Princi and Ors and Commissioner of Taxation

[2007] AATA 1119

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2007] AATA 1119

ADMINISTRATIVE APPEALS TRIBUNAL    ) No WT2001/1107-1108,
  ) No WT2001/1135-1136,
TAXATION          APPEAL         DIVISION     ) No WT2001/1145-1146,
  ) No WT2006/985-987

Re VINCENZO PRINCI, DOMENIC PRINCI, MATE TOLICH, KEVIN DORN

Applicant

And COMMISSIONER OF TAXATION  

Respondent

DECISION

Tribunal Mr B.H. Pascoe, Senior Member  

Date9 March 2007

PlacePerth

Decision The Tribunal varies the decisions under review to the extent of allowing as a deduction in each of the relevant years so much of the deductions claimed in relation to the Northern Rivers Tea Tree Oil Projects as were represented by actual cash outlays of the applicants which were not of a capital nature with a determination under s 177F of the Income Tax Assessment Act 1936 that the excess over such amounts is not an allowable deduction and the Tribunal remits these matters to the respondent with a direction to issue amended assessments to give effect to this decision.

.......(Sgd. Mr B H Pascoe)..............

Senior Member

INCOME TAX – investment in tea-tree oil farming project – allowable deductions – application of part iva – whether federal court decision can be distinguished – validity of determination under part iva

Income Tax Assessment Act 1936

Sleight v Commissioner of Taxation 2003 ATC 4801

Commissioner of Taxation v Sleight (2004) 136 FCR 211

Fletcher v Commissioner of Taxation (1988) 19 FCR 442

REASONS FOR DECISION

9 March 2007 Mr B.H. Pascoe, Senior Member  

1.      These are applications to review decisions of the respondent to disallow objections to amended assessments of income tax in relation to the years ended 30 June 1995, 1996, and 1997.  The amended assessments were issued to disallow deductions claimed for expenses incurred in respect of the planting, cultivation and maintenance of a tea-tree farm and the production of tea-tree oil.  The claims arose from the participation by the applicants in the project known as the Northern River Tea-Tree Project (the project).

2.      At the hearing the applicants were represented by Mr F. Wilson, a solicitor, and Mr D. Romano, a solicitor.  The respondent was represented by Mr D.M. McGovern, SC with Mr A.J. O’Brien of counsel.  Evidence was given by the four applicants, Mr V. Princi, Mr D. Princi, Mr K. Dorn and Mr M. Tolich.  In addition, evidence was given by Mr N. Simpson a former farm management consultant and now an authorised financial advisor and Mr J. Banks, a financial advisory services consultant with KPMG.  Consent was given to the four applications being heard together.

3.      Similar deductions claimed by another participant in the project, Mr K. Sleight, were the subject of decisions in the Federal Court by Nicolson J in the first instance (Sleight v Federal Commissioner of Taxation 2003 ATC 4801) and the Full Court on appeal (Commissioner of Taxation v Sleight (2004) 136 FCR 211). The structure and documentation relating to the project were set out fully in these two decisions and are unnecessary to be repeated here. It was not in dispute that the applicants in this matter completed the same agreements based on the same prospectus and paid the same amounts per share and farm as did Mr and Mrs Sleight.

4.      In summary, the minimum subscription was $1,000 for 1,000 A Class shares in Northern Rivers Land Company Ltd (NRLC) and the right to occupy two farms.  An administration fee of $1,000 was payable to NRLC.  Each participant then entered into an agreement with Northern Rivers Plantation Management Ltd (NRPM) for the management of the farms and the payment of $21,000 prepaid management fees, together with $400 as a loan indemnity fee.  A further agreement with Northern Rivers Finance Company Pty Ltd (NRFC) provided for that company to lend $21,750 being the management fee and 75 per cent of the administration fee to the participant.  Under that agreement the participant paid $3,045 as prepaid interest with a principal repayment of $7,400 on or before 90 days thereafter and a further $2,009 interest in 12 months.  The effect of this agreement and the loan indemnity fee to NRPM was that no further recourse was available against the participant for any further payments in respect to the loan. A further payment of $50 for the purchase of tea-tree seed was required.

5.      Each participant and each applicant in this matter entered into these agreements on or immediately prior to 30 June 1995 and claimed a deduction in the year ended on that date of $25,445 being:-

Management Fees

$ 21,000

Administration Fee

$   1,000

Interest in advance

$   3,045

Loan Indemnity Fee

$      400

$ 25,445

The actual cash outlay by each applicant on or before 30 June 1995 was $3,745 with a further $7,400 on or before 30 September 1995 and $2,009 on or before 30 June 1996.

6.      Each of the applicants entered into identical arrangements on or about 30 June 1996 although trebling their investment to 3000 shares and six farms.  One applicant, Mr Dorn, made a further investment in June 1997 under a second prospectus involving virtually identical arrangements.

7.      The applicants sought to distinguish the decision in Sleight on two main grounds.  The first was the particular circumstances relating to their participation in the project.  The second was the introduction of expert evidence relating to the projected financial return of the project which evidence was not available to the Federal Court.

8.      The particular circumstances said to differentiate these applicants were the alleged significant cash flow negative positions resulting from their investment.  This was primarily brought about by the investment of a further $200,000 allocated as to $50,000 by each of the four applicants.  The four were the directors and shareholders of an earthmoving contracting company which, in the relevant periods, was very profitable.  They had had a reasonably long association with Mr Sleight who they described as their financial advisor.  It was said that Mr Sleight had introduced them to several investments since the early 1990’s including several projects with somewhat similar features to the Northern Rivers project.  This latter project was introduced by Mr Sleight and it was said that several discussions had taken place with Mr Sleight and the managing director of NRLC, Mr B. Hooker, prior to the production of the prospectus dated 14 June 1995.

9.      The applicants gave evidence that, at the same time as their investment in the project or very shortly thereafter, an amount of $200,000 was provided by their company on their behalf to the project.  All described the amount as a loan to NRLC to ensure that the project continued.  It would appear that the amount was provided at the request of Mr Sleight.  It was described as a White Knight investment.  While all applicants were somewhat vague as the precise reason for the loan, it would appear likely from the evidence that it was required to allow NRLC to achieve the minimum subscription of $350,000 in shares required under the prospectus.  The evidence of the applicants was that the $200,000 was a loan and expected to be repaid within three to six months as shares were sold to new investors.  It was said that, as security for the loan, the four applicants were issued with 200,000 A Class shares in the NRLC.  It was said also that interest was to be paid at the rate of $350 per month for each $10,000 outstanding and that a total of $38,400.88 had been received by way of interest.  No documentary evidence of the alleged arrangement or the dates or amounts of interest was provided other than a letter from Mr Hooker of 19 July 1995 confirming an application for 200,000 shares and containing a personal undertaking to purchase back the shares, or continue to pay a facility fee in respect of shares still held by you, after September 30, 1995.  The applicants said that no repayment of the $200,000 had ever been made and, as NRLC has been acquired by Ausforest Ltd, they now hold 510,000 shares in Ausforest Ltd.

10.     It was submitted that this additional transaction resulted in these applicants being significantly cash flow negative as a consequence of their participation in the project as a result of the further $50,000 each invested.  Mr Wilson adopted the words of Mr V. Princi in his evidence to argue that he would have been a “bloody idiot” to participate to the extent of the additional $50,000 investment at risk for the dominant purpose of obtaining tax deductions.

11.     It should be noted that, in fact, the $200,000 was an investment in the purchase of shares in NRLC.  There was no associated interest in the farming of tea-trees or the production of oil as was said to be the principal purpose of the normal participation in the project.  It was seen by the applicants as a short term loan at a very attractive interest rate to the promoters of the project albeit secured by shares in NRLC with its underlying asset of land.  While the applicants sought to argue that this additional investment demonstrated their commitment to a commercial project it was submitted for the respondent that it could be seen, equally, as a short term fix proposed by Mr Sleight to ensure that the applicants and other then participants obtained their expected tax deduction.  In this respect it is relevant to note that, by 25 April 1996, the applicants were sufficiently concerned about the lack of any repayment of their $200,000 for Mr Dorn to write to Mr Hooker expressing disappointment and seeking resolution as a first priority.  Notwithstanding no result from this, all of the applicants then proceeded to make a further participating investment in June 1996 and Mr Dorn a third investment in June 1997.  It is difficult to accept that their dominant motive in 1996 and, in the case of Mr Dorn, in 1997 was to invest in a commercial venture and not the obtaining of a tax deduction when their $50,000 previous investment was still at risk without any sign of promised repayment.  In relation to this $200,000, I am reluctant to accept that the applicants were fully open and frank regarding their motives and understanding of that $200,000 investment.  Given the foregoing, I am of the opinion that the $200,000 investment was a separate and unrelated investment to the transactions involved in these applications and the tax deductions sought.  It was simply an intended short term loan to the promoter of the project at a high interest rate.  While it may have allowed the project to achieve its minimal subscription and proceed under the prospectus, it should not be taken into account as part of the applicants’ expenditure in relation to the deduction claimed.  In this respect, I am unable to distinguish the applicants’ position from that found in Sleight.

12.     A further similar issue of being cash negative in relation to the investment in the project was said to be for Mr Dorn whose income tax return for the year ended 30 June 1996 disclosed a net loss so that he was said not to have derived a tax benefit from his claim for deductions in respect of the project.  However, Mr Dorn acknowledged that the loss arose from deductions claimed in respect of investments in three other similar projects in addition to the Northern Rivers project.  In these circumstances I am unable to distinguish his position from the findings of Hill J in Sleight in paragraphs 87 and 88 of his judgement.  It is noted that at least two of his other investments  Main Camp Tea-Tree Oil and Active Cattle Management were among those referred to by Hill J.

13.     The second issue said to distinguish these cases from Sleight was the production of expert evidence relating to the projected financial returns of the project.  The applicants called Mr Simpson to provide such evidence.  In a relatively short report, Mr Simpson stated that he had calculated an internal rate of return (IRR) over 20 years of the project at 16.82 per cent which he considered favourable when compared with other agricultural projects and, in fact, favourable when compared with any other form of investment.  After reviewing the report of Mr Banks, the respondent’s expert, Mr Simpson amended his IRR to 15.24 per cent.  Mr Simpson was put forward as an expert in agriculture and in finance advice. 

14.     A number of things should be said about Mr Simpson and his expertise. While it is accepted that he has formal qualifications in agriculture and farm management and was a consultant in those areas for 11 years, he last worked in that capacity in 1976.  Since then he has worked in residential and commercial real estate for some 14 years and as a financial planner since 1992.  I have some reluctance in accepting his expertise in agriculture when he has had no practical involvement in that area for over 30 years.  While he has been a financial planner for some years, he did not demonstrate any experience or expertise in assessing projected returns from projects such as this project.  In addition, Mr Simpson acknowledged that he had been a participant in the Main Camp Tea-Tree Oil project where his claimed tax deduction had been disallowed.  He further acknowledged that he had personally invested in some half a dozen other projects with funding arrangements similar to this project.  As such, I have reservations in relation to him bringing an independent and objective mind to his opinion.  It should be said, also, that he gave an impression of being an advocate rather than an independent expert providing such opinion to the Tribunal.

15.     That having been said, it is noted that Mr Simpson utilised no agricultural expertise in his evidence.  In essence, he adopted without question the assumptions, particularly of oil yield and price, contained in the prospectus and calculated an IRR on those assumptions.  Further, and notwithstanding that the prospectus assumptions were for the first five years only with further projections noted as being for demonstration purposes only, Mr Simpson based his calculations on a consistent oil yield of 250 kilograms (kg) per hectare and a sale price of $65 per kg increasing by three per cent per annum for the 20 year period.  While he noted risk factors of uncertain future demand, uncertainty of future pricing, effect of climatic conditions and ongoing ability of the manager, he assumed consistent annual yields and price at the high end of estimates.  The agricultural report in the prospectus stated that:-

Industry extension figures suggest yields in Northern NSW of between 150-200kg of oil per hectare per year on well managed plantations, with exceptional growers achieving yields over 300 kg/ha.

Mr Simpson adopted the consistent annual yield of 250 kg per hectare used in the prospectus assumptions.  It is noted that this is higher than the report suggested yields and it is difficult to accept that any expert would adopt this high yield as an average yield over 20 years notwithstanding climatic and economic risks.  The market report in the prospectus suggested that larger oil producers selling direct were receiving US $52-55 per kg for 100 kg lots or A$70.50-78.60 per kg and that the prevailing prices should be maintained for three years.  A graph in the report appears to show $62 per kg in 1994.  The prospectus projected prices at $65 per kg increasing by three per cent per annum.  Again Mr Simpson adopted that projected price for 20 years.  While he was reporting on the commercial return for the project on the basis of information at June 1995, it is noted that the market report prepared in January 1997 for the second prospectus stated that then current prices were A$58-64 per kg.  This may be seen as hindsight confirmation that the 1995 level of prices was not a guide to future pricing.

16.     The respondent called Mr Banks who had provided a report.  Mr Banks had impressive credentials from a long career of assessing projections of financial returns in a wide range of projects.  Mr Bank’s evidence was attacked on behalf of the applicants for a lack of agricultural expertise.  However, his evidence did not seek to provide any opinion on the agricultural aspects of the project.  It has been noted previously that while Mr Simpson had formal agricultural qualifications he did not seek to utilise them in his evidence.  The applicants further argued that Mr Banks was not legally authorised to provide financial advice to the public.  It is difficult to understand the basis of this attack on his expertise.  Mr Banks was simply providing an opinion on his evaluation of the potential commercial returns of the project on the basis of his experience and expertise in such evaluations.

17.     Mr Banks was concerned at the adoption of relatively high yields and prices as an average over the 20 years.  His report adopted what he described as a best case and worst case scenario and was firm that appropriate allowance must be made for risks inherent in such a project, identified but not allowed for by Mr Simpson.  He preferred the use of mid-points in projections and preferred an estimated yield of 180 kg per hectare and $50 per kg as the estimated sale price.  Mr Banks differed with Mr Simpson on some calculations or figures to be used.  Using the same yields and price on the prospectus assumptions his IRR was some three percentage points below that calculated by Mr Simpson.  While he agreed with Mr Simpson that, accepting without question the prospectus assumption for 20 years, the investment would be paid back in 7-8 years Mr Banks considered this unreasonably optimistic.  Using his preferred base case of yield and price, Mr Banks produced an IRR of 1.55 per cent but his ultimate conclusion was that the pay back period allowing for risk was unlikely to be less than 20 years.

18.     In my view, it is unnecessary to make any positive finding as to what the financial returns for the project could be assessed from the information available to investors in 1995, 1996 or 1997.  In the Full Federal Court decision in Sleight, Hill J said (at paragraph 88) in relation to s 177D(b)(v)

The commercial interest in tea trees which the outlays obtained was considerably less certain than the tax benefit. If the investment lived up to the projected figures in the prospectus many years were likely to pass before Mr Sleight and his wife would see their cash returned to them. In fact the prospectus indicated that in the 1999 and 2000 years their share of the proceeds of the sale of oil was only to be $685 and $727 respectively. The prospectus presents detailed calculation of predicted revenue for the first six years of the project, however, continuing these calculations into the future reveals that it would only be at the end of the 17th year that the investor would have earned, in case, the amount that was initially outlaid (excluding the $1,000 for the purchase of the shares) but subject to any dividend from the separate share purchase.

Carr J (at paragraph 228) regarded this finding of Hill J as indicating a dominant purpose of obtaining a tax benefit.  It was said for the applicants that this comment was made without expert evidence and the evidence in this case is a distinguishing feature from the decision in Sleight.  What the evidence of Mr Banks did was to reinforce the view of Hill J that there was every possibility that there would be no recovery of the investment in less than 17 years or possibly longer.  I do not accept Mr Simpson’s evidence of recovery with 7-8 years given the uncertainty of the projected returns and the incautious assumption that maximum yields and prices would continue every year of the project.  It is sufficient in my view that one expert did find that financial benefits from investments are more likely than not to be very low to not allow these applicants to distinguish their position from that found in Sleight and, for reasons set out earlier, I prefer the opinion of Mr Banks to that of Mr Simpson.

19. A further argument on behalf of the applicants was that the formal determination by the respondent pursuant to s 177F of the Act was made after the date of issue of the relevant amended assessments. It was said that the amended assessments were, therefore, not issued to give effect to such determination and the respondent could not rely on Part IVA of the Act in relation to such assessments. It was argued further that the time limit had expired to make a fresh determination and to give effect to such determination in amended assessments.

20. Section 177F provides that 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 Part IVA applies, the Commissioner may determine that the whole or a part of the deduction shall not be allowable to the taxpayer in relation to the year of income. It is generally accepted that such determination is part of the process of making an assessment and is followed by an assessment. However, s 169A(3) provides:-

In determining whether an assessment is correct, any determination, opinion or judgment of the Commissioner made, held or formed in connection with the consideration of an objection against the assessment shall be deemed to have been made, held or formed when the assessment was made.

In each of the decisions on objections to the relevant amended assessments, the respondent relied on Part IVA as a ground for disallowing the objections. In my view the positive statements as to that ground is such a determination under s 177F which by virtue of s 169A(3) is deemed to have been made when the amended assessments were made. Such amended assessments were issued within the time limits permitted by s 170.

21.     Even if it could be said that no such determination was made, which I do not accept, the determination can be made by the Tribunal.  The Tribunal has the powers and discretions conferred by the Act on the Commissioner and, in reviewing an objection decision, makes a correct or preferable decision on that objection.  Consequently, any determination made by the Tribunal in its decision is a determination referred to in s 169A.  In Fletcher v Commissioner of Taxation (1988) 19 FCR 442 no determination under s 177F had been made by the Commissioner. Part IVA had not been relied upon in the objection decision nor before the Tribunal. Nevertheless, the Tribunal’s decision was by reference to Part IVA. The Full Federal Court said (at p 453):

It follows that, in determining an objection to an assessment, the Commissioner is entitled to make a determination under s 177F of the Act; and thereafter to give effect to that determination by an appropriate decision under section 186.

By force of s 43 of the Administrative Appeals Tribunal Act, the Tribunal has all the powers and discretions that are conferred by s 186 of the Income Tax Assessment Act upon the Commissioner. In exercising those powers and discretions the Tribunal was bound to consider the facts as they were proved in evidence before the Tribunal, making the decision which, upon that evidence and at that time, was the correct or preferable decision to be made in considering the objection. The Tribunal was not confined either to the material which was before the Commissioner, as primary decision-maker, or the events which had occurred up to that time …

Once it is understood that, in exercising his powers under s 186, the Commissioner would have been free to exercise a discretion under s 177F of the Income Tax Assessment Act, it follows that, in reviewing the Commissioner’s decision under s 186, the Tribunal is free to exercise that same discretion if, upon the material then before it, it seems proper to take that course.

It is clear that the Tribunal may, as part of its role, make a determination pursuant to s 177F and that determination is, pursuant to s 169A(3) deemed to have been made when the relevant amended assessments were made.

22. The final issue in these applications is whether this is an appropriate matter for the determination under s 177F to apply only to that part of the deduction claimed which exceeded the actual cash outlay of the applicants. The respondent conceded that it was so appropriate. Given that there are several applicants and more than one year of income involved, it is appropriate to remit the matter to the respondent with a direction to issue amended assessments to allow a deduction in each of the relevant years so much of the claimed deduction as represented the non-capital cash outlays of the applicants.

23. As a consequence of the foregoing, the decisions under review should be varied to the extent of allowing as a deduction in each of the relevant years so much of the claimed deductions as represented by the cash outlays of the applicants which were not of a capital nature with a determination under s 177F that the excess over such amounts is not an allowable deduction and remit the matter to the respondent with a direction to issue amended assessments for the purpose of giving effect to such decision.

I certify that the 37 preceding paragraphs are a true copy of the reasons for the decision herein of Mr B.H. Pascoe, Senior Member

Signed:         .................(Sgd. Ms R Riberi) ........................
  Associate

Date/s of Hearing  12 - 16 February 2007
Date of Decision  9 March 2007
Counsel for the Applicant         Mr F Wilson

Solicitor for the Applicant          Mr D Romano

Wilson & Atkinson

Senior Counsel for the

Respondent  Mr D M McGovern
Counsel for the Respondent     Mr A J O’Brien

Solicitor for the Respondent     Mr T Burrows

Australian Government Solicitor