Westraders Pty. Limited v. Federal Commissioner of Taxation.

Judges:
Rath J

Court:
Supreme Court of New South Wales

Judgment date: Judgment handed down 13 October 1977.

Rath J.: This is an appeal under sec. 187 of the Income Tax Assessment Act 1936 (as amended) against the decision of the Commissioner upon the appellant's objection to an assessment to income tax in respect of the year ended 30th June, 1975.

The appellant, in its return for that year, claimed a deduction of $248,844 in respect of a ``tax loss in share trading partnership Jenspart Trading Co.'' This deduction was not allowed by the Commissioner, and the appeal relates to that matter.

Section 92 of the Act provides that a partner's individual interest in a partnership loss incurred in the year of income shall be an allowable deduction. The definition of ``partnership loss'', so far as relevant, is that that expression means the excess, if any, of the allowable deductions over the assessable income of a partnership, calculated as if the partnership were a taxpayer (sec. 90). A partnership shall furnish a return of the income of the partnership, but shall not be liable to pay tax thereon (sec. 91).

In its return for the year Jenspart Trading Co. showed a ``tax loss'' of $6,463,484. In the

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statement of distribution of the loss included in this partnership return, the appellant was assigned 3.85% of the loss, amounting to $248,844. The actual cost of the shares sold, together with the actual cost of closing stock at 30th June, 1975 was $152,347. The sales were $138,590. After allowing for stamp duty, brokerage and audit fees, the result was a so-called ``book profit'' of $9,072. This profit was converted into the loss of $6,463,484 by reason of the treatment, for tax purposes, of part of the cost of purchases at what was called ``deemed cost in accordance with sec. 36A(2) election''.

Before dealing with the circumstances in which this election was made, it will be convenient to consider other relevant provisions of the Act. By sec. 28, where a taxpayer carries on any business, the value of all trading stock on hand at the beginning of the year of income, and of all trading stock on hand at the end of that year shall be taken into account in ascertaining whether or not the taxpayer has a taxable income. Where the value of all trading stock on hand at the end of the year exceeds the value of all trading stock on hand at the beginning of the year, the assessable income of the taxpayer shall include the amount of the excess. Where the value of all trading stock on hand at the beginning of the year of income exceeds the value of all trading stock on hand at the end of that year, the amount of the excess shall be an allowable deduction. The value of trading stock to be taken into account at the beginning of the year of income shall be its value at the end of the year immediately preceding the year of income (sec. 29). Subject to matters not relevant in this case, the value of each article of trading stock (not being live stock) to be taken into account at the end of the year of income shall be, at the option of the taxpayer, its cost price or market selling value or the price at which it can be replaced (sec. 31). Sections 32 and 33 deal with live stock, and it will be necessary later to consider those sections in relation to one argument advanced by the Commissioner. The expression ``trading stock'' is defined to ``include anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock'' (sec. 6).

Section 36(1) provides that where a taxpayer disposes of trading stock otherwise than in the ordinary course of business, the value of the trading stock shall be included in the assessable income of the taxpayer, and the person acquiring the trading stock shall be deemed to have purchased it at a price equal to that value. For this purpose value is the market value at the date of the disposal; or, if in the opinion of the Commissioner, there is insufficient evidence of market value on that day - the value which in his opinion is fair and reasonable (subsec. (8)).

Section 36A(1) provides that where, for any reason, including the formation of a partnership, a change has occurred in the ownership of trading stock, and the person who owned the trading stock before the change has an interest in the trading stock after the change, sec. 36 applies as if the person who owned the trading stock before the change had, on the day on which the change occurred disposed of the whole of the trading stock to the persons by whom the trading stock is owned after the change.

In this case a company called Jensen Mining & Investments Limited entered into partnership with the appellant and others on 28th May, 1975. This is the partnership named Jenspart Trading Co. On 27th June, 1975 Jensen Mining & Investments Limited (``Jensen'') transferred shares, claimed by the appellant to be trading stock to Jenspart Trading Co. (``Jenspart'') in satisfaction of its contribution of capital. It is this transfer which the appellant claims attracts the operation of sec. 36A. The shares had been purchased by Jensen at a considerable cost, but in Jensen's hands their value was (with one exception) greatly reduced as a result of declarations of dividends upon them. In most instances Jensen had performed what has come to be known as a dividend stripping operation. The result of sec. 36A(1), without more, would be that the deemed price to Jenspart would be in effect that reduced value. But sec. 36A(2) provides that in certain circumstances the parties referred to in sec. 36A(1) may elect that the value shall be cost, not market value, and the appellant contends that those circumstances exist in this case. If this contention is right, then Jenspart is deemed to have purchased the shares at their original, pre-stripping, cost.

The arguments were founded on the meaning of the language used in the relevant provisions, and I therefore shall now quote them. Section 36A(2) was substantially amended by Act No. 57 of 1977 (sec. 6); I shall

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give it in its form as it stood at the relevant time.

``36(1). Subject to this section, where -

(a) a taxpayer disposes by sale, gift, or otherwise of property being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale;

(b) that property constitutes or constituted the whole or part of the assets of a business which is or was carried on by the taxpayer; and

(c) the disposal was not in the ordinary course of carrying on that business,

the value of that property shall be included in the assessable income of the taxpayer, and the person acquiring that property shall be deemed to have purchased it at a price equal to that value.

....

36(8). For the purposes of this section and the next succeeding section -

(a) the value of any property or live stock shall be -

(i) the market value of property or live stock on the day of the disposal; or

(ii) if, in the opinion of the Commissioner, there is insufficient evidence of the market value on that day - the value which in his opinion is fair and reasonable;

...

36AAA...

36AA...

36A(1) Where, for any reason, including -

(a) the formation or dissolution of a partnership; or

(b) a variation in the constitution of a partnership, or in the interests of the partners,

a change has occurred in the ownership of, or in the interests of persons in, property constituting the whole or part of the assets of a business, and being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale, and the person, or one or more of the persons, who owned the property before the change has or have an interest in the property after the change, section thirty-six of this Act applies as if the person or persons who owned the property before the change had, on the day on which the change occurred, disposed of the whole of the property to the person, or all the persons, by whom the property is owned after the change.

36A(2). Where -

(a) property in relation to which the last preceding sub-section applies has become, upon the change in ownership or interests, an asset of a business carried on by the person or persons by whom the property is owned after the change;

(b) the person or persons by whom the property was owned before the change holds or hold, after the change, an interest or interests in the property of a value equal to not less than one-quarter of the value of the property; and

(c) the person or persons by whom the property was owned before the change together with the person or persons by whom the property is owned after the change give notice to the Commissioner, in accordance with this section, that they have agreed that this sub-section shall apply in respect of the property.

the value of the property, for the purposes of section thirty-six of this Act, shall be, instead of the value specified in paragraph (a) of sub-section (8) of that section, the value (if any) that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change.

(3) A notice in pursuance of the last preceding sub-section shall be in writing, signed by all the persons giving it, and lodged with the Commissioner on or before the thirty-first day of August next succeeding the end of the financial year in which the change in ownership or interests occurred or on or before such later date as the Commissioner determines.''

In summary form the submissions for the Commissioner were as follows: -

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(1) Section 36A has no application because the shares transferred from Jensen to Jenspart were disposed of in the ordinary course of Jensen's business. The starting point of this argument is that sec. 36A(1) so ``applies'' sec. 36 as to import into the transaction dealt with by sec. 36A(1) the requirement of sec. 36(1)(c) that the ``disposal'' was not in the ordinary course of business. The argument then proceeds as follows: the shares transferred by Jensen to Jenspart were the assets of a business of ``purveying tax avoidance devices'', and the transfer was made in the ordinary course of carrying on that business.

(2) Section 36A has no application because the shares transferred by Jensen to Jenspart were not trading stock of Jensen.

(3) Section 36A(2) has no application because the shares transferred by Jensen to Jenspart did not become (within the meaning of para. (a) of sec. 36A(2)) an asset of a business carried on by Jenspart.

(4) There was no ``partnership loss'' as defined in sec. 90 because there was no relevant connection, under sec. 51 of the Act, between the cost (or deemed cost) of the shares to Jenspart and its assessable income. The deduction of that cost was not made under sec. 29, but was claimed on the basis that it was an outgoing (within the meaning of sec. 51) incurred in gaining or producing the assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing that business. That cost was in the circumstances (so the argument ran) an outgoing of a capital nature. Subsection (2) of sec. 51 would not operate to prevent this result, for it applied only to the purchase of stock used by the taxpayer (i.e. Jenspart, for the purposes of sec. 90) as trading stock. Even if Jenspart (it was said) carried on a share trading business, these shares were not stock in that business. The effect of this argument (if it is right) is that, for sec. 36A(2) to operate, the shares must not only be trading stock in the business of the transferor (sec. 36A(1)), but also trading stock in the business of the transferee (sec. 36A(2)(a)).

(5) Section 36A(2) applies only to trading stock that was live stock. This submission was based upon a construction of the words ``the value of the property that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change.'' It was said that this provision contemplated a value arising by operation of law. The value of trading stock (other than live stock) depended on the exercise of an option by the taxpayer, but sec. 32 and 33 (so the argument ran) provided a formula in the case of live stock that did not necessarily depend on the exercise of an option by the taxpayer. Sections 32 and 33 are as follows: -

32. The value of live stock to be taken into account at the end of the year of income shall be, at the option of the taxpayer, its cost price or market selling value, and where a taxpayer does not exercise his option within the time and in the manner prescribed, the value so to be taken into account shall be the cost price:

Provided that, where a taxpayer satisfies the Commissioner that there are circumstances which justify the adoption by him of some value other than cost price or market selling value for the whole or part of his live stock, he may, with the leave of the Commissioner, adopt that other value.

33. A taxpayer shall not, except with the leave of the Commissioner, adopt a basis of valuation of his live stock taken into account at the end of the year of income different from the basis on which the valuation of his live stock was made when it was last taken into account at the end of a previous year, whether under this or the previous Act.

(6) If any of the shares transferred were not trading stock, then the notice given under sec. 36A(2) and (3) was not effective, because the agreement made related to all the shares, and was conditional upon all the shares being trading stock. Thus (the argument ran) to treat the notice as effective in respect of such of the shares as were trading stock (the whole of them not being such stock) would in effect be treating the parties as making an agreement which they did not in fact make.

(7) Section 260 was applicable to an arrangement between Jensen and the appellant that, for the purpose of the appellant's avoiding income tax otherwise payable on the taxpayer's assessable income for the year ended 30th June, 1975, the appellant would purchase from Jensen, as an allowable deduction, a potential deemed loss in the value of certain shares held by Jensen.

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I turn now to the facts of the case.

By an agreement made on 28th May, 1975 Jensen entered into partnership with the appellant and seventeen other persons (some of them individuals and others companies). It was a term of the agreement that from the commencement of the partnership (which was 28th May, 1975) certain shares owned by Jensen would be held by it upon trust for the partnership until the same were transferred to the partnership and registered in the names of the partners, or were disposed of by the partnership in the course of its business. The capital account of Jensen in the books of the partnership was to be credited with the sum of $115,000 which the partners agreed was the market value of these shares at the commencement of the partnership. The sum of $345,000 was to be contributed in cash by the partners other than Jensen in certain specified amounts. The business of the partnership was described as that of traders and dealers in shares, share options, stocks and other securities including the purchase and sale of the same and interests in the same. The partnership business was to be carried on under the firm name of Jenspart Trading Co.

Jensen executed transfers of the shares to Jenspart on 27th June, 1975. It will be necessary to examine each parcel of these shares later, in order to determine if it was trading stock of Jensen. The parcels were held in the following companies: -

Renmore Pty. Limited; Toomar Investments Pty. Limited; Magdalene Pty. Limited; L.T. Whitelaw Pty. Limited; Metal Powders Pty. Limited; Powdered Metal Products Pty. Limited; Sintered Iron Pty. Limited; Sinterpress Pty. Limited; C. & H. Junior Pty. Limited; C. & H. Senior Pty. Limited; C. & H. Gear Cutting Pty. Limited; C. & H. Assembly Pty. Limited; Vari Gears Pty. Limited; Southern Grinders Pty. Limited; C. & H. Pty. Limited; Pol-Ann Distributors Pty. Limited; P.P. Bauer Holdings Pty. Limited; Endsleigh Investments Pty. Limited; Beneficial Finance Corporation Limited.

On 28th May, 1975 loans were made to the partners (other than Jensen) by Strang Investments Pty. Limited (``Strang''): Those loans (which totalled $269,770) were in each instance significantly less than the respective contributions of the partners to the capital of the partnership. After the partners' contributions were received, but also on 28th May, 1975, the partnership lent $60,000 to Strang. The partnership lent an additional $221,261 to Strang on 30th May, 1975, making the total loan $282,261. The partners repaid their loans to Strang, with interest, at varying dates in January, 1976. Strang repaid its loans from the partnership on 13th January, 1976. There was no evidence to suggest that any of these loan arrangements were other than genuine commercial dealings, and in my view they have no bearing upon any of the matters that the Court is called upon in this case to resolve. After making the loans, Jenspart still had for trading purposes over $60,000 in cash.

On 27th June, 1975 Jenspart transferred all the shares contributed by Jensen (other than the shares in Beneficial Finance Corporation Limited) in four separate parcels, one to each of the following companies: Pitt Securities Pty. Limited; S.I.M.S.A. Nominees Pty. Limited; Lupsup Pty. Limited; and London Nominees Pty. Limited. Jensen's books show the sale price to Jenspart of these shares as $111,284.20. The selling price by Jensen to the four companies named above as the transferees was $125,199.60, thus showing a profit to Jenspart of $13,915.40.

After its formation, and in the year ended 30th June, 1975, Jenspart dealt in shares of listed public companies through brokers. On behalf of Jenspart approaches were made to these brokers to find purchasers for the shares contributed by Jensen to the partnership (other than Beneficial Finance Corporation Limited). In each case the approach took a similar form, the broker being informed of the likelihood of being able to sell the shares in about six months' time at a profit. The four purchasers were found by the brokers as a result of these approaches, and all of them had some close association with the brokers, though none with Jensen or Jenspart. A company known as Powerlon Securities Pty. Limited (``Powerlon'') made a loan to each purchaser of an amount sufficient to cover the purchase price. The loan agreements provided that at the option of the borrower the lender would accept in full satisfaction of the loan the shares that were the subject of the purchase. The agreements take a common form, though one of them was amended so as to provide for shares being taken in satisfaction of interest as well as principal.

Jensen was instrumental in forming four

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other partnerships, shortly after the formation of Jenspart. It appears that these other partnerships had shares transferred to them by Jensen, and that these shares were also sold in the year ended 30th June, 1975 with similar tax deduction advantages for the partners. I mention this in this context because these other partnerships, as well as Jenspart, participated in the financial transactions connected with the purchase of the shares transferred by Jensen to Jenspart. The loan agreements I have referred to deal with shares contributed by Jensen to these other partnerships as well as with the shares contributed by Jensen to Jenspart. As part of these transactions, Strang lent Powerlon $197,000 on 28th June, 1975. On the same date the partnerships lent Strang $176,000. On 30th June, 1975 the partnership lent Strang $22,000, making the total of their loans to Strang $198,000. Of this sum of $198,000 Jenspart lent Strang $125,000 on 27th June, 1975. Thus Jenspart, on 27th June, 1975, lent $125,000 to Strang, and Strang, on the same date lent to Powerlon the sum of $197,000. Powerlon advanced $125,000 to the purchasers from Jenspart, the purchase taking place on the same day. The inference thus is that Jenspart was the source of the finance for the purchase of the shares from it. However, there is no evidence to suggest that the loans were other than genuine commercial dealings. If the purchasers had exercised their option to require Powerlon to take the shares in satisfaction of their loans, the result would have been that Powerlon would have the shares, but with the obligation to pay its loan to Strang. Powerlon was not shown to be under the control in any way of Jensen. There was a connection between Strang and Jensen, but not of such a kind as to support any inference against the genuiness of the transactions. Four of the six directors of Jensen were directors of Strang, and the shareholders of Strang were family companies of these four directors. In fact Powerlon repaid Strang on 6th January, 1976 the sum of $154,000. The balance of the loan appears to be unpaid. Strang repaid the partnerships on 13th January, 1976. There was no evidence as to whether the options in the loan agreements between the purchasers and Powerlon were exercised or not.

On or about 1st August, 1975 there was lodged with the Commissioner, on behalf of the partnership, the document which is claimed to be the election pursuant to sec. 36A(2) and (3) of the Income Tax Assessment Act. It is conceded that if the document is otherwise valid, it was lodged in the prescribed time. This document was executed by each member of Jenspart (including Jensen) and reads as follows (omitting the schedules referred to in it):

``Jensen Mining & Investments Limited, a Company duly incorporated in the State of Victoria and having its registered office at Sydney at 60 Martin Place, Sydney, in the State of New South Wales and the persons and companies whose names and addresses are set out in the First Schedule hereto (hereinafter referred to as `the parties') hereby notify you pursuant to sec. 36A of the Income Tax Assessment Act, 1936-74 that the said Jensen Mining & Investments Limited and the parties have agreed that sec. 36A(2) of the said Act shall apply in respect of all the property described in the Second Schedule hereto and the change of ownership of that property occurring pursuant to the formation of the partnership between us effected by the Partnership Agreement dated the 28th day of May 1975.''

Jensen was paid a fee or commission by each of its co-partners in Jensen in consideration of its signing this sec. 36A ``election''. The amount of the fee was between 15 and 20 per cent of the tax deduction required: the larger the deduction required, the lower the rate. The fee was non-refundable in the sense that, if it proved the deduction was not in fact allowed in law, the fee could not be recovered. Similar fees or commissions were paid to Jensen by its co-partners in the other four partnerships formed by it in the same income tax year for the same tax deduction purpose. In all it collected in such fees ``well over'' one million dollars.

Mr. P.R. Fox was the chairman of directors of Jensen from August, 1970 until August, 1975. He remained a director until June, 1976, but ceased to take an active part in the affairs of the company after August, 1975. He made the principal affidavit in the case, and was cross examined in depth upon it, and upon the affairs of Jensen. I formed the firm impression that he was a truthful and accurate witness. His recollection of the affairs of Jensen was clear and precise. One of the most important aspects of his evidence was to the effect that

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the idea of forming partnerships such as Jensen occurred to him for the first time in early May, 1975. The significance of this date is that most of the shares forming Jensen's contribution to Jenspart were acquired before May, 1975. Mr. Fox claimed that the ``concept'' was his, and that to his knowledge there was no other such share-trading partnership. He was cross examined in different contexts on his timing of the formation of this concept, and was re-examined on the same matter. His evidence, particularly that relating to Jensen's acquisition of shares in Pol-Ann Distributors Pty. Limited on 30th April, 1975, establishes that the concept of these partnerships had not by that date been formulated. From his re-examination it appears that he was taking legal advice about the matter on 5th May, 1975.

With regard to all the shares transferred by Jensen to Jenspart (with the exception of those in Beneficial Finance Corporation Limited, Renmore Pty. Limited and Toomar Pty. Limited), Jensen's intention at the time of acquisition was to make a profit by a combination of dividends and selling price. This appears in the following evidence of Mr. Fox: -

``Q. At the time that Jensen acquired the shares in the companies that subsequently were transferred to Jenspart, leaving out Beneficial Finance, Renmore and Toomar, was it Jensen's intention they would be transferred to a partnership that would in fact be a sec. 36A partnership?

A. No.

Q. What was the intention of Jensen at the time of the acquisition of the shares?

A. To make a profit.

Q. To make a profit by doing what?

A. By receiving dividends and later sale - the combination with a profit.''

All of the shares referred to in the evidence were acquired on or before 30th April, 1975 with the exception of those in P.P. Bauer Holdings Pty. Limited and Endsleigh Investments Pty. Limited. The shares in P.P. Bauer Holdings Pty. Limited were acquired on 12th or 13th May, 1975, but the acquisition was preceded by negotiations over about 6 or 9 months. Mr. Fox agreed that at the time of the purchase it was in his mind that at least one of the purposes of the acquisition would be the transfer to some 36A partnership in due course. All the shares in the company were acquired, and as the cash asset backing was greater than the purchase price, Jensen would thereby make a profit. With regard to Endsleigh Investments Pty. Limited, Jensen acquired all its shares on 27th May, 1975. Mr. Fox said that the shares were purchased in Jensen's ``normal share trading activities''; but he was sure that at that stage Jensen thought they would be able to sell the shares to Jenspart. It appears from the general tenor of Mr. Fox's evidence that he includes in the expression ``normal share trading activities'' the purchase of shares for dividend stripping, followed by sale of the shares after the dividend stripping has been carried out. In the case of eleven of those companies the dividend received was itself greater than the purchase price. In the case of five the dividend was less. Of these five the combination of dividend and sale price in three instances was less than the purchase price. In the other two instances that combination was greater.

It did not appear whether the shares in Beneficial Finance Corporation Limited were listed on a stock exchange. It appeared from the accounts that 3,000 shares in the company were purchased for $2,148. One thousand of these were disposed of to Jenspart for $670. The balance went to another partnership for $2,110. This does not warrant an inference in itself as to the purpose of acquisition. The only other relevant evidence is that relating to Jensen's share dealings generally. I shall deal with that evidence at a later stage.

The shares in Renmore Pty. Limited were acquired early in the year ending 30th June, 1974, with the result that it became a subsidiary of Jensen. Its only asset was land, and this was revalued in about July, 1973. As a result of the revaluation, Jensen received a dividend in that year of $109,282. The dividend was received in specie by the transfer of the land. Jensen had paid $99,250 for these shares. It sold them to Jenspart for $1.60, and Jenspart sold them for $1.80.

In the year ended 30th June, 1973 Jensen acquired the issued capital of Toomer Investments Pty. Limited for $59,433. Jensen was then issued preference shares, the consideration being described as satisfaction of loan accounts. The result appears to have been a purchase of all the shares, ordinary and

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preference, for $163,000. The only asset of the company was land, and upon the revaluation of this asset, a dividend of $97,000 was declared. Whatever the precise nature of these transactions was, Mr. Fox agreed that the result of them was that Toomar was left virtually a shell. The shares were transferred to Jenspart for $1.60, and were sold by Jenspart for $1.80.

It seems reasonable on these figures that the shares in both Renmore and Toomar at the time of the sale to Jenspart were nearly valueless (except to the extent that the corporate structure might in itself have some value). It was contended on behalf of the respondent Commissioner that the other shares transferred to Jenspart (other than those in Beneficial Finance Corporation Limited) were also virtually valueless and unmarketable, because of the provisions of sec. 106A, 106B, 106C and 106D introduced into the Income Tax Assessment Act by Act No. 51 of 1973 (sec. 19). Prior to the introduction of those provisions, where a private company had made more than a sufficient distribution of profits by payment of dividends to avoid additional tax under sec. 104, it could carry forward the excess distribution as a deemed dividend into the next year (sec. 106). A stripped private company would, by virtue of the stripping of its profits by way of dividends, have made such an excess distribution. The shares in the stripped company, notwithstanding the fact that it had no assets, would have a value for another private company that found itself with undistributed profits on which it was liable to pay additional tax if the profits were not distributed. If the second company (the undistributed profits company) purchased the shares of the first company (the excess distribution company), it could arrange for the excess distribution company to take up shares in the undistributed profits company. The undistributed profits company could then declare dividends on these shares and avoid paying additional tax. The excess distribution company would not itself have to make a further distribution, as it could offset the dividend received against the excess distribution. The enactment in 1973 of the provisions I have referred to (especially sec. 106C) would have the effect of taking away from the shares in the stripped companies transferred to Jenspart a value deriving from the advantages they would otherwise have had to an undistributed profits company. Mr. Fox agreed that the companies in question had been subjected to a dividend stripping operation, but it was not put to him, nor did he say, that such an operation, as understood by him, or as performed in the instant cases, necessarily left the stripped company without any assets at all. In the case of two of the companies, Magdalene Pty. Limited and Pol-Ann Distributors Pty. Limited, the purchase price to Jenspart, and its subsequent selling price, suggest that shares, after the stripping operation, were nearly valueless. In the case of Magdalene, Jensen paid $52,295 for its shares. It received a dividend of $54,770, and then transferred the shares to Jenspart for $48. Jenspart sold the shares for $54. In the case of Pol-Ann Jensen paid $218,000 for shares, and received a dividend of $254,336. It transferred the shares to Jenspart for $80, and Jenspart sold them for $90. But in the case of the remaining companies, the price paid by Jenspart ranged from $1,603 to $51,895. In some of those instances the dividend received by Jensen was less than the price paid by it. These instances are as follows: -

                                    Price       Dividend
                                     paid       received
                                      by           by
                                   Jensen        JensenOB

L.T. Whitelaw Pty.
    Limited                        249,230              247,593
Metal Powders Pty.
    Limited                        235,900              233,003
Southern Grinders Pty.
    Limited                         67,930               62,570
C. & H. Pty. Limited             2,431,982            2,399,164
Endsleigh Investment Pty.
    Limited                        611,258              551,930

These figures are consistent with the possibility that the companies were not entirely without assets when transferred by Jensen. The possibility was not explored in the evidence. Whatever the asset position may have been, however, there is no evidence that the purchase price by Jenspart and the selling price by it were not real prices obtainable in the market place. In his final submissions senior counsel for the respondent did not suggest that these dealings were shams, and in my view the evidence is in fact to the contrary. I have already mentioned the circumstances of the sales by Jenspart of the shares, and in particular the fact that the ultimate

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responsibility for the finance to purchase the shares rested upon Powerlon Securities Pty. Limited. There was no evidence that Powerlon Securities Pty. Limited was other than an independent party in the dealings. There is the further circumstance that Mr. Fox told the brokers that a profit could be made from the shares in six months' time. Apparently this statement was accepted as being made in good faith, and there was no suggestion in the case to the contrary. It seems to me that this circumstance further supports the inference that there was a market for the shares. It may have been a restricted or special market, but it was none the less one in which all of these shares sold by Jenspart had a value, in some instances indeed a considerable value.

I turn to an examination of Jensen's claim to have a business of trading in shares. There were in evidence accounts, income tax returns and reports for the years ended 30th June, 1971 to 30th June, 1975.

The managing director's report for the year 1971 was made by Mr. Fox. In it he says that at the August 1971 meeting of shareholders the management of Jensen was changed, and that following that meeting the direction of the company's ``main activities'' had changed. The company had begun in 1958 as a merchant banker. In the directors' report 1971 is referred to as a year of major change and development in the company. The overall objective (the report states) was that the company should develop as a soundly based and profitable mining and investment company. It went on to say:

``This progress is planned through three main avenues of activity, These are -

the exploration for commercial mineral deposits.

the establishment of working mines at deposits found to be payable.

the investment in the development of other types of commercial enterprises or companies judged to have unusually good future potential for return or investment.''

Under the heading ``Highlights of the Year'' it is said that Jensen made its initial investments in commercial ventures during the year with the purchase of interests in a vineyard and of an interest in a company which was developing a chain of country bistros. The report does not mention sharetrading, though the attached accounts (under the heading ``Investments'') refer to shares in subsidiary companies, shares in listed companies, and investment in unlisted companies. In his affidavit Mr. Fox said that between September, 1970 and 30th June, 1975 the company carried on a business of subscribing for, buying and selling shares in private and public companies. This statement was objected to, and I admitted it subject to objection. I think the objection was well taken, since the statement is a conclusion the correctness of which is a matter for the court, on a consideration of primary facts, such as the accounts and actual dealings of the company. The books of the company show that there was significant activity in the purchase and sale of shares in listed companies in the year ended June 1971. Purchases totalled $232,548. Of these shares costing $203,648 were sold for $160,375, thus showing a loss of $43,273. Mr. Fox during cross-examination said that he would include the sharetrading as a business of the company at that time, but it was not a major operation.

Sharetrading of a similar sort continued in the year ended 30th June, 1972. The purchases were $37,509, the sales $46,791 and the loss $15,557. The report and accompanying accounts for the year make no reference to trading in shares. The only reference to shares in the company's balance sheet is to shares in subsidiary companies.

The income tax returns for years 1971 and 1972 each give details of the share portfolio, including sales and purchases of shares in listed companies. The magnitude of the share trading operation in those two years warrants the inference that the company was carrying on a business of trading in shares. This business was carried on in the ordinary manner of buying and selling shares in listed public companies through brokers. The intention seems to have been to make a profit by trading, though the operations were not in fact profitable. Mr. Fox said, in reference to the 1971 year ``I don't think we were very proud of ourselves at that stage in our share trading''. The operations in the 1972 year were on a smaller scale, but they do not appear to have shown any improvement, and (although there was no direct evidence on the point) management might well have turned its mind to the wisdom of continuing the sharetrading operations in their then present form.

As at 1st July, 1972 Jensen had on hand shares of the value of $3,860. This stock, with

ATC 4454

the exception of a parcel in Arcadia Minerals N.L., was disposed of in the year ended 30th June, 1973. Shares were acquired during that year in the following companies at the cost shown: -

      Metropolitan Tenpin
        Bowling Limited ..........               $128,478.00
      Austral Pacific Mining
        Corporation Limited ......                 10,235.00
      Toomar Investments Pty.
        Limited ..................                153,552.00
      J.J. Finance Pty. Limited                 1,000,000.00
      Norpe Investments Pty.
        Limited ..................              1,000,000.00
      Meik Pty. Limited ..........              1,000,000.00
      George Hudson Holdings
        Limited ..................                    761.00

All these shares were held at the close of the year. The company lodged an income tax return for the year ended 30th June, 1973 without its first being looked at by Mr. Fox. It bears a stamp indicating the lodgment date as 4th March, 1975. No claim was made that the company had carried on sharetrading during the year, but a ``write off on investments'' of $3,778,231 was claimed as a deduction from income in the statement of net profit for the year. When Mr. Fox did see this return, he decided to lodge an amended return. This amended return bears as its lodgment date 24th April, 1975. It shows a profit of $121 from share trading in stocks in four mining companies. Under the heading ``Share Dealing Operations'' it is said: ``As part of its business in share dealing, the company held at the end of the year of income the following shares.'' There follows the list of companies and costs that I have set out, together with Arcadia Minerals N.L., and then it is said: ``By virtue of sec. 31 of the Income Tax Assessment Act, the taxpayer elects the value of the above trading stock to be its cost price''. This amended return was lodged about the same time as the return for the year ended 30th June, 1974, and Mr. Fox was closely cross examined with a view to obtaining from him an admission that about this time, that is 24th April, 1975, he was concerned to establish that Jensen was during the financial year ended 30th June, 1974 actively engaged in share trading. He denied that plans were ``well under way'' for setting up sec. 36A partnerships. I have already said that I accept his evidence on this point. Mr. Fox said that ``it was in Jensen's interest to be a share trader, to establish the right under sec. 31 to elect either cost or market value for the year ended June, 1974''. I understood him to mean that it was to Jensen's advantage, in regard to share dealings, to establish its right of election under sec. 31, and that the amended return was lodged with this in mind. No challenge was made to this being a reasonable purpose in itself; and in my view the circumstances relating to the lodgment of the amended return lend no support to the Commissioner's contention that in April, 1975, when many of the shares were acquired that were later transferred to the five sec. 36A partnerships (as I call them for convenience), Mr. Fox was already planning the formation of such partnerships.

I have already dealt with the acquisition of shares in Toomar Investments Pty. Limited. The shares in Metropolitan Tenpin Bowling Limited were sold within 12 months of acquisition. Jensen had acquired an interest of 54.9% and it acquired a 100% control of the subsidiaries of Metropolitan Tenpin Bowling Limited at or about March, 1974 when it disposed of its shares in that company. In Jensen's report for 1973 the acquisition of what is described as a controlling interest in Metropolitan Tenpin Bowling Limited is referred to under the heading of ``general investments''. Under the same heading it is said that arrangements were finalized during the year to enable the company to maintain its interest in the Saxonvale Vineyards in the Hunter Valley. It might here be mentioned that there is no reference in that report to share trading as such.

The evidence indicates that there is some uncertainty as to the year in which the shares in Austral Pacific Mining Corporation Limited were disposed of, but there is no significance to be attached to that uncertainty. Austral Pacific Mining Corporation Limited was a listed company, and Jensen's interest cost $10,235.

J.J. Finance Pty. Limited, Norpe Investments Pty. Limited and Meik Pty. Limited were all the subject of what was called in the case a Division 7 scheme. The three companies (which were independent of Jensen) presumably had large undistributed profits upon which they would be liable to additional tax if an adequate distribution was not made. Jensen was a listed public company claiming to be entitled to a rebate on dividends under sec. 46. Its arrangement with each of the

ATC 4455

three companies involved it subscribing $1 million for preference shares, and receiving a dividend of $1,020,000. The same solicitors acted for each of the three companies, and the procedure was similar in each case. The circumstances of the acquisition of the preference shares in J.J. Finance Pty. Limited was examined in some detail. Mr. Fox said that he knew at the time of taking up the preference shares that it was ``most likely'' Jensen would be paid for the shares. On 29th April, 1973 J.J. Finance Pty. Limited increased its capital from $200,000 to $1,200,000 by the creation of 500,000 preference shares of $2 each. By an alteration of its articles these preference shares carried the right to one dividend of $2.04 to be paid not later than 30th June, 1973. They ranked pari passu with the ordinary shares to the extent of 1/4000 of the rate per annum of any further dividend declared in that year, but to no further dividend (this particular provision is ambiguous - it may mean that there is attached a right to receive 1/4000 of any further dividend declared). In a winding up or upon a reduction of capital the amount receivable was limited to 1 to 3 cents a share, depending upon when the event occurred. Thus the maximum amount receivable was $15,000. The shares carried no voting rights, except upon a resolution directly affecting the right to receive the dividend. The shares in each of the three companies were sold next year for $5000. There was nothing to suggest that these sales were other than genuine. The shares in George Hudson Holdings Limited were not sold until the year ending 30th June, 1975.

The share transactions for the year ended 30th June, 1974 provide a number of instances of Division 7 schemes. Five companies were involved. In the case of four of them the shares were transferred to sec. 36A partnerships. In the case of the fifth (Colmar No. 1 Pty. Limited) the preference shares, which had been purchased for $105,500, were sold in the next year for $106. The other purchases in the year were as follows. Shares were purchased in Gear Pty. Limited for $100 and were still on hand at 1st July, 1975. There was no evidence as to the circumstances of this transaction. A parcel giving approximately a 10% interest was purchased in N. & K. Properties Pty. Limited for $454,080. The shares were sold through brokers in the year ended 30th June, 1975 for $453,000. Shares were purchased in Saxonvale Vineyards Limited for $36,432 and were sold on the Stock Exchange in the year ended 30th June, 1975 for $21,386. In the report for the year 1974 the directors said - under the heading of ``General Investments'': ``The Company pursued a diverse course of investment programmes during the year which have overall proved profitable. In addition the Company successfully disposed of its majority holding in Metropolitan Tenpin Bowling Limited, a Company acquired the previous year, whilst retaining control of the operating company subsidiary.'' This report further states: ``The principal activities of the Companies in the Group during the year were the financing and operation of mining and exploration ventures, the operation of Wine Bars and country Bistro Restaurants and a wide range of general investments similar to those undertaken in previous years.'' There was no express reference to sharetrading. In its income tax return for the year Jensen made an election for cost value under sec. 31 in respect of shares held by it at the end of the year.

In the year ended 30th June, 1975 shares acquired in the previous year were disposed of, as set out before. Shares were acquired in nineteen public companies at a cost of $31,638. In ten of these companies the shares were sold for $15,759 (cost price $14,728). Shares in seven other public companies were acquired for $13,510 and were transferred to sec. 36A partnerships. A small parcel of shares in Ansett Transport Industries Limited was on hand at the end of the year. Shares in over a hundred private companies were acquired, under Division 7 schemes, and transferred to sec. 36A partnerships (other than Jenspart). In addition Jensen acquired shares in nine New Guinea companies for approximately $18 million and sold them for $18,138.00. The difference between these two figures was reflected in the increased value of one of Jensen's subsidiaries.

With regard to some of the shares transferred to Jenspart, it was contended for the Commissioner that, whatever value they may have had after stripping, that value was negated by a potential income tax liability in respect of current profits. These shares were those of a group of eleven companies, referred to as the Victorian companies. They were acquired from Conort Investments Pty. Limited on 24th April, 1975. Mr. Fox did not

ATC 4456

know, but understood the Victorian companies had current profits. But when the price to be paid by Jensen was fixed, he had in mind that there would not be any tax payable by those companies. It was suggested to him that he was so minded because he already then expected the Victorian companies themselves to join a sec. 36A partnership. He denied this, saying that another arrangement was proposed that had nothing to do with sec. 36A. Apparently this other arrangement would have involved Norfolk Island in some way. However, it was not explored in evidence. In fact a sec. 36A partnership was formed, but Mr. Fox said he was ``not happy'' with the change in the plan. This evidence, in so far as it was elicited for the purpose of showing that Mr. Fox had sec. 36A partnerships in mind when the shares transferred to Jenspart were acquired, in my view failed to achieve that purpose.

The income tax return of Jensen for the year ending 30th June, 1975 shows, in its sharetrading account, sales at actual value $508,386 and at ``deemed value'' $17,623,608. The deemed value was described as ``cost pursuant to sec. 36A(2) election (book value $191,000)''. The deemed value was split between the five partnerships, Jenspart's share being $6,584,513. Jensen elected under sec. 31 the value of its trading stock to be its cost price.

In its income tax return for the year ending 30th June, 1975 Jenspart similarly shows purchases at the deemed cost of $6,584,513. In a sharetrading and profit and loss account it shows purchases $152,347, sales $138,590 and closing stock $27,072. In its ``detailed'' share trading account it shows as purchases the shares transferred to it by Jensen. The same account shows some 48 separate purchases of shares in public companies, and some 23 sales. Apart from the special arrangements for the sale of shares transferred from Jensen, Jenspart generally has effected its share dealings through brokers, and has dealt in shares in listed public companies. Since that time Jenspart has continued actively trading in listed shares through brokers. In his affidavit Mr. Fox said that from 1st July, 1975 Jensen ceased to directly carry on the business of buying and selling shares. This evidence was objected to, and was admitted subject to objection. I think the statement is admissible as evidence that Jensen has not traded in shares since that date. This evidence is supported by the records of the brokers Constable and Bain and John Anschau & Co. The records of John Anschau & Co. show numerous share dealings from September, 1970 to November, 1973; a single dealing in 1974 (Metrop. Tenpin); dealings from 13th March, 1975 to 27th May, 1975; but none thereafter. The records of Constable and Bain show share dealings by Jensen from 7th March, 1975 to 20th May, 1975. Peter Hains & Co. was also employed as a broker by Jensen, but the firm's client sheets were not in evidence.

The following inferences of fact are in my view properly to be drawn on this evidence. Jensen was an active trader in shares during the financial years ending 30th June, 1971 and 1972. Its activity could fairly be classified as a business of share trading. During the financial year ending 30th June, 1973 the share trading in listed shares was still significant. There were two important purchases (in Metropolitan Tenpin Bowling Limited and Austral Pacific Mining Coporation Limited) and having regard to the subsequent sales of these shares Jensen was still carrying on a business of trading in shares in listed companies. In addition it entered in that year into two other fields of share dealing. In the one field is the transaction with Toomar Investments Pty. Limited. This was to be followed in the following year by a similar transaction with Renmore Pty. Limited. In the second field is the participation in Division 7 schemes. Here the evidence establishes that the acquired preference shares had a value after the payment of the dividend. The schemes were entered into with the object of making a profit from two sources, first the receipt of the dividend and secondly the sale of the shares. These dealings in my view were part of the share trading activities of Jensen. I am also of the opinion that the shares acquired in Division 7 schemes were acquired for the purpose of sale within the meaning of the definition of ``trading stock''. One of the purposes of acquisition was sale, and that in my view is sufficient to satisfy the requirement of the definition. If this were not so, it would presumably follow that no purchase of shares ``cum dividend'', where it was intended to take the dividend before sale, could be trading stock within the meaning of the definition.

In the year 1974 there was no activity on the stock exchange by Jensen, but it continued its

ATC 4457

Division 7 schemes. Shares acquired in prior such schemes were sold, and one of the new acquisitions (in Colmar No. 1 Pty. Limited) was sold in the ensuing year. Thus Jensen was still carrying on a business of share trading.

In the year ending 30th June, 1975 Jensen entered into a number of diverse share transactions. One was some profitable dealings with New Guinea companies. The details of the transactions are not in evidence, and are not in themselves important for present purposes. A great number of preference shares were acquired as the result of Division 7 schemes. Having regard to the timing usual in such schemes, these acquisitions were apparently all made in April, 1975. All of these Division 7 shares, for the reasons already given, should be regarded as trading stock. Further, Jensen acquired shares for the purpose of dividend stripping according to a familiar pattern. On the evidence these shares had a residual value after the stripping, and one of the purposes of acquisition was to realise this value by sale. With two exceptions (P.P. Bauer Holdings Pty. Limited and Ensleigh Investments Pty. Limited) these shares were acquired before Jensen considered entering into sec. 36A partnerships (including Jenspart); and even in the case of the two exceptions the negotiations for acquisition would appear to have been in the ordinary course of Jensen's activity as a dividend stripper (though a partnership was contemplated as a likely purchaser). In addition to these activities Jensen was, at least from March to the formation of Jenspart, actively engaged in trading on the stock exchange in shares in public companies. All of these activities may be classified as a business of share trading, and the shares, whether in listed companies, or in companies the subject of Division 7 schemes or dividend stripping operations, were trading stock of that business.

Early in May, 1975 Jensen made plans for another business activity, namely the promotion of partnerships. This new business was intended to take advantage of the deemed price provisions of sec. 36 and 36A. In order that the desired result might be achieved, it was necessary for Jensen to be a member of the partnership, and to bring into the partnership shares which by some process had suffered a considerable diminution in value since their acquisition by Jensen. These shares had to be trading stock in a business carried on by Jensen. The shares transferred to Jenspart answered this description, having been acquired for the purpose of sale in Jensen's business as a share trader. If, contrary to this finding, the shares (or some of them) had been acquired for the purpose of transfer to partnerships of which Jensen was a member (as the Commissioner contended), then the shares might not be trading stock within the meaning of the definition. This would be so if the words ``sale or exchange'' in the definition connote a disposition of the whole interest. Further, if the shares (or some of them) had been acquired for the purposes of Jensen's business of promoting sec. 36A partnerships, then the shares would be assets of that business, and the transfer of them to Jenspart would be in the ordinary course of carrying on that business. On that assumption (and assuming the correctness of the Commissioner's contention that the condition in sec. 36(1)(c) is imported into sec. 36A by reference), then the condition so imported would not be satisfied. My finding on the facts of the case is that all the shares transferred to Jenspart (other than those in P.P. Bauer Holdings Pty. Limited and Endsleigh Investments Pty. Limited) were acquired before the business of promoting sec. 36A partnerships was contemplated. On this finding, the question of the non-fulfilment of the condition in sec. 36(1)(c) could arise only in respect of the shares in those two companies, and even in their case, the proper inference in my view is, as I have said, that those shares also were acquired as assets in Jensen's business as a share trader.

If, contrary to my finding, the shares transferred to Jenspart (or some of them) were not trading stock in a business of share trading, or, having been such trading stock, lost that character, and became assets in the business of promoting sec. 36A partnerships, then two further questions would arise. The first is whether the shares were trading stock of the business of promoting sec. 36A partnerships. They would not fall within the definition, and would be such trading stock only if they fell within the ordinary meaning of that term, and that ordinary meaning was not excluded by the definition. The second question arises in the following way. If the shares were trading stock in the business of promoting sec. 36A partnerships, then the transfer to Jenspart would be in the ordinary

ATC 4458

course of business. It would then be necessary to decide whether the condition in sec. 36(1)(c) is imported into sec. 36A.

I do not agree with the submission that there is any requirement under sec. 36A similar to that in sec. 36(1)(c). The submission obtains its colour from the particular facts of this case. Jensen made a business of dealing in the taxation deductions for which sec. 36A appeared to provide the basis. In general a transfer by a person of the trading stock of his business to a partnership consisting of himself and others would not be in the ordinary course of that business. But this is not a reason for importing into sec. 36A(1) the condition in sec. 36(1)(c). Indeed it is a reason for not importing such a requirement, for the need for such a requirement would scarcely have been apparent until Mr. Fox saw the deduction possibilities of the section. To import a condition in order to close an avenue of otherwise legitimate tax avoidance is not in my view a proper approach to the construction of the Act (cp.
Patcorp Investments Limited & Ors. v. F.C. of T. 76 ATC 4225 per Gibbs J. at p. 4232). In brief, sec. 36A(1) lays down its own conditions of application. If it does apply, then a disposition within sec. 36(1) is deemed to have occurred. The reason for the enactment of sec. 36A appears to have been the decision of the High Court of Australia that a transfer of property from a taxpayer to a partnership including himself was not a disposition of property within the meaning of sec. 36 (
Rose v. F.C. of T. 84 C.L.R. 118). In its original form sec. 36(1) did not include a requirement that the disposal was not in the ordinary course of business. Section 36(1) in its present form was enacted in the same statute as sec. 36A (Income Tax and Social Service Contribution Assessment Act (No. 3) 1952, sec. 6, 7).

If this is correct then it follows that sec. 36A(1) applies if there is the requisite change of ownership of stock where the stock is held for the purposes of a business of effecting such changes, provided the stock is trading stock within the meaning of the section. The stock would not be trading stock by definition, but that definition does not purport to be exclusive. In their joint judgment in
F.C. of T. v. Murphy (106 C.L.R. 146) Kitto, Taylor and Windeyer JJ. said of the definition: ``It is, in form, inclusive and not exhaustive, but its terms are so comprehensive as probably to include everything which would ordinarily be covered, and to go further'' (p. 154). Whether the definition is exclusive or not was not determined in that case, and it is not necessary to determine it here. The inclusive form of a definition may not be decisive (
Y.Z. Finance Co. Pty. Ltd. v. Cummings 109 C.L.R. 395 at 399; cp. ibid., p. 405). In
Investment and Merchant Finance Corporation Ltd. v. F.C. of T. (71 ATC 4140; 125 C.L.R. 249) Walsh J. said (ATC p. 4149; C.L.R. p. 269): ``In the case of a company the business of which includes dealing in shares, it could scarcely be doubted that shares which it buys and which it intends to resell would generally be regarded as part of its trading stock according to the meaning in which, apart from any statutory definitions, that expression would be understood''. Conversely, shares acquired or held for the purpose of satisfying contributions to partnerships would not I think be understood as falling within the ordinary meaning of trading stock, even if the shares were acquired or held in furtherance of a business of promoting partnerships. If Jensen had a business of promoting partnerships of a certain kind or for certain purposes, and even if the business required shares stripped of value, to a large degree, to be transferred in satisfaction of Jensen's own capital contribution, those shares do not appear to me to be articles of trade. They are not being used in what would be understood as a trading relationship. Thus, whether the definition is exclusive or not, the shares which Jensen transferred to Jenspart are property falling within sec. 36A(1) for the reason only that they are properly to be regarded as assets of Jensen's share trading business, that is to say, its business of buying shares for resale, and in due course selling those shares.

In
Modern Permanent Building and Investment Society (In Liquidation) v. F.C. of T. (98 C.L.R. 187) Williams J. said (at p. 190) that the definition of ``trading stock'' relates to tangible things only. But in Investment and Merchant Finance Corporation Ltd. v. F.C. of T. (71 ATC 4140; 125 C.L.R. 249) the majority of the High Court held that the shares in question in that case were ``trading stock'' within the meaning of the definition and for the purposes of sec. 28, 29 and 31. Walsh J. found no warrant for the generalization which Williams J. made (ATC p. 4149; C.L.R. p. 270). It is now clear that shares that have been stripped in the classic dividend stripping

ATC 4459

operation may be trading stock in the hands of a dealer in shares (Patcorp Investments Ltd. & Ors. v. F.C. of T. above). The shares with which the last mentioned case was concerned had been stripped before sec. 106A, 106B and 106C were inserted in the Act; but there is no difference in principle if, as I have held on the evidence in this case, there was still a market for the shares after the stripping.

In my opinion, therefore, all the shares transferred by Jensen to Jenspart were assets of a business, and were trading stock within the meaning of sec. 36A(1), and the conditions of that subsection were satisfied. It appears from the records of the brokers, Constable and Bain, that Jenspart was in business as a sharetrader from the day after its formation. The shares transferred to it from Jensen were sold as part of its sharetrading activities, and were an asset of the business carried on by it within the meaning of sec. 36A(2)(a). There were special circumstances relating to the acquisition and disposal of these shares, but these special features are irrelevant to question whether the shares were assets in the share trading business of Jenspart. The evidence also establishes that conditions (b) and (c) of the subsection are satisfied.

It was argued for the Commissioner that subsec. (2) of sec. 36A was applicable only to live stock. The only basis suggested for this argument related to the words ``the value of the property... shall be... the value that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change''. It was said that these words could relate only to a value which necessarily arose at the end of the year of income, and that only the value of live stock (by reason of sec. 32 and 33) answered this description. But the argument would fail in respect of the first year in which a basis of valuation was adopted, because of the initial option of the taxpayer. Even in respect of later years there is always the possibility of the Commissioner granting leave under sec. 33 to alter the basis of valuation. In any event I see no reason to place any such limitation on the words of sec. 36A(2). The words in question pose a question of fact upon the assumption that the year of income has come to an end and no disposal has taken place. Where the property is shares, sec. 31(1) applies, and the transferor has the option given by that subsection. Leaving aside the possibility of replacement price, the effect of an agreement under sec. 36A(2) is that the assessable income of the transferor shall include the cost price, instead of the market value that would apply under sec. 36A(1) operating alone.

It was further submitted on the part of the Commissioner that, even if I have correctly set out the operation of sec. 36A, nevertheless there was no partnership loss by Jenspart in respect of the sale of the shares transferred to it by Jensen. As I understood it, the argument was as follows. The operation of sec. 36A(1) and (2) would be that Jenspart should be deemed to have purchased the shares from Jensen at their cost price to Jensen. In order to ascertain the ``partnership loss'' within the meaning of sec. 90 it becomes necessary to determine whether either limb of sec. 51 would give rise to an allowable deduction. It was said that the sale price of the shares was not assessable income under the first limb; nor was there any nexus between the deemed cost to Jenspart and any business carried on by it under the second limb. In effect the argument was that the proceeds of the sale of these shares by Jenspart was capital, not income. Subsection (2) of sec. 51 was not applicable, because (it was said) the shares were not trading stock of Jenspart. I have already held that the shares were acquired, held and disposed of by Jenspart as trading stock in its business as a trader in shares and if this is correct, then the argument falls at the threshold.

Apart from the argument based upon sec. 260, it remains to notice the submission that the notice under sec. 36A(2) was not effective if any of the shares transferred by Jensen to Jenspart were not trading stock. As I have held that all the shares were trading stock, it is not strictly necessary to deal with the submission. However I think it is appropriate to make some observation upon it, particularly because the shares in P.P. Bauer Holdings Pty. Limited and Endsleigh Investments Pty. Limited were acquired after Mr. Fox conceived the idea of sec. 36A partnerships. There was evidence that negotiations in respect of the acquisition of the shares in P.P. Bauer Holdings Pty. Limited had been going on over about six or nine months; but there was no evidence as to the negotiations for the shares in Endsleigh Investments Pty. Limited.

The notice expresses an agreement that subsec. (2) of sec. 36A shall apply ``in respect of

ATC 4460

all the property described in the Second Schedule''. There is no formal difficulty in severing some of the items in the Schedule from others; and having regard to the purpose of the agreement, as appearing on its face (when read with the relevant provisions of the Act), and to the circumstances of the parties, it seems to me that no new agreement is made by such severance; on the contrary the substance of the agreement is thereby preserved. To sever in such a case is therefore in accordance with established principle (see:
Whitlock v. Brew 118 C.L.R. 445 at 461; Amoco Australia Pty. Ltd. v. Rocca Bros
Motor Engineering Co. Pty. Ltd. (1975) A.C. 561 at 578). On the question of ascertainment of the intention of the parties to a contract, Lord Wilberforce has said: ``When one speaks of the intention of the parties to the contract, one is speaking objectively - the parties cannot themselves give direct evidence of what their intention was - and what must be ascertained is what is to be taken as the intention which reasonable people would have had if placed in the situation of the parties'' (
Reardon Smith Line Ltd. v. Hansen-Tangen (1976) 3 All E.R. 570 at 574; (1976) 1 W.L.R. 989 at 996). Lord Wilberforce was speaking in a different context, but the principle enunciated is of general application.

The Commissioner also relies upon sec. 260. It was contended for the appellant that the principles stated in
Mullens v. F.C. of T. (76 ATC 4288) applied to the circumstances of the present case, with the consequence that sec. 260 had no application. This was, it was said, a case where there was a provision in the Act entitling the taxpayer to a deduction, and sec. 260 could not be applied to strike down such a deduction. No argument was presented to the Court on behalf of the Commissioner that Mullen's case (above) was in any relevant sense distinguishable.

The argument for the Commissioner took the form of a written submission with only minimal oral elaboration. With minor editing this submission is as follows:

``It was arranged by and between Jensen and the appellant that for the purpose of the appellant's avoiding income tax otherwise payable on the appellant's assessable income for the year ended 30 June 1975, the appellant would purchase from Jensen, as an allowable deduction, a potential deemed loss in the value of certain shares held by Jensen. The appellant would acquire its interest in the deemed loss from Jensen by entering with Jensen into a partnership (Jenspart) to which Jensen would contribute the shares at a fixed price, being the approximate price for which the partnership would sell the shares, and to which partnership the appellant would contribute an amount of cash proportionate to its interest in the partnership. The purpose is to be ascertained from the following overt acts by which the arrangement was implemented: -

(a) at or about the time of becoming a member of Jenspart, the appellant and its fellow partners were made aware of the precise amount of the proportion of the partnership loss which would be made available to them by participating in the scheme and which could be claimed as an allowable deduction;

(b) the appellant and the other partners (except Jensen) paid a fee to Jensen for the losses which varied in amount but which was equal to between 15 to 20 per centum of the expected loss;

(c) the shares which Jenspart received as a capital contribution from Jensen were (with the exception of Beneficial Finance Corporation Ltd.) in private companies that had been acquired by Jensen and which had undergone (while still owned by Jensen) the usual series of transactions involved in dividend stripping operations;

(d) by a complex series of transactions involving an exploitation of the provisions of sec. 36A, tax losses were generated by Jenspart: in this regard -

(i) the relevant shares in the private companies (which at the time carried a potential liability for tax in respect of current year profits and which shares were therefore, in fact, onerous) were contributed by Jensen to Jenspart;

(ii) Jensen retained a sufficient 25% interest in the shares for the purposes of sec. 36A and the remaining partners contributed sufficient capital to acquire a 75% interest; at the same time a substantial majority of this capital was returned to the appellant and other partners by loan by Strang Investments

ATC 4461
Pty. Ltd., a company related to Jensen by way of directorships which in turn had received a loan from Jenspart;

(iii) after dividend stripping operations had been carried out, the appellant and the other partners gave to the Commissioner a sec. 36A notice stating that for taxation purposes the relevant shares should be deemed to have been acquired by Jenspart at prices equal to their substantial `cum. div.' cost price to Jensen; at the same time, however, the books of account of Jenspart recorded the shares at values below their `ex-div.' values, calculated on the assumption that the companies would not have any liability for 1975 tax; and

(iv) subsequent sales of the relevant shares by Jenspart were pre-arranged with four nominee companies at prices at or near their `ex-div.' values;

(e) finance was arranged for the four nominee companies, a condition of which was that the lender, Powerlon Securities Pty. Ltd., would accept at the option of the nominee companies a transfer of the shares the subject of the sale in full satisfaction of the nominee companies' obligations, and an ultimate purchaser was made available to these companies to take the shares at prices which would assure the companies a small profit on the resale;

(f) many of the private companies (whose shares had been acquired and disposed of by Jenspart), at the time they were still owned by the partnership, themselves became members of other sec. 36A partnerships which generated income tax losses and sold a share of those losses (in much the same way as Jenspart had done) to each of the companies.

It was part of the arrangement that the appellant would realise its interest in the deemed loss by the disposition of the shares by the partnership at a price approximating the fixed value. The arrangement was executed (a) by a series of transactions by which the shares passed from Jensen (as a capital contribution to the partnership) through the partnership to subsequent purchasers and most of the cash then contributed by the appellant to the partnership as capital was returned to the appellant and (b) by the payment to Jensen by the appellant of a fee proportionate to the deemed loss realised by the appellant and claimed by the appellant as an allowable deduction from the appellant's assessable income for the year ended 30 June, 1975. The transactions struck down by the operation of sec. 260 are the whole of the arrangement entered into including the formation of the partnership and the dispositions of the shares by Jensen and by the partnership. The appellant is left in the situation that no partnership loss was incurred in the year of income, an individual interest in which the taxpayer may otherwise have been allowed as a deduction to offset against assessable income for the year ended 30 June 1975.''

Even accepting the correctness of the presentation of the facts in this submission, it cannot prevail. Stripped to its essentials, the submission is that the appellant availed itself of a deduction permissible under the Act, and that sec. 260 applied for no other reason than the appellant's intention of so organizing its affairs as to avoid the incidence of tax. It is true that in doing so, the appellant had to enter into an arrangement with Jensen; but that in itself does not constitute an arrangement within the ambit of sec. 260. Nor is the arrangement brought within sec. 260 by reason of the fact that it was Jensen's business to provide for reward to itself means of tax avoidance. Jensen's role was similar to that of Cadiz Corporation Pty. Ltd. in
Slutzkin v. F.C. of T. (77 ATC 4076).

Some matters of fact are stated in the submission in the language of denigration, and others are simply misstated. The statement that the shares carried a potential liability for tax in respect of current year profits and were therefore onerous is not borne out by the evidence. The evidence goes no further than Mr. Fox saying that he ``understood'' that a group of the companies involved (the ``Victorian companies'') had current year profits, that the question of potential income tax liability was discussed by him and the directors of these companies, and that the directors agreed ``to carry out transactions involving Norfolk Island''. Late in June the directors informed Mr. Fox that they intended to form a sec. 36A partnership. He was ``not happy'' with this, but it appears that such a partnership was formed. There is no evidence at all that the shares were ``onerous''; there is in fact evidence to the contrary.

ATC 4462

The statements in para. (d)(iii) and (d)(iv) of the submission are worded in such a way as to make it difficult to disentangle the accurate from the inaccurate parts of it. The facts simply are that Jensen transferred shares to Jenspart at an agreed price, and Jenspart sold the shares at a profit. The circumstances relating to the sec. 36A(2) ``election'' do not call for re-statement here. As to para. (e), there is no evidence that ``an ultimate purchaser was made available... to take the shares at prices which would assure the companies a small profit on re-sale''. The matter of a possible profit on re-sale was discussed, and I have dealt with this. That is as far as the evidence goes.

I do not understand the part of the submission that the appellant would realise its interest in the deemed loss by the disposition of the shares by Jenspart ``at a price approximating the fixed value''. There was no elaboration of this in argument. The statement of the execution of the ``arrangement'' is not in my view an accurate summary of the evidence. I have already set out the facts as I understand them.

For these reasons, I am of the opinion that the appeal should be upheld.

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