Craig & Marjorie Walsh v Janet Taylor (HM Inspector of Taxes)

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.

I heard evidence from Mr Walsh, the farm manager Mr Steve Patch and the Inspector, Mrs Janet Taylor.

I set out a brief summary of the Appellants’ farming arrangements.

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.”

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.

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.

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.

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:

The evidence about expectation of profit consisted of the following:

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.

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.

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).

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.

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.”

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.

I therefore dismiss the appeals against refusal of the loss claims in principle.