Phippen and Commissioner of Taxation

[2005] AATA 952

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2005] AATA 952

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No   NT2004/280
   NT2004/281

TAXATION APPEALS DIVISION		)
Re		ANDREW PHIPPEN CHRISTINE PHIPPEN

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Ms Robin Hunt, Senior Member

Date  30 September 2005

Place               Sydney

Decision  The Tribunal affirms the decision under review

..............................................

Ms R Hunt
  Senior Member

CATCHWORDS

TAXATION – Partnership owning boat - Claim for deductions – Claim that outgoings incurred in carrying on a business – Claim that business was one of using a boat mainly for transporting for payment in the ordinary course of a business – Further claim for depreciation – No business activity found - Objection decision affirmed.

LEGISLATION

Income Tax Assessment Act 1997 – ss8.1, 8.5, 26.50, 40.25.

CASES

Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307

Hope v Bathurst City Council (1980) 144 CLR 1

Federal Commissioner of Taxation v Walker (1985) 79 FLR 161

Newton v Pyke (1908) 25 TLR 127

Evans v Federal Commissioner of Taxation (1989) 89 ATC 4540

Thomas v Federal Commissioner of Taxation [1972-1973] ALR 368

California Copper Syndicate Ltd v Harris (1904) 5 TC 159

Federal Commissioner of Taxation v Myer Emporium (1987) 163 CLR 199

Federal Commissioner of Taxation v Payne (2001) 202 CLR 93

Robe River Mining Co Pty Ltd v Federal Commissioner of Taxation (1989) 21 FCR 1

Stone v Federal Commissioner of Taxation (2002) 196 ALR 221

Inland Revenue Commissioner v Livingston (1927) 11 TC 538

R.W. Parsons, Income Taxation in Australia para 2.432

REASONS FOR DECISION

30 September 2005 Ms R Hunt, Senior Member           

SUMMARY

1.      Mr and Mrs Phippen applied to the Tribunal for review of the Commissioner’s unfavourable decision on their objection to assessments of income tax. The same facts apply for each matter. Mr Andrew Phippen is the applicant in the NT2004/280 matter. Mrs Christine Phippen is the applicant in the NT2004/281 matter. Mr and Mrs Phippen entered into a partnership trading as Sailaway Yatch Charters and claimed income tax deductions in connection with the partnership. The Tribunal has found that the partnership was not carrying on a business. As a result, Mr and Mrs Phippen are unable to claim deductions for outgoings and expenses or for depreciation. It follows that the Commissioner’s objection decision is affirmed.

BACKGROUND

2.      Mr and Mrs Phippen, on 18 February 2002, entered into a boat building and purchase contract for a Lightwave 10.5 Cruising Catamaran, to be named “Phlat Chat”. The boat was delivered on 23 September 2002. Mr and Mrs Phippen gave oral evidence that they purchased a boat with the idea of using it to take paying passengers. The Phippens prepared a formal business plan document. They planned to attract the corporate sector and use Phlat Chat for corporate training and team building activities, as well as leisure cruises. They also agreed to supply the boat to the boat builder as a demonstration vessel. The venture did not proceed as they had planned and they never transported any paying passengers. Mr and Mrs Phippen gave evidence to the Tribunal that they had delayed entering into any charters because they were awaiting the release of a public ruling from the Commissioner on boat charter operations. They did not want to incur more expenses if the Commissioner might disallow them. Public ruling TR 2003/4 Income Tax: boat hire arrangements was issued on 21 May 2003. Mr and Mrs Phippen have since declared, on 5 December 2003, that the boat will be used for private purposes only.

3.      In the income year ended 30 June 2003, Mr and Mrs Phippen paid outgoings in respect of Phlat Chat. After assessments issued on 28 May 2004, they objected to the assessments. Mrs Phippen claimed in her notice of objection to her income tax assessment that, for the year ended 30 June 2003, her taxable income should be reduced by the sum of $31,712 or some lesser amount based on calculation of one half of the partnership losses of $63,424. Mr Phippen lodged a similar objection. This was on the basis that 50% of the outgoings of $9,995 were deductible as was depreciation of $53,429. The Commissioner disallowed their objections.

ISSUES

4.      The main issues for the Tribunal are:

·      whether the boating activities of the taxpayers in the tax year 2002/2003 may be characterized as a business within the terms of the Act; and if so,

·     whether they are entitled to any deductions from their income for the year ended 30 June 2003 in respect of:

·outgoings; and

·depreciation

ANALYSIS

5.      Section 8.5 of the Income Tax Assessment Act 1997 (the Assessment Act) provides that a taxpayer may deduct from assessable income an amount that a provision of the Assessment Act allows the taxpayer to deduct. Section 8.1 permits deductions to the extent that they are incurred in gaining or producing assessable income or incurred in carrying on a business for gaining or producing assessable income.

6.      Section 26.50 contains special provisions governing the types of operations for which a taxpayer may claim expenses for a leisure facility or boat. Subsection 26.50(5) deals with boats. This subsection operates to deny any deduction for expenses for a boat unless, broadly, it is (a) trading stock for sale, (b) mainly letting on hire, (c) transporting for payment, or (d) used for a purpose essential to the business.

7.      The terms of 26.50(5), paragraphs (a), (b) and (c), require the use of the boat in the ordinary course of business. Paragraph (d) refers to use of the boat for a purpose that is essential to the efficient conduct of a business being carried on. In the present case, the provision in subsection 26.50(5)(c) is the closest description of the business purpose of Mr and Mrs Phippen, which is to use the boat for transporting for payment.

8.      The expression “in the ordinary course of business” has been considered on a number of occasions in the revenue context. The concept of a transaction which is part of the "carrying on, or carrying out, of a business", involves the concept of a transaction which is within the "ordinary course of business". See California Copper Syndicate Ltd v Harris (1904) 5 TC 159 and the decision of the High Court in Federal Commissioner of Taxation vMyer Emporium (1987) 163 CLR 199. A transaction outside the ordinary course of business may still be part of the "carrying out of business" if, at the time it was entered into, the taxpayer had the intention or purpose of making a profit: see Federal Commissioner of Taxation v Payne (2000) 202 CLR 93.

9.      In the present case, the taxpayers must show the additional element that their boat is used (or held) in the “ordinary course” of conducting a business.  The addition of the word “ordinary” narrows the spectrum of events that qualify as relevant business for section 26.50(c).  As well, the word “in” has been judicially construed as a restrictive word. See Robe River Mining Co Pty Ltd v Federal Commissioner of Taxation (1989) 21 FCR 1 at 12. Bearing in mind that any claims must be seen as part of the ordinary course of business, the first question is, does section 26.50 of the Assessment Act operate to deny a deduction in respect of the outgoings?

10.     Section 26.50 denies any deduction for expenses of a leisure facility or boat except in limited circumstances. Mr and Mrs Phippen claim that they satisfy the exception set out in subparagraph (5)(c), in that they used the boat or held it “mainly for transporting for payment in the ordinary course of a business …”. To succeed on this ground, they must show that they were carrying on a business during the year in question. If they establish they were carrying on a business, they may be entitled to a deduction of outgoings pursuant to section 8.1 of the Assessment Act.

Was the Taxpayer Carrying on Business?

11.     I have examined whether Mr and Mrs Phippen commenced their partnership business in the 2003 tax year. Commencement of business can be a difficult question and depends on the individual circumstances of each case. Professor R. W. Parsons in Income Taxation in Australia states at paragraph 2.432: 

“(t)he notion of a continuing business involves a pattern of transactions and an appraisal of that pattern as distinct from an appraisal of each transaction as if it stood alone… A continuing business involves a number of transactions which are repetitive and systematic and are overall moved by a purpose to profit.” 

12.      Whether particular activities constitute a business is a matter of fact and degree.  In Stone v Federal Commissioner of Taxation (2003) 196 ALR 221 at 234 in paragraph 64, Hill J summarised the position by reference to previous judgements of the courts. He pointed out that English cases sometimes referred to the "badges of trade", where the concept of "trade" is used in the broader sense of "business", cf Inland Revenue Commissioner v Livingston (1927) 11 TC 538 at 542. In Stone, Hill J continued at para. 65, to say that:

“it will be relevant, although not determinative, to note whether the activity is carried on in a business-like way, and in accordance with ordinary commercial principles: Livingston supra. It will be relevant if there is system in the activity: Newton v Pyke (1908) 25 TLR 127 and Evans v Federal Commissioner of Taxation (1989) 89 ATC 4540 at 4555. Repetition and continuity play a part in the process of characterisation: Hope v Bathurst City Council (1980) 144 CLR 1 at 9, although repetition may come from the closely associated phrase "carrying on" rather than from the word "business" itself: per Mason J in Hope at 8.”

13.      Also see Full Court in Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307, where the Court considered the essential nature of the activity, and noted the question whether it has the characterisation of a business is primarily a matter of general impression and degree. Bowen CJ and Franki J in Ferguson at 311, speaking of an activity of breeding cattle, said that:

“There are many elements to be considered. The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on a business notwithstanding his profit is small or even where he is making a loss.  Repetition and regularity of the activities is also important. However, every business has to begin, and even isolated activities may in the circumstances be held to be the commencement of carrying on business. Again, organization of activities in a business-like manner, the keeping of books, records and the use of system may all serve to indicate that a business is being carried on…..The volume of operations and the amount of capital employed may be significant.”

14.      Some of the main factors that are indicators of business are system and organisation; scale; the extent to which the taxpayer’s activities involve sustained, regular and frequent transactions; conduct of operations with a profit motive and the commercial character of the transactions. In cases such as Ferguson, the taxpayer entered primary production on a small but systematic way that enabled a conclusion that the enterprise was a business. In Federal Commissioner of Taxation v Walker (1985) 79 FLR 161, system and organisation enabled a conclusion that a goat breeder with only one stud goat was in business. In Thomas and Federal Commissioner of Taxation [1972-1973] ALR 368, the taxpayer was able to demonstrate he was in business although he made a loss in his first year and the business was not conducted with maximum efficiency. Walsh J of the High Court found the taxpayer was nevertheless conducting a business of primary production in having planted a number of trees for the production of timber, fruit or other produce. He had made no income due to natural occurrences such as bushfire.

15.      In the present case, the taxpayers never actually engaged in any trading activities. They claimed to have spent time on promotional activities but Mrs Phippen gave oral evidence that they did not pay for any advertising. The grounds of objection named some large companies they approached. They also produced to the Tribunal some draft leasing agreements. They took delivery of the boat on 23 September 2002. They also paid for maintenance of the boat so that it would be suitable for carrying on the business. A copy of a document dated 17 September 2002, shows that Mr Phippen applied for registration of the boat with Waterways under the NSW Water Traffic Regulations. The application sought recreational registration and not commercial registration, as indicated in a box for the purpose on the front page of the form. They obtained a mooring licence. They kept a log book.

16.      Mr and Mrs Phippen produced some email correspondence with Windcraft Australia about possibly chartering the boat and about arranging for a survey of the boat to enable it to be certified for operations to carry six people. They made the boat available for boat shows. They prepared business activity statements (BAS).

17.      Mr and Mrs Phippen told the Tribunal about additional businesslike aspects of their plans for Phlat Chat. These included the signing of a boat building contract, preparation of a document referred to as the Business Plan, the obtaining of an ABN in the names of the partners, registering a business name, and making payments of amounts due under the boat building contract. Mrs Phippen wrote in her grounds of objection that the partnership was officially formed on 18 February 2002, when entering into the jointly executed boat building contract. Mr Phippen prepared a business plan dated August 2002 for the boat to be used as a demonstration and charter boat. The plan projected a profit from year 1.

18.      As there was no trading activity by the partnership and no revenue producing activity, I am not persuaded that the partnership ever commenced carrying on a business. In addition, although Mr and Mrs Phippen say they intended to operate a business, they did not undertake essential first steps such as obtaining registration of the boat under the NSW Commercial Vessels Act 1979. Nor did they obtain a survey or undergo inspections to this end. While they were aware that this was necessary and entered into some correspondence about organising a survey, this did not proceed. Before me is an affidavit by Mr Shankar Ramanathon, a Senior Surveyor, explaining that for a vessel to operate commercially in NSW, a vessel must be issued with a survey identification number and NSW Vessel Permit.

19.      All of the activities brought to the attention of the Tribunal do not in total indicate to me that the partners were operating in a business-like way. While it is reasonable to sort out before commencement of business exactly what conditions must be met for the intended business to comply with legal requirements, the partners never took the enterprise to the next stage of organising any of the special requirements for commercial boat charter. The reason they gave in oral evidence was that they could not proceed further and make financial outlay without knowing that they could proceed as planned because the Commissioner had not released a final ruling on charter operations. To me, this reluctance to commit to the course of action planned and to have the vessel surveyed and registered for commercial operations is a demonstration of the partners’ failure to actually commence business. 

20.      Their operation was so preliminary in 2002/2003 that it provides only slender evidence of any intention to operate a business. Even the emails with Windcraft Australia are tentative. The message sent from Windcraft, dated 29 May 2003, shows that there was a “definite buyer who would like to charter the boat” but Mr Phippen’s reply a short time later on the same day says:

“No the boat is not in Qld – and right now have no plans for that to happen – don’t know where that one came from?”

21.      Indicators of the running of a business in the usual way involve the keeping of books and records. The partners’ log book and BAS returns suggest possible business intentions. Advertising is another indicator of business but Mrs Phippen gave evidence that they did not advertise, although they made personal approaches to some entities. Mr and Mrs Phippen both said they explored profitable activities but there is no evidence that they decided on any particular activity. Their investigations came up with no firm plan or firm client to pay for a charter or the like. There is no indicator of the pursuit of profit before the Tribunal, only a failure to find any. Repetition and continuity are important indicators but not even one charter took place. As to the importance of repetition and continuity, see Hope (supra).

22.      There are very few indicators of a business operation in the material before me. In my view, although there may have been a business plan when the Phippens ordered the boat, it never eventuated. They took a few preliminary steps only but left undone vital steps to enable the business to start such a obtaining a survey to meet the NSW commercial registration requirements. It follows that I find the partnership was not in business in the year ended 30 June 2003. In consequence, they cannot claim any business deduction for outgoings and expenses in connection with their boat under section 26.50, or at all. 

23.      As well, taxpayers operating boat charter may be entitled to a deduction for depreciation. However, pursuant to section 40.25 or Division 328 of the Assessment Act, the depreciation deduction is reduced where the boat does not meet one of the exceptions in section 26.50(5). As the partners had not commenced business and have not met the exceptions in section 26.50(5), they are not entitled to a depreciation deduction on general principles, as enunciated in sections 8.1 and 8.5, nor under section 40.25 of the Assessment Act.

decision

24.      The Tribunal affirms the decision under review.

I certify that the 24 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member Robin Hunt

Signed:         .....................................................................................
Zoe McDonald
Associate

Date of Hearing: 2 August 2005    
Date of Decision: 30 September 2005
Solicitor for the Applicant: Self 
Counsel for the Respondent: Mr Quinn
Solicitor for the Respondent: ATO Legal Services