Case T99

Members:
P Gerber SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 23 October 1986.

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Dr P. Gerber (Senior Member)

In this application, the applicant, a farmer and parliamentarian, had, according to his evidence, a good wheat year in 1978, which left him with some surplus funds. He therefore evinced an intention to diversify his activities. He became aware that some land was on the market which, because of the need of the seller for cash, was available for some $225,000. The applicant formed the view that this land would be eminently suitable to develop for tourist accommodation or what he called a ``wilderness camp''.

2. Because he lacked sufficient cash to pay out the $225,000, he obtained a number of

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partners to come into the venture, although, for present purposes, that fact is not relevant. The only issue I have to decide is whether, in the year now under review, an amount of $3,277 for interest and $89 for borrowing expenses incurred in the 1980 tax year are allowable deductions, pursuant to the Income Tax Assessment Act.

3. Essential to the resolution of this question is the problem whether the loss or outgoing was incurred in the gaining or producing the assessable income or was necessarily incurred in carrying on a business for purposes of producing such income. Whilst I consider this is a somewhat borderline case, I have concluded, after some hesitation, that I am unable to conclude that the outgoings have a sufficient nexus with the derivation of income, bearing in mind the circumstances under which the land was acquired, to be an allowable deduction.

4. In effect, what occurred was that, having been apprised that the land was on the market, the applicant made some informal inquiries from a Mr McDonald and the shire secretary to ascertain what the council's position would be in relation to a rezoning, which was a condition precedent to give effect to the applicant's intention to build a holiday camp on the site, and, whilst he obtained an encouraging response, it was certainly clear, and, indeed, it was not advanced on behalf of the applicant, that he was at any time prior to the acquisition of the land in a position to proceed with his intended plan, for no better reason than that the land was itself in no state - and I use ``state'' in terms of ``zoning'' - to enable him to proceed with his plan.

5. In other words, he was not unequivocally committed to proceed with his stated intention because he could not do so since the land was not appropriately zoned.

6. In order to test this proposition, I ask myself this simple question: supposing the applicant, before committing himself to buy the subject land, had proceeded to seek the appropriate rezoning and had incurred expenses in so doing - that is, obtained surveys, applications, an appeal to the Local Government Court - the kind of preliminary expenses which one would anticipate would be incurred before proceeding with such a venture. Had he succeeded in such a rezoning application would the expenses thus incurred be an allowable deduction? Put this way, the answer is quite clear and unequivocal: those expenses would not constitute an allowable deduction, but would simply be the kind of preliminary expenditures incurred prior to the commencement of a business, the kind referred to in
Softwood Pulp and Paper Ltd. v. F.C. of T. 76 ATC 4439, a decision of his Honour Mr Justice Menhennitt of the Supreme Court of Victoria.

7. Reading from the headnote, at p. 4,440, it is stated:

``(1) The evidence revealed that project planning had never proceeded past a preliminary investigation stage and that neither MacMillan nor the taxpayer had committed itself to the project. This view was supported by the fact that the company's capital was only £100,000 whereas the contemplated capital cost of the project was between 14 and 15 million pounds.

(2) The activities undertaken being entirely preliminary and directed at deciding whether or not an undertaking would be established to produce assessable income, it could not be said that the expenses were incurred in the actual production of assessable income.

(3) Similarly, the company not having decided whether or not the business should be proceeded with, the expenditure could not be held to have been incurred in carrying on a business.

(4) The amounts claimed, if they did otherwise fall within either of the first limbs of sec. 51(1), would nevertheless be excluded from deductibility on the basis that they were losses or outgoings of a capital nature.''

8. That, in itself, was held sufficient to treat this kind of expenditure as preliminary and prior to the undertaking of a business operation. Once I reach that view - and I reach that view with considerable confidence - I ask myself, ``well, what is the effect of, so to speak, putting the cart before the horse - that is, acquiring the land on the off chance that he may ultimately be able to proceed with his

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hoped for plans provided his rezoning application etc. will be approved?''

9. Once put in those terms, I see the answer clearly. If the preliminary investigations and the seeking of approval would be denied deduction, then I am not persuaded that putting, as I said before, the cart before the horse - that is, acquiring the land with the intention of future development - adds anything to the substantive argument of the applicant to claim these deductions pursuant to sec. 51.

10. It is true that the law has not stood still since
Southern Estates Pty. Ltd. v. F.C. of T. (1966-1967) 117 C.L.R. 481 and, indeed, Taxation Ruling IT 166, released on 1 September 1983, which is a guide to assessors, and taken from the headnote of the CCH Digest states:

``A deduction is allowable for interest paid on money borrowed to construct an income producing asset (e.g. a block of flats) even where the interest is paid during the construction period during which no revenue is being derived from the asset. This is subject to the proviso that there must be no room for doubt that the asset is being erected solely and exclusively for the purpose of producing assessable income. Such interest cannot be treated as part of the capital cost of the asset for investment allowance purposes.''

11. Whilst this Ruling, as was pointed out by both parties to this application, is not strictly binding on me, it does, I am satisfied, give effect to the law as it has developed, but it cannot avail the applicant in this case.

12. I find, on balance, that the facts of this case do not go beyond those which were analysed by the High Court in Southern Estates which I had occasion to review in some detail in Case J13,
77 ATC 120. On that occasion, I analysed each of the judgments of their Honours of the High Court in relation to a claim made to deduct the amount of an expenditure incurred on land improvement under the then provision sec. 75 subsec. 1, which provided:

``Expenditure incurred in the year of income by a taxpayer engaged in primary production on any land.''

In that case, the taxpayer had carried on the business of buying and selling land, purchased an area of virgin scrub, and, at that time, was not engaged in primary production. However, soon after, the taxpayer began to improve the land so that it would be capable of being used for grazing purposes until such time as it could be sold at a profit, the taxpayer's ultimate purpose of buying the land being to resell it at a profit.

13. At first instance, Mr Justice McTiernan held, and I quote now from his Honour's reasons (at p. 484), that:

``... upon the widest construction of which the word `engaged' admits, a person who merely has an intention to carry on the business of primary production is not engaged in it.''

From that decision, there was an appeal to the Full High Court, and Chief Justice Barwick, after confessing to some hesitation, stated (at p. 488):

``I am unable to deny the limiting quality of the opening sentence [i.e. `engaged in primary production']. I am unable to read `a taxpayer engaged in' as satisfied by one of whom no more can be said than that he intends to engage in. To prepare land for primary production, even for primary production thereon by the person making the improvement is not of itself, in my opinion, to engage in primary production.''

In the joint judgment of Taylor and Owen JJ., it is stated that (at p. 491):

``[The section] proceeds upon the basis that at the time when the expenditure is incurred the taxpayer is actually engaged in carrying on the business of a primary producer on the land upon which the improvements are effected. But where, as here, the land is, at the time when the expenditure is incurred, incapable of being used for primary production and the expenditure is incurred in order to bring it into a condition in which it will be possible to use it for primary production we are of opinion that it cannot be said that the taxpayer is engaged in primary production on that land.''

Mr Justice Windeyer dissented from that view, although he concurred in the result. Although the Southern Estates case did not deal with sec. 51, I am not persuaded that that section has not

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a like meaning; that is, I find that sec. 51 proceeds upon the basis that, at the time when the expenditure is incurred, a taxpayer must be actually engaged in carrying on a business, or, at the very least, be irrevocably committed to that business.

14. To the extent that there are cases which are decided on that point, the most recent, to which my attention was drawn by the Commissioner's representative, is
Travelodge Papua New Guinea Ltd. v. Chief Collector of Taxes 85 ATC 4432, a case which I had the opportunity to read, and which, although decided pursuant to sec. 68 subsec. (1) of the New Guinea Income Tax Act, is none the less relevant to this jurisdiction in that the sections are identical. Having carefully read the decision, I am satisfied that it also accurately reflects the Australian law and, indeed, is reconcilable with Taxation Ruling IT 166.

15. Be that as it may, his Honour Mr Justice Bredmeyer, who decided the Travelodge case, recognised the limitations imposed on the section and quoted, with obvious approval, the decision of Mr Justice Menhennitt in the Softwood Pulp case to which I have referred, and which, likewise, I dealt with in Case J13.

16. The facts of this case are readily distinguishable from those of the Travelodge case in that, in the latter case, when the land had been acquired, the taxpayer was engaged in the business of running hotels and irrevocably committed to the erection of the hotel in issue. In those circumstances, it follows logically, that such expenses as interest, rates, rent, are allowable deductions pursuant to our sec. 51, notwithstanding that, in the years in which they were incurred, no income was derived for no better reason that it takes some time before a hotel is completed and ready for occupation.

17. In the instant case, what this applicant did amounted to no more than buying land on ``spec'' - that is, in the fond hope that it would in time be rezoned and so enable him to proceed with his plan of erecting a wilderness camp, and this becomes quite clear from the chronology of events which were handed up. These show that the application for consent was lodged with the Council many moons after the land had been acquired.

18. Perhaps the term ``many moons'' needs to be qualified in the sense that on one view it was argued that the acquisition did not occur till August of 1979, albeit the contract was executed in May of that year. Neither party addressed me on this point; both considered it irrelevant. In all events, what flows from this is that the land was indubitably acquired before any application for consent was lodged, and it is therefore classically of the preliminary kind which is excluded from deduction under sec. 51.

19. I find the reasoning of the High Court in the Southern Estates case not only persuasive, but binding on me in this Tribunal.

20. The Commissioner derived some comfort from an unpublished decision of Board of Review No. 3 as it then was in which I, as a Member of that Board, gave the decision. It was a case in which the facts were somewhat similar to the facts in this case, in that a person in employment acquired land with the intention ultimately to erect holiday cabins on it, and, again, as in this case, application for permission to erect these holiday cabins on the land was made after the land had been acquired. Unlike this case, that taxpayer succeeded in his application for permission, and in due course, proceeded to erect his holiday cabins. But this occurred some years after the acquisition of the land, and as in this case, the taxpayer in the earlier case sought to deduct interest payments on a loan he had obtained in order to acquire the subject land, and as in this case, the claim was disallowed.

21. In handing down my decision - I might add it was an ex tempore decision - I said on that occasion that on the facts no business of holiday accommodation letting had commenced until the taxpayer had arrived on the site and commenced to set up the holiday cabins in terms laid down by the shire council. The only expenditure incurred was the acquisition of the property and such activities as travel to and from. I stated:

``Filming the gradual development from virgin land and completed site, can only be viewed as incidental to the preparation of establishing a new business. This case is distinguished from such cases as
Ferguson v. F.C. of T. 79 ATC 4261 where the taxpayer entered into a leasing agreement from a leasing company for five identified half cross Charolais heifers whilst still retaining his commission in the Royal Australian Navy. This activity was viewed

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by the Federal Courts as a positive stepping stone and a start towards the ultimate aim of the taxpayer in that case, namely to resign his commission and to take up cattle breeding as a new occupation. In this case, the Board has concluded that the mere acquisition of land some two years or more before any discernible development towards a change of occupation can be seen to have taken place is not sufficient to characterise such acquisition as the commencement of a business.''

22. Although not strictly necessary for the purposes of this decision, I venture to say that that decision, even in light of later decisions such as the Travelodge case still represents the law, as I understand it, and that the instant case is readily distinguishable from the Ferguson case on which the applicant relies strongly in that in Ferguson's case, one can actually point to a positive stepping stone, a start towards the commencement of the breeding of cattle, whereas in this case, nothing more was done than to acquire land in the fond hope of future development.

23. In no acceptable sense can I view such an activity as one where the expenditure can be seen as an outgoing incurred in gaining or producing assessable income, and for these reasons, I have no alternative but to dismiss the application.

Claim disallowed