Hancock v Federal Commissioner of Taxation

(1961) 108 CLR 258
35 ALJR 228
[1961] ALR 839

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(Judgment by: Dixon CJ)

Between: Langley George Frederick Hancock
And: Federal Commissioner of Taxation

Court:

Judges: Fullagar J

Dixon CJKitto J
Menzies J
Windeyer J

Subject References:
Income tax (Cth)

Judgment date: 8 August 1961

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Judgment by:
Dixon CJ

This appeal is from an order of Fullagar J. dismissing a taxpayer's appeal from an amended assessment of income tax. The year of income is that ended 30th June 1949 for which an accounting period was adopted ended 30th April 1949. The amendment which was appealed against increased the taxpayer's income by 17,759 pounds. This was done as a result of applying s. 260 of the Income Tax Assessment Act 1936-1949. The material part of that section, which of late has become as familiarly known as any provision of the enactment, provides that every contract agreement or arrangement shall so far as it has or purports to have the purpose or effect of in any way directly or indirectly... defeating evading or avoiding any duty or liability imposed on any person by the Act or preventing the operation of the Act shall be absolutely void, as against the Commissioner, or in regard to any proceeding under the Act, but without prejudice to such validity as it may have in any other respect or for any other purpose. (at p275)

It will be observed that the provision merely invalidates a transaction and does so only as against the Commissioner, or in regard to a proceeding under the Act. In the present appeal, as in so many cases under s. 260, the greater difficulty is not to say whether it avoids the transaction as against the Commissioner but to say what is the consequence upon the taxpayer's liability if it does so. Again like so many cases under s. 260 the tax which it is said that the taxpayer has sought to avoid is one or other of the alternatives which Div. 7 appears to make inevitable, viz. the tax upon the "private" company failing to distribute the profits or the tax upon the shareholders if the company does distribute the profits. The company in question is called Mulga Downs Pty. Ltd.: it owned a station property in Western Australia. The shares in the company were held by the members of two families the Lefroys and the Hancocks, the holding of the former being not inconsiderably greater than that of the latter. Apparently if within six months of the end of its accounting period ended 30th April 1949 the company did not make a sufficient distribution of its income of that period the use by the Commissioner of s. 104 would have meant that it paid at least 7,000 pounds in tax. In February 1949 H. K. Watson, a chartered accountant of Perth and moreover a tax adviser, suggested to one of the Hancocks that a company which Watson and his wife owned and which traded in shares and investments might buy all the shares in Mulga Downs Pty. Ltd. A company trading in shares and investments would, of course, take the sales and purchases into account in ascertaining its taxable income. Watson proposed that his company while holder of the shares in Mulga Downs Pty. Ltd. should by a distribution take the accumulating profits of the latter - milk it - and then resell all the shares at the reduced value or price which was consequential upon the loss of the assets representing the withdrawn profits.

The head of the Hancock family had apparently always wished that his family should be the only persons interested in Mulga Downs and he readily entertained the suggestion on the footing that the resale of the shares should be to him. Needless to say this meant that a price must be given to the Lefroy family for their shares which would satisfy them, a price upon which, because it would be capital, no income tax would be payable, that the Hancocks would receive a capital sum for their shares and then that substantially all the shares in the Mulga Downs company, that is to say what had been the shares of the Lefroy family and of the Hancock family, would be sold back to the Hancocks at a very much lower price per share. The difference in the price would, of course, represent the profits of the Mulga Downs company which Watson's company would have received on a distribution as dividend or bonus. The distribution made in the event was 50,000 pounds. The distribution would mean that no tax under Div. 7 would become payable and, although, prima facie, it would mean that 50,000 pounds went into the assessable income of Watson's company, yet, pro tanto, inclusion in the assessable income of that figure would be answered by the loss that company would be shown to make on a comparison between the price at which it had bought the shares from the Lefroys and the Hancocks and the much lower price at which the company had resold them to the Hancocks. The "loss" shown by a comparison of the two prices would be treated as a deduction in arriving at the taxable income of Watson's company because its business was to trade in shares and investments. (at p277)

Of course that company would take a profit on the transaction and the profit would necessarily be one upon which Watson's company would pay tax, that is to say it would pay tax unless the profit were not wiped out by the results of some other transaction or transactions in the course of its business. The expected liability for 7,000 pounds under Div. 7 would be avoided and the transaction would involve none of the parties in any other liability for income tax, that is of course unless the Commissioner invoked s. 260 and did so with success, as in the result he has done at all events up to this point. (at p277)

The transaction was carried out substantially as suggested. When it had been completed the result was simple enough. The Hancocks held all the issued share capital in the Mulga Downs company. The Lefroys had sold their shares to Watson's company for a capital sum of 40,000 pounds, Watson's company had been temporarily the transferees of these and of the Hancocks' shares, the price on the sale to Watson's company being fixed at 23,500 pounds. Of the profits of Mulga Downs Pty. Ltd. 50,000 pounds had been distributed by that company to Watson's company as a dividend or dividends on the shares temporarily held by it. Watson's company retained 7,500 pounds as its profit: it paid 2,500 pounds in money to the Hancocks as part of the price of their shares, and it paid in money 40,000 pounds to the Lefroys. These amounts of course add up to 50,000 pounds the amount of the distribution of accrued and accruing profits. All the issued shares were sold back to the Hancocks at 21,000 pounds an amount which was met by set off with the balance of the price at which the Hancocks' shares were taken (23,500 pounds less 2,500 pounds paid in money), no tax was paid or remained payable under Div. 7, no tax was paid or incurred by any party to the transaction except so far as tax became payable by Watson's company in respect of its profit of 7,500 pounds. That is of course on the hypothesis that the transaction is not void under s. 260. (at p278)

Now although the plan was the product of Watson's ingenuity Hancock adopted it and he knew that an essential feature of it was the escape of the tax that must attach either to the company or to the shareholders if the profits were undistributed and alternatively of the tax which as shareholders they would pay if the profits were simply distributed as dividends. At the same time it was evidene enough that he had no prospect of buying the shares of the Lefroys, except by the application of funds which he might obtain by a distribution of the profits of the company. There was no sense or purpose in selling the Hancocks' shares to Watson's company and then back to Hancock or in Watson's company's buying the Lefroys' shares from that family for the purpose of reselling them to Hancock in lieu of the Lefroys selling them directly to the Hancock family, except to ensure that the distribution of profit by Mulga Downs Pty. Ltd. would not be to the Hancocks or the Lefroys who would incur tax but would be to Watson's company, a company trading in securities; and the mechanics of the transaction were arranged wholly to ensure that the dealings otherwise were of a capital nature. (at p278)

In these circumstances I think that there was an agreement or arrangement to avoid either a liability imposed by the Act on Mulga Downs Pty. Ltd. or upon the Hancocks and to prevent the operation of the Act in respect of the liberation of the company's profits. The liability imposed by the Act on Mulga Downs Pty. Ltd. was to pay tax under Div. 7 if there was not a sufficient distribution of income to satisfy s. 104. It may be said that the company did on any view distribute a sufficient amount of income and that is why liability under Div. 7 was avoided. In the end if you treat the distribution as valid, that is so. But if you look at the matter as at the time the arrangement was made, the parties were confronted with a dilemma, a liability under Div. 7 or a liability under or by reason of s. 44 (Div. 2 sub-div. D) and a purpose of the plan evolved was to avoid the dilemma. The expression "preventing the operation of the Act in any respect" is generally regarded as difficult, but I treat it as simply meaning the operation which the Act would have in a given case if it were not for the contract agreement or arrangement made for the purpose (or having the effect) of preventing it. It is the operation of the Act in relation to the distribution and taxability of the profits of a private company that in part the plan was designed to "prevent". (at p278)

It appears to me that Watson and his company on the one side and Hancock and his son on the other side were the parties to the agreement or arrangement. I have purposely made compendious my statement of the making and carrying out of the plan because I think that the detailed steps by which, as it seems to me, the plan was reached and agreed have nothing but an evidentiary importance and otherwise tend to confuse the matter. It is sufficient that by steps the parties reached and carried out the arrangement and that it answered a description covered by s. 260. (at p279)

It follows that as against the Commissioner the arrangement is void so far as it has or purports to have the purpose or effect of in any way, directly or indirectly avoiding a duty or liability imposed or preventing the operation of the Act in any respect. It is important to keep steadily in view the fact that no longer does the provision now contained in s. 260 make contracts agreements or arrangements void: they are only void as against the Commissioner or in regard to a proceeding under the Act. The result is to require a consideration of the Commissioner's rights and duties on the footing that the contract agreement or arrangement is notionally void. But this notional treatment of the agreement or arrangement as void extends to all the ancillary or subsidiary steps for carrying it out. "But it" (the arrangement), said Lord Denning for the Privy Council, "must in this section comprehend, not only the initial plan, but also all the transactions by which it is carried into effect - all the transactions, that is which have the effect of avoiding taxation, be they conveyances, transfers or anything else. It would be useless for the commissioner to avoid the arrangement and leave the transactions still standing.": Newton's Case [1958] AC 450 , at p 465; (1958) 98 CLR, at pp 7, 8. What is the result in this peculiar case? The Commissioner can treat, as it seems to me, each and every step by which the ultimate situation of George Hancock, the appellant, was brought about as having no legal validity or efficacy or significance. What then does he proceed to tax? He is assessing George Hancock. Ex hypothesi nothing which has been done from the time the arrangement was reached between the Hancocks and Watson or Watson's company can stand in his way. The legal complexion which every step taken would otherwise bear cannot operate to impede him: for the step can have no legal validity in so far as it tends to do so. Again to quote the language of Lord Denning -

"But the ignoring of the transactions - or the annihilation of them - does not itself create a liability to tax. In order to make the taxpayers liable, the commissioner must show that moneys have come into the hands of the taxpayers which the commissioner is entitled to treat as income derived by them" (1958) AC, at p 467; (1958) 98 CLR, at p 10.

It is here that the difficulty of the case arises. The change or enhancement in the position of George Hancock, what had come into his hands, what he had derived, at the ultimate end of the transaction was his proportion of the shares of the Lefroys and his proportion of the 2,500 pounds. I do not think that when Lord Denning employed the word "moneys" in the passage last quoted he intended to distinguish between moneys and any other form of asset the receipt of which may constitute the derivation of income such as an immediately convertible security. But shares in a proprietary company may not be within that category. In the transaction 21,000 pounds was put down as the price to be paid by the Hancocks for the acquisition from Watson's company of the whole of the shares in Mulga Downs Pty. Ltd., that is to say for the acquisition of the shares of the Lefroys and the reacquisition by the Hancocks of their own. One of the recommendations put forward for th e proposal by Watson early in the piece was that "it would enable the Hancocks in due course to acquire all the issued capital of Mulga Downs without any cash outlay at all over and above their present resources". "Their present resources" is a phrase descriptive of their interest in the company as reflecting the funds of the company capable of manipulation; and of course the undistributed profits which had accrued in the period ending 30th April 1949 and were estimated as accruing profits of the next period represented such funds.

When all the movements of credit are treated as over and the result simply (as distinguished from the movements or ostensible movements of credit and money by which the result was accomplished) is looked at and compared with the position from which it began, what has been effected is seen to be the acquisition by the Hancocks of the Lefroys' shares together with a sum of 2,500 pounds added and the acquisition by Watson's company of 7,500 pounds, all done by the application of the Mulga Downs company's profit fund of 50,000 pounds. Indeed the point of the whole arrangement that has been considered void as against the Commissioner was to effect a liberation of the fund of profits without incurring tax and at the same time by means of the fund liberated to acquire the shares of the Lefroys. That was what was done. The Hancocks received 2,500 pounds in addition; and as an incident Watson's company took 7,500 pounds profit. In the distribution of the fund the proportion referable to the shares held at the beginning by the present appellant George Hancock would be as 6,730 is to 18,945, for of the issued capital of 18,945 shares George Hancock held 6,730. For myself I do not see why he should not be assessed on the basis of this fraction of the distributable profit forming part of his assessable income. Section 260 authorizes the Commissioner to disregard every step in an obnoxious plan which stands in the way of a lawful assessment. It must be remembered that, by s. 19, income is deemed to have been derived by a person although it is not actually paid over to him but is reinvested, accumulated, capitalized, carried to any reserve sinking fund, or otherwise dealt with on his behalf or as he directs. The critical object the scheme or plan had in view was to produce without tax the very result which subject to tax could have been obtained by applying, under his direction, George Hancock's share of the distributable fund less the 2,500 pounds received in cash in or towards the acquisition of the Lefroy shares.

Why should not all the intermediate steps be disregarded in pursuance of s. 260? That in fact seems to be what the Commissioner did when he increased the assessable income by 17,759 pounds. Perhaps some adjustments have taken place but if so what adjustment does not appear. I see no reason why any part of the profit taken by the Watson company should be considered as referable to the appellant's proportion of the profits. (at p281)

The view I have expressed depends in no respect upon tracing the identity of moneys employed in the steps taken to reach the result. When the purpose is to assess a taxpayer who has reached a situation which but for a scheme swept away by s. 260 would or might spell liability to tax, it does not appear to me to be necessary to trace the identity of moneys as if one were seeking to identify in an investment trust funds that had been misapplied. Section 260 is directed against the validity of arrangements designed to avoid taxation where, but for the cover the arrangement would give, taxation would fall. The resource of ingenious minds to avoid revenue laws has always proved inexhaustible and for that reason it is neither possible nor safe to say in advance what must be found, after a scheme is struck down under s. 260, before a consequential assessment can be justified. But it seems to me that what matters must be the resulting financial situation, one of change if not invariably of betterment, and the factors which would but for the void scheme have made it taxable. These factors will depend on general conceptions of what is taxable as income, but seldom, I should have thought, would the actual tracing of moneys be the test of that liability. For example when Watson's company actually bought and paid for the Lefroy shares, to finance the payment it was necessary to use the proceeds of bonds which the company had "bought on credit" from Mulga Downs Pty. Ltd. for the purpose and resold for cash, and also to depend to some extent upon some moneys belonging to Watson's company. That does not seem to me to matter. It was all balanced out afterwards, of course, and was only part of the financial expedients for carrying that part of the plan through. It does not seem to me to matter at all what interim financial expedients were resorted to or which moneys or whose credit was used in the course of carrying out the transaction.

It is the result that exposes the taxpayer to liability: a result necessarily involving the employment by the taxpayer of a distribution of the profit fund. The means, if otherwise they could be considered significant upon a question of ultimate liability, would be swept away like other parts of the "arrangement" and the steps by which it was carried into effect. In the present case the only difficulty, as it seems to me, lies in the form in which the appellant George Hancock derived in the end the greater part of benefit of the transaction, namely shares, the Lefroy shares. But for the reasons that I have given that should not be regarded as inconsistent with his having derived income, once the disguising elements of the "arrangement" are stripped away under s. 260. (at p282)

In my opinion the appeal should be dismissed.

I understand that this appeal is to abide the fate of the appeal by George Hancock against the decision by Fullagar J. dismissing the appeal of the latter from the amended assessment of the Commissioner of Taxation. (at p282)

Accordingly the appeal in this case must be dismissed also. (at p282)