Mercantile Credits Ltd. v. Federal Commissioner of Taxation.
Judges:Windeyer J
Court:
High Court
Windeyer J.: Mercantile Credits Limited, which I shall call the taxpayer, appeals from decisions of the Commissioner disallowing objections to assessments of income tax for the years ended 30 June 1966 and 30 June 1967. I heard the two cases together. The critical question is the same in each.
The question with respect to the former year - case No. 34 of 1969 - arises as the result of the purchase by the taxpayer of all the issued shares in two private companies, Bonwood Pty. Limited and Richmond Export Pty. Limited. The question with respect to the latter year - case No.35 of 1969 - arises as the result of a similar purchase of shares in another private company, Swatchfield Pty. Limited.
The taxpayer is a wealthy company. It was said in evidence that its issued share capital is in excess of nine million dollars. It was originally a private company. It became a public company in 1950. It has now, and has for many years past had, an extensive business as a finance company. Speaking broadly, its business has been money lending in various forms or the provision of credit. Some of its transactions have been simple money lending, others more involved and sophisticated. They have varied from hire purchase finance to leasing arrangements having as an incidental element loans to customers. The taxpayer also from time to time became a shareholder in companies. Most of its shareholdings have been transferred to and are now held on its behalf by a subsidiary company, Mercantile Underwood Limited. Investment in shares has been but a small part of the taxpayer's total business. Generally speaking, its acquisitions of shares have been for it incidental to some wider transaction. It has, itself or through its subsidiary Mercantile Underwood, on occasions sold shares that it had owned: but it has not engaged in share-dealing as a business. Shares or suchlike assets, are not for it stock-in-trade. To obtain the money which is the life blood of its business it has borrowed extensively from the public. It was said in evidence that at the present time its borrowings amount to more than a hundred million dollars. It has availed itself of opportunities to obtain money in other ways too. It has, for example, engaged in some `bond-washing' dealings in Commonwealth loans. Thus in addition to funds derived from borrowing it has always had at its command considerable liquid resources represented by reserves and unappropriated profits. Its shareholders' funds were said in evidence to exceed thirteen million dollars.
Bonwood and Richmond Export are `private companies' within the meaning of the Income Tax Assessment Act. They were at one time associated in business. But by 1965 they had both ceased to carry on any active business. They each had then substantial accumulated profits represented in part by liquid funds and in part by readily realisable assets. Bonwood was the richer of the two; but each was laden with profits awaiting distribution to shareholders. If the shareholders were to receive this as income, they would of course be liable to tax. They were therefore willing to sell their shares for prices that in the aggregate would amount to about $50,000 less than the value of their companies' assets. The directors of the taxpayer were made aware of this by one of their number, who was himself interested in Bonwood and Richmond Export. The matter was discussed by the directors of the taxpayer. It was at the time considered in terms of pounds shillings and pence: but, for convenience, I give all monetary figures in decimal currency.
The taxpayer's board decided to act on the suggestion made to them. In January 1966
ATC 4017
formal offers were made to the shareholders in each of the companies to buy all the issued shares. These were accepted. From the point of view of the shareholders as sellers, the arrangement meant that they would receive a price for their shares which would be a capital receipt, and thus not taxable. From the point of view of the taxpayer, it meant that it would gain control of each of the two companies, and that, after all their non-liquid assets had been realised, dividends could be declared which would absorb the accumulated profits of the two companies. The taxpayer's advisers considered that it could in effect get $50,000 for nothing, and that the dividends which it would receive by carrying the plan into effect would for taxation purposes be rebatable in accordance with sec. 46 of the Act. The taxpayer did not have to find any money to carry the plan into effect, because it was arranged that approximately ninety per cent of the sum required to pay for the shares would be advanced by the two companies as a loan at interest to the taxpayer and the remaining ten per cent was not to be payable for five years. The bargain was carried to completion on 27 January 1966 for the Richmond Export shares and on the next day for the Bonwood shares. Bank cheques were handed to representatives of the shareholders of the companies, and thereupon bank cheques were handed to representatives of the taxpayer. The amounts thus paid and received exceeded in each case five million dollars. The total price paid was approximately $50,000 less than the amount the taxpayer received. An exact analysis of the figures is not required here; and several adjustments would have to be taken into consideration, including the fact that at the date of settlement the taxpayer was indebted to Bonwood for $100,000 for money earlier lent to it by Bonwood at thirty days' call. In substance the transaction was settled by an exchange of cheques. The taxpayer's bank waited until the cheques the taxpayer received had been deposited before debiting the taxpayer's account with the amount required for the bank cheques given in payment for the shares. Counsel for the taxpayer was at some pains to establish this; but in my view nothing much turns upon it. A matter involving millions of dollars was carried though in effect by book entries only; but the legal result is not in doubt; and for present purposes the arithmetical details are not important.In January 1966 Bonwood and Richmond Export thus became wholly-owned subsidiaries of the taxpayer. Their boards were reconstituted accordingly. The taxpayer of course owed the companies the money it had borrowed from them to buy the shares in them. It had to pay interest on that money. But that meant only that it owed moneys to its subsidiary. Without any actual expenditure it had gained $50,000 or more. The next thing to be done was for it to gather to itself the assets it had bought, and to do it in a way that would enable it to have advantages that it believed would accrue from sec. 46 of the Income Tax Assessment Act. To this end it decided that such assets of the two companies as were not liquid should be realised and made liquid, and that at some later stage the companies would transfer their accumulated profits to it as dividends.
In March 1966 Bonwood declared a dividend of $36,000. This was, it seems, done then to avoid undistributed profits tax. The main distributions were not made until about the end of June. Richmond Export and Bonwood then on 27 June and 28 June respectively declared dividends designed to absorb substantially the whole of their liquid funds, which had in the meantime been further enriched by interest on loans to the taxpayer and by other income derived before the realisation of assets they had held. The dividends thus declared by Bonwood and Richmond Export produced in the aggregate $5,603,853. Their declaration and payment at this date arose from a decision that after the dividends had been taken the taxpayer would sell the shares which had produced them. When it bought those shares it had not had anything definite in view as to their ultimate disposal or use. It apparently regarded them as merely the key to a money-bag. But some time after it had acquired them it was made aware by a stockbroker that, if dividends took all the profits and reserves of the companies, the shares would still have a value for somebody wanting to avoid income tax. The companies would be what were called `excess distribution' private companies, a description based upon sec. 106 of the Act; and a purchaser might then pay more for the shares than their remaining asset backing to enable him to take advantage of the rebate allowed under Division 7 of Part III of the Act. Such purchasers were sought and found; and after some delay, caused by the need to amend the provisions of some existing debentures, all the shares in each company were sold in June - each on the day after the company concerned had declared the dividend which took up virtually all of its liquid assets.
In the next income tax year - that which ended on 30 June 1967 - the taxpayer entered into an arrangement, similar to those with Bonwood and Richmond Export, by which it took over another private company, Swatchfield Pty. Limited. Some of the procedural steps were slightly different from those in the earlier cases, but not I think in any way that it is, for present purposes, material to notice. I should mention however that whereas in the 1966 transactions the possibility of ultimately
ATC 4018
selling the shares in Bonwood and Richmond Export on the basis that the companies had made `excess distributions' was not at first appreciated, whereas in the case of Swatchfield this was in the taxpayer's mind from the start. But I do not think that is significant. In the case of the Swatchfield shares, as in the others, the critical question is what result, for tax purposes, flows from what in fact was done, not the motives with which it was done or the expectation of those who did it or the description they gave it. It cannot be said that the purpose of the taxpayer in buying the shares in Bonwood, Richmond Export and Swatchfield was to make a profit by selling them.I am grateful to counsel on both sides for their careful and helpful analyses of the evidence, especially of the voluminous accounts and other documents that were tendered, and for their submissions as to their consequences in law. But I can state my conclusions without setting out in detail all the facts and figures that were put before me, and without quoting passages from judgments in other cases to which I was referred. The essential facts are not in dispute. And, as to the law, the case seems to me to raise a fairly clear-cut issue, to be determined according to established general principles, and by reference to a few provisions of the Act. These, in relation to the present facts, seem clear enough without illumination by words in judgments that were given in other cases upon different facts. I recall what Lord Pearce, delivering the judgment of the Privy Council in
B.P. Australia Limited v. F.C. of T. (1965), 112 C.L.R. 386, said, at p. 397: ``As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application''.
In its tax return for the year ended 30 June 1966 the taxpayer brought to account its transactions in Bonwood and Richmond Export shares as separate items, each headed `venture account'; and in each case a `profit on venture' was shewn. The same thing was done in respect of Swatchfield in the next year's return. These venture profits were calculated as the difference between, on the one side, the dividend received plus the proceeds of the subsequent sale of the shares and, on the other side, the cost of the shares including legal expenses and brokerage. Then the taxpayer claimed a rebate, pursuant to sec. 46(2)(b), on the whole of the dividends received by it in respect of all shares it held. Its two tax returns were summarised, for the purposes of the argument, as follows, counsel for the Commissioner agreeing that these statements are correct summaries -
Year ended 30 June 1966.
(i) Taxable Income from all sources other than venture
profits and dividend income................................... $1,093,715
(ii) Dividends received from all sources other than from
Bonwood Pty. Ltd. and Richmond Export Pty. Ltd................ 605,761
(iii) Venture Profits (Bonwood and Richmond Export)
Cash Receipts - Dividends Received........... $5,603,853
- Proceeds of Sale............. 382,850
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$5,986,703
Cash Payment - Cost of Shares................ $5,684,946
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Profit on venture......................................... 301,757
--------
Taxable Income ........................................... $2,001,233
----------
(iv) Claim made in respect of Section 46 Rebates
Dividends from other Companies............... 605,761
Dividends from Bonwood Pty. Ltd. and Richmond Export
Pty. Ltd..................................... $5,603,853
----------
$6,209,614
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(v) Claim made for Bond Rebates was for a rebate of $28,615 being
10% of
By calculations, which it is not necessary to set out, that were based on these figures, and on its premises, the taxpayer claims that in respect of the first year the sec. 46 rebate would exceed its taxable income. It therefore says that no tax is payable by it in respect of that year. By similar calculations in respect of the second year the taxpayer claims that its tax should be $353,287. In each case the taxpayer also put its claim in several alternative ways and tendered in argument detailed computations on these alternative bases. The view I take of the matter makes it unnecessary for me to discuss these. They all resulted in figures less than the Commissioner's assessments, although they much exceeded the surprising claim that for 1966 no tax was payable. The Commissioner assessed the tax for the year ended 30 June 1966 as $564,111: for the next year as $438,502.
The Commissioner arrived at these assessments as follows. He did not question the `Bond Rebates', claimed in respect of interest on Government loans. But in relation to the dividends he refused the rebate claimed in respect of the dividends received from Bonwood, Richmond Export and Swatchfield. He allowed sec. 46 rebates in respect of dividends the taxpayer received from other companies. His attitude was explained in argument by reference to sec. 26 of the Act. It was said that the profits on each `venture' were `profit arising from the carrying out of a profit-making undertaking or scheme'; that the dividends were an incident of carrying it out; that they were absorbed into the calculation of the profit and thus no longer to be regarded as dividends forming part of the taxpayer's taxable income. In this it was said that the Commissioner had simply taken the taxpayer at its word. It had, in its accounts and tax return, separated its transactions in the three companies' shares from its other activities and treated them as separate ventures. However, the question for the Court is not whether the descriptions of the transactions that the taxpayer used were appropriate for its own accountancy. It is what, having regard to the terms of the Act, was the nature and the result of the transactions. The taxpayer controverted the Commissioner's contention by insisting that the moneys it received as dividends were in fact dividends within the meaning of the Act and that they did not lose that character because it brought them into account when computing separately the profits it derived by the `ventures'. However, the primary question seems to me to be whether, for the purpose of arriving at the taxpayer's taxable income, these profits should be computed as the results of profit-making undertakings isolated from the taxpayer's main business. That question is not answered by treating the taxpayer's business as consisting of a number of separate undertakings, the `profit' of each to be separately counted. It seems to me that the entire business of the taxpayer was, for fiscal purposes, a single undertaking, whatever methods of accountancy be applied to its separate elements. I see no reason for isolating any one of the taxpayer's business affairs from others. The transactions now in question were undertaken as parts of a larger and continuous undertaking. They were incidents of a business that involved making money by various means as opportunities offered.
ATC 4020
Thus, while I do not accept the primary propositions of the taxpayer or any of the suggested alternatives, I consider that the Commissioner's assessments are erroneous. The taxpayer is, by sec. 190, limited to the grounds taken in the objection; and the burden of proving the assessments are excessive lies upon it, the taxpayer. The ground on which I find that the Commissioner's assessments are excessive was not precisely covered by any of the taxpayer's grounds of objection as I read them. However, sec. 199 provides that the Court may make such order as it thinks fit, and may by such order confirm, reduce, increase or vary an assessment. I propose to reduce the assessments because, for reasons I shall give, I think them mistaken. The variation I shall make was not propounded by the taxpayer; but that, I consider, does not prevent my making it. I stated my view tentatively during the argument and invited counsel's comments. Counsel for the Commissioner later supplied me and the taxpayer with figures, representing an assessment made in the manner I suggested.
The taxpayer, relying on sec. 51 of the Act, said that the cost to it of the shares in Bonwood, Richmond Export and Swatchfield were outgoings incurred in gaining the assessable income. This of itself is indisputable. But they are not allowable deductions, if and so far as they are outgoings of a capital nature: and to my mind the acquisition of shares in a company which can later yield a dividend, as that term is defined in the Act, is prima facie the acquisition of a capital asset. Dividends when declared and received are income. The shares are capital; and the price paid for them is an outgoing of a capital nature. That is as I see it. This is not a case of buying shares with resale for profit as the dominant purpose. If it were, sec. 26 would bring a profit to tax, or sec. 52 would make a loss an allowable deduction. Those provisions of the Act reflect basic economic doctrine embodied in ordinary concepts of capital and income. In saying that, it is not necessary to resort to the classical economists' theory of circulating capital or modifications of it. But neither sec. 26 nor sec. 52 bears directly on this case, for trading in shares was not the taxpayer's business. In the Swatchfield transaction an intention to sell the shares after a dividend had been taken was no doubt present throughout. Nevertheless in that case, as in the others, I think that when the shares were acquired by the taxpayer they became capital assets in its hands. I was referred to certain passages in the judgment I gave last year in
Investment and Merchant Finance Corporation Limited v. F.C. of T. 70 ATC 4001. As I understand that an appeal from my decision in that case is pending, I say nothing more of it than that its facts were quite unlike those of this case. I am unable to see that anything that I said in that case, or that can be said of it, could have any bearing upon this case, except by way of contrast.
I think that some confusion is engendered by speaking of the taxpayer having bought Bonwood, Richmond Export and Swatchfield. This is elliptical language. What the taxpayer bought were shares. The acquisition of the shares gave it control of the companies. They were replete with moneys. These the taxpayer, having become a shareholder, could obtain, either by way of liquidations or by dividends. But until wound-up the companies would continue to exist as corporations with all their lawful powers and capacities. The taxpayer could set them to work if it chose, and as it chose, and use them and their property and their capacities for its purposes. The shares it bought were upon their acquisition enduring assets in the taxpayer's hands. Their value was diminished when they had yielded dividends; but this does not mean they were not a capital asset when they were acquired, or that they ceased to be such when they had produced income.
The conclusion I come to is that the taxpayer is entitled to a rebate in accordance with sec.46 in respect of all dividends received by it, including the dividends from Bonwood, Richmond Export and Swatchfield, in the years in which they were received: but that it is not entitled to treat the amounts which it paid to buy the shares as an allowable deduction: nor is it I think required to bring into account as part of its assessable income the amount it received when it sold the shares. The price paid was an outgoing to purchase a capital asset: the price received was received upon capital account, not revenue account. This view accords with statements in
Rowdell Pty. Limited v. F.C. of T. (1963), 111 C.L.R. 106, in particular at pp.118 and 131.
On the figures supplied to me by the Commissioner and not disputed by the taxpayer the results, on this basis, can be set out as below.
For the reasons I have given, I find that the Commissioner's assessments were excessive and should be reduced. As I have said, this is not the result of adopting any of the calculations advanced for the taxpayer. But it does involve an acceptance of the basic proposition, which the Commissioner did not accept, namely, that the taxpayer was entitled to a sec. 46 rebate upon the dividends received from Bonwood, Richmond Export and Swatchfield. In the circumstances I think the Commissioner should pay two-thirds of the
ATC 4021
taxpayer's costs, taxed on the basis that the two cases - No. 34 and No. 35 of 1969 - were heard together and that one set of costs covers both.The Commissioner's assessments are varied by reducing the amounts shewn as tax payable to the following -
(1) in respect of the year ended 30 June 1966: $436,138.70;
(2) in respect of the year ended 30 June 1967: $425,397.05.
1. In respect of the year ended 30 June 1966.
(i) Taxable income from sources other than dividends $1,093,715
(ii) Dividends from Bonwood and Richmond Export 5,603,853
(iii) Other dividends 605,761
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$7,303,329
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(iv) Gross tax payable thereon $3,103,414.82
(v) Section 46 rebate on $6,209,614
6209614
------- x 3,103,414.82 = $2,638,660.82
7303329
(vi) Bond rebate 28,615.30 2,667,276.12
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Tax payable $436,138.70
Note: In the figure of $1,093,715 taxable income no allowance is made for legal expenses (amounting it seems to $1911) in connection with the Bonwood and Richmond Export transactions. These expenses were, as I see this case, related to the acquisition and sale of a capital asset. However, it may be that they are an allowable deduction by virtue of sec. 64A(2). But no claim of that sort was made by the taxpayer. It did not dispute the Commissioner's calculation at this point. I have therefore taken these legal expenses, which are only a small item, as outgoings on capital account.
2. In respect of the year ended 30 June 1967.
(i) Taxable income from sources other than dividends $1,179,404
(ii) Dividends from Swatchfield 200,649
(iii) Other dividends 443,084
Taxable income $1,823,137
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(iv) Gross tax payable thereon $774,333.22
(v) Section 46 rebate on $643,733
643,733
-------- x 774,333.22 = $273,409.97
1,823,137
(vi) Bond rebate 75,526.20 348,936.17
----------- -----------
Tax payable $425,397.05
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Note: Similar considerations to those mentioned above arise in this case too in relation to any legal expenses ($902) not brought to account.
ORDER:
Declarations as follows -
- In matter No. 34 of 1969:
- Tax payable is $436,138.70.
- In matter No. 35 of 1969:
- Tax payable is $425,397.05
The Commissioner to pay two-thirds of the appellant's costs to be taxed on the basis that the appeals were heard together. Usual order as to exhibits.
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