Contributed by Associate Professor Justin Dabner, Law School, James Cook University, Cairns and Principal, Tax Resolutions.
All Australian tax aficionados now in their 50s and above can probably recall when they heard of the High Court decision in FC of T v Myer Emporium Ltd 87 ATC 4363. Well, at least this tax tragic can. The “greed is good” generation was in full swing. An era of corporate cowboys and loose bank lending. Concepts like debt defeasance, tax benefit transfer and tax effective financing were all the rage in the blue chip tax world. And then the High Court came along to dampen the party.
Although subsequent decisions (chiefly FC of T v Spedley Securities Ltd 88 ATC 4126) were to calm the initial fears that the High Court had just introduced its own capital gains tax, the application of the Myer principle has been a source of considerable uncertainty. But it has good company. Ambiguity exists both as to when a business can be said to actually exist and then as to whether a particular transaction is in the ordinary course or “incidental” to that business. And then there is the amorphous distinction between a mere realisation (to the best advantage) and a profit-making undertaking or scheme.
Into this minefield, newly minted Judge Thawley ventured in the recent case of Greig v FC of T 2018 ATC ¶20-662.
An unfortunate “investment,” or was that “business”?
The taxpayer, a corporate executive, invested heavily in the share market on the advice of financial advisors and stockbrokers. Many millions of dollars of share purchases occurred between January 2008 and April 2014 with all the transactions being treated as on capital account. However, during the same period shares were also purchased in Nexus Energy Ltd, which it was claimed was in accordance with a “profit target strategy.” Nexus failed and was placed into administration and the taxpayer claimed a deduction (under s 8-1 of ITAA 1997) for his share losses amounting to $11.85m. He argued that either these losses arose out of a business or, at least, “in a business operation or commercial transaction” within the meaning of the Myer principle.
Were losses necessarily incurred in carrying on a “business” within the meaning of s 8-1(1)(b)?
It was always going to be difficult for the taxpayer to satisfy the Court that he was in the business of dealing in Nexus shares. Still the decision is instructive as to the weight to be attached to the relevant considerations where the existence of a business is argued.
Readers would have no doubt be acquainted with the proposition that whether a business exists is a question of fact and degree. Relevant considerations are:
- the existence of a profit-making purposes (versus a hobby)
- nature, size and scale of the activities
- commercial character of the transactions
- repetition and regularity of the activities; and
- whether the activities occurred in a systematic and business-like manner.
The taxpayer’s case was confronted by two uncomfortable and unassailable facts. Firstly, he was a high flying corporate executive (both figuratively and literally it seems) with little time that he could realistically have devoted to any other business. Secondly, he treated (and it was not contested) all his other share transactions as on capital account – only the Nexus transactions were to be characterised as a business venture. The difficulty was that there was little in the way of distinguishing features between the Nexus share acquisitions and the other share transactions all of which occurred through the agency of his advisors.
Critically there were no written business plans, methodologies, separate records or any documentation that supported the existence of a business of dealing in Nexus shares. Importantly (although not decisively), there was no attempt to register a business or form any entity to conduct the transactions. While there was a clear profit-making purpose, with a substantial amount of capital invested in 64 transactions over a 25-month period, his Honour opined that this alone did not transform the share purchases into the carrying on of a business. The circumstances supported the characterisation as an investment activity.
Were losses deductible under s 8(1)(a) because the shares were acquired with a profit-making purpose within the Myer principle?
Readers would again be familiar with the principle that a mere realisation of an asset does not give rise to assessable income, even where the realisation is to best advantage. While an easy proposition to state, in practice distinguishing between a mere realisation (to best advantage) and entering into a profit-making undertaking or scheme that generates assessable income can be very difficult. The High Court in the Myer case seemed to blur the distinction further by acknowledging that assessable income could arise from an extraordinary or isolated business operation or commercial transaction entered into with a profit-making purpose.
A detailed consideration of the Myer principle is outside the scope of this article. Suffice to say that the case dealt with a tax effective financing arrangement that threatened the integrity of tax collections. A judicially active High Court departed from conservative UK precedent to establish a principle that resolved the “hard” case before it. The decision and its potentially broad application came as a shock to commentators and the profession and, indeed, subsequent decisions interpreted the principle narrowly and placed caveats on it (such as Westfield v FC of T 91 ATC 4234).
One of the features of the principle that has remained to be resolved is whether it can have an application to a taxpayer who is not in business. The principle typically arises for consideration in a context, where the court has concluded that a transaction is not part of a taxpayer’s ordinary business (nor incidental to it as per FC of T v Cooling 90 ATC 4472) but rather is an isolated or extraordinary transaction. Is a precursor to an application of the principle, therefore, that there be a business carried on by the taxpayer?
In Greig, there was agreement that no such business was being carried on. Unsurprisingly the ATO has adopted the position that the taxpayer need not otherwise be carrying on a business for the Myer’s principle to apply. However, here we had a situation where the taxpayer was happy to concede this interpretation. Other taxpayers are unlikely to be too impressed with this concession.
The Court did explore the sparse authority on point but given that both counsel were happy to be in agreement in the circumstances of the case, it is suggested that the proposition was not robustly tested. In the event the Court accepted that the existence of a business was not a requirement of the principle but did acknowledge that it was, nevertheless, a relevant consideration in determining whether the transaction was stamped with a commercial character. Thus at paragraph 132 his Honour stated: “The acquisition of an asset by a person carrying on a business might be seen differently to the acquisition of the same asset by a person not carrying on a business”.
Having dispensed with the need for the taxpayer to otherwise be in business and with a clear acceptance that, objectively viewed, the facts surrounding the acquisition of the shares supported the existence of a (not insignificant) profit-making purpose (whether in the short or long term), the critical question to be decided was whether the acquisitions were “in a business operation or commercial transaction.”
Here the taxpayer ran into the same difficulties that countered his argument that he was carrying on a business. The taxpayer attempted to characterise the 64 Nexus share acquisitions over two years as in accordance with a business operation termed the “profit target strategy”. Underpinning this strategy it was said, was an intention to profit from the disposal of the shares upon a “liquidity event”, such as a takeover bid or asset sale.
Regardless as to how the taxpayer chose to characterise the acquisitions his Honour was not persuaded that this was anything other than an investment where the taxpayer had a hope or expectation that the shares would go up in value. Such a hope or expectation did not colour the acquisition as a business operation or commercial transaction. The large size of the portfolio, while relevant, was not decisive. Evidence of taking an interest in the share price or reports from analysts was merely the behaviour of a typical investor. The acquisitions could not be described as commercial dealings.
Does Greig further our understanding as to when a business exists or when the Myer principle applies?
Short answer: maybe not. Although did the ATO score a home goal?
Reading the decision leaves one with a sense that the taxpayer is either a tad vexatious or easily persuaded to litigate. There was evidence that the taxpayer had expended a further $507,000 in legal fees engaged in unsuccessful litigation surrounding the failure of Nexus Energy Ltd. A private ruling request of the ATO had returned an unfavourable verdict. The argument that the Nexus loss arose out of a business was highly speculative. The argument based on Myer required skilfully drawing a distinction between the Nexus share transactions and the other share transactions. No matter what spin counsel for the taxpayer came up with it smacked of a distinction without a difference.
Case law makes it clear that without a business plan and evidence of a system it is an uphill battle to establish the existence of a business. Greig confirms that the absence of the hallmarks of a business will not be excused just because that there are lots of zeroes in the capital sum ventured. Where a taxpayer is not hands on and in their absence relies on agents and advisors, profit-making purpose, scale of activities and repetition will not be sufficient to characterise the venture as a business. Taxpayers purporting (or not as the case may be) to be engaged in share trading might do well to gauge their activities against those of Mr Greig.
In relation to the Myer principle, the decision supports the proposition that it can apply even where the taxpayer is not otherwise engaged in a business. However, as indicated, this proposition was not robustly tested in the absence of counsel taking an opposing view. Furthermore, his Honour did emphasise that whether the taxpayer was otherwise engaged in a business remained a relevant consideration as to whether a transaction had the stamp of a revenue nature.
As to the meaning of “in a business operation or commercial transaction”, the decision suggests that there is little to distinguish this requirement from “carrying on a business” which previously would have been considered a higher threshold to establish than the Myer principle. It is conceivable that the ATO might learn to regret its win!
[This article was originally published in CCH Tax Week on 10 August 2018. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow – Income Tax module. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]