Admin Exploration Pty Limited (in Liq) v Federal Commissioner of Taxation

Federal Court of Australia|1998-05-15|Before: Davies J

REASONS FOR JUDGMENT The taxpayers, Bradley and Brett McCurry, have been assessed to tax under amended assessments issued on 5 May 1995 for the year of income ended 30 June 1989 in respect of profits totalling $75,811 each derived from the sale of three townhouses at 20 Addison Avenue, Lake South. The Commissioner of Taxation alleges that the sums were assessable to tax under s 25(1) of the Income Tax Assessment Act 1936 (Cth) ("the Assessment Act") or, alternatively, that the whole or a part of the profits was assessable to tax under Part IIIA of the Assessment Act as a capital gain. Bradley and Brett McCurry are brothers. In 1986, they were young men, both unmarried, who were employed in Sydney, Bradley as a labourer for Otis Elevators and Brett as a labourer for Heacon Products. Their father, Darryl McCurry, was at the time unemployed as the business in which he had been engaged for many years as a truck driver had closed down on the death of its owner. Darryl McCurry and his wife had lived for many years at Warilla; but the employment opportunities there were not good. Bradley and Brett McCurry had grown up in the Warilla area. In early 1986, they had $17,000 in savings which they had gained from their work and perhaps also from purchasing, doing up and reselling used cars. In early 1986, they saw a property at 20 Addison Avenue, Lake South, which was close to Warilla. The property had an old house on it which was of no value. Both Bradley and Brett inspected the land as did their father. They decided to purchase it and had the intention of constructing, with the assistance of their father, two or three units or townhouses on the land. The purchase price was $32,000. $17,000 came from their own savings and the remaining $15,000 from a loan from the Commonwealth Bank of Australia. Bradley and Brett removed the old house from the land and, in October 1986, obtained an additional loan of $80,000 from the Commonwealth Bank to enable them to construct three townhouses. Council permission was obtained. Unit 3, which was a freestanding unit, was completed in June 1987. Units 1 and 2, which adjoined each other, were completed in August 1987. In May 1987, the McCurrys arranged with Martin & Mullan, Real Estate Agents, to advertise the units for sale. Some interest was shown in the units which were not then completed but no sale was effected. In about June 1987, the McCurry family as a whole decided to purchase a newsagency in Warilla which was then on the market. It was proposed that the parents and their five children, Bradley, Brett, Jason, Joanne and Trent, would all work in the newsagency. Darryl McCurry and his wife sold their home at Warilla and had $80,000 to contribute to the purchase price of the newsagency. They, Bradley, Jason and Trent moved into Unit 3. Bradley and Brett resigned from their employment in Sydney. About the same time, Mrs McCurry's grandparents, Stanley and Coral Long, with whom Bradley and Brett had lived whilst they were in Sydney, moved permanently from Sydney and, with Brett, occupied Unit 2. The newsagency at Warilla was purchased with finance provided by the Commonwealth Bank. Although the members of the family worked hard in the business, it was not successful in the sense that it did not provide enough return for their reasonable upkeep. The newsagency was resold in 1993. On 27 July 1988, Bradley and Brett authorised Paynes Real Estate to market the units at Addison Avenue. Sales occurred in December 1988 with a resulting net profit to Bradley and Brett of $75,811 each. The family remained for some time thereafter in two of the units as tenants. At no time had a real estate agent been instructed to find a tenant for the units. Nor was any other attempt made to let them. One other peripheral fact which I should mention is that Bradley and Brett later undertook a second development in the area. In 1990, they purchased another block of land in the vicinity and in 1994 they constructed units thereon and sold the units. Property may be acquired as an investment to provide either potential income returns which are foreseen or as a hedge against inflation in the value of the currency. As Barwick CJ said in Steinberg v Federal Commissioner of Taxation (1975) 134 CLR 640 at 686: "The retention of property in the hope or expectation that its value will increase is a justifiable form of investment."

If a property is acquired in the course of a business or commercial dealing with a view to obtaining a profit from its development and sale, that venture is not regarded as an investment and the profit derived therefrom will be income for the purposes of s 25(1) of the Assessment Act. In Federal Commissioner of Taxation v Whitfords Beach Pty Limited (1982) 150 CLR 355, Gibbs CJ at 360-1 expressed the principle in this way:

"A profit made on the sale of an asset may be treated as assessable income within the Income Tax Assessment Act 1936 (Cth), as amended (the Act') for one of a number of reasons. In the first place, if the profit should be regarded as income in accordance with the ordinary usages and concepts of mankind, it will be assessable income within s 25(1) of the Act. When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in Californian Copper Syndicate v Harris (1904) 5 Tax. Cas. 159, at p.166, that have so frequently been quoted, what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business'. The Lord Justice Clerk went on to say (1904) 5 Tax. Cas., at p.163:

What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit making?"

In Whitfords Beach at 383, Mason J said at 383-4: "As we have seen, it is enough to answer the statutory description that there was a profit-making undertaking or scheme which exhibited the characteristics of a business deal, even though it did not amount to the carrying on of a business. If what has happened amounted to no more than the mere realization of an asset then it was not a profit-making undertaking or scheme."

At one time, issues of the type now in question would have been considered under the then s 26(a) of the Assessment Act. This section was later repealed and replaced by s25A of the Assessment Act which itself was later amended so as not to apply with respect to the sale of property acquired on or after 20 September 1985, when the capital gains tax provisions of the Assessment Act came into force. Section 26(a) was introduced into the Assessment Act at a time when there was a doubt following Jones v Leeming [1930] AC 415 as to whether the purchase of a property for profit-making by sale of that property would of itself give rise to assessable income. After s 26(a) had been enacted, the doubt was in fact dispelled by the decision in Edwards (Inspector of Taxes) v Bairstow [1956] AC 14. It was there held that a profit arising from a joint venture involving the purchase of a complete spinning plant and its subsequent resale at a profit gave rise to income for the joint venturers who had acquired the plant with the purpose of making that profit. There has since been debate as to whether there was any need to enact the second limb of s26(a) and whether that provision had any operation different from the terms of s 25(1). In Whitfords Beach at 363, Gibbs CJ doubted that there had been any need to introduce the second limb but agreed with the view expressed in Reseck v Federal Commissioner of Taxation (1975) 133 CLR 45 at 49,57 that, ordinarily, the specific provisions of s 26(a) should be given effect in preference to the general provisions of s 25(1). At the present time, of course, we are left with the provisions of s25(1). Before the enactment of s 26(a), the principle I have mentioned was given application in Australia in cases such as Blockey v Federal Commissioner of Taxation (1923) 31 CLR 503; Perrott v Deputy Federal Commissioner of Taxation (NSW) (1925) 40 CLR 450; Federal Commissioner of Taxation v Clarke (1927) 40 CLR 246; Coglan v Federal Commissioner of Taxation (1932) 47 CLR 109. I need not discuss the multitude of cases arising under s 26(a). More recently, the principle was given impetus in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199. Mason ACJ, Wilson, Brennan, Deane & Dawson JJ said at 210, when discussing a gain made otherwise than in the ordinary course of carrying on a business:

"The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit".

Their Honours referred to previous authorities including Whitfords Beach where the principle had been applied. At 213, their Honours said:

"The proposition that a mere realization or change of investment is not income requires some elaboration. First, the emphasis is on the adjective `mere': Whitfords Beach (1982) 150 CLR. at p 383. Secondly, profits made on a realization or change of investments may constitute income if the investments were initially acquired as part of a business with the intention or purpose that they be realized subsequently in order to capture the profit arising from their expected increase in value: see the discussion by Gibbs J in London Australia (1977) 138 CLR, at pp 116-118. It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction."

In a case such as the present where the taxpayers were not carrying on a business, the profit to be assessable must have been derived from a transaction that can be described as a commercial dealing. A profit making undertaking or scheme is such a dealing. In Steinberg at 699, Gibbs J expressed his view as to the nature of a relevant scheme or undertaking: "A profit-making scheme within s 26(a) is a plan, design or programme of action devised and put into effect for the purpose of making a profit. It must be a scheme carried out by the taxpayer himself or on his behalf. It appears that it should - at least where the transaction is one of acquisition and resale - exhibit features which give it the character of a business deal. The mere realization of a capital asset, albeit in an enterprising way, would not amount to the carrying out of a profit-making scheme."

At 699-700, his Honour said: "I am in agreement with the view expressed by Mason J that it is not an essential element of a profit-making scheme in s 26(a) that every step which culminates in the making of a profit should be planned or foreseen before the scheme is put into operation'. Schemes may be precise or vague; every detail may be arranged in advance, or the working out of the plan may be left for decision in the light of circumstances as they may arise. It is no objection to a plan that it allows room for manoeuvre. When property is bought with the purpose of making a profit in the easiest and most advantageous way that may present itself, and the taxpayer adopts one of the many alternatives' that his plan leaves open, thereby returning himself a profit, he will rightly be said to be carrying out a profit-making scheme: cf Premier Automatic Ticket Issuers Ltd v Federal Commissioner of Taxation (1933) 50 CLR 268, at p 300; Buckland v Commissioner of Taxation (1960) 34 ALJR, at p 62; [1960] ALR, at pp 602-603; 12 ATD, at p 169."

"The concept underlying the sub-section is that in an Act confined to the taxation of income there are some circumstances in which what are isolated and not repetitive transactions, which in other circumstances would yield a capital gain, can properly be regarding as producing income. One such circumstance is the acquisition of property by the taxpayer with the purpose of its resale at a profit in what is in truth a commercial dealing: that is the first limb of the section. The second limb, in my opinion, is founded upon the same notion but provides for the case where the property acquired is not itself the subject of resale but is intended at the time it is acquired to be the vehicle for making a capital gain, again in the course of an isolated or single though perhaps complex transaction in the nature of a commercial dealing. For there to be a scheme there must be a plan: it must be the taxpayer's plan and it must exist, in my opinion, at the time of the acquisition of the property: indeed, that acquisition, in my opinion, must be itself part of the scheme and the property acquired the intended vehicle for carrying the scheme into execution. Whilst it need not be fully conceived in all its details at the time of acquisition it must exist as a scheme which in principle embraces all the details yet to be worked out".

The concept as enunciated by Barwick CJ and his reference to the need for a "commercial dealing" was said by Mason J in Whitfords Beach at 380 to be an important comment with which his Honour agreed.

It is not in dispute that that which the brothers intended and carried out, the purchase and clearing of the land and the construction of three townhouses was sufficiently a businesslike venture to be relevantly a scheme or undertaking. Whether profit-making was its purpose, depends upon the objectives which were in view. If the scheme or undertaking was carried out for profit-making, it had the necessary quality of commercial dealing to meet the criteria I have mentioned.

In turning to the facts of the case, it is necessary to keep in mind that the taxpayers have the onus of proof cast upon them by s 14ZZO of the Taxation Administration Act 1953 (Cth) of showing that the assessment is excessive and of satisfying the Court that their purpose in acquiring the land at 20 Addison Avenue and of constructing the townhouses on it was not profit-making. It is the main or dominant purpose of the scheme which is important. See Buckland v Commissioner of Taxation (1960) 34 ALJR 60 at 62; Admin Exploration PtyLimited (in Liq) v Federal Commissioner of Taxation (1972) 72 ATC 4253 at 4260. In examining this question, it is necessary to take account of the factors which influenced or actuated the acquisition of the property and the construction of the units thereon. It is from those factors, the ends to which it was contemplated that the property might be put on the completion of the development, that a determination of the purpose of the scheme must be drawn. It is not inconsistent with there being a profit-making undertaking or scheme that two possible ends were in mind, one, that of deriving a profit on resale and the other of deriving regular income. It does not matter that the taxpayers had in mind these two alternatives provided that the possibility of making a profit by the development of the land and its resale was the predominant factor which actuated the transaction. More strictly, the issue is whether the taxpayers have satisfied the onus of proof of showing that the factor of profit-making was not the predominant factor moving the acquisition and development of the land. In his oral evidence, Bradley McCurry said that when he and his brother purchased the land, it was their intention to construct home units or townhouses thereon and to rent them. He said that the units were ultimately sold because of the financial difficulties which were being encountered, the commitments to the bank and the lack of return from the newsagency. I reject that evidence not only because no attempt to let the units was ever made but also because it was inconsistent with the affidavits of both Bradley and Brett which were filed in these proceedings. In Bradley's affidavit, in paragraph 9, he said: "At the time my brother and I purchased the land it was my intention to have three townhouses constructed subject to Council approval and to either sell or rent them out on completion." Brett's affidavit was to similar effect. At one stage in his cross-examination, Bradley McCurry conceded that he kept his eye on the property market leading up to giving the properties to Mr Payne for sale and that he appreciated that the market was on the rise right through 1988 up to about July/August 1988. Other answers later given were inconsistent with this but I consider that the former evidence is likely to be correct. Bradley McCurry also conceded that, at the time when Payne's Real Estate marketed the units, he had estimated that the brothers would be able to achieve a pretty good price for the townhouses if they would sell them at that time. In his evidence, Brett conceded that, between 1987 and 1988, the property market improved substantially. He conceded that he and his brother were both aware of the improvement in the property market. And when asked whether he and his brother thought in 1988 that they could obtain a good price, he answered: "Yes, the market was right." Neither of the affidavits specified financial difficulties in 1988, although Bradley's affidavit said that interest rates were high and were then escalating and that he decided to sell the units to pay off his personal credit loan and to invest the balance into purchase of a butcher's shop, a residential shop and a residential block at 46 Austin Parade, Warilla. His affidavit said that he was of the opinion he would be better off paying rent and repaying the debt in full as opposed to maintaining high interest repayments. During 1987 and 1988, the value of property in the area increased markedly and when the units were sold in 1988, the prices that were received were much better than the prices for which the units had first been advertised in 1987. A memorandum of the Manager of the Commonwealth Bank at Warilla of 30 September 1988 recorded that: "... the McCurry's have not sold any of their units but have had plenty of interest shown in their purchase. They have held on because of the rising property market." I have concluded from the whole of the evidence that the taxpayers sold the units because they considered it to be a good time to sell, not because they were forced to do so by financial difficulties, although rising interest rates would have been a factor they took into account. One answer which was given by Brett McCurry in cross-examination is particularly revealing as to what the brothers had always had in mind: "You wanted to make as much money as you could out of it, [the development] did you not?---Eventually, one day, yeah."

The case put by counsel for the taxpayers was that, at the time of purchase of the Addison Avenue property, they intended to construct townhouses thereon but they had not made up their mind whether they would sell the units or would rent them. I accept that, when they purchased the property, Bradley and Brett McCurry had in mind as a possibility that, for a time at least, they would rent out the townhouses when completed. Thus, there is in evidence the following note from the Manager of the Commonwealth Bank at Warilla of 7 February 1987: "The applicants [the taxpayers] stated they have received numerous enquiries from people wishing to rent the accommodation provided. However they have not yet decided if they will proceed with rental or sell."

However, I draw the conclusion that, of the two actuating factors which they had in mind, profit-making by sale or receiving rental income, the possibility of reselling the developed property at a profit was the dominant factor. In a case such as this, where the Court must examine the purpose of a transaction, the Court is entitled to have regard not only to the evidence which the taxpayers give of what they had in mind but also to the surrounding facts and to the events which actually occurred. Those events, by hindsight, can throw light upon the considerations which the taxpayer had at the time when the dealing was initiated. That which a person does is a guide to that which he had in mind to do. There are three particular facts from which I draw an inference that the predominant factor influencing the taxpayers in their project was that of making a profit. The first is that most of the moneys were borrowed moneys. As Isaacs ACJ said in Federal Commissioner of Taxation v Clarke at 251: "To transform capital, you must at least have capital to begin with". The project did not represent an investment of surplus funds and it was likely that, at some stage, the property would have to be sold to repay to the Bank the moneys borrowed. Secondly, the units were first put on the market shortly prior to their completion, the intention being to realise the profit which had been foreseen. And the units were put back on the market only 12 months later and were sold. Thirdly, no step whatever was taken to secure tenants for the property and no inquiry as to letting the units was made. Bradley McCurry conceded that no inquiries were made to ascertain the amount that could reasonably be expected to be received from renting out the units. He conceded also that unit 1 always remained unoccupied and was never rented out.

Of course, renting and selling were not necessarily inconsistent objectives. The units when constructed could have been sold either vacant or tenanted. Ultimately, when they were sold in December 1988, the members of the McCurry family remained on in two of the units as tenants. The new owners obviously purchased the units as investments and not for their personal use. The answer that Brett McCurry gave in cross-examination that the brothers had it in mind eventually one day to make as much money as they could out of the development is a strong indication that renting out the units was seen only as an intermediate step towards achieving profit on sale at an appropriate time. In my opinion, the taxpayers entered into a profit-making undertaking or scheme which was a business or commercial dealing in the sense I have described when they acquired the property at Addison Avenue. Their venture was a trading venture and from this venture they made the profit which had been anticipated. Perhaps strictly, as the purpose of the venture was the purpose of the taxpayers, I should say that I am not satisfied the profit-making, by development and sale of the units, was not their predominating objective. It has been submitted on behalf of the taxpayers that, if they undertook a profit-making venture, which they denied, that venture was abandoned. For twelve months from the time that they purchased the newsagency, units 2 and 3 were used as homes for the McCurry family. Unit 1 seems to have been used partly as a storeroom for the newsagency and partly as a residence by one or other of the boys when visited at weekends by his partner from Sydney. I draw the conclusion, however, that the taxpayers' scheme was not totally abandoned and that the units were not irrevocably committed to another activity. Profit-making by the sale of the units always remained an option for the brothers, notwithstanding that, for some period, when it was convenient to do so, the units were used for another purpose. As explained in the authorities I have mentioned, the crucial issue is whether the property generating the profit was acquired in a business operation or commercial transaction for the purpose of profit-making by the means which in fact gave rise to the profit, in other words, whether there was a profit-making scheme or undertaking and profit was derived from the carrying out of that scheme. It matters not that there may be an interruption to or interregnum of the scheme if the profit ultimately is derived from the activity which was planned and carried out to give rise to it. This is not a case such as Kratzman v Federal Commissioner of Taxation (1970) 44 ALJR 293 or Eisner v Federal Commissioner of Taxation, 45 ALJR 110, where the profit-making scheme was abandoned and profit was derived otherwise than in accordance with the scheme. In the present case, the profit that was derived was in contemplation at the time of the acquisition of the land. It follows that the assessments were correct and the applications should be dismissed. In the circumstances, it is not necessary to consider the capital gains provisions in Part 111A of the Assessment Act. There is just one other matter which I should mention. The taxpayers conceded at all times that the profit derived on the sale of unit 1 was assessable. Why this was so has not been made clear. However, there is in evidence a letter from the accountant for the McCurry family to the Australian Taxation Office dated 8 March 1995, which put forward the case that the intention of Bradley and Brett had been to erect three townhouses upon the Addison Avenue property, to sell unit 1 for profit but to use units 2 and 3 as private residences. The accountant therefore conceded that the profit from unit 1 was not assessable. The contention put forward by the accountant did not accord with the evidence given by Bradley and Brett McCurry in these proceedings and was not pursued. However, that appears to have been the source of the concession that the profit from unit 1 was assessable income. The order of the Court will be that the applications are dismissed with costs. I certify that this and the preceding twelve (12) pages are a true copy of the Reasons for Judgment herein of the Honourable Justice Davies.

Solicitors for the Applicants: Freidman Reeves, Lawyers

Solicitor for the Respondent: Australian Government Solicitor

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