Dickson v Federal Commissioner of Taxation

62 CLR 687

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(Judgment by: Evatt J)

Between: Dickson
And: Federal Commissioner of Taxation

Court:

Judges: Latham CJ
Dixon 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)

Hearing date: 23 March 1939; 24 March 1939; 2 June 1939; 31 October 1939; 1 November 1939; 2 November 1939
Judgment date: 21 February 1940

MELBOURNE

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Judgment by:
Evatt J

The Commonwealth Income Tax Assessment Act 1936-1938 includes in the 'assessable income' of a resident who is a shareholder in a company, the dividends paid to such shareholder (s. 44 (1)). 'Dividends' are defined so as to include the paid-up value of shares distributed by the company to its shareholders to the extent to which the paid-up value represents a capitalization of profits (s. 6).

But for the express statutory provision, the paid-up value of bonus shares issued and allotted to a shareholder in pursuance of a scheme of capitalizing profits could not possibly be regarded as 'income' in the hands of the shareholder. But the Commonwealth income-tax legislation made a shareholder's tax liability in respect of his receipt of bonus shares dependent upon the extent to which their paid-up value represented a capitalization of the company's profits.

From the point of view of a sound economic distinction between capital and income, this rule may seem artificial, even arbitrary. For such reason, no doubt, the actual or supposed harshness of the result produced has been mitigated by s. 44 (2) (b) (iii), which provides that the assessable income of a shareholder shall not include dividends paid wholly and exclusively out of 'profits arising from the revaluation of assets not acquired for the purpose of resale at a profit ... if the dividends paid from such profits are satisfied by the issue of shares of the company declaring the dividend.'

This appeal from the judgment of McTiernan J. involves consideration of the meaning and application of such provision. What does it do? It exempts a shareholder from liability to pay income tax in respect of the paid-up value of bonus shares issued to him and does so although the fund which the company uses for the payment of the liability on the bonus shares consists entirely of profits: provided that such profits are of a specified character. The profits must have arisen from the 'revaluation' of what will hereafter be called the 'fixed' (as distinct from the 'floating') assets of the company-i.e., from the revaluation of assets 'not acquired for the purpose of resale at a profit.'

It seems to me that some aspects of the legislative scheme embodied in clause iii of s. 44 (2) (b) may at once be noted.

1.

The clause requires that the 'dividend' of the shareholder shall be 'satisfied' by the issue to him of the bonus shares. This requirement may be expressed with at least equal accuracy by saying that each shareholder's obligation to pay for the bonus shares is 'satisfied' from portion of a special fund of 'profit' which is credited to the shareholder.

2.

The special fund of profits must arise from 'the revaluation' of the fixed assets of the company.

3.

From such special fund and from it alone, the company must 'pay' to each shareholder the 'dividend' representing payment for the bonus shares distributed.

4.

Section 44 (2) (b) (iii) postulates that 'profits' may 'arise' from the 'revaluation' of fixed assets. It contemplates that, from time to time, a company may decide to assign a new valuation to part or all of such assets; and that if such revaluation reveals or evidences an accretion or gain, the fact of such accretion or gain, or any part thereof, if duly capitalized and distributed to the shareholders in the form of bonus shares, will not render a shareholder liable to income tax in respect of such distribution.

5.

In the case of a 'holding' company which retains shares in other companies by way of permanent or indefinite investment, the shares in such companies, including 'bonus shares' issued by it, may be, and ordinarily will be, fixed assets within the meaning of the clause.

6.

The clause does not contemplate, still less require, any departure by a company from the well-established practice of (1) valuing its fixed assets at cost for the purpose of presenting its balance-sheet, (2) continuing such valuation of fixed assets at cost despite the fact that there has been a probable or a certain accretion in value of such fixed assets, and (3) rewriting the value of such fixed assets at a higher figure at such times and upon such occasions as those in charge of the business of the company think fit, even though such higher figure is considered by such persons still to understate the true value of the fixed assets.

The well-established practice in relation to companies is evidenced by many standard authorities. According to Professor L. R. Dicksee, fixed assets are 'those which, in a broad sense, represent the equipment of the undertakings: the possessions which it owns with the object of continuing to hold them in their existing form, and to use them as a means, directly or indirectly of making profits. They are held for use.' (Encyclopaedia Britannica, 14th ed., vol. 2, p. 957). This leading authority has pointed out that:

1. 'Because the fixed assets of an undertaking are not intended for sale, but rather for use, their precise realizable value at any given moment is comparatively unimportant, so long as there is always a sufficiency of floating assets to meet the floating liabilities as they fall due.'

2. 'It is not reasonable in all cases to assume that the figures attached to the various items of a balance-sheet represent in the view of the accounting parties their respective current realizable values; but it is submitted that if, the published balance-sheet is to serve any useful purpose, the basis of valuation should be stated in each case.'

3. 'Most successful companies have fixed assets actually worth more than the figures set against them in the balance-sheet, and the provision for outstanding liabilities is commonly upon the generous side. Usually, therefore, a successful concern has in fact a secret reserve' (ibid.).

In the Australian edition of F. R. M. De Paula's work on Auditing, it is said:

'Fixed assets are valued upon the basis of cost. ... Fixed assets are not valued upon their saleable value, but upon their value to the proprietor of the business-in other words, upon their ability to earn profits (regard being had to their cost) and not upon their intrinsic worth. ... It must be observed that an auditor cannot possibly value the assets of the businesses whose accounts he audits. This valuation must be carried out by the partners, directors or other responsible officials' (The Principles and Practice of Auditing, Austn. ed., pp. 100-101).

From the fact that successful companies will continue to value their fixed assets at cost, despite the fact of antecedent accretion in value, it necessarily follows that the description of the company's position as contained in any particular balance-sheet will understate the true strength of the company's position, and the effect of such understatement will be increased as the fixed assets further appreciate. But, in the absence of any intention to deceive or defraud, this understatement concerns only the company and its shareholders. As Lord Wrenbury has pointed out in relation to a balance-sheet illustrating the above principle, 'the result will be to show the financial position of the company to be not as good as in fact it is. If the balance-sheet be so worded as to show that there is an undisclosed asset, whose existence makes the financial position better than that shown, such a balance-sheet will not, in my judgment, be necessarily inconsistent with the Act of Parliament. Assets are often, by reason of prudence, estimated, and stated to be estimated, at less than their probable real value. The purpose of the balance-sheet is primarily to show that the financial position of the company is at least as good as there stated, not to show that it is not or may not be better' (Newton v Birmingham Small Arms Co Ltd ^[F10] , at p. 666).

These matters are of decisive importance in the interpretation and application of s. 44 (2) (b) (iii) of the Income Tax Assessment Act. As a general rule, a company will gain no advantage by revaluing and 'writing up' fixed assets which have long stood in its books and balance-sheets at cost price. But some tangible advantage will or may be gained if the purpose of the company is to use part or all of the accretion which will ultimately appear when the fixed assets are revalued either at their full value or at some figure higher than the original 'cost.' That those in charge of a company's affairs may attempt to gain such an advantage is not ground for criticism, particularly when the company itself if general meeting approves and endorses the action of its directors. Unless it be for the purpose of gaining some such advantage, revaluation of a company's assets previously taken in 'at cost' would be an absurd and futile procedure. Referring to a case in which it was sought to make the directors of a company liable for misfeasance because a revaluation of assets had been attempted by one of the directors without any 'outside' assistance, Peterson J. said:

'It was said that the object of this revaluation was to enable the company to obtain further capital by the issue of preference shares. I think that this is so; but there is nothing unlawful or reprehensible in that object. The only ground on which complaint could be made is that the object was achieved by improper means. The directors no doubt would have been better advised if they had obtained a revaluation from some expert valuer, although, if one may judge by the evidence on the subject which I have heard, the margin of difference between the views of values on the subject is very great. But there is no rule of law which requires directors to obtain outside assistance in such matters or prevents them from valuing the property themselves, provided, of course, that they act honestly in doing so' (Ammonia Soda Co v Chamber lain ^[F11] , at p. 513).

In the present case, the actions of the company's directors has not been challenged upon the ground of impropriety; and from first to last, such actions have met with the entire approval of the shareholders.

I now turn to the facts of the particular case. The taxpayer, who is the present appellant, was a shareholder in the Castlemaine Brewery Company Melbourne Ltd (hereinafter called the Castlemaine company). He received 801 bonus shares from the company in pursuance of a scheme of capitalizing profits embodied in certain resolutions. The fund from which the obligation to pay for the bonus shares was discharged was a fund of PD87,500 out of a total sum of PD91,483 19s. consisting of profits from a revaluation of fixed assets duly credited to an account called 'the assets revaluation reserve account.' The fixed assets alleged to have been revalued consisted of the company's total holding of 176,121 shares in the Carlton and United Breweries Ltd (hereinafter called the Carlton company). The crucial question is whether in truth the said sum of PD91,483 19s. was a profit arising from the revaluation of such holding of 176,121 shares in the Carlton company.

At all material times, the Castlemaine company was a holding company, a main object being to hold as investments shares in the Carlton company. It is expressly admitted that 'the Castlemaine Brewery Company Melbourne Ltd did not acquire any of the shares held by it at any time in the capital of the Carlton and United Breweries Ltd for the purpose of resale at a profit.' It follows that the whole of the 176,121 shares were fixed assets of the Castlemaine company within the contemplation of s. 44 (2) (b) (iii) of the Income Tax Assessment Act.

The evidence shows that the Castlemaine company's total holding in the Carlton company was acquired over a long period of years. (1) First of all, it acquired 102,500 shares fully paid up to 20s. Until September 30th, 1934, these shares were always included in the assets side of the annual balance-sheets at cost price, viz., PD102,500. (2) The company subsequently acquired 5,125 preference shares in the same company at the cost of PD1 each, and, up to September 1934, these shares also were valued at cost, viz. PD5,125, in the company's balance-sheets. (3) Finally, the company acquired 9,789 preference shares at a cost of 25s. each, and this asset also was always included in the company's balance-sheets at cost, viz. PD12,236 5s.

Accordingly, the balance-sheet bearing date September 30th, 1934, showed that the company held a total holding of 117,414 shares in the Carlton company, and the value ascribed to the total holding was the cost of acquiring the three groups, viz. PD102,500 plus PD5,125, plus PD12,236 5s. totalling PD119,681 5s.

Shortly after the issue of the balance-sheet dated September 30th, 1934, the Carlton company decided to make a bonus issue of fully paid-up shares, and, as a consequence, the Castlemaine company became entitled to receive 51,250 ordinary, and 7,457 preference shares, totalling 58,707 Carlton shares. These shares were duly allotted to the Castlemaine company in December 1934, and the scrip was received by it in January 1935.

The secretary of the Castlemaine company, Mr. Scott, explained that the directors of the company decided to group the 58,707 new shares with the existing shareholding of 117,414 shares, and, in respect of the total fixed asset of 176,121 shares, to continue for the time being the policy adopted throughout the history of the company of valuing at cost. As the cost of the bonus shares was nil, it necessarily followed that the 176,121 shares would be valued at the cost of the 117,414 unwatered shares, viz., PD119,681 5s. 'We decided,' said Scott, 'from the receipt of the shares to continue to value them at cost.' And the same witness pointed out that no consideration whatever was given by the Castlemaine company for the bonus shares. No doubt, it was mainly for this reason that no specific entry in respect of the bonus shares was made in the ledger of the Castlemaine company when the scrip was received in January 1935. There was no absolute necessity for such an entry, and it is beyond question that those in charge of the Castlemaine company had already determined to revalue the company's Carlton shares at some time late in the same year. Indeed, the present appellant, who was the chairman of directors of the Castlemaine company, had announced in December 1934 that when the Carlton company had issued the bonus shares, the directors of his company would, at some convenient period during 1935, consider the advisability of revaluing the assets of the company with a view to making on its own account an issue of bonus shares.

This general plan was duly carried to completion. From first to last there was no concealment whatever; and I do not think that any question as to taxation liability would have arisen, but for the startling effect produced upon the mind of some departmental official by the apparent contrast between the Castlemaine company's balance-sheet of September 1934 and September 1935. Yet what was done in the latter balance-sheet was merely to set forth the company's holding of 176,121 shares in the Carlton company and to value such holding at cost, in strict accordance with accountancy practice and the company's past procedure. Inasmuch as the bonus shares cost nothing, one result was that the 102,500 shares held as at September 30th, 1934, was lumped together with the 51,250 ordinary bonus shares acquired since September 30th, 1934. The 102,500 shares held on September 30th, 1934, were then valued at PD102,500, (i.e., their cost); whereas, on September 30th, 1935, 153,750 ordinary shares were valued at PD102,500, i.e. the same figure. As PD102,500 was undoubtedly the cost price of the 153,750 ordinary shares held on September 30th, 1935, the dilution of the old ordinary shares by the bonus issue was shown as reducing the value of each ordinary share from PD1 to 13s. 4d.

Similarly with the two groups of preference shares. The bonus shares acquired were shown as added to each group.

In my opinion, the procedure adopted in the balance-sheet was justifiable. Once it is admitted that, despite steady accretion in value, fixed assets may properly be valued at cost, such method of valuation should be followed to its logical conclusion until some other basis of valuation is adopted. It may at once be conceded that, on September 30th, 1935, the 176,121 Carlton company shares held by the Castlemaine company were worth a sum considerably in excess of the PD119,861 5s. then attributed to them in the balance-sheet. But this discrepancy, if that is the correct word for it, was equally present in the balance-sheet of September 30th, 1934, and during many previous years as well.

A great deal of the argument for the respondent was based upon the theory that, after the watering of the Carlton shares, none of the shares was reduced in value by the watering: so that the proper inference is that in September 1935 the shares were deliberately undervalued. This theory is opposed to the evidence and to the weight of authority. The evidence shows that, after the issue of the bonus shares in the proportion of one to two, the value of the Carlton shares was reduced to a value of approximately two-thirds of the previous market value per share. Of course, the evidence does not show that, after the bonus distribution, the value of each ordinary share was reduced from PD1 to 13s. 4d. But it does show that, just so far as the value of 13s. 4d. per share failed to express the then market value of each ordinary share so the 1934 balance-sheet value of PD1 per share failed to express the then market value of each ordinary share. Speaking proportionately, the 1935 value of 13s. 4d. per share was just as accurate as the 1934 value of PD1 per share. This matter of fact I refer to hereafter.

The effect of a bonus distribution of paid-up shares upon the value of shares previously held has been adverted to in the leading cases as to the nature of a capitalization of profits carried through by a bonus distribution of shares.

In the leading United States decision Eisner v Macomber ^[F12] , at p. 530, Pitney J. said that the issue of the new shares 'does not alter the pre-existing proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share.' (I italicize the relevant phrase.)

Later, in Blott's Case ^[F13] Viscount Cave referred to the 'luminous reasoning' of Pitney J. which, so far as it discussed the supposed 'income' character of bonus shares or 'stock dividends,' was accepted by Holmes J. whose dissent was based upon a special ground.

In the United States, the economic and business aspects of the dispute have been regarded as authoritatively settled by the judgment of Pitney J. Thus, Thomas Reed Powell, a very eminent authority, commented: 'So far as Eisner v Macomber ^[F14] , at p. 530] turns on economic issues, the majority has much the better of the argument' (Columbia Law Review, vol. 20, p. 536).

Professor Powell also said:

'Only Mr. Justice Brandeis and Mr. Justice Clarke thought that stock dividends really are income, and possibly even they did not go quite so far. They had agreed in Towne v Eisner to include a stock dividend. They acquiesced in the analysis that a stock dividend is nothing but a rearrangement of the indicia of what is already capital to the stockholder. As Mr. Justice Holmes put it: `In short, the corporation is no poorer and the stockholder is no richer than they were before'.'

An excellent illustration of the operations involved was given by Scrutton L.J. in the Court of Appeal in Blott's Case ^[F15] , at p. 676:

'A company of PD10,000 share capital has assets which have increased in value to PD20,000, and it has PD20,000 reserve fund of undivided profits. Its PD1 shares may be worth PD4. It thereupon capitalizes PD10,000 of its reserve fund, and issues 10,000 new shares fully paid. The result is that the same profits and property which were divisible among 10,000 shares become divisible among 20,000 shares with the probable result that the shares which were PD4, may fall to PD2 each, the exact fall depending on the prospects of the company and the higgling of the market.'

It is to be observed that Scrutton L.J. is dealing with cases of actual market value, which in the case of a holding company like the Castlemaine company was of little interest or importance. The company was never interested in the market. When a bonus issue is contemplated, speculators may enter the field and take a profit or make a loss, so that as Scrutton L.J. recognized, the diluted shares may not fall in value per share according to the exact mathematical formula of theory. None the less, a bonus issue of 'one for two' will usually reduce the value of each unwatered share to about two-thirds of its previous value. From a slightly different angle, the illustration of Scrutton L.J. was accepted in the House of Lords in Blott's Case ^[F16] . There Viscount Finlay said:

'The shareholder got his proportionate share in the business of the company as increased by the additional capital. The proportion of his share in that business as compared with the proportions of other shareholders was in no way affected by the issue of the preference shares, as all the shareholders alike got them. The benefit, and the sole benefit, which the respondent derived was that the business in which he had a share was a larger one with more capital embarked in it, precisely as might have been the case if the accumulated profits had been applied in the improvement of the company's works and machinery.'

I cite this imposing array of reasoning not to show that as a matter of law the Castlemaine company was bound to regard its aggregate holding after the bonus issue (i.e., 176, 121 shares) as being of precisely the same intrinsic value as its previous holding (117, 414 shares), but to show that the company was clearly entitled to treat the intrinsic value of its holding as being unchanged by the bonus distribution. If so, the automatic result of the valuation of the aggregate holding at the same figure was to give a reduced value to each old share, the amount of the reduction being 33 per cent of its antecedent value, and of course to give to each new bonus share a value equal to the new value of each old share.

As at September 30th, 1935, therefore, the company's valuation of the 176,121 shares (including the 58,707 bonus shares) remained at PD119,861 5s. The retention of such figure was not part of a scheme of writing down in order to write up, but a necessary result of its decision to retain valuation at cost pending revaluation, a decision amply justified by the economic factors involved in every bonus distribution.

Subsequently, on October 9th, 1935, two independent accountants revalued each of the 176,121 shares, and agreed that each was worth at least 24s. per share. Thereupon, on October 11th, the directors decided to take all the 176,121 shares into account in the company's books at a value of 24s. per share. The resulting aggregate value of the shares was PD211,345 4s. which exceeded by PD91,483 19s. the value of PD119,861 5s. appearing in the balance sheet of September 30th, 1935. Of this excess of PD91,483 19s., it was determined to utilise PD87,500 in order to make a bonus issue to shareholders of 100,000 shares of 17s. 6d. each, fully paid.

The Castlemaine company thus made two distinct and separate valuations of identical assets (the 176,121 shares), the first based upon the principle of cost valuation which had been in force ever since the company was formed, and the second being a valuation based upon the opinion of the directors (confirmed by outside valuers) that the value of each of the 176,121 shares could safely and prudently be treated as increased to 24s. per share. The gain revealed by a comparison of the two figures should be regarded as a profit arising from a revaluation of the 176,121 shares within the meaning of s. 44 (2) (b) (iii) of the Income Tax Assessment Act.

Before analysing certain contentions raised by the commissioner, it is desirable to turn to an examination of the evidence.

A feature of the cross-examination of Mr. William Scott, secretary of the Castlemaine company was the attempt to prove that, in the balance-sheet of September 1935, the valuation of the 176,121 shares (involving with it the assessment of each ordinary share at 13s. 4d., and of each preference share at 16s. 8d.) was not based upon an opinion of the directors that these were the real values of the shares at the time in question. The following is a typical extract from his cross-examination:

'We are still at the September 1935 balance-sheet. You brought in 58,000 new shares that you had got by the bonus issue at the same figure per share as those other ones. 13s. 4d. for some of them and 16s. 8d. for the others. Is that right? A. That would be the effect.

I am not asking the effect. I am asking-did you bring them in at that figure? A. Yes.

Do not be argumentative. I am not saying there is anything wrong. You brought the old ones in at 13s. 4d. and 16s. 8d. respectively, and the new ones at the same figure. That is the position is it not? A. We treated it as a whole.

I know the effect. I am asking what you did. The balance-sheet shows it? A. That is so.

Did you consider that the old shares were worth less than you paid for them in September 1935? A. I consider that the value had been reduced by the bonus issue.

You did not answer my question. I wish you would address yourself to answering the very question asked of you. The question is-did you consider that the old shares were worth less than 20s.?

Mr. Fullagar K.C.: I object to that question. It is not a relevant question in the inquiry.

His Honour: I will admit it.

Mr. Tait: Now will you please answer the question. Did you consider that the old shares were worth less than 20s. in September 1935? A. I did not consider the value of the shares individually at that date.

Do you consider now that any one share, held in the Carlton company was worth less than 20s. on September 30th, 1935? A. I consider they must have been worth at least 20s. at that date.

And you will agree that anybody who had considered it at that time would have thought the same? A. Yes.'

It will be observed that Mr. Scott is merely being forced to repeat what is obvious, viz., that on the 1935 balance-sheet, the directors continued to bring in at cost the 176,121 shares and that this decision necessarily carried with it a reduction in the value per share as compared with September 1934. It is also clear that Mr. Scott believed that the value per share of the old shareholding had been reduced by the bonus issue. His statement that, on September 30th, 1935, as a matter of actual value, all the shares were worth at least 20s. is plainly correct; but in my view the fact is irrelevant.

Later in the cross-examination, the attention of the witness was again drawn to the same point:

'Did they consider the real value of these new shares in-take the next date, August 1935; that being the time when they decided to have the revaluation made? A. They did not consider it then.

They did not consider the real value in September, 1935, when the balance-sheet was made out? A. No.

But they brought those new shares into the balance-sheet at 13s. 4d. and 16s. 8d.? A. They brought the total holdings in at cost. That is the best way I know of answering the question.

Did they consider that same question, the real value of the new shares, in October, 1935, when the directors decided to write up the value? A. They revalued them at 24s.'

In this passage, counsel is only attempting to lay the ground for a contention of law that there can never be any valuation or revaluation of fixed assets within the meaning of the Act unless there is a determination of the governing body of the company as to the 'real value' of such assets. In my view, such contention is erroneous, and it was not pressed very seriously on the present appeal.

Mr. Scott explained the position clearly and frankly:

'One of the things you should consider is, what the values are of assets? A. Not of fixed assets.

You consider the other assets; what the liquid assets are? A. I do the trading assets.

And that you put down as subject to certain things, as the value recorded as true value? A. Of trading assets, that is so.

Whether you put the value in or not; the corresponding true value of fixed assets, the fixed assets have a true value? A. Yes.

But what you are saying is that in the balance-sheet you did not bring in the true value of the fixed assets? A. Not necessarily.

Those Carlton United shares were fixed assets? A. Yes.

Now you know what the true value means? A. Yes.

It is not a thing you bring in on fixed assets in the balance-sheet, but the same value as the trading assets, the true value? A. Yes.

Did they consider it. You do not need to know it. You have told me they were worth much more than 24s.? A. My opinion of the value would be that they would be more than the directors brought them in at.

I want to know whether they considered what was the true value? A. I find it difficult to answer that question.

Then answer this question. Why do you find it more difficult to answer that question than those you have already answered, namely, whether they have considered the true value at the earlier date. You have told me clearly that they did not at the earlier dates? A. Because at the earlier dates they definitely valued the whole holding at cost at a definite value which had no relation to the real value. In the second case they valued them according to the revaluation.

We have gone into the form of revaluation and why it was in that form? A. The directors made that revaluation at 24s., and the advisers merely advised them as to whether that was justified.

Are you telling the court that the directors made a decision that the real value of these shares was 24s., or did they not merely follow what the auditors told them, that the shares were worth at least 24s.? A. They followed the advice that they were worth at least 24s.

They did not give any consideration to the real value at all? A. I do not think they went into any detail as to the real value.'

It is the same point over again. The witness is stating, in my opinion quite accurately, that at no time did the valuation of the fixed assets in the books and balance-sheet of the Castlemaine company imply that the opinion of the directors was that the assets as so valued were worth only the amount of such valuation. This is true however not only in relation to 1935, but in relation to every year before that. For many years, while the Carlton shares were valued at cost, the real value of the shares was gradually increasing, and, by continuing such valuation, the company was only forming an internal or hidden reserve of profits. The procedure adopted in the balance-sheet of September 1935 which appears to have disturbed some officer of the Commissioner of Taxation was in strict accordance with the procedure adopted in all previous years.

The same comment applies to the valuation of the 176,121 shares at 24s. each. The opinion of the directors was that they could safely value them at 24s. each, although, no doubt, they regarded them as being of a much higher value.

If the view which has already been expressed is sound, it follows that a great deal of the evidence which I have quoted is not material to the question at issue. Mr. Fullagar K.C. objected to the admissibility of the evidence, arguing: 'It is not a question of what the real value of the shares was at all; it is what they chose to make of them in order to release funds of the company. That is what has been making me smile from time to time, the suggestion that there has been a deliberate under-valuation. I am suggesting that it is matter for amusement that there is room for criticism somewhere because the company has not valued those shares at their maximum value. Companies frequently do that.'

In my view, the case of the commissioner, however expressed, turns almost entirely upon the fact that, after the distribution, the value of each share was shown as reduced by one-third of its previously stated value. This result follows as a matter of mere arithmetical calculation unless the company was disentitled to pursue its established method of valuing fixed assets, pending their subsequent revaluation. As the aggregate cost was not added to by the free gift of the bonus shares, the cost per share of the increased holding necessarily became reduced by one-third. The authorities cited above show clearly that, if, before a bonus distribution of one for two, the real value of each share was PDX, it necessarily follows that the real value of every such share after the distribution is reduced to approximately two-thirds of PDX. In the present case, the real basis for the criticism of the commissioner is, not that (e.g.) the ordinary shares were valued at only 13s. 4d. each in September 1935, but that they were valued at only PD1 each in September 1934. As a matter of fact, this must be conceded. In spite of this, no valid objection can possibly be raised to the action of the directors in valuing each ordinary share at two-thirds of PD1. It seems to me to be quite unreasonable to isolate the fact of the reduced value assigned to each share when that result followed inevitably from the continuance of the principle of assessing all the fixed assets at cost, and is entirely justified by the economic results of a watering of stock which is held for investment.

At all times, Mr. Scott acted under instructions from his directors. None the less, he was naturally concerned at the suggestion that, in some mysterious way, his conduct was open to criticism. But his procedure seems to have fully commended itself to Mr. Wilson, an actuary and sharebroker, called by the commissioner. Mr. Wilson was cross-examined thus:

'Suppose a company had taken in at cost parcels of shares in another company which it was holding as a permanent investment and the cost was 20s. per share, you see nothing wrong with that? A. I see nothing wrong with it whatever.

Now, suppose in these circumstances, that there is an issue of one to two shares to holders, and among the holders is this company which has on its books a parcel of the shares at cost: would you agree that it was proper to show the new holding at two-thirds of the previous value, assuming no change in policy in the meantime? A. I think that it would be a matter of consideration for the directors, and I do consider that they would take in their account the fact that the market value of the shares had appreciated by reason of that watering. They might still retain the value.

What I am asking you is, first of all, to take a case in which at all times you had them in your balance-sheet at cost, whatever their market value had been, up or down. Do you follow? A. Yes.

And the directors of the company, I am assuming, are maintaining that policy of keeping the assets in at cost.

Would you not agree then that there, after the watering of one to two, they would show at cost the new shares at 13s. 4d.? A. Undoubtedly, if they are maintaining that policy of keeping them at cost, they would not alter it.'

Mr. Wilson was called by the commissioner because prior to, and immediately after, the issue of the bonus shares, the market value of the shares in the Carlton company was said to be considerably in excess of the value attributed by the Castlemaine company both to the unwatered and to the watered shares of the Carlton company. Mr. Wilson was asked:

'Am I right in attributing to you that, as at the time when the distribution was announced, your personal estimate of the value of the Carlton and United shares was 54s. for the unwatered shares? A. Yes.

And for the watered shares it was 36s.? A. Yes.

Is it the position that if your 54s. figure is correct-I do not say it is not-the 36s. follows automatically? A. That is so.

May I take it that your view, as an expert, is that when you have a watering which involves the distribution of 1 to 2, once you find the value of the unwatered stock, it is a matter of simple arithmetic to find the value of the watered stock? A. It is a matter of simple arithmetic, involving sometimes other considerations than a mere proportionate value. Sometimes the watered shares do not carry the same first-year dividend as the unwatered.

Quite so, but I am entitled to conclude from the figures you have given me that this is not an exceptional case? A. I think it was not. I am afraid that is a point, when working out the figures I did not go into, to see if the new Carlton and United shares carried the same dividends as the old shares.'

From this witness, therefore, the Castlemaine company obtained a striking vindication of its action in valuing each share after the watering at precisely two-thirds of its value before watering. This is in accordance with the general principles and illustrations suggested from the cases which I have cited. The fact that in the opinion of the witness each unwatered share was worth 54s. and each watered share was worth 36s. is very interesting, but, in my opinion, quite immaterial and irrelevant. Once it is admitted that it is within the power of the governing body of the company to value its fixed assets at cost, to create an internal reserve by continuing conservative valuations, and to revalue such fixed assets as and when it thinks fit in order to create a fund of profits, consideration of actual or market value becomes irrelevant for the purposes of s. 44 (2) (b) (iii).

I now turn to deal with the grounds relied upon by the commissioner for his decision that s. 44 (2) (b) (iii) does not apply, and that the paid-up value of the 801 shares (fully paid up to 17s. 6d. per share) should be included in the assessable income of the appellant.

1. One contention (that adopted by McTiernan J.) was that the value assigned to the 176,121 shares in the balance-sheet referable to September 30th, 1935, was a 'sham value,' that the directors were 'rather merely altering book values than revaluing the assets,' that, at the time of the balance-sheet of September 30th, 1935, the company or its directors were already of opinion that each share had an actual value of not less than 24s. per share, and that the figure of PD119,861 5s. was retained in the balance-sheet as part of a scheme of writing down values with a view to writing them up subsequently. McTiernan J. thus referred to the balance-sheet of September 30th, 1935:'In truth, that balance sheet did not attribute any value to the additional 58,707 shares allotted in December, 1934. It failed to do so because the shares held by the Castlemaine company had not at that date depreciated in value below par and the par value of these shares, namely, the shares held by the company before it received the 58,707, was the sum of PD119,861. The revision of this fictitious figure is not a revaluation of that asset.'

However, earlier in his judgment, His Honour found that 'the valuation of the 117,414 shares at cost was undoubtedly a genuine valuation.' I take this to mean, not that each unwatered share was worth only the value attributed to it in the balance-sheet of September 1934, but that the company was entitled to assign such value to each share (on the basis of valuation at cost). Obviously the directors, if they addressed their minds to the matter at all, must have considered that in September, 1934, the 117,414 shares then held were worth much more than PD119,861 5s., the figure at which they were valued in the assets column. I agree that the valuation as at September 30th, 1934, was a perfectly proper and justifiable valuation. But it follows that the directors were equally entitled to value the 176,121 shares at precisely the same figure in September, 1935. Each of the two valuations was based upon the cost of acquiring the fixed assets. If valuation at cost was proper in relation to the first balance-sheet, it was equally justified in relation to the second.

I fully accept the finding that in September, 1935, the directors believed that each of the watered shares was worth at least 24s. per share. But it is also plain that in September 1934, they must have believed that the true value of each of the 117,414 unwatered shares was very greatly in excess of the value at which they were then stated in the balance-sheet. I agree that late in 1934, and early in 1935, the directors had, as Mr. Scott admits and asserts, determined to value the 176,121 watered shares at the cost of acquiring them, and that this determination meant that the aggregate value of PD119,861 5s. was to be retained in the September 1935 balance sheet. I will assume also that, early in 1935, the directors determined not to revalue the watered shares until after September 30th, 1935, in respect of which date the balance-sheet of the year 1934-1935 was to be issued. In one sense, undoubtedly, the decision to continue valuation at cost was a step in a scheme of creating a fund of profits which was to be used in a particular way. But all this is true of every balance-sheet valuation in which a successful company values its fixed assets at cost, and deliberately refrains from revaluation until the time arrives when, in the judgment of the directors, it is proper and convenient to obtain the use of the whole or any portion of the resulting accretion as profits of the company. It is only in that sense that the valuation in the balance-sheet of September 30th, 1935, can fairly be characterized as a 'sham' or as being 'fictitious' or as constituting a step in the carrying out of a scheme of making profits available and distributing them.

It is to be observed that s. 44 (2) (b) (iii) does not speak of profits arising from the 'increase in value' of certain assets, but of profits arising from 'the revaluation' of such assets. It is for this reason that I have held that the clause addresses itself to the existing practice of presenting company accounts and of allowing a company a wide discretion in the method it adopts for assigning a value to its fixed assets.

It seems to me that the final conclusion of His Honour was due to his opinion that 'I am satisfied in this case that the value of the holding which the Castlemaine company had in the Carlton and United Breweries Ltd was substantially increased by the allotment to it of 58,707 bonus shares in December, 1934.'

It is to be observed that Mr. Wilson, in his evidence, does not expressly deal with the value of the total holding of the Castlemaine company in the Carlton company (1) before, and (2) after, the bonus distribution. However, he estimated (1) that before the official announcement of the issue of the bonus shares was made, the value of such Carlton shares was 53s. per share; (2) that after the announcement was made, the value was 54s.; and (3) that when the process of watering was complete, the value of each share had fallen to 36s. From these figures, it might be deduced that, long before the allotment of the new shares to the Castlemaine company, the 117,414 shares had appreciated in value from 43s. per share to 54s. per share. If so, the value of the Castlemaine company's holding of Carlton shares was not increased to any degree by the former's actual acquisition of the bonus shares, but rather by the opinion of the market that the unwatered shares were at far too low a price having regard to the fact that a watering was probable, and that, in the long run, shareholders might reasonably expect to receive greater proportionate profits from the business of the Carlton company. The figures would require revision because the shares in the Carlton company were owned almost entirely by holding companies such as the Castlemaine company, so that the market was a peculiarly restricted one. But I am not concerned to dispute the fact that, to a substantial extent, the value of the Castlemaine company's holding in the Carlton company was increased by the proposal to issue bonus shares, and by the formal announcement of such proposal, and by the carrying of such proposal into completion. For the crucial point is whether, in the balance-sheet as at September 30th, 1935, the Castlemaine company was entitled to value its fixed assets upon the basis of cost. Every valuation upon the basis of cost postulates that antecedent accretion of value must be ignored.

II. The commissioner also contended that, before the exemption can operate, the assets first valued must be identical with the assets subsequently valued; otherwise there is no revaluation of identical assets. For the purposes of the present appeal, this contention may be accepted, because the requirement is fully satisfied. For the same 176,121 shares as were valued by the directors of the company as at September 1935 at PD119,861 5s. were subsequently valued at the figure of PD211,345 4s., and the material fund of profits was thereby created. But I do not wish to be taken as holding that, in every case, absolute identity of fixed assets must be established in order to permit of the application of s. 44 (2) (b) (iii). I can imagine cases where assets have been and have to be grouped for the purposes of valuation, where minor changes in such assets must take place before the group is subsequently revalued, and where the section may possibly operate. The point need not be pursued further in the present case.

Perhaps I should repeat here that it was not, and, in my opinion, could not, be disputed that bonus shares issued to a holding company in pursuance of a capitalization of profits are 'assets' within the meaning of s. 44 (2) (b) (iii).

III. The commissioner also contended that the gain of PD91,483 19s. from which the sum of PD87,500 was taken to satisfy the obligation to pay in full for the new 17s. 6d. bonus shares, although admittedly a 'profit' of the company, was not a profit arising solely from the revaluation of the 176,121 shares, and also, as I understand the argument, that the paid-up value of the shares issued to the appellant and other shareholders of the company was not paid 'wholly and exclusively' out of the said profit of PD91,483 19s.

It is important to restate what actually took place. Undoubtedly, the paid-up value of the appellant's shares, being 'dividends' with which he would be otherwise chargeable with income tax, came wholly and exclusively from the fund of PD91,483 19s. profits which had been placed to the credit of the company's 'assets revaluation reserve account.' For the PD87,500, being part of such fund of PD91,483 19s., was devoted entirely to the payment of the new issue of bonus shares. Therefore the 'dividend' of the appellant was paid wholly and exclusively out of the profits contained in the fund of PD91,483 19s.

The earlier part of the argument is different in character. The real contention seems to be that, although the main source of the gain of the PD91,483 19s. was the revaluation of the 176,121 shares, another, though subordinate source, was the allotment to the company of its part of the bonus issue. But if, as has been held, the bonus shares are themselves portion of the assets which were revalued, the mode and scheme by which such assets came into existence and were acquired by the company are of no moment. As a matter of narrative, it is true that the acquisition of the bonus shares played its part in the final gain, and may, in that sense, be regarded as one of the 'sources' of such gain. But equally the acquisition of the 117,414 shares also played its part before the final gain was crystallized. Through excellent business management, a company may succeed in acquiring fixed assets at a very low cost. Then the procedure of valuing at such cost will be adopted until the time is ripe for revaluation. If, upon such revaluation, a considerable surplus is shown over the cost price carried from year to year in the books, I am of opinion that, on the true construction of s. 44 (2) (b) (iii), such gain is a profit 'arising from the revaluation of assets,' although, as a matter of history, and of remote causation too, one of the 'sources' of the final profit was the good bargain which was made when the assets were originally purchased. Exactly the same principle must apply wherever fixed assets have been acquired by a company without any cost to the company. In the case of an acquisition of bonus shares by a holding company, such acquisition can never represent a clear gain because the true value of the new asset will usually be balanced or very nearly balanced by the depreciation in value of the original holding. But, even in cases where a company acquires a valuable fixed asset for no consideration whatever, the gain revealed upon subsequent revaluation of the fixed assets (including the fixed asset acquired fo r nothing) is a profit 'arising from the revaluation of assets' within the meaning of s. 44 (2) (b) (iii), and it is not material that, but for the acquisition, the profit would not or might not have been so large as it turned out to be. In all such cases, the various acquisitions of the fixed assets constitute occasions without which the company could not have subsequently made a profit from its revaluation of fixed assets. But, I hold that, when the provision in the statute speaks of profits 'arising from the revaluation of assets not acquired for the purpose of resale at a profit,' the circumstances surrounding the acquisition of each asset are only material for the purpose of determining whether such asset is of the character contemplated by the provision. If it is of such a character, the clause postulates (1) that it is an asset from a revaluation of which profits may arise, (2) that the first relevant question is whether the asset (either alone or with other assets of the same character) has been revalued, and (3) that the second relevant question is whether upon a comparison of two values, a gain has been shown. Thus, although 'revaluation' itself can never give rise to or cause profits, but can only show that in the opinion of a valuer, profits have already arisen, the statute looks to revaluation as a possible and exclusive source of profit.

I therefore hold that the profit of PD91,483 19s. arose from the revaluation of the 176,121 shares, and not otherwise, and that it is not material either that the acquisition of the bonus shares was of substantial gain to the company, or that the three previous acquisitions of shares in the Carlton company may have been gainful operations in the business life of the company. Indeed, I think that it can be stated quite dogmatically that, in the case of the Castlemaine company, its acquisitions of the 117,414 shares turned out to be far more gainful and advantageous than the subsequent acquisition of 58,707 bonus shares, assuming that some actual gain was derived from the last acquisition.

Learned counsel for the commissioner suggested that, if the appellant was successful, companies might abuse the provision for exemption. I do not think that there is any real danger of such an abuse. If fixed assets are deliberately undervalued solely with a view to subsequent restoration of the real value, the 'profit' shown from the second part of the transaction will do no more than balance the 'loss' shown from the deliberate undervaluing. Thus, the transaction as a whole will reveal no 'profit.' But these exceptional cases can be dealt with if and when they occur. All that s. 44 (2) (b) (iii) does is to mitigate the very rigid rule that the total paid-up value of bonus shares issued in capitalizing a company's profits should be treated as income in the hands of the shareholder. The legislature has modified the rule in relation to profits of a company which are attributable to accretions in the value of the company's fixed assets. In doing so, the legislature has acted prudently in allowing companies to act according to well-established principles of company management and book-keeping, and in regarding the company's own revaluations of fixed assets as occasions of a profit or gain which may be capitalized for the purpose of a bonus issue. The revenue will always be protected by the restrictions which the general law imposes upon the distribution of company profits and by the fact that, as a general rule, the result of issuing bonus shares is not to make shareholders more wealthy, but to enable the company to distribute an equal, or even a greater, money sum while declaring a lower rate of dividend on the watered shares. I should add that, in the present case, it is conceded that all those concerned in the management of the Castlemaine company acted in good faith, and that there was ample justification in law for its material acts and decisions. Perhaps it should also be added that admittedly the reduction in the share capital of the company which was effected in November 1935 (when the nominal amount of each share was reduced from 17s. 6d. to 15s., the reduction being subsequently approved by the court) has no bearing on the case.

In my opinion, the appeal should be allowed with costs here and before McTiernan J., and the Commissioner of Taxation should be directed to amend the assessment by excluding from the amount of the appellant's assessable income the sum of PD701 attributable to the paid-up value of the 801 shares distributed to him as shareholder in the Castlemaine Brewery Melbourne Ltd

Fullagar K.C., Coppel and Ellis, for the appellant.

Ham K.C. and Tait, for the respondent.

Ham K.C. (with him Tait), for the respondent.

Solicitors for the appellant, Rayes Dickson, Kiddle & Briggs.

Solicitors for the respondent, H. F. E. Whitlam, Crown Solicitor for the Commonwealth.