Dickson v Federal Commissioner of Taxation
62 CLR 687(Decision by: Latham CJ)
Between: Dickson
And: Federal Commissioner of Taxation
Judges:
Latham CJDixon J
Evatt J
Subject References:
Taxation and revenue
Income tax
Assessable income
Unrealized profits
Legislative References:
Income Tax Assessment Act 1936 No 27 - s 6; s 44(2)(b)(iii)
Judgment date: 21 February 1940
MELBOURNE
Decision by:
Latham CJ
In an assessment of the appellant, Mr. Raynes W. S. Dickson, under the Income Tax Assessment Acts 1936. 801 bonus shares received by him from the Castlemaine Brewery Company Melbourne Ltd were included in his income for the year ended 30th June 1936. Section 6 of the Act provides that 'dividend' includes, inter alia, the paid-up value of shares distributed by a company to its shareholders to the extent to which the paid-up value represents a capitalization of profits. The shares issued to the appellant represented a capitalization of profits. Prima facie, therefore, they were dividends within the meaning of the Act. Section 44 provides that the assessable income of a shareholder in the company shall, subject to the section, if the shareholder is resident (as the appellant was), include dividends paid to him by the company out of profits derived by it from any source. But sub-s. 2 of s. 44 provides that 'the assessable income of a shareholder shall not include dividends ... (b) paid wholly and exclusively out of one or more of the following ... (ii) profits arising from the sale or compulsory resumption for public purposes of assets not acquired for the purpose of resale at a profit; (iii) profits arising from the revaluation of assets not acquired for the purpose of resale at a profit or from the issue of shares at a premium, if the dividends paid from such profits are satisfied by the issue of shares of the company declaring the dividend.' This section recognizes that profits may arise which are of a capital nature and assumes that they may properly be used for paying dividends (Ammonia Soda Co v Chamberlain [F1] )-and see Verner v General and Commercial Investment Trust [F2] ; Lee v Neuchatel Asphalte Co [F3] . The sub-section is limited to capital profits by the words 'assets not acquired for the purpose of resale at a profit.' If profits arise from the sale of such assets, then, under s. 44 (2) (b) (ii), the dividend may be paid in cash and yet not be assessable. But if the profits arise from revaluation of such assets, then the dividends are excluded from assessment only if they are satisfied by the issue of shares of the company declaring the dividend (s. 44 (2) (b) (iii)). In Laws of England, 2nd ed., vol. 5, p. 393 (f), it is said, with reference to the payment of dividends by a company: 'The question whether accretions to capital can be distributed when they are unrealized but proved to exist has not been decided.' The section assumes that such a distribution can properly be made. In the present case, the court is not, I take it, concerned with the doubt suggested by the passage which I have quoted. If a distribution of bonus shares in fact falls within the terms of the section, the shares cannot be taxed as income under the Act, whatever view may be taken upon the question mentioned.
The commissioner assessed the taxpayer upon the basis that the shares were included in his income. The taxpayer objected that the 801 shares were not assessable dividends within the meaning of the Act because they were shares the issue of which satisfied dividends which were paid wholly and exclusively out of profits arising from the revaluation of certain assets, namely, shares in the Carlton United Breweries Ltd , which had not been acquired for the purpose of resale at a profit. The objection was disallowed and the taxpayer appealed to the High Court. Upon the appeal McTiernan J. held that the profits which were the source of the dividends which were satisfied by the issue of the bonus shares did not arise from a real revaluation of assets and dismissed the appeal. The taxpayer has appealed to the Full Court.
The Castlemaine Brewery Company Melbourne Ltd was a holding company and, from 1902 to 1934, owned 117,414 shares in the Carlton and United Breweries Ltd In 1934 the Carlton United company took advantage of legislation which enabled it to distribute PD975,000 out of accumulated profits in the form of bonus shares without the imposition of any liability in respect of income tax upon the shareholders. The Castlemaine company received 58,707 shares from the Carlton United company when this distribution was made. The Castlemaine company then owned 176,121 shares in the Carlton United company. The 117,414 shares had throughout, that is, from 1902 to 1934, been valued at cost, namely, PD119,861, although it is not disputed that the value of the shares had greatly increased since 1902. When the new shares were received from the Carlton United company, nothing further was paid for them, and the total number of new and old shares, namely, 176,121 shares, was still taken into account in the balance-sheet of the Castlemaine company at PD119,861. The directors of the Castlemaine company, being fully aware of the provisions of s. 44 of the Act, informed the shareholders that they proposed to consider taking advantage of the section so as to make a distribution of bonus shares which would not be taxable as income in the hands of the shareholders. In order to accomplish this result it was necessary under the section to have a revaluation of the shares. It was necessary to determine the basis upon which new shares should be issued, and the directors ascertained the amount of profits which it would be necessary to distribute in order to issue one fully paid bonus share for every two existing shares. An arithmetical calculation showed that if the 176,121 shares (new and old) were valued at 24s. each, the excess of the total value of the shares over the amount of PD119,861 would be sufficient to provide for a bonus issue of fully paid shares in the proportion of one for two. The auditors of the company and another firm of ac countants were, in effect, invited to state whether the shares, that is, the 176,121 shares, were worth not less than 24s. The reports of the two firms of accountants, which were in the same terms, stated that a revaluation of the Carlton United shares held by the Castlemaine company had been made, and certified that, in their opinion, 'these shares are worth not less than 24s.' The directors then directed that the shares should be taken into account at 24s. each. This was done. The result was that the value of the shares was, according to the accounts of the company, shown as increased by PD91,483, out of which a sum of PD87,500 was capitalized, and fully paid bonus shares representing this amount were issued to the shareholders. As already stated, the taxpayer received 801 of these shares. McTiernan J. dismissed the appeal substantially upon the ground that there had been no genuine revaluation of the Carlton United shares held by the Castlemaine company, but that the figure of 24s. had been adopted merely in order to pretend that there was a revaluation, so as to take advantage of s. 44 (2) (b) (iii) of the Act.
The articles of association of the Castlemaine company provide for the issue of bonus shares in certain cases. In the present case the provisions of the relevant article, art. 101 (d), were observed. A recommendation of the directors for the issue of the bonus shares was made, and a general meeting authorized and directed the directors to apply the sum of PD87,500 on behalf of the holders of shares in paying up in full 100,000 unissued shares of 17s. 6d. each which were proposed to be issued. The directors acted under this resolution, and the distribution was accordingly made. The resolution of the directors shows that the provisions of s. 44 of the Act were held in view when the bonus shares were issued. The resolution determined that 'the sum of PD87,500 being part of the profits arising from the revaluation of the shares (not acquired for the purpose of resale at a profit) held by the company in Carlton and United Breweries Ltd carried to assets revaluation reserve account forming part of the undivided profits of the company which are not required for paying dividends be distributed as a capital bonus amongst the holders registered on the twelfth day of November 1935.' Thus, it is quite clear that the directors acted deliberately in order to obtain for the shareholders the benefit of s. 44 of the Act.
Section 44 (2) (b) (iii) requires, in order that dividends should be excluded from the income of a shareholder, that the dividends paid from the profits mentioned should be 'satisfied by the issue of shares of the company declaring the dividend.' The section is, therefore, based upon the view that when bonus shares are issued there is a real or notional declaration of a dividend which is applied to pay for the shares-a view which has been the subject of much controversy in and since Blott's Case [F4] . It is unnecessary, however, to engage in any discussion of this particular question, because it is not disputed that in the present case dividends were satisfied by the issue of bonus shares.
The question which arises is: 'What does this sum of PD87,500 represent?' In the resolution of the directors, which I have already quoted, and in an antecedent resolution of a general meeting of the company, it was described as being part of the profits arising from the revaluation of the shares (not acquired for the purpose of resale at a profit) held by the company in Carlton and United Breweries Limited. If this description of the sum of PD87,500 is accurate, the bonus shares should not be included in the income of the taxpayer for the purposes of the Act.
This sum of money came from the assets revaluation reserve account. This reserve account was, as already indicated, created by writing up the value of certain shares to an amount of 24s. each. The sum of 24s. admittedly does not represent the full value of the shares, and it was known at the time that this was the case. All the evidence on the point is to the effect that the shares at the time of writing up were probably worth 36s. The taxpayer claims that the writing up was a revaluation of the shares within the meaning of s. 44 (2) (b) (iii). What was done by way of revaluation has already been stated in a general way. It is necessary now to state the facts in greater detail. In a balance-sheet dated 30th September 1935, but only agreed upon and signed by the directors on 11th October 1935, the value of the 176,121 shares was stated as at 30th September 1935 at PD119,861. On the same date, 11th October 1935, the directors considered the report of the two firms to which I have already referred, and it was resolved that the 176,121 shares should be taken into account in the company's books at the value of 24s. each. The shares were so taken into account in an entry in the ledger made on 12th October. That entry records an amount of PD91,483 as a profit on the revaluation of the shares, that sum being the difference between the balance-sheet value of PD119,861 and the new value at 24s. per share.
Up to the balance-sheet of 30th September 1934 the 117,414 shares in the Carlton United company had been valued in the balance-sheet of the Castlemaine company at the cost price of PD19,861. In fact these shares greatly increased in value between 1902 and 1934. The estimate given in evidence of the value of the shares in 1934, after the bonus issue contemplated by the Carlton United company had become known, was about 54s. a share. After the bonus issue was actually made the value per share of the then increased number of shares in the Carlton United company became, according to the evidence, 36s. per share. In other words, the evidence showed that before the issue of the bonus shares by the Carlton United company, the market absorbed the additional value which was either revealed or expected to be created by the issue of bonus shares. The result was that, after the issue of bonus shares by the Carlton United company, each share in the company was worth less than each share in the company had been before the bonus issue was made. The directors retained the figure of PD119,861 as the value of the increased number of shares, that is, they continued to value all the Carlton United shares at cost-the acquisition of the new bonus shares not having involved the Castlemaine company in any expenditure.
It is not disputed that the Carlton United shares were assets not acquired for resale at a profit. It is unnecessary in the present case to consider whether the positive words 'acquired for resale at a profit' are applicable only in a case where there was an original acquisition by purchase. The Carlton United shares certainly answered the negative description of assets not acquired for resale at a profit.
The question then is whether the sum of PD87,500, part of the PD91,483 19s. represented profits arising from the revaluation of the Carlton United shares.
The relevant sub-section evidently contemplates that profits may arise from a revaluation of assets. It is, I think, clear that profits cannot be produced, caused, or brought about by a mere process of revaluation. But, though revaluation cannot create profits, it may reveal or disclose profits. In order to give any effect to the section, it must, I think, be read as applying to profits so revealed or disclosed and utilized in the manner stated in the sub-section. Upon any other interpretation the section could never apply in any case, because there could never be any profits to which it could possibly apply.
Upon the basis of the facts stated, the taxpayer contends that the conditions of s. 44 (2) (b) (iii) have been satisfied-there was a valuation of the shares at PD119,861 in the balance-sheet of 30th September 1935, and a revaluation by the directors on 11th October 1935, and the sum of PD87,500 which was appropriated in payment for the bonus shares was part of the profits disclosed by that revaluation. It is contended for the taxpayer that the facts which I have just stated, added to the undisputed fact that the shares were not acquired for the purpose of resale at a profit, bring about the result that the dividends should not be included in the taxpayer's income for the purpose of the Act.
The commissioner, however, contends that other evidence shows that there was no revaluation of assets within the meaning of the section. It is urged that there cannot be a revaluation unless there has been a prior valuation of the same assets; that there was no prior valuation of the 176,121 shares, and that there was no genuine revaluation, but only an alteration of book values for the purpose of endeavouring to pay a dividend in the form of bonus shares which would be free from taxation in the hands of shareholders. The new shares received from the Carlton United company were taken into the balance-sheet as worth nothing because (the taxpayer contends) the figure of PD119,861 remained unchanged as the value of the Carlton United shares, although the number of those shares had increased. But the commissioner argues that the new shares were a new asset and that the attribution of no value to an asset cannot be called a valuation of that asset. It is argued that, when a company merely makes alterations in its books for the purpose of getting the benefit of such a provision as that contained in s. 44 (2) (b) (iii), it is not genuinely valuing or revaluing its assets.
In my opinion the evidence fully justifies the findings of the learned judge that the original 117,414 shares were undervalued at PD119,861 and that the new and old 176,121 shares together were still under-valued at 24s. each. Indeed, these facts are not really disputed. It is also apparent that the distribution of bonus shares was made by the Castlemaine company with a full realization of the existence of s. 44 (2) (b) (iii) and that the bonus issue was made in order to obtain for the shareholders the benefit of that section. Further, the evidence also justifies the further finding of the learned judge that the issue of the bonus shares by the Carlton United company to the Castlemaine company conferred a real benefit upon the Castlemaine company, and that the issue of the bonus shares by the Castlemaine company to its shareholders conferred a real benefit upon the shareholders of the latter company, even though in each case the increased number of shares owned by each shareholder only represented the same proportional right in respect of the assets of the company as he had formerly possessed by virtue of the ownership of a smaller number of shares. Upon these facts the learned judge reached the conclusion that the revaluation relied upon was not 'a genuine valuation' of the shares.
I proceed now to state more in detail certain findings of the learned judge, with which I agree, though, as will be seen, I do not find myself able to agree with the conclusion which he reaches.
The learned judge found that the 117,414 shares were undervalued at PD119,861 but that 'this was, nevertheless, a genuine valuation of those shares and a revaluation of them would have disclosed a large surplus.' His Honour expressed the same view in the words, 'the valuation of the 117,414 shares at cost was undoubtedly a genuine valuation.' His Honour further said: 'I am not satisfied that the Castlemaine company did truly value its holding of 176,121 shares at PD119,861, although its balance-sheet stated that amount as the value of the shares.' Accordingly 'the valuation of PD119,861 was retained for the increased holding of shares, not because it represented the valuation which the company then placed upon its total holding of shares, but as a step in a scheme to disclose a predetermined surplus, which would be produced by writing up the value of the shares to 24s. each.' From those facts his Honour draws the conclusion that the alleged revaluation was a sham or pretended valuation-'the revision of this fictitious figure (PD119,861) is not a revaluation of that asset. ... The directors were rather merely altering book values than revaluing the assets.' Thus the ground of His Honour's decision is that there was 'no genuine revaluation' of the shares.
If revaluation of assets means an estimate of the full value of the assets, then I agree entirely, not only with the findings of fact, but also with the conclusion of the learned judge that the alleged revaluation of the 176,414 shares at 24s. each was not a revaluation. The evidence is clear that the shares were worth more than 24s. each. But if, for this reason only, the revaluation was not a genuine revaluation within the meaning of the section, I have great difficulty in understanding how the figure of PD119,861 in respect of the 117,414 shares can be said to have been a genuine valuation. There was no evidence whatever (as distinct from surmise) to show that the actual value of the shares at any time was PD119,861. That sum represented simply the cost price of the shares, and it was retained as a constant valuation notwithstanding changes in value from time to time. There is much evidence to show that prudent directors of a company decline to overvalue assets in their balance-sheets, and that it is a common and generally approved practice in well-managed companies to understate the value of assets. The reasons which have led to the general adoption of this practice are referred to in the judgment of Fletcher Moulton L.J. in In re Spanish Prospecting Co Ltd [F5] , at pp. 99, 100.
But the existence of this practice, however well founded it may be from a commercial point of view, cannot change into a 'real' valuation, in the sense of a genuine estimate of value, that which is not an estimate of value at all, but simply a figure prudently chosen so as to be certainly not above the real value of the asset in question. When assets are taken into a balance-sheet at a value known to be much less that the real value, it seems to me to be clear that it cannot be said that the stated value represents a valuation of the assets if 'valuation' is interpreted as meaning a genuine estimate of value. But such a figure does represent a valuation if valuation is interpreted as meaning a bona-fide assignment of a figure as representing the value of assets for accounting purposes.
The contention of the appellant may be simply stated in the proposition that profits arise from a revaluation of assets whenever the value of assets is written up in the books of a company. It is urged that s. 44 (2) (b) (iii) recognizes the ordinary safe and sound practice of understating the value of assets for accounting purposes, and that it is intended to permit companies to write up the value of capital assets, and to pay a tax-free dividend out of such written up value, if the dividend is distributed in the form of bonus shares in the company. This is what the company has done in the present case.
In all balance-sheets up to 30th September 1935 the company retained cost price as representing the value of its holding in the Carlton United company. If the adoption of a recognized business practice in assigning cost price as the constant value of assets which have in fact appreciated in value can ever be a valuation in the relevant sense, then the figure of PD119,861 in the 1934 balance-sheet represented the valuation of the 117,414 shares then held and the same figure in the 1935 balance-sheet represented the value of the 176,121 shares then held. In each case the holding of the Castlemaine company in the Carlton United company was valued at its cost to the former company.
The only basis upon which this conclusion can be resisted is that a valuation (and a revaluation) must be a genuine estimate of full value. But this proposition is expressly disclaimed on behalf of the commissioner, who, as already stated, is prepared to concede that the retention of PD119,861 in the balance-sheet for many years as the apparent value of shares which were in fact worth a greater sum was a genuine valuation. The proposition is also rejected by the learned trial judge. But it appears to me to be impossible to define valuation as a genuine estimate of value and at the same time to regard an admitted underestimate of value as a valuation, however commercially wise such an understatement may be.
If it is not necessary to make as true as possible an estimate of value in order to have a valuation within the meaning of the section, I cannot see why what would otherwise be a valuation should cease to be such because it is made in view of provisions of income-tax legislation which allow freedom from tax if a certain course is followed. The desire to take advantage of relatively benevolent provisions of the Income Tax Assessment Act cannot in itself invalidate the procedure which the Act itself requires as a necessary antecedent to the application of those provisions. Thus, in my opinion, upon the basis that a valuation or revaluation is not necessarily an estimate of real value at a particular time, there is no reason for describing a valuation as a sham or as not genuine simply because it is not such an estimate or because it is made for the purpose of obtaining an advantage which the Act offers to those who comply with its terms.
It is objected that on 11th October 1935 the directors signed the balance-sheet as of 30th September 1935 and on the same date determined to write up the value stated in the balance-sheet so as to be able to distribute tax-free bonus shares. This objection is based on the view that the directors could not 'really' have valued the shares at different amounts on the same day-there being no evidence of any change of value on that day. The same criticism, however, would be applicable in any case where a valuation which had been allowed to stand up to a particular day was then varied as the result of the adoption on that day of a revaluation. Whenever there is a revaluation there must be a change at a particular moment from the adoption of one value to the adoption of another value. The objection loses all its force if the section contemplates and provides for the effect of the procedure of writing up in accordance with commercial practice-even though such writing up be done with full knowledge of the provisions of income-tax law.
Thus, in my opinion, the argument actually presented for the commissioner, involving as it does the admission or concession that the adoption of an admitted undervalue may be a valuation within the meaning of s. 44, leads to the result that the appeal should succeed. There was a valuation as at 30th September 1935 of all the shares, new and old, at PD119,861. There was a revaluation on 11th October at 24s. a share. Both figures were undervalues, but both represented a valuation in the relevant sense. Profits arose from the revaluation and the profits were used in dividends which were satisfied by the issue of shares including the shares of the appellant.
It has been urged, however, for the commissioner, that if the section is construed so as to permit a company first to write down assets and then to write them up and to pay a tax-free dividend in the form of bonus shares, the result will be that distribution of ordinary trading profits may be made periodically without any liability in the shareholder to tax. When a company had made profits it could write down some capital asset to any desired extent and then, by subsequently writing it up, could create an apparent capital profit which it could place in a reserve fund and out of that fund distribute a dividend and satisfy the dividend by the issue of bonus shares. In the first place, however, there are practical limitations upon the indefinite issue of bonus shares by a company. Further, such a writing down of assets by a company without any kind of business justification followed by a writing up might well be held to be an arrangement which was obnoxious to s. 260 of the Act and so to be void as against the commissioner. But there would be no reason for the application of that section in a case such as the present where there has been a bona-fide valuation of assets at cost continued for many years in accordance with a common and justifiable business practice, and a subsequent writing up of the value of the assets to a figure which is well within the real value. In the present case the difference between the value of the shares at cost and the written-up value certainly represents a real increase in the value of capital assets, though it does not represent the whole of that increase.
The only alternative to the view which I have put appears to me to involve a disregard of well-known accountancy practice and to deal with the accounts of companies upon a basis which, it is well known, does not exist in fact. If, for the purpose of the section, revaluation means the operation of 'genuinely' re-estimating the real value of assets which have already been the subject matter of valuation (in a corresponding sense), then the section would apply to very few existing companies. The evidence shows that in company accounts it is the ordinary practice to value assets 'conservatively,' that is, not to take them in at full value. The balance-sheet values would hardly ever represent the result of a process of valuation in the sense stated, and yet a balance-sheet provides the necessary and universally recognized means of presenting a view of the assets and liabilities of a company. All or nearly all balance-sheet values would be irrelevant in relation to the section. The possibility of applying the section would depend upon the mere chance of a 'real valuation' of an asset happening to have been made at some time in the past, though in nearly every case that value would not have been represented by any figure in the accounts of the company. In the absence of the accident of such a valuation the section could not be applied unless, indeed, it could be held that a valuation could at any time be made as a retrospective valuation and that a revaluation could subsequently be made. But if the section were interpreted so as to cover such a procedure when both the valuation and the revaluation were made for the purpose of escaping payment of income tax, s. 260 of the Act might well apply. If so, the result would be that the section would in practice, in the case of existing companies, never apply to any company which, for reasons of prudence and good business practice, had followed recognized methods of accounting, unless some value other than that which appeared in the company's balance-sheet had at some time been attributed to a capital asset of the company. An ordinary company could not make a bonus issue of tax-free shares even though there had been a real increase in the value of capital assets. But a company which, in its balance-sheet or elsewhere, had happened to make a valuation of assets at full value could revalue, and then the section would apply to make such an issue of bonus shares possible. Upon such a view the application of the section would necessarily be capricious and arbitrary.
I can see no reason for reading the section in a sense which excludes a recognition of ordinary and well-known company practice. In my opinion the section is intended to recognize that practice, with the result that values attributed bona fide and in the ordinary course of business to assets in the balance-sheet of a company may properly be regarded as the result of valuations. If those assets are found to have increased in value (which is the present case) and are bona fide revalued at a higher figure, then profits are disclosed which arise from a revaluation, and, if the other conditions of the section are satisfied, as they are in the present case, the bonus shares received from the shareholder do not form part of his assessable income.
In my opinion the appeal should be allowed and the assessment should be amended by excluding therefrom all reference to the 801 shares which were issued to the appellant.