XCO Pty. Ltd. v. Federal Commissioner of Taxation.

Judges:
Gibbs J

Court:
High Court

Judgment date: Judgment handed down 25 August 1971.

---

Gibbs J.: This is an appeal from a decision of a Board of Review confirming an assessment made by the Commissioner of Taxation of income tax payable by XCO Proprietary Limited (``XCO'') in respect of the year ended 30 June 1967.

XCO is a company which was incorporated in Victoria on 29 June 1967. At all material times its issued share capital consisted of four ordinary fully paid shares of $1 each of which two were owned by Victor Thomas Davis and two by John Brent Horton and those two gentlemen were the directors of the company. It was formed in the following circumstances. In 1961, Davis and Horton had commenced to carry on in partnership a business of operating automatic car wash centres. The business proved successful and, in 1965, a number of companies were formed to conduct it. At the head of the structure was Auto-Magic Car Wash (Holdings) Proprietary Limited (``Holdings'') a holding company whose shares were all held by Davis and Horton and their respective family companies. Holdings had a number of wholly owned subsidiaries of which one acted as a management company and the others carried on the business in Sydney, Melbourne, Brisbane and Adelaide. The operations of these companies were entirely controlled by Davis and Horton who were the directors of the management company.

Some times early in 1967, an accountant practising in Melbourne, Mr. E.J. Brown, told Davis and Horton that he knew of a company, Kenneth Wright Proprietary Limited (whose name was later changed to Auto-Magic Car Wash (Management) Pty. Limited, but to which I shall refer as the ``loss company'') which had incurred losses amounting to $290,000 and suggested that they should consider acquiring a sixty per cent interest in the company and taking advantage of the accrued losses as permitted by sec. 80 of the Income Tax Assessment Act 1936-1967 (Cth) (``the Act''). Because of the provisions of sec. 80A of the Act this benefit could not be obtained if an interest exceeding sixty per cent were acquired and Davis expressed concern that the shareholders who retained a forty per cent interest in the loss company might wish to participate in the profits it might earn in the future, and asked how protection might be obtained against those shareholders, saying that he would not resort to underhand means for this purpose. Brown replied that the loss company owed debts of about $260,000 and suggested that the necessary protection might be obtained by taking assignments of these debts, the intention being that if the holders of the outstanding forty per cent interest demanded to participate in profits made by the loss company their demands could be defeated by loss company paying, or threatening to pay, the debts to the assignee. Davis and Horton took advice with regard to Mr. Brown's proposal and subsequently decided to proceed with it and decided also that a new company should be formed for the purpose of taking assignments of the debts owed by the loss company.

The plan was then implemented. There were 8,024 issued shares in the loss company, held by Kenneth Wright (2,023), Gerald John O'Donohue (1) and W.J. Vine Proprietary Limited (a company controlled by Kenneth Wright) (6,000), and by an agreement, dated 28 June 1967, Holdings agreed to buy, for a total consideration of $50, 4,814 of those shares. The remaining 3,210 shares were held by W.J. Vine Proprietary Limited. On 29 June 1967, XCO was, as I have said, incorporated; one of its objects, which were widely stated by its Memorandum of Association, was to acquire hold or dispose of debts. On that date the loss company owed to its creditors a total amount of $290,980.38. By three deeds of assignment, each dated 28 June 1967 but executed on behalf of XCO on 29 June 1967, some of those debts were assigned to XCO; the assignors, the amounts assigned and the consideration payable were as follows

   Assignors                      Debts           Consider-
                                                  ation
   Kenneth Wright and W.J.
   Vine Proprietary Limited    $10,581.90          $1
   Kevin James Browne           12,965.51          $1

   Kenneth Wright              184,818.20)
                                         )
   W.J. Vine Proprietary                 )
   Limited                      52,074.77)     $4,000
                              ------------  ----------
         Total                $260,440.38      $4,002
                              ------------  ----------
      

The balance of $30,540 which was not assigned was owed to Kenneth Wright and it was apparently intended that this debt should ultimately be paid, no doubt as part of the consideration for entering into the transaction. To enable it to pay the consideration for the assignments XCO borrowed $4,000 from Holdings and appears to have borrowed $8 from Horton.

Each assignment contained a warranty that each debt ``is due and owing and is legally recoverable'' but there is no doubt that at the time of the assignments all of the debts were worthless, apart from whatever value they had to a company which could use them for the purposes of sec. 80 of the Act. However, the debts were brought into the accounts of XCO at their full face value. During the year of income ended 30 June 1967 - probably on 30 June - the loss company paid to XCO

---

ATC 4154

$5,000 in part satisfaction of the debts assigned to the latter company. To enable the payment of $5,000 to be made the loss company had to be put in funds and this was arranged. After the purchase of the shares Davis and Horton had become the directors of the loss company, which had taken over the name and functions of the management company that had previously been one of the subsidiaries of Holdings and which thereafter carried on business as a member of the group of companies headed by Holdings.

Evidence was given by Davis and Horton that the sole purpose of taking the assignment of the debts was to protect themselves against the possibility that W.J. Vine Proprietary Limited, which remained the holder of forty per cent of shares, might become, or claim to be, entitled to participate in any profit subsequently made by the loss company and that it was intended that XCO should call for payment of the debt unless W.J. Vine Proprietary Limited should make what were described as ``unfair demands'' upon the loss company. However, to this evidence both witnesses made a qualification, namely that from the outset it was intended that an amount of $5,000 would be repaid to XCO immediately for the purpose of obtaining a ruling from the Commissioner as to whether repayments would be taxable. Davis said that they wished to know where they stood and that in their dealings with W.J. Vine Proprietary Limited their position would be strengthened if they knew that they could arrange for the loss company to pay the debt to XCO without exposing the company to a liability to tax, whereas if the debts were taxable in the hands of XCO their bargaining strength would have been reduced.

On 4 March 1968, XCO lodged a taxation return in respect of the year ended 30 June 1967 and in the return showed no income for that year. An accompanying letter to the Commissioner disclosed the relevant circumstances and concluded by saying: ``We would appreciate your confirmation that these instalments, if and when they occur, will not be subject to taxation liability in that they are the repayment of the loan previously owing by Kenneth Wright Proprietary Limited....'' On behalf of the Commissioner some reliance was placed upon the use of the word ``instalments'', but viewing the evidence as a whole, I do not regard the letter as containing an admission that it was intended that further instalments would be paid.

There is no doubt that one purpose of taking the assignment of the debts was to obtain protection against W.J. Vine Proprietary Limited, but it is a question whether this was the only purpose which the parties had in mind when they entered into the transaction. It was suggested on behalf of the Commissioner that the parties had a second purpose, namely, to make it possible in the future for the loss company to pay in full its debt to XCO and for the latter company to make a tax-free distribution to its shareholders. Although I have approached the evidence of Davis and Horton with some scepticism, I see no reason to disbelieve them. Their evidence was uncontradicted; it was consistent within itself and not inherently incredible and the witnesses created a good impression on me when they were in the witnessbox. I accept their evidence. It is obvious, however, that for one reason or other Davis and Horton may in future arrange for the loss company to make further payments of its indebtedness to XCO, notwithstanding that it was not originally intended that this should be done.

The Commissioner, in his assessment, acted on the view that a profit had arisen from the part payment of the debt and that it represented assessable income and he calculated the amount of the profit on an emerging basis. He assessed XCO to tax on a taxable income of $4,923. This amount was reached by spreading the cost ($4,002) of the total amount of the debts ($260,440.38) rateably over every dollar of the debts, which gave a cost of 1.54¢ per dollar of debts acquired.

On appeal the Commissioner took the preliminary objection that the decision of the Board does not involve a question of law within sec.196 of the Act. I find this objection rather difficult to reconcile with the suggestion subsequently made by the Commissioner that I might refer to the Full Court a question of law arising in relation to sec.26(a) of the Act, a suggestion which the appellant opposed and which I do not propose to adopt, for one reason because I consider that it was belatedly made. However the objection taken by the Commissioner is untenable. The decision involves questions as to what constitutes income and as to the construction of sec.26(a) of the Act, which are questions of law (cf.
Hayes v. F.C. of T. (1956) 96 C.L.R. 47 at pp. 501). It is unnecessary to consider whether additional questions of law are involved, since if some question of law be involved, the whole decision of the Board, and not merely the question of law, is open to review (
Ruhamah Property Company Limited v. F.C. of T. (1928) 41 C.L.R. 148 at p.151). Moreover it is immaterial for purposes of jurisdiction whether or not the question of law involved was erroneously decided by the Board (see
Krew v. F.C. of T. (1971) 71 ATC 4091; 45 A.L.J.R. 324 at p.325 and cases there cited); if this were not so the Court might have to determine the

---

ATC 4155

substantial issue involved in an appeal from the Board before it could decide whether an appeal lay.

The first submission made on behalf of the appellant was that XCO did not derive any taxable income in the year in question. The Commissioner, on the other hand, submitted that the amount of $4,923 was ``profit arising... from the carrying on or carrying out of any profit-making undertaking or scheme'' within sec. 26(a) of the Act, or, alternatively, was income within ordinary usages and concepts and assessable under sec. 25 of the Act.

Section 26(a) provides -

``The assessable income of a taxpayer shall include -

• (a) profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme.''

It was not, and could not be, suggested that the first limb of the paragraph has any application to the present case because the debts acquired by XCO were not intended to be resold. It is the second limb whose application is in question. The word ``scheme'' simply means plan, design or programme of action (cf.
Clowes v. F.C. of T. (1953-54) 91 C.L.R. 209 at p.225). It is not necessary, to constitute a scheme within sec. 26(a), that the action planned should involve a series or repetition of acts. ``The alternative `carrying on or carrying out' appears to cover, on the one hand, the habitual pursuit of a course of conduct, and, on the other, the carrying into execution of a plan or venture which does not involve repetition or system'' (per Dixon J. in
Premier Automatic Ticket Issuers Ltd. v. F.C. of T. (1933) 50 C.L.R. 268 at p.298, in a passage adopted by Taylor J. in Clowes v. F.C. of T. supra at p.231). The scheme must, however, be one which is carried out by the taxpayer himself or on his behalf; it is not enough that the taxpayer derives a receipt from somebody else who has obtained it by carrying out a scheme of profit-making (Clowes v. F.C. of T., supra at pp.217-8, 224; and see
Official Receiver v. F.C. of T. (Fox's case) (1956) 96 C.L.R. 370 at p.387).

In the present case, it was said on behalf of the appellant that XCO did not by itself or its agents carry out any scheme and that the only scheme disclosed by the evidence was one in which Davis and Horton, and possibly also Holdings, engaged. I cannot agree. It is true that Davis and Horton were parties to a wider scheme which required certain action of XCO but that does not mean that XCO did not itself carry out a scheme. A taxpayer can, within sec. 26(a), carry out a scheme, notwithstanding that what he does is done for the purposes of a larger scheme to which others are parties. In my opinion, when XCO implemented the plan of action conceived by its directors, and became a party to the three deeds of assignment and thereafter received $5,000 in part payment of the debts assigned to it, it carried out a scheme.

The debts acquired by XCO for $4,002 immediately yielded $5,000. The surplus could not properly be described as an enhancement of capital. This is not one of those cases in which the taxpayer did no more than realise one of his assets in an enterprising way. Before the scheme commenced. XCO had no interest in the debts and the carrying out of the scheme involved the acquisition of the debts, and their almost immediate payment in part. Moreover, the transaction clearly had the character of a business deal, to adopt the test stated in
McClelland v. F.C. of T. (1970) 70 ATC 4115; 120 C.L.R. 487 at p.495. The scheme, in my opinion, gave rise to a profit within sec. 26(a).

However, the argument was advanced on behalf of XCO that the scheme nevertheless was not a ``profit-making scheme'' within sec. 26(a). The second limb of sec. 26(a), unlike the first limb of that paragraph, does not refer in express terms to purpose but, in my opinion, a scheme is not a ``profit-making scheme'' simply because it yields a profit when none was intended; in the ordinary sense of the words a ``profit-making scheme'' is a plan devised in order to obtain a profit, and a scheme only answers that description if the taxpayer carries it out with the purpose of making a profit. It was submitted on behalf of XCO that the dominant purpose of the scheme was not to make a profit and that the receipt of the $5,000 was merely incidental to the main purpose of the scheme, which, it was said, was to take the assignment of the debts and to hold them as a safeguard against the minority shareholder in the loss company. With all respect, this submission confuses XCO's scheme with that of Davis and Horton. The wider scheme which Davis and Horton carried out did have as its main purpose the protection of the position of the purchasers of sixty per cent of the shares in the loss company against any attempt by the minority shareholder, W.J. Vine Proprietary Limited, to assert an interest adverse to theirs. However, the scheme whose purpose is relevant to the question whether the second limb of sec. 26(a) applies is that carried out by the taxpayer; in other words, in the present case, the scheme carried out by XCO. That scheme was a simple one. To repeat what has already been said, it was to acquire the debts and receive a payment on account of some of them. From the

---

ATC 4156

very inception of the scheme it was intended that the payment should be received and the profit made. This intention was of the essence of the scheme. The making of a profit was only incidental to the wider scheme carried out by Davis and Horton, but the scheme carried out by XCO had the purpose of acquiring the debts and of receiving in respect of them a payment sufficient to yield a profit, and it is not possible to say that part of this purpose was incidental to any other part, nor is it to the point that for the purpose of the wider scheme it was not necessary that the payment should be received - the scheme must be taken as it is, not as it might have been. On behalf of XCO, it was said that it was intended that a profit should be made only so that a ruling might be obtained on the question whether repayments would be taxable. To attribute any weight to this fact would be to confuse motive with purpose. The purpose of the scheme was to make a profit, even though the motive for making the profit was to lay the foundation for a test case. It hardly needs saying that the motive with which a profit is made is irrelevant to the question whether the scheme which yielded the profit was a profit-making scheme.

I hold that a profit did arise in the hands of XCO from the carrying out of a profit-making scheme within sec. 26(a). It is, therefore, unnecessary to consider the allied question whether the amount derived was income according to ordinary usages and concepts.

The question remains, however, whether the Commissioner was right in assessing the amount of taxable income at $4,923. That depends on whether the Commissioner should have taken the actual surplus received by XCO, $998, as representing the profit arising during the relevant income year from the carrying out of the scheme, or whether he was entitled to assess the profit on an emerging basis. In the absence of some definite direction in the Act, the Commissioner should, in an assessment of income, adopt the method of accounting which is in fact appropriate to the circumstances of the case, or which in other words ``is calculated to give a substantially correct reflex of the taxpayer's true income'' (
Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (Carden's case) (1938) 63 C.L.R. 108 at p.154). Where the carrying out of a profit-making scheme extends over more than one year, the difference between receipts and disbursements in any one year may not give a true reflection of the profit arising or loss sustained in that year, and the assessment of profit on an emerging basis may be appropriate. The method of assessment adopted by the Commissioner in the present case would no doubt be appropriate if it were probable that the total amount of the debts - $260,440.38 - would be paid to XCO. On the other hand, if it is improbable that this total sum will be received, it is not right to regard the outlay of $4,002 as the cost of the total amount of the debts. According to the evidence that I accept, it was not intended or envisaged that XCO should or would receive any further payment on account of the debts assigned to it, unless the actions of W.J. Vine Proprietary Limited made it necessary to make a further payment. It is of course a matter of speculation whether any further payment will be made, but the evidence does not show that a further payment is likely. Four years have now elapsed since the $5,000 was paid, and no further payment has been made. In all the circumstances, it does not seem fair to regard $4,002 as the cost incurred in gaining receipts that will total $260,440.38. There is no evidence that it would be in accordance with generally accepted commercial or accounting principles to regard $4,923 as representing the profit arising in a case such as this. In all the circumstances, it seems to me fair and appropriate to regard $998, the actual surplus of the amount received over the cost in the year in question, as truly representing the profit arising in that year. I hold that XCO has established that the assessment is excessive, and that the Commissioner should have assessed on a taxable income of $998.

I shall allow the appeal and remit the matter to the Commissioner to re-assess in accordance with my judgment. The taxpayer's success should carry an order for costs, but since the Commissioner succeeded on what both parties regarded as the main issue, they will be limited to the costs of one day.

ORDER:

Appeal allowed with costs limited to those of one day. Matters remitted to the Commissioner to reassess in accordance with the reasons for judgment.

Usual order as to exhibits.