Hancock v Federal Commissioner of Taxation

(1961) 108 CLR 258
35 ALJR 228
[1961] ALR 839

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(Judgment by: Kitto J)

Between: Langley George Frederick Hancock
And: Federal Commissioner of Taxation

Court:

Judges: Fullagar J
Dixon CJ

Kitto JMenzies J
Windeyer J

Subject References:
Income tax (Cth)

Judgment date: 8 August 1961

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Judgment by:
Kitto J

The question for decision in this appeal requires consideration of s. 260 of the Income Tax Assessment Act 1936-1949 (Cth) in relation to a somewhat complicated set of facts. The material provision of the section is that every contract, agreement, or arrangement shall, so far as it has or purports to have the purpose or effect of defeating, evading, or avoiding any liability imposed on any person by the Act or preventing the operation of the Act in any respect, be absolutely void as against the Commissioner. (at p282)

In this case the Commissioner relies upon the section to treat as void portion of what he says was an arrangement having or purporting to have the purpose or effect of avoiding a liability of the appellant to pay income tax. The notorious difficulties of the section have been the subject of a line of cases culminating in Newton v. Federal Commissioner of Taxation [1958] AC 450 ; (1958) 98 CLR 1 . From what is said and implied in the reasons of the Privy Council in that case it is possible, I think, to work out some general propositions by reference to which the present case may be decided.

(1)

The word "arrangement" in s. 260 comprehends a plan made between two or more persons (whether it be legally enforceable or not) and all the transactions by which it is carried into effect.

(2)

An arrangement "has or purports to have the purpose or effect" referred to in the section if, and only if, the concerted action consisting of the making of the plan and the carrying out of the transactions by which it is given effect is properly to be characterized as a means to avoid income tax.

(3)

Whether it is to be so characterized is a question to be answered upon consideration of the overt acts by which the plan has been implemented.

(4)

If those acts are capable of explanation by reference to ordinary dealing, such as business or family dealing, without necessarily being labelled as a means to avoid tax, the arrangement does not come within the section.

An example would be a simple sale or gift of shares, even though the motive of the seller or donor may have been to avoid receiving future dividends and incurring the liability to income tax which the receipt of them would have entailed.

(5)

But the overt acts will enable the arrangement to be characterized as a means for the avoidance of tax, if they have included a transfer of property from the taxpayer in consequence of which income from the property, instead of being received as such by the taxpayer, has followed either of two courses:

(i)

a course which has carried it through the hands of other persons to the taxpayer, but so as to reach him with the character of capital; or

(ii)

a course which has amounted in effect to an application of the moneys by the taxpayer, and so has been a practical equivalent of a receipt by him followed by an expenditure by him.

(6)

If an arrangement has been a means for the avoidance of tax, the fact (if it be a fact) that it has been a means to other ends as well does not prevent the application of s. 260.

(7)

Where an arrangement is found to be within the section because of a transfer having such a consequence as is mentioned in (5) above, the transfer is to be considered as void to the extent mentioned in the section.

The result is that income which has followed either of the courses referred to in (5) is to be regarded as income to which the taxpayer was entitled. Consequently the receipt of the income by the transferee in pursuance of the arrangement is properly to be treated by the Commissioner as a derivation of it, as income, by the taxpayer. (at p283)

A word may be added in explanation of propositions (5) and (7). A clear example of income following the first of the courses mentioned is provided by Bell's Case (1953) 87 CLR 548 , where it was found possible to trace dividend moneys from a company to Bell, and show that although they had in fact reached Bell as capital they were the produce of shares formerly held by him and transferred under an arrangement which ensured that he would receive them, but receive them transformed into capital and so made free of income tax. The Privy Council regarded the bulk of the moneys in question in Newton's Case [1958] AC 450 ; (1958) 98 CLR 1 as in the same category. The second of the courses described in (5) above is illustrated by the Privy Council's treatment of the moneys retained by Pactolus in Newton's Case [1958] AC 450 ; (1958) 98 CLR 1 . It is easy to imagine other possible instances of it. One would be the case in which, by arrangement between A and B, A has transferred his shares to B, and B has applied dividend moneys therefrom in making a payment to C but really as a gift to C from A, or in paying for property to be transferred by C to A, or in securing some benefit or advantage for A, and then (making plain the tax-avoiding nature of the whole arrangement) B has retransferred the shares to A. The contrast with the case of an ordinary straight-out sale or gift by a taxpayer is clear. Such a sale or gift does result, it is true, in the future dividends going to the buyer or donee instead of to the taxpayer; but the diversion of the money from the taxpayer is neither to enable it to be received by him as capital instead of income and therefore free of income tax, nor to enable such an application of it to be made that there is achieved by a single step what, but for the arrangement, would have required the two steps of a receipt by the taxpayer (with consequential tax liability) and an expenditure by him. (at p284)

I turn to the facts of this case. It relates to the year of income ended 30th June 1949. By an amended assessment, the appellant was assessed to tax on the footing that in that year he derived as assessable income an amount of 17,759 pounds over and above the amount which he had included in his return. This was done, and is now supported by the respondent Commissioner, on the ground that by the carrying out of an arrangement between the appellant and his son on one side and a company named Rowdell Pty. Limited (which I shall call Rowdell) on the other, dividend moneys to that amount, which would have been assessable income in the appellant's hands if he had received them from the company which declared the dividends, were paid instead to Rowdell, but the payment, because it was followed by steps which show that the arrangement was a means for the avoidance of a tax liability upon the appellant, should be treated, by an application of s. 260, as a payment of dividend moneys belonging to the appellant and therefore as derived by him so as to form part of his assessable income. An appeal against the amended assessment was dismissed by Fullagar J., who considered that an even higher sum, namely 18,283 pounds, was brought into the appellant's assessable income by the operation of s. 260. From his Honour's decision an appeal now comes before the Full Court. (at p285)

That there was a plan, evolved between the appellant and his son on the one side and Rowdell on the other, there is no dispute. It had been worked out by 14th April 1949, on which day there was an interchange of letters and a concluding telephone conversation. The course of negotiations which had led up to it is traced in the judgment of Fullagar J., and need not be described again. The situation upon which the plan was to operate was this. The appellant held 6,730 and his son 1,000 shares in a grazing company called Mulga Downs Pty. Limited, which will be referred to as Mulga Downs. That company's issued capital consisted of 18,945 shares, all fully paid. Of the shares not held by the Hancocks, 11,210 were held by members of a family who may be called collectively the Lefroys. The remaining five shares were held by a Mrs. Hancock, who is not included in references in this judgment to the Hancocks. The plan provided for three main transactions. First, the Hancocks were to sell and Rowdell was to buy all but two of the Hancocks' shares in Mulga Downs, to be transferred at once, for the price of 23,500 pounds payable as to 2,500 pounds immediately (as a deposit) and as to the balance, 21,000 pounds, on or before 30th June 1949. The carrying out of this transaction was made binding upon the Hancocks and Rowdell by a deed which they executed on 30th April 1949. Secondly, Rowdell was to buy in the Lefroys' shares in Mulga Downs for 40,000 pounds, the Lefroys having already signified their willingness to sell at that price. Thus Rowdell would hold all but seven of the issued shares in Mulga Downs. Finally, after registration of the transfers to Rowdell, Mulga Downs was to distribute 50,000 pounds by means of dividends, and Rowdell, having received its proportion, that is to say almost the whole, of the distributions thus made, was to re-sell all its shares in Mulga Downs. (at p285)

Fullagar J. considered that the plan included two other points of great importance in connexion with the third of the planned transactions, namely, that the resale of the shares by Rowdell should be to the Hancocks, and that the price should be 21,000 pounds. In this respect his Honour's interpretation of the evidence has been challenged, but with an immaterial qualification as to the price it should clearly be accepted. The two points just mentioned were left in the realm of unenforceable arrangement it is true, but they were undoubtedly the subject of a definite understanding which was as much a part of the plan as the stipulations which were made contractually binding. The first concrete proposal which Rowdell made to the Hancocks, contained in a letter of 15th February 1949, included a statement that Rowdell, when it should be ready to sell the shares acquired from the Hancocks and the Lefroys, would be prepared to give the Hancocks the first right of refusal at 21,000 pounds, and indeed to give them a formal option at that figure. In the letter by which the general assent of the Hancocks to the plan was announced, namely a letter dated 14th April 1949 from the Hancocks' accountant to Rowdell, it was said that the sale by the Hancocks to Rowdell would be conditional upon the abovementioned option being given; but Rowdell in its reply of the same date expressed disinclination to give any binding option at any fixed price until after Mulga Downs should have held its annual meeting and paid out the contemplated dividends. The explanation offered was that there would then be no room for dispute as to the precise nature and extent of the assets and liabilities of Mulga Downs; and by way of example it was said that Rowdell might decide to take out a dividend of, say, only 40.000 pounds instead of 50,000 pounds in which case they would want a price of 31,000 pounds instead of 21,000 pounds (i.e. for the shares ex dividends).

The Hancocks gave up the point. They agreed to the plan, and in particular they agreed to sell to Rowdell all their shares but two for 23,500 pounds, without receiving the option. But it is to be observed that at no time was it suggested by Rowdell that the resale might be made otherwise than to the Hancocks if the latter should wish to buy: it was only the price that was kept open for adjustment according to circumstances, and the inference was clear that otherwise the position would be as if the option had been given. Rowdell's managing director, Watson, had known from the time when he first turned his attention to the question of buying into Mulga Downs that the Hancocks had particular reasons which would probably make them desirous of buying all Rowdell's shares in Mulga Downs if they could find the money with which to do so when the time came. In evidence he said that he told the Hancocks at the time when agreement was reached that he would be a seller of the shares in June and that if they wanted them they could have them. When the time came to sell, Watson reported to a general meeting of his company that "as anticipated" the Hancocks desired to buy the shares for 21,000 pounds and the sale was agreed to. It seems too clear for doubt that at every stage there was a clear understanding between the Hancocks and Rowdell, though resting only in good faith, that the Hancocks should be given the first opportunity to buy, and that the price should be 21,000 pounds, subject to adjustment to allow for any deviation from the intention that the distributions by means of dividends should amount in all to 50,000 pounds. (at p287)

To understand the plan, it is not unimportant to see how the adjustable resale price of 21,000 pounds was considered at the time to compare with the assets value of the shares to be resold by Rowdell. This appears from Exhibit D, which contains an approximate analysis by Watson of the affairs of Mulga Downs as at 14th April 1949, the day on which the sale of the Hancocks' shares to Rowdell was finally agreed to. Fixed assets were taken at 52,000 pounds and current assets at 29,000 pounds, giving a total of 81,000 pounds. There were no external liabilities apart from taxes. Taxes were provided for as follows: 3,600 pounds for taxes on 1947-1948 profit, 6,900 for income tax on an anticipated profit of 24,000 pounds for the year ended 30th April 1949, and 7,000 pounds for undistributed profits tax on the latter profits. These figures gave a net worth of 63,500 pounds for the 18,945 pounds issued shares. But if the proposed distribution of 50,000 pounds were to be made, the 7,000 pounds provision for undistributed profits tax on the 1948-1949 profits would not be required. Adding this back, the value from which the 50,000 pounds would be taken becomes 70,500 pounds; so that after the distribution the assets value of the issued shares would be 20,500 pounds, of which nearly the whole would be the value of the shares resold. (at p287)

The plan was carried into effect between 30th April 1949 and 3rd June 1949. Rowdell bought the Lefroys' shares for 40,000 pounds, which it paid in cash. Rowdell also bought all but two of the Hancocks' shares for 23,500 pounds, paying 2,500 pounds in cash and agreeing by the deed of 30th April 1949 to pay the remaining 21,000 pounds before 30th June 1949. When the transfers of the Lefroy and the Hancock shares had been duly effected, Mulga Downs declared and paid dividends totalling 50,000 pounds, of which Rowdell received its due proportion. Rowdell then offered all its shares in Mulga Downs to the Hancocks for 21,000 pounds, and the Hancocks accepted the offer. The price, as will have been noticed, was the same in amount as the deferred portion of the price payable by Rowdell to the Hancocks for the 7,728 shares which the latter between them had sold; and in fact the two amounts were paid by means of an exchange of cheques, on 3rd June 1949. (at p287)

So, by the time all this was completed, the Hancocks, without having had to find a penny otherwise than from the carrying out of the plan, had come to hold the Lefroys' 11,210 shares as well as all those which they themselves had originally held, and had received 2,500 pounds in cash. The Lefroys had received 40,000 pounds in cash for their shares. Rowdell had emerged the richer by about 7,500 pounds. Mulga Downs, on the other hand, had distributed out of its profits 50,000 pounds, equal to the total of the three amounts of cash just mentioned. Of the profits distributed, 17,759 pounds was in respect of the 6,729 shares which the appellant had transferred to Rowdell, for that is the figure which is obtained by applying the fraction 6,729 over 18,945 to 50,000 pounds. (at p288)

Of course, Rowdell may be liable to be assessed to income tax on the footing that the dividend moneys it received from Mulga Downs formed part of its assessable income. If s. 260 applies in relation to the Hancocks so as to include in their assessable incomes a part of the same dividends, the result may seem odd since it would mean that dividend moneys from Mulga Downs are to be treated as if they had been derived as income twice, and by different taxpayers. But that would be because, by the express terms of the section, the avoidance which it produces is only as against the Commissioner, so that the Commissioner may treat transactions as void but no one else is enabled to do so. (at p288)

In the course of the argument an attempt was made on behalf of the Commissioner to trace the whole of the dividend moneys received by Rowdell on the shares it bought from the Hancocks, with a view to showing that they reached the Hancocks in the end, in the form of 2,500 pounds in money and the balance in the form of the Lefroy shares. Even assuming that a tracing into property other than money is relevant for the purpose of applying s. 260, the attempt that was made in this case could not succeed so far as it related to the excess over the 2,500 pounds. Still, it may help towards an understanding of the case as a whole if I describe what Rowdell did with the dividends it received and how it paid for shares it acquired. (at p288)

The dates on which the dividends provided for in the plan were declared and paid by Mulga Downs were 30th April 1949 and 27th May 1949. On the former day there were two dividends, one of 3,500 pounds out of the profits of the year ended 30th April 1948, and the other of 21,500 pounds out of the profits of the year ended 30th April 1949. Rowdell received from these dividends a total sum of 24,990 pounds 14s. 11d., and paid the cheque into its bank account on the same day. It appears from the bank statement that Rowdell began the day with a credit balance of 18,627 pounds 8s. 8d. Of this sum, 1,840 pounds 11s. 2d. had come from sources irrelevant to this case, and 16,786 pounds 17s. 6d. consisted of the proceeds of sale of some bonds which Rowdell had bought from Mulga Downs on terms of deferred payment. The purpose of the bond transaction was to assist in financing the payment of 40,000 pounds to the Lefroys for their shares in Mulga Downs. That payment is the next item appearing in the account, and it is followed immediately and on the same day by the deposit of the dividend moneys that have been mentioned. The result was that of the 40,000 pounds that was paid to the Lefroys for their shares, 1,840 pounds 11s. 2d. came from Rowdell's original moneys, 16,786 pounds 17s. 6d. came from the proceeds of the bonds, and 21,372 pounds 11s. 4d. (i.e. 24,990 pounds 14s. 11d. less 3,618 pounds 3s. 7d.) came from the dividends of 30th April 1949. The credit balance then remaining in the account, namely 3,618 pounds 8s. 7d., consisted wholly of dividend moneys. Out of this credit balance the 2,500 pounds was paid to the Hancocks as the deposit on their shares. The cheque for that amount did not go through the account until 2nd May 1949, but in the interval there had been no operation on the account.

The 2,500 pounds was therefore paid wholly out of the dividend moneys deposited on 30th April 1949. Of course it was a capital receipt in the hands of the Hancocks, being part of the purchase price of their shares; but if the sale and transfer of those shares had not been arranged and carried out there would have been nothing to give it the character of capital, and it would have retained the character of assessable income by reason of its being a distribution by a company to a shareholder: see s. 44 (1) and the definition of "dividend" in s. 6. The arrangement was therefore, to that extent at least, one for avoiding income tax on the Hancocks; and to that extent at least it must fail by force of s. 260. (at p289)

Returning to Rowdell's bank account, it appears that between 2nd and 25th May 1949 the moneys remaining in the account were depleted by sundry debits, and with these we are not concerned. Until 27th May 1949 there were no payments into the account, so that on that day the credit balance, which then stood at 630 pounds 8s. 7d., consisted entirely of dividend moneys from Mulga Downs. Then on 27th May 1949 that company declared the second batch of dividends. One was a further dividend of 2,500 pounds to be paid out of the profits of the year ended 30th April 1949, and the other was an interim dividend of 22,500 pounds to be paid out of the profits of the year ending 30th April 1950, and, as to any deficiency in the amount of those profits, out of accumulated profits standing to the credit of profit and loss appropriation account. Rowdell received as its proportion of these two dividends 24.990 pounds 14s. 11d., which was paid into its bank account on 27th May 1949. On that day there was only one other operation on the account, namely a payment of 17,300 pounds to Mulga Downs to meet a promissory note. This was the deferred payment for the bonds which Rowdell had bought from Mulga Downs and sold in order to finance the purchase of the Lefroy shares. The payment was made out of the combined dividend moneys, and it left a balance of 8,321 pounds 3s. 6d. Then, after a small payment of 47 pounds which is irrelevant, there took place on 3rd June 1949 the exchange of cheques for 21,000 pounds each, one cheque being that given by Rowdell for the balance owing by it on its purchase of the Hancock shares, and the other being the cheque given by the Hancocks for the purchase price of the former Hancock and Lefroy shares. (at p290)

It is said for the Commissioner that when you find that the 17,300 pounds which Rowdell owed for the bonds was paid out of Mulga Downs dividends, you should deal with the case just as if the proceeds of the sale of the bonds had consisted of dividend moneys, and therefore as if the 40,000 pounds which Rowdell paid for the Lefroy shares had been paid out of dividends except to the extent of 1,840 pounds 11s. 2d. only. If you take that step, it is said, the rest follows: the Lefroy shares ultimately got to the Hancocks, ergo so much of the dividends which those shares represented as was proportionate to the Hancock shares should be treated in the Hancocks' hands as dividends, and therefore as assessable income, once s. 260 has annihilated the sale and transfer of the Hancock shares to Rowdell. (at p290)

This argument fails, I think, at two points. In the first place, there is no justification for treating the proceeds of the bonds which Rowdell sold as constituting dividend moneys. They were not, in fact, dividend moneys, and there is nothing in the Income Tax Assessment Act, or in any general legal principle, to give them that character retrospectively simply because Rowdell utilized dividend moneys, when they later came in, to pay for the bonds. All the steps taken in relation to the bonds were no doubt taken in execution of the overall plan, but no disregarding of any of those steps advances the Commissioner's case. Even if the sale of the bonds by Mulga Downs were to be disregarded, and consequently the 16,786 pounds 17s. 6d., which was the proceeds of their sale and formed part of the 40,000 pounds paid to the Lefroys, be considered as having belonged all along to Mulga Downs, that would not make them dividend moneys distributed by Mulga Downs by way of advance payment in respect of the second batch of dividends. Nothing less than that would suffice to give the Commissioner a foothold for his contention that the Lefroy shares, when they reached the Hancocks, contained 1949 dividend moneys in a converted form. Secondly, the Lefroy shares were bought by and transferred to Rowdell before any of the dividends were declared. The bank statement correctly reflects the order of events on 30th April 1949: it was of the essence of the plan that the Lefroy shares should be, and in fact they were, bought and paid for and duly transferred before the dividend was declared. By contrast, the bank statement does not correctly reflect the order of events in relation to the dividends of 27th May, for the promissory note for 17,300 pounds had of necessity to be met, for the most part, out of those dividends. There is, therefore, no justification for the view that the dividend moneys received by Rowdell were used, wholly or in part, to buy in the Lefroy shares. (at p291)

But while the examination that has been made of the steps taken to carry out the arrangement shows, as I think, that the Commissioner cannot succeed in an endeavour to support the impugned assessment wholly by means of a process of tracing, it also puts beyond all question that the transfers which enabled Rowdell to receive so much of the 50,000 pounds as was distributed by Mulga Downs in respect of the 7,728 Hancock shares formed part of an arrangement which was a means for producing to the Hancocks, first, a portion (2,500 pounds) of the distributions, in cash but as capital instead of as income, and, secondly, the Lefroy shares. As regards the 2,500 pounds the case is indistinguishable from Bell's Case (1953) 87 CLR 548 : the money followed a course of the first kind mentioned in proposition (5) above. As regards the rest of the distributions on the 7,728 shares, the money followed a course of the second kind: the Hancocks have never received the money, but they have received the Lefroy shares instead. I say instead, because the practical result which the carrying out of the arrangement achieved was an exchange by the Hancocks of the right to participate in the planned distributions of Mulga Downs for the Lefroy shares in the "milked" company. The effect was exactly that which, in the absence of an arrangement, could have been produced only by the Hancocks retaining their shares, receiving the dividend moneys in respect of them free of income tax, and applying all but 2,500 pounds in purchasing the Lefroy shares after the dividends thereon had been paid. The arrangement was, therefore, a means for avoiding the income tax which the Hancocks would have been liable to pay if they had achieved the same results without an arrangement. One may accept without hesitation their stoutly-maintained assertion that in their minds the arrangement was predominantly a means for getting in the Lefroy shares. That was, no doubt, their longstanding ambition.

It was that which drew them into the arrangement when it was proposed to them. But the stubborn fact remains that, for whatever else the arrangement was a means, it was a means for the avoidance of tax. The consequence which s. 260 produces is that the transfers of the 7,728 shares to Rowdell are to be treated as void, and Rowdell's receipt of the dividend moneys in respect of those shares is to be considered a receipt of the Hancocks' moneys by arrangement with them, and therefore as a derivation of those moneys by the Hancocks, with the character of company distributions still upon them. (at p292)

In my opinion, the amended assessment was correct, and the appeal from the order of Fullagar J. should be dismissed.

It follows from my reasons for judgment in the appeal of George Hancock that in my opinion this appeal too should be dismissed. (at p292)