PROUDFOOT v FC of T

Members:
BJ McCabe SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2004] AATA 823

Decision date: 6 August 2004

---

BJ McCabe (Senior Member)

Introduction

1. Mr Proudfoot is the applicant in these proceedings. His dispute with the Commissioner arises out of the treatment of gains he made from participating in the privatisation of Suncorp-Metway. The applicant says the gains should be treated as capital and taxed accordingly. The respondent says the gains are deemed to be income by statute. The Tribunal has been asked to review the Commissioner's decision.

The material before the Tribunal

2. The Tribunal was provided with the documents required under s 37 of the Administrative Appeals Tribunal Act 1975. An additional volume of documents relating to the privatisation was also tendered in evidence.

3. Mr Proudfoot appeared on his own behalf at the hearing. Ms Brennan of counsel represented the Commissioner. She was assisted by officers from the Queensland Treasury who were familiar with the privatisation process.

The facts

4. Mr Proudfoot decided to participate in the privatisation of Suncorp-Metway. Suncorp- Metway is a Queensland-based financial institution. It is the product of a merger between Suncorp (the former State Government Insurance Office), Metway Bank and the QIDC (Queensland Investment Development Corporation). The state government held 56 million ordinary shares in the company, 100 million Subordinated Dividend Ordinary Shares and 155 million Capital Notes. The state's interest amounted to around 67% of the company's issued capital in 1996.

5. The government decided to sell down its interest in Suncorp-Metway. It commenced that process in 1997. A second phase of the privatisation process began in 1998. The dispute in this case arises out of Mr Proudfoot's participation in the second phase of the privatisation.

6. The privatisation process is described in a public offer document issued by the state of Queensland on 8 October 1998. The state offered up to 142.5 million of its ``exchanging instalment notes'' (presumably the Capital Notes) in the offer to which Mr Proudfoot subscribed. The notes were held by Queensland Treasury Holdings Pty Ltd, an entity controlled by the state. The notes were to be converted into Suncorp-Metway ordinary shares and provided to the subscribers to the offer on 31 October 2001.

7. Subscribers to the offer paid for the notes in two instalments. The first instalment of $4 per note was payable at the time of the application. The second instalment of $3.10 per note was payable under the terms of the offer on 6 November 2000. The applicant was allotted 3,315 notes at $7.10 per note. He paid a total of $13,260 in the first instalment and $10,276.50 in the second instalment (a total of $23,536.50).

8. The offer document provided that the note- holders would receive interest before the notes were converted into shares. The interest was calculated on the basis that the note-holder would be paid an amount equal to 8% of the face value of the notes (that is, $7.10) each year. The applicant received six interest payments on his notes, totalling $5456.48.

9. The applicant received a Suncorp-Metway ordinary share in return for each of his notes on 31 October 2001. The notes were subsequently cancelled. The market value of the shares on that date was $13.34 - meaning that the total value of his investment had increased to $44,222.10.

10. Mr Proudfoot requested a private ruling from the Commissioner dealing with the treatment of the gains on his investment. Apparently Mr Proudfoot had become aware from newspaper reports that there was a question over whether the gains would be treated as capital gains. The Commissioner ruled the gains were assessable income pursuant

---

ATC 2231

to s 26BB of the Income Tax Assessment Act 1936 (ITAA36).

11. The applicant lodged a return including the $20,686 gain in his income for the year ending 30 June 2002. The assessment was issued on 5 May 2003. Mr Proudfoot objected to the ruling. The objection was withdrawn and the applicant objected to the assessment. The objection was disallowed on 9 September 2003.

The legislation

12. Section 26BB(2) of ITAA36 says:

``Where a taxpayer disposes of a traditional security or a traditional security of a taxpayer is redeemed, the amount of any gain on the disposal or redemption shall be included in the assessable income of the taxpayer of the year of income in which the disposal or redemption takes place.''

13. The Commissioner says the allotment of the ordinary shares to note holders and cancellation of the notes is a redemption of a traditional security. If the Commissioner is right, then the gains Mr Proudfoot made must be treated as income unless one of the exceptions elsewhere in s 26BB applies.

14. The first step is to determine whether the notes are a traditional security. The expression is defined in s 26BB(1). A traditional security is a security held by a taxpayer that satisfies certain criteria. For the purposes of the section, a security is defined in s 159GP (in Division 16E) as:

``(a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b) a deposit with a bank or other financial institution;

(c) a secured or unsecured loan; or

(d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.''

15. The state of Queensland was obliged to pay amounts (described in the terms of the offer as ``interest'') to note-holders. I am satisfied the arrangement is therefore a security under sub- paragraph (d). But is it a traditional security? To answer that question, I must satisfy myself that the arrangement satisfies the criteria set out in s 26BB(1).

16. The criteria are satisfied. The notes:

• • Were acquired by the taxpayer after 10 May 1989;
• • Do not have an eligible return. The expression eligible return is defined in s 159GP(3). I am satisfied Mr Proudfoot could not have anticipated receiving payments on the notes that exceeded their issue price;
• • Is not a prescribed security within the meaning of s 26C of ITAA36;
• • Is not trading stock of the taxpayer.

17. The next step is to determine whether this traditional security has been redeemed within the meaning of s 26BB(2). The expression redeemed is not defined in the section. It is defined in s 159GP(1) in the following terms:

```redemption' , in relation to a security, means the discharging of all liability to pay any amount or amounts under the security representing a return of the issue price of the security.''

18. The notes have not been redeemed in that sense: rather, the state caused shares in Suncorp-Metway to be issued to the note holders and then cancelled the notes. It is true that liability to make further payments under the notes ceased at that point, but the definition appears to contemplate the security being paid out or bought back. That has not occurred here.

19. The respondent says I should not rely on the definition in s 159GP. Ms Brennan, for the Commissioner, explained s 26BB did not say the expression redemption had the same meaning as it had in Div 16E - although the reader is expressly referred to Div 16E when defining other terms in s 26BB. Ms Brennan said the failure to refer the reader to s 159GP (the definition section in Div 16E) in relation to the expression redemption meant that definition was not applicable.

20. Ms Brennan properly noted that Merkel J in
Ashton Mining Ltd v FC of T 2000 ATC 4307 assumed in obiter remarks that the s 159GP definition of the expression redemption was applicable in s 26BB(2). But Ms Brennan pointed out that Div 16E deals with discounted securities. While many of the concepts used in that division are relevant - and were therefore referred to in s 26BB - the parliament recognised different considerations might apply in relation to traditional securities, and chose not to apply a common definition of redemption on purpose.

---

ATC 2232

21. Ms Brennan referred me to several cases involving redeemable preference shares. In
Comptroller of Stamps (Vic) v Ashwick (Vic) No 4 Pty Ltd 87 ATC 5064; (1987) 163 CLR 640, for example, Ms Brennan said the High Court had no difficulty with the concept of shares being redeemed in return for a transfer of land - that is, a non-cash consideration. In fact, the shareholder in that case did receive a cash payment along with the land in return for the shares: at 652, per Mason CJ and Wilson, Dawson, Toohey and Gaudron JJ. She also cited the decision of Cohen J in
Re Arrowfield Group Ltd (1995) 13 ACLC 1187. His Honour said (at 1192):

``... The ordinary meaning of redemption in these circumstances, that is to say other than a theological one, is `to buy back, or to pay off'. See Jowett The Dictionary of English Law. The Macquarie Dictionary also refers to `recover (something pledged or mortgaged) by payment or other satisfaction.' It might be thought that other satisfaction is the issue of ordinary shares. The general meaning however, in respect of the redemption of matters such as shares in this case, is to pay them off.''

22. His Honour went on to say (at 1192) that for the purposes of the relevant provision of the companies legislation:

``... I consider a right to repayment is an essential element of a redeemable preference share.''

23. I think Ms Brennan is right, notwithstanding the discussion I have noted. The securities in question in this case are not redeemable preference shares, and the question in relation to them does not arise under the companies' legislation. There is no reason why parliament should wish to confine redemption in s 26BB to circumstances where the discharge of liability occurs in return for a payment of cash. That explains why the parliament did not refer to the definition in s 159GP when it chose to do so in relation to other terms used in s 26BB. Having decided to introduce the special rule in s 26BB which excluded the gains from a particular sort of transaction from being treated as capital gains, parliament recognised that adopting the definition of redemption in s 159GP would produce arbitrary results.

24. It follows I am satisfied there has been a redemption of a traditional security within the meaning of s 26BB(2). The applicant is unable to take advantage of the exceptions in ss 26BB(4) or (5) because the sections were not introduced into the Act until after the transactions in question. The gains are therefore assessable as income.

Conclusion

25. The objection decision under review is affirmed.