The Executors of the Estate of the late Peter Fowler and Commissioner of Taxation (Taxation)

[2016] AATA 416

The Executors of the Estate of the late Peter Fowler and Commissioner of Taxation (Taxation) [2016] AATA 416 (22 June 2016)

Division	TAXATION & COMMERCIAL DIVISION
File Number(s)	2014/4798
Re	The Executors of the Estate of the late Peter Fowler
APPLICANT
And	Commissioner of Taxation
RESPONDENT

DECISION

Tribunal	Deputy President S E Frost
Date	22 June 2016
Place	Sydney

1.    The objection decision in relation to the primary tax is affirmed.

2.    The objection decision in relation to administrative penalty is set aside.  Instead the Tribunal allows the objection in full.

..........................[sgd]..............................................

Deputy President S E Frost

Catchwords

TAXATION – capital gains tax – entitlement to small business CGT exemptions – whether small business entity – active asset test – main use – penalties – failure to take reasonable care – objection decision in relation to primary tax affirmed – objection decision in relation to administrative penalty set aside and objection allowed in full

Legislation

Income Tax Assessment Act 1997 ss 152-10, 152-35, 152-40, 328-110, 995-1

Taxation Administration Act 1953 ss 280-170, 284-75, 284-90

Cases

Ferguson v Commissioner of Taxation (1979) 37 FLR 310

REASONS FOR DECISION

Deputy President S E Frost

INTRODUCTION

1. In 1986 Peter Fowler and his late wife purchased a property for $590,000.  When his wife died in 1994 Mr Fowler became the sole owner of the property.

2. Mr Fowler subsequently sold the property, during the 2012 income year, for $4.1 million.  In his tax return for that year he declared a capital gain of about $3.4 million but a net capital gain of $0. The reason for the reduction from $3.4 million to $0 is that he claimed to be entitled to a capital gains concession called ‘small business relief’. The Commissioner disagreed with respect to the availability of the relief claimed, but accepted that Mr Fowler was entitled to a 50 per cent reduction in the capital gain, from $3.4 million to $1.7 million, for having held the property for at least 12 months.

3. The Commissioner made an amended assessment reflecting a $1.7 million increase in Mr Fowler’s taxable income. He also assessed administrative penalty and shortfall interest charge. Mr Fowler objected against the amended assessment, the assessment of administrative penalty and the shortfall interest charge, but the Commissioner disallowed the objections.  Mr Fowler then applied to the Tribunal for review of the Commissioner’s objection decisions.  The application for review is now being progressed by the executors of Mr Fowler’s estate, Mr Fowler having died in March 2015.

   THE ISSUES

4. A major issue in this review is whether the small business relief provisions in Division 152 of the Income Tax Assessment Act 1997 (the 1997 Act) apply. That depends on a number of questions, including whether Mr Fowler was a ‘small business entity’ for the 2012 income year and whether the property he sold was an ‘active asset’. 

5. The ‘small business entity’ question turns on whether Mr Fowler was carrying on a business.  If he was, then the Commissioner submits that the proper outcome may be that the gain on the sale of the property is not a capital gain as first thought, but is instead a revenue gain – in which case no reduction at all is available from the $3.4 million figure.  Mr Fowler’s representatives respond that the Commissioner cannot raise that entirely new ground on this review because it was not raised either at the audit stage or during the Commissioner’s consideration of the objection. I will put that question to one side for the time being.

6. The ‘active asset’ question turns on whether the property that Mr Fowler sold was used, or held ready for use, in the course of carrying on a business. However, even if it answers that description, the property will not be an ‘active asset’ if its main use by Mr Fowler was to derive rent.

7. Consideration of the administrative penalty will depend on the outcome of the major issue. Shortfall interest charge is not before the Tribunal because it is below the 20 per cent threshold: s 280-170 in Schedule 1 to the Taxation Administration Act 1953 (TAA)[1].

   [1] See also Transcript 17.15-40

   WAS MR FOWLER A ‘SMALL BUSINESS ENTITY’ FOR THE 2012 INCOME YEAR?

8. The meaning of the expression ‘small business entity’ is provided in s 328-110 of the 1997 Act.  In broad terms, you must have an annual turnover of less than $2 million and you must also carry on a business in the current year. The $2 million turnover requirement is satisfied in Mr Fowler’s case; the real contest is whether he carried on a business in the 2012 year.

9. There is one further qualification in s 328-110, and that appears in subsection (5). It provides that Mr Fowler can still be treated as carrying on a business in the 2012 year if in that year he was winding up a business that he previously carried on, provided he was a small business entity for the income year in which he stopped carrying on that business.

10. As I have already indicated, Mr Fowler died in March 2015.  Much of the evidence given in support of this review application has been given by his son, Greg Fowler. Throughout these reasons I will refer to the late Mr Fowler simply as Mr Fowler and to his son as Greg Fowler, or just Greg.

11. Mr Fowler was born in 1927. He practised as a solicitor from the late 1940s to the early 1970s.

12. During the 1950s Mr Fowler undertook some property development activities.

13. From the 1960s to the 1990s Mr Fowler acquired a total of 11 properties, each of which was let from time to time. In 1986 he purchased the property in question together with his second wife. The property was a block of 10 residential units located in Manly. For the entire time that Mr Fowler owned the property it was tenanted, although one or more of the units may have been vacant at any given time. In a document filed in the Supreme Court of New South Wales in June 1995 in respect of the grant of probate of the will of his second wife, Mr Fowler stated that the purchase of the property was financed in part by the sale of several other properties that he owned. He also stated that the reason for purchasing the Manly property was to consolidate his assets into one property, as ‘land tax was becoming too much of a liability to pay on all the properties’[2].

    [2] Exhibit A3, Tab 8, page 62

14. The evidence about what Mr Fowler actually did in relation to the Manly property is somewhat patchy. Greg Fowler is the main source of information about his father’s activities because there is virtually no contemporaneous documentary material available to shed any light on what Mr Fowler was doing.  But while Greg Fowler made a number of statutory declarations in this proceeding in which he set out his understanding of his father’s activities, he had to accept in cross-examination that his father did not speak to him very much about his (Mr Fowler’s) business affairs; that his father rarely talked directly about his personal affairs; that his father rarely talked about his past; that his father rarely spoke to Greg about the Manly property; and that much of Greg’s understanding of his father’s activities had been gathered from random comments made by his father over a period of about 30 years.  Greg also said there was a period in his life where he had less contact with his father because there was ‘a bit of friction’ between Greg and his father’s second wife[3]. But some of Greg’s evidence is based on actual observation. He said[4]:

    I’d been to the property a number of times. I used to race Saturdays and Sundays from Manly Skiff Club, which is right adjacent to it. I would see his car there.  I’d drop in, I’d say, “Hi, dad, what are you doing?” He’d be up to his neck in paint refurbishing the unit, or he might be outside whipper snipping, or he’d be chopping down a tree, or he’d be removing rubbish where a tenant had moved out.  I mean I didn’t take any notice of what he was doing, but I certainly didn’t help him, but I know what he was up to. 

    [3] Transcript 28.8-29.13

    [4] Transcript 29.3-10

15. Greg said that the types of activities his father undertook at the Manly property could be divided into two distinct periods. The first period was from 1986 to 2006; the second period was from 2006 to 2011. The demarcation between the two periods is a result of Mr Fowler’s failing health in his late 70s.

16. Nevertheless, during the period when Mr Fowler was still reasonably active, Greg said his father conducted a number of types of ‘day to day activities’ in relation to the Manly property, including advertising, interviewing prospective tenants and supervising tenant inspections; cleaning units when a tenant moved out; receiving phone enquiries from potential tenants; checking references; providing access for potential tenants to inspect a vacant unit; preparation of some of the residential leases; sending the documentation to the new tenants and lodging rental bonds with the Rental Bond Board; arranging for and making payment of all expenses relating to the ownership and running of the rental units at the Manly property; attending to and performing most of the ground and general maintenance of the Manly property; repairs and maintenance, including cleaning of the common property and gardening. Greg also said his father undertook ‘the refurbishment or improvements of 4 or 5 residential units, including painting/tiling/renovating new kitchens and organising new carpet’[5], but he would leave the larger maintenance jobs to qualified tradesmen.

    [5] Exhibit A3, page 11 at [104]

17. According to Greg, Mr Fowler had a system of rent collection by which new tenants were given a bank deposit slip book containing the information they needed so they could pay the rent. Mr Fowler would regularly reconcile rent receipts against his bank statements.  Mr Fowler would also prepare spreadsheets to calculate the amount of rent collected and expenses incurred on the Manly property. An example of such a spreadsheet from the period 2002 to 2003 is annexed at Tab 13 to Greg Fowler’s statutory declaration dated 6 July 2015 (Exhibit A3).

18. From about 2005 or 2006[6] Mr Fowler’s health went into decline and his physical involvement in the Manly property was reduced. At some stage between 2008 and 2010, Mr Fowler was diagnosed with dementia. 

    [6] Transcript 32.20

19. From late 2010 Greg became aware that the Manly property had some fairly large maintenance issues. The ceiling in one of the bathrooms had collapsed, revealing rusted reinforcing in the concrete wet area floor above. Some of the underground cast iron drainage pipes had failed and required repair. Some sections of the gas distribution piping had severe rusting and required replacement. There was some spalling of the concrete façade. There was moisture and dampness in the lower level walls. There was some timber rot on the exposed balconies and the timber railings. Paintwork was flaking. By now the building was 90 years old and it was looking its age.

20. In July 2010 Mr Fowler had given a general power of attorney to his three children – Greg and his two sisters. In early 2011 Mr Fowler went into an aged care facility. The family considered refurbishing the building but the cost, estimated at about $1.5 million, was prohibitive. Instead they decided to sell it. 

21. The Applicants’ representatives submit that Mr Fowler’s activities with respect to the Manly property amounted to his carrying on a business. That business is described as a business of ‘property ownership and management of the property’[7] or alternatively ‘managing and letting property’[8]. The Commissioner submits that the evidence does not support a finding that Mr Fowler carried on a business by either of those descriptions or indeed any business at all.

    [7] Applicant’s Preliminary Outline of Submissions [117]

    [8] Applicant’s Closing Submissions [44]

22. ‘Business’ is defined in s 995-1 of the 1997 Act to include ‘any profession, trade, employment, vocation or calling, but does not include occupation as an employee’, but those concepts have no relevance to this case. 

23. The authorities have identified the types of circumstances whose existence are relevant to the question of whether a person is carrying on a business. They include things like having a purpose of profit-making; repetition and regularity of activities; organisation of activities in a business-like manner; the keeping of books, records and the use of system; the size of an operation; and the amount of capital employed[9].

    [9] For example, Ferguson v Commissioner of Taxation (1979) 37 FLR 310 at 314 per Bowen CJ and Franki J

24. The difficulty in this case is that the evidence in favour of the existence of a business is quite vague, and ultimately unconvincing.  Greg Fowler was not himself involved in any of his father’s activities and the information he was able to provide to the Tribunal was slim.  Most of it was not based on direct observation but on what his father told him. My impression is that there has been some, perhaps unconscious, embellishment of the extent to which Mr Fowler was actively involved in ‘managing’ the property. It seems to me that Mr Fowler’s approach was more like ‘set and forget’: once a tenant moved in and had been given a bank deposit book, there was little to do (catastrophes and payment reconciliations aside) until the tenant later moved out. I do not ignore the odd bit of ground maintenance and other minor work that Mr Fowler carried out but I am not persuaded that that was anything more than a modest amount anyway, and likely undertaken only infrequently.

25. The Commissioner made much of the fact that the property was, at least by 2005 or 2006, in a state of disrepair, or even neglect. Greg Fowler had written in an email to an accountant in November 2011 that the 10 units ‘had been neglected for the last 15 years’; in February 2012 his summary description of the property was that ‘Rent was low because it was neglected for the last 20 years’[10]; in cross-examination he would not accept that the property had been neglected for more than ‘possibly five or six [years]’[11] prior to 2011; but he did say that ‘it’s never been refurbished’[12]. One thing that can be said with certainty is that the property had been neglected for a number of years prior to its sale in 2011.  As a consequence, and as accepted by Greg Fowler in February 2012, rents were lower than they might have been. While not decisive, that is relevant, since it is a rare business that does not seek to maximise its revenue by maintaining its assets to an acceptable standard.

    [10] Exhibit R2

    [11] Transcript 34.24

    [12] Transcript 37.37

26. I accept that Mr Fowler had no other means of support other than the rental income he derived from the Manly property[13]. That means that he will have wanted to make a profit from the rent, otherwise he would have had nothing to live on.  But it does not mean that his overall activity from owning and managing the property will have been conducted as a business, or even in a business-like manner. The year-to-year ‘profit’ does not take into account the business-related expenditure in respect of repairs and maintenance that would normally be expected to have been incurred but was not.

    [13] Transcript 32.40

27. I am not persuaded that Mr Fowler carried on a business during any part of the period when he owned the Manly property, from 1986 to 2011.  As a result Mr Fowler was not a ‘small business entity’ for the 2012 income year.  My conclusion is not affected by the fact that Mr Fowler was himself incapable of carrying on a business for at least the last few years of his ownership of the Manly property. The evidence is that one of his daughters, by 2008, had ‘taken over some of the day to day affairs’[14]. If his activities prior to the decline in his health had amounted to the carrying on of a business, then those same activities carried on by someone else on his behalf, and in his interests, may well have constituted the continued carrying on of a business by him. 

    [14] Transcript 32.11-12

28. Since Mr Fowler was not a small business entity for the 2012 income year, one of the mandatory ‘basic conditions’ for relief under s 152-10 of the 1997 Act – namely, the condition in subparagraph (c)(i) – is not met. Therefore the capital gain on sale of the Manly property cannot be reduced or disregarded under Division 152.

    THE COMMISSIONER’S ‘ORDINARY INCOME’ ARGUMENT

29. It is conceded in the Commissioner’s Summary of Submissions, at [55], that if Mr Fowler was not carrying on a business, the gain must be on capital account. It is therefore unnecessary, and it would be inappropriate, for me to explore the question whether the Commissioner would have been entitled to raise the alternative ‘ordinary income’ argument in this case.

    THE ‘ACTIVE ASSET’ TEST

30. For completeness, I should deal with the other contentious ‘basic condition’ in s 152-10 – whether the Manly property satisfies the active asset test, referred to in paragraph (d).

31. Section 152-35(1) explains that the Manly property (having been owned by Mr Fowler for more than 15 years) satisfies the active asset test if it was an active asset of Mr Fowler’s for a total of at least 7.5 years during his period of ownership. 

32. Section 152-40(1) provides, relevantly for this case, that the Manly property is an ‘active asset’ at a particular time during Mr Fowler’s period of ownership if, at that time, it is used, or held ready for use, in the course of carrying on a business carried on by him.  Subsection (4), however, says that the property cannot be an active asset if its ‘main use’ by Mr Fowler is to derive rent – even if (contrary to the view I have formed) Mr Fowler was in fact carrying on a business.

33. Mr Fowler’s representatives submit that the word ‘use’ in the expression ‘main use’ is not restricted to physical uses of the asset but can include non-physical uses[15]. They submit that the word ‘use’ has a ‘protean’ quality, noting that the Macquarie Dictionary contains 14 separate definitions of the word as a noun[16]. They contend that holding land for the purpose of securing an incremental accrual in the market realisable value of the land, year to year, is relevantly a ‘use’ of the land within s 152-40(4)(e) of the 1997 Act[17]. 

    [15] Applicant’s Closing Submissions [52]

    [16] Applicant’s Preliminary Outline of Submissions [157]

    [17] Applicant’s Preliminary Outline of Submissions [161]

34. There are two problems with those submissions. 

35. The first is that, to the extent that they rely on Mr Fowler’s main use of the property being characterised as the use for the purpose of securing an increase in its value over time, the evidence does not support that characterisation. The only evidence going to Mr Fowler’s subjective purpose at the time of purchasing the property is to be found in the document filed in the Supreme Court of New South Wales in June 1995, and referred to in [13] of these reasons. In that document Mr Fowler stated that the reason for purchasing the Manly property was to consolidate his assets into one property, as ‘land tax was becoming too much of a liability to pay on all the properties’.  But the properties that he sold all appear to have been rent-producing properties; the logical inference to draw is that Mr Fowler purchased the Manly property for the purpose of deriving rent.

36. The second problem is that the submission is not supported by the text or context of the statutory provision. Section 152-40(1) refers to two distinct concepts – using, on the one hand, and holding ready for use, on the other. In context, the concept of ‘use’, by itself, appears to be only a reference to physical use. And so the question in subsection (4) is directed to whether the main physical use of the asset is to derive rent. Plainly, in this case, that is not only the main physical use, it is the only physical use.

37. For those reasons the Manly property was not an ‘active asset’ at any time during Mr Fowler’s ownership of it, and as a consequence it does not satisfy the active asset test in s 152-35 of the 1997 Act.

    ADMINISTRATIVE PENALTY

1. Penalty was assessed at 25 per cent for failure to take reasonable care: s 284-75(1) and table item 3 in s 284-90(1) in Schedule 1 to the TAA.

2. Mr Fowler’s representatives deny that there was a failure to take reasonable care, but even if they are wrong with that, they submit that the ‘safe harbour’ provision in s 284-75(6) is satisfied. That provision is in the following terms:

   You are not liable to an administrative penalty under subsection (1) or (4) if:

   (a)you engage a *registered tax agent or BAS agent; and

   (b)you give the registered tax agent or BAS agent all relevant taxation information; and

   (c)the registered tax agent or BAS agent makes the statement; and

   (d)the false or misleading nature of the statement did not result from:

   (i)intentional disregard by the registered tax agent or BAS agent of a *taxation law (other than the *Excise Acts); or

   (ii)recklessness by the agent as to the operation of a taxation law (other than the Excise Acts).

3. There is no doubt that Greg Fowler, under the power of attorney given to him by his father, engaged a registered tax agent, Geoff Bertram, for the preparation of Mr Fowler’s 2012 tax return[18]. Furthermore, there is no assertion by the Commissioner that the statement made by Mr Bertram in Mr Fowler’s tax return resulted from either intentional disregard of the law or recklessness. I agree with the Commissioner’s assessment that the false or misleading statement resulted from no higher level of culpability than a failure to take reasonable care. In that event paragraphs (a), (c) and (d) of s 284-75(6) are satisfied.

   [18] Original tax return, page 2, at T3-67

4. The question then is whether Mr Bertram was given all relevant taxation information.

5. Greg Fowler’s evidence, which I accept, is that he approached Mr Bertram in March 2012 for assistance on his father’s CGT position, having become dissatisfied with the responsiveness of the previous accountant. At the first meeting on 29 March 2012, Mr Bertram’s initial opinion on the availability of the CGT exemption was ‘You can’t do this, the situation doesn't exist for your father’[19]. Mr Bertram said much the same in cross-examination when Mr Peadon, counsel for the Commissioner, asked Mr Bertram about the initial meeting[20]:

   MR PEADON:  Mr Bertram, at the first meeting what did Mr Fowler say to you?

   MR BERTRAM:  He told me that his father had a property which was sold in Manly, and sought advice relating to the capital gains tax position.

   MR PEADON:  And that was it?  That’s all he told you?  

   MR BERTRAM:  No.  I understood that there was a rental property involving 10 home units, and my initial advice to him was that a rental property was considered to be a passive investment, and as such he would be entitled to a 50 per cent discount on the otherwise capital gain.  And at that point he added, “What about the small business enterprise 15 year exemption?”.  He’d obviously done a fair bit of reading and research, and I said he had to be carrying on a business for that to be the case.  When he explained to me the circumstances under which his father operated the units, the extensive involvement in running it, it appeared to me that he was, in fact, carrying on a business, and so I said we should further investigate and explore that prospect, and I also gave him further advice, in terms of section 152-40 as in addition to the main use requirement for it to be a main use require for it to be an active asset.

   MR PEADON:  Can you be a bit more specific about what that advice was in relation to 152-40?  

   MR BERTRAM:  Okay.  I told him that he had to have a turnover under $2 million per annum, and he had to be carrying on a business.  We also discussed the prior role of the $6 million net asset threshold, and I also added that he needed to have satisfied the requirements that the main use was not produced from, among other things, rent.  And we determined at that point we should investigate those issues in great detail, which we did.  When I say “we”, Greg Fowler investigated and did a lot of research as well as himself, and we discussed both.

   MR PEADON:  So is it fair to say that you were wholly reliant upon what Mr Fowler told you in relation to the facts, and you didn’t do any independent research of your own as, for example, going and visiting the Manly units?  

   MR BERTRAM:  No, I was well aware of the Manly units though because I’d done the accounting and tax work for his sister for more than quarter of a century, and I also knew his father and ran into him from time to time.  I knew that he had the units [in] Manly.  I didn’t realise the extent of his involvement in putting in the grounds, and so forth.

   [19] Transcript 45.35-36

   [20] Transcript 72.12-47

6. Mr Peadon put it to Mr Bertram that he, Mr Bertram, had been unaware of the ‘main use to derive rent’ exclusion in s 152-40(4)(e) until a discussion between Mr Bertram and one of the Commissioner’s officers in around August 2013[21]. Mr Bertram rejected the suggestion[22], and after further questioning he said ‘To the best of my recollection I would have addressed that issue at the time that we discussed the small business enterprise concession’[23]. Although that later comment is less than definitive, I accept that Mr Bertram did indeed discuss the exclusion with Greg Fowler, if not during the March 2012 meeting, then certainly prior to lodgement of Mr Fowler’s tax return in December 2012.

   [21] Transcript 77.28-30; T7-118

   [22] Transcript 77.30

   [23] Transcript 79.18-20

7. But even if that were not so, the Commissioner’s assertion that Mr Bertram overlooked the provision does not undermine the potential reliance on the ‘safe harbour’ provision in s 284-75(6). At its highest, the Commissioner’s contention is that Mr Bertram made a mistake by overlooking, or even being unaware of, a relevant exclusion. That does not amount to, and nor does the Commissioner submit that it amounts to, either recklessness or intentional disregard of the law. The question instead is, did Greg Fowler provide to Mr Bertram ‘all relevant taxation information’? And the answer to that, in my view, is yes. Greg Fowler’s initial outline of the circumstances led to Mr Bertram’s preliminary opinion that the exemption was not available because he considered that Mr Fowler had not been carrying on a business. But by the end of the first meeting he had reached at least a tentative view that the exemption may be available[24]. That evolution in his thinking can only have come about as he listened to Greg Fowler’s explanation of his understanding of his father’s activities. The explanation of the activities – which necessarily included a reference to the fact that the units were tenanted – together with the undisputed fact that Mr Fowler had owned the property for over 15 years, was the relevant taxation information that needed to be provided so that Mr Bertram could form a view on the CGT position and then lodge the return. Mr Bertram may have got the answer wrong, but provided there was neither recklessness nor an intentional disregard of the law, the ‘safe harbour’ in s 284-75(6) applies.

   [24] Supported by the contemporaneous email sent by Greg Fowler to his sister on 30 March 2012, the day after the first meeting, in which he said ‘The fact that we believe it is correct [that is, “Dad being an active investor until he was placed into a home”] and by all accounts from what we have read is correct, including preliminary assessment by the accountant’: Exhibit A3 [200]

8. Mr Fowler is therefore ‘not liable to an administrative penalty’ under s 284-75(1).

   DECISION

9. The objection decision in relation to the primary tax is affirmed.

10. The objection decision in relation to administrative penalty is set aside. Instead the Tribunal allows the objection in full.

I certify that the preceding 47 (forty-seven) paragraphs are a true copy of the reasons for the decision herein of Deputy President S E Frost

....................[sgd]...........................................

Associate

Dated 22 June 2016

Dates of hearing	30 November 2015 and 1-2 December 2015
Final submissions received	14 December 2015
Counsel for the Applicant	Mr I Young & Mr B Young
Representative for the Applicant	Glen Bertram Pty
Counsel for the Respondent	Mr C Peadon
Solicitors for the Respondent	Australian Taxation Office, Review and Dispute Resolution Group