Contributed by Associate Professor Justin Dabner, Law School, James Cook University, Principal of Tax Resolutions
The Full Federal Court by majority has reversed the decision in Greig v FC of T 2018 ATC ¶20-662;  FCA 1084 and held that a taxpayer could claim a deduction under s 8-1 of ITAA 1997 for share losses of $11.85m, as well as for legal fees incurred following the relevant company entering into voluntary administration: Greig v FC of T 2020 ATC ¶20-733;  FCAFC 25.
The author previously discussed the Federal Court decision (“Greig v FCT: the latest on when a business exists and the Myer principle”, [¶605] 10 August 2018). The author suggested that, considering the facts, the taxpayer’s decision to litigate in the first instance was surprising. Even more surprising, the taxpayer appealed to the Full Court. But most surprising of all, at least to this commentator, he has now been successful.
Determining the line between a transaction of a business nature and a mere capital investment is notoriously difficult. It is hard to find fault in either the majority judgments in the Full Court or that of the dissenting judge and judge at first instance. As discussed below some relevant principles may be drawn from the majority judgments. However, the decision largely fell on the judges’ acceptance of the narrative painted by the taxpayer. There is a clear sense that the dissenting judge and the judge at first instance did not accept the “after the event” spin placed on the evidence to characterise it as supporting the existence of a commercial or business transaction. Adverse findings as to the taxpayer’s credibility as a witness may have had a role in their Honours’ refusal to accept this narrative.
The taxpayer, a corporate executive, invested in the share market on the advice of financial advisers and stockbrokers. Many millions of dollars of share purchases occurred between January 2008 and April 2014. These transactions included the purchase of shares in Nexus Energy Ltd. However, Nexus failed and was placed into administration resulting in losses for the taxpayer. Although originally treated in both the accounts and earlier tax returns as on capital account, after further advice the taxpayer claimed a deduction for these losses and associated legal expenses. It was argued that, in contrast to the other share transactions, those relating to the Nexus shares were in accordance with a “profit target strategy” such that the losses were incurred in gaining or producing assessable income or carrying on a business (within s 8-1) or, at least, “a business operation or commercial transaction” (within the Myer principle).
Decision at First Instance
At first instance, Thawley J rejected the taxpayer’s arguments. His Honour had made adverse findings as to the taxpayer’s evidence suggesting that there was an inconsistency between his oral testimony and the contemporaneous evidence and that he tendered to exaggerate any business element. However, as the tests as to whether a business operation existed focused on objective considerations, not the taxpayer’s subjective intentions, much of his oral evidence was largely irrelevant. Looking at the objective facts, as there was little to distinguish between the Nexus share acquisitions and the other share transactions claimed to be on capital account, all of which occurred through the agency of the taxpayer’s advisors, objectively no business was found to exist.
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. While there was a clear profit-making purpose, with a substantial amount of capital invested, this alone did not transform the share purchases from other than a capital investment.
In addition to finding that there was no business, his Honour also rejected the argument that the losses were deductible as losses from a “business operation or commercial transaction” entered into for the purpose of making a profit (the Myer principle). 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.
A preliminary consideration was whether the Myer principle could have an application to a taxpayer who is not in business. While his Honour accepted that the existence of a business was not a requirement of the principle it was, nevertheless, a relevant consideration in determining whether the transaction at issue was stamped with a commercial character.
Full Court Majority Decision
Before the Full Court, the primary issue was whether the Myer principle entitled the taxpayer to a deduction on the basis that he had incurred a loss from a “business operation or commercial transaction” entered into for the purpose of making a profit.
Justices Steward and Kenny entered judgments disagreeing with the decision at first instance that the Nexus shares were not acquired in a “business operation or commercial transaction”. Rather the shares were acquired with a view that they be sold at a profit in the short term and, while no profit was made, if the taxpayer had realised a gain, the gain would not have been characterised as a windfall or as merely a realisation of a capital asset. Interestingly, their Honours acknowledged the artificiality in distinguishing the Nexus share transactions from the other investments, thereby implying that all the taxpayer’s transactions should be treated as on revenue account.
In teasing out the meaning of a “business” operation their Honours endorsed the view expressed by Professor Parsons in his celebrated treaty: Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (The Law Book Company Limited, 1985). There (at 2.498–2.500) Parsons opined that this was an elusive consideration and that the most that could be said was that if the taxpayer’s activities in acquiring intended profit-making property are the kind of things that a business person would do in seeking to make an intended profit, then generally speaking the property will have been acquired in a “business operation or commercial transaction”.
Their Honours then suggested that there could be little doubt that the taxpayer acted as a business person would do in acquiring his Nexus shares to obtain a profit on their sale and that, therefore, he acquired these shares in a “business operation or commercial transaction”.
Justice Steward identified the following factors (in addition to the Parson’s test) relevant to the issue at hand:
- the share losses could not really be characterised as arising from an isolated trade
- there is no rule that prima facie shares are held on capital account
- the way that a taxpayer characterises a transaction is largely irrelevant (in fact his Honour emphasised that the taxpayer’s evidence in cases such as this had to be viewed with caution)
- any notion as to whether a transaction was of a “private” nature or not is not useful to the consideration, and
- if shares are acquired by an individual for their dividend yield and long-term growth they are likely to be held on capital account (although the mere waiting to make a gain would not alter the character of a transaction otherwise on revenue account).
Furthermore, his Honour identified the following evidence as supporting his conclusion that any profit would have been assessable (and hence loss deductible):
- an intention existing at the time of the acquisition of each share of profit making from their sale
- the existence of a sophisticated plan to generate cash profits within four to five years
- the shares were acquired in a systematic fashion on 64 occasions
- the taxpayer’s participation, either personally or through an agent, in value generation
- the use of the taxpayer’s business knowledge and experience, and
- the taxpayer acted as a “business person” would have.
Justice Derrington differed from the majority in the emphasis his Honour placed on the requirement to identify the commercial or business character of the transaction as existing at the same time as the intention to generate a profit. Here the totality of the transaction was to purchase shares, hold them until the market price increased and then sell them. That transaction had none of the commercial or business qualities identified in the authorities.
Although the taxpayer could point to an intention to make a profit existing on the acquisition, the assertion that post-acquisition conduct designed to maintain or improve the asset’s value could supply the necessary commercial character was rejected. His Honour held that this submission conflated the two limbs of the Myer principle and assumed that the requirement that the transaction be a commercial one or a business operation was inherent in the requirement that it was entered into with the intention of making a profit.
Rather, the element of a commercial transaction or business operation must coexist at the same time as the relevant profit-making intention. Necessarily, the transaction or business operation must involve contemplated or anticipated steps or actions even if they are only identifiable in broad terms. It is the nature and quality of those steps or actions which give a transaction its commercial or business character.
His Honour commented that the case advanced by the taxpayer as to when the alleged commercial venture commenced was somewhat fluid. The precise commencement of the alleged venture was difficult to identify, if for no reason than that it seemed that the taxpayer was not aware that he was engaging in such a strategy until after he had consulted his accountants following the sustaining of significant losses.
Ultimately his Honour concluded that the taxpayer’s attempt to create, ex post facto, a commercial transaction or business operation from conduct engaged by him as an investor who merely was seeking to protect his investment, could not succeed. None of the steps relied upon were in contemplation whatsoever upon the initial acquisitions.
Although the majority did acknowledge the borderline nature of the case, there is a sense that the amounts invested and number of transactions (64 in around 25 months) dwarfed the other considerations in terms of the significance given to them. The result is that the decision does little to clarify the law and, in fact, may have generated greater uncertainty. We should not be too critical of the judiciary though. The underlying principles are inadequate, premised on blurred and illogical distinctions that engender dead weight compliance costs while allowing an opportunity for counsel, skilled in the art of rhetoric, to demonstrate their persuasive powers.
The only clarification that has arisen from the case is that it is now established that the Myer principle can apply even where the taxpayer is not otherwise engaged in a business. Even then this is qualified with the rider that where a taxpayer is not engaged in a business this is a relevant consideration denying the revenue nature of the transaction.
As to the interpretation of the “in a business operation or commercial transaction” element of the Myer principle, the differences in the Full Court judgments largely pivoted on the extent to which a taxpayer must have the details of how they are intending to generate a profit in mind at the time of the acquisition of the property. The majority accepted that the taxpayer’s subsequent activity was sufficiently of a commercial nature and in contemplation (apparently) at the time of the acquisition of the shares. The dissenting judge both doubted whether these subsequent steps had the necessary commercial character nor where in contemplation at the requisite time.
In the earlier article, the author concluded by musing whether the ATO might regret its win by virtue of a possible narrowing of the concept of a business transaction for the purpose of applying the Myer principle (as well the general principles as to the existence of a business). Now the same caveat applies to the taxpayer’s victory. Other (profitable) borderline investors may not have anything to cheer from this case. In fact, the taxpayer himself may have a Pyrrhic victory (subject to limitation periods) as the majority made it clear that there was nothing to distinguish the profitable trades in relation to which the taxpayer claimed to be an investor from the loss-making ones held to be on revenue account. The absence of a distinction for tax purposes between the Nexus share transactions and the other share transactions is a point on which all the judges seemed to agree, regardless of their ultimate conclusion.
[This article was published in CCH Tax Week on 13 March 2020. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]