Applicant 6115 of 2013 and Commissioner of Taxation
[2015] AATA 244
•23 April 2014
Administrative Appeals Tribunal
ADMINISTRATIVE APPEALS TRIBUNAL )
) No: 2013/6115-6118
Taxation Appeals Division )
Re: Applicant 6115 of 2013
Applicant
And: Commissioner of Taxation
RespondentDIRECTION
TRIBUNAL: Senior Member, CR Walsh
DATE: 29 April 2015
PLACE: Perth
The Tribunal directs the Registrar, pursuant to subsection 43AA(1) of the Administrative Appeals Tribunal Act 1975, to alter the text of the decision in this application, as follows:
·The date of the decision be changed from “23 April 2014” to “23 April 2015”;
·The reference in paragraph 77 of the Reasons for Decision to “paragraph 63” be replaced with a reference to “paragraph 64”; and
·The heading on page 21 of the Reasons for Decision, “B. Deductibility of interest, land tax & council rates ($1,894,147),” be replaced with “C. Deductibility of interest, land tax & council rates ($1,894,147)”.
................(Sgd) CR Walsh............................
Senior Member
[2015] AATA 244
Division TAXATION APPEALS DIVISION File Numbers
2013/6115 - 6118
Re
Applicant 6115 of 2013
APPLICANT
And
Commissioner of Taxation
RESPONDENT
Decision
Tribunal Senior Member CR Walsh
Date 23 April 2014 Place Perth The Tribunal affirms the decision under review.
......(Sgd) CR Walsh ...........................................................
Senior Member CR Walsh
Catchwords
INCOME TAX – capital gains tax – property rezoned from "Rural" to "Special Rural", subdivided and sold - whether applicant's capital gain for 2007 year should be offset by carried forward capital losses – whether applicant’s capital gain for 2009 year should be reduced as a result of increase in cost base of CGT asset – whether applicant should be allowed deductions for interest, land tax, council rates incurred in prior income years – whether "intention" of taxpayer to use property acquired for turkey farming business changed –– objection decision affirmed
Legislation
Income Tax Assessment Act 1936 – s 51(1) – s 79E
Income Tax Assessment Act 1997 – s8-1 - s 8-1(1) - s 36-10 - s 36-15 - s 100-45 - s 100-50 - s 104-10 - s 104-10(6) - s 104-20(3) - s 104-25(1) - s 104-25(2), - s 104-25(3) - s 108-5(1) - s 108-20(1) - s 108-20(2) - s 110-23 - s 110-25(2) - s 110-25(2)(a) - s 110-25(3) – s 110-25(4) - s 110-25(5) - s110-25(6) - s 112-25 - s 112-25(3) - s 112-30 – s 112-30(3) - s 112-30(4) - s 116-30 – s 960-20(2)
Income Tax (Transitional Provisions) Act 1997 – s 36-105
Taxation Administration Act 1953 – s 14ZZK(b)(i)
Cases
Commissioner of Taxation v Anovoy Pty Ltd [2001] FCA 447
Federal Commissioner of Taxation v Brown 99 ATC 4600
Federal Commissioner of Taxation v Hatchett 71 ATC 4184
Federal Commissioner of Taxation v Jones (2002) 117 FCR 95
Federal Commissioner of Taxation v Payne 2001 ATC 4027
Federal Commissioner of Taxation v Riverside Road Pty Ltd (in liq) 90 ATC 4567
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd 79 ATC 4279
Fletcher & Ors v Federal Commissioner of Taxation (1991) 173 CLR 1
Goodman Fielder Wattie v Commissioner of Taxation (1991) 29 FCR 376
Guest v Commissioner of Taxation [2007] FCA 193
Inglis v Federal Commissioner of Taxation (1979) 40 CLR 191; 10 ATR 493
Lunney v Federal Commissioner of Taxation; Hayley v Federal Commissioner of Taxation (1958) 100 CLR 478
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation 80 ATC 4542
Oates v Commissioner of Taxation (1990) 27 FCR 289
Re A Debtor [1937] 1 All ER 1
Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47
Steele v Deputy Federal Commissioner of Taxation 99 ATC 4242; (1991) 41 ATR 139
Ure v Federal Commissioner of Taxation (1981) 50 FLR 219
Unilever Australia Securities Pty Ltd v Federal Commissioner of Taxation 94 ATC 4388
Vincent v Commissioner of Taxation (2002) 124 FCR 350
Secondary Materials
Taxation Ruling TR 96/23
Taxation Ruling TR 2004/4
REASONS FOR DECISION
Senior Member CR Walsh
23 April 2015
introduction
In the year ended 30 June 1989, the Applicant acquired 14.508 hectares of unimproved land, zoned “Rural”, situated on the edge of Gnangara Lake in Wanneroo, Western Australia (Property) with the intention of developing it for use as a turkey farm.
However, as a result of what the Applicant describes as “planning (resumption) and environmental obstacles, beyond his control”, the Property was ultimately never used by the Applicant as a turkey farm. Instead, the Property was rezoned from “Rural” to Special Rural”, subdivided and sold by the Applicant in the years ended 30 June 2007 to 30 June 2010, resulting in the realisation of a capital gains tax (CGT) asset for the purposes of the CGT provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997).
At issue in this application is whether:
(i)the Applicant’s gross capital gain for the year ended 30 June 2007 (from the disposal of part of the Property in Lots) should be reduced by the amount of $222,576, which the Applicant contends is a net capital loss he incurred in the year ended 30 June 1998 (or a subsequent year) and carried forward to the year ended 30 June 2007 in respect of a payment made by the Applicant as a guarantor of a tax debt owed by a related company (OCS);
(ii)the Applicant’s gross capital gain for the year ended 30 June 2009 should be reduced by the amount of $340,740, which amount the Applicant contends should have been included in the cost base of Lot 300. Lot 300 was a result of the subdivision of the Property. Lot 300 was compulsorily acquired by the City of Wanneroo in the 2009 year (City of Wanneroo); and
(iii)the Applicant is entitled to deductions totalling $1,894,147 in the years ended 30 June 2007, 2008 and 2010 under S 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or s 8-1(1) of the ITAA 1997, as applicable, for revenue expenses (interest, land tax and council rates) the Applicant claims to have incurred in the years ended 30 June 1990 to 2010 inclusive resulting in deductions in, or “tax losses” carried forward to, the years ended 30 June 2007, 2008 and 2010.
The Applicant contends that each of the above issues should be answered in the affirmative. In contrast, the Commissioner argues that each of the above issues should be answered in the negative.[1]
[1] The Applicant has the burden of proving, on the balance of probabilities, that the assessments are excessive or otherwise incorrect and what those assessments should have been: s 14ZZK(b)(i) of the Taxation Administration Act 1953.
In relation specifically to issue (iii) above, the Applicant’s “intention” as regards the Property is relevant in this case since the Applicant did not produce any income as a result of the expenditure incurred. It is not in dispute that the Applicant “acquired” the Property with the “intention” of developing it for use as a turkey farm. The Applicant’s position is that he maintained this “intention” in relation to the Property at all relevant times. In contrast, the Commissioner asserts that the Applicant’s “intention” with respect to the use of the Property as a turkey farm changed no later than 30 June 1992.
FACTUaL & Procedural Background
A. Purchase of the Property by the Applicant and subsequent events and actions in relation to or in respect of the Property
On 18 April 1989, the Environmental Protection Authority (EPA) wrote to the State Planning Commission (SPC) in relation to a “proposed subdivision” of the Property. The EPA recommended that subdivision of the Property be conditional upon:
· The northern portion of [the Property] being ceded to the Crown and reserved for Parks and Recreation (see plan enclosed)
· The NW-SE boundary of the eastern lot being at least 30 meters from High Water Mark;
· Any future development on the proposed eastern lot being limited to the area currently occupied by the sand pit, and surrounding disturbed areas being rehabilitates utilising endemic vegetation; and
· A covenant being placed on the titles of the proposed lots to restrict areas of development and prevent mining and large scale land clearing.
Also, all potential land purchasers should be aware that they would have to apply to the Water Authority of WA for a license to extract groundwater.
On 13 June 1989, the Applicant offered to purchase the Property from its then owner (Vendor) for $360,000.
On 14 June 1989, the Applicant increased his offer to purchase the Property from $360,000 to $370,000 and the increased offer was accepted by the Vendor.
On 4 September 1989, the City of Wanneroo informed the Applicant (through Link Settlements) of the “System 6 recommendations” affecting the Property. The EPA’s System Six report of 1983 recommended conservation of major communities of natural wildlife and flora types through a comprehensive set of reserves in the hinterland area surrounding Perth, Western Australia.
On 25 September 1989, the Applicant wrote to the Vendor’s agent requesting “cancellation of the contract and refund of monies, plus interest paid” on the basis that the Property “could not be developed as a poultry farm”. More specifically, the Applicant’s letter stated:
With reference to the offer made for the purchase of [the Property], Wanneroo, we must advise that the contract will not now be able to proceed with due to the fact that it is subject to a System 6 Recommendation made in 1983, and approved by the State Government Cabinet in 1984, whereby Lot 883 is to be resumed and set aside for Parks and recreation.
Enclosed is a Copy of City of Wanneroo Land Purchase Enquiry, and after receipt we have had discussions with Mr Symond O’Hara of the City of Wanneroo Council, who stated in his opinion, the property is subject to future acquisition and as such could not be developed as a poultry farm.
We have also been referred to Mr Ian Briggs of the EPA who also stated that his opinion is that System 6 is the current basis for which to assess the property for other than within the terms of Reserve for Parks and Recreation.
We were further recommended to the State Planning Authority…..who were all of the opinion that the property is the subject of an approved recommendation for reserve for Parks and Recreation, and as such would not receive their approval for development other than within the terms of the System 6.
…………
Under the circumstances it is evidence that the land has received Cabinet approval to be set aside for Public Open Space and currently all relevant authorities are still of the opinion that the Lot will eventually be acquired for the purpose of Public Open Space and that we will not be able to utilise the property for development purpose as was envisaged and advised.
It is with regret we must request cancellation of the contract and refund of monies, plus interest paid. [Emphasis added]
On 6 October 1989, the Vendor’s lawyers wrote to the Applicant to advise that:
the Purchaser (sic) does not accept your purported termination of the contract in your letter of 25th September 1989 and affirms the contract and intends to proceed to settlement on the settlement date pursuant to the contract which is 12th October 1989.
A dispute between the Applicant and the Vendor ensued.
On 2 November 1989, the Department of Planning and Urban Development (Department) wrote to the Applicant advising him that:
it appears unlikely that the Commission, as well as the Council, would readily support the development you indicate.
On 8 January 1990, the Vendor’s lawyers wrote to the Applicant proposing terms of settlement in relation to the Applicant’s purchase of the Property. On 25 January 1990, the Applicant accepted terms of settlement proposed by the Vendor. Those terms resulted in the Contract for Sale of Land by Offer and Acceptance being varied, by deed, as follows:
· the purchase price was reduced from $370,000 to $323,112.50;
· the Applicant paid $213,112.50 to the Vendor; and
· the $110,000 balance of the purchase price was satisfied by the Applicant transferring to the Vendor land he owned on Scarborough Beach Road, Osborne Park, Western Australia.
On 30 March 1990, the Applicant was registered as the proprietor of the Property.
On 30 June 1990, BSD Consultants invoiced the Applicant (or OCS) for professional services carried out in the period April to May 1990 in relation to a development involving the rezoning of the Property from “Rural” to “Special Rural”. BDS Consultants recommended that:
the rezoning not be proceeded with as we believe it has no chance of success.
On 30 January 1992, Feilman Planning Consultants (Feilman Planning), wrote to the EPA on behalf of the Applicant. The letter was written “to advise [the EPA] formally of our development intentions for this site, to receive from [the EPA], in return, a level of assessment notification.” As to those “development intentions”, the letter explained:
It is proposed to rezone [the Property] to Special Rural under Town Planning Scheme No 1, to facilitate subdivision into 1ha-2ha lots. The Town Planning Scheme Amendment will include provisions prohibiting environmentally unacceptable land use practices, restricting clearing of vegetation on all new lots, and requiring re-vegetation of the sand pit area.
On 14 February 1992, Dames & Moore wrote to the Applicant to provide their “proposal for a technical assessment of the environmental aspects of the proposed development of [the Property]”. The proposal noted:
Development of about twelve 1 ha lots under Special Rural Zoning is proposed, with the lake side part of the site forming a foreshore reserve.
In or around June 1992, Feilman Planning, on behalf of the Applicant, applied to the City of Wanneroo to have the Property rezoned from “Rural” to “Special Rural” to facilitate its subdivision into one hectare lots.
The Property was rezoned from “Rural” to “Special Rural” in June 1998.
In August 2005, the Property was subdivided into the following Lots:
· Lot 11 for lake front resumption by the Western Australian Planning Commission (WAPC);
· Lot 15 for road resumption by the WAPC; and
· Lot 9000 for further subdivision by agreement between the Applicant and the WAPC.
Lots 11 and 15 were disposed of by the Applicant to the WAPC on 25 August 2005.
On 31 August 2005, the Applicant received an amount of $879,450 in respect of the disposals of Lot 11 and 15 to the WAPC.
In 2009, a part of the Property that remained after the disposals of Lot 11 and Lot 15 to the WAPC, known as Lot 300, was compulsorily acquired from the Applicant by the City of Wanneroo for the purpose of road widening under a power of compulsory acquisition. The Applicant received compensation in the amount of $172,480 in respect of the compulsory acquisition of Lot 300.
In the years ended 30 June 2007, 2008, 2009 and 2010, the Applicant disposed of the remainder of the Property in 10 one hectare lots as follows:
Lot
Contract date
Sale Price $
Settlement date
1
18/04/07
720,000
20/09/07
2
04/09/06
750,000
27/10/07
3
28/10/06
750,000
20/09/07
4
14/06/10
640,000
08/09/09
5
22/04/08
600,000
13/06/2008
6
07/01/09
550,000
19/02/09
7
17/02/07
650,000
26/10/07
8
12/06/07
680,000
26/09/07
9
No contract provided
660,000
03/10/07
10
07/01/08
650,000
29/01/08
Total
–
6,650,000
–
B. Payment of debt by Applicant as guarantor of OCS
The Applicant was at all relevant times a shareholder in OCS.
The Applicant was a director of OCS from:
· 14 February 1974 to 10 August 2001; and
· 21 February 2008 to 30 October 2011.
As at 19 December 1997, OCS was indebted to the Commissioner in respect of group tax, superannuation guarantee charge and penalty tax totalling $116,035.27 (Tax Debts).
On 19 December 1997, the Applicant and the Commissioner entered into a Deed of Acknowledgement, Guarantee and Indemnity (Deed of Acknowledgement, Guarantee and Indemnity) in respect of the Tax Debts.
Pursuant to the Deed of Acknowledgement, Guarantee and Indemnity, the Applicant acknowledged OCS’s “Tax Debt”, totalling $116,035.27 (clause 2.0), guaranteed repayment of the “Secured Moneys” (including the Tax Debt and interest on unpaid amounts) to the Commissioner (clause 3.0), indemnified the Commissioner in respect of the “Secured Moneys” (clause 4.1), and granted the Commissioner security in the form of a mortgage over a portion of the Property (clause 6.1).
External administrators were appointed to OCS on 28 June 2001. OCS was externally administered from 10 July 2001 until 3 June 2010. OCS was ultimately deregistered on 30 October 2011.
On or about 16 December 2004, the Applicant paid the Commissioner $223,097.10 pursuant to the Deed of Acknowledgement, Guarantee and Indemnity.
C. Assessments, Objection, Objection Decision & Application for Review
On 1 October 2012, the Applicant was issued with a Notice of Assessment for the year ended 30 June 2007 which assessed the tax payable by the Applicant for the 2007 year as $648,133.80.
On 28 September 2012, the Applicant was issued with a Notice of Assessment for the year ended 30 June 2008 which assessed the tax payable by the Applicant for the 2008 year as $137,453.25.
Also on 28 September 2012, the Applicant was issued with a Notice of Assessment for the year ended 30 June 2009 which assessed the tax payable by the Applicant for the 2009 year as $38,382.20.
On 4 October 2012, the Applicant was issued with a Notice of Assessment for the year ended 30 June 2010 which assessed the tax payable by the Applicant for the 2010 year as $47,706.98.
On 2 May 2013, the Applicant objected to his assessments for the years ended 30 June 2007, 2008, 2009 and 2010 (Objection). The Applicant’s stated “Grounds of Objection” are:
A. Carried forward capital losses
The taxpayer’s gross capital gain of $3,102,270 in the year ended 30 June 2007 should be reduced by the offsetting carried forward capital losses of $222,576, to $2,879,694.
Alternatively, the gross capital gain should be reduced by some lesser amount than $22,576.
B. Increased CGT cost base
The taxpayer’s assessed gross capital gain of $532,280 in the year ended 30 June 2009 should be reduced by $340,740 to $191,540 due to an increase in the asset’s cost base of that amount.
Alternatively, the gross capital gain should be reduced by some lesser amount than $340,740.
C. Deductions/Carried forward revenue losses
The taxpayer incurred revenue expenditure totalling $1,894,147 on interest costs and other holding costs between the acquisition of the land in 1989 and the sale of the final lot in the year ended 30 June 2010, which should be allowed as deductions under section 51(1) of the ITAA36 and section 8-1 of the ITAA97, as applicable, in the relevant years of income.
Alternatively, deductions of some lesser amount than $1,894,147 should be allowed.
A further $23,053 of interest costs were incurred by the taxpayer in the year ended 30 June 2011.
The taxpayer’s loss for each year should be carried forward for deduction in the relevant future income years of income, under section 79E of the ITAA36 and section 36-15 of the ITAA97.
On 2 October 2013, the Commissioner disallowed the Objection (Objection Decision).
The Objection Decision states:
Questions raised and our response
We consider your objection raises the following questions. These questions and our answers are set out below.
1. Should your taxable income for the 2006-07 to 2009-10 financial years be reduced?
Answer: No
On 25 November 2013 the Applicant applied to the Tribunal for a review of the Objection Decision, stating that he disagrees:
with all adverse aspects of [the] objection decision and Reasons for Decision.
ANALYSIS
A. Carry forward capital loss ($222,576)
The Applicant’s contention is that his gross capital gain of $3,102,270 in the year ended 30 June 2007 should be reduced by the offsetting carried forward capital losses of $222,576 (being the amount the Applicant paid to the Commissioner pursuant to the Deed of Acknowledgment, Guarantee and Indemnity), to $2,879,694. Alternatively, the Applicant contends that his gross capital gain for the 2007 year (of $3,102,27)) should be reduced by some lesser amount than $222,576. In support of these contentions, the Applicant’s Written Closing Submissions”, filed on 15 January 2015 (Applicant’s Submissions), state:
18.The Applicant’s gross capital gain of $3,102,270 in the year ended 30 June 2007 should be reduced by the offsetting of carried forward capital losses of $222,576 to $2,879,694.
19.Alternatively, the gross capital gain should be reduced by some lesser amount than $340,740.
…………
54.The Applicant incurred a net capital loss in the amount of $222,576 in the year ended 30 June 1998 (or a subsequent [year]), in respect of funds that were loaned by the Applicant to [OCS] for payment of its tax debt.[2]
[2] Applicant’s Submissions at [18] and [54].
55.Subsection 104-25(1) of the ITAA97 provides that a CGT event occurs if an Applicant’s ownership of an intangible CGT asset ends by the asset:
…………
58.It follows that the Applicant’s loss of the debt funds loaned to [OCS] is a CGT event C2 that occurs at the time of the loan ending.
………..
60.Under subsection 116-30(1), as the Applicant received no proceeds for the debt funds, he is taken to have received the market value of the debt. The debt had no market value due to the financial position of [OSC].
61.Under section 100-45, the Applicant’s capital loss at the time of the loan ending is calculated as:
$
Deemed capital proceeds Nil
Less: Reduced cost base 222,576
Capital loss (222,576)
In contrast, the Commissioner’s position is that neither CGT event C2 nor any other CGT event happened upon the Applicant entering into the Deed of Acknowledgment, Guarantee and Indemnity (on 19 December 1997). Rather, the Commissioner’s contention is that the Applicant acquired a “CGT asset” in the form of inseverable rights to be: (i) indemnified by OCS for any amount paid by the Applicant pursuant to the Deed of Acknowledgement, Guarantee and Indemnity[3]; and (ii) subrogated to the Commissioner’s rights against OCS when the debt owed to the Commissioner is paid in full[4].
[3] The Applicant’s right of indemnity arises under an implied contract or on equitable principles: Israel v Foreshore Properties Pty Ltd (in liq) (1980) 54 ALJR 421 at 423-424.
[4] The Applicant’s right of subrogation arises under s 5 of the Mercantile Law Amendment Act 1856 (imp) or on equitable principles.
According to the Commissioner, the Applicant’s right of indemnity and subrogation are proprietary and therefore a “CGT asset” under s 108-5(1) of the ITAA 1997: Unilever Australia Securities Ltd v Federal Commissioner of Taxation 94 ATC 4388. See also: Taxation Ruling TR 96/23, titled “Income tax: capital gains: implications of a guarantee to pay a debt”.
The Commissioner’s view is that the Applicant’s right of indemnity was acquired upon entry into the Deed of Acknowledgement, Guarantee and Indemnity on 19 December 1997 but that the Applicant did not acquire the right of subrogation until he paid the Commissioner in full on or about 16 December 2004, at which point an enforceable debt owed by OCS to the Applicant arose: Re A Debtor [1937] 1 All ER 1 at 6.
Further, according to the Commissioner, neither CGT event C2 nor any other CGT event happened upon the Applicant making a payment to the Commissioner (totalling $223,097.10) pursuant to the Deed of Acknowledgment, Guarantee and Indemnity on or about 16 December 2004. Instead, the payment was included in the cost base of the “CGT asset” under s 110-25(2)(a) of the ITAA 1997 and that the Applicant has not established when CGT event C2 or another CGT event “happened” to his “CGT asset”.
In support of these contentions, the Commissioner notes:
13.The Applicant’s evidence merely establishes that he funded OCS in order for OCS to pay the Commissioner. That is, the Applicant acquired a CGT asset in the form of a debt owed to him by OCS. The Applicant’s evidence is entirely consistent with the Commissioner’s submission. There is no evidence of a CGT event happening to the Applicant in respect of the CGT asset.
14.The debt owed by OCS to the Applicant is repayable on demand. The limitation period is six years under section 13 of the Limitation Act 2005 (WA). The limitation period commences upon the Applicant demanding repayment under section 59 of that Act. The Applicant has not established by reference to evidence that he demanded repayment. Further, even if the Applicant demanded repayment, the limitation period could not have expired until after 30 June 2007 (the earliest date being 16 December 2010).
15.OCS was deregistered on 30 October 2011. Even if CGT event C2 happened to the Applicant in respect of the debt owed to him by OCS, it would likely not have happened until 30 October 2011. That is, well after the year ended 30 June 2007 in which the Applicant contends he is entitled to the carried forward net capital loss.[5]
[5] Respondents Submissions, dated 25 February 2015.
As stated above, on or about 16 December 2004 the Applicant made a payment to the Commissioner (totalling $222,576.30) pursuant to the Deed of Acknowledgement, Guarantee and Indemnity (entered into between the Applicant and the Commissioner on 19 December 1997, whereby the Applicant guaranteed the “Tax Debts” and interest payable by OCS to the Commissioner). The Applicant was at all relevant times a shareholder of OCS and was a director of OCS from 14 February 1974 to 10 August 2001 and from 21 February 2008 to 20 October 2011. OCS was in external administration from 10 July 2001 to 3 June 2010 and was ultimately deregistered on 30 October 2011.
Section 108-5(1) of the ITAA 1997 provides that a “CGT asset” is “any kind of property” or “a legal or equitable right that is not property”. Note 1 to s 108-5 of the ITAA 1997 gives “debts owed to you” as an example of a CGT asset.
Section 104-25(1) of the ITAA 1997 provides that “CGT event C2” happens if ownership of an intangible CGT asset ends by the asset “being released, discharged or satisfied”, “expiring” or “being abandoned, surrendered or forfeited”.
Section 104-25(2) of the ITAA 1997 provides that the “time” of “CGT event C2” is “when you enter into a contract that results in the asset ending” or “if there is no contract – when the asset ends”.
Section 110-25(2)(a) of the ITAA 1997 includes in the cost base of a CGT asset “the money you paid, or are required to pay, in respect of acquiring it”.
Section 104-25(3) of the ITAA 1997 provides that a capital loss arises if the capital proceeds from the asset ending are less than the asset’s reduced cost base.
If no capital proceeds are received by a taxpayer from a CGT event, the taxpayer is taken to have received the “market value” of the asset that is the subject of the event: s 116-30 of the ITAA 1997.
The Tribunal agrees with the Commissioner’s contentions that the Applicant acquired a CGT asset (for the purposes of s 108-5(1) of the ITAA 1997) in the form of inseverable rights, being the right to be indemnified by OCS for any amount paid by him pursuant to the Deed of Acknowledgment, Guarantee and Indemnity (and that this right was acquired by the Applicant upon his entering into the Deed of Acknowledgement, Guarantee and Indemnity on 19 December 1997) and the right to be subrogated to the Commissioner’s rights against OCS when the debt owed to the Commissioner is paid in full (and that this right was acquired by the Applicant on or about 16 December 2004 when he paid the Commissioner $222,576 pursuant to the Deed of Acknowledgment, Guarantee and Indemnity). It follows that no CGT event happened upon the Applicant’s entry into the Deed of Acknowledgment, Guarantee and Indemnity.
The Tribunal also agrees with the Commissioner’s contention that no CGT event happened on or about 16 December 2004, when the Applicant paid the Commissioner $223,097.10 pursuant to the Deed of Acknowledgement, Guarantee and Indemnity in respect of OCS’s tax debts and, instead, that the payment formed part of the Applicant’s cost base pursuant to s 110-25(2)(a) of the ITAA 1997.
However, subject to what is said below (under the heading “Personal use assets”), the Tribunal considers that CGT event C2 happened to the Applicant in respect of the debt owed to him by OCS pursuant to the Deed of Acknowledgment, Guarantee and Indemnity on 30 October 2011 when OCS was deregistered as this is when the Applicant’s right to be indemnified came to an end for the purposes of s 104-25(1) of the ITAA 1997. It follows that CGT event C2 happened to the Applicant’s CGT asset (i.e. his inseverable rights to indemnity and subrogation) well after the year ended 30 June 2007 in which the Applicant contends he is entitled to the carried forward the capital loss of $222,576 (or some lesser amount).
Subject to what is said in the following paragraphs (regarding “Personal use assets”), in such circumstances CGT event C2 would give rise to a capital loss in the year ended 30 June 2012 for the purposes of s 104-25(3) of the ITAA 1997 as the capital proceeds from the Applicant’s CGT asset (i.e. the deemed market value of the asset: see s 116-30 of the ITAA 1997) would have been less than the asset’s reduced cost base.
Personal use assets
Section 108-20(1) of the ITAA 1997 provides that: “In working out your net capital gain or net capital loss, any capital loss you make from a personal use asset is disregarded.”
Section 108-20(2) of the ITAA 1997 provides that a “personal use asset” includes a debt arising other than: (i) in the course of gaining or producing your assessable income; or (ii) from your carrying on a business.
The Commissioner’s asserts that even if a CGT event did happen to the Applicant in respect of the debt owed to him by OCS, any capital loss is disregarded under s 108-20(1) of the ITAA 1997 on the basis that the debt due by OCS to the Applicant pursuant to the right of indemnity was a “personal use asset” under s 108-20(2) of the ITAA 1997.
According to the Commissioner, this is because the Applicant has not objectively established that the debt arose in the course of gaining or producing the Applicant’s assessable income or from the Applicant carrying on a business and, therefore, that the debt was not a “personal use asset” as defined in s 108-20(2) of the ITAA 1997: Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation 80 ATC 4542 at 4551-4552 and Fletcher & Ors v Federal Commissioner of Taxation (1991) 173 CLR 1 and TR 96/23.
The Applicant’s evidence is that he entered into Deed to assist OCS continue in business and that he never received any income from OCS in the form of dividends or wages[6]. Accordingly, the Applicant’s circumstances can be distinguished from those of the taxpayer in Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd 79 ATC 4279 where there was an expectation of the taxpayer (shareholder) deriving dividend income from continuing business operations.
[6] Transcript at p81.
The Tribunal agrees with the Commissioner’s contention that the debt due by OCS to the Applicant pursuant to his right of indemnity under the Deed of Acknowledgement, Guarantee and Indemnity was a “personal use asset” for the purposes of s 108-20(2) of the ITAA 1997 for the reason that the Applicant’s evidence does not objectively establish that the debt arose in the course of the Applicant gaining or producing assessable income or from the Applicant carrying on a business. Consequently, at no time (including in the year ended 30 June 2012: refer to discussion above in paragraphs 55 and 56) did a CGT event (including CGT event C2) happen in relation to the Applicant’s CGT asset, being inseverable rights to be indemnified and subrogated.
B. Increased cost base of Lot 300 ($340,740)
The Applicant’s contention is that his assessed gross capital gain of $532,280 in the year ended 30 June 2009 (i.e. in respect of the compulsory acquisition of Lot 300 by the City of Wanneroo for $172,480 in 2009) should be reduced by $340,740, to $191,540, due to an increase in the asset’s cost base of that amount. Alternatively, the Applicant contends that the gross capital gain for the 2009 year (of $532,280) should be reduced by some lesser amount than $340,740. In support of these contentions, the Applicant’s Submissions state:
62.The increase of $340,740 in the assets cost base is required in the year ended 30 June 2009, to recognise the costs associated with the portion of the Applicant’s property that was resumed by Council (refer above summary of relevant facts and circumstances).
63.Those costs (apportioned from the total) referable to the resumed portion of the land are:
$
Land cost 84,618.50
Legal fees 161,275.80
Planning consulting fees 53,085.20
Finance broker fees 41,760.02
340, 739.52
64.These costs have been excluded and not taken into account in calculating the Applicant’s assessed gross capital gain for the year ended 30 June 2009, in which the resumption consideration of $172,480 was included in the capital proceeds for that income year.
65.Alternatively, the amount of $430,740 should be recognised as increased cost base in an earlier year of income.
…………
70.Subsection 104-10(6) specifies the timing of the CGT Event A1 in these circumstances of the acquisition of an asset under a power of compulsory acquisition conferred by an Australian law, being the earlier of the receipt of any compensation or the change of ownership.
71.It follows that the resumption by Council of a part of the Applicant’s property is a CGT event A1 that occurs at the time of the change of ownership by resumption.
72.Under subsection 104-20(3), the Applicant incurs a capital loss if the capital proceeds of the disposal on resumption are less than the asset’s reduced cost base.
73.Under section 100-45, the Applicant’s capital loss on the resumption is calculated as:
$
Deemed capital proceeds 172,480
Less: Reduced cost base (340,740)
Capital loss (168,260)
It is common ground that CGT event A1 happened to the Applicant in respect of Lot 300 upon its compulsory acquisition by the City of Wanneroo for $172,480 in the year ended 30 June 2009 pursuant to s 104-10(1) of the ITAA 1997, titled “Disposal of a CGT asset: CGT event A1”.
What is in dispute is what the Applicant contends should be included in the cost base of Lot 300 for CGT purposes (namely $340,740).
According to the Commissioner, the amount the Applicant contends should be included in the cost base of Lot 300 (i.e. land cost of $84,618.50, Legal fees of $161,275.80, Planning consulting fees of $53,085.20 and Finance broker fees of $41,760.02) has already been in the cost bases of Lots 11 and 15 (which were also compulsorily acquired) and any apportionment to Lot 300 should therefore merely reduce the cost bases of Lots 11 and 15 (or other lots resulting from the subdivisions of the Property): Respondent’s Submissions at [54] and [56]. In support of these contentions, the Respondent’s Submissions state:
The Applicant apportioned $342,740 to Lots 11 and 15 which were also compulsorily acquired. Lots 11 and 15 total 3.5982 hectares (see T76 at page 1137). The Applicant contends that an amount of $340,740 is included in the cost base of Lot 300. Lot 300 is 1.1568 hectares (see T50 at page 685). Further, the Applicant received $879,450 as compensation for Lots 11 and 15, and received $172,480 as compensation for Lot 300. The Applicant’s contention is therefore not supported by either relative area or relative value.[7]
[7] Respondent’s Submissions at [55].
In the Respondent’s Submissions, the Commissioner notes (at [57]), that its above contention is supported by the following evidence given by the Applicant during cross-examination:
Question: So part of that $340,739.42 is actually relating to lots 11 and 15?
Answer: It would be, yes….That was for the total. They took approximately 25 per cent of the land and that’s what they’re allocated. And when Anika went through it, that was what she said, that they had addressed as the proportion relevant to that.
Question: So that’s the total, it is not simply 300?
Answer: Yes. So all the expenses that I had had down here, she reduced them by the amount that she believed that that land was resumed – was what the end result of what the resumption was, and that left the balance, yes.[8] [Emphasis added]
[8] Transcript at p 82.
According to the Commissioner:
The Applicant has not established by reference to evidence what is a reasonable apportionment of each element of the cost base and reduced cost base of [the Property] for the purpose of working out the cost base and reduced cost base of Lot 300.[9]
[9] Respondent’s Submissions at [58].
The cost base of a CGT asset generally has five elements: s 110-23 of the ITAA 1997. These elements are the acquisition cost (s 110-25(2)), incidental costs (s 110-25(3)), ownership costs (s 110-25(4)), enhancement costs (s 110-25(5)) and title costs (a 110-25(6)). Division 112 of the ITAA 1997 contains certain modifications to the general rules for determining the cost base and reduced cost base of a CGT asset.
Of particular relevance here, is s 112-25 of the ITAA 1997 which provides special cost base rules for split, changed or merged assets, such as the Property which was subdivided into separate lots (including relevantly Lots 300, 11 and 15) and sold by the Applicant.
Specifically, s 112-25(3) of the ITAA 1997 provides that the cost base and reduced cost base of each new asset is worked out using the following two step method:
· Step 1: Work out each element of the cost base and reduced cost base of the original asset as at the time of the split; and
· Step 2: Apportion in a “reasonable” way each element of each new asset. The result is each corresponding element of the new asset’s cost base and reduced cost base.
Section 112-30 of the ITAA 1997 contains “apportionment rules” relevant to the method statement in s 112-25(3) of the ITAA 1997. Section 112-30(1) of the ITAA provides that if only part of the expenditure incurred in relation to a CGT asset relates to the asset, the relevant element of the cost base and reduced cost base of the asset only includes that part of the expenditure that is “reasonable attributable” to the acquisition of the asset.
Section 112-30(3) of the ITAA 1997 provides that if a CGT event happens to some part of a CGT asset but not to the remainder of it (as is the case here), the cost base and reduced cost base of that part are generally worked out using the following formula:
Capital proceeds for the CGT event
happening to the part__________
Cost base of the asset X Those capital proceeds plus the market
value of the remainder of the asset
The remainder of the cost base and reduced cost base is attributed to the part of the asset that remains: s 112-30(4) of the ITAA 1997.
The Tribunal agrees with the Commissioner’s submission that the Applicant’s evidence does not establish what is “reasonable” apportionment of each element of the cost base and the reduced cost base of the Property for the purpose of ascertaining the cost base and reduced cost base of Lot 300 in accordance with s 112-30 of the ITAA 1997.
To the extent that the Applicant relies on the cost amounts set out in paragraph 63 of the Applicant’s Submissions (refer to paragraph 63 above), the Tribunal notes that those amounts are virtually identical to amounts identified in a table provided by the Applicant’s representative in a letter to the Commissioner, dated 6 August 2013, to show the reasonably apportionable elements of the cost base of the Property to Lots 11 and 15. The Applicant’s letter of 6 August 2013 was in response to the Commissioner’s letter, dated 14 June 2013, requesting for further information from the Applicant in relation to the Objection. As submitted by the Commissioner, the Tribunal considers it unlikely that the reasonably apportionable elements of the cost base of the Property to Lot 300 would be virtually identical to the total amount apportioned to Lots 11 and 15.[10]
[10] There is only a difference of $2000 in one of the elements listed in both tables. The difference is in relation to the element identified as ‘Land Cost’. Otherwise the element amounts and the total amounts in both tables are identical.
B. Deductibility of interest, land tax & council rates ($1,894,147)
The Applicant’s contention is that he incurred revenue expenses (interest, land tax and council rates) totalling $1,894,147 during the years between the acquisition of the Property in 1989 and the sale of the final lot in the year ended 30 June 2010, and that these expenses are allowable deductions under s 51(1) of the ITAA 1936 or s 8-1(1) of the ITAA 1997. Alternatively, the Applicant contends that he should be allowed deductions of some lesser amount than $1,894,147.
Section 8-1(1) of the ITAA 1997, applicable to the year ended 30 June 1998 and subsequent income years, states:
You can deduct from your assessable income any loss or outgoing to the extent that:
(i) it is incurred in gaining or producing your assessable income; or
(ii)it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
Section 51(1) of the ITAA 1936, which applies to the year ended 30 June 1997 and prior income years, is in substantially similar terms to s 8-1(1) of the ITAA 1997.
The words used in s 8-1(1) of the ITAA 1997 (and s 51(1) of the ITAA 1936) dictate that a loss or outgoing must be incurred by a taxpayer “in” gaining or producing his or her assessable income. This has been interpreted by the courts as meaning incurred “in the course of” gaining or producing assessable income: see in particular the High Court’s decision in Federal Commissioner of Taxation v Payne 2001 ATC 4027 at 4030. In relation in particular to expenditure incurred prior to the production of income (as it the case here) it therefore becomes necessary to establish some “link” or “nexus”, or sufficient connection”, between the loss or outgoing and the production of assessable income.
A taxpayer’s subjective purpose in incurring a loss or outgoing is ordinarily irrelevant for the purposes of s 51(1) of the ITAA 1936 or s 8-1 of the ITAA 1997 in the case of a voluntary loss or outgoing, particularly where the loss or outgoing gives rise to the receipt of a larger amount of assessable income than the expenditure incurred. However, a taxpayer’s “intention” or purpose at the time expenditure is incurred will often be relevant for s 8-1 purposes (and s 51(1) purposes) and, in some cases, the decisive factor, in circumstances where, as is the case here, no assessable income is produced by the taxpayers (see Inglis v Federal Commissioner of Taxation (1979) 40 CLR 191 at 201; 10 ATR 493 at 500; Magna Alloys & Research; Ure v Federal Commissioner of Taxation (1981) 50 FLR 219 at 223 and 232 and Goodman Fielder Wattie v Commissioner of Taxation (1991) 29 FCR 376 at 387) or if the “link”, “nexus” or “connection” between the loss or outgoing and the production of income is not objectively clear (see Fletcher & Ors).
The courts have applied various tests to determine whether a sufficient “link”, “nexus” or “connection” exists between a loss or outgoing and the production of assessable income, including the “incidental and relevant” test (see Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47), the “essential character” test” (see Lunney v Federal Commissioner of Taxation; Hayley v Federal Commissioner of Taxation (1958) 100 CLR 478) and the “perceived connection” test (see Federal Commissioner of Taxation v Hatchett 71 ATC 4184). A large body of case law has developed over time in relation to these tests. The Tribunal does not propose to dwell upon that case law in these reasons for decision. Ultimately whether a sufficient link, nexus or connection exists is a question of fact to be determined based on the circumstances of a particular case.
As stated in the “Introduction”, it is common ground that the Applicant acquired the Property with the “intention” of carrying on a turkey-farming business.
The Applicant’s position is that at all relevant times his “intention” was to use the Property to carry on a turkey farming business such that the interest, land tax and council rates (holding costs) that he incurred in the income 1990 to 2010 income years are deductible expenses under s 51(1) of the ITAA 1936 or s 8-1(1) of the ITAA 1997.
The Commissioner’s disputes this.
In support of his position, the Applicant’s Submissions state:
5..….the Applicant acquired the property with the intention to use the property to carry on a turkey-farming business
6.The Applicant’s evidence is that he maintained that intention at all relevant times, and could and would have commenced the turkey-farming operations, if not for significant planning (resumption) and environmental obstacles that arose and which were outside of his control and which he was unable to overcome, despite considerable efforts and alternative strategies to do so.
………
27.The Applicant’s intention was to commence a turkey-farming business, or alternatively the business was in fact commenced upon his acquisition of the property, based on his intention and purpose, notwithstanding that the turkey-farming activity did not eventuate;
28.……..the Applicant’s purpose in purchasing Portion of Swan Location 883 was to establish and develop (as a sole trader) a long term turkey-farming operation on the property, with the existing operations by Osborne Cold Stores (WA) Pty Ltd being terminated and the existing sheds being transferred from Wyatt Road to the new property.
29.The financial circumstances of his company, and the encroachment of residential housing, were factors leading to the intention by the Applicant to terminate the company’s existing operations and to commence the turkey-farming business as a sole trader at the new property;
30.As the Applicant had previously been engaged in turkey-farming operations through the company, it was not a speculative venture but an intended restructuring and relocation of the previous operations.
31.The acquisition of the new property, the relationship with the existing operations of the company, his ongoing personal industry contacts, and the intended transfer of the existing sheds to the new property, are all matters of “activity” which would have enabled a profitable business on the property if not for the planning (resumption) and environmental obstacles beyond the Applicant’s control.
32.Had those obstacles not arisen or had successfully been overcome, the business could and would have been fully operational upon the (revenue) purchases of turkey chicks and feed. The Applicant had an existing supply line of turkey chicks and sale of birds through the existing operations of the company. Those existing operations continued until a late stage of the Applicant’s holding of the property.
………
34.Due to the restrictions on use of the property (as only became known to the Applicant following purchase, and was subject to legal action for that reason), and the escalating financial costs, the Applicant needed to sell the property.
35.Rezoning of the property to Special Rural was ultimately obtained, which enabled the property to be subdivided into 10 lots of one hectare each for sale.
36.Notwithstanding the forced sale arrangements, the Applicant’s sole and continuing intention had been to establish a long term turkey farming operation on the property.
In relation to his enquiries into the rezoning, subdivision and sale of the Property, the “Applicant’s Statement of Facts, Issues and Contentions”, filed on 26 September 2014, state (at p12):
· He did not at any stage abandon or relinquish his intention to commence a turkey farming business, notwithstanding the unforseen prohibition and difficulties that he encountered with the property zoning and restrictions;
· Had he been able to overcome those obstacles, he could and would have commenced the turkey farming business at the first available opportunity;
· Alternatively, the business was in fact commenced upon purchase of the property with the requisite purposes of carrying on the turkey farming operations on the property.
· His legal actions and enquiries/submissions to the relevant authorities were directed towards overcoming those obstacles for the commencement of the turkey farming business;
· The sale contemplations or enquiries were only as a “mere realisation” in the event that the obstacles could not be overcome, and he had to repay the borrowings;
· The sale contemplations or enquiries were directly attributable and incidental to those obstacles, and were not a new or revised course of action with an abandonment to the intention to commence a turkey farming business;
· The rezoning or sale contemplations or enquiries were forced or necessitates, and did not amount to any change of intention, in order to service his financial borrowings.
In contrast, the Commissioner’s position is that after 30 June 1992:
· the Applicant took various steps to have the Property rezoned “Rural” to “Special Rural” (which prohibited poultry farming) and subdivided into one hectare lots for sale; and
· the Applicant took no steps to develop the Property for use as a poultry farm.[11]
[11] Respondent’s Submissions at [28].
Consequently, the Commissioner’s contention is that the Applicant’s “intention” at all relevant times after 30 June 1992 severed the necessary connection between the losses and outgoings incurred by the Applicant with the gaining or producing of assessable income that the Applicant anticipated would be derived from poultry farming on the Property, such that any losses or outgoings incurred by the Applicant after 30 June 1992 are not deductible under s 51(1) of the ITAA 1936 or s 8-1(1) of the ITAA 1997: see Magna Alloys & Research; Inglis; Federal Commissioner of Taxation v Riverside Road Pty Ltd (in liq) 90 ATC 4567; Fletcher & Ors; Steele v Deputy Federal Commissioner of Taxation (1999) 197 CLR 459; Commissioner of Taxation v Anovoy Pty Ltd [2001] FCA 447; Federal Commissioner of Taxation v Brown 99 ATC 4600; Federal Commissioner of Taxation v Jones 2002 ATC 4135 and Guest v Commissioner of Taxation [2007] FCA 193.
The Commissioner further submits that, due to the severed connection, the Applicant no longer had the requisite expectation of assessable income: Ronpibon Tin NL (1949) 78 CLR 47 at 57.
The Tribunal considers that the evidence clearly supports the submissions of the Commissioner concerning the Applicant’s “intention” in relation to the Property (in paragraphs 89 to 91 above) are correct. In reaching the conclusion that there was an insufficient “link”, nexus” or “connection” between the Applicant’s losses or outgoings and the production of assessable income by him from at least 30 June 1992, the Tribunal notes the following:
· the Applicant became aware of the “System Six” recommendations affecting the Property on 4 September 1989 upon receiving the “ City of Wanneroo Land Purchase Inquiry”;
· on 25 September 1989, the Applicant sought to terminate the contract to purchase the Property from the Vendor and the refund of all monies plus interest on the basis that the Property “could not be developed as a poultry farm”;
· on 2 November 1989, the Applicant was advised by the Department of Planning and Urban Development that “it appears unlikely that the Commission, as well as the Council, would readily support the development you indicate” (i.e. the development of the Property for use as a poultry farm);
· on 25 January 1990, it was agreed between the Applicant and the Vendor that the purchase price for the Property be reduced from $370,000 to $323,112.50 of which $213,112.50 was to be paid in cash and $110,000 was to be satisfied by the transfer of the Applicant’s land on Scarborough Beach Road, Osborne Park;
· the Applicant became the registered proprietor of the Property on 30 March 1990;
· in or around April 1990, the Applicant engaged BSD Consultants in relation to the rezoning of the Property from “Rural” to “Special Rural” (and poultry farming is not permitted under a “Special Rural” zoning);
· in or around January 1992, the Applicant engaged Feilman Planning in relation to the rezoning of the Property from “Rural” to “Special Rural” (and poultry farming is not permitted under a “Special Rural” zoning);
· in or around June 1992, Feilman Planning applied to the City of Wanneroo, on behalf of the Applicant, to have the Property rezoned from “Rural” to “Special Rural” (and poultry farming is not permitted under a “Special Rural” zoning) and to facilitate subdivision of the Property into one hectare lots for sale;
· The Property was rezoned from “Rural” to “Special Rural” in June 1998;
· The Property was subdivided in August 2005; and
· The Applicant sold the subdivided lots in the period 2007 to 2010.
In support of his contention that his “intention” in relation to the Property remained unchanged at all relevant times, the Applicant appears to place considerable reliance on his letter to the Minister for Planning, dated 8 November 1995 (8 November 1995 Letter), which stated:
We have proposed to your Department, that as our land was approximately fourteen and one half hectares (14.5 hectares), and as such if there was to be no acquisition of our land, we could subdivided it into fourteen one Hectare lots; thus we have requested that we are permitted this approval and once the lots are created, we then undertake to transfer free of cost the portion of land off each lot and cede that to the Crown.[12]
[12] Applicant’s Witness Statement, at [24]; Applicant’s Submissions at [33](u) and (v) and Transcript at p24.
The Tribunal is satisfied based on the evidence that the 8 November 1995 Letter is not, as the Applicant asserts, evidence that the Applicant’s “intention” in relation to the Property remained unchanged as at 8 November 1995. Rather, as submitted by the Commissioner, the 8 November 1995 Letter does no more than evidence the Applicant’s original intention in acquiring the Property, which, as stated earlier, is not in dispute.
The Applicant filed and served a witness statement in support of his review application, dated 26 September 2014 (Applicant’s Witness Statement). There is nothing in the Applicant’s Witness Statement that is inconsistent with the Tribunals’ above findings.
The Applicant also gave extensive oral evidence at the hearing of his review application. The Tribunal observes that the Applicant was frequently led by his representative and that, overall, he was an unreliable witness. The Applicant was evasive and regularly attempted to avoid giving direct answers to direct questions.
In addition, on the one hand, the Applicant did not distinguish between himself and his various companies (such as OCS) that are separate legal entities: Transcript at p53. However, on the other hand, the Applicant asserted that he is a Certified Practising Accountant qualified to give evidence about the preparation of the accounts of OCS: Transcript at p86.
Further, the Applicant’s evidence that he applied to have the Property rezoned and subdivided so that he could use it as a poultry farm is not credible. Rezoning the Property “Special Rural” prohibited the use of the Property as a poultry farm. The evidence shows that the Applicant was aware of the impact that that rezoning the Property to “Special Rural” would have and, although the Applicant asserts that he did not intend to go through with the rezoning and subdivision of the Property, he went through with both.
For the above reasons, the Tribunal finds that the Applicant’s oral evidence should be afforded little weight.
Interest costs
The Applicant’s contention is that he incurred further interest costs of $23,053 in the year ended 30 June 2011 and that his “tax loss” for each year should be carried forward for deduction in the relevant future income year pursuant to s 79E of the ITAA 1936 and s 36-15 of the ITAA 1997: Applicant’s Submissions at [24].
In support of this contention, the Applicant relies on the decision of the Full High Court of Australia in Steele v Deputy Federal Commissioner of Taxation 99 ATC 4242; (19991) 41 ATR 139 (Steele): Applicant’s Submissions at [74] to [102]. Broadly, Steele’s case stands for the proposition that the deductibility of a loss or outgoing is not dependent on the result of the expenditure. Thus, if expenditure is not successful in generating assessable income, a deduction is still available if it satisfies the requirements of s 8-1(1) of the ITAA 1997. Importantly, the loss or outgoing must be incidental and relevant to operations or activities from which the assessable income is produced: Steele at 151.
In support of the Applicant’s contention concerning his 2011 year interest costs, the Applicant’s Submissions state:
74.The majority of the Full High Court in Steele v DFC of T 99 ATC 4242 is authority for the deductibility of interest incurred on funds borrowed for the acquisition of land (and for other holding costs) in circumstances where the intended income-producing activity did not eventuate due to unforeseen circumstances.
75.The Applicant contends that the facts and circumstances that existed in Steele are on foot with his facts and circumstances, and therefore the decision of the Full High Court in that case is precedent for the deductibility of his expenses and therefore his carried forward revenue losses.
…………
101.As in Steele, the overriding factor should be that the Applicant had an income-producing purpose of commencing a turkey-farming business, and did not envisage any use or dealing with the property other than the one which would produce assessable income. On that basis, the interest expenses and other holding costs as deductible under section 51(1)/8-1.
102.Further, as in Steele, any non-commencement of the turkey-farming business and the ultimate sale of the property by the Applicant (in this case, in unforseen and involuntary circumstances), should not negate or reduce the deductibility of his interest expenses.
In contrast, the Commissioner contends that Steele may be distinguished from the Applicant’s case. The Commissioner points out that in Steele the taxpayer always intended to put the land to an assessable income producing use. Whereas, here, the intention of the Applicant with respect to the Property changed no later than 30 June 1992: Respondent’s Submissions at [36]. Further, in Steele, from the time of contracting to purchase the property, the only business conducted on the property was that of agisting horses from which modest assessable income was derived. At the same time, the taxpayer, pursued actively and in a variety of ways, the possibility of using the land for motel and residential development. She engaged architects to prepare a proposal for a residential development. She negotiated with a business associate to develop the property jointly. She made applications to the local council for planning approval of a motel. She sold a half interest in the property but subsequently repurchased it. She tried to negotiate the sale of an interest in the proposed motel and management rights over it: Respondent’s Submissions at [37].
The Commissioner asserts that unlike the taxpayer in Steele, in this case the Applicant was in need of an alternative “Plan B”, even before his acquisition of the Property settled. Plan A (i.e. a poultry farming business) may have produced assessable income but could not be implemented. Plan B became the rezoning, subdivision and sale of Swan Location 883 but would not produce assessable income. Moreover, the documentary evidence shows that by 30 June 1992, Plan B had seemingly become the Applicant’s only Plan. The Commissioner contends that there is no evidence that after 30 June 1992 the Applicant actively pursued a use for the Property that may produce assessable income: cf Steele at 475-476 and Respondent’s Submissions at [38].
More specifically, the Commissioner submits (see the Respondent’s Submissions at [39]) that Steele may be distinguished from the present case for the following reasons:
(a)The applicant was made aware that Swan Location 883 could not be used as he originally intended between exchange and completion of the contract pursuant to which he acquired Swan Location 883;
(b)The Applicant negotiated a reduction in the purchase price to compensate him for the risk that Swan Location 883 could not be used as he originally intended;
(c)The Applicant commenced work on the rezoning and subdivision of Swan Location 883 almost immediately upon becoming the registered proprietor;
(d)Rezoning as Special Rural prohibited the use of Swan Location 883 as a poultry farm (see ST1 at page 1, T30 at page 244 and T45 at page 524);
(e)The Applicant took all necessary steps to have Swan Location rezoned and subdivide after 30 June 1992;
(f)There is no evidence of the Applicant taking any steps to have Swan Location 883 developed as a poultry farm after 30 June 1992. In fact, the Applicant’s own evidence is that he took no steps after 30 June 1992 (see transcript at P-69); and
(g)Swan Location 883 was in fact rezoned, subdivided and sold by the Applicant resulting in him making capital gains.
The Tribunal considers that the evidence clearly supports the submissions of the Commissioner (in paragraphs 100 to 102 above) as opposed to those put by the Applicant (see paragraphs 100 to 102 above).
The Applicant also relies on the decisions of the Full Federal Court in Federal Commissioner of Taxation v Brown 99 ATC 4600 and Federal Commissioner of Taxation v Jones (2002) 117 FCR 95, which cases are concerned with the deductibility of interest after the cessation of a business (as well as Taxation Ruling TR 2004/4).
In summary, the Applicant considers those cases to be relevant to his circumstances in relation to:
· The implications on deductibility of the interest where the Applicant was unable (legally or economically) to repay the loan; and
· The implications on deductibility of the interest where unforeseen or involuntary circumstances arose.[13]
[13]See Applicant’s Submissions at [103]-[178].
More specifically, the Applicant’s Submissions state:
Inability to repay the loan
105.The decisions in Brown and Jones are authority for the principle that a legal or economic inability to repay the loan is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities (as noted at paragraph 14 of Taxation Ruling TR 2004/4, referred to below).
106.Applied to the Applicant’s circumstances, his inability to repay the loan without sale of the property indicates that the loan retained its original purpose of being for the intention to carry on the turkey farming business.
Unforeseen and involuntary circumstances
107.In Jones, the circumstances were the death of a partner in the partnership, causing cessation of the business that was carried on. However, that did not preclude deductibility of the interest incurred after cessation of the business.
108.In the Applicant’s circumstances, the unforeseen planning (resumption) and environmental obstacles prevented his intended operation the turkey-farming business. His legal action and attempts to overcome those obstacles evidence his continuing intention, and had he been able to overcome those obstacles, he could have and would have conducted the turkey-farming operations at the first available opportunity.
109. Further, the Applicant did not undertake any subsequent refinancing of the loan.
110.As in Jones, despite the unforseen and involuntary circumstances, there was no break in the nexus between the Applicant’s interest expenses and his intention to carry on the turkey-farming business.
According to the Commissioner, Brown and Jones may be distinguished because the taxpayers did not put the borrowed funds to an alternative use following the cessation of the business, as the Applicant did here consistent with a change of intention: Respondent’s Submissions at [42]. The Commissioner submits that Brown and Jones may be further distinguished on the basis that the Applicant had the capacity to repay the loans from time to time by selling the Property. This is not a case, like Jones, where the “taxpayer had no free choice between continuing the loan and repaying it”: cf Jones at [17] and see Respondent’s Submissions at [44]. In support of these contentions, the Commissioner notes that the Property was valued at $580,000 as at 29 August 1989, at $1,000,000 as at 15 August 1994 and at $1,300,000 as at 24 May 1995 and that these valuations indicate that the Applicant could have sold the Property at any time and made a profit or gain: see Respondent’s Submissions at [45]-[46].
The Tribunal is satisfied that the evidence clearly supports the submissions of the Commissioner (in paragraph 110 above) and not those of the Applicant (in paragraphs 107 to 109 above).
Substantiation of interest, land tax and council rates
The Tribunal considers that the Applicant has not established what, if any, losses or outgoings he incurred in the form of interest, land tax and/or council rates in relation to acquiring and holding the property.
That is, even if the Applicant had the requisite intention at all relevant times, the Tribunal is not satisfied that the Applicant has adequately substantiated the interest, land tax and council rates said to have been incurred by him, their connection to the Property or the availability of any resulting tax losses to him in the relevant income years. The reasons for this include:
· The Applicant’s evidence consists of various handwritten schedules which, in the absences of any corroborating evidence, do not prove the identity of the borrower, the amount of the borrowing, the purpose of the borrowing or the amount of interest. Relevantly, Exhibit A2 tendered by the Applicant at the hearing consists of just 37 pages of documents, many of which are incomplete;
· The Applicant’s own evidence is that he used the borrowed funds upon which the interest is said to have been incurred for purposes including repaying the debt secured against his property at Scarborough Beach Road, Osborne Park (Transcript at p50) and making the payment to the Commissioner under the Deed of Acknowledgment, Guarantee and Indemnity -pursuant to which the Applicant guaranteed the tax debts and interest payable by OCS (Transcript at p38 and pp76 to 77);
· The financial statements of OCS for the year ended 30 June 1992 show that, as at 30 June 1991 and 1992, OCS (as distinct from the Applicant) was liable to the Bank of Singapore in the amount of $350,000 and incurring interest on the liability of $21,308 in the year ended 30 June 1991 and $32,208 in the year ended 30 June 1992 (see T74 at pages 1056 and 1059). Relevantly, for the period 19 March 1990 to 13 January 1992, the Applicant claimed interest at 9% totalling $57,750 in his hand written schedules. For completeness, the Applicant’s assertion in oral evidence that the interest shown in the financial statements of OCS relates to another liability to the Bank of Singapore in the amount of $2,004,423 is, as contended by the Commissioner, implausible given that would represent a simple interest rate of only 1.06% in the year ended 30 June 1991 and only 1.60% in the year ended 30 June 1992 (Transcript at p84);
· The Applicant bought and sold a number of other properties during the income years concerned and, in the absence corroborating evidence, the Tribunal cannot be satisfied that the Applicant used the borrowed funds on which the interest is said to have been incurred solely for the purpose of developing the Property as a poultry farm (i.e. it could have been incurred by the Applicant in relation to his other properties);
· The Applicant’s own evidence is that he had no income and was living off borrowed funds in the income years concerned (Transcript at p72). Again, in the absence of corroborating evidence, the Tribunal cannot be satisfied that the Applicant used the borrowed funds on which the interest is said to have been incurred solely for the purpose of developing the Property as a poultry farm.
Even if the Applicant could establish that he incurred losses or outgoings and that they were deductible to him, the Applicant has not established that, as a result, he had “tax losses” that are available to be “utilised” by him in the years ended 30 June 2007, 30 June 2008 and 30 June 2010 pursuant to either s 36-15 of the ITAA 1997 or s 36-105 of the Income Tax (Transitional Provisions) Act 1997.[14]
[14] Availability and deductibility of tax losses for the 1989/1990 to 1996/1997 income tax years is determined in accordance with s 36-105 of the Income Tax (Transitional Provisions) Act 1997.
In any event, the Tribunal notes that the Applicant’s tax losses are calculated under Division 36 of the ITAA 1997, titled “Tax losses of earlier income years”. Section 36-10 of the ITAA 1997, titled “How to calculate a tax loss for an income year”, requires that regard be had to “the amounts you can deduct for an income year” and to “your total assessable income”. It is not necessary for the amounts you can deduct to have been allowed as deductions. Nor is it necessary for the assessable income to have been assessed.
Accordingly, even if the Applicant is able to substantiate the interest, land tax and council rates said to have been incurred, he has not provided objective evidence proving that any such amounts resulted in a tax loss for a loss year under s 36-10 of the ITAA 1997. The mere fact that the Applicant was not assessed on any income in the same year does not address the question of whether he had any assessable income for that year: Vincent v Commissioner of Taxation (2002) 124 FCR 350 at [91] and Oates v Commissioner of Taxation (1990) 27 FCR 289 at 308.
Under s 36-15 of the ITAA 1997, titled “How to deduct tax losses of entities other than corporate tax”, provides that a tax loss for a loss year is deducted in a later income year to the extent that it has not already been “utilised” (i.e. there is not choice by the taxpayer to deduct the tax loss, the only qualification is prior utilisation). Section 960-20(2) of the ITAA 1997 provides that a tax loss is “utilised” if it is deducted from an amount of assessable income or net exempt income.
Reading s 36-10 and s 36-15 of the ITAA 1997 together, even if the Applicant can demonstrate that he has tax losses for prior loss years, he has not provided objective evidence proving that any such tax losses have not previously been “utilised” prior to the years ended 30 June 2007 to 2010 and the mere fact that the Applicant was not assessed on any income in prior years does not address the question of whether he had any assessable income for prior years which would have utilised any tax losses he may have had.
Decision
For the above reasons, the Tribunal affirms the Objection Decision.
I certify that the preceding 119 (one hundred and nineteen) paragraphs are a true copy of the reasons for the decision herein of Senior Member CR Walsh ....(Sgd) A Tran ....................................................................
Associate
Dated 23 April 2015
Date of hearing 3 December 2014 Date final submissions received 12 March 2015 Representative of the Applicant Mr G Jolley Solicitors for the Applicant Crowe Horwath Counsel for the Respondent Mr J Leek Solicitor for the Respondent Ms A McNally
Australian Taxation Office
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