Harrison v. Federal Commissioner of Taxation.
Judges:Waddell J
Court:
Supreme Court of New South Wales
Waddell J.: Before the Court are two appeals against the disallowance by the Commissioner of Taxation of objections lodged against amended assessments issued for the year ended 30th June 1968. The appeals are heard together by consent, each relating substantially to the same facts. In each case the amended assessment was issued in an amount described as ``income derived by you being your proportion of the distributions by R. Harrison & Son (Holdings) Pty. Limited during the year ended 30th June 1968''. The adjustment made to the taxable income of the appellant Westley Harrison was to increase it by $298,226, and that to the income of the other appellant, Mrs. Jeanette Harrison, his wife, to increase it by $29,822. The amended assessments were issued on the 2nd December 1970. By letter dated the 31st December the Deputy Commissioner advised the appellants' accountants:
``That the amounts added in the amended assessments were based on the respective portions of dividends declared by Harrison & Son (Holdings) Pty. Limited on the basis of the non-preference shares held. It is noted that the amount received for the sale of shares was also divided in the same manner, as shown in the books of account of Harrison Enterprises Pty. Limited.''
In each case the amended assessment is claimed to be supported by the application of sec. 260 of the Income Tax Assessment Act, 1936 to a transaction which took place on the 15th February 1968 whereby the appellants sold to Levart Proprietary Limited the whole of the issued share capital of R. Harrison & Son (Holdings) Pty. Limited.
At the beginning of 1967 the appellants controlled a group of companies (the ``Harrison group'') engaged in the manufacture and sale of poultry equipment, rabbit cages and sheds, and wire mesh and other products. Each member company of the group was a wholly owned subsidiary of R. Harrison & Son (Management) Pty. Limited (``Management'') which, in turn, was a wholly owned subsidiary of R. Harrison & Son (Holdings) Pty. Limited (``Holdings''). The group had had an association as licensee in respect of various technical matters with a number of companies incorporated in the United States, Canada and elsewhere, known as the Marmon group. Early in 1967 there were negotiations between a Mr. Pritzker, representing the Marmon group, and Mr. Harrison. The result of these was embodied in a letter of intent dated the 9th February 1967 which, in summary, proposed that a new company would be incorporated in which each group would have an equal shareholding, that this company would purchase the assets of Holdings and its subsidiaries and would carry on the business previously carried on by the Harrison group. Pursuant to this arrangement Harrison Jamesway Pty. Limited was incorporated on the 24th April 1967. Mr Harrison and Mr. Pritzker were the directors, the latter appointing an alternate to act for him when he was not in Australia. The two shareholders were Jamesway Co. Limited, representing the Marmon group, and Harrison Enterprises Pty. Limited (``Enterprises''), each of whom has, at all relevant times, held 200,000 shares. Enterprises was incorporated on the 17th May 1967 to hold the shares in Harrison Jamesway which would represent the half interest of the Harrison group in the new company.
ATC 4146
On the 26th June 1967 a ``joint venture agreement'' was entered into between the appellant and the Marmon Group Inc. which put into effect the arrangement which had been reached in February. Pursuant to this, agreements were entered into having the same date whereby Harrison Jamesway Pty. Limited purchased the assets of each of the five subsidiaries with the exception of certain bad debts. Thereafter the business previously carried on by the Harrison group was carried on by the Harrison Jamesway Pty. Limited and the Harrison group of companies ceased to carry on any business, the assets and liabilities of each of them consisting of loans in which the other party was either another member of the group of Enterprises except, of course, that Holdings held the shares in Management and Management held the shares in each of the subsidiaries. The appellants then had no further use for the Harrison group of companies. In October 1967 Mr. Harrison asked Mr. Orrock, a member of Arthur Young & Co., a firm of chartered accountants, to explore the results of various alternative ways of dealing with the companies as he did not wish to retain them. Mr. Orrock was aware that each of the companies in the Harrison group had accumulated profits and that each of them would become liable to Div. 7 tax unless dividends were declared which provided for a sufficient distribution before the 30th April 1968. He was also aware that any dividend declared by Holdings before that date would be payable to the appellants and taxable in their hands and that all the profits of the group would ultimately have to be distributed by Holdings by way of dividend to the appellants with the same result. It was at this stage that proposals were made for the disposal of the shares in Holdings and Mr. Orrock nominated Levart Pty. Limited as a likely purchaser. He had previously come in contact with this company in August 1967 in response to an advertisement which he had seen and he knew that it was engaged in the business of dividend stripping. Mr. Orrock got in touch with a Mr. Commins of the firm of B.O. Smith & Son, chartered accountants, who were acting for Levart. Mr. Commins was interested in the proposals. He gave Mr. Orrock to understand that Levart would charge a fee of approximately 5% of the sufficient distribution required to be made in respect of the current tax year. He knew from his previous contact with Levart that on settlement all the assets of Holdings and various subsidiaries would have to be reduced to cash. Neither at that stage nor subsequently did Mr. Orrock have any discussion with Mr. Commins as to what Levart would do with the companies after purchase. At that time Mr. Orrock was not aware in any detail of the operations carried out by dividend stripping companies or of the creation of excess profit companies after a dividend stripping operation had been carried out. He was aware of the existence of excess profit companies and that in conjunction with a Gorton Scheme they might be used to avoid liability to personal income tax and gift duty on the distribution of assets to members of a family.
In subsequent discussions Mr. Orrock supplied further details and financial statements to Mr. Commins. Some time in late November or early December an agreement was reached between them in principle that the transaction would proceed but that was dependent upon the preparation of financial statements to the 31st December 1967 and these were not prepared until some time in January 1968.
Mr. Orrock was aware, certainly by the time agreement was reached in principle, that the purchase price to be paid by Levart would be the difference between the total cash held by the group and the total of Levart's fee and the amount needed to be provided for the income tax liability of each of the companies.
Balance sheets were prepared for each of the companies as at the 31st December 1967. The entries relating to capital and reserves, omitting statements as to authorised capital, are as follows:
ATC 4147
``R. HARRISON & SON (HOLDINGS) PTY. LIMITED
Subscribed Capital
2,050 Shares fully paid
200 Management Shares 400
100 Ordinary "A" Class Shares 200
100 Ordinary "B" Class Shares 200
100 Ordinary "C" Class Shares 200
50 Ordinary "D" Class Shares 100
1,500 No. 1 Redeemable Preference Shares 3,000
-----
4,100
Profit & Loss Appropriation Account
Balance at 30th June, 1967 51,063
Less: Bank Charges & Filing Fees to 31st December 1967 6 51,057
------ ------
TOTAL CAPITAL & RESERVES $55,157
------''
``R. HARRISON & SON (MANAGEMENT) PTY. LIMITED
Subscribed Capital
1,000 Shares fully paid 2,000
Profit & Loss Appropriation Account
Balance at the 30th June, 1967 43,358
Less: Bank Charges to the 31st December, 1967 2 43,356
------ ------
TOTAL CAPITAL & RESERVES $45,356
------''
``R. HARRISON & SON PTY. LIMITED
Issued Capital
24,603 Shares Fully Paid 49,206
Capital Reserve 39,640
General Reserve 111,049
Profit & Loss Appropriation Account 4,120
-------
TOTAL CAPITAL & RESERVES $204,015
-------
R.HARRISON & SON (SPECIALITIES) PTY. LIMITED
Issued Capital
1,000 Shares fully paid 2,000
General Reserve 8,680
Profit & Loss Appropriation Account 32,735
------
TOTAL CAPITAL & RESERVES $43,415
------
R. HARRISON & SON (SALES) PTY. LIMITED
Issued Capital
1,000 Shares fully paid 2,000
General Reserve 22,721
Profit & Loss Appropriation Account 51,316
------
TOTAL CAPITAL & RESERVES $76,037
Some time before the 31st December 1967 Mr. Orrock had prepared for Mr. Commins a statement of the sufficient distribution which should be made by each of the companies. This indicated, among other things, that it would be necessary for Holdings to declare a dividend of $51,063 by the 30th April 1968.
About December 1967 Mr. Commins sent a draft agreement to Mr. Orrock which he referred to a solicitor for his review. The solicitor advised that the agreement might involve a contravention of sec. 67 of the Companies Act relating to the giving of financial assistance by a company to a purchaser of its own shares. It was suggested apparently that this could arise through an exchange of contracts being made prior to the date of settlement with the purchasers having ability to utilise the executed contract as a means of financing the purchaser, and apparently, that the transaction could be looked at as one where Levart would be using the money coming out of the Harrison group for the purchase of the shares. Whether it was for this reason or for some other reason the contract was not in fact executed until the 15th February 1968.
It is convenient at this stage to summarise the terms of this agreement. The parties are Mr. and Mrs. Harrison as vendors, Levart as purchaser, Holdings, as the company whose shares were being sold, and each of the subsidiary companies. The agreement provides for the sale of the shares for $230,691 to be paid in cash upon completion subject to compliance by the vendors and Holdings with the terms of the agreement. Provision is made for the steps to take place on settlement necessary to put Levart or its nominees in control of the Harrison group of companies.
The vendors give the usual warranties as to the assets and affairs of the companies of the group and in particular that their respective tax liabilities are as set out in the balance sheets which are annexed to the agreement as schedules. Provision is made for the actual assessment varying from these figures. The Harrisons as vendors agree that at the date of settlement ``they will cause the company (Holdings) and the subsidiaries to have available in the aggregate in the banking accounts of the company and the subsidiaries a sum not less than three hundred and thirty-seven thousand five hundred and eighteen dollars ($337,518) and will immediately upon settlement...put the purchaser and the directors...in control of such bank accounts''. The vendors warrant that this sum is not less than the net assets of the company and its subsidiaries. The transaction was completed on the 15th February 1968 at the offices of the Commonwealth Trading Bank of Australia, 306 Pitt Street, Sydney. This was the bank at which Harrison Jamesway had had its current account for some time, having moved it from the branch at Merrylands for ordinary commercial reasons. The persons present at completion included Mr. and Mrs. Harrison, Mr. Orrock, one of his partners, Mr. McInerney, Mr. Hutchins representing Levart (he had taken the place of Mr. Commins), an officer of the English Scottish & Australian Bank Limited, 97 Pitt Street, Sydney where Mr. Hutchins had his personal account, Levart's solicitor and Harrison's solicitor. It is convenient to state what happened at the settlement in three parts. Firstly, a meeting of the directors of Holdings was held at which the execution of the agreement was approved, share transfers to Levart were approved, Mr. Hutchins was appointed an additional
ATC 4149
director, the secretary resigned and Mr. Commins was appointed as secretary in her place, the public officer resigned and Mr. Hutchins was appointed in her place, the auditors resigned and other auditors were appointed, the registered office was changed and finally Mr. and Mrs. Harrison tabled their resignation as directors, thus leaving Mr. Hutchins as the sole director. The agreement was then executed by all parties. Secondly, steps were taken to put to the credit of the bank accounts of the Harrison group the amounts representing their respective net assets. For some time prior to the settlement the cash in the Harrison group, totalling $337,518, had been lent to Harrison Jamesway through Enterprises. Earlier that day Mr. and Mrs. Harrison had opened an account at the bank in the name of Enterprises. A cheque for the sum mentioned was drawn on the account of Harrison Jamesway, signed by Mr. Harrison, and this was deposited to the credit of Enterprises. Enterprises then purchased a number of bank cheques in favour of each of the subsidiary companies in the amounts necessary to discharge its indebtedness to each of them. Accounts were opened for each of these companies at the bank, Mr. Hutchins being an authorised signatory. These bank cheques were then deposited to the credit of the appropriate accounts. Management and Holdings likewise purchased bank cheques to discharge their respective liabilities to Holdings and Enterprises and these were deposited in the appropriate accounts. In the result the total amount to the credit of the several accounts of the Harrison group, after allowing for the overdrawn balance of the account of Management, was $337,518. Thirdly, Mr. Hutchins had previously on that day bought from his bank, by a cheque drawn on his personal account, a bank cheque for $230,691 in favour of Enterprises which cheque was brought to the settlement by the officer of his bank already mentioned. Hutchins, in the exercise of his authority as signatory on the accounts of each of the Harrison group of companies, then purchased a bank cheque from the Commonwealth Trading Bank in favour of Levart for $337,518. This reduced the balance in each of the accounts of the Harrison group to nil and these accounts were closed, the bank having previously been directed to debit all charges to the account of Enterprises. The cheque for $337,518 was handed to the officer of Mr. Hutchins' bank who on the same day deposited it into the credit of Mr. Hutchins' personal account. The officer handed to Mr. Orrock the cheque for the purchase price of the shares, $230,691. The evidence of Mr. Orrock, which I accept in all respects, is that the cheque for the purchase price was handed over by the officer before he received the cheque for $337,518. But it is clear enough that the agreement between Mr. Hutchins and his bank was that the bank cheque for the purchase price was to be paid for by the cheque to be drawn upon the accounts of the Harrison group. The cheque for the purchase price was obviously made payable to Enterprises by direction of Mr. and Mrs. Harrison. On the same day a cheque was drawn on Enterprises' account for the amount of the purchase price and deposited in the account of Harrison Jamesway. It so happened that there was an error of calculation in some of the amounts involved. This was later rectified. The detail is of no importance for present purposes.On the 16th February Mr. Hutchins, as the sole director of Holdings, resolved that the company sell its shares in Management to Levart (Vic.) Pty. Limited for the sum of $278,987, and this sale was completed. These shares were shown in the balance sheet of Holdings at cost in the sum of $1,996. The sale therefore represented a capital profit of $276,991.
On the 20th March 1968 Mr. Hutchins, as sole director of Holdings, resolved that an interim dividend of $51,057 be declared and paid forthwith by crediting to the current account of Levart Pty. Limited. This is the dividend which has already been mentioned as necessary to be declared by the 30th April 1968 in order to effect a sufficient distribution in respect of the year ended 30th June 1967. He also resolved ``that the capital profits reserve of $276,991 which is the realised capital profit be transferred to the profit and loss appropriation account and that an interim dividend of $276,991 be declared and paid forthwith by crediting to the account of Levart Pty. Limited''. On the same day Mr. Hutchins as such sole director approved a transfer of the shares in Holdings from Levart to Ants Caljo and Aldur Caljo and these two persons were appointed as directors of the company, Mr. Hutchins resigning. This no doubt effected a sale of the shares in the company as an excess distribution company.
ATC 4150
The arrangement which existed between Mr. Orrock on behalf of the Harrisons and Mr. Commins on behalf of Levart before the 15th February 1968 was, in my assessment of the evidence, as follows:
- 1. The Harrisons were to sell the whole of the issued capital of Holdings to Levart.
- 2. At the time of sale the assets of each company in the Harrison group was to be represented by cash at bank.
- 3. The purchase price was to be the total cash assets of the Harrison group less the total amount of their respective income tax liabilities and less the amount of Levart's fee being 5% of the amount necessary to make a sufficient distribution in respect of the year ended 30th June 1967 for each of the companies.
- 4. The parties were on the date of settlement to execute the agreement a draft of which had already been approved.
- 5. The purchase price was to be paid by a bank cheque drawn in favour of Enterprises.
- 6. Hutchins was to put in control of the bank accounts of each company of the Harrison group and was to draw out the total of the amount standing to their credit in the form of a bank cheque drawn by the Commonwealth Trading Bank of Australia, 306 Pitt Street.
The method by which the assets of the Harrison group were to be put in the form of cash at bank was not part of the arrangement although Orrock had communicated to Hutchins the way in which he would achieve this result. The method by which Levart was to finance the purchase price was not part of the arrangement although it must be found that Mr. Orrock was aware that in substance the purchase price would come from the amount which Mr. Hutchins was to draw from the accounts of the companies of the Harrison group. The steps subsequently taken by Mr. Hutchins on behalf of Levart in selling the shares in Management to Levart (Vic.) Pty. Limited, declaring the two dividends mentioned in Holdings and in disposing of Holdings as an excess distribution company were not taken in pursuance of the arrangement. It was no concern of Mr. Orrock or of his clients how Levart turned to account the purchase of the shares in Holdings just as much as it was no concern of Mr. Commins or Mr. Hutchins how Mr. Orrock put the assets of the Harrison group of companies in the form of cash at bank.
I now turn to consider the application of sec. 260 to the above transaction.
It is, I think, unnecessary to refer to any of the many decisions on the application of this section except one recently given by the High Court upon appeal from this Court:
Slutzkin & Others v. F.C. of T. 77 ATC 4076, 25th February 1977. That case concerned the claimed application of sec. 260 to a transaction in which the shares in a company which had substantial retained profits were sold to another company which had engaged in the operations known as dividend stripping. The interest of the purchaser company was to conduct such operations in the affairs of the company sold when it had possession of its shareholding. The operations by which the purchaser company stripped the company sold of its retained profits were not part of the transaction or of any contract, agreement or arrangement in relation thereto. It was unanimously held that sec. 260 did not apply. In my opinion the application of the reasoning in this decision to the present case brings about the same result. There is little to be gained by setting out this reasoning at length.
Despite all the complications which have been stated the transaction in the present case may correctly be described as ``no more than a realisation by [the taxpayers] of the benefit of their shareholding [in Holdings] in a way which would not attract tax'' (per Barwick C.J. at p. 4 of his reasons, ATC p.4079). The complicated exchange of cheques on the 15th February was no more than was necessary to convert the assets of each of the companies in the group to cash at bank except in the case of Management where account was overdrawn. In so far as cash from the companies sold provided the purchase price of the shares this was not part of the arrangement and, even if it were, it seems to me it would not aid in the application of the section. Here, as in Slutzkin, it may truly be said that ``By no process [of reasoning] could the purchase money for the shares become a dividend paid by the Company to the shareholder'' (per Barwick C.J. at p. 7, ATC p.4080). Further, the subsequent dealings with the shares of the companies in the group were in no way under the control of the taxpayers, and in no way
ATC 4151
pursuant to any contract, agreement, or arrangement to which any of them was a party. It may correctly be said in the present case that ``To fasten the appellants with liability for the dividend subsequently paid is a result quite unreal and not required by the Act'' (per Barwick C.J. at p. 7, ATC p.4080).The present case is one, therefore, in which the objective facts and the character of the acts done and transactions entered into do not establish a ``contract agreement or arrangement'' which can be said to have the ``purpose or effect'' specified in para.(a) to (d) of sec. 260. The only transaction which was actually carried out was the sale of a capital asset. Without doubt this transaction was entered into to avoid the tax which would have been attracted if dividends had been declared or the companies concerned put into liquidation. But this ``does not mean that the ordinary provisions of the Act are defeated or frustrated. It is a transaction which according to the terms of the Income Tax Assessment Act attracts no tax consequence. It is therefore not necessary to consider whether it is an ordinary business transaction...'' (per Aickin J. at p. 5, ATC p.4083.).
For the foregoing reasons the appeals are allowed. Order that each amended assessment be set aside. The respondent Commissioner is to pay the appellants' costs.
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