Iddles and Commissioner of Taxation
[2005] AATA 787
•17 August 2005
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2005] AATA 787
ADMINISTRATIVE APPEALS TRIBUNAL )
)No WT2002/49-51
TAXATION APPEALS DIVISION ) Re NORMAN IDDLES Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Associate Professor G A Barton, Member Date17 August 2005
PlacePerth
Decision The Tribunal sets aside the reviewable objection decisions of 19 April 2002 and remits these matters to the respondent for reconsideration in accordance with the direction that the respondent issue further amended assessments to income tax to the applicant that give effect to the Tribunal’s determination pursuant to s 177 F of the Income Tax Assessment Act 1936 that the tax benefits obtained by the applicant in relation to his participation in the Austvin Vineyards 1997 Project shall not be allowable deductions in calculating his taxable income to the extent of $15,000 in the income year ended 30 June 1997, $7,365 in the income year ended 30 June 1998 and $58 in the income year ended 30 June 1999.
..............(Sgd. G A Barton)...........
Member
CATCHWORDS
Income tax – viticulture project – disputed expenses – prospectus – structure of viticulture project – applicant’s participation in the viticulture project – licence and management agreement – grape sales agreement – loan offer – none of the agreements was a sham – licence and management fees borrowed by growers involved ‘round robin’ arrangements – tax advice in relation to the viticulture project – income and expenditure projections in prospectus – general deductibility of disputed expenses – carrying on a business – management fees excessive – taxpayer’s motive - characterisation of expenses – quantum – colourable relationship to production of assessable income – general anti-avoidance provisions – determination to cancel tax benefits that are otherwise allowable deductions – test prescribed – manner in which the scheme was entered into or carried out – the form and substance of the scheme – the time at which the scheme was entered into and the length of the period during which the scheme was carried out – the result in relation to the operation of the Act that would otherwise be achieved by the scheme – any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme – any change in the financial position of any person connected to the taxpayer that has resulted from the scheme – other consequences for the taxpayer or persons connected to the taxpayer – dominant purpose to obtain tax benefits – determination to partially cancel tax benefits.
Income Tax Assessment Act 1936 - S 51(1)
Part IV A - S 177 F (1), S 177 A (1), S177 C (1), S177 D (a) and (b)(i) – (viii)
Income Tax Assessment Act 1997 - S 8-1
Ure v Federal Commissioner of Taxation (1981) 34 ALR 237;
Puzey v Federal Commissioner of Taxation (2003) 201 ALR 302;
Commissioner of Taxation v Sleight (2004) 206 ALR 302;
Ferguson v FCT (1979) 79 ATC 4261;
Clowes v Federal Commissioner of Taxation (1954) 91 CLR 209;
Milner v Commissioner of Taxation (1975-1976) 133 CLR 526;
Vincent v Federal Commissioner of Taxation (2002) ATC 4742;
Commissioner of Taxation v Cooke (2004) FCAFC 75;
Toohey’s Ltd v Commissioner of Taxation for NSW (1922) 22 SR (NSW) 432;
Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47;
Cecil Bros. Pty Ltd v Commissioner of Taxation (1964) 111 CLR 430;
Fletcher v Commissioner of Taxation (1991) 173 CLR 1;
Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404;
Eastern Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27;
Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531;
Calder v Commissioner of Taxation [2005] FCA 911;
Federal Commissioner of Taxation v Consolidated Press Holdings (2001) 207 CLR 235;
Commissioner of Taxation v Hart (2004) HCA 26;
Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) HCA 55.
REASONS FOR DECISION
17 August 2005 Associate Professor G A Barton, Member 1. The applicant, Mr Norman Iddles, has sought a review of the respondent’s decisions of 19 April 2002 to disallow his objections to his amended assessments to income tax for the years ended 30 June 1997, 30 June 1998 and 30 June 1999 (‘the amended assessments’). In 1997 the applicant became a participant in the Austvin Vineyards 1997 Project (‘the viticulture project’) and, in relation to that project, he claimed allowable deductions in calculating his taxable income, totalling $17,204, $12,765 and $6,058 (‘the disputed expenses’) for the 1997, 1998 and 1999 income years respectively. The respondent disallowed these amounts in full in the amended assessments pursuant to determinations made under section 177F (l) of the Income Tax Assessment Act 1936 (‘the Act’).
2. The issues to be determined are whether the disputed expenses are allowable deductions under s 51(l) of the Act or, in respect of the 1998 and 1999 years, s 8-1 of the Income Tax Assessment Act 1997 (‘the 1997 Act’) and, if so, whether they are tax benefits to be cancelled, wholly or in part, pursuant to the provisions of Part IV A of the Act.
3. The applicant was represented by Mr T N Cullity of Counsel and Mr F C Wilson. He tendered documentary exhibits A1 to A8 and he gave evidence. The applicant filed a statement of facts and contentions and called Mr D G Botting and Mr P D Goodes to testify on his behalf. He filed a written outline of argument and closing submissions.
4. Ms H Symon of Senior Counsel and Ms L Price of Counsel appeared for the respondent who tendered documentary exhibits R1 to R9 and filed a statement of facts and contentions and written submissions.
5. Documents T1 to T20 and T100 to T319 were before the Tribunal pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 and copies of the following documents in relation to the viticulture project provided by the applicant pursuant to a direction of the Tribunal of 28 January 2003: completed application form and power of attorney executed by the applicant; loan offer; grape sales agreement and licence and management agreement executed on behalf of the applicant on 27 June 1997 and the viticulture project prospectus.
The structure of the viticulture project
6. The prospectus for the viticulture project, which was issued by Austvin Vineyards Ltd (‘the manager’) and registered by the then Australian Securities Commission (‘ASC’), discloses that it was lodged with the ASC on 21 April 1997. It is dated 18 April 1997 and it expired on 30 June 1997. No application could be received prior to 6 May 1997 and no interest was to be allotted or issued pursuant to an application received after 17 June 1997.
7. The prospectus offered passive participation in a winegrape vineyard business by licensing the vineyard to participants (‘growers’) in vineplots of 0.2 of a hectare for 15 years and cultivating the grapes on their behalf, in return for licence and management fees, and buying the grapes from the participants pursuant to a grape sales agreement. The offer included the option of a loan to finance the licence and management fees. 142 hectares of vineyard was offered subject to a minimum aggregate subscription of 71 hectares. The minimum subscription for each participant was 2 vineplots or 0.4 of a hectare. The vineyard is located in the Riverland district of South Australia.
8. The companies involved in the viticulture project at its inception were the manager, Coldridge Development Pty Ltd (‘the landowner’), Inteq Custodians Ltd (’the trustee’), Austvin Management Pty Ltd (‘the vineyard manager’), Austvin Finance Pty Ltd (‘the lender’) and Australian Vintage Ltd (‘the grape purchaser’). The grape purchaser controlled the landowner, the manager, the vineyard manager and the lender.
The applicant’s participation in the viticulture project
9. In June 1997, when the applicant was the Executive Vice President of the Toyota Motor Corporation in Australia (‘Toyota’), he was contemplating his retirement in the year 2000, when he turned 60, and the concomitant drop in his disposable income. He testified to his need to make diverse income producing investments in the remaining 3 years of his employment by Toyota to sustain him and his family in his retirement. He was attracted to the viticulture project for a number of reasons. It was in a growth industry. It was a state-of-the-art development of a new vineyard that should have a competitive edge over older vineyards that are fairly labour intensive. It included a contract for the sale of the grapes and it was long term, taking the applicant, as he put it, “to the age of 72 or 3.”
10. The prospectus for the viticulture project commences with an open letter from the chairman of the manager in which prospective growers are told “[The project provides an opportunity to enter into the exciting high growth Australian viticulture industry. The project is structured to include the option of a limited recourse loan which, if utilised, will enable entry to the project for a cash outflow of only $2,204 before 30 June 1997 whilst entrants should qualify for a tax deduction of $17,204 for that year. Participation in the project requires you to enter into a 15 year licence and management agreement for a section of a state-of –the-art vineyard being developed in the Riverland district of South Australia. It also requires entry into a grape sales agreement to sell the produce from your vineyard interest to our parent company Australian Vintage Limited, which is one of Australia’s foremost wine producers.”
11. The applicant testified that although the tax implications are a factor to be taken into account in every investment he was more interested to see whether the viticulture project was “a soundly based long term commercially viable project.” He referred to his annotations and notes on the copy of the prospectus he used (A2) and stated that he spent “a fair bit of time looking at the full financial projections over the life of the project and how that generated a return to me.”
12. The applicant completed an undated application form headed ‘Austvin Vineyards 1997’ in which he applied for licence and management agreements for two 0.2 hectare vineplots pursuant to the project deed made on 1 April 1997 (as amended) between the manager and the trustee. By signing the application form the applicant acknowledged that he would be bound by the terms of the project deed and that he directed the trustee to distribute the purchase price for grapes in terms of the project deed. He certified that if he was accepting the loan offer, he had read and understood the loan offer documents and that by making the interest payments he would be accepting the loan offer and that he would be bound to the terms of the loan offer document.
13. On the 19 June 1997 the applicant executed a power of attorney granting the trustee, as his attorney, the power to execute and to vary a licence and management agreement, and a grape sales agreement in respect of the vineplots allocated to him.
Licence and management agreement
14. Under a licence and management agreement made on 27 June 1997 between the manager, as licensor, and the applicant, as grower, the applicant was granted a licence to cultivate, tend, manage and maintain vineplots V10022 and V10021 (total area approx. 4000 sq m) shown on the plan containing the reference no B3141LS2 (‘the licence’). According to the schedule to this agreement at least 264 vines were contained in each vineplot.
15. By recital C(b) of the licence and management agreement, as required under the project deed, the applicant expressed the wish to appoint the manager to cultivate, tend, manage and maintain his interest in the viticulture project on the terms and conditions set out in the agreement.
16. The licence is a non-exclusive right from 27 June 1997 until 28 June 2012 to enter onto the vineplots to cultivate, tend, manage and maintain the grapes and the vines and to harvest and sell the grapes. The particulars of the services associated with these activities and to be performed by the manager, are set out in item 5 of the schedule to the agreement. By clause 2.2 the grower has the right to enter on to the land.
17. By clause 3.1 of the licence and management agreement the applicant is required to pay the licensor licence fees in accordance with clause 17.2 and item 3 of the schedule. Clause 17.2 provides that the licence fees may be paid by cheque, crossed and marked “not negotiable” and payable to the trustee. Item 3 of the schedule provides that the licence fee for each vineplot is payable on or before 30 June of each year for the year in advance and that the licence fee payable on 30 June 1997, 1998 and 1999 is $500.00. For 2000 and subsequent years the licence fee is $500.00 per year as adjusted at the time that payment is due by the consumer price index (‘CPI’) defined in clause 1, for the movement of that index from 30 June 1997.
18. By clauses 3.2 and 3.3 the applicant is required to preserve and maintain the vineplots in a proper and efficient state of cultivation in accordance with Australian Industry Standard Viticultural Practice as applied by the viticulture industry in South Australian and, immediately prior to 28 June 2012, when the licence expires, to complete all work required to be completed at that time to prepare the vineplots for the next vintage.
19. Clause 4 of the agreement governs the applicant’s rights to assign or transfer his interest in the viticulture project or to grant any licence affecting his vineplots and the manager is appointed by clause 5.
20. Clause 6 of the agreement sets out the functions of the manager and in particular, sub-clause 6.4 provides that the manager is to have the day to day conduct of the applicant’s business. Clauses 7, 8 and 9 govern the harvesting and right to grapes, the termination of the appointment of the manager and the manager’s powers of employment and delegation.
21. Sub-clause 10.1 of the licence and the management agreement provides that in consideration of the manager carrying out its obligations under the project deed and the agreement, for the term of the agreement, it will be paid the management fee by the applicant for the period 1 July to 30 June in advance on or before the 30 June of each year. The management fee for each vineplot is specified in item 4 of the schedule to the agreement as follows:
“Payable on or before 30 June of: Amount Payable
1997 $7,500.00
1998 $5,000.00
1999 $1,436.00
For 2000 and subsequent years, the Management Fee payable is the amount of $1,436.00 per year as adjusted at the time that payment is due by the CPI for the movement of that index from 30 June 1997.”
22. By clause 13, nothing in the agreement will be construed as creating any association or partnership between the manager and the growers.
The grape sales agreement
23. On 27 June 1997 the trustee, as attorney for the applicant, executed a sales agreement between the applicant, as grower, and the grape purchaser, as buyer, for the purchase of the grapes harvested from the applicant’s vineplots (‘grape sales agreement’).
24. The grape prices for pooled grapes of the viticulture project agreed between the parties are set out in clause 4 of the sales agreement as follows:
“4. GRAPE PRICES
The Buyer agrees to pay the Grower, for the Grapes purchased in each Vintage Year, a purchase price of:
(a)For Grapes harvested between 1 January 1998 and December 2003, $747 per tonne adjusted for any increase in the CPI (from the CPI published for 30 June 1997 as published in or about late July 1997) to 30 June of the relevant Vintage Year (as published in or about late July of the relevant Vintage Year);
(b)For Grapes harvested subsequent to 31 December 2003 and until the end of the Term, the market rate discounted by 20%. The market rate is the rate applicable to the Vintage Year at the time the Grapes are delivered to the Buyer as determined by the South Australian Wine Grape Utilisation and Pricing Survey published in or about September of the relevant Vintage Year by the Department of Primary Industries of South Australia or if that publication is discontinued, a corresponding publication as determined by the Manager and advised to the Buyer and Grower.”
‘Vintage Year’ is defined in clause 1 of the sales agreement to mean a 12 month period expiring on 31 December during the period from 27 June 1997 until 31 December 2012.
25. By sub-clause 5.1 the buyer is required to pay the purchase price for the grapes and any default interest payable, at the times set out in sub-clause 5.2, to the trustee to hold on behalf of and distribute to or at the direction of, the applicant in accordance with the terms of the project deed.
26. The buyer has an absolute discretion under the sales agreement to purchase grapes that do not meet the grape quality standards set out in sub-clause 3.2. If the buyer chooses not to purchase the grapes because they do not meet these standards then, by sub-clause 7.1(b) of the licence and management agreement, the manager will harvest the grapes at its absolute discretion and use its best endeavours to sell the grapes on terms that the manager reasonably considers are the best terms obtainable and will require the buyer or buyers to pay the purchase price to the trustee to hold for and distribute to the growers under the terms of the project deed.
The loan offer
27. The prospectus for the viticulture project included a loan offer from the lender to participants to finance a portion of their interest in the project on the terms and conditions set out in the offer document. Borrowers could accept the offer by providing the lender with a cheque payable to the lender for $602 for each vineplot, representing prepaid interest for the period to 30 June 1998, on or before 30 June 1997.
28. The lender offered to lend and pay all amounts payable under the licence and management agreement set out in paras 17 and 21 of these reasons on the dates they became due save for the amount of $500.00 payable in respect of each vineplot on or before 30 June 1997, an amount which equates to the initial licence fee for each vineplot.
29. The applicant’s liability to pay the loan is limited to payment of the primary instalments in the amounts and on the dates set out in item 2 of the schedule to the offer document provided the repayment schedule is adhered to. Item 2 of the schedule relevantly provides:
“2. Primary instalments and primary instalment dates:
Primary instalment: due on or
before 30 September of 1997 1998 1999 2000 2001
Primary Instalment amount $2,700 $3,000 $1,300 $1,000 $600
In addition, the Primary Instalment amount includes the proceeds from the sale of the grapes that are due up to 30 June of the year the Primary Instalment is due under the Grape Sales Agreement (or any other agreement by which the Borrower sells grapes grown in the Vineplot to a third party) and the proceeds from the sale of grapes that are due after 30 June and up to 30 September reduced according to the following formula where the formula produces a number greater than zero:
(grape sales proceeds* - Management License Fees* - Interest*) x 48.5%
* as returned to the Australian Taxation Office for the financial year immediately preceding the date that the Primary Instalment is due.”
30. It was not disputed, and the Tribunal finds, that on or about 19 June 1997, the applicant accepted the loan offer by sending the manager a cheque payable to the lender in the amount of $1,204.00 ($604 for each vineplot) representing prepaid interest for the period to 30 June 1998. At the same time the applicant sent the manager the completed application form, the power of attorney and a cheque for $1,000, payable to the trustee, for licence fees in respect of 2 vineplots. So the applicant made a cash outlay of $2204.00 on entering the viticulture project in the 1997 year, as he was invited to do by the chairman of the manager in the letter referred to in para 10 of these reasons.
31. It was not disputed and the Tribunal finds that none of the agreements in relation to the viticulture project entered into either directly or indirectly by the applicant was a sham. The agreements were entered into with the intention that they bind the parties according to their terms and they were implemented as such.
32. 710 vineplots were licensed under the viticulture project. Growers accepted the loan offer for licence and management fees in respect of 705 vineplots. At the outset of the hearing, counsel for the applicant conceded that the payment by the lender of licence and management fees borrowed by growers involved ‘round robin’ arrangements.
33. On 27 June 1997 the amount of $5,287,500, representing the management fees under the licence and management agreement for 705 vineplots, passed from the manager to the lender, from the lender to the trustee and from the trustee back to the manager (R7). These transactions originated in a loan of $5,287,500 from the manager to the lender (R7 – T1/652). The ledger accounts for the manager and the lender show further loans to the lender of $3,525,00 in 1998 and $1,364,880 in 1999 (R7).
34. The prospectus for the viticulture project included a letter from Norton & Smailes, Barristers and Solicitors, to the directors of the manager considering the income tax implications of the viticulture project. The view taken in the letter is that the management fees paid in advance are not of a capital nature and should be treated as fully deductible in the year in which payment is made, despite the fact that they relate to a succeeding period. The licence fees are likewise considered to be deductible against normal Australian source income when incurred because they relate to the grower’s business and prepayments of interest are similarly considered to be deductible in the year when the payments are made even though they may relate to the use of funds in a succeeding income year. The letter concludes with the recommendation that investors take independent taxation advice in relation to the viticulture project and their personal circumstances.
35. The prospectus contains income and expenditure projections providing an estimate of the returns growers may achieve through participation in the viticulture project. The projections are stated to be based on a number of assumptions including hypothetical assumptions concerning inflation rates and increases in the price of grapes over the 15 year term of the licence. Applicants are cautioned that the hypothetical assumptions may not be reflective of actual future events.
36. The best estimate assumptions used by the directors of the manager are that the first grape yield will be 1.0 tonnes per hectare in 1999 rising to 25.0 in 2003 and remaining at that level until the conclusion of the 2012 grape season; that a typical grower will have a marginal tax rate of 48.5% and that the interest rate charged on the loan from the lender will remain at 11% throughout the term of the loan. The hypothetical assumptions are that the CPI will increase by 3% p.a. over the term of the licence and management agreement and the market price for grapes to be sold pursuant to the grape sales agreement will increase by 12% p.a. over the term of the agreement from a base price of $933.75 per tonne for 1997. Applicants are advised to form their own opinions on the rate of increase in the sales value of grapes saleable to the grape purchaser and to be aware of the risk factors referred to in the prospectus under ‘Risks and Liability”. In particular, the directors draw attention to the views of the Independent Viticultural Expert that it is not possible to predict grape prices after 2003 and that the volume growth stage of wine industry growth will cease in 2002.
37. The returns projected, using the above assumptions, equate to an internal rate of 60% where the limited resource loan facility from the lender is utilised, providing a grower with 2 vineplots, a projected total after tax surplus cash flow over the life of the viticulture project of $70,488. Where the loan facility is not utilised the projected internal rate of return is 17% providing a projected total after tax surplus cash flow of $78,556.
38. The risk adverted to in the prospectus under “Risks and Liability” are agricultural and horticultural risks, financial risks, managerial risks and tax risks. In relation to the latter, prospective applicants are informed that the respondent may disallow, in whole or in part, a deduction for the licence and management fees and/or the interest payable to the lender, and they are advised to read the letter from Norton & Smailes referred to in para 34 of these reasons.
General deductibility of the disputed expenses
39. In the 1997 income year the applicant was liable to pay licence fees of $1,000, a management fee of $15,000 and pre-paid interest of $1,204 under the agreements he made in connection with the viticulture project. He claimed these amounts, totalling $17,204, as allowable deductions from assessable income in his 1997 income tax return pursuant to the general provisions of s 51(1) of the Act.
40. In 1998 the applicant claimed licence fees of $1,000, a management fee of $10,000 and pre-paid interest of $1,765 as allowable deductions under the general provisions of s 8-1 of the 1997 Act and in 1999 he claimed licence fee of $1,000, a management fee of $2,872 and pre-paid interest of $2,186. His claimed expenses in relation to the viticulture project in 1998 and 1999 totalled $12,765 and $6,058 respectively.
41. The applicant did not derive any income from the sale of grapes from his vineplots in 1997, 1998 or 1999, but has done so in the years following.
42. It was not disputed that the applicant incurred the expenses in the years for which they were claimed as deductions. Senior Counsel for the respondent submitted that they were not deductible on the grounds that the applicant was not conducting a business, that they were capital outgoings incurred by the applicant as a passive investor in the manager’s business and, in relation to the management fees for the first two years of the viticulture project, they were excessive and incurred in order to obtain the disputed deductions.
43. The relevant sections in the Act and the 1997 Act provides as follows:
Income Tax Assessment Act 1936
“51.(1) 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.”
Income Tax Assessment Act 1997
“8-1 General deductions
(1) You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b)it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
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; or
(c)it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or
(d)a provision of this Act prevents you from deducting it.
For a summary of provisions about deductions, see section 12-5.
(3) A loss or outgoing that you can deduct under this section is called a general deduction.”
44. The applicant who, by s 14ZZK (b) (i) of the Taxation Administration Act 1953, had the burden of proving, on the balance of the probabilities, that the amended assessments are excessive, asserted that the disputed expenses fall within both positive limbs of s 51 (1) or, for the 1998 and 1999 years, within s 8-1(1) (a) and (b).
45. In the respondent’s principal submission the disputed expenses that are “styled management and licence fees”, are not deductible on any basis because they were outgoings of capital for the purpose of the first negative limb of s 51 (1) or, in relation to the disputed expenses for 1998 and 1999, s 8-1(2) (a). This submission rests on the proposition that the licence and management fees were not incurred by the applicant in carrying on a business for the purpose of gaining or producing his assessable income because he did not commence a business of growing and selling wine grapes from the vineplots that were licensed to him when he executed the contractual arrangements for participating in the viticulture project, but rather he acquired a proportionate beneficial interest or share in the business conducted by the manager from the vineyard constituted by the 710 vineplots that were licensed to growers. So, the respondent contended, the licence and management fees are to be characterised as outgoings of capital to acquire that interest.
46. In light of the focus of the respondent’s submission on the “second positive limb” of s 51 (1) it is expedient to commence by addressing the issue of whether the applicant has been carrying on a business from the vineplots since they were licensed to him under the viticulture project on 27 June 1997. Whether a business is carried on is ultimately a conclusion of fact to be drawn from the facts and circumstances of the case, Puzey v Federal Commissioner of Taxation (2003) 201 ALR 302 at para 50; Commissioner of Taxation v Sleight (2004) 206 ALR 302 at paras 47 and 51. The respondent submitted it ought to be concluded from the following matters concerning the viticultural project that the applicant has not been conducting such a business.
47. The applicant entered into a “package” of agreements offered by the viticulture project prospectus by signing the application form and power of attorney and remitting the sum of $2,204 at the time and in the manner found in para 30 of these reasons. Save for paying the primary instalments by the primary instalment dates set out in para 29 of these reasons the applicant did nothing further in relation to the viticulture project except to receive statements setting out the basis on which his share of the proceeds of the vineyard have been calculated and reports as to the conduct of the project as a whole.
48. In his affidavit (A2) the applicant stated at para 19 that he understood that he would have no direct role in the day to day management or operations of the viticulture project and so would need no special expertise in that business and that all he needed was a knowledge of whether the information in the prospectus presented a good business opportunity to make a commercial return out of investment in the grape growing / wine industry. At para 31 of A2 he states that the manager has sent him regular reports first on the initial development of the viticulture project and thereafter on the maintenance of the vine stock and that he also gets regular reports from the qualified viticulturists. Para 32 of A2 sets out reports received by the applicant from the manager to date (9 October 2003) as follows:
“32.1the Financial Statements for the period ended 30 June 1997 (Annexure ‘NBI17’);
32.2a letter dated 11 March 1998 summarising the Project’s progress and attaching the Financial Statements for the period ended 31 December 1997 and the Agribusiness Manager’s Report (Annexure ‘NBI18’);
32.3a letter dated 25 September 1998 summarising the Project’s progress and attaching the Financial Statements for the period ended 31 December 1998 and the Agribusiness Manager’s Report (Annexure ‘NBI19’);
32.4a letter dated 15 March 1999 attaching the Agribusiness Manager’s Report and the Financial Statements for the period ended 31 December 1998 (Annexure ‘NB120’);
32.5the Viticultural Consultant’s Report on Coldridge North prepared by Peter Hedberg and Associates on 8 May 1999 (Annexure ‘NBI21’);
32.6a letter dated 14 March 2000 attaching the Financial Statements for the period ended 31 December 1999 (Annexure ‘NBI22’);
32.7a letter dated 29 September 2000 attaching the Financial Statements for the year ended 30 June 2000 and the Agribusiness Manager’s Report (Annexure ‘NBI23’);
32.8a letter dated 23 April 2001 attaching the Financial Statements for the period ended 31 December 2001 and an Independent Expert’s Viticultural Report prepared by Mr Adam Jacobs, Managing Director, Vitiwise Pty Ltd (Annexure ‘NBI24’);
32.9a letter dated 28 September 2001 attaching the Financial Statements for the year ended 30 June 2001 and the Agribusiness Manager’s Report (Annexure ‘NBI25’);
32.10a letter dated 8 April 2002 attaching the Financial Statements for the period ended 31 December 2001 (Annexure ‘NBI26’); and
32.11a letter dated 29 November 2002 attaching the Financial Statements for the year ended 30 June 2002 and the Agribusiness Manager’s Report (Annexure ‘NBI27’).”
49. The respondent also cited the following paragraphs from, and annexures to, the applicant’s affidavit:
“33.I have not had any reason to make enquiries with the Project Manager since participating as everything has gone smoothly and according to plan. I believe the Project to be run very professionally, and to have been managed in accordance with the Project Manager’s obligations under the Licence and Management Agreement and certainly with the interests of the Growers in mind. Between 1997 and 2003 the Project delivered the projected returns. While the business is being properly managed and is performing to financial expectations, I see no need to be making enquiries of the Project Manager.
34.In accordance with the Licence and Management Agreement, I have made the following cash payments:
$1,000 on 19 June 1997 to Inteq Custodians Limited being for the initial licence fee.
Annexed hereto and marked with the letters “NBI28” is a copy of the cheque butt recording the above payment
35.In accordance with the Loan Agreement, I have made the following cash payments:
35.1$1,204 on 19 June 1997 to Austvin Finance Pty Ltd being for prepaid interest for the period to 30 June 1998 due on or before 30 June 1997 pursuant to Clause 21;
35.2$5,400 in late September 1997 to Austvin Finance Pty Ltd being the primary instalment due on or before 30 September 1997 pursuant to Item 2 of the Schedule;
35.3$6,000 on 1 September 1998 to Austvin Finance Pty Ltd being the primary instalment due on or before 30 September 1998 pursuant to Item 2 of the Schedule;
35.4$2,600 on 27 September 1999 to Austvin Finance Pty Ltd being the primary instalment due on or before 30 September 1999 pursuant to Item 2 of the Schedule;
35.5$2,000 on 2 October 2000 to Austvin Finance Pty Ltd being the primary instalment due on or before 30 September 2000 pursuant to Item 2 of the Schedule; and
35.6$1,200 in late September 2001 to Austvin Finance Pty Ltd being the primary instalment due on or before 30 September 2001 pursuant to Item 2 of the Schedule.
Annexed hereto and marked with the letters “NBI28” are copies of the cheque butts recording the payments referred to in paragraphs 35.1, 35.3, 35.4 and 35.5 above. I do not have records of the payments referred to in paragraphs 35.2 and 35.6 above as these payments were made by bank cheque.
36.I accepted the financing option set out in the Loan Offer in the Prospectus and did not consider other options as I decided the financing option was reasonable.
37.I have kept a record of all income receipts totalling $25,393.89 that I have received from the Project to date. These came in two ways: payments that were applied in repayment of my loan and some cheques for net grape proceeds that have exceeded the loan repayments. I have received $1,404.90 in cash payments to date despite the Prospectus forecasting nil cash payments to date. Annexed hereto and marked with the letters “NBI19” through “NBI15” (as above) are annotated copies of my loan account summaries for the years ending 30 June 1998 through 30 June 2003 which quantify both the amount of grape sale proceeds applied against the loan account and cash payments issued to me. Annexed hereto and marked with the letters “NBI29” and “NBI30” are letters from Austvin Finance Pty Ltd enclosing my net grape sale cheques dated 28 September 2001 and 2 October 2002 respectively
38.All my reconciliations of these amounts were in line with my expectations under the Prospectus.
39.My outstanding loan amount is currently about $17,000.”
50. The respondent referred to the fact that 710 vineplots were offered by the viticulture project prospectus and that other investors would sign the same “package” of agreements with the same project companies as parties.
51. By the licence and management agreement the applicant engaged the manager to manage vines on vineplots to be allotted to him. The licence and management agreement executed on behalf of the applicant on 27 June 1997 is referred to in paras 14 to 22 of these reasons. The respondent relies on clause 6.4 (referred to in para 20 above) which stipulates that “[T]he Manager has clear authority to manage and carry on the Grower’s Business within the scope of the Manager’s authority and the Grower will not interfere with the day-to-day management and conduct of the Grower’s Business.” Sub-clause 7.1(a) provides that “[F]or the period that the Buyer is a party to the Grape Sales Agreement, the Grapes will be harvested by the Manager at the time agreed by the Manager and the Buyer.”
52. Mr Phillip Dudley Goodes who testified on behalf of the applicant, states at para 3 of his affidavit (A5) that in June 1997 growers in the viticulture project obtained licences over an area of approximately 140 hectares of the Coldridge Vineyard known as “Coldridge North” and contracted with the manager to manage the area on their behalf in accordance with licence and management agreements. At para 12 he states that the growers’ vineyard is a small vineyard and that the larger Coldridge Vineyard Project located in the same area consists of approximately 327 hectares. Mr Goodes testified that he manages the whole vineyard area, including the growers’ vineyard, using management procedures that are “reasonably common”. In cross-examination he explained that the growers’ vineyard was an integral part of the Coldridge Vineyard Project served by the same staff using the same plant and equipment and a single irrigation system. A map of the Coldridge Vineyard is attached to A5 indicating that the applicant’s vineplots are located in a planted area of approximately 10 hectares marked ‘N16 Merlot’. He conceded in cross-examination that he would not normally be aware of the location of a particular grower’s vineplots and that the information was supplied by his head office in Adelaide for the purpose of the hearing. He stated further that growers visiting the vineyard would not expect to be shown particular vines that had been allotted to them.
53. Mr David Gregory Botting who testified on behalf of the applicant, confirmed in cross-examination that there is an irrigation infrastructure which is common to both the Coldridge North Vineyard and the rest of the vineyard.
54. By sub-clause 5.5, headed ‘Pooling of Grapes’, of the grape sales agreement, the applicant was to receive a proportionate share of the proceeds of the vineyard as a whole. Sub-clause 5.5 provides:
“The Grower acknowledges that the Grapes will be mixed with grapes grown in vineplots of other growers and will be weighed and a determination made as to the grape quality standards set out in clause 3.2, together with all of those other grapes. The proceeds of sale of all of the grapes (including the Grapes) will be distributed in proportion to the Grower’s Proportional Interest as that terms (sic) is defined in the Project Deed.”
55. The proceeds fund in relation to the viticulture project includes moneys payable to the trustee, pursuant to licence and management agreements, representing the gross proceeds of the sale of grapes. By clause 37 of the trust deed, the trustee must distribute among growers who hold licence and management agreements on the day of the Distribution Day, each grower’s proportional interest in the proceeds fund relating to the period between the Distribution Date and the previous Distribution Date.
56. Seven varieties of grape are grown across the viticulture project vineyard. Both Mr Goodes and Mr Botting agreed in cross-examination that it would have been impractical to plant vines of each variety on each vineplot. It was not disputed, and the Tribunal finds, that the vineplots allotted to the applicant were not chosen by him and they were planted exclusively with merlot grapevines.
57. The respondent relied on the following paragraphs 21 and 23 of the applicant’s affidavit A2 to show that he did not intend by his outgoings to commence a business:
“21.Overall, it looked to me to be a sound, long-term business that, firstly, was in an industry that had great growth potential and secondly, given I was planning retirement, matched my investment profile. I was looking for a business opportunity that would give me the income I needed post retirement. This project could provide this as it had a 15 year horizon. Finally, it stacked up better than other investment projects that I had looked at such as rental properties, more shares and things which I could put cash into as I was not short of cash. The Project was attractive as it allowed me to spread my risk due to my wife and I already having significant property and share holdings. Additionally at that time the self-managed super fund had $1,500,000 in cash which was soon to be put into managed funds and shares etc.
22.I took up two vineplots in the Project being the minimum of 0.4 hectares.
23.I did not look at taking more vineplots because my philosophy at the time was to spread my risk in diversified areas and therefore I was looking at making smaller monetary outlays in different fields. Additionally, as grape growing and the wine industry were areas of business I had not participated in before, I took a cautious approach.”
In cross-examination in answer to the suggestion that his investment in the viticulture project was ‘just like a share’ the applicant said that the prospectus for the viticulture project made it very clear that it was an investment with a 15 year horizon and that he regarded it as his business venture seeing he was exposed to a lot of the risks.
58. In his affidavit of 30 June 2004 (A4) Mr Botting stated that the cost of ownership and operation of a basic set of vineyard equipment, if purchased new and fully depreciated over 4 years, would typically require a minimum vineyard area of approximately 25 hectares.
59. The Tribunal finds that the applicant has been carrying on the business of growing and selling wine grapes since 19 June 1997 when he executed the documents and made the payments referred to in para 30 of these reasons.
60. It was not disputed that the activities conducted by the manager on and from the viticulture project vineyard, which includes the vineplots licenced to the applicant, constitute a business of growing and selling wine grapes. The Tribunal finds that by the genuine transactions concluded by the applicant in relation to the viticulture project, he conducts, through the manager, the business of growing and selling wine grapes from the vineplots licenced to him.
61. By sub-clauses 2.1 and 2.2 of the licence and management agreement the applicant has the non-exclusive right to enter onto the vineplots licenced to him to cultivate, tend, manage and maintain the grapevines located on the vineplots and the grapes harvested from them from time to time and to harvest and sell the grapes.
62. By sub-clause 5.1 of the licence and management agreement the applicant has appointed the manager, until 31 December 2012, to cultivate, develop, manage and maintain his vineplots according to Australian Industry Standard Viticultural practice as applied by the viticulture industry in South Australia. The manager’s appointment includes providing the services set out in item 5 of the schedule to the agreement and harvesting the grapes.
63. The manager is required by sub-clause 6.1 of the agreement, and subject to its power to delegate under clause 9, to manage the applicant’s interest in a commercial manner and in accordance with all relevant legislation and licences and, by sub-clause 6.5, to provide the applicant with six monthly reports.
64. The applicant may by written notice terminate his agreement with the manager in accordance with sub-clause 8.1 and, by sub-clause 8.2, the manager may be removed from its appointment by ordinary resolution of growers passed at a meeting of growers convened in accordance with clause 35 of the project deed which contains provisions relating to the duties and obligations of the trustee and in particular the trustee’s obligation to watch over and protect the interests of growers.
65. By sub-clause 10.1 of the agreement the manager is paid the management fee by the applicant annually in advance.
66. The applicant’s grapes are sold to the grape purchaser pursuant to the grape sales agreement.
67. The above arrangements clearly indicate that the applicant is conducting a business of growing and selling wine grapes and none of the matters raised by the respondent, considered alone or collectively, detract from that conclusion.
68. The fact that the applicant together with the other participants in the viticulture project did no more than execute the documents referred to in paragraph 30 of these reasons and make the disbursements he became liable to pay under those arrangements is no basis for concluding that he is not conducting a business. A full time employee, as the applicant was in June 1997, or indeed any other person, may carry on a business even if that person does not personally conduct the activities of the business but does so through an agent, Ferguson v FCT (1979) 79 ATC 4261 at 4270; Puzey v FCT (2003) ATC 4782 at 4791, cited with approval in Commissioner of Taxation v Sleight (2004) FCAFC 94 para 50.
69. The Tribunal rejects the respondent’s contention that the applicant did not intend by his outgoings to commence a business. This contention is irreconcilable with the terms of the agreements concluded by the applicant in particular those referred to in paragraphs 61 to 66 of these reasons, and so it cannot be sustained in circumstances where the genuineness of the relevant agreements is not disputed.
70. The fact that economies of scale may dictate that only the sale of the grape produce of at least 25 hectares will turn a profit does not preclude the applicant from conducting a grape growing business from his vineplots. It simply explains the nature of his business within the viticulture project in conjunction with the activities of other growers. The same may be said of the applicant’s undertaking not to interfere in the day-to-day management of his vineplots and of the facts that the applicant did not choose his vineplots, which are dedicated exclusively to the merlot grape variety rather than all the varieties named in the prospectus; that vines are planted in block units, using shared equipment, staff and irrigation facilities, according to the needs of the greater Coldridge Vineyard; that harvests are pooled for sale and that the applicant receives a proportionate share of the proceeds.
71. It follows from the Tribunal’s finding that the applicant is conducting a business of growing and selling wine grapes for the purpose of gaining or producing assessable income, that his proportionate share of the sale proceeds for the pooled grape harvests of the viticulture project constitute business profits in the applicant’s hands and not passive income from capital that consists of a beneficial interest or share in a business conducted by the manager. So the Tribunal finds that the disputed expenses, including the annual licence and management fees are not outgoings of capital for the purpose of s 51(1) or s8-1(2)(a), to acquire an interest in a business conducted by the manager. The viticulture project involves the seasonal growing, harvesting and sale of wine grapes over a 15 year period pursuant to the rights and obligations contracted for by the applicant or the trustee on his behalf. So the applicant’s interests in the viticulture project are to be distinguished from the taxpayer’s interests considered in Clowes v Federal Commissioner of Taxation (1954) 91 CLR 209 and Milne v Commissioner of Taxation (1975 – 1976) 133 CLR 526; see Vincent v Federal Commissioner of Taxation (2002) ATC 4742; Commissioner of Taxation v Cooke (2004) FCAFC 75 para.69.
72. The respondent made the further and alternative submission in relation to the management fees paid by the applicant for the first two years of the viticulture project, that they were excessive and were incurred in order to obtain the claimed deductions, and so tax savings, which funded the cash payments the applicant was required to make to the viticulture project. This submission raises the issue of the applicant’s motive in incurring the relevant management fees and its effect on their characterisation for the purpose of s 51(1) of s 8-1. The respondent referred the Tribunal to the decision in Ure v Federal Commissioner of Taxation (1981) 50 FLR 219.
73. According to the respondent the evidence shows that the applicant intended to participate in the development of a new vineyard; that the licence and management fees incurred in the first year were appropriate to the development of the vineyard; that the costs charged to the applicant in the first two years of the viticulture project reflect the high “start-up” costs to be expected in that period; that by the licence and management agreement, the applicant did not engage the services of the manager in respect of the development of the vineyard but in respect of the management of a vineyard that was already surveyed, irrigated, trellised and planted; that fees paid by the manager in sub-contracting its management services ($1, 175 per vineplot) were slightly higher than the fees appropriate for those services and that the applicant was aware that the licence and management fees borrowed by him might not be the subject of an actual exchange of funds between the manager and the lender.
74. The prospectus for the viticulture project contains an independent viticultural expert’s report (‘the report’) which briefly describes the proposed sequence of events at the viticulture project vineyard during year 1 of the project as follows:
“soil survey, irrigation design and layout, rip vine rows, sow cereal crop for soil conservation and windbreak, apply fertiliser, gypsum, organic manure, cultivate, install irrigation main pipelines, install trellis posts and wires, install and connect drip irrigation lines, spray vine row with weedicide, plant vines, irrigate, fertilise, weed, train young vines to trellis.
A high level of management and an experienced labour force, contractors and permanent staff, are required for the successful development of a vineyard.”
75. Mr Botting, in cross-examination, confirmed that from his observation of the development of the vineyard and the maps of the soil survey, he was left with the impression that the above works were diligently carried out in 1997 and 1998. The report confirms the budgeted per hectare development costs in year 1 of $37,233, inclusive of plant, equipment and water purchases as comparable with current industry costs, a view, Mr Botting testified, he shared.
76. At p 71 of the prospectus, under the heading ‘Utilisation of Funds’, $1,175 of the management fee for the year ending 30 June 1998 is allocated to maintenance expenditure for the services set out in item 5 of the schedule to the licence and management agreement, an amount which Mr Botting testified is relatively high but not excessive for those services.
77. In his evidence in chief, the applicant was referred to the concession made at the beginning of the hearing that the payment by the lender of licence and management fees borrowed by growers involved ‘round robin’ arrangements (see para 32 above) and he was asked whether he was aware of those arrangements. He responded as follows:
“I understood that I didn’t have to provide a lot of up front funding but I wasn’t aware of how the funding would move between the finance company and the manager and the developer. I really didn’t pay a lot of attention to that.”
78. As a general rule the quantum of an expense or outgoing is not relevant to its characterisation as an allowable deduction under s 51(1) or s 8-1, which refer to actual expenditure as opposed to the notional amounts that a more capable, more experienced or more prudent taxpayer might have incurred; Toohey’s Ltd v The Commissioner of Taxation for NSW (1922) 22 SR (NSW) 432 at 441. “It is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent”; Ronpibon Tin NL and Tougah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 60, cited in Cecil Bros Pty Ltd v Commissioner of Taxation (1964) 111 CLR 43 at 434.
79. S 51(1) and s 8-1, by the words “to the extent to which in s 51(1), and “to the extent that”, in s 8-1(1), provide for an undivided outgoing to be apportioned where, as a matter of fact, it is found not to have been wholly incurred for a deductible purpose sanctioned by the ‘positive limbs’ of s 51(1) or s 8-1).
80. The fact, however, that a voluntary outgoing, formally incurred in conducting a business to derive assessable income, is commercially out of all proportion to the service or other advantage contracted for, may lead, in the light of all the relevant circumstances, including the taxpayer’s subjective purpose, or that of the taxpayer’s agent, in incurring the contested expense, to the conclusion that all or some of it was expended for a different purpose. Similarly an outgoing that is formally a revenue expense may be characterised, either wholly or partially, as an outgoing of capital. The law in this regard was explained in the joint decision of the High Court in Fletcher and others v Commissioner of Taxation (1991) 173 CLR 1 at 18-19 as follows:
“The question whether an outgoing was, for the purposes of s51(1), wholly or partly ’incurred in gaining or producing the assessable income’ is a question of characterization. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. It has been pointed out on many occasions in the cases that an outgoing will not properly be characterized as having been incurred in gaining or producing assessable income unless it was “incidental and relevant to that end” (32). It has also been said that the test of deductibility under the first limb of s 51(1) is that “it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income’ (33). So to say is not, however, to exclude the motive of the taxpayer in making the outgoing as a possibly relevant factor in characterization for the purposes of the first limb of s 51(1). At least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterization of either the whole or part of the outgoing for the purposes of the sub-section (34). In that regard and in the context of the sub-section’s clear contemplation of apportionment, statements in the cases to the effect that it is sufficient for the purposes of s 51(1) that the production of assessable income is ‘the occasion’ of the outgoing (33) or that the outgoing is a ‘cost of a step taken in the process of gaining or producing income’ (35) are to be understood as referring to a genuine and not colourable relationship between the whole of the expenditure and the production of such income.
Nonetheless, it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of s 51(1) without any need to refer to the taxpayer’s subjective thought processes. That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income. In such a case, the characterization of the particular outgoing as wholly of a kind referred to in s 51(1) will ordinarily not be affected by considerations of the taxpayer’s subjective motivation. If, for example, a particular item of assessable income can be earned by making a lesser outgoing in one or two possible ways, one of which is a loss or outgoing of the kind described in s 51(1) and the other of which is not, it will ordinarily be irrelevant that the taxpayer’s choice of the method which was tax deductible was motivated by taxation considerations or that the non-deductible outgoing would have been less than the deductible one. In such a case, the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterize the whole outgoing as one which was incurred in gaining or producing assessable income. If the outgoing can properly be wholly so characterized, it ‘is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent’ (36).
The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing (37). Where that is so, it is a ‘commonsense’ or ‘practical’ weighing of all the factors which must provide the ultimate answer (38). If, upon consideration of all those factors, it appears that notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourable incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is either somehow excluded by the exception of ‘outgoings of capital, or of a capital, private or domestic nature’ or ‘incurred in relation to the gaining or production of exempt income’. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.”
(32)See e.g. Ronpibon Tin (1949), 78 CLR at p 56; Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956), 95 CLR 344, at p 350; Lunney v Commissioner of Taxation (1958), 100 CLR 478, at p 497; John (1989), 166 CLR at p 426; Ure v Federal Commissioner of Taxation (1981), 50 FLR 219, at pp 223, 231; 34 ALR 237, at pp 241, 248; Riverside Road (1990) 23 FCR at pp 311-312.
(33)See eg Ronpibon Tin (1949), 78 CLR at p 57; John (1989), 166 CLR at p 426.
(34)See eg W Nevill & Co Ltd v Federal Commissioner of Taxation (1937), 56 CLR 290 at pp 301, 308; Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978), 140 CLR 645 at p 660; John (1989), 166 CLR at p 426; Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980), 49 FLR 183 at p 189; 33 ALR 213 at pp 218-219; Ure (1981), 50 FLR at pp231-232; 34 ALR at pp 248-249; Federal Commissioner of Taxation v Ilbery (1981), 58 FLR 191 at pp 199-201; 38 ALR 172 at pp 179-180.
(35) See John (1989), 166 CLR, at p 427.
(36)See eg Ronpibon Tin (1949), 78 CLR at p 60; Cecil Bros Pty Ltd v Federal Commissioner of Taxation (1964), 111 CLR 430 at p 434.
(37)See eg Robert G Nall Ltd v Federal Commissioner of Taxation (1937), 57 CLR 695 at pp 699-700, 706, 708-709, 712-713.
(38)See eg BP Australia Ltd v Federal Commissioner of Taxation (1965), 112 CLR 386, at pp 396-397; [1966] AC 224 at p 264; Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946), 72 CLR 634 at p 648; Federal Commissioner of Taxation v Foxwood (Tolga) Pty Ltd (1981), 147 CLR 278 at pp 285, 293.
81. The applicant submitted that all of the disputed expenses are deductible pursuant to s 51(1) and s 8-1 in the 1997, 1998 and 1999 years because they were incurred in the gaining or production of assessable income or necessarily incurred in carrying on a business for the purpose of gaining income. The applicant relied on the contentions set out in paras 82 to 88 of these reasons.
82. None of the agreements by which the applicant participated in the viticulture project is a sham and so the disputed expenses were ‘incurred’ for the purpose of s 51(1) or s 8-1.
83. The relevant income is the proceeds from the sale of the wine grapes harvested from the applicant’s vineplots.
84. In characterising the disputed expenses it is necessary to identify what they were for; Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213. The disputed expenses were incurred to obtain the use of and to manage and maintain a commercial vineyard of wine grapes which could be harvested and sold at a profit. To the extent that the applicant’s subjective purpose is relevant to the characterisation of the disputed expenses, it was the same.
85. This is not a case where it can be said objectively that at the time the applicant’s vineplots were licensed to him there was no prospect of deriving assessable income greater than the disputed outgoings or that at the time the disputed expenses were incurred it was not expected that the viticulture project would run its course.
86. The applicant has derived assessable income from the sale of wine grapes in each year since 2000 and has been making a gross profit from his wine growing business before interest since 2002.
87. The existence of the required nexus between the disputed expenses and the gaining of income is confirmed by the applicant’s expert Mr Botting and the objective evidence of the income derived by the applicant from the viticulture project to date which has exceeded $31,000 and is within 2.5% of prospectus forecasts after 7 years. If the viticulture project continues to perform according to prospectus forecasts the applicant will make substantial profit from his business.
88. The disputed expenses were on revenue account because the applicant paid a management fee to the manager to operate and manage an agricultural business on his behalf on a continuing basis from which the applicant intends to derive assessable income. As licensee for a fixed term, the applicant has obtained no enduring benefit from the licence or management fees. The applicant cited the following decisions in support of this contention: Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157; Commissioner of Taxation v Brand (1995) 95 ATC 4633; Commissioner of Taxation v Lau (1984) 6 FCR 202; Merchant v Commissioner of Taxation (1999) 99 ATC 4221; Puzey v Federal Commissioner of Taxation 2002 FCA 1171; Commissioner of Taxation v Sleight (2004) FCAFC 94 and Commissioner of Taxation v Cooke (2004) FCAFC 75.
89. It was not disputed, and the Tribunal finds, that the applicant was alerted to the viticulture project by his stockbrokers after he had informed them that he wanted to look at business opportunities for his impending retirement. They sent him the promotional brochure and the project prospectus in early June 1997 and suggested that he should read them closely (A2 para 11). The evidence establishes that this is precisely what the applicant did. He chose to participate in the viticulture project on the basis of his evaluation of the information in the disclosure documents which were available to the investing public generally. The evidence clearly establishes that the agreements by which the applicant participated in the viticulture project were concluded at arm’s length and, in particular, that the applicant played no part in designing the offer that the prospectus contained. So the applicant’s position is distinguishable from that of the taxpayer in Ure v Federal Commissioner of Taxation (1981) 34 ALR 237, who obtained three separate loans from different lenders at interest rates varying from 7.5% to 12.5% p.a. He then on-lent the moneys to related parties at an interest rate of 1% p.a. to achieve the non-income producing objects and advantages of providing family accommodation and bettering the financial position of his wife and family trust, in contrived circumstances that would make the interest cost of those advantages deductible. As Brennan J found in his reasons for judgment at p.242 “there is an air of unreality about the proposition that the borrowed moneys were laid out wholly for the purpose of earning a return of 1% p.a.” The Tribunal finds that the same cannot be said of the proposition that the applicant expended the management fees for the first two years of the viticulture project wholly to produce assessable income or in carrying on a business for that purpose.
90. It may be inferred that the offer made to prospective participants in the viticulture project prospectus would have been considerably less attractive without the prospect that the prepaid management fees were deductible for income tax purposes. A similar threshold observation was made in relation to the horticultural project under consideration in Commissioner of Taxation v Cooke (2004) FCAFC 75 para 54. Indubitably that prospect played a role in the applicant’s decision to participate in the viticulture project – the extent to which it objectively did so is a matter considered elsewhere in these reasons in relation to the general anti-avoidance provisions in Part IVA of the Act.
91. If one proceeds on the basis that the prepaid management fees in years 1 and 2 of the viticulture project, incurred by the applicant, were excessive for the services contracted for in those years, the question posed by the respondent’s submission is whether on that account they are to be characterised as non-deductible for the purpose of s 51(1) of the Act, or s 8-1 of the 1997 Act, because their relationship to the production of assessable income is colourable and they point to the applicant’s subjective pursuit of a tax deduction rather than assessable income; Fletcher and others v Commissioner of Taxation (1991) 173 CLR 1 at 18-19 reproduced at para 80 of these reasons. The Tribunal finds that the answer is no because although the disputed fees may have been disproportionate to the services they bought, they, together with the other expenses incurred by the applicant, were not disproportionate to the assessable income that was expected to flow to the applicant from the viticulture project. They were incurred by the applicant in genuine transactions at arm’s length in the course of his acceptance of the offer to participate in the viticulture project contained in the prospectus. In these circumstances the amount of the disputed fees and the applicant’s subjective motivation in relation to their income tax treatment are irrelevant to their characterisation for the purposes of s 51(1) of the Act or s 8-1 of the 1997 Act.
92. The Tribunal finds that the disputed expenses of $17,204 were allowable deductions in calculating the applicant’s taxable income for the year ended 30 June 1997 pursuant to s 51(1) of the Act and the disputed expenses of $12,765 and $6,058 were general deductions in calculating the applicant’s taxable income for the years ended 30 June 1998 and 30 June 1999 respectively pursuant to s 8-1 of the 1997 Act.
Part IVA of the Act
93. By Part IVA, the respondent has a discretion to cancel a tax benefit obtained by a taxpayer in connection with a scheme if it would be concluded, having regard to the matters stipulated in s 177D(b) (i) to (viii), that any of the persons, including the taxpayer, who entered into or carried out the scheme (or part of it) did so to enable the taxpayer to obtain the tax benefit. An outgoing or loss deductible under s 51 of the Act or s 8-1 of the 1997 Act is a tax benefit for these purposes where the requirements of s 177C (1) (b) are satisfied
Legislation
94. The following provisions in Part IVA are relevant to this matter:
‘177A(1) In this Part, unless the contrary intention appears:
…
‘scheme’ means:
(a)any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b)any scheme, plan, proposal, action, course of action or course of conduct;
…
177C(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
…
(b)a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
…
and for the purposes of this Part, the amount of the tax benefit shall be taken to :
…
(d) in a case to which paragraph (b) applies – the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph;
177DThis Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date) whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:
(a)a taxpayer (in this section referred to as the relevant taxpayer) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b)having regard to:
(i)the manner in which the scheme was entered into or carried out;
(ii)the form and substance of the scheme;
(iii)the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v)any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi)any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonable be expected to result, from the scheme;
(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii)the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
It would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).
…
177F(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may:
…
(c)in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income – determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
…”
The Schemes
95. It was not disputed, and the Tribunal finds, that the making and implementation of the prospectus, the licence and management agreement, the loan agreement, the grape sale agreement and the project deed, by which the viticulture project was set up, constitute a scheme in this matter for the purpose of s 177A(1) (‘the scheme’).
96. The respondent formulated the following alternative schemes in his amended facts and contentions:
’42. Alternatively, there was a scheme comprised of:-
A.the terms of the licence and management agreement by which participants, including the applicant were obliged to pay in advance annual management fees and licence fees totalling $43,2000 in the 1997, 1998, 1999, 2000, 2001 and 2002 income years;
B.the terms of the loan agreement by which participants, including the applicant:-
(i)borrowed all fees payable under the management and licence agreement (save for payment of the initial licence fee, $1,000);
(ii)made interest prepayments of $602 per vineplot by 30 June 1997;
(iii)borrowed all interest payable on the loan (save for the initial payment by him of$602 per vineplot);
(iv)were obliged to and made the principal repayments;
(v)satisfied the remaining obligations under the loan agreement from the proceeds under the grape sales agreement reduced by 48.5% of the balance remaining after the deduction of licence and management fees and interest.
C.entries in the books of account of the lender, manager and trustee by which the lender’s obligation to remit the principal sum in satisfaction of the participants’ obligations under the licence and management agreements, including the applicant’s, was effected without any actual exchange of funds.
44.Further alternatively, there was a scheme comprised of:-
A.the terms of the loan agreement by which participants, including the applicant:-
(i)borrowed all fees payable under the management and licence agreement (save for payment of the initial licence fee, $1,000);
(ii)made interest prepayments of $602 per vineplot by 30 June 1997;
(iii)borrowed all interest payable on the loan (save for the initial payment by him of $602) per vineplot);
(iv)were obliged to and made the principal repayments;
(v)satisfied the remaining obligations under the loan agreement from the proceeds under the grape sales agreement reduced by 48.5% of the balance remaining after the deduction of licence and management fees and interest;
B.entries in the books of account of the lender, manager and trustee by which the lender’s obligation to remit the principal sum in satisfaction of the participants’ obligations under the licence and management agreements, including the applicant’s, was effected without any actual exchange of funds.”
97. The applicant conceded that the respondent’s alternative formulations constitute schemes for the purpose of s 177A (1) but denies that the disputed expenses are tax benefits in connection with the alternative schemes.
98. In relation to the scheme identified in paragraph 43 of the respondent’s amended facts and contentions, the applicant submitted that because the scheme is limited to the years 1997 to 2002, in which time he did not derive any business profits and incurred a substantial loss, there would be no tax benefits because the principles set out in Fletcher and others v Commissioner of Taxation (1991) 73 CLR one would apply to make the disputed expenses non-deductible under s 51(1) of the Act and s 8-1 of the 1997 Act.
99. In relation to the scheme identified in paragraph 44 of the respondent’s amended facts and contentions, the applicant submitted that because it is confined to the loan agreement, which generates interest expenses and no assessable income, the interest expenses would not be generally deductible under s 51(1) or s 8-1 and so the applicant could not obtain a tax benefit in connection with the scheme. Alternatively if there is a nexus with the derivation of income (which is denied) the only tax benefit obtained in connection with the scheme is the allowable deduction for interest. The applicant referred the Tribunal to the decision in Commissioner of Taxation v Sleight (2004) FCAFC 94 at para 99 denying the respondent leave to formulate a different, narrower scheme at the appeal.
100. The respondent’s written submissions include the general submission in para 17 that if the scheme or the alternative schemes had not been entered into or carried out the disputed expenses would not have been allowable deductions to the applicant.
Tax Benefits
101. It was common ground between the parties, and the Tribunal finds, that the disputed expenses are tax benefits obtained by the applicant in connection with the scheme for the purposes of ss 177C(1)(b) and 177D(a) of the Act.
102. In para 18 of the respondent’s written submissions alternative tax benefits were identified as follows:
“18.However, as the Full Court was in Sleight, so might this Tribunal be attracted to the view that the appropriate part of the tax benefit obtained in connection with the scheme, in the proper exercise of discretion under section 177F (1), be confined to the difference between the whole of the respective amounts claimed by the applicant as deductions and the amount of cash payments the applicant was required to make to the project, as follows:-
1997$15,000 ($17,204 - $2,204)
1998$7,265 ($12,765 - $5,400)
1999$58 ($ 6,058 - $6,000)
Although the cash payments were termed interest and principal repayments by the project documents, it was by these cash payments that the project was actually funded. They formed the “commercial” component of the total deduction obtained by the participants.”
103. The passage adverted to in the above submissions, in Commissioner of Taxation v Sleight (2004) FCAFC 94 paras 112 to 114, reads as follows:
“122 At the close of the hearing Senior Counsel for the Commissioner indicated that the Court might consider that the tax benefit should be cancelled only to the extent of the deductions not reflected in the cash outlays actually made by Mr Sleight and his wife, but excluding such outlays as were of a capital nature such as the subscription for shares and the cost of seeds. However, it had not been argued on behalf of Mr Sleight that a deduction should be allowed of the actual cash outlaid. Rather the case was argued on what may be called an “all or nothing” basis, that is to say that either the whole amounts claimed were deductible or none of them were.
(b)By the licence and management agreement, the grape sales agreement and the loan offer, the grape purchaser, by itself or through its subsidiaries, retained the proceeds from the vineyard:
(i)Until December, 2003, the participant’s share of the proceeds were $747 per tonne of grapes, adjusted to CPI increases. (That was 80% of the 1997 market price of $933.75 per tonne. After December, 2003, the participant was to be paid 80% of the defined market rate;
(ii)Until the loan was repaid, the participants’ 80% share of the proceeds was reduced by licence and management fees and interest. The remainder was allocated to repayment of the loan save for 48.5%, enough for the participant to pay tax on the proceeds earned;
(iii)According to the project projections the participant would only begin to pocket returns from the vineyard from 2007, once the loan was repaid. The participant’s 80% share of the proceeds of the sale of grapes would continue to be reduced by licence and management fees charged throughout.
132. It was unlikely that the projections would be met. They were based on the unrealistic assumption that grape prices would increase by 12% in each of the 15 years of the project. In the result, the loan would never be repaid and the grape purchaser would continue to retain proceeds of the vineyard by way of application against the participant’s loan account.
133. Ultimately, because of the early year tax savings and the non-recourse loan, grape prices would never matter. Participants would never have a negative net cash flow from the project. If grape prices went down, participants would still obtain positive cashflows on the tax savings generated by losses on the project.
134. The applicant submitted that the substance and form of the arrangements in relation to the viticulture project were the same. None of the agreements in connection with the project was a sham and the project as a whole was not a sham. The contractual arrangements were neither complex nor artificial and were similar to many managed investment scheme projects which are carried on for commercial gain in the viticultural field. All of the viticulture project agreements were entered into at arm’s length and the fees charged were not excessive and compared favourably with fees charged in other like viticultural projects which have been endorsed with product rulings by the respondents.
135. At the hearing the applicant sought to lead evidence of the management fees charged in connection with another viticulture project, covered by a product ruling issued by the respondent, to show inferentially that the management fees in relation to the present matter are not excessive. The Tribunal ruled the evidence irrelevant and so inadmissible, on the basis that the question of whether the management fees in this matter are excessive must be decided on the facts and circumstances by which they were determined and not inferentially from the facts of another, albeit similar, viticulture project.
136. The applicant made the further submission that the viticulture project was established and is operated and managed by the manager in a professional, commercial and business-like manner.
S 177D (b) (iii): the time at which the scheme was entered into and the length of the period during which the scheme was carried out.
137. The issues raised in the respondent’s submission in relation to s 177D (b) (iii) are set out in paragraphs 138 to 140 of these reasons.
138. The project was designed to take advantage of the “tax selling season”.
139. The applicant applied for vineplots on 19 June, 1997.
140. The project continues until 2012 when the vineyard will revert to the grape purchaser.
141. The applicant’s submission in this regard was that the duration of the viticulture project points to an ongoing commercial operation taking place over a 15 year period. It is not a short term project which terminates once the deductible expenses have been claimed for income tax purposes. It is a project which both in form and in substance contemplates an activity over some 15 years before the various agreements terminate and the vineyard reverts to the landowner.
142. The applicant also submitted that he had an existing knowledge and interest in the wine industry and that he carefully considered the commercial merit of the viticulture project prior to participating in it. The applicant’s participation in the project did not result from a flurry of activity on the last day of June 1997 but was entered into well before 30 June 1997 and after careful consideration by the applicant of the project’s commercial merit.
S 177D(b)(iv): the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme
143. But for Part IVA, the only result in relation to the operation of the Act and the 1997 Act, identified by the respondent and not disputed by the applicant, is that the disputed expenses are allowable deductions in the years they were incurred under s 51(1) of the Act, or s 8-1 of the 1997 Act, in calculating the taxable income of the applicant.
S 177D(b)(v): any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme
144. The issues raised in the respondent’s submission in relation to s 177D (b) (v) are set out in paragraphs 145 to 147 of these reasons.
145. As a result of the project, the applicant could expect a total improvement in his after-tax cashflow over the life of the project of $70,488.
146. However, before 2003, his net cash inflow was to come not from earnings from the vineyard, but from tax savings (1997-2002). This financial result arose because the applicant’s claimed deductions (totalling $36,031) far exceeded the cash payments (totalling $19404) required of him. The resulting tax savings exceeded those cash payments and created an internal rate of return on investment in the project of 60% compared with 17% if the participant funded the licence and management fees himself. These were the only numbers that are set out in the prospectus. Figures such as forecast average before tax return of 39% per annum referred to in paragraph 4 of the Applicant’s Outline of Argument do not appear anywhere in the prospectus.
147. From 2003 to 2006, the applicant was to have no net cashflow owing to loan commitments and taxation liabilities. Only 10 years after the project commenced, in 2007, was the applicant first to obtain after-tax returns from the vineyard.
148. The applicant relied on his actual position to date of the hearing as commercial justification for the investment. However, as noted by Carr, J. in Commissioner of Taxation v Sleight [2004] FCAFC 94; 2004 ATC 4477 at [224], the applicant’s actual position is not material because
“on a proper construction of s 177D(b) the assessment is to be made … as at the time of entry into the scheme.”
The applicant contended that in his case the essential premise on which the project’s financial projections were based remains the same. The actual deductions generated tax savings which covered the cash payments required of him. Thus they gave him the same substantial benefit. The applicant’s current position (at year 6 of the 15 year project) results from another factor, the better than expected yields in the early years of the project and the fixed prices payable for grapes over the same period pursuant to the grape sales agreement.
149. In paragraph 4 of the applicant’s outline of argument (see paragraph 142 above) the applicant made the submission that the viticulture project made commercial sense ignoring tax advantages because it forecast net before tax returns of $186,000 on a net before tax outlay of $33,562 which equates to a forecast average before tax return of 39% per annum over the 15 year life of the viticulture project.
150. The applicant submitted that the actual income he has derived from the viticulture project to date indicates that it is commercially viable. Unlike the miniscule projected returns which are delayed over a long period of time from the tea tree project that was the subject of the decision in Commissioner of Taxation v Sleight (2004) FCAFC 94, both the actual and the projected returns from the viticulture project are reasonable and commence from the second year of the project and are projected to increase each year over the 15 year period. If the viticulture project continues to perform according to prospectus forecasts the applicant will make a substantial profit.
151. The applicant submitted further that this is not a case where there is substantial uncertainty concerning the investment yields the viticulture project might realise. The objective evidence of the commercial returns derived by the applicant to date confirm that the projected returns and yields are far from being uncertain.
152. Relying on the evidence of Mr Botting that it would cost approximately $1.5million for an investor to participate in the wine grape industry on a stand-alone basis, the applicant submitted that his participation in the viticulture project was therefore the only commercially viable alternative for an investor like the applicant who was approaching retirement and who wished to participate.
S 177D(b)(vi): any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonable be expected to result, from the scheme
153. The respondent made the submissions in paragraphs 154 to 156 of these reasons in relation to s 177D (b) (vi).
154. The project companies and their ultimate holding company, the grape purchaser, had a business connection with the applicant. He was a participant in their project.
155. By the project, the grape purchaser obtained funds for the development of its Coldridge North Vineyard. It did so by selling licence and management agreements through its subsidiary, the manager. These licence and management agreements gave purchasers access to tax savings which they ultimately paid to the grape purchaser through another subsidiary, the lender, in return for a (small) share of the profits of the vineyard.
156. As a result of the project, substantial profits were generated for the group as a whole.
S 177D(b)(vii) and (viii): any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)
157. The respondent submitted that it is significant that there are no other consequences to the participant owing to the effects of the tax benefits and the non-recourse loan.
158. The respondent submitted that the following critical matters emerge from a consideration of each of the matters listed in s 177D(b):
“The project was structured and then marketed (as appears in the prospectus and promotion documents) to participants on the basis that by accepting the limited recourse loan option:
(i)entry into the project could be obtained for a limited cash payment;
(ii)project payment obligations would be met from the loan;
(iii)participants would qualify for tax deductions in respect of the payment obligations;
(iv)the cash repayments under the loan in the 1997 to 2001 years were the only cash payments required of the participants and were fully funded by savings in income tax otherwise payable.
Participants in the project, including the applicant, incurred obligations:-
(i)in the 1997 year totalling $17,204 for management fees ($15,000), licence fees ($1,000) and prepaid interest ($1,204);
(ii)in the 1998 year totalling $12,769 for management fees ($10,000), licence fees ($1,000) and prepaid interest ($1,765);
(iii)in the 1999 year totalling $6,058 for management fees ($2,872), licence fees ($1,000) and prepaid interest $2,158);
(iv)in the 2000, 2001 and 2002 years for fees and interest totalling $17,944 adjusted by the cumulative effect of the consumer price index from 30 June, 1997.
By contrast, the only payments required of participants in the project, including the applicant, were:
(i)in the 1997 year, $2,204 for licence fees ($1,000) and prepaid interest ($1,204);
(ii)the principal repayments being, in the 1998 year, $5,400, in the 1999 year, $6,000, in the 2000 year, $2,600 in the 2001 year, $2,000, and in the 2002 year, $1,2000.
The taxable income of participants in the project, including the applicant, in each of the 1997, 1998, 1999, 2000, 2001 and 2002 years was reduced by the amount of the obligations incurred. The resulting tax savings were greater than the cash payments required of them (prospectus, page 3).
Obligations incurred by participants in the project, including the applicant, in each of the 1997, 1998, 1999, 2000, 2001 and 2002 years did not serve the commercial purpose of funding the project:-
1.Save for the initial payment of $1,000 for licence fees, all licence and management fees payable pursuant to the licence and management agreement were satisfied on behalf of participants, including the applicant, by the lender without any actual exchange of funds, by means of a “round robin” transaction (in the 1997 year) and entries in the books of account (each of the 1997, 1998 and
(i)1999 years) (sic) of the lender, the manager and the trustee as described in paragraphs 15-17 above;
(ii)Save for the initial prepayment of interest in the amount of $1,204, prepaid interest payable pursuant to the loan agreement was debited to the loan accounts of participants, including the applicant, in each year;
(iii)Save for the principal repayments, other repayment obligations under the loan agreement were to be satisfied from the pro rata share of participants including the applicant, in the proceeds of the sale of grapes grown on the project land.
Accordingly, it would be concluded that the sole or dominant purpose of the applicant in undertaking the obligations incurred by him in relation to the project was to generate a large up-front tax deduction resulting in tax savings to him which were sufficient to fund the cash payments the applicant was required to make in respect of his participation in the project whilst leaving him a cash surplus expected to amount to $1,376 by the 2002 year (prospectus, page 5).
Further or alternatively, it would be concluded that the sole or dominant purpose of the manager and/or the lender and/or the buyer and/or the trustee and/or Price Waterhouse and/or Mr J. Pope and/or Porter Western Ltd was to create obligations in participants in the project, including the applicant, which generated large up-front tax deductions from which the funding requirements of the project would be met.”
159. The applicant submitted that after consideration of all the evidence and the facts and circumstances of this matter, and having regard to the eight factors in s 177D(b), a reasonable person would not conclude that the sole or dominant purpose of the applicant in participating in the viticulture project was to obtain the taxation benefits flowing from it.
160. The applicant contended further that a reasonable person could not conclude that the dominant purpose of the grape purchaser, the manager, the lender, the trustee or their respective professional advisers was to obtain the relevant tax benefits for the applicant. The dominant purpose of the promoter and its related entities and advisers was to obtain a profit from the arrangements for the promoter, Vincent v Commissioner of Taxation (2002) 193 ALR 686; Puzey v Federal Commissioner of Taxation (2002) FCA 1171; Commissioner of Taxation v Sleight (2004) FCAFC 94 and Cooke v Commissioner of Taxation (2002) FCA 1315. The promoter derived a significant profit from fees charged under the viticulture project and on its completion the fully established and profitable vineyard will revert to the promoter.
161. The applicant referred to the following conclusion in the decision of Justices Gummow and Hayne in Commissioner of Taxation v Hart (2004) HCA 26 at paragraph 53:
“The bare fact that a taxpayer pays less tax, if one form of transaction rather than another is made, does not demonstrate that Part IVA applies. Simply to show that a taxpayer has obtained a tax benefit does not show that Part IVA applies.”
162. In a letter to the Tribunal after the hearing, the applicant drew the Tribunal’s attention to the decision of the High Court in Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) HCA 55 at paragraphs 43 to 56.
163. At the outset the Tribunal finds that, for the purpose of s 177D (b) of the Act, it would not be concluded on the evidence in this matter that the grape producer, its professional advisers or any of the entities it created to implement the viticulture project, entered into or carried out the scheme, or any part of it, to enable the applicant, or any other taxpayer, to obtain a tax benefit in connection with it. The evidence establishes that the grape producer, and its professional advisors, designed and marketed the viticulture project as an extension of its existing Coldridge Vineyard in South Australia and that the unrelated participants in the project, through their licence and management agreements, have access to the land, infrastructure, skills, expertise and goodwill associated with the promoter’s pre-existing, substantial wine growing business. These facts are indicative of the project’s commercial viability and a prevailing business purpose to obtain profits, on the part of the promoter and its associates, in entering into it. Although the viticulture project was designed to include the tax benefits, it cannot be said, on the evidence, that the principal purpose of the promoter, or the entities associated with it, was to enable the applicant to obtain the tax benefits. So it remains to be determined what the applicant’s principal objective purpose was in entering the scheme having regard to the matters enumerated in s 177D(b).
164. In relation to the manner in which the applicant entered into the scheme, the Tribunal finds the following facts relevant to his objective purpose in doing so: by accepting the loan offer described in paras 27 to 29 of these reasons, the applicant borrowed the relevant licence and management fees and the interest cost of the loan, save for an initial outlay of $2,204, in circumstances where the pre-payment of the licence and management fees by the lender on behalf of the applicant involved the ‘round robin’ arrangement set out at para 33 of these reasons and the applicant’s liability was limited to the primary instalment amounts per vineplot set out at para 29 of these reasons; so the lender recovers the balance of the loan from the proceeds of the sale of the applicant’s grapes and the applicant’s liability for the primary instalments is funded by the income tax saved by deducting the disputed expenses which the parties were agreed are the tax benefits in connection with the scheme. The Tribunal finds that these facts objectively indicate a prevailing purpose on the applicant’s part to obtain the tax benefits, a finding which, in the Tribunal’s view, is not diminished by the facts that the applicant is a man of means; the applicant did not claim the relevant tax refunds at the earliest opportunity; the applicant participated in the viticulture project at the minimum level; the promotional material did not over-emphasise the tax benefits; the ‘round robin’ arrangements are legally effective – Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) HCA 55 at para 47 and the limited recourse loan was a commercially sensible option for the applicant in his circumstances.
165. In relation to the form and substance of the scheme, the Tribunal finds that they are different in two respects material to the application of s 177D (b). First, although the genuineness of the relevant arrangements concluded by the applicant is uncontested, they relate to extant ‘vineplots’ which the evidence establishes were brought into existence sometime after the contracts were made. Secondly, and more significantly, the formal arrangements by which the applicant conducts his business of growing wine grapes, including the limited recourse loan, have the practical effect of a passive investment which, but for the tax benefits, would ordinarily have been cast in a different legal form. The Tribunal finds that these distinctions between the form and substance of the scheme point to a prevailing purpose on the part of the applicant to obtain the tax benefits.
166. In relation to the time at which the applicant entered into the scheme and the duration of the scheme, the fact that the disputed expenses were incurred towards the end of the year preceding the commencement of the viticulture project would indicate the purpose of obtaining those tax benefits whereas no such inference is to be made from the length of the period during which the scheme is being carried out and which, the Tribunal finds, points to a predominantly commercial purpose.
167. The result in relation to the operation of the Act and the 1997 Act that, but for Part IVA, would be achieved by the scheme is that the applicant is entitled to the tax benefits that accrue from the income tax deductibility of the disputed expenses, a result that unequivocally indicates a dominant purpose of obtaining those benefits which exceed his disbursements in respect of the viticulture project.
168. S.177D (b) (v) requires the Tribunal to have regard to “any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme”. The Tribunal has referred to the commercial viability of the viticulture project elsewhere in these reasons and the evidence establishes its success to the date of the hearing and no cause to doubt that it will proceed to a successful conclusion in 2012. The respondent, citing the reasons for judgment of Carr J. in Commissioner of Taxation v Sleight (2004) FCAFC 94 at para 224, submitted that the matter in s 177D (b) (v) is to be assessed as at the time of entry into the scheme. It was implicitly held in the reasons for judgment of Nicholson J in Calder v Commissioner of Taxation [2005] FCA 911 at para 106 that the decision maker must find whether, at the point of entry, the commercial benefits were certain or uncertain as against the certainty of tax benefits incorporated in the scheme. Commercial benefits are seldom without risk and so absolutely certain. The viticulture project is managed as an extension of the grape purchaser’s wine growing operations and as such is not subject to risks of failure beyond those ordinarily associated with a vineyard business. On the other hand, according to the prospectus projections, the applicant would begin to derive after tax returns in 2007 i.e. after 10 years. This projection at the time of entry into the scheme would indicate a prevailing purpose on the part of the applicant to obtain the tax benefits.
169. In relation to any change, emanating from the scheme, in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the applicant, the Tribunal finds that the connection, which arose when the applicant entered the scheme, between the applicant and the grape producer, including the companies created to implement the scheme, is not a connection of the nature contemplated in s 177D (b) (vi); Commissioner of Taxation v Sleight (2004) FCAFC 94 paras 89 and 229.
170. The Tribunal finds that there are no other relevant consequences for the applicant, or connections between the applicant and any person referred to in s 177D (b) (vi), that arise from the scheme in relation to matters in ss 177D (b) (vii) and (viii) and the fact that there are no such consequences or connections is neutral in applying the test in s 177D (b).
171. The Tribunal has found on the evidence in this matter that, by participating in the viticulture project, the applicant is carrying on the business of growing wine grapes and that he had a discernable commercial or business purpose in entering the scheme to achieve the further purpose of providing for his retirement. These findings, however, do not determine the answer to the question whether, for the purpose of s 177D (b) of Pt IV A of the Act, the applicant entered the scheme for the dominant purpose of obtaining the tax benefits; Federal Commissioner of Taxation v Spotless Services Ltd. (1996) 186 CLR 404 at 416; cited with approval in Commissioner of Taxation v Hart (2004) HCA 26 at para 52. By the same token “[S]imply to show that a taxpayer has obtained a tax benefit does not show that Pt IV A applies” and the question is always whether the terms of the Act apply to the facts and circumstances of the particular case; Commissioner of Taxation v Hart (2004) HCA 26 at paras 52 and 53.
172. By s 177D (b), the Tribunal is required to reach a conclusion as to whether the applicant entered into the scheme predominantly to obtain the tax benefits, based exclusively on the objective matters identified in ss 177D (b) (i) to (viii) and so without referring to his subjective motives for entering into the scheme; Commissioner of Taxation v Hart (2004) HCA 26 at para 65.
173. The Tribunal considered each of the matters listed in s 177D (b) singly and collectively, in relation to the facts and circumstances of the scheme and the Tribunal finds that, on the balance of the probabilities arising in connection with the listed matters, the applicant entered into the scheme with the prevailing purpose of obtaining the tax benefits and so the Tribunal finds that Part IV A of the Act applies to the scheme.
174. Where a taxpayer has obtained tax benefits referable to allowable deductions in connection with a scheme to which Part IV A of the Act applies, the respondent, by s 177 F (1) (b), may determine that all or part of the deduction shall not be allowable in the relevant year of income. In this matter the respondent determined to cancel the whole of the tax benefits, a determination which the Tribunal finds inappropriate to those parts of the cancelled tax benefits attributable to the applicant’s disbursements of $2,204, $5,400 and $6,000 in 1997, 1998 and 1999 respectively. So the Tribunal determines, pursuant to s 177 F of the Act, that the tax benefits obtained by the applicant in relation to the scheme shall not be allowable deductions in calculating his taxable income to the extent of $15,000 in the income year ended 30 June 1997, $7,365 in the income year ended 30 June 1998 and $58 in the year ended 30 June 1999.
175. The Tribunal sets aside the reviewable objection decisions of 19 April 2002 and remits these matters to the respondent for reconsideration in accordance with the direction that the respondent issue further amended assessments to income tax to the applicant that give effect to the Tribunal’s determination pursuant to s 177 F of the Act that the tax benefits obtained by the applicant in relation to his participation in the Austvin Vineyards 1997 Project shall not be allowable deductions in calculating his taxable income to the extent of $15,000 in the income year ended 30 June 1997, $7,365 in the income year ended 30 June 1998 and $58 in the income year ended 30 June 1999.
I certify that the 175 preceding paragraphs are a true copy of the reasons for the decision herein of Associate Professor G A Barton, Member
Signed: ..........(Sgd. N D’Rozario) .................................
AssociateDate/s of Hearing 12 – 15 July 2004
Date of Decision 17 August 2005
Counsel for the Applicant Mr T N Cullity
Solicitor for the Applicant Mr F C Wilson, Messrs Wilson & AtkinsonCounsel for the Respondent Ms H Symon of Senior Counsel and Ms L Price of Counsel
Solicitor for the Respondent Mr T Burrows, Australian Government Solicitor
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