Walsh & Anor v HM Inspector of Taxes [2003] UKSC SPC00386 (15 October 2003)

LOSES – whether farming carried on a commercial basis and in such a way that profits in the trade could reasonably be expected to be realised in that period or within a reasonable time thereafter – no – whether trade had started in the first year under appeal – no  

THE SPECIAL COMMISSIONERS

	CRAIG WALSH AND MARJORIE WALSH	Appellants

	- and -

	JANET TAYLOR
	(HM INSPECTOR OF TAXES)	Respondent

		Special Commissioner:	DR JOHN F AVERY JONES CBE

Sitting in public in London on 30 September 2003

Craig Walsh appeared in person and also represented Marjorie Walsh

Barry Williams, London Appeals Unit, for the Respondents

© CROWN COPYRIGHT 2003

DECISION

1.	Mr and Mrs Walsh appeal against refusal of their claim for loss relief under section 381 of the Taxes Act 1988 in relation to their farming partnership losses for the four years 1994/95 to 1997/98.  Mr Walsh appeared for himself and his wife and they were assisted, particularly in their reply, by Mr Ian Mitchell of the Appeals Unit, London; the Inspector was represented by Mr Barry Williams of the Appeals Unit, London.
2.	I heard evidence from Mr Walsh, the farm manager Mr Steve Patch and the Inspector, Mrs Janet Taylor.
3.	I set out a brief summary of the Appellants’ farming arrangements.
(1)	Lucies Farm Partnership was formed on 1 April 1994 between Mr and Mrs Walsh.  Mr Patch stated that it issued its first invoices on 19 May 1994 although these are not contained in the accounts.  They had a 10 acre field and two further fields were purchased, one of 11.29 acres for £19,000 and one of 4.19 acres for £17,000 in May 1994.
(2)	Mr Patch is the farm manager, having previously been employed to drive the Appellants and look after their house.  He has horticultural qualifications.
(3)	There was originally a proposal to import alpacas from Peru for breeding and sale.  Although this was looked into in detail, including visiting Peru, and a draft agreement was prepared with the aid of lawyers in England and Peru dealing with their import, there were problems in importing them from Peru owing to health restrictions and this proposal was abandoned in about December 1994.  Two alpacas were purchased in June and July 1994 initially as pets.  In the 1998 period one alpaca was sold for £4,000 and two died and were covered by insurance.  
(4)	From June 1995 other farming was started with the first purchase of a pig 18 May 1995, the first cattle on 16 June 1995 and the first sheep in October 1995 resulting in their specialising in Gloucester Old Spot pigs, Hampshire Down sheep and Highland cattle.  The first sale of Highland cattle was on 8 May 1998.  Sales were low at the time because of the need to grow numbers through breeding.  Sheep and cattle were exhibited at various shows from 1996, winning prize money of £668 in 1995 and 1996.
(5)	At the end of the accounting period to 31 March 1995 land of about 28 acres was available for farming, stables had been constructed and there were 6 alpacas; at 31 March 1996 the same acreage was available and there were 8 alpacas, 22 sheep, 6 cattle and 8 pigs; at 31 March 1997 about 54 acres were available for farming and there were 8 alpacas, 22 sheep, 19 cattle and 28 pigs.  The farming operations were put into a limited company on 17 June 1998 when there were the same acreage available, and 6 alpacas, 27 sheep, 64 cattle and 11 pigs.
(6)	The Appellants had their own company, Transax plc, operating in 5 countries in the cheque credit guarantee field.  This was sold in June 1996.  They live in Hawaii and operate the farm through regular communication with Mr Patch.
4.	Section 381 of the Taxes Act 1988 provides for losses in the year in which a trade begins and the next three years of assessment against other income.  This is subject to the restriction in subsection (4):
“(4) Relief shall not be given under subsection (1) above in respect of a loss sustained in any period unless the trade was carried on throughout that period on a commercial basis and in such a way that profits in the trade (or, where the carrying on of the trade forms part of a larger undertaking, in the undertaking as a whole) could reasonably be expected to be realised in that period or within a reasonable time thereafter.”
5.	The loss claims were all refused on the basis of section 381(4), and in addition for 1994/95 that the trade had not commenced.
6.	Mr Walsh contended that he always intended to make a profit but this was prevented by the problems of the farming industry generally.  Mr Williams contended that in the first year the trade had not commenced and in the other years the trade was not carried on on a commercial basis and profits could not reasonably be expected in those years on in a reasonable time thereafter.
7.	So far as trading is concerned in the year to 31 March 1995 there was no income except for £170 described in the accounts as “bunker rental,” which Mr Williams contends, and I agree, is not trading income.  Mr Patch referred to a sale of arable crop and grass keep for £779 which does not appear in the accounts and in view of this I am not satisfied that there was any trading income in the year; it seems highly unlikely that in preparing and approving the accounts the Appellants would overlook the sole item of income in the year.  In July 1994 a tractor was purchased, and in December 1994 stables were constructed.  There seems to have been very little activity but at the year end there were 6 alpacas.  The first Alpaca sale was not until the 1998 period.  Although there was a serious proposal to import alpacas, very little happened in this year.  There is insufficient evidence that a farming trade had actually started.  Accordingly the losses for that year are not allowable against other income.
8.	In relation to the following years, I shall concentrate in this decision on the second part of the statutory test, whether profits in the trade could reasonably be expected in each period or within a reasonable period thereafter.  The actual results according to the accounts (in all cases excluding depreciation; I have stated below the amount of the capital allowances claim to give some idea of what depreciation might have been, although allowances are probably higher than depreciation) were:
Year ended 31 March 1996 loss £54,515 (capital allowances  £7,293)
Year ended 31 March 1997 loss £82,028 (capital allowances  £29,119)
Period ended 16 June 1998 loss £85,282 (no capital allowances claimed because of transfer to the company)
9.	The evidence about expectation of profit consisted of the following:
(1) A cash flow forecast by Arthur Andersen on 24 April 1996 which includes all their income and expenses, including personal income and expenses, and is therefore not helpful for the present purpose.
(2) A projection dated 17 November 1997 by KPMG in Norwich of farm income and expenditure for the year ending 31 March 1998 of a loss of £86,068 (made up of income £9,205, direct costs £19,344, and overheads £75,929, of which labour is £52,309).  For comparison the actual figures for a slightly longer period to 16 June 1998, the transfer to the company, were loss £85,282 (made up of income £9,321, direct costs £23,312,  and overheads £71,291, of which labour £42,498).  These figures do not include any depreciation; there is no capital allowance claim for the year because of the transfer to the company but the claim for the previous year was £29,119 (comprising cars £6,000, plant and machinery £21,391 and agricultural buildings £1,728).  KPMG conclude that the farm will have considerable difficulty in producing a gross margin to sustain the level of overheads it currently incurs, and they state “Unless there is a reduction in overheads and a market found where there is a significant premium for Highland cattle, we doubt whether the farm can produce a profit in the foreseeable future continuing as it is.”  Mr Walsh said that that this projection was based on some erroneous assumptions, which may well be true but it would need a very large change in any assumptions to turn that loss into a profit.  I also saw an email from Mr Walsh to Mr Patch of 18 November 1997 expressing concern about the predicted loss containing 11 paragraph of questions and giving 5 thoughts for change designed to reduce it, such as concentrating on one type of animal, the possibility of reducing staff, and purchasing more land so as to increase the livestock.  Among the papers a solicitors bill for services between January and March 1998 relating to proposed redundancies of farm staff, showing that something was being done about reducing staff overheads, as is reflected in the reduction in labour costs of over £9,800.  
(3) A projection made by KPMG on 27 January 1998 for the year to 31 March 1999 (i.e. made two months after the previous projection and before the start of the year in question) of a loss of £7,835 (made up of income £16,879, direct costs £3,052, and overheads £21,662, of which labour is £14,000), again excluding depreciation.  Compared to the previous projection this assumes an increase in income, and a very substantial decrease in overheads as the previous projection said was required.  For comparison the actual figures, now in the company, were a loss of £105,713 (income £14,018, direct costs £36,733, overheads £82,998 (including depreciation of £15,550), of which labour is £25,602, and legal and professional fees is £16,270).  
(4) Detailed profit and loss projections comprising 8 pages prepared by Messrs Edwards, chartered accountants in Walsall dated 20 March 1998 for the years ended 31 March 1998, 1999 and 2000 on the basis of two alternative purchases of land.  These show on the assumption of the purchase of “Hams” losses of £15,000, £8,389 and £11,042 respectively; and on the purchase of “Crown East” profits of £15, £4,804 and £8,644 respectively (included in these figures for 1999 only is rent of £5,000 from letting land excess to requirements).  These figures also exclude depreciation.  They do not include financing costs of the land purchases, presumably because Mr Walsh proposed to finance these personally and inject the land into the partnership as capital.  The income figures are those predicted by Doorbars, chartered surveyors and land agents, on 20 February 1998.  The breakdown of the figures to 31 March 1998 for comparison with the KPMG figures is income £18,829 (Hams)/£24,985 (Crown East, excluding rent), direct costs £8,400/£23,415, overheads £23,400 in both cases, of which labour is £12,800.  Neither piece of land was ultimately purchased but some further land was leased on 15 October 1998; rent of £800 is shown in the 1999 accounts.  Unfortunately there is no projection including the leased land and I do not know how it compares in size with the proposed purchases of land.
(5) Mr Walsh gave evidence, which I accept, that he was intent on making profits.  This is demonstrated by the email of 18 November 1997 to Mr Patch mentioned in paragraph (2) above.  At the end of this email he says:
“We need to make a profit because we need to convince the Inland Revenue that the farm isn’t a ‘hobby,’ but a serious business pursuit.  We need to make a profit because we don’t have Transax around to ‘support’ (via salaries or dividends to us) a Stg 86,000 loss each and every year.  We need to make a profit because, as we’ve said for quite some time, we’re spending less and less time in the UK.”
The reference to the income from Transax suggests to me that before its sale he could afford to be less concerned about the time it took before the farming made a profit because he could afford to wait.  The reference to spending less time here also suggests that he was no longer prepared to pay to enjoy any hobby element.
10.	Looking at these figures, which are the only hard evidence I have, the following points arise.  Although the partnership started on 1 April 1994 the first projection was for the year ended 31 March 1998, the fourth year (if one includes the 1995 year, although I have decided that the trade had not commenced).  I shall assume that any prediction for the earlier years would have shown losses.  In the year to 31 March 1998 the loss was £86,068 (predicted) and £85,282 (actual, excluding depreciation) mainly due to insufficient income and excessive overheads.  The figures for the year to 31 March 1999 were a predicted loss of £7,835 (excluding depreciation) with the existing land, a predicted loss of £15,000 after purchasing one alternative additional purchase of land, and a profit of £15 after purchasing the other, compared to an actual loss of £105,713 (including depreciation) after leasing additional land.  I do not give much weight to the 1999 actual result as it will have been affected by the outbreak of TB on an adjoining farm resulting in the cattle being quarantined period from November 1998 to March 1999 during which no livestock could be moved, followed by the ultimate destruction of the cattle.  The 1999 figure shows much lower labour costs £15,000 (KPMG prediction), £12,800 (Edwards prediction) and actual £25,602 (compared to predicted £52,309 and actual labour costs of £42,498 for 1998) showing that great progress had been made with the reduction of these costs but not enough to make a profit.  I also take into account that the BSE crisis started in March 1996 and figures from the NFU show that between September 1996 and September 1998 beef prices fell by 35 per cent, lamb by 36 per cent and pigmeat by 57 per cent.  In these circumstances forecasting must have been difficult and any estimates of income are likely to be too high.  But the projections were made in early 1998 which would have taken some of this fall in prices into account, and the main reason for losses seems to be on the expenses side rather than the income side.
11.	The earliest a profit was predicted on any basis was in the year to 31 March 1998 if Crown East had been purchased but this excluded depreciation (as an indication, capital allowances were for the 1997 year were £29,119, and depreciation for the 1999 year was £15,550).  In fact the purchase of Crown East did not take place and the lease of additional land did not occur in that period.  It is not realistic to suppose that a profit would be made in 1998 on the basis of the existing acreage.  
12.	In the fifth year, to 31 March 1999, the Edwards projection was a profit of £4,804.  Even if one assumes in favour of the Appellant that the actual income taking into account the additional leased land was the same as the predicted income if the Crown East land had been purchased, rent of £800 must be deducted and also depreciation (of which the actual depreciation was £15,550) and so there was no realistic chance of a commercial profit for that year.  The best estimate for the year ending 31 March 2000 is the Edwards projection of a profit of £8,644 before rent and depreciation the inclusion of which is highly likely to turn that profit into a loss (there was an actual loss of £92,758 (but this is likely to have been affected by the TB and other problems).
13.	Based on this evidence, however much I accept that the Appellants wanted to make a profit, a commercial profit could not reasonably be expected in any of the years up to and including the sixth year to 31 March 2000.  In the first two years they had income from Transax, which made them less concerned about the time when profits were made.  In late 1997 they were waking up to the continuing level of losses and decided to do something about it.  But even then the best predictions did not suggest a commercial profit any time before 31 March 2000 even on the assumption of further purchases of land and consequent increase in the size of the herd.  I am prepared to assume, although strictly I have no evidence of it, that farming operations comprising breeding will have a slow start but I do not consider that profits could reasonably expected in any of the years under appeal, comprising the accounting periods ending 31 March 1995 (although I have decided that no trade was carried on in this year) to 1998 within a reasonable time after any of them, when on the best prediction I have no commercial profit could be made until at least after 2000.
14.	In view of that decision it is not strictly necessary for me to decide whether the trade was carried on throughout those periods on a commercial basis.  I was referred to the following passage in Wannell v Rothwell 68 TC 719 in which Robert Walker J (as he then was) said:
“I was not shown any authority in which the Court has considered the expression ‘on a commercial basis,’ but it was suggested that the best guide is to view ‘commercial’ as the antithesis of ‘uncommercial,’ and I do find that a useful approach.  A trade may be conducted in an uncommercial way either because the terms of trade are uncommercial (for instance, the hobby market-gardening enterprise where the prices of fruit and vegetables do not realistically reflect the overheads and variable costs of the enterprise) or because the way in which the trade is conducted is uncommercial in other respect (for instance, the hobby art gallery or antique shop where the opening hours are unpredictable and depend simply on the owner’s convenience).  The distinction is between the serious trader who, whatever his shortcomings in skill, experience or capital, is seriously interested in profit, and the amateur of dilettante.”
15.	Leaving aside the expectation of profit within a reasonable time, I saw nothing uncommercial about the operation in this sense.  The Appellants had the best advice and acted on it.  They are in regular touch with Mr Patch who seems well capable of managing the farming operations, although not very good on accounting.  Good computerised records were kept.  They subscribe to industry publications, and belong to the relevant associations (and Mr Patch has been a member of the Council of the Highland Cattle Society).  Overheads started too high but were cut substantially.  Accordingly, apart from the time when profit could reasonably be expected I find that the trade was carried on throughout on a commercial basis.  The main reason for the losses seems to have been that the farm was too small to be viable when it could not be run by the owner in person.
16.	I therefore dismiss the appeals against refusal of the loss claims in principle.

J F AVERY JONES

SPECIAL COMMISSIONER

SC 3051-2/02

Authorities referred to in skeletons and not referred to in the decision:
Governors of the Rotunda Hospital, Dublin v Coman 7 TC 517
The Birmingham & District Cattle By-Products Co Ltd v IRC 12 TC 92
Salisbury House Estate Ltd v Fry 15 TC 266
Long v Belfield Poultry Products Ltd 21 TC 221
Shop Investments Ltd v Sweet 23 TC 38
Sywell Aerodrome Ltd v Croft 24 TC 126
Jennings v Middlesbrough Corporation 34 TC 447
Ridge Securities Ltd v IRC 44 TC 373
Salt v Chamberlain 53 TC 14
Webb v Conlee Properties Ltd 56 TC 149
Wilson and Garden Ltd v IRC 56 TC 279
Griffiths v Jackson 56 TC 583
American Leaf Blending Co Sdn Bhd v D-G of Inland Revenue [1978] 3 All ER 1185
Walls v Livesey [1995] STC (SCD) 12
Brown v Richardson [1997] STC (SCD( 233
Delian Enterprises v Ellis [1999] STC (SCD) 103