"The Taxpayer" and Commissioner of Taxation
[2007] AATA 1228
•12 April 2007
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2007] AATA 1228
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT200500255
TAXATION APPEALS DIVISION ) Re “THE TAXPAYER” Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr A Sweidan, Senior Member Date12 April 2007
PlacePerth
Decision The Tribunal affirms the decision under review. ..........(Sgd. Mr A Sweidan).................
Senior Member
CATCHWORDS
Income Tax – deductions claimed – whether outgoings incurred – whether anti-avoidance provisions apply – penalty
LEGISLATION
Income Tax Assessment Act 1997 s 8 – 1
Income Tax Assessment Act 1936 Part IV A
CASES
Upper Hunter County District Council v Australian Chilling & Freezing Co Ltd (1968) 118 CLR 429
Thorby v Goldberg (1964) 112 CLR 597
Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) CLR 295
Ronpibon Tin NL v FCT (1949) 78 CLR 47
Ure v FCT (1981) 34 ALR 237
Fletcher v FCT (1991) 173 CLR 1
FCT v Whitfords Beach Pty Ltd (1981-2) 150 CLR 355
Whitfords Beach Pty Ltd v FCT (1983) 83 ATC 4277
Moana Sand v FCT (1988) 88 ATC 4897
FCT v Montgomery (1999) 198 CLR 639
Puzey v Commissioner of Taxation (2000) 124 FCR 514
DECISION AND REASONS FOR DECISION
12 April 2007 Mr A Sweidan, Senior Member BACKGROUND AND TRIBUNAL’S FINDINGS
1. The applicant seeks a review by the Tribunal of a decision of the respondent made on 16 May 2005 disallowing an objection made by the applicant on 1 February 2002 to an amended assessment dated 10 January 2001 for income tax and penalties in respect of the year of income ended 30 June 1998.
2. The applicant claimed to be entitled to deductions totalling $18,000 in the year ended 30 June, 1998 as a franchisee of Greencare Resources Pty Ltd (Greencare).
3. In issue in this proceeding is whether the applicant is entitled to the claimed deductions: -
(a)pursuant to s 8-1 of the Income Tax Assessment Act 1997 (1997 Act); and if so;
(b)whether a deduction is denied because of the operation of Part IVA of the Income Tax Assessment Act 1936 (1936 Act).
4. For the reasons set out below the Tribunal is of the view that on the evidence provided the applicant has not established that the amounts claimed were allowable as deductions.
5. There is a further issue of whether the applicant is liable to pay the additional tax by way of penalty assessed to him. In respect of that issue, the Tribunal finds that:
(a)the applicant also has not discharged the burden of showing that the necessary statutory preconditions to the imposition of penalty did not exist; and
(b)there is nothing in the applicant’s material which would support a remission of the penalty.
Evidence and Material provided by the Applicant and the Respondent
6. The Tribunal had before it the “T” documents. The following copy documents were produced in support of the applicant’s case:-
(a)““The Taxpayer”, Reasons for entering into the Greencare Franchise Agreement” (Reasons document);
(b)“Greencare Resources Pty Ltd Firewood Franchise Business Opportunity Disclosure Document “Silver Perch Plantation”” (Opportunity Document). The Opportunity Document contains as appendices forms of a: -
(i)Franchise Agreement;
(ii)Farm Afforestation Management Agreement;
(iii)Farm Afforestation Management Loan Agreement –
(the Agreements);
(c)“Regulations for Greencare Resources Pty Ltd Franchise Owners”;
(d)“Silver Perch Plantation Woodlot Certificate” certifying the applicant to be “the holder of two Woodlots in the Silver Perch Plantation being situated in the Shire of Collie on a portion of Wellington Location 4163 and 4165 and contained in Title Volume 1417 Folio 137A and being number 32 to 33 on the plan held by” Greencare. The certificate is dated “30 June 199” and signed “for and on behalf of” Greencare;
(e)a balance sheet and trading, profit and loss statement for Farm Afforestation Management Pty Ltd (FAM) for the year ended 30 June, 2000;
(f)management accounts for FAM for the year ended 30 June, 2002;
(g)“Submissions in support of notice of objection against amended assessment” (Submissions document).
7. Pursuant to the order of the Tribunal made on 10 November, 2006, the applicant also filed a witness statement dated 22 November, 2006 (incorrectly entitled “Respondent’s Statement of Facts and Contentions”) (witness statement) to which is annexed the following further copy documents: -
(a)signed “Memorandum of Agreement” between Greencare and the applicant and “Agreement” between FAM and the applicant, both dated 25 June, 1998;
(b)letter from Greencare dated 21 November, 2006 providing details to the applicant of principal repayments for four Greencare Franchises;
(c)document headed “Banking after 30 June 1998”;
(d)bank statement for account in the name of Mr I V “The Taxpayer” for the period 8 August, 2003 to 15 August, 2003;
(e)bank statements for accounts in the name of Greencare for the periods 10 July, 2003 to 1 August, 2003, 17 June, 1998 to 17 September, 1998 and 24 June, 1999 to 14 July, 1999;
(f)invoices from Greencare to “The Taxpayer” for “interest loan” and “Forest Rent and Maintenance” dated 30 June, 1999 and 20 January, 2004;
(g)bundle of correspondence from Greencare to the applicant.
8. The applicant gave evidence in support of his application.
9. In the Tribunal’s opinion, the applicant’s evidence and the material provided establishes at best that the applicant paid $3,000 to Greencare in the relevant year. The Tribunal finds that: -
(a)the applicant did not incur an obligation in the amount of $18,000 in the relevant year because the documents he signed lacked essential terms;
(b)any obligation was not incurred in connection with the gaining or producing of assessable income because it cannot be discerned what the obligation might have been incurred for;
(c)any obligation was not incurred in connection with a business;
(d)the occasion or loss of the outgoing was not the earning of assessable income but the obtaining of a tax advantage;
(e)if an outgoing was incurred, it was an outgoing of capital.
The claimed outgoings were not incurred – lack of essential terms
10. The respondent submited that the claimed outgoings were not incurred and the Tribunal finds this to be so.
11. The Memorandum of Agreement cannot be said to constitute a contract between the parties. It lacked essential and critical terms. See Upper Hunter County District Council v Australian Chilling & Freezing Co Ltd (1968) 118 CLR 429 at 436; Thorby v Goldberg (1964) 112 CLR 597 at 607. Neither did it purport to incorporate the terms of any of the Agreements which appeared in the Opportunity Document. In fact it made no reference to those documents.
12. On the basis of the available material, the Tribunal cannot construe the Memorandum of Agreement as creating obligations between the parties or as being intended to do so, particularly with respect to the payment of franchise fees. In this regard the Tribunal notes that:
(a)according to the Submissions document: “the Memorandum of Agreement had been used as an interim means of obtaining the investor’s commitment to the Greencare Firewood Franchise, with the intention being that the investor would, if considered necessary, subsequently sign the franchise documentation”.
(b)this is consistent with the Opportunity Document which indicated that Greencare did not then have a business or system capable of being franchised. It described, not a business but a “Franchisor’s Policy” “[t]o source supplies of sustainable wood and build domestic firewood distribution to a maximum of 60 clients per franchise. Furthermore the franchise will produce 8-10 year old Eucalyptus Globulus trees to a maximum quality commensurate with practical forest management for the period of growth.”
(c)accordingly,”[f]ranchises will be granted on the basis of a commitment to pay the annual franchise fees.” Consistently with the Submissions document, the Memorandum of Agreement was no more than a means of obtaining a prospective franchisee’s commitment to a franchise at such time as Greencare had a business or system which was capable of being made available to a franchisee.
(d)in fact, no franchises were operated. According to the Reasons document, firewood distribution commenced through service stations and supplying Rottnest Island but production levels never permitted independent operations. The witness statement (page 3) confirms that “the firewood distribution business was arranged by [FAM] as a co-operative for the franchisees from 1998, 1999 and 2000.
The Respondent submitted that the claimed outgoings were not incurred because it cannot be ascertained what they were incurred for and the Tribunal agrees that this is so, noting that:
13. If one assumes that the Memorandum of Agreement was effective in obliging the applicant to pay the amount of $9,000 per franchise it is not established what that amount was paid for.
14. The applicant asserts that he was in a business of afforestation.
15. However, if the claimed outgoings were incurred, they were not incurred in the business of afforestation. That business was provided for by the payment of: -
(a)an Annual Licence Fee ($286) for occupation of a Woodlot;
(b)a management fee ($750 then $35 per year).
16. Assuming, further, that the form of Franchise Agreement was entered into by the Memorandum of Agreement, the form of Franchise Agreement specifies two separate fees:-
(a)a franchise fee of $9,000;
(b)an Annual Licence Fee ($286) for occupation of a Woodlot.
17. The covenants in the form of the Franchise Agreement appear to be concerned with the latter fee. No provision is made for the conduct of a franchise business. There is no definition of services in respect of which the fee of $9,000 might be said to be paid, except, possibly, for marketing services to be provided many years later.
18. The franchise regulations which the applicant says he was given (witness statement, page 2) do not assist. First, one has to read the documents actually signed by the applicant as incorporating not only the terms of the Agreements contained in the Opportunity Document but also the franchise regulations. Secondly, they assume a business defined elsewhere, presumably by a franchise agreement. Both the franchise agreement and the franchise regulations lack essential terms, critically, definition of the applicant’s particular territory or business.
19. Even if the regulations might be regarded as defining services in respect of which the amount of $18,000 could be said to be paid, they cannot to be given any weight because:
(a)the evidence indicates that they were created following the respondent’s inquiries into the operations of the Greencare business;
(b)the applicant has not produced them now.
(See ATO file notes dated 3 September and 8 September, 1999 (T142, page 272 and T143, page 274). Both file notes record discussions with Greencare personnel pointing out late production of the franchise regulations and discrepancies in those which appear at T105, page 108. By comparison, in the copy franchise regulations, provided by the applicant’s advisors under cover of a letter dated 22 February, 2006, those discrepancies do not appear.)
As contended by the Respondent the Tribunal finds that the claimed outgoings were not incurred in connection with a business
20. Neither party intended to or did commence a franchise business: -
(a)the applicant did not intend to operate any such business: “Works in the Northwest ... and saw the franchise in two lights. One was to give him or his sons the opportunity to run a fire wood franchise when they returned to Perth” (underlining added);- see Reasons document, page 1
(b)the applicant did not appoint any person to operate on his behalf a business of sourcing, marketing and selling firewood;
(c)the Opportunity Document indicated that Greencare did not then have a business or system capable of being franchised. It described, not a business but a “Franchisor’s Policy” “[t]o source supplies of sustainable wood and build domestic firewood distribution to a maximum of 60 clients per franchise. Furthermore the franchise will produce 8-10 year old Eucalyptus Globulus trees to a maximum quality commensurate with practical forest management for the period of growth.”
(d)accordingly,”[f]ranchises will be granted on the basis of a commitment to pay the annual franchise fees.”
(e)no franchises were ever operated. According to the Reasons document, firewood distribution commenced through service stations and supplying Rottnest Island but production levels never permitted independent operations. The witness statement (page 3) confirms that “the firewood distribution business was arranged by [FAM] as a co-operative for the franchisees from 1998, 1999 and 2000.
21. Ultimately, then, any payment made by the applicant was in respect of a business or system which did not exist. No connection has been established between the making of any payment and the conduct of any business or the earning of assessable income. On the evidence there was no business and no means of earning any assessable income.
On the evidence before the Tribunal the claimed outgoings were not connected, sufficiently or at all, with the earning of assessable income.
22. Consideration of the overall factual context indicates that the outgoing was not directed to gaining or producing assessable income.
23. The determination of whether outgoings are deductible for the purposes of s 8-1(1)(a) is a matter of characterization by reference to the advantage the outgoings seek to achieve. The outgoing must be incidental and relevant to gaining or producing assessable income. Put another way, the production of assessable income is the occasion of the outgoing: Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) CLR 295 at 309 and Ronpibon Tin NL v FCT (1949) 78 CLR 47.
24. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing a character of an outgoing of the relevant kind. Where there is a disproportion between the outgoings incurred and the amount of assessable income, the question of the character of the outgoings must be answered by:
“a common sense appreciation of the overall factual context in which the outgoings were incurred. It necessarily involves a consideration of the contents and implications of the overall contractual arrangements … pursuant to which the outgoings … became payable. … it also encompasses a consideration of the purpose which the members of the partnership … had in incurring the outgoings.”
Fletcher v FCT (1991) 173 CLR 1 at 20-21
25. For amounts to be deductible, this “commonsense” or “practical” weighing of all the factors ought to indicate that the relationship between the whole of the expenditure and the production of assessable income is "genuine and not colourable". See Fletcher at 17.1-18.2, 18.7-19.4 and Ure v FCT (1981) 34 ALR 237 per Brennan, J at 241, lines 20-31 and per Deane and Sheppard, JJ at 248-249, line 25 and 249, line 35 -250.The
26. The occasion of the loss or outgoing is not the earning of assessable income where the circumstances point to another purpose. See Fletcher v FCT (1991) 173 CLR 1 at 17-18.
27. Here, the circumstances do not point to the purpose of the outgoing as being the earning of assessable income. The commercial advantage the payment ostensibly secured for the applicant is, at best, poorly defined and difficult to discern from the forms of agreement. It is extremely doubtful whether those agreements, if regularly made, gave rise to enforceable obligations at all, particularly with respect to the operation of a franchise for which not even a territory was defined or allocated.
28. Having regard to the terms of the forms of agreement, the Tribunal cannot conclude that the relationship between the outgoing and the earning of assessable was “genuine and not colourable.”
29. The applicant has claimed deductions of $18,000 in respect of two franchises. The evidence suggests that he paid $3,000 on 25 June, 1998 and three instalments of $1,000 each on 6 July, 1998, 31 July, 1998 and 7 September, 1998, ie, a total of $6,000.
30. Based upon the applicant’s tax return, those total claimed deductions of $18,000 (in respect of two franchises) resulted in tax savings of $7,762.64 (not including Medicare levy) which exceeded his total cash deposit of $6,000 by $1,762.64.
31. In light of the difficulty of discerning what commercial advantage any outgoings secured, the upfront tax advantage provides the only sensible explanation for them in the opinion of the Tribunal.
32. The Tribunal notes that the applicant entered into the arrangements on 25 June, 1998 and gives evidence (in the witness statement, page 2) of having entered into subsequent arrangements in June, 1999.
Capital
33. At best for the applicant, any payment he made was an outgoing of capital. On his own evidence it secured for him a share of Greencare’s or FAM’s business of selling firewood.
34. By the form of Franchise Agreement (clause 2.1), the sum of $9,000 was to be paid in consideration for capital items, namely “a non-exclusive franchise, to operate the Business” being the growth, sourcing and marketing of renewable fuel resources and “a licence to use the Knowhow” (as defined in clause 1.1).
35. Further, as the Reasons document indicates: -
“Because the machine did not produce enough firewood it was decided to pool the proceeds and share amongst the franchisees until production could be increased enough to allow for independent operations.”
and
“No management agreements were put in place because production levels were never great enough.
[FAM] ran a co-operative for the franchises for three years with small profits in the first two years.”
36. Even if it could be said that the amount of $9,000 was incurred with respect to the afforestation activities rather than franchise activities, then, to the extent to which the applicant's activities had a profit-making purpose, the outgoings were the costs to the applicant of carrying out a profit-making scheme or undertaking, the profit or loss of which is properly calculated and brought to account on the completion of the scheme, (see Income Tax Assessment Act 1997) [section 15-15 (net profit) or section 25-40 (deductible loss)].
37. In this respect, in participating as a “franchisee” of Greencare, the applicant did no more than acquire seedlings which were to be grown for a single financial outcome in 10 years’ time, when the timber was to be harvested, marketed and sold. In these circumstances, the only assessable income derived by the applicant will be assessable profit: FCT v Whitfords Beach Pty Ltd (1981-2) 150 CLR 355 at 364-5, 366-371. The outgoings claimed by the applicant will be taken into account in determining the amount of the assessable profit and are not separately deductible under section 8-1: see eg; Whitfords Beach Pty Ltd v FCT (1983) 83 ATC 4277; Moana Sand v FCT (1988) 88 ATC 4897, FCT v Montgomery (1999) 198 CLR 639 at 672 - 677.
38. A similar submission was rejected by the learned judge at first instance in Puzey v Commissioner of Taxation (2002) 124 FCR 514 at [63] (not dealt with on appeal). By contrast with Puzey, however, the evidence does not support the provision of ongoing management of the applicant’s Woodlot or the payment of fees by him in respect thereof. Annual licence and management fees were, respectively, $286 and $750, then $35 per Woodlot.
39. The letter from Greencare dated 21 November, 2006 asserts that the applicant has paid woodlot rent and tree maintenance. No accounting was produced in connection with the assertion. It is supported by only 2 statements, dated 30 May, 1999 and 20 January, 2004.
40. The Tribunal accordingly finds that the claimed deductions are not allowable under s 8-1 of the Income Tax Assessment Act 1997 for the reasons set out above.
41. In the circumstances the Tribunal does not find it necessary to consider whether Part IVA of the 1936 Act has any application.
42. The Tribunal also finds that there is no basis for the remission of penalties.
DECISION
43. The Tribunal affirms the decision under review.
I certify that the 43 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member
Signed: ...................(Sgd. Ms R Riberi).....................
AssociateDates of Hearing 13 November 2006 & 12 December 2006
Date of Decision 12 April 2007
Applicant’s Representative Mr G Watt
Counsel for the Respondent Ms H SymonSolicitor for the Respondent Mr T Burrows
Australian Government Solicitor
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