. It is, of course, obvious that if the caravan park venture had been successful Tourist was certain to buy out the ``investors'' whose funds had enabled it to be developed. If it was thought that B and L had been aware of the true nature of the option at the time of signing it would, in my view, not be possible to believe that they were investors in what they regarded as a promising commercial venture. No sane investor in a commercial venture would agree to such an option. To an ``investor'' in a tax scheme such an option would, of course, be irrelevant.

All of the documents signed by B and L on the night of 29 March 1978 were dated 30 March 1978.

6. On 10 April 1978 B and L entered into agreements to lease two caravans from Industrial Acceptance Corporation. The caravans were invoiced to Industrial Acceptance on that day by a dealer, the cost prices being $11,500 for a twenty-five-foot van and $5,200 for a sixteen-foot van. Monthly payments by B and L to the lessor were $259.08 and $121.67 respectively and the terms of the leases were in both cases five years. A witness who was in 1978 employed in the despatch section of the caravan manufacturer gave evidence that he delivered both vans to the site of Z's proposed caravan park, one in February 1978 and the other on 20 April 1978. Two despatch dockets were tendered, the one claimed to be in respect of the February delivery was, according to the witness, signed by Z acknowledging receipt of the van, and the April docket was signed by ``June Z''. The witness said that over a period he delivered a number of vans to the same property and parked them in ``a large yard... we positioned all the vans between the home and the river''. It was not an arrangement in which the vans could be used, and he described it as ``just storing them''. There was no evidence which could be said to pinpoint the date on which the leased caravans were put on to the leased sites, and none which identified the date on which the vans were ready for occupancy. The caravan park did not open until 18 December 1978 and, in the absence of evidence to the contrary, it must be assumed that that is the earliest date on which the vans were actually offered for rental. Whether the vans were ready for rental before this date is probably an inconsequential question when there was no evidence that they were even on

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the leased sites in the tax year in question, i.e. before 30 June 1978.

7. Although it was obvious from the evidence of both B and L that the representations of X were most influential in their participating in the caravan park venture. X was not called by either side. The Board was told that X resided in Brisbane where the hearing took place and was, when last seen by his partner Y a day or so earlier, in good health. Y gave lengthy evidence and it seems he was also an investor in one leased caravan and one site and he had similar agreements with Holiday and Tourist to those entered into by the taxpayers. He said that between Christmas 1977 and February 1978 Z ``approached us to see if we had any investors who would be interested in investing in his proposed holiday caravan park''. He also said that Z had clear-cut proposals about how investments would be made and ``spread sheets showing what the cash requirement for each person would be, what their anticipated income would be, and what their total position would be, and what return they might expect''. Y named the large firm of Sydney solicitors who drafted the agreements and, by implication, provided Z with the plan so clearly laid out on ``spread sheets''. He agreed that the investment advising business he carried on with X received a commission as a result of introducing B and L to the arrangement. He also agreed that in view of the anticipated tax benefits and the guaranteed minimum income from Tourist he told B and L that their outlay would be ``not a lot''. He rejected the notion that he might have said: ``This will really cost you nothing.''

8. Many questions come to mind in the light of these facts and some of them remain unanswered. Ignoring altogether the prepayment of service charges and site rentals the following annual costs were unavoidable if two caravans were to be placed on two sites: 

                                               $

      Caravan lease rental as per

        agreement with I.A.C. ($122 and

        $269) per month                     4,692

      Service fees                          3,200

      Site rentals                            800

                                           ------

                                           $8,692

                                           ------

This represents expenditure of $24 for every day of the year and, assuming a 50% caravan occupancy rate which one could expect to be realistic, $48 per occupied day. Daily rentals from one large and one medium-sized caravan in 1978 could not possibly cover costs of $48 per day and probably could not cover $24 per day. In that year, it was possible to secure acceptable motel units in favoured parts of the resort region in which the caravans were to be located for about $24 per day. There is cause to ponder whether the taxpayers did no calculations such as this, or whether they did and saw the tax advantages of the proposal as the only factor that would render it financially rewarding. The evidence of L was, in summary, that she believed the caravan park would be ``a very successful project'' and she ``could see it as an investment where we could make some money''. The guaranteed minimum return gave her confidence and she ``could not see how we could get into too much trouble money-wise''. I am inclined to accept her evidence, but it is difficult to do so in view of what seem to me to be reasonable expectations at the time. Her husband, B, said he left all financial matters to her and, in any case, he trusted X and believed he gave sound investment advice. If these taxpayers were two naive people led into a financial deal by X I cannot understand why they did not call X to give evidence. The proposal drawn up for Z by the Sydney solicitors has at least some of the marks of a tax avoidance scheme and truthful evidence from X about how he put the proposal to B and L could be expected to indicate whether the taxpayers entered into such a scheme or made a commercial investment. However, regardless of the tax avoidance characteristics of the proposal, B and L outlaid real money and there are not here the self-cancelling outflows and inflows of money that this Board is accustomed to seeing in some references. In addition, I have concluded that, regardless of the financial manoeuvres that Z was prepared to engage in to raise the necessary funds, his plan for a caravan park seemed to be a plan for a bona fide commercial venture. On balance, I am prepared to accept that B and L regarded it in that light, but they come perilously close to failing to satisfy the onus placed upon them by sec. 190(b) in the face of the Commissioner's resort to sec. 260.

9. Having set out the facts and indicated my conclusion about the attitude of the taxpayers at the time of entering into the proposal, I turn

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now specifically to each of the reasons put forward by the Commissioner for refusing a deduction under sec. 51 for site rental and management fees (both prepaid for five years), lease rental of caravans and interest on borrowed money. The Commissioner argued that ``the expenditures were not incurred by the partnership in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income''. On the evidence at the hearing there was nothing to suggest that the partnership carried on any business after transferring the concreting business to a trustee on 12 October 1977. However, whether or not it did carry on business does not really matter, in view of my conclusion in the preceding paragraph. In the 1978 year the partnership received $2,125 from Tourist as guaranteed minimum income under the management agreement and amounts were also received in the subsequent year. The agreements with Holiday and Tourist were arm's-length agreements and the receipts by the partnership were in my view income falling under sec. 25(1). It follows that, short of the whole arrangement falling foul of sec. 260 or being designated a fiscal nullity or a sham, the outgoings are deductible under the first limb of sec. 51. There was no prohibition before 19 April 1978 on the deductibility of prepaid expenses in the year in which the outgoing was incurred. After that date Subdiv. D of Div. 3 of the Act virtually ruled out such deductions but as the cheques were handed over by B and L on 29 March 1978, and the related agreements were dated 30 March 1978, Subdiv. D does not apply in this case. What is important is that the liability for the outgoing had, as it were, settled (
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 ). Under the agreements Holiday could demand payment of fees for the full five years, and did so demand, and consequently the liability fell due and the outgoings were incurred in the tax year in question.

10. The matters of sham and fiscal nullity can be disposed of quickly. There is nothing here that can be designate sham in the light of the ``meaning in law'' of the word accepted since the decision of Diplock L.J. in
Snook v. London and West Riding Investments (1967) 2 Q.B. 786 . Nor do the facts depict a ``circular game'' with the taxpayers in the same position at the end as they were at the beginning, save for some claimable tax deductions. The decisions of
W.T. Ramsay Ltd. v. I.R. Commrs (1979) 3 All E.R. 213 and
Furniss v. Dawson (1982) S.T.C. 267 are not relevant here even if they are applicable in Australia, a matter that is now in much doubt as a result of the Federal Court decision in
Oakey Abattoir Pty. Ltd. v. F.C. of T. 84 ATC 4718 and the decision of Connolly J. in the Supreme Court of Queensland in
Law v. F.C. of T. 84 ATC 4618 . It is, however, not possible to dismiss sec. 260 quite so easily. In the first place here we have taxpayers incurring expenditure in one tax year and receiving guaranteed income plus a possible payout figure after three years and possessed at that point of a significant equity in two caravans. The Board did not get sufficiently precise evidence to conclude that the expenditure outflows and income inflows over three years, plus receipts from ``cashing'' the equity in the caravans at the end thereof, would approximately equate. But on the figures available it seems that the expenditure and the receipts could have been expected to be approximately the same. In these circumstances the arrangement becomes one that may be seen to be entered into primarily for the tax deductions to be achieved from expenditures that would be recovered in full. Here, as in Oakey Abattoir Pty. Ltd. (supra) ``it is impossible to suggest any business or commercial justification, from the taxpayer's point of view, in the prepayment of five years' interest'' (at p. 4723). The interest in that case is analogous to the site rentals and service fees here, and the prepayment of the interest was a factor in the Full Federal Court finding against Oakey Abattoirs under sec. 260. However, in that case the prepayment of interest was not of itself sufficient to invoke sec. 260 and I have concluded that the prepayments by B and L are similarly insufficient to cause the arrangement to be annihilated by sec. 260. The intention of tax saving was clearly present - and both taxpayers readily conceded this - but the arrangement had considerably more commercial reality than was apparent in, for example,
Cridland v. F.C. of T. 77 ATC 4538 and, as already indicated, I accept that these taxpayers were naive and, as a result of that, did consider that they were entering into a bona fide commercial venture with decided tax benefits. It seems to me the present state of the law regarding the invoking of sec. 260 is well

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put in the following paragraph from the decision in Oakey Abattoir (at pp. 4729-4730):

``If there were no more to the case than the payment of interest on the notes, we would be disposed to agree with the appellant that, in accordance with the reasoning in Cridland, the motives of the taxpayer are not sufficient to entitle the Commissioner to invoke sec. 260. But we think that the present case should be viewed with the wider perspective that the payment of interest was merely one step in a circuitous series of transactions which bore `ex facie the stamp of tax avoidance' (
Gulland v. F.C. of T. 84 ATC 4587 per Bowen C.J.). To borrow the language of Bowen C.J. in Gulland (supra) this taxpayer did not merely, as in Cridland, `create a situation by entry into a transaction' to attract particular tax consequences. Given its complexity, its artificiality, its circular operation and its sole purpose of avoiding liability to tax, the arrangement in this case goes well beyond mere entry into a transaction such as a university student buying units in a trust. In our view, sec. 260(1)(c) is applicable to such an arrangement.''

It will be apparent from the above reasons that I find sec. 260 cannot be applied in these references for much the same reasons as were sufficient to avoid the section in Cridland's case . It follows that the partnership of B and L is entitled to deductions for site rental, service fees, lease rental of caravans and interest on borrowings.

11. Turning to the claimed investment allowance, $6,680, the deduction must be considered in terms of sec. 82AA which reads:

``... this Subdivision applies in relation to a unit of eligible property acquired or constructed by the taxpayer that is -

  • (a) in the case of any taxpayer, for use by the taxpayer wholly and exclusively -
    • (i) in Australia; and
    • (ii) for the purpose of producing assessable income otherwise than by -
      • (A) the leasing of the eligible property;
      • (B) the letting of the eligible property on hire under a hire-purchase agreement; or
      • (C) the granting to other persons of rights to use the eligible property.''

In sec. 82AQ(1) ``eligible property'' is said to mean ``plant or articles within the meaning of section 54''. In sec. 54 the plant or articles must be ``owned by a taxpayer and used by him during that year for the purpose of producing assessable income'' or must be ``installed ready for use for that purpose and during that year (be) held in reserve''. It will be recalled that a witness said one of the caravans leased by I.A.C. to B and L on 10 April 1978 was delivered by him in February and parked between Z's house and the river. The second caravan was delivered and parked in approximately the same location on 20 April 1978. It will also be recalled that the caravan park did not open until 18 December 1978 and there was no evidence at all of the date on which either caravan was placed on a site leased from Holiday by B and L. On the very vague evidence as to progress with the physical development of the park it is most unlikely that either caravan was on its allotted site before 30 June 1978 and until it was so located it could not by any stretch of imagination be said to be ``installed ready for use''. It is not possible to argue that a plant item can be installed ready for use when it is not positioned on the taxpayer's land where it can be used. This failure of the caravans to satisfy the criterion laid down by sec. 54 effectively settles the claim for investment allowance. There is, therefore, no need to consider whether the caravans were used to produce income by granting the right to use them to other persons, which would preclude the investment allowance (
Tourapark Pty. Ltd. v. F.C. of T. 82 ATC 4105 ).

12. Finally for consideration is the question of penalty. B and L were each assessed for $3,470.39 as ``additional tax for incorrect return''. As indicated in para. 1 the Commissioner's representative conceded at the hearing that this amount should be reduced by $935.83 to rectify errors of calculation. Both partners claimed a partnership loss of $34 in the tax year in question and the imposition of a penalty on partners under sec. 226(2) when they have claimed a proportionate part of a

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partnership loss was considered at some length by my colleague, Dr Gerber, in Case Q23,
83 ATC 84 at pp. 106-107. He referred to three earlier cases heard by No. 1 Board ( Cases P120-P122,
82 ATC 604 ,
611 and 623 ) and concluded that a partner's claim for his share of a partnership loss is not a claim for ``expenditure incurred by him'' within sec. 226(2). The imposition of additional tax on a partner under these circumstances was, therefore, inappropriate. I am in agreement with that view, and, because there is no doubt that expenditure was actually incurred by the partnership, the Full Federal Court decision in
F.C. of T. v. Rabinov & Anor 83 ATC 4437 seems to indicate that the penalty should be removed. Even more persuasive is the decision of Fullagar J. in
F.C. of T. v. Sahhar 84 ATC 4167 which was an unsuccessful appeal by the Commissioner against the decision of No. 1 Board in Case P120, now reinforced by the decision of the Full Federal Court in that case on further appeal (85 ATC 4072).

13. The net income of the partnership of B and L for the year ended 30 June 1978 should be adjusted by increasing assessable income by $2,125 and by allowing deductions as follows: 

                                                  $

      Site rental in respect of caravans        4,000

      Service fees in respect of caravans      16,000

      Lease rents                                 781

      Interest on borrowings                      663

                                              -------

                                              $21,444

                                              -------

The taxable incomes of B and L should be reduced by their respective shares in the adjustment to partnership net income and additional tax imposed under sec. 226(2) is to be excised from both assessments.

Claims allowed in part

 

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