Cooke v Commissioner of Taxation

THE COURT ORDERS THAT:

1. The appeal against the objection decisions of the respondent communicated to the applicant by letter of 24 August 1998 be allowed.
2. The respondent allow the applicant's objections.
3. The respondent pay the applicant's costs of this proceeding.
4. Liberty to either party to apply in relation to the form of orders within 21 days. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

REASONS FOR JUDGMENT 1 The applicants, Graham George Cooke and Hugh Hunter Jamieson, appeal against the disallowance of their objections to Notices of Assessment issued by the respondent in respect of tax years ending 30 June 1988 and 1989 for Mr Cooke and ending 30 June 1988 for Mr Jamieson. The appeals concern the respondent's treatment of expenses incurred by the applicants through their participation in a project, known as the Australian Horticultural Project Number 1 ("AHP No 1"), which was promoted by a company called Growth Industries Pty Limited ("Growth Industries"). Section 14ZZO of the Taxation Administration Act 1953 (Cth) imposes on the applicants the onus of proving that these assessments are excessive. Because all three proceedings raise the same issues they were heard at the one time. 2 Information about AHP No 1 is contained in a prospectus dated 16 May 1988 which was lodged with the Australian Securities Commission. The prospectus offered for subscription, units in a unit trust known as the Australian Horticultural Trust Number 1 ("Trust"). The principal purpose of the Trust was stated to be raising funds from investors who wished to conduct their own businesses growing Protea and Australian native flowers for domestic and overseas consumption. A subscription of $10,000 was required for each unit in the Trust. On the acquisition of a unit or units, an investor (as "Grower") would enter into a Plantation Agreement (in a form annexed to the prospectus) with Growth Industries Management Limited (the "Plantation Manager") and with the trustee of the Trust, A.T.A. Services Limited ("Trustee") as the investor's representative. The application form contained a power of attorney in favour of each director of the Trustee to execute the Plantation Agreement on the subscriber's behalf. Clause 10 of the Trust deed provided for the redemption of the units once the number of units issued under the Trust reached 500. On redemption the amount of $9,750 in respect of each unit was to be paid to the Plantation Manager on behalf of the relevant investor. The Plantation Manager was also the manager of the Trust and, in this capacity, it was paid a service fee of $250 per unit.

Projected returns 3 AHP No 1 had an estimated life of 15 years. As set out in the prospectus, the projected cash distributions per $10,000 invested during the first five years were: 1989 $2,006 1990 $2,422 1991 $4,466 1992 $4,979 1993 $5,681 These returns were estimated on the basis of assumptions set out in the prospectus.

Plantation agreement 4 The Plantation Agreement commenced on the date the units were redeemed and was expressed to continue, "unless sooner terminated," until 30 June 2003. Under the Plantation Agreement the Grower was to be sold one plantation for each unit held by the investor at a price of $250 each. A plantation consisted of 192 seedlings with growth material, each contained in its own Growth Bag. A Growth Bag is a special container made of spun polypropylene material and designed to promote efficient and healthy plant growth. The plantations were to be physically constituted over a period of twelve months, tagged so as to identify the owner and delivered to production sites during that period. The plantations were capable of being transported to and from the plantation sites. There were two production sites, 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 use the sites for the purposes of AHP No 1. The Plantation Manager, as permitted under the Plantation Agreement, engaged VCAH Services Limited ("VCAH") as Technical Manager and Growth Industries Marketing Pty Ltd as Marketing Manager. 5 The terms of the Plantation Agreement are crucial to the issues raised by the applicants. In addition to the above, the material terms can be summarised as follows: (a) The $250 price of each plantation was to be paid out of the amount realised on the redemption of the units. (b) The Plantation Manager was responsible for the cultivation, harvesting, marketing and sale of the flowers and for the provision of all necessary equipment and ancillary services. (c) The flowers for sale were to be pooled with the flowers of all the other investors. (d) The property in the flowers was to pass to the Plantation Manager at the time of pooling. (e) The Plantation Manager was to distribute the proceeds of sale of the flowers to investors, each investor being entitled to the percentage of the proceeds that his or her number of plantations bore to the total number of plantations (the "Grower's percentage") "without reference to the quality, volume, prices or any other factor" in relation to that investor's flowers or those of any other investor. (f) The Plantation Manager was entitled to: (i) an initial management fee of $9,455 in respect of each plantation, to be paid out of the amount realised on the redemption of the units; (ii) a productivity fee equal to 10% of the Grower's percentage of the gross sale proceeds derived after 30 June 1989; and (iii) reimbursement of all costs, expenses and liabilities incurred after 30 June 1989, with the intent that the Grower's percentage of such costs etc. were to be paid by each investor. (g) The Plantation Manager had "full and unqualified" powers of management including in relation to all things incidental to such management "subject only to the general duty of the Plantation Manager to act bona fide in the interests of the Grower". (h) The Grower's representative 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. (i) Subject to instructions given by the Grower's representative, the Plantation Manager had absolute and uncontrolled discretion as to the exercise of its powers under the Plantation Agreement. (j) The Grower was to have the benefit of a "Guaranteed Return" if the Grower so indicated in the application form for units in the Trust.

Guaranteed return 6 The Plantation Manager offered to investors a Guaranteed Return secured by letters of credit issued by the then State Bank of New South Wales. Under the guarantee the investor was to receive, no later than 31 August 1993, an income of $10,000 in respect of each unit originally purchased in the Trust. The cost of this guarantee was a fee of 0.5% of the amount of the investment, payable once only. The prospectus contained a taxation opinion provided by a well-known national law firm, Mallesons Stephen Jaques, which described the Guaranteed Return in the following terms: "The Plantation Agreement contains the provision whereby a grower may elect to enter into a guaranteed minimum return arrangement. Under the arrangement the Plantation Manager guarantees a minimum net return of $10,000 per plantation in respect of year 5 of the Project term, which amount we are instructed is a responsible estimation of the net return that a grower could otherwise expect to receive per plantation in respect of that year. The Plantation Manager further agrees to absorb any losses that grower may suffer on the Project in years 1, 2, 3, 4 and 5 of the Project term."

The opinion then set out the fees that Growers entering the arrangement would be required to pay to the Plantation Manager. 7 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 arrangement was to limit, to an extent not disclosed in the prospectus, the amount of funds available for cultivation of flowers under AHP No 1.

Taxation liability 8 The prospectus contains the following comment about the taxation liability of 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." 9 The prospectus urged that prospective investors read the taxation opinion included in the prospectus. This opinion is consistent with the above comment, although it contains rather more detailed qualification and assumptions. In particular the opinion states: "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 provisions of ss 82KJ, 82KK, 82KL and Pt IVA of the Income Tax Assessment Act 1936 (Cth) and concluded that these provisions were unlikely to affect the tax deductibility of a grower's expenses.

Financial arrangements 10 A facility agreement between Growth Industries, Mid-West Finance Pty Limited ("Mid-West"), the Plantation Manager and the State Bank of New South Wales ("Bank") dated 24 May 1988 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 investors in APH No 1. The plan was for Mid-West to lend the whole of the purchase price of units to subscribers who took advantage of the Guaranteed Return.

Issues 11 The issues raised in this proceeding, which are the same for both applicants, are whether, in the relevant year of income any of the management fees (paid at the rate of $9,455 per plantation), licence fees (paid at a rate of $45 per plantation) and guaranteed return fees (paid at the rate of 0.5% of the amount of the investment, or $250, whichever was the greater) are deductible expenses for income tax purposes. Because the relevant years of income are prior to 1997, the relevant legislation is the Income Tax Assessment Act 1936 (Cth) ("Assessment Act") rather than the Income Tax Assessment Act 1997 (Cth). The questions are whether the above fees (together the "outgoings") are deductible under s 51(1) of the Assessment Act and, if so, whether s 82KJ or Pt IVA of the Assessment Act operate to disallow the deductibility of the outgoings in whole or in part. 12 The respondent contends in relation to both applicants that no part of the outgoings is deductible pursuant to s 51(1) of the Act because they fall within the capital exception in that section. If, contrary to the respondent's contentions, any such amount is deductible then such deduction, it is submitted, is disallowed by s 82KJ or by Pt IVA of the Act.

Mr Cooke's investments 13 In June1988, Mr Cooke subscribed for 45 units in the Trust. On redemption of those units Mr Cooke received $9,750 per unit amounting to a total of $438,750. The whole of this amount was borrowed from Mid-Westat an interest rate of 15.65%. On redemption of the units the amount was appropriated as to $11,250 for 45 plantations, $2,025 for the first year's licence fees and $425,475 for the first year's management fees. In addition he paid $2,250 by way of the guaranteed return fee. In his income tax return for the year ended 30 June 1988, Mr Cooke claimed a deduction for the total licence and management fees and also for the guaranteed return fee. He did not claim a deduction for the cost of the plantations. 14 In November 1988, Mr Cook subscribed for a further 10 units in the trust at a total price of $100,000 which he again borrowed from Mid-West. In his income tax return for the year ended 30 June 1989 he again claimed a deduction in respect of the licence fees ($450), management fees ($94,550) and guaranteed return fee ($500). 15 On 20 February 1995, the respondent issued a Notice of Amended Assessment to Mr Cook in which he disallowed the deductions claimed for the management fees, the licence fees and the guaranteed return fees for the year ended 30 June 1988. On 18 July 1995, the Commissioner issued another Notice of Amended Assessment disallowing the same deductions in the tax year ended 30 June 1989.

Mr Jamieson's investment 16 On 19 May 1988, Mr Jamieson subscribed for 25 units in the Trust, the price of $250,000 being borrowed from Mid-West. In accordance with the terms of his Plantation Agreement the funds due to Mr Jamieson on redemption of the units were appropriated as to $6,250 for 25 plantations, $1,125 for the first year's licence fees and $236,375 for the first year's management fees. In addition, as he had elected to receive the guaranteed minimum return, Mr Jamieson also paid $1,250 by way of the guaranteed return fee. In his income tax return for the year ended 30 June 1988, Mr Jamieson claimed a deduction for the total licence and management fees and also for the guaranteed return fee. 17 On 9 March 1995, the respondent issued a Notice of Amended Assessment to Mr Jamieson in which he disallowed the deductions claimed for the management fees, the licence fees and the guaranteed return fees.

Mr Jamieson's evidence 18 Mr Jamieson's evidence was given by affidavit dated 13 July 1999. He stated that he commenced articles with a major law firm in 1952. He was admitted to practice as a solicitor in 1954 and worked as an employed solicitor with that firm until 1961 when he was made a partner. He retired from the firm in December 1995. During this long career he was fully engaged in legal work and in the administration of the firm. He had little time to devote to other activities. With one exception, he did not devote much time to his personal financial planning. The exception was his investment, through a wholly owned company, in an orchard that he developed at Bilpin in New South Wales. He visited the property as often as possible, supervising the work and, at times, participating in it. Mr Jamieson stated the orchard generated significant revenue most of which was put back into the business. In the early 1980's the operation was subject to an audit by the Australian Tax Office. Following that audit the Tax Office accepted that he was a bona fide primary producer. 19 Mr Jamieson stated that during the 1980's, although his firm's legal practice flourished, he realised that he had not accumulated sufficient assets to provide for his retirement. Early in 1988 at the suggestion of one of his partners, he contacted Mr Paul Brazenor of Davey & Associates to obtain advice in this regard. Mr Brazenor suggested, among other things, investment in AHP No 1. Mr Jamieson stated that, from his discussions with Mr Brazenor and from his reading of the prospectus he was attracted to the investment for a number of reasons including that,

• it has the potential to produce an attractive return for a period well into his 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 as he did not have 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 management fees he had to pay. 20 Mr Jamieson said that at the relevant time he believed that the project had "every chance of being successful" although he was aware that there were risks involved. He was influenced by the fact that others of his partners, including Mr Cooke, whose business acumen and caution he respected, were also planning to invest in AHP No 1. Mr Jamieson also said that he relied on reports contained in the prospectus and the advice of Mr Brazenor. 21 On 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 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. Although Mr Jamieson agreed that he was aware of the risks involved in any horticultural project and had a general understanding of the scheme, it is clear that he did not acquaint himself with the details of the documents. Mr Jamieson said that he was not aware that a substantial part of the management fee paid to the Plantation Manager would have to be expended in obtaining the letter of credit. He had assumed that all the money went into growing maintaining and selling the flowers. Mr Jamieson stated that in placing his affairs in Mr Brazenor's hands he followed the practice he "habitually adopted" with other professional advisors and followed Mr Brazenor's advice while "continuing to give proper consideration to his various proposals and trying to ensure that I did not get out of my depth nor allow myself to be burdened with too much worry." 22 Mr Jamieson agreed that in the latter part of the 1988 financial year he was aware that his income from his legal practice would be substantially higher for that financial year than for previous years. On 29 June 1988,he wrote to his then accountant advising that he was transferring management of his accounting and income tax affairs to Mr Brazenor's firm, Davey & Associates. In that letter Mr Jamieson wrote, "What I clearly need is an investment adviser 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." 23 Mr Jamieson admitted that "drastic steps" was a reference to his investment in AHP No 1. It was put to Mr Jamieson that it was of "the utmost importance" to him to obtain the tax deduction in the 1988 tax year and that his investment in this project was taken "almost entirely" for tax reasons. Mr Jamieson rejected this suggestion; according to him the tax issue was only one of a number of considerations including those specified in [19] above.

Mr Cooke's evidence 24 Mr Cooke's evidence was given by affidavit dated 12 July 1999. From 1957 Mr Cooke was a solicitor in the same firm as Mr Jamieson. He was made a partner in 1963 and retired from the firm in December 1989. During the period from 1970 to 1985 Mr Cooke spend most of his time working for one major corporate client. He stated that following the break up of that corporate client his work for that client was dramatically reduced and his legal practice correspondingly diminished. He was not optimistic about the prospect of building up another practice. As retirement had thus become a "real possibility" he turned his mind to his likely financial position on retirement. He expressed his position thus: "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 down-side 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." 25 Mr Cooke became aware of the AHP No 1 at about the same time and in the same way as Mr Jamieson. He sought information and advice from Mr Brazenor in June 1988. He was provided with copies of the prospectus, a memorandum dated 7 June 1988 prepared by one of his partners, Mr John McKillop, and a letter to Mr McKillop from Mr Howard Anderson with an attached investment summary. Having read these documents, including independent reports in the prospectus, Mr Cooke said that he formed the view that AHP No 1 was an attractive venture for reasons not dissimilar to those of Mr Jamieson. He saw a potential for the business to produce "super" profits geared to later rather than earlier years, which suited his plans for a retirement income. Because he did not have cash available for investment, the finance available through Mid-West was important, as was the option for a guaranteed return. Mr Cooke stated that he was aware of risks inherent in the project because the type of horticulture was relatively new. He noted that the existence of the guarantee lessened but did not eliminate these risks 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 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 loans from other sources would be met less than enthusiastically; and (c) under 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)." 26 Mr Cooke admitted on 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 in the previous year. He rejected, however, the suggestion that his dominant interest in the project was to gain the tax deduction for the 1988 financial year. While he agreed that he was influenced by the memorandum of 7 June 1988 from Mr McKillop (see [25] above) in which the tax advantages of the project were highlighted, he said that he was also influenced by the potential of the project for long-term income generation. Mr Cooke admitted that his investment of $450,000 was the largest amount he had invested and that he was only able to do so because it was possible to borrow the whole of the investment. He also admitted that were it not for the tax deduction he may have had to borrow to pay his tax. Despite this commitment it was evident that Mr Cooke had not read the documents concerning AHP No 1, or the agreements that he was required to sign, with particular care. There was, for example, a clause missing from the copy of the plantation agreement that he had been sent and it would appear that Mr Cooke did not notice this omission. The respondent suggested that the terms were of little concern to him because his prime concern was the tax deduction. Mr Cooke, however, insisted that the commercial and horticultural aspects of the project were his prime concern.

Mr Flude's evidence 27 Mr Peter Flude is the Managing Director of the Trustee and Growers' representative, now known as Australian Rural Group Limited. Mr Flude has qualifications in agriculture and biological sciences and is a member of a number of professional associations and a fellow of the Australian Institute of Management. He has long experience in agricultural and management consulting. Mr Flude established the Trustee to provide agricultural consultancy, production and agricultural management services. In his affidavit sworn on 9 August 1999 Mr Flude gave a brief history of AHP No 1 outlining the difficulties the project encountered. He described the breakdown of the relationship between the Plantation Manager and VCAH and the eventual appointment of a liquidator to Growth Industries in 1991. On cross-examination Mr Flude agreed that the new technology involved in AHP No 1, namely the use of growth bags, meant that the project had risks beyond those attendant on more conventional horticultural projects. He stated that it was not unusual to cultivate Australian natives and proteas although this method of cultivation for export was unusual. He also agreed that the scale of the project created risk and that expert opinion in Australia was divided as to the applicability of the technology for use in Australia.

Mr Hunter's evidence 28 Mr Dallas Raymond Hunter is the Associate Director (Curriculum Business Development) and Head of Department (Management Studies) at the Dalby Agricultural College in Queensland. In his affidavit sworn on 29 July 1999, Mr Hunter stated that in 1988 he was a manager for AgriValuers Australia which provided "rural consulting and valuation services, including farm financial assessments, feasibility studies and farm business management." 29 AgriValuers Australia was a technical consultant for AHP No 1. Mr Hunter prepared a report that was included in the prospectus. The purpose of his report was stated in the introduction to the report contained in the prospectus as being to: "1. Independently validate the information presented in: (i) The Horticultural Consultant's report prepared by [VCAH]. (ii) The Marketing report prepared by [the Plantation Manager]. 2. And to critically assess the overall viability of the Project."

30 Mr Hunter confirmed the views expressed in his report as to: · the reasonability of the projected yields set out in the prospectus; · the suitability of the production sites for the project; and · the appropriateness of the production budgets and the flower varieties selected.

Mr Hunter stated that, based on his examination of the above reports and further documentation provided by the Plantation Manager, he formed the opinion that AHP No 1 was a viable project.

Mr Weeks' evidence 31 Mr Alan Weeks is a partner in the accounting firm Deloitte Touche Tohmatsu. On the instructions of the solicitors for the applicants, Mr Weeks provided a report reviewing the report prepared by Mr Geurtsen ("Geurtsen report" - see [37] below). The respondent objected (unsuccessfully) to certain paragraphs of this report and to certain of the appendices on the basis that in those paragraphs Mr Weeks was giving hearsay evidence of statements of Mr A S Wehby. In his report Mr Weeks referred to the Business Consultant's Report contained in the prospectus. That report was prepared by Mr Wehby, at that time a partner of Coopers & Lybrand. The purpose of that report was stated to be the independent confirmation of the "application of the assumptions made by the directors" to the preparation of the projected cash distributions set out in the prospectus. Mr Weeks stated in his report that: "I have examined the files of Coopers & Lybrand, including the working papers … relating to the work undertaken by Mr Wehby and his staff in 1988 in preparing the Investigating Accountant's Report and the Business Consultant's Report for inclusion in the Prospectus. These files were produced to the Court under subpoena. In respect of certain working papers, eg cashflow projections and budgets, there were a number of versions contained with in the files. I was unable to identify the specific workpapers which related directly to the cashflow projections contained in the Prospectus. I did, however, sight workpapers which indicate that work was undertaken in reviewing the projections in the Prospectus." 32 Mr Weeks quoted from the papers contained in the Coopers & Lybrand files. He then used the information that he derived from examination of those files in conjunction with the establishment costs of AHP No 1 as set out in the prospectus to estimate the costs of the management services that the Plantation Manager was contracted to provide and the margin of profit that would have accrued to the Plantation Manager. He concluded that, on the figures so derived, the management fee was reasonable. As an alternative, Mr Weeks attempted to estimate the direct and indirect costs that would have been recouped from the prepaid management fee for the 1988/89 year using wherever possible cost details assumed in the Geurtsen report. On this approach he also concluded that the fee was reasonable and "not greater than might reasonably be expected under an arm's length transaction."

Dr Martin's evidence 33 Dr Peter Martin is a highly qualified scientist who has more than 25 years experience in horticultural research including cut flower production. He has held senior academic appointments and, among other important consultancies, he has been principal landscape and arboricultural consultant to the Centennial Park and Moore Park Trust and tree consultant to the Royal Botanic Gardens Sydney. On instructions from the solicitors for the applicants Dr Martin prepared a report giving his expert opinion on whether, at about the time the applicants subscribed for units in the Trust, AHP No 1 was horticulturally viable. Dr Martin was asked to consider the matters raised in the Geurtsen Report. His brief specified in some detail other issues that he should consider, including the state of knowledge about cultivation of Australian native and protea species at the relevant time, the suitability of the productions sites, the suitability of the growing medium used in the project, the use of the growth bag system and the predicted yields and risks as set out in the prospectus Dr Martin was asked to comment whether it was reasonable, as at the date of the prospectus, for the applicants to believe that Australian natives and protea could be marketed in the United States, Japan and Europe and whether at the relevant time it was reasonable for the applicants to believe the project to be horticulturally viable. 34 Dr Martin provided a detailed and carefully reasoned report addressing these issues. He analysed the suitability of the plantation sites in terms of access to international airports, the climatic conditions, incidence of frosts, disease and weeds, availability of established site facilities, adequacy of water and growing media supply and availability of labour, technical management and administration services. It is not necessary to summarise this analysis. Based on his consideration of all the issues and his analysis of the suitability of the plantation sites he expressed the following conclusions: "In my view the Project as outlined in the Prospectus dated 16th May 1988 was horticulturally viable. The Project was innovative and therefore to some degree speculative, but given good general and technical management backed by a research and development capability as outlined in the Prospectus, I consider that the project had the potential to reach its goal of the production of high-value cut flowers for export. … I consider that the risks as set out in the Prospectus provided a reasonable and fair warning to investors' [sic] of the horticulturally speculative aspects of the proposal. … … I believe it was perfectly reasonable for [the applicants] to believe that there were good prospects for marketing of the Flowers in the United States, Japan and Europe." 35 Shortly before his report was completed, Dr Martin was asked to address an additional question, namely whether there would have been a marketable yield of flowers in the first 13 months of AHP No 1. His answer was: "There would only have been a marketable yield of Kangaroo Paw flowers in the first thirteen months of operation of the Project if preparations had commenced well before the close of the Prospectus and the transfer of Kangaroo Paw plants to field growth bags had taken place early in 1989." 36 Dr Martin also made some comments on the methodology and conclusions of the Geurtsen Report. These are discussed below at [43].

The Geurtsen report 37 This report, commissioned by the solicitors for the respondent, was prepared by Mr Johannes Paul Geurtsen, the principal of JPG Prohart Consulting. It was the only evidence presented by the respondent. Mr Geurtsen, who has academic qualifications in science and economics, has experience as a horticulturalist, an agronomist and in the economic analysis of farming systems and enterprises. In particular, he has expertise in cut flower production. The applicants objected to the whole of Mr Geurtsen's evidence on the basis that it was not prepared solely by Mr Geurtsen but was a joint report with Mr Richard Ivey. It is clear from the report itself that this complaint had substance as the report stated that it was prepared by Mr Geurtsen "with the assistance of Richard Ivey of Ivey ATP." The report also stated that: "Further assistance was provided by other consultants at Ivey ATP under the supervision of Richard Ivey."

It was not possible to tell from the report which parts of it, if any, were prepared solely by Mr Geurtsen. Despite this, the respondent was not planning to call Mr Ivey. 38 To be admissible, an expert opinion must be wholly or substantially based on the expert witness's specialised knowledge; Sydneywide Distributors Pty Ltd v Red Bull Australia Pty Ltd [2002] FCAFC 157 per Branson J at [12]. This requirement clearly cannot be met if it is partly based on the knowledge or opinion of someone else. I was not prepared, however, to exclude this report, comprising as it did, the whole of the respondent's evidence without giving the respondent the opportunity to elicit (in non-leading questions) evidence from Mr Geurtsen as to the parts (if any) for which he had been solely responsible. This approach is consistent to the approach referred to with approval in Rhoden v Wingate [2002] NSWCA 165 per Heydon JA at [61] which was decided after the hearing of this case. 39 In evidence given at the hearing, Mr Geurtsen said that he required Mr Ivey's assistance "to complete all aspects of the report in the required time due to my own work load." In addition, he felt that it was best to ensure that a fully qualified person presented the economic analysis in the right format. Mr Geurtsen gave the background material to Mr Ivey so that Mr Ivey could check the basis for the assumptions. However, not all the material on which he based his assumptions was in the documents he gave to Mr Ivey; some of it would have come from personal discussions. 40 In this case Mr Ivey had a considerable role in the preparation of that part of Mr Geurtsen's report dealing with the economic viability of the project. Although Mr Geurtsen checked the material prepared by Mr Ivey in a general way he admitted that Mr Ivey had expertise that he did not. Although Mr Geurtsen gave the assumptions and the background material to Mr Ivey there was no evidence as to what Mr Ivey did with those assumptions. In these circumstances the section of the report dealing with the financial viability of the project cannot be regarded as based "wholly and substantially" on the specialised knowledge of Mr Geurtsen. For this reason I ruled that part of the report inadmissible. The consequence was that the respondent had no evidence to support its submissions that the project was not economically viable.

41 In the part of his report dealing with horticultural viability Mr Geurtsen's assessment of the project was that: "several critical areas lacked adequate consideration. These 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." 42 Consequently he concluded that horticulturally the project was not viable. On cross-examination Mr Geurtsen agreed that his conclusion about the unsuitability growth bags was pessimistic. He also agreedthat his report identified significant advantages in a number of aspects of the project. Ultimately Mr Geurtsen's reservations appeared to depend on his opinion that cultivation of flowers in AHP No 1 was for cut flower production while the information which he was presented with was general or related to the production of plants for general landscape purposes. According to Mr Geurtsen, cut flower production is a "very different field" from the production of plants for general landscape purposes. Mr Geurtsen did not explain why or in what way this was so but stated that he would want evidence that species used for cut flower production would respond in the same manner as plants cultivated for general landscape production. Mr Geurtsen observed that there was some agreement between his report and Dr Martin's and was not able to point to any specific part of Dr Martin's report with which he disagreed. 43 Dr Martin disagreed with Mr Geurtsen on a number of issues. It is not necessary to detail all such instances. One will suffice. Mr Geurtsen stated that the frost risk at the Longerenong site was "extremely high". Dr Martin disagreed and provided a convincing analysis of the climatic data to support his conclusion. He also pointed out that the fact that the growth bags would elevate the plants above the general ground level would have a moderating effect that would make the frost risk insignificant. He referred to research about the use of growth regulators to promote frost resistance. In relation to Mr Geurtsen's reservation about the special nature of cut flower production, Dr Martin was of the opinion that Mr Geurtsen's views were informed by hindsight. He stated that in 1988 the growth regulator approach was sufficiently promising to warrant its inclusion in the AHP No 1. 44 Dr Martin provided a convincing rebuttal of many of the negative findings of Mr Geurtsen and his views were not seriously challenged on cross-examination. Where they conflict, I accept his views in preference to those of Mr Geurtsen.

Amounts of outgoings 45 The amounts of outgoings in issue for each applicant are as follows: Mr Cooke Mr Jamieson

Management Fee 1988: $425,475 1988: $236,375

Licence Fee 1988: $2,025 1988: $1,125

Guaranteed income return fee 1988: $2,250 $1,250

Deductibility of outgoings 46 Section 51(1) of the Assessment Act provides: "All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income." 47 There are negative and positive aspects to this section. For expenditures to come within it they must satisfy one or other of the positive criteria in the section (the "assessable income" and the "business" criteria) and not fall within any of the negative criteria', that is the expenditure must not be either "capital", or of a "capital, private or domestic" nature, or be incurred in relation to exempt income. The respondent submits that the applicants' outgoings were neither incurred in producing "assessable income" nor in carrying on a "business". In any event, the respondent also submits that the outgoings were of a capital nature and that therefore fall within that exception. I propose to consider first if the outgoings that the applicants' claims meet the positive criteria as there is no need to consider the exception if this is not established; Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 at 468 ("Steele").

Assessable income 48 It is clear from the words of the section, and well established by authority, that an expenditure may meet the positive requirement of s 51(1) even though no income is produced in the relevant tax year; Fletcher v Commissioner of Taxation (1991) 173 CLR 1 at 16 ("Fletcher"); Steele at 474. The proper approach to the question of whether expenditure is incurred in "gaining or producing" assessable income has been considered by the High Court on a number of occasions. In this case the only assessable income arising from AHP No 1 was the $10,000 per unit that flowed from the Guaranteed Return. In Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 57 ("Ronpibon Tin") the High Court, referring to s 51(1), stated: "[T]o come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income." 49 In Fletcher the High Court, at 17, quoted this statement with approval but commented that this did not exclude the taxpayer's motive as a relevant factor in characterising the outgoing under s 51(1). The High Court continued: "At least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterization of either the whole or part of the outgoing for the purposes of the sub-section."

The High Court emphasised that the relationship between the whole of the expenditure and the production of income must be genuine and not colourable. 50 The respondent submits that the applicants' expenditure has only a colourable relation to the production of income. He contends that the critical question is the advantage that the applicants sought to achieve by the payments in question and submits that "viewed objectively" the object of the applicants' investments was the present tax advantage not the potential for future income. The respondent submits this conclusion is confirmed by the fact that the project was not horticulturally or economically viable and the somewhat careless attitude of the applicants to the agreements that they were required to enter into. 51 The prospectus for AHP No 1 contained income projections based on assumptions set out in the prospectus. Those projections ranged from $2,006 per plantation in 1989 to $5,681 per plantation in 1993 (see [3] above). A Grower who elected to take the guaranteed return option, thereby giving up a portion of his net return would, on these estimates, still have made a substantial profit on the investment. The fact that the projected income did not eventuate does not make unreasonable an investment that was reasonable at the time it was made. As the Full Court remarked in Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157 at 162 ("Emmakell"), "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)."

Similar views were expressed by Beaumont J (with whom Jenkinson J agreed) in Commissioner of Taxation v Lau (1984) 6 FCR 202 at 219 ("Lau"). In this case, as in Lau and Emmakell, the investments made by the applicants were at arms length and were based on genuine commercial consideration. The applicants made the investments after consideration of the material in the prospectus and on the advice of those whom they trusted and were entitled to trust. Although the evidence suggests that neither applicant gave the documentation the close attention they presumably would have given it if acting on behalf of a client, this does not suggest to me any lack of bona fides or that their motives were different from those claimed by them. 52 The evidence as to the viability of the project has been summarised in some detail above. Mr Hunter, Mr Weeks and Dr Martin, focusing on different aspects, all support the viability of the project. In particular, Dr Martin's report is detailed and convincing and, as I have indicated, is to be preferred to the only evidence put forward by the respondent, namely the Geurtsen report. 53 Although neither applicant denies the prospect of an immediate tax benefit was an advantage, they both insist that the potential for an income stream in their retirements was their main object and the precipitating factor in their making the investment. In Ure v Federal Commissioner of Taxation (1981) 50 FLR 219 at 233 ("Ure"), Deane and Sheppard JJ said: "One of the most difficult aspects of the problem of characterizing an outgoing is the assessment of what, if any, weight is to be given to indirect objects which a taxpayer had in mind in incurring the outgoing. Such objects form part of the relevant circumstances by reference to which the problem of chararacterization must be resolved. There is however no rigid principle which can be applied in determining what, if any, weight should be given to them. In the ordinary case, such as, for example, where the immediate object achieved by the outgoing is the production of assessable income which is commensurate with the amount of the outgoing or where it is clear that the outgoing was for the purchase of stock-in-trade or the acquisition of services or hire of equipment used in earning assessable income, indirect objects or motives of a personal or domestic character will plainly not prevent the characterisation of the outgoing as having been incurred in earning assessable income. … In other cases, the immediate object or effect of an outgoing will not suffice either to explain or to characterize it. In such cases, indirect objects or motives can assume a sometimes decisive importance." 54 Ure is concerned with dominant and subordinate purposes. It concerned a taxpayer who borrowed money at commercial rates of interest (up to 12.5%) and then lent the borrowed money to his wife and to a family company at 1% interest. The Full Court was unanimous in finding, in the words of Deane and Sheppard JJ (at 230) that there being, "neither suggestion of miscalculation or lack of business understanding nor suggestion of anticipation or hope of income being derived by the taxpayer either in another form or by way of interest at a higher rate", the explanation for the transaction had to be found in "private and domestic considerations". The object of earning assessable income in the form of interest was subordinate to these considerations. 55 In this case the evidence of both applicants has shown that the tax deduction was an important issue for them. Both applicants, however, resolutely deny this was their only concern or even their dominant interest. I see no reason to disbelieve them. Neither was shaken on cross-examination and both impressed me as giving truthful, straight-forward accounts of the circumstances leading up to their investment in AHP No 1 and their motives for the investment. Both averred that in a busy life as a solicitor they had made insufficient provision for their retirement. This evidence was not challenged. It is entirely feasible that, at their stage in life, they would be looking to provide some form of post-retirement income. Clearly an investment that had a tax advantage would be more attractive. Given their increase in income it may even have been a requirement in that, without sufficient liquid resources to fund either their tax or an investment, borrowing money for an investment that provided immediate tax relief may have been the only possible means of making such an investment. The situation here can be distinguished from that in Ure where the transaction made no sense if the private and domestic considerations were not taken into account. 56 The respondent submitted that investment in AHP No 1 made no sense without the tax incentive. It was submitted that this position could be distinguished from that in Lau where the Full Federal Court held that a taxpayer who invested in a commercial pine tree plantation, on terms that have some similarity to the applicants' investments in AHP No 1, was entitled to a deduction for a lump sum management fee paid at the outset of the venture. The management services in Lau were to be rendered over a period of up to 21 years and were to vary as the occasion required. Beaumont J distinguished Ure on the basis that the transaction in Lau was at arm's length. His Honour observed, at 217, that Lau, "was not a case where, as in Ure's case, the taxpayer was in a position to mould the transaction so as to maximise its tax advantages from his standpoint." 57 His Honour observed that while the tax advantages "were never overlooked" the arrangements between the parties were "were negotiated in a genuine commercial setting" in which, for rewards set by themselves, one party offered a lease of the site for the pine tree plantation, another offered management services and another offered financial accommodation. 58 The respondent also sought to challenge the genuine commercial nature of AHP No 1 on the basis of the fact that the Guaranteed Return was funded by the management fees (see [7] above). The applicants point to further comments by Beaumont J in Lau where his Honour said, at 218: "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 arm's 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." 59 -The failure of the project to yield income above the guaranteed minimum return does not detract from its genuine commercial purpose but merely shows a failure of the project to perform according to estimates

Were the respondents carrying on a business? 60 The second limb of the positive requirement of s 51(1) applies where the losses or outgoings are "necessarily incurred in carrying on a business for the purpose of gaining or producing such income." In this case the applicants, if they were carrying on business, were not doing so directly but through the agency of the Plantation Manager. It is not in contention that it is possible to carry on a business through an agent; Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310, Federal Commissioner of Taxation v Brand (1995) 95 ATC 4633, Merchant v Federal Commissioner of Taxation (1999) 99 ATC 4221 ("Merchant"), Lau and Emmakell are all examples where this has occurred. The issue, however, is whether the Plantation Manager in AHP No 1 was such an agent. The respondent submitted that the financial arrangements showed that the Plantation Manager was an independent contractor. In this regard the respondent drew attention to a number of aspects of the arrangements, including that under the Plantation Agreement:

• the Plantation Manager had the authority, discretions and powers of an independent contractor (cl 5.3);
• the Plantation Manager entered into all contracts with third parties as principal and not as agent (cl 5.4);
• the Plantation Manager's duties could be delegated (cl 6.1);
• flowers were to be pooled and proceeds divided between growers without reference to any particular growers' production or their quality (cl 7.1);
• the Plantation Manager was to be paid an initial management fee of $9,455 per plantation as well as a productivity fee (cl 8.1);
• the Plantation Manager was to be reimbursed all costs after 30 June 1989 (cl 8.2); and
• the Plantation Manager had full and unqualified powers to manage the plantations (cl 16.1). 61 The respondent submitted that in the light of those powers and the fact that once the guaranteed option was taken up a Grower had no more expenses until the Guaranteed Return eventuated, the only available conclusion is that the Plantation Manager was carrying on these activities on its own behalf and not on behalf of the Grower. The grower, it was submitted, was a mere passive investor and was not carrying on a business. The Plantation Manager's powers were such that the Grower had no control over his investment. He could surrender his investment at any time (cl 24) and still get his guaranteed return but he could not interfere with the running of the project. 62 I have already expressed my opinion (see [55] above) that AHP No 1 was a commercial enterprise and that, at the time of the prospectus it was reasonable for the applicants to believe that it was a viable project. None of the elements identified by the respondent, and set out in [60] above, detract from that assessment. The project is distinguishable from that considered by the High Court in Clowes v Federal Commissioner of Taxation (1954) 91 CLR 209. That case concerned an agreement whereby investors sought "a beneficial interest" in the produce of certain land on which timber was to be grown and, on maturity, cut and marketed. The land was divided into one-acre lots which were notionally assigned to each investor so that the produce of each lot was dedicated to the relevant lot-holder. At the outset the lot-holder invested Ł25 per lot but was not required to make any contribution to expenses. On sale of the timber the company was entitled to recover its costs and expenses from the proceeds and retain one-tenth of the balance. The remaining nine-tenths was to be distributed between the lot-holders in predetermined proportions. Despite the use of the term, "beneficial interest" the investor did not acquire ownership of the land or the trees but only a right to "an aliquot share in nine-tenths of the net proceeds of marketing". Dixon CJ described the arrangements as follows, at 217: "[T]he taxpayer did nothing but lay out his money on the faith of the contract and await the result. The company was in no sense his agent. The money which he paid in pursuance of the contracts became part of the general funds of the company. … It made the contract for its own advantage and in performing it acted independently of the direction or control of any lot-holders, whose relationship to the company was simply that of persons providing it with money on special terms."

Later in his reasons (at 218) the Chief Justice observed, "From the taxpayer's point of view it was nothing but a casual investment of capital in hope of enlargement at the end of many years. It was not done in the course of the taxpayer's business." 63 Although cl 18.1 of the Plantation Agreement expressly disclaims any partnership or joint venture between the individual investors, the arrangement for the pooling of flowers has some of the characteristics of a joint venture and the extensive powers given to the Plantation Manager are a reflection of the tighter structure that is required for a joint endeavour to be successful. At best, as Beaumont J observed of the arrangements under scrutiny in Lau (at 218), the issues are "equivocal on the point sought to be made". As his Honour commented: "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 tight legal constraints upon the conduct of their business activities. For the taxpayer to insist upon rigid legal guidelines for the operation of the project may well have been commercially counterproductive in the long run." 64 Under AHP No 1 investors acquired ownership of the plantations. The Plantation Agreement was expressed to be, inter alia, for the provision of management services "to the Grower in respect of the Grower's plantations". The Plantation Manager's "independent contractor" powers were subject to the terms of the Plantation Agreements (cl 5.3). Under cl 8 the Plantation Manager was to be remunerated for those of its management services which were subject to instructions from the Trustee as the grower's representative (cl 5.1). The Grower's representative has a significant role to play in the project, for example being involved in any final determination of a cost as a project cost (cl 16.3). These and other provisions (see [5] above) provided for the Grower to have a continuing involvement in the project although not personally being responsible for cultivation of the flowers. In my view the Grower was not just a 'passive investor' but was involved in carrying on the business of growing flowers. 65 In so far as the criterion in s 51(1) requires that expenditure be "necessarily incurred" in carrying on the business, it is has been held that this means no more than that it was "clearly appropriate or adapted for" the carrying on of the relevant business; Commonwealth and the Postmaster-General v Progress Advertising & Press Agency Co Proprietary Limited (1910) 10 CLR 457 at 469 per Higgins J; Ronpibon Tin NL 56 - 57. The expenditure incurred by the applicants meets this criterion and, in my opinion, it falls within the "business" test of s 51(1). The outgoings were paid by the applicants out of the proceeds of the redemption of their units in the Trust. While the subscription for units in the Trust may have been preparatory to the commencement of the business, the payment of the outgoings were payments made in the course of the business, even if they were the first, or among the first steps taken in that business; Re Griffin; Ex Parte the Board of Trade (1890) 60 LJQB 235 at 237; Fairway Estates Pty Ltd v Commissioner of Taxation (1970) 123 CLR 153 at 165 per Barwick CJ.

Were the expenditures in the nature of capital? 66 The respondent submits that, even if the outgoings meet one or other of the positive criteria in s 51(1), they are not deductible because they also fall within the exception by being of a capital nature. Whether an outgoing is capital or revenue depends on what, as a practical, commercial matter, the expenditure is calculated to achieve; Hallstroms Proprietary Limited v Federal Commissioner of Taxation (1946) 72 CLR 634 at 648 per Dixon J ("Hallstroms"). Both parties referred to the following statement by Dixon J in Sun Newspapers Limited and Associated Newspapers Limited v Federal Commissioner of Taxation (1938) 61 CLR 337 at 363 as the test for distinguishing between expenditure on capital account and on revenue account: "There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment." 67 The outgoings in question were fees paid in respect of management services, guaranteed return and a licence to use land. It is true, as the respondent submits, that in characterising a payment the Court is not bound by the juristic classification adopted by the parties; Hallstroms at 648. However, the classification adopted by the parties is not irrelevant and it is not to the point, as Gibbs ACJ observed in Commissioner of Taxation v South Australian Battery Makers Proprietary Limited (1978) 140 CLR 645 at 660, that the parties may have arranged 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." 68 The respondent submits that the expenditure by the applicants was a means of acquiring an asset, being the possibility of a future income stream. At the very least, it is submitted, the outlay was partly on capital account because it was a means of securing the establishment of the plantations. I do not accept this submission. The Plantation Agreement obliged the Plantation Manager to provide certain services that are quite distinct from the establishment of the plantations. It has not been contended that the Plantation Agreement was a sham and I see no reason why payments said to be in respect of ongoing services to be provided by the Plantation Manager should not be accepted as such. The fact that the management fees were paid at the commencement of the project does not support the conclusion that they should be characterised as capital. In Lau prepaid management fees in respect of services to be rendered over a period of 21 years were held to be on revenue account; see also Emmakell, Brand and Merchant. 69 In Commissioner of Taxation v Osborne (1990) 26 FCR 63 at 71, Pincus J, with whom Spender and French JJ agreed, held that expenses incurred in establishing a plantation of trees were capital expenses, "at least up to the stage of getting seedlings established in the ground". In this case however, the applicants have not sought to deduct the $250 cost of acquiring each plantation. The management fees are attributable to the costs of the management services the Plantation Manager was obliged to supply under clause 5 of the Plantation Agreement. Similarly the licence fee and the guaranteed return fee can be seen to relate respectively to the ongoing management of the plantations and to the ongoing protection of the applicants from risk.

Should the deductions be disallowed under s 82KJ of the Act 70 Section 82KJ provides that an otherwise deductible outgoing incurred after 18 April 1978 will be disallowed if the expenditure is incurred: "(a) … … 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". 71 In simple terms, s 82KJ can be seen as directed to the situation where under an arrangement (which is a "tax avoidance agreement") involving payments to be made on revenue account and on capital account, the former are inflated and the latter diminished so that a disproportionate amount of the total payments is attributed to revenue and therefore, but for the section, would be tax deductible. 72 A "tax avoidance agreement" is defined in s 82KH(1) as: "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 applicants conceded that the Plantation Agreement pursuant to which the outgoings were incurred falls within that definition. The question then is whether the other three criteria apply. 73 The respondent relied on s 82KJ only in relation to the management fees. It was not contended that either the licence fee or guaranteed return fee were subject to s 82KJ. The section will prohibit the deduction of the management fees if: (a) they were incurred under a tax avoidance agreement (which is conceded); (b) the tax agreement included the acquisition of property; (c) the management fees were greater than reasonably to be expected taking into account the services for which the fees were paid and disregarding the property to be acquired under the tax avoidance agreement; (d) the consideration payable in respect of the property to be acquired was less than the consideration that might reasonably be expected if the management fees had not been incurred. 74 As indicated above, the applicants concede that the management fees were incurred in the context of a tax avoidance agreement. There is also no disagreement that the tax agreement involved the acquisition of property, although there was some dispute as to the extent of that property; see [76] below. The respondent submitted that the management fees were greater than might reasonably be expected. The respondent had no evidence to support this although senior counsel for the respondent, Mr Shaw QC, pointed out that a large part of the management fees would have had to be expended in obtaining the letter of credit taken out to secure the Guaranteed Return. The respondent's submission was that these proportions speak for themselves. If such a large part of the management fee was to be expended other than on management then it must be concluded that the management fees were unreasonably high. This submission, however, is inconsistent with the evidence of Mr Weeks (see [32] above) who concluded that the amount of $9,455 incurred by each applicant in respect of management fees for each plantation was reasonable and "not greater than might reasonably be expected under an arm's length transaction." I accept this evidence and find that the requirement of s 82KJ(b) is not met. 75 Given my views in relation to s 82KJ(b) it is not strictly necessary to consider the submissions made in relation to the requirement in s 82KJ(d). In deference to the arguments put by both counsel, and because there is no relevant authority, it may be helpful if I express at least some tentative views. 76 The respondent submits that in these proceedings the relevant property is the right acquired by the applicants: · to ownership of the plantations; · to a guaranteed minimum return of $10,000 per plantation in respect of the year ended June 1993; and · to have the Plantation Manager pay all contributions that would have been payable under the Plantation Agreement but for the exercise of the guaranteed minimum return option. 77 For the purposes of s 82KJ, property is defined in s 82KH as including: "a chose in action and also includes any estate, interest, right or power, whether at law or in equity, in or over property".

Applied without reference to context or purpose, this definition might comprehend all of the rights identified by the respondents. It is appropriate, however, to have regard to the purpose of the provision. This is stated in the explanatory memorandum to the Income Tax Assessment Amendment Bill (No 5)1978 ("memorandum") where, at page 8, it is said that the Bill is to apply to schemes that involve, "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 the tax avoidance arrangement, to be acquired by the taxpayer or an associate." 78 The applicants submit that the property to which the section refers is confined to property "the acquisition of which would involve an outgoing of a capital nature." Furthermore, they submit that the requirement of s 82KJ(d) is met only if the outgoing for which a deduction is claimed, in this case the payment of the management fees, "works a reduction in the value" of relevant property "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. They submit that neither of these requirements are met in this case and that therefore s 82KJ does not apply. Counsel for the applicants, Mr Edmonds SC, admitted that he had no authority to support this contention and relied on the mischief to which the provision is directed and the explanation and examples given in the memorandum and the Minister's second reading speech. 79 In my view, Mr Edmond's first submission that property within the meaning of s 82KJ must be property whose acquisition involves an outgoing of a capital nature must be correct. There could be no taxation avoidance object in a scheme designed to assign a disproportionately small consideration to the acquisition of property bought on revenue account since such an outgoing is likely to be deductible in its own right. The memorandum indicates that the mischief s 82KJ is designed to address does not arise except in circumstances indicated by Mr Edmonds. For this reason only the property in the plantations is relevant for the purpose of s 82KJ. 80 That being so, the condition in s 82KJ(d) will not be met unless the cost of the plantations is less than one might reasonably expect to have been payable if there had been no provision for payment of management fees and, according to the applicants, unless that cost reflects a value which has been diminished by payment of the management fees. 81 The example given on page 8 of the memorandum illustrates the applicants' point: "Under one such scheme, the taxpayer borrows (say) $1,000, ostensibly for income producing purposes, and promptly makes a payment of $700 which represents a pre-payment 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 4% to apply after the pre-payment of 5 years' interest, the loan has a reduced value and can be acquired for $370."

In this example the diminution in the value of the property (the loan) has arisen as a direct result of the inflation of the outgoing (the 5 year interest payment). Another example in the memorandum involves the prepayment of rent under a long-term lease. This has the effect of reducing the value of the lessor's reversionary interest and, on acquisition by the lessee or its associate, the capital cost of the reversionary interest would be less than would have been the case if there had not been the prepayment of rent. This is not the case in relation to the payment of the management fees. The value of the plantations would not be diminished by the payment of management fees, although it is conceivable that their value would be increased by the up-front payment of management fees. 82 The cost to the applicants of the plantations (each comprising 192 seedlings in individual growth bags) was $250 each. The respondent, relying on a Horticultural Report prepared by VCAH, submits that the cost to the Plantation Manager of each plantation was considerably greater than this. That report, dated September 1987, sets out the cost assumptions for establishment of 1000 grower holdings in the project. The report estimates the establishment and capital cost per bag at $7.28 and $3.21 respectively. On those figures a plantation of 192 growth bags would cost considerably more than $250. However, it is not sufficient to trigger s 82KJ for the property to have been acquired below cost. The section requires, and the memorandum makes clear, that the low consideration payable for the plantations must be an "effect" of the payment of the management fees. There is no evidence before me to support such a conclusion and I do not accept that this is the case.

Does Part IVA of the Assessment Act apply? 83 Part IVA of the Assessment Act permits the respondent to cancel a tax benefit, including to disallow otherwise deductible expenditures, where there is a scheme in connection with which the taxpayer derives a benefit and, having regard to the eight criteria set out in s 177D(b) it can be concluded that the purpose or the dominant purpose of the person who entered into the scheme is to obtain a tax benefit. 84 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 reasonably 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 reasonably be expected to results, 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 reasonably 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 of 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; …"

The scheme 85 The respondent identified the scheme in similar terms in relation to the claims of both applicants. As set out in his reply to Mr Cooke's request for particulars for the 1988 year the scheme 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 Midwest to the Mr Cooke, Loans from the Bank to the Plantation Manager and from the Plantation Manager to Midwest, the deposit of part of the proceeds of Mr Cooke's management fees by the Plantation Manager with a subsidiary of the Bank and by that subsidiary with the Bank in order to secure the letter of credit. The respondent identified as an alternative a scheme consisting only of the Plantation Agreement and the Trust Deed, "entered to in the context of the agreements, events and circumstances" comprising the other documents and transactions identified. The respondent also put forward a further alternative that would include 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 Midwest to such investors financing their participation in AHT No 1 and AHP No 1." 86 The evidence of the applicants establishes that at the time of making their investments they knew nothing about the transactions emphasised in bold in [85]. The applicants therefore submit that these transactions cannot be part of the scheme. In Commissioner of Inland Revenue v BNZ Investments Limited (2001) 20 NZTC 17,103 Blanchard J, referring to a New Zealand anti-avoidance provision dealing with tax avoidance "arrangements", made a similar point saying at [172]: "It is a fundamental pre-requisite to the use of s 99 against the taxpayer that there be a contract, agreement, plan or understanding (the words the legislature chose to use in s 99(1) in defining "arrangement") in which the taxpayer is a participant. This state of affairs cannot exist for the taxpayer unless there has been formally or informally - even if unenforceably - a consensus between the taxpayer and another or others as to what, in general terms, will occur pursuant to the arrangement. The taxpayer does not have to know all the detail or be able to discern exactly how the arrangement will avoid tax by producing the illegitimate tax advantage, by which I mean an advantage which the legislature cannot have contemplated as flowing from the legislation. But the taxpayer must at least have a broad appreciation of the character of what is occurring." 87 Those comment of Blanchard J can equally apply to the identification of the relevant "scheme" under Part IVA. For this reason, the transactions of which the applicants were unaware at the relevant time cannot be part of the Part IVA scheme. 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. 88 It my view, it is only the respondent'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] ("Hart") that the definition of a scheme must be able to "stand on its own feet". The tax benefit identified by the respondent is 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 of 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). 89 The respondent submits that although AHP No 1 was itself speculative, the provision for a guaranteed return meant that the applicants obtained deductions at little or no risk to themselves. Most of their initial outlay was secure and they were expecting a tax deduction for 95 % of their contributions. Furthermore both applicants had experienced a significant rise in income that, in the absence of a substantial tax deduction, would generate a tax liability that they would have difficulty in meeting. This it is submitted, "made the success or failure of the project a matter of indifference" to the investors and indicates that their dominant purpose was obtaining the tax deduction. 90 In assessing whether the dominant purpose of the applicants in entering into the scheme was to obtain a tax benefit, it is the objective purpose that must be ascertained not the subjective purpose or state of mind of the applicants; Commissioner of Taxation (Cth) v Spotless Services Ltd (1996) 186 CLR 404 ("Spotless") at 421 - 422; Eastern Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27 at [81] - [82] and [87] - [88] per Carr J with whom Sundberg J agreed. In Spotless, at 416, the majority of the High Court stated that a dominant purpose, in its ordinary meaning, is one "which was the ruling, prevailing or most influential purpose". This must be assessed having regard to the matters set out in s 177D(b) and the conclusion must be one to which a reasonable person would come; Spotless, at 422. The matters stated in s 477D(b) are comprehensive and as Hill J (with whom Ryan and Cooper JJ agreed) stated in Peabody v Commissioner of Taxation (1993) 40 FCR 531 at 543: "In arriving at his conclusion, the Commissioner must have regard to each and every one of the matters referred to in s 177D(b). This does not mean that each of those matters must point to the necessary purpose referred to in s 177D. Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers." 91 There has been no suggestion that the AHP No 1 was a sham. Nor has it been denied by either of the applicants that the taxation advantages of their investment in the project was an important aspect. The evidence of Mr Cooke and Mr Jamieson has already been summarised (see [18] to [26] above). Their evidence was that they were within some years of retirement and that they had not made adequate provision for income during their retirement. They wanted to provide an income for their retirement and for that reason they wanted a relatively long-term project. At their stage of life there was not much time in which to achieve these goals. The reality of their respective financial positions at that time was that they did not have significant personal resources to finance investment and therefore they needed to borrow for investment. It was also a reality that at the relevant time both were experiencing an increase in income that would generate additional tax liability that had to be met. An investment that did not carry with it a substantial tax deduction would significantly compromise their ability to make an income producing investment for their retirement. 92 The fact that both applicants elected to take the option of receiving a guaranteed return is consistent with the applicants prudently protecting their investment. While it may not have been of great concern if the investment were not to produce substantial income immediately, it was important not to incur liabilities that would prejudice their retirement situation. It seems to me to be objectively reasonable that the applicants would have regarded the success of AHP No 1 as important, even while they took steps to protect themselves if it were not successful. Moreover, the guaranteed return did not entirely protect them as the amount of the return was taxable in the hands of the applicants and therefore only the after-tax portion would be available for repayment of their loans. 93 It is also reasonable to assume that the purpose of the Plantation Manger in providing for a guaranteed return was to facilitate promotion of the scheme and thereby generate more fee income. The fact that the tax deductibility of the outgoings was an integral part of the structure of the arrangement does not support the conclusion that there was a dominant purpose to produce a tax benefit in the hands of the applicants. 94 In my view the manner in which the scheme was entered into and carried out, the form and structure of the scheme, the time at which it was entered into, and the duration of the scheme are all consistent with the applicants having a dominant purpose of generating income for their retirement rather than enabling them to obtain a tax benefit. 95 Subparagraph (iv) of s 177D(b) requires one to assume that the applicants would be entitled to the deductions claimed, apart from Part IVA. In relation to the applicants the result would be that they would be entitled to deductions in respect of the outgoings. This is not sufficient to point to the dominant purpose of the scheme being to obtain that benefit. Subparagraph (v) directs attention to any change in the applicants' financial position resulting from, or reasonably expected to result from, the scheme. At the time the applicants invested in AHP No 1, being the time at which the purpose of persons involved in the scheme must be objectively assessed, they could reasonably expect retirement income if AHP No 1 succeeded, a comparatively small loss if it failed and, in any event, a significant tax deduction. As was pointed out in the applicants' submissions, that tax deduction was "offset by inclusion in their assessable income of an equivalent amount in the 1994 year of income". In the applicants' submission this gave them a timing advantage but does not of itself point to a dominant purpose of obtaining a tax benefit. Subparagraphs (vi), (vii) and (viii) of s 177D(b) are not relevant here. 96 While the tax benefit that each applicant obtained through their investment in AHP No 1 was important and, as a practical matter, may have made their investments feasible, objectively viewed it is not the case that the investment made no sense without the tax benefit. The scheme here is distinguishable from the scheme considered in Spotless. That scheme involved off-shore investment to obtain exemption from taxation under Australian taxation law through a series of artificial steps. The High Court agreed that the scheme made no sense without the advantage; see Spotless at 422. McHugh J, at 425, referred to the "elaborate nature of the scheme and its attendant circumstances" stating that this led inevitably to the conclusion "that the scheme was not merely tax driven but that its dominant purpose was to enable the taxpayer to obtain a tax benefit by participating in the scheme". Similarly comments could be made in relation to the schemes considered in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 179 ALR 625 and Hart.

Conclusion 97 For the above reasons I consider that the applicants are entitled to the deductions claimed in respect of the outgoings each incurred. On that basis, the appeals should be allowed, the respondent's objection decisions set aside and the respondent directed to allow the objections. The applicants should have their costs of this appeal. I certify that the preceding ninety-seven (97) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Stone.

Counsel for the Applicants: R F Edmonds SC with M Richmond

Solicitor for the Applicants: Allens Arthur Robinson

Counsel for the Respondent: J W Shaw QC with S J McMillan

Solicitor for the Respondent: Australian Government Solicitor

Date of Hearing: 26, 27, 28 November 2001