The Full Federal Court of Australia denied the application of the CGT small business 50% active asset reduction on the basis that an unusual activity carried on by an associated entity to the taxpayer contributed to the aggregated annual turnover of the taxpayer and associated entity to be more than $2,000,000. The decision illustrates the great care that an entity must take in calculating its annual turnover, particularly when determining what constitutes income derived in the ordinary course of carrying on a business.
In Doutch v Commissioner of Taxation, Mr Doutch sold mining tenements to Golden West Resources Pty Ltd (GWR) for the consideration of $5,000,000 cash and $5,000,000 ordinary shares in GWR. In the income year ended 30 June 2009, Mr Doutch declared the capital gain he made on the sale of the tenements and claimed the 50% CGT discount under the provisions of the Income Tax Assessment Act 1997 (ITAA97). On 19 December 2013, Mr Doutch objected to the 2009 assessment on the basis that the small business 50% active asset reduction in Subdivision 152-C of the ITAA97 should also apply to the capital gain.
The concession is available to a taxpayer that does not carry on a business but owns a CGT asset that is used in a business by an affiliate or connected entity to the taxpayer, as long as the aggregated turnover of the taxpayer and associated entity is less than $2,000,000. In his objection, Mr Doutch contended that the aggregated turnover of Denarda Holdings Pty Ltd (Denarda), which carried out exploration activities on the land, the subject of the tenements for the years prior to 2008, was less than $2,000,000 (an adjusted annual turnover of $1,977,723), therefore the CGT concession should apply.
The Commissioner disallowed the objection in full as he was not satisfied that Denarda was a small business entity within the meaning of sub-section 328-111(1), as its annual turnover was more than $2,000,000. According to sub-section 328-120(1), “an entity’s annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.”
Mr Doutch then appealed to the Administrative Appeals Tribunal (AAT) contending that receipts totalling $55,106 in respect of fuel disbursements provided to two customers did not form part of Denarda’s annual turnover. In summary, Mr Doutch argued that fuel charges were not derived in Denarda’s ordinary course of carrying on a business. The drilling operation contracts required the clients to provide fuel. In practice, Denarda supplied the fuel and invoiced the clients for fuel at cost.
The AAT dismissed the taxpayer’s appeal and found that “Although it may be accepted that Denarda’s customers usually purchased and provided fuel for Denarda’s drilling operations, the transaction in question, namely the provision of drilling services by Denarda to two customers, were part of the ordinary and common flow of transactions of Denarda’s business.”
The Full Federal Court found that there was no error of law by the AAT because:
- the passage from Commissioner of Taxation v The Myer Emporium Limited (1987) 163 CLR 199, upon which Mr Doutch relied to construe the meaning of “in the ordinary c course of carrying on a business” as excluding extraordinary transactions, is concerned with income according to ordinary concepts, and not what constitutes ordinary course of carrying on business;
- the AAT has correctly referred to the Explanatory Memorandum for the Tax Laws Amendments (Small Business) Bill 2007 (Cth) to confirm that the words “in the ordinary course of carrying on a business” in sub-section 328-120(1) bear their ordinary meaning, and that while the words have been used in other provisions, they do not have a technical legal meaning;
- the meaning given to the expression “ordinary course of business” in the context of bankruptcy legislation is not wholly applicable in the context of sub-section 328-120(1). The Court clarified that “in the context of sub-section 328-120(1), it seems likely that it is the ordinary course of the particular business that is relevant. The provision is concerned with the “annual turnover” of a particular entity, and the reference to “business” is to the business of that entity”; and
- although Denarda’s customers usually purchase and provide fuel for Denarda’s drilling operations, those operations were part of the ordinary and common flow of transactions of Denarda’s business, and relevant fuel receipts were an incident of an ordinary part of the relevant entity’s business.
The decision demonstrates the importance of carefully applying the case law principles of what constitutes income derived in the ordinary course of business to the specific circumstances of the taxpayer when calculating its annual turnover for the purpose of the CGT small business concessions.
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