Balestra and Commissioner of Taxation
[2007] AATA 1845
•5 October 2007
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2007] AATA 1845
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT200500042
TAXATION APPEALS DIVISION ) Re FRANK BALESTRA Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr S E Frost, Member Date5 October 2007
PlacePerth
Decision The objection decision under review is affirmed.
...........(Sgd. S E Frost).................
Member
CATCHWORDS
TAXATION - income tax - deductions - partnership losses - mass marketed scheme - Part IVA - scheme - tax benefit
LEGISLATION
Income Tax Assessment Act 1936 – ss 90 and 92 and Part IVA
Income Tax Assessment Act 1997 – s 8-1
Taxation Administration Act 1953 – s 14ZZK
Administrative Appeals Tribunal Act 1975
CASES
Commissioner of Taxation v Dalco (1990) 168 CLR 614
Commissioner of Taxation v Sleight (2004) 136 FCR 211
Hope v Bathurst City Council (1980) 144 CLR 1
Puzey v Commissioner of Taxation (2003) 131 FCR 244
Amalgamated Zinc (de Bavay’s) Ltd v Federal Commissioner of Taxation (1935) CLR 295
Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47
Fletcher v Commissioner of Taxation (1991) 173 CLR 1
Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459
Softwood Pulp and Paper Ltd v Federal Commissioner of Taxation 76 ATC 4439
Federal Commissioner of Taxation v Maddalena (1971) 45 ALJR 426
Federal Commissioner of Taxation v Zoffanies Pty Ltd 2003 ATC 4942
Eastern Nitrogen Ltd v Federal Commissioner of Taxation (2001) 108 FCR 27
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404
Federal Commissioner of Taxation v Consolidated Press Holdings (2001) 207 CLR 235
Peabody v Federal Commissioner of Taxation (1993) 93 ATC 4104
Peabody v Federal Commissioner of Taxation (1994) 181 CLR 359
Lenzo v Commissioner of Taxation (2007) FCA 1402
REASONS FOR DECISION
Mr S E Frost, Member Introduction
1.Frank Balestra has been a self-employed pharmacist for over 20 years.
2. In the 1998 financial year he invested in the Rydal Hard Rock Joint Venture Project No. 1 (the Joint Venture). His 1998 income tax return shows that he claimed over $100,000 in deductions in respect of the Project. The Commissioner disallowed the deductions and raised amended assessments relying on the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (the 1936 Act). Mr Balestra objected against the amended assessments and the Commissioner disallowed the objection. That objection decision is under review here.
The issues
3.The issues in this review are:
(1)whether the Joint Venture is entitled to deductions totalling $12,370,200 under s 8-1 of the Income Tax Assessment Act 1997 (the 1997 Act);
(2)whether the Joint Venture incurred a partnership loss of $12,370,155 within the meaning of s 90 of the 1936 Act;
(3)whether the taxpayer, Mr Balestra, is entitled to a deduction of $97,250 under s 92 of the 1936 Act as his individual interest in a partnership loss incurred by the Joint Venture;
(4)whether the taxpayer is entitled to a deduction of $8,665 under s 8-1 of the 1997 Act for interest accrued in advance;
(5)whether the taxpayer is entitled to a deduction of $3,750 under s 8-1 of the 1997 Act for indemnity fees;
(6)whether Part IVA of the 1936 Act applies to disallow any of the deductions that might otherwise be allowable under issue (3), (4) or (5) above;
(7)whether an assessment of additional tax, by way of penalty, in the sum of $4,627.60 should stand.
4. For the purposes of the review in this Tribunal, Mr Balestra is limited by section 14ZZK of the Taxation Administration Act 1953 (TAA) to the grounds stated in his objection against the amended assessment made by the Commissioner. Under that same provision he has the burden of proving that the amended assessment is excessive.
The evidence
5. Mr Balestra made a written statement and also gave oral evidence by videolink from Thailand. In addition to Mr Balestra’s evidence, I had before me a substantial number of documents that were lodged under section 37 of the Administrative Appeals Tribunal Act 1975. There were of course all the relevant project documents (to which I will refer in detail later in these reasons), and reports, correspondence, tax returns and financial records of all the relevant entities.
Mr Balestra’s written statement
6. Mr Balestra’s written evidence in relation to his investment in the project was that:
(a) In the 1998 financial year he wanted to diversify his investment portfolio and was attracted to “riskier” investment opportunities, of which the Joint Venture was one[1].
(b) It was his previous accountant, Mr Rod Del Carlo, who told him about the Joint Venture project. Mr Del Carlo was aware of the taxpayer’s financial goals, which were said to be “to produce an income stream and create wealth from many commercial investments”. Mr Balestra became aware of the Joint Venture Prospectus which was issued on 25 May 1998[2].
(c) Mr Del Carlo explained that an investment in the Joint Venture would enable Mr Balestra to “participate in and carry on a business of quarrying”[3] and, although Mr Balestra knew little about the extraction and processing of rocks[4], he understood from the Prospectus that his investment would enable him to be “a part of a joint venture which had the rights to quarry the site in New South Wales” identified in the Prospectus and that he would “share in the profit from the sale of the rock and other material extracted from the site”[5].
(d) After reading the Prospectus and discussing the matter with his wife, Mr Balestra decided to invest in the project[6]. On or around 30 June 1998 he signed several documents, including an Application Form for the purchase of five units in the project, a Loan Indemnity Agreement and a Loan Agreement[7].
(e) The taxpayer appointed Jedidiah Management Limited (Jedidiah) as his “true and lawful attorney” to admit him as a participant in the project, sign as his agent an application for registration of the Joint Venture, and execute an “assumption agreement” with respect to the Joint Venture deed[8]. His understanding was that Jedidiah’s execution of the Assumption Agreement on his behalf bound Mr Balestra to the terms of the Joint Venture deed[9].
(f) His understanding was that by completing the application form and appointing Jedidiah as his true and lawful attorney, he was indicating his desire to carry on the business of extracting rock and to have Jedidiah, on his behalf, enter into a Technical Management Agreement (by which he was bound) with Rydal Management Pty Ltd (Rydal)[10].
(g) He understood that Rydal had an extraction licence from the Department of Lands and Water Conservation to extract the rock on the property and that the rights under the extraction licence were provided to the Joint Venture to allow the participants in the Joint Venture to extract the rock. He paid Rydal a licence fee of $6,250 for his five interests in the project and was to pay Rydal 2.5% of the revenue earned from the project for each of the remaining six years of the project[11].
(h) He lacked the time and the expertise to carry on the day to day operations of the project but felt that it was a good opportunity for him that Rydal would manage the affairs of his rock extraction business. He would pay Rydal $18,000 per interest for the services that they would supply to him, and he considered this a reasonable fee for the work that Rydal was to undertake[12].
(i) He took up a loan option that was offered to him. Under this loan option he borrowed from Horizon Lending Company (Horizon) his “initial capital contribution” of $19,450 per unit in the project. He pre-paid interest (for the first year) of $1,733 per unit[13].
(j) He also entered into an Indemnity Agreement with Rydal. Under this agreement he would pay Rydal an amount of $750 per unit and he would then be indemnified against any inability of his business to meet the interest and principal repayments under the Loan Agreement. In other words, if his business did not produce enough income to repay the loan then Rydal would pay the shortfall[14].
(k) When he completed the application for units in the project he paid the following amounts on or before 30 June 1998[15]:
o $1,000.00 for the Manager’s fees payable to Jedidiah;
o $6,250.00 for Licence Fees payable to Rydal;
o $90,000.00 for Technical Management fees payable to Rydal;
o $8,665.00 for prepaid interest payable to [Horizon]; and
o $3,750.00 for the Indemnity fees payable to Rydal.
(l) On 24 September 1998 he paid $7,800 per unit as a repayment of the principal under the Loan Agreement[16].
(m) He received updates and financial statements for the years ended 30 June 1998 and 1999 from Jedidiah[17] but eventually, in 2000, he received a report indicating that the project was likely to be wound up, partly because development consent for the quarry had been refused by the New South Wales Land and Environment Court[18]. The project was eventually wound up, without any aggregate having been extracted from the site.
Mr Balestra’s evidence under cross-examination
7. Under cross-examination by Mr Davies QC for the Commissioner, Mr Balestra said that, contrary to the claim set out at paragraph 6(k) above, the only amount that he paid on or before 30 June 1998 was the $1,000 (or $200 per unit) referred to in that paragraph as the “Manager’s fee” but described by him under cross-examination as the “deposit of $200 per share”. Furthermore, his oral evidence was that the only other payment that he made after 30 June 1998 (in fact, in September 1998) was for the amount of $39,000 (or $7,800 per unit). The total amount paid, then, was $40,000, or $8,000 per unit.
8. He said that in relation to the project he signed “a number of documents. This was done under the advice of an accountant and a financial planner. There was an indemnity document. There was a loan from Horizon, a lending company. There was an agreement to purchase five shares. The manager was JML, Jedidiah Management Ltd. They were to take their fee for managing the joint venture, and that’s as far as I can recall.”[19]
9. He was asked whether he retained copies of the documents he signed, and he said: “They were passed on to the accountant [presumably Mr Del Carlo] and he dealt with them.”[20] (It seems that Mr Balestra no longer has any dealings with Mr Del Carlo.)
10. He was asked whether he had asked his accountant for copies of the documents he had signed, and he said: “Not personally, no. I believe they exist. Wilson & Atkinson was acting on my behalf, so I believe they do exist.”[21]
11. Mr Davies asked Mr Balestra whether he had done anything else in relation to his participation in the Joint Venture, “apart from signing some documents and paying a total of $8,000 per share”. Mr Balestra answered: “My understanding from my accountant and from the financial planner was that Jedidiah Management was going to manage on my behalf and I was a business owner from that perspective.”[22]
MR DAVIES: So is the answer no, you didn’t do anything else?‑‑‑No, I didn’t on advice from my accountant and from the lawyers and from the prospectus.[23]
12. Mr Davies then asked Mr Balestra a number of questions about the tax consequences of his entry into the arrangement. What follows is taken from the transcript of the proceedings[24], although I have corrected obvious transcription errors.
MR DAVIES: You were aware when you signed [the documents] that that would entitle you to a deduction for around $109,000 for that financial year?‑‑‑Yes, I was.
Was the tax saving consequent on claiming that deduction for you around or in excess of $44,000?‑‑‑Yes, yes, I guess it was, based on tax scales, yes.
…
Now the obtaining of the tax benefit and the consequent tax saving was a reason why you entered into the joint venture. Is that correct?‑‑‑No, it’s not.
So are you saying that the tax consequences were not something that you took into account when determining whether or not to buy your five shares in the joint venture agreement?‑‑‑My whole purpose of entering in this agreement was to have an income stream later down the track. Taxation savings were not a consideration. I don’t consider spending a dollar to save a dollar in tax makes any sense at all. My whole purpose was to invest so I could have an income stream when I retire, hopefully within five to 10 years, retire, semi‑retire, so it just is nonsensical to put in that kind of money to save the same kind of money. It just wasn’t a consideration at all.
Right. The figures I have taken you to, Mr Balestra, show that the tax saving was about $5000 in excess of the payments, actual cash payments that you would have to make by entering into the joint venture?‑‑‑Yes.
Are you saying that that consideration was not something that you took into account in deciding to purchase shares in the joint venture?‑‑‑No, it isn’t, no. That’s a very small consideration for the amount of money that was invested in the scheme.
13. Later, Mr Davies asked Mr Balestra in more detail about the amounts that he had paid.
MR DAVIES: Forty thousand. It’s your recollection that that’s what you paid?‑‑‑Yes, it is.
What did you get in return for payment of that money?‑‑‑Well, I believed that I was getting part of a business.
Did you get a receipt for it, Mr Balestra?‑‑‑Look, I thought I did. I mean, I can’t – I don’t have anything in front of me now, but I thought I did at the time from the accountant.
So at the moment you don’t have a receipt for it?‑‑‑Yes.
You have your own personal cheque book that records the payment?‑‑‑Yes, it does, yes.
Other than that, you don’t have any contract setting out the rights that you acquired by the payment?‑‑‑Look, I assumed the accountant had all that in order. I assumed I didn’t have to check every contract and everything. I trusted his advice and I went with that. I mean, I don’t have the time to sit down and examine every single item. I’ve got a business and I’ve got three kids. I don’t have time to sit down and go through every contract and every piece of paper that comes my way. I assumed my accountant was looking after my interests and that’s the way I went.
But you say, Mr Balestra, that the reason why you entered into the joint venture was to secure an income stream?‑‑‑That’s correct, yes.
You’re saying that notwithstanding that intention you were happy to assume that your accountant had [done] everything for you?‑‑‑Well, look, I – as I said, my expertise is in pharmacy. I trust people to give me the correct advice. In my line of business, I’m responsible for everything that happens in my pharmacy and everything my pharmacy does, and I expect the same from other people. Now, this accountant was a family friend. I trusted him and I trusted the advice I got from the financial planner. I’ve got 100,000 pages of legal documents which to me looked correct. I assumed I was investing in a legitimate business which was going to have an income stream. It’s beyond my level of expertise and time to go through and check every dot and every “I.” It’s the way life is, unfortunately.
…
It’s your recollection, is it, that you borrowed the sum of your initial capital contribution of the 19,450 from Horizon? That’s per unit?‑‑‑That was the capital contribution. Yes, it was.
That figure included, did it not, the $200 that you’ve referred to earlier?‑‑‑That’s the management fee to Jedidiah Management?
Yes. So is the answer yes?‑‑‑Yes, the answer is yes. I believed, yes, $200 was paid there, yes.
So it’s your recollection then that the payment of the $200 was paid by Horizon on your behalf?‑‑‑Yes, I believe so, yes.
So is it then fair to say that the only payment that you have made out of your bank account was the 39,000 in September?‑‑‑That was for the five units, yes, but the $200 was paid prior to 30 June 1998. The $200 was paid initially as the manager’s fee. That was paid up‑front.
By Horizon?‑‑‑Well, it was paid by me. I believed it went to Jedidiah. I’m not sure where it went to, but it was the manager’s fee to manage the business for the joint venture.
Well, if you had paid that, were you then reimbursed the $200 by Horizon when you borrowed the full amount of the 19,450?‑‑‑I don’t recall that, no.
Well, why would you borrow the full amount of the application fee, the 19,450, if you yourself had personally paid the $200?‑‑‑I’m not sure how that worked. That’s how the funds were requested for in the prospectus and I didn’t look beyond that, so I didn’t look that closely to see how the fees were administered.
At paragraph 29 [of your witness statement], you refer to an indemnity agreement. Do you recall the indemnity agreement at your paragraph 29?‑‑‑Yes, I do; yes.
You say there that under the indemnity agreement that you were required to pay a once off indemnity fee of $750 per unit?‑‑‑Yes. Yes, I do; yes.
Yes. That $750 per unit was in addition to the application fee of 19,450?‑‑‑That’s correct.
Yes. Well, is it the position then, Mr Balestra, that the payment of the $750 was never paid?‑‑‑I’m not sure how the funds were administered but I believe that I was paying a loan – I was repaying a loan to Horizon that had covered all those fees, so my initial $7800 was a loan repayment to cover all those fees that you’ve listed there.
You say in paragraph 27, Mr Balestra, that you only borrowed $19,450. That figure wasn’t enough to cover the $750 per unit that was required to be paid under the indemnity agreement, was it?‑‑‑I’m not sure how the financial arrangements were made. Like I say, I trusted my accountant to have these kind of answers for me. I didn’t look that closely at all the contractual agreements.[25]
14. I find that Mr Balestra purchased five participation interests in the Joint Venture and that, as a result, he committed to contributing a total of $97,250 to the project. I also find that the total cash outlay that he made was $40,000. Of this, $1,000 was paid on or around 30 June 1998, but in any event during the 1998 financial year. The remaining $39,000 was paid on 24 September 1998[26]. As to the method of financing his contribution, I am left in some doubt. I will refer to this aspect later in these reasons, in the context of my discussion of Issues 4 and 5 set out in paragraph 3 above.
Project documents and project structure
15. It is necessary to set out in some detail the relevant documents and agreements relating to the Joint Venture Project. The relevant documents are:
(a) the Prospectus dated 25 May 1998, amended by a Supplementary Prospectus dated 3 June 1998;
(b) the Rydal Hard Rock Joint Venture Deed dated 15 April 1998;
(c) an application for participation in the Joint Venture (included in the Prospectus);
(d) the Assumption Agreement for each participant;
(e) the Technical Management Agreement dated 30 June 1998;
(f) the Loan Agreement for each participant who chose the finance option offered in the Prospectus;
(g) the Indemnity Agreement; and
(h) a Deposit Agreement dated 30 June 1998 between Rydal Management Pty Limited (Rydal) (as Depositor) and Horizon Lending Company Pty Ltd (Horizon).
The Prospectus and Supplementary Prospectus
16. On or about 25 May 1998, Jedidiah Management Limited (Jedidiah) issued a Prospectus[27] containing an offer to apply for participation interests in the Joint Venture. The Joint Venture was stated to be for a term of 7 years, the term to run from the time when a minimum subscription of 450 interests was achieved[28]. Jedidiah issued a Supplementary Prospectus on 3 June 1998[29].
17. The Prospectus stated that the Joint Venture would conduct the business of extracting and processing rock and other materials required for the production of coarse aggregate products for road, building, construction and other industries. The Joint Venture would engage Rydal to “conduct that Business on its behalf”[30]. It further stated that Rydal held an extraction licence over the project site[31], which was said to be an area of 6.5 hectares in the north-eastern corner of a property, totalling 130 hectares in size, 12 kilometres west of Lithgow and 2.5 kilometres south-west of the township of Rydal[32].
18. The Prospectus further stated that:
(a) investment in the Project was speculative[33];
(b) the extraction licence issued to Rydal was not transferable, assignable or otherwise capable of being dealt with in any manner, and if Rydal was placed in liquidation or receivership, its rights under the licence would be terminated[34];
(c) development approval for the project had not been given at the time of the Prospectus, and could not be guaranteed[35];
(d) projections of income were dependent upon, amongst other things, the availability of rail transportation[36]; and
(e) Rydal had commenced consultation with the Rail Services Authority for provision of a rail siding for loading product to be transported out, and had commenced negotiation for the provision of rail services, but the provision of services was subject to several factors including “agreement on final operating parameters and specifications, and agreement on commercial arrangements.”[37]
19. A person wishing to become a participant was required to make a “capital contribution” of $19,450 for each participation interest[38]. Upon commencement of the Joint Venture, Jedidiah would pay initial fees as follows:
(a) the Manager’s Fee of $200 per interest, payable to Jedidiah;
(b) the Licence Fee of $1,250 per interest, payable to Rydal; and
(c) the Technical Management Fee of $18,000 per interest, payable to Rydal[39].
20. There was a further fee payable, to ARG as the Representative, at the commencement of the Joint Venture, but this fee would not be paid directly out of money contributed by the participants. Instead it would be paid by Rydal from its Technical Management Fee[40]. This fee was called a Representative’s Fee, and for the first year it had two components. The first component was a one-off amount of $7,500. The second component was an amount of $25,000 plus $25 for each participation issued above the minimum subscription of 450 interests[41].
21. For the remainder of the term, annual fees would be payable out of the Joint Venture revenue as follows:
(a) the Representative’s Fee, payable to ARG, equal to the previous year’s fee plus a CPI adjustment or 5%, whichever was less[42];
(b) the Manager’s Fee, payable to Jedidiah, equal to $80 (for year 2) for each interest issued, plus a CPI adjustment for each subsequent year[43];
(c) the Licence Fee, payable to Rydal, equal to 2.5% of the Joint Venture revenue[44]; and
(d) the Technical Management Fee, payable to Rydal, equal to 55% of the Joint Venture revenue[45].
22. Participants were not required to make any further contribution beyond the initial capital contribution of $19,450 for each interest for which they applied[46].
23. The Prospectus advised that immediate tax advantages were available to participants as follows:
(a) in the first year of the project, an operating loss for each interest of $19,450 would be passed on to participants[47];
(b) the losses should be an immediate taxation deduction to participants to offset other taxable income[48]; and
(c) participants who financed their capital contribution could receive further deductions for payment of interest and indemnity fees[49].
24. The Supplementary Prospectus was issued on 4 June 1998 and set out revised budgeted expenditure for the first year. However, it contained a significant error, in that the “Total Expenditure” if the minimum subscription was achieved, was shown as $8.1 million[50], although in reality it added up to over $11.3 million. As a result, the apparent “Surplus to Technical Manager” of $607,990 actually became a deficit of $2,606,510.
25. Funding to participants was offered through Horizon. The Prospectus offered two loan options to finance the whole or part of the application fee. Under the first option, the loan would attract interest computed daily at 15%, payable monthly in arrears, while principal would be repaid in 60 monthly instalments from the participant’s own resources.
26. The second option, which required entry into the Loan Agreement and the Indemnity Agreement, offered a lower interest rate, a pre-payment of interest for the first year, a repayment of principal within 90 days or by 30 September 1998 (whichever was the later), payment of interest and repayment of outstanding principal thereafter from the proceeds of the business, and an agreement by Rydal to indemnify the borrower against any shortfall in the payments of interest and principal[51].
The Joint Venture Deed
27. The Joint Venture Deed[52] was dated 15 April 1998. Although the Deed was said to be made between Jedidiah as Manager, ARG as Representative, Rydal as Technical Manager and the participants[53], none of the participants executed the agreement[54].
28. The term of the Joint Venture was for a maximum of 7 years[55]. The Deed recited that Rydal had been granted an extraction licence to quarry rock substance on a property, and had agreed to assign its rights under the licence to the Joint Venture. In consideration the Joint Venture would pay Rydal fees in accordance with the agreement[56].
29. The terms of the Joint Venture Deed included:
(a) the Joint Venture was established to conduct, for the benefit of the participants, the business of extraction, processing and sale of rock and other materials required for coarse aggregate production[57];
(b) the assets of the Joint Venture were to vest in ARG, as Representative, on behalf of the participants[58];
(c) Jedidiah was appointed Manager of the Joint Venture[59];
(d) participants could apply for interests in the Joint Venture. The maximum number of interests was limited to 1250, with a minimum subscription of 450[60];
(e) entitlements of participants were expressly limited and did not entitle a participant to interfere with the powers of the Manager or Representative[61]; and
(f) income of the Joint Venture Business was to be paid by the Manager to the Representative, and held by the Representative and distributed to participants according to the agreement[62].
30. Rydal, as Technical Manager, agreed that in consideration of receiving Licence Fees, it would permit the Joint Venture to use its rights under the extraction licence during the term of the Joint Venture[63]. Rydal also covenanted to perform specified works, on its own behalf and at its own expense, in relation to site preparation and access to power, water and roads[64]. Rydal also agreed to grant to the Representative a charge over its assets, and to pay moneys received on behalf of the Joint Venture to the Representative[65].
31. The Joint Venture Deed also provided for payment of the Manager’s Fee, Licence Fee, Technical Management Fees and Representative’s Fee referred to in paragraphs 19 to 21 of these reasons[66].
32. The Manager and Representative were also entitled to payment or reimbursement from the assets of the Joint Venture of all expenses properly incurred in respect of the Joint Venture[67].
The application form
33. The Prospectus included an application form by which a person who wished to take up the offer in the Prospectus could apply for one or more interests in the project. By executing the application form, a participant appointed Jedidiah and ARG as his lawful attorney and agent to do specified things, including to execute an Assumption Agreement on his behalf. The application form included a warranty by the participant that he was aware that the Joint Venture business involved commercial risk and uncertainties[68].
The Assumption Agreement
34. The Assumption Agreement[69] was stated to be between Jedidiah as Manager, ARG as Representative, Rydal as Technical Manager, and the “person listed in the attached Schedule of Participants”, who would be referred to as the Participant. It was contemplated that the Participant would assume the obligations and be bound by all terms of the Joint Venture Deed to the same effect as if the Participant personally executed that deed[70].
35. The Assumption Agreement before the Tribunal is not executed by Jedidiah, ARG, Rydal or any individual Participant. Furthermore, no Schedule of Participants was included in the documents tendered to the Tribunal.
The Technical Management Agreement
36. Jedidiah as Manager and Rydal as Technical Manager executed a Technical Management Agreement dated 30 June 1998[71]. The terms of the Technical Management Agreement included:
(a) Jedidiah appointed Rydal as Technical Manager to manage the Joint Venture Business[72];
(b) the term of the appointment was to commence on the Commencement Date[73] and expire on 28 June 2005[74];
(c) Rydal agreed to carry on and conduct the Joint Venture Business in a proper and efficient manner, and to carry out services including site works such as stripping of overburden, excavation, drilling and blasting, hauling, crushing and stockpiling[75], and arranging for the marketing and sale of all product extracted from the quarry[76];
(d) in consideration of the performance of its duties as Technical Manager, Rydal was entitled to receive the following Technical Management Fees:
i.on the commencement date, to be paid from application moneys, $18,000 for the first year for each interest issued; and
ii.from 1 July 1999 and for the remainder of the term, 55% of the gross income of the Joint Venture[77].
37. The agreement specified that Rydal was to perform its services as Technical Manager as a principal for remuneration, and not as an agent of the Manager or the participants[78].
The Loan Agreement
38. According to the Horizon general ledger at 30 June 1998[79], of the 636 participants, all but one of them – 635 – financed their participation under the second loan option described at paragraph 26 of these reasons.
39. The Loan Agreement which Mr Balestra says he entered into has not been produced to the Tribunal. He says that he applied under the second loan option to borrow $19,450 per participation interest (being a total of $97,250) and prepaid interest for the first year in the sum of $1,733 (being a total of $8,665)[80]. However, apart from Mr Balestra’s assertion, there is no evidence of the amount borrowed by him, no evidence of the amount of interest incurred by him in respect of the first year and no evidence that he prepaid any interest. For what it is worth, the Report to Joint Venture Participants, dated 31 July 2000, and made by Jedidiah (the Manager), says:
Loan and Indemnity Agreements were entered into for 635 of the 636 Units issued[81].
40. There is an incomplete, unexecuted pro forma Loan Agreement in evidence[82]. The page or pages containing clauses 1 and 2 are missing. According to that document, there were terms relating to interest as follows:
(a) interest was calculated as follows:
i.9% of the amount advanced for the period from the day the loan was advanced until 29 June 1999;
ii.6% of the balance of the loan outstanding on 30 June of each year, commencing 30 June 1999, while any amount of the loan remained outstanding[83];
(b) interest was payable as follows:
i.at the time the application for a loan was accepted, the borrower was to pay interest in advance, in the amount specified in the agreement[84]; and
ii.from 30 June 1999, the borrower was to pay interest in advance on the balance outstanding at 30 June of each year[85];
(c) from 30 June 1999 at the direction of the borrower the Manager would seek to pay each interest payment on behalf of the borrower from the Joint Venture Profit earned during the immediately preceding 12 months. Any shortfall between the Profit and the due interest was to accrue until there was sufficient income to meet the accrued interest[86].
41. According to the incomplete pro forma loan agreement there were terms relating to principal as follows:
(a) the borrower was required to make a partial repayment of principal within 90 days after the signing of the loan agreement by Horizon or 30 September 1998, whichever was later[87];
(b) from 30 June 1999, while any amount of the principal remained outstanding, the borrower was required to make a repayment of an amount equal to 45% of the Joint Venture Profit earned during the preceding 12 months[88].
42. According to the incomplete pro forma loan agreement there was a further term relating to principal and interest as follows:
(a) if any accrued interest or principal remained outstanding on 30 June 2005, the Manager was obliged to pay to Horizon the amount owing to the participant under the Indemnity Agreement[89]; and
(b) Horizon was not to make further demand or take any further action against the participant for payment of the shortfall[90].
The Indemnity Agreement
43. The Prospectus provided that a participant taking the second loan option was required to enter into an Indemnity Agreement with Horizon as Lender and Rydal as Indemnifier[91].
44. Mr Balestra says that he entered into an Indemnity Agreement[92]. However, no Indemnity Agreement executed by Mr Balestra has been produced to the Tribunal and there is no evidence (apart from Mr Balestra’s assertion[93]) that he ever paid any money pursuant to such an agreement. Again, for what it is worth, as mentioned above (paragraph 39), the Report to Joint Venture Participants, dated 31 July 2000, and made by Jedidiah (the Manager), says:
Loan and Indemnity Agreements were entered into for 635 of the 636 Units issued[94].
45. There is an unexecuted pro forma Indemnity Agreement in evidence[95]. According to that document:
(a) in consideration of a single payment of $750 per participation interest, Rydal agreed to pay to the participant any accrued interest or shortfall in principal under the Loan Agreement[96]; and
(b) the participant irrevocably directed Rydal to pay to Horizon, on demand, such amounts of accrued interest and shortfall in principal[97].
The Deposit Agreement
46. Rydal and Horizon made a Deposit Agreement dated 30 June 1998[98]. Under that agreement:
(a) Rydal agreed to deposit the “Fees” – described as “pre-paid licence, management and indemnity fees” – with Horizon[99]. Presumably the reference to management fees is a reference to the Technical Management Fee to which Rydal was entitled under the Joint Venture Deed;
(b) Rydal was not entitled to withdraw or require payment of any part of the deposit other than as expressly provided[100];
(c) Horizon was required to pay interest to Rydal on the deposit at 6.81% in the first year, and for each subsequent year at 3.28% of the balance outstanding on 30 June each year[101];
(d) the interest was payable by Horizon as and when it received interest and principal paid and/or payable by participants under the Loan Agreements[102];
(e) should the interest and principal paid and/or payable by participants under the Loan Agreements exceed the interest accrued, Rydal would be entitled to that amount in reduction of the principal deposited by Rydal, less “Horizon Entitlements”[103]. “Horizon Entitlements” were defined as:
i.in the first year, an amount calculated as $192,600 plus 1.75% of Joint Venture Payments; and
ii.in each subsequent year, an amount calculated as 1.75% of Joint Venture Payments[104].
Implementation of the arrangement
47. A series of round robin payments was made between 30 June 1998 and 8 July 1998, in the following way[105]:
48. It will be seen that the sum of $12,185,250 completed the full circuit. An additional sum of $142,650 flowed from ARG to Jedidiah. This sum was made up of 616 amounts of $200 plus $19,450 in cash[106].
49. Aside from the creation of the various project documents and the series of round robin payments, there was little activity in relation to the project. In particular, there was no quarrying activity carried out. The Land and Environment Court eventually refused consent to Rydal’s quarry proposal[107].
50. I now turn to consider the issues in detail.
The preliminary issue – the burden of proof
51. At the outset the Commissioner put the taxpayer on notice that, in reliance on section 14ZZK of the TAA, he required the taxpayer to prove all the facts on which he relied[108]. Paragraph 75 of the Respondent’s Submissions, which I accept as correct, reads as follows:
In an appeal from an assessment the burden of proof lies upon the taxpayer to establish affirmatively that the amount of taxable income which has been assessed exceeds his actual taxable income: Taxation Administration Act 1953, s14ZZK. The question for the tribunal is not whether the grounds have been made out but whether the amount assessed as taxable income is wrong: see, e.g. Commissioner of Taxation v Dalco (1990) 168 CLR 614 at 621. The Commissioner is entitled to rely on any deficiency in proof that the amount of the assessment is excessive: see Dalco at 625.
Issue 1 – is the Joint Venture entitled to deductions under s 8-1 of the 1997 Act?
52. Section 8-1 of the 1997 Act provides as follows:
(1)You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b)it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
(2)However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
…
53. Mr Balestra’s case starts with the proposition that the Joint Venture is to be treated as a partnership for the purposes of the income tax law. He contends that in the 1998 year the “JV Partnership” incurred expenditure of $18,000 per participation on technical management fees, $1,250 per participation on licence fees and $200 per participation on management fees[109].
54. He says that the fees are losses or outgoings incurred by the JV Partnership in carrying on a quarrying business for the purpose of gaining or producing assessable income and are not losses or outgoings of capital or of a capital, private or domestic nature[110]: in other words, that they are deductible under s 8-1(1)(b).
55. Alternatively, he says that if the JV Partnership was not carrying on a quarrying business, then the fees were incurred in the gaining or producing of assessable income and were incidental and relevant to the gaining or producing of assessable income and are not losses or outgoings of capital or of a capital, private or domestic nature[111]: in other words, that they are deductible under s 8-1(1)(a).
56. It is necessary to mention here the special treatment of partnerships under the income tax law. Partnerships, of course, have no legal personality. For this reason, section 90 of the 1936 Act says that the net income of a partnership means the assessable income of the partnership, “calculated as if the partnership were a taxpayer who was a resident”, less (with some exceptions) all allowable deductions. Similarly, a partnership loss is the excess (if any) of allowable deductions over the assessable income of the partnership, “calculated as if the partnership were a taxpayer who was a resident”.
57. A partnership is required to lodge a return of its income, but it does not itself pay tax. Instead, the partners include their share of the net income of the partnership in their own individual assessable income. Similarly, if the partnership incurs an overall loss, then the partners claim a deduction equal to their individual share of the loss.
58. In response to Mr Balestra’s contentions set out in paragraphs 53 - 55 above, the Commissioner contends that the Joint Venture did not carry on a business. At best it was a passive investor in a business to be carried on by another entity. This contention is largely based on the fact that the Joint Venture did not hold the extraction licence necessary to carry on a quarrying business. The licence was held by Rydal and could not be transferred, assigned or dealt with in any manner[112]. For that reason, the Commissioner says, if there was any business being carried on, it was not the business of the Joint Venture.
59. The first point to make is that a person can still carry on a business even if the activity is unlawful or in breach of licensing or other regulatory requirements. A dealer in illicit drugs was found to be carrying on a business and was not denied a deduction for a loss incurred by the theft of money which was the proceeds of the illegal activity[113]. So it is not fatal to the Joint Venture’s business argument that it may be lacking some formal approval to carry on the activity. Rather, the question needs to be examined by reference to all the factual circumstances.
60. There are several cases summarising the factors that are relevant to the question whether a person is carrying on a business. A recent one is Commissioner of Taxation v Sleight (2004) 136 FCR 211 where Hill J as a member of the Full Court set out a helpful summary at 224-228 ([47]-[61]).
61. His Honour emphasised the following points:
(a)Whether a business is carried on is, ultimately, a conclusion of fact. Furthermore, it is common sense to say that every business must have a first transaction, so long as it is at least part of a plan, intended to be carried out, to undertake the activity which is the intended business …[114]
(b)There is no one test of what constitutes a business. In some contexts, repetition and continuity have been seen to be necessary[115]. However, the place which repetition may play will depend upon the activities undertaken.
(c)Mason J in Hope v Bathurst City Council (1980) 144 CLR 1 at 8-9 spoke of “activities engaged in for the purpose of profit on a continuous and repetitive basis”. His Honour spoke also (at 9) of the activity in that case having a “permanent character”, (meaning perhaps “indefinite”).
(d)In Puzey v Commissioner of Taxation (2003) 131 FCR 244 at 256-257 Hill and Carr JJ set out various propositions derived from the case law. Their Honours, after dealing with some of the matters set out above, said:
…
In deciding whether or not a business is carried on courts have pointed to what have been called in the United Kingdom the “badges of trade”, indicia which, while no one of them will be determinative of whether a business is carried on, collectively will demonstrate a business. These include the profit motive (although a non profit company may still carry on a business), acting in a business like way, (although many businesses may be found which operate in a non-business like way), the keeping of books of account and records, (although the fact that there are none will not necessitate the conclusion that a business is not carried on) and repetition (although a fixed term project may still be a business).
62. From Mr Balestra’s perspective, he says that he thought that he was carrying on a quarrying business. The information that he gathered from the Prospectus created the impression that it would be “his” business. He acknowledged that he had no expertise[116], but that was the whole point of appointing a Technical Manager who did have that expertise. He entered into the arrangement for the purpose, as he said, of producing an income stream and creating wealth[117]. He became a participant in a Joint Venture which would last for 7 years and from which he could reasonably expect some benefit through the sale of coarse aggregate.
63. But what were the activities carried out in relation to the Joint Venture in the 1998 year that might support the contention that the Joint Venture was carrying on a business? Jedidiah was appointed the Manager of the Joint Venture. Jedidiah made the Technical Management Agreement with Rydal, and under that agreement, Jedidiah appointed Rydal the Technical Manager. Jedidiah became liable to pay Rydal the Licence Fee for the use of Rydal’s rights and interests under the Extraction Licence[118] and also to pay Rydal the Technical Management Fee for the various services Rydal would perform. Rydal was bound to perform those services for a period of 7 years. The services – including stripping of overburden, excavating benches, drilling and blasting, winning, hauling rock to plant, crushing and screening rock, and stockpiling product – are the types of services expected to be performed for a Joint Venture carrying on a rock quarrying business. As Hill J said in Sleight[119], every business must have a first transaction. On one view, these could be regarded as the first transactions of the Joint Venture.
64. I take a different view. I consider, on the basis of the principles summarised by Hill J in Sleight and reproduced at paragraph 61 of these reasons, that the proper view of the arrangement is that the participants had not, by the close of the 1998 financial year, commenced to carry on a business of rock quarrying. Even if it is the case that what would eventuate was the carrying on of a business by the Joint Venture, and not merely the passive investment by the participants in the business of Rydal, the taxpayer has not established that, as at 30 June 1998, whatever business the Joint Venture would carry on had in fact already commenced. As I have already mentioned, the only activities that were carried out were the entry into the various project documents and the making of the round robin payments over the space of 9 days. The fact that the physical activities were to be undertaken by Rydal as the Technical Manager rather than by the participants is not itself fatal to the claim that the Joint Venture was carrying on a business. But what weighs heavily against the business argument is the fact that the relevant parties were not in a position to carry out the rock quarrying activities; the property was not prepared for the activities to be carried out; and the entity which would have wanted to carry them out had no funds to do so. It is perhaps nothing more than the inevitable outcome of this state of affairs that the activities were, in the end, never carried out.
65. On that basis the outgoings of $12,370,200 are not deductible to the Joint Venture under section 8-1(1)(b) of the 1997 Act.
66. The same factors, in my opinion, weigh against a conclusion that the outgoings might be deductible under section 8-1(1)(a) of the 1997 Act. As the Commissioner submitted (correctly, in my view):
In order to be deductible under s 8‑1(1)(a), the outgoing must be incidental and relevant to the gaining or producing of assessable income. In other words, the production of assessable income must be the occasion of the outgoing: Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) CLR 295 at 309 and Ronpibon Tin NL v FCT (1949) 78 CLR 47; Fletcher v Commissioner of Taxation (1991) 173 CLR 1. An outgoing is not deductible where it is “entirely preliminary” to the gaining or producing of assessable income or is incurred “too soon” before the commencement of the business or the income producing activity or where the occasion of the outgoing lies in the pursuit of a tax deduction: Steele v FCT (1999) 197 CLR 459 at [43]‑[46]; Softwood Pulp and Paper Ltd v FCT (1976) 76 ATC 4439 at 4450; FCT v Maddalena (1971) 45 ALJR 426; Fletcher v FCT (1991) 173 CLR at 17‑19.
Here, the Joint Venture incurred expenses on 30 June 1998 at a time when the necessary preconditions for undertaking quarrying activities were not satisfied and the services and benefits nominally sought by the expenditure could not be achieved without the fulfilment of those preconditions. The expenditure was not incurred in gaining or producing assessable income. It was incurred entirely preliminary to any income producing activity. The occasion of the expenditure lay in the pursuit of tax deductions for the 1998 year of income.[120]
67. In all the circumstances it could not be said that the outgoings were “incurred in gaining or producing [the Joint Venture’s] assessable income” and for that reason the outgoings are not deductible to the Joint Venture under section 8-1(1)(a) of the 1997 Act.
Issue 2 – Did the Joint Venture incur a partnership loss of $12,370,155?
68. It follows from the outcome in relation to Issue 1 that the answer to this question must be: No.
Issue 3 – Is the taxpayer entitled to a deduction of $97,250 under s 92 of the 1936 Act as his individual interest in a partnership loss incurred by the Joint Venture?
69. Again, it follows from my conclusion in relation to Issue 1 that the taxpayer is not entitled to a deduction for that amount.
Issues 4 and 5 – Is the taxpayer entitled to deductions under s 8-1 of the 1997 Act of $8,665 for interest accrued in advance, and $3,750 for indemnity fees?
70. There were two loan options and Mr Balestra said that he took the second option. However, the Loan Agreement which Mr Balestra says he entered into has not been produced to the Tribunal. There is no evidence of the amount borrowed by him, no evidence of the amount of interest incurred by him in respect of the first year and no evidence that he prepaid any interest. The oral evidence that Mr Balestra gave, and which is reproduced at paragraph 13 of these reasons, did not clarify the position at all. He is supposed to have paid $200 per unit in cash, and yet is supposed to have borrowed the full amount of $19,450 so that the Joint Venture could be put into funds. He could not explain what happened to the $200 surplus.
71. The position in relation to the indemnity fee was similarly confusing. Clearly he did not pay it from his own funds. Equally clearly he did not borrow it. How then he “incurred” it has not been established.
72. The statement by Jedidiah, referred to in paragraphs 39 and 44 of these reasons, that Loan and Indemnity Agreements were entered into for 635 of the 636 Units issued does nothing to support his case. Quite clearly the round robin payments were made on the basis that this was the case, but again, there is no objective evidence to support the proposition.
73. I am not satisfied that Mr Balestra incurred the amounts of $8,665 or $3,750 and accordingly he is not entitled to a deduction for either of these amounts.
Issue 6 – Does Part IVA of the 1936 Act apply to disallow any of the deductions?
74. For Part IVA to apply, there must be identified a “scheme”, and there must be a “tax benefit” that is obtained by the taxpayer in connection with the scheme. Both “scheme” and “tax benefit” are defined – the former in s 177A(1) and the latter in s 177C(1).
75. The taxpayer accepted “that the scheme is within the meaning of section 177A(1) of the 1936 Act”[121] without expressly identifying what constituted the scheme. Therefore, although the Commissioner identified the “scheme” in three alternative ways[122], nothing turns on exactly how the scheme is identified.
76. As to the question of “tax benefit”, the taxpayer accepted “that he did, in respect of the 1998 year, obtain a tax benefit within the meaning of section 177C of the 1936 Act”[123].
77. I have found that the taxpayer did not obtain a tax benefit, because the deductions that he claimed were not available to him. However, in case I am wrong with that conclusion, and for completeness, I propose to consider the issues that are presented by Part IVA.
78. Once the “scheme” and “tax benefit” issues are disposed of, what remains for determination under Part IVA is whether, having regard to the eight matters set out in s 177D(b):
… it would be concluded that [a person] who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling [Mr Balestra] to obtain a tax benefit in connection with the scheme or of enabling [Mr Balestra] and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme …
79. A scheme will have been entered into for a particular purpose if that purpose is the dominant purpose: s 177A(5).
80. In Commissioner of Taxation v Sleight (2004) 136 FCR 211, Hill J said at 229-230 [67]:
There have by now been a number of cases, both in the High Court and in this Court where the provisions of Part IVA have been considered. The propositions which may now be taken as decided may be summarised as follows:
1. Part IVA does not authorise consideration of evidence of the subjective purpose or motivation of a particular person. The subjective state of mind of a person is not a matter listed in s 177D(b) to which regard may be had. Rather the section requires consideration of the eight matters listed in s 177D(b) and no other matters. The subjective state of mind of a person is not such a matter. Hence the section seeks to establish the conclusion which would be reached by reference to what may be referred to as objective factors, that conclusion being however, a conclusion as to the purpose of a person who entered into or carried out the scheme: Federal Commissioner of Taxation v Zoffanies Pty Ltd 2003 ATC 4942 at paras 53-54 per Hill J, with whom, on this point, Hely and Gyles JJ agreed, Eastern Nitrogen Ltd v Federal Commissioner of Taxation (2001) 108 FCR 27 at 44 per Carr J, with whom Sundberg J agreed.
2. The reference to dominant purpose in a case where more than one purpose is present is a reference to the “ruling, prevailing or most influential” purpose: Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at 423.
3. The conclusion as to dominant purpose may be reached not only with respect to the dominant purpose of the taxpayer, it may be reached by reference to the dominant purpose of any other person or persons so long as they are persons who entered into or carried out the scheme or any part of it: Spotless (at 418). Likewise, the purpose of an adviser may be attributed to the taxpayer in an appropriate case: Federal Commissioner of Taxation v Consolidated Press Holdings (2001) 207 CLR 235 at 264.
4. It is possible to arrive at the conclusion as to purpose by making a global assessment of the facts, so long as it is clear that the relevant eight factors are taken into account: Consolidated Press Holdings at 263.
5. Some of the eight factors (there is clearly some overlap among them) may point one way, others may point in the opposite direction, and some may be neutral: it is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers: per Hill J in Peabody v Federal Commissioner of Taxation (1993) 93 ATC 4104 at 4113-4. Nothing said on the appeal at (1994) 181 CLR 359 would cast doubt on this proposition.
6. There is no inconsistency between a finding that the purpose of a person lay in the pursuit of commercial gain in the course of carrying on a business and a finding that the dominant purpose was to enable the relevant taxpayer to obtain a tax benefit: per Gleeson CJ, Gaudron, Gummow, Hayne and Callinan JJ in Consolidated Press Holdings Ltd at [96].
81. I now consider in turn the eight matters in s 177D(b).
(i)The manner in which the scheme was entered into or carried out
82. This was a mass marketed scheme that was promoted as tax effective. Participants were offered a deduction of $19,450 per interest by way of a share in a partnership loss to be incurred by the Joint Venture. That deduction would be achieved through the outlay in the relevant tax year of only $200 plus, perhaps, an interest amount of $1,733 and an indemnity fee of $750.
83. Mr Balestra’s involvement came about after an examination of the Prospectus and the Supplementary Prospectus. His examination of those documents seems to have been only cursory. He said that he “had a good look at the prospectus, as much as [he] could understand …”[124], but he also said that he relied on the advice given to him by his accountant and by a financial planner[125]. I find that he accepted at face value the information and forecasts in the Prospectus and he did not take any real steps to understand critical financial or commercial arrangements. Mr Balestra did not make any enquiries as to what Rydal was entitled to do under its extraction licence[126]. He did not ask about the Development Consent but “assumed all the licences and approvals were in place”[127]. He also made no enquiries about the commissioning of the rail line[128]. In short, he was prepared to make a cash outlay of $40,000, purportedly “to have an income stream later down the track”[129] and “to earn income from and create wealth from to provide for [his] future”[130], with the barest examination of the arrangement.
84. It is clear that the scheme was entered into at a time when Development Consent had not been granted for the operation of the quarry. Participants were therefore applying to become involved in the project before the Technical Manager was permitted to provide the services that were subcontracted to it.
85. Any product of the quarrying operations had to be transported from the site in some way. While Rydal had commenced consultation with Rail Services Authority for provision of the rail siding for loading product to be transported out[131], no arrangements had been finalised. Rydal had also commenced negotiation for the provision of rail services and “had received indicative quotes for the provision of services which include the supply of wagons”[132] but again, nothing had been concluded. The fact that these arrangements had not been settled, at least in principle, placed some of the projected commercial outcomes in doubt.
86. The taxpayer says that he took the second loan option and therefore entered into an agreement by which Rydal agreed to indemnify him in relation to any shortfall in the payment of interest and principal under the loan. His investment, although speculative, exposed him to no risk.
87. The payment of money to Rydal under the Technical Management Agreement was effected as part of the round robin of cheques involving Rydal, ARG, Jedidiah and Horizon. With the possible exception of one participant, the only funds available to Rydal to conduct the business of extracting and processing rock were the cash payments which each participant, including the applicant, made in September 1998.
88. It is also the case that the Technical Management Agreement, at least in part, has an uncommercial ring to it. The services to be provided by Rydal to the Joint Venture would be valued in the first year at something between $8.1 million ($18,000 multiplied by 450) and $22.5 million ($18,000 multiplied by 1250), the final sum depending not on the amount of work actually undertaken but on the amount of money contributed by the participants and therefore available to pay for the services.
89. These factors point towards a tax purpose in entering into and carrying out the scheme.
(ii)The form and substance of the scheme
90. As the Commissioner stated[133], the form of the scheme is that which appeared in the Prospectus and which was embodied in the various project documents. In form, the taxpayer paid $97,250 in application fees and claims also to have incurred interest of $8,665 and indemnity fees of $3,750. In form, the Joint Venture paid fees totalling $12,370,200 and incurred a loss of $12,370,155.
91. The Commissioner says that in substance[134]:
no funds were available for use in relation to the commercial objectives of the project. In substance, the money provided to the Joint Venture by the applicant was limited to $39,000 which he paid in September 1998. In substance, the Joint Venture did not have $12,370,200 to apply to the pursuit of income from quarrying activities. With the possible exception of one participant, its funds for that purpose could not have exceeded $7,800 per participation interest (being at most a total of $4,960,800) none of which was provided to it prior to September 1998.
92. In substance, the contribution that Mr Balestra made was (as he readily acknowledged) a capital contribution. Because of the structure of the scheme that capital contribution became deductible.
93. The disparity between the form and substance also points towards a tax purpose.
(iii)The time at which the scheme was entered into and the length of the period during which the scheme was carried out
94. The Prospectus was dated 25 May 1998 and the Supplementary Prospectus was dated 3 June 1998. By 30 June 1998, 636 interests in the Joint Venture were issued and no others were to be issued[135].
95. The taxpayer’s submission was that he spent “considerable time undertaking due diligence prior to investing”[136] although the time that was available to him was only around 4 weeks, and there is little to indicate that “due diligence” was truly undertaken.
96. The scheme was entered into towards the end of the 1998 financial year, at a time when Development Consent had not been granted, and when arrangements for the transportation of the product from the quarry site were nowhere near finalised. If the tax considerations had not been dominant, then the entry into the scheme could have occurred at any time of the year, and could have been delayed until these critical operational factors had been resolved.
97. The proposal was that the Joint Venture activity would continue for 7 years, but because the Development Consent could not be secured, the project was wound up in the middle of 2000.
98. Even if the project had continued for the proposed 7 years, the taxpayer was not required to do anything after 30 September 1998, when he was to make the repayment of $39,000 (5 units of $7,800 each).
(iv)The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme
99. The taxpayer’s position is that, if it were not for Part IVA, he would be entitled to a deduction of $109,665 for a cash outlay in the relevant year of $1,000 plus, perhaps, $12,415.
(v)Any change in the financial position of the taxpayer resulting from the scheme
100. Mr Balestra claimed that his total cash outlay was $40,000. His tax saving, if he were entitled to the deduction, and if Part IVA did not negate it, would have been almost $45,000.
(vi)Any change in the financial position of any person who has a connection with the taxpayer, being a change resulting from the scheme
101. There are none that are relevant.
(vii)Any other consequence for the taxpayer, or for any person referred to in subparagraph (vi)
102. There was no other relevant consequence.
(viii)The nature of any connection between the taxpayer and any person referred to in subparagraph (vi)
103. There is no evidence of any connection between the parties except the one arising from the project documents.
Conclusion under Part IVA
104. I agree with the Commissioner’s submission[137] that, having regard to the matters referred to in s 177D(b) of the 1936 Act, a reasonable person would conclude that:
(a) the dominant purpose of the taxpayer in entering into and carrying out the scheme was to obtain the tax benefit in connection with the scheme for the year ended 30 June 1998; and
(b) the dominant purpose of the project entities, Jedidiah, Rydal, and Horizon in entering into and carrying out the scheme was to enable the taxpayer to obtain the tax benefit in connection with the scheme for the 1998 year of income.
Issue 7 – Should the assessment of additional tax stand?
105. Additional tax was remitted to 10% because of voluntary disclosure. In the hearing there was almost no discussion about the level of additional tax. In my view the level of additional tax is appropriate and I see no reason to disturb it.
One final matter
106. After I had drafted these reasons, Mr Balestra’s solicitors brought to my attention the recent decision of French J in Lenzo v Commissioner of Taxation [2007] FCA 1402. I was already aware of that decision but did not consider that anything said by his Honour warranted any change in my thinking in this case. Nevertheless, since it has specifically been raised, I need to explain why I hold that view.
107. There are significant factual differences between Mr Lenzo’s case and Mr Balestra’s. I note only some of the differences by way of illustration.
108. Mr Lenzo had shown himself to be interested in the investment product – sandalwood – for over 12 months before eventually committing himself to the particular investment[138]. He had rejected earlier investment opportunities, in the same product and in the same area, because of shortcomings that he perceived in the management teams involved in them[139]. He carried out research into the Indian sandalwood industry and “read some books from his local library discussing the general nature of the product”[140].
109. When he eventually decided to invest, Mr Lenzo “read [the prospectus describing the investment opportunity] and considered the commercial returns shown in it. … Mr Lenzo considered the assumptions underpinning the forecast returns and based on his knowledge of Indian Sandalwood, and discussions with people experienced in the relevant market, formed the view that they were reasonable. As appears from the evidence of expert witnesses called in these proceedings this was a well based view”[141].
110. Mr Lenzo “undertook inquiries into the project. He described the inquiries as a ‘due diligence process’. He had discussions with the management about the risks. … He formed the impression that everybody involved with the project was making an effort to ensure that it was operated, according to its plans, in order to take advantage of the buoyant Indian sandalwood market predicted for the future”[142].
111. There was extensive evidence presented to the Court to support the commercial merits of the sandalwood plantation and the suitability of the investment[143]. Finally, and significantly, the Commissioner accepted that the project was a genuine commercial operation and that Mr Lenzo was entitled to the various deductions under section 8-1 of the 1997 Act[144].
112. The distinction between the factual findings made by French J in Lenzo and those that I have made here could not be starker. I need not repeat what I have already said, but refer simply to my findings as reflected in paragraph 83 of these reasons. I also note that in this case the Commissioner did not accept (as he did in Lenzo) that this was a genuine commercial operation.
113. As a result of what Mr Lenzo established in relation to his investment in the project, and the merit of the project itself, French J was able to find, objectively, a significant commercial purpose which outweighed whatever tax considerations there may have been. There was nothing in Mr Balestra’s case that pointed me towards a similar outcome. As I have indicated, if the outgoings had been deductible, nevertheless I would have agreed with the Commissioner’s view that Part IVA applied.
Conclusion
114.The objection decision under review must be affirmed.
I certify that the 114 preceding paragraphs are a true copy of the reasons for the decision herein of Mr S E Frost, Member.
Signed: ...............(Sgd. C Skinner)...........................................
AssociateDate of Hearing 10 July 2007
Date of Decision 5 October 2007
Counsel fro the Applicant Mr D Romano
Solicitor for the Applicant Wilson & Atkinson
Counsel for the Respondent Mr G Davies QC and Mr J AllansonSolicitor for the Respondent Mr T Burrows
Australian Government Solicitor
[1] Applicant’s Witness Statement, paragraph 6
[2] Applicant’s Witness Statement, paragraph 13
[3] Applicant’s Witness Statement, paragraph 14
[4] Applicant’s Witness Statement, paragraph 15
[5] Applicant’s Witness Statement, paragraph 17
[6] Applicant’s Witness Statement, paragraph 18
[7] Applicant’s Witness Statement, paragraph 19
[8] Applicant’s Witness Statement, paragraph 20
[9] Applicant’s Witness Statement, paragraph 21
[10] Applicant’s Witness Statement, paragraph 23
[11] Applicant’s Witness Statement, paragraph 24
[12] Applicant’s Witness Statement, paragraph 25
[13] Applicant’s Witness Statement, paragraph 27
[14] Applicant’s Witness Statement, paragraph 29
[15] Applicant’s Witness Statement, paragraph 30
[16] Applicant’s Witness Statement, paragraph 31
[17] Applicant’s Witness Statement, paragraph 32
[18] Applicant’s Witness Statement, paragraph 34
[19] Extract of Transcript of Proceedings, P-2
[20] Extract of Transcript of Proceedings, P-2
[21] Extract of Transcript of Proceedings, P-2
[22] Extract of Transcript of Proceedings, P-2 to P-3
[23] Extract of Transcript of Proceedings, P-3
[24] Extract of Transcript of Proceedings, P-3 to P-4
[25] Extract of Transcript of Proceedings, P-11 to P-13
[26] Applicant’s Witness Statement, paragraph 31
[27] T103
[28] T103, p. 80, item 3
[29] T104
[30] T103, p. 80, item 1
[31] T103, p. 80, item 2
[32] T103, p. 79
[33] T103, p. 76, 77, 91
[34] T103, p. 82, item 13
[35] T103, p. 82, item 13
[36] T103, p. 82, item 13
[37] T103, p. 86
[38] T103, p. 80, item 5
[39] T103, p. 81, item 6.1
[40] T103, p. 81, item 6.1
[41] T103, p. 136
[42] T103, p. 136
[43] T103, p. 81, item 6.2(b)
[44] T103, p. 81, item 6.2(c)
[45] T103, p. 81, item 6.2(d)
[46] T103, p. 80, item 5
[47] T103, p. 92
[48] T103, p. 78
[49] T103, Independent Tax Opinion, p. 124, items 3.14.1 and 3.14.2
[50] T104, p. 146
[51] T103, p. 90
[52] T102
[53] T102, p. 13
[54] T102, p. 53-54
[55] T102, p. 20, clause 4.3
[56] T102, p. 13, Recital E
[57] T102, p. 20, clause 4.1(b), and definition of “Joint Venture Business” at p. 16
[58] T102, p. 20, clause 4.1(a)
[59] T102, p. 22, clause 6.1
[60] T102, p. 16, definitions
[61] T102, p. 36-37, clause 10.1
[62] T102, p. 38-39, clause 12.1 and 12.3
[63] T102, p. 23, clause 7.1
[64] T102, p. 23, clause 7.2(a) and (b)
[65] T102, p. 23, clause 7.2(d) and (e)
[66] T102, p. 45-46, clause 16.1, 16.2, 16.3, 16.4
[67] T102, p. 47, clause 16.6
[68] T103, p.143
[69] T102, p. 55-57
[70] T102, p. 55, clause 2
[71] T102, p. 70-75. The document contains references to both 1998 (p. 70) and 1997 (p. 75) but the latter must be regarded as an error. Clause 7.3 of the Joint Venture Deed (T102, p. 24) provides that the Technical Management Agreement would be entered into once the Minimum Subscription was achieved – this must be some time after the Prospectus was issued in May 1998.
[72] T102, p. 72, clause 2
[73] T102, p. 72, clause 3.1. “Commencement Date” is defined at p. 70, clause 1.1, as “the commencement date specified in Item 3 of the First Schedule”. The copy of the Agreement provided to the Tribunal does not contain any Schedules.
[74] T102, p. 72, clause 3.1 and definition of “Termination Date” at p. 71
[75] T102, p. 73, clause 4.1
[76] T102, p. 74, clause 6.1
[77] T102, p. 74, clause 7
[78] T102, p. 73, clause 4.2 and p. 74, clause 8
[79] T518, p. 1574
[80] Applicant’s Witness Statement, paragraph 27
[81] Attachment FB12, p. 176, to Applicant’s Witness Statement
[82] T105, p. 184-187
[83] T105, p. 184, Schedule Item D.1, and p. 185, clause 3.3
[84] T105, p. 184, Schedule Item D.2(a), and p. 185, clause 3.3(a)
[85] T105, p. 184, Schedule Item D.2(b), and p. 185, clause 3.3(b)
[86] T105, p. 185, clause 3.3(b)(i)
[87] T105, p. 184, Schedule Item C.1. According to the Prospectus the amount was $7,800 per participation interest ‑ T103, p. 90
[88] T105, p. 184, Schedule Item C.2, and p. 185, clause 4.2(a)
[89] T105, p. 185, clause 3.3(b)(ii)(i), and p. 186, clause 4.2(b)(i)
[90] T105, p. 185, clause 3.3(b)(ii)(ii), and p. 186, clause 4.2(b)(ii)
[91] T103, p. 90
[92] Applicant’s Witness Statement, paragraph 29
[93] Applicant’s Witness Statement, paragraph 30.5
[94] Attachment FB12, p. 176, to Applicant’s Witness Statement
[95] Supplementary T14, p. 65
[96] Supplementary T14, p. 65, clause 1(a)
[97] Supplementary T14, p. 65, clause 3 and 4
[98] T105, p. 173-177
[99] T105, p. 175, clause 2
[100] T105, p. 175, clause 5
[101] T105, p. 175, clause 3
[102] T105, p. 175, clause 4.1, and definition of “Joint Venture Payments” at p. 174
[103] T105, p. 175, clause 4.1
[104] T105, p. 175, clause 1
[105] T522, p. 1659-1662; T526, p.1804-1806; T529, p. 1902-1905; T540, p. 2040-2043
[106] T542, p. 2097
[107] International Study Programs Pty Ltd v Greater Lithgow City Council [2000] NSWLEC 91
[108] Respondent’s Statement of Facts and Contentions – Introduction
[109] T11, p. 48, grounds 2, 4 and 6
[110] T11, p. 48, ground 8
[111] T11, p. 48, ground 9
[112] T103, p. 82, item 13; see also section 48 of the Crown Lands Act 1989 (NSW)
[113] Commissioner of Taxation v La Rosa [2002] FCA 1036
[114] Fairway Estates Pty Ltd v Commissioner of Taxation (Cth) (1970) 123 CLR 153 at 165 per Barwick CJ (quoting Lord Esher in Re Griffin; Ex parte Board of Trade (1890) 60 LJQB 235 at 237)
[115] Fairway Estates Pty Ltd at 164
[116] Applicant’s Witness Statement, paragraph 25
[117] Applicant’s Witness Statement, paragraph 13
[118] T102, p. 45, clause 16.2
[119] (2004) 136 FCR at 224 [47]; referred to at paragraph 62 of these reasons
[120] Respondent’s Submissions, paragraphs 90-91
[121] Applicant’s Outline of Closing Submissions, paragraph 112
[122] Respondent’s Submissions, paragraphs 112-114
[123] Applicant’s Outline of Closing Submissions, paragraph 113
[124] Extract of Transcript of Proceedings, P-7
[125] Extract of Transcript of Proceedings, P-2
[126] Extract of Transcript of Proceedings, P-6
[127] Extract of Transcript of Proceedings, P-11
[128] Extract of Transcript of Proceedings, P-11 – and see below
[129] Extract of Transcript of Proceedings, P-4
[130] Applicant’s Witness Statement, paragraph 5
[131] Prospectus, T103, p. 86
[132] Prospectus, T103, p. 86
[133] Respondent’s Submissions, paragraphs 132-133
[134] Respondent’s Submissions, paragraph 134
[135] Applicant’s Witness Statement, Annexure FB 10, p. 124
[136] Applicant’s Outline of Closing Submissions, paragraph 75
[137] Respondent’s Submissions, paragraph 152
[138] Lenzo v Commissioner of Taxation [2007] FCA 1402 at [5]
[139] Lenzo at [6] and [8]
[140] Lenzo at [7]
[141] Lenzo at [9]
[142] Lenzo at [22]
[143] Lenzo at [53] to [80]
[144] Lenzo at [104]
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25
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