INCOME TAX - prospectus issued by promoters of flower growing and export scheme of fifteen years duration - estimated annual financial returns for first 5 years of scheme projected in prospectus - prospectus provided that proceeds of subscriptions to scheme be applied partly in payment for so-called 'growth bags' or plantations partly in payment of license fees in respect of plantation sites and predominantly in payment of management fees - scheme plantation manager corporately related to scheme marketing manager - option to subscribers to obtain guaranteed return of $10,000 per plantation in relation to fifth financial year of scheme operations - option for guaranteed return exercisable at time of subscription for units - promoters procured irrevocable letter of credit from banking corporation to secure guaranteed returns - no reference to means or source of securing guaranteed returns to subscribers made in prospectus nor to that cost - security for guaranteed returns comprised prospectus subscriptions - expert evidence adduced as to horticultural viability of scheme accepted by primary judge - respondents professional persons not previously engaged in horticulture - respondents subscribed for units close to culmination of fiscal year of promotion - further subscription made by one taxpayer midway in following fiscal year - disallowance by Commissioner of entirety of deductions for license fees and management fees - proceedings at first instance contested by Commissioner upon basis as to unavailability of deductibility of entire license and management fees without apportionment in relation to cost of provision of guaranteed returns - claims at first instance contested by Commissioner on 'all nor nothing' basis - acceptance by primary judge of credibility of dominant purposes of taxpayers in entering into scheme - finding by primary judge that financial failure of scheme unrelated to prospective viability of scheme as at time of subscriptions of taxpayers - credibility and tax avoidance issues resolved at first instance wholly in favour of taxpayers - tax deductibility wholly allowed at first instance - appeal dismissed
[2]
Income Tax Assessment Act 1936 ss 51(1), 82KJ, 82KK, 82KL, 177
[3]
Clowes v Federal Commissioner of Taxation (1954) 91 CLR 209
Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428
Commissioner of Inland Revenue v BNZ Investments Limited (2001) 20 NZTC 17
Commissioner of Taxation of the Commonwealth of Australia v Spotless Services Limited (1996) 186 CLR 404
Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157
Commissioner of Taxation v Lau (1984) 6 FCR 202
Commissioner of Taxation v South Australian Battery Makers Proprietary Limited (1978) 140 CLR 645
Eastern Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27
Fairway Estates Pty Ltd v Commissioner of Taxation (1970) 123 CLR 153
Federal Commissioner of Taxation v Brand (1995) 95 ATC 4633
Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235
Ferguson v Commissioner of Taxation (1979) 37 FLR 310
Fletcher v Commissioner of Taxation (1991) 173 CLR 1
G.P. International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1989-1990) 170 CLR 124
Hallstroms Pty Limited v Commissioner of Taxation (1946) 72 CLR 634
Howland-Rose v Commissioner of Taxation (2002) 118 FCR 61
Merchant v Federal Commissioner of Taxation (1999) 99 ATC 4221
Metwally v University of Wollongong (1985) 60 ALR 68
Milne v The Commissioner of Taxation of the Commonwealth of Australia (1975-1976)133 CLR 526
Puzey v Commissioner of Taxation (2003) FCAFC 197
Rhoden v Wingate [2002] NSWCA 165
Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47
Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459
Sun Newspapers Limited and Associated Newspapers Limited v Federal Commissioner of Taxation (1938) 61 CLR 337
Ure v Federal Commissioner of Taxation (1981) 50 FLR 219
Vincent v Federal Commissioner of Taxation (2002) ATC 4742
COMMISSIONER OF TAXATION v GRAHAM GEORGE COOKE
N 1228 OF 2002
COMMISSIONER OF TAXATION v HUGH HUNTER JAMIESON
N 1229 OF 2002
COMMISSIONER OF TAXATION v GRAHAM GEORGE COOKE
N 1230 OF 2002
LEE, SUNDBERG AND CONTI JJ
26 MARCH 2004
SYDNEY
[4]
ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA
[5]
THE COURT ORDERS THAT:
The appeals be dismissed.
The Appellant Commissioner pay the Respondents' respective costs of the appeals.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
[6]
ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA
[7]
REASONS FOR JUDGMENT
THE COURT
1 The appellant ('the Commissioner') appeals from judgments of the primary judge, given on 29 October 2002, whereby her Honour allowed appeals by the respective respondents against disallowance of their objections to notices of assessment issued by the Commissioner in respect of the fiscal years ended 30 June 1988 and 1989 in the case of Mr Cooke, and 30 June 1988 in the case of Mr Jamieson. The appeals concern the Commissioner's treatment of losses and expenses incurred by the respondents pursuant to their participation in a project known as the Australian Horticultural Project Number 1 ('AHP No 1'), promoted to the public by Growth Industries Pty Limited ('Growth Industries'). The proceedings at first instance and the appeals were heard together.
Background circumstances
2 Information about AHP No 1 was set out in a prospectus dated 16 May 1988, which was lodged and registered with the Corporate Affairs Commission of New South Wales as delegate for the National Companies and Securities Commission. The prospectus offered to the public subscription in units in a unit trust known as the Australian Horticultural Trust Number 1 ('the Trust'). The function and purpose of the Trust was said to be to use the funds subscribed pursuant to the prospectus on behalf of persons who wished to conduct a business of growing proteas and Australian native flowers for domestic and overseas consumption. The sum payable for a unit in the Trust was $10,000. The minimum subscription stipulated in the prospectus was 500 units. That was satisfied by 2,500 units being underwritten by well-known Australian stockbrokers. In fact approximately 3,314 units were subscribed. Of the sum payable for each unit in the Trust, $250 was to be paid to Growth Industries Management Limited ('the Plantation Manager'), for what was described in the prospectus, firstly, as a 'service fee' and later as 'establishment costs'. On an acquisition of units, an investor (called therein and hereafter a 'Grower') would enter into a plantation agreement, in the form annexed to the prospectus, with the Plantation Manager and the trustee of the Trust, namely A.T.A. Services Limited (called therein and hereafter 'the Trustee' and referred to in certain of the documentation as the 'Grower's Representative'). For that purpose, the application form for units contained a power of attorney in favour of each director of the Trustee to execute a plantation agreement on a Grower's behalf. Clause 10 of the trust deed provided for the so-called redemption of the units, once the minimum subscription was attained. The sum of $9,750 payable on redemption of each unit was to be paid to the Plantation Manager on behalf of the Grower.
3 AHP No 1 had an estimated life of 15 years. Projected returns per unit in the first five years of operation ending 30 June 1993 were set out in the prospectus as follows:
On the basis of On the basis of
2,500 units 3,500 units
1989 $1,996 1989 $2,006
1990 $2,380 1990 $2,422
1991 $4,424 1991 $4,466
1992 $4,938 1992 $4,799
1993 $5,641 1993 $5,681
These projected returns were based on assumptions set out in the prospectus.
4 The plantation agreement was expressed to commence on the date the units were redeemed, and to continue, unless sooner terminated, until 30 June 2003. Pursuant to the plantation agreement, a Grower was to acquire from the Plantation Manager one plantation per redeemed unit at a price of $250 per plantation. A plantation consisted of a holding comprising at the time it is physically constituted 192 seedlings each contained in its own Growth Bag together with growing material. A growth bag was a special container made of spun polypropylene material, designed to promote efficient and healthy plant growth. It had a limited life and one-third of the plantations were to be 'rebagged' each year after the first three years. The price paid for a plantation was said to include the cost of transporting the seedlings from a propagation site to a production site. It was the duty of the Plantation Manager under the plantation agreement to 'physically constitute' each plantation by planting each seedling in a growth bag with growing material, to deliver and establish the plantations at a production site, and to tag each growth bag with the name of the Grower who owned it. In fact the latter step did not occur and the location of each Grower's property was said to be ascertained according to computer records. The remainder of the proceeds payable on redemption of each unit was to be applied in payment of $45 to the Plantation Manager as a sub-licence fee for use of the production site for the plantation, and in payment of $9,455 to the Plantation Manager as a fee for management services. The product of each plantation was to be transported from the production site to a market. There were two large production sites made available to the Growers, one near Wellington in New South Wales, being part of the land known as Narroogal Park, and one that was part of the Longerenong campus of the Victorian College of Agriculture and Horticulture near Horsham in Victoria. For an annual fee, the owners of the production sites licensed the Plantation Manager to locate the plantations at the sites, and to otherwise use the sites for the purposes of AHP No 1. As noted above, sub-licence fees were payable by the Growers to the Plantation Manager. The Plantation Manager, pursuant to the plantation agreements, engaged VCAH Services Limited ('VCAH') as technical manager and Growth Industries Marketing Pty Ltd as marketing manager. The Plantation Manager and Growth Industries Marketing Pty Ltd were related companies of the promoter Growth Industries.
The facility agreement and the investments made by the respondents
5 A facility agreement made on 24 May 1988 between Growth Industries, Mid-West Finance Pty Limited ('Mid-West'), the Plantation Manager and the State Bank of New South Wales ('the Bank') provided that the Bank would make a facility available to Growth Industries for an amount not exceeding $255,500,000. The purpose of the facility was stated to be, inter alia, to make funds available to Mid-West so that it could provide loans to Growers to participate in AHP No 1, and for like purposes in respect of several other unit trusts promoted by Growth Industries. Mid-West also appears to have been a related company of Growth Industries.
6 On or about 23 June 1988, Mr Cooke subscribed for 45 units in the Trust, by filling out the application form contained in the prospectus for that number of units, and by borrowing the full amount required for that subscription, namely $450,000 from Mid-West, pursuant to a loan approval given four days later on 27 June 1988. The interest rate charged on that borrowing was 15.65%. On the redemption of the units the Plantation Manager, on behalf of Mr Cooke, received the redemption sum of $438,750, which was appropriated, as to $11,250 for the purchase of 45 plantations, $425,475 for management fees and $2,025 for sub-licence fees.
7 In November 1988, Mr Cooke subscribed for a further 10 units in the Trust at a total cost of $100,000, again borrowed from Mid-West on similar terms. The process undertaken was the same as that in relation to the 45 units, the numbers involved in terms of plantations and outgoings being commensurately smaller.
8 On or about 19 May 1988, Mr Jamieson subscribed for 25 units in the Trust and borrowed the whole of the subscription sum of $250,000 from Mid-West. On redemption of the units the funds payable to the Plantation Manager on behalf of Mr Jamieson, namely $243,750, were appropriated as to $6,250 for the purchase of 25 plantations, $236,375 for management fees, and $1,125 for sub-licence fees.
9 In November 1988, Mr Jamieson gave notice of an intention to subscribe for a further 15 units in the Trust but it appears that the subscription did not proceed.
The plantation agreement
10 The relevant terms of the plantation agreement may be summarised as follows:
(i) the Plantation Manager was to be responsible for the cultivation, harvesting, marketing and sale of the flowers, and for the provision of all necessary equipment and ancillary services;
(ii) the flowers for sale harvested from each plantation were to be pooled with the flowers of the plantations of all the other Growers;
(iii) the property in the flowers was to pass to the Plantation Manager at the time of pooling;
(iv) the Plantation Manager was to distribute the proceeds of sale of the flowers to the Growers, each being entitled to the percentage of the proceeds that his or her number of plantations bore to the total number of plantations (called the 'Grower's percentage'), without reference to the quality, volume, prices or any other factor in relation to the Grower's flowers or those of any other participant;
(v) the Plantation Manager was to receive from each Grower:
(A) a management fee of $9,455 in respect of each plantation, for management services to be rendered by 30 June 1989, out of which the Plantation Manager was to pay to the Trustee $18 as remuneration for the year ending 30 June 1989;
(B) a productivity fee equal to 10% of the Grower's percentage of the gross sale proceeds derived after 30 June 1989; and
(C) reimbursement of all costs, expenses and liabilities incurred by the Plantation Manager after 30 June 1989, with the intent that each Grower should bear the proportion of such costs represented by the number of plantations owned;
(vi) the Plantation Manager was given 'full and unqualified' powers of management, including powers in relation to all things incidental to such management, to be exercisable subject only to the duty of the Plantation Manager to act bona fide in the interests of each Grower;
(vii) the Trustee was entitled, on reasonable notice, to enter the production sites and inspect the books and records of the Plantation Manager and to give the Plantation Manager instructions concerning the provision of the management services;
(viii) subject to instructions given to the Trustee, the Plantation Manager had absolute and uncontrolled discretion as to the exercise of its powers under each plantation agreement;
(ix) the Grower was to have the benefit of a so-called guaranteed return option, and if the Grower elected to exercise the option in the application form for units in the Trust and paid the necessary fees, the Plantation Manager undertook to pay to the Grower a guaranteed return of $10,000 per plantation for the year ending 30 June 1993;
(x) the Grower was to pay to the Trustee by way of remuneration $18 per plantation for years 2, 3, 4 and 5 of AHP No 1 and increased remuneration in subsequent years; and
(xi) the Grower was to pay a sub-licence fee to the Plantation Manager of $45 per annum per plantation increased according to Consumer Price Index increases after the first year.
11 The guaranteed return was secured by an irrevocable letter of credit issued by the Bank in favour of the Trustee, to be held on behalf of each Grower electing to take the guaranteed return. A Grower was to receive the guaranteed return from the Plantation Manager by no later than 31 August 1993. Exercise of the option prevented the Grower from receiving any return for the year ended 30 June 1989, and limited the Grower to a net return of $2,000 per plantation for each of the financial years ended 30 June 1990, 1991 and 1992, and $12,500 for the financial year ended 30 June 1993, 'provided there [was] a Grower's net return available for distribution'. Any additional income per plantation otherwise available for distribution to a Grower in respect of those financial years was to be paid to the Plantation Manager, and for the later years ending 30 June 1994 to 30 June 1998, the Plantation Manager was entitled to receive 25% of the Grower's annual net return in respect of each plantation. The Plantation Manager would meet any contributions payable by the Grower in the financial years up to and including the year ending 30 June 1993. Presumably that included not only costs incurred in maintaining the plantation but also the sums the Grower was required to pay for licence fees and trustee remuneration. It followed that if AHP No 1 failed to provide a net return in those years, the Plantation Manager would have to meet all costs from its own resources. The cost of the guaranteed return was an up-front fee equal to 0.5% of the amount of the sum subscribed.
12 The respondents elected to exercise the guaranteed return option. Mr Cooke paid a fee of $2,250 in respect of the 45 plantations he acquired in June 1988 and $500 for the 10 plantations he acquired in November 1988. Mr Jamieson paid a fee of $1,250 in respect of the further 25 plantations he acquired in May or June of 1988.
The claimed deductions
13 The prospectus contained the following statement concerning the taxation benefits for investors:
'For investors who become Growers, income from the Project will be assessable for income tax. However as investors become Growers in their own right their expenses in the business are tax deductible. On redemption of each unit $9,500 of the amount invested of $10,000 per unit is applied in payment of deductible expenses. Therefore, based on existing law, investors who become Growers can expect to receive a tax deduction for ninety five percent (95%) of the amount they subscribe.'
The learned primary judge observed that the statement was consistent with the taxation opinion of Mallesons Stephen Jacques, although the opinion contained what her Honour described as more detailed qualifications and assumptions; the primary judge extracted the following therefrom:
[8]
'In our view expenses relating to the maintenance of a grower's plantation and the harvesting and sale of blooms will be deductible under section 51 of the Income Tax Assessment Act 1936 ("the Act") by reason of such expenses being characterised as outgoings necessarily incurred in carrying on a business of bloom production for the purpose of gaining or producing assessable income. Subject to our comments in relation to various disentitling provisions of the Act set out below such outgoings under the Project will be deductible in the year of income in which they are incurred. The fact that the benefit resulting from expenditure by a taxpayer will not enure to the taxpayer until a year beyond the year of assessment is not relevant to the question of deductibility according to the general principles of law … The deductibility of a grower's outgoings is, however, subject to various anti-avoidance provisions of the Act.'
The opinion then discussed the anti-avoidance provisions of ss 82KJ, 82KK, 82KL and Part IVA of the Income Tax Assessment Act 1936 (as amended) (the 'Tax Act'), and concluded that these provisions were unlikely to affect the tax deductibility of a Grower's expenses.
14 The expenses or outgoings incurred pursuant to the plantation agreements and claimed by the respondents as deductions were as follows:
(i) as to Mr Cooke in relation to the year ended 30 June 1988:
(a) $425,475 for management fees;
(b) $2,025 for licence fees; and
(c) $2,250 for the guaranteed income return fee;
(ii) as to Mr Cooke in relation to the year ended 30 June 1989:
(a) $94,550 for management fees;
(b) $450 for licence fees; and
(c) $500 for the guaranteed return fee; and
(iii) as to Mr Jamieson in relation to the year ended 30 June 1988:
(a) $236,375 for management fees;
(b) $1,125 for licence fees; and
(c) $1,250 for the guaranteed return fee.
On 20 February 1995 and 18 July 1995, by notices of amended assessments, the Commissioner disallowed Mr Cooke's claims for management, licence and guaranteed return fees for the fiscal years ending 30 June 1988 and 30 June 1989, and on 9 March 1995 the Commissioner did likewise in relation to Mr Jamieson's management, licence and guaranteed return fees for the fiscal year ended 30 June 1988.
The expert evidence
15 The expert evidence adduced at the hearing before the primary judge was given on behalf of the respondents, with the exception of evidence given by a Mr Geurtsen on behalf of the Commissioner. The first expert witness was Mr Flude, the managing director of the Trustee. He had qualifications in agricultural and biological sciences, and had long experience in consulting in agricultural management. Mr Flude established the Trustee in order to provide agricultural consultancy, production and management services. As summarised by the primary judge, he addressed the following matters in chief and under cross-examination:
(i) the history of AHP No 1 and the difficulties the project encountered;
[9]
(ii) the breakdown of the relationship between the Plantation Manager and VCAH, and the eventual appointment of a liquidator to Growth Industries in 1991;
[10]
(iii) the agreed circumstance that the new technology involved in AHP No 1, including the use of growth bags, meant that the project involved risks beyond those affecting more conventional horticultural projects;
[11]
(iv) it was not unusual to cultivate Australian natives and proteas, although cultivation for export was unusual; and
[12]
(v) the scale of the project created risk, and expert opinion in Australia was divided as to the applicability to Australian conditions of the technology adopted for AHP No 1.
[13]
16 The next expert witness was Mr Hunter, the Associate Director (Curriculum Business Development and Head of Department (Management Studies)) at the Dalby Agricultural College in Queensland. In 1988, he was the manager of Agri Valuers Australia, the technical consultant to AHP No 1, and he addressed the viability of the VCAH report and the Plantation Manager's marketing report contained in the prospectus, and the overall viability of the project. The primary judge summarised his conclusions as supporting the following propositions:
(i) the reasonability of the projected yields set out in the prospectus;
(ii) the suitability of the production sites for the project; and
(iii) the appropriateness of the production budgets and the flower varieties selected.
[14]
Mr Hunter stated that based on his examination of those reports and further documentation provided by the Plantation Manager, he was of the opinion that AHP No 1 was a viable project as conceived or planned.
17 The respondents then provided evidence from Dr Martin, described by the primary judge as a highly qualified scientist, having more than 25 years experience in horticultural research, including flower production, and having held senior academic appointments. Among his consultancies, he was the principal landscape and aboriconsultant to the Centennial Park and Moore Park Trust, and a tree consultant to the Royal Botanic Gardens in Sydney. He furnished a report in the proceedings as to whether, at about the time the respondents subscribed funds to the Trust, AHP No 1 was horticulturally viable. Dr Martin's report was described by the primary judge as 'a detailed and carefully reasoned report'. He analysed the suitability of the production sites in terms of access to international airports, climatic conditions (including the incidence of frosts, disease and weeds), the availability of established site facilities, the adequacy of water and growing media supply, and the availability of labour, technical management and administration services. Based on his consideration of all of those factors, and his analysis of the suitability of the plantation sites, he expressed conclusions affirmatively in favour of the horticultural viability of the project, and the potentiality thereof to reach its goal of production of high-value cut flowers for export, and in particular, the prospects for the marketing thereof in the United States, Japan and Europe.
18 Expert evidence was also given on behalf of the respondents by Mr Weeks of Deloitte Touche Tohmatsu. His source material included the business consultant's report contained in the prospectus, prepared by Mr Wehby of Coopers & Lybrand, concerning the cash distributions projected in the prospectus, and also certain papers contained in the Coopers & Lybrand files. His conclusion was that on the figures so derived, the rate or basis of calculation of the management fees payable to the Plantation Manager was reasonable, and not greater than might reasonably have been expected under an arm's length transaction. Four of Mr Weeks' conclusions provided areas of controversy in the appeals, and the text thereof appears below:
'7.24 As can be seen from the table, the estimated total cost for 2,500 units is $7,059. In my opinion it would be reasonable for [the Plantation Manager] to recoup costs equal to this amount through the management fee because there was a risk that only 2,500 units would be issued under the Prospectus. This amount is not materially different to the amount of $7,170 that was deducted from the prepaid management fee to calculate the margin to [the Plantation Manager].
7.25 On the basis of the two foregoing analyses, in my opinion, the amount of $9,455 incurred by the respondents in respect of the management fees for the first 13 months of the project was reasonable and not greater than might reasonably be expected under an arm's length transaction.
7.26 The Geurtsen Report concludes that the prepaid management fee of $9,455 for the period up to 30 June 1989 was too high on the basis that the management fee margin was excessive. Section 9 of the report states "It is apparent that there is a large margin between the expenses of the project in the first year and the prepaid management fee. This margin appears to be $8,000 to $9,000 per plantation or $28 million to $31 million over 3,500 units."
7.27 This margin is based on the projections calculated in the Geurtsen Report which are in turn based on certain assumptions which vary significantly from those adopted in the Prospectus. In particular, the margin is calculated on the assumptions of no income and minimal expenses in the year ended 30 June 1989.'
19 The Commissioner's expert witness Mr Geurtsen was qualified academically in science and economics, and he was an experienced horticulturist and agronomist, and an analyst of farming systems and enterprises, including cut flower production. He had prepared a report jointly with another author. The primary judge permitted Mr Geurtsen to testify only in relation to the parts of the report for which he had been responsible, consistent with the approach taken in Rhoden v Wingate [2002] NSWCA 165 per Heydon JA at [61], an appeal which was determined after the hearing of the present proceedings at first instance, and before judgment was given. Her Honour's ruling in that regard was not challenged on the appeal. Those parts of that joint report admitted into evidence did not include a segment related to economic viability, being a subject addressed by the other author. As to the issue of the horticultural viability of the project, Mr Geurtsen expressed the view that 'several critical areas lacked adequate consideration', being:
site selection in relation to intended species;
risk assessment and management;
flower periods in relation to markets and site location;
plant yields; and
field growth bag system.
20 Mr Geurtsen's evidence in chief concluded that horticulturally, the project was not viable. Under cross-examination, however, he agreed that his conclusions as to the unsuitability of the growth bags was pessimistic, and moreover that his report identified implicitly significant advantages in relation to a number of aspects of the project. Ultimately in the view of the primary judge, Mr Geurtsen's reservations as to capacity for viability appeared to depend on his opinion that the cultivation of flowers in AHP No 1 was for cut flower production, and in any event, the information with which he was briefed was too general in nature, or else related to the production of plants for general landscape purposes. Mr Geurtsen considered that cut flower production is a 'very different field' from the production of plants for general landscape purposes, but according to the primary judge, he did not explain why or in what way that was so. Instead, as the primary judge recorded, Mr Geurtsen merely said that he would need evidence to the effect that the species used for cut flower production would respond in the same manner as plants cultivated for general landscape production.
21 The primary judge recorded Mr Geurtsen's acknowledgment that there were some areas of agreement between his report and that of Dr Martin, and that Mr Geurtsen was not able to point to any specific part of Dr Martin's report with which he disagreed. Moreover Dr Martin disagreed with Mr Geurtsen's views on a number of issues, one of which her Honour thought appropriate to exemplify, namely Mr Geurtsen's opinion that the frost risk at Longerenong was 'extremely high'. The primary judge considered that Dr Martin had provided a convincing analysis of climatic data to support his contrary view, and in addition that Dr Martin had made the following observations of value:
· the fact that the growth bags would elevate the plants above general ground level would have a moderating effect, thereby making the frost risk insignificant; and
· the existence of research as to the use of growth regulators to promote frost resistance.
Dr Martin also expressed the view that Mr Geurtsen's reservation as to the special nature of cut flower production was based on views informed by hindsight, and that in 1988, the growth regulator approach was sufficiently promising to warrant its inclusion in the prospectus. The conclusion of the primary judge was that Dr Martin provided a convincing rebuttal of many of the negative findings of Mr Geurtsen, and that Dr Martin's views were not seriously challenged in cross-examination. The primary judge considered that where Dr Martin's views conflicted with those of Mr Geurtsen, she should accept the former in preference to the latter.
The primary judge's summary of the respondents' evidence
22 Mr Cooke became a partner in the firm of Allen Allen & Hemsley in 1963, and retired from the firm and from legal practice in 1989. During the period from 1970 to 1985, he spent most of his professional time working for one major corporate client. Following the break-up of that corporate client, his work for the client was dramatically reduced, and his legal practice as a partner correspondingly diminished. He was not optimistic about the prospect of building up another substantial clientele. Since retirement had thus become a real possibility, Mr Cooke turned his mind to his likely financial position as a consequence. He described the dilemma in which he found himself placed as follows (being a position which was reached at about the same time as he became aware of the promotion of AHP No 1, pursuant to an internal report of 7 June 1988 distributed within the firm by one of his partners Mr McKillop):
'I became interested in seeking out business ventures which would provide a good financial return for my retirement. In particular, I was looking for business ventures which would provide regular cash flow during my retirement. Typically, business opportunities that had significant up-side and little downside were attractive to me. At this stage in my life I could ill afford to place funds into ventures that carried significant risk of failure, although, I must admit, I was keen to make better than average returns.
As part of my retirement objectives, it was also important to me to find a business opportunity that did not require every day "hands on" involvement in managing the business. Accordingly an opportunity to engage in a business, which could be managed by other persons was also attractive.'
23 Mr Cooke sought advice from Davey & Associates, accountants and financial planners, at the suggestion of Mr McKillop. That firm recommended inter alia that he invest in AHP No 1. Having read the prospectus, he formed the view that AHP No 1 was an attractive venture, having the potential to produce 'super' profits geared to later rather than earlier years, which suited his needs for retirement income. Mr Cooke further said that because he did not have cash available for investment, the finance to be available as described in the prospectus was important to him, as was the option for a guaranteed return of income, albeit limited in scope. He acknowledged an awareness of the risks inherent in the project, because this type of horticulture was relatively new. He recognised that the existence of the guaranteed return lessened, but did not eliminate, the risks he envisaged, which he explained as follows:
'(a) … I recognised from my experience as a commercial lawyer that the guarantee was only as good as the legal efficacy and security under which it was set up. There was a limited but real risk that the guarantee may not be effective. Even if the funds were returned under the guarantee (as they eventually were) there was still a risk that the purchasing power of those funds was likely to be seriously reduced as a result of the then high rates of inflation and the fact that the guaranteed minimum return did not cover my net interest cost from June 1988 to 1 September 1993 (which was to be substantial).
(b) I was also very much aware of the "opportunity cost" of making the investment in AHP No 1. Put simply, the fact that I was to participate in AHP No 1 meant that my financial ability to contribute to other business ventures would be curtailed. In addition, the fact that I had to borrow the funds meant that any further requests for loan from other sources would be met less than enthusiastically.
(c) [U]nder the loan I took out to buy the original units in [the Trust] I was required to pay considerable interest payments all of which reduced my return on the overall business. I had no doubt that the project needed to succeed commercially for me to be put back into the same position as I was before commencement (even after allowing for the guaranteed minimum return).'
24 Mr Cooke admitted under cross-examination that towards the end of the 1988 financial year, he was aware that his income for that year would be considerably higher than for the previous year. He rejected however the suggestion that his dominant interest in the project was to gain the tax deduction for the 1988 fiscal year that he subsequently claimed. While he agreed that he was influenced by the memorandum of 7 June 1988 from Mr McKillop, in which the tax advantages of the project were highlighted, he said he was also influenced by the potential of the project for long-term income generation. Mr Cooke admitted that his investment was the largest amount he had ever privately invested, and that he was only able to do so because it was possible to borrow the whole of the amount required for the project. He also admitted that were it not for the availability of the represented tax deduction, he may have had to borrow to pay his income tax shortly to fall due for payment in respect of the 1988 fiscal year. It was evident to the primary judge that Mr Cooke had not read the AHP No 1 documents, or the agreements he was required to sign, with particular care. However Mr Cooke denied that the terms of that documentation were of little concern to him, or that his prime concern was the availability of the tax deduction. Mr Cooke insisted that the commercial and horticultural aspects of the project were his prime concern.
25 Mr Jamieson became a partner in Allen Allen & Hemsley in 1961, and retired from the firm in December 1995. During that time he engaged in legal work and in the administration of the firm. He said he had little time to devote to activities outside of the firm, and with one exception, he did not devote much time to any personal financial planning. That exception was his investment, through his wholly owned company, in an orchard which he had acquired and developed in Bilpin in the State of New South Wales. He said he visited the property as often as possible, supervising the orchard activities and, at times, physically participating therein. He further stated that the orchard generated significant revenue, most of which he put back into the orchard business, and further, that the orchard business had been subject to an audit by the Australian Tax Office in the early 1980s, following which he was in effect acknowledged by the Commissioner to be a bona fide primary producer.
26 Mr Jamieson further testified that during the 1980s, although his firm's legal practice was flourishing, he realised that he had not accumulated sufficient assets to provide for his retirement. Early in 1988, he also got in touch with Davey & Associates to obtain financial advice, and, inter alia, investment in AHP No 1 was recommended. From his discussions with Davey & Associates and his reading of the prospectus, he was attracted to AHP No 1 investment for a number of reasons, including the following:
[15]
Whether Part IVA of the Tax Act applies to the respondents
86 The relevant sections in Part IVA are as follows:
'177A(1) [Definitions] In this Part, unless the contrary intention appears:
…
"scheme" means:
(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct;
…
177C(1) [Obtaining a tax benefit] Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
…
(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonable be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
…
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:
…
(d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph;
…
177D This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:
(a) a taxpayer (in this section referred to as the relevant taxpayer) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b) having regard to:
(i) the manner in which the scheme was entered into or carried out;
(ii) the form and substance of the scheme;
(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonable by expected to result, from the scheme;
(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonable be expected to result from the scheme;
(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii) the nature of any connection (whether of a business family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one o the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).
…
177F(1) [Commissioner's discretion to cancel tax benefit] Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may:
…
(c) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
…'
87 Her Honour gave compendious consideration to the matters required to be considered under s 177D(b). It was not submitted by counsel that her Honour erred in that regard. The primary judge recorded that the Commissioner's Part IVA case presented below concerned a scheme which 'included the Plantation Agreement, the Trust Deed, the prospectus, the application for units in the Trust, the Letter of Credit Agreement between Growth Industries and the Plantation Manager, the loan from Mid-West to the respondents, loans from the Bank to the Plantation Manager and from the Plantation Manager to Mid-West, the deposit of part of the management fees by the Plantation Manager with a subsidiary of the Bank in order to secure the letter of credit' (the emphasis was that of the primary judge). Alternatively a Part IVA scheme for present purposes was identified by the Commissioner as consisting only of the plantation agreement and the Trust Deed 'entered into in the context of the agreements, events and circumstances comprising the other documents and transactions identified', or alternatively again, all of the above as well as 'other similar AHP No 1 plantation agreements with other investors incorporating the "guaranteed return option" and/or similar loans from Mid-West to such investors financing their participation in AHP No 1'.
88 The primary judge found that the evidence of the respondents was to the effect that at the time of making their respective investments, they knew nothing about the transactions identified in the emphasized passage in the preceding paragraph. Upon that footing, her Honour accepted the submission of the respondents that those transactions could not be part of any scheme, and purported to apply the dictum of Blanshard J of the New Zealand Court of Appeal in Commissioner of Inland Revenue v BNZ Investments Limited (2001) 20 NZTC 17 at [103] to the effect that a taxpayer's ignorance of the arrangements the subject of an income tax avoidance scheme renders the New Zealand anti-avoidance legislation unavailable to the New Zealand revenue authority. However as was pointed out in Howland-Rose at [134], Part IVA of the Tax Act is distinguishable from the New Zealand legislation in that regard. Thus in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235, in the joint judgment of Gleeson CJ, Gaudron, Gummow, Hayne and Callinan JJ at [95], it was pointed out that '[o]ne of the reasons for making s 177D turn upon the objective matters listed in the section, it may be inferred, was to avoid the consequence that the operation of Part IVA depends upon the fiscal awareness of a taxpayer'.
89 The reasoning of the primary judge proceeded thereafter as follows in relation to the transactions whereof the respondents were aware:
'In so far as the respondent contends that the persons who entered into the scheme or carried out the scheme include the applicants, the Plantation Manager and the other parties to the dealings and transactions identified by the respondent as included in the scheme, there is a difficulty. There is no evidence before me as to what the other investors did or did not do, for instance whether all or any of them took advantage of the guaranteed return.'
Upon that basis, the primary judge continued as follows:
'In my view, it is only the [Commissioner's] alternative "scheme" that can be considered in this proceeding. This scheme meets the requirement noted by Hill J in Hart v Commissioner of Taxation [2002] FCAFC 222 at [44] that the definition of a scheme must be able to "stand on its own feet". The tax benefit identified by the [Commissioner] was the deductions that would be obtained by each applicant in respect of management fees, licence fees and guaranteed return fees. This leaves for consideration the question whether the sole or dominant purpose of the applicants in entering into the scheme was to obtain a tax benefit having regard to the matters set out in s 177D(b); see also s 177A(5).'
The decision of the Full Federal Court in Hart is now reported at (2002) 121 FCR 206.
90 The primary judge referred in the present context to the evidence of the respondents, which she accepted, that they had not made adequate provision for their retirement, and for that reason each of them had wanted to participate in a relatively long-term project, yet they did not have sufficient personal resources to finance any such investments, and that therefore they needed to borrow money for that purpose. The primary judge further found that the respondents elected to exercise the option of receiving a guaranteed income return consistently with prudently protecting part of their investment. The primary judge referred also to the reality that each of the respondents expected a significant increase in income for the fiscal year ended 30 June 1988 which would generate an increased income tax liability, so that an investment which did not carry with it a substantial tax deduction would compromise their ability to invest in an income producing investments for the benefit of their retirement. Moreover the primary judge accepted that it was important to the respondents that they avoid incurring liabilities that would prejudice their respective approaching retirement situations, and that objectively it was reasonable that they would have regarded the success of AHP No 1 as important to them, irrespective of the steps they took to protect themselves if the project was not successful. In any event the guaranteed return was substantially less than the amount of interest each had to pay over five years, and moreover in effect only the after-tax portion of the guaranteed return would be available to repay the borrowings undertaken to subscribe for units in the project.
91 Senior counsel for the respondents was adamant that as matters transpired in the course of the hearing before the primary judge, the Commissioner did not rely on the three alternatively alleged schemes as described above, and that what the respective parties ultimately contended in the course of addresses below, both orally and in writing, related to the most narrowly based scheme emerging from that recorded above. In particular, it was emphasised that the Commissioner did not put any alternative proposition, orally or in writing, to the primary judge that the relevant dominant purpose could be attributed to the Plantation Manager. Upon that footing, it was submitted that the Commissioner was bound by the conduct of the case at the trial, and reliance was placed on the following passage from the judgment of the High Court in Metwally v University of Wollongong (1985) 60 ALR 68 at 71, as follows:
'It is elementary that a party is bound by the conduct of his case. Except in the most exceptional cases, it would be contrary to all principle to allow a party, after a case has been decided against him, to raise a new argument which, whether deliberately or by inadvertence, he failed to put during the hearing when he had an opportunity to do so.'
Senior Counsel for the respondents further submitted that there were no exceptional circumstances to justify the Commissioner raising the existence of alternative schemes on the appeal, irrespective of the primary judge's apparently unintentional oversight in her reasons by referring to the 'narrow scheme'.
92 The written response of counsel for the Commissioner to the objections raised on behalf of the respondents was in the following somewhat ambiguous terms:
'…, it has always been the appellant's case to rely upon each of the three alternative particularised schemes (which under one alternative requires a consideration of the purpose of [the Plantation Manager]) as set out at paragraph [85] of the reasons of the learned primary judge. The appellant is entitled to do this. It was on this basis that the learned primary judge felt compelled to consider and reject (wrongfully in the submissions of the appellant) the wider scheme identified by the appellant. At trial counsel for the appellant did not abandon any of these alternatives. Further, the respondents do not contend that they are prejudiced by the appellant's continued reliance upon each alternative scheme for the purposes of this appeal. The alternatives pleaded in this case are not "new" arguments in the sense described in University of Wollongong v Metwally (No 2) (1985) 60 ALR 68.'
Without deciding the entitlement of the Commissioner to pursue an issue which may not have been propounded appropriately before the primary judge, raising in particular the need for the Full Court to address de novo the intentions of the Plantation Manager, we will nevertheless address the full extent of the Commissioner's submissions on the subject. We observe, in so doing, that no application was made on behalf of the respondents in response to re-open their case at first instance or to lead further evidence on the appeal.
93 The Commissioner's principal Part IVA submission to the Full Court was that objectively ascertained, the dominant purpose of each respondent was to obtain the tax benefits available in connection with each so-called relevant scheme, or alternatively, that 'it was [the Plantation Manager's] dominant purpose, objectively ascertained, that each respondent, together with the other participants in the AHP No 1 project who elected to take the guaranteed return, obtain the tax benefits in connection with each relevant scheme'. The following passage from the judgment of Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ in Spotless at 415 was said to reject the existence of a dichotomy between the presence of a dominant purpose of obtaining a tax benefit and the pursuit of a commercial gain:
'A person may enter into or carry out a scheme, within the meaning of Pt IVA, for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where that dominant purpose is consistent with the pursuit of commercial gain in the course of carrying on a business.'
The dominant purpose found in Spotless was to achieve a tax benefit in Australia in the form of an exemption from income tax upon a very large deposit of funds not for the time being required in relation to the taxpayer's Australian business operations. The following passage (at 423) was said by the Commissioner to support the case for the existence of a dominant purpose on the part of each respondent of obtaining a tax benefit, having regard to the particular means adopted by the respondents to invest for the benefit of their respective retirements from legal practice:
'… The scheme was the particular means adopted by the taxpayers to obtain the maximum return on the money invested after payment of all applicable costs, including tax. The dominant purpose in the adoption of the particular scheme was the obtaining of a tax benefit… It is true that the taxpayers were concerned with obtaining what was regarded as adequate security for an investment made "off-shore". However, the circumstance that the Midland Letter of Credit afforded the necessary assurance to the taxpayers does not detract from the conclusion that, viewed objectively, it was the obtaining of the tax benefit which directed the taxpayers in taking steps they otherwise would not have taken by entering into the scheme.'
Thus the scheme adopted must be first identified and the dominant purpose for entering into it objectively ascertained. In our opinion the evidence before the primary judge could not be described as compelling a conclusion of dominant purpose as reached in Spotless.
94 As noted above the Commissioner asserted that the High Court in Spotless 'rejected the existence of a dichotomy between the presence of a dominant purpose of obtaining a tax benefit and the pursuit of a commercial gain', and moreover 'considered the question of purpose having regard to the particular means adopted by the taxpayers'. The first of those assertions was pitched too widely. The circumstances in Spotless were thatsubstantial funds were deposited offshore in the 'tax haven' of the Cook Islands for a short term at a rate of interest of about 4% below applicable bank bill rates available in Australia. The Cook Islands levied withholding tax upon interest income at only 5%. It was contended inter alia that the interest derived in the Cook Islands fell outside the scope of operation of Part IVA. However the taxpayer forewent a higher interest rate obtainable in Australia for the purpose of achieving a lower fiscal exposure in Australia.
95 The Commissioner sought to contend, upon the footing of Spotless, that the particular means adopted by the respondents in entering into AHP No 1 displayed a dominant purpose of obtaining the tax benefits, being a purpose said to be revealed by the following steps, overt acts or circumstances reflecting matters enumerated in s 177D(b) of the Tax Act:
(i) the fact that the partnerships drawings of each respondent from their legal practice had increased materially during the 1988 fiscal year, thus giving rise to a significantly increased tax liability. In the case of Mr Jamieson, in particular, he acknowledged that his investment in AHP No 1 was a 'drastic step' designed to deal with the income tax that would otherwise have to be payable in respect of professional earnings for that year;
(ii) each respondent obtained the advantage of deferring income tax on their increased professional income for five years; Mr Jamieson claimed deductions relevantly of $238,750, and as a result, his income tax savings for the year ending 30 June 1988 year was said to be $119,971.87; Mr Cooke claimed deductions relevantly of $429,750.00 for that year, and as a result he also made commensurately a substantial income tax saving; in cross-examination Mr Cooke said that his disposable income from his professional practice for the 1988 fiscal year increased from $150,000 to $330,000;
(That kind of fiscal result was described in Eastern Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27 at 47 (Carr J with whom Lee and Sundberg JJ agreed) as 'point[ing] towards a purpose of obtaining [a] tax benefit')
(iii) those income tax advantages in respect of the 1988 fiscal year were obtained by each of them for a minimal cash outlay; in the case of Mr Jamieson, the evidence was that his cost of participation in AHP No 1 for the 1988 year of income was $3,750; in the case of Mr Cooke, his corresponding outlay for the 1988 year of income was $6,750;
(iv) those income tax advantages were obtained by constructing a liability to pre-pay management fees at an inflated cost;
(v) the income tax advantages were prominently presented in the internal memorandum of Mr McKillop sent to the respondents, and also in the prospectus under the heading 'Taxation' which stated that investors could expect to receive a tax deduction for 95% of the amount subscribed; that prospectus statement was supported by the tax opinion from Mallesons Stephen Jaques included in the prospectus; and
(vi) putting to one side the available income tax benefits, the project was said to be un-tried, and carried significant risks of failure above and beyond the ordinary risks associated with a horticultural project; in that regard, Mr Flude admitted that the project exhibited a higher risk by reason of the new technology involving the use of growth bags; Mr Flude was said to have also admitted that the promoters were 'looking' at a scale of operations that had not been undertaken previously, and that so much involved an additional element or risk; he was also said to have conceded that there were problems in the two locations in which the flowers were to be grown, and that at Naroongonal Park in particular, there were problems in relation to water supply evident prior to the commencement of the project; the project was asserted, objectively speaking, to be not a suitable means of obtaining a 'regular cash flow during… retirement… that carried [no] significant risk of failure'.
96 The response of senior counsel for the respondents may be outlined as follows:
(i) in determining the dominant purpose of a person who entered into or carried out a scheme, the only matters to be taken into account were those set out in s 177D(b), and what the Commissioner did not do, or do adequately, was to demonstrate how the matters enumerated above fell within s 177D(b);
(ii) any such matters were then required to be weighed against the other commercial aspects of the scheme in order to determine the ruling, prevailing or most influential purpose of each respondent (Hart at 227-228); moreover the matters identified by the Commissioner could not be viewed in isolation, as the Commissioner had sought to do;
(iii) a number of the matters referred to in the Commissioner's submissions were not supported by the evidence; for instance, it was said on behalf of the respondents that there was no evidence that the management fees were inflated; moreover whilst the project was untried and untested, the primary judge found that the project was horticulturally and economically viable and was the subject of genuine commercial objectives;
(iv) whilst the respondents stood to receive a significant upfront deduction in respect of their outlays for management fees, their outlays were funded by loans bearing significant rates of interest;
(v) the respondents were not aware that the management fees were used or to be used by the Plantation Manager, in part, to 'fund' letters of credit to be provided by the Bank, and whilst they obtained the guaranteed return, secured by letters of credit, the obtaining of that guaranteed return was consistent with their concern for prudent protection of their respective substantial commitments;
(vi) the circumstance that each respondent borrowed funds, in order to fund the payment in advance of the management fees, did not establish the dominant purpose alleged by the Commissioner (being a borrowing to be repaid on which there was a substantial liability for interest);
(vii) the circumstance that the respondents limited their participation in the businesses the subject of contention reflected no more than a recognition that each was conducting his separate business undertaking and involvement through the Plantation Manager, at least for certain activities, and did not point to any dominant purpose of obtaining the tax benefits;
(viii) whilst the prospectus addressed (and highlighted) the income tax advantages of participation in the project, it also addressed (and highlighted) the commercial advantages thereof, including the potential income returns;
(ix) the fact that neither respondent personally signed the plantation agreement executed on their behalf by the Trustee was essentially a matter simply of convenience;
(x) whilst the commencement of the scheme took place towards the close of the 1988 fiscal year, so much was largely explicable by the fact that the prospectus was not registered until 16 May 1988, nor was there any certainty that it would be open to either respondent to participate in the project at a later time; and
(xi) on the basis of the prospectus, each respondent was reasonably entitled to expect that he would receive income from the project from 1989 onwards; notwithstanding that expectation, they did not receive income until 1993, that being confined to the guaranteed return.
97 Having given the matter some thought, we are of the opinion that neither the functions undertaken relevantly by the Plantation Manager, nor any of the contractual obligations to which it was privy, provide any additional assistance to resolution of the Part IVA issues purportedly arising. In the particular circumstances of this case, and on the facts found by her Honour, there is no reason to conclude that the dominant purpose of the Plantation Manager in carrying out a scheme so defined was to obtain tax benefits for the respondents.
98 The remaining submissions of the Commissioner summarised above also face the considerable obstacle of the findings made by the primary judge relevant to the issue of purpose, and, in particular by reference to the expert evidence accepted by her Honour.
99 The primary judge found that the project was a genuine commercial enterprise and was potentially viable, based on the matters represented and portrayed in the prospectus. As observed by her Honour, Mr Cooke found the report in the prospectus as to income potential to be so attractive that he subscribed for further units in November 1988.
100 We are satisfied that her Honour applied the correct principles to the facts as found by her in respect of the Part IVA issues and that no error on the part of her Honour has been demonstrated by the Commissioner in his submissions on those issues. The findings of fact of the primary judge that were relevant to Part IVA were findings that were open on the evidence placed before her Honour, permitting her Honour to reach the conclusion she did as to the absence of a dominant purpose of either respondent of obtaining an income tax benefit or benefits, within the scope of operation of Part IVA, by entering into or carrying out a scheme as described by the Commissioner.
101 The Commissioner's appeal must be dismissed with costs.
I certify that the preceding one hundred and one (101) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Court.
[16]
Counsel for the Applicant: G T Pagone QC and S H Steward
[17]
Solicitor for the Applicant: Australian Government Solicitor
[18]
Counsel for the Respondent: R F Edmonds SC and M Richmond
[19]
Solicitor for the Respondent: Allens Arthur Robinson
it had the potential to produce an attractive return for a person well advanced into retirement;
· it did not require his active involvement, as did his legal practice and the Bilpin orchard;
· the whole of the funds to be invested could be borrowed, he not having the necessary cash resources;
· he could reduce his exposure by electing to take the guaranteed minimum return on his investment; and
· he would be entitled to a tax deduction for the substantial management fees.
27 In his further testimony, Mr Jamieson said he believed the project had 'every chance of being successful', although he was aware that there were risks involved; moreover he was influenced by the fact that partners of his, including Mr Cooke, whose business acumen and caution he respected, were also planning to invest in AHP No 1. He also testified that he relied on reports contained in the prospectus and on the advice of Davey & Associates.
28 Under cross-examination, Mr Jamieson conceded that at the time he applied for units in the Trust, he had not read the plantation agreement, although he had seen references to it in the prospectus. The plantation agreement which he entered into was signed under the power of attorney Mr Jamieson granted to the directors of the Trustee at the time of making his application for units. He agreed that he was aware of the risks involved in any horticultural project and had a general understanding of the scheme. However the primary judge said it was clear that Mr Jamieson did not acquaint himself with the detail of the scheme documents. He stated that in placing his affairs in the hands of Davey & Associates, he thereby followed the practice he habitually adopted with other professional advisers, namely to follow the advice proffered, whilst continuing to give proper consideration to the proposal on hand, and trying to ensure that he did not get out of his depth, or allow himself to be burdened with too much worry.
29 Mr Jamieson agreed under cross-examination that in the latter part of the 1988 financial year, he became aware that his professional income from legal practice would be substantially higher for that financial year than it had been for previous financial years. On 29 June 1988, he wrote to his then accountant and advised him that he was transferring the management of his accounting and income tax affairs to Davey & Associates, stating therein:
'What I clearly need is an investment advisor and intense tax planning guidance. The financial year just ending has seen a substantial jump in our income and I had to take drastic steps about that over the last couple of weeks. I have approached Davey & Associates…to look after these planning matters for me in the future.'
Mr Jamieson admitted that his above reference to 'drastic steps' was to his investment in AHP No 1, but he rejected the propositions that it was of the utmost importance to him to obtain the tax deduction in the 1988 year which he sought in relation to his participation in AHP No 1, and that his investment in the project was made 'almost entirely' for tax reasons. He asserted that the tax issue was only one of a number of considerations referred to above.
The issues arising at first instance
30 From the foregoing summary the following issues arose and were addressed by the primary judge:
(i) whether the expenditures or outgoings incurred and losses sustained by the respondents by participating in AHP No 1 were so sustained and incurred in gaining or producing assessable income, within the first limb of s 51(1) of the Tax Act;
(ii) whether the expenditures incurred and losses sustained by the respondents were necessarily incurred in carrying on a business of flower production for the purpose of gaining or producing such income, within the second limb of s 51(1) of the Tax Act;
(iii) whether any such otherwise deductible outgoings or losses should be disallowed, pursuant to the operation of s 82KJ of the Tax Act; and
(iv) whether any such otherwise deductible outgoings or losses should be disallowed, pursuant to the operation of Part IVA of the Tax Act.
It appears that of the expenses or outgoings claimed by the respondents, the Commissioner now concedes the deductibility of the licence fees. Moreover as matters transpired in the course of the litigation, the impression to be gained was that deductibility in respect of the guaranteed return fee was not strenuously disputed.
Section 51(1) of the Tax Act at all material times provided 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 producing of exempt income.'
Section 82KJ of the Tax Act provided at all material times as follows:
'Where -
(a) a loss or outgoing in respect of which a deduction would, but for this Subdivision, be allowable, was incurred by a taxpayer after 19 April 1978 by reason of, as a result of or as part of a tax avoidance agreement;
(b) having regard to the benefit in respect of which the loss or outgoing was incurred (but without regard to any benefit relating to the acquisition or possible acquisition of the property referred to in paragraph (c)), the amount of the loss or outgoing was greater than the amount (if any) that might reasonably be expected to have been incurred, at the time when the loss or outgoing was incurred, in respect of that benefit if the loss or outgoing had not been incurred by reason of, as a result of or as part of a tax avoidance agreement;
(c) property has been, will be, or may reasonably be expected to be, acquired by the taxpayer or by an associate of the taxpayer as a result of, by reason of, or as part of the tax avoidance agreement; and
(d) the consideration (if any) that was payable in respect of the acquisition of that property was less, or the consideration that may reasonably be expected to be payable in respect of the acquisition of that property is less, than the consideration that might reasonably be expected to have been payable, or to be payable, as the case may be, in respect of the acquisition of that property if the loss or outgoing had not been incurred,
notwithstanding any other provision of this Act, a deduction is not allowable to the taxpayer in respect of the loss or outgoing.'
Section 82KH(1) of the Tax Act defined at all material times a 'tax avoidance agreement' as follows:
'an agreement that was entered into or carried out for the purpose, or for purposes that included the purpose, of securing that a person who, if the agreement had not been entered into or carried out, would have been liable to pay income tax in respect of a year of income would not be liable to pay income tax in respect of that year of income or would be liable to pay less income tax in respect of that year of income than that person would have been liable to pay if the agreement had not been entered into or carried out.'
The primary judge's resolution of the s 51(1) issues
31 The primary judge referred at the outset to the circumstance that although the only assessable income actually derived by the respondents from AHP No 1 was the so-called guaranteed return of $10,000 per plantation in respect of the fiscal year ending 30 June 1993, it is well established by authority that an expenditure may meet the requirements of s 51(1) of the Tax Act, even though no assessable income is produced in a relevant tax year. Authority for that proposition appears in Fletcher v Commissioner of Taxation (1991) 173 CLR 1 at 16-17 and Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 at 468. The primary judge also acknowledged the principles that a taxpayer's motive may be a relevant factor in characterising a voluntary outgoing under s 51(1), and that the relationship between expenditure and the production of income must be genuine and not colourable.
32 The Commissioner submitted to the primary judge that the expenditures of the respondents had only a colourable connection to the production of income from AHP No 1, and that the advantage which they both sought to achieve by the payments in question, once viewed objectively, was an immediately operative tax advantage, and not the potential for future assessable income. In support of that submission, the Commissioner contended below that the project was not, never was, and was never going to be horticulturally or economically viable, and that each respondent had adopted a somewhat careless attitude to the contractual arrangements into which he was required to enter, their purpose in so doing being substantially tax driven. The primary judge referred however to the existence of the income projections, albeit based on assumptions contained in the prospectus, and pointed out that a Grower who elected to take up the guaranteed return option, thereby giving up portion of a potentially larger return, would still have made a substantial profit on his or her investment, based on that election. The primary judge adopted, in that context, the observations of a Full Federal Court in Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157 at 162 (Wilcox, Burchett and Ryan JJ) that 'the characterisation of a payment does not depend on its effectiveness, either economically (in the sense that it really earned a profit), or legally (in the sense that its contractual setting was valid in law)', being views similar to those earlier expressed in Commissioner of Taxation v Lau (1984) 6 FCR 202 by Beaumont J at 219 (with whom Jenkinson J agreed).
33 The primary judge found, as in the case for instance of Emmakell and Lau, that the subject investments were made by the respondents at arms-length, and were based on genuine commercial considerations, after taking into account the material contained in the prospectus, and the advice of persons whom they trusted and were entitled to trust. The primary judge accepted the implication of the evidence that neither respondent gave the AHP No 1 documentation the close attention he would have given if acting on behalf of a client, but that circumstance did not indicate any lack of bona fides on his part, or that his motive differed from that asserted in the course of his evidence. Moreover her Honour found that the respective expert testimonies of Messrs Hunter and Weeks, and also of Dr Martin, albeit focusing on different aspects of the case, each supported the viability of the project, and further that Dr Martin's report in particular was detailed and convincing, and was to be preferred to that provided by Mr Geurtsen. Those findings were open to her Honour, and were not challenged in the appeals. Moreover earlier trends of judicial authority have implicitly, if not explicitly, demonstrated that the payment of tax deductible expenditure in advance, even for a lengthy period of time, is not necessarily beyond the scope of s 51(1) of the Tax Act, subject of course to certain subsequent legislative reforms not here relevant. Whether the primary judge may have modified those findings, had the Commissioner been able to adduce the whole of the evidence the subject of the joint report only partly written by Mr Geurtsen, can only be a matter for speculation.
34 The primary judge accepted as truthful the evidence of the respondents to the effect that although income tax deductibility was an important issue for them, that was not their only concern, or even their dominant interest, in participating in AHP No 1. The evidence of neither of them on those matters, in her Honour's view, was shaken in the course of cross-examination. Each impressed her as giving a truthful and straightforward account of the circumstances leading up to his investment in AHP No 1, and of his motive for undertaking the investment. The primary judge recorded her acceptance also of the evidence of each of the respondents that 'in a busy life as a solicitor they had made insufficient provision for their retirement'. She thought it was 'entirely feasible', at their stage in life, that they would be looking for the provision of 'some form of post-retirement income', and moreover, that '[c]learly an investment that had a tax advantage would be more attractive'. She further considered that given the income increase experienced by each respondent in respect of the then current fiscal year, each being without sufficient liquid resources to fund either the prospective income tax liability or investment in AHP No 1, borrowing money for an investment that provided immediate tax relief may have been 'the only possible means of making such an investment'. In so finding, the primary judge distinguished the contrived circumstances in Ure v Federal Commissioner of Taxation (1981) 50 FLR 219, which concerned the borrowing by a taxpayer of money at commercial rates of interest of up to 12.5% interest, and the on-lending at non-arms length of the proceeds of that borrowing at 1% interest, the rationale thereof being described by Deane and Sheppard JJ at 233 as the subordination of the object of earning assessable income in the form of interest to private and domestic considerations. Conversely, the primary judge thought that the transactions here involved 'did make sense', to adopt the well known expression used by the High Court in Commissioner of Taxation of the Commonwealth of Australia v Spotless Services Limited (1996) 186 CLR 404 at 422, without the income tax deductibility incentive.
35 The Commissioner challenged the genuine commercial nature and purposes of AHP No 1 on the basis that the guaranteed return was in truth funded by the sizable management fees paid by Growers. The respondents countered by referring to the dictum of Beaumont J in Lau at 218 as follows:
'Once it is concluded that the moneys were outlaid by the taxpayer for a real or genuine commercial purpose, any inquiry as to the manner in which those funds were subsequently applied by their recipients is immaterial for the purposes of s 51. The reason is that, where as here, the parties are at arms length, the use made of the funds by the other parties to the transactions is not capable of throwing any light upon the purpose for which the taxpayer incurred the outgoings.'
The primary judge accepted that contention and found the outgoings of the respondents to be deductible under the first limb of s 51(1). Her Honour commented that the failure of AHP No 1 to yield income above the guaranteed return received in September 1993 in respect of the year ending 30 June 1993 did not detract from the genuine commercial objectives of the project, but merely reflected the failure of the project to perform according to the estimates of the promoters of the scheme.
36 With regard to the second limb of s 51(1), her Honour noted that it was not in contention that a taxpayer could carry on a business through an agent, and the outgoings of that business qualify for deductibility under the second limb Her Honour referred to long standing authority to that effect, including Emmakell and Lau, and more recently Merchant v Federal Commissioner of Taxation (1999) 99 ATC 4221. The Commissioner submitted however that the Plantation Manager was not the agent of the respondents for the purpose of conducting the business activities of AHP No 1. The Commissioner contended that the financial arrangements of AHP No 1 showed that the Plantation Manager was an independent contractor. The Commissioner relied on the following provisions of the plantation agreement:
· the Plantation Manager had the authorities, directions and powers of an independent contractor (clause 5.3);
· the Plantation Manager entered into all contracts with third parties as principal and not as an agent (clause 5.4);
· the Plantation Manager's duties could be delegated (clause 6.1);
· flowers were to be pooled and proceeds divided between Growers without reference to any particular grower's production or the quality of that Grower's flowers (clause 7.1);
· the Plantation Manager was to be paid an initial management fee of $9,455 per plantation as well as a productivity fee (clause 8.1);
· the Plantation Manager was to be reimbursed for all costs after 30 June 1989 (clause 8.2); and
· the Plantation Manager had full and unqualified powers to manage the plantations (clause 16.1).
The Commissioner submitted that in the light of those contractual powers and authorities, and the fact that once the guaranteed return option was taken up, the Grower had no further expenses to meet until the guaranteed return eventuated, the only available conclusion to be drawn was that the Plantation Manager was carrying on the plantation activities on its own behalf, and not on behalf of the Growers, they being merely passive investors who were not carrying on business. It was further submitted by the Commissioner that the powers of the Plantation Manager were such that a Grower had no control over his or her investment, and could not interfere with the running of AHP No 1.
37 The primary judge held that given that she had found that AHP No 1 was established as a commercial enterprise, and that at the time the respondents subscribed for their units, it was reasonable for them to believe that they were engaging in a viable project, the Commissioner's submissions should not be accepted and it should be concluded that each respondent had commenced a business of flower production pursuant to AHP No 1. The primary judge considered that the circumstances of AHP No 1 were distinguishable from those in Clowes v Federal Commissioner of Taxation (1954) 91 CLR 209, where at 218, Dixon CJ described the object of the taxpayer's outlay of funds as '…nothing but a casual investment of capital in hope of enlargement at the end of many years', and as '…not done in the course of the taxpayer's business'. The primary judge's reasoning was that although clause 18.1 of the plantation agreement expressly disclaimed the existence of any partnership or joint venture between the individual Growers, the arrangement for the pooling of the flowers had 'some of the characteristics of a joint venture, and the extensive powers given to the Plantation Manger are a reflection of a tighter structure that is required for a joint endeavour to be successful'. At best, the primary judge said the issues were 'equivocal on the point sought to be made' by the Commissioner and adopted the observations of Beaumont J in Lau at 218 :
'The more likely explanation is that the taxpayer, not unnaturally, preferred to rely upon the business judgment and expertise of [the project managers] rather than to impose legal constraints upon the conduct of their business activities. For the taxpayer to insist upon rigid legal formalities for the operation of the project may well have been commercially counterproductive in the long run.'
38 In addition the primary judge had regard to the following aspects of the plantation agreements in concluding that each respondent had commenced the carrying on of a business:
(i) investors in AHP No 1 acquired ownership of their respective plantations;
(ii) each plantation agreement was expressed to be, inter alia, for the provision of management services 'to the Grower in respect of the Grower's plantations';
(iii) the Plantation Manager's powers were exercisable subject to the terms of the plantation agreements (clause 5.3);
(iv) the Plantation Manager was to be remunerated for those of its management services (clause 8) which were subject to instructions from the Trustee, who was also the 'Grower's representative' (clause 5);
(v) the Trustee was to have a significant role to play in the project, for example being involved in any final determination of a cost as a project cost (clause 16.3); and
(vii) those and other provisions provided for the Growers a continuing involvement in the project, albeit not personally being responsible for cultivation of the flowers (to which may be added the harvesting and sale of the flowers).
Thus the primary judge concluded that each Grower was not merely a passive investor, but was relevantly and sufficiently involved in carrying on the business of growing flowers. In support of the foregoing conclusion, the primary judge referred to well known authorities concerning the operation of the second limb of s 51(1) of the Tax Act and, in particular, the expression therein 'necessarily incurred' in relation to carrying on a business. For instance, the expression has been paraphrased as no more than 'clearly appropriate or adapted for' the carrying on of the relevant business (Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56-57). The primary judge found that while the subscriptions by the respondents to AHP No 1 may have been made at a time prior to commencement of their respective business undertakings, payment of the outgoings to the Plantation Manager actually occurred in the course thereof, even if the payments were the first, or among the first, steps taken in the operation of those businesses, her Honour citing the well-known observation of Barwick CJ in Fairway Estates Pty Ltd v Commissioner of Taxation (1970) 123 CLR 153 at 165 made in the context of the initial transaction in a business of the lending of money. That notion has been since adopted and applied in many authoritative decisions of this Court.
39 The primary judge then addressed the Commissioner's concluding submission upon the s 51(1) issues to the effect that the outgoings of the respondents were in any event not deductible, because they were of a capital nature and thereby excepted under s 51(1). Citing the well-known dictum of Dixon J in Sun Newspapers Limited and Associated Newspapers Limited v Federal Commissioner of Taxation (1938) 61 CLR 337 at 363, and his Honour's subsequent restatement thereof in Hallstroms Pty Limited v Commissioner of Taxation (1946) 72 CLR 634 at 648, as to the test for distinguishing between expenditure on capital account and expenditure on revenue account, her Honour acknowledged that any juridical language of classification adopted by the parties in the formation of their contractual arrangements was not to be characterised as irrelevant, nor however was it necessarily in point. The primary judge also referred to the later observations of Gibbs ACJ in Commissioner of Taxation v South Australian Battery Makers Proprietary Limited (1978) 140 CLR 645 at 660 that the parties to a transaction may legitimately arrange their affairs '… so that payments, which if made by different persons and under different circumstances, might in part have been of a capital nature, were, when made by the taxpayer, truly of a revenue character'.
40 The primary judge also rejected the Commissioner's submission that the expenditures of the respondents were to be characterised as a means of acquiring an asset which provided a future income stream, or at the very least, that the expenditures were partly on capital account, being merely the means of securing the establishment of the plantations. Part of the substance of the plantation agreement, in her Honour's view, was the Plantation Manager's obligation to provide ongoing services that were quite distinct from the establishment of the plantations, which took place of course by way of planting seedlings into the growth bags. The primary judge recorded furthermore that no contention going to sham arrangements had been made, and the fact that the management expenses were paid in advance at the commencement of the project, yet in respect of ongoing services, did not support a conclusion that those expenses should be characterised as capital. In that context, the primary judge again referred to the circumstances involved in Lau, Emmakell and Merchant, and also in Federal Commissioner of Taxation v Brand (1995) 95 ATC 4633, and in particular the fact that in Lau, the management services were to be rendered over a period of 21 years, being six years longer than in the present case. Her Honour distinguished, moreover, the circumstances in Commissioner of Taxation v Osborne (1990) 26 FCR 63 at 71, where Pincus J, with whom Spender and French JJ agreed, held that expenses incurred by a scheme investor in establishing a plantation of trees were of a capital nature 'at least up to the stage of getting seedlings established in the ground', her Honour emphasising that neither of the present taxpayers had sought tax deductibility for the cost of $250 involved in acquiring each of their respective plantations containing 192 seedlings. The conclusion, therefore, of the primary judge was that the management fees were attributable to the costs of the management services which the Plantation Manager was obliged to provide under clause 5 of the plantation agreement. Her Honour therefore rejected the proposition that outgoings for management fees incurred by the respondents were affairs of capital.
The Commissioner's contentions on appeal relating to the s 51(1) issues
41 The focus or emphasis of the Commissioner's submissions on appeal was upon the pre-paid management fees, being by far the largest of the three items of pre-payment. The major issue said to arise was paraphrased by the Commissioner, in summary, as whether or not those fees in reality, or in truth, or in substance, were outlaid by the respondents for the purposes prima facie defined by the terms of the prospectus.
42 In so framing that issue, the Commissioner invoked the tests adopted by Fullagar J, with whom Kitto and Taylor JJ agreed, in Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428, which concerned an agreement whereby landholders transferred to a life assurance company certain property, in consideration of the promise by the transferee to pay, for a period of fifty years, an amount equal to 90% of all rent, as and when received, from lessees of shops and a basement in a new building to be erected on the land so transferred. Fullagar J, (at 454) said as follows:
'…it is incontestable here that the moneys are paid in order to acquire a capital asset. The documents make it quite clear that those payments constitute the price discussed and payable on a purchase of land, and that appears to me to be the end of the matter. It does not matter how they are calculated, or how they are payable, or when they are payable, or whether they may for a period cease to be payable. If they are paid as parts of the purchase price of an asset forming part of the fixed capital of the company, they are outgoings of capital or of a capital nature. It does not indeed seem to me to be possible to say that they are incurred in the relevant sense in gaining or producing assessable income or in carrying on a business - any more than payment of a lump sum would have been so incurred if the purchase price had been a lump sum payable on transfer. The questions which commonly arise in this type of case are (1) what is the money really paid for? - and (2) Is what is really paid for, in truth and in substance, a capital asset?'
43 The Commissioner also referred to the oft cited description of the test framed by Dixon J in Hallstroms (at 648) namely:
'What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.'
In that case a trade competitor of the taxpayer had petitioned for an extension of the terms of certain letters patent. If the extension had been granted, heavy losses would have been caused to the taxpayer in the conduct of its business, by reason of its trade commitments, and expenditure on the reorganisation of its plant in anticipation of the expiry of the letters patent of its competitor. The taxpayer successfully opposed the extension of the patent. The deductibility of the legal costs incurred in so doing was upheld on the ground that the expenditure was directed to avoidance of revenue losses rather than to a capital expense incurred in avoiding renewal of a competitor's intellectual property.
44 The thrust of the Commissioner's case in the appeal was that the process of characterisation was not to be limited to a juristic analysis of what was bargained for within the framework of the standard form of plantation agreement, and clause 5 thereof in particular, relating to the management and marketing services to be undertaken by the Plantation Manager, involving the growing and harvesting of the plantations, the pooling of the flowers and the disposal thereof. It was contended by the Commissioner that from 'a practical and business point of view', 'at least part' of the funds paid by the Growersas pre-paid management fees was applied by the Plantation Manager in relation to activities other than those stipulated by clause 5, being activities of a capital nature, and that as a consequence, '… the instruments were not genuine'. The expression 'not genuine' was not a contention that the document was a sham. Counsel for the Commissioner placed considerable weight on the submission that in deciding what an outgoing is 'really paid for', for the purposes of s 51(1), the Court must examine all relevant facts and circumstances, and that such examination should include the manner in which the recipient of the outlay applied the funds, in order to identify the advantages obtained or secured by the payer from the expense or outgoing from 'a practical and business point of view'.
45 The Commissioner sought to identify what he contended to have been expenditure on matters of a capital nature by reference inter alia to the following finding of the primary judge:
'Although it does not appear from the prospectus, it seems that the Guaranteed Return was to be funded from the management fees paid by investors under the Plantation Agreement. The effect of this was to limit, to an extent not disclosed in the prospectus, the amount of funds available for cultivation of flowers under AHP No 1.'
It will be recalled that the guaranteed return of $10,000 was to be paid at the end of the year of operations ending 30 June 1993, in respect of each plantation acquired by a Grower who had elected to take up that option. The Commissioner submitted that 'at least part of the money' paid by a Grower was outlaid to fund a deposit to secure a letter of credit, but the Commissioner was unable to quantify, whether precisely or by way of estimate, what the cost was of securing the letter of credit.
46 It is appropriate to set out that part of the Commissioner's written submissions -
(a) '… The letters of credit were obtained by [the Plantation Manager] and its parent [Growth Industries] pursuant to an agreement entered into with the [Bank]. The project contemplated that the guaranteed return would be a charge over deposits lodged by [the Plantation Manager] with State Nominees Ltd, and that these deposits would have a grossed up value which would equal the value of the letters of credit at maturity. The total amount of funds borrowed by [Growers] in [APH No 1] was $33,140,000 and the project proposed the making of deposits with the Bank in the sum of $17,676,932 (presumably to secure a guaranteed return of $33,140,000 (sic) by 1 September 1993). The sums raised by the guaranteed return fees payable by participants, together with [the Plantation Manager's] own resources, could not have funded these deposits. The total number of units issued by [AHP No 1] the subject of the guaranteed return was 3308 which would have raised guaranteed return fees of only $165,400. Further, the prospectus disclosed that [the Plantation Manager] in May 1988 had issued capital of $50,000 represented by cash;
(b) in addition there was evidence that the pre-paid management fees were used in part to recoup the [Plantation Manager's] cost of establishing [AHP No 1]. Mr Weeks, who was called by the respondents gave his opinion of the reasonableness of the management fee on behalf of each respondent. He reviewed the Investigating Accountant's Report and the Business Consultant's Report, as prepared by Mr Wehby of Messrs Coopers & Lybrand, which were included in the prospectus. Based upon his review of the working papers of Mr Wehby, he concluded the [Plantation Manager] was seeking 'to recoup the costs of establishment of AHP No 1,' including underwriting, legal and over-head. He estimated that the management fee recouped estimated set-up costs of $7,046,370 and prospectus costs of $2,888,000 (sic). Mr Weeks concluded that the estimated cost per plantation (assuming 2,500 units) was $7,059.00 of which $2,819.00 related to set-up costs and $1,152,00 related to prospectus costs'.
47 Upon the basis of those statistics and calculations, it was submitted by the Commissioner that the advantage of management services in respect of particular plantations, obtained by the respondents, 'was of minor significance in the context of the nature and extent of the rights and obligations created by the project', having regard to the facts that:
(i) each participant was only able to acquire what was described by the Commissioner as a heavily qualified, temporary and reduced right of ownership in the plantations; reference was made in that context to the prohibitions contained in the plantation agreement against assignment etc by Growers without the consent of the Plantation Manager, and upon the pooling of the flowers of the respondents with those of other participants prior to sale, the title thereto having passed to the Plantation Manager; the Commissioner also emphasised that Mid-West, the lender to Growers, was the assignee of their ownership rights by way of security for the total funding of the full cost of their acquisition of their units in the Trust;
(ii) there was no entitlement of a Grower to the proceeds of sale of the flowers physically produced from his or her plantations, but merely a right to share in the overall profits from the sale of flowers produced by all of the plantations generally; and
(iii) there was no entitlement of any Grower to inspect the flowers the subject of his or her plantations, nor to give instructions to the Plantation Manager or the Trustee.
48 It was submitted by the Commissioner that virtually uncontrolled discretions and powers were given to the Plantation Manager, subject to the responsibility of the Trustee for monitoring the performance of the Plantation Manager, and that the Plantation Manager therefore was given the authority, discretions and powers of an independent contractor and principal in providing those services, and not those merely of an agent, being authority, discretions and powers for instance as to the harvesting and sale of the flowers. On true analysis therefore, so the submission continued, no relationship of agency on the part of the Plantation Manager or the Trustee was brought into existence in favour of the Growers. The respondents were of course entitled to receive a guaranteed return to assist them to fund the repayment of their respective loans from Mid-West in respect of the 1993 year of operations, and in the meantime to be at least shielded from losses arising out of their participation as Growers. In respect of that submission it may be observed that an investor could deposit with a stockbroker a sizeable sum of money to invest in listed stocks and shares by way of buying and selling regularly at the stockbroker's uncontrolled discretion for an indefinite period of time, the stockbroker's only explicit obligation being to notify each transaction to that person and in such a circumstance no doubt it would be contended that any profits emerging were taxable as income of a business conducted by the investor.
49 It was further contended by the Commissioner that from a practical business point of view, the ownership of plantations by the respondents, and the provision of management services in respect of those plantations, was insignificant to the means by which each of them obtained his entitlement to any net profits from the project, including their guaranteed return of profits, in that each of them was a merely passive investor, who subscribed for units in the Trust in order to secure a financial return from the planting, growing, harvesting and marketing activities of the Plantation Manager. Moreover the pre-paid management fees were said by the Commissioner to have been outlaid by each respondent in reality for the right merely to receive a proportion of the net proceeds of sale of all of the plantations, without regard to the quantum derived by the Plantation Manager or the Trustee from the sale of what had been, before pooling, each individual participant's flowers, together with the right to obtain the guaranteed return. It should be observed at the outset that the foregoing contention in respect of the pooling of a product does not demonstrate a decisive circumstance adverse to the claims of the respondents. For example, a number of growers of olives may agree to aggregate their product for delivery to a crushing mill for the production of olive oil and for sale of that oil to a wholesaler. In that example there would be no relationship between the amount of oil produced by the olives supplied by a grower and the share received by that grower of the proceeds of sale of the oil produced from the pooled the pooled olives but, obviously, all growers would have continued to conduct separate businesses.
50 It was further submitted by the Commissioner that the funds subscribed by each respondent were outlaid once and for all to secure enduring rights, which were the means by which they participated in the Plantation Manager's 'covenanted activities', and that the creation of a temporary and limited interest in the flowers in the period before sale could not convert what was in substance a passive investment, involving a defined share of a distribution of the net proceeds of sale of the flowers, into an active business of growing flowers for sale. It is of course a well established principle that a person may conduct, or share in the conduct of, a business through an agent or agents or contractors, so that passivity alone is not necessarily a decisive test. Otherwise a 'silent partner' might be said not to be a person carrying on a business in partnership. Nevertheless the authority of the unanimous decision of the High Court in Milne v The Commissioner of Taxation of the Commonwealth of Australia (1975-1976)133 CLR 526, which adopted a similar approach to that earlier taken by the High Court in Clowes, was said by the Commissioner to be 'relevantly indistinguishable' in relation to the circumstances of the present case. In Milne, so the Commissioner asserted, each Grower obtained a proprietary interest in plantations generally, and each enjoyed a right to share in the proceeds of sale of those plantations, and obtained the undertaking of a third party to manage the plantations. Moreover each Grower was said by the Commissioner to have obtained a promise from a third party to tender or manage his or her plantations, and each was protected by a Grower's representative.
51 The Commissioner sought to distinguish the circumstances underpinning the reasons for the decisions of this Court in Lau, Emmakell, Brand and Merchant from those here involved, for the following reasons:
(i) in Lau, as appeared from the contractual arrangements, each grower/taxpayer was entitled to the proceeds of sale of the trees managed on his or her behalf, and was at liberty to appoint his or her own harvester and/or seller of the trees, and moreover the plantation manager's role under the management agreement with each grower there involved did not relate to management in its own right, but to management on behalf of the participant, and each grower had the right to terminate the manager's services at any time; in the present case, so the Commissioner continued, neither respondent had the contractual right to terminate the services of the Plantation Manager, had no right to the proceeds of sale from the flowers physically contributed from his plantations to the Plantation Manager, had no contractual right to sell the flowers produced by their respective plantations by their own means or resources or at all, and had no contractual right to terminate the services of the Plantation Manager otherwise than on the grounds of its default or liquidation etc;
(ii) in Emmakell, the manager (as distinct of course from the participants) had no contractual interest in the harvested crop, except to the extent of a lien for its unpaid fees;
(iii) in Brand, the participants retained the contractual right at all times to harvest and market their prawns, and had the right to enter the property where the prawning activities were being conducted for the purpose of supervising, inspecting and directing the manager, provided that they did not purport to direct the manager to undertake work which was not a best practice of the prawn industry (of course, the extent to which that right would have been exercised in practice was another matter); and
(iv) in Merchant, the manager was found to have acted on behalf of the taxpayer and did not manage the relevant activities in its own right, and had no special contractual rights in relation to the sale of the timber; moreover the manager's services could be contractually terminated at any time; in the present case, the Commissioner submitted there was a significant contrast, in that the Plantation Manager was to carry on the business activities of growing, harvesting and selling on its own account, and was deemed to own the flowers at the time of sale thereof, though it was obliged to make distributions of the net proceeds of sale to the participants, albeit on a shared basis without regard to the production actually achieved by each participant's plantation(s), and the management services of the Plantation Manager could not be terminated in the absence of default or a relevant insolvency event.
52 Additionally in Lau, so it was emphasised by the Commissioner, Beaumont J distinguished Clowes and Milne upon the basis that in Lau, there was an arrangement whereby the taxpayer was granted by way of lease a specific area of land and an identifiable interest in specific trees within that area, and the manager, who was contractually required to act on behalf of each taxpayer, did not own the land and had no right to enter that land, and there was a right conferred upon the taxpayer to terminate the manager's services. In the present case, the Commissioner's submission continued, the Plantation Manager managed the plantations as a whole and made distributions from the sale of all of the flowers to the Growers in accordance with their agreed shares, that is to say, their respective numbers of plantations or units, and participants had no interest in any identifiable area of land, and were said to have only a temporary and limited interest in flowers, with no right to the proceeds of sale of the flowers that physically emanated from their own plantations, and moreover they could not terminate the Plantation Manager's appointment, except in limited circumstances.
53 It was then submitted by the Commissioner that the guaranteed return fee was on capital account. That payment was said to have been made once and for all to secure a promise to make a larger payment in five years, being a payment which 'could not be described as a working expense' because 'it secured an asset of an enduring nature'.
Our conclusions upon the s 51 (1) issues
54 It may be inferred by way of threshold observation that without the prospect of income tax deductibility in respect of the prepaid management fees, subscription of funds by the public to this horticultural scheme may have been unlikely. But that observation does not resolve the issues raised in the appeal. The prospect of achieving fundraising objectives was present partly by reason of judicial precedent established in relation to commodity type projects involving income tax deductible expenditure, a feature whereof was prepayment of management or service fees to the promoters. It may be speculated that the impact of the now superseded provisional tax structure of the Tax Act upon rising incomes contributed indirectly to the proliferation of such schemes. The evidence available from reported authorities indicates that many of such schemes ultimately failed financially because the business operations sought to be established were not well conceived. The present is one such example. Perhaps a member of the public to whom the prospectus was addressed was entitled to expect that flaws in the prospectus proposal, such as insufficient working capital to be made available for the project, would have been addressed by the authorities charged with supervising the issue of such documents and with protecting the interests of investors. That factor is not per se however a ground for denial of income tax deductibility, though it is not an immaterial factor. It is apparent from the findings of the primary judge in relation to the expert evidence that serious errors of judgment on the part of the experts and their advisers occurred, but that does not determine that the claims of the respondents for deductions under s 51(1) has to be denied.
55 The principal focus of the Commissioner's case on the appeal has been directed of course to the pre-paid management fees, and the apparent use of a major part thereof to pay and/or secure the guaranteed income return for the financial year ended 30 June 1993. Although the findings of the primary judge show that the funding of the guaranteed return was the subject of attention at first instance, it does not appear, from the reasons of the primary judge, that it received the emphasis given to it in the Commissioner's submissions on the appeal. The principal areas of the Commissioner's attack at first instance, at least from an evidentiary aspect, related to the horticultural issues and the prospect of income derivation under AHP No 1. That attack was not pursued on the appeal with the same vigour, largely by reason of the findings of fact made by the primary judge.
56 The obstacle to the Commissioner's principal submission lies in the principles concerning the operation of s 51(1) of the Tax Act, which appeared in Lau and were restated by the High Court in G.P. International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1989-1990) 170 CLR 124, in the joint judgment of Brennan, Dawson, Toohey, Gaudron and McHugh JJ, as follows (at 137-138):
'The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid…
Although the amount received as establishment costs was expended by, and was intended by [an electricity authority] to be expended by the taxpayer to meet the costs of constructing the plant so far as that amount would extend, and although the amount expended on the construction of the plant was a capital expenditure, it does not follow that the taxpayer's receipt of the establishment costs was a receipt of capital. To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.'
From our reading of the reasons for judgment below, the primary judge sought to apply those principles. In our opinion, the Commissioner has not shown that her Honour erred in so doing or in her characterisation of the management fee. Senior counsel for the respondents correctly submitted that the written submissions of the Commissioner, recited earlier, were irrelevant to the characterisation in law of the expenditures incurred by the respondents, in particular the management fees.
57 The prospectus disclosed that the anticipated cost of establishing the project for submission to the public for subscription was $2,880,000. It was stated that these expenses had been paid, or were payable, by the Plantation Manager. As noted in the evidence of Mr Weeks, it appeared to be the intention of Growth Industries that the Plantation Manager recoup the whole of those expenses ('the prospectus costs') from the management fees to be paid by the Growers. Of the 3,314 plantations acquired, 3,308 were subject to an election to take up the guaranteed return option. The amount of prospectus costs that could be said to be paid or recouped from each management fee paid, therefore, could be estimated, according to the method set out in the evidence of Mr Weeks, to be approximately $869 per plantation.
58 It may be said that in the hands of the Plantation Manager part of the management fee received was 'ear-marked' for the discharge or recoupment of the capital expense. But that had no bearing on the character of the payment described as a management fee as made to the Plantation Manager by a Grower. As far as the Growers were concerned it was for the Plantation Manager to determine how the profit it made from the remuneration received for its services was distributed.
59 The Commissioner did not submit that so much of the outgoing for management fees as was applied by the Plantation Manager to discharge or recoupment of prospectus costs was apportionable as a capital expense paid by the respondents. The submission was that the whole of the management fee, as paid by the respondents, was in the nature of a capital expense paid by persons who were not carrying on business, with a view of obtaining a right to receive a distribution from the net proceeds of sale of pooled flowers in a business carried on by the Plantation Manager. Having determined that her Honour held correctly that the payments were outgoings of each respondent in the course of carrying on a business the submission of the Commissioner falls away, although it rises again in another form in respect of the application s 82 KJ of the Tax Act.
60 In addition, the evidence of Mr Weeks stated that part of the management fee could be attributed to 'set-up' costs which, if allocated to the 3,314 plantations, would be approximately $2,126 per plantation. The 'set-up' costs so described seemed to include not only the cost of growing material and growth bags, and of establishing the plantation by planting the seedlings in growth bags with growing material, but also outgoings relevant to the management of the plantation thereafter. There was no submission by the Commissioner that the outgoings by way of management fees were apportionable under s 51(1) in respect of 'set-up' costs, or any part thereof, and, as noted earlier, the argument on appeal was limited to the characterisation of the outgoing as an entire sum.
61 In support of the argument that the management fee was an affair of capital, the Commissioner referred to the finding by her Honour that part of the management fee paid to the Plantation Manager was to be deposited by the Plantation Manager with the Bank to secure letters of credit to satisfy the undertaking of the Plantation Manager to provide a guaranteed return to each Grower who had elected to take up that option. On the evidence provided, the amount deposited to obtain letters of credit was, as noted in the Commissioner's submissions, $17,673,932. After having regard to the guaranteed return fees paid by the Growers who elected to take up that option, namely the guaranteed return, approximately $165,400, the amount that could be nominally allocated in that regard to a management fee paid for a plantation entitled to a guaranteed return was approximately $5,290. The Commissioner submitted that the magnitude of the sum required to be placed on deposit to obtain the letters of credit, together with the application by the Plantation Manager of part of the management fee to the discharge or recoupment of the prospectus costs, and 'set-up' costs, revealed that 'in truth and in substance' the management fee was 'really paid for a capital asset'. Again, there was no submission that the management was apportionable by reason of the foregoing matters. The difficulty with the submissions of the Commissioner is that there was no evidence as to what movement of funds actually occurred, when and in what sequence. It is one matter to project from a prospectus various hypotheses as to future movements of cash, and as to when those movements might occur. It is another matter to be presented with the actual movements of funds that occurred and the events which happened. For example, the subscription of funds through a project anticipated to produce revenue would not, in principle, be characterised for income tax purposes by the circumstance that the cost of fundraising was in effect recouped in cash forthwith out of the proceeds of the fundraising.
62 If it were assumed that the Plantation Manager intended to apply, and did use part of the management fees received from Growers, for Bank deposits to back letters of credit, that could suggest that the management fee paid by a Grower was inflated beyond a reasonable cost for the services to be provided by the Plantation Manager, or it may suggest that the Plantation Manager had made, or may have to make, other arrangements to discharge the cost of the duties it had undertaken to perform under the plantation agreement within the period ending 30 June 1989. Neither circumstance would alter the character of the payment made by a Grower.
63 We are unable to discern any error in her Honour's findings and conclusions upon the operation of the first limb of s 51(1) of the Tax Act. As the primary judge rightly pointed out, there is compelling authority for the proposition that expenditure may meet those requirements, even though no assessable income is thereby derived by the taxpayer in the fiscal year of outlay or thereafter; nor does a correct characterisation of the expenditure for the purpose of deductibility under the first limb depend on the effectiveness of that expenditure, either economically or legally as authorities already cited attest. As was said in Fletcher at 18-19 (per Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ), the issue arising under the first limb of s 51(1) is one of characterisation of the outgoing, and although the subjective motivation of a taxpayer in making an outgoing may be conceivably relevant to the task of characterisation of the objects and advantages thereby sought by taxpayers, nevertheless if upon a consideration of all of the circumstances, including the direct and indirect objects and advantages sought by taxpayers in making an outgoing, it is apparent that the same has been genuinely and not colourably incurred in gaining or producing assessable income, the outgoing will satisfy the first limb, unless of course it is expenditure of a capital, private or domestic nature, or incurred in the production of exempt income.
64 The fact that a much larger fund may have been required to provide for the guaranteed returns to Growers who elected to take up that option is not relevant to issues arising under the first limb of s 51(1). The expenditure required to fund the guaranteed income returns was a factor '… relevant to the ascertainment of the character of a receipt of money', rather than '… relevant to the ascertainment of the character of its payment' (see Pipecoaters at 137-138)). To the extent that the management fees paid by the respondents may have been utilized to secure the guaranteed returns, or to meet costs of fundraising, whether temporarily or permanently, it would not follow that the outgoings were not deductible under s 51(1). The nature or character of the advantages sought by the respondents falls to be determined by reference to the nature and extent of the advantages and purposes for which they respectively subscribed their funds pursuant to the prospectus and associated legal documentation. In this regard, her Honour's findings, as to the income projections of the prospectus, and as to the economic viability of the project established by the expert evidence, and as to the genuine commercial considerations involved in the project, are relevant.
65 Moreover the primary judge made important findings as to the dominant concerns, interests and objectives of the respondents in participating in AHP No 1 material to satisfaction of the requirements for deductibility under the first limb of s 51(1), and as to the genuine commercial nature and purposes of AHP No 1, notwithstanding the ultimate failure thereof to perform according to the estimates of the promoters. Those factors are also germane of course to the Part IVA issues raised by the Commissioner to be considered later in these reasons.
66 As to fulfilment of the requirements of the second limb of s 51(1), alternatively to the first limb, we have already indicated that sufficient evidence existed for her Honour to conclude that business activities were carried on by each of the respondents. The reasons provided by her Honour applied the correct principles and it was reasonably open to the primary judge to find that the respondents each carried on business in relation to the extent of their respective involvement in AHP No 1, notwithstanding that their initial involvement comprised making payments for the various outlays for management, licence and guaranteed returns as a first step, as well as for the purchase of seedlings for plantation purposes.
67 Having regard to the statements made in the relevant authorities in respect of deductibility under s 51(1), including the entitlement to rely upon the business judgment and expertise of others (Lau),the need to look at the individual circumstances of a particular case (South Australian Battery Makers), the distinction which may be made for income tax purposes between planting and growing (Osborne), the need to rely on management services in relation to projects to be provided over commensurate periods of time (Lau, Emmakell, Merchant and Brand), contrasting circumstances of merely casual investments (Clowes and Milne), and the significance of engagement in small business undertakings (Ferguson v Commissioner of Taxation (1979) 37 FLR 310), the conclusion was supportable that the outgoings of the respondents met the requirements.
68 There are distinguishing features apparent in the present circumstances from those in Clowes and Milne. Clowes was concerned with 'the assessability as income of the proceeds of a forestry bond', as Barwick CJ pointed out in the leading judgment in Milne (his Honour's reasons in Milne were the subject of agreement by the four other members of the High Court, explicitly or implicitly). The finding in Clowes (Dixon CJ and Kitto J, Webb and Taylor JJ dissenting) in favour of the taxpayer was to the effect that he was not assessable to tax on the proceeds of the realisation of timber derived in 1945 pursuant to agreements made with the bondholders as far back as in 1926 and 1929. In addition to the dictum from Clowes referred to above, the findings of Dixon CJ (at 218) in favour of the taxpayer included the circumstance that '… both in fact and in law the operations of the company [were] conducted on [the grower's] own behalf and not on behalf of the lot-holders'. In the instant case the first profitable distribution from the proceeds of sale of the flowers was anticipated by the prospectus (which bore the date 16 May 1988) to be made in respect of the fiscal year ended 30 June 1989, and to be followed by profit distributions for the fifteen year life of the project. The contrasting circumstances in Clowes may also be identified in the dictum of Kitto J (at 223) as follows:
'Moreover, it was foreign to the whole idea of the transactions that the money paid to the company by the lot-holders should produce any periodical profit, or even a single profit as a separately identifiable amount. That a larger amount would some day be received was assuredly hoped, perhaps believed, but not promised… The essence of the matter simply was that the company bound itself to follow, over an indefinite period of years, a course of action which it expected would yield substantial net proceeds… it promised to pay him a proportion of those net proceeds if and when they should come in.'
As Barwick CJ subsequently pointed out in Milne at 533, in the context of referring to Clowes, '… the Commissioner now seeks from this Court a contrary decision even if the facts of this case are indistinguishable from those in that case'. In the present case, the respondents received the contractual promise of one year's guaranteed financial return, in respect of what was effectively the fifth year of operations involving the planting, harvesting and selling of flowers, and of non-exposure to an y losses of the preceding four financial years, and more significantly, participation in supposedly profitable flower harvesting operations thereafter for the remaining ten financial years ended 30 June 2003. The circumstances here involved are in our opinion closer to the pine tree plantation circumstances in Lau, in relation to which the taxpayer succeeded. The pine trees planted in Lau were due for harvesting verymuch earlier than those in Clowes and Milne. Professor Parsons in Income Taxation in Australia (LBC 1985) at par 3.63 (p 201) observed that '… Clowes… insisted that merely to outlay money in the hope of more in return was not enough. Otherwise, every casual bet or purchase of a lottery ticket might have been caught by the second limb of s 26(a)', being a reference to the former subsection of the Tax Act which related of course to gains from profit-making schemes. Here of course, it was yearly harvesting of flowers that was anticipated from the outset, in contrast to grown timber.
69 Although the circumstances of pooling presented an element of the matters considered in Clowes and Milne nevertheless the planned and anticipated growing of flowers for harvesting and sale periodically over a term of fifteen years, pursuant to the legal rights and obligations created by the subject documentation, provides a contrast of significance to the factual circumstances involved in both Clowes and Milne. In Vincent v Federal Commissioner of Taxation (2002) ATC 4742, a Full Federal Court (Hill, Tamberlin and Hely JJ) emphasised (at 4758) the existence of distinguishing features between the circumstances in Clowes and Milne and those in Lau, albeit that all three cases related to the growing and harvesting of timber. In Lau, the lease of land on which the pine trees were to be planted, with a view to the subsequent harvesting and sale of timber, did not involve the acquisition of any asset, and the outgoings in Lau were directed not to any profit-yielding subject, but to the process of operating the same.
70 The promoters of AHP No 1 were perhaps mindful of at least that distinction when conceiving the nature of the transactions which the Growers were to undertake, in that the expense of purchase of the seedlings was treated as being in the nature of capital, and the revenue outgoings were to comprise the management, licence and guaranteed income return fees, the management fees being of course the most significant in quantification. It might be observed that in their report to the Plantation Manager of 13 May 1988, reproduced in full in the prospectus, Mallesons Stephen Jaques stated as follows:
'The $250 payable under the Plantation Agreement for the purchase of seedlings forming the basis of a grower's plantation and the transportation of that plantation to the plantation sites is considered to be of a capital nature and accordingly non-deductible in the event that the actual cost of acquiring the seedlings and transporting the plantation is $250. Should the actual cost be in excess of $250 then some amount less than the full $9,455 proposed management fee will be allowed as a deduction to the grower.'
71 Moreover the promoters were doubtless also mindful of the principle, restated by a Full Court of this Court in Ferguson at 314 (per Bowen CJ and Franki J) and at 321-322 (per Fisher J), to the effect that every business has to begin, and even isolated activities may evidence the commencement of a business for income tax purposes, notwithstanding the limited or preparatory nature of those activities. (See also Puzey v Commissioner of Taxation (2003) FCAFC 197 per Hill and Carr JJ at [54]). It has also been often said, in contexts such as the present, that isolated activities may conceivably evidence the continuation of a business already commenced. By way of contrast, where initial activities comprise research and development for the purpose of establishing a business, if and when thereafter considered to be feasible in the light of the outcome of the research and development, a distinguishable situation would normally arise adversely to the concept of commencement of a business for fiscal purposes (Howland-Rose v Commissioner of Taxation (2002) 118 FCR 61 at [96]).
72 The factual findings made by the primary judge, were open to her Honour on the evidence before her. That evidence disclosed that the outlays made by the respondents were undertaken at arm's length, based on a genuine consideration of the representations set out in the prospectus, and on the independent advice of those in whom they placed their confidence. Moreover the expert evidence adduced by the respondents as to the commercial viability of AHP No 1 was found by her Honour to be substantially more persuasive than that tendered by the Commissioner, limited as that was by the evidentiary rulings of her Honour referred to earlier. The primary judge found the explanations of the respondents of their respective reasons for participation in AHP No 1 to be truthful, namely the possibility it offered of providing annual income for a number of years after their retirement from professional practice which was then imminent. Whilst the obtaining of substantial tax deductions was obviously an important factor in persuading each of them to subscribe to AHP No 1, that was not their only concern or motivation, 'or even their dominant interest', as the primary judge explicitly found. Senior counsel for the respondents rightly submitted in the appeal that at the time of their respective considerations of the prospectus, and of taking the advice from Davey & Associates, and of subscribing for their respective interests in AHP No 1, it was reasonably open for each of them to believe and accept that the project was a genuine commercial enterprise, and although not without risk, was both economically and horticulturally viable. So much was duly found by the primary judge.
73 Of course neither respondent personally conducted the activities of flower growing and selling; indeed that feature was an additional attraction, at least for Mr Jamieson. As noted earlier, decisions of this Court such as Lau, Emmakell, Brand and Puzey make it clear that neither that circumstance, nor the fact that the plantation agreements,in effect,declared the Plantation Manager to be an independent contractor in various contexts or various purposes, denied the application of the second limb of s 51(1), to the activities described. As was emphasised in the joint judgment of Bowen CJ and Franki J in Ferguson at 314, the fact that a taxpayer carries on the practice of a profession, or another business, does not preclude a finding that additional activities on his or her part of a different nature may constitute the carrying on of a business for income tax purposes. Having regard to her findings made, it was correct in principle for the primary judge to characterise the expenditures made by the respondents by way of management fees, licence fees and guaranteed return fees, as outlays undertaken in the course of a business in which each was involved individually, namely the growing and selling of flowers, through the Plantation Manager on their behalf, notwithstanding that the payment of those fees constituted the first, or among the first, steps taken by each of them in pursuit of that activity. Payment of the management fees was calculated to secure the performance of the management services the Plantation Manager was obliged to provide to Growers pursuant to the plantation agreement. The licence fees and guaranteed return fees were attributable to the ongoing conduct of the plantations and the production of product for sale, and to the partial protection of the respondents against the risk of loss of income, if the project did not meet expectations of profitability in the first five years of operation. As noted earlier, deductibility of the licence fees was not in issue on the appeal.
74 It was not correct for the Commissioner to contend that the sums paid by the respondents for the management services of the Plantation Manager could be described as made once and for all, or that they were so made to 'secure rights of an enduring nature'. For instance, a Grower also undertook to continue to pay to the Plantation Manager a productivity fee and to reimburse the Plantation Manager for outgoings incurred in managing the Plantation.
75 The grounds of appeal based on s 51(1) of the Tax Act fail in relation to both limbs thereof.
Whether s 82KJ of the Tax Act applies
76 It was conceded below on behalf of the respondents that the plantation agreement fell within the comprehensive definition of a 'tax avoidance agreement', as defined in s 82KH(1) of the Tax Act, with the consequence that it became necessary for the primary judge to address the applicability or otherwise of pars (b), (c) and (d) of s 82KJ of the Tax Act. As the primary judge prefaced her reasoning on this issue, s 82KJ is directed to the situation where under an arrangement involving payments required of Growers to be made, both on revenue account and on capital account, the former are inflated and the latter diminished, so that a disproportionate amount of the total payments required to be made for services is attributed to revenue and, therefore, but for s 82KJ, would be tax deductible. As to the payments to be made on revenue account, the Commissioner appeared to invoke the operation of s 82KJ only in relation to the management fees, which were of course the most substantial of the three categories of fees originally put in issue by the Commissioner. The difficulty remained however for the Commissioner in relation to payments to be made on capital account, which were confined to the cost of acquisition of the seedlings and perhaps also of the planting of the seedlings.
77 The Commissioner submitted below that the management fees were greater than might reasonably have been expected in the context of these plantation operations, and that a major component of the management fees was required by the Plantation Manager to fund the letters of credit from the Bank, in order to secure the guaranteed return. It was submitted that the very size of that expenditure, in contrast with the capital expenditure upon the establishment of the plantations, spoke for itself. As a consequence, so the Commissioner's submission continued, if the major proportion of the management fees was to be expended on securing the letters of credit, rather than upon management activities per se, it must be concluded that the management fees were higher than might reasonably have been expected. The submission as to the quantification of the management fees was rejected by the primary judge upon the basis of inconsistency with the evidence of Mr Weeks, who had concluded that the amount of $9,455 incurred by both respondents by way of management fees for each plantation was reasonable, and was 'not greater than might reasonably be expected under an arm's length transaction'. Her Honour accepted that evidence, and upon that footing, found that the requirements of s 82KJ(b) of the Tax Act were not met by the Commissioner.
78 As a consequence of this finding as to an absence of an adverse operation of s 82KJ(b) upon revenue losses or outgoings incurred or outlaid by the respondents, it became unnecessary for the primary judge to consider the submissions made in relation to the operation of s 82KJ(d) upon property acquisitions conceivably involved in the establishment of the plantations, but nevertheless her Honour expressed some tentative views on that issue, partly because of an absence of authority in relation to the scope of operation of s 82KJ(c) and (d). For the purposes of s 82KJ, 'property' is defined in s 82KH(1) to include 'a chose in action' and also 'any estate, interest, right or power, whether at law or in equity, in or over property'. The Explanatory Memorandum to the Income Tax Assessment Amendment Bill (No 5) 1978 states that s 82KJ is to apply to schemes involving 'the pre-payment of an otherwise deductible expense, the effect of which is to reduce the consideration payable in respect of the acquisition of property that is, as part of a tax avoidance agreement, to be acquired by the taxpayer or an associate'.
79 The submission advanced below on behalf of the respondents was that the property to which s 82KJ refers is confined to property the acquisition of which would involve an outgoing of a capital nature, and that the disqualifying requirement of s 82KJ(d) is met only if the outgoing for which the deduction is claimed, in the present case the payment of the management fees, works a reduction in the value of property of a capital nature, so that the consideration for its acquisition is less than the consideration that might reasonably be expected to have been payable for that property if the relevant outgoing had not been incurred. Since those requirements were said by the respondents not to have been met in the present case, it was therefore submitted that s 82KJ did not apply. That interpretation of s 82KJ was said to define by clear implication the nature of the legislative response to the decision of the High Court in favour of the taxpayer in South Australian Battery Makers handed down on 10 August 1978, being an interpretation further said to be in line with what appears in the Explanatory Memorandum.
80 The Commissioner contended below that the relevant property comprised the rights acquired by the respondents to:
· ownership of the plantations;
· a guaranteed return of $10,000 per plantation in respect of the year ended 30 June 1993; and
· have the Plantation Manager pay all contributions that would have been payable under the plantation agreement but for the exercise of the guaranteed return option.
The first of those three elements postulated by the Commissioner was correct, but there is conceptual difficulty with each of the second and third elements. Unless the second and third elements can be characterised as property to be acquired within paras (c) and (d) of s 82KJ, the Commissioner's contention must fail, given the above finding of fact made by the primary judge concerning the reasonableness of the quantification of the initial management fees of $9,455. The second and third elements above might conceivably be susceptible to characterisation as property in the nature of choses in action, but it is not easy to appreciate how any such interpretation would accommodate the statutory framework of s 82KJ, as exemplified in the Explanatory Memorandum. A particular chose in action is to be valued upon the footing of the rights attaching to it, and any modification of those rights may operate to constitute a different chose of action and, therefore, different property.
81 The primary judge observed, in any event, that the submission advanced on behalf of the respondents, to the effect that property within the meaning of s 82KJ must be property the acquisition of which involves an outgoing of a capital nature, must be correct, since there could be no taxation avoidance objective of a scheme designed to assign a disproportionately small consideration to the acquisition of property on revenue account, at least for the reason that any such outgoing is likely to be tax deductible in its own right. For that reason in her Honour's view, only the property in (i.e. ownership of) the plantations was relevant for the purpose of s 82KJ. That being so in the view of the primary judge, the condition in s 82KJ(d) would not be met, unless the cost of the plantations was less than might reasonably be expected to have been payable if there had been no provision for payment of management fees and, according to senior counsel for the respondents, unless that cost reflected a value which had been diminished by payment of the management fees. The primary judge considered that an example given in the Explanatory Memorandum illustrated the point made by counsel, that example being framed as follows:
'Under one such scheme, the taxpayer borrows (say) $1,000, ostensibly for income producing purposes, and promptly makes a payment of $7,000 which represents a prepayment of interest at 14% for 5 years. Upon payment of that interest, the taxpayer or an associate is entitled to acquire the lender's rights under the loan agreement. Because the terms of the loan provide for a reduced interest rate of 14% to apply after the pre-payment of 5 years' interest, the loan has a reduced value and can be acquired for $370.'
82 In that example, the primary judge pointed out, the diminution in the value of the property, being the loan, would have arisen as a direct result of the inflation of the outgoing, being the five years interest pre-payment. Another example in the Explanatory Memorandum, the primary judge further pointed out, involved a scheme of which an element was the pre-payment of rent under a long term lease. That had the effect of reducing significantly the value of the reversionary interest, and therefore of the property when sold as part of the scheme. The situation would not have been the same however, the primary judge pointed out, in relation to the payment of the management fees, since the value of the plantations would not have been diminished by the payment of the management fees per se, although it was conceivable that their value would have been increased for the time being by the up-front payment thereof.
83 The primary judge thereafter concluded her consideration of the s 82KJ issue by addressing the factor of the cost to the respondents of the plantations. As noted earlier, that cost of $250 was for 192 seedlings, growing material and individual growth bags 'physically constituted' as a plantation. The Commissioner submitted that the cost to the Plantation Manager of establishing each plantation was in reality considerably greater than this, placing thereby reliance upon a horticultural report prepared by VCAH in September 1987, which set out the cost assumptions for the establishment of 1000 so-called grower holdings for the project, each containing 192 growth bags. That report estimated the 'capital' costs at $3.21 and 'establishment costs' at $7.28 per growth bag. On those figures, the primary judge pointed out, a plantation of 192 seedlings would have cost more than $250 to acquire. But the 'capital' costs as apportioned in the VCAH report were projected outgoings in respect of items of plant and machinery to conduct the project over five years, and not the capital cost of the plantations per se. The 'establishment costs' calculated in the report were included items to the capital cost of producing the seedlings and constituting the plantations. No doubt, however, those costs may have been somewhat less if applied to 3,314 plantations rather than 1000. Whilst it may appear that $250 for each plantation may have been less than the true cost of a plantation, the extent of the inadequacy appears to have been insufficient for the Commissioner to have moved to apportion the management fees in order to attribute a sum to the non-deductible cost of establishing the plantations. As noted earlier under the plantation agreement the Plantation Manager was to "cause each plantation… to be physically constituted" but that work was not within the services for which the Grower undertook to pay the management fee pursuant to the plantation agreement. The operation of s 82KJ was not attracted by such an underpayment for a plantation because the section required that any such low consideration payable for a plantation must be an effect of the payment of the management fee. The primary judge concluded there was no evidence before her to support any such effect of the payment of the management fee, being a conclusive with which we agree.
84 It is difficult to envisage a viable basis for inclusion, within the scope of pars (c) and (d) of s 82KJ, of choses or rights in relation to derivation of aspects of the very assessable income which forms part of the consideration for the acquisition of property within par (a) of s 82KJ, which is what the Commissioner effectively contends in relation to the second and third elements described above. To do so would seem to be foreign to the notion of 'expenditure recoupment' envisaged by the section.
85 The Commissioner's submission that s 82KJ had any operation in relation to the deductions claimed by the respondents must be rejected.