Income Tax Assessment Act 1936: ss51(1), 53(1), 54(1), 55(1), 72(1) and 72(1B)

Southern Estates Pty Ltd v FCT [1967] HCA 16; (1967), 117 CLR 481; 14 ATD 543

20 December 1996 Associate Professor R D Fayle (Senior Member)

1. During the year ended 30 June 1995 the applicants, husband and wife, purchased a rural property with a view to establishing thereon a sheep farm. They incurred certain expenses in this regard, totalling $10,177, which amounts contributed toward an amount of $10, 127 being claimed a partnership loss pursuant to section 90 of the Income Tax Assessment Act 1936, ("the Act"), resulting in each partner claiming their respective share, being $5,064 for one and $5,063 for the other. The Deputy Commissioner of Taxation ("the respondent"), after providing an income tax ruling in relation to the claimed deduction for that year, issued amended assessments to each taxpayer increasing their taxable incomes by their claimed share of the partnership loss. The taxpayers objected and upon their objections being disallowed they applied to this Tribunal, pursuant to s14ZZ of the Taxation Administration Act 1953, for a review of the respondent's objection decisions.
2. The Tribunal had before it documents filed by the respondent pursuant to s37 of the Administrative Appeals Tribunal Act 1975 and two signed witness statements, neither of which the respondent sought to cross-examine. The husband taxpayer gave evidence. The applicants were represented by Mrs C Carpenter a public accountant. The respondent was represented by Mr E Krispler, a departmental advocate.
3. It is relevant to recite the applicants' history pertinent to the matter before the Tribunal. They will be referred to as Mr and Mrs C or "the applicants" where the context permits.
4. The applicants formerly lived, with their two small children, in an outer suburb of Perth. Mr C had a full time job. He and his wife had hankered for a farm and to bring up their children in a rural setting which they preferred to urban living. Each applicant had farming experience as a teenager. Some time in 1992 the applicants purchased a small rural holding, 45 acres, in Toodyay, a country district some 100 or so kilometres from Perth. They planned to develop this as a cross-bred sheep farm. However, it soon became apparent that the property had many deficiencies, none the least of which was a lack of sufficient water to be self-sustaining. Mr C learnt a lot about the sort of property he should be seeking from what he regarded as his mistakes in acquiring the Toodyay property, which he decided could never have been made into a viable farm. The applicants decided to search for a more suitable property which they would make their home and business. Mr C began many inquiries of Agriculture WA and farming organisations. He gathered information about breeding cross-bred sheep, about suitable pastures and feed supplements, prevention of poisons, sheep management such as branding, mulsing, lambing and wool production. He subscribed to farming journals and made inquiries about rainfall estimates and relevant weather patterns.
5. About 18 months after having purchased the Toodyay property the applicants purchased a 420 acre property in Dudinin, a country town in the Kulin Shire, Western Australia. As the property did not have a house they concomitantly purchased a house in the small township of Dudinin and moved there, selling up in Perth. The children were enrolled at the Kulin school about 37 kilometres away, travelling by school bus. Mr C took employment with the Kulin Shire as a plant operator and he and Mrs C spent all their spare time on the property. The Toodyay property was leased to its neighbour and put up for sale but remains unsold.
6. Prior to their purchase of the property the former owner, who truncated the property from his larger farm and continued to farm on his remaining 2,000 or so acres, used the property as part of his larger farming and sheep breeding business. He maintained the property in good order.
7. At the time of negotiating to buy the Dudinin property the vendor told the applicants about the sort of jobs which needed doing on the property to maintain it as a viable farm. These included repairing fences as some of the posts were in need or replacement, treating box poison which has a potential to kill livestock, fencing off some prickly poison, scooping the dam and repairing its contours. All these were jobs which the vendor believed needed attending to annually as it was not possible to eradicate the box and prickly poison so they had to be contained. He had successfully run sheep on the property over the years. The next door neighbour suggested to the applicants that they should scarify the paddocks annually, turning the soil and turning in the weeds, a better way of dealing with them than using weedicide as scarifying brings on the pasture at the same time.
8. After acquiring the property and the house in May 1995, on advice from a stock agent [Ex.A1], Mr C negotiated with a neighbour to purchase 150 head of breeding ewes. It was agreed in June that after shearing the neighbour would turn out 150 of his best breeding ewes and deliver them to the applicants at an agreed price of between $10 and $15 per head. The applicant considered this to be a good deal since the sheep in question were then being fed on lupins and as he had no lupins on the property it gave him a chance to bring on his pastures before taking delivery. Also, he was attracted to the deal because, despite offering to pay in June, the vendor did not want to be paid until he delivered the sheep in October and that also there would be no freight since the sheep could be walked from one property to the other. Further, it gave him time to attend to the fences, the poisons and to scarify.
9. In a similar vein, in June 1995 Mr C negotiated with a local breeder of Suffolk sheep to purchase two rams at $100 each [Ex.A2], to be delivered when the ewes were on his property. In response to questions put to him by Mr Krispler, Mr C said that it was not advisable to have breeding rams on a property without ewes because they become quite agitated and can injure themselves on fences. It was best to leave them where they were until the ewes were available.
10. Immediately after acquiring the property the applicants set about digging out the box poison and fencing off the prickly poison, carrying out some fence repairs and dam repairs and scarifying some paddocks. Mr C's evidence is that these tasks are of a repetitive nature and he understands that the previous owner attended to them annually as he has done since. Similarly, scarifying the paddocks is regarded as an annual maintenance task which together with a programme of rotation of crops between lupins and cereals ensures the best pastures from year to year.
11. Mr C gave evidence that the ewes and rams were delivered in October 1995 and since then he and his wife have successfully raised cross-bred sheep and maintained the pastures.
12. It was submitted by Mr Krispler for the respondent that the business of farming conducted by the applicants did not commence until the time when the sheep and rams were delivered to the property in October 1995. Therefore, all work carried out on the property prior to that and all expenses incurred prior to that were preparatory to commencing business and of a capital nature.
13. It was submitted on behalf of the applicants that the business of farming, or more correctly, cross-bred sheep raising, commenced when the property was purchased since the property had been actively used as a sheep farm by the vendor immediately before the purchase and the activities carried out by the applicant were nothing more than ongoing maintenance of a revenue nature in that the particular tasks are necessary from year to year in carrying on such a business. Both submissions were accompanied by references to cited cases which will be addressed as appropriate in these reasons.
14. The actual partnership return of the applicants claimed the following expenses against which has been set the relevant section of the Act, as agreed between the parties at the hearing:

1. The relevant provisions of the Act are set out below [emphasis added]:

"51(1) [Deductions for losses and outgoings] 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.

53(1) [Deduction allowable] Expenditure incurred by the taxpayer in the year of income for repairs, not being expenditure of a capital nature, to any premises, or part of premises, plant, machinery, implements, utensils, rolling stock, or articles held, occupied or used by him for the purpose of producing assessable income, or in carrying on a business for that purpose, shall be an allowable deduction.

54(1) [Depreciation deductible] Depreciation during the year of income of any property, being plant or articles owned by a taxpayer and used by him during that year for the purpose of producing assessable income, and of any property being plant or articles owned by the taxpayer which has been installed ready for use for that purpose and is during that year held in reserve by him shall, subject to this Act, be an allowable deduction.

55(1) [Calculation of percentage] The annual depreciation percentage for a unit of property owned by a taxpayer is worked out as follows.

55(2) Step 1: 100% depreciation. If:

(a) either:

(i) the cost of the property does not exceed $300 or such higher amount as is prescribed; or

(ii) the effective life of the property is less than 3 years; and

(b) the taxpayer does not nominate, in accordance with subsection (8), an annual depreciation percentage less than 100%;

the annual depreciation percentage is 100%.

72(1) [Allowable deductions] Sums for which the taxpayer is personally liable and which are paid in Australia by him in the year of income for

(a) rates which are annually assessed; or

(b) land tax imposed under any law of a State or of a Territory being part of Australia (other than taxes which are deductible under section 17 of the Estate Duty Assessment Act 1914-1940),

shall be allowable deductions.

72(1B) [Conditions for deduction] A deduction is not allowable under this section in respect of an amount paid by a taxpayer unless

(a) the amount is paid in respect of land that is, or premises that are, used by the taxpayer during the year of income for the purpose of gaining or producing income or carrying on a business for the purpose of gaining or producing income; or

(b) not relevant_."_

1. Each of the pivotal provisions, subsection 51(1), subsection 53(1) and subsection 72(1B) requires that the relevant expense be incurred in deriving assessable income or in carrying on business for the purpose of deriving assessable income. Subsection 54(1), in relation to a claim for depreciation, whilst differently worded implies that those conditions be met and depreciation is also available on plant which, whilst not used in the year, is held ready for use.
2. It is common ground that no assessable income was derived from the farming activities in that year. The relevant question therefore, is whether, in terms of the Act, the applicants carried on business, or more particularly, the business of farming, during the year ended 30 June 1995. Or put differently, were the activities engaged in by the applicants during the time from acquisition of the property in May 1995 till 30 June 1995 tantamount to them having carried on business in that time?
3. The respondent relied on several cases to support its contention that what the applicants did in the year ended 30 June 1995 was not carrying on business but rather preparatory to doing so from October 1995. One case in point is the Full High Court decision in Southern Estates Pty Ltd v FCT [1967] HCA 16; (1967) 117 CLR 481; 14 ATD 543. In that case the taxpayer company joined a partnership which acquired a large tract of land substantially in its primitive condition in a rural setting which set about reclaiming and improving the land. The object of the partnership was to clear the land and prepare it for grazing and to graze livestock until such time as the land could be profitably sold as grazing land. The partners expended large sums in the years ended 30 June 1960, 1961 and 1962 in reclaiming and improving the land. The work progressed on part of the land to the point of sowing pasture and nearly to that stage on the rest when the plan was abandoned due to the ill health of the taxpayer's partner. The land was then sold at a substantial loss. The taxpayer claimed deductions, under the then section 75 of the Act (since repealed), for expenditure incurred in reclaiming and improving the land. These were disallowed and therefore in question before the High Court. The Full Court in upholding the decision of McTiernan J at first instance to disallow the claims, held that the specific wording of s75, which required the taxpayer to be "engaged in primary production on ... land ..." precluded a finding in favour of the taxpayer because at no time was it engaged in primary production as the land at the time the expenditures were incurred was incapable of being used for primary production. (Taylor and Windyer JJ). Barwick CJ was of the opinion that the section did not apply to a taxpayer who "no more than intends to engage [in primary production] whilst he is doing no more than mak[ing] preparations to enable him to do so." (p.546) Windeyer J, in dissenting on this point, was of the view that a person was engaged in primary production even if no produce results if "the activities in which the taxpayer is there engaged are for the purpose of obtaining produce from it." (p.549)
4. The decision in Southern Estates can be distinguished from the present case on facts. In the present case the applicants acquired land which had been actively used in primary production up to the date of purchase and was ready for that use from that date. The applicants intended to engage in primary production activities per se as soon as was commercially sensible - they had on order the livestock to enable them to conduct the business but they deferred taking delivery of that livestock for sound reasons - first, the ewes were in wool and would be eventually shorn by the vendor before delivery at the agreed price; secondly, the vendor would continue to feed them on lupins not available on the applicants' property at the time; and thirdly whilst the applicants could have taken delivery of the two rams they were advised not to until the ewes were in situ. What the applicants were engaged in during the year in question was not fanciful nor a mere intention - they were actively setting about carrying on the business which included carrying out necessary ongoing maintenance of the property as distinct from devoting themselves to "reclaiming land, substantially in a primitive condition and improving it". In support of this the Tribunal points to the High Court decision of Walsh J in Thomas v FCT 72 ATC 4094 where his Honour said at p.4098:

"It is common ground that the appellant did not obtain any income from primary production before or in the tax year. No harvest had yet been obtained from any of the trees. But, in my opinion, that fact does not necessarily preclude a finding that the appellant was carrying on a business of primary production. This was not a case in which land was being improved in order to bring it to a condition in which it might be used for primary production for which it was not yet suitable. I am of opinion, therefore, that the decision in Southern Estates Pty Ltd v FCT [1967] HCA 16; (1967) 117 CLR 481 does not stand in the way of the appellant's claim. Trees had been planted and were growing, although they had not yet grown to an age at which they would yield marketable produce."

1. The respondent also relied on the Full Federal Court decision in FCT v Osborne 90 ATC 4890. In that case the taxpayer leased land with the intention of establishing chestnut trees for their produce. During the year of income in question the taxpayer incurred expenditure on making inquiries about the growing of chestnuts and acquiring seedlings. On advice he planted lupins to overcome nitrogen deficiency in the soil and ploughed them in but soon after abandoned the project as he considered it to be uneconomic due to the shortage of water and the need to spend money developing a dam. The court considered that costs incurred in establishing a plantation of trees to produce fruit or nuts are of a capital nature and not deductible under s51(1) of the Act. The court found that the costs of an annual nature such as fertilising the crops or indeed fertilising the chestnut seedlings, on the authority of Thomas' case, were deductible. In finding that the other costs were of a capital nature Pincus J cited with approval the following passage from Saunders v Pilcher (1942) 2 All ER 1097 where Jenkins LJ said:

"It is a well settled principle that outlay on the purchase of an income-bearing asset is in the nature of capital outlay, and no part of the capital so laid out can, for income tax purposes, be set off as expenditure against income accruing from the asset in question. This principle ... [applies] in the case of a capital asset such as an orchard of fruit trees which, subject to periodical replacement of casualties among the trees and the usual attention in the form of pruning, spraying, manuring, and so on, constitutes what may be describes as a permanent source of income (pp 1103-1104)".

1. Osborne's case can be distinguished, on the facts, from the present matter. As stated above, the applicants were not engaged in establishing pastures from virgin land, fencing them and otherwise developing them. On the contrary, they were carrying out activities which are more appropriately classified as ongoing maintenance on a property which had been actively used in the immediate past for the very purposes now intended to be undertaken by the applicants.
2. The respondent directed the Tribunal to the Full Federal Court decision in Ferguson v FCT 79 ATC 4261 in which Bowen CJ and Franki J set out certain criteria indicative of whether a business is being carried on. Their Honours, after pointing out that the s6(1) definition of "business" is fairly unhelpful, list what they regard as the principal elements which are to be considered. Firstly there must be a purpose of profit making. There is no doubt that the applicants in this case have a profit-making purpose in acquiring the sheep. Their Honours note that an immediate purpose of profit is not essential. The evidence suggests that whilst there was no expectation of profit in the year in question that was not necessarily the case in future years. Their Honours also refer to a need for repetition and regularity of activities. The evidence in this case is that the sort of activities carried out in the year of income are of a repetitious nature and necessary to maintain the property in a productive state. Their Honours also mention the need for organised activities in a business like manner and the systematic keeping of books and records. Whilst there was no evidence about the latter (although it was apparent that the applicants' tax affairs are attended to by a public accountant, Mrs Carpenter), there is evidence of organised activities - citing as cases in point the manner in which Mr C undertook research into cross-bred sheep raising, the business-like way he negotiated to purchase the ewes and rams and the manner in which he approached the task of containing the poisons. Finally their Honours mention the volume of operations and the amount of capital involved. The evidence is that the applicants were to begin with 150 ewes and build up to about 400 head as capital permitted. This level of flock is well beyond that which might be regarded as a hobby farm and whilst there was no direct evidence about the amount of capital involved, there was evidence that the applicants had to borrow to partly fund the purchase, using their Toodyay property as partial security. It is clear that there is a considerable capital commitment on the part of the applicants. On these criteria the applicants commitment to the property was tantamount to a business undertaking.
3. Finally, the respondent pointed to the Board of Review decision in Q105 83 ATC where the taxpayers purchased 1,200 acres of run down farming land and over the following seven years spent considerable sums of money on it to bring it into a productive state. It was decided by the Board that no business commenced until the property was first stocked that being after the seven year period mentioned. That case does not assist the respondent as the facts of the present case are clearly distinguishable. The applicants made immediate arrangements to stock their property once they had purchased it and it was stocked within 5 months. Expenses incurred in the meantime were of an ongoing maintenance nature.
4. Having regard to the foregoing the Tribunal is of the opinion and so finds that the applicants were carrying on a business of farming from when they purchased the property in May 1995 and moved to Dudinin. It finds that all of the deductions set out above and claimed by the partnership, were incurred in the course of carrying on that business. It also finds that none of those expenses were of a capital nature but rather were ongoing maintenance, depreciation or administrative expenses connected with the carrying on of the business.

1. The Tribunal sets aside the decisions under review and remits the matter to the respondent for reconsideration in accordance with a direction to issue notices of amended assessment for the year ended 30 June 1995, for each applicant allowing the claimed deductions of $5,064 and $5,063 respectively, pursuant to s.92(2) of the Act.

I certify that this and the 11 preceding pages are a true copy of the decision and reasons for decision herein of Associate Professor R D Fayle (Senior Member)

Signed: .....................................................................................

Counsel for the Applicant Mrs C Carpenter (a Public Accountant)

Counsel for the Respondent Mr E Krispler (Departmental Advocate)