Palmarc Investments Pty. Limited v. Federal Commissioner of Taxation.
Judges:David Hunt J
Court:
Supreme Court of New South Wales
David Hunt J.
The taxpayer, Palmarc Investments Pty. Ltd., appeals pursuant to the Income Tax Assessment Act 1936 against the Commissioner's tax assessment for the year ended 30 June 1981. The Commissioner included in the taxpayer's assessable income:
``Profit on sale of share rights in Magnum Explorations Limited... $341,746.''
The taxpayer had disclosed in its return that it had sold its ``rights to an issue of shares in a listed company'', but had claimed that the proceeds from that sale were a capital asset. The Commissioner has sought to support his assessment of those proceeds as assessable income in various alternative ways:
- (a) as profit arising from the sale by the taxpayer of property before the expiration of a period of 12 months from the date upon which it was purchased (sec. 26AAA(2)); or
- (b) as profit from the sale by the taxpayer of property acquired by it for the purpose of profit-making by sale (the first limb of sec. 26(a)); or
- (c) as income in accordance with ``the ordinary concepts and usages of manking'' (sec. 25(1)); or
- (d) as the value to the taxpayer of payment to it in respect of services rendered by it (sec. 26(e)).
Reliance upon the second limb of sec. 26(a) was withdrawn during the course of the hearing before me. No suggestion was made that the transaction in question was a sham, or that the provisions of sec. 260 applied.
An examination of the background to the transaction in question commences in the 1960s. Mr Paul Lincoln Smith, the chairman of directors of the taxpayer, had been engaged during that period in a number of mining ventures. Magnum Explorations NL was incorporated in 1969, and Mr Lincoln Smith was and is its chairman of directors. It subsequently became a limited liability company and is now called Magnum Resources Limited. I will refer to it as ``Magnum''. Magnum has carried on substantial mining activities since its incorporation. The taxpayer is a family investment company for Mr Lincoln Smith, and its shareholding in Magnum effectively gives to Mr Lincoln Smith a controlling interest in Magnum's issued capital.
Over the years since the incorporation of Magnum, the taxpayer has from time to time taken up new shares and sold shares in Magnum. Another company incorporated by Mr Lincoln Smith was Pada Pty. Ltd. (``Pada''), and this was used by him for estate planning purposes as the trustee for a number of trusts for the benefit of his children. That company also acquired shares in Magnum. By September 1978, the taxpayer and Pada between them held 53% of the issued share capital of Magnum (which had been reconstructed in 1975).
Early in 1980, Magnum was seen by its directors to need approximately $750,000 to meet exploration expenditure over the next two years. Instead of raising further capital from its shareholders, the directors of Magnum resolved to sponsor the public flotation of a no liability company in which Magnum and its shareholders would retain a substantial interest and to which Magnum would sell a substantial interest in some of its subsidiary companies. The new company so hived off, Carbon Minerals NL (``Carbon''), was incorporated on 25 January 1980. Of the four directors of Carbon, two (including Mr Lincoln Smith)
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were also directors of Magnum. For every share in Carbon allotted, the person to whom it was allotted was entitled also to purchase an option to apply for and be allotted one further share. By the prospectus issued by Carbon, the directors offered shares and options for subscription by the shareholders of Magnum on the basis of one share and one option in Carbon for every one share held in Magnum. The offer of these shares to shareholders of Magnum was made non-renounceable by them.Late in 1980, just before the prospectus was issued by Carbon, Mr Lincoln Smith formed the view that, because of the substantial interest which the taxpayer held in Magnum, which in turn would hold a substantial interest in Carbon after that company's flotation, he did not wish the taxpayer to subscribe for any further shares in Carbon. Accordingly, he decided that the taxpayer would subscribe for those shares in Carbon to which it was entitled on behalf of another family company in which it held all the ordinary shares, D.J. Sewell Pty. Ltd. (``Sewell''), pursuant to an agreement between them. The true nature of that agreement, dated 18 November 1980, is the major issue in this appeal.
The agreement is in the form of a deed between Pada, the taxpayer and Sewell. It recites the beneficial ownership by Pada and the taxpayer of specified shares in Magnum, the offer to them as shareholders in Magnum of the right to subscribe for shares and options in Carbon, and the following statement:
``Pada and Palmarc do not wish to take up any entitlement that may arise pursuant to the rights issue by virtue of their holdings in Magnum, but instead wish to assign all their right title and interest in and to the rights issue to Sewell for the sum of One million eight hundred and sixty two thousand and ninety four dollars ($1,862,094) on the terms and conditions hereinafter contained.''
Pada can be ignored for present purposes. Pursuant to that agreement, and in consideration of the sum of $341,746.60 paid by Sewell to it, the taxpayer by cl. I assigned to Sewell all its right title and interest in and to the rights issue absolutely. It is that amount which the Commissioner has included in the taxpayer's assessable income. By cl. 2, the taxpayer covenanted with Sewell that, pursuant to its obligations under the deed, it would duly apply for shares and options in Carbon in its capacity as a Magnum shareholder, and it declared that any benefits whatsoever accruing to it in relation to the rights issue were held by it on trust for Sewell absolutely. By cl. 3, Sewell covenanted to pay the plaintiff the allotment moneys in relation to the Carbon shares and options applied for. By cl. 4, the taxpayer covenanted with Sewell that, pursuant to its obligations under the deed, it would hold all its estate right title and interest in the shares and options to be issued by Carbon for and on behalf of Sewell absolutely. The remainder of the deed consists of the usual machinery provisions to be found in such an agreement.
The taxpayer subsequently (on 11 December) applied for and (on 12 December) was allotted the shares and options in Carbon to which it was entitled as a Magnum shareholder, in accordance with the offer made to it in the Carbon prospectus. Sewell paid to the taxpayer the allotment moneys for those Carbon shares and options, plus the sum of $341,746.60.
It is conceded by the taxpayer that, if as a shareholder in Magnum it had taken up its entitlement of shares and options in Carbon in its own right and if it had then sold what it had acquired to Sewell, it would have been liable to pay tax on any profit it made on the sale (because of sec. 26AAA). It is also conceded by the taxpayer, and I accept, that the sum of $341,746.60 fixed as consideration under the deed represented an estimate of the profit which it would have obtained by selling the shares and options so acquired on the stock exchange. The taxpayer, however, denies that it acquired the shares in question. The Commissioner asserts that it did.
The principal argument on behalf of the Commissioner is that the legal effect of the deed between the taxpayer and Sewell amounted to an assignment for consideration by the taxpayer of its future rights in property, being the Carbon shares and options which it was offered. Upon the allotment of those shares by Carbon to the taxpayer, therefore, the total property in those shares vested in the taxpayer for an instant of time before the declaration of trust came into effect and the shares were held in trust for Sewell as their beneficial owner. Before equity imposes the obligation to hold the shares in trust for Sewell, the Commissioner says, the taxpayer must have
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had the legal title vested in it. Reliance was placed upon the judgment of Dixon J. inPalette Shoes Pty. Ltd. v. Krohn (1937) 58 C.L.R. 1 at pp. 26-27, and upon statements in two stamp duty cases in which it was held that the legal and equitable title to property cannot be severed until after the legal estate has been acquired:
Commr of Stamp Duties (N.S.W.) v. Perpetual Trustee Co. Ltd. (Quigley's case) (1926) 38 C.L.R. 272 at pp. 277-278;
D.K.L.R. Holding Co. (No. 2) Pty. Ltd. v. Commr of Stamp Duties (N.S.W.) 82 ATC 4125 at pp. 4131-4132, 4144-4145, 4150-4152; (1982) 149 C.L.R. 431 at pp. 442-443, 463-464, 473-474.
This argument, however, proceeds upon a misconception as to the nature of the agreement enshrined in the deed. That agreement does not purport to assign the shares in Carbon, nor is that is legal effect. What it assigns is the taxpayer's present interest in what is described as ``the rights issue''. Whether that description is legally appropriate or not is beside the point. (I note that the Commissioner accepted that description in the adjustment sheet.) What is assigned is the taxpayer's present interest in the offer made by the directors of Carbon to the Magnum shareholders - whatever may be the true nature of that interest. The taxpayer applied for the shares and options so offered to it by reason only of the obligation to do so imposed by the deed itself; and it held those shares and options by reason only of the obligation to do so imposed by the deed itself. There was no purchase by the taxpayer of the shares in its own right and then a severance of an equitable interest in favour of Sewell. It was not the taxpayer's future interest in the Carbon shares which was assigned, but the taxpayer's present interest in the offer which was assigned. The equitable interest in such present property passed to Sewell immediately:
F.C. of T. v. Everett 80 ATC 4076 at p. 4081; (1980) 143 C.L.R. 440 at pp. 450-451;
F.C. of T. v. Galland 84 ATC 4890 at pp. 4893-4894.
A simple illustration will suffice to demonstrate the Commissioner's misconception. If a citizen asks his neighbour, who is going shopping at the local shopping centre, to purchase a case of wine for him at the local liquor store, the transaction which the neighbour undertakes is not one of purchase by him of the legal interest in the wine with the impression upon that legal interest of an equitable interest in favour of the citizen for whom he purchased it. He never obtains a legal interest in the wine at all. The legal situation is no different in the present case because the Carbon shares did not come into existence until they were allotted to the taxpayer.
I am no doubt unnecessarily repeating myself, but it comes back to the true nature of the property which was assigned. All that the taxpayer was assigning was its interest in the offer made to it as a Magnum shareholder by the directors of Carbon, whatever that interest was. At worst, it was no more than a preferential right to stand at the top of the queue for the Carbon shares. Its value was measured by the prospect that the price to be paid for the Carbon shares and options by Magnum shareholders was less than they would be worth on the stock exchange after allotment, and that that would be a result of a demand for those shares which was greater than their supply upon allotment. That was a present right, not a future right, which the taxpayer was assigning, and the Commissioner's argument to the contrary must be rejected. Whether the right was legally enforceable or not does not matter; it was a commercially valuable right which arose solely by reason of the taxpayer's status as a shareholder of Magnum, and it was a present right which could be assigned. The legal effect of the assignment was that Sewell became presently obligated to the taxpayer to pay it the amount of $341,746.60, and the taxpayer became presently obligated to Sewell to apply for the shares and options in Carbon. By reason of the obligations of trust imposed by the deed upon the taxpayer, there attached immediately upon the allotment of those shares and options to it a trust of Sewell. At all material times, the taxpayer held those shares and options upon trust for Sewell. (The Carbon articles contain the usual provision, in art. 6, that the company is not bound to recognize any equitable or other claim to or interest in its shares on the part of any person other than the registered shareholder, whom it is entitled to treat as the absolute owner thereof.)
The transaction in question involved no acquisition of property by the taxpayer. The taxpayer had not acquired any interest itself in the Carbon shares and options, nor had it assigned those shares and options to Sewell; that necessarily follows from the rejection of the Commissioner's argument as to the nature
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of the agreement contained in the deed. The taxpayer, of course, acquired the shares in Magnum which gave rise to the interest in the Carbon offer which it did assign; the property which was sold to Sewell was a benefit which accrued to the taxpayer by reason only of its shareholding in Magnum - namely, its interest in the offer made to it as a Magnum shareholder by the directors of Carbon, whatever that interest was - but it was not the sale of anything which the taxpayer had acquired in the relevant sense. Where a shareholder sells his rights to take up new shares in the same company, he is not selling property which he has acquired in the relevant sense:F.C. of T. v. Miranda 76 ATC 4180 at pp. 4191-4192; and see
F.C. of T. v. N.F. Williams 72 ATC 4188 at pp. 4190, 4192-4193, 4194; (1972) 127 C.L.R. 226 at pp. 241, 245, 248. The sale of the taxpayer's interest in the offer made by the directors of Carbon was similarly not the sale of something which had been acquired by it in the relevant sense; indeed, its interest in the offer so made was even more separate and distinct from the shares which it had acquired in Magnum and which gave rise to that offer: cf. Miranda at pp. 4188-4189.
In the event that the Commissioner's argument as to the true nature of the agreement enshrined in the deed were to be accepted, the taxpayer also put forward an alternative argument - based upon the judgment of Deane J. in F.C. of T. v. Everett 78 ATC 4595 at p. 4609 - that, although the legal title in the Carbon shares vested in it when the shares were allotted to it, the beneficial interest never did. Consequently, the taxpayer says, there was no purchase (or acquisition) and sale of the beneficial interest by it of the shares. The Commissioner says that the judgment of Deane J. is inconsistent with the stamp duty cases to which reference has already been made, and should not be accepted as correct. That answer, it seems to me, overlooks the necessary consequence of what the High Court held in Everett's case at 80 ATC pp. 4080-4081; 143 C.L.R. pp. 450-451, rejecting a similar argument by the Commissioner in that case. However, in view of the rulings which I have already given, it is unnecessary for me to determine whether the taxpayer's alternative argument is correct, and I do not propose to consider it further.
The first basis upon which the Commissioner sought to support his assessment was that the $341,746.60 was the taxpayer's profit arising from the sale by the taxpayer of its property within 12 months of its purchase (sec. 26AAA). The property which he identified as having been purchased and sold consisted of the shares in Carbon allotted to the taxpayer, such allotment being deemed by subsec. (1)(d) to be the purchase of those shares. The Commissioner also relied upon the deeming provisions of subsec. (1)(f), which are in the following terms:
``For the purposes of this section -
- ... if property is transferred from a person... to another person... in exchange for other property or without consideration, the transfer shall be deemed to constitute the sale of the property by the first-mentioned person... and the purchase of the property by the second-mentioned person...''
This provision has nothing to do with this case, even if the rest of the Commissioner's argument were to be accepted. Subsection (1)(f) is concerned with a barter or a gift; the present case is neither.
But the Commissioner's argument fails at a much earlier stage. There was no purchase by the taxpayer in its own right of any interest in the Carbon shares when they were allotted to it; nor was there a sale by the taxpayer to Sewell of the equitable interest in those shares. The shares were allotted to the taxpayer only (and at all times) as trustee for Sewell, and the taxpayer held those shares only (and at all times) as trustee for Sewell. The taxpayer acted in exactly the same way as any nominee company which was a Magnum shareholder - such as, for example, ANZ Nominees Ltd. which held shares in Magnum as trustee for the taxpayer. As between Magnum and that company, ANZ Nominees was the shareholder and was entitled to payment of a dividend and to vote at meetings and it was liable for calls, etc. Similarly, when it no doubt accepted the offer of the directors of Carbon and took up shares and options in Carbon it was, so far as Carbon was concerned, the shareholder but it acquired those shares and held them as trustee for the taxpayer. It is a misconception to say (as the Commissioner would say) that there was first of all a purchase by ANZ Nominees of the
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legal and equitable interests in the Carbon shares and then a transfer of the equitable interest to the taxpayer, so that if a consideration is paid (or the provisions of subsec. (1)(f) apply) there is a sale and the amount so paid (or deemed to have been paid) becomes assessable income because of sec. 26AAA. I am satisfied by the taxpayer that the payment of $341,746.60 was not assessable income by virtue of sec. 26AAA.The second basis upon which the Commissioner sought to support his assessment was that this amount was the taxpayer's profit from the sale of its property acquired for the purpose of profit-making by sale (the first limb of sec. 26(a)). It was correctly conceded on behalf of the Commissioner that, in the circumstances of this case, there was a considerable overlap between sec. 26(a) and 26AAA. I am satisfied for the reasons expressed earlier that there was no acquisition by the taxpayer in the relevant issue of what was sold to Sewell, namely the taxpayer's interest in the offer made to it as a shareholder in Magnum by the directors of Carbon. The taxpayer also argues that, for the purposes of sec. 26(a), there must be an identity between the property acquired and sold which cannot be shown in the present case. That argument, however, arises only in the event that the Commissioner's principal argument as to the true nature of the agreement enshrined in the deed were to be accepted. If that argument were to be accepted, it seems to me that the identity required for the purposes of sec. 26(a) could be established by showing that the beneficial interest in the Carbon shares was part of what was acquired by the taxpayer, and it was that beneficial interest which was sold. However, as I have not accepted the Commissioner's principal argument, it is unnecessary for me to determine this alternative argument of the taxpayer, and I do not propose to consider it further.
The Commissioner also argued that the taxpayer had originally acquired the Magnum shares (which gave rise to the offer from the directors of Carbon) for the purposes of profit-making by sale, and that the sale of its interest in the offer which it received as a shareholder in Magnum from the directors of Carbon was no more than a realization of part of those profits. The taxpayer had, as I said earlier, from time to time over the years since the incorporation of Magnum taken up new shares and had sold shares in that company. The same submission was made by the Commissioner in relation to the subsequent acquisitions of those shares by the taxpayer. Mr Lincoln Smith in his evidence dealt with the circumstances of each transaction in considerable detail; in effect, he said, each sale was to meet a particular financial need at the time. These circumstances were fully tested in cross-examination. In the end, there was no submission made that I should disbelieve his evidence as to the reasons for these sales. In any event, I accept that evidence. It was nevertheless submitted that, because these were speculative mining shares, I should infer that the taxpayer's purpose in acquiring them was to sell them at a profit. I decline to draw that inference. The long period for which the taxpayer held the shares militates strongly against it. I accept the evidence of Mr Lincoln Smith that his intention was that he should always hold a controlling interest in the issued capital of Magnum, and that the acquisition by the taxpayer of its shares in Magnum (by which he exercises that control) was not for the purpose of resale at a profit. That acceptance concludes the matter in favour of the taxpayer:
Allied Pastoral Holdings Pty. Ltd. v. F.C. of T. 83 ATC 4015 at pp. 4021-4022; (1983) 1 N.S.W.L.R. 1 at p. 11. I am satisfied by the taxpayer upon all of the evidence that none of the shares in Magnum taken up by it was acquired for the purposes of profit-making by sale. Such a finding is also made necessary in this appeal because of a number of subsidiary issues which arise in relation to disputes between the taxpayer and the Commissioner concerning earlier years of income (I shall refer to these disputes again at the conclusion of this judgment). The Commissioner's argument in relation to sec. 26(a) and the transaction in question in the year of income primarily in issue in this appeal fails in any event because there was no acquisition by the taxpayer in the relevant sense of its interest in the offer from the directors of Carbon: Miranda at pp. 4191-4192;
Macmine Pty. Ltd. v. F.C. of T. 79 ATC 4133 at pp. 4140-4141; (1979) 53 A.L.J.R. 362 at p. 367. Accordingly, I am satisfied by the taxpayer that the payment of $341,746.60 was not assessable by virtue of sec. 26(a).
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The third basis upon which the Commissioner sought to support his assessment was that this amount was income in accordance with ``the ordinary concepts and usages of mankind'' (sec. 25(1)). There was, as I understood it, no argument put forward by the Commissioner that the taxpayer was a trader in Magnum shares; in any event, I am satisfied on the evidence that it was not. The sale of the taxpayer's interest in the offer from the directors of Carbon was a ``one-off'' transaction. It was not made in the course of any business of selling such interests or as part of any profit-making undertaking or scheme. It was, in my judgment, no more than a realization by the taxpayer of a benefit which flowed by virtue of its shareholding in Magnum that is, it was a realization of a capital asset:
F.C. of T. v. McClelland 69 ATC 4001 at p. 4003; (1969) 118 C.L.R. 353 at p. 372. Such receipt must therefore also be on capital account. The Commissioner simply said that the receipt must be on income account rather than capital ``because there is no other explanation for the payment''. It was, he suggested, a payment to the taxpayer for acting as a trustee, or for services rendered. That submission repeats the Commissioner's misconception as to the true nature of the transaction. The money was paid to the taxpayer in consideration for the sale of its interest in the offer from the directors of Carbon. It was not paid for carrying out any work; its quantum was tied neither to the functions performed by the taxpayer nor to the time taken to perform them. I accept the evidence of Mr Lincoln Smith that the price was fixed as representing the estimate of the profit which the taxpayer would have obtained if it had acquired the shares and options in its own right and had then sold them on the stock exchange. I am satisfied by the taxpayer that the payment of $341,746.60 was not assessable income by virtue of sec. 25(1).
The last basis upon which the Commissioner sought to support his assessment was that this amount was income as the value to the taxpayer of payment to it in respect of services rendered by it (sec. 26(e)). The Commissioner's argument must fail for the same reason as did the last. The money was paid to the taxpayer in consideration for the sale of its interest in the offer from the directors of Carbon, and not for any services rendered. I am satisfied that the payment was not assessable income by virtue of sec. 26(e).
It follows that the taxpayer's appeal must be upheld, as the payment of $341,746 should not have been included in the taxpayer's assessable income for the year ended 30 June 1981. It is common ground between the parties that the taxpayer's assessable income for that year will accordingly be nil. The subsidiary issues which arose in relation to the 1978, 1979 and 1980 years of income should now be resolved by my finding in favour of the taxpayer that the shares in Magnum which were sold in those years at a profit had not been acquired by it for the purposes of profit-making by sale. According to the issues prepared by the taxpayer (and agreed to by the Commissioner at the hearing before me), the figures involved were $44,936 for 1978, $89,080 and $49,757 for 1979 and $34,493 for 1980. The parties were agreed that I should leave it to them to sort out the effect upon the assessments or the amended assessments to be issued for those years.
Orders
I uphold the taxpayer's appeal. I order the Commissioner to pay the taxpayer's costs. I direct the parties to bring in short minutes giving effect to the findings which I have made in my reasons, and to enable me to direct the entry of judgment.
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