Crees and Commissioner of Taxation

[2001] AATA 70

DECISION AND REASONS FOR DECISION [2001] AATA 70

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          QT2000/46-48

TAXATION APPEALS  DIVISION         )          
           Re      CECIL CREES       
  Applicant
           And    COMMISSIONER OF TAXATION          
  Respondent

DECISION

Tribunal       Mr. D.W. Muller, Senior Member

Date5 February 2001       

PlaceBrisbane

Decision      The Tribunal affirms the objection decisions under review.   
  ...............(Signed)...............................
  D.W. MULLER
  SENIOR MEMBER
CATCHWORDS
INCOME TAX – whether carrying on a business – primary production
Income Tax Assessment Act 1936: ss 51
Case K9 78 ATC 98
Thomas v Federal Commissioner of Taxation 72 ATC 4094

REASONS FOR DECISION

Mr. D.W. Muller, Senior Member             

1. This is an application by Cecil Crees to review decisions of the respondent to disallow objections to amended assessments for the three income tax years ending 30 June 1995, 1996 and 1997.

2. Mr. Crees has been growing orchids since 1984.  He first claimed to be in the business of growing orchids in the 1989 taxation year.  The questions for determination by the Tribunal are:

   (i)Whether the orchid growing activities of Mr. Crees amount to carrying on a business of primary production, or whether he is an enthusiast/hobbyist;

   (ii)Whether income from the orchid growing activities should be included and whether deductions associated with the growing of orchids should be allowed in the assessment of Mr. Crees' income tax;  and

   (iii)Whether additional amounts for penalty and interest should have been imposed.

3. The following facts are not in dispute and the Tribunal finds as follows:

   (i)Mr. Crees was born on 8 June 1950.

   (ii)In the late 1960s he spent three years as a student at Queensland Agricultural College.

   (iii)His main source of income during his working life has been derived from his expertise as a technician.  He was employed full-time by Telecom/Telstra until he accepted a voluntary redundancy package in April 1998.  He then obtained full-time work with Transfield as a technician.  His contract with Transfield will cease in May 2001.

   (iv)He started growing orchids in 1984.

   (v)He has sold orchids from time to time but his expenses associated with producing orchids have far outweighed his income from sales.

   (vi)His property consists of 2,023 square metres.  On that property he has his residence, an old hothouse (built in 1988), a bush house (built in 1992), an air-conditioned cold house (built in 1993), a shed (built in 1996), a tank (built in 1998) and a new hot house (built in 1998).

   (vii)He registered his business name "Valley View Orchid Nursery" on 6 May 1993 and still maintains registration to the present.

   (viii)He advertises in a magazine called "Orchids Australia".  He also advertises in local newspapers.  His sales are mainly done on a mail order basis.  He does not encourage customers to walk in off the street because of security worries.

   (ix)Since 1997 he has significantly boosted his income by growing and selling day-lillies.

   (x)The following table sets out the income and expenses, as presented to the Tribunal, of Mr. Crees for the years stated, from salary and wages, sales of orchids/day-lillies, expenditure and cost of breeding stock.

Tax year ended 30 June Salary/ wages Income    Sales of orchids & day-lillies    Expenses re: orchids and day-lillies         Losses from orchids and day-lillies       Cost of breeding stock 

1. $   632 $  7,874        $ 7,242          

2. $   661 $  8,940        $ 8,279          

3. $1,465  $  9,524        $ 8,059          

4. $37,135          $1,729  $12,205          $10,476          $5,176 

5. $46,119          $1,350  $13,689          $12,339          $3,341 

6. $41,569          $1,485  $14,145          $12,660          $5,170 

7. $3,302  $13,113          $  9,811        $2,117 

8. $6,035  $10,809          $  4,774                  

9. $4,000 (approx)  

10. $5,500 (approx)  

(xi)Accumulated losses since 1989 have been well in excess of $75,000.

(xii)At the date of audit, 30 June 1997, Mr. Crees' records consisted of receipts for purchases, log book for car use and a record of which species of orchids he had crossed with what.  He had never done a stocktake.  He has since conducted a stocktake to ascertain the value of his stock.

(xiii)Mr. Crees' orchid stock is currently valued by him at approximately $70,000.

(xiv)Most orchids take three or four years to prepare them for sale.  Some can take two years and some can take five years.  A few rare varieties can take fifteen years.

1. Mr. Crees gave evidence to the Tribunal that he began to get the idea of turning his hobby of growing orchids into a business in the late 1980s.  He said that his work with Telstra (Telecom as it then was) was both demanding and insecure because of the rapid changes in technology.  He intended to back up his retirement package/superannuation with income from selling orchids.  He said that he had hoped to be running the business at a profit by the year 2000.  He is doubtful whether he could ever make a profit of more than $5,000 per annum from the business.

2. The auditor, Tony Yates, gave evidence that when he visited the property in 1997, the whole operation appeared to him to be poorly run.  He could detect no planning or organisation done with a view to direct the activity towards making a profit.  He described the hot house as being in a "shambles".

3. Mr. Crees told the Tribunal that he and his wife put in about 30 hours per week between them on the orchids and day-lillies.  His wife puts in about 10 hours during the week.  He puts in about 20 hours per week, including about 16 hours every weekend.

4. From the material placed before the Tribunal, the following deductions can be made:

   (i)If all goes well and Mr. Crees achieves his aims, he may at some time in the future make a profit of $100 per week ($5,000 per annum).

   (ii)If Mr. Crees achieves his aim of making a profit of $100 per week, it will be achieved by an effort requiring him and his wife to work a total of at least 30 hours per week.  That is, he and his wife will make about $3 per hour between them.

   (iii)If Mr. Crees achieves his aim he should have paid off his accumulated losses of at least $75,000 by about the year 2015 at the earliest.  Which means that he and his wife will have worked extremely hard for over 25 years (1990 to 2015) for a nil return.  They would need to make a significant profit after 2015 to have made the whole enterprise worthwhile.

5. The question as to whether or not an activity amounts to a business of primary production is a fact to be determined by the evidence in each individual case.  The taxpayer's subjective view that he has been running a business has to be taken into account, but the question should ultimately be decided by an objective test.  Some guidance as to the objective tests to be applied have been provided from time to time by the Courts, Boards of Review and Tribunals.  The cases regularly cited in this area of the law are Thomas v Federal Commissioner of Taxation 72 ATC 4094 and Case K9 78 ATC 98. In Thomas, Walsh J, at 4099 said:

   "There is no doubt that the appellant's chief occupation was the practising of his profession and that the tree farming, if it had a business character, was relatively of minor importance both as to the time devoted to it and as to the returns to be expected from it.  But a man may carry on a business although he does so in a small way.  In my opinion the appellant's activities in growing the trees ought not to be found to have been carried on merely for recreation or as a hobby.  I leave out of account the pine trees, the growing of which did not have, I think, a significant commercial purpose or character.  But the appellant in planting the avocado pear trees and the macadamia nut trees set out to grow them on a scale that was much greater than was required to satisfy his own domestic needs and he expected upon reasonable grounds that their produce would have a ready market and would yield, if the trees became established, a financial return which would be of a significant amount, with a relatively small outlay of time and money and that this return would continue for a very long time.  In these circumstances I think it is proper to find, and I do find, that he set out to engage in producing the pears and the nuts as a business and that he was in the tax year carrying on that business, which was a business of primary production."

I also note the remarks of Fairleigh Q.C. (Board of Review Member) in Case K9, where he said:
At 102:

"The 'purpose' as shown by 'Thomas' has to be to carry on activities which have a significant commercial character."

At 103:

"….. the conduct of a venture in a businesslike way is not decisive of the question in issue, though it is important."
"The fact that a property will be incapable of ever providing fair monetary returns for the orchardist, dairy farmer, grazier, oyster-bed lessee, etc., who conducts it as a full-time or part-time occupation is but one of many factors for consideration (cf. the financial position of the coffee shop proprietor in The Commonwealth v Reeve (1949) 78 C.L.R. 410). If the activities carried on have the indicia of a business (e.g., a significant commercial purpose or character) it is of little consequence that despite continuance for many years a profit has not been shown and none is presently envisaged."

1. I find that in the case of Mr. Crees and his wife:

   (i)The orchid growing operation was not run in a business-like manner from 1984 until, at the earliest, the audit conducted in June 1997.  There had never been a stocktake, sales were very low, expenses were high and the physical appearance of the business premises was "a shambles".

   (ii)For at least ten years, the operation has been incapable of producing a profit.  Indeed, there have been very significant losses.

   (iii)The hope of Mr. Crees seems to be that eventually he will be able to cover his expenses and make a small profit.

   (iv)Even if Mr. Crees does eventually make a profit there will not be a fair monetary return for the effort expended by him and his wife.  It is envisaged that eventually they may make the very low amount of $3 or $4 per hour for their very considerable labour.

   (v)There is in reality only a very remote possibility that Mr. Crees will ever recoup his losses.

2. It would be a most unusual business operator who would expend large amounts of money and labour, for more than ten years, on a business which was unlikely to ever cover the expenditure and even if it did, was not likely to give a reasonable return for effort.  Under the circumstances I find that the orchid growing enterprise of Mr. Crees does not have a significant commercial character and that, therefore, it does not amount to a business of primary production.

3. As far as the additional amounts for penalty and interest are concerned, I find that, at the very least, it was very ambitious of Mr. Crees to attempt to claim that his operation was a business and not merely a hobby.  The penalties should remain.

4. The decisions which disallowed objections to amended assessments for the income tax years ending 30 June 1995, 1996 and 1997, are affirmed.

   I certify that the 12 preceding paragraphs are a true copy of the reasons for the decision herein of Mr. D.W. Muller, Senior Member

   Signed:         .....................................................................................
              R. Hayes, Associate

   Date/s of Hearing  17 November 2000
   Date of Decision  5 February 2001
   Applicant  Mrs. C. Williams
   Counsel for the Respondent    Mr. M. Stunden
   Solicitor for the Respondent    Australian Taxation Office