Case H6

Judges:
AM Donovan Ch
GR Thompson M
RK Todd M

Court:
No. 2 Board of Review

Judgment date: 20 February 1976.

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A.M. Donovan (Chairman); G.R. Thompson and R.K. Todd (Members): These references came before the Board at the request of five taxpayers who or which shall, for the purposes of these reasons, be referred to as follows: P Nominees (being the trustee of a trust in relation to the family of F); H Nominees (being the trustee of a trust in relation to the family of H); A Nominees (being the trustee of a trust in relation to the family of A); L Holdings (a family company of B, a solicitor), and R (being the trustee of a trust in relation to the family of L). The taxpayers and the Commissioner agreed that the references be heard together.

2. Some time prior to 16th November, 1969, an opportunity came into the way of a group of businessmen and others in a capital city to become involved in a gemstone mine in another State. The mine was visited by persons acting on behalf of the group in late November, and on 24th November, 1969, one G, the registered proprietor of a Mineral Claim granted to him in respect of specified minerals on or in the mining property, granted to B (referred to above), who was the solicitor for at least some of the group of men referred to, an option to purchase all the right, title and interest of G to and in the Mining Claim together with all ore, stones, sands, tailings and residues thereon and all documents of title affecting the same and the full benefit and advantage thereof. The term of the option was 28 days with provision for such term to be extended, as it apparently was on several occasions prior to its eventual exercise. The option was granted to B ``as nominee for a syndicate''. The price was $80,000, payable as to $40,000 thereof on execution and as to the remaining $40,000 ``when (sic, semble `within') the period of twelve months from the date of exercise of the option''.

3. On 4th December, 1969, a document headed ``Memo, to all syndicate members'' was sent out referring to what had occurred, to further intended work, and to the drawing up of a deed which would enshrine the terms of the agreement between the syndicators. On 8th December, 1969, this deed was executed. The entry by B into the option agreement as trustee for the members of the syndicate was recited. The members of the syndicate, and the due proportions of their interests in it, were set out in a schedule to the deed, and included the taxpayers referred to in para. 1 above save for the taxpayer R. Clause 1 of the deed provided as follows:

``The Members do hereby constitute a partnership for the purpose of investigating the said mineral claim and exercising the said option if the members so decide and to procure the incorporation of a Company upon the terms and conditions hereinafter contained.''

4. Without rehearsing the evidence in detail, we find that at the date of execution of the deed none of the aforementioned taxpayers acquired whatever property they had at that stage acquired for the purpose of profit making by sale. This finding involves the acceptance of evidence given that the intention was that the mine should be further investigated, and then developed and worked through the medium of a company to be formed. The opening paragraph of the ``Memo'' dated 4th December, 1969, to which we have referred, might lead to some doubt as to whether in all the circumstances prevailing at the time this was the case in relation to F and H, but on the whole we conclude that no differentiation should be made in their case. It should be added that by cl. 2 of the deed B declared that he held his interest in the option agreement upon trust and as nominee for the members of

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the syndicate in the stipulated proportions, and that he agreed to exercise the option contained in the option agreement if and when called upon to do so by the members. There were other provisions but, in view of the finding made, we think that it is unnecessary to set them out.

5. At about this time L, who was B's partner in a solicitors' practice, asserted to B for background reasons that are immaterial that he should have been entitled to a share in the enterprise. B had not thought this was so, but relations between them were good and he was not disposed to make an issue of it. More, pressed as he was by preparations to go overseas on the 10th, he agreed on the 9th December to sell to L the whole of his company's interest under the syndicate agreement for a sum of $11,000. This represented a surplus of $8,000 over B's company's initial contribution to the syndicate. On 10th December, B went off overseas and did not return until early in February. On 15th December the L family trust, with R as trustee, was brought into existence by the execution of a deed. If there had been some prior oral declaration of trust, it was not satisfactorily proved, but the point does not in the result seem to be of importance. A formal deed confirming that L Holdings had agreed to sell all its right, title and interest in the syndicate to R was executed on 7th February, 1970.

6. To return to the chronology of events, some time late in December M and G, who controlled a company which was one of the syndicate members, embarked on a vigorous campaign to peg a large number of mineral claims in the same State as that in which the gemstone mine was found. These claims apparently sought to establish claims to search for nickel, and appear to have been embarked upon at the instigation of the interests represented by F, H and A, who were business associates.

7. Some time in January 1970, but before the 16th of that month, F was in touch with his sharebroker, Z, about various matters. It is not clear who raised the matter, as the evidence of the two men differed, but the likelihood is that F raised with Z the question of forming a listed company to carry out the objects of the syndicate. Z pointed out the difficulties in such a project and suggested in effect that it would be preferable to use an existing listed company as a vehicle which, after assignment to it of the syndicate's mining properties, would seek listing on the Stock Exchange of a further issue of shares. T Ltd., a company which was suitable for the purpose, and the management of which was thought to be likely to be interested in the proposal, was introduced and the upshot was that a meeting of importance was held on 18th January, 1970, at which directors of T Ltd. were present, and also representatives of the syndicate. Not all such members knew of these dealings, indeed two of them were overseas, but we approach the matter on the basis that those present at the meeting had full authority to act.

8. We must rely on the minutes of the meeting for evidence of what occurred. These minutes were described as Minutes of a Special Meeting of Directors of T Ltd. So far as relevant the minutes were as follows:

``Agreement With a Group of Private Individuals: A general discussion took place in regard to the proposals put before the Board and it was unanimously agreed that the proposals be accepted in principle subject to certain variations. After thorough discussion the following agreement was arrived at between the Board of Directors on behalf of the Company and the Syndicate headed by Messrs. (F) and (G) -

1. The Company will acquire a (gemstone) producing mine in... together with various nickel exploration areas in that State.

• The mine is situated at...
• The group will also assign all its rights and interests in approximately 120 mineral claims, some of which are located at...

2. The Company would change its name to one which is more appropriate to its expanded range of activities.

3. The Company would increase the nominal capital from its present level of $500,000 to $5 million.

4. The Company would subdivide each existing $1 share into 10 units of 10 cents each.

5. In consideration for the transfer of the interests in the various leases to the Company, it is proposed that the

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Company will grant to the Syndicate referred to above 2,000,000 unlisted options each of which will carry the right to apply for one 10 cent share at par at any time within five years from the date of the grant of the option. The Company will bear all costs of pegging and establishing the claims.

6. The consideration for the transfer of the (gemstone) mine will be $125,000 cash and the Company will also bear all costs hitherto incurred by the Syndicate in connection with the mine and will be entitled to all materials so far mined.

7. The Company would spend not less than $500,000 within the next twelve months in exploring the nickel claims taken over. In order to provide these funds and to provide further working capital for the Company's present business and other ventures contemplated the Syndicate would procure a number of investors who would take up - and the Company would allot to them - for cash at par, 8,240,000 shares of 10 cents each. Each of these shares will carry one separable option entitling the holder to apply for one 10 cent share at par in the months of June 1971, 1972, 1973 or 1974.

8. The Company would allot to each existing shareholder one separable option, at a cost of 2 cents per option for each 10 cent share held, these options carrying the same rights as those referred to in (d) above.

• It was considered that the above allotments will place $880,000 at the disposal of the Company. After satisfying all sums charged or to be charged in respect of expenditure undertaken on the mine, for stocks of (gemstone) on hand, and in respect of expenditure already incurred on other leases, the Company will have some $500,000 to be applied towards future exploration and development of its mining interests.

9. An extraordinary general meeting of the Company would be called as soon as possible to give effect to the foregoing agreement.

• The present timber business of (T Ltd.) will continue as usual under the existing management and be expanded when possible.
• In due course applications will be made to have the Company's shares and options listed...''

9. On 7th February, 1970, the agreement between B and L to which reference has already been made in para. 5 above was executed.

10. On 16th February, 1970, an Extraordinary General Meeting of T Ltd. was held at which, inter alia, the ``arrangement'' made by the Board of Directors was approved. It was certainly an important meeting, for an ailing timber company was about to turn miner in a distant State.

11. On 2nd March, 1970, a letter was sent in the name of T Ltd. to B in the following terms, so far as material:

``We refer to our conversation and confirm that you are to exercise the option on the (gemstone) mine making all necessary arrangements for the drawing up of documents, etc. and for payment of the first $40,000 as called for under the existing agreement...''

The reference to the ``existing agreement'' was to the agreement between G and B which had been entered into on 24th November, 1969.

12. On 7th March, 1970, B duly exercised the option to purchase the Mineral Claim. Following the terms of the grant of the option, he exercised it ``as nominee for a Syndicate''.

13. On 8th May, 1970, G executed a transfer of his right, title and interest in the Mineral Claim to B. The Declaration lodged in support declared the consideration to have been $80,000, being the consideration stated in the agreement of 24th November, 1969.

14. On 15th May, 1970, B in turn transferred to T Ltd. (under a new name which it had by then assumed) his right, title and interest in the Mineral Claim. The consideration was stated in the Declaration to be $205,000. This sum is to be taken to be the total of $80,000, being the total price payable to G (and thus a cost ``hitherto incurred by the Syndicate in connection with the mine'' within the meaning of cl. 6 of the Minutes of the Meeting of 18th January), and the sum of $125,000 also referred to in the same cl. 6. Oddly enough, no reference is made in the statement of the consideration to a further sum of $36,589.98

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which had also been incurred by the Syndicate. That the sum of $125,000 represented clear profit was due to the fact that T Ltd. was to ``bear all costs hitherto incurred by the Syndicate in connection with the mine''.

15. For the taxpayers, Mr. Davies contended that the case for assessability was to be seen if at all as one involving the applicability of the second limb of sec. 26(a). At such a suggestion he struck a double blow. First, he said that it was not possible to find that such a scheme came into existence. Second, the Commissioner had never at any stage or in any way purported to assess upon such a basis and it was simply not right, at the stage of a closing address before a Board of Review, that a taxpayer should have to make out a case in rebuttal of an argument for assessability not theretofore propounded by the Commissioner. This latter submission would appear to be contrary to the decision of Menhennitt J. in
F.C. of T. v. G.J. Coles & Coy. Ltd., 74 ATC 4111; (1974) V.R. 443. But in any event we need not go past his first assertion, which we consider to have been well founded. Viewed at the commencement of the narrative, we find that the original project involved the exploration and development of a mine. The scheme was to be considered upon a view of the legal arrangements enshrined in the agreement of 8th December, 1969, and this was a partnership the purpose of which was to explore and develop, and the end result of which was to be the allotment of shares in a company which would control and operate the mine. Money making was of course intended, but this was not enough, Mr. Davies argued, to justify a finding that there was a profit making undertaking or scheme. With this we agree. Nor do we think that a profit making undertaking or scheme can be wrested out of the subsequent events that developed out of the search for nickel leases and out of the association with T Ltd. Not the least of the difficulties in this area would be to work out precisely who was involved in such a scheme at any particular time.

16. It remains to consider the question whether the profit which accrued to each taxpayer was properly assessable under the first limb of sec. 26(a). We have already found that as at the date of the syndicate agreement, namely 8th December, 1969, there was no intention to acquire any property for the purpose of profit making by sale, and if the profit which did ultimately accrue arose from a sale of any property acquired by the syndicators pursuant to and at the time of that agreement then the taxpayers would be entitled to a decision in their favour. But it is necessary to see how the profit arose as a matter of law. An analysis of a transaction for the purpose of the first limb seems to us to have to work backwards, in the sense that the enquiry proceeds as follows:

• (1) Did a profit arise,
• (2) from the sale,
• (3) of any property,
• (4) acquired,
• (5) for the purpose of profit making by sale?

It is therefore here necessary to establish whether and when there was a sale from which the profit arose (there being in this case an undoubted profit). If the profit assessed arose from the sale of property effected by an agreement spelled out of the events, as recorded in the minutes referred to above, which occurred on 18th January, and if that property so sold was the property which was acquired by the syndicators on 8th December, then we think that, as already stated in para. 4 above, such property was not acquired for the purpose of resale at a profit. But in fact we do not think that the profit arose from any such sale. The so-called agreement of 18th January, 1970, seems to have been no more than an expression of a mutual intention to enter in the future into legal relations. We find that it was not an executory contract. It is true that the word ``agreement'' was used on a number of occasions. But there are other significant indications. The proposals were ``accepted in principle''. The company ``would'' change its name; the company ``would'' increase the nominal capital; the company ``would'' subdivide each existing $1 share; it was ``proposed'' that the company will grant options; the consideration for the transfer of the gemstones ``will be'' $125,000 cash; the company ``would'' allot one separable option; an extraordinary general meeting ``would'' be called as soon as possible to give effect to the foregoing agreement. But the acid test lies surely in this, that the only property which the syndicators had at that stage was not a mine but an option to acquire a mineral claim. This must have been well known, yet no legal step seems to have been taken to ensure that the option would be exercised and it seems to me quite plain that had the syndicators declined to instruct B as trustee to exercise the option, or

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had instructed him not to do so, T Ltd. could not, on the strength of the ``agreement'' of 18th January, have obtained a decree of specific performance calling upon the syndicators to do what was necessary to vest the mineral claim in them in order to give effect to the ``agreement'' of 18th January. In fact of course the option was exercised, T Ltd. having written and ``confirmed'' that the option was to be exercised. In due course B in fact executed a transfer of his right, title and interest in the mining claim and it was out of this transaction that the profit of $125,000 arose. The payment by T Ltd. out of which the profit arose, was in our opinion made in consideration of the actual transfer of the rights in and to the Mineral Claim. But these rights in and to the Mineral Claim which were so transferred were not acquired in December 1969. They were acquired at the earliest when on 7th March, 1970, B exercised the option to purchase the Mineral Claim. By that date it is plain that the taxpayers, other than B, to whom reference will be made later, were acquiring the property in question for the purpose of resale at a profit. It is not possible to refer back to the intention which the taxpayers had in relation to the acquisition of the option to purchase in December 1969. The property then acquired was not the property which was sold when the profit was taken. The reasons for this view are fully set out in Case F47,
74 ATC 266. There is simply no legal correspondence between the property constituted by the holding of an option to purchase on the one hand and the property constituted by the rights acquired upon the exercise of that option. Since the decision in Case F47 was given, the necessity for an identity between the property acquired and the property sold has been emphasised by the High Court in
A.L. Hamblin Equipment Pty. Ltd. v. F.C. of T. 74 ATC 4310 at p. 4314, and in
Steinberg v. F.C. of T., 75 ATC 4221 at p. 4225.

17. The position of L Holdings is different. The property that was sold to L or his nominee, if that is how the transaction is to be regarded, was the property which was acquired at a stage when we are satisfied that B, by whose intentions the purpose of acquisition of L Holdings must be ascertained, had no intention to resell at a profit. While there are some difficulties in relation to the way in which this transaction was effectuated, we consider that the taxpayer has discharged the burden placed upon it by sec. 190(b) of the Act.

18. The result is that in relation to the reference brought before the Board by L Holdings, we are of opinion that the objection should be allowed in full and the assessment amended accordingly. In relation to the other references, we are of the opinion that in each case the decision of the Commissioner was correct and that the relevant assessment should be confirmed.

19. In two of the references the objections raised a ground of objection under sec. 98 of the Income Tax Assessment Act, but we were informed that these grounds were not being pressed.

Claims allowed in part