FEDERAL COURT OF AUSTRALIA

Nelson v Commissioner of Taxation [2014] FCA 57

THE COURT ORDERS THAT:

The application dated 27 September 2012 be dismissed.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

1    This is an appeal by Mr Jeffrey Nelson from a decision of the Administrative Appeals Tribunal (“Tribunal”) in which the Tribunal affirmed an objection decision of the Commissioner of Taxation. In its decision the Tribunal concluded that the Commissioner was correct in taking the view that the applicant, Mr Nelson, was not “carrying on a business” for the purposes of s 8-1 of the Income Tax Assessment Act 1997 (Cth) (“the Act”). In this Court, and despite a number of grounds of appeal in the supplementary notice of appeal from a tribunal filed by Mr Nelson, it is primarily with this aspect of the Tribunal’s decision that Mr Nelson takes issue.

2    It is not in dispute that appeals from the Tribunal to this Court are in the original jurisdiction of this Court, and can be founded only on questions of law (s 44 Administrative Appeals Tribunal Act 1975 (Cth)).

3    At the hearing before me both parties were legally represented, and made extensive oral and written submissions. Before turning to consideration of this appeal it is useful to set out the background facts as well as the decision of the Tribunal which Mr Nelson seeks set aside.

Background facts

4    The background facts are helpfully explained in the decision of the Tribunal. I do not understand there to be any dispute with the Tribunal’s summary of the facts, and it is convenient to extrapolate relevant facts from that summary. In particular I note the following observations of the Tribunal:

3.    The taxpayer is the trustee of a family trust. The trust acquired a 500 acre property (approximately 195 ha) in 2002. At that stage, the taxpayer was working as a building inspector for a local council. He said in his evidence that it was always his dream to own his own property. He says he entered into a tenancy arrangement with the trust: he claims he is renting the property. I understand he has claimed deductions in respect of the rent in a number of the years of income. Interesting questions have arisen about whether the taxpayer is entitled to the income generated from aspects of the property, like trees, which would ordinarily flow to the property owner. Happily, I do not need to resolve that issue at this point. I need only focus on whether the taxpayer was involved in the conduct of a business.

…

9.    The taxpayer says he has planned, conducted or commenced up to 14 different business activities on the property during the years of income in question. None of those activities produced any income for the taxpayer in those years. The list of activities which was distilled by the respondent includes:

(a)    Aquaculture: the taxpayer wants to build a dam to stock fish for sale to restaurants. He has been researching fish species, talking to local restaurants, consulting experts and visiting other fisheries. He has drawn up some plans and identified a site for the dam and done some preparation work – but the dam has not been built yet.

(b)    Cropping: the taxpayer has prepared the pastures for cropping and improved fences and other structures. He tested a number of crops during the years of income, but none were a success. He still has not identified an appropriate crop, although he remains positive – and he knows more about the potential as a result of his experimentation.

(c)    Free-range pigs: the taxpayer has investigated the establishment of a free-range piggery. He has done extensive research and spoken with a number of people in the industry. He has prepared plans and done calculations, but he still has not obtained the finance necessary to execute the proposal even several years after the years of income in question.

(d)    Growing timber for fencing: the taxpayer has harvested some timber for fencing purposes. He also planted seedlings to grow more timber during the years of income but most of those seedlings were eaten by wildlife. He has been planning to plant more seedlings and commence a timber growing operation, and cleared an area of the property to that end during the years of income in question.

(e)    Growing timber for milling: the same can be said of the taxpayer’s efforts to establish a timber milling operation. He has taken some limited steps towards establishing a forest. He had not acquired a mill. He did some research and talked to some people about the potential and he concluded from his experience in the building industry that there might be a market for the type of timber he could produce in years to come.

(f)    Storing and breeding cattle: a number of cattle have been agisted on the property for some time. Fences have been built and some other improvements have been made to this end. The taxpayer has been looking into establishing his own herd. He has been talking to experts, drawing up plans, and identifying appropriate sites for dams and other improvements. He has not yet obtained finance to commence the operation.

(g)    Conducting a nursery and producing seedlings and plants for cultivation: the taxpayer established a shade house and nursery (two, in fact: the first was destroyed in a flood in 2004). He has cultivated a number of seedlings and plants for use on the farm: he has a small area near the accommodation block where he has tested different species. Most of the seedlings in the relevant years perished. The taxpayer has been researching and consulting experts about the way forward.

(h)    Producing seedlings and plants for sale: the same can be said of the efforts to produce plants and seedlings for sale. None have yet been sold.

(i)    Growing an orchard: the taxpayer has identified an area on the property that will be used for an orchard. He has commenced clearing and preparing the area, and he has worked on the dam that will supply water. He has done extensive calculations and planning for the irrigation system, investigated machinery and consulted experts and potential customers. He has not yet identified suitable fruit trees, but he has been experimenting.

(j)    Poultry: the taxpayer has a relatively small number of chickens in a small hen house. He acquired an incubator. He proposes establishing a commercial operation but so far the hens only produce enough eggs for private consumption. He anticipates he will be able to produce more eggs and has been researching the business. He does not yet have enough chickens to justify obtaining a permit from the local council to conduct a poultry operation.

(k)    Building cabins for accommodation on the property: the taxpayer showed me the sites on which he proposed establishing some cabins which would be built from timber harvested on the property. The sites are very pleasant and it is easy to see how such an accommodation business might flourish. He has conducted some research into the opportunity and drawn up plans. He does not have any finance to undertake the construction of the cabins.

(l)    Manufacturing relocatable cabins out of local timber: the same can be said of the plan to produce cabins for sale. The proposal is still at the investigation stage.

(m)    Meat processing: the taxpayer has been researching the establishment of a meat processing operation. He has drawn up some plans and sought advice but he has not yet obtained the necessary approvals or finance.

(n)    Producing stock feed: the taxpayer is considering producing stock feed for sale. His research so far suggests corn and lucerne might be the best crops but his experience to date has not been good: the test crops he sowed all failed.

Decision of the Tribunal

5    The critical question before the Tribunal was whether Mr Nelson was carrying on a business of primary production during the 2004-2009 years of income. As the Tribunal explained at [1]:

[Mr Nelson] did not make any income out of the farming operation during this period, but he wants to claim a number of deductions in respect of improvements he made to the property and other expenses he incurred, including the depreciation of assets. The Commissioner of Taxation acknowledges the taxpayer was running a farm alongside his other business activities during the years in question and concedes he did carry out a number of improvements – but the Commissioner insists the operation had not reached the point where it could be characterised as a primary production business. In those circumstances, the Commissioner says the taxpayer’s claims should be disallowed in full.

6    At [5] the Tribunal noted that the starting point of the analysis was the general deduction provision in s 8-1 of the Act, which enables a taxpayer to deduct losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. The Tribunal further examined the definitions of “business” and “primary production business” in s 995-1 of the Act, and the Commissioner’s ruling TR97/11 which provides guidance on indicia one would expect to see in a primary production business. In particular “business” is defined by s 995-1 to include:

Any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

7    “Primary production business” is defined in s 995-1 as the business of:

(a)    cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment; or

(b)    maintaining animals for the purpose of selling them or their bodily produce (including natural increase); or

(c)    manufacturing dairy produce from raw material that you produced; or

(d)    conducting operations relating directly to taking or catching fish, turtles, dugong, bÊche-de-mer, crustaceans or aquatic molluscs; or

(e)    conducting operations relating directly to taking or culturing pearls or pearl shell; or

(f)    planting or tending trees in a plantation or forest that are intended to be felled; or

(g)    felling trees in a plantation or forest; or

(h)    transporting trees, or parts of trees, that you felled in a plantation or forest to the place:

(i)    where they are first to be milled or processed; or

(ii)    from which they are to be transported to the place where they are first to be milled or processed.

8    The Tribunal examined TR97/11 and observed:

7.    … [TR97/11] provides some useful guidance on the sort of indicia one would expect to see in a primary production business. The ruling reviews a number of the relevant authorities and explains (at [26]):

26.    From the judgments it is clear that the relevant indicators of whether a business of primary production is being carried on by a taxpayer are:

*    does the activity have a significant commercial purpose or character?

*    does the taxpayer have more than a mere intention to engage in business?

*    is there an intention to make a profit or a genuine belief that a profit will be made? Will the activity be profitable?

*    is there repetition and regularity in the activity? i.e. how often is the activity engaged in? How much time does the taxpayer spend on the activity?

*    is the activity of the same kind and carried on in a similar way to that of the ordinary trade?

*    is the activity organised in a businesslike manner?

*    what is the size or scale of the activity?

*    is the activity better described as a hobby, a form of recreation or a sporting activity?

9    The Tribunal considered that the Commissioner’s approach as explained in TR97/11 was “fair enough” but noted the importance of avoiding the list of indicia as some sort of rigid check-list (at [8]).

10    The Tribunal was satisfied that Mr Nelson’s operation met a number of the criteria referred to in TR97/11 and observed:

10.    … [Mr Nelson] has carefully researched the various business activities. He has identified a great many opportunities and he has assessed those opportunities in a careful and informed way. He has prepared extensive business plans. He keeps meticulous books and records. He has a well-stocked library of resource material. There is evidence of a systematic approach: he has conducted a number of experiments in relation to crops, for example, which have been unsuccessful – but which he says have yielded valuable lessons about what crops are worth cultivating. He has acquired a good deal of machinery, although he is constrained by his financial resources. The operation is small, but not necessarily unsustainable. I also think he is genuinely committed to making a profit out of the farming operation in due course. I accept he does not see the property as a mere hobby or lifestyle. He has obviously worked hard on the property and he and his family have made many sacrifices to get the property to its current state.

11.    I accept the taxpayer has made a number of improvements to the property. He has cleared parts of the property and laid down or improved vehicular access routes. He has built fences out of harvested timber. He has planted trees in test orchards and established farm outbuildings, including a hen house and nursery. He has installed irrigation pipes. He has a large machinery shed adjoining the residential accommodation he shares with his family. All of these things are consistent with the operation being characterised as a business.

11    At [12] the Tribunal concluded that, notwithstanding its findings concerning the activities of the taxpayer during the relevant years, nonetheless Mr Nelson had not engaged in a business during those years. Importantly the Tribunal continued:

12.    … None of the activities identified by the taxpayer had advanced much beyond the planning stage. Some of the activities had not even gone that far: they remained glimmers in the taxpayer’s eye during the period in question. He has certainly put a lot of thought into the various activities he would like to undertake, and he has taken some steps towards achieving those plans. He may yet manage to make a success of some of the proposals, but the link between the activities he has already undertaken and the production of income at some future point is too tenuous during the years of income in question.

12    The Tribunal concluded:

13.    The taxpayer is an honest, enterprising and hard-working man. He has lots of good ideas about how to make his farm turn a profit. One wishes him every success in that quest. But his operation had not reached the point during the years of income where it could properly be described as a business in the relevant sense. In those circumstances, the objection decision under review must be affirmed.

Grounds of appeal

13    In his supplementary notice of appeal Mr Nelson relied on seven grounds of appeal. As I observed earlier in this judgment, while the applicant raises questions of the reasonableness of the Tribunal’s decision (grounds 4 and 7) and whether the Tribunal failed to take into consideration the applicant’s contention that he only carried on a single, core forestry business (ground 5), in substance the applicant relied primarily (in grounds 1 2, 3 and 6) on his claim that the Tribunal had erred in its interpretation and application of principles relevant to “carrying on a business”. Notwithstanding this it is useful to set out the grounds of appeal in full:

Grounds relied on

1.    The Tribunal committed an error of law by failing to correctly identify and apply the relevant principles of law which define the “carrying on a business” in s.8-1 of the Income Tax Assessment Act 1997.

2.    The Tribunal’s decision is guided solely by the Commissioner of Taxation’s Ruling TR97/11 as to principles regarding when a taxpayer will be held to be “carrying on a business”. As such, the Tribunal has

a.    Relied solely upon the Commissioner’s interpretation of the law; and

b.    Did not apply the legal principles as determined by the relevant judicial authorities, such as Spriggs v Commissioner of Taxation (2009) 239 CLR 1; [2009] HCA 22, the Full Federal Court decision in Ferguson v Commissioner of Taxation (1979) 26 ALR 307 and the Qld Supreme Court in Federal Commissioner of Taxation v Walker (1985) 79 FLR 161.

3.    As a result of failing to consider the legal principles as determined by the relevant judicial authorities, the Tribunal failed to identify that the authorities establish that a taxpayer may be carrying on a business, notwithstanding that:

a.    The taxpayer did not earn income in the relevant years; or

b.    The taxpayer’s business activities could be considered preparatory in nature.

4.    On the evidence, no reasonable decision maker could have found that s8-1 and Division 35 of the Income Tax Assessment Act 1997, on its interpretation, would not extend to the losses incurred by the Applicant.

5.    The Tribunal wholly ignored the principal contention of the Applicant, emphasised in the course of oral submissions, that he only carried on a single, core forestry business, and thus adopted a manner of decision-making that resulted in it failing to discharge its obligations according to law.

6.    The Tribunal failed to identify and apply the correct conception of “carrying on a business” in s 8-1(1)(b) of the Income Tax Assessment Act 1997, particularly by:

a.    characterising activities as only “preparatory” [(2)] because “the link between the activities… and… income at some future point… is too tenuous” ([12]), despite finding the Applicant: (i) had a subjective intention to carry on the alleged business activities profitably; (ii) actually carried on a range of activities specified; and (iii) was committed to the enterprise; and/or

b.    not applying the definition of “carrying on” in s 995-1 of that Act, as picked up and applied (to s 8-1) by the definition of “primary production business” in that section, as well as not considering contextual factors such as the notion of “non-commercial business” activities in Div 35 of that Act.

7.    The findings of the Tribunal concerning the credibility and intention of the Applicant, actual activities undertaken and related matters (specified mainly at paragraphs [10] and [11] of its reasons) lead to the conclusion that it made a finding concerning the asserted business that was based on no evidence or otherwise not reasonably open.

Consideration

14    As the Tribunal observed, s 8-1(b) of the Act enables a taxpayer to deduct from assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business. Clearly, whether an entity is “carrying on a business” is a question of fact in any particular circumstances. In Spriggs v Federal Commissioner of Taxation (2009) 239 CLR 1 at [59] the High Court observed:

The existence of a business is a matter of fact and degree. It will depend on a number of indicia, which must be considered in combination and as a whole. No one factor is necessarily determinative. Relevant factors include, but are not limited to, the existence of a profit-making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised, often described as whether the activities are carried out in a business-like manner.

(Footnotes omitted.)

15    While the question of whether a taxpayer is “carrying on a business” for taxation purposes is a question of fact, principles relevant to determination of that question in any particular case have been the subject of much academic writing and judicial attention. In determining the factual question of whether a taxpayer is carrying on a business, it is appropriate for the Court or relevant tribunal to have regard to relevant principles developed by the Courts, in addition to the general guidance provided by the Act (and in particular, in this case, the definition provided in s 995-1 concerning the carrying on the business of primary production). So, for example, in relation to whether a taxpayer is carrying on a business:

    The relevant expense must have been incurred as part of the cost of trading operations (John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30 at 49).

    Losses incurred in circumstances where the taxpayer has not engaged in any form of trading activity during the relevant financial year may not be incurred in carrying on a business (Case V71 (1988) 88 ATC 516). This includes the cost of establishing the business (John Fairfax at 48) or terminating the business (Peyton v Federal Commissioner of Taxation (1963) 109 CLR 315).

    The cost of a step taken in the process of gaining or producing income is one incurred in carrying on a business (John v Federal Commissioner of Taxation (1989) 166 CLR 417).

    Expenditure must have been incurred in the course of activities which manifest the essential characteristics of a business – that is, the conduct of a commercial enterprise in the nature of a going concern, wherein activities are engaged in on a repetitive and continuous basis for the purpose of profit.

    It is not necessary that the expenditure has been incurred for the purpose of profit in the short-term provided that there is a profit-making purpose (Tweddle v Federal Commissioner of Taxation (1942) 180 CLR 1, Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307, and other cases cited in Australian Federal Income Tax Reporter (CCH, subscription service) at [31-581]). Similarly, it is irrelevant if the profit or loss is small.

    It is irrelevant that the scale of the business is small. The activities engaged in by the taxpayer must, however, be more than mere domestic activities adequate for private purposes.

    An isolated transaction may constitute carrying on a business, particularly if it is the transaction by which the business commences (Federal Commissioner of Taxation v St Hubert’s Island Pty Ltd (in liquidation) (1978) 138 CLR 210).

    Keeping detailed records kept in a systematic and business-like fashion suggests the carrying on of a business (Ferguson).

    Activities which are merely preparatory to the carrying on of a business are not necessarily conducted in the carrying on of a business (Commissioner of Taxation v Osborne (1990) 26 FCR 63, Vance v Commissioner of Taxation (2005) 146 FCR 440, Esso Australia Resources Ltd v Commissioner of Taxation (1998) 84 FCR 541).

16    In its decision in this case, the Tribunal referred extensively to the Commissioner’s ruling in TR97/11, entitled “Income tax: am I carrying on a business of primary production?” (“the Ruling”). As is plain from the Ruling, the Commissioner in TR97/11 has explained his view of circumstances where a taxpayer carries on a business of primary production for the purposes of the Act. In particular, at [12-16] of the Ruling the Commissioner states:

12.    Whilst each case might turn on its own particular facts, the determination of the question is generally the result of a process of weighing all the relevant indicators. Therefore, although it is not possible to lay down any conclusive test of whether a business of primary production is or is not being carried on, the indicators outlined below provide general guidance. This is explained further at paragraph 25 of this Ruling.

13.    The courts have held that the following indicators are relevant:

•    whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators (see paragraphs 28 to 38);

•    whether the taxpayer has more than just an intention to engage in business (see paragraphs 39 to 46);

•    whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity (see paragraphs 47 to 54);

•    whether there is repetition and regularity of the activity (see paragraphs 55 to 62);

•    whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business (see paragraphs 63 to 67);

•    whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit (see paragraphs 68 to 76);

•    the size, scale and permanency of the activity (see paragraphs 77 to 85); and

•    whether the activity is better described as a hobby, a form of recreation or a sporting activity (see paragraphs 86 to 93).

14.    A taxpayer does not need to derive all his/her income from the primary production activity. The taxpayer may also be employed in some other occupation or profession. What is important is that the taxpayer’s primary production activity amounts to the carrying on of a business. This activity is considered separately from any other employment or business carried on by the taxpayer. The fact that another business is carried on does not necessarily mean that the primary production activity is also a business.

15.    We stress that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922), and there is often a significant overlap of these indicators. For example, an intention to make a profit will often motivate a person to carry out the activity in a systematic and organised way, so that the costs are kept down and the production and the price obtained for the produce are increased.

16.    The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the ‘large or general impression gained’ (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a ‘commercial flavour’ (Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

17.    Subject to all the circumstances of a case, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will amount to a business.

17    It is clear that this excerpt from TR97/11 contains many principles which have been endorsed by the Courts to guide determination of whether a taxpayer is, in fact, “carrying on a business”.

18    In my view no criticism of substance can be levelled at the reasoning of the Tribunal in making detailed reference to TR97/11. While perhaps not an exercise in learned examination and articulation of legal principles, it is apparent that in its reference to TR97/11 the Tribunal was adopting a “shorthand” approach to discussion of the relevant law concerning the meaning of “carrying on a business” for the purposes of the Act. I am unable to identify any legal error in this approach. In particular:

    It is plain that the Tribunal was fully cognisant of the task before it.

    The Tribunal recognised that TR97/11 reflected legal principles articulated in many relevant cases in this area of law.

    The Tribunal recognised that it was not required to rigidly adopt the principles explained in TR97/11, and that the case required determination on its peculiar facts.

    The Tribunal carefully considered the facts of the case, and the arguments put to it by Mr Nelson. In doing so, the Tribunal had regard to principles relevant to determination whether Mr Nelson was, in fact, carrying on the business of primary production.

    It was open to the Tribunal as a conclusion of fact to form the view that the activities of Mr Nelson were preparatory to the carrying on of a business, rather than incidental to the carrying on of a business.

19    I am not persuaded that the Tribunal failed to correctly identify and apply the relevant principles of law which define the “carrying on a business” as claimed by Mr Nelson, or that the Tribunal failed to properly consider the facts before it in light of those principles. Similarly, I am not persuaded that the decision of the Tribunal was unreasonable, or not open on the material before it.

20    I note Mr Nelson’s contention that the Tribunal failed to appreciate his claim that, in fact, he was carrying on only one single, core, forestry business. However I am not persuaded that the decision of the Tribunal was affected by error as Mr Nelson claimed. While I accept Mr Nelson’s contention that cases advanced by litigants in person may lack some degree of clarity, in this case I am satisfied that the Tribunal understood the case put to it by Mr Nelson, and that it had thoroughly and carefully considered Mr Nelson’s claims in their entirety.

21    That the Tribunal found against Mr Nelson on the facts was not a result of any confusion on the part of the Tribunal, but the view taken by the Tribunal on the facts before it of whether Mr Nelson was carrying on a business.

22    The appropriate order in this case is to dismiss the application.

Associate:

Dated:    11 February 2014