Scott and Commissioner of Taxation - [2002] AATA 1158

DECISION AND REASONS FOR DECISION [2002] AATA 1158

ADMINISTRATIVE APPEALS TRIBUNAL )

) No QT2001/542-544

TAXATION APPEALS DIVISION )
           Re      ANDREW WILLIAM SCOTT
  Applicant
           And    COMMISSIONER OF TAXATION
  Respondent

DECISION

Tribunal Mr B J McCabe, Member

Date12 November 2002
PlaceBrisbane

Decision The objection decision under review is set aside and the matter is remitted to the respondent to be dealt with in accordance with these reasons.

....................(Sgd).....................
B J McCabe
Member
CATCHWORDS
TAXATION – income tax – deductions – travel costs and rental property – whether costs of transporting work equipment deductable – whether special arrangements are justified for transporting equipment – whether costs associated with rental property are deductable

Income Tax Assessment Act 1936

Lunney v Federal Commissioner of Taxation (1958) 100 CLR 478
Federal Commissioner of Taxation v Vogt (1975) 75 ATC 4073
U107 (1987) 87 ATC 650
Re Scott and Commissioner of Taxation [2002] AATA 778
Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1
Federal Commissioner of Taxation v Groser (1982) 13 ATR 445
Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) 15 FCR 348
Madigan v Federal Commissioner of Taxation (1996) 33 ATR 164
Federal Commissioner of Taxation v Kowal (1984) 84 ATC 4001

REASONS FOR DECISION

12 November 2002 Mr B J McCabe, Member

Introduction

Dr Andrew Scott has challenged the Commissioner's decision to disallow several claims to deductions in the years of income ending 30 June 1993, 1994 and 1995. The Commissioner disallowed deductions claimed in respect of travel costs and costs connected with a rental property occupied by the applicant's parents.
The Material Before the Tribunal
The Tribunal was supplied with the documents required under s 37 of the Administrative Appeals Tribunal Act 1975. Dr Scott gave evidence at the hearing. He also supplied a statement. Dr Graham Miller gave evidence on behalf of the applicant by telephone, and supplied a statement. Mr Ian Kennedy, an officer employed by the respondent, also gave evidence.
The applicant was represented by his mother, Mrs Clara Scott. Mr Curran represented the Commissioner.
The Claim for Travel Expenses
The applicant is a dentist. He graduated from the University of Sydney with a Bachelor's degree in dental surgery in 1992. (He completed the course in 1991). Dr Scott commenced employment with Dr Graham Miller at Dr Miller's Kippa Ring surgery in January 1992.
Dr Miller operated a second surgery at Kilcoy, about 70 kms from the main surgery. A dentist (either Dr Scott or Dr Miller) would travel to the Kilcoy surgery at least once a week to see patients. Dr Scott made the trip on most Tuesdays, and sometimes on a Friday as well. The Kilcoy surgery did not have much equipment or supplies. The dentist would bring almost everything that was required with him from the Kippa Ring surgery on each visit. Some of the material would have to be returned to the Kippa Ring surgery after each visit.
Dr Scott claimed the costs of travelling to and from the second surgery each week. He drove his car to the surgery – usually from his home, but sometimes from the principal surgery at Kilcoy. On each trip he carried a box that was provided by his employer. The box typically contained patient files, the cash float, dental supplies, denture moulds and a spare dental motor. Some of the items were bulky, and some, like the wax denture moulds, were sensitive to heat. It was impossible to carry the items in a regular brief-case because of the size and shape of some of the items. The box was apparently open at the top and could not always be sealed because of the odd shape of the items inside.
Dr Scott and his former employer, Dr Miller, described the box to the Tribunal in the course of their evidence. Its contents varied, it seemed. On trips home from Kilcoy it might not be full – although on many occasions it was. The box was not especially large. .Dr Scott's description of the box suggested it was about the size of an archive box. It was not particularly heavy either – certainly not too heavy for Dr Scott to carry it. The applicant suggested in his evidence that it might weigh ten kilos, but sometimes it was lighter.
Lunney v Federal Commissioner of Taxation (1958) 100 CLR 478 is the leading case on the deductibility of the cost of travel to and from work. Williams, Kitto and Taylor JJ held in a joint judgment that the cost of travelling to and from one's place of employment was not deductible because it was a private expense. After referring to the British authorities, their Honours explained (at 501):
"No doubt the legislative provisions which required consideration in these [British] cases were not identical with s. 51 [ITAA36], but the process of reasoning by which they were decided consistently rejects the notion that expenditure incurred by a taxpayer in order to travel from his home to his place of business is, in any sense, a business expenditure or an expenditure incurred in, or, in the course of, earning assessable income. Indeed they go further and refuse assent to the proposition that such expenditure is, in any relevant sense, incurred for the purpose of earning assessable income and unanimously accept the view that it is properly characterised as a personal or living expense. This view agrees with that which we, ourselves, entertain. Expenditure of this character is not by any process of reasoning a business expense; indeed, it possesses no attribute whatever capable of giving it the colour of a business expense. Nor can it be said to be incurred in gaining or producing a taxpayer's assessable income or incurred in carrying on a business for the purpose of gaining or producing his income; at the most, it may be said to be a necessary consequence of living in one place and working in another."
Dixon CJ agreed with the result in a separate judgment, although his Honour doubted the quality of the reasoning that led to the rule. He said it was appropriate to continue to apply the rule because it was well-established and widely accepted. Only parliament could change the rule now, his Honour said (at 485-486).
The shortcomings Dixon CJ identified in the reasoning in Lunney have led to uncertainty in the application of the rule. The Courts and the Tribunal have, from time to time, recognised situations that are not covered by the rule. The best-known example is the decision in Federal Commissioner of Taxation v Vogt (1975) 75 ATC 4073. In that case, a musician who needed to transport his instruments with him to and from work was permitted to deduct the costs associated with travel. The instruments in question were large, and the musician had to purchase a new car to accommodate them. He could not leave them at his place of work as there was nowhere to store them. In any case, he needed them with him at home so he could rehearse.
In the course of distinguishing that case from Lunney, Waddell J treated the claim as a cost of transporting the essential business tools – the instruments – rather than the costs of the musician transporting himself. His Honour concluded that transporting the items in the musician's own vehicle was the only practical way of delivering the instruments to the place they were needed for the purposes of producing assessable income. His Honour explained (at 4078):
"…in a practical sense, the expenditure should be attributed to the carriage of the taxpayer's instruments rather than to his travel to the places of performance. The mode of his travel was simply a consequence of the means which he employed to get his instruments to the place of performance, that is by carrying them in the motor vehicle which he drove. In the light of these matters it is my opinion that the essential character of the expenditure was such that it should be regarded as having been 'incurred in gaining or producing assessable income'."
The approach in Vogt was followed by the Tribunal in U107 (1987) 87 ATC 650. That case concerned a ground maintenance engineer employed by an airline. The taxpayer was required to supply his own tools that were kept in two large boxes. The taxpayer took his tools home at night because of the risk of theft. The boxes were too heavy to carry on public transport, so the taxpayer transported them in a vehicle and claimed a deduction for the costs. After considering Lunney and Vogt, the Tribunal concluded the taxpayer was entitled to the deduction. In the course of its reasons, the Tribunal said (at 652):
"This taxpayer is one of those fortunate few who is able to hitch a free ride to work on his tool box – "free" in the sense that the cost of transporting this magic box from home to work and back again constitutes an allowable deduction incurred in the course of gaining the taxpayer's assessable income."
These cases appear to proceed on the assumption that the taxpayer would travel on public transport but for the difficulties associated with transporting the goods. It is not necessary to establish that the taxpayer incurred some extra cost in making alternative arrangements – having to hire or purchase a specially-fitted vehicle, for example. It appears to be enough if the taxpayer is unable to use public transport even if the circumstances suggest he or she was unlikely to use public transport in any case. That is a curious way to approach the matter, but that appears to be the accepted view.
In this case, it was necessary to transport the various items to the surgery so they might be used in the production of assessable income. But it is clear the box was not heavy like the tool-boxes in U107, or cumbersome like the instruments in Vogt. If the exception to the rule in Lunney only extends to items that require special transport arrangements because of their physical characteristics, Dr Scott's claim for a deduction must fail. His box could be usefully compared to the violin example that was discussed in Vogt. There, his Honour concluded (at 4078) that the cost of transporting a violin could not be claimed because it was unnecessary to make special arrangements for an item that could be comfortably carried by the taxpayer, who was travelling to work anyway.
I think the exception is broader than that. A taxpayer may think it is necessary to make special arrangements to transport essential items to his workplace for reasons other than their size or weight. An item that is essential to a business might have other features or attributes that make special transport arrangements appropriate. The simplest example is valuable items, like jewellery or cash. But it is easy to imagine items that are awkward to transport. Items that have a noxious smell, or which are offensive or which might scandalise or embarrass other people might require special arrangements for their transport. The taxpayer may be uncomfortable transporting the items in the usual way, and could therefore justify making a claim for the cost of transporting those items through alternative means. He or she is free to "hitch a free ride to work" on those items: U107 at 652.
Dr Scott carried cash (although not in large amounts) and patient files including, on some occasions, x-rays. The files were confidential. The wax moulds were also grotesque. He said a patient would be disturbed if she knew that her dentures were being ogled by the dentist's fellow passengers on a bus.
While it easy to imagine better examples of items that might be regarded as awkward to transport in the sense that I have described, I am satisfied Dr Scott should be able to claim the cost of making the special arrangements for transporting the goods in his own vehicle. He was carrying items that were sensitive and valuable. He (and his fellow travellers were he to use public transport, and his patients) might feel distinctly uncomfortable were the contents of the box to spill or be observed by others. Since the evidence suggests the contents of the box might be visible to others because it often could not be sealed, special arrangements for its transport were justified. It follows that the cost of those arrangements should be an allowable deduction.
The Costs Associated with the Rental Property
Dr Scott purchased his home at 53 Old Gympie Road, Kallangur in July 1992. He bought the house from his mother. The purchase price was $150,000. The applicant said he intended to keep the property as an investment that would appreciate in value. He decided to rent it out. I was left with the clear impression that he anticipated receiving a taxation benefit through negative gearing – an important consideration for a young professional person who was just starting out in his career with the expectation of a good income.
Dr Scott moved into the house. His parents stayed, and they resided there with Dr Scott throughout the years of income in question. Dr Scott says part of the house was used as an office for Scott Practice Services, the family's tax return preparation business. There was no formal lease agreement. The applicant said he fixed the rent by examining newspaper advertisements for similar houses in the area. He claimed the market rent was in the order of $180 per week at the time. The Tribunal was shown a copy of a newspaper classified advertisement suggesting that other comparable houses were in fact renting for that amount. Since he also lived in the house, the applicant reduced the rent by one third. He declared rental income in the amount of $120 per week. The rent remained the same throughout the years of income in question.
In order to demonstrate that the transaction was at arms' length and intended to be binding, Dr Scott referred to a letter that accompanied a loan application. The letter referred to the rental arrangement with his parents and was apparently intended to give the financial institution some comfort in making a loan. The applicant noted that several letters had been written to this effect to different institutions, including Citibank and Advance Bank.
At least some of the rent was paid by Scott Practice Services. Mr Kennedy, who audited Scott Practice Services on behalf of the respondent, explained in his evidence how the rental payments were treated in the partnership's accounts. He was very critical of the book-keeping practices he saw during the audit. He said the books did not conform to the basic principles of accounting, and did not present an accurate picture of the finances of the partnership. The entries for rent were an example of the questionable book-keeping. Rental payments were apparently made out of the petty cash account. The mortgage payments on the property were being met in part out of the salary account at the direction of the applicant's father. Those payments were apparently made in satisfaction of an obligation owed by Mr Scott to Dr Scott. That arrangement was the subject of evidence in an earlier hearing before the Tribunal involving the applicant and other members of his family in relation to the distribution of partnership losses, reported at [2002] AATA 778.
There was also evidence that the applicant's parents purchased groceries that Dr Scott consumed in lieu of cash payments.
Dr Scott said in his evidence that he was not concerned about who paid the rent, or the form those payments took. He insisted that rent was paid pursuant to an arms' length transaction. In those circumstances, he argued, he was entitled to deduct at least a portion of the costs associated with the property, including interest payments on the loan secured by a mortgage.
Was this a private arrangement? The starting point is the decision of the High Court in Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1. In that case, the Court said in a joint judgment (at 17):
"The question whether an outgoing was, for the purposes of s.51(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."
The Court accepted that it was relevant to consider the subjective motives of the taxpayer to assist in characterising the expenditure. The Court explained (at 17):
"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."
The Court went on to say (at 18) that it was probably unnecessary to refer to the taxpayer's intentions in a case where the outgoing gives rise to a much larger amount of assessable income. But where - as in the case of Dr Scott – the costs being claimed in each year of income substantially exceed the amount of income generated the characterisation process may require closer scrutiny of the taxpayer's motives. The Court said (at 18-19):
"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. Where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer."
The courts have undertaken the required analysis in a number of cases involving rental arrangements. In Federal Commissioner of Taxation v Groser (1982) 13 ATR 445, for example, the Supreme Court of Victoria considered whether deductions were properly claimed on a rental property provided to the taxpayer's invalid brother at a rent of $2 per week. Jenkinson J held the rent was not assessable income and disallowed the deductions claimed by the taxpayer because the arrangement was a private one between the taxpayer and his brother. His Honour concluded the taxpayer was fulfilling his familial duty to take care of his brother, and the reference to a lease arrangement that generated income was an illusion designed to prevent his brother from appreciating the charitable nature of arrangement.
The Full Court of the Federal Court considered another rental arrangement in Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) 15 FCR 348. In that case, the trustee of a family trust acquired a property that it leased to the beneficiaries at commercial rates. The Commissioner argued the arrangement should be characterised as a purely domestic matter that did not give rise to assessable income, and which did not justify any deductions. The Court disagreed. Lockhart J said the purchase of the home "was dictated by 'sound business considerations'": at 353. His Honour noted the beneficiary was happy to enter into the arrangement because he had personal and family considerations to take into account. But his Honour accepted that the corporate trustee was a separate entity whose motivations needed to be examined on its own. His Honour concluded the property was probably justified as an investment that was likely to appreciate in value: at 353. In those circumstances, the deductions were allowed.
Hill J returned to the question in Madigan v Federal Commissioner of Taxation (1996) 33 ATR 164. In that case the taxpayer rented a house to his father at one quarter of the market rent. His Honour concluded that the only possible explanation for the favourable rent was the personal relationship between the taxpayer and his father: at 169. However his Honour also acknowledged there might be alternative explanations for low rent in other cases apart from a familial relationship. Hill J explained:
"The fact that the rental received was not identical with market value might also not preclude the deduction of the outgoings. For example, a property may be let to a good tenant at a lower than market rent on the basis that the tenant will look after the property. The mere fact that the rental is thus below market rental will not preclude deductibility of the whole of the outgoings. "

Dr Scott's rental arrangement with his parents can be distinguished from the arrangements considered in Groser and Madigan because there is evidence to show that his parents were charged an amount that approximated a market rent. In those other cases, the rent was artificially low – a token amount in Groser, and a quarter of the market rent in Madigan.
Mr Curran for the respondent emphasised there was no formal written lease agreement in place between the applicant and his parents. He referred to the decision of the Supreme Court of Queensland in Federal Commissioner of Taxation v Kowal (1984) 84 ATC 4001. In that case, the presence of a formal lease document appeared to weigh in favour of the taxpayer's contention that the rental arrangement with his mother was not a private arrangement. I note that in Kowal the rent was below the market rate. His Honour accepted that the figure had been determined arbitrarily: at 4004.
It is true that a formal lease document would ordinarily be a feature of an arms' length leasing arrangement. But it will not always be the case. Just as one might give good tenants a discount (as Hill J observed in Madigan), one might dispense with a formal lease agreement if one has tenants whom one could trust. Dr Scott said he was content to do without a formal lease document because he was close to his parents and trusted them to be good tenants. He said he did not feel the need for a formal document to protect his interests against his parents, but that did not prevent this arrangement from being a proper rental agreement that yielded assessable income.
G N Williams J in Kowal was also influenced by the fact that the rental property appeared to make commercial sense. His Honour observed (at 4008):
"…looked at over a period of some years, it is clear that the respondent intended to obtain and in fact obtained a net profit from the renting of the premises."
Mr Curran pointed out that the applicant did not appear to have the intention of making a profit on the rent. Dr Scott said his intention was to make a profit from capital appreciation when he sold the property; making money out of rental income did not appear to be a priority.
There are other factors that assist in the characterisation process in this case, however. The fact he appeared to be consuming rental payments in the form of groceries and cooking and perhaps other domestic services provides further evidence to suggest it is a private arrangement. The fact the taxpayer occupied the rental property alongside his parents tends lends the arrangement the flavour of a private arrangement. I acknowledge Dr Scott reduced the amount of the rent by a third to reflect the fact of his occupation. I think in all the circumstances this was a case of a young man returning from university to live with his mum and dad while acquiring an investment property. Securing a rental return was not the object of the exercise.
It follows I am unable to characterise the expenditure in this case as being incurred for a business purpose in accordance with Income Tax Assessment Act 1936.
Conclusion
The objection decision under review is varied in part and the matter is remitted to the respondent to be dealt with in accordance with these reasons.
I certify that the 37 preceding paragraphs are a true copy of the reasons for the decision herein of Mr BJ McCabe, Member
Signed:         Sarah Oliver
  Associate
Date of Hearing  23 September 2002
Date of Decision  12 November 2002
For the Applicant  Mrs C Scott
For the Respondent                 Mr M Curran, ATO Legal Practice