FEDERAL COURT OF AUSTRALIA Puzey v Commissioner of Taxation [2002] FCA 1171 INCOME TAX – deductions – taxpayer invested in sandalwood plantation project – whether project arrangements a facade – whether outgoings were incurred – whether outgoings on revenue or capital account - whether taxpayer carrying on a business INCOME TAX – Part IVA – "scheme" – whether determination properly made under s 177F that deductions be disallowed Taxation Administration Act 1953 (Cth) s 14ZZ Income Tax Assessment Act 1936 (Cth) s 51(1), s 177A(5), s 177C(1), s 177 D, s 177F(1) Income Tax Assessment Act 1997 (Cth) s 8-1 Corporations Law FCT v Jackson (1990) 27 FCR 1 referred to FCT v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561 cited Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 cited Albion Hotel Pty Ltd v FCT (1965) 115 CLR 78 cited Calkin v Commissioner of Inland Revenue (1984) 1 NZLR 440 cited Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 80 SASR 1 cited Clowes v FCT (1954) 91 CLR 209 cited Commissioner of Taxation v Lau (1981) 6 FCR 202 applied Milne v FCT (1976) 133 CLR 526 cited Fletcher v FCT (1991) 173 CLR 1 followed Ronpibon Tin NL v FCT (1949) 78 CLR 47 followed FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355 referred to Moana Sand Pty Limited v FCT (1988) 88 ATC 4897referred to RAC Insurance Pty Ltd v FCT (1990) 95 ALR 515 referred to Hallstroms Pty Ltd v FCT (1947) 72 CLR 634 referred to Steele v DCT (1999) 197 CLR 459 cited FCT v Consolidated Press Holdings Ltd (2001) 179 ALR 625 cited FCT v Spotless Services Ltd (1996) 186 CLR 404 applied Eastern Nitrogen Ltd v FCT (2001) 108 FCR 27 followed FCT v Metal Manufactures Ltd (2001) 108 FCR 150 followed Ferguson v FCT (1979) 26 ALR 307 NOEL PUZEY v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA W545 OF 2001 LEE J 19 SEPTEMBER 2002 PERTH IN THE FEDERAL COURT OF AUSTRALIA WESTERN AUSTRALIA DISTRICT REGISTRY W545 OF 2001 BETWEEN: NOEL PUZEY APPLICANT AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT JUDGE: LEE J DATE OF ORDER: 19 SEPTEMBER 2002 WHERE MADE: PERTH THE COURT ORDERS THAT: By 4 October 2002 the parties file submissions on the orders to be made pursuant to the reasons for judgment. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA WESTERN AUSTRALIA DISTRICT REGISTRY W545 OF 2001 BETWEEN: NOEL PUZEY APPLICANT AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT JUDGE: LEE J DATE OF ORDER: 19 SEPTEMBER 2002 WHERE MADE: PERTH REASONS FOR JUDGMENT LEE J: 1 This is an "appeal" pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) against "appealable objection decisions" of the respondent ("the Commissioner") which disallowed "taxation objections" lodged by the applicant against "taxation decisions" of the Commissioner, namely, assessments made by the Commissioner of the taxable income of the applicant and of the tax payable on that income in respect of the years of income ending 30 June 1997 and 30 June 1998. 2 Before setting out the relevant facts it is necessary to explain in more detail the history of the proceeding. 3 By amended assessments issued on 24 January 2000, the Commissioner disallowed deductions that had been claimed by the applicant in Income Tax Returns lodged by the applicant for the 1997 and 1998 years of income. There was no issue as to when or how the original assessments were made nor as to the power of the Commissioner to amend those assessments. 4 The amended assessments calculated the applicant's liability to income tax for the 1997 and 1998 years of income by disallowing a sum of $40,000 as a deduction from taxable income and imposing penalty tax of $1,274.18 in respect of the 1997 year and by disallowing a sum of $42,575 as a deduction from taxable income and imposing penalty tax of $1,550.98 for the 1998 year. 5 In due course "taxation objections" against the "taxation decisions" of the Commissioner were lodged by the applicant and disallowed. In October 2000 "appeals" against those "appealable objection decisions" of the Commissioner were commenced in this Court. In those proceedings it was contended that determinations made by the Commissioner under s 177F of Pt IVA of the Act had been made after the Commissioner had amended the assessments and, therefore, could not be relied upon by the Commissioner to ground the amended assessments. (See: FCT v Jackson (1990) 27 FCR 1). 6 On 8 November 2001, "new" determinations, in the same terms, were made under Pt IVA of the Act "as a precaution". The Commissioner determined that the amounts of $40,000 that were otherwise allowable deductions in each of the 1997 and 1998 income years were not allowable in those years. On the same day further amended assessments were made and notified to the applicant. Again "taxation objections" were lodged and disallowed and an "appeal" commenced against those "appealable objection decisions". It is that "appeal" that is the subject of these reasons. The parties have agreed that disposal of the prior "appeal" proceedings is to await the determination of this "appeal". 7 At all material times the applicant was employed as a meteorologist at the Perth office of the Bureau of Meteorology and received an annual salary, paid by fortnightly instalments, from which were deducted amounts payable under the "PAYE deduction obligation" provisions of the Income Tax Assessment Act 1936 (Cth) ("the Act") and Income Tax Assessment Act 1997 (Cth) ("the 1997 Act") on account of the applicant's liability to pay income tax in the relevant years of income. 8 In about March 1997 Mr Serra, the proprietor of a firm which carried on a business described as "Financial Services & Systems", informed the applicant of a "tax effective investment" in a sandalwood project. 9 Sandalwood is an aromatic wood highly valued in India and many Asian countries. It has been a traded commodity in those countries and elsewhere for hundreds of years. Shortly after the colony was established in 1829 it was discovered that a species of sandalwood occurred naturally in Western Australia, in particular in the areas that became known as the wheatbelt and the goldfields. By the mid-1840's sandalwood was one of the colony's major exports. Sandalwood is a parasitic tree that is difficult to regenerate and the "pulling" of the trees for export led, inevitably, to significant depletion of the resource. 10 In the mid-1980s a research project was commenced by the Western Australian Department of Agriculture in the Ord River Irrigation Area at Kununurra in the Kimberley region of Western Australia to ascertain whether the Indian species of sandalwood, a tropical species, could be grown under irrigation. Indian sandalwood is the most highly valued sandalwood because of the high oil content in its hardwood. By 1997 the research area of sandalwood plantings in the Ord River region consisted of 25 hectares of an irrigated plantation of Indian sandalwood and host-trees. As at June 1997 commercial production of Indian sandalwood in the Ord River region may have been regarded as a prospective or emerging industry but its viability had not been proved. 11 The information given to the applicant by Mr Serra was in a folder inscribed "Ord River Sandalwood Co". The folder described a proposal for the purchase and planting of sandalwood seedlings in the Ord River Irrigation Area. Included in the material was a document headed "Tax Table – 96-97" which calculated the impact on the taxation liability of a participant in the project who had an assessable income of $58,000, a sum adjacent to the salary payable to the applicant. In somewhat oblique terms the document provided the following summary of that calculation: "Total Rebate due from Franchise Purchase: $16,021 Gross Investment: $14,000 Cash Flow Advantage: $2,021 " 12 Also included in the folder was a sheet headed "Tropical Forestry Project" which set out a summary of the elements of the project, and in particular its fiscal consequences. In relevant respects the document read as follows: "INVESTMENT IN TROPICAL FORESTRY · Lease of two acres of land in Ord River Irrigation Area (15 year lease) · Purchase of seedlings comprising: 400 Indian Sandalwood; 160 East African Ebony; 160 Rosewood; 160 Mahogany and 640 Acacia. · Engage a Plantation Manager YEAR 1 PURCHASE · Purchase 1 acre this tax year (ie. 1996 – 97) · $40,000 tax deduction this tax year · $14,000 deposit paid out of tax refund (25 Sept. 97) · $26,000 balance to pay from harvest (ie. $40,000 less deposit of $14,000) · Interest Option 2 of Finance Schedule recommended · NO REPAYMENTS UNTIL HARVESTED YEAR 2 PURCHASE · Purchase 1 acre next tax year (ie. 1997-98) · $40,000 tax deduction next tax year · Tax Variation used to get tax refund back monthly in your pay from Sept. 97 · $14,000 deposit paid out of tax refund in monthly instalments from 25 Nov. 97 · $26,000 balance to pay from harvest (ie. $40,000 less deposit of $14,000) · Interest Option 2 of Finance Schedule recommended · NO REPAYMENTS UNTIL HARVESTED RENT & MAINTENANCE · $1000 rent & maintenance per acre tax deductible · NB:- Payable only when trees are planted". 13 The words "Interest Option 2 of Finance Schedule" set out in the above document, referred to a clause for the payment of interest that was part of a pro forma document ("the Loan Agreement") prepared by the promoter of the project, Allrange Tree Farms Pty Ltd ("Allrange"). The Loan Agreement, a two page document, described the lender as Sandalwood Finance Pty Ltd ("Sandalwood"). Sandalwood had no assets apart from a subscribed share capital of $1.00, the beneficial interest in that share being held by Allrange. The beneficial interest in the three shares issued in Allrange were held by Grubb, Williamson and Baker who, at June 1997, were the three directors of Sandalwood. 14 The "interest" clause in the Loan Agreement read as follows: "Interest (1.) OPTION 1 Seven percent (7%) per annum calculated daily on the balance of the Loan for the time being and payable in monthly instalments in arrears on the 1st day of each month commencing on 30 July 1997. (2.) OPTION 2 Seven percent (7%) of the proceeds from the sale of the timber grown on the Land referred to in Item 8 nett of all costs and is payable upon receipt of sale proceeds by the Borrower on the Scheduled Repayment Date." 15 If a Borrower elected that Option 2 would apply, liability to pay the sum described in the Loan Agreement as "interest" arose only if the proceeds received from the harvesting and sale of timber exceeded "all costs". The Loan Agreement provided for a sum of $79,800 to be lent in two instalments of $39,900, the first instalment to be advanced on 30 June 1997 and the second on 30 June 1998. Partial repayment of the sum lent was to be made by two instalments of $13,900, the first on 15 August 1997, and the second on 15 August 1998. The balance of the sum lent, $52,000, was repayable on demand. However, save for the default or insolvency of the borrower, demand could not be made before proceeds from the sale of timber were received by the borrower, or, before 30 December 2012, whichever event occurred first. Whether for the purpose of Option 2 repayment of the sum owing under the loan was to be a "cost" deducted from the proceeds of sale before the "nett" proceeds of sale were calculated was not made clear. The proposed time for the harvest of the timber was left uncertain in the project documents. It was represented that the harvest was expected to take place 15 years after the commencement of the project, that is to say "in 2012". 16 In May 1997 the applicant sought further information on the project and received a printout of a spreadsheet which suggested that a person who "invested" in the terms set out in the Tropical Forestry Project document could expect, in 15 years time, to receive a "Net Return" of $673,000 from the proceeds of the sale of trees harvested at that time. 17 Earlier in 1997 Allrange had entered a contract with Lincfel Enterprise Pty Ltd ("Lincfel") under which Lincfel agreed to provide services as "nursery manager" of the project. Under the contract Lincfel was instructed to supervise the erection of a seedling nursery for Allrange on land in the Ord River Irrigation Area including the installation of machinery, and to carry out the propagation of sandalwood seedlings in that nursery. The fee payable to Lincfel for its services was $115,000. Lincfel's duties were to commence in March 1997 and to continue until all seedlings had been "handed over to the plantation manager who will be planting these seedlings on behalf of the individual growers". Lincfel undertook that the seedlings would become available for delivery in May 1998. Lincfel was a company controlled by a Mr and Mrs Heading. Mr Heading, formerly an employee of the Department of Agriculture, had obtained knowledge in respect of the propagation of Indian sandalwood in the Ord River region through his employment in tropical agricultural research conducted by that Department at Kununurra. In September 1997, Allrange entered a licence agreement with the Department of Conservation and Land Management ("CALM") under which CALM agreed to provide information to Allrange on the growing of Indian sandalwood in the Ord River Irrigation Area and to supply technical support to Allrange for that purpose. CALM had succeeded the Department of Agriculture as the operator of the research project relating to the propagation of Indian sandalwood in the Ord River region. The consideration payable for the grant of the licence was $100,000. Allrange agreed to sub-let to CALM part of the nursery premises erected by Allrange on land held on lease in the Ord River Irrigation Area and to grant to CALM a licence to use another part of that nursery. 18 The promotional material distributed by Allrange was to the effect that Allrange would sell Indian sandalwood and host-tree seedlings to participants in the project. The material purported that Sandalwood, in effect, would provide loans for the whole of the cost of the seedlings. In particular it was represented to the applicant that if he entered an agreement with Allrange to buy sandalwood and other seedlings for a price of $40,000 in each of the years ending 30 June 1997 and 30 June 1998, the applicant would be able to reduce his assessable income by those amounts in each of those years. The "Tax Table" document given to the applicant showed that such deductions would provide a "tax-saving" sufficient to enable the applicant to pay $14,000 to the project in each of those years. 19 In May 1997 the applicant executed an option to purchase seedlings from Allrange in the terms proposed. The cost of the option was $100, that sum to be applied in part-payment of the price payable for purchase of the seedlings under an agreement for the sale of seedlings ("the seedling purchase agreement") which would come into effect upon exercise of the option if the option were exercised within the "option period", namely, one month from the commencement of the option. The seedling purchase agreement provided that the cost of the seedlings was $80,000, payable as follows: $100 on exercise of the option; $39,900 on 30 June 1997; $100 on 15 July 1997, and $39,900 on 30 June 1998. It can be seen that, apart from the sum of $100 payable on 15 July 1997, the amounts payable, and the dates thereof, corresponded with the sums and dates specified in the Loan Agreement. 20 In or about May 1997, the applicant entered a lease in respect of a plot of land of almost one hectare in the Ord River Irrigation Area. The term of the lease was until 30 November 2013 and possession of the lot to be given to the applicant on 1 May 1998. A plan attached to the lease represented that the land of the lessor was divided into 115 lots the size of the applicant's lot. The rental payable by the applicant under the lease was $1,200 per annum, reviewable annually. The applicant also executed a management agreement under which Lincfel, as "Plantation Manager", agreed to provide "plantation services" for the term of the appointment, namely, from the date of the agreement to "the date of harvesting of the Trees". The Plantation Manager was engaged to plant trees on the lot leased by the applicant and to maintain the trees thereafter. The fees payable by the applicant pursuant to the management agreement were a "preparation and establishment fee" of $2,000 and an "annual Plantation management fee" of $800. In addition the applicant signed a Loan Agreement. 21 On or about 3 June 1997, the applicant exercised the option, and by 30 June 1997 the applicant was one of approximately 310 participants who had agreed to enter the project. 22 At the time the applicant entered agreements with Allrange, and others, the project promoted by Allrange was structured as follows. Allrange had arranged for standard forms of lease, management agreements and loan agreements to be prepared for execution by participants in the project. The proposed lessors occupied three contiguous blocks in the Ord River Irrigation Area and had agreed with Allrange that their properties would be made available on lease to participants in the project for the planting of a sandalwood plantation. The standard form of management agreement provided for Lincfel to be appointed by each participant to provide "plantation services" as "Plantation Manager". In addition Allrange had pro forma lettersand acknowledgements prepared that conveyed the impression that each participant, independently, had made its own arrangements to lease land for the planting of sandalwood seedlings to be purchased by the participant and to appoint a manager to plant and maintain the seedlings. In the applicant's case I am satisfied that the purpose of the letters and acknowledgements prepared by Allrange and signed by the applicant was to satisfy the Australian Securities Commission ("ASC") that conditions imposed by the ASC in September 1996, for the exemption of the project from compliance with relevant provisions of the Corporations Law, had been met. The conditions imposed by the ASC were that there were to be no express or implied obligations in the contract for the sale of seedlings that: an investor was required to lease any particular area on which to plant the seedlings; if an investor elected to lease any particular area on which to plant the seedlings the investor must engage a manager to cultivate the seedlings; and, if an investor elected to engage a manager a particular manager must be selected. It was a further condition imposed by the ASC that any management agreement entered into by an investor be terminable by the investor on one month's notice if dissatisfied with the management service. 23 At the time the project was promoted to prospective investors, Allrange intended that most of the funds received from participants in the project would be distributed upon receipt. On 26 June 1997 Allrange executed a "Consultancy Agreement" under which Allrange, as trustee of a unit trust that was said to carry on the business of propagating and selling sandalwood seedlings, contracted with itself, as trustee of a trust said to carry on business as a consultant "in assisting (Allrange as trustee of the unit trust) with respect to the marketing and sale of sandalwood seedlings," that Allrange, as consultant, would be paid $24,000 for each "seedling contract" entered into by Allrange as trustee of the unit trust. That is to say of the "deposits" of $28,000 to be paid to Allrange by project participants out of "tax refunds", $24,000 was to be distributed to Allrange as trustee of a trust providing consultancy services. By reason of the "round-robin" arrangements discussed below, which discharged the amounts payable to Allrange by participants under seedling purchase agreements and replaced them with liabilities to pay like amounts to Sandalwood for monies advanced, the capital available for the purposes of the project was not the aggregate of amounts of $40,000 paid by participants in each of the first two years but the sum of the payments of $14,000 paid to Allrange by each participant in those years. After the cost of building and establishing the seedling nursery was met; the fees payable to Lincfel as nursery manager were paid; the fees payable to CALM pursuant to the licence agreement were discharged; and the fees payable to canvassers, salespersons, agents and others engaged in promoting the project were distributed, the funds on hand to meeting further capital requirements of the project or other contingencies; or otherwise to advance the project, would have been limited. 24 In June 1997 Allrange and Sandalwood executed an "Offer to Loan" (sic) under which Allrange offered to lend to Sandalwood up to an amount of $25 million for a term ending on 30 June 2011, the offer to be accepted by Sandalwood depositing an "Establishment Fee" of $100 in the bank account of Allrange before 30 June 1997. Interest was said to be payable at 6.95 percent on the daily balance of the amount borrowed, the first payment of interest to be made on 1 July 1998 and annually thereafter. It may be noted that the date for repayment by Sandalwood of monies due to Allrange was 18 months prior to the date on which monies advanced to participants would become repayable by them to Sandalwood. 25 On 27 June 1997, apparently by arrangement with its bank, Allrange effected a "round-robin" transaction in the accounts of Allrange and Sandalwood at the bank. The "back-to-back" simultaneous entries comprised the withdrawal from the Allrange account of $12,369,000 and the deposit of that sum in Sandalwood's account; the withdrawal from Sandalwood's account of $12,369,000 by 310 cheques, each drawn in an amount of $39,900, and the deposit of those cheques in the Allrange account. 26 In the taxation return lodged for the 1997 year of income, the applicant deducted $40,000 as an outgoing incurred for the purchase of seedlings. Purportedly, $39,900 of that outgoing was on behalf of the applicant by one of the 310 cheques drawn by Sandalwood and paid into the Allrange account in the "round robin" described above. On about 25 August 1997, the applicant received $18,876.88 by way of refund of income tax already paid by PAYE instalments, the refund being calculated upon the applicant's liability to income tax after deduction of the $40,000 from the applicant's assessable income. 27 On 28 July 1997 the applicant applied under s 221D of the Act for reduction of the PAYE instalments deducted from his salary on account of income tax. The claim for variation was based on the applicant's anticipation that his assessable income for the 1998 year of income would be reduced by a deduction of $42,000 as outgoings incurred by him in that year as a "Grower of Sandalwood and other Tropical Forestry Trees". The PAYE instalments payable by the applicant were reduced accordingly. In due course the taxation return lodged by the applicant for the 1998 year of income claimed a deduction of $42,575 for outgoings incurred in respect of the project, being $40,000 for the acquisition of seedlings; $2,000 for plantation establishment costs; $400 for manager's fees; and $175 for other fees and charges. 28 On 9 July 1997 the ASC revoked the exemption granted to Allrange in respect of the project. The ASC stated that the conditions stipulated for the grant of exemption had not been satisfied, there being no individual negotiations between investors and landowners in respect of the lease of Ord River land nor between investors and a manager in respect of the planting, care and maintenance of seedlings on behalf of investors. The ASC noted that all investors had signed pro forma letters provided by Allrange addressed to a lessor and to a plantation manager selected by Allrange. The ASC formed the view that the project constituted a scheme for the offering of "prescribed interests" under the Corporations Law for whichexemption from the operation of that law should not be granted. The ASC required Allrange to offer investors the choice of withdrawing from the project and receiving a refund of all monies invested, or of participating in a project that would operate as a scheme of mutual investment supervised and managed by a trustee. Upon that offer being put to the applicant he elected not to receive a refund of his monies but to participate in the project as reformed. 29 In May 1998 the project was restructured as directed by the ASC. The applicant became a beneficiary of the Kununurra Tropical Forestry Trust ("the trust") pursuant to a trust deed which stated that the trust commenced when monies first became payable by an investor to Allrange under an agreement to purchase seedlings. Professional Funds Management Pty Ltd ("the trustee") was appointed trustee of the trust. The trust fund was said to consist of all monies payable to Allrange, or any other party, under an agreement to purchase seedlings, a management agreement, or a lease entered into by an investor in relation to the project. The trust deed was predicated on continuation of those contracts. Under the trust deed the manager of the trust fund, and Allrange, were to ensure that all monies payable to Allrange under the agreement for the purchase of seedlings were to be paid to the trustee and applied under the terms of the trust deed. It appears that the "Consultancy Agreement" described above was abandoned or terminated. Under the trust deed Allrange undertook to establish an "Administration Fund" in an amount of $300,000 for the purposes of the trust. A further party to the trust deed was Allrange Tree Farms Management Pty Ltd ("Allrange Management") which, pursuant to the deed, undertook to provide services to the trustee as manager of the "Trust and the project." Allrange Management was incorporated on 17 February 1998, the directors on incorporation, and at the time of execution of the trust deed, being Grubb, Williamson and Baker who held three of the five shares issued in that company. 30 The applicant, and others who elected not to withdraw from the project, signified by their conduct acquiescence in the alteration of their position to conform with the purpose and terms of the trust deed. Pursuant to the trust deed the applicant became a participant in a pooled investment conducted by the trustee, in which the beneficial interest of the applicant consisted of a right to participate pro rata in any distribution made by the trustee of proceeds obtained from the sale of timber produced by the trustee from the conduct of the project. In other words, the seedlings acquired by the applicant, and the land leased by the applicant, were made available to the trustee by the applicant for the purpose of conducting the enterprise provided for by, and under, the trust deed. The interest of the applicant was not in the net proceeds of sale of products produced on the land leased by him but a shared interest in the net proceeds of sale obtained by the trustee in the conduct of the project by the trustee. 31 On 29 June 1998, Allrange and Sandalwood, again it may be assumed by arrangement with the bank, conducted a second set of "round-robin" transactions through their respective bank accounts by deposits, withdrawals and the negotiation of cheques. On that day a deposit of $14,084,700 was recorded in the account of Sandalwood and a withdrawal in a like amount in the account of Allrange. The same sum was withdrawn from the account of Sandalwood by 287 cheques drawn in amounts of $39,900, and three cheques drawn in amounts of $877,800. The cheques were negotiated by being deposited to the account of Allrange. 32 Between May 1997 and October 1998, the applicant paid a sum of $28,000 to Allrange by instalments. That sum corresponded with the two "deposits" of $14,000 set out in the "Tropical Forestry Project" document referred to above which indicated that the payments would be for the purchase of seedlings. The applicant did not direct that, pursuant to the Loan Agreement, the monies paid to Allrange be remitted to Sandalwood as part repayment of monies lent by Sandalwood to the applicant. 33 Between July 1998 and December 1998, sandalwood and host-tree seedlings were planted as a plantation on the land leased to participants in the project. The plantation covered approximately 275 hectares. That part of the plantation that contained the applicant's lot performed poorly. By October 1999 the project as a whole required significant replanting in areas where the seedlings had failed. Allrange Management had resigned as manager and had not been replaced. The participants were facing a decision that the project be abandoned. In October 1999 the trustee obtained a report from a consultant forester, Mr Underwood. Mr Underwood, an experienced forester who had been the Manager of Forestry Research and General Manager of CALM, advised that a replanting operation was required "over almost the entire plantation". A number of the host-trees used had proved to be unsuitable. Mr Underwood noted that the project did not have funds available to meet such a contingency and that the project had not provided for forestry expertise to be employed to oversee the project. 34 Mr Underwood gave evidence in the "appeal" and was cross-examined by counsel for the applicant. I accept Mr Underwood's opinion that the price charged by Allrange for the seedlings sold to participants, namely $80,000, was an extraordinary sum and that a reasonable price to be paid for the seedlings supplied would have been not much more than $3,000. 35 It would have been obvious to a participant that the project represented a high risk venture. It would have been less obvious to the ordinary investor that the risk had been exacerbated by the promoter making insufficient provision of capital for contingencies, failing to undertake sufficient depth of planning for the venture, and by failing to employ a person with expertise in forestry to provide services to the project. 36 The applicant adduced evidence from a Mr Padmanabha a forester with considerable experience of Indian sandalwood in Indian conditions. He was of the opinion that there was still some chance that the Ord River plantation could become a commercial venture but, of course, that opinion depended upon the replanting of the plantation, the construction of an effective drainage system and upon other contingencies being met as they arose. 37 I turn now to the issues of the "appeal" namely, whether the deductions claimed by the applicant for outgoings incurred in relation to the project were properly disallowed by the Commissioner. 38 The first issue is whether the applicant incurred an outgoing that was deductible under s 51(1) of the Act, or s 8-1 of the 1997 Act, the same principles being applied in each case, the 1997 Act being said to be the re-statement of the Act in plain English. 39 Respectively s 51(1) and s 8-1 read as follows: "51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income." "8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your exempt income; or (d) a provision of this Act prevents you from deducting it. (3) A loss or outgoing that you can deduct under this section is called a general deduction." 40 The Commissioner relied on the following grounds for submitting that the amounts claimed as deductions by the applicant for the 1997 and 1998 years of income were not deductible under s 51 of the Act, or s 8-1 of the 1997 Act: a. The applicant did not incur outgoings in the sums of $40,000 in respect of the purchase of seedlings in the 1997 and 1998 years of income, the incurrence and payment of $80,000 being a 'fiction'. b. None of the claimed expenses was incurred in the course of a business carried on by the applicant. c. There was no relevant assessable income to which the claimed expenses could relate. d. Some or all of the claimed expenses were outgoings of capital, or of a capital nature. e. Some or all of the claimed expenses were not incurred, for the purpose of gaining assessable income but were incurred, at least in part, for the purpose of obtaining a tax deduction. 41 I will deal with each of those grounds in turn. a) outgoings of $40,000 were not incurred by the applicant in each year of income and the purported incurrence and payments of those amounts were a fiction 42 The Commissioner submitted that the liability incurred by the applicant to pay $80,000 for seedlings, payable in moieties in the 1997 and 1998 income years, was a sham and the purported payments of those amounts by loans obtained from Sandalwood was a fiction. It was further submitted that the charges actually raised against the applicant by Allrange in those years, $28,000, and paid by the applicant, represented the true arrangement in respect of the purchase of the seedlings. 43 In the material distributed by the promoter under the description "Tropical Forestry Project", it was proposed that a participant undertake to pay Allrange $80,000 for the seedlings, payment of that sum to be made by the participant as to $28,000, the balance of $52,000 to be paid from proceeds received from the sale of timber upon completion of the project. Although the arrangements actually entered into by the applicant did not match the arrangements represented in the promotional material, little turns on that discrepancy in determining whether the arrangements actually made were intended to have binding effect. The applicant participated in the arrangements as put forward by the promoter, namely, that liability for the purchase price of the seedlings would be discharged by an entity related to Allrange and the liability of the applicant to that entity to repay the sum advanced would, in effect, be an assignment of the applicant's liability to Allrange. For the applicant the practical result was the same, namely, that the applicant undertook a liability to pay $80,000 of which the applicant would pay $28,000 in the 1997 and 1998 income years, the balance of $52,000, ostensibly or impliedly, being payable from proceeds obtained from the sale of timber produced by the project. 44 It follows that the applicant incurred a liability to pay Allrange a sum of $80,000 under the seedling purchase agreement. (See: FCT v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561). The fact that other arrangements entered into by the applicant provided that that sum was to be paid to Allrange by a loan advanced to the applicant by Sandalwood did not bear upon the issue whether the liability had been incurred. Even if it could be said that the loan arrangements were a "façade" the applicant still incurred the liability to Allrange upon entry into the seedling purchase agreement, unless that agreement itself was found to be a sham. 45 Although the Commissioner submitted that the seedling purchase agreement was a "fiction", he appeared to do so on the ground that the true arrangement between the applicant and Allrange was that the actual purchase price agreed to be payable to Allrange for the seedlings was $28,000, not $80,000. It would follow from that submission that upon execution of the seedling purchase agreement the applicant incurred a liability to pay a price of $28,000, the parties intending the seedling purchase agreement to have binding effect to that extent. The applicant may have held an expectation based on trust or hope or, perhaps, on rights in estoppel arising out of implied representations, that neither Allrange nor Sandalwood would enforce a right to recover further monies from the applicant unless the venture succeeded in producing a return to the applicant from which that payment could be made. However, such an expectation, or right to rely on estoppel, would not disclose that either the seedling purchase agreement or the Loan Agreement was a fiction or a sham. There was no evidence that the applicant and Allrange agreed that the cost and, therefore, the liability incurred by the applicant for the seedlings was $28,000 and that it was their mutual intention by execution of the agreement to disguise the true agreement. (See: Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449; Albion Hotel Pty Ltd v FCT (1965) 115 CLR 78.) 46 It may be said that the loan arrangements between Allrange and Sandalwood lacked commercial integrity and that the provision for "interest" in the loan to the applicant by Sandalwood was a non-commercial provision which made no sense, unless, perhaps, the venture produced a windfall return to the applicant. The loan arrangements between Allrange and Sandalwood were book entries that converted the liability of the applicant to pay a sum for the purchase price of the seedlings to repayment of a loan advanced by Sandalwood. However, as between the applicant and Sandalwood the Loan Agreement executed by the applicant was intended to have consequences at law. It entitled Sandalwood to recover from the applicant the balance owing under the Loan Agreement, and also part of the proceeds of sale of timber from monies payable to the applicant at the end of the venture, if such a circumstance eventuated. Whether that liability under the Loan Agreement would be enforceable if the project did not provide a distribution, or sufficient distribution, from the sale of timber may be a question for determination in other proceedings. 47 The Commissioner submitted that because the applicant paid the sum of $28,000 to Allrange when that sum, or rather $27,800, was payable to Sandalwood under the terms of the Loan Agreement to reduce the sum advanced, it could be concluded that the true arrangement went no further than a contract made between the applicant and Allrange, and that the Loan Agreement between the applicant and Sandalwood was a sham. For the reasons already outlined I am not satisfied that such a circumstance has been demonstrated. The applicant paid to Allrange as promoter, the amount he was required to pay under the arrangements of the project and was not concerned to direct Allrange as to the application thereof. It was left to Allrange, and later to the trustee, to deal with the sum paid in accordance with the arrangements the applicant had entered. It may be anticipated that Allrange would account to Sandalwood by reducing the monies due from Sandalwood to Allrange by way of interest or principal under the loan arrangement made between Allrange and Sandalwood. b) no business was carried on by the applicant 48 This submission addressed the "second limb" of s 51(1) and s 8-1(1), namely, an entitlement to deduct outgoings necessarily incurred in carrying on a business. 49 This question is not easily resolved. On the one hand, as at June 1997 the project was still being put together by Allrange as promoter. The licence agreement with CALM, necessary for the provision of crucial know-how on the propagation of sandalwood seedlings, was not in place and was not executed until September 1997. As at June 1997 the applicant had entered contracts on which the promoter could rely to progress the creation of an enterprise but the applicant had neither entered nor adhered to a business of sandalwood production then being carried on by the promoter or by investors in common. Indeed, under the lease it was not to be until 1 May 1998 that the applicant could take possession of his lot to make it available for use in conjunction with land leased to other participants for the purpose of planting sandalwood seedlings in a plantation. That is to say that as at June 1997 it could be argued that the operation of the project was in no more than a formative stage. (See: Calkin v Commissioner of Inland Revenue (1984) 1 NZLR 440). It may also be said that the applicant could not point to indicia capable of supporting a conclusion that he had commenced a business on his own account for the purpose of gaining assessable income. He had responded to a canvasser who represented that investment in the sandalwood project would be "tax effective", and when he invested in the project the applicant did not turn his mind to whether he would be entering into the conduct of a business nor, if so, how he would carry on that business. No activities were undertaken by the applicant thereafter that reflected the operation of a business such as the maintenance of books of account or other records relating to the conduct of a business, nor did he inform himself of any matters affecting the day to day running of the business. It was not suggested that the applicant could carry on business as a sole producer of sandalwood on the lot he held on lease. Although the applicant purchased seedlings, agreed to lease an area of land on which the seedlings were to be planted and entered an agreement for the planting and maintenance of the seedlings, it could be suggested that, in truth, he was a passive investor in a project which the promoter of the project would control, or carry on, as an enterprise by use in common of the several interests of the participants in the project. (See: Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 80 SASR 1 at 16). 50 Certainly, it may be concluded that from May 1998, when the applicant accepted reformation of the project according to the directions of the ASC, the applicant was not carrying on a business. Henceforth the applicant's interests as lessee, purchaser of seedlings, and beneficiary of services supplied by Lincfel, were applied to, or invested in, the purposes of the trust and the applicant became an investor in a project carried on by the trustee who was authorised to use the investments of the participants to grow, harvest and sell timber. The applicant had no longer a defined interest in the trees on his lot as a product to be produced, harvested and sold by the applicant. The applicant had an interest in the outcome of the conduct of a business carried on by the trustee and in the distribution by the trustee of the proceeds of the conduct of the trustee's business. The trustee was not conducting the applicant's business as agent for the applicant. (See: Clowes v FCT (1954) 91 CLR 209; Milne v FCT (1976) 133 CLR 526.) 51 However, before the project was varied the applicant retained an interest in the trees grown on the lot he held on lease, employed a manager to plant and maintain the seedlings on his behalf, and, in theory, could control the harvest and sale of the timber product on his lot. Up to that point it could be said that the applicant was engaged in carrying on a business of sandalwood production by use of the skill and services of the promoter and the plantation manager. Notwithstanding that the arrangement with the promoter may have been informal, the applicant's business was carried on through the agency of the promoter and the plantation manager. That is to say the promoter conducted the several interests of participants in the project as a business of sandalwood production and did so as agent for each participant. Although the respective interests of the participants may have been dealt with in common by the promoter, and the plantation manager carried out the day to day activities required for the conduct of the applicant's business, it remained the case that those services were carried out on behalf of the applicant as a grower, producer and vendor of sandalwood. 52 Until the project was restructured, the circumstances described support the conclusion that the applicant had committed to a business venture, albeit one conducted for him by agents, and that when the applicant executed the several agreements which signified his participation in the project he commenced to carry on a business of sandalwood production. 53 A similar conclusion was reached in Commissioner of Taxation v Lau (1984)6FCR 202 where the taxpayer had agreed to lease an area of land from the promoter, or its associate, on which pine trees were to be planted by a manager employed by the taxpayer. The fee paid to the manager by the taxpayer took into account that the manager had to provide and plant the seedlings that became the taxpayer's property situated on the land held on lease. By reason of the specific area of land controlled by the taxpayer as lessee, the rights of the taxpayer in the trees planted on that land and management of the taxpayer's interests on the taxpayer's account and not on the manager's account, it was concluded that the taxpayer was carrying on a business. (See: Lau per Beaumont J at 221). 54 In the instant case it should be concluded that the applicant was carrying on a business until at least he entered the project in which the trustee became the producer of sandalwood by use of the property of the applicant and others with their accord. It follows that at the time the relevant outgoings were incurred under the contractual commitments the applicant entered into before May 1998, they were outgoings incurred in respect of the relevant years of income. 55 As in Lau it was not submitted in the instant case that the outgoings in respect of the acquisition of seedlings were in themselves outgoings of a capital nature. The submission that the outgoings were on capital account, discussed later in these reasons, was a more limited submission. 56 It was part of the business of the applicant that the seedlings acquired by the applicant were a product for consumption by harvest and it should be concluded as stated by Beaumont J in Lau at 221: "the outgoings fell within s 51, being directed not to the profit-yielding subject of the taxpayer's business but to the process of operating it". (c) no relevant assessable income. 57 This submission was directed to whether the applicant was entitled to a deduction pursuant to the "first limb" of s 51(1) and s 8-1(1) in the event that it was found that the applicant was not carrying on a business. If the applicant was not carrying on a business which included the purchasing, planting and maintenance of sandalwood seedlings, and the harvest and sale of sandalwood, was it nonetheless the case that outgoings incurred for the cost of sandalwood seedlings were outgoings of a revenue character able to satisfy the requirements of the first limb of s 51(1) or s 8-1, namely, as outgoings incurred in gaining or producing assessable income? 58 As discussed below, I am satisfied that at the time they were incurred the outgoings were for a purpose that could reasonably be expected to gain or produce assessable income for the applicant, the amount of such income being subject to contingencies and the skill and commitment of the promoter. On its face it was not a project obviously devoid of prospect. There may have been cause for a participant to be concerned as to whether the promoter had the skill to operate the venture successfully, and to note carefully that the promoter would remain well-rewarded and, therefore, undisturbed if the venture did not succeed. Notwithstanding those concerns, the proposal represented to a participant a reasonable expectation that assessable income could be gained therefrom. 59 The remaining question is whether the outgoings incurred were "incidental and relevant" to the gaining or producing of that assessable income. That question is to be resolved by asking whether the occasion of the outgoing is to be found in what is expected to provide assessable income. (See: Fletcher v FCT (1991) 173 CLR 1 at 17; Ronpibon Tin NL v FCT (1949) 78 CLR 47 at 56-57.) 60 The revenue character of an outgoing is identified by the purpose it serves. The outgoings incurred by the applicant were not for the acquisition of an income bearing asset from which commodities for sale would be produced, but for products to be planted, in effect, as a crop to be matured and harvested for sale. The profit obtained by selling the wood produced would be a revenue, not a capital return, and the cost of acquisition of the product to be developed and sold, albeit over some years, should be characterised as an outgoing of revenue character. 61 The Commissioner did not contend that an outgoing for the acquisition of seedlings could only be of a capital nature and not on revenue account. (See: Lau per Fox J at 208). The way in which the Commissioner put the submission was to suggest that there is distinction between realisation of the profit of a venture and the gaining or producing of assessable income. The Commissioner submittedthat the single object of the project, namely, to plant seedlings and harvest a crop after 15 years did not produce assessable income against which outgoings to obtain that income could be properly deducted as and when incurred, but represented a project to obtain a future or emerging profit that was to be calculated by deducting from the eventual proceeds of the venture the costs incurred in constructing the venture and bringing it to fruition. In other words, it was a "profit-making scheme" and not the production of income according to ordinary concepts. 62 The authorities relied upon by the Commissioner for that proposition discussed principles that were applicable where a taxpayer carrying on a business obtained a profit from a separate activity or transaction that was not part of the trading activities of the business in which the taxpayer was engaged. (See: FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; Moana Sand Pty Limited v FCT (1988) 88 ATC 4897; RAC Insurance Pty Ltd v FCT (1990) 95 ALR 515.) 63 However, in the instant case the applicant was engaged in a project to obtain a return from the pooling of his interest in timber seedlings with like interests, and from the management of those interests in common to produce a commodity able to be harvested and sold at a profit. The interests included an area of land held under lease by the applicant on which sandalwood seedlings purchased by the applicant were to be planted. At the time the outgoings in issue were incurred the applicant was to pay regular outgoings by way of rent and management fees in connection with the growing and maturation of his seedlings. Therefore, the return sought was not a capital accretion on a sum invested but a return from the growth, harvest and sale of a product purchased for resale, that return to be promoted by regular outgoings incurred for the purpose of producing the product for sale. Accordingly the distribution to the applicant of monies obtained as proceeds from the sale of timber harvested from the plantation would represent the gaining of assessable income according to ordinary concepts. 64 I am satisfied that if the second limb of s 51(1) or s 8-1 did not apply, the outgoings incurred for the purchase of seedlings were deductible under the first limb of s 51(1), or s 8-1, when incurred and were not the costs of an isolated venture, the profit of which fell to be calculated at the end of the venture. 65 In respect of the amended assessment issued for the 1998 year of income, the applicant pleaded that the assessment was excessive in that the applicant had not been allowed the following deductions: (i) $40,000 for the purchase of seedlings; (ii) $2,000 for plantation establishment fees; (iii) $800 for plantation management fees; and (iv) $1,200 for "lease fees". Item (iv) was not included as a ground of objection disallowed by the Commissioner. 66 Upon execution of the management agreement the applicant incurred a liability in respect of that year of income to pay to Lincfel a plantation preparation and establishment fee of $2,000 and an annual management fee of $800. As with the payments made to purchase seedlings, those amounts may be characterised as payments on revenue account being payments made to further the purpose of gaining or producing assessable income and the sums claimed were deductible under s 51(1) and s 8-1. 67 No submissions were made on item (iv) nor leave sought to raise as a further ground a ground not relied upon in the objection. On its face, however, the sum payable by way of annual rental was an outgoing incurred on revenue account and would have constituted an allowable deduction if so claimed. (d) outgoings were of a capital nature. 68 Counsel for the Commissioner submitted that the amounts payable under the seedling purchase agreement were for the cost of obtaining rights in the venture, in particular, rights under the trust deed and, therefore, were of a capital nature. (See: Hallstroms Pty Ltd v FCT (1947) 72 CLR 634.) 69 Properly analysed it cannot be said that the payments made by the applicant were intended to purchase, or obtain, rights or an entity from which a source of income would be derived. By the outgoings the applicant purchased seedlings to be used as part of a crop to be harvested after growth over a number of years and to provide a return from the sale of the product. In addition the applicant incurred regular outgoings for rent and management fees to assist the purpose of obtaining assessable income from the production and sale of timber. 70 Furthermore, as discussed above, if the applicant were engaged in carrying on a business, the outgoings were directed to the process of operating that business. (See: Ferguson v FCT (1979) 26 ALR 307.) 71 The claimed outgoings, therefore, were not of capital, or of a capital nature, expended to obtain rights under the trust deed. (e) the outgoings were incurred for the purpose of obtaining a tax deduction. 72 It was submitted by counsel for the Commissioner that if the relationship between the expenditure claimed to be deductible and the production of assessable income is no more than colourable, and not genuine, then deductibility of the outgoing is not established. (See: Fletcher at17‑18.) 73 It was submitted that in the instant case the "disproportion" between the amount of the outgoings and the assessable income, demonstrated that the outgoings did not bear the character of deductible sums under the first limb of s 51(1) or s 8-1. 74 The matters relied upon to support that submission were that the price paid for the seedlings was grossly inflated; that the amounts actually paid by the applicant to the project were "totally funded out of tax savings"; and that the applicant had entered a loan arrangement to enable him to make payment of the outgoings in the amounts claimed. 75 It may be said at once that no disproportion between the outgoings and the prospective assessable income was established sufficient to point necessarily to a conclusion that the object of obtaining a deductible outgoing was merely colourable and not genuinely related to the gaining or producing of assessable income. 76 As has been stated earlier in these reasons, the worth of the venture was yet to be proved and the long lead-time to production of timber carried substantial risks for any participant. However, the fact that a participant may have been naďve or unquestioning as to the plausibility of a promoter's claims will not, necessarily, demonstrate objectively that the taxpayer's purpose must have been other than the gaining or producing of assessable income. 77 Even if it were accepted that the applicant was persuaded to participate in the project because the outgoings claimed would provide the applicant with an interest in the venture at least cost until the project was completed, that would not, in itself, deny that the outgoings were incurred by the applicant for the purpose of gaining or producing the assessable income of the applicant if, on its face, the project represented an opportunity to gain or produce that income. 78 Once it is acknowledged that there was some prospect of obtaining assessable income, the amount of which would vary according to contingencies, it could not be said that assessable income to be gained was so disproportionate to the outgoings incurred to deny genuine anticipation of gaining such income. As long as outgoings of a revenue nature display sufficient connection with the gaining of assessable income they will be deductible notwithstanding that the time at which the outgoing is incurred may be not coincident with the gaining of the assessable income. (See: Steele v DCT (1999) 197 CLR 459 at [43]; FCT v Consolidated Press Holdings Ltd (2001) 179 ALR 625 at [74].) 79 This submission also must be rejected. 80 It follows that the disallowed outgoings were deductible outgoings under s 51(1) of the Act or s 8-1 of the 1997 Act. Part IVA 81 It is now necessary to decide whether the determinations made by the Commissioner under s 177F(1) of the Act were properly made, namely, that the deductions for outgoings incurred for the purchase of seedlings, $40,000 in each year of income, were to be disallowed in exercise of the Commissioner's discretion. 82 Section 177F(1) reads as follows: "Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may – (a) … (b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taypayer in relation to a year of income – determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income; and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination." 83 Section 177C(1) provides that the reference to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to, inter alia, "a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out" and the amount of the tax benefit shall be taken to be the amount of the whole of the deduction or of the part of the deduction, as the case may be. 84 Section 177D defines "a scheme to which this Part applies" and in relevant respects it is a scheme where: "(a) a taxpayer (in this section referred to as the "relevant taxpayer") has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and (b) having regard to – (i) the manner in which the scheme was entered into or carried out; (ii) the form and substance of the scheme; (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme ; (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme, (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi), it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)." 85 Section 177A(5) states: "A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose." 86 In FCT v Spotless Services Ltd (1996) 186 CLR 404 at 416 the High Court made the following observation on what constitutes a "dominant purpose" attracting the operation of s 177D and permitting a determination to be made by the Commissioner under s 177F(1): "Much turns upon the identification, among various purposes, of that which is 'dominant'. In its ordinary meaning, dominant indicates that purpose which was the ruling, prevailing, or most influential purpose. In the present case, if the taxpayers took steps which maximised their after-tax return and they did so in a manner indicating the presence of the 'dominant purpose' to obtain a 'tax benefit', then the criteria which were to be met before the Commissioner might make determinations under s 177F were satisfied. That is, those criteria would be met if the dominant purpose was to achieve a result whereby there was not included in the assessable income an amount that might reasonably be expected to have been included if the scheme was not entered into or carried out." 87 Those comments are directed to a scheme under which a tax benefit is obtained from the diversion of assessable income but they apply equally to a scheme under which a tax benefit is obtained from a deduction from assessable income. 88 The scheme entered into was the presentation and execution of a seedling purchase agreement under which the cost of seedlings was calculated to provide to a participant in the project an outgoing in an amount able to provide a tax benefit in a sum understood by the participant and the promoter to be necessary to reduce the assessable income of the participant in such a degree that the tax "saved" would cover payments to be made by the participant to, and for, the purposes of the project, including the delivery of seedlings to the participant. The Loan Agreement, and the agreement for loan made between Allrange and Sandalwood, were ancillary to the seedlings purchase agreement and to the scheme. The Loan Agreement fixed the time at which the balance of monies payable by a participant under the project was to be paid and provided the contract under which the participant could pay monies to the project out of the consequences of the tax benefit. The agreement for loan between Allrange and Sandalwood provided the means by which the foregoing steps could be undertaken. 89 The evidence established that the cost of seedlings set out in the seedling purchase agreement was grossly inflated and unrelated to the reasonable value of the items purchased. The evidence also established that the inflated price was an element of a scheme designed to obtain a sufficient tax benefit for a participant to make participation in the project attractive for that person. The representational material distributed by the promoter stated that the amount to be paid by the applicant to the project for seedlings would be met out of the tax savings to be received by the applicant by deduction from the applicant's assessable income of the amounts set out in that material as the cost of the seedlings. Insofar as there was a "balance" to be paid by the applicant for the cost of the seedlings, it was to be paid from the "harvest". Although the applicant entered a legal obligation to pay a sum of $80,000 for the seedlings, supplanted in part by an obligation to pay $79,800 in repayment of a loan advanced by Sandalwood said to have been applied to payment of the purchase price of $80,000, that obligation itself was part of the scheme by which a deduction of $40,000 was to be obtained in each year of income. The essence of the scheme by which the tax benefits in the form of deductions would be obtained was the seedling purchase agreement. By that agreement the price stipulated for the seedlings was inflated as required for the purpose of obtaining tax benefits for the applicant sufficient to generate taxation savings for the applicant commensurate with the sum of $28,000 to be paid by the applicant to the project. The construction of the tax benefit by the scheme was important to the marketing of the project as a "tax effective" investment. 90 The foregoing payment was all that the applicant would pay to Allrange and Sandalwood, until timber was harvested and sold 15 years later. Although the scheme constructed a liability for the applicant to pay a further sum of $52,000, the underlying arrangement was that the seedlings would be produced by Allrange and delivered to the applicant in return for the payment by the applicant to the project of the sum of $28,000. If, after 15 years, timber was harvested and sold and proceeds of sale distributed to the applicant, only then would Allrange receive in hand any balance of the purchase price payable for the seedlings, that sum to be obtained, or accounted for, by Allrange as a repayment by Sandalwood of a loan made to Sandalwood by Allrange, the monies paid by the applicant from the proceeds of timber sales being applied to repayment of a loan advanced to the applicant by Sandalwood. 91 Although the scheme was based on legal obligations undertaken by the applicant under the seedling purchase agreement and the Loan Agreement, the representation made to the applicant in connection with entering into or carrying out the project was that $28,000 would be the sum payable to the project by the applicant from funds obtained from refunds of income tax and for that sum he would obtain seedlings to be used in the project. It was represented that further monies would be payable by the applicant in the event that the venture succeeded in producing saleable timber from which proceeds of sale were distributed to the applicant. The implication that arose from the representations as to the arrangements on which the project would operate, was to the effect that the applicant would pay $28,000 for the seedlings and if the venture succeeded, and sale proceeds were distributed to the applicant, the promoter's interests would receive 7 percent of that distribution and a further sum of $52,000 therefrom. 92 In respect of the matters to which the Commissioner must give regard pursuant to s 177D(b) of the Act, the following may be taken to be those of significance on the facts of this case. (i) the manner in which the scheme was entered into or carried out. 93 The relevant circumstances leading to the applicant entering into the scheme are to be found in the promotion of the project as "tax effective" by canvassers and salespersons on behalf of the promoter. The promotional material explained that the tax effect of the proposal would be that a participant would be able to obtain "tax refunds" sufficient to meet the payments required to be made by the applicant to obtain seedlings for planting on his lot in the plantation. More than 300 participants entered the project as a result of the representations made in respect of it. The applicant, and each participant, was required to do no more than sign documents prepared by the promoter to implement the scheme. 94 The scheme was duly carried out by the applicant and the promoter (including Sandalwood) executing relevant documents and the applicant claiming the deductions specified by the promoter and following the promoter's instruction to have PAYE taxation instalments varied. (ii) the form and substance of the scheme. 95 The scheme consisted of pro forma documents prepared for the marketing of the project and for presentation for execution to each participant agreeing to enter the scheme. 96 The form of the scheme was the generation of deductions of $40,000 for each of the two years of income. The substance of the scheme was that the applicant, and each participant, would pay $28,000 for the cost of the seedlings and for their participation in the project. The purported payments made under the loan transactions between Allrange, Sandalwood and the applicant undertaken at the end of June in each year were formalities undertaken for the purpose of re-ordering rights and liabilities between those parties. The transaction had substantive effect insofar as legal consequences attached thereto but the payments involved notional sums and not payments in substance. (iii) the time at which the scheme was entered into and the length of the period during which it was carried out. 97 The time at which the scheme was entered into was consonant with the promoted "tax effective" purpose of the project. The times at which payments were to be made by the applicant under the project were structured to allow the applicant to receive a refund of tax after lodgement of an income tax return for the 1997 year of income and to obtain a variation of PAYE taxation instalments for the 1998 year of income sufficient to put the applicant in funds in respect of payment of the sum of $28,000 required to be paid in those years. 98 Nothing turns on the length of the period in which the scheme was carried out. (iv) the result in relation to the operation of the Act but, for Part IVA, would be achieved by the scheme. 99 As held earlier in these reasons the amounts of $40,000 incurred by the applicant as outgoings pursuant to the scheme were allowable deductions from the applicant's assessable income in each year of income and, therefore, but for the operation of Part IVA and a determination made by the Commissioner thereunder, the applicant would receive the tax benefits in the amount of those deductions. (v) any change in the financial position of the applicant that has resulted, will result, or may reasonably be expected to result, from the scheme. 100 By use of the tax benefits in the allowable deductions created by the scheme, the applicant obtained an interest in the sandalwood project by expending $28,000 on the cost of seedlings from monies retained by the applicant by way of reduction of the incidence of income tax that otherwise might reasonably have been expected to apply. (vi) any change in the financial position of any person who has, or has had, any connection with the taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme. 101 Mr Serra received a commission for introducing the applicant to the project and, therefore, from the implementation of the scheme. As a result of the applicant entering the scheme Allrange received the sum of $28,000, the substantial part of which was to be applied to the benefit of Allrange as "consultancy fees". 102 The totality of the foregoing shows that this was not a case where the applicant was a party carrying on an existing business where, in the course of that business, a choice was made as to a course of action, that choice being influenced by consideration of taxation consequences, but without that consideration constituting the dominant purpose of the taxpayer. (See: Eastern Nitrogen Ltd v FCT (2001) 108 FCR 27; FCT v Metal Manufactures Ltd (2001) 108 FCR 150). This was a case where the applicant elected to participate in a project represented as being "tax effective". The represented tax effectiveness of the project was the delivery of tax benefits that would produce tax "savings" that would underwrite the principal initial payments the applicant was required to make to the project. 103 The overwhelming disparity between the cost of the seedlings and their reasonable value provided the basis on which the arrangements made between the applicant and the promoter, namely, the establishment of contractual terms to record such a cost for the seedlings and to establish a relationship of lender and borrower to purport to discharge payment of that cost by payments obtained by way of loan, may be properly isolated from the totality of the transactions that constituted the project. 104 Those dealings between the applicant and the promoter, when isolated from the project, display a scheme as defined by the Act for which there was a discrete purpose distinct from any purpose or purposes that may have been relevant to entering into or carrying out the project. Objectively determined, the dominant purpose of the applicant in entering into or carrying out the scheme was to obtain a tax benefit of sufficient magnitude to provide tax "savings" to underwrite participation in the project. 105 Furthermore, a reasonable person considering the circumstances objectively, would conclude that the dominant purpose of the promoter in entering into and implementing the scheme was to achieve a result whereby the applicant would obtain deductions in the years of income that might reasonably be expected not to have been allowable to the applicant if the scheme had not been entered into. That is to say, but for the scheme it might reasonably be expected that the outgoings incurred by the applicant under the project for the cost of seedlings, and the allowable deductions therefore in each year of income, would not have exceeded $14,000 in each year. In putting the project together the promoter sought enrichment. In constructing and implementing a scheme to inflate the cost of seedlings as part of that project, the plain and dominant purpose of the promoter in entering into and carrying out that scheme was to create tax benefits for the applicant by way of deductions in such amounts as proposed in each year of income that would encourage the applicant to participate in the project and subscribe funds thereto to be applied to the benefit of Allrange. 106 I am satisfied that the determinations made by the Commissioner under s 177F(1) were properly made. Whether the applicant, under s 177F(5) of the Act, may request the Commissioner to make a further determination under s 177F(3) to the effect that each disallowed deduction be allowed as to $14,000, is unnecessary to determine. 107 No submissions were made in respect of the matters of penalty and interest and I make no findings in respect of those elements of the assessments. ORDERS 108 I will direct the parties provide further submissions on the orders to be made in consequence of the foregoing reasons. I certify that the preceding one hundred and eight (108) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lee. Associate: Dated: 19 September 2002 Counsel for the Applicant: B J Shaw QC, S H Steward Solicitor for the Applicant: Wilson & Atkinson Counsel for the Respondent: G J Davies QC, H Symon SC & L B Price Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 3, 4, 5, 6 December 2001 Date of Judgment: 19 September 2002