Donaldson v. Federal Commissioner of Taxation.
Judges:Bowen CJ
Court:
Supreme Court of New South Wales
Bowen C.J. in Eq.: This is an appeal by Mr. D.G. Donaldson against an income tax assessment including in his assessable income an amount in respect of ``share options'' conferred upon him by his employer, Hooker Corporation Limited, during the year ended 30th June, 1971.
The facts are not is dispute. On 13th August, 1970, at a meeting of directors of the Corporation it was decided to introduce a ``Supplemental Key Personnel Option Scheme'', in which fourteen employees, whose names and particulars were on a list placed before the meeting, would participate. Mr. Donaldson, then Manager, Land Development, Newcastle, was one of these. An extract from the minutes is in evidence.
It is as follows -
``It was resolved that the Supplemental Key Personnel Option Scheme for the benefit of the Key Executives listed on the Schedule tabled at the Meeting and initialled for identification by the Chairman be adopted.''
It was further resolved that: -
- 1. Druitt Nominees Pty. Limited be trustee of the Scheme for the Trusts contained in form of Trust Deed tabled at the Meeting (and initialled for identification by the Chairman).
- 2. The Corporation issue to Druitt Nominees Pty. Limited as trustee of the said scheme 6½% Convertible Notes totalling face value of $295 for payment on allotment of $295 in the form tabled at the Meeting (and initialled for identification by the Chairman) such Convertible Notes to give Druiit Nominees Pty. Limited options to subscribe for a total of Two hundred and ninety-five thousand (295,000) unissued ordinary shares of 50 cents each in the capital of the Company at a total price (including premium) of Ninety-one cents (91¢) for each of such shares - to enable Druitt Nominees Pty. Limited to fulfil its obligations as trustee.
It was noted that -
``A. The options were exercisable on 1st January and 1st July during the currency of the scheme in respect of the under-mentioned number of shares within the dates set opposite thereto -
Number of Not Not Ordinary 50 Earlier Later cent Shares Than Than (or Stock Units) 155,000 1/1/74 1/1/78 102,500 1/1/78 1/7/81 37,500 1/7/81 1/7/84 ------- 295,000 -------and that the options provided, upon exercise, for the issue to the trustee or its nominee/s 295,000 (or part thereof) ordinary shares (or stock units) of 50 cents each paid to one-tenth of one cent (0.1¢) per share and bearing the condition that the balance payable (90.9¢) on each share (49.9¢ call and 41¢ premium) shall be called up by the Corporation within one month of the date of issue.
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B. The scheme provided, pursuant to the Convertible Notes and Trust Deed: -
- (i) Ordinary stock option entitlements as hereinafter provided for the 14 employees, of the Corporation and its subsidiaries, whose names and positions were detailed in the proposals and schedule for the scheme presented to the Meeting (and initialled for identification by the Chairman) subject to their remaining in their respective positions of employment (or some other position certified by the Board of the Corporation as equivalent thereto) for the periods prescribed by the schedule.
- (ii) Upon completion of the qualifying period of employment each employee the right to take up, through the trustee, the option entitlement for that employment period during the period prescribed by the schedule and herein and if not taken up within that period the option entitlement (including pro rata benefits, if any, under B(iii) hereof) in respect of that employment period to lapse without affecting future option entitlements in respect of subsequent periods of employment (if any).
- (iii) For the option holder to be entitled to participate, fully and pari passu as if it were an ordinary stockholder in respect of fully paid stock units, in any general issues including bonus issues of the Corporation's ordinary stock units or any general cash distributions (other than ordinary dividends) or other special entitlements to all ordinary stockholders made during the term of the various Convertible Notes, such participation to be provided by the Corporation in its Accounts or otherwise and to be applied and issued pro rata and when appropriate and in accordance with the provisions of paragraph B(i), (ii), (iv) and (v) hereof upon exercise of the relevant options.
- (iv) In the event of the death of any employee during any qualifying period of employment his estate to be entitled to a pro rata proportion of the option entitlements for that employment period up to the date of his death including pro rata entitlements under B(iii) hereof even although that qualifying period has not been served in full.
- (v) In the event of the Corporation ceasing to be a listed public company or in the event of an acquisition of shares in the Corporation under a Takeover Scheme as defined in the Companies Act or in the event of the company becoming a subsidiary or another company (as defined by the Companies Act) each participant in the scheme to be entitled to a pro rata option entitlement for the qualifying employment period during which the event/s occurs up to the date of the event/s and also a further option entitlement equal to one-third of the option entitlement in respect of the balance of that qualifying employment period and the qualifying employment period/s not then commenced. The calculation of the option entitlement herein to include adjustment for the pro rata entitlements, if any, arising from paragraph B(iii) above.
- (vi) That subject to the prior written consent of the Corporation and upon advice to the Trustee, the employee the right to transfer his entitlement to the scheme to approved nominee/s.
C. In requiring Druitt Nominees Pty. Limited to take his option entitlement each participant in the scheme may require the shares to be allotted to Druitt Nominees Pty. Limited or himself or his nominee.
D. The Convertible Notes and the Trust Deed/s contained normal legal provisions in such documents.
The Chief General Manager was authorised to forthwith advise staff of their entitlements subject only to the exercise price being subject to further consideration in the event of any taxation disability.''
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Mr. Glover, Assistant General Manager of the Corporation, was given the task, under the direction of the Chief General Manager, of implementing the Scheme. He had prepared a memorandum dated 13th August, 1970, a copy of which was to be forwarded to each key executive participating in the scheme. The relevant part of this memorandum in the form in which it was forwarded to Mr. Donaldson, was as follows:
``KEY PERSONNEL STAFF OPTION SCHEME
Appreciation
The Corporation Board is appreciative of the contribution which you and others are making towards the increasing profitability of our Group and has been pleased to endorse a recommendation whereunder you now be granted the right to take up 20,000 ordinary stock units in the Corporation at various future dates subject to your compliance with certain special terms and conditions.
Exercise Price - Taxation
For taxation reasons it is necessary for the exercise price of the stock units, to be subscribed for, at your option, in the future, to be at or about the market value at the date of the grant. Accordingly it has been necessary for us to fix a price of par 50¢. and premium 41¢. - total consideration 91¢. - in the hope that you may be exempt from taxation in your hands at the date of the making of the grant, viz. 13th August 1970.
Taxation Return 1970/71
Attached hereto is a note which it is considered necessary for you to include in your 1970/71 taxation return.
Convertible Note - Companies Act
To comply with the Companies Act it is necessary for the option to be attached to a convertible note. A subscription (payment) of one tenth of 1 cent per option will have to be paid by you as soon as convenient on this convertible note which will bear interest at 6½% simple per annum. Upon exercise, in due course, of the option or part thereof, the balance of 90.9¢ per stock unit will be further payable. If the option is not exercised at maturity, or lapses for any other reason, the 0.1¢ is repayable to you.
Term
The special staff options require the optionee to continue to serve the Corporation in his present position or in some senior approved equivalent position for periods spread over approximately 3.4, 7.4 and 11 years, the period generally varying with the age and present position of the employee. An endeavour has been made to grant at least one half the full entitlement in the first 3.4 year eligibility period so that employees may have an opportunity to obtain capital gain at a time when they and or their families may most need this. After employment service period, the options may be exercised in part or whole from time to time up to a specified date.
Death - Takeover
The scheme provides for pro rata entitlement to the employee's beneficiaries (estate) in the event of death and also provides for a pro rata plus entitlement in the event of a `Takeover' of the Corporation - notwithstanding, in each case, the fact that the full employment period may not have been served.
Right to Transfer
The Corporation shall have the right to approve the transfer of the convertible note and the options attaching thereto to family companies etc. of the employee. The right to transfer, however, will be very restrictive.
Number of Options Granted to You
The number of options granted to you, the amount payable in the initial subscription of these, the period of service
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requirement and the last dates upon which you may exercise the options attaching to the notes are detailed in the schedule hereunder -Number of Face Value of Amount of Period of Last Options Convertible Initial Service Date of Granted Notes Payment Required Exercise $ $ 10,000 10 10 to 1/1/74 1/1/78 5,000 5 5 to 1/1/78 1/7/81 5,000 5 5 to 1/1/81 1/7/84 ------ -- -- 20,000 20 20 ------ -- --
Capital Gain - Potential Benefit
Under existing known taxation laws, gains by employees under this scheme are expected to be tax-free. It is hoped that this benefit will be significant. (It may be worth noting that an employee on $10,000 salary (say taxable income) per annum, and in receipt of 10,000 options over 3.4 years, would be receiving the approximate equivalent of a rise in taxable salary of $7,500 per annum should the market price of the Corporation's stock units rise to $2.00 by the end of the 3.4 year period (discounted cash flow application has been ignored - the increase is, of course, significantly greater for incomes above $10,000).
It is not intended, however, that the option scheme be a substitute, in any way, for regular salary revisions to market level.
Trustee
Druitt Nominees Pty. Ltd. (the Group's Superannuation Fund Trustee) has been interposed as Trustee for employees/optionees under this scheme. Trust Deed/s evidencing this and requiring your signature is enclosed. Also enclosed is a copy of the Trust Deed/s and the draft relevant Convertible Note/s for retention in your records.
Cheque for Initial Payment
It is planned to have your convertible note (option) formally issued as early as possible. It would be appreciated, therefore, if you could let Mr. G. Vernon, Hooker House, Angel Place, Sydney, have a cheque in favour of Druitt Nominees Pty. Ltd. for the amount of your initial subscription prior to 15th January, 1971.''
It seems that the memorandum, although dated 13th August, was not in fact sent out until some time in December 1970. In the meantime approaches were made to the Commissioner of Taxation to obtain his views on the incidence of tax. By letter dated 26th October, 1970, the Deputy Commissioner of Taxation informed the corporation's taxation consultants as follows -
It has been decided that, for the purpose of the application of section 26(e) of the Income Tax Assessment Act, a benefit in respect of each entitlement to take up one share will be assessed to each of the participants in the scheme, in the year of income in which the notes were issued, as follows -
1974/1978 options: 10c per share
1978/1981 options: 5c per share
1981/1984 options: 2c per share.
Subsequently Mr. Glover had prepared another memorandum, dated 21st December, 1970. This was sent out to key executives at or about the same time as the memorandum dated 13th August, 1970. Its terms were as follows -
``KEY PERSONNEL STAFF OPTION SCHEME TAXATION
I refer to my memo to you of 13th August 1970 wherein you were advised of the granting of certain share options in the form of a 6½% Convertible Note.
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It has been the Corporation's experience that issues of this type were exempt from taxation - hence the suggested statement accompanying the memo of 13th August 1970 for inclusion in your 1970/71 income tax return.
It is with regret that I have to advise you that by letter dated 26th October 1970 from the Department of Taxation, copy of which is enclosed, the Commissioner intends to assess employees on the basis set out in that letter. The Corporation's taxation advisers and the Corporation itself do not agree with the Department's right in this particular connection and should the Department in fact assess the employee it is our recommendation to you that a formal Notice of Objection be lodged by you in a form approved by the Corporation's tax advisers. To the extent, in part or in whole, that this Objection and any appeal following same is unsuccessful, it would be the Corporation's intention to financially assist the employee to the extent of any tax.
I have to finally add that notwithstanding constant negotiations since 26th October 1970, the Department has not been prepared to change its view of assessability irrespective of whether the exercise price is increased or not. It is still our recommendation to you that, despite the Department's letter of 26th October 1970, you still enclose in your income tax return the suggested form attached to the beforementioned memo of 13th August 1970. If in doubt in this connection please contact Mr. B.A. Glover.''
In the case of Mr. Donaldson the memorandum of 13th August, 1970, was accompanied by three trust deeds for signature by him. Each deed was between Hooker Corporation Limited (the ``Corporation''), Druitt Nominees Pty. Limited (the ``Trustee'') and Mr. Donaldson (the ``Beneficiary''). They related to convertible notes for $10, $5 and $5 respectively. Also enclosed was a copy trust deed with pro forma convertible note for Mr. Donaldson's records. Mr. Donaldson signed the deeds, and on 15th January, 1971, gave them, with his cheque for $20 in favour of the trustee, to Mr. Vernon, who was nominated in the memorandum to receive them. In order to indicate the terms of these deeds and notes an example of each is set forth below -
``TRUST DEED
THIS TRUST DEED made the Fifteenth day of January One Thousand nine hundred and seventy one BETWEEN HOOKER CORPORATION LIMITED a Company incorporated in the State of New South Wales and having its registered office at Hooker House, Angel Place, Sydney, New South Wales (hereinafter called `the Corporation') of the One part AND DRUITT NOMINEES PTY. LIMITED a Company incorporated in the Australian Capital Territory and having its registered office at 37 Northbourne Avenue, Canberra City in the said Territory (hereinafter called `the Trustee') of the Second Part AND David George DONALDSON of Bradman Street, Charlestown, N.S.W. (which person is hereinafter called `the Beneficiary') WHEREAS -
A. The Trustee is the holder of a certain Convertible Note Certificate numbered 1978 - No. B (4) (copy of which is attached to this Trust Deed) issued by the Corporation.
B. The Beneficiary holds the position of Manager, Newcastle with the Corporation or with a subsidiary or sub-subsidiary of the Corporation (hereinafter called `the employment position').
C. The Trustee holds the said Convertible Note in trust for the Beneficiary herein named on the trusts and subject to the terms and conditions set forth hereafter in this Trust Deed the Beneficiary herein named having provided the whole of the `principal moneys' referred to in the Convertible Note.
NOW THIS DEED WITNESSETH in consideration of the premises as follows -
1. Declaration Of Trust
The Trustee hereby declares that it holds the said Convertible Note and all its interest therein and all its rights benefits
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and entitlements thereunder and herein IN TRUST for the Beneficiary (or approved assignee or legal personal representative upon death) on the trusts herein.
2. Option And Other Entitlements
The Beneficiary shall subject to the provisions of Clause 10 of this Trust Deed be entitled to participate in the options rights benefits and entitlements granted by the said Convertible Note and herein subject as hereinafter defined.
3. Option Entitlement - Employment
Subject to the provisions of Clause 10 hereof -
- If the Beneficiary shall have remained in `the employment position' (and/or some other position or positions certified by the Board of the Corporation to such Beneficiary as being equivalent thereto) from the Thirteenth day of August 1970 up to and including the First day of January 1974 (hereinafter called `the employment period') there shall thereupon accrue to the Beneficiary and to his assignee, if any, and legal personal representative upon death, if applicable, and the Beneficiary and his assignee, if any, and legal personal representative upon death, if applicable, shall have and enjoy during the period commencing on the First day of January 1974 and ending on the First day of January 1978 (hereinafter called `the option entitlement period') the options rights benefits and entitlements (without limiting the generality thereof) set forth pursuant to the said Convertible Note and this Trust Deed.
4. Pro Rata Option Entitlement - Death
In the event of the death of the Beneficiary during `the employment period' and subject to Clause 10 hereof there shall accrue to the legal personal representative of the Beneficiary or any previously approved assignee of such Beneficiary and such legal personal representative or previously approved assignee shall have and enjoy immediately following death and up to the expiration of `the option entitlement period' the options rights benefits and entitlements (without limiting the generality thereof) set forth pursuant to the said Convertible Note and this Trust Deed which the Beneficiary would have had and enjoyed if he had completed the employment period but such option rights benefits and entitlements are limited to the proportion which that part of `the employment period' actually served up to the date of his death bears to the whole of `the employment period'.
5. Immediate Option Entitlement - Takeover Or Other Similar Events
- (a) In the event of the Corporation ceasing to be a listed public company or in the event of any effective acquisition of shares in the Corporation under a Takeover Scheme as defined in the Companies Act or in the event of the Company becoming an effective subsidiary of another company (as defined by the Companies Act) all or any of such events happening during `the employment period' and subject to Clause 10 as hereinafter defined there shall immediately accrue to the Beneficiary and the Beneficiary shall immediately have and enjoy upon the happening of such events (in addition to any other option or other entitlements which may have accrued to him prior to the date of such events) -
- (i) The options rights benefits and entitlements (without limiting the generality thereof) set forth pursuant to the said Convertible Note and this Trust Deed which the Beneficiary would have had and enjoyed if he had completed `the employment period' at the date of such events as aforesaid but such options rights benefits and entitlements are limited to the proportion which that part of `the employment period' actually served up to the date of such events bears
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to the whole of `the employment period' and- (ii) One third of the total of the options rights benefits and entitlements in respect of `the employment period' not yet served at the date of such events as aforesaid, and
- (iii) One third of the total of the options rights benefits and entitlements in respect of `the employment period/s' not then commenced at the date of such events but provided for and anticipated in other and similar Trust Deeds and Convertible Notes of even date herein between the parties to this Trust Deed.
- (b) The calculation of the option and other entitlements herein to include adjustment for the pro rata entitlements, if any, provided by Clause 5 of the Convertible Note and this Trust Deed.
6. Exercise Of Option Entitlement
The Beneficiary may from time to time during `an option entitlement period' (subject to Clause 6 of the Convertible Note) or other periods approved from time to time by the Corporation or as provided for by Clause 5 of this Trust Deed by notice in writing to the Trustee call upon the Trustee to exercise the options or rights granted to the Trustee by the said Convertible Note to the extent of the whole or any part of such options or rights of the Beneficiary pursuant to the said Convertible Note and this Trust Deed and the Trustee will upon receipt of such notice and payment in full by such Beneficiary of all amounts payable by the Trustee pursuant to the said Convertible Note exercise such options or rights accordingly on the relevant date provided by the said Convertible Note and herein nominating the said Beneficiary (or the nominee of the Beneficiary if the Beneficiary shall make a nomination in such notice) as the nominee of the Noteholder pursuant to the said Convertible Note and the Trustee will sign all such documents and do all such acts and things as shall be necessary to cause the Corporation to issue to the Beneficiary (or the nominee of the Beneficiary, if any, as aforesaid) all the rights benefits and entitlements of the Beneficiary pursuant to the said Convertible Note and this Trust Deed.
7. Trusts Of Principal And Interest
- (a) The trustee shall hold the outstanding principal contribution of the Beneficiary from time to time as hereinafter defined and all payments of principal or payments of interest pursuant to the provisions of the Convertible Note as are attributable to the said outstanding principal contribution IN TRUST for the Beneficiary AND the Trustee will from time to time and as and when appropriate and applicable pay to the Beneficiary (or the nominee or nominees of the Beneficiary nominated in such notice) all amounts of principal or interest so held by the Trustee in trust for the Beneficiary as aforesaid.
- (b) The outstanding principal contribution of the Beneficiary from time to time shall mean the amount of the total principal of the convertible Note contributed by the Beneficiary less the amount of principal redeemed from time to time pursuant to the Convertible Note by reason of exercise of option in respect of the option entitlement of the Beneficiary and also less any previous repayments of the Beneficiary of any part of such principal contribution.
8. Trusts Of General And Pre-Emptive Issues And Rights
If the Trustee shall have allotted to it, or have provided for it, any shares, rights, benefits, entitlements or payments pursuant to the Convertible Note and this Trust Deed the Trustee will hold the Beneficiary's portion of such shares rights benefits entitlements or payments IN TRUST for the Beneficiary AND the Trustee on notice in writing from the
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beneficiary requiring the same will from time to time transfer or pay to the Beneficiary (or the nominee or nominees of the Beneficiary nominated in such notice) any shares rights benefits entitlements or payments so held in trust by the trustee as aforesaid subject at all times to the Beneficiary being presently entitled thereto pursuant to the Convertible Note and this Trust Deed.
9. Right Of Beneficiary To Assign
- (a) Subject to the Beneficiary having complied with the conditions of Clause 3 hereof in respect of `the employment position' and `the employment period' he may assign transfer mortgage charge or otherwise encumber his interest as Beneficiary pursuant to this Trust Deed and the Convertible Note and may within `the option entitlement period' by notice in writing to the Trustee require the Trustee to comply with the Beneficiary's requirements and nominations in respect thereto.
- (b) The Beneficiary without the prior written consent of the Corporation shall not assign transfer mortgage charge or otherwise encumber or attempt to transfer assign mortgage charge or otherwise encumber his interest as Beneficiary pursuant to this Trust Deed provided however that the Trustee shall upon receipt of written advice from the Corporation that such written consent as aforesaid has been given record register and otherwise deal with the requirements of the Beneficiary herein upon receipt of written notice from the Beneficiary so to do.
10. Lapse Of Trusts
In the event that the Beneficiary shall (subject to Clause 4 hereof) -
- (a) At the expiration of `the employment period' cease to hold `the employment position' (or any other position certified by the Board of the Corporation to the Beneficiary and the Trustee as being equivalent thereto); or
- (b) Prior to the completion of `the employment period' whether voluntarily or by operation of law other than with the prior written consent of the Corporation (who shall also duly advise the Trustee) assign transfer mortgage charge or otherwise encumber or attempt to transfer assign mortgage charge or otherwise encumber his interest as Beneficiary pursuant to this Trust Deed;
The Beneficiary shall thereupon ipso facto cease to have and enjoy any further rights or benefits under this Trust Deed and the relevant Convertible Note and the trust of this Deed shall lapse and be dissolved save in respect of the amount of the outstanding `principal moneys' of the Beneficiary (or his nominee) and all amounts of interest payable pursuant to the Convertible Note as are attributable to such outstanding `principal moneys' and accrued up to the date of his ceasing to hold such employment position (or equivalent position) all of which amounts shall as soon after lapse of the trusts as aforesaid as possible under the terms of the Convertible Note be recovered by the Trustee from the Corporation and paid to such Beneficiary (or his nominee) or his legal personal representative.
11. Notices
All notices and other communications from the Beneficiary to the Trustee shall be properly served on the day after being posted by registered mail postage prepaid to the Trustee at the address set forth at the commencement of this Trust Deed or to any other address furnished by the Trustee to the Beneficiary in writing for the purposes of this Clause. All notices and other communications from the Trustee to the Beneficiary shall be properly served on the day after being posted by registered mail postage prepaid to the last known address of the Beneficiary furnished by the Beneficiary to the Trustee in writing for the purposes of this Clause.''
CONVERTIBLE NOTE CERTIFICATE
``This is to certify that DRUITT NOMINEES PTY. LIMITED a Company incorporated in and in
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accordance with the laws of the Australian Capital Territory and having its registered office at 37 Northbourne Avenue, Canberra City in the said Territory (hereinafter called `the Noteholder') is the holder of a Convertible Note in the sum of - (hereinafter referred to as `the principal moneys') created by resolutions of the Directors of Hooker Corporation Limited (hereinafter called `the Corporation') on the Thirteenth day of August, 1970 upon and subject to the following covenants terms conditions and provisions.
1. Repayment Of Principal
The Corporation will on and not before the Second day of January, 1978 but subject to the provisions of Clauses (3), (4) and (7) hereof repay to the Noteholder the principal moneys payable hereunder being the sum of - and subject as aforesaid the Corporation shall not be entitled to repay the said principal moneys so as to cause the option contained in Clause (4) hereof to lapse.
2. Payment Of Interest
The Corporation will until repayment of the said principal moneys pay to the Noteholder interest thereon at the rate of Six Dollars fifty cents ($6.50) per centum per annum such interest to be payable annually commencing on the first anniversary of the date of this convertible note and also to be payable on the date of any repayment or redemption whether in whole or in part of any principal moneys as to the amount of principal so redeemed and calculated on annual rests from the date of this Convertible Note.
3. Earlier Repayment
The principal moneys payable hereunder shall become immediately repayable on the happening of any one or more of the following events: -
- (a) If an order is made or a resolution is passed for the winding-up of the Corporation.
- (b) If a receiver is appointed or an encumbrancee takes possession of the undertaking of the Corporation or any part thereof.
- (c) If an official Manager of the Corporation shall be appointed pursuant to Part (ix) of the Companies Act, 1961.
And the Noteholder elects by notice in writing to the Corporation to require such repayment.
4. Option For Conversion To Shares
The Corporation hereby grants to the Noteholder an option subject as provided in Clause (7) to apply for and have issued to the Noteholder and/or to any person or persons and/or Corporation or corporations nominated in writing by the Noteholder (hereinafter called `the Nominees of the Noteholder')
ordinary shares (or stock units) of Fifty Cents (50¢) each in the capital of the Corporation each paid to one-tenth of one cent (0.1¢) per share and bearing the condition that the balance of Forty-nine and nine-tenth cents (49.9¢) payable on each share shall be called up by the Corporation within one (1) month of the date of issue and on further condition that a premium of forty one cents (41¢) for each such share is also payable to the Corporation within that time. The Noteholder may exercise this option on the Option Days specified in Clause (6) hereof in whole or in any parts by delivering this Convertible Note Certificate to the Corporation together with nominations in writing of the nominees of the Noteholder (if any) and a form of subscription for shares in form attached hereto duly executed by the Noteholder or by the nominee/s of the Noteholder of any Option Day. The Corporation will within fourteen (14) days thereafter: -
- (a) Cause to be issued to the Noteholder or the nominee or nominees of the Noteholder as the case may require certificates for the number of shares for which this option has been exercised; and
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- (b) Return this Convertible Note Certificate endorsed to reflect the extent of the Noteholder's exercise of this option.
And thereafter this option shall be only exercisable on any subsequent Option Day for that number of shares (including pro rata benefits, if any, granted by Clause (5) hereof) remaining subject to this option or any parts thereof. This Note shall ipso facto be and become redeemed to the extent to which the shares issued on exercise of the option are paid on issue and the extent of such redemption shall be endorsed from time to time on the Convertible Note Certificate.
5. General And Pre-Emptive Issues And Rights
If the Corporation shall during the term of this Convertible Note Certificate make or offer to make any general issues of ordinary shares or stock units (including any bonus issues) or make any general cash distributions (other than by way of ordinary dividends) or grant any other special entitlements in each and every case to all the then holders of its ordinary shares then in any such event/s the Noteholder shall be entitled to participate, fully and pari passu, in such issue or payment or entitlement as if it had been at the date of such event/s the holder of that number of the ordinary shares then the subject of the Option contained in Clause (4) of this Note (and the pro rata holder of any previous issues, payments or entitlements pursuant to Clause (5) herein) as at the date of such issue or payment or entitlement and such number of ordinary shares were fully paid such participation to be provided for by the Corporation in its Accounts, or otherwise, and to be applied and issued pro rata, and as and when and where appropriate, in accordance with the provisions of this Clause and Clauses (4), (6), (7) and (8) hereof. PROVIDED HOWEVER That the Noteholder shall only be entitled to so participate to the extent required to enable the Noteholder to fulfil its obligations as Trustee under certain Trust Deeds of even date between the Noteholder and a certain employee of the Corporation, or its subsidiaries or sub-subsidiaries. (For the purpose of the application of this Clause it is intended that: -
- (i) The Noteholder be entitled, only upon exercise of the option contained in Clause (4), to participate in applicable past general and bonus issues to all ordinary stockholders, the Corporation to have provided as at the date of such issue/s for the potential entitlement.
- (ii) The Noteholder immediately participate in any Convertible Note issues or any other special issues not herein particularly described but including (without limiting the generality thereof) participation of share issues in proposed associated companies in each and every case herein offered to all the then ordinary stockholders of the Corporation.
- (iii) The Noteholder participate in any other issues or entitlements to all ordinary stockholders subject to such participation being offered by the Corporation at relevant date).
6. Option Period
The option granted by Clause (4) hereof shall only be exercisable on the First day of January in each of the years 1974 to 1978 inclusive and on the First days of July in each of the years 1974 to 1977 inclusive (herein called `the Option Days') subject however to the provisions of Clause (8) hereof.
7. Lapse Of Option
- (a) The Option (including pro rata benefits, if any, granted by Clause (5) hereof) granted by Clause (4) hereof (or any part thereof not previously exercised) shall lapse on the Second day of January 1978 and upon such lapse The Corporation shall repay to the Noteholder the whole amount of the outstanding principal of this Convertible Note after taking into
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account all redemptions pursuant to the provisions of Clause (4) and Clause 7(b) hereof and thereupon this Note shall ipso facto be and become redeemed.- (b) If the Noteholder shall by notice in writing to the Corporation notify the Corporation that the Noteholder desires the whole or any part of the option granted by Clause (4) hereof to lapse then such option (including pro rata benefits, if any, granted by Clause (5) hereof) shall ipso facto upon receipt of such notice by the Corporation and to the extent so notified thereupon lapse and in the event of the lapse of the said option as aforesaid the Corporation shall thereupon repay to the Noteholder the amount of the outstanding principal of this Convertible Note relating to such notice and to the extent of such notice and thereupon this Note shall ipso facto be and become redeemed to the extent of such payment and the extent of such redemption shall be endorsed from time to time on the Convertible Note Certificate and the option contained in the said Clause (4) shall thereafter only be exercisable on any subsequent Option Day for that number of shares remaining subject to such Option (including pro rata benefits, if any, granted by Clause (5) hereof) or any part thereof.
8. Acceleration Of Option
Notwithstanding the provisions of Clauses (4) and (6) hereof the option granted by Clause (4) hereof (including pro rata benefits, if any, granted by Clause (5) hereof) shall also be exercisable by the Noteholder to the extent required to enable the Noteholder to fulfil its obligations as Trustee under certain Trust Deeds of even date between the Noteholder and certain employees of the Corporation and of its subsidiaries and sub-subsidiaries as provided for under such Trust Deeds and in particular Clause (4) (Death) and Clause (5) (Takeover) thereof.
9. Dividends
All shares allotted to the Noteholder pursuant to Clause (4) hereof shall rank for dividend on and from the date on which such shares are fully paid and all premiums payable in respect thereof are payable to the Corporation.
10. Notices
All notices and other communications from the Corporation to the Noteholder shall be properly served on the day after they are posted by registered mail postage prepaid to the Noteholder at the address set forth at the commencement of this Convertible Note Certificate or to any other address furnished by the Noteholder to the Corporation in writing for the purposes of this Clause. All notice and other communications from the Noteholder to the Corporation shall be properly served on the day after they are posted by registered mail postage prepaid to the Corporation at its registered office for the time being in the State of New South Wales.''
From one point of view it might be said that the effect of all this was that Mr. Donaldson had made a loan, or rather three loans for different periods, to the trustee with interest payable at the rate of 6½% per annum, and that these loans had special rights attached to them. However, this would not be an adequate description of the effect of the transaction. It is the right which Mr. Donaldson obtained under the transaction which are of more significance than the loans themselves. In summary, these rights are, through the trustee, and by means of convertible notes issued to the trustee, to take up 50 cent shares (or stock units) of the Corporation at 91 cents at any time during the specified period (in one case four years and in the other two cases three years) subject to his meeting certain conditions, particularly his remaining in the employment of the Corporation and holding his position or an equivalent position, with a restriction against assigning or attempting to assign the rights without the prior written consent of the Corporation.
In his income tax return Mr. Donaldson disclosed the transaction, but claimed the
ATC 4205
rights were not taxable. The Commissioner thought otherwise. He issued a notice of assessment, with an adjustment sheet which referred to the rights as follows -Employees share options benefit, included in assessable income, calculated as follows -
Options over 10,000 shares at 10 $1000
Options over 5,000 shares at 5 $ 250
Options over 5,000 shares at 2 $ 100
-----
1350.
-----
The notice of assessment showed tax payable amounting to $34.21. This figure does not precisely reflect the tax payable in respect of the option rights, since Mr. Donaldson would have been entitled to a refund, if an amount had not been included in respect of the rights.
Mr. Donaldson duly objected on 10th December, 1971. His objection was disallowed on 11th July, 1972. He requested on 16th August, 1972, that his objection be treated as an appeal and forwarded to the High Court of Australia, and then later requested on 17th July, 1973, that his appeal be transferred to this Court. The matter came on for hearing on 12th and 13th June, 1974.
The main question which arises is whether the rights fall within sec. 26(e) of the Income Tax Assessment Act, 1936, as amended. The relevant part of that section is as follows -
``26. The assessable income of a taxpayer shall include -
........................................................
- (e) the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise.''
Counsel for Mr. Donaldson argued that sec. 26(e) is concerned only with items which -
- (i) are of an income nature according to ordinary concepts;
- (ii) can be valued and the value of which can be cast in money terms; and,
- (iii) have a present value to the taxpayer and are enjoyed or capable of being enjoyed by him in the income year.
Counsel for the Commissioner was disposed to agree with (i) and (ii), but not with (iii). He argued that sec. 26(e) looks first to see what is ``allowed, given or granted'' to the taxpayer, and then includes in the taxpayer's assessable income the value to him of the benefit so conferred. If it appears there is conferred a benefit of an income nature which can be given a monetary value, then it is assessable income of the taxpayer.
Forensic or judicial glosses upon the section are no substitute for its words, which seem plain enough. However, the points raised do concentrate attention on specific areas of contention in the application of the section. As to (i) the words of sec. 26(e) suggest that any item which falls squarely within its terms is rendered assessable income. So far as the words of the section are concerned, it seems to matter not whether the item would otherwise be of an income or capital nature according to ordinary concepts. There is little difficulty with meals. They operate in relief of the taxpayer's purse as well as his stomach. So too, I think, the use of premises or quarters, which also operate in relief of his purse and save him from having to pay rent, would be regarded as being of an income nature, at least in these days, if not eighty years ago. (cf.
Tennant v. Smith, (1892) A.C. 150; 3 Tax Cas. 158.) But what of an outright gift of a house or a car? Are these capital receipts which fall outside sec. 26(e)? Of course, a benefit does not come within sec. 26(e) unless it is ``allowed, given or granted'' to the employee in respect of or for or in relation directly or indirectly to any employment of or services rendered by him. If it answers this description, is it thereby transmuted into income according to ordinary concepts, whatever it may be? Perhaps the proposition is not so much that sec. 26(e) applies only to income and not to capital items, but rather that it is so worded
ATC 4206
that there is nothing it covers which would not be of an income nature in any event.It is unnecessary for present purposes to pursue this. Counsel for both parties are agreed that sec. 26(e) applies only to items of an income nature, and they are strongly supported by what was said by Fullagar J. in
Hayes v. F.C. of T. (1956) 96 C.L.R. 47, at p. 54) and by Windeyer J. in
Scott v. F.C. of T. (1966) 117 C.L.R. 514 at pp. 525-526). Did the rights which Mr. Donaldson acquired in the present case constitute a benefit allowed, given or granted which was of an income nature? It is not unusual for companies to give to senior employees rights of varying kinds to take up shares upon terms which are beneficial to the employee. Methods vary. It may be by way of allotment of shares for an amount less than market value in pursuance of a particular offer to the employee without any legally enforceable option having been conferred upon him, (see
Weight v. Salmon (1935) 51 T.L.R. 333; 19 Tax Cas. 174;
Ede v. Wilson (1945) 1 All E.R. 367; 26 Tax Cas. 381; cf.
Bridges v. Hewitt (1957) 1 W.L.R. 59;, 67437 Tax Cas. 306). It may be by way of legally effective option rights which entitle the employee to take up shares in the future at a time when their market value may exceed the price fixed by the option agreement;
Abbott v. Philbin (1961) A.C. 352; 39 Tax Case. 120). These cases turn upon the provisions of the English Income Tax Legislation - in particular Schedule E of the Income Tax Acts, ranging from the Act of 1842 to the Act of 1918, and later the Act of 1952. The wording of these provisions is markedly different from our sec. 26(e), particularly with its reference to ``perquisites'' of office or employment. But in its practical application in many respects it is not dissimilar. I think it is fair to say that in these days, such benefits are regarded as being in the nature of a bonus or an addition to salary and are of an income nature, where they are conferred in relation to the employment or to services rendered. My conclusion in the present case is that a benefit was allowed, given or granted to Mr. Donaldson of an income character.
As to (ii) the question arises whether the rights acquired by Mr. Donaldson constituted a benefit which could be valued and the value of which could be cast in money terms. This suggested requirement bears a family resemblance, although it is not identical, with the gloss propounded by Lord Watson on Schedule E of the Income Tax Act, 1842, (Eng.) in Tennant v. Smith (supra); and see
Heaton v. Bell (1970) A.C. 728).
Counsel for both parties were in broad agreement about this requirement; they were in dispute whether the requirement was met. Counsel for Mr. Donaldson argued that the taxpayer had only a future expectancy; in effect, that machinery had been set up under which he might in the future gain a benefit, but that he had presently received none. Further, it was said that no value could be placed upon the rights he acquired, or no value which could be cast in money terms.
Counsel for the Commissioner disputed these propositions. It was argued that Mr. Donaldson acquired immediate rights which were intended to confer, and regarded by the Corporation and Mr. Donaldson as conferring, a valuable benefit upon him; that these rights could, if Mr. Donaldson wished, be turned to pecuniary account by his giving to a ``purchaser'' undertakings to remain in employment, and to exercise his right to take up shares at the appropriate time in accordance with the directions given to him by the purchaser, and then to transfer any shares, after allotment to him, to the purchaser. It was further argued that, in any event, sec. 26(e) spoke of ``value to the taxpayer'', and even if Mr. Donaldson was unable to dispose of his rights they had a value to him which could be cast in money terms.
In my opinion, there is room for argument as to what is the appropriate method of valuation to be applied under sec. 26(e), and room for disagreement as to the value of the rights acquired. However, I am not persuaded that these rights, which related to shares quoted on the Stock Exchange, had no immediate value to Mr. Donaldson or were incapable of being valued in money terms. Accordingly, if proposition (ii) applies, I am of opinion that it does not operate to prevent Mr. Donaldson's rights from falling within sec. 26(e).
ATC 4207
As to (iii), I find myself in general agreement with the argument advanced by counsel for Mr. Donaldson that the Income Tax Assessment Act is dealing with what ``comes in'' to the taxpayer, and, generally, with what is enjoyed or capable of being enjoyed by the taxpayer in the income year in question. But these are generalisations which do not greatly assist in the resolution of the present case. I an unable to accept a proposition that the option rights conferred on Mr. Donaldson did not ``come in'' to him or were not enjoyed by him in the year of income. Items rendered assessable income by sec. 26(e) have to be regarded according to their nature, whether they are meals, use of quarters, or option rights. To say the option rights could not be exercised in the year of income is no answer to the application of sec. 26(e). Indeed, it is to confuse the enjoyment of the fruit of the rights with the enjoyment of the rights, a mistake made in argument on behalf of the Crown in Abbott v. Philbin (supra). Again, to say rights are non-transferable is no answer to the application of sec. 26(e). Meals which are consumed may be non-transferable and yet they are within sec. 26(e). what is made assessable income by sec. 26(e) is the value to the taxpayer of the benefit allowed, given or granted to him, that is to say, the rights conferred on him which others lack. Whether they have any value to him, and what that value is, are matters to be determined according to the facts of each particular case, preferably with the assistance of expert evidence. But that does not affect the principle that where such rights are given they are present rights, though exercisable in the future, and confer an immediate benefit upon the taxpayer which he enjoys as the owner of them.
This brings me to the two remaining questions: What is the proper basis for valuation, and what, if any, is the value?
Where what is given is freely transferable, its value may be found by determining what a willing but not anxious purchaser might pay for it. Where what is given is subject to restrictions, its value may be found by determining what a willing but not anxious purchaser, who would, if he bought it, be subject to the same restrictions, might pay for it. Where, as here, what is given to the employee is subject to restrictions and conditions which he alone can fulfil, valuation is more difficult. In case it be material, I should express my view that counsel for the Commissioner was correct in his contention that, notwithstanding the restrictions and conditions in the present case, the taxpayer might make an arrangement for a money sum with a purchaser by giving appropriate undertakings to remain in employment and, so far as lay within his power, to keep his present employment position or an equivalent, to exercise his option at the appropriate time in accordance with directions from his purchaser, and, subsequently, to transfer the shares when he acquired them. In my view he could do this without breaching the restrictions regarding assignment (see Abbott v. Philbin (supra) per Lord Simonds at p. 366 and per Lord Reid at p. 371). If one adopted this approach, one would find the value of the benefit by determining what a willing but not anxious purchaser would pay for such an arrangement. But there is, I think, a simpler approach and it is one which I would prefer to adopt. Section 26(e) speaks of ``value to the taxpayer''. This is a notion familar in valuing to determine compensation for resumption purposes. In a case such as the present under sec. 26(e) I consider it is appropriate in ascertaining value to the taxpayer to determine what a prudent person in his position would be willing to give for the rights rather than fail to obtain them. (cf.
Pastoral Finance Association Limited v. The Minister, (1914) A.C. 1083 at p. 1088).
In Abbott v. Philbin (supra) Lord Simonds was able to say the taxpayer had paid £20 for the option rights - ``not a large sum, truly, but £20 deserves a second thought''. The present case presents no such easy comment. True the taxpayer paid $20, but this was in the form of a loan which was repayable if he did not exercise the option, and also in certain other events, and which in the meantime carried interest. Nevertheless this does not mean the rights had no value to him. Indeed, it is not what is paid for the rights which will determine their value, but what they are worth to him in the sense I
ATC 4208
have mentioned. On this basis, what was the value of the rights to him when he acquired them on 15th January, 1971? I accept Mr. Glover's oral evidence that the scheme for key personnel was designed to give them a feeling of partnership within the company by their having shares in the future. But it is clear that the Corporation believed it was conferring rights upon key personnel which would be beneficial to them, so much so, that the existence of the rights exercisable in the future might induce them to remain in the service of the Corporation in order to have the opportunity of harvesting the fruit in due time.I do not consider the reference in the Corporation's circular of 13th August, 1970, to what the profit to the employee would be, if the shares which might be taken up at 91 cents were quoted on the Stock Exchange at $2 when the option matured, should be taken as the basis for evaluating the benefit being conferred on the employee. I think $2 was a round figure taken as a basis for calculation, and in this sense, as Mr. Glover put it, was ``picked out of the air''. On the other hand, it seems from his cross-examination that Mr. Glover did not regard the figure as unrealistic, as appears from the following questions and answers -
``Q. You certainly did not think it improbable that the stock units would be worth $2 by the end of the three to four-year period from the date of your memorandum? A. No.
Q. I'm sorry. Just to get it clear, you did think it improbable? A. It was probable, and it was improbable. We considered that the shares may go to $2; they may go to $1.50; they might drop back to 80 cents, as they have just done recently. We did not know. We put a figure in.
Q. The whole purpose of putting the figure in was to give some approximation? A. Yes, that is right.''
Turning to the expert evidence, the two witnesses called on behalf of Mr. Donaldson expressed the opinion that the rights were incapable of valuation. Mr. Alexander Stuart MacWilliam, a stock and sharebroker, who formerly practised as a chartered accountant and for a period was Assistant General Manager of Australian Fixed Trusts responsible for the investment of its funds, and who was a man having considerable experience in the valuation of shares, was one of these witnesses. Having set forth in para. 7 of his affidavit what he described as the basic criteria to be taken into account in valuing shares, which included dividend yield, asset backing, price earnings ratio, extent of dividend cover, trend of company's earnings, the general state of the market, the calibre of management, and so on, he said -
``In my view it is not possible to presently value shares and/or options in listed or unlisted companies at future dates, whether such future dates be 3½, 7½ or 11 years hence, or any other date in the future.
The reasons why I am of this opinion are perhaps best summarised by saying that any of the investment criteria as outlined in paragraph 7 hereof are subject to change in the future. In addition to these local criteria, there can be unforeseeable changes in the international situation. Any one or all of these changing factors have a direct bearing on the market price of any particular stock at any given time.''
Later he said -
``In my view it is both impossible to place a value on the Options as at the date of grant and to presently foresee and predict what will be the value if any of the shares to which the Options relate at particular times in the future when the Appellant may become entitled to exercise the Options.''
If by placing a value on options one means stating a precise figure which will prove to be correct, then one would agree that in the case of a complex set of rights involving a multiplicity of contingencies the task is an impossible one. But if by placing a value on rights one refers to the formation of a judgment of what the rights might be worth, or what some willing but not anxious person might be prepared to give, rather than fail to obtain them, then I do not think it can be said that valuation in this sense is
ATC 4209
impossible. The Courts are accustomed to dealing with difficult questions of valuation where opinions may differ, but where a figure has to be arrived at. Again, in the ordinary affairs of life, the multiplicity of contingencies which renders precise valuation impossible does not deter people from laying out their money, whether it is for a premium for insurance, a bet on a racehorse, the purchase of wool futures or the acquisition of convertible notes. I am not convinced that it is impossible to place a value on the option rights in the present case.Perhaps the explanation of Mr. MacWilliam's approach is to be found in some answers which he gave in cross-examination as follows -
``Q. So that it is fair to say, is it not, that the art of putting some price or worth on options is a well recognised one in the market place? A. Yes.
Q. Would I be right, therefore, in saying that the features which made it difficult for you in the present case to ascribe any monetary worth to the bundle of rights were the various contingencies? A. Yes.
Q. Had it not been for these contingencies one would have been able to make some valuation which the future would no doubt have proved right or wrong? A. Yes.
Q. Leaving contingencies aside if I may for a second; the exercise of trying to put a monetary worth on these options did of necessity involve an estimate being made of the likely price of Hooker Corporation shares at the time of exercise of the options, if any? A. Right.
Q. I think we have agreed, have we not, that to make a forecast of what sort of price is likely to be the price of Hooker shares four years hence is something that stockbrokers do every day, albeit you may not like to do so yourself? A. Some may do it every day, but as a matter of practice we do not do it ourselves.
Q. The period for which a stockbroker is willing to make a forecast of future prices of shares varies with the individual stockbroker? A. Yes, depending on his attitude.
Q. And it may go up to the ten years which is the period under consideration here? A. It may.''
In this passage his view appears rather as a personal predilection or attitude which he adopts which is no doubt in ordinary affairs a prudent one, and one which he believes to be correct. But he concedes that other stockbrokers would be willing to make a judgment in such matters, although he would not.
The other expert witness called on behalf of Mr. Donaldson was Mr. Bruce Whittle, a consulting actuary and licensed investment adviser, whose work consists principally of advising life insurance companies, general insurance companies and superannuation funds on various matters, including investment matters. He listed the elements to which he considered a person attempting to value the rights would have regard. These included uncertainty about the ultimate value of the shares; the necessity that the employee should continue in employment; the possibility that the employee might be dismissed; the possibility of abatement by death; the non-transferability of the rights, and various other matters. These, as an actuary, he found incapable of quantification.
His view is summed up in the following statement, to which he deposed -
``In order for me to value the options as at 15th January, 1971 it would be essential to either know as a fact what the value of the shares would be at the option date or be able to establish probabilities that the value of the shares at 1st January, 1974 or at other times within the option periods would be at a particular price (or fall within a particular price range). But even if I did have the value of the shares at the option date or could establish the probability of such value, the absence inter alia of the undermentioned data would, in my opinion, make it impossible for me to value the options as at the date of grant:
- (a) The precise date on which the options will be exercised.
ATC 4210
- (b) The probability that the option holder would continue in employment or survive until the option exercise date.
- (c) The appropriate discount to be made on account of the effective non-transferability of the options.
- (d) The possible action which may be taken by the Directors of the Company in making additional issues of shares to shareholders between 15th January, 1971 and the option date either at par or at a premium.
For the reasons hereinbefore set out, I do not think it is possible for me using actuarial methods to assess a value of the options as at 15th January, 1971.''
I think that Mr. Whittle's evidence, like that of Mr. MacWilliam, does stress the very great difficulties in arriving at any well-based judgment about the value of the rights. But I remain unconvinced that they are incapable of valuation.
One point which was not entirely clear was whether Mr. MacWilliam's evidence went to the extent of saying that the rights were, in his judgment, worth nothing. At the conclusion of his oral evidence, I asked him some questions about this as follows -
``Q. Is that to be taken to be the same as saying that you would attach a nil value to them? A. It may well be.
Q. It is not intended? The words are carefully chosen, are they? There is no value you could attach? A. Yes.
Q. Not that you would attach a nil value? A. Well, I might attach a nil value to them, yes. I think it is a matter of how it is expressed here in the affidavit.
Q. Do those statements amount to the same thing from your point of view? A. In my mind at the time, yes, they did.''
It is clear that he did not intend to cast his evidence, either in his affidavit or in his oral evidence, in the form of a statement that he valued the rights at nothing; but I think it fair to accept his statement in his answers to those questions that he thought that it amounted to the same thing. However, I am not persuaded the rights were worth nothing.
There is one other matter I should mention. No doubt the prospective market value of the shares is the major element in determining the value of the rights. However, the holder of such rights is in a position to take advantage of a rise in the quotation of the shares at any time during the relevant period, should it occur. An insurance policy is not valueless simply because no loss occurs in respect of which one can claim under it. People are prepared to pay a premium for the cover. In the same way, in reverse, people are prepared to pay in effect, a premium for convertible notes against the possibility that shares may rise, without necessarily calculating precisely that they will, or to what extent. The option rights in the present case are associated with convertible notes, albeit with complex conditions.
The expert witness called on behalf of the Commissioner was Mr. Robert George Alexander. He is a chartered accountant, with considerable experience in valuing shares. He deposed -
``Sales of the company's 50 cent ordinary shares ranged from $1.20 to $1.26 per share during the period 4th to 15th January 1971 inclusive and 12,950 shares were sold at $1.23 per share on 15th January, 1971.''
He considered the company's record and its financial statements for the year ending 30th June, 1968, 1969 and 1970, and for the six months ending 31st December, 1970, and considered the nature of the Corporation and its activities, describing it as a ``growth company''. Because there was no indication as to what time after maturity the options would be exercised, he took the middle of the period in each case. He expressed the opinion that Mr. Donaldson, as vendor, and a hypothetical but not anxious purchaser on 15th January, 1971, could reasonably expect that the market value of the Corporation's ordinary shares would not be less than $1.23 per share (after deducting stamp duty and brokerage) on each of the assumed dates. In these circumstances an estimated profit of 32 cents per share (i.e. $1.23 minus 91 cents)
ATC 4211
would be derived by the purchaser of the unsecured notes on each of his assumed dates. The amount of his valuation, then, was the present value (calculated as at 15th January, 1971) of the estimated future profit on each parcel of shares. He applied an interest rate of 20 per cent per annum in making the calculation. In selecting the substantial discount afforded by the adoption of the rate of 20 per cent, he took into account both beneficial elements, such as the right of the holder of the convertible note to participate in cash or bonus issues during the term of the note, and depreciatory factors, such as the requirement of continuing employment and holding the employment position. He summed up the result of his findings as follows -``I value the benefit arising to Mr. David G. Donaldson from the issue by Hooker Corporation Ltd. of three 6½% convertible notes totalling $20.00 as follows -
Amount of Unsec- No. of Shares of Estimated Total valuation of
ured Convertible 50 cents each total benefit at 15th
Note. fully paid. benefit. January 1971 (date of
issue of unsecured
note).
$ $ $
10 10,000 3,200 1,272
5 5,000 1,600 322
5 5,000 1,600 178
-----
TOTAL 1,775
-----
In the course of his cross-examination, Mr. Alexander indicated that in arriving at present value by using an interest rate of 20 per cent he had in mind one favourable factor, that there would be an entitlement to participate in intervening issues of capital, and two unfavourable factors, that Mr. Donaldson had to stay in employment and retain his employment position. He further indicated that he considered a purchaser would, perhaps, be more concerned with the depreciatory factors than would be Mr. Donaldson, because Mr. Donaldson would know his own intentions and the regard in which he was held by the Corporation better than any purchaser. Having stated -
``I have said that a purchaser would expect a 20 per cent discount rate taking all the factors into account,''
he later gave evidence as follows -
``Q. If, for instance, he were to attempt, or to consider, buying with the knowledge that if the vendor were to attempt to sell them to him without getting the written consent of the Corporation, in your view would he be getting anything of any value at all? A. I don't think the sale could take place unless the Corporation gave their approval. The buyer could not get possession of them. The transfer could not be recorded without the Board's approval. I assumed that the buyer would have been approved by the Corporation.
Q. So is your calculation based on the assumption that the purchaser would in fact have had evidence of the vendor having the approval of the Corporation to the assignment? A. Yes.''
The key factors in Mr. Alexander's valuation, therefore, were -
- (a) His assumption that the option would be exercised in the middle of such relevant period during which the option might be exercised.
- (b) His judgment that the shares of the Corporation would not at that time be quoted at less than $1.23, being the figure at which they were quoted on 15th January 1971.
- (c) His assessment that a purchaser would expect a discount rate of 20 per cent by reason of the contingencies involved.
ATC 4212
- (d) His assumption that the purchaser would have been approved by the Corporation.
The correctness of each of these factors was challenged by counsel for Mr. Donaldson. Each is open to some criticism, but (a), (b) and (c) represent the kind of judgments or assessments which are made and which may well be the basis of dealings in the kind of market place we are considering. The soundness of the result depends to a considerable extent upon the experience and knowledge of the market of the person using these factors and making the valuation. Mr. Alexander's experience and knowledge of the market are not unimpressive, although in the light of the assessment of contingencies made by Mr. MacDonald and Mr. Whittle, each of whom also has high qualifications, his assessment regarding the likely price of the Corporation's shares at the date taken by him in five, 8½, 9 and 12 years time may be said to be too high, and his discount rate may be said to be somewhat low. I consider that his assumption that the Corporation had approved the purchaser was not strictly a correct approach, and might tend to make the valuation higher than it otherwise would be, if this restriction were not disregarded. However, it may be argued that this basis of valuation would not necessarily produce a result much different from that produced from either of the two bases which I have suggested.
The position reached on the appeal is that none of the witnesses called supports the value placed upon the rights by the Commissioner in his assessment, and I am not satisfied that I should adopt the assessment of any one of the three expert witnesses. The Commissioner's valuation in his assessment has been criticised as having been arrived at as early as 26th October 1970, the date of his letter, whereas it is said the relevant date for valuing the shares is 15th January 1971. In the meantime the annual report had been issued containing good results and in the directors' report favourable comments on the Corporation's future prospects. The shares had risen in value on the market by 15th January 1971. It does not appear that the Commissioner's valuation is too high; the suggestion flowing from Mr. Alexander's valuation is rather that it is too low.
Having this suspect origin, it is argued it must be wrong. However, the principal factor being considered is the likelihood of the shares rising above the contract price of 91 cents at periods ranging upwards of ten years ahead, and the extent of that rise. The difference between making such long range assessments from October 1970 to January 1971, while having some significance, can easily be exaggerated. The Commissioner's assessment is not inevitably to be disregarded.
It has not been sufficiently demonstrated to me either that the Commissioner's assessment is wrong, or that some other figure should be taken, whether this be nil or some other positive value (see
Trautwein v. F.C. of T. (1936) 56 C.L.R. 63 at p. 88)). Under the Act the burden of proving the assessment is excessive rests upon the taxpayer (see
George v. F.C. of T. (1952) 86 C.L.R. 183 at p. 201)). This burden has not been discharged to my satisfaction.
I may mention that the appellant does not ask me to remit the assessment to the Commissioner for reconsideration; he desires rather a decision in point of principle.
In the circumstances I hold that the assessment should be confirmed. The order I make is that the appeal will be dismissed, with costs. The exhibits may be returned unless an appeal or application for leave to appeal is instituted within twenty-eight days.
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