XTJT and Commissioner of Taxation

[2013] AATA 936

[2013] AATA 936  

Division	TAXATION APPEALS DIVISION
File Numbers	2013/2806; 2013/2807; 2013/2808
Re	XTJT
APPLICANT
And	Commissioner of Taxation
RESPONDENT

DECISION

Tribunal	Deputy President I R Molloy
Date	23 December 2013
Place	Brisbane

The objection decisions are affirmed.

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Deputy President I R Molloy

CATCHWORDS

TAXATION – Assessment of income – Whether deductions incurred in carrying on business – Whether deductions incurred in gaining or producing assessable income – Objection decisions affirmed

LEGISLATION

Income Tax Assessment Act 1997 (Cth) ss 8-1, 6-5

CASES

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

Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310
Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333
ReInglis v Federal Commissioner of Taxation (1987) 87 ATC 2037
Re The Applicant v Commissioner of Taxation [2012] AATA 174

Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47

SECONDARY MATERIALS

Taxation Ruling TR92/3

Taxation Ruling IT2167

REASONS FOR DECISION

Deputy President I R Molloy

23 December 2013

INTRODUCTION

1. This is an application for review of objection decisions in respect of XTJT’s amended assessments for income tax in the tax years 2007, 2008 and 2009.

2. In 2000 XTJT’s husband and his brother inherited a property situated in a coastal area about three hours’ drive from Perth. The property had been in their family since the 1950s.

3. In 2006, XTJT purchased her brother-in-law’s interest. She and her husband’s plans were to subdivide and develop the property. Part of the property would then be sold and part of it retained.

4. XTJT borrowed monies to acquire her brother-in-law’s share in the property. She made interest payments on the loan and there were other outgoings relating to the property.

5. By amended assessments, the Commissioner disallowed most of the deductions claimed by XTJT relating to her interest in the property.

6. The objection decisions, dated 17 April 2013, from which this application is brought, resulted in only minor adjustments.

   ISSUES

7. Section 8-1(1) of the Income Tax Assessment Act 1997 (Cth) (“ITTA”) states:

   (1) You can deduct from your assessable income any loss or outgoing to the extent that:

   (a) it is incurred in gaining or producing assessable income; or

   (b) it is necessarily incurred in carrying on a business for the purpose of gaining  or producing your assessable income.

8. The issues are:

   ·whether the claimed deductions (or some of them) were incurred in carrying on a business;

   ·whether such deductions were incurred in gaining or producing assessable income; and

   ·the appropriate apportionment of deductions.

   CARRYING ON A BUSINESS

9. XTJT contends that she was carrying on a business of property development in respect of the property, falling within s 8-1(1)(b).

10. Whether or not a business is carried on is a question of fact and degree: Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310. The facts are as follows.

11. The property was 2024m² in area. It was a deep lot with a single street frontage and a tidal inlet at the back. The only improvement on the property of any significance was a modest cottage, used principally as a holiday home, but rented at certain times of the year.

12. The cottage was located towards the front of the block. It had one bedroom, two sleep-outs, and lacked many modern facilities. The property was not connected to a sewerage line.

13. XTJT’s husband and his brother thought about, but did not reach agreement on, redeveloping the property. Fundamentally, the brother wanted to sell, whilst XTJT’s husband had an emotional tie to the property and wanted to keep it in the family.

14. Property in the area, and surrounding locations, was going through a boom. By 2006 XTJT and her husband had decided to purchase the brother’s interest in the property.

15. In April 2006, XTJT and her husband engaged a project manager. The objective was to obtain two green titles for the property. A green title, I understand, is a title unaffected by the ownership of any adjoining properties, in contrast, for example, to a strata title.

16. On 4 August 2006, XTJT entered into a contract to purchase her brother-in-law’s half share of the property (by then in his company’s name) for $1,080,000. There was a condition in the contract that the seller would do all things necessary to facilitate the planned subdivision and development of the property.

17. On 19 September 2006 XTJT and her husband entered into a loan agreement as co-borrowers with Adelaide Bank Ltd for the amount of $1,350,000. The purpose of the loan was described as “Residential Purchase” and for “Personal Use”.[1] Sub-clause 10.1 of the loan agreement stated that it was not a building loan. XTJT says she relied on the expertise of a finance broker to select the appropriate loan.

    [1] Exhibit 1, T-Document 12, p. 103.

18. There had been various proposals for developing the land, including the involvement of at least one adjoining property. However by this time XTJT and her husband had decided to develop the property alone. They had in mind subdividing and constructing a duplex (that is, two units) on the back part of the property. Their plan was then to sell the cottage, for re-location elsewhere, and to erect either one or two units at the front.

19. The intention was that XTJT and her husband would retain at least one unit or, if they decided not to develop the front, then to keep the cottage.

20. Following settlement of the purchase, in November 2006, title to the property was held by XTJT and her husband as joint tenants.

21. In late November or December 2006, the project manager applied to the local council for planning consent for three, two-storeyed grouped dwellings on the property. The council’s response was the application was non-compliant and could not be processed.

22. In March 2007, XTJT and her husband engaged surveyors to subdivide the property.

23. By June 2007 the council was proving difficult.  In July 2007 the council notified the project manager of approval of part of the development application to allow two group dwellings subject to conditions.

24. XTJT’s husband instructed the project manager to continue, and to assist with sewerage installation and with the subdivision approval. His intention was to level the block and prepare for building in the beginning of 2008.

25. In October 2007 the Adelaide Bank loan was refinanced with Bank of Western Australian. The loan was increased by $150,000, to a total of $1,500,000. There was a declaration that the refinancing was for business purposes.[2]

    [2] Exhibit 2, Attachment 22, pp. 158-162.

26. There is evidence that in November 2007 XTJT’s husband was commencing a feasibility study for a duplex development, and that he would do a SWOT analysis and write up a business plan.[3] However the market had apparently changed.

    [3] Exhibit 6, Attachment 33, p. 126.

27. In November 2007, XTJT and her husband concluded that the development was uncommercial. The plan was changed from developing the property, to subdividing it, and selling the back lot as vacant land. In January 2008 the back lot was listed with a real estate agent. 

28. In July 2008 the council notified approval of a development at the front of the property subject to conditions. In the same month, the listing of the rear block was extended, and the front block was also listed for sale. The listings were renewed periodically, with downward adjustments in the asking prices. 

29. In July 2009 the surveyors advised that the subdivision had received final approval. In April 2010 the rear lot was advertised for $995,000, and the front lot for $1,450,000.

30. In February 2013, XTJT and her husband entered into a contract to sell the front lot, including the cottage, for $1,175,000. That transaction has settled. The rear lot remains on the market.

31. The above is not a complete chronology of events relating to the property but a broad outline.

32. In Ferguson v Federal Commissioner of Taxation (supra), at 314, Bowen CJ and Franki J said, that there are many elements to be considered in determining whether a business is being carried on.

33. Some of the matters referred to in Ferguson were the nature of the activities, whether they have the purpose of profit-making, repetition and regularity of activities, organisation of activities in a business-like manner, and the keeping of books, records and the use of system.

34. It is clear from the judgment that the presence or absence of any particular factor is not necessarily decisive. It depends on the facts of the particular case.

35. On behalf of XTJT it was said that she had the purpose of making a profit. It was also pointed out, as was said in Ferguson, that making a profit in a particular year is not essential. 

36. It was submitted that XTJT’s activities displayed repetition and regularity, in that she was tenacious, in the face of adversity, in attempting to gain development approval, subdivision, and (finally) a sale. I am not sure that that is the type of repetition or regularity that the court had in mind in Ferguson. However I accept that such conduct is relevant.

37. It was pointed out that XTJT kept detailed records of her business dealings, including her dealings with professionals, banks, government authorities, and real estate agents. It was also submitted that activities were organised in a business-like manner.

38. Against this it can be said that XTJT and her husband were well-educated, and experienced in running businesses (other than property development). Keeping records, and employing a business-like approach, could be expected of them. 

39. On behalf of XTJT it was also submitted that the capital employed was significant, over $1 million on the initial purchase, and there was significant further expenditure in undertaking the subdivision and sewerage works.

40. The fact that, concurrently, XTJT may have been involved in another business, does not preclude a finding that her activities in respect of the property constituted carrying on a business. It was also pointed out that every business has a beginning.

41. The Commissioner did not dispute that XTJT intended to make a profit.

42. For the Commissioner, it was contended that XTJT’s activities were not conducted in a business-like manner, and that the volume of activity and the total monetary outlay were both small. These matters are all relative as the submission recognises. 

43. The Commissioner also referred to cases in which, it was said, taxpayers were involved in much more substantial subdivisions than in this case, yet they had been found not to be carrying on a business, but had merely realised capital assets in a profitable way. However in the end the facts and circumstances of the particular case have to be considered.

44. It was also pointed out that XTJT’s interest in the property was not acquired as a result of evaluating this property against other properties. It was submitted that neither she, nor her husband, had any experience in property development, nor any qualifications or professional training in that regard. They did have some experience with renovations and extensions, and in that regard dealing with professionals.

45. The Commissioner also pointed out that XTJT and her husband were living inter-state throughout the relevant time. Against this, it was said, and I accept, that it is possible for a person to conduct a business through the provision of services by others, and even if the business is handed over to a manager.

46. The Commissioner also relied on the failure of XTJT to obtain an Australian Business Number, or to register for Goods and Services Tax for a property development business (although it was not established that such registration was required). It was also pointed out that a blank space was left in XTJT’s tax returns for her principal business activity,[4] and that she did not claim deductions for the loan interest in her original 2007 and 2008 returns.

    [4] For example see exhibit 1, T-Document 3, pp. 23-42.

47. I think the parties have touched on every fact or circumstance for or against a finding that XTJT was carrying on the relevant business. No one feature is decisive.

48. In my view XTJT was not carrying on a business of property development.

    ISOLATED TRANSACTION

49. XTJT contends that the amounts claimed were incurred in gaining or producing assessable income, in the terms of s 6-5 of the ITAA, so the interest and other expenses were deductible under s 8-1(1)(a).

50. Reliance was placed on Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199, elucidated in Taxation Ruling TR92/3. The matter was also said to fall squarely within the guidance provided in Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333, particularly at 343-344.

51. Profit on the realisation of an investment may or may not constitute income depending on the circumstances of the case. A profit may well constitute income if the property generating the profit was acquired for that purpose, particularly in the context of carrying on a business, or carrying out a business operation or commercial transaction: Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199, 209-213.

52. In Westfield, at 342, Hill J (with whom Lockhart and Gummow JJ agreed), referring to Myer, said:

    The judgment, not only in this passage, but in several other passages (at 211-213), emphasises that where a transaction occurs outside the scope of ordinary business activities, it will be necessary to find, not merely that the transaction is “commercial” but also that there was, at the time it was entered into, the intention of making a relevant profit.

    … It does not, however, follow from the judgment in Myer, or, for that matter, from the judgments in later cases, that every profit made by a taxpayer in the course of his business activity will be of an income nature. To so express the proposition is to express it too widely, and to eliminate the distinction between an income and a capital profit.

53. It was submitted that the facts satisfied the requirement that the transaction be “commercial”. It was pointed out that a plan was formed for development of the property prior even to XTJT acquiring her interest. XTJT was not looking to mere realisation of the property, but was taking positive steps to improve and develop it.

54. The scale of the development, it was submitted, with major costs for purchase, sewerage, and engaging consultants, stamped this as a commercial operation. XTJT and her husband steadily pursued their objective until a change was brought about by external economic factors. Nonetheless, it was submitted, they achieved subdivision, and gained development approval, matters which improved the property.

55. It was also pointed out that XTJT took the opportunity to generate income, whilst the land was being held for development, by renting the cottage on occasions.

56. As previously stated, the Commissioner does not dispute that XTJT acquired her interest in the property with the intention of a making a profit, but submits that the facts lack the commercial flavour referred to in Myer and Westfield, and the other cases referred to.

    
    

    I agree with that.

57. XTJT’s principal purpose in purchasing her share in the property was to assist her husband to retain the property, or so much of it as he could, because of his sentimental attachment to it. The purchase was not made on a commercial basis.

58. A commercial price was paid but essentially it was a family dealing. The property was not chosen for its development potential. Development was obviously problematic as the events proved. Similarly the property was not attractive for its rental potential. It was competing against more modern houses or units and was only assured of being let in peak holiday times. 

59. I accept the Commissioner’s submissions that the transaction was driven by the desire of XTJT’s husband, supported by XTJT, to retain the property in the family. The operation, to them relatively significant, did not involve substantial investment.

60. Whilst there were commercial aspects to XTJT’s actions, I do not think this was a business operation or commercial transaction, in the sense referred to in the cases.

    APPORTIONMENT

61. Apportionment involves a fair and reasonable assessment of the extent of the relation of the outlay to assessable income: Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 59.

62. XTJT’s approach is to calculate and then deduct the percentage of private use of the property. Private use has been calculated by XTJT’s accountant, broadly-speaking, as about 12% per year.

63. This was said to be justified, firstly, because XTJT’s interest in the property was held in an actively prosecuted property development business, or was necessarily held while a profit-making scheme was prosecuted. In any event, it is submitted, if the property was available all year for rent (whether or not attractive to renters) then the same result is achieved.

64. To this submission the Commissioner refers to Taxation Ruling IT2167 and contends that this approach should only be taken where it is established that active and bona fide efforts to let the property at a commercial rate were made during the relevant period.

65. The Commissioner contends that XTJT is limited to a proportionate deduction of interest that reflects the proportion of days in the relevant years that the property was rented on a commercial basis, and thus producing assessable income. The objection decision followed that approach.

66. The cottage was used by XTJT and her husband as a holiday home, although, of course, less frequently than in previous times after they moved interstate. XTJT’s husband made a point of staying there overnight on 30 June each year, believing this was relevant to liability to Western Australian land tax.

67. The property was rented on a more or less recurring basis at certain times of the year. XTJT’s husband said it had been rented to persons organised by his brother and that was simply continued. The rent charged was not always on a strictly commercial basis.

68. The property was not advertised or listed for rental with any real estate agents in the relevant years. The evidence was that the agents said it could only be rented at holiday times, when it was already taken, and there was no point in listing it for other times.[5]

    [5] Exhibit 6, Attachment 54, p. 181.

69. On the other hand, there was evidence that since 2012 the property had been listed with real estate agents, which has resulted in rentals, although not always satisfactory occupants.[6] I think at the relevant time XTJT and her husband were content to allow the cottage to be used as it had in the past. It remained available at certain times of the year for those who had been renting it on a more or less regular basis and to family. 

    [6] Exhibit 1, T-Document 21, pp. 164-166.

70. Reference was made to Re Inglis v Federal Commissioner of Taxation (1987) 87 ATC 2037 where a beach house was let for approximately 10 weeks per year (mainly in school holidays and at Easter) and the respondent allowed 20% of expenses to be deducted. The house was not placed with a real estate agent. It was let generally only to people from Canberra, as a result of 20 or less advertisements in the Canberra Times each year.

71. The Tribunal, in Inglis, found that there had been insufficient done for it to be said that the property was available for letting all year. It could not be said that the property was truly available for letting unless some perceptible effort was being made to obtain tenants, or at least some steps taken to draw its availability to the attention of the public.

72. This may be contrasted with ReThe Applicant v Commissioner of Taxation [2012] AATA 174. There the applicant’s efforts to find tenants had not been “vigorous”, but the Tribunal was satisfied that the property had been available for rent in the relevant year in light of the applicant’s evidence of advertising in local newspapers, and accepting the applicant’s evidence that word-of-mouth was the most effective means of finding tenants.

1. Again it is a question of fact and degree so as to assess what is fair and reasonable. In my view the apportionments allowed in the objection decisions do that.

   CONCLUSION

2. The objection decisions are affirmed.

I certify that the preceding 74 (seventy-four) paragraphs are a true copy of the reasons for the decision herein of Deputy President I R Molloy

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Associate

Dated 23 December 2013

Date of hearing	6 December 2013
Counsel for the Applicant	D Marks
Solicitors for the Applicant	Tucker & Cowen Solicitors
Counsel for the Respondent	S Monks
Solicitors for the Respondent	Australia Taxation Office, Legal Services Branch