Federal Commissioner of Taxation v. Solling.Judges:
Supreme Court of New South Wales
These two cases, which have been heard together, relate to deductions claimed by each respondent pursuant to sec. 51(1) of the Income Tax Assessment Act 1936, as amended, for the financial year ending June 1977. Each claimed a deduction of the whole of the amount paid to a company, Beswar Pty. Ltd. (hereafter referred to as Beswar) for the leasing, agistment and management of certain sheep. Dr Solling claimed a deduction of $31,000 and Dr Pepper a deduction of $16,000. This meant that the total deductions to which Dr Solling claimed to be entitled amounted to $33,888, and deducted from his net partnership income of $40,354 gave a taxable income of $6,466. In Dr Pepper's case the $16,000 reduced his taxable partnership income from $20,308 to $4,308. The lease in each case was for four years and the whole of the amount of the fees charged by Beswar for leasing management and agistment over the full four year period - but discounted at 11.34% to allow for present payment - had been paid by each respondent just before the end of the financial year ending 30 June 1977.
The Commissioner in each case disallowed the deduction. The respondents then appealed to the Board of Review No. 3. In Dr Pepper's case [Case Q101,
83 ATC 495] the Board by majority allowed as a deduction the full amount of $16,000 claimed. In Dr Solling's case [Case Q102,
83 ATC 512] the Board by majority allowed a deduction of $9,040, being the amount of lease, agistment and management fee paid in 1977, according to the evidence then before the Board. This was in fact erroneous, $31,000 having been paid in that year (at p. 512). The Commissioner has appealed against both decisions and Dr Solling has been given leave in these proceedings to cross appeal.
The case has been a lengthy one, having taken 13 days of hearing and much evidence has been given. The evidence in this Court bears but a faint resemblance to that presented to the Board. Cross examination of witnesses by counsel for the Commissioner has been thorough, penetrating and exhaustive in regard to all aspects of the transaction giving rise to the proceedings.
The evidence discloses that the sheep leasing arrangement entered into by the respondents was devised by a Mr Warburton, an accountant, practising at Bathurst. He was managing director from 1974 of Beswar and also managing director of another company, Mana Holdings Pty. Ltd. (to which I shall refer as ``Mana'') which, through his actions took a prominent part in the transaction. According to Mr Warburton's evidence, the scheme was one intended both to produce income for such lessees as could be persuaded to become involved and also to provide substantial funds for the owners of the land on whose property the sheep were running. There were, according to Mr Warburton's evidence, to be many lessees who would pay the lease fees, preferably in advance, and thus provide immediate funds in large amounts for the properties selected to participate in the scheme, these funds being treated as income spread over the period of the lease (
Arthur Murray (N.S.W.) Pty. Ltd. v. F.C. of T. (1965) 114 C.L.R. 314).
So far as the present proceedings are concerned, the sheep leased were running on two properties - Sylvia Vale near Bathurst, the property of the Sinclair family, and Wattle
ATC 4520Grove, near Oberon, the property of the Humphries family. Two other properties were also brought into the scheme, one ``Myalla'' at Woodstock and the other ``Allomby'' at Blayney. Beswar had been acting as trustee and manager of the Sinclair property since 1974. When Mr Humphries decided that he would lease his sheep, Beswar arranged to become trustee for the Humphries family and thus became the lessor of the sheep.
The evidence shows that Dr Solling's accountant, Mr Cameron, dealt with Mr Warburton in regard to all relevant aspects of the scheme and passed on to Dr Solling the information which he received as to the nature and purpose of the scheme. Mr Warburton was Dr Pepper's accountant and Dr Pepper dealt directly with him in regard to entering into the lease. Mr Warburton dealt directly with Mr Sinclair and Mr Humphries, so far as their co-operation in the scheme was required. The evidence shows that Mr Warburton also dealt with other lessees involved in the scheme and there were, it seems, 11 lessees of sheep on the Sinclair property and 11 also on the Humphries property.
The Commissioner, in his attempt to establish that the sheep leasing arrangement was one directed to tax avoidance and not commercial gain, has sought to rely upon the entirety of the scheme and the purposes which it discloses not only in regard to Dr Solling and Dr Pepper but also in regard to the Sinclair and Humphries families. On the Sinclair property Dr Solling was the only lessee of Beswar but there were also ten other lessees running sheep who were sub-lessees of a lessee of Beswar, namely Chameleon Livestock Pty. Ltd., a company of which Mr Warburton was a director. 3,145 sheep were involved in the leases. On the Humphries property there were 11 lessees, eight from Beswar and three from Chameleon. All or most lessees or sub-lessees of Beswar paid their lease fees in advance (Affidavit of Mr Warburton 7 May 1985 cl. 18 and 20. Transcript p. 243). It is therefore necessary at this point to refer to the evidence showing how the sheep on the properties, Wattle Grove (Humphries family) and Sylvia Vale (Sinclair family) became available for leasing to the respondents and the part which Mr Warburton played in the transaction under consideration.
Mr Warburton, the evidence shows, had been closely associated throughout his life with farming and grazing and his practice as an accountant brought him into contact with many farmers and graziers. He had been raised on his father's grazing property at Millthorpe near Orange. Two thousand sheep were at all times running on the property, and fat lambs and wool were of course produced.
So far as the Sinclair property, Sylvia Vale, is concerned the evidence shows that it was owned by a company, Abenger Investments Pty. Ltd. and the members of the Sinclair family were shareholders in that company. A family trust for the Sinclair family using the name Sylvia Vale Pastoral Co. had been established in 1974 and Beswar Pty. Ltd. (of which Warburton was director) trustee. The lambs bred were cross-bred from Merino ewes. The evidence discloses that probably about the end of 1976, Mr Sinclair was interested in purchasing another property for his son and in fact Mr Warburton accompanied him on inspection of other properties at times.
The evidence also showed that the Humphries family was in considerable financial difficulty in early 1977 and that the bank was pressing for a sale of portion of the property to discharge the family's indebtedness. Mr Warburton, who was Mr Humphries' accountant, conceived a plan which he considered would result in capital being available to the families on each property to achieve their particular financial objectives. The scheme, so far as the Humphries family was concerned, required Beswar to become trustee of the stock on the property and also manage the same. The arrangement was as follows: each trust would enter into an agreement with certain persons to lease ewes for a period of four years with the total lease, agistment and management fees preferably being payable in advance. All bodily produce, natural increase and wool would be the property of each lessee. The lease, agistment and management fees, whilst paid in a lump sum in advance upon the signing of the lease documents, were to be brought to account as income by each trust over the period of the lease, namely, four years. In this manner each trust would receive a lump sum initially but account for it for tax purposes over the period of the respective leases. The lump sums so raised would be applied for the particular
ATC 4521purposes of the trust. The proposal, as originally formulated, included the proposition that the Rural Bank at Oberon would provide any finance required by lessees, but the evidence is that that bank was unwilling to provide finance unless the lessees transferred their business to the bank, and this was unacceptable. This, according to Mr Warburton, was the reason why finance was provided by his company, Mana Holdings Pty. Ltd.
The evidence discloses that in February 1977 Mr Warburton, in company with Mr Martin Humphries, had a long discussion with the manager of the Rural Bank at Oberon in regard to the proposed scheme. The details of the scheme were subsequently included in a letter from Mr Warburton to the Rural Bank, which is Annexure A to Mr Warburton's affidavit sworn 28 May 1984 (No. 704 of 1983), and as counsel for the Commissioner he relied strongly upon this document as indicating the purpose of tax avoidance. I set down the scheme as therein disclosed in so far as it was intended to overcome the indebtedness of the Humphries family:
``At present the family indebtedness amounts to about $120,000 secured by mortgage over the various parcels of land and a cottage in Oberon to the Rural Bank of New South Wales, Oberon Branch.
The present dilemma of the Humphries as I see it lies in choosing between two courses of action: 1. Sell the Oberon house and Portions 170 and 189 owned by Rudolph Victor Humphries - this would have an effect of reducing the debt to somewhere in the region of $60,000 to $70,000 when the consequent reduction in the stock numbers is effected.
The limitation inherent in taking this course of action is that the carrying capacity of the property is reduced, and the indebtedness is not sufficiently reduced to enable the property to operate under the current economic conditions with a sufficient level of profitability to service the remaining debt and make capital reductions. It could well be that if this course of action is taken, that the indebtedness would be somewhere in the areas of $100,000 again within say four to five years unless there is a substantial improvement in the rural economy.
2. The other alternative is as I see it for the family to do the following things:
- (a) For the family partnership now trading as `Wattle Grove' (Oberon) to dispose of its livestock and plant through an interposed partnership to a family trust to be instituted having as beneficiaries - Martin Dix Humphries, his wife and children.
- (b) For the family trust then to dispose of all of the cattle on the property and increase the flock of cross-bred breeding ewes to 4,000 and possibly 4,500 subject to climatic conditions prevailing.
- (c) For the trust then to enter into an agreement with certain professional people having high income to lease the livestock for a period of say three years with the total lease premiums of $120,000 being payable before 30th June 1977. The lessees would also be charged an annual management fee to cover as far as possible the costs of running the property.
- (d) Rental payable under the lease would be a deduction under section 51 of the Income Tax Assessment Act to the professional people in the year in which it is paid and the alleviation of provisional tax liability payable in the current year and the actual tax liability payable in 1978 together with the resultant effect of the provisional tax liability for 1979 would generate substantial cash flows for the professional men to meet their obligations under the lease.
- (e) All bodily produce, natural increase and wool would be the property of the lessees and by dealing with this through an interposed partnership with the lessees' family trusts, these amounts would in effect on transfer to the family trust become a capital receipt in the hands of the lessee. The beneficiaries of his or her family trust would of course pay tax on the proceeds, however at a lower rate than would be payable on the professional income of the lessee.
- (f) The lease payments even though paid in a lump sum in advance on the signing of the documents would be brought to
ATC 4522account as income by the lessor (i.e. the beneficiaries of the Humphries family trust), over the period of the lease following the principle established in the Arthur Murray case. In this manner, the income would be spread over the Humphries family and the minimum tax attracted, and in addition to this, there would be certain tax losses available to the Humphries in the first year to offset the income in that year.
- (g) Sell the house in Oberon. We understand that the proceeds of this sale plus recent livestock sales will reduce indebtedness to $100,000 or less.
- (h) It is considered possible that although the initial lump sum payment of the lease premiums would completely free the Humphries family from debt, it may not be possible to charge a sufficiently high management fee to cover the cost of running the property and the living costs plus taxation of the Humphries family. Therefore it may well be that they would be indebted to the bank to the extent of say $20,000 at the end of the lease period.
- (i) The next result should be that at the end of the lease period the Humphries family trust would own the livestock (although there would be a need to replace some of the ewes, due to age), and plant and that the properties would be still in the possession of the Humphries family and saved to the extent of the supplemental borrowing as discussed in the previous sub-paragraph which may be necessary if the management fees fall short of the required amount. In any case, if the debt amounted to say $20,000 it is a much stronger position than the existing $120,000.''
There was evidence that at the conference with the bank manager, just referred to, Mr Warburton had referred both to the tax deduction available and the variation of provisional tax, as the advantage to those lessees entering into the scheme, and to the necessity to have the proposal completed by 31 March 1977 - being the date from which assessments for that year might have issued with provisional tax being payable (sec. 221YDA). Mr Warburton denied that he had told the manager that the main concern of the doctors entering into the scheme would be tax saving.
The fundamentals of the scheme, as revealed by the evidence, were these:
(a) The setting up of a family trust.
(b) The use of the tax scheme, described by Mr Warburton as a ``double shuffle'', to avoid tax for the Humphries family on the disposal of the plant and trading stock. There was in existence a partnership between Mr Humphries senior and his wife and Martin Humphries (T [Transcript] p. 236). The proposal was that a partnership be formed between Beswar, as trustee of the Humphries family trust, and the several persons who had previously been in the partnership and the Humphries' interests would sell a substantial part of its interest in the stock to Beswar. The partnership would then be carried on in the sheep and cattle so that the stock was an asset of the business. Notices of election under sec. 26A(2) and 55AA of the Act would be given by both Humphries and Beswar. The partnership between Beswar and the Humphries' interests would be terminated. The Humphries' interest would then sell their remaining interest in the stock to Beswar and a further notice would be given under sec. 36A(2) and 59AA by Humphries and Beswar. Beswar, as trustee, could then grant the lease. This procedure enabled the livestock and plant to be transferred at their tax values (T p. 211).
According to counsel for the Commissioner, the next step was the marketing of the scheme to persons on high incomes who would, in Mr Warburton's view, get a deduction for the lease prepayment. Provisional tax would be varied and then the income of the lessee sheltered so that the lessee, by utilising sec. 36A(2) of the Act would get a capital receipt, as referred to in cl. (e) of Mr Warburton's letter to the Rural Bank just set out.
The evidence showed that Mr Warburton was active in attracting participants as lessees, that he found these through his own clients, through Mr Cameron, Dr Solling's accountant - who introduced Dr Solling to the scheme - and, inter alia, through his solicitor who also participated. A selling brochure explaining the scheme was prepared and distributed. He widened the scheme by involving the two other
ATC 4523properties, earlier referred to, ``Myalla'' and ``Allomby''.
So far as the Sinclair property is concerned, it appears that Mr Warburton first raised the question of the sheep leasing arrangement with Mr Sinclair about April 1977 and he related it directly to the opportunity which it presented to Mr Sinclair to obtain the capital to purchase another property.
So far as Dr Pepper was concerned, Mr Warburton approached him directly in the early part of 1977 and induced him to enter the scheme. In all, some 28 persons participated in the scheme as lessees. I shall refer later to criticisms made by counsel for the Commissioner of the claim made by Mr Warburton and Mr Sinclair - that the purpose of the scheme, so far as it affected Sylvia Vale, was to assist Mr Sinclair to purchase another property for his son and the claim made by Mr Warburton and Mr Humphries that so far as Wattle Grove was concerned the lease was entered into to enable Mr Humphries to overcome his indebtedness to the Rural Bank. But it is convenient now, against this background, to consider what the evidence discloses so far as the entry into the leases by Dr Solling and Dr Pepper was concerned, and I now set out my findings in that regard:
- (1) Each respondent entered into a lease agreement whereby each leased a number of ewes; 400 Merino ewes in the case of Dr Solling and 206 first cross-bred ewes in the case of Dr Pepper. It was the understanding of each of the taxpayers that the ewes leased were prime breeding ewes and this they were, but neither Dr Solling nor Dr Pepper realised that as many maiden ewes would be leased as was in fact done. Maiden ewes are ewes one and a quarter to two years old - two teeth. Their lambing rates, particularly in the case of Merinos, are considerably lower than older ewes. Their wool, however, is better and their lambing capacity improves as each year goes by (T p. 101). Maiden Merino ewes have a lambing rate as low as 66 to 70% according to Mr Sinclair (T p. 94) who said that Mr Warburton had mentioned 100% (T p. 95). Mr Warburton could not recall this. Mr Humphries said that of the sheep (cross-breds) leased on his property half would be maiden, and no more than 100% would be expected (T pp. 155, 168). Mr Aubin thought the rate could be only 80% (T p. 187). It appears that Dr Solling (and probably Dr Pepper too) was not aware until the Board of Review hearing of the relationship of maiden ewes to the low lambing rate which occurred (T p. 19). Mr Cameron was surprised to learn that maiden ewes had been leased (T p. 55).
- (2) Each lease was expressed to be for a period of four years and each respondent has sworn that he intended to hold this lease for the full four years. Each lease is dated 24 June 1977.
- (3) The lease gave to the lessor the option of requiring the lessee to pay the lease fee, agistment fee and management fee (all of which were the same in amount) in one of two ways, namely, four annual payments, the first immediately and the other three yearly thereafter or an immediate payment of the sum of those annual payments but discounted at 11.34%. This meant that in Dr Solling's case, four annual payments of $9,040 or an immediate payments of $31,000. In Dr Pepper's case it meant four annual payments of $4,654 or an immediate payment of $16,000. Each respondent was called upon to pay, and did pay, lease agistment and management fees in advance for the four years. As to Dr Solling, this amounted to $31,000 and, in the case of Dr Pepper, the sum was $16,000.
- (4) Further, under the lease conditions, the management of each respondent's interests were placed in the hands of Beswar. Neither respondent had any association with Beswar prior to entry into the lease. Beswar was owned and controlled by Warburton, who was also a director of the company. Dr Solling did not know Warburton - Dr Pepper knew him well - he was his accountant. The terms of the management, inter alia, called for Beswar to supply rams and sell the progeny and wool from the ewes and thereafter, to account for the proceeds to each respondent.
- (5) In the case of Dr Solling, his ewes were depastured at Sylvia Vale. The animals on the Sylvia Vale property, including the ewes leased by Dr Solling, were owned by Beswar. Beswar so owned the animals as trustee of a trust for the benefit of the Sinclair family and traded in relation thereto
ATC 4524under the style ``Sylvia Vale Pastoral Co.'' as earlier set out. There were over 7,000 sheep at Sylvia Vale.
- (6) In the case of Dr Pepper, his ewes were depastured at Wattle Grove. The Wattle Grove property was owned by two members of the Humphries family but a trust was set up under which Beswar became trustee. Beswar leased the animals as trustee of a trust for the benefit of the Humphries family and traded in relation thereto under the style ``Wattle Grove (Oberon) Pastoral Co.''. There were some 4,000 to 4,500 sheep on Wattle Grove.
- (7) In the case of the respondents, as was the case with other lessees not parties to these proceedings, the leased ewes were tagged so as to identify them as belonging to their respective lessees.
- (8) In the case of Dr Solling, as matters transpired, his 400 Merino ewes produced 240 lambs in the first 12 months of the lease. All of these were sold and the proceeds of sale accounted to him at the end of June 1978 on a pro rata basis of all sales of lambs on the Sylvia Vale property during the 12 months July 1977 to June 1978. Additionally, wool was clipped from the 400 ewes and this was sold; again, the proceeds were accounted to him at the end of June 1978, similarly pro rata. The total amount received was $5,562 but no dissection of this amount to show how much for wool and how much for progeny was made. Dr Solling returned the proceeds of lamb and wool sales in his assessable income for the year of income ended 30 June 1978. The above-mentioned proceeds were accounted for towards the end of June 1978.
- (9) In the case of Dr Pepper, as matters transpired, his 206 ewes produced 115 lambs in the first 12 months of the lease. All of these were sold and the proceeds accounted to him at the end of June 1978 on a pro rata basis of all sales of lambs on the Wattle Grove property during the 12 months July 1977 to June 1978. Additionally, wool was clipped from the 206 ewes and this was sold; again the proceeds were accounted to him at the end of June 1978, similarly pro rata. The total amount received was $2,558 but again no dissection was made. Dr Pepper returned the proceeds of lamb and wool sales in his assessable income for the year of income ended 30 June 1978. The above-mentioned proceeds were accounted for towards the end of June 1978.
- (10) Each respondent before entering into the lease made enquiries as to the efficacy and financial aspects of the arrangement. This was done both directly and through the agencies of their accountants. Each was satisfied in this regard. It is important to see this aspect of the matter by reference to the actual evidence given and I shall deal with that as a separate matter shortly.
- (11) Each respondent at the end of June 1977 borrowed money from Mana Holdings Pty. Ltd. to finance his involvement in the arrangement. In the case of Solling, this was $31,000 and, in the case of Pepper, $12,000. Dr Pepper also contributed $4,000 of his own funds. The loan in each case was for two years. The evidence is that on 30 June 1977 Dr Pepper received $12,000 from Mana and paid $16,000 to Beswar; Dr Solling received $31,000 from Mana and paid it to Beswar, on 30 June 1977. The rate of interest was 13% which was a normal commercial rate.
- (12) Neither respondent had any association with Mana Holdings prior to the borrowing made by him in relation to the arrangement. Mana Holdings was owned and controlled by Warburton, who was also a director of the company.
- (13) Each respondent complied with the terms of his borrowing from Mana Holdings, both as to payments of interest and repayments of principal. In the case of Dr Solling the loan of $31,000 was made at the end of June 1977 but the written agreement was not executed until 14 November 1977. Interest, owing from June to November of $1,697.17 was added to the principal for the purposes of the loan, which was thus in the amount of $32,679.17. Interest was at the rate of 13%. Dr Solling paid monthly instalments of $1,500 from November 1977 to June 1978, i.e. $12,000. He later in April or June 1979 (T pp. 37, 87) received a refund of interest of $2,750 arising from the fact that the agreement had been terminated in June 1978. In the case of Dr Pepper, there was no written loan
ATC 4525agreement for the $12,000 borrowed and the arrangement was that Dr Pepper need not pay instalments until he received proceeds. This arrangement, it appears, was made with a number of other lessees. On 30 June 1978 Dr Pepper paid $1,000 off the principal of the loan and $1,560 off the interest, i.e. $2 more than the amount which he had received as income under the lease viz. $2,558.
- (14) Each respondent, according to his evidence, perceived sound commercial reasons for agreeing to terminate the arrangement after 12 months. The termination was effected by an assignment by each, for consideration, of his interests under his lease, to Mana Holdings. The consideration received by each respondent upon assignment was calculated at 75% of the value of his leasehold interests. The consideration received by the respondents was not in cash by way of a set-off against their outstanding indebtedness to Mana Holdings. Mana then sold its interest in each leasehold to Beswar. Although the agreement did not, in law, come to an end until after 30 June 1978 it ``terminated'' as far as Mr Sinclair and Mr Humphries and Dr Solling and Dr Pepper were concerned at the end of June 1978. I shall refer shortly to some aspects of the evidence in regard to termination.
- (15) The effects of the termination of the arrangement on the respondents was to leave each out of pocket; leaving aside any adjusting benefit for tax deductions.
Mr Cameron, Dr Solling's accountant, claimed that Dr Solling lost in all $3,688 (T p. 45). This figure was computed on the basis that Dr Solling had paid eight instalments of $1,500 and received back $5,562 in income and $2,750 as a refund of interest overpaid when the leasing arrangement was terminated. Dr Pepper put in $4,000 of his own money, paid $1,560 interest and $1,000 principal off the loan making a total of $6,560 and received income of $2,558 leaving an amount of $4,002 loss.
Let me now deal with the extent to which it has been shown by the respondents that each, bona fide, entered into the arrangements intending to receive commercial profit therefrom and not for the purpose, or dominantly for the purpose, of tax avoidance. It will be convenient to deal with Dr Solling's case first but many of the conclusions arrived at are equally applicable to Dr Pepper.
Dr Solling had lived in the Bathurst district for 22 years and had experience in primary production activities, namely stud pony breeding for some 12 years. He was well acquainted with the property, Sylvia Vale, was on friendly terms with Mr Sinclair and knew him as an experienced, competent farmer and grazier. His object, he said, in going into the project was to generate further income because he was faced with the situation of looking forward over many years to heavy expenses in regard to the education of his children. Two of his children were soon to enter the university and a younger son and daughter were about to commence senior school. His accountant, Mr Cameron, obtained the details of the scheme designed by Mr Warburton and also Mr Warburton's projections as to the profit that could be obtained therefrom; these are contained in Annexure A to the affidavit of Mr Warburton sworn 28 May 1984 (No. 705 of 1983). The evidence of Mr Warburton is that these projections were made by him in March (or April) 1977 (T pp. 194, 199) and Mr Cameron, and other evidence, confirms this. The evidence shows that these projections were put forward by Mr Warburton after he had made fairly extensive enquiries amongst valuers and graziers including Mr Sinclair and Mr Humphries and consulted journals and newspaper reports in regard to prices for wool and fat lambs and also in regard to lambing rates. The projections which related indifferently to both the Sinclair property and the Humphries property (and presumably the other two properties involved) were as follows:
Livestock leasing - financial aspects
$ 1 Lease Payment - based on capital recovery to lessor (grazier) of $4 per annum plus interest factor if paid annually: discounted for prepayment to $3.75 per annum by 4 years. 15.00
$ 2. Agistment - based on 8 cents per week per lamb raising ewe plus interest factor if paid annually; discounted for prepayment to $3.75 per annum for 4 years. 15.00 3. Management Fees $ Year 1 - no discount 14.00 Year 2 - $14 less $1.10 12.60 Year 3 - $14 less $2.80 11.80 Year 4 - $14 less $4.60 9.80 49.60 ----- ------ $77.60 ------ Projected results Pessimistic Probable Optimistic Wool proceeds per head 10 12 15 Lamb proceeds per head 12 17 20 Lambing rate 100% 125% 140% Wool sales 10 12 15 Lamb sales 12 21 28 -- -- -- 22 33 43 Agistment, lease and management Annual basis 22.60 22.60 22.60 Projected profit (loss) (.60) 10.40 20.40 On discounted prepaid basis average annualised outgoing is 19.40 19.40 19.40 Projected profit (loss) 2.60 13.60 23.60
Dr Solling discussed these with Mr Cameron and took his advice thereon. He discussed prices and prospects with his brother, who had been a grazier all his life. He visited the property, Sylvia Vale, on some occasions and discussed the condition of the animals and like matters, both with Mr Cameron and Mr Sinclair. He regularly paid his interest and capital obligations under his loan agreement with Mana Holdings as I have earlier detailed.
Mr Cameron, his accountant, came forward and supported substantially what Dr Solling said. A number of persons - Mr Aubin, a grazier, registered valuer and retired stock and station agent, Mr Sinclair, Mr Humphries, Mr Johnson, a stock and station agent and grazier, all gave evidence on the matter of prices that might have been expected for fat lambs and wool and details of lambing rates, and although their evidence is not entirely identical in all respects, and although it conflicts in some respects with details of sales put to them by counsel for the Commissioner, it does nonetheless establish to my satisfaction firstly that the lease agistment and management fees established by Mr Warburton are properly based, and are appropriate to the sheep leasing arrangement and secondly that Mr Warburton's projections, as set out in Annexure A, can in no sense be said to have been wholly unrealistic. One cannot close one's eyes to the fact that Mr Sinclair and Mr Humphries quite plainly
ATC 4527entered into this scheme expecting that it would result in considerable injection of capital and they undoubtedly thought that it would work. The very fact that two experienced graziers obviously thought that there would be worthwhile returns has a significant bearing upon the view which the Court should take in regard to the motives of Dr Solling and Dr Pepper.
A brief summary of the evidence as to lambing rates and sale prices is as follows: putting to one side lambing rates for maiden ewes, which are conceded to be lower, the evidence of Mr Sinclair was that the lambing rates of Merinos were 90-100%. For the cross-bred ewes, non-maiden, it is up to 120%. Mr Humphries put it at 100% for ewes up to two years, and thereafter between 145% and 150%. Mr Aubin put it at 120%, maiden ewes aside. Mr Warburton's feasibility study took a range of 100-145%. Mr Cameron, I would mention, claimed that he ``had words'' with Mr Warburton later about the lambing not measuring up to 100% as he, Mr Warburton, had promised (T p. 56). So far as the wool yields and prices were concerned, Mr Aubin gave evidence that the kilogram yield per ewe can be expected to be between 4.6 kg and 5 kg, with more for Merino ewes. Humphries gave a yield per ewe of between 4.5 kg and 5.5 kg. Taking the average of these yields (5 kg), the wool yield in dollars in 1977-1978 could have been expected to be in the order of $11 plus per fleece, with more for Merino ewes. Mr Warburton's feasibility study showed $10 to $15. In regard to lamb prices, the evidence of Messrs Aubin, Johnson, Buchanan and Humphries indicates that a range of lamb prices between $15 and $30 could have been expected during 1977-1978. The evidence discloses that such figures would depend very much upon whether the lambs were fat lambs or store lambs, the extent of the market demand, the time of sale and other factors. Sale prices of lambs present a difficulty from the point of view of seeking to ascertain what might have been expected from sheep leasing, but bearing in mind that the lambs to be sold were to be sold as fat lambs, there seems to be no reason why one should not conclude that $15 to $20 at least could be expected. Mr Johnson gave evidence to this effect. Mr Warburton's feasibility study referred to $12 to $20.
Mr Warburton took the view, and this was passed on to the respondent Dr Solling, that the profit generated should be not less than $1,000 a year and could be as high as $9,000 per year. These figures can be extracted from the projection put forward by Mr Warburton, which have earlier been set out. If one takes 400 ewes at $35 per lamb and wool and adds an additional 40% to the lambing figure to give 140% lambing, one reaches a figure of $17,200 per annum. If one allows $3,750 from each of the two years interest involved, one has a figure of about $13,550 and, allowing for taxation, the ultimate figure of profit involved could be $9,000 or more. The figures were, however, too optimistic and although it may have been possible in some sales to have produced the results which were set out, the overall effect of the evidence is that they were too high as figures from which to see the real commercial worth of the venture. A cardinal factor in the overstatement of the likely profit in these projections was the fact that they did not allow for any appreciable number of maiden ewes which, as I earlier said, do not give high lambing results until they pass their two tooth stage. Counsel for the Commissioner has pointed to the evidence of actual sales and lambing results in the period before the agreement was entered into and from that has been able to contend that on those prices little commercial worth ought to have been expected from the agreement, certainly in the first year.
However, if one puts to one side the fact that, particularly in Dr Solling's case, attention was not paid by Mr Warburton or the taxpayer to the significance of maiden ewes, the figures stand up tolerably well. This conclusion applies also in the case of Dr Pepper. It is to be mentioned that both Dr Solling and Dr Pepper conceded that they did not allow for the mortality rate in lambs although there is evidence that Dr Pepper understood that the flock itself would be kept up to the number expressed in the lease. I would say at this point that there can be no doubt that both Dr Solling (T p. 15) and Dr Pepper were strongly influenced by the advantage, from the point of view of taxation, of being able to make an immediate deduction of the whole of the lease fees payable in advance and I would also say that there is no question, in my mind, that the variation of their provisional tax was an integral part of the overall scheme. The evidence
ATC 4528disclosed that even before Dr Pepper signed the leasing agreement or made any real inquiries about the likely success of the venture he arranged for application to be made to vary the provisional tax assessed by an amount which included the $16,000 which in fact became payable as lease fees. The application was made on 2 May 1977. In Dr Solling's case an application for refund of part of the 1977 provisional tax was lodged about the middle of July 1977 and again it sought to reduce the provisional tax by an amount which included the full amount of the prepaid lease fees. One would be naive to believe that the fact that the transaction permitted a notice calling upon the taxpayer to pay out in advance the whole of the lease etc., fees payable under the agreement, and that this transaction came into existence just before 30 June 1977 in each case was not specifically related to the element of tax advantage from the scheme. Counsel for the Commissioner submitted, and correctly, that one can perceive a flurry of activity in those closing days before the end of the financial year in each case. To an extent Mr Warburton and the respondents sought to play down the significance - unsuccessfully so far as I am concerned - in their minds, of the tax advantages, but this does not necessarily have the consequence that it should be held that they did not, bona fide and with reasonable grounds, anticipate a worthwhile and not merely illusory commercial return from the venture.
The loan agreement between Dr Solling and Mana Holdings showing a loan of $32,679.17 is plainly, as between the parties, a genuine document and it is clear that Dr Solling sought and took the advice of his accountant, Mr Cameron, on the question of finance. The rate of interest charged, 13%, was an ordinary commercial rate having regard to the security which it offered to the lender, and of course it is not surprising that, as the only security which the lender required was over the lease and the respondent's interest in the sheep, this was a considerable attraction. Land is usually required as security, as Mr Cameron pointed out.
An attempt was made by counsel for the Commissioner to suggest that the amount of the loan (which equalled the total of the lease, agistment and management fee discounted) was designedly related to an income level where tax would, from a practical point of view, be insignificant (Exhibit AS). There cannot, as I have earlier said, be any doubt that the tax advantage was seen by both Dr Solling and Dr Pepper to be considerable but that fact cannot of itself, in the present case, deprive the agreement of commercial reality nor prevent a finding that both respondents were telling the truth from the witness box as to their intentions in entering into the scheme. They can be criticised, as counsel for the Commissioner has criticised them, for not having looked more closely than they did at the matter of prices and lamb numbers and the difficulty that would arise if the drought worsened, and it may well be said that they went into the matter with a lighthearted disregard for the very real hazards affecting profitability. But then, so many commercial enterprises are undertaken with unwillingness to accept that the risks that are there will actually eventuate.
The termination of the agreement before the conclusion of the following year, that is 30 June 1978, has been pointed to by the Commissioner as a feature indicating that the true purpose of the agreement was tax advantage and not commercial enterprise generating worthwhile income. But this overlooks a substantial body of evidence which points to the venture having failed for a number of reasons. Dr Solling had only acquired 240 lambs from the 400 Merino ewes which he had leased. The drought conditions and the general rural conditions had not picked up as had been hoped at the outset and the future certainly provided little reason for belief that the scheme would be a success. The drought appeared to have ``set in''. Anticipated sale price increases had not occurred. The evidence is that Dr Solling took advice from his accountant, Mr Cameron, and also from his brother - who, as I have earlier said, had been a grazier all his life - as to whether he should go on with the lease. He was considerably influenced in coming to his decision by the fact that his brother, whose property admittedly was in another area, was greatly concerned about the drought and had decided to sell up his farm. Once again it can be said that, looking back with hindsight, the income return which Dr Solling received under the lease was as much as probably could reasonably have been expected if all relevant considerations had been given their proper weight before entering into the scheme, but that is as much as can be said. It
ATC 4529does not displace a finding that Dr Solling genuinely saw profit in the undertaking when he signed the lease. The evidence (T p. 223) suggests that shortly before the middle of 1978 Dr Solling and Dr Pepper would have become aware that the Commissioner intended or might be intending to refuse to allow the deduction of the amounts prepaid, and one would again be naive not to recognise that this would have made the future of the venture to appear even more dismal in their eyes. The minutes of Mana Holdings of 5 July 1978 (Exhibit 5SP) refers to the Commissioner's attitude. The undeniable fact is that Dr Solling received from Beswar income from the sheep leased of $5,562 and paid tax upon this amount, and that each month he paid $1,500 off the loan he had received from Mana Holdings.
Turning to the evidence relevant to Dr Pepper's entry into the leasing agreement, once again it is not a factor of insignificance that the doctor had lived and practised in the Bathurst area for 30 years until he moved to Hornsby in 1983. He had an 18 acre property near Bathurst and had had experience with fruit growing and the running of cattle and sheep in a small way. Mr Warburton had been his accountant for many years and it should be said at the outset that the evidence makes plain beyond question that Dr Pepper placed great reliance upon Mr Warburton's advice in financial matters. The scheme was first put to him in March 1977 by Mr Warburton. When it was told to Dr Pepper that the sheep were on the Humphries property, Wattle Grove, Dr Pepper was able to state that he knew the property well and that it was ``certainly in a good area''. In May 1977 Mr Warburton discussed with him the projections he had calculated. Dr Pepper, however, made independent inquiries from Mr Aubin, Mr Johnson (to whom I have earlier referred) and Mr Buchanan, a grazier of 50 years' standing in the Bathurst district. Each one can be said to have confirmed Dr Pepper in his expectation that the lease was a worthwhile venture, and this goes a long way, in my view, to establish that Dr Pepper was looking at the matter from the point of view of commercial gain from the enterprise. I have no doubt that he made the inquiries about the Humphries family, which he says he did. He, like Dr Solling - and no doubt others - knew that there had been little rain but hoped that this state of affairs would alter. He, like Dr Solling with Mr Sinclair, regarded Mr Humphries and his father as ``good reliable farmers'' (T p. 125) and the property as ``one of the safest tableland areas'' for fat lambs in New South Wales (T p. 132). Mr Humphries Jnr suffered from a kidney complaint and had had a kidney transplant, which was rejected. He had been on a home dialysis three nights a week for ten hours a night. But there was no evidence that this should have influenced Dr Pepper's approach to the leasing of the sheep nor any evidence that it significantly affected Mr Humphries' ability to run the property - he had been running it for a considerable time and the evidence is that he is still running it.
The considerations which induced Dr Solling to borrow from Mana Holdings Pty. Ltd., to which I have earlier referred, are equally applicable to Dr Pepper. Dr Pepper has sworn (T p. 117) that there was in fact a written loan agreement - but this has never been produced. He gave an explanation that it may have been destroyed or lost when he and his wife moved from Bathurst to Sydney. Mr Warburton's evidence (T pp. 239-240) was that there was no such agreement, that the solicitors did not prepare it as asked. There can be no doubt, however, that Dr Pepper received a cheque from Mana Holdings in the sum of $12,000 on 30 June 1977 and that that amount was paid by him to Beswar. There is equally no doubt, and it is of the greatest significance, that he paid $4,000 from his own money to Beswar. There is evidence that he paid $1,560 for interest when Mr Warburton requested it at the end of June 1978, and also the sum of $1,000 principal. In my opinion, the evidence establishes affirmatively that there was an enforceable obligation between him and Mana that he would repay the $12,000 to Mana, although in his case (as with other lessees) the arrangement was that the payments were to be deferred until he received actual proceeds from the sale of wool and lambs. As Mr Warburton said, it was never contemplated that there would be no returns. So far as the termination of the arrangement in 1978 was concerned, once again it seems to me that the only proper conclusion from the evidence is that Dr Pepper, like Dr Solling, could see at the stage when only 115 lambs - just over 50% of the 206 ewes leased - had been produced that the returns received were not likely to be greatly improved on in view of the weather, the
ATC 4530drought and general depression in the industry (T p. 132). He had hoped for 250 lambs. I would reject the Commissioner's contention that either Dr Solling or Dr Pepper entered into the agreement on the footing or with the contemplation that it would be terminated before it had run its full course.
Counsel for the Commissioner has pointed to a considerable number of features in the evidence which he claims throw doubt upon the credibility of the claims made by the respondents. He claims that if Dr Solling was really interested to obtain income for education purposes, this was not the best way to achieve that result, that he made no really detailed inquiries about the commercial viability of the scheme, that he committed himself to the scheme before he had received the loan cheque from Mana, that he never did inquire whether Beswar owned the sheep or what the agreement between Sinclair and Beswar was, that there were other features he should have inquired into if he was really interested in the income to be gained from the sheep leasing, that he never took legal advice, that he knew that the area was in a drought declared area and that the rural industry was depressed. It was claimed on behalf of the Commissioner that if he really was looking at this project as a business returning income to him, he would not have shown such lack of interest as he did in the conduct of the business and the income it was producing and the matters which were affecting it and would affect it in providing him with an income. It was also pointed out that there was no written document finally terminating the arrangement, and that this was done merely by means of a phone conversation between his accountant and Mr Warburton yet the minutes of Mana Holdings (Exhibit 7SP) show an entry as late as 14 October 1979 referring to the acquisition of the leases by the lessor pursuant to a resolution of 30 September 1978. Counsel pointed to the fact that Dr Solling in his return claimed $3,470 for interest paid under the loan from Mana whereas Mr Warburton's records showed that $4,664 was paid (T p. 256). Counsel also contended that Dr Solling was aware of the fact that the loan which he received from Mana Holdings, the amount of which he immediately paid to Beswar, was then returned to Mana by way of loan but I am quite satisfied having seen Dr Solling in the witness box that he had no knowledge of this and is to be accepted notwithstanding what appears in the record before the Board of Review.
So far as Dr Pepper was concerned, submissions of the same nature were made in regard to his lack of credibility. It was pointed out that on Dr Pepper's evidence, he had arranged for the variation of his provisional tax and ``committed'' himself to prepayment of the lease fee before he even had the figures from Mr Warburton as to the feasibility of the proposal or the number of sheep involved. Great stress was laid upon the fact that no loan agreement between Mana and Dr Pepper for the sum of $12,000 advanced ever came into existence or was ever produced but I have already indicated that I am quite satisfied that Dr Pepper, on receipt of the cheque for $12,000 from Mana, knew full well that he was bound in law to repay the amount at 13% interest. It was pointed out that before the Board of Review Dr Pepper had little memory of conversations but seemed to be able to give much more detailed evidence now. In this regard it is not without significance that Dr Pepper said in his evidence (T p. 107) - and this was in no way challenged:
``I had a very poor memory. I was several months out of two heart operations when I was at the Board of Review. I was frail and my memory certainly was bad.''
Of course in considering the evidence of both respondents and the other witnesses, it must be borne in mind that they were deposing to events, circumstances and conversations which took place eight years ago, and the difficulty of remembering the details of a conversation or whether a conversation took place in March, April or May, or as the case may be, must be recognised when inconsistencies are relied upon. Counsel for the Commissioner likewise criticised Dr Pepper's evidence on the basis that he had shown little, if any, interest in the actual conduct of the sheep leasing operation and the details of the income which he received from it. He kept no books. In his case the loan was terminated orally by agreement between him and Mr Warburton, and the circumstances and reasons for termination were criticised as in the case of Dr Solling. Dr Pepper advanced the same reasons for being prepared to terminate as Dr Solling and my observations earlier made in that regard applies to Dr Pepper.
The submissions which have been made along these lines, in my view can properly be made but they do not, in my opinion, justify the conclusion that either respondent entered into this arrangement essentially for the purpose of the tax deduction. As I have said earlier, I am quite satisfied that the doctors saw the arrangement as one which, in their minds, achieved two important purposes from their point of view, namely worthwhile financial gain and tax advantage. The scheme was particularly attractive to a professional man because the generation of income and financial gain was in the hands of competent and experienced graziers who themselves had the greatest incentive to run their properties and manage their whole stock, including that leased, in the fashion most likely to give them the greatest financial gain. The evidence is all one way that all the sheep on the properties were treated or managed in the same way. It was not surprising, in my view, that the respondents would not have troubled themselves greatly as to the actual working and management of the sheep on the properties. They were closely cross-examined and, although there were inconsistencies, I formed the opinion that they were genuine in their assertions as to their intentions and further that the objective facts establish that their purposes in entering into the leases were as they claimed.
Having considered all the evidence on this aspect of the matter, the conclusion I have drawn is that the two respondents and Mr Warburton quite genuinely believed that there was real commercial gain to be had from entering into the lease, that each respondent did make genuine inquiry as to the likelihood of success of the venture before signing the lease agreement but that they did not make sufficient inquiry in depth as to the real situation in regard to prices nor take steps to guard against the low lambing rate of maiden ewes. I am satisfied also that both respondents took the optimistic view that although there had been little rain, this state of affairs would not continue. I am satisfied that the scheme failed to live up to expectations because its projected returns were too optimistic in any event, and because of the low lambing rate and the drought conditions and the general state of the rural industry.
The clear impression then which I have gained is that, so far as the respondents were concerned, they were, in entering into the leases, doing so in the belief that financial gain in a worthwhile amount would accrue to them and accordingly the question of deduction of the amounts prepaid for the leasing, agistment and management fees, should unless there are other factors, be viewed in no different light from a deduction claimed in respect of a business which has not lived up to commercial expectations.
The material which I have dealt with thus far relates essentially to the transaction looked at from the point of view of what Dr Pepper and Dr Solling knew and believed when they entered into the transaction. This was the general nature of the evidence put before the Board of Review. There is, however, in the case a great body of evidence relating to Mr Warburton's dealings with Mr Humphries and Mr Sinclair so far as their involvement in the overall lease scheme was concerned. Counsel for the Commissioner has submitted that there are many unsatisfactory features in this evidence which ought to be taken into account in considering the genuineness or otherwise of the sheep leasing agreements entered into by Dr Solling and Dr Pepper. The effect of his submissions is that Mr Warburton devised a scheme which involved the two doctors as well as many others, two other properties besides Mr Sinclair's and Mr Humphries' properties and that the whole scheme so devised was a tax avoidance scheme. The question is whether this evidence together with, of course, the evidence with which I have already dealt, should lead to a different conclusion from the one which I have just expressed.
It became apparent from the cross-examination of the respondents by counsel for the Commissioner that they knew little, if anything, about the arrangements which Mr Warburton made with Mr Humphries and Mr Sinclair in regard to the working of the scheme and its termination, and counsel for the Commissioner has sought to claim that when these aspects of the evidence are looked at, the conclusion should be drawn that the whole scheme was, from beginning to end, so far as it affected the respondents and the property owners, nothing more than a tax avoidance scheme.
In his affidavit sworn 7 May 1985 Mr Warburton said:
``18. Insofar as the said proposal involved the Humphries family trust and the property
ATC 4532at Wattle Grove, Oberon, eleven persons participated in the proposal. Of these eleven persons, eight persons participated on the basis that they paid leasing, agistment and management fees in advance. Three persons participated in the proposal as sub-lessees of a lessee of Beswar, namely Chameleon Livestock Pty. Limited. As between Beswar and Chameleon Livestock Pty. Limited, lease, agistment and management fees were paid on an annual basis. These three persons were Messrs Kelly, Williams and Stern.
The amount of money raised in terms of advance fee payments in relation to the Humphries family trust and the property at Wattle Grove, Oberon, was $175,320. I annex hereto marked with the letters `C', `D' and `E', respectively, true copies of the face and reverse of a deposit slip to the account of Beswar, folio 5 of the journal of Beswar as trustee of the Humphries family trust, and a copy bank statement for the Humphries family trust account for the period 24th June, 1977, to 1st July, 1977. These funds were disbursed as follows:$ (1) Rural Bank, Oberon 120,000 (2) Mana Holdings 41,250 (3) Neil Warburton & Co. 6,000 (4) Commercial Continental 8,000 Ltd. -------- $175,250 --------''
He then explained that $120,000 of the funds received were in fact paid to the Rural Bank at Oberon in discharge of the indebtedness of the Humphries family to that bank. $41,250 was paid by Beswar to Mana, representing the loan to Mana at call at 12%. $6,000 was paid to Neil Warburton & Co., the firm in which Mr Warburton was a partner, for professional fees, and the sum of $8,000 was paid by Beswar to Commercial Continental Ltd., representing a deposit on the short-term money market at 24 hours call. There is the fact, which cannot be ignored, that the Humphries family was in serious financial difficulty before the transaction was entered into, that the need to sell portion of this property was very great and that the financial arrangements made by Mr Warburton through Beswar resulted in a substantial amount of money being paid to the Rural Bank. The Humphries family has not been required to sell any part of their property.
So far as the Sinclair family was concerned, Mr Warburton's affidavit goes on in para. 20:
``Insofar as the said livestock leasing proposal involved the Albert Bruce Sinclair Family Trust and the property `Sylvia Vale', only one person, the respondent Solling, accepted my invitation to participate in the proposal on the basis of an advance payment of leasing, agistment and management fees. There were ten other lesses running sheep on the `Sylvia Vale' property but these were sub-lessees of a lessee of Beswar, namely, Chameleon Livestock Pty. Limited. As between Beswar and Chameleon Livestock Pty. Limited, lease, agistment and management fees were paid on an annual basis. The moneys paid by the respondent Solling to Beswar ($31,000) were loaned by Beswar to Mana Holdings, at call and at interest of 13 per cent per annum. I also refer to annexure `L' hereto. It was always my intention, as managing director of Beswar, that upon sufficient persons accepting my invitation to participate in the said proposal on the basis of advance payments of lease, agistment and management fees, that such advance payments, together with the advance payment made by Beswar, as trustee of the Albert Bruce Sinclair Family Trust, to fund the purchase of the further property referred to by me in paragraph 14 hereof. It was also my intention that upon sufficient persons participating in the proposal on an advance payment of fees basis, Beswar would call up its call loan with Mana Holdings ($31,000) and use the total funds in the purchase of the said further property.''
The evidence of Mr Warburton at p. 242 of the transcript shows the amount of money paid by way of prepaid lease fees (Exhibit 12SP specifies the individual lessees). The total amount paid in respect of the four properties involved in the scheme was $650,000. $243,000 (it may have been $233,000) of that was applicable to the Sinclair property and $220,320 was applicable to the Humphries property. All the leases were financed to a substantial extent by Mana, Dr Solling being the only one, however, who borrowed the
ATC 4533whole of his payment. Mr Warburton said that the lessees of Chameleon ``were not known to Beswar'' but this cannot be accepted as Mr Warburton himself was controlling both Beswar and Chameleon. The provisions of cl. 18 and 20 earlier set out of his affidavit are quite misleading when compared to Mr Warburton's evidence in the witness box (T. p. 240). He explained that loans were made by Beswar and Chameleon to Mana of the lease fees and so counsel for the Commissioner put to him that it was a ``round robin'' completed by Mana then lending the amounts required for prepayment of the lease fees. Exhibit 12SP shows that at the end of 1978 the amount still owing under the loans was $524,572.23. The evidence to which I have already referred shows that $175,320 was disbursed from fees received from the Humphries property, $120,000 being used to pay off the overdraft so that there can be no doubt that moneys from the scheme (Mr Warburton said $220,320 was referable to the Humphries property) were paid in the case of that property but the evidence nowhere discloses that the Sinclair property received any payment at all. Mr Warburton stated that it was always his intention that in future years the scheme should involve a great number of people who would make advance payments which would not be financed. This raises the question as to the extent to which Mr Humphries and Mr Sinclair were really aware of how this scheme operated. I have no doubt that they thought it was a real venture and yet they both, on Mr Warburton's persuasion, agreed to bring the scheme to an end.
One of the difficulties in the case is to understand how it could be said that it was in the interests of Mr Humphries and Mr Sinclair to agree to a termination of the arrangement, and I find no satisfactory answer to this question. Mr Sinclair and Mr Humphries have each given evidence before me that Mr Warburton discussed the matter of termination with them and that they agreed. I have no doubt that Mr Sinclair and Mr Humphries were prepared to be wholly guided by Mr Warburton. Counsel was able to demonstrate, for instance, that Mr Humphries was quite unable to give an explanation as to how Beswar came to be the owner of the sheep which were leased on his property, that is, he had no knowledge or understanding of that transaction involving the ``double shuffle'', which I have referred to earlier nor was he or Mr Warburton able to produce any partnership agreement, or other documentation in relation to it. But he and Mr Sinclair were in my opinion honest witnesses who both had the utmost faith in Mr Warburton. Mr Humphries said he had ``no choice'' in the matter of termination and that he did not inquire about it although he had to borrow $90,000 to pay out the lessees. Mr Sinclair also said (T p. 99) he had ``no choice''. Mr Sinclair stated that he did not ask Mr Warburton where the money that had been paid by the lessees had gone to and what advantage Sylvia Vale had got from it. 3,145 sheep were involved in the scheme. None of the participants in the scheme, Dr Solling or Mr Sinclair, Dr Pepper or Mr Humphries had any idea that the loans made by Mana for the sheep leasing payment, after being paid by them to Beswar was paid by Beswar as a loan to Mana. Mr Warburton in his evidence referred in a number of places to the ``conflict of interest'' which faced him arising from his being managing director of Beswar, the trustee of the properties in each instance and the lessees being his clients (in some cases). The evidence shows that Mr Warburton was instrumental in persuading all participants in the scheme to terminate their agreements at the end of June 1978. It is, in my view, not difficult to recognise that from the point of view of Dr Solling and Dr Pepper, the arrangement had not turned out the way they had anticipated, but why Mr Sinclair and Mr Humphries would not have sought to hold them (and the other lessees) to it over the ensuing three years until the agreement terminated is a real problem. Mr Warburton sought to suggest in his affidavit that he thought that one reason for the failure of the scheme in each case was the inability to find further lessees but this does not wholly accord with the evidence. According to Mr Sinclair his property had its full complement of lessees (T p. 99). Mr Humphries, however, could have taken more lessees (T p. 174). Another difficulty is to accept Mr Warburton's explanation in regard to Exhibit 13SP which is a document which was prepared by a clerk in his office and is dated 30 June 1979. It shows Dr Solling with an entitlement to wool of $3,200 and an entitlement to lambs of $4,800 totalling $8,000. Mr Warburton claimed that it was brought into existence to show how the lessees would have fared if the arrangement had not been terminated (T p. 247). Nor is there
ATC 4534any satisfactory explanation of Exhibit 5SP being a minute from the minute book of Mana stating ``that the lessors had expressed dissatisfaction with the arrangement particularly in view of the generally improving prospects present and long term for rural commodity prices''. Mr Humphries swore that Mr Warburton told him that the arrangement was not working out for him and Mr Sinclair said that he was very disappointed that the lessees did not want to go on with the arrangement.
It is not for the Court to speculate as to whether Mr Humphries of Mr Sinclair may have taken a different attitude to termination if they had been independently advised. There is no issue joined in these proceedings between Mr Humphries and Mr Warburton or Mr Sinclair and Mr Warburton. The evidence shows, I should also mention, that Mr Warburton obtained counsel's opinion, both on the question of deductibility of the lease fees if paid in advance and on the question of the consequences of termination of the arrangements. This latter opinion was a written advice which refers to termination as ``step 12'', and this could be taken to suggest that termination during the currency of the lease was part of the scheme proposed by Mr Warburton. The lease agreement itself specifically dealt with termination - cl. 14 - and provided that it might be terminated after it had been in force for six months. In that event, the lessee was to be reimbursed that proportion of the moneys advanced as was attributable to the unexpired portion of the lease. Mr Warburton denied that termination was intended to take place at the end of the first year. He said that counsel, in dealing with ``step 12'' - termination - was dealing with what he, Mr Warburton, described as a ``perceived risk not a predetermined step'' (T p. 215).
Taking all the evidence into account including the unsatisfactory features of Mr Warburton's evidence I nonetheless adhere to the view I expressed earlier, namely, that there was not any intention on the part of Dr Solling or Dr Pepper that termination should take place before the agreement ran its course nor any awareness that Mr Warburton may have had this in mind. So far as Mr Humphries and Mr Sinclair are concerned, I have the gravest doubt that they had any real knowledge of the scheme into which they had entered except that they understood that it was in their interests to do so and that they would be receiving capital moneys from it. It is plain that they accepted Mr Warburton's statements to them that it was better to terminate the agreement than go on with it but I am certainly not prepared to find that they entered into the arrangement with any intention other than that it should run its full course. In seeking to evaluate Mr Warburton's evidence, I am fully mindful of the fact that he had devised the scheme and then found himself plainly in a ``conflict of interest'' situation in which the lessees were not getting the returns that he had indicated they would get and which they thought they would get, and that the lessors were not getting the capital injection he had promised them because it was not possible to attract lessees with actual funds to lay out. As matters stood in March 1978 the agreement of all those involved to bring the whole arrangement to an end was from his point of view plainly the best solution - for it was a solution which would prevent financial loss of sizeable proportions and enable him to keep his clients and maintain the trusteeship of the Sinclair property and the Humphries property.
As I see the whole transaction, it seems to me that Mr Warburton, at the inception of the sheep leasing scheme, considered that it would work to the advantage of all parties, that it would provide an income for the doctors and substantial capital for the property owners, with tax advantages for both, but that these expectations were not met, partly because the anticipated profits were overrated and partly because the drought conditions did not sufficiently improve and it was not possible to attract lessees with actual funds to invest. It may well be that from Mr Warburton's point of view, the sheep leasing scheme under consideration falls into that category about which the most appropriate comment is ``It seemed like a good idea at the time''.
But there is no satisfactory basis upon which the respondents can in any way be held to have had knowledge of or to have been associated in any way with Mr Warburton's dealings with Mr Sinclair and with Mr Humphries or the method of accounting and dealing with the moneys received from the respondents as prepayment of the lease fees and as repayments of the loans made. The fact that Dr Solling had a general knowledge that other persons were involved
ATC 4535along with himself in the same type of leasing arrangement and that Dr Pepper had specific knowledge that others were involved in no way alters the conclusion just stated. The fact that Dr Solling left it to Mr Cameron and Dr Pepper, Mr Sinclair and Mr Humphries left it to Mr Warburton to arrange what to them would be the mechanics of the venture is in no way inconsistent with the claims that each regarded it at the time as a worthwhile financial venture. Even if one were to view Mr Sinclair and Mr Humphries' evidence with suspicion, and I do not, this, in the circumstances of this case, would be far from decisive or significant on the question whether the two respondents acted bona fide and for the purpose of obtaining profit from the leasing of the sheep.
In the result, I am of the opinion that the respondents in each case bona fide entered into an agreement with Beswar which resulted in sheep being leased to them from whose wool and progeny they expected to obtain worthwhile profit and that they considered - rightly or wrongly - that they had reasonable grounds for expecting commercial gain. I am satisfied that the written agreement in each case (except for cl. 4(a), (b)) correctly reflects the transaction entered into. I am satisfied that the venture was itself a commercial venture - in fact a business as I shall shortly explain - and that its failure is no indication at all to the contrary, nor any basis, on the facts of this case, from which to conclude that tax advantage and not profit was the overriding purpose of the respondents. I am satisfied that the respondents expected from the lease agreement to obtain as a tax deduction the amounts paid for the lease etc. fees and that they thought that having prepaid those fees as required by the terms of the agreement, the deduction of that amount paid would be available for the year ended 30 June 1977.
I am not prepared to find that tax advantage was the dominant motive. The finding which I make is that the lease scheme, offering as it did (as they believed) worthwhile commercial profit coupled with a tax advantage, was regarded by each of the respondents as a worthwhile financial venture in which to participate. The mere fact that the respondents were motivated in entering into the agreement by a desire to obtain a tax advantage which they believed was available, or even the fact - if it be the fact - that they would not have entered into the agreement if that advantage had not been available cannot stand in the way of them being entitled to that tax advantage if the venture can in fact be said to have amounted to the carrying on of a business as required by sec. 51(1) of the Act.
``My Lords, it seems to me that a trading transaction does not cease to be such merely because it is entered into in the confident hope that, under an existing state of the law, some fiscal advantage will result. In judging the essential nature of a transaction it will often be relevant and of assistance to consider the objects and intentions which are the inspiration of the transaction. In the present case, however, I cannot think that there is room for doubt as to the essential nature of the transaction: it was a transaction which was demonstrably of a trading nature and it was not divested of that nature merely because it was entered into with the expectation that as a result (but not as part of the trading activity of the company as such) some tax recovery might be claimed.''
(per Lord Morris of Borth-y-Gest in
Griffiths v. J.P. Harrison Ltd. (1962) 1 All E.R. 909 at p. 919).
No case decided in this country has, in my researches, stated a proposition contrary to that just quoted.
F.C. of T. v. Walker 84 ATC 4553 (special leave to appeal to the High Court refused) is a recent acknowledgement that notwithstanding that substantial tax advantage is sought from embarking upon a particular venture, this of itself will not prevent deductions from assessable income under sec. 51(1) if the venture is in truth a real commercial venture.
The only remaining question then is whether each respondent was in fact carrying on a ``business''. In my view, they regarded the enterprise as a business and plainly were carrying on business, albeit the management of that business was under the lease agreement in the hands of Beswar. Indeed management of the sheep for the purpose of production of profit was specifically part of what was paid for under the terms of the agreement - the agreement provided for a payment of an agistment fee, a lease fee and a management fee. The lease agreement in each case (cl. 7 and 8) left to each respondent the important matter of deciding at what price the wool or progeny should be sold, and each respondent was entitled (cl. 3) to
ATC 4536inspect the sheep at any time. The sheep the subject of the leases were real sheep capable of producing real profit. They required constant management and supervision in order for their wool and progeny to be commercially profitable. It was necessary for the wool to be sold when the sheep had been shorn and for the lambs to be sold at the appropriate time. This enterprise was, in my opinion, the carrying on of a business of primary production. The fact that the business was carried on by the respondent's manager in each case, in no way prevents a conclusion that the respondents were not personally carrying on that business
F.C. of T. v. Walker 85 ATC 4179). Counsel for the Commissioner has referred to the decision in
Ferguson v. F.C. of T. 79 ATC 4261, F.C. of T. v. Walker 84 ATC 4553 and
Hope v. The Council of the City of Bathurst 80 ATC 4386; (1979-80) 144 C.L.R. 1 at p. 8 where the importance of repetition of acts and of activities possessing something of a permanent character is stressed as a significant feature of the carrying on of a business and he has claimed that the lack of interest in the management of the business by each respondent and the failure to keep books of account should lead to a conclusion that they were not carrying on a business. In my view, this contention should not be upheld. The fact that the respondents could leave it to their manager to carry on the business was, in this particular case, one of the most attractive features of the lease arrangement from the point of view of the respondents for it meant leaving the management of the sheep to competent graziers who themselves had a vital interest in ensuring that their respective properties were run in the most efficient fashion. The fact that the respondents did not trouble to keep books - they would only expect a cheque perhaps two and three times a year - is of little significance. There is no doubt from the evidence that they relied, as they were entitled to, upon their manager, Beswar, to keep such records as were necessary and to remit to them the amounts which they were entitled to receive. The extent to which a principal concerns himself with the way in which his manager conducts his business is very much a matter for the principal. In my view, each of the respondents was carrying on a ``business'' for the purpose of gaining or producing income within the provisions of sec. 51(1) of the Act and the lease etc. fees were ``necessarily'' paid for the purpose of gaining income for the business.
The Commissioner, I should mention, sought to rely on sec. 260 of the Act but, assuming that that section applies to deductions under sec. 51(1), I am satisfied that it has no application to the facts as I see them. I also mention for the sake of completeness that the Commissioner sought to contend that the sheep leasing scheme was a ``fiscal nullity'' so as to prevent any deduction being made under sec. 51(1). It has, however, been held in
Oakey Abattoir Pty. Ltd. v. F.C. of T. 84 ATC 4718 that that doctrine does not apply in Australia in any event it would not be applicable to the facts as I have found them.
Counsel for the Commissioner sought to contend that the prepayment of the lease etc. fees was to be treated as an expenditure of a capital nature and thus not deductible but I can see no basis in the present case for that submission. It was, however, contended on behalf of the Commissioner that on the evidence of Mr Miles, a chartered accountant, the ``accrual basis of accounting'' should be applied to the deductions in each case, so that instead of the whole amount being deducted in the year of payment, viz. 30 June 1977, it should be spread over the subsequent years; and as the agreement was terminated at the end of the first year the amounts referable to the subsequent years should be written off. The accrual basis was considered in
F.C. of T. v. Australian Guarantee Corp. Ltd. 84 ATC 4642 and it is appropriate here to give a short explanation of the nature and application of that method of accounting.
One begins with the proposition in para. 2 of Statement APS1 issued in 1978 by the two Australian accounting bodies (the Institute of Chartered Accountants in Australia and the Australian Society of Accountants):
``Statements of Accounting Standards describe methods of accounting approved by the Councils of the Australian accountancy profession for application to all financial statements intended to give a true and fair view of the state of affairs and profit or loss. Accounting Standards are designed to improve the quality and uniformity of reporting and introduce a definitive approach to the concept of what gives a true and fair view.''
The accrual basis is defined in AAS6 (Statement of Accounting Standards - Accounting policies etc.) para. 2(c) as meaning ``that revenue and expense are recognised as they are respectively earned and incurred (and not as money is received or paid) and are brought to account in the financial statements of the periods to which they relate''. This definition links the accrual concept to the concept of truth and fairness (in presenting the affairs of the business entity under consideration as set out in para. 2 of Statement APS1 issued in 1978 by the two Australian accounting bodies) implicit in the definition of the periodic profit or loss in para. 5 AAS1 which refers to revenue earned and expenses incurred. Statement AAS9 deals specifically with ``Expenditure Carried Forward to Subsequent Periods'' and is a statement of accounting practices rather than a standard. AAS6 goes on to state (at para. 8) that ``the accrual basis and the going concern basis are so generally adopted in the preparation of financial statements that their use can be assumed in the absence of any statement to the contrary''. Mr Miles in his affidavit said in regard to the two sheep leasing ventures under consideration here:
``17. Therefore, in my opinion, to show in the accounts of each business the whole of the amount paid on 30th June 1977 by each lessee as an expense incurred in respect of the year ended 30th June 1977 where no other transactions of the business had occurred in that year, and no income to which such expenditure could have contributed could have been derived in that business in that financial year, would not, having regard to generally accepted accounting principles, show a true and fair view of the results of such business for the year ended 30th June 1977.
18. In my view, for such accounts to show a true and fair view for the year ended 30th June 1977 only that proportion of the total payments of $31,000 and $16,000 respectively as is represented by the ratio of the number of days for which the Agreement had been in force up to 30th June 1977 over the total number of days covered by the Agreement should have been charged as an expense in the accounts for the year ended 30th June 1977. The balance of such payments should have been carried forward under the heading of `prepaid expenses' as an asset of the business.
19. My only qualification to the opinions expressed in paragraphs 17 and 18 of my Affidavit is that I should comment that when at some later date it became apparent that the arrangements with Beswar Pty. Limited were not working out and the decision to terminate them had been made, generally accepted accounting practice would require that the remaining uncharged balance of the advance payments made by each lessee be then written off in their accounts drawn up for the period in which the termination took place. This write-off would be made after allowing for the amount of any rebate or refund of the payments previously made which may have been received by the lessees pursuant to the termination agreements.''
It is clear from Mr Miles' evidence that he considered that the accounts of the two respondents if prepared in accordance with proper accounting principles, would have apportioned the prepaid lease etc. fees over the whole period of the agreement. Mr Cameron, who is also a chartered accountant, however, in his evidence introduced a qualification to the application of the accrual basis. He said:
``Q. What item would you show in the year ended June 30, 1977 in the amount of expenditure in showing the profit and loss of that business? A. Without having the advantage of time to consider it I would think that under the accountant recommendations I would look at it in terms of prepayment or a part of it only shown in the profit and loss account.
Q. Yes, clearly part only but what part? A. The part that is attached to the first year.
Q. Would you put that in a 1977 year accounts or would you put it in the 1978 year accounts? A. That is a good question. It could be apportioned. Yes, in the lease I may put a few days in.
Q. You would only put a few days in and that would be proper accounting treatment? A. Under the Institute's recommendation.
Q. Under the Institute's recommendation? A. For public accounting bodies.
Q. You agree with me that would be the right way of accounting? A. I qualify that
ATC 4538because we don't do it that way in our normal accounts for small returns.
Q. You do not prepare accounts for Dr Solling because he does not keep them, I imagine, in that form? A. Yes.''
Although there is no other specific evidence before me in regard to the accountancy practice in regard to small businesses I think I should say that it is within my own knowledge from evidence given before me in other cases that the accrual basis is not always applied, particularly in the case of small businesses. Indeed, I should think it was well known throughout our community that many businesses, including of course professions, use a cash-received expenditure-paid basis both for their accounts and for taxation purposes.
What then is to be done in the present case? In my opinion, the taxpayers should be entitled to have deducted from their income the whole of the amounts paid by them for the lease etc. fees on the grounds I now refer to. In Arthur Murray (N.S.W.) Pty. Ltd. v. F.C. of T. (1965) 114 C.L.R. 314 the question arose as to whether fees paid in advance to a dancing studio were to be regarded as income in the year in which they were paid notwithstanding that portion of them related to dancing lessons to be supplied in future years. In deciding whether income should be taken to mean earnings or receipts their Honours said at pp. 318-319:
``The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income. A conclusion as to what that understanding is may be assisted by considering standard accountancy methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items... A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinctions it implies. What ultimately matters is the concept; bookkeeping methods are but evidence of the concept...
The word `income', being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs. To apply the concept which the word in that sense expresses is not to substitute some other test for the one prescribed in the Act: it is to give effect to the Act as it stands.''
It should follow from what has been said in that passage that where accountancy practice does not require, as a matter of proper accounting, that the accrual basis be applied to an outgoing in a particular case under consideration then the question when it was ``incurred'' must be dealt with without reference to the accrual basis - that method in that instance throws no light on the question when the outgoing is to be taken to have been incurred. Nor is it for the Court to require that the accountancy practice be altered so as to produce uniformity. The words of Lord Denning M.R. in
United Dominions Trust v. Kirkwood (1966) 2 Q.B. 431 at p. 455, although used in a somewhat different context, are apt in this regard:
``When merchants have established a course of business which is running smoothly and well with no inconvenience or injustice, it is not for the judges to put a spoke in the wheel and bring to to a halt. Even if someone is able to point to a flaw, the courts should not seize on it as to invalidate past transactions or produce confusion.''
No suggestion was made before me that any confusion has been occasioned because small business accounts are treated differently from those of larger enterprises. In Arthur Murray (N.S.W.) Pty. Ltd. v. F.C. of T. it is to be noted, it was agreed between the parties (at p. 319) that the amounts received in advance were, in accordance with established accountancy and commercial practice, not to be credited to revenue until the services were rendered, and it was the taxpayer who contended for the application of that method in the determination of the amount of assessable income which had been received in particular years. In F.C. of T. v. Australian Guarantee Corp. Ltd. 84 ATC 4642 the opinion of Mr Miles that the accrual basis was appropriate to the accounts was not contradicted by other evidence, and again it was the taxpayer who sought to apply the
ATC 4539accrual basis to the determination of the question of the amount to be deducted under sec. 51(1). In that case the outgoing - interest under a debenture - was not payable until redemption, which could not take place until five years had elapsed. The accrual basis has as its object (as do the other accounting standards prescribed) ``the giving of a true and fair view of the state of affairs and profit and loss'' (Statement APS1 para. 2) and whilst it is easy to see the practical business necessity for accounts to show a true and fair view of the state of affairs in the case of large business enterprises, particularly public bodies or companies, it is not so easy to discern this in the case of small businesses where the state of accounts is only ever within the knowledge of the owner and of no real significance in most instances to anyone other than the owner. In the present case, Mr Cameron said that he did not use the accrual basis in ``our normal accounts'' for small returns, and as the taxpayers in the present case were each under a legal liability to pay, immediately on receipt of the notice to pay given by Beswar, and did in fact pay, the entire lease etc. fees (discounted) before the end of June 1977, for the purpose of gaining assessable income, I do not see on what basis they can be denied the conclusion that the whole outgoing in each case was ``necessarily incurred'', within sec. 51(1), in that year, and that they are therefore entitled to the deduction of the full amount in each case. In
Creer v. F.C. of T. 85 ATC 4104, Lusher J. allowed a deduction of rent of $63,800 paid on 30 June 1977, when the lease was executed, and representing a substantial portion of the total rent payable under the lease which was for a term of five years. The lease required that this amount be paid on execution, and that two smaller payments be made off the total rent at the end of the second and third years respectively. His Honour, however, did not have to consider the question of any apportionment by reference to accountancy practice.
In the result then the Commissioner fails in each appeal and Dr Solling succeeds in his cross-appeal. In case No. 705/83 (Dr Solling) the order will be appeal dismissed, cross-appeal allowed, decision of the Board of Review varied by substituting for the amount of $9,040 allowed as a deduction the amount of $31,000. In case No. 704/83 (Dr Pepper) the order will be appeal dismissed.
The costs of both proceedings are to be paid by the Commissioner.
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