R & D Holdings Pty Ltd v Deputy Commissioner of Taxation

Introduction 12 Put shortly this issue arises in the following way. In 1993 Mr Richardson became aware that the property at 27 Reiby Place, Sydney ("Bulletin Place") was available for acquisition. On 23 June 1993 Richardson Properties entered into a contract for its acquisition. Mr Richardson then entered into discussions with the owners of the neighbouring property at 22 Pitt Street for the purchase of that property. The owners would only sell a small parcel of their land used for parking that fronted onto Bulletin Place. Richardson Properties purchased this parcel on 24 August 1995. Both purchases were made by Richardson Properties for the Hallinn Trust. 13 Over the following 18 months plans for constructing a new office building on the composite site were prepared; approvals were sought; and financing was secured. The building was designed as a strata building. A contract was entered into for the construction of the building in early 1997. Practical completion occurred in April 1998. The final cost of the project was about $19,857,408. 14 In the period June - August 1998 a draft strata plan and by-laws were prepared. These were lodged with the Titles Office for examination. They were later withdrawn. The building was not subsequently made the subject of strata title. 15 In 1996, for the purposes of raising finance for the construction of the building, Mr Richardson sought advice from Landsbury's (Aust) Pty Ltd as to (inter alia) "the total gross realisation potential [of Bulletin Place] on completion of construction and registration of a strata plan". The valuation given by Landsbury's was $40,096,000. 16 On 2 June 1998 Mr Richardson had a meeting with Richard Bobb. Mr Bobb was a chartered accountant and was responsible for the tax returns and financial accounts for Chapel Road, R & D Holdings, the Hallinn Trust and Richardson Properties. He made the following note of that meeting on 5 June 1998: "On 2 June 1998 I spoke with Andrew Richardson and have been informed that the Bulletin Place property has now been completed and a valuation is available. The valuation shows the property to be worth $40,000,000. Based on this valuation, Mr Richardson advised he would like to revalue the property in the accounts of The Hallinn Trust as at 30 June 1998 to market value. This effectively means The Hallinn Trust will elect, under section 70-45 to treat the property at Bulletin Place (being trading stock) at market selling value. To corroborate the treatment of this asset as trading stock I have emphasised that all relevant external documentation should support the view that the property was acquired for development and resale. With this in mind, I would like Debby to check the minutes of the trust at the time the property was acquired from the liqudiator [sic]." 17 Having ascertained that the trust's file contained no minute approving the 1995 purchase of the Bulletin Place property, Mr Bobb prepared draft minutes of a meeting of Richardson Properties as trustee of the Hallinn Trust dated 24 August 1995. That draft noted that "the property was acquired for development and resale". Mr Richardson received and returned a signed copy of the minutes. 18 Mr Bobb's affidavit evidence concerning this meeting, which I accept in preference to Mr Richardson's (for reasons I give later) where they are inconsistent, was that Mr Richardson wanted R & D Holdings to take a distribution of income from the Hallinn Trust in relation to which losses transferred from Chapel Road to R & D Holdings could be used as deductions. 19 Keo Chui, a partner in Mr Bobb's firm, read and initialled Mr Bobb's 5 June note around the time it was made. In April 1999 he prepared the draft financial accounts and tax return for the Hallinn Trust for the year ending 30 June 1998. The accounts reflected the Landsbury valuation that had been provided by Mr Richardson. Included was an amount for income of $20,482,888 resulting from the revaluation. The accounts and tax return were explained to, and approved by, Mr Richardson. 20 In the 1998 tax year Chapel Road executed an agreement to transfer to R & D Holdings losses incurred in the 1993, 1994, 1995, 1996 and 1997 years in the sum of $25,943.314. 21 The Bulletin Place property was not sold and has remained an asset of the Hallinn Trust.

The applicant's contentions 22 R & D Holdings' case in this proceeding accepts that while the treatment of the Bulletin Place property as trading stock in the 1998 accounts and tax return was intentional, it was nonetheless mistaken, the mistake being in relation to the operation of the definition of trading stock in s 70-10 of the 1997 Act. 23 Section 70-10 defines trading stock insofar as presently relevant as including - "(a) anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business." 24 It is R & D Holdings' contentions that (i) the Bulletin Place property was acquired and constructed as a long term investment and was not "held for purposes of … sale … in the ordinary course of business"; and (ii) the Bulletin Place property could not have been trading stock in any event because at the end of the 1998 tax year the property was not a subdivided parcel of land and hence it lacked marketability. 25 The first of these contentions requires an analysis of Richardson Properties' purpose or purposes as trustee in relation to the holding of the Bulletin Place property and particularly as at 30 June 1998. That inquiry is essentially one into Mr Richardson's state of mind as he asserts he was responsible for the making of decisions on behalf of the Trust, his co-director sister acting in accordance with his decisions and recommendations. As will be seen below, R & D Holdings also seeks to place a gloss on the definition of "trading stock" in its reference to "in the ordinary course of business" by asserting that it requires "trading in", i.e. repeated buying and selling, of the stock in question. 26 The second ("the lack of marketability") contention involves some examination of case law relating to land and in particular the decisions of the High Court in Federal Commissioner of Taxation v St Hubert's Island Pty Ltd (1978) 138 CLR 210 and of Rogers J in Barina Corporation Ltd v Federal Commissioner of Taxation (1985) 4 NSWLR 96. 27 The final introductory comment to be made is this. If I conclude that Bulletin Place was trading stock of the Hallinn Trust, it is not disputed that the "market selling value" of the property as at 30 June 1998 was not the amount of $40,096,000 adopted by the trustee. Rather it was no more than $29,000,000. In consequence the net income of the Hallinn Trust for the 1998 year was not $24,619,100 (as stated in the 1998 tax return). It was no more than $13,523,100.

The Legal Context 28 Sections 70-10 and 70-35 of the 1997 Act are the relevant statutory provisions for present purposes. I have set out the s 70-10 definition of "trading stock" above. It is cast in relatively similar, but by no means identical, terms to the s 6(1) definition in the 1936 Act which, prior to 1997, included "anything … acquired or purchased for purposes of … sale". The two notable differences are that the 1997 definition refers to the property being "held for" purposes of manufacture, sale or exchange "in the ordinary course of business". I would emphasise in this that, as acknowledged in s 70-5 and s 70-10 of Part 1, Schedule 5 of the Tax Law Improvement Act 1997 (Cth)the 1936 and 1997 definitions are not coextensive in what they include within their respective definition. Importantly, while the s 6(1) definition emphasised the purpose for which property is "produced, manufactured or acquired", the s 70-10 definition is concerned with the purpose for which property is "held". The s 6(1) definition was amended by the Tax Law Improvement Act to reflect the s 70-10 definition in the 1997 Act. 29 Section 70-35 provides: "70-35 You include the value of your trading stock in working out your assessable income and deductions (1) If you carry on a business, you compare: (a) the value of all your trading stock on hand at the start of the income year; and (b) the value of all your trading stock on hand at the end of the income year. (2) Your assessable income includes any excess of the value at the end of the income year over the value at the start of the income year." 30 R & D Holdings' submissions on the application of the definition of trading stock raises, as I earlier noted, two issues of law. The first is that to satisfy the requirement that property be "held for purposes of sale … in the ordinary course of a business", it is necessary to show that there was an identifiable business which "traded in" the property in question. 31 The second, as noted previously, is the contention that property which was not subdivided lacked marketability and hence could not have been trading stock.

(i) The "trading in" contention 32 As I understand the applicant's contention it proceeds from the submission that the evidence does not support the view that the Hallinn Trust ever conducted a business of trading in anything, with the consequence that there could not have been any sale in the ordinary course of business. It is then said that while land can constitute trading stock of a taxpayer whose business involves buying and selling land, there must nonetheless be an identifiable business of trading in land with some regularity or system. Here there was no evidence of a business of trading in land. 33 Later in these reasons I find that the Bulletin Place property was held for the purpose of development, strata subdivision and sale of subdivided lots. In light of this finding the question the 1997 Act requires to be answered is whether the envisioned sale of the subdivided lots would be in the ordinary course of business. For reasons I give below, I am satisfied that this "one venture": cf Federal Commissioner of Taxation v St Hubert's Island Pty Ltd (in liq), above, at 237-238, of holding the Bulletin Place property for the purpose I have found, necessarily entailed that the envisioned sale of lots would occur in the ordinary course of a business of developing, etc the Bulletin Place property. That business was functioning in the 1998 tax year, as will later become apparent when I indicate the business activity that was engaged in in that period, for the purpose of effectuating the property's development, strata subdivision and sales of lots. 34 To anticipate what I have to say below, I reject R & D Holdings' contention that, for the Bulletin Place land to be trading stock, it must first be shown that the Hallinn Trust carried on a business of trading in land in the sense of buying and selling land with some regularity or system. That contention is not supported by the language of s 70-10 and is inconsistent with the decision in St Hubert's Island (see esp per Jacobs J at 237-238 quoted below).

(ii) The "marketability" contention 35 R & D Holdings' submission is that, as the relevant business for which property is held for sale involves trading in subdivided land, an unsubdivided parcel will not be trading stock because it lacks marketability and there can be no market value. 36 To answer this submission it is necessary to refer in a little detail to case law on the definition of trading stock under the 1936 Act for such guidance as it provides in construing the 1997 Act. 37 Both sides accept that the seminal decision on whether land can be trading stock was the St Hubert's Island case, above. In that case the taxpayer company bought the whole of one small island and part of another for the purpose of developing and subdividing them and selling the allotments for residential purposes. It was incorporated with this purpose in mind. It procured an alteration in the land's zoning to permit the desired development. Substantial development works were carried out when the company was put into voluntary liquidation. The development works had not then been completed nor had places of subdivision been approved for any of the land. The liquidator was authorised to transfer and did transfer the land in specie to the sole contributory of the company who was then assessed for tax on the basis that the transfer was a disposal of trading stock to which s 36(1) of the 1936 Act applied. That issue was ultimately determined favourably to the Commissioner of Taxation in the High Court by a majority of three to two. 38 The issues of present relevance addressed by the Court were (1) whether the land in question was capable of being trading stock for the purposes of the 1936 Act and (2) whether it was trading stock in the business carried on by the taxpayer. The latter of these was raised by the express requirements of s 36(1) which dealt specifically with the question of disposal of trading stock. 39 Of the majority judges, Mason J noted that (i) it had become generally accepted that land may become trading stock according to the common understanding of this expression; and (ii) accountants and commercial men have recognised that raw materials used for the purpose of manufacture and partly manufactured goods could constitute trading stock. His Honour went on (at 228-229): "… as the definition of 'trading stock' contained in s 6(1) is not an exclusive definition, it requires us to give effect to the ordinary, and in this case that happens to be the commercial, meaning of the expression, notwithstanding that in part at least it is a meaning which may have derived from or may have been influenced by accounting principle or practice. If trading stock according to its ordinary meaning denotes land as well as goods and commodities, it must follow that land may form part of the trading stock of a business before it has been converted into the condition in which it is intended to be sold. Just as raw materials and partly manufactured goods form part of the trading stock of a manufacturer, so also virgin land which has been acquired by a land developer for the purpose of improvement, subdivision and sale in the form of allotments will form part of his trading stock. … Once it is accepted that land acquired for the purpose of improvement and development as a preliminary to sale in allotments in its improved form constitutes part of the trading stock of the land developer's business, notwithstanding that the land as acquired differed in condition from the land as intended to be sold, the issue in the present case is whether the land in question was acquired by the respondent taxpayer for its business as a land developer, that is, for improvement and development as a preliminary to sale in subdivided allotments. That substantial work remained to be undertaken in connexion with the land before it would achieve the condition in which it was intended to be sold as an immaterial consideration. It is enough that the respondent was carrying on the business of a land developer and that it acquired the land in the course of carrying on that business. The facts as outlined by the primary judge make it plain that the land was acquired by the respondent taxpayer for this very purpose." 40 His Honour later described (at 230-231) the developmental activity undertaken by the taxpayer and then commented (at 231): "The features to which I have referred stamp the enterprise with the characteristics of a business which had as its object the making of a profit from the ultimate disposition of the land in subdivided form. The land was acquired in 1960 in a series of transactions as the first step in a substantial business undertaking which was to endure for some years. Indeed, it was a long way from completion in 1972 though it is fair to say that the respondent encountered some difficulties which may not have been foreseen. The land was not acquired as an investment and its development for subdivision and sale was not simply the realization of a capital asset. In these circumstances it is impossible to treat the proposed enterprise as one which lacked the characteristics of a business and to say that it constituted no more than an isolated transaction capable on yielding assessable income under s 26(a) rather than s 25(1)." 41 The second majority judgment, that of Jacobs J, considered (at 234) land could be trading stock but that, for the purposes of s 36(1) of the 1936 Act, the property "must be an asset of a business of trading in that stock". His Honour went on (at 235): "Once it is concluded that land may be trading stock, then I can see no reason to limit the application of the words to land which is in the condition in which it is intended that it should be sold. I am inclined to the view that land acquired or purchased for purposes of sale falls within the words of the definition whether or not the land is in the condition in which it is proposed that it shall be sold. The definition does not say otherwise. But whether this be so or not, the definition is by way of extension, not limitation, of the ordinary meaning of the words 'trading stock'; and undeveloped and unsubdivided land acquired for the purpose of development, subdivision and sale is a stock of land in which the person acquiring it may be said to trade or to propose to trade. It may therefore properly be described as trading stock not only when the processes of development and subdivision have been carried out but also when it is acquired for the purpose of carrying out those processes upon it. Whether or not it will be held to be trading stock depends on whether the person carried on or had previously carried on the business of trading in that land." 42 Whether there was such a business in that case was answered thus (at 237): "Here there was what I think should be treated as a 'one-off' purchase of an area of land with an intention thereafter, as one continuous course of activity of which the purchase was the commencing act, to improve, develop, subdivide and sell in subdivided lots the area of land so purchased. Did the taxpayer thereby carry on the business of trading in that land? I have come to the conclusion that it did, and that the land became the trading stock of that business even though at the relevant time none of the land had been sold. The fact that none of the land had then been sold did not change the character of the business carried on or the character of the stock, the land, held as an asset with which it was intended to trade. A contrary conclusion would appear to me to involve the proposition that a person can only carry on the business of trading if he does or intends to do repeated acts both of buying and of selling in the course of the business. Ordinarily to carry on the business of trading in a thing does involve repeated acts of buying and selling … However, although this repetition of both buying and selling is a usual feature of trading I do not think that it is an essential feature." Acknowledging that a "one venture" can be a "trading operation", Jacobs J concluded (at 238): "Once it is recognized that land may be trading stock then an acquisition of land for the purpose of resale, after development improvement and subdivision, in subdivided lots, and a continued activity in fulfilment of that intention brought into existence a trading operation. The company was carrying on the business of trading so long as it was pursuing its activities with an intention to sell off the land in subdivided lots and the land was its trading stock so long as the intention continued." 43 Justice Murphy agreed with both Mason J and Jacobs J. 44 For the minority Stephen J, while accepting that land could be trading stock, concluded that the land in question was not trading stock because, at the time of its purchase it did not possess the character of being substantially in the state in which the taxpayer intended to trade in it. It was devoid of the characteristics of subdivided land. The emphasis on the time of purchase was necessary in his Honour's view because of the language of the s 6(1) definition of "trading stock". 45 Finally, Aicken J in dissent also accepted that land or interests in land could constitute trading stock but rejected that the taxpayer's land was such for the following reasons (at 246): "In my opinion items of property (including land) can only be regarded as trading stock in circumstances in which the business in which they are employed involves some continuity or repetition of both buying and selling, so that one is able to say in a real sense that the stock is being turned over by a process of buying and selling. A single purchase of land, however substantial in area, made, not as part of a continuing business of trading in land, but none the less with a view to its subdivision and development into a residential area, individual allotments in which will be sold, does not seem to me to have the qualities required for answering the description of trading stock …" 46 The significance of this case for present purposes is that it is authority for the propositions that (i) land acquired for the purpose of development, subdivision (or strata division) and sale by allotment (or lots) can constitute trading stock of a business having that purpose irrespective of whether the land has been so developed and subdivided; and (ii) that business will be carried on for so long as the taxpayer engaged in the effectuation of the purpose of development, etc of the land. The emphasis in St Hubert's Island on the need to have the relevant intention of sale at the time of acquisition of the property in question is, though, without significance for s 70-10 purposes which as I have earlier noted links the intention or purpose of sale with the purpose (or purposes) for which the property is held. 47 Despite St Hubert's Island, R & D Holdings seeks to draw comfort from the following observations made in the five judge joint judgment in John v Federal Commissioner of Taxation (1989) 166 CLR 417 at 429: "The Act defines 'trading stock' in s 6(1) as including 'anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock'. The definition looks to the nature of goods that may constitute trading stock and posits that they will constitute trading stock if acquired for any of the specified purposes, including sale. It presupposes that the person by whom they are produced, manufactured, acquired or purchased is or will be engaged in trade in those goods. But it does not render an inquiry into whether or not the person is or will be engaged in that trade irrelevant. A single transaction does not render a person a trader, although, of course, a single transaction may constitute an adventure in the nature of trade. Nor, we think, is a single item acquired for the purpose of manufacture, sale or exchange an item of trading stock, unless the purchaser is or will be engaged in trading goods of that nature. Thus it is relevant to inquire whether the person who acquires an item claimed to be trading stock is a trader in the sense that he is engaged or will be engaged in trading goods of the nature of the item acquired." 48 The issue in John, insofar as presently relevant, was whether shares acquired by a partnership which carried on the business of trading in shares were trading stock within s 6(1) of the 1936 Act. They were found to be such. This context is important in considering whether their Honours were intending in any way to cast doubt upon the majority judgments in St Hubert's Island. In my respectful view, the above should not be taken as intended to address the quite particular and distinctive issues raised in cases of single venture land development and subdivision for purposes of sale by lots. The judgments of Mason J (who participated in the joint judgment in John) and of Jacobs J in St Hubert contain a particular and detailed course of reasoning to bring what I will call single venture land subdivision cases within the scope of s 6(1). The observations in John as generalisations are, with respect, uncontroversial, but as generalisations suited to the general context exemplified in John. If they were intended to undermine St Hubert's Island in any way, I am of the view this would have been done explicitly, given the particular attention given to land in that case. In saying this I would draw particular attention to the comments of Jacobs J in St Hubert's Island quoted earlier rejecting the alleged need for repeated acts of buying and selling to establish "trading". 49 Though in this case, as in St Hubert's Island, the land together with such transformation as it underwent through development etc was stock in trade, the respective businesses carried on involved a purpose of sale of the transformed property, i.e. in the present matter the sale by lots of a strata subdivided building. 50 While I do not consider the quoted observations from John as being of relevance in this proceeding, there is one aspect of John which is of present assistance. It was indicated in the joint judgment (at 430) that the s 6(1) definition of "trading stock was predicated on the prescribed purpose (i.e. of manufacture, sale or exchange) attending the acquisition of the item in question". However, it was indicated that the definition did not require that the relevant purpose be the sole or dominant purpose". I can see no reason why a like view should not be taken to the like purpose requirement for which the relevant property is held in the s 70-10 definition of the 1997 Act. The significance of this for present purposes is that I have found below that R & D Holdings held the Bulletin Place property at the relevant time for the dual profit making purposes of sale or lease of subdivided lots. These two purposes clearly are not "contrary or inconsistent": John at 430. 51 The principal authority relied upon in support of the applicant's "marketability" contention, is the decision of Rogers J in Barina Corporation Ltd v Federal Commissioner of Taxation,above. In that case, Rogers J held that, for the purposes of s 31(1) of the 1936 Act (which related to the valuing of "each article of trading stock"), proposed lots in land acquired for the purposes of subdivision but which was not at that stage subdivided could not be described as "an article of trading stock" distinct from the land in globo. That is not the issue with which I am concerned in this matter. The relevant item of trading stock is the Bulletin Place land itself. As the Landsbury report indicates and as was relied upon by the trustees in making their election, that property was capable of being valued and was itself marketable. For this reason it is unnecessary for me to consider further the Barina case. It has no bearing on this matter. 52 The final authority relied upon by the applicant - ARM Constructions Pty Ltd v Federal Commissioner of Taxation (1987) 19 ATR 337 - merely illustrates that whether or not property subdivided in a joint venture will be trading stock under the 1936 Act turned on the purpose or intention of the venturers when acquiring the property. If that purpose was retention, the lots etc subdivided and constructed would not be trading stock notwithstanding that the venturers acknowledged it might be necessary to sell some to discharge indebtedness as in fact happened. It does not assist R & D Holdings in this matter given my findings as to the Trust's purposes in holding Bulletin Place in the 1998 tax year.

The Purpose or Purposes for which Bulletin Place was held in the 1998 Tax Year 53 Mr Richardson gave considerable evidence - oral and affidavit - on this matter. I should state at the outset that I have treated his evidence with considerable circumspection. I am satisfied that both his evidence and the tendered documents for which he was responsible have on occasion been contrived or framed to advance R & D Holdings' interests. Accordingly I place greater reliance on the contemporary record of events (other than several clearly self-serving R & D Holdings documents to which I will refer specifically below). 54 The Hallinn Trust was, according to Mr Richardson, his family trust and it was his intention in relation to properties purchased by it that "they would be held, so far as practicable, as investment (sic) for the ultimate benefit of my children". His own affidavit, though, does suggest that there are other trusts associated with his "family interests" - "the Austcorp 208 Unit Trust": Aff [14]-[15]; and "the A J Richardson Family Trust": Aff [128] - though the provenance and character of these trusts is unexplained. 55 A deal of evidence (both documentary and from Mr Richardson) has been advanced by the applicant. The annual accounts of the Hallinn Trust are said to show that its activities involved the acquisition of assets held as investments, with the assets acquired (whether as real property, shares in companies or investments in trusts) being shown, save in one instance, as "investments" and not as trading stock. The exceptional instance related to the Bulletin Place property which was treated as trading stock at the end of the 1998 year though having been shown as an "investment" in the 1996 and 1997 accounts. 56 In his affidavit Mr Richardson provided his account of the properties (in whatever form) acquired by the Hallinn Trust from the 1993 tax year until June 1998. I do not intend to set this out in detail though I would note the following. First, a number of the properties acquired were used for the domestic residential or office purposes of Mr Richardson and/or his family. Several of these were sold. I accept Mr Richardson's evidence that the reasons for these sales related to changing family circumstances and his divorce. Several rental properties were held by the trust, one of which was sold to its tenant at a time where it required extensive renovations. A distinct group of "investments" was of shares in companies or of units in trusts which were engaged in, or beneficially owned, property developments of some variety that were being undertaken as joint ventures which involved Mr Richardson. The intent of several of these joint ventures was to "refurbish, strata subdivide and sell" the property concerned. While Mr Richardson's evidence is that all of the units acquired by the Hallinn Trust "have been held as capital investments and have not been sold", it is pointed out correctly by the respondent that the trust had direct or indirect interests in some number of ventures which were sold wholly, or following subdivision. 57 Mr Richardson was cross-examined on an annexure to his affidavit which outlined his commercial activities since the early 1980s. That annexure and the cross-examination reveal, as the Deputy Commissioner contends, that he had a long history of land development, including CBD office premises, for resale using both corporate and trust structures. It is unnecessary to outline the detail of this history. 58 Both Mr Richardson and Mr Dunkley (Richardson's business associate until, seemingly, 1997) gave evidence to the effect that their practice in property developments was to keep their "plans fluid" and "their options open". Mr Richardson said in cross-examination: "With joint venture properties, when we were building properties, the option whether to sell it or to keep it was dependent on many things: interest rates, the tenancy take-up, the economy. Sometimes these things take a long time to happen." 59 The applicant objected to the cross-examination of Mr Richardson in relation (a) to his land development activities beyond that of Bulletin Place and (b) to his practices in relation to joint ventures. In particular it was contended that it is inappropriate to characterise the activities of the Hallinn Trust, not by reference to what went on in the Hallinn Trust, but by reference to a whole range of other entities. I allowed the questioning, not because I considered that the character of the business of the Hallinn Trust was to be derived simply from an analysis of the businesses of other entities, but because I considered it provided relevant context in which to consider Mr Richardson's decisions and actions in relation to the Bulletin Place property given that the Trust was itself a shareholder or unit holder in some of those joint venture entities. 60 R & D Holdings' submission is that the evidence shows that in the 1993 to 1998 years the activities of the trustee of the Hallinn Trust involved acquiring assets and holding them as investments and that nothing would support a conclusion that its activities in those years involved any activity of trading in property whether real property, shares, or investments in trusts. 61 The respondent's submission is that, considered in the light of Mr Richardson's history in development of land for resale, including CBD properties, it was the ordinary course of the business activity of the Hallinn Trust - directly or through special purpose vehicles - to acquire, when appropriate redevelop, and sell interests in real estate and in particular city office buildings. In written submissions [par 69] reference is made (inter alia) to a number of property developments in which the Trust had an interest where the property was wholly or partly sold thereafter. 62 My own view on the evidence is that no single description of the Hallinn Trust's business encapsulates the various activities engaged in by the Trust over time. I am prepared to accept that certain properties were acquired for retention. I refer specifically to the properties acquired for family or own office use. Others were acquired and held for the purposes of carrying on a particular business activity, for example, a boat hiring business, and the letting out of properties for rent. I equally am satisfied that the Hallinn Trust acquired direct and indirect interests (through shares in, or unit trusts conducted by, special purpose vehicles) in joint venture property developments the purposes of which involved the development and strata sale of the properties in question. Though these share and unit acquisitions do not preordain the answer to the question of the Hallinn Trust's purposes in relation to Bulletin Place, they provide some context in which the relevant characterisation ought properly be considered. 63 The Bulletin Place development differed from the joint venture developments in that the Hallinn Trust alone was interested in the development, with the trustee engaged directly in this particular activity. That activity was sufficiently singular for the Trust as to make it quite inappropriate for it to be characterised for present purposes simply by reference to what may have been the common or indeed usual real property investment of the Trust over the 1993-1998 period. In particular I consider it inappropriate to begin with the priori assumption that it was an "investment" because some other real property acquisitions made in that period might properly be able to be so described. The trustee was engaging directly in property development rather than investing in some special purpose vehicle or trust. Its purposes in relation to that development as at 30 June 1998, not some general overarching characterisation of the Trust's business, will determine whether or not Bulletin Place was then properly characterised as "trading stock".

The evidence of purpose 64 I have already indicated that there is no direct evidence on the Trust's file held by its accountants which betrayed it had an interest in the Bulletin Place property when the second parcel of property was acquired in 1995. Hence the need for the backdated minute of intent signed by Mr Richardson in June 1998. I will later return to that minute. 65 Such contemporary documentation as there is on the question of Richardson Properties' acquisition and holding of Bulletin Place begins with its obtaining the Landsbury's valuation of it in September 1996. The instruction to Landsbury's was, for present purposes, to assess the "Potential Gross Realisation of the individual Strata Floors on completion in 1998 and available For Sale with separate Strata Title". Mr Richardson's evidence is that a strata design was chosen for the building as it created "the highest potential valuation for the purposes of obtaining finance for its construction". 66 The design and construction were done by Multiplex under a Design, Construct and Finance Contract of 16 January 1997. Richardson's evidence is at the time of contract he intended the Hallinn Trust would retain the property "as a long term investment" and would seek tenants for the building. 67 Richardson Properties' arrangements for financing its building were with Westpac Banking Corporation and involved a Bank Guarantee in favour of Multiplex and two Commercial Bill lines which were available to Richardson Properties when the guarantee was called upon. The two bill lines were to be repaid six months from the date of call on the guarantee. The relevant correspondence between the Richardson Properties and Westpac of 6 November, 14 November, 27 November 1996 relating to this financing arrangement was premised upon the strata titling of, and the sale of at least half of, the building. Richardson Properties' repayment obligations and other contractual provisions were linked directly to the sale of strata lots as, for example, in the 27 November letter of approval of finance which indicated (inter alia) that "the Bank will provide a discharge of mortgage over each strata lot on payment of 100% of the net sale proceeds". Equally Richardson Properties had to provide "monthly reports on sales and marketing activity from June 1997". 68 On 23 January Mr Richardson wrote to a Senior Manager in Westpac thanking him for his help in procuring the support of Westpac. It went on: "As I have advised you in the past, it is my intention and has been my intention from the outset to retain this office building as a long term investment and as such, on completion of the building contract I will be paying down Westpac the complete amount of $16.55 million from other funds or refinance. It will be my intention to keep a mortgage of some $12 million on the building and the balance will be funded from my own cash flow. The strata alternative is a strong fall back and if getting closer to the end of the construction period I am unable to be confident of sourcing a strong income stream through tenancy arrangements, then the strata sale option will be the fall back. As mentioned in my letter of 6th November, 1996 there are strong predictions in the market and it should be an ideal time to capitalise on a strong rental demand." 69 The Westpac reply of 14 February 1997 commenced with the observations: "We refer to recent discussions and your letter of 23 January 1997. We acknowledge your intention to retain the building as a long term investment, and accordingly we would be pleased to consider the possibility of providing take out funding of $12 million as outlined in your letter. Any terms would need to be discussed closer to practical completion to ascertain the viability of such term financing." The applicant attributes particular significance to this correspondence. 70 The call on the Bank Guarantee was made in May 1998 and the drawdown on the bill line facility was made. It is Mr Richardson's evidence that in mid-1998 when there was only one tenant in the building, Westpac informed him that it would not provide finance on a long term basis and sought repayment of its loan on expiration of the six month term. An extension of time was in fact secured while Mr Richardson put in place a financing arrangement with ANZ Funds Management in January 1999. 71 It is essentially from the above that the applicant submits that the Bulletin Place property was held as an investment by the trustee and all that occurred was that the possibility of sale was explored at the end of the 1998 income year in circumstances where it was not known whether refinancing could be obtained to repay Westpac. Refinancing was the preferred alternative and when it was obtained any possible alternative of sale was abandoned. The applicant goes on to note that the building is still held by the Trust. 72 The above is not the only evidence which throws light on the trustee's purpose in holding the property in the 1998 income year. It is this additional evidence that the respondent highlights in its submissions. In addition to the trustee's backdated "1995" minute, the Landsbury valuation and the financing correspondence of 6 and 27 November 1996, reliance is placed on the following. (a) On 16 November 1996 Mr Richardson sponsored an item in the Australian newspaper reporting the commencement of construction of the building as "the only new building specifically designed for the strata market … in Sydney," undertaken in the course of his "turning his hand to strata subdivision of existing CBD office buildings". "[D]eveloping offices based on strata sales is a trend that has not emerged yet in Australia but is common in Hong Kong," and he "expects to begin marketing the 380 sq m floors in the new building next year." In cross-examination after attempting to minimise the import of his reference to strata designing the building, Mr Richardson accepted what this item clearly was designed to convey. (b) A press release approved by Mr Richardson on 16 December 1997 described the building as "built for its own niche market … a specific sector where tenants want the individuality of their own floor". (c) On 10 May 1998 a Mr La Grouw of the Amstal Property Group Pty Ltd (a property marketing company) wrote to Mr Richardson setting out fee arrangements for sales or leases achieved of lots in the building. Mr Richardson struck out the portion concerning leasing, leaving the commission arrangements on sales intact, and initialled the letter. (d) On 12 May the selling agent, First Pacific Davies (NSW) Pty Ltd ("FPD") wrote to Mr La Grouw concerning an "information package for prospective purchasers" referring to the property as "strata office floors". (e) A glossy brochure advertising the property as being available "for sale or lease" was prepared and circulated in mid 1998 showing (despite Mr Richardson's denials in cross-examination) a Ms La Grouw as the agent for "sales". (f) In May 1998 the project manager convened a meeting to discuss an action plan for "implementation of coordination sales and leasing program". (g) In June 1988 a strata plan was prepared for lodgement with the Land Titles Office, although preliminary lodgement steps were not carried through to registration. (h) On 16 June 1998 Mr Richardson signed an exclusive agency agreement with FPD appointing it agent to achieve the sale of lots in the building. (i) The building was advertised in the print media in June 1998 "for sale or lease". (j) At mid-June 1998 the trustee's agent stated it was marketing the building for "sale or lease" and actively pursuing "strata sales prospects" in its "Half Yearly Update" prepared for the Trustee. (k) On 24 June FPD (with Mr Richardson's authority) wrote to a number of prospective purchasers offering inspection of the building which it described as a "Boutique Strata Office Building". (l) In the accounts of the trust estate for the year ended 30 June 1998 the property was shown as "land held for resale" at its market value, and distribution of $24,083,800 was made accordingly. (m) On 13 August 1998 Mr Bobb, the accountant, noted in a Hallinn Trust note that "Mr Richardson advised that the Bulletin Place property was not selling at a satisfactory rate. Accordingly the Hallinn Trust may need to retain the property for investment purposes. I advised the trust always has the right to convert any assets from trading stock to investment property". 73 It is unnecessary for me to make a finding as to Richardson Properties' particular purpose or purposes when acquiring the Bulletin Place Property and I decline to do so. I would only say that in the 1993-1995 period Mr Richardson intended to construct an office building on the composite Bulletin Place sites and I incline to the view that, consistent with other office developments in which Mr Richardson had been engaged (albeit through joint ventures), it was likely his then intent involved the multiple purposes (or "open" options) of sale and/or lease after construction because the options themselves were likely to be affected by the contingencies of interest rates, the economy and tenancy take up - to use the trio to which Mr Richardson referred in his evidence. 74 Be that as it may, I am satisfied that from at least September 1996 when the Landsbury's valuation was sought, Mr Richardson (hence the trust) was committed to the strata subdivision of the property to be constructed with a view to strata sales. I reject Mr Richardson's explanation that the strata design in the valuation was adopted for the purposes of obtaining finance for the buildings construction insofar as he intended to convey that this was simply an expedient and reflected no change in his "investment" purpose. I consider his comments as reported in the Australian newspaper of 16 November 1996 about strata subdivision and his reasons for, experience in, and expectations of, it better reveal his contemporary purposes (being that of development, subdivision and sale). 75 Those purposes in turn were translated into the bases on which finance was sought from Westpac. Though the 6 November 1997 letter referred to the sale of only half of the building with the rest retained as a long term investment - a statement of intent which could only have been made if great store was placed by Mr Richardson in the Landsbury valuation - I am satisfied that sale of strata lots was Mr Richardson's dominant purpose. 76 I infer that the form of financing sought and the short repayment period for the Commercial Bills after drawdown (6 months) reflected his expectations of the marketability of the strata lots on completion of the building. As he said in concluding his 6 November 1996 application to Westpac formally seeking finance: "Given the current strong predictions of the market, it is an ideal time to commence this office building and bring it on the market early 1998. We will capitalise on the very high demand that should exist at that time." 77 Mr Richardson's 23 January 1997 letter to Westpac stating that it "has been my intention from the outset to retain this office building as a long term investment" contradicts the basis on which he sought and received financing. It probably does no more than evidence a desire to keep his options open notwithstanding the commitment made to strata subdivision. I am not prepared to attribute any operative significance to it. As with the backdated "1995" trust minute, I consider the letter reflects a preparedness to reconstruct the past for possibly presently expedient reasons. Westpac's reply I regard as throwing no light on the issue before me. Its acknowledgement of Mr Richardson's intention does not evidence that intention and was made, furthermore, in a context in which Westpac was itself prepared to consider a further lending opportunity to Richardson Properties. 78 Practical completion of the building was not envisaged until early 1998 - it occurred on 8 April. The advertising of the building appears to have commenced prior to that date (as witness the 16 December press release). From April/May 1997 advertising and marketing materials were produced with the property being offered for sale or lease. I am satisfied that Richardson Properties' dominant purpose at this time was the sale of the lots. Leasing was subordinate to this. Significantly in this context it was in June 1998 that a strata plan was prepared and lodged with the Titles Office for examination. 79 In the event then, I am satisfied that as at 30 June 1998 the Bulletin Place property was held for the purposes of sale in the ordinary course of business of the Hallinn Trust. That business was the development, strata subdivision and sale of subdivided lots of the Bulletin Place property: cf St Hubert's Island; this being one of a number of business activities of the Hallinn Trust. 80 It may well have been the case that this particular business activity was abandoned not particularly long after 30 June 1998: see Mr Bobb's 13 August 1998 note referred to above. It is not necessary for me to decide whether and when this occurred for the purposes of this application.

Conclusion on trading stock 81 The Bulletin Place property was held for the purpose of strata subdivision and sale of the subdivided lots. As such it was trading stock as defined in the 1997 Act as at 30 June 1998. The election to value it as strata subdivided at market value invoked the operations of ss 70-45 and 70-35 of that Act. The resultant net income of the Hallinn Trust - calculated for the purposes of s 95 of the 1936 Act - was included in the assessable income of R & D Holdings. As the respondent does not contest that as at 30 June 1998 the market value of the land at 30 June 1998 was in the order of $29 million, the assessment for the 1998 tax year should be adjusted accordingly.

Introduction 82 Two separate issues arise in this matter. Chapel Road, a joint venture company, acquired land for redevelopment, the construction of an office block and its letting. It borrowed to finance this project but made early default under its mortgage after the building was completed. Chapel Road was unable to pay its interest obligations from rental income, the unpaid interest being compounded. Over a ten year period before the property was sold by the mortgagee in possession, the annual interest liability and the principal sum increased dramatically. Chapel Road claimed deductions in respect of interest and other property expenses. For the 1997, 1998 and 1999 income years, it transferred losses of variously, $2,832,045, $25,943,314 and $53,299 to the applicant under the loss transfer provisions of the 1936 Act and then of the 1997 Act. What is now in question is whether R & D Holdings is entitled to a deduction for the transferred losses, it being disputed whether Chapel Road had any "loss" that was transferable in any relevant year. Distinctly, because there was a partial change in the ownership of R & D Holdings in 1997, there is a question whether it can meet the conditions of s 165-13 of the 1997 Act so as to be eligible to deduct a transferred loss.

Background 83 There is no substantial factual dispute between the parties, their disagreement being as to the correct legal characterisation of what occurred. The relevant facts can be stated relatively shortly. 84 Chapel Road acquired a number of properties at 402-410 Chapel Road in Bankstown, in late June 1987 at a cost of approximately $3.37 million. Between 1987 and 1989 it constructed a 7 floor commercial office block on the properties with a view to its being let to tenants. The company borrowed $12.3 million from Burns Philp Trustee Company Ltd as trustee for Estate Mortgage Trusts ("the EMT loan"), the debt being secured by a mortgage over the property. The loan was later extended to $14 million to accommodate variations to the building contract. 85 In late 1989 Chapel Road appointed Raine & Horne, a managing agent, to let and manage the building. At much the same time Mr Richardson was asked by a Mr Lew of Estate Mortgage Managers Ltd if the EMT loan could be refinanced as this would be of help to the Estate Mortgage Trusts which were experiencing a run. Mr Lew appears to have secured approval for a loan of $14 million to Chapel Road subject to a valuation from Mercantile Mutual Life Insurance Company Ltd ("MMLIC"). That loan was entered into on 19 March 1990 and was secured by a first registered mortgage over the Chapel Road property. Chapel Road had recently obtained a valuation of the property of $17.5 million. 86 The term of the MMLIC loan was for two years with an interest rate of 21.5 per cent pa. The interest was calculated on daily balances, was payable on the last day of each month and was to be added to the principal sum on that day. If interest was received within 7 days of the due date and the mortgagor was not otherwise in default, then interest was payable at the reduced rate of 17.5 per cent pa. In the event that interest was not paid to MMLIC on the due date, the rate was to be 21.5 per cent and the unpaid amount, having been added to the principal sum, was to bear interest accordingly. 87 At the time of the MMLIC loan approximately 60 per cent of the lettable space in the building was leased to commercial tenants, though some number of them, according to Mr Richardson, were not paying rent as they had the benefit of rent-free periods. The rent received was insufficient to cover all of the outgoings including interest. Chapel Road did not pay the amounts of interest that were due on 31 March 1990 and 30 April 1990. 88 In late May 1990 MMLIC served a notice and an amended notice under s 57(2)(b) of the Real Property Act 1900 (NSW) in respect of the defaults, non-compliance with the amended notice being a trigger to the mortgagee's power of sale under s 58 of the Act. MMLIC had, apparently, earlier indicated to Mr Richardson that it wished to collect the rents directly from the tenants and to apply them to the interest owed by Chapel Road. On 17 May MMLIC's solicitors sent letters to the tenants giving notice that it was exercising its rights under s 63 of the Real Property Act to enter into receipt of the rents of the Chapel Road property which were now to be paid directly to its agent, Dyson Austen & Co Pty Ltd. 89 On 5 June 1990 Mr Richardson in turn wrote to the tenants noting the new rental payment arrangements but indicating that "the property will continue to be managed by ourselves [i.e. the "Richardson Property Group"] and Raine & Horne". 90 These arrangements remained in place until January 1991 when, according to Mr Richardson, he was asked by MMLIC if, on grounds of expense, a single agent should replace the two then managing the building. The new agent was to be Jones Lang Wooten ("JLW") that would take over the roles of Raine & Horne and Dyson Austen. Mr Richardson's evidence is that he agreed to this provided that JLW kept him fully informed and provided management reports on the property. Thereafter MMLIC was a mortgagee in possession. 91 During the relevant income years (1992-1997 inclusive), MMLIC through its agent JLW continued to collect the rent and paid the outgoings of the building from rents collected. JLW supplied Chapel Road with annual reports on collections and outgoings. What in those reports was shown as "net income" was described as "repayments" in MMLIC's annual loan statements that were supplied to Chapel Road. Those repayments were made monthly. The loan statements further reveal the loan's initial capital sum stood at over $20 million (including capitalised interest) at the beginning of the 1992 tax year and had grown to over $65 million by the end of the 1997 tax year. The amount of interest payable daily by that time was over $38,000. 92 MMLIC retained the building until late 2000 when it was sold as "a going concern". It had made an unsuccessful attempt to sell in late 1997. By the time of the sale Chapel Road's debt to MMLIC exceeded $100,000,000. The sale price was $11,750,000. 93 In its Financial Statements for the year ending 30 June 1992 Chapel Road's directors reported that while the principal activity of the company had been property investment and development, it had "ceased trading during the financial year". Mr Richardson's evidence is that the quoted statement was inaccurate and could only have been included by oversight as Chapel Road was continuing to trade, receive rental income and incur expenses. 94 The Financial Statements for the years 1993-1998 record the company's principal activities as "Property Investment and Development". The Statements also contained the directors' declarations that there were "reasonable grounds to believe the Company will be able to pay its debts as and when they fall due". The declarations from 1993 to 1995 added the rider that the above "statement is dependent upon the continued support of the company's creditors and financiers". 95 In 1997 after receiving an MMLIC document which appeared to indicate that MMLIC had characterised the loan as a "bad debt" and had written down the debt to approximately $11.5 million, Mr Richardson approached MMLIC officers to be told that the document received was an internal one and that there had not been a write down. Later in 1997 Mr Richardson sought a refinancing of the loan on the basis that MMLIC had written down the loan to the value of the property. Again he was told that the loan had not been written down and the loan was accruing at the default interest rate. 96 The losses transferred by Chapel Road to R & D Holdings arose from deductions claimed in respect of interest liabilities in the 1992 to 1997 income years and were recouped sequentially by R & D Holdings in the 1997, 1998 and 1999 tax years. 97 At all relevant times Chapel Road was a wholly owned subsidiary of R & D Holdings. However, in July 1997 there was a 50 per cent change in the beneficial ownership of the shares in R & D Holdings, Mudipo selling its interest to Mr Richardson's sister, Diana. 98 For convenience in exposition I will deal separately later in these reasons with the question whether R & D Holdings satisfied the conditions of s 165-13 so as to be able to deduct a transferred tax loss in any event.

"Allowable deductions" - the Legislative context 99 For there to be a transferable loss in any relevant year, the excess interest of that year had to be an allowable deduction under s 51(1) of the 1936 Act or s 8-1 of the 1997 Act. 100 Section 51(1) provides: "Losses and outgoings (1AA) Subsection (1) does not apply to the 1997-98 year of income or a later year of income. (1) 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." 101 Section 8-1, insofar as presently relevant, provides: "General deductions (1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or …" 102 Given what is said later in these reasons, the only comment I should make here is to reiterate the warning of Hill J in Kidston Goldmines Ltd v Federal Commissioner of Taxation (1991) 30 FCR 77 at 85 that: "there is a danger in substituting for the words of … subsection [51(1)] language which does not appear in it."

The parties' contentions 103 Put at its simplest, R & D Holdings' case is that Chapel Road was entitled to claim deductions, pursuant to s 51(1) of the 1936 Act, in respect of interest due to MMLIC under the MMLIC loan on the basis that such interest was incurred in gaining or producing assessable income and, although it says it is unnecessary to show it, that it was also necessarily incurred in carrying on business for the purpose of gaining or producing assessable income. The basis of this claim is that: (a) in the years relevant to Chapel Road (1992 to 1997 income years inclusive) Chapel Road was the registered proprietor of the office building at 410 Chapel Road, Bankstown;

(b) the building was a substantial multi level office building, parts of which were let to several different tenants;

(c) throughout the 1992-1997 period Chapel Road was deriving rental income in respect of its ownership of the property;

(d) that rental income was returned by it as assessable income for the purposes of its income tax returns;

(e) Chapel Road continued to derive the rent as income notwithstanding that MMLIC had exercised its powers under the mortgage over the property to take possession in early 1991;

(f) throughout the 1992-1997 period Chapel Road was incurring liabilities for interest due to MMLIC under the terms of the Loan Agreement dated 19 March 1990;

(g) as legal liability for interest arose, such liabilities constituted outgoings incurred within the meaning of s 51(1) of the 1936 Act;

(h) those outgoings were incurred in gaining or producing assessable income, and in carrying on business for the purpose of producing assessable income;

(i) the interest liabilities of Chapel Road were (in the same way as for any other "negatively geared" property investment) deductible to Chapel Road pursuant to s 51(1) of the 1936 Act.

(j) in the 1992 to 1997 income years the quantum of the deductions exceeded the rental income derived by Chapel Road as a consequence of which it incurred losses pursuant to s 79E of the 1936 Act; and

(k) in each of the 1997, 1998 and 1999 income years, Chapel Road transferred losses to the applicant in accordance with the requirements of s 80G of the 1936 Act (1997 year) or subdivision 170A of the 1997 Act (1998 and 1999 years). 104 In preparing and lodging its income tax returns in respect of the 1992 to 1997 years of income Chapel Road claimed other deductions arising in respect of its ownership of the office building. These were for: (a) repairs and maintenance - pursuant to s 53 and s 51(1) of the 1936 Act;

(b) depreciation - pursuant to s 54 of the 1936 Act;

(c) capital allowances - pursuant to Div 10D of the 1936 Act;

(d) rates and taxes - pursuant to s 72 of the 1936 Act; and

(e) other miscellaneous expenses - pursuant to s 51(1) of the 1936 Act. 105 While the above amounts were treated as deductible to Chapel Road at the time of the assessments, the initial position taken by the Deputy Commissioner in this proceedings was that they were not properly deductible: see Respondent's Amended Statement of Facts, Issues and Contentions, pars 36-42. No point is now taken by the Deputy Commissioner in relation to the deductibility of these outgoings or, for that matter, for such part of Chapel Road's interest obligation as was in fact discharged in each income year by MMLIC's monthly application of net rental income it received from JLW in partial discharge of that obligation. 106 The Deputy Commissioner's case, as I now understand it, is that it is concerned only with whether the excess amount of interest over that which was discharged by the MMLIC's application of the net rental income to the interest debt, was an allowable deduction. This contrived focus has been taken because the loss in issue in this proceeding, i.e. that transferred to R & D Holdings, was computed by Chapel Road on the basis that it was the excess of allowable deductions over assessable income. I say "contrived" focus for the reason that it formally avoids the need to determine whether the net income applied to reduce in part the interest debt from time to time was a deductible outgoing. I will return to this matter later. 107 As to the excess interest, the Deputy Commissioner's contention is that when one has regard to the requirements of s 51(1) of the 1936 Act or s 8-1(1) of the 1997 Act, Chapel Road fails. There was no loss or outgoing. It was not incurred in gaining or producing assessable income or was not necessarily incurred in carrying on a business to that end. It was not referable to the period in which the deduction was claimed. And it was of a capital nature. 108 Put shortly, it is said, first, there was no outgoing in any income year as there was no actual disbursement of the excess interest and there was no practical possibility of payment of the excess interest. Equally, it is claimed there was no loss resulting in any diminution of the net assets of the company. The "equity of redemption" was utterly valueless. Chapel Road was beyond suffering the loss. 109 Secondly, the excess amount was not incurred in gaining assessable income. From 1992 onwards the liabilities to MMLIC were almost meaninglessly in excess of any value that could be ascribed to the property. The excess interest did not contribute to the accrual of any assessable income to Chapel Road. The excess interest was not an outgoing incidental and relevant to the gaining of income. The nexus between the two was broken when the excess interest ceased to be a contributor, and to have any possibility of being a contributor, to the derivation of assessable income. 110 Thirdly, it is said that assuming there was a loss or outgoing incurred in gaining assessable income, it nonetheless was not referable to the year in which it is claimed the transferable loss was incurred. No advantage was obtained by the increasing accrual of the compounding interest because the taxpayer was in no better position as a result of it. It did not derive any income as a result of that outgoing in any relevant year of income. 111 Fourthly, it is contended that at the point at which the excess interest compounded beyond any possibility of its being met from the income generated from, or the principal value of the mortgaged property, the accumulating compound debt was simply a capital liability, and the increase (the excess interest) was an increase in a capital liability not a revenue liability such that even if it was a loss or outgoing, it was "one of capital or of a capital … nature". 112 The Deputy Commissioner's general characterisation of Chapel Road was that there was no income producing activity of the company and a fortiori no business of the company. For more than a decade - effectively the entire time that it was the mortgagor of the land - Chapel Road was irretrievably insolvent, had no prospect of ever paying the accumulating excess interest, made no attempt to do so and carried out no activities. The augmentation of the excess interest debt in no way contributed to the derivation (or even the possibility of derivation) of any assessable income.

Consideration on "allowable deductions" 113 The issues presently raised by the anomalous circumstances of this matter may seem distinctive. But considered from the standpoint of a primary judge, they are not "untrammelled by authority" (to use the respondent's description) that is binding on me. Their resolution, in consequence, is relatively straightforward. 114 I have, predictably, been taken to quite some number of appellate decisions in which differently nuanced descriptions of what might be comprehended by the language of s 51(1) or its equivalents have been emphasised by one or other of the parties (but particularly by the Deputy Commissioner) to its own apparent advantage or to the other's apparent disadvantage. I would have to say that that process illuminated what is already well known and well accepted. The generalised language in which judicial explanation of a statutory provision is cast often enough reflects the context in which that explanation is given with the consequence that it does not or may not capture all of the various possibilities that can be subsumed in that provision. Where, as here, the context is very distinctive more than usual care needs be taken in applying well-accepted statements that have been tailored with quite different contexts in mind. 115 As I earlier indicated, the Deputy Commissioner has focused in its submissions on the "excess interest" for the reason that that was all in the circumstances that could be transferred to the applicant under the loss transfer provisions of the 1936 and 1997 Acts. While it, doubtless, is the case that the ultimate question to be answered is whether the losses transferred were allowable deductions, it is artificial to fragment the interest liability of a given year into that part which was discharged by MMLIC's monthly application of the available net rental income and that part which was not and which in consequence remained capitalised. I do not accept that the correct characterisation of the interest payable in a given income year turns on whether each monthly liability was discharged in part, or was and remained capitalised. The anomaly in the bifurcation involved in the respondent's submissions is that, if it be the case that Chapel Road had an allowable deduction to the extent that the annual interest liability was discharged in a given income year, Chapel Road must be incurring a loss or outgoing in gaining or producing income. But the contrivance in this would be that Chapel Road would never be able to make a return other than a nil return. It would not, despite earning assessable income, be able to incur a tax loss. I note that the applicant's submissions presuppose that its interest liabilities were indivisible for s 51(1) purposes. 116 It has not been suggested that, when Chapel Road entered into the 1987 EMT loan or the 1990 MMLIC refinancing loan, its purpose was to generate transferable losses. On the evidence the purpose of the EMT loan - and hence of the MMLIC loan: Commissioner of Taxation v Roberts (1992) 37 FCR 246 at 257 - was to purchase and redevelop land by constructing an office block to be used to produce rental income. The money borrowed was used for that purpose. 117 There is a large body of authority to the effect that where borrowed money is laid out for the purposes of gaining assessable income this "furnishes the required connection between the interest paid upon it by the taxpayer and the income derived by [it] from its use": Ure v Federal Commissioner of Taxation (1981) 81 ATC 4100 at 4104; see generally Federal Commissioner of Taxation v Munro (1926) 38 CLR 153 at 170-171; Hart v Commissioner of Taxation (2002) 121 FCR 206 at [26]-[27]; reversed by the High Court but not on this point: see (2004) 217 CLR 216. The interest paid is thus "incidental and relevant" to the gaining of that income for the purposes of s 51(1) and s 8-1: Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56. I would note in passing that the "incidental and relevant" formula is commonly used to describe the necessary connection between the loss or outgoing incurred and the gaining or producing of assessable income, though it has been acknowledged that the formula does not constitute "an exclusive or exhaustive test" of the scope of s 51(1) requirement: Lunney v Commissioner of Taxation (1958) 100 CLR 478 at 497. Importantly, for present purposes, as was said by Gibbs CJ, Stephen, Mason and Wilson JJ in Commissioner of Taxation v Smith (1981) 147 CLR 578 at 586: "What is incidental and relevant … falls to be determined not by reference to the certainty or likelihood of the outgoing resulting in the generation of income but to its nature and character, and generally to its connection with the operations which more directly gain or produce the assessable income." 118 It is appropriate to add that the advantage secured by incurring an interest liability on money borrowed and laid out for the purpose of gaining income, is "the use of borrowed money [for that purpose] during the term of the loan": Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 at [29]. 119 When, for s 51(1) or s 8-1 purposes, an interest liability has been "incurred" on a loan the monies of which have been laid out for the purpose of gaining income, it will be characterised as a "loss" or "outgoing" not only if the liability has been discharged by payment but also if it has been capitalised, even if this results for the future in interest being payable on interest: see Hart v Commissioner of Taxation, above, at [23] ff. As was said in Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 at 506: "The word 'outgoing' might suggest that there must be an actual disbursement. But partly because such an interpretation would produce very strange and anomalous results, and partly because of the use of the word 'incurred', the provision has been interpreted to cover outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement." 120 Commonly, the more problematic question is when has a loss or outgoing been incurred or, to relate the question to s 51(1) and s 8-1, to what year of income is the loss or outgoing referable? 121 There is a large and in some respects not easily reconcilable body of case law on these questions: for a recent statement of some of the principles that are well settled, see City Link Melbourne Ltd v Commissioner of Taxation (Cth) (2004) 141 FCR 69 at [27]-[29]; and, on appeal, Commissioner of Taxation (Cth) v Citylink Melbourne [2006] HCA 35 at [122] ff. It is unnecessary for present purposes for me to enter in significant detail upon the case law much of which is directed towards losses and outgoings in "commercial" activities having characters and purposes far removed from the present. 122 It is useful by way of introduction to begin with Dixon J's well worn statement on s 51(1) in New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 at 207: "To come within [the] provision there must be a loss or outgoing actually incurred. 'Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected." 123 Putting to one side the circumstances arising subsequent to the entry into the MMLIC loan (to which the respondent attributes decisive significance in negativing any connection between the excess interest and the gaining of assessable income), the terms of the interest liability assumed in the mortgage itself illuminate how the liability to pay interest should be characterised for s 51(1) purposes. 124 The mortgage contemplated that interest would be paid for the two year term of borrowing at either of two interest rates (depending on whether payments that were due were paid punctually or at all) unless the mortgage was terminated earlier by either the mortgagee or the mortgagor (by repaying the principal, etc in accordance with cl 7 of Annexure A to the mortgage). It could properly be said that at the time of entry into the mortgage, Chapel Road assumed a defeasible liability to pay the interest. But to say that all of the loss or outgoing attributable to the interest liability was then "incurred" for s 51(1) purposes would be to disregard how the mortgage itself contrived and structured the interest liability. It was (i) to be calculated on the daily balances of the principal sum or on such sum that remained outstanding; (ii) to be computed from the date on which the first advance was made; (iii) to be calculated and charged to the mortgagor on the last day of each month at the higher rate of interest, but be payable at the lower rate if the mortgagor made (inter alia) all payments due under the mortgage; and (iv) to be paid on the last day of each month; and (v) to be added to the principal on the last day of each month and bear interest thereafter. 125 The above regime contemplated that, for each month of the mortgage and at the end of each month, interest would be capitalised or paid (i.e. an actual loss or outgoing would occur), in respect of that month. Each periodic liability whether capitalised or paid represented the cost of the money borrowed for the preceding month. Given that these losses or outgoings would occur monthly across the life of the loan - i.e. the interest liability would come home monthly: Nilsen Development Laboratories v Federal Commissioner of Taxation (1981) 144 CLR 616 at 623 - the parties themselves created a means of allocating (or apportioning) losses or outgoings to the relevant years of income over the life of the loan. It could be said that they have in substance done for themselves what in Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640 was considered required to be done by way of apportionment over successive income years for s 51(1) purposes in the circumstances of that case: see esp 665-666. 126 Alternatively, it could be said that the mortgage agreement so structured the interest liability that the taxpayer only "completely subjected itself to" the outgoings or losses in respect of interest month by month: Federal Commissioner of Taxation v James Flood Pty Ltd, above, at 506. Each monthly liability was "payable for its period": Commissioner of Taxation (Cth) v Citylink Melbourne Ltd [2006] HCA 35 at [146]. 127 It is, perhaps, unsurprising that in some number of decisions courts have assumed or have accepted that interest which accrues from day to day is so apportionable: see Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483; Commissioner of Taxation v Mercantile Mutual Insurance (Workers' Compensation) Ltd (1999) 87 FCR 536 at 552; see also Texas Co (Australasia) Ltd v Federal Commissioner of Taxation (1940) 63 CLR 382 at 468 where the "recurrent expenditure" of interest to secure working capital was described as clearly deductible; see also in relation to recurrent expenditure, Commissioner of Taxation (NSW) v Ash (1938) 61 CLR 263 at 282. 128 I have stated the above principles relating to s 51(1) and s 8-1 without considering the distinctive circumstances in which Chapel Road found itself in the 1992-1997 income years. Chapel Road's submissions proceed on the premise that they apply as of course to it and, in consequence, that the totality of its interest liability in and for each relevant income year was an allowable deduction to it which, in consequence, gave rise to the "excess interest" loss. 129 It is the correctness of this premise that the Deputy Commissioner's case challenges. 130 It is appropriate, initially, to have regard to the position in which Chapel Road found itself in the relevant tax years and the causes of that state of affairs. The company borrowed and laid out the borrowed moneys for the purpose of gaining assessable income. From the time the offices were first let until when the building was sold, assessable income was produced as originally intended albeit from 1991 through the interposition of MMLIC as mortgagee in possession. The effect of this interposition is considered later in these reasons. The original purpose of the borrowing did not change, let alone change to a purpose not involving the gaining of assessable income. 131 Chapel Road's difficulty, which became apparent close on the heels of the refinancing loan, was that its rental income did not meet, and relatively quickly became incapable of ever meeting, its interest liability. The resultant default and the steps taken by MMLIC first under the Real Property Act and then in entering into possession, placed Chapel Road's financial destiny in MMLIC's hands. The provisions of the Real Property Act and the terms of the mortgage (particularly the interest capitalisation provision) saw to that. The loan was in the circumstances a losing contract for Chapel Road. By the end of the first relevant income year the balance of its debt to MMLIC was almost $25 million and growing sharply. By that time or shortly thereafter it is likely that the value of Chapel Road's actual interest in the building was illusory, although I make no finding as to when this actually occurred it not being the subject of evidence before me. 132 Short of inducing MMLIC to write down the debt (which MMLIC would not do, though one can infer that MMLIC appreciated at least at some time during the relevant income years that the debt itself was a bad debt), the directors of Chapel Road had no ability to control the rising level of its debt. Notwithstanding their adventurous preparedness to declare in the company's financial statements that it was able to pay its debts, it is unlikely the directors could have procured a members' voluntary winding up of Chapel Road: cf Corporations Act 2001 (Cth) s 494 (declaration of solvency). 133 For its own purposes, MMLIC let this state of affairs continue. Chapel Road was manifestly incapable of paying its debt, though MMLIC both tolerated this and took no steps to ameliorate Chapel Road's plight. I do not suggest it was obliged to do so. But the building continued to be let and to generate rental payments which, as will be seen, were to be applied (subject to the payment of outgoings) on account of Chapel Road's interest liability under the mortgage. 134 Turning to the Deputy Commissioner's contentions, I would have to say that I do not consider that the atomistic or word by word treatment of the component parts of s 51(1) and s 8-1 reflected in its submission adequately acknowledges the symbiotic character of the language of these sections. Be this as it may, I am unable to accept the contentions advanced. 135 The moneys borrowed were laid out for the purpose of constructing a building and earning rental income from it. That purpose was effectuated and the building generated and continued to generate rents for which Chapel Road was assessable, as both parties have accepted in argument, until its sale in 2000. In light of what had happened, Chapel Road was obliged to pay interest on the use it was able to make of that money until the principal sum (including capitalised interest) was repaid or the loan arrangement was terminated. The use of the money enabled Chapel Road to construct the building and to earn, and to continue to earn, rental income. That was the advantage secured by incurring and continuing to incur the interest liability. Because Chapel Road could not repay the continually swelling principal sum, the interest liability persisted. Nonetheless, in my view, its nature and character did not change. Neither did the purpose for which the borrowed moneys were laid out change, though doubtless Chapel Road would have wished to, but could not, bring to an end the state of affairs in which it found itself. The interest liability, though capitalised in each income year, was incurred for the purposes of gaining assessable income. As I have earlier indicated, the actual interest liability which accrued in a given income year was referable to that year. 136 It may have been the case that that income was relatively insignificant when considered against the ballooning in the principal sum caused by capitalisation of interest. This, though, only demonstrated the dramatically losing character of the loan arrangement to Chapel Road in the circumstances. 137 It is, in my view, irrelevant that it was MMLIC, not Chapel Road, that continued the state of affairs in which the building remained income producing for the benefit of Chapel Road. MMLIC, seemingly, was unable to sell the property. The interest liability derived its nature, character and connection with the gaining of assessable income at the time the borrowed moneys were laid out and the liability began to accrue. Nothing which transpired in the period thereafter altered its nature etc. I should add, though it is otiose to say it, that the exhaustion of the borrowed moneys in the construction of the building did not alter the nature, etc of the interest liability. In this respect it makes no difference whether, thereafter, interest was capitalised in circumstances where a borrower either was unable to repay the mortgage or was not required to repay it. 138 The underpinning of all of the Deputy Commissioner's contentions is that because of Chapel Road's parlous circumstances, it suffered no loss or outgoing on account of its interest liability which itself did not contribute to, or arise from circumstances contributing to, the derivation of income (i.e. it was not in the relevant years "incidental and relevant to" the gaining of income). For the reasons I have given above, I reject the latter of these contentions because I do not accept that the nature and character, and the connection of, the interest liability to the gaining of rental income were as the Deputy Commissioner has contended. I would also add that I do not consider that, for Chapel Road, the liability for the "excess interest" (as the Deputy Commissioner would have it) can properly be treated as if it was a distinct interest liability with its own nature, etc from the monthly liability incurred under the mortgage agreement. It is the nature, etc of the latter alone which is of importance for the purpose of determining whether Chapel Road had allowable deductions in respect of its monthly interest liability. 139 It may well be said that Chapel Road was far beyond repaying its capitalised interest liability and was so in all of the relevant income years. It equally may well be said that the commercial reality was that its losses attributable to the capitalisation of interest would be without financial consequence to it in the sense that the "excess capitalised interest" was never able to be repaid. This said, those losses nonetheless represented legal liabilities that had not been discharged. They could have been relied upon in founding a creditor's petition to have Chapel Road wound up. At law, they were not sham or illusory liabilities. 140 The Deputy Commissioner's contention that there was no loss or outgoing is founded in part on the alleged "implicit assumption" in the cases that the deductibility of an outgoing in the year in which the obligation accrued is that it will in due course be met, i.e. that payment in the future is a certainty. This seeks to transform what may be a well-founded factual assumption in a given case as to what will happen in the future, into a legal prerequisite of deductibility. This, in my view, is how the respondent seeks to extract support from the comment of Ferguson J in Commissioner of Taxation (NSW) v Manufacturers' Mutual Insurance Ltd (1931) 31 SR (NSW) 575 at 585 relating to the deductibility of the calculated value of claims unmatured in the financial year in question, that "it is just as certain that some money will have to be paid". His Honour there was not concerned with, and was not addressing, whether the certainty of actual payment was a legal prerequisite to deductibility. 141 There is no such prerequisite. It is not an express requirement of s 51(1) or s 8-1. To insist upon it would introduce an unacceptable measure of uncertainty into these sections. It would require that the deductibility of losses could often turn on a fallible prophesy as to future events. And this would be so notwithstanding that deductions commonly have been allowable in respect of debts which were never later paid because of the onset of bankruptcy or liquidation: cf Oates v Federal Commissioner of Taxation (1990) 27 FCR 289 at 295. 142 The circumstances of this case, doubtless, provide an extreme example of inability to discharge a liability. But this does not assist the Deputy Commissioner. The articulation of the point at which an otherwise allowable deduction of a loss is to be transformed into a loss which is not allowable for the reasons relied upon by the Deputy Commissioner is obviously beset with no little difficulty. If it is to be the law that there is to be such a point, it is in my view the function of the legislature to identify it. It is not a matter for a court to add such a further and difficult implication and process of speculation into s 51(1) and s 8-1. 143 A distinct submission of the Deputy Commissioner is that the "excess interest" was of a capital nature and hence was expressly excluded from deductibility under s 51(1) and s 8-1. This submission appears to flow from the contention that the excess interest was not incidental and relevant to the derivation of any income of the company: (Respondent's Outline of Submissions pars 38-39). I have rejected the latter contention. I likewise reject the "capital nature" submission. Notwithstanding the financially disastrous position of Chapel Road given its circumstances and the terms of the loan, the interest outgoing was, and remained, "merely interest on a loan": cf Macquarie Finance Ltd v Commissioner of Taxation (2005) 146 FCR 77 at [111]; see generally Steele v Federal Commissioner of Taxation above, at 466-472. 144 My conclusion is, then, that in the relevant income years Chapel Road's monthly losses in respect of interest were allowable deductions.

The transfer of tax losses - the legislative context 145 The first of the three loss transfers was recouped by R & D Holdings in the 1997 income year. That transfer was governed by the provisions of s 80G of the 1936 Act. In light of my conclusion that the rental liability was an allowable deduction, and because the other relevant requirements of the 1936 Act on loss transfers have been satisfied, it is unnecessary to set out the provisions of s 80G. R & D Holdings was entitled to recoup the losses in question. 146 The subsequent two loss transfers were recouped in 1998 and 1999 and, as such, the transfers were governed by Subdivision 170-A of the 1997 Act. In respect of each of these transfers s 170-35(3) imposes the requirement that Chapel Road would itself have been able to deduct the relevant losses in the 1998 and 1999 income years respectively if it had enough assessable income. To satisfy this requirement Chapel Road had to meet either the "continuity of beneficial ownership" test: s 165-10(a) and s 165-12; or the "same business" test: s 165-10(b) and s 165-13. Because of the 50 per cent change in its beneficial ownership in 1997, Chapel Road could not satisfy the former of these and hence was disqualified from relying upon it to effect a tax loss transfer. Could Chapel Road satisfy the latter test? It is sufficient for present purposes to consider only the 1998 income year, there being no operative difference between it and the 1999 year. 147 The two presently relevant statutory provisions in relation to it are s 165-13 and s 165-210. The former of these provides: "165-13(1) If the company fails to meet a condition in section 165-12 (which is about the company maintaining the same owners), it must instead meet the conditions in this section. 165-13(2) There must be some period (the continuity period) that satisfies these conditions: (a) it must start at the start of the loss year (and end before, at or after the end of the loss year): (b) if the period were the loss year, each of the conditions in section 165-12 about the loss year would be satisfied. 165-13(3) The company must satisfy the same business test for the income year (the same business test period). Apply the test to the business that the company carried on immediately before the time (the test time) when the continuity period ends." 148 The "same business test period" is the 1998 income year. The "test time" is the time when the "continuity period ends" which was 17 July 1997 when the change in beneficial ownership of Chapel Road occurred. 149 Section 165-210(1) (which defines the same business test) provides: "165-210(1) The company satisfies the same business test if throughout the same business test period it carries on the same business as it carried on immediately before the test time." 150 The issue to be determined, in other words, is whether Chapel Road carried on for the whole of the 1998 income year the same business that it carried on immediately before 17 July 1997. 151 As to the requirement that there is in fact a "business" being carried on, it is sufficient for present purposes to note the following comments on what constitutes a "business" and the "carrying on of a business". In Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 at [54], the majority observed: "A business is not a thing or things. It is a course of conduct carried on for the purpose of profit and involves notions of continuity and repetition of actions." 152 In Evans v Federal Commissioner of Taxation (1989) 20 ATR 922 at 939 Hill J commented: "The question of whether a particular activity constitutes a business is often a difficult one involving as it does questions of fact and degree. Although both parties referred me to comments made in decided cases, each of the cases depends upon its own facts and in the ultimate is unhelpful in the resolution of some other and different fact situation. There is no one factor that is decisive of whether a particular activity constitutes a business. As Jessel MR said in the famous dictum in Ericsen v Last (1881) 8 QBD 414 at p 416: 'There is not, I think, any principle of law which lays down what carrying on trade is. There are a multitude of things which together make up the carrying on of trade.' Profit motive (but see cf Inland Revenue Commissioners v Incorporated Council of Law Reporting (1888) 22 QBD 279), scale of activity, whether ordinary commercial principles are applied characteristic of the line of business in which the venture is carried on (Inland Revenue Commissioners v Livingston (1927) 11 TC 538), repetition and a permanent character, continuity (Hope v Bathurst City Council (1980) 144 CLR 1 at 9; Ferguson v Federal Commissioner of Taxation (1979) 79 ATC 4261, 4264), and system (Newton v Pyke (1908) 25 TLR 127) are all indicia to be considered as a whole, although the absence of any one will not necessarily result in the conclusion that no business is carried on."

Factual Context 153 As previously noted, MMLIC entered into possession of the Chapel Road property as mortgagee from early 1991 and continued in possession until the property was sold in November 2000. From 1991 in all relevant subsequent years, the property was managed for MMLIC by JLW as its agent. From the JLW reports it appears that JLW engaged in the forms of activity relating to upkeep, provision of services to tenants, the receipt of rentals and payment of outgoings, etc to be expected of a manager of an office rental property such as Chapel Road. This is made particularly obvious in its "Charges and Receipts" reports from July 1998. JLW accounted for the net rental income received to MMLIC and both it and MMLIC provided annual financial statements to Chapel Road. 154 As at July 1998, by way of example, gross rents were in the order of $163,000 per month and monthly outgoings were in the order of $41,000. 155 There is no evidence relating to the process of letting of offices over the period relevant to these proceedings. It is clear, though, that the building was let and was being managed by JLW as an income producing activity. 156 Chapel Road's financial accounts and its income tax returns identified the income it received and outgoings incurred including its interest obligations.

The legal context 157 Under s 63(1) of the Real Property Act, when MMLIC exercised its s 60 rights to enter into receipt of the rents and profits of the Chapel Road property, all of Chapel Road's powers and remedies in regard to receipt and recovery of, and giving discharges for, such rents and profits, were suspended and transferred to MMLIC. So they remained at all relevant times. 158 The mortgage agreement (cl 3.02) empowered MMLIC on default (inter alia) to "enter upon and take possession of and manage the mortgaged land" (subcl 2(c)); to lease the mortgaged land by one or more leases (subcl (h) which excluded some of the provisions of s 106 of the Conveyancing Act 1919 (NSW)); to provide services to all or any of the occupants of the mortgaged land (subcl (i)); to carry on any business on the mortgaged land (subcl (k)); and to employ agents to effect any of MMLIC's rights (subcl (u)). 159 The powers so conferred by the mortgage and by the Real Property Act were for the benefit and protection of MMLIC. In entering into possession, appointing JLW as its agent and carrying on a rental business, MMLIC was not supplying services to Chapel Road. Rather it was exercising powers primarily for its own benefit, albeit with due regard to the interests of Chapel Road, and subject to its duty to account to Chapel Road: National Australia Bank Ltd v Sproule (1989) 17 NSWLR 505 at 510; on the duty to account see generally Fisher and Lightwood's Law of Mortgage 19.34 (2nd Aust ed, 2006); see also on the accounting obligation Chaplin v Young (No 1) (1864) 33 Beav 330 at 336-337.

The parties' contentions 160 Chapel Road contends that, notwithstanding that MMLIC's exercise of its rights as mortgagee in possession limited its scope for direct involvement in the running of the business, it experienced the financial consequences of those activities. It had a clear financial commitment to, and involvement in, what were substantial business operations. Whether it was carrying on business in the 1998 income year was a question of fact and the appropriate conclusion is that it was for the purposes of the same business test. 161 The Deputy Commissioner contends that Chapel Road carried on no business at any time from 1990 onwards; relevantly to the present issue, it carried on no business in July 1997 (the "test time": sec 165-13(3)). It was the legal owner of the mortgaged land, but it was not in possession and carried on no management business. It in fact received no money and paid nothing. It had no prospect of profit and did not conduct its affairs in expectation of deriving profits. There was neither repetition, nor permanence (it was irretrievably insolvent), nor continuity of activity, nor system. Apart from some sporadic enquiries about the compounding balance of the MMLC debt, its directors did nothing except sign accounts and tax returns. There was no such continuity and regularity of activity as could be characterised as a business. 162 By July 1997, it is said, Chapel Road had been inactive for more than six years, its financial position was irretrievably hopeless and there was no prospect of its ever resuming any business activities. This was not a case of a hiatus in a business activity. To the extent that there was a business of managing the property it was that of MMLC, which had exercised its powers under the mortgage. JLW acted not as agent for Chapel Road but as agent for MMLC. Chapel Road was no more than an observer. There was, moreover, no intention and no prospect that any business activity be resumed by Chapel Road.

Consideration 163 There are significant gaps in the material before me concerning the activities engaged in, and the relationships created by, JLW. Though no agency agreement was put in evidence, I am prepared to infer that JLW was, and acted throughout as the agent of MMLIC as mortgagee in possession. There is nothing to suggest that JLW acted as agent of Chapel Road as a receiver and manager. Having demanded and accepted rents from the existing tenants, it may well be that the relationship of landlord and tenant was thus created between it and those tenants by attornment: Tymray Pty Ltd v Mercantile Mutual Life Insurance Co Ltd (1993) NSW Conv R 55-700; but cf Sykes and Walker, The Law of Securities, 248 ff (5th ed, 1993). 164 There is no direct evidence demonstrating that there were new lettings in the periods of present relevance although the case has been conducted on the assumption that there were. From at least JLW documentation from 1998, I am prepared to infer that new lettings were made on occasion. Consistent with JLW being the agent of MMLIC, I infer that MMLIC was constituted the landlord in such cases. I should add, given the express power to lease granted in the mortgage agreement, it is unnecessary to otherwise consider MMLIC's power to lease and the effect of the exercise of that power vis-ŕ-vis Chapel Road: cf Finn v London Bank of Australia (1898) 19 NSWR(L) 364. 165 I am satisfied that at the time at which Chapel Road entered into the MMLIC refinancing loan it was then carrying on, and was intending to continue carrying on a business activity in respect of the ownership, leasing and operation of the Chapel Road property. That was, and was intended to remain, a commercially substantial operation having significant rental income and significant outgoings. 166 The mortgage Chapel Road entered into was of property on which an existing business was being conducted - a business moreover for which that property has been developed. Even in the absence of the express mortgagee's power to carry on a business on the mortgaged property, I would in the circumstances have been prepared to imply a mortgagee's power to carry on the business being conducted at Chapel Road: cf Mercantile Credits Ltd v Atkins (No 1) (1985) 9 ACLR 757 at 762. The conduct of the rental business was, in my view, integral to the loan and its business efficacy. 167 A business of the type conducted by Chapel Road at the time of the mortgage continued to be conducted after MMLIC went into possession in 1991. I would observe in passing that it is unnecessary in this proceedings to determine by whom that business was conducted in the interregnum period after the s 63(1) notices were given and prior to JLW's appointment as MMLIC's manager. 168 I am satisfied that, from the time of MMLIC's entry into possession, a business involving the management and rental of the Chapel Road land and building continued to be carried on until the land was sold. There was a course of conduct engaged in by MMLIC through JLW which involved continuity, repetition and system. The indicia of a business being carried on was there: cf Evans v Federal Commissioner of Taxation, at 939. But who was carrying on that business? 169 Speaking colloquially, it could well be said that at least from when MMLIC went into possession and appointed JLW as its agent to manage the Chapel Road property, MMLIC was continuing to carry on "Chapel Road's business", the moreso as it was the legal owner of the principal asset of the business. This, though, would be a mischaracterisation of what in fact was occurring. And it would treat a business as a "thing", not a "course of conduct carried on". 170 Significantly MMLIC did not appoint a receiver and manager. If such had been the case, the receiver would have received the rents and managed the property as agent for the mortgagor: cf Conveyancing Act 1919 (NSW) s 115(2); see also Visbord v Federal Commissioner of Taxation (1943) 68 CLR 354; and would have been required to apply all money received by him in accordance with s 115(8) which includes (subcl (d)) "payment of the interest due and unpaid … in respect of any principal money due under the mortgage": see generally Butt, Land Law, 18118 ff (5th ed, 2006). 171 Rather MMLIC elected to go into possession itself and to receive the rents, to manage the property and to carry on the rental business itself, through its agent JLW. It can be inferred that it took this course for the purpose of preserving its security by enhancing the prospects of the building's sale as tenanted, i.e. as a "going concern". It is improbable in my view that having entered into possession, MMLIC would not have wished to carry on the business. It may well have been to its disadvantage in preserving its security if it had failed to do so: cf County of Gloucester Bank v Rudry Merthyr Steam & House Coal Colliery Co (1895) 1 Ch 629 at 638. 172 MMLIC was acting primarily for its own benefit. There was nothing fiduciary in the powers it was exercising. It was not acting as Chapel Road's agent: cf Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307 at 319; see also Federal Commissioner of Taxation v Walker (1984) 2 FCR 283. It was not providing services to Chapel Road: National Bank of Australia v Sproule, above, at 510. If MMLIC's primary purpose in carrying on the business was, in all probability, to preserve the value of the property pending its sale, it nonetheless was conferring an incidental benefit on Chapel Road. It did not have a free hand in dealing with the rents received by its agent. It was constrained by the mortgage itself and by its position as mortgagee in possession. In reality its position differed little, in my view, from that of a receiver under the Conveyancing Actat least in respect of the application of the rents received. The rental income had to be accounted for to Chapel Road. What this meant in practical terms was, first, that it was to be applied in payment of outgoings. The net income was then to be applied "on account of some liability under the mortgage": cf Visbord v Federal Commissioner of Taxation at 370; and in the circumstances this was Chapel Road's monthly rental liability: see Fisher and Lightwood's Law of Mortgage, at 19.33, 39.24 ff; In re Morley's Estate; Hollenden v Morley [1937] Ch 491 at 496. The rental income never being in surplus over what was required for interest, MMLIC was never, and never likely to be, in the position of having to elect whether to apply it in reduction of the principal sum as such or to hand it over to Chapel Road because it did not wish the capital to be repaid by "driblets": Nelson v Booth (1858) 3 De G & J 119 at 122. Put shortly, though MMLIC received the rents, the manner of their application was preordained by the mortgage and its legal consequences. 173 It is a question of fact whether or not, throughout the relevant test period, Chapel Road carried on a business at all let alone "the same business" as it may claim to have carried on immediately before the test time. In my view, it did not carry on a business at all in the relevant periods on the Chapel Road site. MMLIC did. Chapel Road had no access to business assets. I would add that while it could, in a sense, be said that Chapel Road's assets were being put to gainful use: cf American Leaf Blending Co Sdn. Bhd v Director-General of Inland Revenue [1979] AC 677 at 684; it was not Chapel Road that was doing this. It was MMLIC. 174 Accordingly I am satisfied that the same business test of s 165-210 of the 1997 Act was not satisfied and, in consequence, that neither the losses claimed to be transferred in both the 1998 and 1999 income years were deductible to R & D Holdings. 175 There is a seeming anomaly in this conclusion, especially given my earlier finding that the monthly interest liabilities were allowable deductions giving rise, in the circumstances, to significant tax losses. However, the conclusion itself, when considered in light of the "same business" test for loss transfer purposes, is the inexorable consequence of MMLIC having entered into possession as a mortgagee with all that that entailed.

Conclusion on the loss transfers 176 The loss transfers made by Chapel Road and recouped by R & D Holdings in the 1997 income year were valid and effectual. Not so those made and purportedly recouped in the 1998 and 1999 years as the conditions for a transfer of tax losses for these income years imposed by s 170-35 of the 1997 Act could not be met.

PENALTIES 177 In light of my conclusion in relation to the 1997 income year there was no tax shortfall in that year and no penalty could be imposed by the provisions of Part VII of the 1936 Act. 178 In the 1998 and 1999 income year assessments the Commissioner disallowed the deductions claimed by R & D Holdings for losses transferred by Chapel Road. There were resulting tax shortfalls and penalty taxes were imposed under s 226H of the 1936 Act in each instance.

Legal Context 179 Penalty tax is imposed by the 1936 Act and not by decision of the Deputy Commissioner. The two presently relevant provisions are s 226H and s 226K which provide: "226H Penalty tax where shortfall caused by recklessness 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. 226K Penalty tax where unarguable position taken 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 taxpayer, in a taxation statement, treating an income tax law as applying in relation to a matter or identical matters in a particular way; and (c) the shortfall or part, as the case may be, so caused exceeded whichever is the higher of: (i) $10,000; or (ii) 1% of the taxpayer's return tax for that year; and (d) when the statement was made, it was not reasonably arguable that the way in which the application of the law was treated was correct; The taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part." 180 Insofar as concerns the requirement of "recklessness", it is sufficient to refer to the observations of Hill and Hely JJ in Hart v Commissioner of Taxation (2003) 131 FCR 203 at [43]-[44]: "Recklessness is a concept well known to the law, particularly in the fields of tort and criminal law. In those fields, recklessness will usually be found to have been established if the person's conduct shows disregard of, or indifference to, consequences foreseeable by a reasonable person. In some contexts a subjective test is applied, but in others the test is objective. In BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) 46 ATR 347 at 364 Cooper J made the following observations in relation to recklessness in the context of s 226H: Recklessness in this context means to include in a tax statement material upon which the Act or regulations are to operate, knowing that there is a real, as opposed to a fanciful risk, that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct, and that a reasonable person in the position of the statement-maker would see there was a real risk that the Act and regulations may not operate correctly to lead to the assessment of the proper tax payable because of the content of the tax statement. So understood, the proscribed conduct is more than mere negligence and must amount to gross carelessness. There is a line between recklessness and dishonesty, and as the Explanatory Memorandum for the Taxation Laws Amendment (Self Assessment) Bill 1992 (Cth) (at p 89) confirms, a finding of dishonesty is not necessary for a taxpayer to be subject to a s 226H penalty. Wherever a tax return includes deductions that are not allowable, a foreseeable consequence is that there will be a tax shortfall, particularly in a system of self assessment. But, in the ordinary case, the mere fact that a tax return includes a deduction which is not allowable is not of itself sufficient to expose the taxpayer to a penalty. Negligence, at least must be established although there are some sections (e.g. s 226K) which impose a liability in particular circumstances even if the taxpayer has not been negligent. The context makes it clear that recklessness means something more than failure to exercise reasonable care (s 226G), but less than an intentional disregard of the Act (s 226J)." 181 The "not reasonably arguable" requirement of s 226K is elaborated in a definition in s 222C(1) of the 1936 Act. It provides: "222C(1) [Regard to relevant authorities] For the purposes of this Part: (a) the correctness of the treatment of the application of a law; or (b) another matter; Is reasonably arguable if, having regard to the relevant authorities and the matter in relation to which the law is applied or the other matter, it would be concluded that what is argued for is about as likely as not correct." The word "authority" is defined to include the relevant income tax Act, intrinsic material of which account can be taken in interpreting that Act, the decisions of a court, Tribunal or board of review and public rulings. 182 The above subsection was analysed in some detail by Hill J for the purposes of s 226K in Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 at [105] ff. I will not reiterate what was said there other than to note that his Honour indicated that an argument could not be as likely as not correct if there was a failure on the part of the taxpayer to exercise reasonable care in making it, although reasonable care alone would not result in an argument being, objectively, "about as likely as not correct". I agree with this view. I would add that encompassed in what constitutes reasonable care in this context is the need for the taxpayer, or its advisers who are reasonably relied upon, positively to advert to the applicability of the law in question to the taxpayer's circumstances and actually to form a reasoned view on the matter.

Factual context 183 The material before the court is slight which deals with the bases on which the taxpayer considered it could recoup in the 1998 and 1999 income years the tax losses purportedly assigned to it by Chapel Road. There is some evidence that Mr Richardson took advice from his own tax agents on the matter and that advice was taken from an external adviser. Though the advice related to whether Chapel Road's losses could be transferred to R & D Holdings, the focus of that advice was on the question whether, because of its interest liability, Chapel Road had allowable deductions. It seems to have been assumed for the most part that if there were allowable deductions generating tax losses, these were transferable. 184 The only evidence put forward to indicate advice was given on the question of satisfying the conditions for a transfer of tax losses was contained in a facsimile from Mr Bobb, R & D Holdings' accountant, to Mr Richardson in April 1996 prior to Mudipo's sale of its interest in R & D Holdings. Mr Bobb noted that that sale would breach s 80A of the 1936 Act ("continuity of beneficial ownership"). He went on to indicate that R & D Holdings would, nonetheless, continue to satisfy the "same business" test. And he then observed: "Compliance with section 80E must also apply to 410 Chapel Road Pty Ltd, after the transfer of shares from MPL to AJR in R&D. We believe section 80E will not be breached by 410 Chapel Road Pty Ltd after the share transfer in R&D. Therefore, we expect domestic revenue losses incurred by 410 Chapel Pty Ltd will still be capable of being transferred to R&D." 185 When advice was sought from an external adviser in November 1997, the sole issue relating to loss transfers on which advice was sought was whether the interest charges by MMLIC "were capable of creating tax losses each year". Equally, there is no evidence at all to suggest that consideration was given to whether Chapel Road satisfied the "same business" text when the transfer forms in respect of the 1998 and 1999 income years were prepared by Mr Chui in May 1999 and January 2001. 186 It was apparent from the reasons given for the two objection decisions in respect of the above two income years that the Commissioner's delegate was of the view that "Chapel Road … does not meet the continuity of beneficial ownership tests and the same business tests of division 165 of the ITAA 1997". In the reasons given for imposing penalty tax in both years the delegate stated (in respect of the 1998 year). "28. The directors and advisers of Chapel Road and the taxpayer were aware by the time the 1998 income tax return for Chapel Road and the taxpayer were being prepared that the mortgagee had taken possession of the property more than 7 years earlier and that after the taking of possession they took no further part in the management of the property, paid no interest and had no expectation that interest would be paid and they knew that no increase in income was coming to Chapel Road from a new source of income." 187 As I have previously indicated, this question was a live issue in the present proceedings and submissions were made and objective evidence was relied upon by the applicant to support its contention that it was carrying on a business at all relevant times. What is surprising is the poverty of contemporary evidence concerning why Chapel Road and its advisers considered they could assert that Chapel Road was carrying on a business and why it satisfied the same business test.

Consideration 188 If Chapel Road was to assert that its losses were properly transferable to R & D Holdings because it satisfied the same business test, it necessarily had to form a view about the significance of MMLIC being in possession and about whether it in consequence was in fact "carrying on a business". This was not demonstrated by referring to its financial statements and income tax returns or by the deductibility of its monthly interest liability. 189 Mr Bobb in his affidavit provided no basis at all for the "belief" on this matter expressed in the April 1996 facsimile. At best it seems an assumption was being made that whatever the effect of the Mudipo share transfer on continuing beneficial ownership of the shares in R & D Holdings, it would have no effect on Chapel Road's business whatever that was. 190 I am satisfied on the materials before me that the two companies and their advisers did not positively engage with the questions (i) whether Chapel Road was, in the circumstances, "carrying on a business" having regard to the test usually applied in answering that question of fact; and (ii) what was the significance of MMLIC being in possession and managing the property, having regard to affects of the law of mortgages in this regard. At best it was simply assumed that if Chapel Road had tax losses, those could be transferred to R & D Holdings. No advice was sought when careful and considered advice was needed, the moreso given the sums in question. 191 I am in consequence satisfied that it was not open to Chapel Road to say it was reasonably arguable that the loss transfer provisions were applicable in the circumstances. It had no informed view, reasonable or otherwise, on this matter at all. Section 226K applied to it. 192 I am, moreover, satisfied that Chapel Road was indifferent to the consequences of its reliance on the loss transfer provisions. A reasonable person would foresee there was a real risk of their inapplicability to it because of the circumstances in which it found itself. It had a mortgagee in possession and it was positively excluded from participation in the management of the business being carried on on the mortgaged proper. One can only conclude that its desire was to be reassured it had tax losses. Once it was satisfied that it had these, it sought the tax advantage of them without regard at all to whether it satisfied the applicable law relating to the transfer of such losses. 193 The penalty tax was properly imposed under s 226H.

CONCLUSION 194 I have rejected R & D Holdings' claim that the Bulletin Place property was not trading stock. I have upheld R & D Holdings' claim that Chapel Road was entitled to claim deductions under s 51(1) of the 1936 Act in respect of interest due to MMLIC under the MMLIC loan for each relevant income year. I have found that the tax losses transferred by Chapel Road to R & D Holdings were able to be recouped by R & D Holdings in the 1997 income year. I have rejected R & D Holdings' claim that it was entitled to recoup transferred tax losses in the 1998 and 1999 years. I have found that penalty tax was properly imposed under the Act in respect of the 1998 and 1999 income year assessments, but not in respect of the 1997 year assessment. 195 I direct the respondent to bring in short minutes of order to give effect to my reasons within 14 days of the date of these reasons. On the issue of costs, neither party has been completely successful, although the respondent has been predominantly so. I direct the parties to put in submissions on costs within 14 days of the date of these reasons. I certify that the preceding one hundred and ninety-five (195) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Finn.

Associate: Dated: 2 August 2006 Counsel for the Applicant: Mr B J Sullivan SC with Mr L S Einstein and Ms M Hirschhorn

Counsel for the Respondent: Mr A H Slater QC with Mr S J McMillan

Solicitor for the Respondent: Australian Government Solicitor

Date of Hearing: 13, 14 & 15 March 2006