Hart v Commissioner of Taxation

REASONS FOR JUDGMENT SPENDER J: 1 This is an appeal against the dismissal by a single Judge of this Court of an appeal pursuant to s 14ZZ of the Taxation Administrataion Act 1953 (Cth) ("the Administration Act") against the decision of the Commissioner of Taxation concerning the appellant's assessment to income tax for the year ended 30 June 1996. The Commissioner had increased the amount of the appellant's taxable income as returned by an amount of $108,580, and penalties. It was conceded before the primary judge that the Commissioner was correct in disallowing an amount of $50,000. The appeal before the primary judge concerned the balance of $58,580 and the penalties in relation thereto. 2 The Commissioner disallowed deductions claimed by Unlimited Aerobatics Pty Ltd ("Unlimited") as trustee of the Unlimited Aerobatics Discretionary Trust ("the Unlimited Trust"). Mrs Hart is a beneficiary under the terms of the Unlimited Trust. Unlimited resolved that she should receive all of the Unlimited Trust income for the 1995-1996 tax year. The disallowance by the Commissioner of the relevant deductions therefore led to a consequential increase in her assessable income. 3 In the Commissioner's reasons for decision for disallowing the claimed deductions in the income tax return of Unlimited Trust in the amount of $58,581, the Commissioner noted the taxpayer's contentions, including contentions that: '8. Unlimited has at all material times operated a business of aviation. 9. Unlimited has a stable of aircraft built up over a number of years consisting of ex-military aircraft, aerobatic aircraft and charter aircraft. 10. Each aircraft has a differing scale of charges for air shows or joy rides. The invoice prices depend upon the length and complexity of the air show and the ferry time to transport the aircraft to the air show. 11. Air shows have been performed at the Gold Coast Indy Grand Prix, Bundaberg, Archerfield, Raglan, Mareeba and other venues. 12. It is anticipated that the air show sector of the business will be profitable in the financial year ended 30 June 2001 or 2002. 13. The collection of aircraft is a unique collection and the reputation and attractions associated with the hire of aircraft has been built up over a number of years.' 4 The decision in respect of the claimed expenses was: 'The Commissioner has disallowed expenses of $58,581 claimed in respect of the operation of the aerobatic/airshow aircraft as it is considered those operations do not constitute the carrying on of a business.' 5 The reasons for decision referred to what was said to be "the principles that were particularly relevant", namely: '(i) It is not for the Commissioner to tell a taxpayer how to carry on a business (Tweddle v FC of T (1942) 7 ATD 186). (ii) It is necessary for the activities to manifest the essential characteristics required of a business. The activities must be undertaken as a commercial enterprise in the nature of a going concern, that is, generally speaking, activities engaged in for the purpose of profit on a continuous and repetitive basis (Ferguson v FC of T (supra) at 79 ATC at p 4264). However, activities may constitute the carrying on of a business even though carried on in a small way (Thomas v FC of T 72 ATC 4094; Hope v Council of the City of Bathurst 80 ATC 4386), while it is possible to have the elements of repetition and continuity present without a business being carried on (Hudson Bay Co v Stevens (1909) 5 TC 424; Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR 188; 9 ATD 135). (iii) It is the extent of the activity and not the state of mind or intention of the taxpayer which determines whether a business is being carried on (Inglis v FC of T 80 ATC 4001). However, intention may be relevant, for example where a transaction produces no income (John v FC of T 89 ATC 4101 at p 4105) or it constitutes the first step in a business (Fairway Estates Pty Ltd v FC of T 70 ATC 4061). (iv) Whether a person is a trader (ie in the business of trading) is a question of fact. "If trading has not commenced or if there is no discernible trading pattern, the question of intention or purpose may be relevant in the sense that if there is an absence of intention or purpose to engage in trade regularly, routinely or systematically then the person may well not be a trader. A fortiori if some contrary or inconsistent intention or purpose is present. But if trading has commenced and the activities reveal a discernible trading pattern, then it seems to us that the motive for undertaking the activities or for undertaking a particular transaction cannot serve to characterise the person engaging in those activities as a non-trader, or as a non-trader in relation to a particular transaction." (John v FC of T (supra) at p 4107). Where the issue is whether a taxpayer is carrying on a business of trading or dealing in shares, the mere fact that an investment adviser is employed who brings to bear professional management principles will not, of itself, require the conclusion that a business is carried on if the activities themselves do not amount to a business (Trent Investments Pty Limited v FC of T 76 ATC 4105; FC of T v Radnor Pty Ltd 91 ATC 4689 at p 4701). (v) It is possible for a person to carry on more than one business (Howden Boiler & Armaments Co Ltd v Stewart (1924) 9 TC 205; IR Commrs v W Ransom & Son Ltd (1918) 12 TC 21; H & G Kinemas Ltd v Cook (1933) 18 TC 116). It is also possible for a person to carry on a business as a part-time sideline to that person's main activities (Ferguson v FC of T (supra) at p 4, 264).' 6 The core reason for the Commissioner's disallowance of the relevant expenses appears as follows: 'It is considered that the operation of the aerobatic/airshow aircraft does not constitute the carrying on of a business, but would be a hobby, albeit an expensive one. Steve Hart is a licensed pilot and an aerobatic pilot - he has been Australian Champion. The monies received in relation to the aircraft are for prizemoney in aerobatic competitions or joy rides at airshows. It appears that Mr Hart's passion is aerobatic and similar aircraft - he has amassed a reasonable stable of them, but this does not necessarily constitute a business. The reasons for concluding that this activity does not amount to the carrying on of a business for the purpose of deriving assessable income are: s The activities are not undertaken as a commercial enterprise - the activities are a reflection of Mr Hart's passion for these sort of aircraft. He has been requested to provide evidence of activities being of a business nature, but has failed to do so. s The records do not indicate any great extent of revenue earning activity being undertaken - there are many expenses, but little income. This is an indication that the activity is a hobby of Mr Hart's. s The records do not indicate there is a discernible trading pattern. It appears that Mr Hart attends a very limited number of airshows and championships each year. The irregularity would appear to indicate that a business is not being conducted. s The level of income is extremely low - only $6,190 earned over an eight year period. However in the same period expenditure of $357,381 has been spent on the relevant aircraft. This indicates that the activity would be incapable of providing any profit. s The aircraft were inspected by auditors from the ATO on 10 April 2000. That inspection did not alter their view that, apart from the Baron, the aircraft do not form part of a business.' 7 The primary judge recorded: 'The applicant has submitted that the justification for the claimed deduction is that they were incurred by Unlimited in the 1995-1996 tax year in carrying on the business of providing air show activities. Should the applicant fail to establish that proposition, then the appeal must fail.' After reviewing the eight-year history of income and outgoings for the tax year ending 30 June 1991 to the tax year ending 30 June 1998, and noting that: '… during the 1995-1996 tax year Unlimited was involved in business-like activities in the aviation industry', his Honour said: 'I am not satisfied that Unlimited operated such a business [involving airshow activities] during the 1995-1996 tax year.' His Honour said: 'My primary reason for that conclusion is simply the unlikelihood that anybody running a business would continue to incur such heavy losses for so long.' (During that eight-year period the income was $6,190 and the claimed expenditure was $357,381). In relation to penalties, his Honour said: '… I see no reason to doubt the correctness of the finding of recklessness for the purposes of s 226H.' [of the Income Tax Assessment Act 1936 (Cth) ("the Act")] 8 The appellant in this Court challenges the ultimate finding by the primary judge that Unlimited did not operate a business involving airshow activities during the 1995-1996 tax year. It was submitted that, in reaching that conclusion, the primary judge made findings of fact which were either unsupported by the evidence or against the weight of the evidence. It was further submitted that the ultimate finding by his Honour involved a breach of the rules of procedural fairness, in that the conclusion by his Honour that: '… the operations in connection with airshow activities undertaken by Nemesis prior to the end of 1994 and by Unlimited thereafter and until the end of the 1995-1996 tax year were in connection with Mr Hart's hobby. No business was being conducted.' was inconsistent with two affidavits of the appellant and an affidavit by her husband, Steven Irvine Hart, an accountant, and the tax agent who submitted the 1995-1996 income tax return. It was pointed out by counsel for the Appellant that it was never put to Mrs Hart in cross-examination, that the airshow activities undertaken by Nemesis Australia Pty Ltd ("Nemesis") prior to the end of 1994 and by Unlimited thereafter until the end of the 1995-1996 tax year, were in connection with Mr Hart's hobby, and that Mr Hart was not cross-examined at all. 9 Finally, it is contended that his Honour erred concerning the finding of recklessness for the purposes of s 226H of the Income Tax Assessment Act 1936 (Cth) ("the Act"), particularly having regard to an audit conducted by the Tax Office in late 1987 or early 1988 in respect of the affairs of Nemesis for the period from 1981 to 1987, and to the absence of any suggestion or disallowance of aircraft expenses connected with the business of aerobatic airshows since 1985 on the basis that Nemesis was not conducting a business. 10 It is convenient to deal with each of these three broad areas in turn. Expenses the subject of disallowance in the present case: 11 In relation to the operation of aerobatic/airshow aircraft, whether the operation of those aircraft constitutes the carrying on of a business is central to the deductibility of those expenses within the second positive limb of s 51(1) of the Act. 12 While it might seem trite, that provision is central to this appeal. Section 51(1) relevantly provided: '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.' 13 It is also trite that losses and outgoings may be allowable deductions in accordance with the provisions of s 51(1) of the Act, although incurred in a year in which no assessable income is actually gained or produced by the activities in relation to which the losses or outgoings are incurred: Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56. 14 There can be no argument but that the case for Mrs Hart below was on the basis that the airshow activities were undertaken as a commercial enterprise for the making of a profit, albeit not necessarily with the immediate purpose of profit making in any particular year. The applicant submitted below that the business commenced in or about September 1985, originally under the business name Rufus Splice Aero Services. The business name was registered and a bank account was opened. Originally the business was carried on by Steve Hart Family Holdings Pty Ltd, which later changed its name on 1 October 2001 to Nemesis Australia Pty Ltd. Unlimited was incorporated on 20 January 1995 and the Unlimited Trust was established by deed of settlement dated 17 February 1995, with Unlimited as trustee. 15 Shortly thereafter, Unlimited took over the existing aviation business previously operated by Steve Hart Family Holdngs Pty Ltd, as trustee for the Steve Hart Family Trust. In October 1985 Nemesis purchased a Pitt Special aircraft for about $36,000. In late 1987 Nemesis decided to purchase another aircraft, and in early 1988 it purchased a Laser aircraft for $90,000. In 1991 Nemesis acquired a Beechcraft Baron aircraft. It was not for use in airshow activities, and the admitted facts are: 'The Baron aircraft is used in the business of Harts Accountants and all expenses associated with this aircraft are not in question.' 16 In October 1994 Nemesis ordered a CAP 232 aircraft expecting that it would be delivered in April 1995. In December 1994 Nemesis disposed of its aircraft other than the Beechcraft Baron, in order to fund the acquisition of the CAP 232. In about January 1996 Mr Hart negotiated for the acquisition from Mr Malcolm Rolph-Smith of a half share in a North American Trojan T28 aircraft for $130,000 for which, according to the contract dated 29 April 1996, Unlimited was the purchaser. Apparently, it was later agreed that the Trojan T28 aircraft would be operated by another company, Wings and Wheels (Aust) Pty Ltd as trustee of another discretionary trust, the Wings and Wheels (Aust) Discretionary Trust, of which Unlimited and Mr Rolf Smith were the beneficiaries. In about August 1996 Unlimited acquired another aircraft in partnership with Mr Rolph-Smith. 17 The evidence as to the income received and deductions claimed in connection with aircraft other than the Beechcraft Baron in the tax years 1990-1991 to 1997-1998 was: Year ended 30 June Income Expenditure Claimed By Steve Hart Family Trust 1991 $1,000.00 $28,046.00 1992 $940.00 $20,966.00 1993 $1,000.00 $35,943.00 1994 $1,000.00 $12,028.00 1995* $0.00 $11,274.00 By Unlimited Trust 1996 $0.00 $58,581.00 1997 $2,450.00 $111,052.00 1998 $700.00 $79,491.00

18 The primary judge said of this evidence: 'However, in the eight years for which figures are set out, total income was $6,190.00. For the same period claimed expenditure was $357,381.00. I accept that establishing such a business necessarily involved development of a reputation over time. Mr Arnott's evidence demonstrates as much. However the continuing disparity between income and outgoings is difficult to reconcile with an intention to carry on a business. Although one may incur losses in conducting a business in the hope of a subsequent profit, hope usually gives way to reality, at least where money is concerned. A prudent person, in the position of Nemesis or Unlimited, would have concluded, by 1995, that no profit was likely. By that time, the alleged business had been operating for almost ten years. There is no reason to believe that the figures for the period 1985-1990 were any more promising than those for the years 1991-1998. By late 1992 or early 1993, Mr Hart had identified the need for a new aircraft, and yet it was not ordered until late 1994. This is also inconsistent with an intention to trade at a profit. In fact, the new aircraft did not arrive until late 1995, three years after Mr Hart had identified the need for it. Mr Hart and the applicant undoubtedly share a keen interest in aviation. Although the figures may not be conclusive, they strongly suggest an expensive pastime rather than a business.' 19 An appeal to this Court is by way of rehearing: Western Australia v Ward (2002) 76 ALJR 1098. As recently confirmed by the High Court in Fox v Percy [2003] HCA 22, the correct approach by an appeal court hearing such an appeal is to be found in the judgment of the majority in Warren v Coombes (1979) 142 CLR 531 at 551: '… in general an appellate court is in as good a position as the trial judge to decide on the proper inference to be drawn from facts which are undisputed or which, having been disputed, are established by the findings of the trial judge. In deciding what is the proper inference to be drawn, the appellate court will give respect and weight to the conclusion of the trial judge, but, once having reached its own conclusion, will not shrink from giving effect to it.' 20 Having regard to those principles, I am satisfied that no error attends the conclusion of the primary judge that in the 1995-1996 tax year, the relevant outgoings were not incurred in connection with a business operated by Unlimited involving airshow activities. Denial of procedural fairness 21 The appellant contends that the respondent breached the rule in Browne v Dunn (1894) 6 R 67, and that in the premises, this amounted to a breach of the rules of procedural fairness. 22 The rule in Browne v Dunn (supra) is summarised by a Full Court of the Federal Court (Lee, Hill and Sundberg JJ) in Flower & Hart (a firm) v White Industries (Qld) Pty Ltd (1997) 87 FCR 134 at par 51: 'As a general rule, before an adverse finding is made against a witness in contradiction of sworn testimony given by that witness, a matter in issue, the subject of that finding, must be put to the witness in cross-examination to enable him or her to give an explanation. However, there can be no need to put such an issue to a witness who has notice that there is other material in the proceedings that will be relied upon to contradict the evidence of the witness: see Allied Pastoral Holdings Pty Ltd v Commissioner of Taxation (Cth) [1983] 1 NSWLR 1 at 16; R Cross, Cross on Evidence (4th ed, 1991), par 17445.' 23 In this case there can be no doubt that the appellant and Mr Hart were on notice that the respondent asserted that the activities carried on in connection with the airshow aircraft did not amount to the carrying on of a business and were, in effect, the pursuit of an expensive private hobby of Mr Hart. The reasons of the Commissioner earlier set out in these reasons make the position plain. 24 What Mrs Hart did depose to is the following: 'I believe that at all material times the abovementioned expenses were necessarily incurred in the carrying on of an aviation business for the purposes of gaining or producing assessable income by Unlimited since it took over the business on 17 February 1995.' In her other affidavit Mrs Hart said: 'We knew the training would take a long time possibly years, and that it would also take several years for our reputation to grow. I could not expect to make a profit within the first five years at least and in fact the income did not grow until after the first five years of operation. It was always my expectation that once profits were made that tax would be levied on the income. At all times as referred to later in this affidavit decisions were made regarding the operations of the business which reflected the commercial nature of the business being undertaken.' 25 It was sufficient for the trial judge, and sufficient for this Court, to find that the appellant has not established, on the balance of probabilities, that any airshow business was carried on by Unlimited in the 1996 tax year. The onus of proof on a taxpayer in these circumstances was explained by the Federal Court in Richard Walter Pty Ltd v FCT (1996) 67 FCR 243. 26 The determination of whether the airshow activities and aircraft involved the carrying on of a business or the pursuit of a pastime were the subject of express submissions by the appellant below. The determination of that question by the primary judge involved the proper legal character to be placed on the evidence and the agreed facts. It did not involve weighing contradictory evidence or making findings as to the credit of the witnesses. The belief of Mrs Hart that Unlimited was conducting such a business in the 1996 year was not the subject of any challenge, it is true. That, however, is not determinative of the question before the Court, which was whether in fact and in law a business involving airshow activities was being carried on in 1996. The finding that there was no business in the 1996 year had the consequence that the appellant's belief was mistaken; that finding does not involve the collateral finding that the assertion by the appellant of her belief was deliberately false. Penalties 27 Section 226H of the Act provides: 'Subject to this Part, if: (a) a taxpayer has a tax shortfall for a year; and (b) the shortfall or part of it was caused by the recklessness of the taxpayer or of a registered tax agent with regard to the correct operation of this Act or the regulations; the taxpayer is liable to pay, by way of penalty, additional tax equal to 50% of the amount of the shortfall or part.' 28 The primary judge rejected the claim that the contention that Unlimited was carrying on a business involving airshow activities in the 1996 tax year were "fairly arguable". His Honour commented: 'If Harts Pty Ltd had considered this matter in light of the long history of Nemesis receiving very low income for very high outgoings, it would inevitably have had serious reservations about the deductibility of the expenses in question. It is, to say the least, extremely unusual for a business persistently to incur substantial expenses for no appreciable return.' And later: 'Harts Pty Ltd should also have taken into account the suggestion that reputation was important in earning income in air show activities and the need for pilot training. These matters would have led to doubts about whether Unlimited was conducting such a business, given the absence of any activity until very later in 1995 when Mr Hart commenced training.' His Honour concluded: 'Any rational consideration of the facts would have demonstrated that by 1995, no business was being carried on in connection with air show activities.' One is left to infer, by implication, that to contend there was such a business was recklessly to make that claim. 29 So much might be accepted if the matters rested there. However, Mr Hart, who was not cross-examined, deposed: 'In a previous audit no question had been raised as to the appropriateness of the treatment adopted.' Mr Hart in his affidavit said: "I also recall that in or around late 1987 to early 1988 the ATO conducted an audit into the affairs of Nemesis. The Audit was conducted by a Mr Lawson and a Mr Smith. The period of the audit was for 19871 to 1987 to my recollection. At the time of the audit, Nemesis was conducting the business of Aerobatic air shows since 1985. While some adjustments were made to the assessable income to Nemesis for that 6 year period, to my recollection, there was no suggestion or disallowance of the aircraft expenses by stating that Nemesis was not conducting a business.' 30 His Honour said: 'In 1987-1988 it may well have been arguable that Nemesis was seeking to establish a business with a view to trading at a profit. The business had been going for less than three years. However, as I have observed, hope cannot last forever in the face of adversity. By 1996 it was patently clear that the undertaking had failed to yield a profit. That inevitably raised the question of whether or not persistence in it by Mr Hart, the applicant and associated entities was motivated by a desire to carry on business or by some other personal motivation such as interest in aviation. Harts Pty Ltd could hardly have relied on an opinion formed in 1988 in light of the subsequent trading history. For those reasons I see no reason to doubt the correctness of the finding of recklessness for the purposes of s 226H.' 31 Section 226H permits the imposition of a penalty only in circumstances of recklessness by the taxpayer or his agent. A knowingly false claim is not within the section, which was the section on which the Commissioner relied. 32 While it may have been wrong of Mr Hart to have relied on an 'opinion formed in 1988', having regard to the 'subsequent trading history' in making a claim that a business was being conducted, in my opinion it is not properly to be regarded as "reckless" to have persisted in a claim which was not the subject of any disputation at an earlier time, even accepting that the period of losses and the extent of them had not been as extensive as they were at a later time. 33 It is not reckless simply to make a claim that is erroneous. Nor, in my view, is it reckless to make a claim, "knowing there is a real risk that the claim might be wrong;" cf the observations of Cooper J in BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) ATC 411 at 4129. If a jockey knows that in a horse race there is a real, as opposed to a fanciful, risk of serious injury or death involved in participation in the race, it would not be reckless conduct on the part of the jockey according to the proper meaning of "reckless", to take part in the horse race. So, too, a driver in a Formula 1 motor vehicle race. 34 Recklessness consists in making a claim, not caring whether the claim is true or false. The character of the undertaking had not changed between the time of the audit to 30 June 1996. If the character of the undertaking might properly be characterised as a business after about three years of operation, while it was wrong to claim that it was still a business in 1996, in my view it cannot be said to be reckless within the proper meaning of that word in s 226H of the Act, to make that claim, notwithstanding that no profit had been made up until then. 35 I would allow the appeal in part, by reducing the penalties which have been imposed on the appellant in this respect by the respondent in respect of the 1995-1996 tax year, to nil. 36 As to costs, the appellant failed in its primary contention, but in my opinion is entitled to succeed on the discrete issue as to penalties. In the circumstances, a fair exercise of the discretion as to costs would be to not interfere with the costs order below, and to order that there be no order as to the costs of the appeal. I certify that the preceding thirty-six (36) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Spender

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