DQTB and Commissioner of Taxation (Taxation)
[2023] AATA 515
•28 March 2023
DQTB and Commissioner of Taxation (Taxation) [2023] AATA 515 (28 March 2023)
Division:SMALL BUSINESS TAXATION DIVISION
File Numbers:2020/3464-65, 2020/3747
Re:DQTB
APPLICANT
Re KHMQ
APPLICANT
AndCommissioner of Taxation
RESPONDENT
DECISION
Tribunal:Senior Member R Olding
Date:28 March 2023
Place:Brisbane
1.The decision under view in respect of DQTB is set aside and remitted to the respondent for reconsideration with directions that:
(a) a further deduction for legal expenses in the amount of $1,776.50 is to be allowed;
(b) the base penalty assessment is to be reduced to reflect the additional deduction for legal expenses of $1,776.50 and remitted by $5,000.2.The decision under review in respect of KHMQ is affirmed.
..............................[SGD]..........................................
Senior Member R Olding
Catchwords
TAXATION – INCOME TAX – where applicants provided agistment for stock owned by their related company – whether agistment activities constituted carrying on a business – consideration of indicia of a business – whether legal expenses related to claim against former employer deductible – whether legal expenses related to claim for future economic loss capital in nature – whether legal expenses related to claim for future expenses and past special damages of a private or domestic nature – whether amount of legal expenses related to past economic loss and interest on past economic loss proven – decision set aside and remitted for reconsideration with direction that legal expenses relating to past economic loss and interest on past economic loss are allowable deductions
TAXATION – ADMINISTRATIVE PENALTIES – whether shortfall due to recklessness or lack of reasonable care – whether penalty should be wholly or partly remitted – decision set aside and remitted for reconsideration
Legislation
Income Tax Assessment Act 1997 (Cth), s 8-1(1)
Taxation Administration Act 1953 (Cth), s 14ZZK; Schedule 1, ss 284-75(5), 284-90(1).Cases
Allied Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation (1983) 44 ALR 607
Anglo American Investments Pty Ltd (Trustee) v Commissioner of Taxation [2022] FCA 971
Commissioner of Taxation v Complete Success Solutions Pty Ltd ATF Complete Success Solutions Trust [2023] FCAFC 19
Federal Commissioner of Taxation v Cassaniti[2018] FCAFC 212.
Imperial Bottleshops Pty Ltd v Commissioner of Taxation [1991] FCA 276; (1991) 22 ATR 148Martin v Commissioner of Taxation (1952) 90 CLR 470
Melbourne Corporation of Australia Pty Ltd v Commissioner of Taxation [2022] FCA 972
Sanctuary Lakes Pty Ltd v Federal Commissioner of Taxation [2013] FCAFC 50; (2013) 212 FCR 483
WT94/60-63 and Commissioner of Taxation [1995] AATA 582REASONS FOR DECISION
Senior Member R Olding
28 March 2023
These are proceedings for the determination of applications for review of decisions of the respondent Commissioner disallowing in full objections to income tax assessments issued to:
(a)DQTB – an amended income tax assessment for the income year ended 30 June 2017 and a related assessment of an administrative penalty at the rate of 50% of the alleged shortfall; and
(b)KHMQ (DQTB’s partner) – an amended income tax assessment for the income year ended 30 June 2017.
The income tax assessments raise common issues concerning whether DQTB and KHMQ are entitled to certain deductions for expenses said to be associated with agistment activities on a property in Tasmania acquired jointly by DQTB and KHMQ during the 2017 income year. Although there are separate applications for review, because of these common issues the reviews were joined to enable them to be resolved in the same proceeding.
The applicants claim they are entitled to various deductions on the basis that they were carrying on a business of providing agistment and full care animal husbandry and veterinary services to a company they owned. The Commissioner says the applicants have not proved they were carrying on a business and assessed the applicants in each case on the footing that the deductions allowable are limited to the amount of the agistment income of $10,000 derived by each applicant in the 2017 income year.
Additionally, in respect of DQTB’s assessment, there is an issue concerning the extent to which DQTB is entitled to a deduction for legal expenses incurred in connection with proceedings against her former employer. As noted, there is also a penalty assessment against DQTB but not KHMQ.
BURDEN OF PROOF
The applicants have the burden of proving the assessments are excessive and what amounts should have been assessed.[1]
[1] Taxation Administration Act 1953 (Cth), s 14ZZK.
In considering whether the applicants have discharged that burden, the principles to be applied include:
(a)Facts may be found on the basis of oral evidence alone.
(b)In other words, there is no requirement that direct evidence by oral testimony may only be accepted if corroborated, for example, by documentary evidence; a fact may be found on basis of the uncorroborated evidence of a witness.
(c)However, self-serving statements should be given close scrutiny.
(d)Nevertheless, evidence of a taxpayer is not to be regarded as prima facie unacceptable.[2]
(e)If the taxpayer succeeds in ‘weighing down [the] scales ever so slightly in [the taxpayer’s] favour then [the taxpayer] has discharged the burden [the taxpayer] carries’.[3]
[2] For this and the preceding propositions, see, for example: Imperial Bottleshops Pty Ltd v Commissioner of Taxation [1991] FCA 276; (1991) 22 ATR 148, 155; and Federal Commissioner of Taxation v Cassaniti[2018] FCAFC 212.
[3] Federal Commissioner of Taxation v Cassaniti[2018] FCAFC 212, [88]; Allied Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation (1983) 44 ALR 607, 612.
I am also mindful of recent observations of Logan J that, in relation to small business, it is unremarkable that great informality can and often does attend the formation of legal relations. As his Honour went on to note:
Even more is this so where the relevant corporate actors are or are represented by the same individual acting in different capacities or by individuals who are close family members or business associates. Sometimes the only documentary manifestation of that legal relationship may be a transaction recorded in a ledger or perhaps just an annually prepared profit and loss account and accompanying annotations. There may then, in a taxation appeal, be related oral evidence of the individual(s) concerned that the transaction was as recorded . . .[4]
[4] Anglo American Investments Pty Ltd (Trustee) v Commissioner of Taxation [2022] FCA 971, [54].
That is not to say there is any special or lesser standard of proof for a small business. Where informality is present, “much can depend on the credibility one affords the accounts given by participants and, where they exist, representations in business records created under their supervision or with their approval”.[5]
BACKGROUND[6]
[5] Melbourne Corporation of Australia Pty Ltd v Commissioner of Taxation [2022] FCA 972, [47].
[6] This summary is based on witness statements filed on behalf of the applicants.
The applicants’ former employment and health issues
Both applicants were formerly employed by the same organisation. DQTB’s position was made redundant in November 2016. The details in respect of the cessation of KHMQ’s employment are not altogether clear. KHMQ referred to the effects of a “workplace injury” and events commencing before and during 2013 while he was still employed, and to a depressive disorder, panic and anxiety disorders and PTSD. By October 2015, Comcare had accepted that KHMQ was permanently impaired with no prospects of recovery.
DQTB holds high-level tertiary qualifications in veterinary science. She has published extensively in scientific journals, and had a particular focus on, in broad terms, sheep and their reproduction.
DQTB is also diagnosed with a major depressive disorder and has been in the care of a psychiatrist who suggested returning to activities relating to her scientific background could be therapeutic and form part of long-term rehabilitation goals. Following that advice, DQTB and KHMQ considered the idea of running a sheep farm. In view of his condition, KHMQ also saw this as his best and last opportunity to make a financial contribution to his life with DQTB.
Obtaining financial advice and setting up the company
It was against this background that in 2016 DQTB and KHMQ sought advice from a financial adviser. The adviser gave evidence, which I accept, that at the time he was consulted the applicants were looking to relocate to Tasmania. They had in mind to operate a business but at that time had not selected a property and exactly what type of business was “up in the air”; they had not settled on a particular idea.
The applicants sought advice regarding business structures. After the Tasmanian property had been acquired, the adviser assisted the applicants in setting up the company which was incorporated on 10 May 2017. The company is owned by the applicants. DQTB is the secretary and KHMQ is the sole director.
One of the purposes of setting up the company was, the adviser said, for the company to “run the farming business and hold any intellectual property and to provide some asset protection against any liability they as individuals might encounter”.
In his witness statement, the adviser continued:
We had also discussed the ability for the business to effectively lease the property as the property was in individual names, and the income would need to be declared in their personal income, and any expenses associated with the commercial lease would also be in their personal names as the ownership was already set up that way. The business would thus run the rest of the farm.
The acquisition and improvement of the property
The applicants acquired the Tasmanian property in 2017 for $450,000, with settlement occurring on 20 February 2017. The applicants also acquired from the vendors chattels at a price of $30,000, including a tractor with various attachments and two generators.
The property comprises 75.42 hectares (186.37 acres) and includes a dwelling and sheds. The sale listing description included:
Approximately 140 acres of grassed and 50 acres of light bush land which is level to undulating with a restored character home. Eleven paddocks, numerous spring filled dams of which there are 8, and 3 waterholes with a winter creek. Strong steel stock yards and several usable outbuildings including a barn/machinery shed.
According to a 2017 rates notice, the capital value of the property including improvements at 1 July 2015 was $190,000, with a land value of $130,000.
After completing the purchase, the applicants engaged contractors to construct approximately four kilometres of fencing at a cost of $42,720. This work was completed in the 2017 income year. Several large dams and large water tanks were also added in the 2017 income year.
In the 2017/18 year, the applicants incurred $74,728.99 for internal fencing and repair work. This included approximately three kilometres of internal fencing, including construction of a laneway to facilitate movement of stock and subdividing paddocks at the northern end of the property into smaller paddocks.
ARE ENTITLED TO THE DEDUCTIONS RELATING TO THE AGISTMENT ACTIVITIES?
The applicants’ entitlement to the deductions claimed is primarily governed by the general deductions provision contained in section 8-1 of the Income Tax Assessment Act 1997 (“ITAA 1997”), which relevantly provides:
(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 necessary incurred in carrying on a business for the purpose of gaining or producing your assessable income.
Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other 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
(b)it is a loss or outgoing of a private or domestic nature . . .
The Commissioner does not take issue with the agistment income of $10,000 or other income each applicant returned but has not otherwise confined the issues in dispute. Both parties conducted the matter on the basis that whether the applicants are entitled to the claimed deductions relating to the agistment activities would turn upon whether the applicants were relevantly carrying on a business.[7]
[7] Income Tax Assessment Act 1997 (Cth), s 8-1(1)(b).
Therefore, the issue to be decided by the Tribunal in relation to the agistment activities is: Have DQTB and KHMQ discharged the burden of proving they carried on a business?
Before turning to consider that issue, it may be helpful to set out some preliminary observations about the agistment activities.
Preliminary observations about the agistment activities
The applicants say they decided a grazing business would be conducted on the property by their company which would agist stock on the property. An amount of $20,000 p.a. was agreed as the agistment fee payable by the company, as the entity to conduct the grazing business, to the applicants as the owners of the property.
I use the neutral expression “arrangements” in respect of the agistment deliberately. At the heart of the dispute is whether, in conducting those arrangements, the applicants were carrying on a business.
The applicants say they were. The Commissioner says the applicants’ activities on the property were in the nature of a hobby, reflecting in particular the professional background and interests of DQTB, and in any case that the applicants have not discharged the burden of proving they were carrying on a business.
In that regard, it is important to note that the question of whether the company was carrying on a business is not directly in issue. The question in issue is whether the applicants, in conducting the agistment arrangements, were carrying on a business.
However, the nature and extent of the company’s activities are not entirely irrelevant. The activities of the two “entities” – the alleged partnership comprising the applicants and the company – were intertwined. The applicants acknowledge that the potential for any agistment services business carried on by the applicants to thrive was dependent upon the success of the grazing business they said was to be carried on by the company. Although the applicants say they provided loan funding to the company to enable it to pay the agistment fees, it would only be if the company succeeded in breeding and selling stock that it would be able to afford to fund payment of the annual agistment fee over the longer term.
Mere agistment or agistment with animal husbandry and veterinary care services?
In WT94/60-63 and Commissioner of Taxation,[8] Senior Member Associate Professor Fayle drew a distinction between mere agistment and agistment with management and care of animals, stating:
Agisting another’s livestock does not ordinarily constitute the carrying on of a business. Agistment fees ordinarily are in the nature of rent. However, where a land owner is charged with the management, maintenance and care of the animals agisted then it is possible that the person is carrying on a business, the reward for which is the agistment fee. This is more likely if the level of the agistment fee depended on the effective management, maintenance and care of the animals. For example, if a land owner agreed with the owner of a herd of cattle to ensure their good health, proper veterinary care and husbandry of the progeny, marketing of their bodily produce and maintenance of the herd, then that land owner may be carrying on a business of primary production . . .[9]
[8] [1995] AATA 582.
[9] [1995] AATA 582, [29].
Ultimately, that reasoning in WT94/60-63 played little part in the Tribunal’s decision relating to the alleged primary production activities. The decision turned upon the absence of relevant evidence.
Nevertheless, the Commissioner submitted that in the current case there was insufficient evidence to prove the arrangements between the applicants and the company were such that the $20,000 agistment fee was in return for both making the land available for agistment and provision of animal husbandry services and veterinary care as the applicants maintained.
The Commissioner acknowledged, though, that there is no special rule relating to whether providing agistment arrangements constitutes carrying on a business. That is a question of fact to be decided by reference to all the relevant evidence and having regard to well-known indicia of a business referred to in numerous case authorities which include:
(a)the existence of a profit-making purpose;
(b)the scale of the activities;
(c)the commercial character, or otherwise, of transactions; and
(d)whether the activities are systematic and organised, often described as carried out in a business-like manner.
None of these factors are determinative, nor are they exhaustive. The determination is based on the overall, large or general impression gained from consideration of the relevant activities and intentions of those engaging in the activities.[10] Applying these principles, whether the agistment arrangements were merely for the provision of the land and basic supervision and care, or involved additional animal husbandry and veterinary care services, is not determinative of whether the applicants were carrying on a business but is a relevant consideration.
[10] Martin v Commissioner of Taxation (1952) 90 CLR 470.
The applicants’ case was that it was always intended such additional services would be provided and they point to evidence that they did in fact provide some animal husbandry and veterinary care.
The Commissioner says the applicants did not produce to the Commissioner’s officers during the audit and objection processes or to the Tribunal any documents indicating that the agistment fee covered such services until they filed an amended Statement of Facts, Issues and Contentions and further witness statements in August 2022. The inference I am implicitly invited to draw is that the agistment fee was never intended to cover animal husbandry and veterinary care services, the applicants’ assertions to that effect being a late invention.
This issue is clouded by several controversies.
The agistment “contract” or “note”
As the end of the 2017 tax year approached, KHMQ prepared what, until the final day of the hearing, had been referred to as an agistment “contract”. On its face, that document appeared to have been signed by KHMQ both as director of the company and on behalf of the property owners. The document provided:
(a)for payment of an agistment fee of $20,000 p.a.;
(b)that there would be no apportioning or pro rating of the annual fee for part years – which is relevant to the 2017 income year, as discussed below; and
(c)for the provision of stock-proof fencing.
Notably, it was not signed by KHMQ’s co-owner, DQTB. Indeed, although KHMQ said he discussed the amount of the fee with her, after satisfying himself that it was affordable for the company, DQTB said she was not aware of the document until she came across it when preparing to respond to the Commissioner’s audit. Also notably, the document made no reference to animal husbandry and veterinary care services.
In the applicants’ evidence and written submissions, it was said that this document partially recorded the terms of an agreement between the applicants and the company. Somewhat surprisingly, in the course of closing submissions on the third and final day of the hearing, Mr Allan, who appeared for the applicants, submitted that as a matter of law the document, although until then referred to by the applicants as such, was not a contract at all. Mr Allan cited authorities relevant to the position of joint tenants to support a submission that the document did not create a contract because it was not signed by, and therefore could not bind, both co-tenants. Additionally, Mr Allan produced a document referencing evidence given by the applicants which was said to evidence the terms of an oral agreement between the applicants and the company which included provision for animal husbandry and veterinary care services.
It is not immediately clear to me that the authorities cited directly support Mr Allan’s proposition. But even if that is so, and the document is not a contract, it is nevertheless a contemporaneous document prepared and signed by KHMQ. As such, it is evidence relevant to what KHMQ considered to be the terms of the agreement between the applicants and the company.
Statements made during a mediation
When it was put to KHMQ in cross-examination that he had not raised the matter of animal husbandry and veterinary care services before the revised documents were filed on behalf of the applicant in August 2022, he disputed this. KHMQ said it had been discussed at length with the Commissioner’s officers in an earlier mediation. Because of the confidential nature of mediations, I told KHMQ I did not want to hear what was said in the mediation.
In closing submissions, Mr Allan submitted that, although statements in mediations are generally on a without prejudice basis, the privilege afforded to such statements is not absolute and cannot be asserted to allow the Tribunal to be misled. In my view there are some difficulties with accepting that I should take into account KHMQ’s evidence regarding what was said in the mediation.
One is that such a step should not be taken lightly as it may tend to undermine the efficacy of mediations if discussions thought to be confidential are later allowed to be ventilated in Tribunal proceedings.
Another is that the applicants have had ample time to raise this issue. It has been clear for some time that the Commissioner’s case would include that inclusion of animal husbandry and veterinary care services was a late invention. As a matter of procedural fairness to the Commissioner, the applicants should not be permitted to raise this issue for the first time in oral testimony. That is especially so when the Commissioner would for all practical purposes be unable to test the testimony relating to what occurred during the mediation and whose counsel could not be expected to have come prepared for otherwise without prejudice communications to be before the Tribunal.
Further, the probative value of such evidence is doubtful. As Ms Bishop clarified it, her question related to whether animal husbandry and veterinary care services were first mentioned in documents filed in the Tribunal in August 2022. Further, the Commissioner’s submission is not that such services were not provided – although the Commissioner did refer to the minimal evidence regarding the extent of veterinary services provided - but that there is insufficient evidence that animal husbandry and veterinary services were intended to be provided in return for the agistment fee.
Accordingly, I have not taken into account KHMQ’s statement under cross-examination regarding what he says occurred during the mediation. Ultimately, little may turn on this as there is other evidence, which I accept, that the applicants did actually provide some animal husbandry and veterinary care services for the calves and lambs on the property. By not taking into account KHMQ’s statement about what was said at the mediation, the Tribunal has not been misled into a contrary conclusion. The evidence would not have taken the question of whether such services were intended to be covered by the agistment any further. Nor would it have met the Commissioner’s submission that assertions to that effect were not made in documents filed in the Tribunal before August 2022.
Other references relevant to the intended nature of the arrangements
In the published reasons for judgement of the court in the proceeding brought by DQTB against her former employer, the court stated that DQTB had agreed the company “had been established and was used primarily to agist livestock to create a negatively geared situation for the property”.
Under cross-examination, DQTB asserted that the paragraph in which that comment appears contains inaccuracies, pointing to an error regarding the date on which the company was said to have been established. She asserted that what appears in the paragraph cited is not an accurate characterisation of what had occurred.
Again, I consider that little turns on this. It is self-evident that, if the applicants were entitled to the deductions claimed, their borrowing and other costs would exceed by a very considerable margin their agistment income at least in the short term.
The amount of the agistment fee ($20,000 p.a.)
As noted, the amount of the agistment fee is $20,000 p.a. without, according to the contract/note, any pro-rating for part years. This means that, although the agistment only occurred for a few months of the 2017 income year, the full amount of $20,000 was charged to the company by the applicants for that period.
Mr John Tuskin, who has 35 years’ experience in the agricultural service industry, gave evidence to the effect that a fee of $20,000 p.a. was within a commercial range for agistment of the scale to be provided at the property. It became apparent during cross-examination that Mr Tuskin had not appreciated the $20,000 fee was not pro-rated for 2017, with the full amount being charged for a few months of agistment. However, that does not detract from Mr Tuskin’s evidence, which I accept, that an annual fee of $20,000 was not an uncommercial amount to charge for agistment on the property.
The applicants had acknowledged in their revised materials filed in August 2022 that this absence of pro-rating – charging the full $20,000 for a few months - meant the agistment fee for this short period was “excessive”. Mr Allan explained that this meant the applicants accepted that it was, for 2017, an uncommercial amount for the agistment and services said have been provided.
There is no suggestion that the applicants’ assessable income from agistment activities should be reduced to a pro-rated amount for the 2017 income year. The full amount was received by the applicants – or taken to be, about which see further below – and continued to be regarded by both parties as part of the applicants’ income. I adopt this approach.
KHMQ gave evidence, which I accept, that he came up with the $20,000 amount by projecting on a conservative basis the number of calves and lambs the property could produce annually, and the prices for such stock that could be obtained. In so doing, he satisfied himself that the $20,000 annual fee would be “affordable” for the company.
In his witness statement, KHMQ set out a different calculation which included a 30% uplift to allow for animal husbandry and veterinary care services. However, it was clarified that this calculation does not purport to reflect considerations by the applicants at the time the agistment rate was set. Rather, it is a calculation KHMQ undertook in preparing for these proceedings to demonstrate, as he saw it, the reasonableness of the agistment fee in the context of the additional services being provided by the applicants.
Conclusion regarding applicants providing animal husbandry and veterinary care services
I accept the applicants in fact provided care services for the stock, especially the calves and lambs, on the property. The extent to which such services were provided is not detailed comprehensively in the evidence. There is only one example of services of a veterinary nature being provided. However, DQTB gave evidence, which I accept, that poddy calves required twice-daily hand feeding.
There is, however, an absence of persuasive evidence that the applicants had agreed to provide any particular level of care in return for the agistment fee. The applicants say they provided “full animal husbandry and veterinary care” but that was not asserted in those terms during the course of the audit or the objection, or in any materials filed in the Tribunal until the applicants abandoned their earlier witness statements and Statements of Facts Issues and Contentions and filed revised materials in August 2022. Those services were not mentioned in the contract/note prepared and signed by KHMQ during the 2017 income year. Nor were they reflected in the way KHMQ calculated the annual agistment fee of $20,000.
Further, it emerged in cross examination that, notwithstanding the description in the applicants’ materials of the services provided as “full service welfare and veterinary care to the Company’s livestock”, there were veterinary services that DQTB, not being a licensed veterinarian, could not provide. There were, for example, invoices in evidence for services provided to the company by a local veterinarian, including dehorning vaccinations and a faecal float. Although KHMQ sought to draw a distinction between veterinary services and veterinary “care”, the assertion in the applicants’ materials strikes me as misleading. That the external veterinary services were provided to the company, rather than the applicants, is also inconsistent with a conclusion the applicants provided “full service” husbandry and veterinary care service. At least some required veterinary care was not provided by the applicants either directly or by the applicants engaging a veterinarian.
Accordingly, I accept the applicants provided some care to the stock on the property, but I do not accept that they undertook to provide the company with the full range of veterinary care required. So far as the evidence establishes, this is somewhat different to the distinction drawn in the observations in case WT94/60-63 set out above between mere agistment and the circumstance in which “an owner agreed with the owner of a herd of cattle to ensure their good health, proper veterinary care and husbandry of the progeny, marketing their bodily produce and maintenance of the herd”.
I am left with an impression the applicants did not merely make the property available to the company for agistment of stock. They also provided some care to animals. But the evidence does not establish that they undertook to provide any particular level of care in return for the $20,000 fee or in particular that they undertook to provide full veterinary care.
In my view, on the spectrum of potential agistment arrangements, that does not place the arrangement in the full-service category of the type described in WT94/60-63, but nor is it mere agistment. The latter is, however, consistent with the applicants’ own description of the arrangements deriving “rent” in their tax returns; in communications during the audit; and with the absence of any references to services in the contract/note.
In any case, as already noted, this matter is not to be determined on the basis of some special rule for agistment activities. I therefore turn to consider the evidence relating to whether the indicia of a business were present in relation to the applicants’ activities. In so doing, I respectfully recognise the reality emphasised by Logan J in the comments in the judgement extracted above that small businesses, especially in “internal” transactions between related parties, are commonly conducted in an informal way. Nevertheless, my task is to determine whether the applicants’ have discharged the burden of proving as a matter of fact that they carried on a business.
Profit-making purpose
There is evidence that KHMQ undertook research in relation to particular breeds and of DQTB, drawing upon her particular expertise, considering particular approaches which it could be argued would support a conclusion that the company had a profit-making purpose.
The same cannot be said of the applicants’ agistment activities. In determining the $20,000 annual fee, KHMQ undertook calculations to determine that the fee would be affordable by the company. There is no evidence of any calculations to determine whether the fee would generate a profit for the applicants after allowance for expenses. It never did so in 2017 or later years. In fact, there is no direct evidence in either of the applicants’ witness statements or their oral testimony that they expected the agistment activities to generate a profit or the basis on which they formed any such expectation.
In the course of the hearing, I raised with Mr Allan that I was having difficulty in determining from the evidence whether, after allowance for expenses, the $20,000 annual fee would be capable of generating a profit for the applicants. Mr Allan freely acknowledged that there was no evidence which would allow a precise mathematical calculation to be made. Of course, that is not essential to reach a conclusion that the applicants had a profit-making purpose. Nevertheless, if there were evidence from the applicants that they had a profit-making purpose for the agistment activities it would be appropriate to test such assertions against other evidence.
Mr Allan pointed to evidence that the applicants intended to improve the carrying capacity of the property. That in turn may have allowed the company’s profitability to improve. Mr Allan invited me to draw an inference that, with its capacity increased, the company would be able to pay a higher per-head based agistment fee. A statement to this effect was included in DQTB’s witness statement which was also adopted by KHMQ.
The applicants say they were unable to continue with plans to increase the capacity of the property because their funds were depleted by DQTB incurring legal fees in excess of $400,000 in pursuing her unsuccessful action against her former employer and the costs of responding to the tax audit. I accept that before those events the applicants had plans to increase the carrying capacity of the property which they hoped would increase the profitability of the company.
However, even if an inference that the agistment fee would increase could be drawn, that is only one side of the picture. Increased stock numbers under the type of full care arrangement the applicants assert was in place would, one presumes, also mean increased costs for the applicants. I have no evidence on which to make even a rough assessment of whether the claimed profit-making purpose was credible.
Mr Allan produced a schedule based on the actual expenses for the 2017 income year, which purported to separate expenses into capital and non-capital expenses. Although of some assistance, it is not appropriate to exclude capital expenditure altogether. Depreciation of capital assets is a cost of doing business. Further, it is not clear that all of the costs Mr Allan allocated to the non-recurring category were in fact of that nature; many were, for example, payments to fuel suppliers such as BP.
In the absence of detailed direct evidence from the applicants; any sound basis on which I could draw relevant inferences; and any profit ever emerging, I find it difficult to reach any degree of satisfaction that the applicants actually turned their mind to the question of profitability of the agistment arrangements. That being so, I am unable to determine that they had a profit-making purpose for the agistment arrangements.
Given the earlier advice obtained, I am left with the impression the applicants understood an agistment fee would be required if they were to be able to deduct claimed business expenses, but that they did not turn their minds to the question of whether the agistment arrangements – as opposed to the farming business conducted by the company - would be profitable. That is consistent with DQTB’s statement, recorded in the judgement in the employment proceeding, that they aimed to achieve a negatively geared position. It is not necessary to decide whether that is so to determine whether the applicants had a profit-making purpose. It is sufficient to note that, for the reasons I have outlined, I am not persuaded the evidence is sufficient to establish such a purpose for the agistment arrangements.
Scale of the agistment activities
The agistment activities were on a relatively small scale. There was only one client, the company, although the number of stock agisted ranged up to a maximum of around 80. The partners indicated they may have considered taking on external agistment clients in the future although it is not clear how that would have fitted with the needs of the company. The annual gross income was a mere $20,000 with no indication it would be likely to increase in the immediate future.
That is not, in itself, fatal to the applicants’ case. A business may be conducted on a small scale. It is but one factor relevant to forming an overall impression of the activities.
Commercial nature of the transactions
Based on the expert evidence that an annual $20,000 fee would be a commercial amount, I infer the $20,000 fee for a few months in the 2017 income year is in excess of commercial rates. The applicants themselves agree it is uncommercial. However, an ongoing fee of $20,000 which was apparently intended would be a commercial amount.
That the $20,000 fee for a few months of agistment in 2017 was accepted by both parties, and no-one apparently noticed that it was excessive until preparations for the hearing of this matter were well advanced, indicates the transaction was not conducted on a commercial basis. So, too, does the absence of a clear statement in a written record or otherwise of the level of services to be provided.
The arrangements for payment of the fee were also uncommercial. On the applicants’ evidence, confirmed by financial accounts they prepared, the applicants loaned the amount of $20,000 to the Company.
The loan was not documented and there are no agreed repayment terms. It was said to have been effected by a withdrawal of cash from the applicants’ bank account which was retained in a safe at the property and used by the applicants to pay for their expenses.
Overall, the evidence points to the agistment transaction being conducted in an uncommercial way.
Whether the agistment activities were systematic and organised/ carried out in a business-like manner
The applicants prepared financial statements and maintained records of care provided to the stock on the property. On the other hand, paying suppliers in cash drawn from a safe and not consistently obtaining receipts is not particularly business-like on the standards of contemporary business practices in Australia and having regard to well-known taxation requirements, even for a small business. The same may be said for the applicants lending money in cash to the company without any record of the loan other than in the financial statements, in particular without any agreed terms for repayment.
Overall, in the context of an alleged small business that would amount to no more than making land available to a related company and providing care services, I accept the applicants conducted activities to some extent in a business-like manner. However, there is no denying there was an exceptional degree of informality especially in respect of the loan and payment of the agistment fee.
The Commissioner, as commonly occurs in cases where the existence of a business is in issue, also drew attention to the absence of a formal business plan for the agistment activities. The applicants maintained they did have a business plan, involving staged improvement of the property to increase its carrying capacity, just not one reduced to writing. The Commissioner suggested this was not a plan but a mainly a recitation, after the events, of work the applicants had carried out or caused to be carried out.
In the context of an alleged small agricultural business, I would give little weight to the absence of a formal written business plan. There would be countless small businesses in Australia that do not have a written business plan. I accept the applicants had plans to progressively improve the property, as evidenced by the applicants’ witness statements and consistently with the works actually carried out in the 2017 and 2018 income years. Whether those plans were specifically identified as numbered stages and sub-stages as the applicants maintained is, in my view, of little moment in the context of this matter.
However, even accepting the applicants’ evidence of a plan, as already noted there is no evidence that any such plan addressed the most fundamental aspect of carrying on a business – how the activities would generate a profit or whether they were capable of doing so.
Expenses disproportionate to income?
For completeness, I note that the Commissioner’s approach of limiting the deductions to the extent of the $20,000 in agistment fees led to the applicants submitting that their expenses were not disproportionate to the income received.
In that regard, the Commissioner referenced Fletcher v Federal Commissioner of Taxation.[11] Fletcher’s case is not concerned with s 8-1(1)(b) but rather with the predecessor to s 8-1(1)(a). As already noted, the applicants’ submissions focussed upon whether the applicants were carrying on a business and thus entitled to deductions under s 8-1(1)(b).
[11] (1991) 173 CLR 1
Nevertheless, since the question of disproportion between expenses and income was the subject of submissions, I make the following observations.
I accept, as the applicants submitted, that Fletcher does not establish a principle that, whenever deductions claimed are highly disproportionate to the assessable income derived or likely to be derived, the deductions allowed must be limited to the extent of the assessable income. Rather, characterisation of the outgoings is required by reference to all of the relevant circumstances and the objects sought by the expenditure. To be clear, the Commissioner did not suggest otherwise.
In the current matter, as already noted, the applicants denied the deductions claimed were disproportionate to the agistment income. Applying the apportionment suggested by the applicants to remove the residential component, the $10,000 per applicant allowed by the Commissioner would more than cover the remaining proportion of the interest on the borrowing and the rates, but not the various other expenses claimed. The applicants referred in particular to the significant boundary fence expenses of $42,720 noting those expenses were required to prevent stock escaping and thus were required to enable the agistment fee to be earned. The applicants went on to submit that “[o]nce the fencing expenses are considered in their proper light, there is no relevant disproportion between the assessable income and the outgoings”.
There are some difficulties with that submission.
In the discussion above, I identified that there is no evidential foundation upon which any reasonable assessment could be made of whether the agistment activities could be expected to generate a profit. A similar difficulty arises in relation whether outgoings incurred or to be incurred are disproportionate to the income to be derived from the agistment activities in the income year under review and future income years.
The applicants’ representatives sought to meet this difficulty by filing, after the hearing, schedules listing expenditure on “All repairs and other items” claimed to be deductible in respect of the 2017 income year. The first schedule listed all expenditure said to be in this category, with the total amount claimed being $40,014.19. The items of expenditure are cross-referenced to invoices or other documents in evidence. The claimed percentage of business expenditure is noted against each item.
The second schedule separates out those items of expenditure said to be “recurring expenses/operating expenses”. Notations on this schedule purport to indicate the nature of the expenditure. Almost all of the items are notated as “Fuel, as needed”. The total claimed expenditure in this category is $2,541.48.
The third schedule lists approximately 90 items of what are said to be “non-recurring expenses/capital expenditure”. However, unlike the second schedule, there are no notations indicating the nature of the expenditure. There is a column headed “Type” but the entries in this column appear to be limited to the name of the various suppliers. The total of these claimed “not recurring deductions” is $37,473.09.
The apparent purpose of this delineation between recurring and non-recurring expenditure is to suggest that, once the non-recurring items are disregarded, the expenditure claimed is not disproportionate to the assessable income of $10,000 per applicant. There are several difficulties with that submission.
The first is that the schedules are not evidence. They are effectively submissions drawn together by the applicants’ representatives. There is no direct evidence as to which of the items of expenditure are recurring or non-recurring and why that is said to be so. There are no submissions or other explanations based on the evidence or otherwise of why those items said to be non-recurring are properly characterised as such.
Rather, it seems the Tribunal is left to examine the invoice or other document referenced in the schedules for the 90 odd items of expenditure; from that examination determine the expenditure was both incurred in producing the agistment fee and non-recurring in nature. In any case, it is not immediately clear why some of the categories of expenditure would necessarily be of a non-recurring nature. For example, various expenditure for purchases from fuel suppliers appear in the third schedule.
That is not a satisfactory foundation upon which the Tribunal could determine that the expenditure in the third schedule is of a one-off nature. In any case, it is not clear to me that disregarding non-recurring expenditure is appropriate in this context. The implicit submission seems to be that one-off expenditure should be removed to give a more realistic picture of the relationship of expenses to income. But who is to say there will not be other non-recurring expenditure in future years? Substantial capital expenditure was incurred, for instance, in the 2018 income year.
Further, comparison of the actual expenditure over a few months against the $20,000 agistment fee is itself potentially misleading. That fee is acknowledged to be uncommercial. A commercial fee for the few months in which the agistment activities took place in the 2017 year would amount to about a quarter of that amount.
For these reasons, the applicants have not provided evidence that persuades me the expenditure incurred is not disproportionate to the income derived or likely to be derived from agistment fees. More to the point, these submissions do not establish a basis on which a conclusion that the applicants had a profit-making intention could be reached.
Conclusion on whether the applicants were carrying on a business
There are indicators pointing in favour of and against a conclusion that the agistment arrangements constituted a business.
As noted, there is a degree of systematic, business-like behaviour. The scale of the alleged enterprise is small, but as already observed that is not fatal. In the context of this matter, I give little weight to this feature of the arrangements.
However, the absence of a satisfactory basis on which I could conclude the applicants had a profit-making purpose for the agistment arrangements tells against the arrangements constituting a business. So, too, does the uncommercial nature of the transactions as outlined above. Even giving full weight to the recognition that small business transactions between related persons are commonly attended by a high degree of informality, the arrangements with the company – involving no clearly recorded agreement on the services to be provided and terms for, or indeed any indication of an expectation of repayment of, the loan without which the transactions could not occur – are uncommercial and not business-like in nature.
In my view, the weight of the evidence points against a conclusion that the applicants were carrying on a business. I am not persuaded the applicants have discharged the burden of proving they were doing so.
DQTB’S LEGAL EXPENSES – ACTION RELATING TO PREVIOUS EMPLOYMENT
In her action against her former employer, DQTB claimed damages for losses arising under various heads of damage said to relate to “adverse action” taken by the employer against DQTB. The claim was ultimately litigated in a hearing in the Federal Court extending over a period of 19 days, with the outcome being that DQTB was wholly unsuccessful other than in respect of a minor award of damages of $1,000.
It is common ground that the character of the legal fees is to be determined by reference to the relief sought. In other words, that DQTB’s relative lack of success is not relevant to the characterisation of the expenses incurred in conducting the litigation.
DQTB’s relevant legal fees incurred in the 2017 income year were $9,924.60. The parties agree that DQTB is entitled to a percentage of those expenses based on the percentage represented by some of categories of the damages claimed but not others. Specifically, the Commissioner does not dispute that DQTB is entitled to a deduction calculated by reference to the proportions of the claim that were for past economic loss and interest on past economic loss.
However, the Commissioner maintained DQTB had not put forward sufficient evidence to justify the basis on which she claimed the expenses could be apportioned. I do not accept that submission.
DQTB’s witness statement annexed a schedule (annexure 23) which DQTB stated was prepared by lawyers acting for her in the action against her former employer. That schedule sets out amounts claimed as damages under various categories of alleged losses. Those amounts are largely replicated, apart from the addition of a further amount for past economic loss from the date of the trial to the date of the judgement, in a schedule verified by DQTB in the course of her oral evidence.
Accordingly, I accept past economic loss and interest on past economic loss amounted to 16.97% and 0.93% respectively of the total claim and that provides a reasonable basis for apportionment of the expenses claimed. A deduction should be allowed for the amount of $1776.50 calculated by reference to these percentages of the legal fees of $9,924.60.
On the same evidence, I accept the other categories of expenditure addressed below are apportioned on a reasonable basis.
The parties are in dispute regarding whether expenses relating to the following aspects of the claim are deductible:
(a)“future economic loss” – 53.39% of the damages claimed;
(b)“future expenses” – 3.74%;
(c)“past special damages” – 0.10%.
The Commissioner accepts that legal expenses referable to each of these categories of damages have the necessary nexus with DQTB’s former employment and therefore fall within s 8-1(1)(a) of the ITAA 1997. However, the Commissioner says the proportion(s) referable to:
(a)future economic loss - is disqualified by s 8-1(2)(a) because it is capital in nature; and
(b)future expenses and past special damages - are disqualified by s 8-1(2)(b) because they are private or domestic in nature.
The applicant cited various cases in support of the proposition that an amount paid to compensate for loss generally takes the character of that for which it is substituted. So, for example, a lump sum to compensate for lost wages would be regarded as on revenue account.
I accept that proposition. However, that does not assist DQTB in relation to whether deductibility of the expenses relating to the disputed categories of damages sought is disqualified by s 8-1(2).
The damages claimed under the first disputed category – future economic loss – would not have been in substitution for wages due. To the extent the legal expenses were incurred in seeking damages of that kind, they sought to obtain a lump sum of lasting value and were thus capital in nature. The damages claimed under the other categories – future expenses and past special damages – relate to personal expenses such as costs of medication.
Since no other basis on which the claimed additional proportions of the expenses would be deductible was put forward on behalf of DQTB, I am not satisfied DQTB has discharged the burden of proving the assessment is excessive so far as it relates to these matters.
ADMINISTRATIVE PENALTY
The Commissioner assessed DQTB for a base penalty of $15,403.95 calculated as 50% of the shortfall of $30,807.99 in her return on the basis of recklessness and declined to wholly or partly remit the base penalty.
The shortfall of $15,403.95 relates to three categories of expenses claimed by DQTB:
(a)So-called work-related expenses which appear to include expenses for dinners and wine for employees and contractors of DQTB’s former employer;
(b)Expenses relating to the agistment activities; and
(c)Legal expenses relating to DQTB’s claim against her former employer.
The base penalty should be proportionately adjusted to take account of the extent to which I have decided DQTB is entitled to a further deduction for legal expenses.
DQTB gave evidence that she prepared her return personally without any legal or taxation assistance and that she has limited skills and knowledge in relation to taxation. DQTB also pointed out that she had been under the care of a psychiatrist since July 2015 for various conditions and her mental health was aggravated by the stress of the litigation with her former employer. I accept this unchallenged evidence.
The evidence outlined provides some context for the circumstances in which DQTB prepared her return and is part of the factual matrix against which the question of remission may be considered. It does not, however, provide a basis on which I could be satisfied that DQTB exercised reasonable care or was not reckless in the preparation of her return. It provides no insight into the thought processes leading to the claiming of what were, in the context of the return as a whole, substantial deductions and which, if accepted as returned, would have had a material effect upon her overall taxation liability. Indeed, the evidence does not reveal to what extent, if any, DQTB turned her mind at all to the basis on which these substantial expenses could be said to be deductible.
I note that DQTB abandoned her claim for the so-called work-related expenses which included items that were plainly not deductible. To that extent, at least, there might be an inference available to support a positive finding that DQTB was reckless in her approach to claiming deductions.
However, it is not necessary for me to make any such positive finding. In the circumstances outlined above, there is no evidentiary basis on which it could be concluded that DQTB has discharged the burden of proving the assessment of the base penalty at 50% for recklessness is excessive. I therefore turn to consider whether the base penalty should be remitted in whole or in part.
In that regard, case authority establishes the discretion to remit is broad. Essentially, the question the Tribunal must answer is whether it is appropriate in all the circumstances to wholly or partly remit the penalty.
Without the benefit of recent judicial guidance, I might have taken the view that whether or to what extent DQTB had engaged with the requirements for deductibility of the various categories of expenditure claimed would be a factor the Tribunal must take into account to make a legally valid decision regarding whether it is appropriate to remit the base penalty. Without relevant evidence in this regard, it is difficult to determine the degree of recklessness involved which might be thought to be relevant to whether it is appropriate to remit penalty.
However, in Commissioner of Taxation v Complete Success Solutions Pty Ltd ATF Complete Success Solutions Trust,[12] the Full Federal Court unanimously stated:
The Tribunal stated that it had no evidentiary basis “to consider whether remission to any extent would be appropriate in the circumstances”: at T [180]. It emphasised that “there is no evidence that [CSS] through [its director] or its tax agents engaged at all with the statutory requirements for GST-free supplies of bullion”. The power in s 298‑20 of Sch 1 to the Taxation Administration Act 1953 (Cth) to remit a penalty is constrained only by the purposes and object for which the power is conferred: Sanctuary Lakes Pty Ltd v Federal Commissioner of Taxation [2013] FCAFC 50; (2013) 212 FCR 483 at 521 [193] (Greenwood J). In determining whether to remit a penalty, the Tribunal is not confined only to considering the circumstances surrounding the failure on the part of the taxpayer or its agent to exercise reasonable care or to not act recklessly in making the statement to the Commissioner that might explain the conduct the subject of the penalty. It is also relevant to consider what circumstances, on the evidence, ought to be taken into account in determining, as a matter of discretion, that, notwithstanding the imposition of a penalty on the taxpayer on the basis of a failure to take reasonable care or acting recklessly in making the statement, the penalty ought nevertheless be reduced either in whole or in part: Sanctuary Lakes at 524 [209] (Greenwood J).[13]
[12] [2023] FCAFC 19.
[13] [2023] FCAFC 19, [54(2)].
Those remarks suggest that, notwithstanding the absence of evidence concerning the basis on which DQTB decided to claim the deductions, I should nevertheless consider what other circumstances, on the evidence, ought to be taken into account to determine whether the penalty should be wholly or partly remitted. I proceed accordingly.
Although not supported by expert medical evidence, DQTB gave unchallenged evidence that she was suffering from serious mental health issues and the impact of the proceedings against her former employer. I accept that evidence and have taken it into account in determining whether any remission of penalty is appropriate. I have also taken into account her otherwise apparently good tax compliance record and co-operation in the course of the audit to which DQTB referred, without challenge, in her witness statement.
So far as the shortfall relates to the legal expenses, I consider a penalty of 50% to be harsh. This is a rather technical area and taking into account DQTB’s personal circumstances, a mistaken view that the expenses were deductible as related to her employment is somewhat understandable. On the other hand, there is no evidence that DQTB undertook any inquiries to determine the proper tax treatment of these expenses. Weighing up all these circumstances, I consider that a penalty in the order of 10% of the shortfall so far as it relates to the legal expenses issue is appropriate.
The position in relation to the agistment expenses is more difficult. On the one hand, DQTB had obtained advice that, to a layperson, might have left her with the impression that, if the applicants were to establish a business on the property, expenses related to that business would deductible. However, taxpayers must live with the consequences of structures they create. It is the agistment activities, not the pastoral activities conducted by the company, that determines the deductions allowable to the applicants. The question of whether as a matter of fact a business is carried on is itself notoriously contested in the context of small-scale operations. However, very substantial deductions were claimed without, so far as the evidence reveals, inquiries being made or other steps taken by DQTB to satisfy herself as to the validity of these claims.
Doing my best to weigh these factors and taking into account DQTB’s personal circumstances, I consider a penalty in the order of 30% is appropriate so far as the shortfall relates to the agistment activities.
In relation to the other work-related expenses, I am not persuaded any remission is appropriate. As noted, these expenses included alcohol and other outlays that were plainly not deductible as inquiries would have readily established. There is no evidence that any such inquiries were made. Even having full regard to DQTB’s personal circumstances, it would be contrary to the object of the penalty regime to remit penalties for reckless deduction claims in that context.
Taking into account these considerations and the proportions of the shortfall relating to each of the categories of deductions, I consider it appropriate to remit the base penalty remaining, after adjustment for the further legal expenses allowed, by $5,000.
DISPOSITION OF APPLICATIONS FOR REVIEW
Rather than risk error in re-calculating the primary tax assessment for DQTB and consequent adjustment to the base penalty, I consider it is appropriate to remit the objection decision in respect of DQTB to the Commissioner for reconsideration in accordance with these reasons. The objection decision for KHMQ must be affirmed.
I certify that the preceding 135 (ONE HUNDRED AND THIRTY-FIVE) paragraphs are a true copy of the reasons for the decision herein of Senior Member R Olding
.........................[SGD]..........................................
Associate
Dated: 28 March 2023
Dates of hearing: 24-26 October 2022 Date final submissions received: 28 November 2022 Counsel for the Applicant: G Allan Solicitors for the Applicant: Walt Allan Counsel for the Respondent: E A Bishop SC Solicitors for the Respondent: ATO Litigation & Legal Services
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