Hart v Federal Commissioner of Taxation [2002] FCA 1559

FEDERAL COURT OF AUSTRALIA

Hart v Federal Commissioner of Taxation [2002] FCA 1559 TAXATION – income tax – deductions – deductibility of expenses for business – whether carrying on an aviation business – where engaged in aerobatic activities – whether activities constituted carrying on a business – where business showed minimal profit and very large expenditure – penalties – whether reckless for tax agent not to enquire further where circumstances suggested no business being carried on – whether appropriate for penalty to be applied Taxation Administration Act 1953 (Cth) s 14ZZ Income Tax Assessment Act 1936 (Cth) s 226H LAURA HART v THE FEDERAL COMMISSIONER OF TAXATION A 31 OF 2001 DOWSETT J 16 DECEMBER 2002 BRISBANE

IN THE FEDERAL COURT OF AUSTRALIA

QUEENSLAND DISTRICT REGISTRY A 31 OF 2001

BETWEEN: LAURA HART

APPLICANT

AND: THE FEDERAL COMMISSIONER OF TAXATION

RESPONDENT

JUDGE: DOWSETT J

DATE OF ORDER: 16 DECEMBER 2002

WHERE MADE: BRISBANE

THE COURT ORDERS THAT: 1. The appeal be dismissed. 2. The applicant pay the respondent's costs of the appeal. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA

QUEENSLAND DISTRICT REGISTRY A 31 OF 2001

BETWEEN: LAURA HART

APPLICANT

AND: THE FEDERAL COMMISSIONER OF TAXATION

RESPONDENT

JUDGE: DOWSETT J

DATE: 16 DECEMBER 2002

PLACE: BRISBANE

REASONS FOR JUDGMENT 1 This is an appeal by the applicant pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) (the "Administration Act") against a decision of the respondent concerning the applicant's assessment to income tax for the year ended 30 June 1996. The respondent increased the amount of the applicant's taxable income as returned by an amount of $108,580.00 and penalties. The increase reflected the disallowance by the respondent of deductions claimed by Unlimited Aerobatics Pty Ltd ("Unlimited") as trustee of the Unlimited Aerobatics Discretionary Trust (the "Unlimited Trust"). Unlimited subsequently changed its name to Harts Flying Fighters Pty Ltd and then to Flying Fighters Pty Ltd. The applicant is a beneficiary under the terms of the Unlimited Trust. Unlimited resolved that she should receive all of the trust income for the 1995-1996 tax year. The respondent's disallowance of the relevant deductions therefore led to a consequential increase in the applicant's assessable income. It is now conceded that the respondent was correct in disallowing the amount of $50,000.00. This appeal concerns the balance of $58,580.00 and penalties. 2 Unlimited was incorporated in January 1995. The Unlimited Trust was established by deed of settlement dated 17 February 1995, with Unlimited as trustee. Shortly thereafter, it allegedly took over an existing aviation business which had previously been operated by another company, Steve Hart Family Holdings Pty Ltd as trustee for the Steve Hart Family Trust. That company is now known as Nemesis Australia Pty Ltd. I will refer to it as "Nemesis". The applicant claims that Unlimited took over that business in its capacity as trustee of the Unlimited Trust, in which capacity Unlimited was also a beneficiary under the terms of two family trusts, including the Steve Hart Family Trust. The applicant's 1995-1996 income included income received from those trusts through the Unlimited Trust. It seems that the parties to this appeal have proceeded upon the basis that outgoings totalling $58,581.00 were deductible if incurred by Unlimited in carrying on an aviation business. This factual question is the only matter in dispute in these proceedings, other than the question of penalty. 3 The applicant is married to Steven Irvine Hart, an accountant. Since the mid-1980s Mr Hart has also been actively involved in aviation. He is a licensed pilot. The applicant shares his interest. In about September 1985 the directors of Nemesis, as trustee for the Steve Hart Family Trust, decided to enter the aviation industry. At that time Mr Hart, the applicant and Ms Shirley-Ann Petersen were directors of Nemesis. Although it is not entirely clear from the affidavits, it seems that the proposed business involved performing aerobatics and demonstrating aircraft at air shows. Mr Hart was to act as pilot. It was hoped that income would eventually be generated from those sources and from offering joy rides. These activities are hereinafter collectively described as "air show activities". The capacity to earn income from such activities no doubt depended to some extent upon the type of aircraft and its relative rarity and also upon the skills of the pilot, particularly in the area of aerobatics. The evidence suggests that as the reputation of a pilot and that of his or her aircraft increase, the capacity to demand fees and the level of such fees are also likely to increase. The applicant said that Nemesis always expected that it would be some considerable time before any substantial financial return was derived from its air show activities. 4 In October 1985 Nemesis purchased a Pitts Special aircraft for about $36,000.00. A business name, "Rufus Splice Aero Services", was registered. Mr Hart undertook training with a leading aerobatic pilot. In May 1986 he was first paid for attending an air show. In late 1987 Nemesis decided to purchase another aircraft. In early 1988 it purchased a Laser aircraft for $90,000.00. The Pitts aircraft was retained. Mr Hart claims to have continued appearing at air shows during "the balance of the 1980's". However there is little available detail of such activities. In 1991 Nemesis acquired a Beechcraft Baron aircraft. It was not for use in air show activities. I will discuss it further at a later stage. Mr Hart said that: … it became apparent in late 1992 early 1993 that the aircraft that we were using were no longer appropriate for the type of performances required by Airshow Organizers. 5 Nemesis became interested in the "Sukhoi 26" aircraft and in two competing aircraft, the CAP 232 and the Extra 300S. Mr Hart saw the Sukhoi 26 flown in Australia and concluded that air show organizers would be interested in it. He tested one such aircraft owned by Mr Nigel Arnott who has also sworn an affidavit in these proceedings. In August 1993 Mr Hart and the applicant visited Russia to inspect the Sukhoi factory and in order that the former could undertake training on the aircraft in question. They were there for about three weeks, during which time Mr Hart flew over fifty hours on the aircraft. They returned home via America to inspect other competing aircraft but did not think that they were as suitable as the Sukhoi 26. Upon return to Australia they decided to defer any decision until after a forthcoming event in Hungary. After attending that event, the applicant and Mr Hart went to France to test-fly the CAP aircraft. In October 1994 Nemesis ordered a CAP 232 aircraft, expecting that it would be delivered in April 1995. In December 1994 Nemesis disposed of its aircraft other than the Beechcraft Baron, in order to fund the acquisition of the CAP 232. 6 As I have observed, Unlimited was incorporated in January 1995 and became trustee of the Unlimited Trust by deed of settlement dated 17 February 1995. According to the applicant, at about that time, Unlimited took over the "existing aviation business" previously conducted by Nemesis. In April 1995 Mr Hart and the applicant visited the CAP factory in France, expecting that the former would there undertake training on the aircraft which Unlimited was to acquire. However they found that the aircraft was unfinished. It was not delivered until late November 1995. As a matter of business prudence I find it surprising that they should have gone to France expecting the aircraft to be available, without first ensuring that such was the case. Whilst there, Mr Hart trained on another aircraft. The new aircraft arrived in Australia in late November. Assembly took about two weeks. Mr Hart then commenced training. He found that he needed much more training than he had initially expected in order to become sufficiently proficient to perform at air shows. Mr Hart said that in February 1996 Nemesis brought a leading air show pilot to Australia to train him and other pilots. The applicant asserted that "we had arranged" for this visit. 7 In about October 1995 Unlimited decided to acquire military aircraft of Second World War vintage. In about January 1996 Mr Hart negotiated for the acquisition from Mr Malcolm Rolph-Smith of a half-share in a North American Trojan T 28 aircraft for $130,000.00. This acquisition is evidenced by a contract dated 29 April 1996, pursuant to which Unlimited is the purchaser. The contract was to be completed within thirty days of that date. The agreement contemplated that the aircraft would be operated by Mr Rolph-Smith and Unlimited and that Mr Rolph-Smith and Mr Hart would be the pilots. Apparently the parties subsequently agreed that the aircraft would be operated by a company, Wings & Wheels (Aust) Pty Ltd as trustee of another discretionary trust, the Wings & Wheels (Aust) Discretionary Trust, of which Unlimited and Mr Rolph-Smith were the beneficiaries. The deed of trust is dated 1 July 1996. In about August 1996 Unlimited acquired another aircraft in partnership with Mr Rolph-Smith. As a matter of policy, neither Nemesis nor Unlimited has claimed deductions for depreciation of aircraft acquired for air show activities. It is thought that they do not depreciate. In the Unlimited Trust tax return for 1995-1996, the main business of the trust is said to be "Beneficiary". In the 1996-1997, 1997-1998, 1998-1999 and 1999-2000 returns, its main business activity is said to be "Aircraft leasing". In the 2001-2001 return, it is said to be "Aircraft charter". 8 As I have observed, in 1991 Nemesis acquired a Beechcraft Baron aircraft. It was transferred to Unlimited in early 1995 and disposed of by that company in September 2001. This matter caused some confusion at the hearing, at least part of which was caused by me. In the respondent's reasons for disallowing the relevant deductions, it is said that: The Baron is used in the business of Harts Accountants and all expenses associated with this aircraft are not in question. The applicant did not challenge this as a matter of fact. These proceedings have been conducted upon the basis that the expenses with which I am presently concerned were not incurred in connection with the Beechcraft Baron aircraft. The applicant has submitted that the justification for the claimed deduction is that they were incurred by Unlimited in the 1995-1996 tax year in carrying on the business of providing air show activities. Should the applicant fail to establish that proposition, then the appeal must fail. The Beechcraft Baron was not used for that purpose and is largely irrelevant for present purposes.