Dickson v Federal Commissioner of Taxation

62 CLR 687

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(Judgment by: Dixon J)

Between: Dickson
And: Federal Commissioner of Taxation

Court:

Judges: Latham CJ

Dixon JEvatt J

Subject References:
Taxation and revenue
Income tax
Assessable income
Unrealized profits

Legislative References:
Income Tax Assessment Act 1936 No 27 - s 6; s 44(2)(b)(iii)

Hearing date: 23 March 1939; 24 March 1939; 2 June 1939; 31 October 1939; 1 November 1939; 2 November 1939
Judgment date: 21 February 1940

MELBOURNE

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Judgment by:
Dixon J

The taxpayer is a shareholder in the Castlemaine Brewery Company Melbourne Ltd , one of six holding companies which among them hold five-sixths of the share capital of Carlton and United Breweries Ltd The former company made a capitalization of profits and distributed to its shareholders one fully paid-up share in its own capital for every two shares previously issued. The law now is that the paid-up value of bonus shares distributed by a company forms part of the shareholder's assessable income, unless the capitalization falls within one or other of a limited number of exceptions. The question for decision is whether the case falls within that exception which excludes the paid-up value of shares if paid wholly and exclusively out of profits arising from the revaluation of assets not acquired for the purpose of resale at a profit.

In my opinion the case does not fall within this exception, because the profits capitalized arose in part from a distribution that had been made by Carlton and United Breweries Ltd among its shareholders of one new paid-up share in its capital for every two previously issued, a distribution which meant an increment not only in the number of shares held by its constituent members, including Castlemaine Brewery Company Melbourne Ltd , but also in the value of their holdings.

The grounds for this opinion lie rather in the facts of the case than in any special construction of the legislation, the meaning of which does not seem obscure. The matter is governed by the Income Tax Assessment Acts 1936 and the material provisions are s. 44 (1), s. 6, definition of 'dividends,' and s. 44 (2) (b) (iii); provisions which were introduced by the Income Tax Assessment Act 1934, s. 7, in consequence of an interim report of the Royal Commission on Taxation Laws. In 1924 the question whether shareholders should be liable to income tax on distributions of bonus shares was attacked by the Federal legislature from a new standpoint. The question had been dealt with by the courts both here and in Great Britain by considering the nature of the benefit, if any, which a shareholder obtains either as a result of or in the course of the capitalization of profits and the distribution of new paid-up share capital. One view, that adopted in Blott's Case ^[F6] , denied that the shareholder received any advantage that could be called income; what he got was a greater number of shares, representing the same proportionate right to share in the assets and vote upon the management of the company. The other view, that supported by Lord Sumner in Blott's Case ^[F7] , emphasised the fact that the shareholder obtained a marketable security in the form of a share, his liability upon which had been discharged by an appropriation to that purpose of a ratable part of the company's distributable profits. The presence in the Commonwealth Income Tax Assessment Act 1915-1918, s. 14 (b), of an express direction that the income of any person should include profits credited to the shareholder of a company made this consideration decisive in Australia against the shareholder (James v Federal Commissioner of Taxation ^[F8] ).

But in 1924 the Federal legislature deserted altogether the ground taken by these rival views and established the nature, source or taxability of the profits whence the bonus shares had been paid up as the test of the shareholder's liability (Act No. 51 of 1924 s. 4 (h)). From that time the assessable income of a shareholder has included bonus shares unless they have been paid up out of some special class of profits and on the ground that they have been paid up from that source are made the subject of an express exception. The course of the legislation has been to narrow the scope of the exemptions; and the principle has been not only maintained but strengthened, the principle that stock dividends are taxable as income in the hands of the shareholder subject to particular exemptions based upon some peculiarity in the profits capitalized. Section 6 of the Act of 1936 includes in the meaning of the word 'dividend,' the paid-up value of shares distributed by a company to its shareholders to the extent to which the paid-up value represents a capitalization of profits. Section 44 (1) (a) provides that the assessable income of a shareholder in a company shall, subject to what follows, include, if the shareholder resides in Australia, dividends paid to him out of profits derived by it from any source. Section 44 (2) then follows with the exceptions. Of these, we are concerned with par. b (iii) only, which, so far as material, is expressed thus:The assessable income of a shareholder shall not include dividends paid wholly and exclusively out of profits arising from the revaluation of assets not acquired for the purpose of resale at a profit if the dividends paid from such profits are satisfied by the issue of shares of the company declaring the dividend.

The facts of this case, which, in my opinion, show that some other element, namely, the acquisition of a new asset, contributed to the profits capitalized, present features which are perhaps out of the common run, but they are not complicated. Carlton and United Breweries Ltd had been formed many years ago as an amalgamation of the undertakings of the companies which now hold most of its shares. In the five years from 1930 to 1934 its rate of dividend had ranged from fifteen to ten per cent per annum, but in none of these years was the annual profit nearly absorbed by the dividends declared. The income-tax legislation of 1924 contained a provision exempting from liability to tax in the hands of shareholders the paid-up value of shares distributed by a company to its shareholders to the extent to which the paid-up value represents the capitalization of profits derived before 1st July 1915 or of profits upon which the company had paid or was liable to pay income tax for any year prior to the financial year beginning 1st July 1923 (No. 51 of 1924, s. 4 (h)). But the Act of 1934 terminated the latter part of this exemption as from the 31st December 1934 (No. 18 of 1934, s. 7, inserting s. 16AA (2) (b)). Carlton and United Breweries Ltd had large reserves of profits falling within the exemption and decided to capitalize enough to enable it to make a distribution of bonus shares in the proportion of one paid-up share for every two shares of its existing issued capital and, of course, to do so before 31st December 1934. The decision was carried out on 19th December 1934. 58,707 fully paid-up shares of PD1 in Carlton and United Breweries Ltd were allotted to Castlemaine Brewery Company Melbourne Ltd , which already held 117,414 PD1 shares. Its holding thus became 176,121 shares. Both the new shares and the old consisted partly of preference and partly of ordinary shares. In the last balance-sheet of the latter company, that for the year ending 30th September 1934, the old shares numbering 117,414 were set down o n the assets side at cost, a sum of PD119,861 5s. The same figures appeared in the company's ledger, where the shares, of which some had been acquired on the amalgamation and some had been taken up at a premium, were entered in respect of the money equivalent of the consideration that Castlemaine Brewery Company Melbourne Ltd had given, a money sum carried down from year to year. The scrip for the new shares was received in January 1935, but no further entry was made in the company's ledger. On 4th December 1934 a general meeting of the Castlemaine Brewery Company Melbourne Ltd was held for the purpose of adopting resolutions in connection with the capitalization of profits by Carlton and United Breweries Ltd then in progress. The chairman, who is the appellant taxpayer, made a statement to the shareholders which, after describing the capitalization and the reason for it and giving the number of new bonus shares the company would receive, went on as follows-'These shares, of course, will be allotted to our company and will not go to individual shareholders, but your directors will subsequently consider at some convenient period next year the advisibility of revaluing the assets of our company and of issuing bonus shares to our shareholders individually in respect of such valuation.'

The shares of the Carlton and United Breweries Ltd are not listed on the Stock Exchange, and there are no market quotations for them. But the shares of the holding companies are listed and were quoted. They began to rise in price from the time when the information leaked out that the capitalization was in contemplation, and after the fact that Carlton and United Breweries Ltd would capitalize PD950,000 of reserves of profits was announced they reached prices which showed a very considerable appreciation in value. This meant that the distribution of the bonus shares was regarded as substantially increasing the assets of the constituent companies which would receive them. The reason was obvious; for, as an experienced share-broker said in evidence, it was anticipated that the total profits which would be distributed by Carlton and United Breweries Ltd after the capitalization would be much greater than before. The expectation was based on good grounds and was realised. The percentage rate of dividend had been high; yet, applied to the existing capital, it had failed to absorb the profits earned. Even if the rate fell somewhat, applied to the new capital, it would liberate a much greater sum to the holding companies. The value of shares is affected by the prospect of dividends at least as much as by considerations which go only to capital strength. In the event, the belief that a greater amount of profits would be distributed was more than borne out. In the following year the percentage rate of dividend was eight per cent on the increased capital; in the year after that it rose to ten per cent and then to 12 per cent.

In these circumstances it appears to me to be quite clear that the distribution of bonus shares by Carlton and United Breweries Ltd in December 1934 meant a considerable increase in the assets of the Castlemaine Brewery Company Melbourne Ltd The value of the existing shares was no doubt to some extent adversely affected by the issue of half as many paid-up shares again. But, after compensating for such a loss in the value of the old shares, the remaining value in the new shares meant a large increment of wealth or, in other words, profit. The increment or profit was not a mere enhancement in value of the original shares. It was the fruit they bore. The bonus shares are in truth new and independent things distributed by way of dividend upon the original shares. As appears from the statement made by the chairman on 4th December 1934, the fact that the bonus shares were distributed by Carlton and United Breweries Ltd was the occasion of the distribution of the bonus shares by the Castlemaine Brewery Company Melbourne Ltd In July 1935 the secretary of the latter company worked out the amount which it was necessary to obtain by a revaluation of its shareholding in Carlton and United Breweries Ltd in order to make a distribution of one fully paid-up share for every two already issued. At the same time and as part of the same scheme it was decided that a reduction of capital would be effected in order to return PD37,500 in cash to the shareholders. For this purpose money was available lying invested in government stocks. The plan was to increase the capital so as to issue bonus shares paid up out of profits arising from the revaluation of assets not acquired for the purpose of resale and then to reduce the increased capital by 2s. 6d. per share in order to allow of the distribution of PD37,500 as a return of capital and therefore without liability to income tax in the hands of the shareholders. In August the directors decided to instruct the auditor to make a valuation of the company's shareholding in Carlton and United Breweries Ltd , and in September they resolved that the government securities should be sold to provide the sum required in connection with the reduction of capital.

As the old shares stood in the company's books at cost and the new shares had not been taken into the books at all, it must have been quite clear that the shares, the value of which was much above par, contained a surplus value much more than enough to provide a fund sufficient for the capitalization in hand. The accountants were accordingly instructed, not to determine the value of the shares, but to certify whether they were not at least of the value found to be sufficient for that purpose. Two accountants returned certificates dated 9th October 1935 that in their opinion the shares held by Castlemaine Brewery Company Melbourne Ltd in Carlton and United Breweries Ltd were worth not less than 24s. per share. On the following day, 10th October 1935, the profit and loss account for the year ending 30th September 1935 and the balance-sheet as at that date, which had been in course of preparation, were certified by the auditor. This balance-sheet showed the increased number of shares, viz., 176,121, but retained the same amount of money as appeared in the books and in the previous balance-sheet for the old number of shares, 117,414, that is, a sum of PD119,861. The balance-sheet and the certificates of the accountants as to the value of the shares came before the board of directors next day, both at the same meeting. The balance-sheet was approved, and the certificates of value were acted upon. It was resolved that the 176,121 shares be taken to account in the company's books at a value of 24s. each and the amount by which that valuation exceeded the present book value of the shares, namely PD91,483 19s., be credited to an assets revaluation account. Up to this time no entry had been made in the company's books in reference to the 58,707 new bonus shares which had been allotted to the company on 19th November 1934. But the minutes of the next directors' meeting, held on 25th October 1935, record that the books of the company were produced by the secretary showing a sum of PD91,483 19s. standing to t he credit of assets revaluation reserve account representing profit arising from the revaluation of the company's shareholding in Carlton and United Breweries Ltd

Regular steps were then taken to increase the capital of Castlemaine Brewery Company Melbourne Ltd from 200,000 shares of 17s. 6d. to 300,000 shares of that amount and to issue the additional 100,000 shares as fully paid up out of the sum at the credit of the assets revaluation reserve account, PD87,500 being required for that purpose.

In one respect only did these proceedings go outside the common course; the resolutions for increasing the capital and for capitalization were accompanied by resolutions, expressed to be contingent thereon, for the reduction of the increased capital by 2s. 6d. a share. In the result the allotment of the bonus shares was made on 12th November, the resolution for reduction was passed on 22nd November and for confirmation 10th December and the confirmation of the Supreme Court was given on 19th December 1935.

Upon these facts it appears to me that an analysis of the profits credited to the assets revaluation reserve account out of which the taxpayer's bonus shares were paid up is enough to show that they are not wholly and exclusively profits arising from the revaluation of assets not acquired for the purpose of resale at a profit. The sum credited to that account represented the difference between the value, or minimum of value, of 24s. a share applied to the whole 176,121 shares in Carlton and United Breweries Ltd belonging to Castlemaine Brewery Company Melbourne Ltd , that is to say, a sum of PD211,345 and the consideration given by the latter company for the original 117,414 shares, which amounted to PD119,861. The difference between these two sums, PD91,484, is composed of two quite distinct ingredients. One of them consists of the increase in value assigned to the original 117,414 shares, that is to say, the difference between PD119,861, the original consideration given for them, and their value at 24s. each, or PD140,896, a difference amounting to PD21,036.

The other ingredient consists in the full value of the bonus shares at 24s. each. The value at 24s. of the 58,707 bonus shares is PD70,448. This latter sum cannot, in my opinion, fill the description 'profit arising from the revaluation of assets.' It is the value, or minimum value, of the whole asset, scil., of the bonus shares. It is the value placed upon that asset for the first time after its acquisition, if that be material. The asset, the bonus shares, had been recently acquired and represented a profit, whether of a capital nature or of an income nature is immaterial, accruing to the Castlemaine Brewery Company Melbourne Ltd upon its shares in Carlton and United Breweries Ltd The exemption in s. 44 (2) (b) (iii) is of profits arising from the revaluation of assets and does not extend to a profit accruing, not by an enhancement in value of a capital asset, but in the form of money or property received in virtue of the enjoyment or ownership of an investment or other capital asset. Here the Castlemaine Brewery Company Melbourne Ltd , in virtue of the enjoyment or ownership of their investment or asset consisting of their original 117,414 shares, received valuable securities, namely, the 58,707 bonus shares. To place a value on these securities is only to determine the amount of the gain arising from their receipt. It may be true that it is right to take into account against that gain the diminution in value, no very great diminution in value apparently, suffered by the original 117,414 shares as a consequence of the distribution of the bonus shares and the capitalization of the Carlton and United Breweries Ltd 's reserves of profit. But the twenty-four shillings falls so far short of the actual value of the shares that it does not reflect any part of the diminution and in any case, after deducting enough to make up the decrease in the value of the original shares, the remaining value of the bonus shares is very great. A great part therefore of the sum of PD70,448 represents the net gain or profit arising to the Castlemaine Brewery Company Melbourne Ltd from the new securities, that is to say, from the allotment to it of bonus shares by way of stock dividend. An increment in the total value of assets arising from the allotment of new and additional shares is quite a different thing from the growth or increase in value which a revaluation of capital assets may show that they have undergone. The purpose of the exemption given by s. 44 (2) (b) (iii) is to exclude capitalizations of unrealized profits which the company consider to have been produced by an enhancement in value of assets of a capital nature ascertained by comparison between, on the one hand, a former value as fixed by the purchase price paid by the company or by estimate and, on the other hand, a later value fixed by an estimate made for the purpose of finding a figure proper for use in commercial accounting. A profit consisting in the acquisition, growth or creation of a new thing falls outside its purpose. A flock of stud sheep kept for breeding purposes has been held to be things not produced for the purpose of sale (Austin Pastoral Co of Bringagee Ltd v Federal Commissioner of Taxation ^[F9] : See, at p. 81, per Knox C.J.). According to the decision, a flock of stud ewes kept for breeding purposes would apparently form assets not acquired for the purpose of resale at a profit. Surely it would be impossible to treat the added value given to the flock by the lambs dropped since the last valuation as a profit arising from the revaluation of the asset, simply because a new value at so much a head was placed upon the flock, sheep and lambs.

I have just said that it is immaterial whether the profit accruing from the allotment by Carlton and United Breweries Ltd of the bonus shares is of a capital nature or of an income nature. The reason is that in neither case does the profit arise from revaluation. But it is significant that under the provisions with which we are dealing the stock dividend or distribution of bonus shares by Carlton and United Breweries Ltd would form part of the assessable income of Castlemaine Brewery Company Melbourne Ltd It happens that because the distribution was made before 31st December 1934 and out of a special class of profits, it was excluded under an exemption, now expired. But this ought not to obscure the fact that the distribution of bonus shares is classed as a dividend by the legislation we are applying and, unless a specific exemption covers it, is included in the shareholder's assessable income. Here the taxpayer is seeking to bring under the exemption in favour of profits arising from the revaluation of assets what the Act regards as a dividend and as forming, unless specifically excluded, part of the company's assessable income, a result which to say the least of it, appears odd.

In my opinion the taxpayer's claim that the capitalization falls within the exemption in favour of shares paid up wholly and exclusively out of profits arising from the revaluation of assets not acquired for the purpose of resale fails on the ground that, in part, the profits capitalized arose from something else, namely, the allotment to the company of paid-up shares by way of stock dividend. It was sought, however, to avoid this consequence by reliance upon a matter which, to my mind, is quite beside the question whether the profits capitalized arose in part from the allotment to Castlemaine Brewery Company Melbourne Ltd of bonus shares by Carlton and United Breweries Ltd That matter is the inclusion in the former company's balance-sheet as at 30th September 1935 of the full number of 176,121 shares at the same figure of PD119,861 as stood in the company's books and previous balance-sheet as the cost or value of the original 117,414 shares in Carlton and United Breweries Ltd It will be remembered that at the time this balance-sheet was prepared the valuation of the shares as at least worth 24s. was in course of settlement and the certificates on this valuation and the balance-sheet were both presented at the same meeting of the directors and then and there approved and adopted by the board. Nevertheless it is said that the balance-sheet adopted one value for the entire number of the shares, namely, PD119,861, and the valuation a higher value by PD91,484, that is to say, a value of PD211,345 or 24s. a share for the entire number of 176,121 shares. The difference between the two, it is claimed, is a profit arising on revaluation. The directors in adopting the balance-sheet were not purporting to value the bonus shares. They were simply stating the number of shares held by the company and the cost to the company. They were, for the purpose of the balance-sheet, simply ignoring the fact that the allotment of the bonus shares included in the number of shares set down meant an increase in the value of the holding. That fact they brought into account elsewhere but at the same time. It was brought into account by adopting the revaluation of the total holding.

But to my mind it would not matter what value they placed upon the bonus shares in the balance-sheet. It would not alter the fact that the profit arose from their allotment and not from their revaluation. Once it appears, as, in my opinion, it clearly does from the evidence, that the stock dividend brought net gain or profit to the company, it is futile to attempt to use the figure in the balance-sheet as taking up the profit and then to use the valuation, adopted on the same day, as giving rise to a new and independent profit, namely, a profit arising from revaluation, a profit of which the stock dividend formed no part. It is the same profit, and it was taken up, at all events in part, in the valuation at not less than 24s. and not in the balance-sheet.

By relying on the figure in the balance-sheet as a valuation which formed a basis for a revaluation giving rise to a profit, notwithstanding that both the alleged valuation and the revaluation were made at the same time, the taxpayer has provoked an attack, by way of retort, upon the genuineness of the alleged valuation. The retort is not unnatural, but its justification lies, not in what the directors did or intended to do, but in the contention which is now advanced. In putting the total number of shares down in the balance-sheet at the cost of the original shares there was in fact no attempt to value the bonus shares, nor for that matter the total holding. The facts show that from the beginning the distribution of the bonus shares by Carlton and United Breweries Ltd among its shareholders, the holding companies, was the occasion of a corresponding distribution by Castlemaine Brewery Company Melbourne Ltd of bonus shares to its shareholders. The chairman in effect said so in his statement to the shareholders on 4th December 1934. Not only did the head distribution provide the occasion of the subsidiary distribution but it provided the source, at all events in part. The value of the bonus shares received by the Castlemaine Brewery Company Melbourne Ltd could not be utilised as a source whence to pay up the bonus shares distributed by that company without exposing its shareholders to income tax in respect of the distribution.

Part of the plan of the company was to reduce capital at the same time and thus to distribute cash as a return of capital. To increase capital and reduce it at the same time is an operation which, I imagine, would not be undertaken except for the purpose of following a path which would allow of the distribution of money without the recipients incurring a consequent liability to income tax. In the view I have taken liability to tax is incurred by the shareholder at an earlier stage, viz., when the bonus shares are allotted, and the return of capital upon the reduction does not come into the question.

In my opinion the order appealed from is right and the appeal should be dismissed with costs.