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03 Aug 06 Property trading stock; losses not transferable - R & D Holdings

The Federal Court (Finn J) has substantially upheld assessments issued to the taxpayer company (R & D) by the Commissioner. Three issues were involved.

The first issue was whether the net income of a trust, the Hallinn Trust, which was distributed to R & D in the 1998 tax year, included an amount assessable under s 70-35 of ITAA 1997 in respect of the revaluation of trading stock from cost to market value. That amount was attributable to the revaluation of land and buildings at 2-4 Bulletin Place, Sydney, these being a trust asset. R & Ds’ claim was that the treatment of the Bulletin Place property in its tax return as trading stock (against which it claimed deductions for losses transferred to it by another group company (Chapel Road)), was mistaken. The Court concluded, on the evidence, that the property was trading stock and that the amount was properly included in the net income of the trust on the revaluation of the property. It was therefore properly included in R & D's assessable income.

The second issue was whether R & D was entitled to a deduction for the losses claimed to have been transferred to it by Chapel Road. The Court concluded that in consequence of a change in its shareholding in July 1997, R & D was entitled to a deduction for transferred losses recouped in the 1997 income year but was not entitled to a deduction for transferred losses recouped in the 1998 and 1999 income years as in those latter years it did not satisfy the same business test for loss transfers. The Court found that, as a result of a mortgagee taking possession of Chapel Road's property in 1991, Chapel Road "did not carry on a business at all in the relevant periods on the Chapel Road site. [The mortgagee] did. Chapel Road had no access to business assets."

The third issue was whether the tax shortfall in the 1998 and 1999 year assessments was caused by recklessness, such that the Commissioner was entitled to assess penalties equal to 50% of the shortfall under the former s 226H ITAA 1936. The taxpayer argued that that it had not been reckless, and that any penalties otherwise imposed in the alternative by the former s 226K should be reduced to nil because it had a reasonably arguable position.

In relation to the interaction between lack of reasonable care and a reasonably arguable position, the Court said this at para 182:

"The above subsection [the former s 222C(1), about relevant authorities] was analysed in some detail by Hill J for the purposes of s 226K in Walstern Pty Ltd v FCT (2003) 138 FCR 1 at [105] ff. I will not reiterate what was said there other than to note that his Honour indicated that an argument could not be as likely as not correct if there was a failure on the part of the taxpayer to exercise reasonable care in making it, although reasonable care alone would not result in an argument being, objectively, "about as likely as not correct". I agree with this view. I would add that encompassed in what constitutes reasonable care in this context is the need for the taxpayer, or its advisers who are reasonably relied upon, positively to advert to the applicability of the law in question to the taxpayer’s circumstances and actually to form a reasoned view on the matter."

The Court held that the taxpayer and its advisors had not adverted to whether Chapel Road satisfied the same business test. As such, it was not open to it to say that "it was reasonably arguable that the loss transfer provisions were applicable in the circumstances. It had no informed view, reasonable or otherwise, on this matter at all. Section 226K applied to it" (para 191). Moreover, the Court found that the taxpayer was "indifferent to the consequences of its reliance on the loss transfer provisions" (para 192). Accordingly, it was reckless and s 226H applied, with the result that the penalties had been correctly assessed.

R & D Holdings Pty Ltd v FCT [2006] FCA 981 (Federal Court, Finn J, 2 August 2006).

For a copy of the decision, go here

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