Emmakell Pty Ltd in its capacity as trustee of W.K. Stevenson Family Trust v The Commissioner of Taxation

[1989] FCA 532

Re: EMMAKELL PTY. LTD. in its capacity as trustee of W.K. STEVENSON
FAMILY TRUST
And: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
No. VG39 of 1989
FED No. 532
Income Tax
89 ATC 4919
20 ATR 1197

COURT

IN THE FEDERAL COURT OF AUSTRALIA

VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
Sweeney J.(1)

CATCHWORDS

Income Tax - appeal from Administrative Appeals Tribunal - allowable deductions - whether payments by taxpayer were within either limb of sub-s.51(1) Income Tax Assessment Act, whether questions of law involved constitute the subject matter of the appeal and determine its scope.

Income Tax Assessment Act 1936 s.51(1)

Commissioner of Taxation v. Brixius (1987) 16 FCR 359

Lau v. Federal Commissioner of Taxation (1984) 6 FCR 202

Federal Commissioner of Taxation v. Finn (1961) 106 CLR 60

Statham v. Federal Commissioner of Taxation (1988) 89 ATC 4070

HEARING

MELBOURNE

#DATE 8:9:1989

Counsel for the applicant: Mr. N.H. Forsyth Q.C.

with Mr. J.W. de Wijn

Solicitors for the applicant: MacPherson and Kelley

Counsel for the respondent: Mr. G.A. Nettle

Solicitors for the respondent: Australian Government Solicitor

ORDER

The decision of the Administrative Appeals Tribunal dated 23 January 1989, insofar as it affirms the respondent's decision to disallow as deductions in determining the applicant's taxable income the "lease" payments of $12,000 in respect of the 1983 year and $11,700 in respect of the 1984, year be set aside.

The matter be remitted to the Administrative Appeals Tribunal, constituted differently from the way in which it was on 23 January 1989, to be heard and determined according to law.

The taxpayer's costs of the appeal to the Court be paid by the Commissioner.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

JUDGE1

Emmakell Pty. Ltd. ("Emmakell") in its capacity as trustee of the W.K. Stevenson Family Trust ("the Trust") appeals from the decision of the Taxation Appeals Division of the Administrative Appeals Tribunal, constituted by Deputy President Dr. P. Gerber, given on 23 January 1989 at Melbourne, in which the Tribunal affirmed the decision of the Commissioner of Taxation disallowing Emmakell's objections under s.185 of the Income Tax Assessment Act ("the Act") against assessments of income allegedly derived by it during the years of income ended 30 June 1983 and 1984 ("the years of income") which were issued by notices dated 9 July 1984 and 8 March 1985.

1. In 1983 and 1984 Emmakell on behalf of the Trust made a number of payments to Austral Estates Limited ("Austral") purporting to be "lease payments" for portion of a property known as "Daalkoo" in northern New South Wales. The major part of Daalkoo was to be used for planting eucalypt trees in order to produce an oil said to possess germicidal qualities. "Lease payments" for three acres in 1983 and for six acres in 1984 were claimed as allowable deductions in the returns for each of the years of income. The Commissioner disallowed these claims on the grounds, amongst others, that the amounts so claimed were losses or outgoings of a capital nature and that the taxpayer was not, during the years of income carrying on a business of primary production.

2. In its reasons for decision the Tribunal referred to what it described as the "undoubted fact" that at no relevant time did Austral have "any title - legal or equitable - over the land which would enable it to grant enforceable leases to the taxpayer," adding that "for good measure, to the extent that the lessor (Austral) purported to grant a lease, no attempt was made to identify the land. In addition, it was not clear just when the agreements for the 1983 leases were executed, nor was it established to my satisfaction that any of the six acres involved in this application - to the extent that an attempt was made to identify them - were the subject of any activity which, would qualify as primary production at any relevant time".

3. The Tribunal then set out the history of the development of the project to propagate "melaleuca alterifolia known as Tea-Tree" on approximately 3500 acres of the 4279 acre property and reviewed the evidence relating to the development, before finding as follows:
   

"10. On the whole of the evidence, I am satisfied that no activity of any kind took place on Daalkoo up to 30 June 1983, and whilst Perry (the Plantation Manager) may have investigated the feasibility and logistics of tea tree propagation in the neighbourhood towards the dying days of the 1983 financial year, this is a far cry from Austral being engaged in a business of primary production; a company is not so engaged 'of whom no more can be said than that it intends to engage (therein)', per Barwick CJ Southern Estates v. FC of T

(1966-1967) 117 CLR 481 at 488. Brochures and looking around the neighbourhood do not a primary producer make.

11. It follows that to the extent that lease payments were made in the 1983 tax year, they come at a point too soon to be properly regarded as expenditures incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business.

12. Having concluded that no activity of primary production was carried on by Austral in the 1983 tax year, the taxpayer cannot succeed in that year.".

1. The Tribunal, in the course of reviewing the evidence relating to the 1984 year of income, said that the Commissioner sent an investigator to look over Daalkoo on 8 and 9 October 1984, who took a number of photographs including one of part of a 100 acre lot planted with tea-tree, which he said was "identified by a wooden marker peg stuck in the soil with the sign 'G4'".

2. In the words of the Tribunal, this peg satisfied the investigator that the "investor had an identifiable lot, because G4 would have been a certain investor's lot". However, the Tribunal added in paragraph 13:
   

"I am not prepared to make any such an assumption for reasons which will appear shortly. It seems from this witness' evidence - although this was not explored in any detail by either counsel - that there appeared to be only one 100 acre lot which was then under cultivation, which does not, semble, include any of the acreage claimed to have been leased to the trust in the two years now before me, assuming that these were identifiable in any legal sense. In the view I have formed of the evidence, this feature is merely one of the many nails in this taxpayer's coffin.".

1. The Tribunal was satisfied that the activities of Austral in the 1984 year of income had reached a level of activity which justified being characterised as a business, adding, in paragraph 14:
   

"However, Austral is not the taxpayer and it must still be shown

(i) that the Trust had a lease over its six acres, and

(ii)that its land was being used for primary production.".

1. The Tribunal found, in paragraph 17, that there had been "a total failure to identify any of the six acres involved in the two years now under review," which was in itself "sufficient to render the leases unenforceable, affording the lessor no greater right than to approach the Supreme Court of New South Wales to obtain a legal interest in the land. This is not an 'interest' sufficient to characterise the payments as lease payments incurred in gaining or producing the trust's assessable income at any time relevant to this application".

2. The Tribunal then turned to consider a submission by counsel for the taxpayer that it could succeed by reference to a management agreement entered into by Austral and the taxpayer on 26 September 1983, the same day as that on which the second lot of lease agreements were executed. In paragraph 19 it set out the relevant terms of the management agreement as follows:
   

"'WHEREAS:

A. The Lessee is the Lessee of certain of the lands set forth in the schedule hereto. B. The Lessee is desirous of establishing a plantation of Melaleuca alternifolia commonly called "tea tree" on three (3) acres of land within the said lands which lands together with all other hereinafter be called "the plantation" and which the manager has identified and shall identify as most suitable for the purpose.

C. It is intended that the Manager will establish operate and manage a tea-tree plantation on the plantation for the production of Melaleuca Oil and provide the services hereinafter referred to on the terms and conditions hereinafter contained.

NOW IT IS HEREBY AGREED AND DECLARED: I. The Manager agrees to establish operate and manage the plantation on the terms and conditions hereinafter set forth for a period commencing on the date of this Agreement and expiring on the 1st day of July, 1998. II. The Manager shall:

(a) ...

(b) ...

(c) ...

(d) Acquire and have planted out Melaleuca alternifolia of a suitable quality sufficient to establish the plantation and in any event by planting approximately fourteen thousand

(14,000) tea-trees to the acre.

(e) ...

(f) Promote in a proper and husband like way the health safety and development of the tea-trees.

...

(k) Harvest the crop as required throughout the term of this agreement.

III. The Lessee shall agree to the reimbursement from oil proceeds to Manager of all direct costs, without any margin of profit for the first five years of this agreement and thereafter at a margin of profit equal to fifteen per cent (15%) of such costs relating to harvesting of the trees, distillation of the oil, packaging of bulk oil and delivery to the stated delivery place but not in any circumstances exceeding twenty per cent (20%) of the gross oil proceeds payable to the Lessee in respect of a particular harvest. V. The Manager shall not be obliged, in the harvesting of the crop, to keep separate and distinct the exact quantity referable to any particular area of land; but may aggregate the produce of the plantation with that of other land in the vicinity which is also managed by the Manager where to do so is in the opinion of the Manager necessary for the economical harvesting of the crop and is not prejudicial to the Lessee.

XIV. This Agreement shall not be construed as constituting the Lessee and the Manager as partners with each other nor as constituting any relationship other than that of independent contractors, with the Manager providing services for the Lessee in accordance with the terms hereof. Either party may assign its interests under this Agreement provided that in case of any assignment by the Manager such assignee shall be demonstrably capable of fulfilling the Manager's functions hereunder.'".

1. The Tribunal then concluded its reasons as follows:
   

"21. The first thing to observe is that the title description of the land referred to in lease agreement differs from the title description where it appears in the management agreement (Portions 31 are excluded from the latter). Be that as it may, it seems to me that deduction claimed as 'lease payments' cannot be salvaged by recourse to contractual rights said to emerge in a management agreement not incorporated into the lease or forming part of it. Furthermore, the provision in paragraph V, which entitles the manager to aggregate the crop 'with that of other land in the vicinity', makes it clear that, at its highest, the trust was merely a party to a profit-making scheme conducted by Austral qua manager. If the unenforceable lease is put to one side, what emerges is that the trust made a series of payments to Austral for the right to participate in the future profits to be derived from a tea tree growing venture, its entitlement to the profits being the numerator of a fraction, the denominator of which is the contribution of all the investors. The payment is thus no different in kind from, say, buying a share in an adventure to salvage the Titanic.

22. The applicant having put all its 'eggs' in the basket of lease payments, I am satisfied on the evidence that these payments do not qualify under this head. The applicant has thus not proved the case it sought to make out, nor has demonstrated any other basis which would entitle it to the claimed deductions. It therefore fails on the onus of proof. No argument was advanced by the respondent that the payments to Austral were a capital expense and disqualified from deduction on that ground. No concluded opinion on this aspect is therefore required.

23. For the sake of completeness, I find that no assessable income was derived by the trust from this tree growing venture and, to the extent that some nominal amount (either $207 or $309) was returned as 'INCOME - TEA TREE' in 1984, this was conceded to have been a mere device by Austral to lend greater verisimilitude to its activities of primary production. Again, an amount of $5,514, claimed as an expense 'INTEREST ON LOAN TO LEASE TEA TREE - INTEREST ONLY' was conceded at the hearing to have involved a loan wholly unconnected with the tea tree venture. No evidence was led which would enable me to permit this deduction; indeed Mr de Wijn" (for the taxpayer) "virtually conceded as much.

24. I feel bound to add that this trustee did all that could reasonably be expected of a prudent trustee determined to ensure that the proposed investment was commercially sound; he obtained legal advice and himself looked into the viability of the venture, even to the point of visiting the property. He is not the first to have become a victim of Mr Knight's proverbial charm, nor the first to have lost his investment." (Mr Knight had earlier been described as the principal promoter of the tea-tree venture).

"25. I have set out the facts of this case with greater particularity than is customary since I was informed from the bar table that this case was in the nature of a 'test' case. It is therefore possible that there may be other taxpayers, having different leases, who may be able to distinguish their facts from those of this unfortunate taxpayer.

26. For the above reasons, the Tribunal will affirm the objection decisions in the two years under review.".

1. The reference before the Tribunal proceeded simply as a claim for a deduction under s.51 of the Act. Contentions based on sham and the application of the anti-avoidance provisions in Part IV A and ss.82 KH to KL were abandoned by the Commissioner.

2. In Commissioner of Taxation v. Brixius (1987) 16 FCR 359, a Full Court of this court held that, in a case such as the present, the existence of a question of law is not merely a qualifying condition to ground an appeal but is the sole subject matter of the appeal, the scope of which is confined to the question of law.

3. The "questions of law" referred to in the Notice of Appeal as originally drawn appeared, at least to some extent, to amount to thinly veiled invitations to review the Tribunal's findings of fact. Counsel for the taxpayer, by leave, filed in Court on the second day of the hearing the following formulation of the questions of law upon which they sought to rely:-
   

"1. Whether the Tribunal erred in failing to consider whether the deductions claimed were deductible under the first limb of sub-section 51(1). (See paras. 10-12, 14.)

2. Whether the Tribunal erred in failing to consider whether the payments were deductible, irrespective of whether they were properly described as 'lease payments' (see paras. 15, 18).

3. Whether the Tribunal erred in concluding that the deductions claimed in the 1984 year were deductible only if:

(a) the Applicant had a lease over its 6 acres (para. 14);

(b) identifiable land of the Applicant was being used for primary production in the 1984 year (para. 14); and

(c) the acreages were identified in the 'leases' or at the time the leases were executed (para. 17).

4. Whether the Tribunal erred in finding that:

(a) the deductions claimed could not be allowed by recourse to rights under a management agreement which was not incorporated in the lease and did not form part of it (para. 21);

(b) the payment was no different in kind from buying a share in an adventure to salvage the Titanic (para. 21).

5. (a) Whether the Tribunal did hold that the payment was of capital, or of a capital nature (see the last two sentences in paragraph 22).

(b) If so, whether the Tribunal erred in law in so concluding from the facts as found and whether there was any evidence reasonably capable of supporting such a conclusion.

(c) If the Tribunal held that the payment was of capital, or of a capital nature, whether it erred in law in failing to consider that:

(i) the payments in question were annual and recurrent;

(ii) the taxpayer acquired no enduring asset or benefit;

(iii)the payments related to the use of land and the provision of services and the like;

(iv) the payments were not materially distinguishable from those the subject of Lau v. F.C. of T..".

1. Counsel for the taxpayer submitted that its case before the Tribunal was not simply based upon the contention that there was a lease, and that if it failed on that contention that was an end to the case. The taxpayer had claimed before the Tribunal, it was said, to be entitled to a deduction whether the document in question was technically a lease or was enforceable as a lease or as an agreement to lease. The taxpayer's primary case was said to arise under the first limb of sub-sec.51(1) to which the existence of a lease or an agreement to lease was irrelevant. Counsel conceded that in the taxpayer's return the deduction was claimed as a "lease payment - $12,000.00," following immediately after a paragraph which read as follows:
   

"Schedule regarding Tea-Tree Investment During the year ended June 30, 1983 the taxpayer entered into a lease agreement to lease THREE acres of land at Whiporie via Grafton with the intention of establishing a teatree plantation for the production of Tea-Tree Oil. This oil is in high demand on world markets and currently sells at $A22,000 per tonne. Whilst no income has been derived in the current year it is anticipated that substantial income will be derived in the coming and subsequent years. It is the contention of the taxpayer that such expenditure is deductible within the provisions of Section 51 of the Act.".

1. The first four paragraphs of the Notice of Objection read as follows:
   

"1. THAT the whole of the amount of $12,000.00 being the amount of rental paid by the Trust in respect of the Trust's Primary Production business is an allowable deduction pursuant to the provisions of Section 51(1) of the said Act.

2. THAT the said amount of $12,000.00 was a loss or outgoing incurred by the Trust in gaining or producing the Trust's assessable income or necessarily incurred by the Trust in carrying on a business for the purpose of gaining or producing assessable income and was not a loss or outgoing of capital or of a capital, private or domestic nature or incurred in relation to the gaining or production of exempt income.

3. ALTERNATIVELY, THAT if some part of the said $12,000.00 was not incurred by the Trust in gaining or producing the Trust's assessable income or was not necessarily incurred by the Trust in carrying on a business for the purpose of gaining or producing assessable income or was a loss or outgoing of capital or of a capital, private or domestic nature, or was incurred in relation to the gaining or production of exempt income, none of which is admitted, then the remainder of the said amount of $12,000.00 which was incurred by the Trust in gaining or producing the Trust's assessable income or was necessarily incurred by the Trust in carrying on a business for the purpose of gaining or producing assessable income and was not a loss or outgoing of capital or of a capital, private or domestic nature or incurred in relation to the gaining or production of exempt income, is an allowable deduction under Section 51(1) of the said Act, and a deduction should have been allowed for that portion of the said amount.

4. THAT the expenditure incurred by way of rental expenditure was for the lease of Freehold land pursuant to the lease agreement executed by the Trustee during the year of income, and upon which land the Trust conducted the Trust's Primary Production business of the growing of Melaleuca Alternifolia and the production of Essential Oil there from.".

1. It was submitted that, while the Tribunal considered the question of the lease, it failed although asked to do so, to deal with the questions involved in both limbs of the sub-section.

2. Numerous references were given to the transcript before the Tribunal to show that the taxpayer was relying upon both limbs. It will be sufficient to refer to the following passages. In his opening, counsel for the taxpayer said "We get the deduction under either limb of s.51".

3. Later, he said:
   

"Now it may well be that the leases are not registerable at the moment, or at the time they were entered into. It may well be that they do not create an interest in land, but that does not affect the character of the payments made pursuant to this document and it does not affect what the 'lessor' thought he was getting or thought he was entitled to. The fact that it turns out, or may turn out, that Austral Oil did not have any interest in the land is, in my submission, totally irrelevant.'"

"The income amounts that were paid, the distributions of $207, were paid to people who had invested in the first year and were paid to Mr Stevenson's trust, leads to the irresistible conclusion that on the part of both parties there was a commitment, and obligation to take two acres of land prior to 30 June and entirely with the payment for that lease by 30 June 1983. With respect there can be no suggestion that the $8000 was not incurred in 1983. It was incurred at the time business had started and was carried on by the taxpayer's agent, Bowanna" (as Austral was formerly called) "and leaving aside for a moment the second limb, it was incurred for the purposes of producing assessable (sic) and deductible under both limbs, with respect.".

1. In the final paragraph of his closing address, counsel for the taxpayer said:
   

"The principal issue to be decided is the character of the payments made under the document called 'lease' in my submission inescapable conclusions

(sic) that the character of those payments are of a revenue nature, were paid for the purposes of deriving assessable income, deductible under the first limb, were paid in carrying on the business through its agent, Austral Oil Estates, deductible also under the second limb.".

1. Section 51(1) of the Act provides as follows:
   

"All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.".

1. In a case such as the present, in which the taxpayer relied upon both limbs of the sub-section, the Tribunal should, in my opinion, have instructed itself that it was necessary to consider the following questions:-
   

1. whether the payments by the taxpayer to Austral were outgoings incurred in gaining or producing assessable income;

2. whether those payments were necessarily incurred in carrying on a business for the purpose of gaining or producing such income;

3. whether those payments were losses or outgoings of capital, or of a capital, private or domestic nature.

1. The Tribunal did not so instruct itself, but became pre-occupied with questions relating to the form of the lease and its effect as a matter of property law.

2. Counsel for the Commissioner submitted that
   

"The Tribunal was correct, as a matter of law, in holding that:

'(Once) the unenforceable lease is put to one side, what emerges is that the trust made a series of payments to Austral for the right to participate in the future profits to be derived from a tea tree growing venture, its entitlement to the profits being the numerator of a fraction, the denominator of which is the contribution of all the investors ... '

and hence that:

'the payment is thus no different in kind from say, buying a share in an adventure ... ' to salvage the Titanic. (paragraph 21)".

1. In my opinion, the Tribunal erred in putting the "lease" to one side because it concluded that it was unenforceable. It remained one of the circumstances to be taken into account in determining the questions arising under the sub-section, as reference to Lau v. Federal Commissioner of Taxation (1984) 6 FCR 202 shows. In that case the taxpayer had invested in a pine-growing development, involving a lease and a management agreement. The Commissioner contended that the lease was void, as the required approval of the local authority had not been obtained. The Court held that even if that were so, it did not follow "that any deduction on that account is to be ignored for taxation purposes anymore than would income derived from that activity" (per Beaumont J. at p 220).

2. As Fox J. pointed out (at p 207):
   

"In the application of s.51 ... what is to be looked at is the nature of an outgoing, on the one hand, or the nature of a receipt, on the other. The mere fact that there was an illegality is often not critical, and would not be critical in the present case. It is necessary to see what was done, and to what end, and to relate that to the concepts being dealt with".

1. In the present case the Tribunal did not relate what was done to the concepts involved in the sub-section, but misdirected itself, as, for example, when it concluded that the deductions claimed in the 1984 year were deductible only if
   

(a) the taxpayer had a lease over six acres (para 14);

(b) identifiable land of the taxpayer was being used for primary production in the 1984 year (para 14);

(c) the acreages were identified in the "leases" or at the time when they were executed (para 17).

1. Taking the reasons of the Tribunal as a whole, and without imposing upon it any standard of perfection, I am satisfied that it failed to consider and determine the questions arising under the sub-section. It failed to consider whether there was a rational objective foundation for concluding that significant assessable income would be derived by the taxpayer, not necessarily in the year of income.

2. In Federal Commissioner of Taxation v. Finn (1961) 106 CLR 60 at p 68 Dixon CJ. said
   

"For it is impossible to suppose that an expenditure directed to gaining future income cannot be allowed as a deduction unless its productive effect within the current year is seen or expected ... The better view, however, is that s.51 as now drawn does not in either limb require a rigid restriction to the gaining or production of assessable income of the current year".

1. One may contrast with these words paragraphs 10, 11 and 12 of the Tribunal's reasons set out above.

2. The Tribunal itself said (in paragraph 22) that "no concluded opinion" was required as to whether the payments by the taxpayer to Austral were "a capital expense and disqualified from deduction on that ground". Its failure to decide this question was, in my opinion, an error of law. It found (in paragraph 14) that Austral was carrying on a business in 1984 but, in my opinion, it did not determine, as it should have, whether that business was carried on by it on behalf of the taxpayer and others pursuant to the "leases" and management agreements.

3. Both parties invited the court to determine for itself the questions which were before the Tribunal. That there may be circumstances in which the position is sufficiently clear to justify the Court in disposing of a matter itself is to be seen from Statham v. Federal Commissioner of Taxation (1988) 89 ATC 4070, a case in which, as the Court observed (at p 4075) the facts were "largely undisputed and the Tribunal had made some findings of fact on material matters".

4. However, in the present case, counsel for the taxpayer rightly conceded that, unless it appeared clearly to the Court that the Tribunal would have come to a conclusion favourable to the taxpayer, "no doubt a further hearing would be inevitable".

5. The case before the Tribunal "proceeded over three days, involved numerous witnesses and included over 800 pages of exhibits" (Reasons para 2).

6. In my opinion, the role of the Court in a case such as this is not to attempt, from a reading of the transcript, to deal with the issues which have been committed to the Tribunal, but rather to decide the questions of law which constitute the subject matter of the appeal and determine its scope.

7. I was asked by the taxpayer not to return the matter to the Tribunal as previously constituted in view of the opinions which it had emphatically expressed. This submission, in my opinion, is a weighty one.

8. Accordingly, the Court orders that:
   

1. the decision of the Administrative Appeals Tribunal dated 23 January 1989, insofar as it affirms the respondent's decision to disallow as deductions in determining the applicant's taxable income the "lease" payments of $12,000 in respect of the 1983 year and $11,700 in respect of the 1984, year be set aside.

2. the matter be remitted to the Administrative Appeals Tribunal, constituted differently from the way in which it was on 23 January 1989, to be heard and determined according to law.

3. the taxpayer's costs of the appeal to the Court be paid by the Commissioner.