Commissioner of Taxation v Osborne, K

Re: COMMISSIONER OF TAXATION
And: KENT OSBORNE
No. QLD G14 of 1990
FED No. 517
Income Tax - Administrative Law
26 FCR 63

COURT

IN THE FEDERAL COURT OF AUSTRALIA

QUEENSLAND DISTRICT REGISTRY
GENERAL DIVISION
Spender(1), Pincus(2) and French(3) JJ.

CATCHWORDS

Income Tax - deductions in carrying on a business of primary production claimed - whether taxpayer's agricultural business had begun or whether merely preparatory steps taken - capital/revenue distinction considered in relation to costs of establishing a plantation.

Administrative Law - whether oral or written reasons given by Administrative Appeals Tribunal - whether reasons contained sufficient findings on material questions of fact.

Income Tax Assessment Act 1936 s.51(11)

Administrative Appeals Tribunal Act 1975 ss.43(2A), 43(2B)

HEARING

BRISBANE

#DATE 18:9:1990

Counsel for the applicant: Mr J. Logan

Solicitors for the applicant: Australian Government Solicitor

Counsel for the respondent: Mr P. McMurdo

Solicitors for the respondent: Bugden Summerton Sheehan

ORDER

The appeal be allowed.

The decision of the Administrative Appeals Tribunal of 28 December 1989 be set aside.

There be no order as to costs.

JUDGE1

I agree with the reasons for judgment of Pincus J., and the orders he proposes.

JUDGE2

This is an income tax appeal brought from the Administrative Appeals Tribunal, which allowed an objection made by the respondent taxpayer to his assessment under the Income Tax Assessment Act 1936 ("the Tax Act") for the 1982 tax year. The respondent taxpayer, Mr Osborne, had claimed outgoings of $12,951 said to have been incurred by him in carrying on a business of primary production. The taxpayer's income tax return that year gave his occupation as "economist/farmer" and showed his income from primary production to be nil. The sum of $12,951 was said to be made up of 10 items, the largest three being $7,000 rent paid, $3,430 depreciation and $1,806 for contract labour. It is to be noted that the findings as to the nature of these deductions are not detailed; in particular, there was no finding as to whether there was a lease, or whether the rent was payable in a lump sum or otherwise to the owner, a company associated with the taxpayer. All these deductions were disallowed by the Commissioner, and that was sought to be supported in argument before us by contentions that the respondent's activities were merely preliminary to the conduct of a business of primary production, that they related to the "structure of the business to be established" and that they were on capital account. As a separate argument, it was put that the Tribunal should not have allowed the sum claimed in respect of depreciation, because the depreciated articles were "for a purpose preliminary to the production of assessable income".

Some reference must be made to the procedural history of the matter before the Tribunal. To save expense, no shorthand note or other recording of the evidence was made. The Commissioner argued that there had been a breach of s.43(2B) of the Administrative Appeals Tribunal Act 1975 ("A.A.T. Act") which reads:

"Where the Tribunal gives in writing the reasons for its decision, those reasons shall include its findings on material questions of fact and a reference to the evidence or other material on which those findings were based."

The applicant's complaint was that the reasons did not contain enough findings on material questions of fact to enable the Tribunal's conclusions sensibly to be reviewed.
That point appears to be one of a preliminary kind, in that if it is made good, the only practical remedy is to set the Tribunal's decision aside and remit the case to be heard and decided again, under s.44(5) of the A.A.T. Act; it would seem unlikely that the Tribunal, having no record of the evidence available, could at this stage adequately supplement its reasons.
The reasons include a statement inserted in the document, immediately before the main text: "These reasons were given orally at the hearing of this matter". That course is contemplated by s.43(2) of the A.A.T. Act:

"Subject to this section and to sections 35 and 36D, the Tribunal shall given reasons either orally or in writing for its decision."

Neither s.35 nor s.36D contains anything relevant to the present problem. Sub-section 43(2A) reads as follows:

"Where the Tribunal does not give reasons in writing for its decision, a party to the proceeding may, within 28 days after the day on which a copy of the decision of the Tribunal is served on that party, request the Tribunal to furnish to that party a statement in writing of the reasons of the Tribunal for its decision, and the Tribunal shall, within 28 days after receiving the request, furnish to that party such a statement."

The nature of the distinction intended between reasons given orally and reasons given in writing is not absolutely clear. If reasons are given orally in the first place, and, being recorded, are later reduced to writing and certified (as appears to have happened here), have reasons been given in writing? Another possibility is that written reasons have been prepared initially, but instead of being issued are simply read out to the parties. In my opinion, reasons are given in writing within the meaning of s.43(2) if and when they are issued by the Tribunal in written form, whether or not they have been delivered orally in the first place. Of course, if very informal reasons are delivered orally, and a request is then made under sub-s.43(2A), the Tribunal will be unlikely to comply with sub-s.(2B) unless more elaborate, written reasons are then produced.
The result is that these reasons, although described as having been given "orally at the hearing", later became reasons in writing, when they were reduced to writing and delivered to the parties, certified (as they were) as a "true and correct copy of the Reasons for Decision herein". The question arises whether they were delivered in breach of sub-s.43(2B) of the A.A.T. Act; this is a question of degree. A breach of that provision is not necessarily shown by pointing to matters which might, with advantage, have been the subject of fuller and more detailed discussion or to possible issues which have not been mentioned. Where there are (as is usual in the Tribunal) no pleadings or other documents formally defining the questions which the parties desire to have decided, sub-s.(2B) does not necessarily and always require discussion of every point which might have been raised before the Tribunal, whether or not it has been argued. For example, in a case of this sort, the parties might treat all the items of expenditure in question as governed by the same considerations, or else make particular submissions about some of them. It appears from the reasons that the representative of the Commissioner at the hearing before the Tribunal took the former course. Reading the reasons as a whole, one cannot predicate of them that they fail to reach the standard required by sub-s.(2B). It is easy to think of matters which might have been but have not been dealt with; one which was particularly relied on before us was the absence of any separate discussion of the question of depreciation. But the content of the reasons suggests that the case was conducted on the basis that all the deductions claimed stood or fell together.
The conclusion just reached - namely that no breach of sub-s.43(2B) has been demonstrated - makes it unnecessary to consider whether the question just discussed is one of law, so as to give this Court jurisdiction under s.44(1) of the A.A.T. Act.
It is, however, desirable to make some further observations on the state of the record. It is mentioned in the reasons that the Tribunal accepted the evidence of the taxpayer. Counsel suggested that this implied acceptance by the Tribunal of all the assertions in the rather detailed notice of objection; but that document is not signed by the taxpayer personally and one does not know whether he swore to its content. In making his findings, the Deputy President who heard the matter might have relied entirely upon the taxpayer's testimony and found it unnecessary to consider the factual correctness of the notice of objection. This Court is not entitled to speculate about the extent to which the content of the notice of objection was accepted. No doubt the Court should regard the list of expenses set out in the tax return as incorporated in the reasons of the Tribunal, but otherwise those reasons must be treated as self-sufficient.
In summary, the facts to be considered are as follows. In 1980 a private company, in which the respondent and his wife had a quarter interest each, bought 50 acres of land near Bowral in New South Wales. The respondent decided to lease the land from the company for the purpose of farming and began to research the feasibility of growing chestnuts commercially. He made appropriate inquiries and made contracts to buy chestnut plants and seedlings.
The respondent was advised to plough that part of the land (30 acres) which was suitable for chestnut cultivation, to plant lupin seed on it and when the lupin matured, briefly to graze sheep on the land before beginning to plant the chestnut trees. The reason for growing lupin was to remedy a nitrogen deficiency in the soil. The respondent planted the 30 acres with lupin and ploughed it back into the soil, but then abandoned the project. That was done because he decided that it was uneconomic; there was a shortage of water, to counteract which would have required the construction of a bigger dam than was then on the property, "an expenditure thought to be unjustified by the projected profits ...". All the outgoings were sought to be deducted under s.51(1) of the Tax Act, as being incurred in relation to preparing the ground for planting.
The taxpayer's agricultural operations were conducted on a sufficient scale to be more than a hobby; he devoted a substantial amount of both time and money to the project and he seems to have seriously intended a commercial venture. The difficulties he has in defending the Tribunal's decision, then, lie in two issues: the first is whether the business had begun and the second whether establishing a nut tree is a capital or revenue matter.
According to the Tribunal's reasons, the Commissioner's opposition to the taxpayer's claim to the deductions relied solely on the decision of the High Court in Southern Estates Pty Ltd v. F.C.T. (1967-1968) 117 CLR 481. After discussing that case and some other decisions, the Tribunal held that the taxpayer was engaged in the business of primary production in the relevant year and allowed the deductions claimed.
As the Commissioner's counsel contended before us, the Southern Estates case concerned interpretation of s.75(1) of the Tax Act, not s.51(1), which is in issue here. Section 75(1) related to expenditure incurred before 21 August 1973 or under a contract made on or before that date, and such expenditure might, in certain circumstances, have been allowed as a deduction if it was "incurred in the year of income by a taxpayer engaged in primary production on a new land". The taxpayer in Southern Estates was a company which bought land "to clear it of the scrub upon it, fence, water and grass it for the carriage of stock and thereafter to graze it until such time as it could profitably be sold as grazing land" (486). Barwick C.J. could not read "a taxpayer engaged in" in the section as "satisfied by one of whom no more can be said than that he intends to engage in" (488). Taylor and Owen JJ. said that the "sub-section is not designed to benefit a taxpayer who buys land which, as it stands, cannot be used for primary production and expends money upon improvements to it so that he may resell it to the best advantage when it is in, or approaching, a state in which it can be used for that purpose. Its purpose is to benefit a taxpayer who, at the time he incurs the expenditure, is himself engaged in primary production on the land" (491).
None of the judges in the High Court who dealt with the case referred to the line of authority dealing with s.51(1) and its statutory antecedent in the Income Tax Assessment Act 1922, to the effect that "expenditure may be allowed as a deduction though it produces and is possibly designed to produce results in the way of income in a future year and not in the year in relation to which income is being assessed ...": Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation (1935-1936) 54 CLR 295 at 303. The Southern Estates case is not of great assistance in determining the effect of s.51(1), because the majority of the judges in the High Court decided it primarily on the basis that s.75(1) required that the claiming taxpayer be "actually carrying on primary production" (488) or "actually engaged in carrying on the business of a primary producer", which conveys the idea that preliminary endeavours will not do. It seems important to note that the word "business" did not occur in s.75(1), the test being whether the taxpayer was, at relevant times, "engaged in primary production on any land".
The question of deductions for outgoings said to be merely preparatory to carrying on a farming business has not been much discussed judicially, but was treated to some extent by Walsh J. in Thomas v. Commissioner of Taxation (1972) 46 ALJR 397. The judge remarked that:

"There is authority justifying me in holding that losses and outgoings may be allowable deductions, in accordance with the provisions of s.51(1) of the Act, although incurred in a year in which no assessable income is actually gained or produced by the activities in relation to which the losses or outgoings are incurred ... " (400)

His Honour was principally concerned with the question whether the taxpayer was a "primary producer" within the definition in s.157 of the Tax Act. Nevertheless, some of the comments of Walsh J. are of present assistance. The taxpayer there had bought and planted macadamia nut trees and avocado pear trees but had not, at any relevant time, got a harvest. He had also started a pine tree plantation. Walsh J. said:

"On the foregoing facts, the question whether or not the appellant embarked upon a business venture has to be determined. There is no doubt that the appellant's chief occupation was the practising of his profession and that tree farming, if it had a business character, was relatively of minor importance ... But the appellant in planting the avocado pear trees and the macadamia nut trees set out to grow them on a scale that was much greater than was required to satisfy his own domestic needs and he expected upon reasonable grounds that their produce would have a ready market and would yield, if the trees became established, a financial return which would be of a significant amount, with a relatively small outlay of time and money, and that this return would continue for a very long time. In these circumstances, I think it is proper to find, and I do find, that he set out to engage in producing the pears and the nuts as a business and that he was in the tax year carrying on that business, which was a business of primary production." (400-401)

These remarks tend to support the view that a person who proposes to enter the business of growing macadamia nuts should be regarded as having done so well before the trees begin to bear. The precise time at which the business should have been regarded as having begun was not fixed by Walsh J., but it would seem to follow from what his Honour said, that during the time when the trees are growing, such a business is in being.
Thomas' case was referred to by the Full Court in Ferguson v. Federal Commissioner of Taxation (1979) 26 ALR 307. There, it was argued on behalf of the Commissioner that the taxpayer's cattle breeding activities, which were on a very small scale, were merely preparatory to the commencement of a considerably larger breeding operation. That was rejected (312-313), but the discussion of the facts there does not appear to throw any light upon the general question of when an agricultural business begins. Here, according to the findings, there was likely to be a gap of about six years after planting "before chestnut trees will yield an economic return". All the expenses claimed related to the growing of a crop of lupin to remedy a nitrogen deficiency and the intention (never put into effect) apparently was to plant the trees at some time after the lupin had grown, been grazed and then ploughed in. But in my opinion, there is no sufficient justification for distinguishing Thomas' case, on this aspect of the matter. A person starting a business of raising annual crops may, in general, deduct the cost of the fertiliser he applies, even if no crop is ever harvested. It seems to me that, likewise, the steps taken to fertilise the ground preparatory to putting in the chestnut plants should be regarded as incurred in carrying on a business.
To this point I have treated the matter as depending on the answer to the question: had the business begun? The remaining question is whether the outgoings are of a capital nature within the meaning of s.51(1); some outgoings made after commencing business are of a capital kind - e.g. building an extension to one's factory. There is a lack of authority as to the distinction between expenditure on revenue account and that on capital account, in an agricultural context. Presumably that is due to the presence in the Act of provisions such as s.75(1), whose effect was considered in the Southern Estates' case, as well as s.75A; these sections made special provision for deductions (spread over ten years) in respect of expenditure by primary producers which might have been treated as of a capital kind. No reliance is placed on such provisions here.
The best-known statement on the distinction between capital and income is perhaps that of Pitney J. in Eisner v Macomber 252 US 189, beginning:

"The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; ..."

This dictum appears to have been referred to, expressly or otherwise, in a number of English cases, one example being Inland Revenue Commissioners v. Reid's Trustees (1949) AC 361, a case concerning taxation on a dividend paid from capital profits: see per Lord Morton at 381 and per Lord MacDermott at 383. In the High Court, the metaphor was used in the Commissioner of Taxation v. Smith (1980-1981) 147 CLR 578. In the majority judgment one finds:

"If the ability to earn is the tree, and income the fruit thereof, a policy of insurance against impairment of the fruit-bearing capacity of the tree may well take the form of providing the fruit until such time as the tree recovers its proper role ... Any fruit is better than none, whether or not it represents adequate compensation for the loss." (583)

The question is whether these expressions are mere figures of speech or should be taken as authority in favour of the general proposition that a fruit tree is a capital asset. I think the latter view to be correct. When established, a fruit tree, and likewise a nut tree, is an "asset or advantage of a lasting character which will enure for the benefit of the" owner: Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 at 361. It is true that payments to secure some fairly long lasting advantages have been treated, on occasions, as on revenue account; an example is BP Australia Limited v Commissioner of Taxation (1965) 112 CLR 386. But in cases of that sort, one usually finds that exceptional circumstances are pointed to as taking the case out of the general rule. For example, in BP Australia Limited, the Privy Council said:

"Where a trader buys out a rival in order to secure his goodwill or to suppress it and so provide or maintain a clear field for his own enterprise over a substantial period, there is a definite prima facie pointer towards a capital payment. But in the present case BP was not achieving a monopoly nor buying off competition nor obtaining any substantial area for its own domain." (395)

There is no finding as to the likely useful life of a chestnut tree in the area in question; as a matter of judicial knowledge, such trees must be taken to be potentially long-lived. They may, of course, be destroyed by disease or fire or because it is desired to put the land to another use, but the very length of time between planting and harvest - six years - tends to give the project of establishing the trees a capital character. One could hardly expect so much time and trouble to be invested if the trees were expected or intended to have only a short bearing life.
In Saunders v. Pilcher (1949) 2 All ER 1097, the taxpayer bought a cherry orchard and later sold the crop. He was held by the Court of Appeal to be taxable on the proceeds without making allowance for that proportion of the purchase price which he said represented the cost of the fruit. Jenkins L.J. said that:

"It is a well settled principle that outlay on the purchase of an income-bearing asset is in the nature of capital outlay, and no part of the capital so laid out can, for income tax purposes, be set off as expenditure against income accruing from the asset in question. This principle ... (applies) in the case of a capital asset such as an orchard of fruit trees which, subject to periodical replacement of casualties among the trees and the usual attention in the form of pruning, spraying, manuring it, and so on, constitutes what may be described as a permanent source of income."

(1103-1104).

Apart from this English decision, the Commissioner gains some assistance from the treatment of the problem in the United States, as illustrated by the authorities to which I shall refer. They contain mention of a United States tax law identified as Treas. Reg. 1.162-12(a), providing in part:

"Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may, at the election of the taxpayer, be regarded as investments of capital."

This has been held to allow such an election as to "expenditures ... of such a character that in the course of regular farming operations they would be regarded as operating expenses and therefore currently deductible": Thompson and Folger Co v. Commissioner of Internal Revenue 17 TC 722 at 725,726.
It is explained in The Estate of Richard Wilbur 43 TC 332 that the regulation operates so as to provide a solution for expenditures which "fall in a band of gray between black and white", by which was meant that they might or might not have been treated as capital expenditures.
The notion of the "band of gray" was picked up in Maple v. Commissioner of Internal Revenue 440 F 2d 1055 (1971). It was explained that the reason for its use was that many costs of running a producing farm are similar in kind to those incurred in creating the farm. The Court pointed out in Maple that the Commissioner had identified expenditures which were not "purely capital" and therefore gave the farmer an election under the regulation, as follows:

"Expenditures incurred during the development period which represent ordinary and necessary expense items as an incident of current operations, such as the upkeep of a grove or orchard, taxes, water for irrigation purposes, and cultivating and spraying of trees ... " (1057)

Byrne J., who dissented as to the result in Maple, expressed the view that the "band of gray" would fall between the planting of the trees and their producing period some years later.
In Pesantes v. U.S. 621 F 2d 175 (1980), pecan tree seedlings were transplanted onto the taxpayer's land. Again, the distinction was drawn between farming expenditures within the band of gray and those which were "clearly capital", such as the cost of purchasing the seedlings and grafting onto them the particular variety of pecan which it was desired to produce.
Lastly, in Amfac Inc. v. Commissioner of Internal Revenue 626 F 2d 209 (1980), money was spent in preparation for planting. Land was cleared and reshaped, topsoil was added and drainage effected. The case concerned in part the question whether a particular provision of the U.S. Internal Revenue Code (26 U.S.C. s.175(a)) applied, but for present purposes, it is enough to note that the expenses were held to be on capital account.
It appears to be consistent with the trend of these authorities to hold that, in general, costs incurred in establishing a plantation of fruit or nut trees, at least up to the stage of getting seedlings established in the ground, are capital expenses. Beyond that point, they may, under Australian law, fall within a "band of gray", not in the sense that they are caught by a provision giving the farmer an election, but in the sense that there may well be room for argument as to whether they are of a capital kind. I permit myself the observation that it may be thought unsatisfactory that the would-be venturer in agriculture in this country must be left in a state of uncertainty as to deductibility of establishment expenses of the kind dealt with by the U.S. regulation mentioned above. There is a vast store of discussion on the capital-revenue distinction, but it may not provide any clear answer as to many expenses incurred before the trees bear.
Here, in my opinion, the taxpayer cannot succeed, for the costs of preparing the ground for planting the nut trees cannot be deducted under s.51(1), being excluded by the words "except to the extent to which they are losses or outgoings of capital, or of a capital ... nature." Whether or not other activities before the first nut harvest might produce deductions, it is my view that the costs of preparing the ground to plant the trees should be treated as in the same category as the costs of buying and planting them - i.e. capital expenditure.
The appeal should be allowed, in my opinion, and the Tribunal's decision set aside, but without costs.

JUDGE3

I have read the reasons for judgment of Pincus J. and agree with them and the orders proposed.

[1990] FCA 517

18 SEPTEMBER 1990