UNDERSHAFT NO 1 LTD v FC of T; UNDERSHAFT NO 2 BV v FC of T

Judges:
Lindgren J

Court:
Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2009] FCA 41

Judgment date: 3 February 2009

Lindgren J

1. In these two proceedings, that were heard together, taxpayers appeal against deemed appealable objection decisions of the respondent (Commissioner).

2. As in the recent case of
Virgin Holdings SA v Commissioner of Taxation 2008 ATC 20-051; [2008] FCA 1503 (Virgin Holdings), a decision of Edmonds J given on 10 October 2008, the issue in each proceeding is whether income tax is not payable on the amount of a capital gain by reason of the operation of a Double Taxation Agreement (DTA). In Virgin Holdings the DTA was that between Australia and Switzerland. In the case of proceeding NSD


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1283 of 2006 (the First Proceeding), in which Undershaft (No 1) Ltd (First Applicant) is the applicant, the DTA is between Australia and the United Kingdom of Great Britain and Northern Ireland (UK) (not the current DTA between those countries but an earlier one) (the UK Agreement). In the case of proceeding NSD 1282 of 2006 (the Second Proceeding), in which Undershaft (No 2) BV (Second Applicant) is the applicant, the DTA is between Australia and the Netherlands (the Netherlands Agreement).

3. The full title of the UK Agreement is: Agreement between the Government of the Commonwealth of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital Gains. The UK Agreement was signed on 7 December 1967. The full title of the Netherlands Agreement is: Agreement between Australia and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income. The Netherlands Agreement was signed on 17 March 1976.

4. The UK Agreement was Schedule 1 to the International Tax Agreements Act 1953 (Cth) (Agreements Act). The UK Agreement was replaced in 2003 by a new DTA between Australia and the UK, which is the present Schedule 1 to the Agreements Act. This new UK Agreement is not presently relevant because the capital gain in question was made in the financial year ended 30 June 2001. The Netherlands Agreement is found in Schedule 10 to the Agreements Act.

5. The two proceedings result from a merger on or around 20 December 2000 of the businesses of CGU Insurance Australia Ltd (CGUIA) and Norwich Union Australia Ltd (NUA). All of the shares in those two companies were sold by their respective parent companies, the present applicants, to a company then known as CGNU Australia Holdings Ltd. It was those sales that gave rise to the capital gains.

6. Each applicant filed an income tax return for the year ended 30 June 2001 which did not include its capital gains as assessable income. The Commissioner issued a notice of assessment to each applicant dated 9 December 2005. Each applicant lodged a notice of objection against its assessment, objecting to the inclusion of any net capital gain in its assessable income. On 22 May 2006, the Commissioner made objection decisions disallowing the applicants' objections. On 3 July 2006, the applicants appealed against the objection decisions by filing the applications that commenced these proceedings.

7. The question in the First Proceeding is whether the capital gain made by the First Applicant, formerly called CGNU Holdings (Australia) Ltd, on the sale of shares in CGUIA is not subject to income tax in Australia by reason of Art 5 of the UK Agreement. The question in the Second Proceeding is whether the capital gain made by the Second Applicant, formerly called Norwich Union Overseas Holdings BV, on the sale of shares in NUA is not subject to income tax in Australia by reason of Art 7 of the Netherlands Agreement. Articles 5 and 7 have, for convenience, been referred to as "Business Profits" Articles, and I shall use that form of reference.

8. It is not in dispute that each sale was a CGT Event A1 within s 104-10 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) - each sale was a disposal of a CGT asset (within s 108-5 of the ITAA 1997) having the necessary connection with Australia (within the then s 136-25 of the ITAA 1997 (Div 136 was replaced by Div 855 by the Tax Laws Amendment (2006 Measures No. 4) Act 2006 (Cth) (No 168 of 2006))).

9. The parties agree that the gain of $273,000,000 made by the First Applicant and the gain of $108,585,000 made by the Second Applicant were on capital account and were not income within the meaning of s 6-5 of the ITAA 1997. The parties agree that the gains were capital gains within the meaning of s 104-10(4) of the ITAA 1997 because the capital proceeds from the disposal of the shares were more than their cost base.

10. In the UK Agreement, the Business Profits Article prevented Australia from taxing the "industrial or commercial profits" of a UK enterprise unless that enterprise carried on business through a permanent establishment in


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Australia. In the Netherlands Agreement, the Business Profits Article prevented Australia from taxing the "business profits" of an enterprise of the Netherlands unless that enterprise carried on business through a permanent establishment in Australia. It is agreed that the First Applicant was a UK enterprise and that the Second Applicant was an enterprise of the Netherlands and that neither of them carried on business through a permanent establishment in Australia. It follows that if the respective capital gains fell within the Business Profits Articles, Australia was prevented from taxing those capital gains.

Facts

11. The facts in each case have been agreed by the parties in statements entitled "Matters Agreed between the Parties solely for the Purpose of this Proceeding" which can be summarised as follows.

12. The First Applicant was a resident of the UK for the purposes of the UK Agreement, and was not a resident of Australia for the purposes of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), the ITAA 1997, or the UK Agreement. The First Applicant acquired, after 19 September 1985, all of the issued shares in CGUIA. At that time the First Applicant was a subsidiary of CGU plc.

13. The Second Applicant was a resident of the Netherlands for the purposes of the Netherlands Agreement, and was not a resident of Australia for the purposes of the ITAA 1936, the ITAA 1997 or the Netherlands Agreement. The Second Applicant acquired, after 19 September 1985, all of the issued shares in NUA. At that time, the Second Applicant was a subsidiary of Norwich Union plc.

14. On 30 May 2000, CGU plc and Norwich Union plc merged their respective insurance businesses to form the Aviva group of companies, and the First and Second Applicants became subsidiaries of Aviva plc. Shortly after the merger, the Aviva group decided to restructure its Australian shareholdings. On 10 November 2000, it established a new Australian holding company, CGNU Australia Holdings Ltd (now called Aviva Australia Holdings Ltd).

15. By contract dated 20 December 2000, the First Applicant sold the shares in CGUIA to CGNU Australia Holdings Ltd for a consideration of $950,000,000. By contract dated 20 December 2000 the Second Applicant sold the shares in NUA to CGNU Australia Holdings Ltd for a consideration of $570,585,000.

16. I referred at [8] and [9] above to the parties' agreement as to the capital gains to which the two sales gave rise.

The UK Agreement

17. The UK Agreement was enacted into Australian domestic law by s 5 of, and Schedule 1 to, the Agreements Act. Under s 5, the provisions of the UK Agreement, so far as those provisions affected Australian tax, were deemed to have the force of law in relation to tax in respect of, relevantly, income of the year ended 30 June 2001.

18. Articles 2 and 3 of the UK Agreement contained definitions for the purposes of that Agreement. Paragraph (4) of Art 2 is of general relevance. It provided:

"In the application of the provisions of this Agreement by one of the Contracting Governments any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that Government relating to the taxes which are the subject of this Agreement."

19. The "Taxes Covered" Article (Art 1) and the Business Profits Article are central to the dispute in the First Proceeding.

The "Taxes Covered" Article

20. Article 1 of the UK Agreement sets out the scope of that Agreement's application by defining the "Taxes Covered". It provided, relevantly:

  • "(1) The taxes which are the subject of this Agreement are -
    • (a) in the United Kingdom of Great Britain and Northern Ireland:

      the income tax (including surtax), the corporation tax and the capital gains tax

    • (b) in Australia:

      the Commonwealth income tax , including the additional tax upon the undistributed amount of the distributable income of a private company.


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  • (2) This Agreement shall also apply to any identical or substantially similar taxes which are imposed after the date of signature of this Agreement in addition to, or in place of, the existing taxes by either Government or by the Government of any territory to which the present Agreement is extended under Article 2.2." (my emphasis)

21. Subparagraph (1)(f) of Art 2 defined the terms "Australian tax" and "United Kingdom tax" to mean tax imposed by the Commonwealth of Australia and tax imposed by the UK respectively, being tax to which the UK Agreement applied by virtue of Art 1.

The "Business Profits" Article

22. Article 5 of the UK Agreement, the Business Profits Article, provided relevantly:

  • "(1) Industrial or commercial profits of a United Kingdom enterprise shall be exempt from Australian tax unless the enterprise carries on trade or business in Australia through a permanent establishment situated therein . If the enterprise carries on trade or business as aforesaid, Australian tax may be imposed on the industrial or commercial profits of the enterprise but only on so much of them as is attributable to the permanent establishment.

    ...

  • (7) The term "industrial or commercial profits" means income derived by an enterprise from the conduct of a trade or business, including income derived by an enterprise from the furnishing of services of employees or other personnel but it does not include -
    • (a) dividends, interest, royalties ... or rents other than dividends, interest, royalties or rents effectively connected with a trade or business carried on through a permanent establishment which an enterprise of one of the territories has in the other territory; or
    • (b) remuneration for personal (including professional) services;
    • (c) income arising from, or in relation to, contracts or obligations to provide the services of public entertainers or athletes referred to in Art 13." (my emphasis)

23. The term "United Kingdom enterprise" was defined in para 3 of Art 3 to mean an industrial or commercial enterprise or undertaking carried on by a UK resident. As noted earlier, it is agreed between the parties to the First Proceeding that the First Applicant was a UK resident and a UK enterprise for the purposes of the UK Agreement.

The parties' positions

24. The First Applicant contends that the tax that would otherwise have been imposed by Australia on its capital gain of $273,000,000 falls within the expression "the Commonwealth income tax" or, if it does not do so, within the expression "substantially similar tax", and is therefore within the scope of the UK Agreement. The Commissioner, on the other hand, contends that it falls within neither expression and that therefore the tax that would have been imposed on the capital gain by Australia is outside the scope of the UK Agreement.

25. The First Applicant also contends that its capital gain of $273,000,000 falls within the Business Profits Article, while the Commissioner contends that it does not. The Commissioner submits that in denying Australia the right to tax the industrial or commercial profits of a UK enterprise, the Business Profits Article applies only to revenue profits; it does not deny the power to tax capital gains that are not revenue profits, since capital gains, not being income from the conduct of a trade or business, do not fall within the exhaustive definition of "industrial or commercial profits" given in Art 5(7).

26. The Commissioner accepts that the expression "the Commonwealth income tax" in Art 2(1)(b) refers to a tax assessed under the ITAA 1936. It is therefore not in dispute that, for the purposes of para 4 of Art 2 of the UK Agreement, the ITAA 1936, at least as it stood as at the date of the signing of the UK Agreement in 1967, is a law of the Commonwealth relating to taxes subject to the UK Agreement. It follows, according to Art 2(4) that the ITAA 1936 is relevant to the interpretation of any undefined term in the UK Agreement.


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The Netherlands agreement

27. The Netherlands Agreement was enacted into Australian domestic law by s 11A of, and Schedule 10 to, the Agreements Act. Under s 11A, the provisions of the Netherlands Agreement, so far as those provisions affected Australian tax, were deemed to have the force of law in relation to tax in respect of, relevantly, income of the year ended 30 June 2001. The Netherlands Agreement has been amended by two Protocols, the first dated 17 March 1976 and the second dated 30 June 1986.

28. Article 3 of the Netherlands Agreement contained definitions for the purposes of that Agreement. Paragraph (3) of Art 3 is of general relevance. It provided:

"As regards the application of this Agreement by either of the States, any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that State relating to the taxes to which this agreement applies."

29. The "Taxes Covered" Article (Art 2), the "Business Profits" Article (Art 7) and the "Alienation of Property" Article (Art 13) are central to the dispute in the Second Proceeding. It will be noted that the UK Agreement did not contain an equivalent to Art 13 of the Netherlands Agreement.

The "Taxes Covered" Article

30. Article 2 of the Netherlands Agreement provided:

  • "(1) The existing taxes to which this Agreement shall apply are -
    • (a) in Australia:

      the Australian income tax , including the additional tax upon the undistributed amount of the distributable income of a private company.

    • (b) in the Netherlands:
      • ... (income tax);
      • ... (wages tax);
      • ... (corporation tax);
      • ... (dividend tax).
  • (2) This Agreement shall also apply to any identical or substantially similar taxes which are imposed by one of the States after the date of signature of this Agreement in addition to, or in place of, the existing taxes. At the end of each calendar year, the competent authority of each State shall notify the competent authority of the other State of any substantial changes which have been made in the taxation laws of his State to which this Agreement applies." (my emphasis)

31. Subparagraphs (g) and (h) of para (1) of Art 3 respectively defined the term "Australian tax" to mean tax imposed by Australia being tax to which the Netherlands Agreement applied by virtue of Art 2, and the term "Netherlands tax" to mean tax imposed by the Netherlands being tax to which the Netherlands Agreement applied by virtue of Art 2.

The "Business Profits" Article

32. Article 7 of the Netherlands Agreement, the "Business Profits" article, provided:

  • "(1) The profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other State through a permanent establishment situated therein . If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State, but only so much of them as is attributable to that permanent establishment.
  • ...
  • (5) For the purposes of this Article, except as provided in the Articles referred to in this paragraphs, the profits of an enterprise do not include items of income dealt with in Articles ..., 13, ..."

    (my emphasis)

33. Subparagraph (j) of para (1) of Art 3 defined the terms "enterprise of one of the States" and "enterprise of the other State" to mean an enterprise carried on by a resident of Australia or an enterprise carried on by a resident of the Netherlands, as the context required. As noted earlier, it is agreed between the parties to the Second Proceeding that the Second Applicant was a resident of the Netherlands and an enterprise of the Netherlands for the purposes of the Netherlands Agreement.


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The "Alienation of Property" Article

34. Article 13 of the Netherlands Agreement (the Alienation of Property Article) provided:

  • "(1) Income from the alienation of real property may be taxed in the State in which that property is situated.
  • (2) For the purposes of this Article
    • (a) the term "real property" shall include-
      • (i) a lease of land or any other direct interest in or over land;
      • (ii) rights to exploit, or to explore for, natural resources; and
      • (iii) shares or comparable interests in a company, the assets of which consist wholly or principally of direct interests in or over land in one of the States or of rights to exploit, or to explore for, natural resources in one of the States.
    • (b) real property shall be deemed to be situated...
      • (i) where it consists of direct interest in or over land-in the State in which the land is situated;
      • (ii) where it consists of rights to exploit, or to explore for, natural resources-in the State in which the natural resources are situated or the exploration may take place; and
      • (iii) where it [the alienated real property] consists of shares or comparable interests in a company, the assets of which consist wholly or principally of direct interests in or over land in one of the States or of rights to exploit, or to explore for, natural resources in one of the States-in the State in which the assets or the principal assets of the company are situated.
  • (3) Gains from the alienation of shares or 'jouissance' rights in a company the capital of which is wholly or partly divided into shares and which is a resident of the Netherlands for the purposes of Netherlands tax, derived by an individual who is a resident of Australia, may be taxed in the Netherlands."

The parties' positions

35. The Second Applicant contends that the tax that would otherwise have been imposed by Australia on its capital gain of $108,585,000 falls within the expression "the Australian income tax" or, if it does not do so, within the expression "substantially similar tax", and is therefore within the scope of the Netherlands Agreement. The Commissioner, on the other hand, contends that it falls within neither expression and that therefore the tax that would have been imposed on the capital gain by Australia is outside the scope of the Netherlands Agreement.

36. The Second Applicant also contends that its capital gain of $108,585,000 falls within the Business Profits Article, while the Commissioner contends that it does not.

37. The parties agree that the Alienation of Property Article does not apply in the present case. However, the Commissioner seeks to rely on it as relevant to the construction of the Business Profits Article. I set out that submission in greater detail at [138]ff below.

Construction of double taxation agreements

38. Although the provisions of the UK Agreement and the Netherlands Agreement form part of the domestic law of Australia (see [17] and [27] above), the character of those Agreements as treaties between Australia and another country attracts the approach to construction applied to international treaties. In
Thiel v Commissioner of Taxation (Cth) 90 ATC 4717; (1990) 171 CLR 338 at 356 (Thiel), McHugh J, citing
Shipping Corporation of India Ltd v Gamlen Chemical Co (A/Asia) Pty Ltd (1980) 147 CLR 142 at 159, said that the Swiss Agreement (in Schedule 15 to the Agreements Act and given the force of law in Australia by s 11E of that Act) was to be interpreted in accordance with the rules that are recognised by international lawyers and that are found in the Vienna Convention on the Law of Treaties (Opened for signature 23 May 1969. [1974] ATS 2. Entered into force 27 January 1980.) (Vienna Convention).

39.


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In
Applicant A v Minister for Immigration & Ethnic Affairs (1997) 190 CLR 225 at 230-1, Brennan CJ said:

"If a statute transposes the text of a treaty or a provision of a treaty into the statute so as to enact it as part of domestic law, the prima facie legislative intention is that the transposed text should bear the same meaning in the domestic statute as it bears in the treaty [
Koowarta v Bjelke-Petersen (1982) 153 CLR 168 at 265]. To give it that meaning, the rules applicable to the interpretation of treaties must be applied to the transposed text and the rules generally applicable to the interpretation of domestic statutes give way [
Chan v Minister for Immigration and Ethnic Affairs (1989) 169 CLR 379 at 413]."

40. The Full Federal Court in
McDermott Industries (Aust) Pty Ltd v Commissioner of Taxation 2005 ATC 4398; (2005) 142 FCR 134 at 143 (Hill, Sundberg and Stone JJ) summarised the principles applicable to the construction of DTAs in this way:

"Double tax treaties are bilateral treaties entered into between two states. As such they are to be interpreted in accordance with the requirements of the Vienna Convention on the Law of Treaties (23 May 1969, entered into force on 22 January 1974) (the Convention) and in particular Art 31 of the Convention.

The application of the Convention has been discussed by McHugh J in
Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225 and in
Thiel v Commissioner of Taxation (Cth) (1990) 171 CLR 338, the latter case being concerned with the interpretation of the double taxation agreement between Australia and Switzerland. The leading authority in this Court on interpretation of double taxation agreements is [
Commissioner of Taxation v Lamesa Holdings BV (1997) 77 FCR 597]. It is unnecessary here, to set out again what is there said. The following principles can be said to be applicable:

  • • Regard should be had to the 'four corners of the actual text'. The text must be given primacy in the interpretation process. The ordinary meaning of the words used are presumed to be 'the authentic representation of the parties' intentions': Applicant A.
  • • The courts must, however, in addition to having regard to the text, have regard as well to the context, object and purpose of the treaty provisions. The approach to interpretation involves a holistic approach.
  • • International agreements should be interpreted 'liberally'.
  • • Treaties often fail to demonstrate the precision of domestic legislation and should thus not be applied with 'taut logical precision'.

41. Articles 31 and 32 of the Vienna Convention provide as follows:

"Article 31: General rule of interpretation

  • (1) A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to terms of the treaty in their context and in the light of its object and purpose.
  • (2) The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:
    • (a) any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty;
    • (b) any instrument which was made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.
  • (3) There shall be taken into account, together with the context:
    • (a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;
    • (b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;
    • (c) any relevant rules of international law applicable in relations between the parties.

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  • (4) A special meaning shall be given to a term if it is established that the parties so intended.

Article 32: Supplementary means of interpretation

Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31:

  • (a) leaves the meaning ambiguous or obscure; or
  • (b) leads to a result which is manifestly absurd or unreasonable."

42. Background to the UK Agreement arguably included the 1963 Organisation for Economic Co-operation and Development (OECD) Draft Double Taxation Convention on Income and Capital (Draft Convention) and the "Commentaries on the Articles of the Draft Convention" (Draft Commentary) which formed Annex II to the Draft Convention. The Commissioner submitted that the UK Agreement was also influenced by what the Commissioner referred to as the "Colonial Model Treaty". According to the Commissioner, the Colonial Model Treaty was used by the UK in treaties with Commonwealth countries. The Commissioner explained that there was no published edition of the Colonial Model Treaty. The Commissioner explained that he drew attention to the Colonial Model Treaty simply to make the point that there were both similarities and differences as between the UK Agreement and the Draft Convention, and that the background to the UK Agreement extended beyond the Draft Convention and the Draft Commentary to include the Colonial Model Treaty. The Commissioner argued that the Draft Convention and the Draft Commentary did not assist in interpreting the UK Agreement and that the ordinary principles of statutory construction should be applied to the text of the UK Agreement. The First Applicant did not seek to draw assistance from the Draft Model or the Draft Convention.

43. In
Lamesa Holdings BV v Federal Commissioner of Taxation (1997) 97 ATC 4229, which, like the Second Proceeding, concerned the Netherlands Agreement, the primary judge accepted (at 4,237), on the basis of expert evidence, that the supplementary material relevant to construction of the Netherlands Agreement was the 1977 OECD Model Double Taxation Convention on Income and Capital which included as Annex I "Model Convention for the Avoidance of Double Taxation with respect to taxes on Income and Capital" (Model Convention) and as Annex II "Commentaries on the Articles of the Model Convention) (Model Commentary) because they had been "largely formulated and published" before the conclusion of the Netherlands Agreement. Neither party submitted that the Model Convention or the Model Commentary was not able to be taken into account as relevant to the construction of the Netherlands Agreement, and indeed, the Commissioner submitted that the Netherlands Agreement must be construed in light of these documents.

44. Authority for resort to extraneous materials of the kinds referred to may be found in Thiel at 344 (per Mason CJ, Brennan & Gaudron JJ), 349 (per Dawson J), 357 (per McHugh J);
Unisys Corporation Inc v Federal Commissioner of Taxation 2002 ATC 5146 at [44]; and
Commissioner of Taxation v Lamesa Holdings BV 97 ATC 4752; (1997) 77 FCR 597 (Lamesa) at 604.

45. A purpose of a DTA is to avoid the potential for the imposition of tax by both of the Contracting States on the same income. It is appropriate to say that the Contracting States achieve their objective by "allocating" as between themselves the right to bring to tax a particular item to one Contracting State while the other State agrees to abstain from doing so (Lamesa at 600,
Chong v Commissioner of Taxation 2000 ATC 4315; (2000) 101 FCR 134 at [24]-[27]).

46. A DTA does not give a Contracting State power to tax, or oblige it to tax an amount over which it is allocated the right to tax by the DTA. Rather, a DTA avoids the potential for double taxation by restricting one Contracting State's taxing power.


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Inclusion of capital gains in assessable income in Australia

47. It is the Income Tax Act 1986 (Cth) that imposes "income tax". Section 5(1) of that Act provides that income tax is imposed in accordance with that Act and at the relevant rates declared by the Income Tax Rates Act 1986 (Cth). Section 12(1) of the latter Act provides that the rates of tax are those set out in Schedule 7 to that Act. Section 7 of the Income Tax Act 1986 provides, relevantly, that the tax imposed by s 5(1) is levied, and shall be paid, for the financial year commencing on 1 July 1986 and for all subsequent financial years.

48. Part IIIA of the ITAA 1936 (dealing with capital gains) was inserted into that Act by the Income Tax Assessment Amendment (Capital Gains) Act 1986 (Cth) (No 52 of 1986) with effect from 24 June 1986 but operating in respect of assets acquired after 20 September 1985. The result, which is now produced under the ITAA 1997, is to include net capital gains in the assessable (and therefore taxable) income of a taxpayer (currently by s 102-5 of the ITAA 1997, formerly by s 160ZO of the ITAA 1936). Taxable income is calculated by reducing the assessable income by "deductions" (s 4-15 of the ITAA 1997, s 48 of the ITAA 1936 (which used the expression "allowable deductions")). The so-called "capital gains tax" is not a separate tax. The applicants submit, and the Commissioner does not dispute, that if it were, the Income Tax Act 1986 would offend s 55 of the Constitution, which requires that laws imposing taxation deal with one subject matter only: cf
Mutual Pools & Staff Pty Ltd v Commissioner of Taxation (Cth) 92 ATC 4016; (1992) 173 CLR 450.

49. The Commissioner assessed to tax the net capital gains made by the First Applicant and the Second Applicant under what I will, for convenience, call the "Pt IIIA règime" even though, in fact, it was the ITAA 1997 that applied in the year ended 30 June 2001. As will be already clear, both the UK Agreement and the Netherlands Agreement were entered into before the Pt IIIA règime was introduced.

50. The following legislative chronology will serve to introduce provisions and events of relevance to the proceedings and to the parties' submissions:


2 June 1936 The ITAA 1936 was enacted by the Commonwealth Parliament. Section 25 was the familiar "income according to ordinary concepts" provision. Other receipts were also deemed to form part of a taxpayer's assessable income. For example, s 26(a) provided that the assessable income of a taxpayer also included:
"(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."
29 October 1946 The first DTA between Australia and the UK was signed (the 1947 UK Agreement). It entered into force on 3 June 1947.
11 December 1953 The Agreements Act was enacted. The 1947 UK Agreement became Schedule 1 to the Agreements Act.
7 December 1967 The UK Agreement was signed. It became Schedule 1 to the Agreements Act, in place of the 1947 UK Agreement.
11 December 1973 Section 26AAA was introduced into the ITAA 1936. In general terms it included in the assessable income of a taxpayer any profit arising from the sale of property that the taxpayer purchased after 21 August 1973 and sold before the expiration of the period of 12 months from the date of purchase.

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17 March 1976
The Netherlands Agreement was signed. It became Schedule 10 to the Agreements Act. A "First Protocol" to the Agreement was signed on the same day.
28 February 1980 A DTA between Australia and Switzerland was signed (later referred to as the Swiss Agreement). It became Schedule 15 to the Agreements Act.
25 June 1984 The Income Tax Assessment Amendment Act (No 3) 1984 (No 47 of 1984) came into operation. That Act omitted s 26(a) and enacted a similar provision as s 25A(1).
24 June 1986 Part IIIA was introduced into the 1936 Act by Income Tax Assessment Amendment (Capital Gains) Act 1986 (Cth) (No 52 of 1986), having an operation in relation to assets acquired after 20 September 1985. Section 26AAA was prevented from overlapping with the new Pt IIIA by s 160L(3), and s 25A was prevented from overlapping with the new Pt IIIA by s 25A(1A).
30 June 1986 A Second Protocol to the Netherlands Agreement was signed
4 November 1986 The Income Tax Act 1986 came into operation, levying income tax in respect of the 1986-1987 income year and all subsequent years.
4 November 1986 The Income Tax Rates Act 1986 came into operation, with effect for the 1986-1987 income year and subsequent income years.
1 July 1997 The ITAA 1997 commenced operation.
22 June 1998 Part 3-1 of the ITAA 1997 commenced operation, with effect for the 1998-1999 income year onwards (see s 102-1 of the Income Tax (Transitional Provisions) Act 1997).

Virgin Holdings- comity

The decision of Edmonds J

51. In Virgin Holdings, Edmonds J considered whether Australia was precluded from taxing a capital gain made by the applicant in that case, a company which was incorporated in, and a resident of, Switzerland, by the Business Profits Article (Art 7) of the DTA between Australia and Switzerland (the Swiss Agreement). The Swiss Agreement was entered into in 1980, was found in Schedule 15 to the Agreements Act, and was given the force of law in Australia by s 11E of that Act. His Honour also briefly addressed an argument that if Art 7 did not apply, then Art 13(3), which denied Australia the right to tax income from the alienation of capital assets in certain circumstances, applied. There is no equivalent to Art 13(3) in either the UK Agreement or the Netherlands Agreement.

52. His Honour commenced by considering whether tax imposed pursuant to the Pt IIIA règime fell within the Taxes Covered Article (Art 2) of the Swiss Agreement. Article 2 provided, relevantly, that the Swiss Agreement applied to "the Australian income tax" (subpara 1(a)), or any "identical or substantially similar tax" (para 2).

53. His Honour considered whether the expression "the Australian income tax" in the Swiss Agreement included tax imposed on a "net capital gain" under the Pt IIIA règime. The expression "the Australian income tax" was not defined in the Swiss Agreement which, in those circumstances, gave it the meaning that it had under Australian law.

54. Edmonds J referred (at [30]) to the definition of "Australian tax" in s 3(1) of the Agreements Act as meaning, relevantly, "income tax imposed as such by an Act". His Honour referred (also at [30]) to s 4(1) of the Agreements Act which provided, relevantly, that the ITAA 1936 was incorporated and to be read as one with the Agreements Act. He observed (also at [30]) that s 6(1) of the ITAA 1936 defined "income tax" or "tax" as


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meaning "... income tax imposed as such by any Act as assessed under [the ITAA 1936]".

55. Edmonds J decided (at [31]) that the expression "the Australian income tax" in subpara (1)(a) of Art 2 of the Swiss Agreement meant income tax as assessed under the ITAA 1936, and (at [49]) that the expression included tax on net capital gains under the Pt IIIA règime. His Honour referred (at [44]) to several examples of capital gains that were already included in assessable income under the ITAA 1936 when the Swiss Agreement was signed in 1980, as showing that income tax under the ITAA 1936 was not limited to tax on income in accordance with ordinary concepts. His Honour also referred to observations made in
Resch v Federal Commissioner of Taxation (1942) 66 CLR 198 (Resch) and
South Australia v The Commonwealth (1992) 174 CLR 235 (
South Australia v Commonwealth).

56. Edmonds J also concluded (at [58]) that if he was wrong in finding that the expression "the Australian income tax" included tax on net capital gains under the Pt IIIA règime, the latter tax was nevertheless a "substantially similar tax" to "the Australian income tax", and was for that alternative reason, a tax covered by the Swiss Agreement pursuant to Art 2(2) of that Agreement.

57. His Honour then went on to consider whether the capital gain made by the applicant fell within the Business Profits Article, Art 7, of the Swiss Agreement. That Article denied Australia the right to tax the "profits of an enterprise" of Switzerland unless the enterprise carried on business in Australia through a permanent establishment in Australia. The parties were agreed that the applicant did not carry on business through a permanent establishment in Australia.

58. The Commissioner in that case had sought to argue that, having regard to the existence of Art 13 of the Swiss Agreement headed "Alienation of Property", Art 7 was concerned only with revenue profits of an enterprise. Edmonds J did not agree, concluding (at [72]) that Art 7(1) of the Swiss Agreement denied Australia the right to tax the capital gain concerned.

Relevance of Virgin Holdings to the First Proceeding and the Second Proceeding

59. The Commissioner submits in the First Proceeding that Virgin Holdings is distinguishable, and in both proceedings that I should not consider myself obliged by considerations of comity to follow Virgin Holdings.

60. First, he submits that the terminology of the UK Agreement differs from that of the Swiss Agreement that was before Edmonds J. In support of this submission, the Commissioner refers to the UK Agreement's use of the expression "the Commonwealth income tax" rather than "the Australian income tax" in the Taxes Covered Article. He also refers to differences between the Business Profits Articles of the two Agreements: Art 5 of the UK Agreement and Art 7 of the Swiss Agreement. Article 5 of the UK Agreement uses the expression "industrial or commercial profits" which is defined in para (7) of that Article to mean "income derived by an enterprise from the conduct of a trade or business..." (see [22] above). Article 7 of the Swiss Agreement, on the other hand, uses the expression "profits" which it does not define.

61. In my view, there is no substance in the difference between the expressions "the Commonwealth income tax" and "the Australian income tax". However, the Commissioner's submission in relation to the definition of "industrial or commercial profits" is of more substance. I address the meaning of that expression at [112]ff below.

62. Second, the Commissioner submits that the UK Agreement was entered into 13 years before the Swiss Agreement was entered into, and, in particular, that it was entered into before the Parliament inserted s 26AAA into the ITAA 1936 in 1973 (by s 7 of the Income Tax Assessment Act (No 5) 1973 (No 165 of 1973) with effect from 11 December 1973).

63. In my view it is not to the point that s 26AAA was not introduced into the ITAA 1936 until 1973, and therefore did not form part of that Act when the UK Agreement was signed. Edmonds J referred to s 26AAA only as one of several illustrations of the inclusion of capital gains in assessable income. His Honour's adoption (at [44]) of the examples given in the submissions (noted at [38]) supported a proposition that rested on the reasons for judgment in Resch of Rich J at 210-211 and Dixon J (as Dixon J then was) at 224-225, and the reasons of the majority joint judgment in
South Australia v Commonwealth at 251. (I refer to Resch at [94]-[97] below and to
South Australia v Commonwealth at [100] below). Edmonds J stated (at [45]) that Pt IIIA was introduced into the ITAA 1936 as part of the same legislative scheme and history as were referred to by Dixon J in Resch and by the majority in
South Australia v Commonwealth.

64. His Honour relied on the fact that if the relevant transactions had occurred at the time of the conclusion of the Swiss Agreement, when s 26AAA was still in the ITAA 1936, they would have been assessed under that provision, only as fortifying his earlier conclusion that the term "the Australian income tax" under the relevant laws of Australia accommodated and encompassed, at the time of the conclusion of the Swiss Agreement, the assessment of capital gains as income (at [48]).

65. In sum, the unavailability of the s 26AAA example in respect of the UK Agreement does not serve to make Virgin Holdings distinguishable.

66. The Commissioner recognises that, in relation to the Second Proceeding, the precise wording of the Swiss Agreement differs from that of the Netherlands Agreement in various respects, but does not suggest that the provisions of the Swiss Agreement were materially distinguishable from those of the Netherlands Agreement.


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67. I turn now to the comity aspect.

Judicial comity

68. The notion of judicial comity raises interesting questions. I am not bound to follow Edmonds J in Virgin Holdings, it being a decision of co-ordinate authority. However, the answers to the following questions are not so obvious. In what circumstances, if at all, am I bound to accord influence to his Honour's decision? Am I bound independently to reach my own conclusion? If so, and my conclusion does not accord with that of his Honour, by reference to what principles, if at all, am I at liberty to discard my own conclusion in favour of his Honour's?

69. Before referring to the authorities, I will state my understanding of the role of considerations of judicial comity by reference to the task confronting me.

70. First, I must embark on my own independent consideration of the issues for decision with a view to reaching my own independent conclusion on them. The oath of judicial office requires me to do no less. If my own conclusion, independently reached, is consistent with his Honour's, there is no scope for his decision to influence me beyond "fortifying" me in my conclusion.

71. Second, I must not follow his Honour should I reach the view that his Honour was "clearly" or "plainly" wrong.

72. Third, I may (not must) follow his Honour's (supposedly inconsistent) decision once it is clear that that decision is not "plainly" or "clearly" wrong.

73. Fourth, accepting the strong desirability of certainty and stability in judicial decision-making in the administration of justice, I will in fact follow his Honour's inconsistent decision unless I conclude that it was clearly or plainly wrong, or that for some other reason those same interests of justice demand that I adhere to my own conclusion in preference to his Honour's supposedly erroneous one.

74. While the expression "clearly wrong" and "plainly wrong" may be open to criticism, they usefully remind the later judge of the interests of justice in consistency of decision-making in a system of which the individual judge is but a part. The "choice" to follow an earlier inconsistent decision of co-ordinate authority is, however, as a matter of law, discretionary and depends on the circumstances of a particular case. These will properly include considerations of the length of the period during which the earlier decision has stood, and whether it has been relied upon in the arrangement of human affairs.

75. I turn now to the authorities to which I was referred.

76. Submitting that I should follow Virgin Holdings, the applicants cite
Cooper v Commissioner of Taxation (2004) 139 FCR 205 at [46]-[47] per Lander J and
Hicks v Minister for Immigration, Multicultural & Indigenous Affairs [2003] FCA 757 at [76] per French J. In the first case, Lander J followed a statement by me in
Bank of Western Australia Ltd v Commissioner of Taxation 94 ATC 4815; (1994) 55 FCR 233 at 255 that I would follow a certain earlier decision unless I thought it was "clearly wrong". In the second case, French J accepted (at [75]) that it was well established that a judge of this Court should follow an earlier decision of another judge of the Court unless of the view that the earlier decision was "plainly wrong". French J added (at [76]) that where questions of law and statutory construction are concerned, the proposition that a judge who had taken one view of the law or statute was "clearly wrong" was one not lightly to be advanced having regard to the choices that so often confront the courts, particularly in the area of statutory construction.

77. The Commissioner relied on a decision of the Court of Appeal of the Supreme Court of Western Australia in
Mustac v Medical Board of Western Australia [2007] WASCA 128 (Mustac). After reviewing the authorities, Martin CJ, with whom Wheeler JA and Buss JA agreed, said (at [46]) that the authorities showed that judicial comity is a practice, not a legal principle, the practical application of which varied depending on the circumstances of the two cases in question. Martin CJ quoted from a judgment of Priestley JA in
R v Hookham (1993) 31 NSWLR 381 (Hookham) at 391, in which Priestley JA observed:

"... it seems inescapable that [the New South Wales Court of Appeal] retains jurisdiction to reach its own decision, different from that of the other court [with the same standing in its jurisdiction as the New South Wales Court of Appeal has in New South Wales], in a case where it feels convinced that the law and justice of the case require a different decision ."

(my emphasis)

78. In relation to the relevant circumstances here, the Commissioner points out that:

  • • the issue that was decided in Virgin Holdings is not one that had been previously decided;
  • • the decision in Virgin Holdings was given only as recently as 10 October 2008; and
  • • it could not be said that taxpayers had relied upon existing binding authority in organising their affairs.

79. I do not see the approach taken by the Western Australian Court of Appeal in Mustac to be in conflict with the practice to which Lander J and French J (and I) referred. Clearly, and inevitably, their Honours accepted that an earlier decision of a court of coordinate authority is not required, as a matter of binding judicial precedent, to be followed. Moreover, French J quoted the following passage from the judgment of Burchett J in
La Macchia v Minister for Primary Industries and Energy (1992) 110 ALR 201 at 204:

"... the authorities illustrated that [the approach of usually following a decision of another judge as a matter of judicial comity] may be influenced, either towards or away from an acceptance of the earlier decision, by circumstances so various as to be difficult to comprehend within a single concise formulation of principle ..."

(my emphasis)

80. Similarly, in Re McKean (unreported, Federal Court of Australia, 16 April 1996), Burchett J pointed out that in the circumstances of a particular case, other considerations may prevail over considerations of comity.

81. Since writing what appears at [68]-[80] above, I have become aware that the issue of comity has been the subject of considerable judicial discussion to which the parties did not refer. In
Fernando v Commissioner of Police (1995) 36 NSWLR 567 (Fernando) the New South Wales Court of Appeal (NSWCA) considered the matter. The question was whether the NSWCA should follow a decision of the Full Court of the Supreme Court of South Australia in
R v Franklin (1979) 22 SASR 101 (Franklin) on a statutory provision in substantially identical words to those of the relevant New South Wales statute. All three members of that Court thought that the South Australian Full Court's construction of the provision had been wrong. Priestley JA described (at 584) the "rule of comity" as a "sound one for most purposes", such that the NSWCA "usually follows the decisions of courts of like position in other Australian jurisdictions on similar points". Priestley JA said (also at 584) that the reasons favouring the construction of the provision which his Honour thought to be right, were "so strong" that an exception should be made to the "rule of comity". Powell JA was of a similar view, going as far as to describe the South Australian decision as "clearly wrong" (at 593). However, Clarke JA, while also preferring the construction favoured by Priestley JA and Powell JA, considered (at 591) that the question was one on which minds could reasonably differ and that Franklin was not "plainly wrong". Applying as a matter of comity a rule that the NSWCA should follow a decision of another Australian intermediate appellate court on the construction of the substantially identical statutory provision unless "it is convinced that the earlier decision is clearly wrong or that considerations of justice require the court to decline to apply the decision of the other court" (at 589-590), his Honour decided that Franklin should be followed.

82. In
R v Dyson (1997) 68 SASR 156 (Dyson) the Supreme Court of South Australia Court of Criminal Appeal was specially constituted as a bench of five members to consider the conflict between Franklin and Fernando. Bollen J distinguished Fernando. All other four judges, and Bollen J in the alternative, considered that Franklin was correct and Fernando incorrect.

83. The issue of comity as between intermediate appellate courts was again discussed by the NSWCA in
Tillman v Attorney-General for the State of New South Wales (2007) 70 NSWLR 448 (Tillman). Tillman was decided on 26 November 2007, not longer after Muscat which had been decided on 21 June 2007. The judgments in Tillman do not refer to either Dyson or Muscat.

84. In Tillman, Giles and Ipp JJ A, in a joint judgment, declared themselves (at [110]) in favour of following a decision of the Victorian Court of Appeal in
TSL v Secretary to the Department of Justice (2006) 14 VR 109 (TSL) because it was not "plainly wrong".

85. Mason P took a different approach. The learned President recognised that the Victorian legislation in question was relevantly indistinguishable and was not convinced that the Victorian decision was plainly wrong, yet departed from it in favour of his own firmly preferred different interpretation (at [19]). His Honour appears to have been content to accept the "not plainly wrong" or "not clearly wrong" formulation. He acknowledged (at [25]) that there was "a rule of precedent obliging intermediate appellate courts not to depart from decisions in intermediate appellate courts in another jurisdiction [but only] on the interpretation of (a) Commonwealth legislation or (b) uniform national legislation or (c) the common law of Australia unless convinced of plain error". The statutory provisions before the Victorian and NSWCA in TSL and Tillman respectively were State enactments that were not part of a uniform national scheme.

86. Although Virgin Holdings is not a decision of a court of another jurisdiction, that case and the present proceedings concern the interpretation of Commonwealth legislation and DTAs that are given the force of law in Australia by that legislation. In this respect, therefore, the circumstances fall within class (a) identified by Mason P. Assuming it to be indistinguishable, I will follow Virgin Holdings unless I consider it to be clearly wrong or plainly wrong.

87. Interestingly, in their joint judgment in Tillman, Giles and Ipp JJ A stated (at [110]):

"The place now occupied by the Federal Court in the Australian legal system adds to its unity, and to the desirability of consistency in the interpretation of substantially similar non-national legislation."

In the light of such a statement, it would be a most unwelcome irony if single judges of this Court did not respect the strong desirability of consistency in their decision making.

88. I note that the applicants did not suggest that I am relieved by considerations of judicial comity of the necessity of embarking on a full consideration of the parties' submissions with a view to arriving independently at my own conclusion, and in my view, I am obliged to do so.

The UK Agreement - consideration

89. The sole issue in dispute is whether Art 5 of the UK Agreement prohibits the taxation in Australia of the capital gain made by the First Applicant. In order for Art 5 to have that effect, the tax that would otherwise be levied on the capital gain must be a tax covered by the UK Agreement according to its Taxes Covered Article, Art 1.

90. I set out the relevant provisions of the UK Agreement at [18]-[23] above, and I summarised the parties' contentions at [24]-[26] above.

91. The dispute centres around the term "the Commonwealth income tax" (which was not defined in the UK Agreement) and the term "industrial or commercial profits" (which it will be recalled was defined by Art 5(7) to mean "income derived by an enterprise from the conduct of a trade or business...").

92. The term income is relevant to the meaning of both expressions, but it too is undefined in the UK Agreement. I therefore turn to its meaning in the ITAA 1936 (see [26] above).


ATC 9356

The meaning of the term "income" in the ITAA 1936

93. Both before and since the enactment of the ITAA 1936, it has been judicially recognised by the highest authority that the concept of income for income tax purposes extended to include amounts that were not income according to ordinary concepts.
Scott v Commissioner of Taxation (1935) 35 SR(NSW) concerned the Income Tax (Management) Act 1928 215 (NSW) which provided for the assessment and collection of a tax on incomes. Jordan CJ said (at 219):

" 'Income Tax,' said Lord Macnaghten, 'If I may be pardoned for saying so, is a tax on income':
London County Council v Attorney-General ([1901] A.C. 26 at 35);
Seymour v Reed ([1927] A.C. 554 at 560). The word 'income' is not a term of art, and what forms of receipts are comprehended within it and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income , or that special rules are to be applied for arriving at the taxable amount of such receipts: ..."

(my emphasis)

94. Perhaps the leading authority on the broad nature of the "income" which is the subject of the Commonwealth income tax is Resch. The question in Resch was whether the Income Tax Assessment Act 1922 (ITAA 1922) and the Income Tax Act 1930 infringed s 55 of the Constitution by reason of their dealing with more than one subject of taxation by bringing to charge profits of a capital nature as well as profits in the nature of income according to ordinary concepts. Section 16B of the ITAA 1922 deemed to be assessable income of a company's shareholders, amounts which the liquidators of the company received as the proceeds of the sale by them of the company's assets and which they paid to the shareholders.

95. At 213, Starke J said (at 213):

"Income is as large a word as can be used to denote a person's receipts (
Re Huggins;
Ex parte Huggins [(1882) 51 LJ Ch 935 at p938]); it signifies that which comes in. An 'Act to impose a tax upon incomes' is not less general in scope; it must be liberally construed, and include everything which by reasonable understanding might fairly be regarded as income."

96. In a separate judgment, Rich J observed (at 210-211):

"It is maintained that the Act does not confine itself to one subject of income but extends to another subject of taxation, namely, capital profits. The subject is profits or gains, and the distinction between gains of an income nature and gains of a capital nature is neither instituted nor maintained by the assessment Act. An income-tax Act usually groups together more than one subject of income, profit, revenue or receipts, but such a grouping does not necessarily involve the conclusion that these subjects are separate and distinct. It is a question of fact in each case and the substance and provisions of the particular Act must be considered. That a particular label or a general name has been given to the Act is of little or no importance where there is no ambiguity in the provisions of the Act. The word 'income' is comprehensive enough to include the subjects dealt with in the Act, and its use in this connection is in accordance with common understanding, which is one main clue to the meaning of the legislature: Cf.
Bank of Toronto v Lambe [(1887) 12 App Cas 575 at 582]. Over and over again, this Court has upheld the validity of the Act by deciding that its subject matter is single and has been dealt with by Parliament as a unit."

97. In the same case, Dixon J observed (at 224-225):

"The subject of the income tax has not been regarded as income in the restricted sense which contrasts gains of the nature of income with capital gains, or actual receipts with increases of assets or wealth. The subject has rather been regarded as the substantial gains of persons or enterprises considered over intervals of time and ascertained or estimated by standards appearing sufficiently just, but nevertheless practical and sometimes concerned with avoidance or evasion more than with accuracy or precision of estimation.

...

We ought, I think, to hold that all the particular provisions upon which reliance is placed, and to which I have referred, have a sufficient connection with and relevance to the substantial subject upon which tax is imposed by the Income Tax Act 1930. They are in fact attempts to ensure that where income or profit has been earned or wealth increased, those whom it advantages shall at some point or other incur a proper measure of liability to tax on that account, or, in other words, that they shall not escape the consequent aggregation of taxable income. The distinction between profits of a capital nature and profits in the nature of income in the strict sense is not one which the Act maintains. Nor is it a discrimination which the legislature is bound to regard. Indeed, in the United States, under the 16th Amendment which speaks of 'income,' the term is considered to include all profits whether on account of capital or on account of income in the strict sense. In
United States v Stewart [(1940) 311 US at p 62] Douglas J. says: '"Income" is a generic term amply broad to include capital gains for purposes of income tax,' citing
Merchants' Loan & Trust Co. v. Smietanka [(1921) 255 US 509]. On the other hand, a distribution of stock dividends in consequence of the capitalization of profits is considered to be a transaction in relation to capital and therefore outside the constitutional power (
Eisner v Macomber [(1920) 252 US 189]). The Commonwealth enactment proceeds somewhat differently; it treats the appropriation of income in order to effect the capitalization as the occasion of taxing the shareholder: See
James v Federal Commissioner of Taxation [(1924) 34 CLR 404] and
Nicholas v Commissioner of Taxes (Vict.) [(1940) AC 744; 63 CLR 191]. In requiring the inclusion of the paid-up value of shares distributed by a company representing the capitalization of profits sec. 16(b)(ii) does not appear to me to introduce a new subject of taxation. The subject is profits and the occasion is the appropriation of the profits to be used for the advantage of the shareholder." (my emphasis)

98. The term "income" has never been defined in the ITAA 1936. However, when it was enacted, the ITAA 1936 brought to charge as "assessable income" a wide range of classes of amounts, many of which were not income according to ordinary concepts.

99. In
Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540, Dixon CJ and Williams J stated (at 555):

"[The ITAA 1936] begins with the general conception of gross income and specifies in s 23 what is exempt and in s 26 and other sections particular classes of income that are to be included. Sometimes these classes of income appear to be specified simply for greater certainty, sometimes because they do not fall within the natural understanding of gross income ..."


ATC 9357

100. In
South Australia v Commonwealth at 251, Mason CJ, Deane, Toohey and Gaudron JJ, after referring to Dixon J's statement in Resch that the ITAA 1922 did not maintain the distinction between profits of a capital nature and profits in the nature of income in the true sense, observed as follows:

" 'Income' is a generic term which, in the United States, has been regarded as wide enough to include capital gains for purposes of income tax .... Nonetheless, it is correct to say of [the ITAA 1936], as Starke J. said of the Income Tax Assessment Act 1922, that income tax 'is not a tax upon everything that comes in whether as income receipt or a capital receipt' [
New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 at 197]."

101. The breadth of the nature of "income" for the purposes of income tax statutes recognised in these cases is demonstrated by the fact that when the UK Agreement was signed in 1967, the ITAA 1936 already included in assessable income several amounts that were not income in accordance with ordinary concepts. In Virgin Holdings, Edmonds J referred, inter alia, to the following examples (at [38]):

  • • Notional amounts that were not derived by the taxpayer at all; eg where stock was disposed of at less than market value and outside the ordinary course of trade, the market value was included in assessable income (s 36 of the ITAA 1936, re-enacting s 17(3) of the ITAA 1922); and, where its criteria were satisfied, amounts caught as a result of the operation of s 260 of the ITAA 1936;
  • • Distributions by a liquidator in satisfaction of a shareholder's interest in a company to the extent to which they represented income derived by the company (s 47 of the ITAA 1936);
  • • Consideration received on the disposal of property in respect of which depreciation had been allowed, to the extent that the consideration exceeded the depreciated value (s 59 of the ITAA 1936);
  • • Gains made on the disposal of capital assets in cases where certain circumstances of acquisition were met (s 25A and its predecessor s 26(a) of the ITAA 1936 - s 26(a) formed part of the ITAA 1936 from its commencement, but its predecessor, para (ba) of the definition of "income" in s 4 of the ITAA 1922, had been introduced into that definition by s 2(c) of Act No 50 of 1930).

The meaning of the expression "the Commonwealth income tax" in 1967

102. The expression of present interest is not "income" in isolation but the expression "the Commonwealth income tax" in Art 1(1)(b). As mentioned, this expression was not defined in the UK Agreement. Nor was the expression defined in the ITAA 1936. It has not subsequently been defined in either the ITAA 1936, or its successor, the ITAA 1997.

103.


ATC 9358

However, in 1967 this was a well-known category of tax - the tax imposed by the Commonwealth on "income" as assessed under the ITAA 1936. Section 6(1) of the ITAA 1936 defined "income tax" to mean "income tax ... imposed as such by any Act, as assessed under the [ITAA 1936] or under that Act as amended at any time " (my emphasis).

104. As noted at [101] above, the ITAA 1936 imposed tax on certain amounts coming in on capital account at the time when the UK Agreement was entered into in December 1967.

105. It would be artificial and unreasonable to construe the expression "the Commonwealth income tax" as the tax imposed as income tax on only some of the categories of income referred to in the Commonwealth's income tax statute. Indeed, the ITAA 1936 did not (and nor does it or its successor, the ITAA 1997, now) separately impose tax on particular amounts or categories of income making up a taxpayer's assessable income. It imposed tax on taxable income which is an amount equal to the total of assessable income minus the total of (allowable) deductions.

106. It cannot be accepted that "the Commonwealth income tax" referred, in 1967, to the income tax that was notionally imposed on only those categories of income brought to tax by the ITAA 1936 that merited the description "income according to ordinary concepts" or "income on revenue account", and that omitted all other categories of income that were brought to tax by the same income tax statute.

The meaning of the expression "the Commonwealth income tax" - an ambulatory or static meaning

107. The Commissioner also suggests that the reference to "the Commonwealth income tax" in the UK Agreement is a reference only to tax for which the ITAA 1936 provided at the instant when the UK Agreement was signed (a "static" meaning), and that all changes subsequent to 7 December 1967 were intended to be catered for by para (2) of Art 1. I disagree.

108. To my mind, the expression "the Commonwealth income tax" refers to tax imposed at any time and from time to time by the Commonwealth Parliament as what that Parliament characterised as an "income tax" (see [103] above). That is to say, the expression "the Commonwealth income tax" is the tax for the assessment of which the ITAA 1936 or, its successor, the ITAA 1997, provided or might provide at any time and from time to time (an "ambulatory" meaning). The expression "the Commonwealth income tax" does not refer to the income tax for the assessment of which the ITAA 1936 provided only as at the time when the UK Agreement was entered into.

109. An ambulatory approach has been supported by leading commentators: see Avery Jones et al, The Interpretation of Tax Treaties with Particular Reference to Article 3(2) of the OECD Model (1984) BTR 14 at 25 - 48, esp at 47 - 48; Gzell J, Treaty Application to a Capital Gains Tax Introduced After Conclusion of the Treaty (2002) 76 ALJ 309 at 316 - 317; Deutsch R and Sharkey N, Australia's Capital Gains Tax and Double Taxation Agreements (2002) 56(6) Bulletin for International Taxation 228 at [3.2] and [3.3].

110. In my view, while subsequent amendments to the Commonwealth Act providing for the assessment of an "income tax" were


ATC 9359

intended to be accommodated within the expression "the Commonwealth income tax" in subpara (1)(b) of Art 1, para (2) of Art 1 is directed to the different idea of an independently assessed tax. (An Australian example of an independently assessed tax is the Goods and Services Tax for which the A New Taxation System (Goods and Services Tax) Act 1999 (Cth) provides).

111. It follows that the amendment to the ITAA 1936 by the introduction of the Pt IIIA règime in 1986 formed, at the time when the First Applicant made its capital gain, part of the Commonwealth income tax referred to in Art 1(1)(b), and is therefore a tax covered by the UK Agreement.

The meaning of the expression "industrial or commercial profits"

112. It will be recalled that the term "industrial or commercial profits" was defined in the UK Agreement to mean "income derived by an enterprise from the conduct of a trade or business..." (Art 5(7)). I referred at [92] above to the fact that the term "income" was not defined in the UK Agreement, and at [93]ff above, to the meaning that that term had under the ITAA 1936 at the time when the UK Agreement was entered into, and, in particular, to the fact that the term included a reference to amounts that were not income according to ordinary concepts.

113. However, pursuant to Art 2(4), that meaning of the term "income" applies only if the context does not otherwise require. The Commissioner points to a number of contextual factors in the UK Agreement which he submits demonstrate that the expression "industrial or commercial profits" refers only to revenue profits, and has no operation in relation to capital gains.

114. First, the Commissioner points to the distinction between income and capital that is maintained elsewhere in the UK Agreement, such as in the title: "Taxes on Income and Capital Gains"; and in Art 1(1)(a) which refers to "the income tax...and the capital gains tax" of the UK. The Commissioner submits that this distinction shows that where the term "income" is used elsewhere in the UK Agreement, such as in Art 5, it refers only to income of a revenue nature.

115. Second, the Commissioner relies on the definition of "industrial or commercial profits" in para (7) of Art 5 as "income derived by an enterprise from the conduct of a trade or business". The Commissioner argues that capital receipts would not usually arise from the normal conduct of a trade or business.

116. Third, the Commissioner refers to Art 5(4) which applies if an enterprise resident in one of the two countries has industrial or commercial profits attributable to a permanent establishment in the other country. The industrial or commercial profits that are taxable in the country of source are to be determined after allowing "as deduction all expenses of the enterprise ... which would be deductible if the permanent establishment were an independent enterprise and which are reasonably connected with the profits so taxable ...". The Commissioner points out that a net capital gain is not determined by subtracting expenses of the enterprise, but rather as the difference between capital proceeds and a cost base (see s 100-40(1) of the ITAA 1997). The Commissioner submits that therefore para (4) of Art 5, which is expressed to apply to all industrial and commercial profits, cannot be applied to capital gains.

117. Fourth, the Commissioner draws attention to the exclusions in subpara (a)-(c) of the definition of "industrial or commercial profits" in Art 5(7) (set out at [22] above). He points out that all three exclusions refer to receipts that are income according to ordinary concepts.

118. Fifth, the Commissioner refers to Art 13 of the Draft Convention which provided for the allocation of taxing rights in respect of, to quote its heading, "Capital Gains". The Draft Commentary stated that Art 13 was "applicable only when the laws of one or both Contracting States provide[d] for the taxation of such gains". Article 13 was omitted from the UK Agreement. The Commissioner submits that the Commentary referred to is consistent with Art 13 having been omitted intentionally because Australia did not impose a tax on capital gains. It follows, according to the Commissioner, that the UK Agreement was not intended to allocate taxing rights in respect of capital gains.

119. Sixth, the Commissioner points to Art 19 of the UK Agreement which is the operative provision affording relief from double taxation. It provides:


ATC 9360

  • "(1) Subject to the provisions of the law of the United Kingdom regarding the allowance as a credit against United Kingdom tax of tax payable in a territory outside the United Kingdom ...
    • (a) Australian tax payable under the laws of Australia in accordance with this Agreement, whether directly or by deduction, on profits, income or chargeable gains from sources within Australia ..., shall be allowed as a credit against any United Kingdom tax computed by reference to the same profits, income or chargeable gains by reference which the Australian tax is computed; and
    • ...
  • (2)
    • (a) Subject to the provisions of the law of Australia from time to time in force and which relate to the allowance of a credit against Australian tax of tax payable in a country outside Australia ..., United Kingdom tax payable under the laws of the United Kingdom and in accordance with this Agreement ..., whether directly or by deduction, on income derived by a resident of Australia from sources in the United Kingdom ... shall be allowed as a credit against the Australian tax assessed by reference to the same income by reference to which the United Kingdom tax is payable;
    • ...
  • ..."
  • (my emphasis)

The Commissioner points to the fact that where "profits, income or chargeable gains" are liable to tax in Australia, they are not to be liable to tax in the UK, and where "income" only derived by an Australian resident in the UK is liable to tax in that country, it will not be taxed in Australia. The Commissioner submits that this is consistent with the notion that it is the Australian tax on income only which is the subject of the exclusionary provisions, such as Art 5, of the UK Agreement.

120. In my view, while relevant, none of the submissions made by the Commissioner persuade me that the parties did not intend to adopt the expansive notion of income that underlay the ITAA 1936, which already included in 1967 certain amounts that were gains on capital account. I will address the Commissioner's arguments in turn.

121. In relation to the first argument, the references to income and income tax on the one hand and to capital gains and capital gains tax on the other can be explained by the fact that in the UK in 1967 there was an independent capital gains tax (see Pt III of the Finance Act 1965 (UK) entitled "Capital Gains"). The Commentary to Pt III of the Finance Act 1965 stated that "This Part of the Act ... imposes a new tax called "capital gains tax" which is distinct from income tax, ...". Section 19(3) provided that "Subject to the said provisions, a tax, to be called capital gains tax, shall be assessed and charged for the year 1965-66 and for subsequent years of assessment...". The terms of the UK Agreement had to be wide enough to embrace the income taxes of both Australia and the UK, as well as the then recently introduced UK capital gains tax. There was no occasion to take into account a comparable Australian independent capital gains tax, because none existed. Those capital gains that were taxed fell within a taxpayer's "assessable income", and were liable to income tax.

122. In relation to the Commissioner's second argument, I do not think that either the expression "carries on trade or business" in Art 5(1) or the expression "the conduct of a trade or business" in Art 5(7) is to be read so as to require continuing or repeated business activities so as to stamp the word "profits" or "income" in those articles respectively with a revenue character: cf Thiel at 343-345 per Mason CJ, Brennan and Gaudron JJ; 347-352 per Dawson J; 355-361 per McHugh J.

123. The Commissioner's third argument does not persuade me. Paragraph 4 of Art 5 may raise a question as to the interaction of the deductibility provided for in that paragraph, the measurement of net capital gains under the Pt IIIA règime and the general deductibility provisions of the ITAA 1936 and the ITAA 1997, but any complexity involved does not, to my mind, show an intention to confine the operation of Art 5 of the UK Agreement in the manner contended by the Commissioner.

124. The Commissioner's fourth argument is likewise unpersuasive. The circumstance that the three exclusions happen to be items of income according to ordinary concepts does not mean that "income" as used earlier in that paragraph refers only to income according to ordinary concepts.

125. I note in relation to the Commissioner's fifth argument the Commissioner's submission (noted at [42] above) that it was not only the Draft Convention, but also the Colonial Model Treaty on which the parties relied in formulating the provisions of the UK Agreement, and that Art 5 should be interpreted by applying the ordinary principles of statutory construction to the text. I agree with that submission. I therefore draw no assistance from the fact that Art 13 of the Draft Convention or a provision similar to it was not carried forward into the UK Agreement.

126. Nor am I persuaded by the Commissioner's sixth argument. The expression "profits, income or chargeable gains" was no doubt chosen as an expansive catch-all expression intended to be capable of application generally to all amounts that might be subjected to tax by both countries.

127. It follows that Art 5 of the UK Agreement is not, in my opinion, limited in its potential application to "revenue profits" or "income according to ordinary concepts", but extends to "capital profits", including the capital gain made by the First Applicant.

An alternative reason why the tax imposed on capital gains pursuant to the Pt IIIA règime was covered by the UK Agreement - Art 1(2)

128. The First Applicant submits that even if the tax on net capital gains for which the Pt IIIA règime provided does not fall within the expression "the Commonwealth income tax" in para (1)(b) of Art 1 (I concluded that it does fall within that expression at [111] above), it is nonetheless a "substantially similar tax" within para (2) of Art 1. The First Applicant puts its argument in two ways.

129. First, the First Applicant submits that the tax on net capital gains imposed by the Pt IIIA règime is a "substantially similar tax" to "the Commonwealth income tax". In this respect, the First Applicant relies on the reasons given by Edmonds J in Virgin Holdings at [54]-[58] with respect to the Swiss Agreement. The First Applicant submits that a similar conclusion was reached in both Canada and Ireland, citing
Gadsden v Minister of National Revenue [1983] CTC 2132; 83 DTC 127 at 132;
Gladden Estate v Minister of National Revenue [1985] 1 CTC 163; 85 DTC 5188; and
Kinsella v Revenue Commissioners [2007] IEHC 250. The First Applicant also submits that this approach is consistent with that of the commentator Klaus Vogel in Klaus Vogel on Double Tax Conventions (Kluwer Law International, 1997) at p 157 where the author states:

"Taxation of capital gains is normally dealt with in income tax laws, though in some instances separate legislation is devoted to that subject (...). Consequently, any new capital gains tax will for treaty purposes normally have to be considered as being at least similar to income tax; ...."

130. Resolution of the issue that arises under Art 1(2) requires me to make assumptions, the nature of which are not obvious. If the assumption to be made is that the Pt IIIA règime tax is not within the expression "the Commonwealth income tax" because the latter expression embraces only tax on income according to ordinary concepts, then the Pt IIIA règime tax is not substantially similar to "the Commonwealth income tax". But to construe "the Commonwealth income tax" so narrowly would also mean that tax on the various other forms of capital gain that the ITAA 1936 included in a taxpayer's assessable income as at the time of the signing of the UK Agreement (referred to at [101] above) would likewise be excluded, and tax on them would also not be a "substantially similar tax" to "the Commonwealth income tax".

131. In my view, the only assumption to be made for the purposes of Art 1(2) is that the Pt IIIA règime tax is not within the expressions "the Commonwealth income tax" and I am not to go further and make any assumptions as to the reason. The Pt IIIA règime tax can then be seen to be substantially similar to the remaining tax for which the ITAA 1936 provided, if for no other reason than because other kinds of capital gains remain included in a taxpayer's assessable income.

132.


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In my view, the capital amounts that formed part of the Australian income tax base in 1967 (referred to at [101] above), and the broad nature of "income" for Australian income tax purposes (referred to at [93]-[100] above) suffice to show that tax hypothetically imposed pursuant to the Pt IIIA règime regarded in isolation would be substantially similar to the tax hypothetically assessed pursuant to the ITAA 1936 as it stood in 1967 without Pt IIIA.

133. The second submission made by the First Applicant is that the tax on capital gains under the Pt IIIA règime is a "substantially similar tax" to the UK capital gains tax referred to in Art 1(1)(a). The tax that is hypothetically imposed by the Pt IIIA règime regarded in isolation is to be compared not only with "the Commonwealth income tax" referred to in subpara (b) of Art 1(1), but also with the "income tax ..., the corporations tax and the capital gains tax" of the UK referred to in subpara (a) of Art 1(1). Again, I make no assumption as to the reasons why the Pt IIIA règime tax does not (hypothetically) fall within the expression "the Commonwealth income tax".

134. I referred to the UK capital gains tax that existed in 1967 when the UK Agreement was signed at [121] above. That tax was only applicable to individuals. The capital gains made by corporations were taxed by means of the corporations tax. The inclusion of both the UK capital gains tax and the UK corporations tax as taxes covered by the UK Agreement suggests that the parties would have regarded an Australian tax imposed on capital gains, whether through the existing income tax or by means of a new tax, on either individuals or corporations, or both, subsequent to the signing of the UK Agreement, such as the tax hypothetically imposed by the Pt IIIA règime regarded in isolation, as "substantially similar" to either of the UK taxes referred to or to both of them viewed in combination.

135. In sum, if I should be wrong in thinking that the tax introduced on the tax base as enlarged by the Pt IIIA règime fell within the notion of the "Commonwealth income tax" of subpara (1)(b) of Art 1 of the UK Agreement, nonetheless it was a tax substantially similar either to that tax or to the UK capital gains tax (or the UK corporations tax) referred to in Art 1(1)(a), or to both of them viewed in combination, and was therefore one of the taxes covered by the UK Agreement.

Conclusion in respect of the UK Agreement

136. It follows that the tax on the capital gain made by the First Applicant referred to at [7]-[9] above is subject to the provisions of the UK Agreement by reason of Art 1(1)(b) (or in the alternative, Art 1(2)) of that Agreement and is exempt from Australian tax by reason of Art 5 of that Agreement.

The Netherlands Agreement - consideration

137. I set out the relevant provisions of the Netherlands Agreement at [28]-[34] above, and I referred to the parties' contentions in respect of the Netherlands Agreement at [35]-[37] above. I referred to the relevance of the Model Convention and Model Commentary at [43] above.

138. Senior counsel for the Commissioner summarised his argument in respect of the Netherlands Agreement in the following way:

"... it really comes down to the proposition that there are matters which would indicate from an Australian perspective that it was not intended when the [Netherlands Agreement] was entered into that it would comprehensively allocate the right to tax capital gains."

The Model Convention

139. The title of the Model Convention was "Model Convention for the Avoidance of Double Taxation with respect to taxes on Income and on Capital".


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Article 7 of the Model Convention

140. Article 7 of the Model Convention was in terms similar to those of Art 7 of the Netherlands Agreement. In particular, it was headed "Business Profits" and referred to "profits of an enterprise of a Contracting State". It contained in Art 7(7) a provision similar to that of Art 7(5) of the Netherlands Agreement, namely, that where profits of an enterprise within Art 7 include items of income dealt with separately in other Articles, then the provisions of those Articles were not affected by the provisions of Art 7.

141. The Model Commentary stated in respect of Art 7(7) (at para 31) that although it had not been found necessary to define the term "profits", it should be understood that that term when used in Art 7 and elsewhere in the Model Convention had a broad meaning including all income derived in carrying on an enterprise, and that such a broad meaning corresponded to the use of the term made in the tax laws of most OECD Member countries.

142. Paragraph 34 of the Model Commentary in respect of Art 7(7) explained that it had seemed desirable to lay down a rule of interpretation in order to clarify the field of application of Art 7 in relation to categories of income that were treated separately in other Articles but that were within the "profits" addressed in Art 7. The Model Commentary stated that para (7) of Art 7 gave first preference to the special Articles. It further stated:

"It follows from the rule that [Art 7] will be applicable to industrial and commercial income which does not belong to categories of income covered by the special Articles, ...."

Article 13 of the Model Convention

143. Article 13 of the Model Convention was headed "Capital Gains" and provided:

  • "1. Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.
  • 2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent established (alone or with the whole enterprise) or of such a fixed base, may be taxed in that other State.
  • 3. Gains from the alienation of ships or aircraft operated in international traffic, boats engaged in inland waterways transport or movable property pertaining to the operation of such ships, aircraft or boats shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.
  • 4. Gains from the alienation of any property other than that referred to in paragraphs 1, 2 and 3, shall be taxable only in the Contracting State of which the alienator is a resident."

144. The Model Commentary in respect of Art 13 noted (at para 1) that a comparison of the tax laws of the OECD Member countries showed that the taxation of capital gains varied considerably from country to country. It also noted (at para 2) that in some OECD Member countries, capital gains were taxed as ordinary income and therefore added to the income from other sources, whereas in others, capital gains were subjected to special taxes that were levied, mostly at special rates, on each capital gain or on the sum of the capital gains accrued during the year without regard to the other income (or losses) of the taxpayer.

145. Paragraph 3 of the Commentary on Art 13 noted that Art 13 did not deal with such questions, leaving it to the domestic law of each Contracting State to govern the question whether capital gains should be taxed and, if so, how. The Model Commentary continued (para 3):

"[Art 13] does not specify to what kind of tax it applies. It is understood that the Article must apply to all kinds of taxes levied by a Contracting State on capital gains. The wording of Article 2 [the Taxes Covered Article] is large enough to achieve this aim and to include also special taxes on capital gains."

146. Paragraph 33 of the Model Commentary noted in respect of Art 13 that Australia was reserving the right to propose changes to reflect the facts that Australia did not levy a capital gains tax and that the terms "movable property" and "immovable property" were not terms used in Australian law.

147.


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The Commissioner submits that the Model Convention is based upon a distinction between Art 13, which was a "code" that dealt comprehensively with capital gains, and Art 7, which was therefore confined in its operation to revenue profits.

Differences between the Netherlands Agreement and the Model Convention

148. There are differences between the Model Convention and the Netherlands Agreement including the following:

  • • The title to the Netherlands Agreement (set out [3] above), unlike the title to the Model Convention, contained no reference to "Capital".
  • • Article 13 of the Netherlands Agreement was headed "Alienation of Property", whereas Art 13 of the Model Convention was headed "Capital Gains".
  • • The provisions of Art 13 in the Netherlands Agreement referred to "income from the alienation of real property" as opposed to the "gains" from the "alienation of [movable/immovable] property" to which Art 13 of the Model Convention referred.
  • • Australia's reservation with respect to Art 13 was not referred to in the Netherlands Agreement, although, as noted at [146] above, it was referred to in the Model Commentary.

149. The Commissioner argues that, seen against the background of the Model Convention, those changes suggest a deliberate decision that taxing rights in respect of capital gains should be dealt with only on the limited basis that is found in Art 13 of the Netherlands Agreement.

150. Paragraphs 25 and 26 of the Commissioner's submissions in relation to the Second Proceeding are as follows:

  • "25. So far as the operation of Article 13 of the Dutch Agreement is concerned, it must be recognized that while the Model Convention contained Article 13 which dealt generally with the taxation of capital gains, Australia and the Netherlands did not include in the Dutch Agreement any provision dealing in a comprehensive way with capital gains. That non-inclusion was against the background of Australia's reservation [noted at [146] above]. Article 13 of the Model Convention was implemented in the Dutch Agreement in a modified form appropriate to the taxation regimes of Australia and the Netherlands.
  • 26. Against that background, the language used in Article 13 was significant. Whereas Article 13(4) of the Model Convention referred to ' gains from the alienation of any property', Article 13(1) of the Dutch Agreement refers to ' income from the alienation of real property'. Article 13(3) on the other hand refers to 'Gains from the alienation of shares or "jouissance" rights in a company ... which is resident in the Netherlands'. The appropriate conclusion is that the parties intentionally abandoned the word 'gain' in favour of the word 'income' in Article 13(1) because Australia did not impose a general capital gains tax and did not want the treaty to deal with such a tax in the event that it subsequently did introduce such a tax."

151. In oral submissions, senior counsel for the Commissioner submitted that the conclusion that should be drawn is that Art 7 of the Netherlands Agreement was intended to have the same operation as Art 7 of the Model Convention, and that the allocation of taxing rights in respect of capital gains was subject to a decision to deal with that topic only on the limited basis that is found in Art 13 of the Netherlands Agreement.

Consideration of the construction of the Business Profits Article (Art 7)

152. I do not accept the Commissioner's submission that the Model Convention and the Model Commentary show that the taxation of capital gains was not to be regulated by Art 7, which he submits was confined to dealing with revenue profits.

153. Article 7 applied to "[t]he profits on an enterprise". Section 3(2) of the Agreements Act provided:

"For the purposes of this Act and the Assessment Act, a reference in an agreement to the profits of an activity or business shall, in relation to Australian tax, be read where the context so admits, as a reference to taxable income derived from that activity or business."

154. Section 3(1) of the Agreements Act defined "the Assessment Act" to mean the ITAA 1936 or the ITAA 1997. Section 4(1) provided that subject to a qualification not presently relevant, the Assessment Act was incorporated and read as one with the Agreements Act.

155. The opening words of s 3(2), "[f]or the purposes of this Act" mean at least "for the purposes of the Netherlands Agreement having the force of law in Australia". Accordingly, for that purpose, s 3(2) requires us to read the reference to "profits" in Art 7 of the Netherlands Agreement as referring to the Second Applicant's taxable income derived from the carrying on of its business in Australia.

156. Provided the Second Applicant's capital gain is properly to be seen as being derived from the carrying on of its business in Australia, the conclusion seems inescapable that it falls within the "profits" of the Second Applicant within the scope of the Business Profits Article (Art 7). At least that is the case unless Art 13 produces a different effect.

157. I do not think that Art 13 produces a different effect. Whereas Art 13 of the Model Convention dealt in four paragraphs with the subject of "gains" from the alienation of classes of property that covered all alienable property, Art 13 of the Netherlands Agreement was confined to dealing with the subject of gains from the alienable property of particular specified classes of property that did not exhaust the field of all alienable property. Other gains that were taxed by taxes within the Taxes Covered Article (Art 2 considered at [162]ff below) were left to be the subject of the Business Profits Article (Art 7).

158. I do not accept the Commissioner's submission that the Netherlands Agreement was not intended to apply in respect of capital gains at all. In this respect, the Commissioner sought to rely on the following comments made by the Full Court of this Court in Lamesa Holdings (at 601B):

"Unlike more recent treaties, the [Netherlands Agreement] is concerned only with taxes on income. It has no direct concern with capital gains: cf the double tax agreement between the United Kingdom and Australia which refers specifically both to taxes on income and capital gains."

159. In my view, these observations and the omission of a reference to "capital gains" in the title to the Netherlands Agreement must be understood in light of the distinction between an independent tax on capital gains on the one hand (such as operated in the UK - see [121] above), and the encompassing of capital gains within the income tax base on the other hand. The Pt IIIA règime taxes capital gains only in the sense that it includes net capital gains in the income tax base, that is to say, as part of "assessable income". The fact that the title to the Netherlands Agreement refers only to "Income" and not to "Capital" is not inconsistent with this position.

160. My conclusion is supported by Art 6(a) of the Protocol to the Netherlands Agreement which stated:

"Where one of the States is entitled to tax the profits of an enterprise, that State may treat as profits of the enterprise, profits from the alienation of capital assets of the enterprise, not being profits that consist of income to which paragraph (1) of Article 13 applies."

This provision was agreed at the time of the signing of the Netherlands Agreement (see the preamble to the Protocol). The entitlement to tax the profits of an enterprise referred to in the above provision is a reference to an entitlement under the Netherlands Agreement. The opening words of para (1) of Art 7 are "[t]he profits of an enterprise". I agree with the Second Applicant that Art 6(a) of the Protocol indicates that a party to the Netherlands Agreement was to be at liberty to include capital gains as part of those profits, without prejudice to the allocation of taxing rights in Art 13(1) in respect of "[i]ncome from the alienation of real property".

161. It follows that Art 7 will deny Australia the right to bring to tax the capital gain made by the Second Applicant, if the tax imposed in respect of that capital gain is a tax covered by the Netherlands Agreement.


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The Taxes Covered Article of the Netherlands Agreement

162. The final issue to be resolved is whether the tax imposed on capital gains in Australia by the Pt IIIA règime fell within the taxes covered by the Netherlands Agreement (Art 2 set out at [30] above).

163. The Taxes Covered Article of the Netherlands Agreement is similar to that of the UK Agreement. As mentioned above, in my view, there is no substance in the difference between the expressions "the Commonwealth income tax" and "the Australian income tax".

164. I adopt mutatis mutandis, in relation to the Taxes Covered Article of the Netherlands Agreement, what I have said earlier in relation to the Taxes Covered Article of the UK Agreement, save in respect of the First Applicant's argument noted at [133]-[135] above which was not available in respect of the Netherlands Agreement.

165. By the time the Netherlands Agreement was signed in 1976, s 26AAA had been introduced into the ITAA 1936. This provision was therefore a further illustration of a capital gain that was treated as income for the purposes of "the Australian income tax".

166. The Commissioner also raises some additional arguments which I address below.

The meaning of "the Australian income tax" - a static or ambulatory approach

167. The Commissioner referred to para 6 of the Model Commentary in respect of Art 2(3) of the Model Convention (which was comparable to Art 2(1) of the Netherlands Agreement) which stated:

"This paragraph [Art 2(3)] lists the taxes in force at the time of signature of the Convention. The list is not exhaustive ... In principle, however, it will be a complete list of taxes imposed in each state at the time of signature and covered by the Convention."

The Commissioner relies on this statement to argue that whatever might be the position with respect to the interpretation of treaties generally, Art 2(1) of the Netherlands Agreement was intended to set out the specific position at the point in time at which the Netherlands Agreement was entered into, and that an ambulatory interpretation was therefore inappropriate.

168. I disagree with the Commissioner's submissions to the extent that he seeks to argue that the taxation of capital gains under the Pt IIIA règime is not caught by Art 2(1)(a) of the Netherlands Agreement. In my view, the "existing taxes" referred to in Art 2(1)(a) are classes of independent self-contained taxes, as distinct from a class or classes of things included in the tax base of one of them. Had capital gains been taxed in Australia by means of an independent and self-contained tax rather than being encompassed within the tax base of the income tax, it would not have been caught by Art 2(1)(a). It is in respect of that situation that the comments in the Model Commentary show that Art 2(3) of the Model Convention (and Art 2(1) of the Netherlands Agreement) applied only to the classes of tax imposed in each Contracting State at the time of signature that are listed in Art 2(1).

169. As noted above, the taxation of capital gains in Australia was not introduced by way of a new tax, but rather by an enlargement of the scope of "assessable income" of the existing Australian income tax. That tax was included in the list in Art 2(1)(a) at the time of signature of the Netherlands Agreement. The term "the Australian income tax" must be given an ambulatory meaning, and the Netherlands Agreement should not be construed so that it applies only to the Australian income tax assessable in accordance with the provisions of the ITAA 1936 as they existed at a particular point in time (see [107]ff above).

A "substantially similar tax" - no notification pursuant to Art 2(2) of the Netherlands Agreement

170. The Commissioner submits that the introduction of the Pt IIIA règime marked a substantial change to the taxation laws of Australia, yet, as he points out, there is no evidence that the Australian competent authority ever notified the Netherlands of its introduction, as required by the second sentence of Art 2(2).

171. For present purposes, I will assume, without deciding, that the introduction of the Pt IIIA règime did indeed mark such a substantial change. The answer to the Commissioner's submission, in my respectful opinion, is that non-compliance with the second sentence of Art 2(2) does not prevent the first sentence from operating according to its terms. The first sentence is a self-contained substantive provision. The second sentence imposes a procedural requirement that is enlivened after the substantial change has been made. Whether a substantial change has resulted in the imposition of an "identical or substantially similar tax" is to be determined on the merits. The procedural


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requirement imposed by the second sentence goes to no more than administrative convenience.

Conclusion in respect of the Netherlands Agreement

172. It follows that the tax on the capital gain made by the Second Applicant referred to at [7]-[9] above is subject to the provisions of the Netherlands Agreement by reason of Art 2(1)(a) (or in the alternative, Art 2(2)) of that Agreement and is exempt from Australian tax by reason of Art 7 of that Agreement.

Conclusion

173. It will be clear from my reasoning above that I have independently reached conclusions on the issues that were common to the present proceedings and Virgin Holdings. It will also be clear, for what significance it may be thought to have, that I do not think that Virgin Holdings was wrongly decided.

174. Both appeals succeed, the Commissioner's objection decisions should be set aside and the objections allowed. The Commissioner should be ordered to pay the costs of the applicant in each proceeding.


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