FEDERAL COURT OF AUSTRALIA

McGlinn v Commissioner of Taxation [2018] FCA 1275

ORDERS

THE COURT ORDERS THAT:

1.    The parties file within seven days:

(a)    the orders that they agree ought to be made to reflect the reasons for decision published this day; or

(b)    if no agreement as to the proposed orders can be reached between the parties, written submissions, limited to four pages in length, concerning the form of orders for final disposition of this appeal.

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

REASONS FOR JUDGMENT

STEWARD J:

Introduction

1    The applicant is in the business of breeding Arabian horses. For the year of income ending 30 June 2012, this business made an income tax loss for the purposes of the Income Tax Assessment Act 1997 (Cth) (the “1997 Act”). The applicant applied this loss to reduce her other taxable income in that year to nil. On 6 December 2013, the respondent (the “Commissioner”) issued her a notice of amended assessment deferring the loss. Dissatisfied with this assessment, the applicant filed a notice of objection, and on 4 March 2016, this was disallowed (the “Objection Decision”). The applicant now appeals that decision to this Court pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) (the “TAA”).

Background

2    The applicable facts are not in dispute and may be described briefly. The applicant commenced a business of breeding Australian bloodline Arabian horses in the 1998 income year, using the trading name “Mystica Arabians”. The business was not a success. In the 2008 income year, changes were made. Instead of breeding Australian bloodline Arabian horses, the applicant purchased for the first time Arabian horses from overseas, and commenced breeding from these animals. It is the applicant’s contention that these horses are greatly superior to those which have been bred domestically. They cost considerably more than domestic Arabian horses. The applicant claims that what occurred in the 2008 income year constituted the commencement of a distinct and different business activity from that previously pursued. It involved a great deal of additional capital (largely for the purposes of acquiring international stock), the purchase of more land and equipment, a different customer base and a different method of breeding. The Commissioner disagrees. In his view, the applicant’s business activity in 2008 was not new but remained the same; the business had simply evolved with a new focus. Whether a new business activity had commenced is critical to the disposition of this matter.

Division 35

3    The applicant’s tax loss was deferred by the Commissioner pursuant to s 35-10(2) of the 1997 Act, which relevantly provides:

(2)    If the amounts attributable to the business activity for that income year that you could otherwise deduct under this Act for that year exceed your assessable income (if any) from the business activity for that year, or your share of it, this Act applies to you as if the excess:

(a)    were not incurred in that income year; and

(b)    were an amount attributable to the activity that you can deduct from assessable income from the activity for the next income year in which the activity is carried on.

4    The term “business activity” is not defined. The word “business” is defined by s 995-1 of the 1997 Act as follows:

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

5    The question of what constitutes a “business activity” divides the parties before me.

6    In general terms, the object of Div 35 is to quarantine tax losses which are the product of uncommercial business activities. When it applies, the Division prevents such losses being used to offset other assessable income derived by the taxpayer. The Division only applies in certain circumstances, and is limited to individuals and partnerships. Section 35-5 describes the object of the Division in these terms:

(1)    The object of this Division is to improve the integrity of the taxation system by:

(a)    preventing losses from non-commercial activities that are carried on as businesses by individuals (alone or in partnership) being offset against other assessable income; and

(b)    preventing pre-business capital expenditure and post-business capital expenditure by individuals (alone or in partnership) in relation to non-commercial activities being deductible under section 40-880 (business related costs);

unless certain exceptions apply.

7    If a taxpayer passes one of four tests (the “assessable income test” in s 35-30; the “profits test” in s 35-35; the “real property test” in s 35-40; the “other assets test” in s 35-45), he or she will be allowed to apply a tax loss arising from a “non-commercial” activity against his or her other assessable income. This is prescribed by s 35-10(1) which provides:

(1)    The rule in subsection (2) applies for an income year to each business activity you carried on in that year if you are an individual, either alone or in partnership (whether or not some other entity is a member of the partnership), unless:

(a)    you satisfy subsection (2E) for that year, and one of the tests set out in any of the following provisions is satisfied for the business activity for that year:

(i)    section 35-30 (assessable income test);

(ii)    section 35-35 (profits test);

(iii)    section 35-40 (real property test);

(iv)    section 35-45 (other assets test); or

(b)    the Commissioner has exercised the discretion set out in section 35-55 for the business activity for that year; or

…

8    Section 35-10(2E) provides:

You satisfy this subsection for an income year if the sum of the following is less than $250,000:

(a)    your taxable income for that year, disregarding your assessable FHSS released amount for that year;

(b)    your reportable fringe benefits total for that year;

(c)    your reportable superannuation contributions for that year;

(d)    your total net investment losses for that year.

For the purposes of paragraph (a), when working out your taxable income, disregard any excess mentioned in subsection (2) for any business activity for that year that you could otherwise deduct under this Act for that year.

9    Where s 35-10(2) applies, the tax losses are not disallowed forever. They are deferred until such time as the “business activity” produces assessable income.

10    The applicant here did not pass any of the four tests. To access her tax losses she had to rely on the Commissioner’s limited discretion to dispense with the operation of s 35-10(2), as prescribed by s 35-10(1)(b). That discretionary power is conferred by s 35-55 of the 1997 Act, which in 2012 was in the following terms:

(1)    The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(a)    the business activity was or will be affected in the excluded years by special circumstances outside the control of the operators of the business activity, including drought, flood, bushfire or some other natural disaster; or

Note: This paragraph is intended to provide for a case where a business activity would have satisfied one of the tests if it were not for the special circumstances.

(b)    for an applicant who carries on the business activity who satisfies subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made--the business activity has started to be carried on and, for the excluded years:

(i)    because of its nature, it has not satisfied, or will not satisfy, one of the tests set out in section 35-30, 35-35, 35-40 or 35-45; and

(ii)    there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will either meet one of those tests or will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)); or

(c)    for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made--the business activity has started to be carried on and, for the excluded years:

(i)    because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

(ii)    there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

Note: Paragraphs (b) and (c) are intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. For example, an activity involving the planting of hardwood trees for harvest, where many years would pass before the activity could reasonably be expected to produce income.

(2)    The Commissioner may, on application, decide that the rule in subsection 35-10(2B) does not apply to a business activity for an income year if the Commissioner is satisfied that it would be unreasonable to apply that rule because special circumstances of the kind referred to in paragraph (1)(a) of this section prevented the activity from starting.

Note: This subsection is intended to provide for a case where a business activity would have begun to be carried on and satisfied one of the tests if it were not for the special circumstances.

(3)    An application for a decision by the Commissioner under this section must be made in the approved form.

11    The applicant here invoked s 35-55(1)(c). She submitted to the Commissioner that she had commenced a new and distinct business activity in the 2008 income year, namely the breeding of international bloodline Arabian horses, and:

(1)    because of the nature of this activity, it will take between 10 to 15 years of breeding before a profit can be earned; and

(2)    that there is an objective expectation that the business will become profitable within that time, which for this industry is a commercially viable period.

12    The Commissioner, as already mentioned, disagreed. In his view, the business activity had “started to be carried on” for the purposes of s 35-55(1)(c) in the 1998 income year, and that even accepting a “lead time” of 10 to 15 years, by the 2013 income year (based upon an income tax return lodged for that year), the business activity was still in a loss situation after 15 years. Accordingly, the Commissioner declined to exercise his power to suspend the application of s 35-10(2). In the Commissioner’s opinion, the changes made to the breeding program in the 2008 income year did not constitute a new and distinct “business activity” because the “same” business had been continuously carried on since the 1998 income year.

13    Both parties proceeded on the basis that s 35-55 left it to the Commissioner, and not to this Court, to decide these factual issues, and in particular, to decide whether it “would be unreasonable to apply” s 35-10(2) to the circumstances here. What was left to the Court to decide was whether the Commissioner had erred in law in exercising his power in s 35-55. If he had, it was agreed that the amended assessment issued to the applicant was excessive, it having been, on this hypothesis, issued in reliance upon an exercise of a power that had miscarried: McAndrew v Federal Commissioner of Taxation (1956) 98 CLR 263 at 271. The task for this Court was thus, according to the parties, as expressed by Dixon J (as his Honour then was) in Avon Downs Pty Ltd v Federal Commissioner of Taxation (1949) 78 CLR 353 where his Honour said at 360:

If [the Commissioner] does not address himself to the question which the sub-section formulates, if his conclusion is affected by some mistake of law, if he takes some extraneous reason into consideration or excludes from consideration some factor which should affect his determination, on any of these grounds his conclusion is liable to review.

14    In that respect, the parties were in agreement that the record of the Commissioner’s decision not to exercise his power in s 35-55 was contained in the Objection Decision. The applicant contended that the record showed that the Commissioner had asked the wrong question for the purposes of determining when the “business activity” here had “started to be carried on” for the purposes of s 35-55(1)(c).

Avon Downs Judicial Review?

15    It is a matter for the Court to decide whether the parties were correctly of the view that the Court’s jurisdiction for the purposes of this tax appeal concerning the application of s 35-55 of the 1997 Act was limited to judicial review of the kind described by Dixon J in Avon Downs (“Avon Downs judicial review”). In my opinion, they were correct.

16    The applicable authorities are traversed by Lindgren J in his Honour’s judgment in W R Carpenter Holdings Pty Ltd v Federal Commissioner of Taxation [2006] FCA 1252; (2006) 63 ATR 577 (the result was upheld in the Full Federal Court at (2007) 161 FCR 1, and in the High Court at (2008) 237 CLR 198). That case concerned a request for particulars about how the Commissioner had made certain determinations under former s 136AD of the Income Tax Assessment Act 1936 (Cth) (the “1936 Act”). The taxpayer had argued that the lawful making of those determinations formed part of the criteria for liability. It thus needed to know the basis upon which each determination had been made. The Commissioner disagreed. In his view, the making of each determination was merely a procedural step which formed part of the “due making” of an assessment for the purposes of former s 177 of the 1936 Act (the equivalent provision is now contained in s 350-10 of the TAA), and that accordingly, the way in which each determination was made could not be the subject of curial investigation in a tax appeal.

17    The Commissioner’s view was upheld. For that purpose, Lindgren J drew a distinction between provisions of the 1997 and 1936 Acts which require the Commissioner to undertake a procedural step (not reviewable by a court) and provisions which require the Commissioner to take a step which forms part of the criterion for liability which, when appealed to this Court, is reviewable on judicial review grounds (called a “state of mind” provision). As his Honour said at [42]:

It will prove to be important to identify precisely the conditions of tax liability specified in the [1936 Act], and to distinguish between provisions referring to the Commissioner’s state of mind, eg his “opinion”, or his being “satisfied” or “not satisfied”, on the one hand, and provisions referring to his taking a step, such as making a “determination” or “decision” on the other hand. I will refer to them as “state of mind” and “Commissioner’s determination” classes of cases, respectively.

18    After reviewing the authorities, and noting that it was difficult to reconcile all that they had said, Lindgren J concluded that the making of determinations under former s 136AD was only a procedural step, which did not form part of the criteria for liability under Australia’s transfer pricing rules. At [154] his Honour said:

The position established by Peabody [(1994) 181 CLR 359] (see [119] above), Sleight [(2004) 136 FCR 211] (see [136]–[145] above), and Syngenta [(2005) 61 ATR 186] (see [146]–[150] above) seems to be that a distinction is to be drawn between cases in which the [1936 Act] specifies a state of mind on which the assessment of the amount of taxable income (and tax) depends (cf Avon Downs [(1949) 78 CLR 353], George [(1952) 86 CLR 183], Giris [(1969) 119 CLR 365], Duggan [(1972) 129 CLR 365], Brian Hatch [(1972) 128 CLR 28], Kolotex [(1975) 132 CLR 535], WA Capital [(1989) 23 FCR 388], Dalco [(1990) 168 CLR 614]), and those in which it specifies, not a state of mind, but the making of a determination, as the event on which the amount of taxable income (and tax) depends (cf Jackson [(1989) 20 ATR 611], Peabody, Richard Walter [(1995) 183 CLR 168], Binetter [(2003) 130 FCR 135], Sleight, Syngenta). In the latter class of case, the legislature is taken to indicate that the interaction between s 177(1) of the [1936 Act] and s 14ZZO(b) of the TAA produces the result that the Commissioner’s state of mind, on the basis of which the determination was made, is part of the due making of the assessment, and cannot be put in issue by the taxpayer.

19    Where a provision of the 1997 Act or the 1936 Act requires the Commissioner to undertake some step or reach some conclusion, it is a matter of examining the criteria for liability to determine whether the role to be played by the Commissioner is merely procedural, or is more than that. Here, the criterion for the exercise of the Commissioner’s power in s 35-55(1)(c) of the 1997 Act ostensibly turns upon the application of objective tests to the facts, concerning, amongst other things the “nature” of the business activity, and the “objective expectation” that the activity will produce assessable income within a commercially viable period of time. But, the factors set out in subs (c) of s 35-55(1) are not an exhaustive statement of the applicable criteria. That is because, the criteria also includes the Commissioner determining that it would be “unreasonable to apply” s 35-10(2) “because” of the tests set out subs (c). In my view, it is the Commissioner’s opinion, lawfully formed, concerning the application of those tests that is determinative.

20    This conclusion is supported by the following considerations:

(1)    First, there is the presence of the word “satisfied” in s 35-55. As Lindgren J in W R Carpenter ([2006] FCA 1252; (2006) 63 ATR 577) observed, this word is often used to indicate that a provision is a “state of mind” section, making the Commissioner’s “state of mind” part of the criteria for liability.

(2)    Secondly, the phrase “it would be unreasonable to apply” resembles the language used in s 99A(2) and (3) of the 1936 Act which was considered by the High Court in Giris Pty Ltd v Federal Commissioner of Taxation (1969) 119 CLR 365. Like s 33-55 of the 1997 Act, s 99A(2) turns upon the Commissioner forming an opinion that it would be unreasonable to apply a section, and s 99A(3), like the tests in subs (c) of s 35-55(1), supplies factors to be considered for that purpose. In 1969, s 99A(2) and (3) provided:

(2)    This section does not apply in relation to a trust estate (other than a trust estate referred to in the last preceding sub-section) in relation to a year of income if the Commissioner is of the opinion that it would be unreasonable that this section should apply in relation to that trust estate in relation to that year of income.

(3)    In forming an opinion for the purposes of the last preceding sub-section –

(a)    the Commissioner shall have regard to the circumstances in which and the conditions, if any, upon which, at any time, property (including money) was acquired by or lent to the trust estate, income was derived by the trust estate, benefits were conferred on the trust estate or special rights or privileges were conferred on or attached to property of the trust estate, whether or not the rights or privileges have been exercised;

(b)    if a person who has, at any time, directly or indirectly -

(i)    transferred or lent any property (including money) to, or conferred any benefits on, the trust estate; or

(ii)    conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of the trust estate, whether or not the right or privilege has been exercised,

has not, at any time, directly or indirectly -

(iii)    transferred or lent any property (including money) to, or conferred any benefits on, another trust estate, not being a trust estate referred to in sub-section (1) of this section; or

(iv)    conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of another trust estate, not being a trust estate referred to in sub-section (1) of this section, whether or not the right or privilege has been exercised,

the Commissioner shall have regard to that fact; and

(c)    the Commissioner shall have regard to such other matters, if any, as he thinks fit.

In Giris, Barwick CJ and Windeyer J were of the view that the foregoing was a “state of mind” provision, to use the nomenclature of Lindgren J. Barwick CJ said at 374:

Thus the Commissioner must hold the opinion. The Court can decide whether or not he did hold it. In my opinion, the Court can require him to form it. It can determine whether the opinion is held bona fide and, although as I have said, the discretion is wide and though being really legislative in nature, what is relevant to its formation may range over an extremely wide spectrum of fact and consideration, the Court can determine whether or not the opinion was formed arbitrarily or fancifully, or upon facts or considerations which could not be regarded as relevant even to such a question as the unreasonableness of applying a taxing provision to a particular taxpayer in respect of the income of a particular year.

Windeyer J said at 384:

Here the Commissioner’s discretion is apparently at large. It does not clearly emerge from the Act in respect of what matter – or whose interest, that of the taxpayer or of the revenue – he is to consider whether it would be reasonable or unreasonable to apply s. 99A in the case of any particular trust estate. He is to have regard to certain stated matters; but what weight or influence each is to have is not made clear. Moreover, the Act requires that he “shall have regard to such other matters, if any, as he thinks fit”. However I assume that he is to be guided and controlled by the policy and purpose of the enactment, so far as that is manifest in it. That would exclude from his consideration any matter which it would be unlawful for him to take as a criterion, such as the State of residence of a trustee or of the beneficiaries of a trust. It would also, I think, exclude all merely fanciful and prejudiced tests which were hypothetically suggested in argument, such as vocation, religion, colour of skin or hair.

Similar considerations apply here. In determining whether the Commissioner had lawfully decided that it was not unreasonable to apply s 35-10(2), the Court can, for example, ascertain whether the right question was asked at law, whether the decision was based upon irrelevant considerations, whether the decision-maker failed to have regard to relevant considerations, and whether the decision was a product of arbitrary or illogical reasoning.

(3)    Thirdly, these considerations have greater weight when regard is had to the general design of the 1997 Act. That design included an object of removing discretionary powers given to the Commissioner by the 1936 Act. The Explanatory Memorandum which accompanied the Income Tax Assessment Bill 1996 states at 67:

Removal of discretions

One of the aims of this rewrite of the law is to replace with objective criteria many of the discretions that the Commissioner of Taxation may exercise under the existing law, to more fully reflect the introduction of the self assessment system.

Where a discretion is being replaced with more specific criteria, that change is explained in the explanatory material on the new law. In many cases, however, the change will merely replace the test of what the Commissioner considers to be reasonable with a simple test of reasonableness. In these cases, the explanatory material will only identify the clauses where such a change has occurred. In this Division, those clauses are 165-20, 165-55(3), 165-60(2), 165-80, 165-85, 165-90, 165-150(2), 165-155(2), 165-160(2), 165-165(2) and 170-25(1).

Choosing the phrase “Commissioner is satisfied” in s 35-55, given that statutory context, makes it easier to conclude that this was intended to be a “state of mind” provision.

(4)    Fourthly, I have given consideration to the possibility that the provision contains a mixture of objective criteria and criteria turning upon the Commissioner’s state of mind. I reject that possibility because the ostensibly objective criteria set out in subs (c) of s 35-55(1) are tied inexorably to the formation by the Commissioner of his view about reasonableness through the use of the word “because”. It is the Commissioner who must examine criteria in subs (c) to determine whether “because” of their application to facts found it is unreasonable to apply s 35-10(2).

(5)    Fifthly, the Explanatory Memorandum which accompanied the bill which introduced Div 35 (New Business Tax System (Integrity Measures) Bill 2000) lends some support to my conclusion. The Explanatory Memorandum describes the Commissioner’s power in s 35-55 as a “safeguard provision in the form of a Commissioner discretion”. Paragraphs [1.46] and [1.47] relevantly state:

Where certain conditions exist, the Commissioner may exercise a discretion to allow a taxpayer to offset amounts which are deductible against their other income if the business activity does not satisfy any of tests 1 to 4. [Schedule 1, item 3, section 35-55]

The discretion may be exercised for one or more income years if the Commissioner is satisfied that it would be unreasonable not to allow the losses to be offset because either:

•    special circumstances are applicable to the business activity; or

•    the business activity has started to be carried on, and because of its nature it has not yet satisfied one of tests 1 to 4, and there is an objective expectation that it will either pass a test or produce profit within a reasonable time. [Schedule 1, item 3, subsection 35-55(1)]

Paragraph [1.49] then states:

The first of these rules operates where there are special circumstances outside the control of the business operators that demonstrate it would be unreasonable not to recognise the loss in an income year. The special circumstances include drought, flood, bushfire or some other natural disaster. Special circumstances are not limited only to natural disasters, but may also include other circumstances of a special nature. The list is merely indicative to enable the Commissioner to consider circumstances outside the control of the taxpayer which may arise in specific cases. [Schedule 1, item 3, paragraph 35-55(1)(a)]

(My emphasis)

The last sentence of par [1.49] is entirely consistent with the proposition that Parliament intended that the criteria for substantive liability includes the lawful exercise by the Commissioner of the power to dispense with the application of s 35-10(2).

(6)    Finally, the statutory context here is different to that applicable under former s 136AD and Pt IVA of the 1936 Act (as to which, relevantly, see Federal Commissioner of Taxation v Sleight (2004) 136 FCR 211). The determinations made under s 136AD and s 177F of the 1936 Act are procedural in nature, and form part of what is now called the “proper making” of an assessment (s 350-10 of the TAA) because, unlike here, in each case the criteria for liability comprises or comprised a series of objective tests, and no more. In the case of s 136AD, it comprised, amongst other things, the requirement that there be a supply of property under an “international agreement”, and the receipt or payment of consideration that was more or less (as the case may be) than the “arm’s length consideration in respect of the supply”. In the case of Pt IVA, the objective criteria is found in s 177D, read with ss 177A and 177C.

21    For these reasons, the parties were correct to conclude that the role of the Court is limited here to Avon Downs judicial review. It is thus, within the parameters of lawful decision-making, for the Commissioner, and not the Court, to determine whether it is unreasonable to apply s 35-55, and more specifically here, the factual controversies in this tax appeal about when the “business activity” in question “started to be commenced”. Obviously, different considerations would apply in the Administrative Appeals Tribunal, where the Tribunal could re-exercise Commissioner’s power in s 35-55: cf Federal Commissioner of Taxation v Eskandari (2004) 134 FCR 569 at [45] per Stone J.

Further Observations

22    The applicant’s primary case was that in the Objection Decision the Commissioner had asked the wrong question about the identification of the “business activity” in question. In simple terms, it was contended that the decision-maker had misconceived his or her statutory task. I shall return to the detail of this complaint below. For the moment, it is important that I make the following observations about the statutory scheme of Div 35 that bear upon the applicant’s case.

23    First, Div 35 is concerned with amounts which are “attributable to the business activity” (s 35-10(2)) rather than with amounts attributable to a “business”. In my view, it will often be the case, as a matter of fact, that what might be described as a business activity might also constitute an entire business. But in particular cases, the concept of “business activity” may be apt to describe a part only of one business, and the phrase permits losses produced by an uncommercial part of a singular business to be quarantined, so long as that part constitutes a “business activity” (see below). This position may be contrasted with the meaning of the word “business” as it is sometimes applied elsewhere in the 1997 Act and the 1936 Act. In Allied Mills Industries Pty Ltd v Federal Commissioner of Taxation (1988) 19 ATR 1724, the taxpayer conducted its business in nine separate divisions. One of these received a lump sum payment in consideration of it surrendering rights under a certain contract. In determining whether the amount was assessable income, the role played by the contract in the business had to be evaluated. Gummow J said at 1737 - 1738:

…counsel for the taxpayer submitted that the termination of the agreement had the effect of destroying or crippling, if not the taxpayer, then the Allied Grocery Products divisional operations of the taxpayer.

However, to my mind, the taxpayer conducted activities in relation to foodstuffs and ingredients for foodstuffs, which activities answered various descriptions but collectively constituted its business as one business. As a matter of convenience to itself and particularly for purposes of confidentiality, the taxpayer conducted its business in several “divisions”. But that does not have the consequence that when asking the questions thrown up by this case, one looks to a plurality of frameworks, capital structures, profit making apparatus and the like, to see whether they or any of them are mortally wounded, destroyed, crippled, maimed, or, on the contrary, quite uninjured. The taxpayer received a certain sum and the issue is whether this had in the hands of the taxpayer the character of income in accordance with the ordinary concepts and usages of mankind. Viewed in the light of the conduct of business of the taxpayer as a whole, one cannot sensibly say that the taxpayer went out of business, that the taxpayer parted with a substantial part of its business undertaking, or that its profit making apparatus was materially crippled.

It may be that the activities of a taxpayer are so disparate in character and so discrete in the manner they are conducted, that one properly asks questions of the type posed by the facts of this case by reference to some but not the whole of those activities; examples of several distinct businesses conducted by the one taxpayer may be provided by the Board of Review decisions Case 52, 6 CTBR (NS) 328 (retail jeweller and real estate letting agent), and Case 2, 11 CTBR (NS) 7 (printer and seller of goods on commission). But, in my view, for the reasons I have given, the present is not such a case.

His Honour was upheld on appeal: (1989) 20 FCR 288.

24    The reasoning in Allied Mills contains a recognition that what may be understood to be a business can comprise a series of different parts and yet constitute a singular business. Thus a vigneron may own more than one vineyard at different locations; the vineyards may grow different grape varieties and the market for the wine they produce may vary. Yet a singular business may exist of wine production. It would not, however, necessarily follow from that conclusion that each vineyard was not a distinct “business activity” for the purposes of Div 35.

25    Secondly, in Watson v Deputy Commissioner of Taxation (2008) 171 FCR 77, Mansfield J observed that for the purposes of Div 35 the phrase “business activity” was not intended to convey a different meaning from the word “business”. His Honour said at [27]-[29]:

The Commissioner also contended that the use of the term “from the business activity” as distinct from the term “from the business” had some special significance. It was said that it was a narrower concept than the expression “from the business”.

The contrast between the scope of the two expressions was said to be illustrated by BHP Petroleum (Timor Sea) Pty Ltd v Minister for Resources (1994) 49 FCR 155 (BHP Petroleum) and Watson v Secretary, Department of Family and Community Services (2003) 128 FCR 564 (Watson) on the one hand, and cases such as Murry 193 CLR 605; Hope v Bathurst City Council (1980) 144 CLR 1 (Hope), and Ferguson v Federal Commissioner of Taxation (1979) 9 ATR 873; 26 ALR 307 (Ferguson) on the other.

In my opinion, the extrinsic materials do not indicate an intention to distinguish between those two expressions.

With very great respect, I do not think that this conclusion is correct. Watson concerned an application of Div 35 to a loss arising from the business activity of a self-employed financial planner. Following an illness, the taxpayer commenced to receive periodic partial disability payments pursuant to an income protection policy he had earlier acquired. The payments were assessable income. The taxpayer sought to include these payments as income “from” his business activities for the purpose of s 35-10(2). Mansfield J rejected this approach and decided that the disability payments were not “from” the business activity carried on. His Honour’s decision was upheld on appeal ((2010) 182 FCR 104), but the observation set out above concerning the meaning of the phrase “business activity” would appear to have neither been adopted nor rejected by the Full Court. In my view, Mansfield J’s observation was not essential to his Honour’s reasoning and conclusion, which turned upon the meaning and application of the word “from” in s 35-10(2). As such, I am not required to follow it as a matter of judicial comity.

26    The starting point is that the word “business” is not being used as a noun in Div 35 but as an adjective to describe the type of activity Div 35 is concerned with. It is the ordinary and natural meaning of the word “activity” which must be applied. The word is defined relevantly by the Shorter Oxford English Dictionary (5th ed, Oxford University Press, 2002) in these terms:

an operation, an occupation, a pursuit

In my view, each of these words reflect the intended meaning of the word “activity” for the purposes of Div 35. A course of conduct which constitutes a business operation, occupation or pursuit will, in the usual case of an individual or partnership, also comprise a business. However, it is possible for a course of conduct to refer to parts of what might otherwise be described as a single business, so long as the part in question is sufficiently distinct and can fairly be described as an independent operation, occupation or pursuit.

27    Thirdly, this conclusion is supported by the Explanatory Memorandum accompanying the New Business Tax System (Integrity Measures) Bill 2000 which commences with a criticism of the term “business” when used for fiscal purposes. Paragraphs [1.7] and [1.8] state:

In administering the tax law, the concept of what constitutes carrying on a business has been found to be very difficult to administer and resource intensive. Often a case by case approach is the only way to ensure this concept is complied with.

A broad interpretation of the current law has resulted in significant revenue leakage from individual taxpayers claiming deductions for unprofitable activities. A Tax System Redesigned described many of these activities as hobbies and/or lifestyle choices. Further, even those that have business characteristics (under existing tax law) are often unlikely to ever be profitable.

Given the foregoing difficulty with “the concept of what constitutes carrying on a business” it is unlikely that Parliament intended to adhere to that very concept in Div 35. Instead, in my view, the role played by the term “business” in the phrase “business activity” is to ensure that the Division does not extend to assessable income arising from the receipt of passive income, where the activity carried on does not otherwise constitute a “business”. Section 35-5(2) thus provides:

This Division is not intended to apply to activities that do not constitute carrying on a business (for example, the receipt of income from passive investments).

28    This requirement is explained in the Explanatory Memorandum to the New Business Tax System (Integrity Measures) Bill 2000 at [1.17] in these terms:

Division 35 only operates in a framework where an individual (including an individual in partnership) is considered to be carrying on a business activity. Business deductions relating to that activity and to which Division 35 will apply, must be otherwise deductible under the ITAA 1936 or the ITAA 1997 before Division 35 can have any application [Schedule 1, item 3, subsection 35-10(1)]. The rules in Division 35 will not apply to the receipt of passive investment income from activities which do not constitute carrying on a business (e.g. the receipt of rent from real property, dividends from shares or interest on financial securities such as infrastructure bonds when the investment activity is not a business).

It follows that the activity in question must satisfy the requirement that it also be a “business” activity. Case law concerning when an activity sufficiently bears that character such as, for example, Federal Commissioner of Taxation v Stone (2005) 222 CLR 289 and Ferguson v Federal Commissioner of Taxation [1979] FCA 29; (1979) 9 ATR 873 will be relevant to that inquiry.

29    In that respect, it is true that Div 35 does not alter the requirements for assessability and deductibility prescribed elsewhere in the 1936 and 1997 Acts, and where this involves the concept of carrying on a business, that concept remains as explained by Gummow J in Allied Mills, supra. Paragraph [1.10] of the Explanatory Memorandum to the New Business Tax System (Integrity Measures) Bill 2000 thus states:

Division 35 does not change the existing income tax concept of what constitutes the carrying on of a business. The Division will apply within that environment to those individuals able to claim business deductions under the existing law on the grounds that they are carrying on a business and meet all existing tests of deductibility.

This was the passage referenced by Mansfield J in Watson, supra. However, in my view, it does not detract from the conclusion I have reached concerning the meaning of the phrase “business activity”.

30    Fourthly, it follows that, in my view, the type of activity to which Div 35 is directed is all that course of conduct constituting a distinct business operation, occupation or pursuit which produces assessable income or a tax loss. In that respect, Div 35 refers to activities which have “produced” income, to income “from” the activity and to “amounts” which are “attributable” to an activity. In each case, the focus of the Division is upon the identification of activities which are the source or origin of income or a loss. As the Full Federal Court observed in Watson ((2010) 182 FCR 104) at [28]:

The primary question for present purposes is the meaning of the word “from” in the expression “assessable income ... from the business activity for that year”. In BHP Petroleum (Timor Sea) Pty Ltd v Minister for Resources (1994) 49 FCR 155 at 170-171, Beaumont J said, concerning the use of the word “from” in connection with an application for the issue of a certificate, which application was to be “from a person”:

In my opinion, ... “from” is intended to have its dictionary meaning, that is to say, to indicate the starting point, source or origin, of an application or request.

A similar meaning should be given to the word for the purposes of s 35-10(2).

It will be a question of fact and degree to determine when a course of conduct constitutes a separate and distinct business operation, occupation or pursuit and thus a separate “business activity”. The function and purpose of the activity will need to be considered. Whether the activity exists only to serve a broader business would also be a relevant consideration, as would the extent to which activities are objectively connected. The matter should be tested as a matter of substance and not of form.

31    Fifthly, the fact that an individual may carry on distinct operations, occupations or pursuits that are “similar” or of a “similar kind” will not necessarily compel a conclusion that they form part of one singular “business activity”. This is made clear by the presence of s 35-10(3) which provides:

(3)     In applying this Division, you may group together business activities of a similar kind.

This section is a strong indication that even similar activities may be treated as distinct business activities unless the taxpayer elects to group them. Notably, the Commissioner has no similar power to group similar activities.

32    Finally, two business activities carried on by a taxpayer may be the same but nonetheless be sufficiently distinct, so that each is a separate business activity, if, for example, one follows the other sequentially. A forester who plants and then after many years harvests a pine forest, may plant another pine forest on the same land. The second plantation could, in my view, be a separate business activity even though, at all material times, it could be said that the forester was otherwise carrying on the same continuous business. That possible conclusion follows from Parliament’s decision to use the phrase “business activity” instead of the word “business”. Much, however, would turn upon the particular facts and circumstances of a given case.

The Submissions of the Parties and the Objection Decision

33    The Objection Decision set out certain background information, summarised the applicant’s argument, and addressed the requirement for the exercise by the Commissioner of his power in s 35-55(1)(c). This included asking the question, as required by the section, as to when the business activity commenced. For that purpose, after noting some of the changes that had been made in the 2008 income year, the decision-maker posed the following question:

The question is therefore whether the change in bloodlines constituted a new business activity for the purposes of the [non-commercial business losses (NCL)] legislation and thus reset the lead time as established above.

The appropriateness of this question was not disputed. However, difficulties arose in answering it. The decision-maker consulted the Commissioner’s ruling on the subject, TR 2001/14, and after reproducing certain paragraphs concerning the Commissioner’s view as to what constitutes a “business activity”, proceeded to extract certain further paragraphs concerning when business activities are “of a similar kind” for the purposes of s 35-10(3). The following question was then posed by the decision-maker

The question then is whether your business activities pre and post 2007/08 are of a similar kind and would be grouped together such that they would be considered the same business activity for the purposes of determining the lead time.

That question, raising as it did for consideration the grouping provision in s 35-10(3), was undoubtedly misconceived. The applicant here made no election to group her pre-2008 activities with her post-2008 activities. The decision-maker had thus asked the wrong question. So much so was very properly conceded before me by counsel for the Commissioner.

34    Nonetheless, the Commissioner did not further concede that the Objection Decision should now be set aside. In his submission, the question posed about the similarity of the activities was of no moment and did not form part of the ultimate decision reached. That is because the decision-maker in fact found that the pre-2008 business activity and the post-2008 business activity were not similar but the same. Counsel for the Commissioner, in that respect, highlighted the following finding:

Your activities are much more than related. They are in fact the same business activity that has been carried on continuously from 1998 to today.

Counsel submitted that this passage showed that the issue of similarity had been excluded by the decision-maker, or, if not excluded, subsumed by the finding of sameness. The Commissioner also submitted that the decision-maker had, in any event, found that the business activity was not capable of generating a profit within the suggested lead time of 10 to 15 years. It was submitted that no evidence, or no sufficient evidence, of likely profitability had been presented to the decision-maker.

Disposition

35    In Haritos v Federal Commissioner of Taxation (2015) 233 FCR 315, the Full Court of this Court decided that the Administrative Appeals Tribunal erred in excluding certain expert evidence led to corroborate the evidence of the lay taxpayer in that case. The Court found that there was “a good deal to be said against the appellants’ case” (at [255]). Nonetheless, the Tribunal’s decision was set aside and the matter was remitted to be reheard. That was because the error identified could not be “quarantined”. The Court said at [254] and [255]:

As we have said, the Tribunal expressly said in the particular case of the alleged loan from Mr Kyritsis to Mr Haritos in 2009, that it needed more than Mr Haritos’ evidence. We think that that indeed was the premise of the whole of the Tribunal’s analysis of the appellants’ case that the payments from the Westpac account were loans by the company. It follows that we think that the Tribunal’s erroneous approach to the evidence which potentially corroborated Mr Haritos’ evidence in relation to the subcontractor expenses and, therefore, Mr Haritos’ credit and reliability, has also led to an error of law in the conclusion that the payments from the Westpac account were income according to ordinary concepts. The legally flawed failure to address the potential corroboration of Mr Haritos’ evidence by the evidence of Mr Della Costa, Mr Karlovsky and Mr Adrian cannot be quarantined. It is not for this Court to consider how a Tribunal should view Mr Haritos’ evidence once it is assessed by the Tribunal, including by reference to potentially corroborative evidence. Unless it be the case (which it is not) that the corroboration could not possibly affect the finding of fact that the payments were income according to ordinary concepts, that matter must be seen as affected by the error to which we have earlier referred.

We reach this conclusion with some reluctance because there was a good deal to be said against the appellants’ case, particularly their case that the payments from the Westpac account were loans by the company, and significant aspects of the Tribunal’s reasons are unexceptional. However, unless it is quite clear that the result would have been no different without the error of law (and it is not in this case), it is not for this Court to reach its own conclusions on the papers (Rosenberg v Percival (2001) 205 CLR 434; Minister for Immigration and Multicultural Affairs v Rajamanikkam (2002) 210 CLR 222).

(My emphasis)

36    These principles also apply to other decisions of an administrative character, such as the Objection Decision here where the appeal to this Court involves Avon Downs judicial review: see, for example, Sydney Water Corporation v Caruso and Others [2009] NSWCA 391. In that case, Allsop P (as his Honour then was) expressed the principle in these terms at [27]:

If, however, the error goes to the heart of the cognitive and evaluative process and one cannot be satisfied that it did not play a relevant or material part in the decision then the appellant has established that the decision is vitiated.

37    In my view, it is not “quite clear” that the result here would have been no different if the decision-maker had not asked the wrong question set out above. Nor am I satisfied that asking the wrong question did not “play a relevant or material part” in the decision-making process. On the contrary, I am of the view that asking the wrong question here “could” have affected the determination of the applicant’s objection. Like the error in Haritos, the error here cannot be safely “quarantined”.

38    I have reached this conclusion largely because the erroneous question was not posed in isolation. It followed the reproduction of three paragraphs ([49]-[51]) from TR 2001/14 which were concerned with an application of s 35-10(3). The decision-maker then went on to apply the criteria for determining similarity for the purposes of s 35-10(3), as set out at [51] of the Commissioner’s ruling. Detailed analysis followed of the following factors: “[t]he locations where [the activities] are carried on”; “[t]he types of goods or services provided”; “[t]he market(s) (&) conditions in which these goods or services are traded”; “[t]he types of assets employed in each”; “[o]ther factors affecting how the activities were conducted”. These are the same factors or tests listed at [51]. Tellingly, earlier paragraphs in the Commissioner’s ruling directed at identifying what constitutes a “separate business activity” ([40]-[48]) were neither referred to, nor reproduced in the Objection Decision.

39    It follows that it would appear that the decision-maker wrongly assumed that s 35-10(3) was engaged. He or she therefore looked at the Commissioner’s ruling concerning that provision, reproduced the relevant paragraphs addressing it, and then applied the criterion for similarity specified in those paragraphs. In such circumstances, even though the process of reasoning led the decision-maker to reach a conclusion that the activities pre- and post-2008 were one and the same, I cannot be confident that the same conclusion would have been reached in any event, and more particularly, if the erroneous question had not been posed. Focusing on issues of similarity in the mistaken belief that s 35-10(3) applied would appear to have infected the decision-maker’s course of reasoning and took him or her away from a determination of whether the changes made in the 2008 income year constituted a distinct and new business activity, to issues of similarity and then sameness. As set out above, a finding about sameness or similarity is not necessarily an answer to the question whether a new business activity had commenced where a previous one – which is very similar or the same as the activity in question – may have ceased. In that respect, because of the presence of s 35-10(3), distinct business activities which are of a “similar kind” should probably be treated as separate unless grouped by a taxpayer. In this way, the error which took place can be seen as one which “could” have affected the outcome of this case.

40    With respect to counsel for the Commissioner, I do not think that the reasoning concerning similarity was excluded by the finding about sameness set out above. Rather, that conclusion was the product of that reasoning. Nor am I satisfied, based on the contentions concerning the alleged lack of evidence concerning the expected profitability of the business, that the applicant was in any event bound to fail. The decision-maker did not reach his or her decision on this alternative basis. He or she considered this issue on the basis that the business activity had commenced in the 1998 income year.

41    For these reasons, in my view, the Objection Decision should be set aside and the matter should be remitted to the Commissioner for re-determination in accordance with law. It will be for him to determine, in accordance with these reasons, whether, on the facts, a business activity separate from that commenced in the 1998 income year, started in the 2008 income year. Because of the conclusion I have so reached, it is unnecessary for me to consider the other grounds of review relied upon by the applicant.

42    I will give the parties seven days within which to agree upon final orders, or failing that, to file and serve written submissions limited to four pages in length, concerning the form of final orders.

Associate:

Dated:    24 August 2018