A New Tax System (Goods and Services Tax) Act 1999 s 38-325

Income Tax Assessment Act 1997 s 8-1, 70-10, 70-15, 70-25

Taxation Administration Act 1953 Sch 1 s 284-75, 284-90

Re Midford and Deputy Commissioner of Taxation [2005] AATA 623; (2005) 60 ATR 1009; 2005 ATC 2189

Re Nitram Consulting Pty Ltd and Commissioner of Taxation [2008] AATA 1119; (2008) 71 ATR 755

Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337

1. The taxpayer is a company that was, at the relevant times, carrying on a business of property development and property investment. It has two disputes with the Commissioner.
2. The first dispute relates to GST. In November 2003 the taxpayer sold a property to a buyer, to which I will refer as B Pty Ltd, in circumstances which, according to the taxpayer, amount to the GST-free supply of a going concern. The taxpayer did not pay GST to the Commissioner on that supply. The Commissioner says that the supply was not GST-free. An assessment was made of the GST claimed by the Commissioner to be payable. The taxpayer objected against that assessment and the objection was disallowed.
3. The second dispute relates to income tax. During the income year ended 30 June 2004, the taxpayer incurred an outgoing of $220,000 which it claimed was for the acquisition of trading stock. On that basis it claimed a deduction from its assessable income. The Commissioner disallowed the deduction, and made an assessment reflecting that disallowance. The disallowance of the deduction entirely absorbed the taxpayer's declared net loss for the year, so that its taxable income was now greater than zero. This adjustment had a consequential impact on the taxpayer's taxable income for the following income year, ended 30 June 2005. An amended assessment was made for that income year. Administrative penalty was imposed in respect of both years. The taxpayer objected against these assessments and against the assessment of administrative penalty. These objections were also disallowed.
4. The taxpayer has applied to the Tribunal for a review of the Commissioner's objection decisions.
5. The taxpayer was represented by a director in these proceedings who will be identified as "Mr S" in these reasons.

1. There are three issues. The first is whether the sale of the property to B Pty Ltd was a GST-free supply of a going concern. The second issue is whether the taxpayer is allowed a deduction for the outgoing of $220,000 during the 2004 income year. The third issue - which arises only if the second issue is decided against the taxpayer - is whether the taxpayer is liable to administrative penalty arising from the deduction claim, and, if it is, whether the penalty should be remitted in whole or in part.

1. The taxpayer submits that the sale of the property is a GST-free supply of a going concern. It relies on the exemption from GST provided by s 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). Section 38-325 provides as follows:

(1) The *supply of a going concern is GST-free if:

(a) the supply is for *consideration; and

(b) the *recipient is *registered or *required to be registered; and

(c) the supplier and the recipient have agreed in writing that the supply is of a going concern.

(2) A supply of a going concern is a supply under an arrangement under which:

(a) the supplier supplies to the *recipient all of the things that are necessary for the continued operation of an *enterprise; and

(b) the supplier carries on, or will carry on, the enterprise until the day of the supply (whether or not as a part of a larger enterprise carried on by the supplier).

1. The requirement in paragraph (1)(c), that the supplier and the recipient have agreed in writing that the supply is of a going concern, has been described by the Tribunal as a "threshold requirement" for the application of s 38-325: Re Nitram Consulting Pty Ltd and Commissioner of Taxation [2008] AATA 1119; (2008) 71 ATR 755, per Deputy President Walker, at [33]. That is no doubt correct. It is therefore convenient that I first explore whether that requirement has been satisfied.
2. Before doing so, I should briefly mention the dissatisfaction expressed by Mr S about what he described as the "enforcement" action by the Commissioner in relation to a claimed amount of GST which, even if it is payable, would presumably be creditable to B Pty Ltd as an input tax credit under s 11-5 of the GST Act. I am not in a position to speculate on what triggered the Commissioner's interest in this transaction. Perhaps it was that B Pty Ltd claimed the input tax credit, and the Commissioner was then faced with the uncomfortable prospect of refunding, to the recipient of the supply, an amount of tax that had not been paid by the supplier. The GST system is not supposed to work that way, and so one would readily understand the Commissioner's desire to retrieve the GST properly payable. This is because input tax credits are payable to recipients, in specified circumstances, in the expectation that a corresponding amount of GST has been paid to the Commissioner by the supplier.
3. But if it was not the input tax credit claim that triggered the Commissioner's interest in the transaction, then the practical GST outcome may differ from the theoretical expectation, for a different reason. That is because, if I find that GST was payable on this supply, but the parties both thought that it was not (and if, as a result, B Pty Ltd has never claimed an input tax credit), then GST will be payable by this taxpayer in a business-to-business (and apparently creditable) transaction, but B Pty Ltd will be, on the face of it, out of time to claim the credit: see s 105-55(1) in Schedule 1 to the Taxation Administration Act 1953 (Administration Act).
4. In any event, and whatever the Commissioner's motivation, the Tribunal's role is to apply the law to the facts as found: either GST is payable or it is not. If it is payable, the Tribunal must say so. The Tribunal has no discretion to waive tax that it finds is payable.
5. I now turn to the substantive GST question.
6. The written agreement between the parties in relation to the sale of the property is described as a "Contract For Houses and Land - Fifth Edition", and has been approved by The Real Estate Institute of Queensland Limited and the Queensland Law Society Incorporated. It is apparently the standard form of contract used for the sale of houses and land in Queensland.
7. Apart from setting out the names of the buyer and the seller, and the purchase price of the property, the contract included three paragraphs of handwritten "Special Conditions". Mr S was not sure, but he thought that the handwritten Special Conditions might have been the work of the real estate agent who facilitated the sale. These were the Special Conditions:

The seller hereby agrees to sign whatever relavent (sic) documentation which may be required by the [local] council or relavent (sic) authority for the purpose of gaining approvals to build residential dwelling units on the subject property.

This contract is subject to and conditional upon the seller having the existing structure on the subject property demolished and removed from the property prior to settlement. The seller hereby agrees to employ [a specified demolition company] to demolish and remove the existing structure including foundations and deliver the property to the purchaser as a clean, clear vacant block of land at settlement. (with the exception of existing trees, builders power pole and builders fence)

The buyer and seller hereby a[c]knowledge that this contract is for the sale and purchase of vacant residential land and GST is not applicable. ($[xx] is the purchase price;

1. In the second paragraph, the words "builders power pole and builders fence" were originally specified in the Special Conditions but, by the time the contract was signed, they had been crossed out. The deletion of those words was initialled by Mr S, for the seller, and by the director of B Pty Ltd, the buyer.
2. The third paragraph of the Special Conditions appears in the Tribunal's documents exactly as it is shown above (but with a specific dollar amount as the purchase price). Unfortunately, in the copy available to me, the paragraph seems incomplete, ending with a semi-colon rather than a full stop, and with no closure of the parentheses that open before the price. This is apparently the best copy available to the parties and to the Tribunal. I proceed on the basis that what is before me is the extent of the written agreement between the parties.
3. I now turn to the "threshold requirement" in s 38-325(1)(c). It is clear to me that, to the extent that the parties "agreed in writing that the supply is of" any particular thing, they agreed that the supply is of "vacant residential land". That is evident from the third paragraph of the Special Conditions. They did not agree that the supply is of "a going concern". The contract, styled as a "Contract For Houses and Land", is not a particularly appropriate document to use for the supply of a going concern.
4. Mr S, for the taxpayer, argued that the Special Conditions, overall, provided evidence of a written agreement between the parties that an enterprise of some sort was being supplied by the seller to the buyer. (The focus on "enterprise" was no doubt driven by the reference to that expression in s 38-325(2) of the GST Act.) This was indicated, he said, by the reference to the requirement to provide to the buyer relevant documentation for the local council for the purpose of gaining approvals to build residential dwelling units on the property. That might be what Mr S thought the first special condition specified, but I do not read it in the same way. The requirement, in my view, is that the seller sign documentation. Whether such signed documentation was required to be provided to the buyer, is a different question entirely, as is the question of what the buyer might wish to do, or might be entitled to do, with any such documentation. The further requirement to demolish the existing structure, on which Mr S also sought to rely, does not, in my view, advance the taxpayer's position at all.
5. I also note that on 19 February 2007, Mr S, on behalf of the taxpayer, wrote to the Commissioner's office in the following terms (T17):

...

I have examined my diary (and memory) for specific entries in relation to this matter and advise you that I:

...

03/11/03 revised offer to $[xx] (excluding GST) as the agent and the purchaser told me that GST is not payable on a sale of vacant residential land; ...

04/11/03 met with real estate agent who further assured me that GST was not payable and so I signed [the] sales contract with [the B Pty Ltd director] - I had the contract amended on advice that the transaction related to a residential land sale on a site that had previously had GST paid on it and that was therefore not subject to further GST. ...

1. In Re Midford and Deputy Commissioner of Taxation [2005] AATA 623; (2005) 60 ATR 1009; 2005 ATC 2189, Associate Professor Barton, Member, said at [8]:

... Clearly ss 38-325(1)(c) is satisfied where the supplier and recipient of a particular supply have agreed or settled between themselves, at or before the time that the supply is made, that the supply is of a going concern and they have reduced that agreement to writing. The written memorial of their agreement, when reasonably read, must identify the relevant supply and express a mutual understanding that it is a supply of a going concern. Ss 38-325(1)(c) does not prescribe a form or formula for the written agreement so it may be separately documented or included in any documentation for making the supply.

1. I find that the relevant supply identified in writing by the parties is the "sale and purchase of vacant residential land", as is set out in the third paragraph of the Special Conditions. There is no written recording of any mutual understanding that the supply was of a going concern. In fact, it is unlikely, given the way Mr S described his thinking at the time (see [19] above), that there could have been any such mutual understanding. Instead, the agreement between the parties was an agreement to supply an item of real property, in a particular condition, presumably to enable the buyer more easily to carry out its own planned activities in relation to that property. But it was not agreed in writing that the supply was of a going concern. The threshold requirement in s 38-325(1)(c) has not been satisfied, and it follows that the supply cannot be GST-free in reliance on s 38-325.

1. The taxpayer's contentions in relation to the outgoing of $220,000 are confusing.
2. In the taxpayer's notice of objection, dated 27 April 2007 (T4), the payment was described as having been paid to a property development company (to which I will refer as R Pty Ltd):

... for a profit share interest in a 17 unit residential property development at [a specified location] and as such is a business cost: it was the acquisition of trading stock.

1. That is very similar to the way it was expressed in paragraph 22 of the taxpayer's statement of facts and contentions:

The payment was a business cost: it was the acquisition of trading stock made in the ordinary course of the Applicant's business as a property investor and property developer and in the circumstances was deductible.

1. Those contentions differ somewhat from the way it had been explained to the Commissioner in a letter dated 7 July 2007 (T5), in which the taxpayer said:

The entire sum paid into [R Pty Ltd] was in the nature of income paid in the course of and incidental to the ordinary course of [the taxpayer's] business as a property developer. The project jointly undertaken by [R Pty Ltd] and [the taxpayer] was not intended to be undertaken as a partnership, nor represented to any third parties as such. To the contrary, it was the intention of the parties who entered into the agreement, as is quite clear from the Joint Venture Agreement, that it was a joining of the separate equity, opportunities, skills and interests of each party for profit in a specific property development project.

1. At T31 is an unexecuted version of what is described as a "Property Joint Venture Agreement". Mr S was not sure if the agreement was ever executed, but as far as he was concerned, the arrangement between the parties (the taxpayer, referred to in the agreement as "B", and R Pty Ltd, referred to in the agreement as "A") was as set out in the document at T31. Mr S explained that the agreement had been drafted by "a mate" of his, to whom I will refer as Mr H.
2. Mr S explained the background to the transaction as follows (Transcript, page 48):

... [A] finance broker ... said to me, "Hey, I've heard about another deal. Are you interested in looking at something?" And I said, "What?" He told me about this deal. He said, "These guys can't raise the finance." I said, "Yes, well, what's the company like?" And he said, "I don't really know much about them, but they can't get the finance. If they don't get $220,000 to settle this land they're going to lose their deposit." I went and spoke to them. I thought, yes, these guys seem to be okay. And you'll see it goes on and it says that I was actually going to get a role as director in the company. That was to try and ensure the money because we didn't know these guys. And that was the subsequent agreement. ...

1. Mr S said that Mr H told him "I have a joint venture agreement. I'll just change it around a bit so it fits the circumstances. I think it's pretty right." Mr S was content with that approach.
2. Clause 3 of the agreement stated:

"A" and "B" (hereafter where the context permits called "the joint venturers") acknowledge and agree that the property will remain registered solely in the name of "a" (sic)

1. Clause 4(a) of the agreement noted the parties' acknowledgment that:

(1) The purchase of the property (being the purchase price, all costs of acquisition and construction) will be funded through a contribution of:

(i) By finance to "A" provided by [a specified financial institution] which is secured by registered first and second mortgage over the property (hereinafter called the mortgage) serviced by capitalized interest.

(ii) Private funding of $22000.00 [sic - this should be $220,000] provided by "B".

(iii) The joint venture shall pay the private funding interest at the rate of 100% of the first $100000.00 or from construction costs and/or project management of projects for [Mr H].

This interest will be repaid to [Mr H] from projects not associated with this joint venture. Joint venture partner [DF - perhaps the principal of R Pty Ltd] will not be involved in the repayment of this interest component to [Mr H]. The $100000.00 will be repaid to [Mr H] on the final sale and settlement of the ... project.

(iv) In consideration of "B" lending a further $100000.00 to "A", "B" will be entitled to share one third of the profit on realization of the project. This will include one third of the constructions builders profit (15%). The $100000.00 will be repaid on realization (sale and settlement on the ... project.

1. During the hearing, Mr S gave evidence as follows (Transcript, pages 43-44):

MR KASEP: ... Mr [S], do you understand the concept of trading stock?

...

MR S: ... Of course I know what trading stock is.

MR KASEP: Okay. Thank you. And is it the profit share interest that you say is the trading stock on which you place your entitlement to deduct the $220,000 you paid to [R Pty Ltd]?

MR S: What I say is this is construction finance, if you like, the same as any other person with financial development, for a profit share of a 17 unit residential development.

MR KASEP: What I am getting at, Mr [S], and there is no trickery involved, is just trying to identify what you say is the trading stock. Is the trading stock the profit share interest in the development that you describe in the - - -?

MR S: What document are you referring to with the definition of "trading stock"?

MR KASEP: I'm not taking you to the definition of trading stock. I'm taking you -?

MR S: Well, I can't answer your question then.

MR FROST: ... Well, perhaps if I could put it a little bit differently. What do you say the company bought for the $220,000?

MR S: A share of the realisation.

MR FROST: A share of the realisation?

MR S: Yes.

MR FROST: of what?

MR S: The sale, the completion of the building.

MR FROST: A share?

MR S: It's like construction finance, yes.

MR FROST: Okay. Well, just let me understand what you have said. A share of the realisation of the building when it was sold?

MR S: Yes.

MR FROST: Is that right?

MR S: Yes.

MR FROST: So some share of the proceeds of sale of the building, once completed?

MR S: Yes.

MR FROST: Right. And that's what you say the $220,000 was paid for?

MR S: Yes.

1. It seems to me that Mr S's description of the $220,000 payment as "construction finance" is one reasonable way of describing the arrangement, if not the only one. To the extent that any sense can be made of the so-called Joint Venture Agreement, I regard clause 4(a)(1)(ii) as indicating that the taxpayer will lend $220,000 to R Pty Ltd to fund the purchase of the property, of which the registered proprietor will be R Pty Ltd.
2. It is clear that the payment of $220,000 by the taxpayer was not for the acquisition of "trading stock". Trading stock is generally regarded as those things in which a business trades - the things that it buys (or makes) and sells. A merchant buys and sells merchandise - the merchant's trading stock is made up of the items of merchandise that it buys for the purpose of resale. A real estate trader buys and sells real estate - its trading stock will be the items of real estate that it buys for the purpose of resale.
3. For tax purposes, the expression "trading stock" is defined in s 70-10 of the Income Tax Assessment Act 1997 (ITA Act) to include:
   • (a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a *business; and
   • (b) *live stock;

but does not include a *Division 230 financial arrangement.

1. Whatever the taxpayer acquired, it was not "trading stock". It was not something acquired for the purpose of manufacture, sale or exchange. What the taxpayer acquired might be characterised as the right to a proportion of the proceeds of the sale of the units, but in no way was that right acquired for the purpose of resale. The right, if one was acquired, was acquired to be held by the taxpayer for the benefit that it would provide to the taxpayer once the units were sold by their owner, R Pty Ltd.
2. If the outgoing had been incurred in connection with the acquisition of "trading stock" within s 70-10 of the ITA Act, then it would be deductible to the taxpayer under s 8-1 of the ITA Act because it would not be "an outgoing of capital or of a capital nature" (s 70-25). It would be deductible in the income year in which it was acquired (s 70-15(2)).
3. However, as I have found that it was not an outgoing incurred in connection with the acquisition of an item of "trading stock", I need to consider whether it is otherwise deductible under s 8-1 of the ITA Act.
4. If it is assumed, for the sake of the argument, that the outgoing satisfies the second positive limb of s 8-1 in that it was "necessarily incurred in carrying on a business for the purpose of gaining or producing [the taxpayer's] assessable income", to be deductible it must not be "a loss or outgoing of capital, or of a capital nature". For if it has that character, it will be excluded from deductibility by s 8-1(2)(a) of the ITA Act.
5. The "classic formulation" of the matters to be taken into account in determining whether an outgoing is of a capital nature was stated by Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337 at 363:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

1. In my view, when the taxpayer paid the $220,000 to R Pty Ltd, it was making a one-off investment in an addition to the business structure by which income would be derived by it, rather than incurring a cost of earning that income itself or performing the income-earning operations. As such it incurred an outgoing of capital or of a capital nature. For that reason, the outgoing of $220,000 is not deductible.

1. Penalty was assessed at 25% because the taxpayer had made a statement in its tax return (to the effect that the amount of $220,000 was deductible) that was false or misleading, the statement had led to a "shortfall amount" in two tax years, and the shortfall amounts had been caused by a failure, on the part of the taxpayer or its agent, to take reasonable care to comply with a taxation law (s 284-75(1), and item 3 in the table in s 284-90(1), in Schedule 1 to the Administration Act).
2. The taxpayer's statement of facts and contentions, prepared by Mr S, said:

...

[25] The Applicant fully described the nature of the transaction and of our business to its accountant before the accountant prepared its income tax return.

[26] The Applicant provided all relevant documents and information to the Applicant's accountant.

[27] The Applicant sought and relied on the advice of the Applicant's accountant in respect of the way income and expenses and GST which are the subject of this application, should be characterised and treated in its returns.

...

1. Mr S's oral evidence, however, did not support those assertions, as the following exchanges demonstrate (Transcript, pages 46-47):

MR FROST: You're being asked questions about who gave you advice on the income tax issue?

MR S: Okay, sorry. With respect to the income tax issue, I submitted my taxation documents to my accountant as I normally did. He contacted me if there was any issues. Did I go and seek specific advice from him concerning this matter? No, I submitted all my documents to him for the preparation of my tax return, which he prepared, submitted. I understand my responsibilities in relation to signing.

MR KASEP: Mr [S], what I want to take you to is paragraph 27 of your statement - of the applicant's statement of facts, issues and contentions. There it says that the applicant sought and relied on the advice of the applicant's accountant in respect of the way income and expenses and GST, which are the subject of this application, should be characterised and treated in its returns?

MR S: Yes.

MR KASEP: Where do I find any evidence that the applicant, [the taxpayer], sought advice in relation to income tax?

MR S: But you won't. It hasn't been produced in writing. I have - when you're doing this kind of business you ring your accountant very often, and I don't have my telephone records. It's a very common thing, if I [went] and sat down with my accountant in his office, he'd say, "What are you up to?" I'd say, "I'm doing this, this and this." We would drink coffee and we'd sit there for an hour, two hours. He also developed property. We talked generally. Did I ask him specifically, "Please provide me with a document in writing in relation to this." No, I didn't.

MR KASEP: Well, Mr [S], what I'm asking you is that you say that the applicant sought advice. Now, am I correct in reading that, that [the taxpayer] had made payments of $220,000, approached its accountant and said, "Listen, [the company] has made these payments. Are they deductible?" Is that what happened?

MR S: We would have had a conversation in relation to the submission of tax, which we always did. We would go through. I would bring him all of my stuff. We would sit down. He'd have it on his desk. We would go through it and we would discuss it. If there was any issues he would say, "Hey, what about this, I'm not sure about this. Tell me more about this." I don't believe that it became an issue or for a direct lengthy discussion. It was just general in the course of business.

MR KASEP: What I'm asking you is, did [the taxpayer] actually seek advice on the way that these payments of $220,000 were to be treated?

MR S: Please tell me what you mean by seek.

MR KASEP: Well, I'm using the word that is taken from the applicant's statement of facts, issues and contentions, and that is the applicant sought and relied on the advice. Are you able to explain why the words sought and relied, the words sought and relied were used?

MR S: Yes, because I asked questions. I do it all the time. This is new business. I don't know what I'm doing here, hence the different contracts that have been used. I was trying to figure out what to do. I ask people questions all the time. I have friends in the trade. I talk to people. I sought advice from an awful lot of people. And if there was even an issue I used to ring my accountant and say, "Hey, Manny, this is what's going on, I've been told this. What do you think about that?" I can't - I don't think, you know, you've got all my tax affairs. You know that I didn't make any money. I don't lightly put in claims and I don't lightly deal with $200,000 ever. The reality is, yes, I talked to people. Can I tell you on what particular day? No, I can't.

1. This was an atypical transaction for the taxpayer. It had not done anything like this before. A prudent taxpayer, in those circumstances, would do its best to ensure that the transaction was treated properly in its income tax return. Given the amount of money involved, a prudent taxpayer would specifically ask its agent, or a tax adviser, to advise on the proper treatment of the transaction. The taxpayer did not do that. It did not take reasonable care to comply with the taxation law.
2. On Mr S's version of events, the agent asked no specific questions about the transaction. He took no more care to get things right than did the taxpayer itself. The failure on the part of both the taxpayer and its agent to take reasonable care to comply with a taxation law attracts the 25% penalty in item 3 in the table in s 284-90(1) in Schedule 1 to the Administration Act. On the material before me, there is no reason why there should be any remission of that penalty.
3. In the circumstances, the Commissioner's objection decisions must be affirmed.

I certify that the 46 preceding paragraphs are a true copy of the reasons for the decision herein of Mr S E Frost, Member

Signed: ..............[sgd]..................................................................

Appearance for the Applicant "Mr S", the director of the taxpayer

Solicitor for the Respondent Mr R Pandey, ATO Legal Services