Jaques v Federal Commissioner of Taxation

34 CLR 328
31 ALR 61
[1924] HCA 60

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(Judgment by: ISAACS J)

JAQUES v COMMISSIONER

Court:

Judges: Knox CJ
Isaacs J
Starke J

Subject References:
Taxation and revenue
Income tax
Deduction
Arrangement for purpose of relieving person from tax
Mining company

Legislative References:
Income Tax Assessment Act 1915 (No 34) - 1

Hearing date: 6 December 1923; 7 December 1923; 15 December 1923; 1 April 1924; 2 April 1924
Judgment date: 10 June 1924

MELBOURNE

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Judgment by:
ISAACS J

I am of opinion that the appeal should be dismissed, and substantially for the reasons given by Rich J.

The learned Judge of first instance has elaborately stated the facts, and little is left to me except to state, in my own words and with as little repetition of his narration as possible, why, in view of the arguments addressed to us, I am in accord with the judgment appealed from.

On 23rd June 1920, as appears by Exhibit K (the minutes of meetings of directors of the Kandos Cement Co Ltd and of the Kandos Collieries Ltd ), there were created, as between the New South Wales Cement Lime and Coal Co Ltd and the Kandos Cement Co Ltd and as between the first-named company and the Kandos Collieries Ltd , contractual obligations of a definite character. These obligations, added to the statutory rights of the shareholders of the old company, gave rise to the following legal positions:(1) The old company and the new Cement Company were bound respectively by a sale and purchase of the cement assets of the old company in consideration of 500,000 fully paid shares in the new company. (2) The old company and the new Collieries Company were bound respectively by a sale and purchase of the colliery assets of the old company in consideration of 200,000 fully paid-up shares in the new company. (3) Each shareholder in the old company was entitled by force of the Companies' Statute to share proportionately in the winding up of that company in its assets, which would then be represented by the paid-up shares to be received from the two new companies, subject, of course, to equalization within the old company by paying up their calls. Those legal positions were in full accordance with the company law and the winding-up resolutions of the old company, and no shareholder could object to them.

In that state of affairs, however, each shareholder would in respect of his ordinary Federal income tax be utterly unaffected by the several company transactions. Whatever income he had outside those transactions would be subject to the operation of the Income Tax Act, and his liability would be determined accordingly. That liability would not be lessened if the bargains were carried out and the statutory distributions effected according to law. But before those obligations were performed an idea occurred to one of the auditors of the three companies which he communicated to Mr. Campbell, who occupied a chameleon like position. He was secretary of each of the three companies, and also liquidator of the old company. He also, in the course of the subsequent transactions, acted as the personal agent of the numerous shareholders of the old company. The idea from which sprang the later transactions was that, by what is euphemistically called "a slight modification in the method of carrying through the reconstruction agreement," the shareholders might escape the taxation of their ordinary income by obtaining deductions amounting in all to over PD500,000. The "slight modification" was a distinct departure from the windingup resolution, and had no direct authority from the law. Any shareholder in the old company could have objected. Nothing but the personal assent of the shareholders to the new arrangement could sustain it. But the arrangement was so obviously beneficial to them that, even apart from their express consents to Campbell, their dissent was unthinkable. And so the new arrangement constituting the slight modification went through. I entirely agree with Rich J. that it must be regarded as a real arrangement. The new companies agreed to it formally and lawfully from their side of the transaction. The old company agreed by its liquidator. The shareholders of the old company are each and all precluded from objecting; and indeed they are unanimous in fervently adhering to it, and endorsing the liquidator's action. The new companies in fact issued contributing shares on which there was full liability of PD1 each. They made a call of the whole amount; and that liability, thereby becoming a debt, has been discharged by what is in law equivalent to payment. If they were to sue a shareholder on a new call, they would fail. If in a winding up creditors claimed that the shareholders were contributing for PD1 each, they would fail. On the other hand, the old company has in law been paid by the new companies, and the shareholders in the old company have in effect received their respective shares of its assets. The method by which these results were mutually achieved were no doubt devious, but as between the parties themselves it has legally operated as intended.

The reality of the transaction in law is established by the principle of Salomon v A. Salomon & Co ^[F1] . This reality includes the complete individual distinctness of the new companies from the old company. The fact that what is commercially known as "reconstruction" is the purpose of a winding up and a transfer to another company does not in the smallest degree affect the separateness of the two or the legal operation of whatever transfers of property or contracts are employed in the process. My reasons for this are stated with some fulness in Webb v Federal Commissioner of Taxation ^[F2] , at pp. 471, 472. In Wankie Colliery Co v Inland Revenue Commissioners ^[F3] this view is verified. The whole House of Lords recognized this position, and two of their Lordships thought that determined the case. The majority, however, thought that, notwithstanding that undoubted position ^[F4] , the enactment made the "business" liable even in the hands of a totally distinct owner.

The reality here, then, is complete according to State law, which governs these transactions; and according to State law nothing has been suggested in argument which would disturb their binding force, it having been established that all concerned acquiesced in and joined in carrying them out.

But then comes the Federal income tax law, by which the Commonwealth Parliament, in its own absolute discretion, declares the primary liability, permits deductions in certain cases, and also, by s. 53, declares occasions when (inter alia) deductions shall not be allowed. Section 53, which in no way affects any transaction so far as its effect under State law is concerned and in no way affects it with respect to any other Federal law, does avoid a transaction coming within its purview for all the purposes specified in the section. That the transaction is a reality is no reason for the non-application of the section. On the contrary, if the transaction were not real and effective apart from the section, that section would be unnecessary. A sham transaction in inherently worthless, and needs no enactment to nullify it. But supposing it real and otherwise effective, what kind of transaction is struck at by s. 53? The words are "Every contract, agreement, or arrangement made or entered into, in writing or verbal, ... so far as it has or purports to have the purpose or effect of in any way, directly or indirectly"-then follow the pars. (a), (b), (c) and (d). It must be a "contract, agreement, or arrangement." "Arrangement" is no doubt an elastic word, and in some contexts may have a larger connotation. But in this collocation it is the third in a descending series, and means an arrangement which is in the nature of a bargain but may not legally or formally amount to a contract or an agreement. The section does not include a conveyance or transfer of property, legal or equitable, as such. It presupposes that apart from the "contract, agreement, or arrangement" a taxpayer would bear a certain liability either to make a return, or to pay tax in respect of certain income. Then, assuming that the income (if any) still remains that of the taxpayer (because s. 53 does not contemplate an instrument actually changing the real ownership), the section supposes some "contract, agreement, or arrangement" which apart from the provisions of the section itself would legally operate or purport to operate in one or more of the ways set out in pars. (a), (b), (c) and (d). Then, says the section, such a "contract, agreement, or arrangement" shall be "absolutely void" for any such purpose, but is not otherwise affected. The effect is that the taxpayer's liability to make a return, or in respect of any other liability under the Act, remains just as if there were no such "contract, agreement, or arrangement." The ingenious but necessarily artificial process of arriving in this case, by means of legal doctrines intended to facilitate commercial transactions without burdensome formalities, at a certain legal situation in ordinary cases carries its special purpose as well as its effect on its face. There is hardly needed the express admission that exists, that it was with the design of securing a deduction for income tax. It is not at all on the same footing as an ordinary purchase of shares in an existing company, even with the accompanying object of satisfying the requirements of the law as to payment of calls. In that case the enterprise exists, and offers the opportunity of investment. There the investor is doing nothing more than the Legislature contemplated the taxpayer might legitimately do, or even be induced to do, and none the less that besides the risk of capital the advantage of a deduction in relation to income tax was part of the inducement.

But here, as in effect is said by the learned primary Judge, the combined arrangement entered into by the three companies and the shareholders in the old company-Mr. Campbell acting in various and even conflicting capacities as intermediary-was simply to manufacture a situation to get the better of the Income Tax Act. It in no way altered the income of the taxpayer or changed its ownership. It was in no true sense a business operation. But, by first deliberately preparing the ground for the misuse of legal expedients recognized as equivalents for payment, and then by such misuse, a factitious liability to pay a call and a factitious payment of the call ensued, but throughout, from conception to completion, except for a similar object of escaping stamp duty, with the express and sole purpose of lessening the statutory liability of the taxpayers.

Therefore, though it cannot be said there was not a call, or that there was not a payment of the call, so as to satisfy s. 18; yet, for the reasons given, that payment cannot, in the circumstances, be taken advantage of, and the appeal should be dismissed.

The learned primary Judge thought it unnecessary to consider whether the Cement Company was a mining company within s. 18. I also do not think it necessary to decide the point. But I am of opinion it is not a mining company. The principles we have laid down in the Slate Quarries Case ^[F5] lead, in the circumstances of the present case, to the conclusion that the dominant character, and therefore the true character, of the Cement Company is that of a manufacturing company and not a mining company.