Macpherson and Commissioner of Taxation

[2007] AATA 1092

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2007] AATA 1092

ADMINISTRATIVE APPEALS TRIBUNAL                   N° VT2004/145

TAXATION        APPEALS        DIVISION
Re:		JAN MACPHERSON

Applicant

And: COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal:Mr B.H. Pascoe, Senior Member

Date:28 February 2007

Place:Melbourne

Decision:The Tribunal affirms the decision under review.

(sgd) Mr B.H. Pascoe

Senior Member

TAXATION – investment in grape project – whether expenditure deductible – whether expenditure of capital nature – Part IVA – tax benefit – objective purpose of scheme – penalties

Income Tax Assessment Act 1936

Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404

Howland-Rose v Commissioner of Taxation (2002) 118 FCR 61

Macpherson and Commissioner of Taxation (2007) AATA 1022

REASONS FOR DECISION

28 February 2007  Mr B.H. Pascoe, Senior Member

1.      This is an application to review a decision of the respondent Commissioner of Taxation to disallow an objection against the applicant’s amended assessment of income tax for the year ended 30 June 1997.  The objection was against the disallowance of deductions claimed in respect of an investment in a project described as Budplan “A” Series No 1 (BAS1).

2.      At the hearing the applicant, Ms J. Macpherson, was unrepresented.  The respondent was represented by Ms D. Harding of counsel.  Evidence was given by Ms Macpherson and by Mr R. Watts, the financial adviser who recommended the investment to Ms Macpherson.

3.      After consultation with Mr Watts of Personal Financial Planners Pty Ltd, Ms Macpherson decided to invest in this particular project.  The prospectus for the project summarised the purpose in the following terms:

By participating in Budplan “A” Series No. 1 a participant engages in the business of development for growing, sale, and licensing of the intellectual property of specified table grape varieties, or enhanced varieties, including the carrying out of all necessary scientific research and the growing for sale of table grapes.

It is intended that, subject to the inherent risks, which are set out later in this Prospectus, a participant’s business will return profits from the sale or licensing of the relative intellectual property to growers wishing to grow the varieties, or to agents who may sub-licence the use of the varieties, regional joint ventures of strategic alliances.  Participants will also be in the business of growing table grapes for sale.

An applicant will commence business by entering into a Farm Agreement, a Management Agreement and a Research Agreement via the enclosed Power of Attorney and paying $200 (or multiple thereof) to cover business establishment expenses.

A participant’s efforts will be combined with others to maximise returns and the scope of a participant’s business activities.

The prospectus then stated:

In the main the object of a participants business will be to develop new varieties of table grapes for registration of plant breeders rights.

Research and development will be aimed at incorporating all or some of the following attributes into various existing varieties:

·Variations in flavour and sweetness

·Variations in colour

·Disease and pest resistance

·Achievement of optimum shape, texture and structure in bunch and fruit

·Accelerating growth rate

·Adapting growth to fill “market windows”

·Achieving optimum vine configuration for the environment

·Adaptation to climate

·Optimising grape lifespan in different climates

·Optimising storage life

·Maximising water usage efficiency

·Optimising vigour.

And continued:

As well, applicants will become farmers involved in the business of growing table grapes on 100 hectares of land on “Jabiru”, approximately 220klm north of Alice Springs.

…

Participants will contract with Australian Land and Cattle Company Pty Limited for the right to use a portion of the land owners land for the growing of table grapes, Business and Research Management Limited for the provision of management services for their business, and to undertake commercialisation of the varieties produced by that business, and with Australian Agriculture Research Institute Limited for the provision of scientific research in the generic development of new varieties of grapes for the business.

Participation in this business is achieved by completing the Application Form and Power of Attorney attached hereto which appoints an attorney to enter into the Farm Agreement, Management Agreement, and Research Agreement, on your behalf.

More particular details of the business and the structure of this Budplan are set out in the Prospectus and you are urged to read this document thoroughly and to seek the advice of your own advisers or your financial planner if your are unclear of any aspect.

4.      The payments to be required from a participant were stated as follows:

To participate at the minimum level in the Budplan “A” Series No.1 a participant will be required to make the following payments;

1.a once only payment of $200 to cover business establishment expenses;

2.$22,500 on establishment of the business comprising a $4,500 farm fee, a management fee of $1,800 and scientific research expenditure of $16, 200.

3.$2,500 on the anniversary of the commencement of the project covering the year 2 farm fee of $500, management fee of $200 and scientific research expenditure of $1,800.

A participant may increase the amount of his participation by increments of $12,500 plus $100 Business Establishment Fee being the amount of a half participation.

Under the terms of the arrangement, no further payments were required from a participant beyond the first two years as all costs including management fees, farm fees and research costs were said to be payable solely from revenue earned.  Ms Macpherson applied for one and one-half participations.

5.        A further part of the arrangement was that participants could apply for a loan from Project and General Finance Pty Ltd (PGF) of an amount equal to 100 per cent of the first and second years’ farm, management and research fees.  Under the terms .of such loan, the borrower was to pay interest in advance of $3,000 per participation on execution of the loan deed and a principal reduction of $6,800 per participation of or before 1 October 1997.  Provided such payments were made, the loan agreement provided that subsequent liability for interest and principal repayments were to be provided from income of the project and the leader had no recourse to the borrower other than from such income.

6.        In her return of income for the year ended 30 June 1997, Ms Macpherson claimed deductions in relation to the project of $25,505.  She said that this amount was incorrect being the expenditure related to one unit of participation.  In her objection and before this Tribunal she claimed a deduction of $33,750 for one and a half units.  As a result of her erroneously advising the respondent that this later figure was the amount claimed in 1997, it was this amount which was disallowed in the amended assessment.  The additional $8,245 disallowance was adjusted in a later amended assessment.

7.        It would appear that the deduction actually claimed in the 1997 year was made up of:

Farm Fee	$4,500
Management Fee	$1,800
Research Fee	$16,200
Interest in advance	$3,000
$25,500

It is not clear where the additional claim of $5 came from.  On this basis, it would seem that, if the applicant was to be successful in her application, the deduction which she would be seeking for one and a half units would be the $33,750 plus $4,500 for interest in advance, a total of $38,250.

8.        The actual amounts paid in cash by Ms Macpherson prior to 30 June 1997 totalled $5,100 being $300 to The Australian Rural Group as a business establishment fee and $4,800 to PGF as $300 loan establishment fee and $4,500 interest in advance.  In the year ended 30 June 1998 she made a further payment to PGF of $10,200 being the principal reduction amount required.  No further payments were made or required under the arrangement.

9.        In a similar arrangement to that set out in the decision of Conti J in Howland–Rose v Commissioner of Taxation (2002) 118 FCR 61 concerned with Budplan Personal Syndicate project, the evidence was that the purported loans to participants involved a round robin of book entries and did not result in any funds for the project.  The only funds available were those provided by the participants.  In the case of Ms Macpherson, the only funds provided in relation to her participation were the two payments over the two years totalling $15,300.  I accept the evidence of Ms Macpherson that she was not aware that no actual funds were provided by PGF.

10.     Ms Macpherson said that she saw Mr Watts in May 1997 for investment advice.  Among the suggestions for investment were three tax effective investments in which she agreed to participate.  These were BAS1, Central Highlands Wine Grape Project No. 3 and a No Regrets sub-franchise.  Separate amended assessments were issued disallowing deductions claimed in relation to each of these investments.  The Central Highlands matter has been the subject of an earlier decision of the Tribunal reported as Macpherson and Commissioner of Taxation (2007) AATA 1022. In relation to BAS1 Ms Macpherson said that her work as a legal representative for the Northern Territory and the Ti Tree Station Aboriginal Land Claim hearing made her aware of a good subterranean water supply close to the township and a successful grape growing enterprise in the area. As a consequence she considered that the project had a good chance of success and would be a viable investment. She believed that there was a plan setting out identifiable location of each participant’s vines but had not seen the plan nor visited the location. She said that she was not qualified to perform her own financial analysis and had relied on the projections in the prospectus. She was influenced in her decision by the fact that Mr Watts had invested personally in the project. She acknowledged that the expected tax deductions and the resultant reduction of her taxable income below the threshold for superannuation surcharge was a factor in the recommendations by Mr Watts.

11. It was submitted for the respondent that the deductions sought for farm fee, management fee and research expenditure were not allowable under s 51(1) of the Income Tax Assessment Act 1936 (the Act) as being of a capital nature.  It was said that Ms Macpherson invested in the project as one of several long term investments and was not in the context of any business activities.  Under the agreement she obtained a right to farm 38 table grape vines but no location was specified, there were no identifiable assets or activities for the agent, Business and Research Management Ltd (BARM), to manage on her behalf and BARM’s activities were limited to establishing the project.  It was argued that the only liability for payment of fees was the initial amount at commencement of the project and a small amount in the second year.  Both of them were said to have the character of establishment costs and of a capital nature.  Ms Harding submitted that the research fees were of a similar nature to those considered by Conti J in Howland–Rose and were in substance and reality for the undertaking of research and development for a defined period which would not necessarily lead to any product being developed which might subsequently be commercialised or to any assessable income ever being derived therefrom.  As such they were of a capital nature.  It was submitted further that, if the Tribunal was to find that the expenditure was deductible, the provision of Part IVA of the Act applied to disallow such deduction.

12.     Although not specifically raised on behalf of the respondent, the question of whether Ms Macpherson actually incurred the expenditure needs to be considered.  The claim was for farm fees, management fees and research fees allegedly incurred through the agent, BARM.  However, the evidence was that, apart from a $300 establishment fee, the applicant paid no money to BARM.  She entered into a loan agreement with PGF under which PGF would pay the fee on her behalf.  However, it is clear that no actual funds were provided by PGF to the project.  There were, in fact no loan.  Equally, it is difficult to see that the amount of $4,500 described as interest in advance can be characterised as interest when no funds were ever provided by way of loan.  At best, the $4,800 likely finished up as funds contributed to the project as part payment of the fees and, in the subsequent year, the $10,200 described as a payment in reduction of loan principal would have been contributed to the project.  It could be argued, that no amount totalling $33,750 was in fact incurred by or on behalf of Ms Macpherson to the project.  On this basis, no amount exceeding $4,500 could be seen as having been incurred.  How it would be allocated over the three alleged fees is not clear.

13.     Even if I am incorrect in finding that the expenditure claimed by Ms Macpherson was not incurred, I would find that the expenditure was of a capital nature.  The only payment required from a participant for one unit of participation were $22,500 initially and $2,500 at the end of the first year.  No further payments were required or contemplated.  Further expenditure relating to the project was to be met from future income, if any.  Given that the project involved planting and growing of table grapes and research into new varieties of grapes, such an upfront payment has all the earmarks of establishment costs of a new venture.  For the same reasons as advanced by Conti J in Howland–Rose the research fee has all the characteristics of capital.  Given the circumstances of the balance of this project I am of the view that the so called farm fee and management fee were also of a capital nature.  In my view, at best, this was an investment by Ms Macpherson in the possible hope that it might generate income in the long term, she was not in the business of grape growing prior and I am unable to find that she carried out any relevant business activity in relation to this project.

14. If, contrary to my view on deductibility of any amounts claimed part or all of the deductions claimed are allowable pursuant to s 51(1) of the Act, I would find that the provisions of Part IVA of the Act apply to disallow such deductions. In the circumstances of this case and having regard to the objective facts of the arrangement, a reasonable person would conclude that Ms Macpherson entered into the scheme for the dominant purpose of enabling her to obtain a tax benefit in connection with the scheme. The terms of the arrangement involving an upfront expense cost, the limit of liability to the first two years only, the ability to borrow the amount payable on a non recourse loan, the round robin of entries producing no actual cash from the lender, the alleged deductions significantly exceeding the actual cash outlay required and the hoped for tax savings exceeding the cash outlay are virtually identical to the arrangements in Howland–Rose and in the investment by Ms Macpherson in the Central Highlands Wine Grape Project No 3.  The former involved research activities only with the latter involving alleged grape growing only.  This arrangement has both but the documentation and structure were unsurprisingly similar.

15.     In Howland-Rose, Conti J found that Part IVA applied and set out fully the reasons for that finding.  In a decision handed down after this hearing, Member Fice in this Tribunal found that Part IVA applied to Ms Macpherson’s claimed deductions for the Central Highlands investment.  Having had the benefit of reading both decisions, I adopt the reason for the decisions in this application.  Given their particular similarity, it is unnecessary to repeat the findings and reasons again and I adopt in particular the findings and reasons of Member Fice set out in paragraphs 20 to 64 inclusive with appropriate modifications as to the names of the various parties involved in the agreement entered into and the amounts.

16.     The major defence by Ms Macpherson against the application of Part IVA was that she believed that the project had good commercial prospects and she was unaware that no actual funds were being provided by the project lender.  In this context it is relevant to note the comments of the High Court in Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at 415 where it said:

A person may enter into or carry out a scheme, within the meaning of Part IVA, for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where that dominant purpose is consistent with the pursuit of commercial gain in the course of carrying on business.

My findings do not result from any rejection of the evidence of Ms Macpherson but from the view that the structure of the arrangement lead to a conclusion that, viewed objectively, the dominant purpose was to obtain a tax benefit well in excess of the amount outlaid having regard to the eight factors in s 177D(b) of the Act.  The taxpayer’s subjective views are not relevant.

17.     The final issue is that of penalties.  Additional tax by way of penalty was imposed at the rate of 5 per cent of the tax shortfall.  This was said to be initially 50 per cent under s 226L or, alternatively s 226 if Part IVA applies. This rate was reduced to 10 per cent under s 226E and s 226F and further remitted to 5 per cent under s 227.  As was the case in penalties imposed in relation to the non‑allowance of deductions relating to the Central Highlands project, there were some difficulties where earlier amended assessments disallowed amounts in excess of that actually claimed and which were adjusted in later amendments.  For the same reasons as those of Member Fice in the earlier decision, I find that the rate of penalty imposed should be affirmed.

18.     For all the forgoing reasons, the objection decision under review in relation to the year ended 30 June 1997 should be affirmed.

I certify that the eighteen [18] preceding paragraphs are a true copy of the reasons for the decision herein of:

Mr B.H. Pascoe

Signed:  Ursula Noyé

Clerk

Date of Hearing:  6 December 2006
Date of Decision:  28 February 2007
Counsel for the Applicant:           Self-represented
Counsel for the Respondent:        Ms D. Harding