Carter and Anor and Commissioner of Taxation

[2007] AATA 2012

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2007] AATA 2012

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No WT2005/291-296

TAXATION APPEALS DIVISION		)
Re		STEPHEN CARTER CHRISTINE ANNINOS-CARTER

Applicants

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Mr S E Frost, Member

Date3 December 2007

PlacePerth

Decision The objection decisions under review are set aside as detailed in paragraph 39 of these reasons.  The matters are remitted to the Respondent for implementation of this decision.

.............(Sgd. S E Frost)..........

Member

CATCHWORDS

TAXATION - income tax - deductions - mass marketed scheme - tea-tree oil investment - Main Camp No. 3 - Part IVA - scheme - tax benefit - approach where the lead case dealing with this scheme has been decided in the Federal Court

REASONS FOR DECISION

3 December 2007   Mr S E Frost, Member        

INTRODUCTION

1.      In 1994 Stephen Carter and his wife Christine Anninos-Carter were attracted by an investment opportunity in the Main Camp Tea-Tree Oil Project No. 3.  They had invested in tea-tree oil farming and production before: in the previous year they had invested in the Main Camp Tea-Tree Oil Project No. 2.

2.      As a result of their investment in Main Camp No. 3, the Carters claimed (as they had in respect of Main Camp No. 2) significant tax deductions.  This time, however (unlike with Main Camp No. 2), the Commissioner disallowed their deductions under the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (the Act).  The matters are before me because the Commissioner only partly allowed the Carters’ objections against the amended assessments he made.

3.      The issue before the Tribunal is whether Part IVA of the Act operates to disallow the deductions claimed by the Carters in each of the 1994, 1995 and 1996 income years.

4.      A hearing was held on 13 July 2007. At the end of the hearing a timetable was agreed for the lodgment of further submissions. The final submissions were received on 24 September 2007.

BACKGROUND

5.      Similar deductions claimed by another investor in the Main Camp Project No. 3 were the subject of judgements in the Federal Court by Nicholson J at first instance (Calder v FCT (2005) 59 ATR 655) and the Full Court on appeal (Calder v FCT (2005) 61 ATR 267). At first instance Nicholson J proceeded on the basis that the payments made by Mr Calder were prima facie allowable deductions and his Honour was not satisfied that that position had been rebutted by the Commissioner's submissions. The case therefore turned on the question whether Part IVA of the Act operated to disallow those deductions.

6.      After weighing, individually and cumulatively, the factors in s 177D(b) of the Act (s 177D being the pivotal provision in Part IVA), his Honour concluded at [132] that the taxpayer should be objectively seen to have a dominant purpose of obtaining a tax benefit, and dismissed the taxpayer's appeal.

7.      In the matters before me, the parties agreed that I should adopt the findings of fact relating to the Main Camp No. 3 project which were made by the Federal Court in Calder, but allow the taxpayers to give their own evidence to support their argument that the circumstances of their participation in the project were different from those of Mr Calder.  Accordingly, the Carters sought to focus my attention on the particular circumstances surrounding their investment in the project, their fundamental submission being that it would not be concluded in their case, in terms of s 177D of the Act, that they had a dominant purpose of obtaining a tax benefit.

8.      The main reasons for that submission were that:

(i)Taxation was a partial consideration only;

(ii)As a result of their investment they were substantially cash-negative;

(iii)They invested to such an extent that none of their taxable income attracted tax at the top marginal rate.  This, they said, demonstrated that they did not have tax savings as the dominant purpose;

(iv)They did not engage in a “flurry of activity” around year end;

(v)Their investment was funded by external borrowings from Westpac;

(vi)They were not aware of any round-robin financing arrangements.

The findings of fact relating to the Main Camp No. 3 project

9.      Before turning to Part IVA, and specifically s 177D of the Act, it is necessary to set out what was involved in the investment in Main Camp No. 3.  The detailed “project circumstances” in relation to Main Camp No. 3 were summarised by Nicholson J in Calder at [6] to [13] as follows:

THE PROSPECTUS

6Participation in the Project was invited by a prospectus dated 20 April 1994 (‘the Prospectus’) which described the purpose of the Project as follows: -

‘By investing in this Project you will engage in the business of growing tea-trees on land at Rappville near Casino, NSW for a period of 15 years unless the relevant agreements are terminated earlier. The trees will be harvested and processed by the Manager on your behalf to produce tea-tree oil for sale at a profit.’

7Participants completed and signed an Application Form and a Principal Agreement which formed part of the Prospectus. By the terms of the Application Form participants elected to pay in advance management fees totalling $26,175 in the 1994 and 1995 income years.

PRINCIPAL AGREEMENT

8The Principal Agreement was between Summerland Lands Pty Ltd (‘the Land Owner’), Main Camp Tea-Tree Oil (No. 3) Limited (‘the Manager’), Australian Rural Group Limited (‘the Trustee’) and, where applicable, Project and General Finance Pty Ltd (‘the Lender’) and each individual participant who was named in its schedules as ‘Farmer’ and ‘Borrower’.

9The Principal Agreement provided that, by executing it, the Farmer/Borrower automatically, upon acceptance of the Application Form by the Land Owner, the Manager and, where applicable, the Lender, became a party to and bound by the Farm Agreement, Management Agreement and, where applicable, the Loan Agreement which were annexed to the Principal Agreement as Annexures ‘A’, ‘B’ and ‘C’ respectively.

FARM AGREEMENT

10The Farm Agreement was between the Land Owner, the Trustee and the Farmer named in the Principal Agreement and recited that:

(a)under a lease dated 20 April 1994, the Land Owner would lease certain specified parts of the property known as ‘Main Camp’ to the Trustee to be held on trust for the Farmers (‘the Project Land’);

(b)under a sub-lease dated 20 April 1994 the Trustee would sub-lease the Project Land to the Land Owner.

11The Farm Agreement provided as follows:

(a)the Land Owner granted to the Farmer a right to farm 10,000 tea-trees on the site or sites forming part of the Project Land on which the said tea-trees were established (‘Farm’);

(b)the term of the right was deemed to commence on 30 June 1994 and end on 30 June 2009;

(c)the fee payable to the Land Owner for the grant of the right (‘farm fee’) was:

(i)for each of years 1 and 2 a prepaid fee per Farm of $50;

(ii)for each of years 3 to 15 a fee calculated monthly in advance on the basis of $50 plus an annual increment equal to the Consumer Price Index of Sydney to be paid from the income arising from the sale of tea-tree oil from the Project;

(d)after the first 2 years the farm fee was to be paid out of the gross income of the Project prior to the payment of management fees pursuant to the Management Agreement. If in any year the gross income was not sufficient to pay the farm fee it could be paid out of the gross income in any subsequent year;

(e)the Land Owner was to supply to the Farmer at the Farmer's expense germinated seeds in a healthy condition in numbers equal to 10,000 trees per Farm;

(f)the Land Owner would procure the design and survey of the Farm and would record and, if requested, notify the Farmer the position of such Farm;

(g)the Farmer would:

(i)purchase germinated tea-tree seeds from the Land Owner and grow them out into harvestable trees;

(ii)maintain the trees and tree placements according to principles of good husbandry and thereafter harvest the trees and process the leaf into oil;

(iii)generally maintain the Farm and conduct the business of farming tea-trees in an efficient manner according to good farming practice.

MANAGEMENT AGREEMENT

12The Management Agreement was between the Manager and the Farmer named in the Principal Agreement and provided as follows:

(a)the Farmer became a party to and bound by a Deed made between the Land Owner, the Manager and the Trustee (‘the Investment Deed’, sometimes described in submissions as the Project Deed);

(b)the Farmer engaged the Manager to manage the business of farming the Farmer's Farm and the harvesting and processing of the tea-trees thereon to produce and market tea-tree oil;

(c)the agreement was to commence on 30 June 1994 and continue for 15 years thereafter;

(d)the Manager agreed to perform at its expense all the obligations of the Farmer to the Land Owner under the Farm Agreement except for the Farmer's obligation to pay farm fees to the Land Owner and within the initial 13 month period of the Management Agreement to:

(i)receive from the Land Owner germinated tea-tree seeds selected to the best of the knowledge and belief of the Manager and the Land Owner from known high yielding stock and in healthy condition;

(ii)do all things necessary to ensure that the germinated tea-tree seeds were tended according to principles of good husbandry, grown into seedlings and then planted at the rate of 10,000 per Farm;

(iii)conduct the Farm in a commercial manner in keeping with accepted tea-tree oil industry standards;

(iv)create and maintain shelter belts and fencing for the protection of the plant placements;

(v)prepare the land with adequate drainage and ensure proper drainage was supplied by the Land Owner;

(vi)provide suitable fertilisation to the tea-trees;

(vii)eradicate pests, keep the Farm free of competitive weeds and keep down and exterminate vermin, noxious animals, insects, plants and weeds (‘the Initial Obligations’);

(e)subsequent to the Initial Obligations, the Manager agreed to perform at its expense all the obligations of the Farmer to the Land Owner under the Farm Agreement except for the Farmer's obligation to pay farm fees to the Land Owner and to:

(i)continue to perform the obligations set out at subpars (iii) to (vii) above;

(ii)use its best endeavours to harvest the tea-trees at or about the time estimated by it to produce the best results for the Farmer;

(iii)use processing facilities supplied by the Land Owner to process the harvested tea-tree leaf into oil;

(iv)sell and distribute such tea-tree oil using its best endeavours to obtain the maximum price available and account to the Farmer and the Trustee for the proceeds of such sale;

(v)where the Manager believed it was in the best interests of the Farmer to do so, to pool the oil produced from the Farmer's trees with oil produced from other Farmers' trees and other projects in which event the proceeds of sale of oil pro rata would be divided between the Farmers.

(f)the Farmer agreed to pay the Manager as follows:

(i)if the Farmer prepaid the fee in respect of the Initial Obligations, $23,450 per Farm (reduced from $27,000);

(ii)for the period of 13 months commencing at and including 30 June 1995, $2725 plus $12.50 per kilo of oil produced (reduced from $3133 if paid in advance on 30 June 1995);

(iii)for each year thereafter commencing 30 June 1996 the management fee was the sum of $2725 per Farm plus $12.50 per kilo of oil produced, and thereafter such costs would increase at an increment equal to the Consumer Price Index of Sydney;

(iv)the management fees for the year commencing on 30 June 1996 and thereafter were to be paid out of the gross income of the Project and in the event that the gross income in any year was not sufficient to pay the management fees for that year the fees could be paid out of the gross income of the Project in any subsequent year;

(v)subject to the gross income of the Farmer being made available in its entirety by the Farmer to the Manager for the purpose of paying the management fees the Manager would have no recourse to the Farmer for such management fees;

(g)the Farmer authorised and directed the Manager to pay to the Land Owner out of the Farmer’s gross income of the Farmer's Project any farm fees due and payable by the Farmer to the Land Owner pursuant to the Farm Agreement prior to payment of the Manager's remuneration.

LOAN AGREEMENT

13The Loan Agreement was between the Lender and the Borrower named in the Principal Agreement and provided as follows:

(a)the Lender advanced to the Borrower the Principal Sum referred to in the Principal Agreement and being:

(i)$23,500 per Farm in Year 1;

(ii)$2775 per Farm in Year 2;

(b)the term of the loan was eight years from the date of the Loan Agreement and deemed to commence on 30 June 1994 for the purpose of calculating principal and interest;

(c)as consideration for the Lender discounting the interest rate by 2 per cent per annum, the Borrower agreed to pay upon execution of the Loan Agreement the first year's interest at the rate of 15 per cent per annum;

(d)as consideration for the Lender reducing the rate of interest during the second year of the Loan Agreement to 12.66 per cent, the Borrower agreed to pay the Lender on 30 June 1995 interest for 12 months in advance on the principal then outstanding;

(e)as consideration for the Lender reducing the rate from and including year 3 onwards to 6.5 per cent per annum, the Borrower agreed to pay the Lender interest monthly in advance on the principal sum outstanding subject to such payment being due from the sale of oil and payable from the income there from after payment of all farm fees and all management fees and charges;

(f)the Borrower was to make one principal repayment to the Lender on 1 October 1994 of $8500 per farm;

(gthe balance of the principal sum and interest was to be repaid to the Lender by direct deduction from the income from the business (as defined) and by executing the Loan agreement the Borrower authorised the Manager to pay the Lender all such monies;

(h)the Borrower could elect to have the income of the Farmer available for repayment of principal calculated as either:

(A) the balance of the gross income of the farm (a term not defined in the Loan Agreement) after payment in order of priority of all farm fees, all management fees and interest due and payable; or

(B)$250 plus 50 per cent of the balance of the gross income of the farm (a term not defined in the Loan Agreement), after payment in order of priority of all farm fees, all management fees and interest due and payable;

(i)subject to the Borrower making the specified principal and interest payments by the due dates and performing his obligation under the Farm Agreement, the Borrower would have no other liability for payment of the balance of the principal sum or interest thereon other than out of the income from the Project, provided that should the Borrower's income from the Project be insufficient to pay the principal sum and interest by the expiration of eight years from the date of the Loan Agreement then the term of the loan was to be extended for no more than 15 years from the date of the Loan Agreement until the principal and interest is paid from such income;

(j)at the expiry of 15 years from the date of the Loan Agreement, the Loan Agreement and the Borrower's obligations to repay any outstanding principal and interest were to cease;

(k)the Borrower authorised the Lender to remit the Principal Sum to the Trustee to be applied by the Trustee toward the obligation of the Borrower to pay management fees and farm fees, and the Lender irrevocably agreed to remit such funds in satisfaction of the Borrower's obligations under the Farm Agreement and the Management Agreement.

Part IVA of the Act

10.     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).  The taxpayers did not attack the Commissioner’s position that there existed both a “scheme” and a “tax benefit” that was obtained in connection with it (although, because of corrections that need to be made to some of the figures relied on in the amended assessments, the Commissioner accepts that there is no tax benefit accruing to either taxpayer in the 1996 income year).  For the remaining two years the real issue 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 the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme …

11.     A scheme will have been entered into for a particular purpose if that purpose is the dominant purpose: s 177A(5).

12.     It is well settled that, in considering the question whether a taxpayer entered into or carried out a scheme for the purpose of obtaining a tax benefit, all eight matters set out in s 177D(b), and no others, must be taken into account.  In particular, the provision does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers or others who entered into or carried out the scheme or any part of it: FCT v Hart (2004) 217 CLR 216 at 243 [65] per Gummow and Hayne JJ.

13.     In Calder, Nicholson J dealt with each of the eight matters in turn.  In relation to some of those matters, his Honour had regard to distinct factors that needed to be dealt with separately.  His Honour’s comprehensive analysis of the eight matters and the distinct factors within them led to a conclusion that Mr Calder should be objectively seen to have had a dominant purpose of obtaining a tax benefit.

14.     As mentioned in [8] of these reasons, the taxpayers in the current matter confined their submissions to a handful of propositions which have a bearing on some of the eight matters in s 177D(b).  However, the general submissions they made to the effect that taxation was a partial consideration only, their claimed special interest in tea-tree oil as a product, largely because of its unique Australianness, and their desire to support the industry and to maintain that Australianness, go to the question of their subjective motives in investing in the project and, as stated in Hart, those motives are irrelevant to the question before me, except to the extent that the facts that they have been able to establish to support those contentions may throw some light upon some of the specific matters in s 177D(b).

The Tribunal’s task in relation to Part IVA

15.     Notwithstanding the parties’ agreement about the conduct of this matter, it is not appropriate for me simply to take, from Calder, Nicholson J’s assessment of the relevant matters and accept that, unless the Carters’ circumstances differ from those of Mr Calder, his Honour’s assessment of a matter is the proper assessment of that matter in relation to the Carters.  Even though Calder was regarded as the leading case on the Main Camp No. 3 project, my task is to make my own assessment of the eight matters in s 177D(b) as they relate to the Carters.  My assessment of any of the eight matters may be the same as that of his Honour, or it may differ from his Honour’s assessment even though the facts may be identical.  Having made the assessments, I must then weigh the matters collectively and come to my own view as to whether it would be concluded that the Carters entered into the scheme for the dominant purpose of obtaining a tax benefit.

16.     Having said that, the primary facts relating to the Carters are as found by Nicholson J in Calder – because this is what the parties agreed here – unless there is something about the Carters’ involvement that differentiates them from the leading case.

17.     I will now deal with each of the eight matters in s 177D(b). 

(i)The manner in which the scheme was entered into or carried out

18.     The Carters invested in seven farms and in doing that, they took on an obligation to pay, in the 1994 income year, $350 (or $50 per farm) in farm fees and $164,150 (or $23,450 per farm) in management fees. 

19.     Each of them claimed, in relation to the 1994 income year, deductions of $175 (one-half of $350) for farm fees and $82,075 (one-half of $164,150) for management fees.  For the same year they claimed interest deductions – in Mr Carter’s case the deduction claimed was $14,646, and for Mrs Anninos-Carter the claim was for $12,396.

20.     For the 1995 year each of the taxpayers claimed $175 in farm fees and $9,538 in management fees.  Further interest claims of $10,978 each were made as well.

21.     The cash outlays that they made during these income years were funded by their Westpac borrowings and amounted to:

1 June 1994 – $26,075

30 September 1994 – $29,750

30 December 1994 – $29,750

19 June 1995 – $15,750

22.     The structure of the investment has as one of its outcomes the prima facie availability of tax deductions (excluding interest), for the 1994 income year, totalling $164,500 for a cash outlay of only $26,075 (and of that latter figure, $1,400 – or $200 per farm – is a capital outlay for the purchase of seeds).  The position for 1995 is that actual outlays total $75,250 while the deductions are only $19,426. 

23.     Although the taxpayers claim that they were cash-negative when the 1994 and 1995 income years are taken together (and the Commissioner appears to accept this), the reality is that the arrangement saved them a total of $86,352 in tax for the 1994 year while they only had to outlay $24,675 in non-capital expenditure to generate that tax saving.  There was a further tax saving to Mr Carter in 1995 of $4,387.

24.     The cash-negative position is a consequence of the investment being made equally by both of the taxpayers, rather than by one of them alone, and of the fact that the magnitude of the claimed deductions reduced the income of each of the taxpayers to a figure which was too low to attract the top marginal rate of tax.  They say that these factors, taken together, point away from a conclusion that they should be objectively seen to have tax savings as the dominant purpose of their entry into the scheme.

25.     I do not agree.  At best, these factors indicate that the taxpayers did not maximise the tax savings that might have been available to them.  The structure of the investment that the Carters made, with management fees paid in advance and the consequent increase in the level of deductions claimed for the 1994 year, points strongly towards the obtaining of a tax benefit as their purpose.

26.     I accept their evidence that they were unaware of the round-robin finance arrangement, but on the authorities this lack of awareness is irrelevant.  In Calder the Full Court stated at [114]:

… lack of awareness of the way in which the funds were actually processed does not mean that those factors are to be disregarded in the objective assessment of purpose under s 177D any more than the unread details of the contracts which constitute the framework of the scheme.

27.     The one apparent difference between the Carters’ circumstances and those in Calder is that there was some external funding of the Carters’ investment. That means that there was some real money contributed to the project. But there was real money contributed by the Calders as well – see 59 ATR at 661 [14]: “[Mr Calder] and his wife received funds from the sale of their yacht, which they decided to invest for the purpose of producing additional income for their retirement” – and in my opinion this does not justify any more favourable assessment of their circumstances than was reached in Calder.

28.     In all the circumstances I consider that the manner in which the Carters entered into the scheme and the manner in which the scheme was carried out point towards a tax benefit purpose.

(ii)The form and substance of the scheme

29.     The Carters gave no evidence and made no submissions in relation to this matter.  After adopting the factual findings of Nicholson J, I must say, with respect, that I would make the same assessment as to purpose as did his Honour – that is, that the form and substance of the scheme point towards a tax benefit purpose.

(iii)The time at which the scheme was entered into and the length of the period during which the scheme was carried out

30.     It is true that there was no “flurry of activity” by the Carters at or near the end of the financial year.  The prospectus was issued on 20 April 1994 and the Carters apparently applied to participate in the project on 18 May 1994.

31.     The Carters gave evidence, not challenged by the Commissioner, that they had been active investors over many years, and had previously invested in Australian films, shares and, as already mentioned, Main Camp No. 2.  The scheme was to run for 15 years.

32.     These factors weigh marginally against a tax benefit purpose.

(iv)    The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

33.     There is no dispute that, but for Part IVA, the scheme would achieve for the taxpayers deductions far in excess of their cash outlays – see [22] above.  This favours a tax benefit purpose.

(v)     Any change in the financial position of the taxpayer resulting from the scheme

34.     For a cash outlay of $101,325 (a figure that includes $1400 of capital expenditure), the taxpayers obtained tax deductions, over two income years, of $183,926.  The amount of tax saved was over $90,000 in the 1994 and 1995 income years.  At a time when the top marginal rate of tax was 48.4%, over 90% of their cash outlay was funded by the Australian taxpayer.  Those factors point strongly towards a tax benefit purpose.

(vi)    Any change in the financial position of any person who has a connection with the taxpayer, being a change resulting from the scheme

(vii)   Any other consequence for the taxpayer, or for any person referred to in subparagraph (vi)

(viii)     The nature of any connection between the taxpayer and any person referred to in subparagraph (vi)

35.     There is nothing relevant in relation to any of these matters.

Conclusion in relation to Part IVA

36.     Taking into account all eight matters in s 177D(b), I consider that the taxpayers should be objectively seen to have had a dominant purpose of obtaining a tax benefit. 

37.     As to penalty, I agree with the Commissioner’s contention that the correct penalty amount is 50% (there being no reasonable argument that Part IVA does not apply) but reduced by 80% to 10% as a result of the taxpayers’ voluntary disclosure.

38.     The Commissioner has conceded that certain increases to both taxpayers’ assessable income, affected as a result of the various Part IVA determinations that were made, should not have been made.  There are also some further deductions that the Commissioner concedes should be allowed.  These figures are all detailed in the Commissioner’s Outline of Submissions dated 12 July 2007 and the Commissioner’s Further Submission dated 14 September 2007 and need not be repeated here.  I understand that, if I conclude that Part IVA applies, the parties agree on these adjustments.

DECISION

39.     Therefore, the objection decisions under review are set aside to the extent previously conceded by the Commissioner and as detailed in the Commissioner’s Outline of Submissions, as amended by the Commissioner’s Further Submission.  For the avoidance of doubt, I express my concurrence with the Commissioner’s contentions and calculations in paragraphs 4 to 6 and 11-12 of his Further Submission dated 14 September 2007.

40.     The matters are remitted to the Commissioner for implementation of this decision.

I certify that the forty [40] preceding paragraphs are a true copy of the reasons for the decision herein of Mr S E Frost, Member

Signed:         ...................(Sgd. R Riberi).............................
  Associate

Date of Hearing  13 July 2007
Date of Final Submissions                 24 September 2007
Date of Decision  3 December 2007
Representative for the Applicant       Self Represented
Counsel for the Respondent              Ms L Price

Solicitor for the Respondent              Mr T Burrows
  Australian Government Solicitor