Case: Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333
Outcome: applied
The applicant lodged notices of objection against the ATO assessments and the penalty imposed. As indicated earlier in this judgment, on 27 September 2002 the respondent disallowed the applicant's objections. TRIBUNAL DECISION 5 In the Tribunal, the submissions of the applicant and the subsequent findings were as follows: 1. The applicant contended that the activities of the applicant in relation to the land were in the nature of a profit-making venture. However the learned Senior Member was not persuaded by that characterisation of the applicant's business activity (Reasons for Decision para 34), and was of the view that the land was a capital asset, with the result that the loss on its sale was a capital loss (para 35). 2. The applicant contended that company losses could be carried forward, on the basis that the "continuity of ownership" test in s 80A ITAA 1936 had been satisfied, and during the relevant period the beneficial ownership of shares in the applicant remained with Mr Paul Doumany; or that the "same business" test in s 80E ITAA 1936 had been satisfied. The Senior Member observed that, given his findings concerning the characterisation of the applicant's business activity and the resultant loss, it was strictly unnecessary for him to reach a decision on either of these issues. In any event however, the Senior Member was satisfied that: &#8226; while the legal ownership of the shares in the applicant may have remained with Mr Doumany, at the time the loss on the sale of the land was incurred the beneficial ownership of shares in the applicant rested in Mr Iwasaki, having been transferred to Mr Iwasaki on or before 20 December 1991. Accordingly the applicant failed on the "continuity of ownership" test in s 80A (para 40 ); and &#8226; there had been a significant break in the business activities of the applicant between November 1992 and 1996, and the applicant therefore failed on the "same business" test in s 80E (para 45 ). 3 . The Tribunal noted that the applicant bore the onus of proving the objection decisions should have been made differently: s 14ZZK(b) Taxation Administration Act 1953 (Cth) ("TA Act") (para 27). Although the Senior Member was not prepared to draw an adverse inference from the failure of Mr Doumany to give evidence in accordance with the rule in Jones v Dunkel [1959] HCA 8 ; (1959) 101 CLR 298 (para 28), he noted that the failure of Mr Doumany to give evidence meant that it was more difficult for the applicant to show that the Commissioner's decision was wrong (para 29). 4. The applicant contended that a penalty of 75% was inappropriate because it acted with the advice of senior counsel. However the Senior Member was satisfied that the penalty of 75% under s 226J ITAA 1936 was appropriate (para 50). QUESTIONS OF LAW RAISED ON APPEAL 6 The questions of law raised on appeal in this case were as follows: a. are the losses incurred by the applicant allowable as deductions under s 51(1) ITAA 1936? b. if yes to a., in the relevant years of income: i did s 80A ITAA 1936 apply to deny the applicant deductions?; or ii did s 80E ITAA 1936 apply to allow the applicant deductions? c. if the applicant was wrong in claiming deductions, were penalties correctly imposed under s 226J ITAA 1936? d. did the Tribunal err in instructing itself as to the applicant's onus of proof and as to its role in reviewing the objection decision? e. did the Tribunal err in not providing reasons for its rejection of the preponderance of the evidence as to the beneficial ownership of the shares? f. did the Tribunal err in finding that the applicant was not carrying on the same business in the relevant years within s 80E? g. could a reasonable tribunal have made, on the material before it, the findings made? h. does the Tribunal's apparent error of fact namely that Mr Doumany was prosecuted in the criminal courts for causing the applicant to claim the deductions show that the Tribunal failed to give due consideration to the material before it, or give rise to a reasonable apprehension of wrongful bias against the applicant? 7 I shall address each of these questions in turn. a. ARE THE LOSSES INCURRED BY THE APPLICANT ALLOWABLE AS DEDUCTIONS UNDER SECTION 51(1) ITAA 1936? 8 As the relevant loss occurred in the 1993 year of income both applicant and respondent accepted that the relevant statutory provision was s 51(1) ITAA 1936. 9 The applicant submitted that: &#8226; the Tribunal applied the wrong test of deductibility to the facts as found &#8226; the Tribunal did not refer to the relevant test of when a profit from sale of a capital asset as opposed to the proceeds of sale of a revenue asset was on revenue account, which it submitted was whether the asset was acquired with a purpose or intention of profit-making by sale . This, the applicant submitted, was the relevant inquiry, not whether the land was trading stock or whether the gross proceeds were on revenue account &#8226; the Tribunal failed to direct itself as to the proper test of whether land is acquired as part of a profit-making undertaking, being whether one of the purposes of its acquisition, rather than the purpose, was profit-making by sale. &#8226; the test was not whether the applicant was in the business of property development, with the land being trading stock: Moana Sand Pty Ltd v Federal Commissioner of Taxation (1988) 88 ATC 4897. In particular, the applicant submitted that in Moana Sand 88 ATC 4897, the profit made by the taxpayer was held to be income because one of the taypayer's purposes was profit-making by subdivision and sale, even though the subdivision was not in fact carried out and the taxpayer had to sell the land en globo due to a compulsory acquisition. The applicant also cited in support of its case Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42 and Westfield Ltd v Federal Commissioner of Taxation (1991) 28 FCR 333. 10 In response, the Commissioner submitted that: &#8226; the necessary requirement of deductibility under s 51(1) is that the loss is "incidental and relevant" to the income-earning operations of the taxpayer &#8226; the ultimate question must remain whether the loss incurred had the necessary connection with the applicant's gaining or producing assessable income, or the carrying on of its business &#8226; the question of whether the taxpayer carries on a business is a question of fact &#8226; citing Gibbs J in Commissioner of Taxation v Williams [1972] HCA 31 ; (1972) 127 CLR 226 at 249, proceeds resulting from the mere realisation of a capital asset are not income, even though the realisation is carried out in an enterprising way so as to secure the best price. However, a distinction needs to be drawn between mere realisation of an asset, and development and improvement of land to such a marked degree that it is impossible to say that it is mere realisation of an asset, as was the case in Federal Commissioner of Taxation v Whitford's Beach Pty Ltd [1982] HCA 8 ; (1982) 150 CLR 355 &#8226; the test propounded by the applicant was referable to the former s 26(a) ITAA 1936 and was of no application in this case. The land in question was purchased subsequent to the introduction of the capital gains tax provisions in September 1985 and s 26(a), the more recent s 25A and s 52 have no application to the transaction &#8226; profits brought to tax under statutory income provisions are not to be equated with net gains which may well fall within the ordinary concept of income &#8226; in this case the Tribunal found that the applicant did not acquire the land for the purpose of subdivision, development and sale, and the steps taken towards further development of the property were so limited that the whole undertaking could not be said to be comparable to the situation in Whitford's Beach [1982] HCA 8 ; 150 CLR 355 (Reasons for Decision para 32). Section 51(1) ITAA 1936 11 This section has been interpreted many times, and at the highest judicial level in Australia. At the relevant time it read as follows: All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income. 12 In the context of the section it is clear that: &#8226; the expression "incurred in gaining or producing the assessable income" requires that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income, or if none be produced, would be expected to produce assessable income: Ronpibon Tin NL v Federal Commissioner of Taxation [1949] HCA 15 ; (1949) 78 CLR 47 at 57 &#8226; the reference to losses and outgoings "necessarily incurred in carrying on a business for the purpose of gaining or producing such income" adds little to the operation of the leading words "losses or outgoings to the extent to which they are incurred in gaining or producing assessable income": Ronpibon Tin 78 CLR at 56 &#8226; losses and outgoings of capital are clearly excluded from the operation of the section even if they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income. 13 In the case before the Senior Member, a key issue in dispute was whether the loss in this case should be characterised as capital or income. If the loss was a capital loss, it would not be an allowable deduction within the meaning of s 51(1). Capital vs income 14 In a regulatory environment where taxation legislation is as extensive as it is complex, the issue in question before the Senior Member was one of deceptive simplicity. Were the losses claimed by the applicant to be characterised as capital or revenue/income? Despite the plethora of cases over the years considering the distinction between income and capital (to paraphrase Wilson J in Whitford's Beach 150 CLR at 393 the battle lines drawn by the parties in this case have a familiar ring) the outcome of each case will invariably depend on the facts of that case. Before turning to the decision of Senior Member McCabe, it is useful to summarise general legal principles relevant to this question. Definitions 15 Despite extensive legislative intervention over the years to identify forms of "income" and "capital" for the purposes of Commonwealth taxation legislation, neither term is legislatively defined. It is clear that, because of the traditional characterisation of receipts and expenditure as either income or capital, the term "income" has not extended to all forms of gain; nor has loss in revenue terms included all forms of loss (for an interesting discussion of this issue see the article by Professor Jeff Waincymer "If at first you don't succeed... reconceptualising the income concept in the tax arena" (1994) 19 MULR 977). However as observed by Jordan CJ in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 at 219 in relation to "income": The word "income" is not a term of art, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts... 16 A consequence of taxation reform has been that the traditional distinction between gains characterised as either income or capital has blurred over time, with obvious examples being the introduction of concepts of "statutory income" in the ITAA 1936 and Income Tax Assessment Act 1997 (Cth), and the treatment of profits made in respect of disposal of assets acquired after 19 September 1985 following the introduction of the capital gains tax regime in Australia. However, notwithstanding what has been termed the almost arbitrary nature of the distinction (note for example comments of Greene MR in Inland Revenue Commissioners v British Salmson Aero Engines Ltd [1938] 2 KB 482 at 498) the continued existence of that distinction means that the task of identifying transactions as related to either income or capital becomes a live issue in many cases. 17 This matter is one such case. As I have already noted, the applicant originally characterised the loss from the sale of the relevant land as capital, but subsequently, and now before the Court, claims that the loss was revenue according to ordinary principles. There was no issue in contention that the loss was deductible according to statutory concepts of revenue. 18 The traditional delineation between income and capital, so far as referable to outgoings, was described by Dixon J in Sun Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 72 ; (1939) 61 CLR 337 at 359, 363 as follows: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure or organization set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss...There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. (These principles have been considered and applied many times by Australian courts: see for example Hallstroms Pty Ltd v Federal Commissioner of Taxation [1946] HCA 34 ; (1946) 72 CLR 634 at 645-646; Williams [1972] HCA 31 ; 127 CLR 226, Whitford's Beach [1982] HCA 8 ; 150 CLR 355, United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169 per Sundberg and Merkel JJ at 191-192; Lamont v Commissioner of Taxation [2005] FCA 513 ; Macquarie Finance Limited v Commissioner of Taxation [2005] FCAFC 205 at [105-106] , and Commissioner of Taxation v Citylink Melbourne Ltd [2006] HCA 35 per Crennan J (Gleeson CJ and Gummow, Callinan and Heydon JJ agreeing) at [147-154] and per Kirby J at [20-25].) 19 I shall return to this principle later in this judgment. Capital or revenue and real property 20 Real property is commonly regarded as a capital asset. Generally speaking, unless a sale of real property is made in the operation of a business the resulting profit will not be income according to the ordinary concepts and usages of mankind. The courts have historically addressed the issue of whether a gain made by a taxpayer, in relation to the sale of what would otherwise be a capital asset, was capital or income, in terms of whether the taxpayer was merely realising the asset (in which case the gain is characterised as a capital gain), or whether the gain was made in the operation of business in carrying out a scheme of profit-making (in which case the gain is characterised as income or revenue): see for example California Copper Syndicate v Harris (1904) 5 TC 159 at 165-166, Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001 at 1009, Ruhamah Property Co Ltd v Federal Commissioner of Taxation [1928] HCA 22 ; (1928) 41 CLR 148 at 151, and Whitford's Beach 150 CLR per Gibbs CJ at 367-368, Mason J at 372, Wilson J at 400. 26 Although the High Court in Myer Emporium [1987] HCA 18 ; 163 CLR 199 found that receipts from sale of capital assets generated as profit components of profit-making schemes were capable of constituting income, equally clearly the decision is not authority for the proposition that all gains made by business entities are assessable income. As pointed out by the Full Court of the Federal Court in Commissioner of Taxation (Cth) v Spedley Securities Ltd (1988) 19 ATR 938 at 942, such a proposition would be contrary to authority, to the Act itself, and to basic concepts concerning the distinction between capital and income (note similar comments by the Hill J in Cooling 22 FCR at 55 and again by Hill J (with whom the other members of the Court concurred) in Westfield 28 FCR at 342). Nature of purpose 27 In determining whether a sale receipt is generated as a profit component of a profit-making scheme, and therefore income in accordance with ordinary usages, it is only necessary that the intention or purpose of profit-making by sale was one aspect of a profit-making scheme in existence at the time of the acquisition of the asset (or, as was the case in Whitford's Beach [1982] HCA 8 ; 150 CLR 355, coming into existence during the course of the taxpayer's ownership of the asset and remaining in existence at the time of the sale): Westfield 28 FCR at 343-344. It is not necessary that the intention or purpose of profit-making by sale be the sole or dominant purpose of the taxpayer entering into the profit-making scheme: Cooling 22 FCR at 56-57 (cf Myer Emporium [1987] HCA 18 ; 163 CLR 199 where the motivating purpose of the transaction was for Myer to obtain working capital to enable it to diversify; and Moana Sand 88 ATC 4897 where the dominant purpose of the taxpayer in acquiring the land was not resale of the land at a profit). However the Full Court of the Federal Court in a number of cases has indicated that the purpose of profit-making must be a "not insignificant" aspect of the taxpayer's activities: Cooling 22 FCR at 57, Selleck v Commissioner of Taxation [1997] 799 FCA (20 August 1997). 28 The meaning of "profit-making scheme" is well-known. It is useful to note in the present context that: &#8226; it is not necessary that the profit-making scheme was specific in detail, or that every step which culminated in the profit was planned or foreseen ( Westfield 28 FCR at 344); and &#8226; the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised ( Westfield 28 FCR at 344). 29 As Hill J further noted in Westfield 28 FCR at 333-345: (I)t is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of the scheme involving the acquisition and resale of land, there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold. The same may be said to be the case where s 25(1) of the Act is involved. As the court observed in Myer...the property which generates the gain must be acquired in an operation of business or commercial transaction 'for the purposes of profit-making by the means giving rise to the profit. Whose purpose 34 In my view the submissions of the applicant that the Tribunal erred in law in its findings respect of this issue cannot be supported. I form this view for the following reasons: 1. Senior Member McCabe stated the law correctly when he referred to "the well-established rule that the proceeds from the 'mere realisation' of a capital asset will not give rise to income according to ordinary concepts and any loss incurred on the disposal of the asset will not lead to a loss that can be offset against other income of the taxpayer". This is clearly supported by the body of case law to which I referred earlier in this judgment, beginning with California Copper (1904) 5 TC 159. 2. The applicant in its submissions contended that the Senior Member erred in making the inquiry as to whether the land was trading stock or whether the gross proceeds were on revenue account. However: &#8226; I note from the Statement of Facts, Issues and Contentions filed by the applicant in the Tribunal that the applicant had contended that the loss incurred by the applicant on the sale of the land in the year ended 30 June 1993 was a revenue loss by reason either of the trading stock provisions or as a loss on a profit-making undertaking or scheme. Further, the evidence showed that LGHH, in its letter of 14 July 1994 to the ATO on behalf of the applicant, described the land as "trading stock". In light of this it is to be expected that the Senior Member would address the issue whether the land was trading stock or the gross proceeds were on revenue account (paras 30-31). &#8226; In any event, in my view it is clear from reading para 30 of the Reasons for Decision that the Senior Member, in referring to the situation "if the asset was more like trading stock", was giving an example of a scenario where the proceeds of sale of capital assets such as real property can properly be characterised as income rather than capital. The Senior Member did not base his decision that the loss in this case was not in the nature of revenue, solely on this principle. 3. The applicant submitted that the Tribunal erred in that it did not refer to what the applicant defined as the relevant inquiry in the circumstances, namely whether the asset was acquired with a purpose or intention of profit-making by sale. The applicant submitted further that, in failing to direct itself as to the proper test of whether land was acquired as part of a profit-making undertaking, the Tribunal also failed to direct itself as to whether one of the purposes of its acquisition, rather than the purpose, was profit-making by sale. However, in my view the Senior Member made it clear that he had applied the test of whether the applicant had acquired the land with a profit-making purpose, but that in doing so as a finding of fact he was not satisfied that the applicant had had that purpose at all , ie as either "the" purpose or one of a number of purposes be they significant or otherwise. Rather, the Tribunal considered the range of purposes of acquisition of the land and the characterisation of the applicant's business activity as submitted by the applicant, and on the facts found against the applicant. This is apparent from the Reasons for Decision, including: &#8226; At para 31, where the Senior Member specifically acknowledged: "The applicant says this was a profit-making venture... The company acquired the land with a view to developing it or on-selling the property to another entity. The company investigated various development options before completing a sale and then distributed a portion of the proceeds to the foreign businessman". &#8226; At para 32, where the Senior Member specifically stated: "I am not persuaded by that characterisation of the company's business activity. The taxpayer was a shelf company until it contracted to purchase a parcel of land from a foreign businessman who was a client of one of the company's directors. The correspondence between the businessman's solicitors and the FIRB make it clear the property was acquired by the businessman to construct accommodation. As it happened, that was the only use to which the property was ever put... The taxpayer did investigate whether the property could be sub-divided or on-sold for the purposes of development, but I do not think the evidence establishes that was the purpose for which the land was acquired." 4. Although the applicant submitted that the findings of the Tribunal in para 32 of its Reasons for Decisions namely that the applicant had considered sub-division or on-sale for the purposes of development as one option and that steps were taken to achieve that purpose required the Tribunal to conclude that the loss on sale of the applicant's land was deductible under s 51(1), I do not so find. Rather, in my view: &#8226; The finding of the Tribunal in the circumstances of this case that the proceeds from the sale of the land were on capital account rather than income is consistent with the legal principles as articulated by Dixon J in Sun Newspapers [1938] HCA 72 ; 61 CLR 337. The land was purchased by Mr Iwasaki, transferred to the applicant, and used for the purposes of constructing student accommodation which in turn generated income. It bore all the hallmarks of a capital asset. The fact that the applicant was a corporate entity does not mean that any disposal of asset is on revenue account ( Myer Emporium [1987] HCA 18 ; 163 CLR 199). &#8226; In any event, as found by the Tribunal, Mr Iwasaki was the directing mind and will of the applicant between 1991 when the land was transferred to the applicant, and 1993 when Mr Iwasaki relinquished any claim he may have had as to the beneficial ownership of shares in the applicant following the sale of the land. Accordingly, during that period, the purpose of Mr Iwasaki with respect to the land was the relevant purpose (cf Whitfords Beach [1961] HCA 25 ; 105 CLR 355; Austin RP and Ramsay IM, Ford's Principles of Corporations Law (13th ed, Butterworths, 2007) Ch 16; Lipton P and Herzberg A, Understanding Company Law (13th ed, Law Book Co, 2006) at pp 103-108). That purpose as found by the Tribunal was bi-fold, namely that the land was a capital asset to be used for constructing student accommodation, and the applicant was to hold the land on Mr Iwasaki's behalf as part of the re-ordering of Mr Iwasaki's affairs. As found by the Tribunal, other than consideration of the option of development of the land, neither Mr Iwasaki nor the applicant at the relevant time held the land for the purpose of resale consistent with a profit-making scheme (cf Hill J in Westfield 28 FCR at 344-345). Further, as found by the Tribunal at para 32, there was no change of purpose of the applicant with respect to the land, as evinced, for example, by steps towards further development of the property, so as to result in the applicant acquiring a profit-making purpose akin to the situation in Whitford's Beach [1982] HCA 8 ; 150 CLR 355. &#8226; Notwithstanding the submissions of the applicant, in my view the law is not that, in the absence of a clear intention of a taxpayer in acquiring the property that it be used for a profit-making purpose, any subsequent consideration by the taxpayer of exploitation of a capital asset (for example by the possible options of either subdivision or on-selling) results in the immediate creation of a profit-making scheme and the resultant characterisation of profits or losses made in respect of subsequent dealings with that asset as revenue. A bare claim that this was the intention of the taxpayer is insufficient to manifest that intention in the absence of evidence of that intention, for example, by steps to progress those options. The surrounding circumstances must be taken into account in ascertaining the true intention of the taxpayer, and also characterising the receipts in the hands of the taxpayer. To find otherwise would potentially sanction any manifestation of intention of the taxpayer to convert a capital asset to the revenue account (or vice versa), however meagre or fleeting such manifestation of intention. By analogy I note comments of the High Court in GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation [1990] HCA 25 ; (1990) 170 CLR 124 at 142 where their Honours said: ... it cannot be accepted that an intention on the part of a payer and a payee or either of them that a receipt be applied to recoup capital expenditure by the payee determines the character of a receipt when the circumstances show that the payment is received in consideration of the performance of a contract, the performance of which is the business of the recipient or which is performed in the ordinary course of the business of the recipient.