Income Tax - losses necessarily incurred in carrying on a business - producing assessable income - gambling activities - whether constituted carrying on a business - criteria - system - scale - profit motive - skill - involvement with another business - conventional usage - gambling losses - not deductible.

Income Tax Assessment Act 1936 s.51(1), 187(1)(b)

Martin v Federal Commissioner of Taxation [1953] HCA 100; (1953) 90 CLR 470

Jones v FCT (1932) 2 ATD 16

Trautwein v FCT [1936] HCA 46; (1936) 56 CLR 196

Babka v Commissioner of Taxation (unreported, 21 September 1989)

Ferguson v Federal Commissioner of Taxation [1979] FCA 29; (1979) 26 ALR 307

R v Connare; Ex parte Wawn [1939] HCA 18; (1939) 61 CLR 596

R v Martin; Ex parte Wawn [1939] HCA 39; (1939) 62 CLR 457

Mansell v Beck [1956] HCA 70; (1956) 95 CLR 550

Graham v Green (1925) 2 KB 37

Mr A. Sweidan

Solicitors for the Appellant: Mallesons Stephen Jaques

Counsel for the Respondent: C.J.L. Pullin Q.C. and

Mr G.J. Windsor

Solicitors for the Respondent: Australian Government Solicitor

The appellant pay the respondent's costs of the appeals.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

These are appeals from judgments of Jenkinson J. in six income tax cases. The appellant objected to his income tax assessments for the years ending 30 June 1980 to 30 June 1985 inclusive i.e. a total of six years. As to the first four years, the objection was against disallowance of losses incurred in gambling and in the last two years the question was whether the previous years' gambling losses could be carried forward. His objections being unsuccessful, the appellant asked that they be forwarded to the Supreme Court of Western Australia and that was done in September 1986: see the former s.187(1)(b) of the Income Tax Assessment Act 1936 ("the Act"). Since the proceedings in respect of the objections had not begun before the "commencement day" referred to in s.4 of Act No. 23 of 1987, namely 1 September 1987, the proceedings were transferred to this Court by virtue of para.(3)(a) of that provision.

2. On 18 February 1988, Jenkinson J. made an order in each matter to the effect that the questions whether the appellant's winnings were assessable income and whether his losses were allowable deductions be decided "separately from and before the trial of any other question in the appeal". It was apparently thought that, to save time and expense, it was desirable to remove from the initial hearing of the case any question of quantum. Nevertheless, it was necessary for his Honour to give some consideration to the amounts involved, because it appears that larger scale gambling may be treated differently from small scale gambling for tax purposes.

3. Since Jenkinson J. determined that none of the relevant winnings were assessable and none of the losses deductible, each appeal was dismissed, because the losses exceeded the winnings in each year.

4. It is necessary to set out the learned primary judge's views of the facts in some detail, but this will be done principally by way of summary, rather than setting passages out at length. It should be mentioned, however, that some of the learned primary judge's discussion of the facts does not include any definite conclusion as to whether evidence his Honour recounts is accepted.

5. The appellant, who is 46 years old, grew up in Kalgoorlie, where he was introduced to gambling at an early age. He came to Perth when he was about 25 and worked as a life insurance salesman and real estate agent. From 1970 he began to develop and trade in real estate, particularly from about 1975 when he formed a profitable partnership with a Mr M.F. Brown. By 1979, the assets he controlled were worth over $1 million more than "the liabilities to which he and entities controlled by him were subject". The expressions just quoted were used by the primary judge because most of the assets were held by trusts and companies.

6. Before 1980, the appellant did not gamble a great deal, but he had the ambition of amassing enough money to pursue a gambling career. When the appellant was 36 (in 1979), he dissolved his partnership with Mr Brown and began to gamble extensively and often. He did not terminate his real estate activities, although they involved, from 1979 on, much less of his time. By February 1980 he had ceased to occupy business premises and ceased to employ staff; he took his real estate files home.

7. The appellant's principal methods of gambling were on horse races and in card games and an illegal two-up school. He also bet, to a small extent, on Australian Rules football. He claimed that he lost the following sums by gambling:

Year Ended 30 June Net Loss

1980 $125,000

1981 $392,000

1982 $280,000

1983 $146,750

8. In November 1982, the appellant, because of his losses, scaled down his gambling considerably. According to his evidence, he thereafter gambled only in a small way and for purely recreational purposes. It is convenient to refer to the period from the end of 1979 to November 1982 as "the gambling period".

9. The appellant ordinarily attended horse races two or three times a week during the gambling period, and for most of that time bet on credit, attending Tattersall's Club in Perth each Monday to settle his bets. He would, on that occasion, play cards at the club, gambling heavily. He used then to go to the two-up game where, according to his evidence, he commonly played until about 5 a.m. on Tuesday.

10. Before the gambling period began, the appellant had interests in racehorses and he continued to do so during that period. He was, however, not very interested in participating as an owner and his main purpose in keeping horses in a number of stables, as he did, was to obtain information to assist him in his gambling. During the gambling period, he had interests in horses fluctuating in number between 8 and more than 20. His training expenses aggregated about $50,000 per year, but he did not claim to deduct them.

11. When the appellant won, he did not ordinarily pay his winnings into a bank account, but used the money in gambling or paying gambling debts. His evidence was that in nearly all the many weeks of his heavy gambling period, he made net losses. He also said that at the start he thought he could earn at least $100,000 a year by gambling but, plainly, he was soon disabused of that notion, by his persistent losses.

12. The learned primary judge appeared to have some reservations about the appellant's figures. He remarked:

"If the applicant's evidence be accepted, his net

gambling losses are represented substantially by

the aggregate of the amounts for which he drew

cheques payable to his gambling creditors".

13. His Honour did not expressly say whether that evidence was accepted, but it could hardly have been. The evidence referred to appeared to be confused and unreliable.

14. It is necessary to give specific examples of this general proposition, to which Mr Pullin Q.C., senior counsel for the respondent, referred us.

15. It will have been seen from the list above that the largest losing year was that ended 30 June 1981, for which the claim was $392,000. It seems clear that that figure came from the appellant's cheque butts, listed at pp 550 to 554 of the record. But what of the winnings? A Tax Department investigator who looked into the claim found four bank deposits made by the appellant, totalling $31,650, which were apparently accepted to represent receipts from gambling. That would have reduced the claim for deductions to about $360,000. When preparing a schedule for the hearing, to justify the original figure, the appellant included a statement "LOST CASH TWO-UP $30,000" which, as Mr Pullin pointed out, nearly balanced the winnings which had been found. It should be added that Mr Pullin argued (correctly, as it appears to us) that the evidence showed that an additional $9,800 in cash, which had been ascertained to be winnings, was deposited in that year; it may be that, as Mr Pullin says, the $9,800 was forgotten by the appellant when preparing his summary. It is difficult to attain a state of any faith in the appellant's version of how much he lost in the 1981 year; it seems likely that it was simply assumed by him that the total of the cheques paid out for losses in that year fairly represented the excess of losses over gains. As we have pointed out, by orders of the learned primary judge, the question of quantum was left over for further determination, but the nature of the records available to support the claims made throws light upon the question whether the appellant treated his gambling as a business.

16. The second example relates to the year ended 30 June 1982 when $280,000 was claimed, which was, according to a summary presented by the appellant, made up of $362,005, being the total of cheques paid out for gambling losses, less $82,500 "cash received from cards, two-up, races". The appellant gave evidence that he obtained the figure of $82,500 from a record which he kept on pieces of paper for which he had had a "quick look" a couple of weeks before the trial.

17. He thought those records "could have disappeared", but the fact was that he produced no contemporaneous records with respect to his gambling activities, except cheque butts and race-books, the latter admittedly not giving a complete account. There was mention of the possibility of records having been lost in being moved from place to place and of a small fire, and he also gave evidence that he habitually made and kept his business records in an untidy fashion.

18. Again, the description the appellant gave of the way in which he handled gambling funds makes it difficult to accept that the sum of $280,000 truly represented the net result.

19. It may be remarked that as a practical matter, the difficulty of substantiation of losses or gains may loom large, when they are taken into account for tax purposes. Gambling is often done without much concern for record keeping, and it may even be difficult to determine whether gains attributed to gambling really came from that source; in Martin v. Federal Commissioner of Taxation [1953] HCA 100; (1953) 90 CLR 470, the trial judge plainly had serious doubts on that score. He appeared to think, perhaps relying upon local knowledge, that the money in question might have come from illegal liquor sales, but that notion was abandoned when the case went on appeal.

20. To return to the learned primary judge's reasons, his Honour found:

"... that the amounts wagered by the applicant

during the gambling period were of the order

indicated by his evidence and that during that

period his gambling was undertaken at the places,

and with the regularity, asserted by him". (p 20)

The expression "of the order" is, in our view, significant and is consistent with our view that it would not have been possible on the evidence to have any confidence in even the rough accuracy of the figures put forward.

21. His Honour also found that the appellant continued to have an interest in racehorses during the gambling period in order to obtain information for his gambling activities and that he took other steps to enhance his prospects of success, by watching television, studying the newspapers and so forth.

22. As to the appellant's state of mind, his Honour was not persuaded that the appellant believed that he would make substantial gains by gambling in the long run. His Honour said:

"It was, as I find, the desire to be free, at least

for a time, of the disciplined effort of conducting

the business in which he had been engaged, and the

desire to experience the excitement which he

thought he would derive from successful gambling,

that led the applicant to diminish his activities

in real estate and to embark upon gambling

activities". (p 21)

23. His Honour went on to find that the Brajkovich Trading Trust (a real estate trust controlled by the appellant) disclosed aggregate net profits of $721,011 from 1 July 1979 to 30 June 1983 - i.e. in the four years for which the gambling losses are claimed. His Honour also pointed out that in the same period gross income of the trust from the appellant's sales of real estate aggregated over $4 million and found that:

"... during that period he relied only on real

property transactions (including the leasing by him

of real estate) as the source of the funds by which

he intended to support himself and his family ..."

(p 23)

24. His Honour gave some consideration to the question whether, on the evidence, a distinction could be drawn between the appellant's gambling on horse races on the one hand and gambling on cards and two-up on the other, the postulated difference being that in respect of cards and two-up there was no evidence that the appellant "took any measure to enhance the chance of winning". In the end, his Honour rejected the possibility of holding that gambling on horse racing by the appellant was in a different category from the rest of his gambling activity. He held that the gambling on horse races suggested -

"... a whole hearted involvement in a recreational

world of gambling and in the world of 'inside

information' to which the punter not uncommonly

craves access, rather than the conduct of a

business". (p 28)

25. One possible answer to the appellant's contentions is simply that he was not regarded by the learned primary judge as an entirely reliable witness and that he failed to satisfy his Honour, as a pure question of fact, that he was carrying on his activity of gambling as a business. But, although in the end the question is a factual one, it is necessary to give some consideration to such tests as are able to be extracted from the reported cases.

26. We think it convenient first to consider a group of High Court cases dealing specifically with the question of gambling gains and losses. In Jones v. FCT (1932) 2 ATD 16, a grazier made substantial losses by betting at horse and pony racecourses. The appellant was unable to say how much he won or lost because he "almost invariably lost"; in these respects, in our opinion the case has some similarity to the present. Evatt J. found that "the element of sport, excitement and amusement was the main attraction" and we think that was so here also. His Honour concluded:

"... the appellant acquired and developed a bad

habit which he was in a special position to

gratify. I do not think that the gratification of

this habit was a carrying on of any business on his

part, despite his many bets and his heavy losses."

Four years later, the same judge heard a similar case and distinguished Jones: Trautwein v. FCT [1936] HCA 46; (1936) 56 CLR 196. The bases on which the taxpayer in Trautwein was held to be in a different position was that his betting, which was described as "systematic", was "part and parcel of the carrying on of a horseracing business", which included ownership of a stud farm and racing owned or leased horses "sometimes ... to a very considerable extent". Evatt J. emphasised, in his reasons, the large and organised scale of the taxpayer's operations and concluded that his case was "much more analogous to that of the bookmaker himself than to that of the mere punter at starting price ..." (pp 206, 207).

27. In Martin's case[1953] HCA 100; , 90 CLR 470 (referred to above), the successful appellant was a hotelkeeper and then a farmer during the relevant period. He kept proper records of his wins and losses and in two of the relevant years raced and bred racehorses. The Full High Court remarked:

"The onus ... is on the appellant to satisfy the

Court that the extent to which he indulged in

betting and racing and breeding racehorses was not

so considerable and systematic and organised that

it could be said to exceed the activities of a keen

follower of the turf and amount to the carrying on

of a business" (p 479).

The Court went on to point out that the taxpayer frequented only one racecourse and then only on ordinary racing days; he averaged about one bet per race. The Court thought the evidence illustrated:

"... the normal and usual activities and nothing

more of persons who derive pleasure from betting on

the racecourse and racing under their own colours"

(p 481).

28. It was held that the winnings were not assessable income.

29. These cases were discussed by Hill J. in Evans v. FCT 89 ATC 4540 where the question, again, was whether a successful punter should be taxed on his winnings. In deciding that the relevant income was tax free, Hill J. pointed out that gambling is more likely to be a business where associated with "some other business such as that of bookmaking breeding or training horses" (p 4555). His Honour also suggested that there was no decision of a Court in this country or the United Kingdom "where it has been held that a mere punter was carrying on a business" (p 4557). It was held that the taxpayer's activities there were in "volume and extent sufficient to characterise him as being addicted ... to gambling but they lack the system and organisation essential if they are to be characterised as a business".

30. More recently, facts more suggestive of a punting business came before the same judge in Babka v. Commissioner of Taxation (unreported, 21 September 1989). We do not comment on the facts of that case in detail, but note that his Honour referred to the absence from the taxpayer's operations of features which might be found in some punting businesses (p 4), and discussed the extent to which a punter on horse races may be compared to a player of cards or purchaser of lottery tickets (p 13).

31. Counsel for the appellant placed reliance upon authorities, of which Ferguson v. Federal Commissioner of Taxation [1979] FCA 29; (1979) 26 ALR 307 is an example, holding that deductions under s.51 of the Act might be obtained in respect of rather small-scale business activities. The successful appellant there was a serving Naval officer who had paid out moneys to take on lease and to have managed by others five Charolais half-cross cows, for breeding purposes. It was held, having regard to the whole of the circumstances, that the officer was carrying on a business. It appears to us, however, that the law does not necessarily equate mere gambling with true commercial activity, for purposes of this kind. That proposition is illustrated by another group of High Court cases, in the constitutional field, namely R. v. Connare; Ex parte Wawn [1939] HCA 18; (1939) 61 CLR 596, R. v. Martin; Ex parte Wawn [1939] HCA 39; (1939) 62 CLR 457 and lastly Mansell v. Beck [1956] HCA 70; (1956) 95 CLR 550, which affirmed the other two decisions.

32. These cases concerned the question whether the conduct of lotteries across State boundaries may be regulated or prohibited by governments, free from the restraints imposed by s.92 of the Constitution. In the first, R. v. Connare, Latham C.J. held that the purchase and sale of lottery tickets was a matter of trade and commerce and therefore legislation on the topic was subject to s.92, but he was in the minority. So was Rich J., who conceded that "taking part in a lottery ... may not amount to trade or commerce" (p 613) and relied on the word "intercourse". An important, if subsidiary, theme of the majority's reasons was the special character of lotteries; they were "inimical to the welfare of citizens of New South Wales" (p 616). McTiernan J. remarked (p 631):

"Some trades are more adventurous or speculative

than others, but trade or commerce as a branch of

human activity belongs to an order entirely

different from gaming or gambling. Whether a

particular activity falls within the one or the

other order is a matter of social opinion rather

than jurisprudence."

His Honour then cited Dr Johnson for the propositions attributed to him by Boswell that:

"Gaming is a mode of transferring property without

producing any intermediate good. Trade gives

employment to numbers and so provides immediate

good."

33. When the constitutional question was reagitated in Mansell v. Beck, with the same result, two members of the majority were again attracted by this ground: p 570, pp 594-597. In the latter passage, Taylor J. gave an account of the long history of legislative attacks on lotteries and other games of chance, and referred to the fact that statute not only prohibited lotteries and certain cognate activities, but declared them to be common and public nuisances and those who engaged in them to be rogues and vagabonds. Taylor J. remarked:

"To speak of the sale of a lottery ticket as though

it were the sale of a commodity is to fail to

recognise that the transaction is essentially and

exclusively one of gambling in which the purchaser

stakes his subscription on his chances of winning a

prize. This is gaming purely and simply and, to

say this is, immediately, to reject the contention

that it constitutes trade or commerce" (p 596).

34. It may be a question whether what was said in these cases as to the meaning of 'trade commerce and intercourse' remains consistent with the present doctrine concerning s.92 of the Constitution. But those authorities do indicate that gambling has been seen as bearing a particular legal character. In the light of these authorities, one should not assume that decisions on the revenue consequences of commerce, properly so called, are necessarily applicable to mere gambling. It is true that the borderline between commerce on the one hand and gambling on the other may seem uncertain, as to some activities. But there is no doubt into which category the present appellant's activities fell; he was merely gambling. Nor can it, in our view, be doubted that in the proper use of language and for the purposes of income tax law, gambling as ordinarily conducted by members of the gambling public will but seldom be classified as a "business", even where there are large gains or losses.

35. The principal criteria by which questions of the present sort appear to have been judged are the following:

1. whether the betting is conducted in a systematic, organised

and "businesslike" way;

2. its scale: i.e. the size of the wins and losses;

3. whether the betting is related to, or part of, other

activities of a business-like character, e.g. breeding

horses;

4. whether the bettor appears to engage in his activity

principally for profit or principally for pleasure;

5. whether the form of betting chosen is likely to reward skill

and judgment or depends purely on chance;

6. whether the gambling activity in question is of a kind which

is ordinarily thought of as a hobby or pastime.

36. We think it desirable briefly to discuss the way in which these criteria apply in the present case. There seems to us to have been very little organisation or system about the appellant's betting activities. On the other hand, cases can be imagined in which activities of a gambling kind are carried on, perhaps quite successfully, in a chaotic way, bereft of either records or system. The same may be said, of course, of some businesses which are not ordinarily described as "gambling", such as trading in futures.

37. Secondly, on the appellant's evidence and the learned primary judge's findings, the appellant was gambling on a fairly large scale. As to the third criterion, the appellant raced horses. He apparently did not regard that as a business in itself, but only as ancillary to his gambling. Next, on the findings, it is impossible to regard the appellant as having engaged in his gambling throughout the gambling period with a serious intention of making substantial profits; yet how could one think that he derived pleasure from persistently losing?

38. On the question of skill and chance, some comment should be made. Gambling which involves a significant element of skill, for example a professional golfer's betting on himself, is more likely to have tax consequences than gambling on merely random events. It is difficult to imagine circumstances in which people in the latter category could be regarded as in a gambling business. Particularly is that so where the form of gambling chosen is such that the "house" takes a percentage, so that the overall result is necessarily a continual diminution of the collective funds of the customers. Although many roulette players sometimes earn substantial sums by their efforts, it is hard to see how one could characterise as a business playing a game in which the results are (or should be) purely random and in which there is a high probability that each player will lose in the long run. For these reasons, we are of opinion that the present appeal must inevitably fail with respect to the "two-up" losses. On the evidence, the proprietor of the game took a substantial profit each night, so that there was a probability that on any single night most of the players would lose; there must have been close to a certainty that a person playing as many times as the appellant did would lose in the end. In those circumstances, the profit motive which is characteristic of a business was present only in a theoretical way; any such motive must have been based on mere self-delusion.

39. We agree also with the learned primary judge that, in his punting and card-playing activities, the appellant was not engaged in any business. His evidence shows that he had from his youth a simple passion for gambling on a large scale; on the authorities, merely indulging that, without more, is not engaging in a business. And more as a matter of usage than logic, it may be said that the gambler who seeks to demonstrate that he is thereby a businessman has more to show by way of system and profit motive than those who engage in more conventionally "commercial" activities.

40. There was also evidence, as we have mentioned, of some minor gambling on football; no different conclusion is warranted as to that.

41. That would be the end of the matter, were it not for an argument raised, without much enthusiasm, by the appellant's counsel. Even if the appellant were not found to have been carrying on a gambling business, he might, it was suggested, be entitled to deductions under the first limb of s.51(1) of the Act on the basis that his losses were "incurred in gaining or producing the assessable income". We think it enough to say that gambling cases have always been treated on the basis that winnings are not assessable unless they are derived from a business or "vocation": see Graham v. Green (1925) 2 KB 37. As FCT v. Myer Emporium Limited [1987] HCA 18; (1987) 163 CLR 199 illustrates, an isolated transaction may produce assessable income within the meaning of sub-s.25(1) of the Act. In that case, the High Court referred (supra at 211) to several strands of thought which so far had deterred the courts from accepting the proposition that the existence of an intention or purpose of making a profit or gain is itself enough to stamp the receipt with the character of income. The second of these strands was described by their Honours as follows:

"(T)he apprehension that windfall gains and gains

from games of chance would constitute income unless

the concept of income, apart from income from

personal exertion and investments, was confined to

profits and gains arising from business transactions."

However, we do not understand what was said in the Myer Emporium case as supporting the notion, inconsistent with all the authorities to which we have been referred, that an isolated bet at the races may produce assessable income or an allowable deduction. We are of opinion that (at least in general) gambling, unconnected with what might ordinarily be regarded as commercial activity, has no tax implications unless it is of itself, or is an aspect of, a business.

42. We respectfully agree with the conclusion arrived at by the learned primary judge. The appeals will be dismissed with costs.