Puzey v Commissioner of Taxation [2004] HCATrans 426 (28 October 2004)

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Puzey v Commissioner of Taxation [2004] HCATrans 426 (28 October 2004)

Last Updated: 9 November 2004

[2004] HCATrans 426

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
Perth Nos P59 and P60 of 2003

B e t w e e n -

NOEL PUZEY

Applicant

and

COMMISSIONER OF TAXATION

Respondent

Applications for special leave to appeal

GUMMOW J
HEYDON J

TRANSCRIPT OF PROCEEDINGS

AT PERTH ON THURSDAY, 28 OCTOBER 2004, AT 10.46 AM

Copyright in the High Court of Australia

MR M.J. McCUSKER, QC: May it please the Court, I appear with my learned friend, MR F.C. WILSON, for the applicant. (instructed by Wilson & Atkinson)

MR G.J. DAVIES, QC: If the Court pleases, I appear with my learned friend, MS L.B. PRICE, for the respondent. (instructed by Australian Government Solicitor)

GUMMOW J: Yes, Mr McCusker.

MR McCUSKER: May it please the Court. This application involves at least three matters of considerable importance in terms of afforestation and other industries - - -

GUMMOW J: There are two matters numbers.

MR McCUSKER: Yes.

GUMMOW J: Is that because - - -

MR McCUSKER: That is because what occurred - - -

GUMMOW J: - - -of the plurality of assessments?

MR McCUSKER: Yes, it is. Quite so.

GUMMOW J: Thank you.

MR McCUSKER: The first of those, and they are not necessarily in order of significance, is the question of whether establishment costs for establishing a plantation such as this are to be treated as capital on account of revenue. There is a product ruling, which has been in existence for a considerable time, by the Commissioner, which asserted that the establishment costs for plantations of this nature on account of revenue were deductible, and those product rulings are to be found in the volume. It is at tab 20, and just to get – it is Ruling 95/6, and if I can just direct your Honours’ attention to the pages. Page 6 of 34 – the page number is in the top right-hand corner, again at page 10 of 34, although it says somewhat ambiguously:

46. Expenditure incurred in the course of establishing a plantation or forest, provided the expenditure is not of a capital nature, is an allowable deduction under subsection 51(1).

Page 20 of 34, paragraphs 106 and 107, halfway down page 21 of 34 there are statements:

(c) Non-capital site preparation costs, such as deep ripping, mound ploughing, stick picking, raking and levelling or weed control, are viewed as part of the planting operations and are deductible under subsection 51(1) . . .

(e) Expenditure incurred on seedlings and planting costs is incidental and relevant to carrying on a business and is deductible in the year of income in which it is incurred –

Consistently with that product ruling, your Honours, the judge at first instance, Justice Lee in this case, allowed as deductible the claim for a deduction of $2,000 for plantation establishment fees. That was not the subject of an appeal, or cross-appeal, by the Commissioner. Indeed, if I could perhaps hand up copies of the notice of contention and appeal – they are not in the appeal book I notice - your Honours will see in the notice of cross-appeal, which is annexed to the notice of contention, the cross-appeal was against the primary judge’s ruling on costs. In paragraph 2 it is stated:

The learned primary judge erred in holding (except in relation to deductions for the plantation establishment fees of $2,000 –

and so on. Nevertheless, the Full Federal Court, notwithstanding that there was no cross-appeal on this and notwithstanding the product ruling, as I have mentioned, concluded that the expenditure for plantation establishment fees was not deductible because it was capital.

HEYDON J: Are you taking a natural justice point, or are you taking a substantive point - - -

MR McCUSKER: Substantive point, your Honour, yes. We are not appealing on the ground of natural justice. The plantation establishment costs, in our submission, have been correctly characterised by the learned primary judge as being on account of revenue. It is a very important question. There is, in the papers in the application book itself, an affidavit by Mr Cummine at 152. He deposes, through his background experience in the afforestation industry – and I will not read through that, your Honours, but at page 154 in paragraph 13 he refers to the difficulties that are likely to face the industry, and says if that interpretation by the Full Court that establishment fees are not deductible is to be maintained:

were to be applied broadly to all timber plantations –

I interpolate to say there is nothing different about - - -

GUMMOW J: This is independent of any Part IVA argument, is it?

MR McCUSKER: This is independent of any Part IVA argument, yes.

GUMMOW J: Where does the Full Court crucially deal with this question?

MR McCUSKER: Of the establishment fee?

GUMMOW J: Capital outgoing, yes.

MR McCUSKER: Yes. It was actually in a second set of reasons, your Honour.

GUMMOW J: Yes.

MR McCUSKER: Page 114 and what occurred was that there had been no cross-appeal and no argument before the Full Federal Court - - -

GUMMOW J: Sorry. Is it the judgment appearing at 109 of the application book?

MR McCUSKER: Yes, that is so, your Honour. It is the supplementary reasons.

GUMMOW J: Yes.

MR McCUSKER: Because what occurred is that the court delivered its reasons, its first set of reasons, and the question of the establishment fee was raised by the court, on which there had been no argument, of course, because there was no cross-appeal from the decision of Justice Lee. So written submissions were received by the court. There was no oral argument.

GUMMOW J: I see.

MR McCUSKER: Then the court gave its decision on the establishment fee, which appears at page 113. It starts at 112, the appellant’s contentions, and at 113, at paragraph 9 it refers to the submissions on behalf of the Commissioner, which were submissions received as a result of the court’s invitation. They were indeed a one-off payment, as the court says at paragraph 9, but the court then simply says:

Accordingly, they constituted expenditure directed to securing an advantage of a lasting character.

There is nothing further said by way of reasoning on that point except over at page 114, paragraph 11. Having detailed the nature of the establishment costs, said again they “are properly characterised as on capital account” and, they say further down, “a lump sum, one-off fee”.

In our submission, the fact that a payment is a one-off fee does not necessarily make it capital. As to it being for the purpose of a lasting nature, this plantation of sandalwood was expected to mature and then be totally harvested with no residual value at all, in about 15 years from the date of the agreement.

GUMMOW J: What do you say about Mr Davies’ submissions on this point at page 145, paragraph 33?

MR McCUSKER: Your Honour, that is a different proposition that is argued there. The court reached the conclusion that it did that this was capital based on a one-off fee for something of a lasting nature. Mr Davies put an alternative proposition, which is not echoed in the court’s reasons. As to the restructuring - - -

GUMMOW J: I mean at the special leave level we have to, as it were, look broadly at the dynamics of the litigation.

MR McCUSKER: Certainly, your Honour. I accept that. But as to the context of restructuring, there is a different issue that we wish to ventilate on that, and that is that the restructuring made no difference to the fact that the taxpayer was in the year one carrying on a business, and all that the restructuring did was to pool the product so that the same purpose was involved so far as the establishment fee went, whether it be in year one or year two.

GUMMOW J: Now, if you were successful on this particular point, what necessary favourable consequence does that have for you on Part IVA?

MR McCUSKER: So far as Part IVA is concerned, your Honour, I think that – well, can I elaborate on that? We say that Part IVA is inapplicable in any event so that it would not necessarily - - -

GUMMOW J: Well, assume - - -

MR McCUSKER: Well, we would say if it is not capital account but revenue, then Part IVA clearly cannot apply in any event to this fee. No, Part IVA is not in issue, I am reminded on this one, or on the leasing fee. So the payment of the establishment fee was made. The management fee and the leasing fees are ongoing expenses, which I understand to this day are still being paid.

Coming to that point, your Honour, there is also the fact which was not taken into account in dealing with Part IVA, that the taxpayer, even if the deductions claimed are all allowed, will unless the venture is commercially successful, have a net outlay over the period of this plantation of some $72,000. So it makes no sense whatever for the taxpayer to have gone into this project with the primary object or purpose of securing a taxation benefit. It would be madness to do that if the taxation benefit still leaves the taxpayer with a liability, a net outgoing after allowing for the tax, of some $72,000.

That, in our submission, is something which the court, with respect, did not take into account when looking at Part IVA; yet the evidence was all there, of course. There is no issue as to the fact that the taxpayer will have this ongoing liability. The court, both at first instance where sham was argued, but rejected, and there was no issue of sham raised by cross-appeal, and the court accepted at first instance and on appeal that the agreements entered into were real agreements raising a real liability for the taxpayer. So the taxpayer had a real liability to repay the loan which was made to him which was used for the purpose of purchasing the seedlings, and he had real liability not only for the establishment fees but the ongoing management costs.

Part IVA was applied, as your Honours can see from our outline, for a number of reasons, but probably the principal reason it was applied was the view taken by the Full Federal Court and Justice Lee that the cost of the seedlings, even if, as Justice Lee held, deductible under 51(1) in the first two years and, as the Full Court held, deductible in the first year but not the second because of the restructuring, the cost of the seedlings was grossly in excess of their true market value. The problem – and again this issue was raised in Mr Cummine’s affidavit – a concern that if that approach is to be taken then the question will be on each occasion, “Well, what’s said to be grossly excessive?” In the instant case the taxpayer, Mr Puzey, as was found, did not know that the price for the seedlings was, as it was put, excessive at all. It was also found as a fact that the - - -

GUMMOW J: That is not critical, is it? That is not determinative?

MR McCUSKER: Not determinative, but we say that is an objective fact. That is a finding of fact. It was also found, as an objective fact, that Allrange was the only supplier of seedlings. The Full Court speculated, with respect, that he might have been able to negotiate a better price with CALM, that is Conservation and Land Management, which was in the process of producing seedlings in a nursery, but at that stage they were not available. To suggest that because the price was grossly excessive therefore the objective, the primary objective of the taxpayer in entering the scheme was a tax benefit, again ignores the fact that this is a real liability that he incurred for the purchase of the seedlings. He did not know that the price was excessive. The supplier Allrange was the only supplier, and the taxpayer will have a net loss unless the venture is commercially successful of some $72,000, as I said.

So we say, your Honours, that this is an important issue of principle; that is, if a cost or an outgoing is deductible, as it was found to be under section 51(1) – that is, the seedlings cost – the fact that the price is said to be excessive of course does not affect that unless it is a sham, and it was not a sham. Cecil Brothers’ Case and other cases have long held that it is not for the Commissioner to determine what outgoings the taxpayer has properly incurred in conducting his business - - -

GUMMOW J: Cecil Brothers was a 260 case, was it not?

MR McCUSKER: It was indeed. Yes, your Honour. But the same principle applies; that is that, in our respectful submission, if – and in that case the court said you cannot simply apportion the expenditure and say, “This much is allowable and this much is not.” The view that was expressed by Justice Lee that if it was not the taxpayer’s primary object to achieve a tax saving or a tax benefit in entering the scheme then it was, he opined, the promoters, was something which runs right against both the facts of the case and, indeed, the decision of the Federal Court in Vincent, where it was held that clearly in a situation where there has been a large charge made the primary object of the promoter must surely be, where it is a real liability to the promoter, it must surely be primarily a commercial purpose – that is, the promoter is seeking to make a profit, and a very large profit in this case. But that does not make his primary object the gaining of the tax benefit either for himself, obviously, or for the taxpayer.

Now, it is important to appreciate, going back to the establishment costs, that the business of sandalwood production was held to be a real business conducted in the first year by the applicant, and that Justice Lee, like the Full Court, dealt with the grossly inflated price. The Full Court also dealt with the question of the underlying agreement and suggested, without saying it was a sham because there was no issue as to sham, that the reality was other than that which was found to be the true liability under the agreements. That appears in Justice Lee’s reasons at application book 29 at paragraph 90, where he misstates, with respect, the effect of a loan agreement by talking about what the representations were.

It is true that there were representations made by the promoter that the repayment of the loan should occur from the process of the harvest,
which were expected in 15 years, but there was a liability, regardless of the harvest proceeds, to repay the whole of the loan by December 2012. So, in our submission, this transaction was only explicable by there being a dominant purpose of commercial profit. We put our submissions on that point at page 130, at paragraphs 17 and 18. It made no sense unless the objective was commercial profit.

The disallowance of the second year seedling costs as a deduction under section 51, contrary to the view taken by Justice Lee, on the ground that they were capital as a result of restructuring, deals with the important question of pooling of the proceeds, because that is all that occurred in the restructuring. The proceeds were to be pooled so that there was to be, as a result of the establishment of a trust, there was to be a pooling of all proceeds of the sandalwood. In that way all participants would share equally in the profits. That was at the express direction, as your Honours have seen, from the Australian Securities Commission.

So, in essence, that is all that occurred. To say that pooling means that there is no deduction under section 51, cuts right across the Full Court’s decisions in Emmakell, which is at tab 546, and in Cooke. In Emmakell there was the pooling of proceeds of a tea-tree plantation. In Cooke there was a pooling of a product, in that case flowers. In neither case was it held that because there was a pooling arrangement between all the investors that was a bar to deductibility under section 51(1).

For public interest matters in this case, we have referred to both in Mr Cummine’s affidavit, which sets out in full, and the tax rulings that I have taken your Honours to. May it please the Court.

GUMMOW J: Yes, Mr Davies. What do you say first about this supplementary judgment, and its treatment of the capital character of the fees?

MR DAVIES: It follows on, your Honour, from the finding that was made by the Full Court, that the restructure meant that the applicant was no longer carrying on a business and, therefore, the payment made for the preparation of the land was not a payment that was made in the course of carrying on a business. Their Honours obliquely deal with it in the first of the two judgments, page 102 at paragraph 99, about five lines up from the bottom. Their Honours note:

No separate argument was addressed before us to the two amounts of $2,000 and $800, although there seems to be no reason why the latter –

which was for ongoing management fees –

at least, would not be deductible but for the determination. The former, however –

which is the plantation establishment –

would for the reasons already given be capital.

Now, the capital argument results – the reference in dealing with whether or not the acquisition of the seedlings was on capital account in circumstances where the applicant was no longer carrying on a business – that capital discussion starts at page 90 and is completed on page 92, directed to the acquisition of the seedlings.

The important matter in relation to the land preparation expense is the finding as to what the nature of the change was. The conclusion was that the business had stopped, but what had been the business up till that date had simply been the execution of contracts that had committed the applicant to a course of carrying on a business. The court held – well, the execution of the contracts committing the applicant to a future course of carrying on a business meant that the business commenced at that time. In fact, the applicant did nothing more other than to execute the contracts. The restructure, which occurred a few months later, was to change the context in which the agreements were to operate; a unit trust was adopted.

Justice Lee had held, at pages 12 and 13 of the appeal book, and again at page 19, that the adoption of the unit trust was that the applicant committed his interest in his block of land and his interest in the trees to a business carried on by the trustee. Your Honours will see at paragraph 30 that his Honour found:

The applicant, and others who elected not to withdraw from the project . . . conform with the purpose and terms of the trust deed. Pursuant to the trust deed the applicant became a participant in a pooled investment conducted by the trustee, in which the beneficial interest of the applicant consisted of a right to participate pro rata in any distribution made by the trustee of proceeds obtained from the sale of timber produced by the trustee from the conduct of the project. In other words, the seedlings acquired by the applicant, and the land leased by the applicant, were made available to the trustee by the applicant for the purpose of conducting the enterprise provided for by, and under, the trust deed.

So it is a very particular fact situation, and it is in the context of that, that change in arrangement, that the applicant spends money to prepare the land. In our submission, the court was correct in saying in those circumstances the expenditure was on capital account. The taxation ruling that my learned friend has referred to, your Honour, is a ruling - - -

GUMMOW J: Yes, I was going to ask you about that.

MR DAVIES: It is a ruling that deals with people who are conducting businesses. Your Honours will see behind tab 20 on the first page, paragraph 4 at the bottom of the page:

A taxpayer who is engaged in ‘forest operations’ is a primary producer for income tax purposes if those forestry activities constitute the carrying on of a business.

The passages that my learned friend then took the Court to are passages where the ruling is dealing with forestry operations, in other words a business.

GUMMOW J: Yes, I see.

MR DAVIES: So, in our submission, the decision by the Court will have no impact upon the subsequent administration of that ruling, or in relation to those who are truly carrying on a business.

GUMMOW J: Now, coming to Part IVA, what do you say of the complaint that the taxpayer was not conscious of the price significance?

MR DAVIES: Your Honour, in our submission, it does not assist the applicant at all. What the applicant was conscious of was that the figure of $80,000 – or the two figures of $40,000 – that he agreed to pay for the trees, was a figure that would give him a deduction for those amounts and, therefore, tax savings of $26,000, which he would then use to repay a loan. The taxpayer knew that. He was told that in the promotional material. The evidence was that that is what he did. He signed the agreements on – I think they became executed in June 1997, in July 1997 he applied for a deduction, and then varied his PAYE instalments and used the tax savings to pay the $26,000 back in repayment of the loan. He knew that.

What he did not know was that the price of $80,000 was far in excess of what is said to be the reasonable value of $3,000. Of course, your Honour, the reason why he did not know was because he did not care. He did not care because what he was interested in was the tax deduction. The Full Court recognises that. It recognised that he did not know the excessiveness of the price, page 94. There is a finding, your Honours, an acceptance that - - -

GUMMOW J: Yes.

MR DAVIES: - - - Mr Puzey did not know the excessiveness. I cannot find that for the moment. But, your Honour, then dealing with – paragraph 54, my learned friend tells me, paragraph 54 of 89. Yes, it is about seven lines up from the foot of paragraph 54:

The fact that the purchase agreement for seedlings may have been for an excessive price was not a matter known to Mr Puzey.

Their Honours accept that. Then, of course, their Honours must deal with the application of Part IVA and the way in which Part IVA is required to be applied according to the Act. Their Honours, therefore, deal with each of the matters set out in section 177D(b).

GUMMOW J: Yes, it comes under the heading of the manner in which the scheme was entered into.

MR DAVIES: Yes, your Honour. Then at paragraph 71:

Another matter . . . is the significant fact that the amount paid for the seedlings was grossly excessive. One might naturally ask why would Mr Puzey –

and so on - - -

GUMMOW J: Yes, I think we have had our queries answered, Mr Davies.

MR DAVIES: Yes, your Honour. So, your Honours, in our submission, the decision in relation to the plantation expenses is clear on the facts, and it is a decision relating to the particular facts. My learned friend has not demonstrated any error of principle in relation to the application of Part IVA and, in our submission, the final matter that my learned friend referred to was that part of the decision that related to whether or not a business was being conducted after the adoption of the unit trust structure, and I have taken your Honours to the passage of Justice Lee, where Justice Lee had looked at the effect of the documents and formed the view that what occurred was that the business, after the adoption of the trust deed, was being carried on by the trustee, and the Full Court accepts that finding - - -

GUMMOW J: Yes, all right. Look we do not need to hear you any further on that.

MR DAVIES: If your Honour pleases.

GUMMOW J: Yes, Mr McCusker.

MR McCUSKER: Your Honours, on the question of the establishment fees, can I direct your Honours’ attention to page 90 in the appeal book at paragraph 58 where, in their judgment – the first of the two judgments that is – the court said, halfway through this paragraph:

The only question of any difficulty is whether a different result follows in respect of the purchase of seedlings.

So that they have dealt there with the other outgoings, and again at page 92, where they say in paragraph 62:

It follows, in our view, that to the extent that the amounts outlaid by the taxpayer in the 1998 year of income were for the seedlings they are not deductible . . . However, for the reasons given we are of the view that the balance of the outgoings in both years of income would be.

That would be but for Part IVA. Now, they change their approach on that. My learned friend said, “Well, the product rulings refer only to these persons who are carrying on a business.” Whilst that may arguably be so, it begs the question at 89 appeal book, at paragraph 54, in the last few lines – you have already been taken to that paragraph earlier – the court said:

Rather, it seems to us that the correct analysis is that Mr Puzey committed himself to a business with the first step of entering into the relevant agreements and that in so doing Mr Puzey commenced a business.

GUMMOW J: Well, this sort of debate does not really sound like a special leave point at the moment.

MR McCUSKER: Your Honour, I am just dealing with the - - -

GUMMOW J: Yes, I understand.

MR McCUSKER: - - - the proposition that there is some – but the commencement of the business, as found by the Full Federal Court, and we do not wish to obviously depart from that, and the only question is whether the pooling arrangement resulted in ceasing to carry on a business.

Now, my learned friend has taken you to what Justice Lee said about the effect of the restructuring, but what both Justice Lee and the Full Federal Court said was clear and uncontested that the restructuring in no way affected the lease agreement, or management agreement and the
seedlings purchase agreement, nor, indeed, the loan agreement – all of which remained on foot and were enforceable. So the net effect of the restructuring was simply the pooling of the proceeds of the harvest of the sandalwood once it occurred.

As to the Part IVA point about the price, not only was the taxpayer unaware that the price was excessive, there was no other supplier. So how do you gauge market value of something when there is only one supplier in Australia, and that was the case here; uncontested evidence to that effect and a finding to that effect. There is no evidence the taxpayer did not care about price, with respect. He would be crazy not to care about the price because he is left with a large continuing and enforceable debt, and the price agreed to be paid for the seedlings constitutes a major part of that. So he cared about price. Certainly, he saw it as a deduction because, like most taxpayers, he would not have entered the business at all unless the deduction was available, but that does not mean that was his primary object. May it please the Court.

GUMMOW J: Thank you.

In our view the prospects of success on any appeal in these two applications are insufficient to warrant a grant of special leave. Accordingly, special leave is refused with costs.

AT 11.22 AM THE MATTERS WERE CONCLUDED