Evans v Deputy Federal Commissioner of Taxation (South Australia)
55 CLR 801936 - 0213B - HCA
(Judgment by: Rich J, Dixon J, Evatt J)
Between: Evans
And: Deputy Federal Commissioner of Taxation (South Australia)
Judges:
Rich JStarke J
Dixon J
Evatt J
Subject References:
Taxation and revenue
Income tax
Shareholder in company
Profit arising from sale of assets
Purpose of original acquisition
Mining company
Acquisition of leases by nominees
Subsidiary companies
Enlargement of capital
Distribution of shares
Capital or income
Distribution of surplus assets
Appreciation
Legislative References:
Income Tax Assessment Act 1922 (Cth) No 37 - s 16(b)(i)(1); s 16(b)(i)(2)
Judgment date: 13 February 1936
MELBOURNE
Judgment by:
Rich J
Dixon J
Evatt J
In assessing the appellant for income tax for the financial years ending 30th June 1931 and 1932 upon his income derived during the respective preceding years, the Commissioner included in the assessable income amounts representing distributions by a company called "Guinea Gold No Liability" in which the appellant was a shareholder.
On 16th September 1929 the directors of that company made a distribution in specie of shares which it had acquired in two other companies. In doing so the directors assumed to act under an article of association adopted for the purpose which empowered them to declare a dividend to be paid to members in proportion to the number and nominal amount of their shares, and to pay dividends, wholly or in part, by the distribution of specific assets, and, in particular, of paid up shares of any other company. The distribution thus made among the shareholders consisted of 10,000 paid up shares of PD1 in Guinea Airways Limited which the company had acquired in November 1927, and of 90,000 paid up shares of PD1 in New Guinea Goldfields Ltd which the company had acquired on or after 30th June 1929. For every five shares in Guinea Gold No Liability the shareholders received one share in Guinea Airways Ltd and five shares in New Guinea Goldfields Ltd The shares were not included in the appellant's assessable income at their face value, but at their market value, which, in the case of Guinea Airways Ltd was PD2 each, and in that of New Guinea Goldfields Ltd was 5s. 6d. each.
The second of the two distributions with which this appeal is concerned was made by Guinea Gold No Liability on 14th August 1930. It consisted of an amount of 10s. a share paid in cash.
The appellant resides in Australia, and, in including these distributions in his assessable income, the Commissioner relied upon s. 16 (b) (i) of the Income Tax Assessment Act 1922-1932. The material portions of the provision require that the assessable income of a shareholder of a company shall include dividends, bonuses or profits paid or distributed by the company to a shareholder, who is a resident, out of profit derived by the company from any source. But a proviso enacts that, where the company distributes any of the profits arising from the sale of assets which were not acquired for the purpose of resale at a profit, the profits so distributed shall not be assessable income to the shareholder. The appellant claims the protection of the proviso, which, he says, protects both distributions entirely. The shares of which the first distribution consisted were allotted to the Guinea Gold No Liability as part of the consideration for the sale by it of assets which, with a negligible exception, admittedly had not been acquired by it for resale at a profit. The shares in Guinea Airways Limited formed part of the consideration for the sale to that company of an air service established by Guinea Gold No Liability. The shares in New Guinea Goldfields Limited formed part of the consideration for the sale to that company of gold mining leases acquired by Guinea Gold No Liability to work by sluicing.
While the Commissioner does not deny that the shares are the proceeds of the sale of assets not acquired for the purpose of resale, he does deny that the shares when distributed represent nothing but profits from that resale, and, accordingly, he has allowed only a partial immunity as the result of the application of the proviso. To this the appellant answers that, in so far as the shares do not represent profit upon the resale of the assets, they do not represent profit at all, or, at any rate, they do not represent profit "derived" by the company. In other words, he says that the distribution ought not to be included in the assessable income of a shareholder under s. 16 (b) (i), because no profit derived by the company entered into the composition of the amount distributed in the form of shares, except profit arising from the sale of assets which were not acquired for resale at a profit.
In the case of the distribution made in cash in the following year, the ground upon which the Commissioner denies the applicability of the proviso is different. The money distributed arose from the sale of some other leases held by the company. But these leases, the Commissioner says, the company did acquire for the purpose of resale at a profit.
The appellant appealed against the assessments to the Supreme Court of South Australia. His appeals were heard by Murray C.J. who found in favour of the Commissioner. From his judgment dismissing the appeals the present appeal is brought to this Court.
Guinea Gold No Liability was incorporated in South Australia as a mining company on 11th May 1926. It was formed as a result of communications received from a prospector who was carrying on his operations on the Bulolo River in the Mandated Territory of New Guinea. He had sent reports to his attorney under power that there existed, along the river, large areas from which a high return of gold could be obtained by sluicing or dredging. The natural features of the country divided the areas into two parts. Below a gorge the river ran through flats which were considered most suitable for dredging. None of this area had been pegged out. Above the gorge deposits existed which in fact were not suitable for dredging, but were valuable for sluicing. Part of this area had been applied for and leases had been granted, one at least of which the prospector had acquired. In a memorandum which, before the formation of the company, was circulated among those who were invited to join it, the distinction between the two fields was drawn. The upper section was described as a matter of simple surface working then being exploited by sluicing, and the lower as one of straight-forward dredging. The greater extent of the latter was explained, and the announcement was made that, if it commended itself to the experts, the prospector was ready to offer, as an adjunct to the lower section, the lease he had already acquired in the upper section. A working option for six months from the registration of the company was given by the attorney under power over the lease in the upper section. The promoters of the company decided to send a mining engineer to New Guinea to report upon the field, and, in the meantime on the day of registration a radio was sent to the prospector urging him to peg out immediately the best of the lower alluvial land "on behalf of the interested" pending the arrival of the expert. The latter left a week later armed with numerous powers of attorney to enable him to take up leases in the names of the company's nominees.
At the first meeting of the company, it was decided to send after him four men to assist him. The prospector was invited to take charge of the party when it arrived on the field in the capacity of "field superintendent" at a high salary. He, in the meantime, acquired another lease on the upper section. It was in the neighbourhood of his earlier lease, but situated on a tributary of the Bulolo River. He set about obtaining rights in the lower field. Six leases were pegged out, and on 23rd June 1926 applications were lodged in the name of the nominees. The expert reported that it was thought desirable to obtain further leases lower down, and, before his return, he informed the company by radio that he had made arrangements to acquire five such leases six miles below those already applied for. He reported also that these lower leases could be worked by sluicing. He advised the company to acquire the upper leases pursuant to its option. In the result the company did acquire the leases in the upper section of the field, and its nominees applied for and obtained eleven leases in the lower section. The six leases first applied for were granted to the applicants on 23rd November 1926. Three more, which had been applied for on 8th September, were granted on 4th December 1926 and the remaining two, which were applied for on 13th December 1926, were granted on 21st February 1927. It is these eleven leases which have been held to fall outside the proviso to s. 16 (b) (i) on the ground that in their acquisition the purpose of resale at a profit was not absent. It is the leases in the upper section of the field which admittedly were not acquired for the purpose of resale at a profit.
It appears that, at a meeting of the company on 25th August 1926, the members were informed that the first thing to be done was to work the upper leases, and that, in a report of the directors of 10th November 1926, it was announced that it was intended to undertake the flotation of the lower section when complete reports were received.
In the following month a long report upon the field was received from the original prospector, now the company's field superintendent. He urged a thorough examination of the lower leases and warned the company against too speedy a development. The directors decided to raise some more capital. Their statements appear to show that they desired to exploit the whole field, but contemplated the formation of subsidiary companies to undertake different parts of it. They had been advised by their solicitor in New Guinea that one company could not hold all the leases applied for, and that of the various courses open, that to be preferred was to form three more companies among which the lower leases would be distributed. This course they eventually adopted. On 23rd March 1927 they incorporated no liability companies, called respectively New Guinea Gold North, Central and South. But it was some time before the leases were transferred by the nominees to these companies. Each of them issued a nominal amount of capital only, viz., five shares, and these the parent company held. In the meantime, in a memorandum relating to the issue of further capital, the shareholders were told that shares in the company would carry rights to participate in the flotation of further companies to handle the lower areas, which were then being sampled and surveyed. In their report of 27th May 1927 the directors said that the three new companies had been registered "with a view to acquire and work these areas," and that when the engineer's reports were made "flotation will be proceeded with immediately if justified." In July 1927, when more capital was to be issued, the directors stated that shares in the company "carried rights to participate in the share issue of the three new companies, Guinea Gold North, Central and South, which hold the lower leases."
Much was done by the company particularly with the upper leases, and the very great difficulty of transport was largely overcome by the company's establishing an air service. The air service, although begun for the purposes of the company, grew into a separate business of the company. It naturally became the means of communication with the locality for the service of all.
In April 1927 negotiations with the company were opened up by a group of strangers who desired to float a company for the active working of part of the lower area. The proposal was that the company should transfer some of its lower leases for a consideration in cash and shares. The negotiations went on for some time, and, in December 1927, a three months option was granted. But, before the three months were up, the holders of the option decided not to exercise it. The work done, however, in the course of the transaction established that the lower leases must be worked by dredging and not, like the upper, by sluicing.
In the meantime, on 7th November 1927, the company had registered the company called "Guinea Airways Ltd ," to take over the air service. It did so because it was advised that it might be considered beyond the powers of a no liability mining company to conduct an air service. The consideration for the transfer of the air undertaking to Guinea Airways Limited was 10,000 fully paid up PD1 shares of its capital. It was these shares which Guinea Gold No Liability distributed to its members on 16th September 1929.
When the option granted over part of the lower area was declined, the directors of Guinea Gold No Liability decided to seek further capital in Great Britain. But, before this resolve could be carried into effect, a Canadian company applied for an option over all the lower leases. After some negotiations, on 27th April 1928 a working option was given for their sale for a consideration of PD50,000 in cash, and, in shares, ten per cent of the issued capital of the company or companies which should be formed to work the leases. The currency of the option was long. It extended until 30th June 1930.
Almost concurrently with the negotiations in Australia for this option, negotiations were opened in New Guinea for an option over the upper leases. The proposal came from an independent undertaking. It resulted in the grant of an option to New Guinea Goldfields Ltd over all the upper leases in consideration of PD2,000 cash and 90,000 paid up shares of PD1 in that company. The option was exercised on 30th June 1929. The 90,000 shares were distributed by Guinea Gold No Liability to its members on 16th September 1929 together with the shares in Guinea Airways Ltd The option over the lower leases was exercised by the Canadian company on 30th June 1930, and, out of the amount paid on account of the consideration, the distribution on 14th August 1931 of 10s. a share among its members was made by Guinea Gold No Liability.
It is convenient to deal first with the question whether this distribution is liable to inclusion in the shareholder's assessable income. It depends upon the question whether the money distributed arose from the resale of assets which were not acquired for the purpose of resale at a profit.
The first objection made by the Commissioner to the application of the proviso is that the lower leases were never acquired by the company at all; that they were not its assets, but at best the assets of the three subsidiary companies and that it could not resell them. This point is not dealt with in the judgment under appeal, and no evidence appears to have been directed to it at the hearing. It may be inferred that the leases were ultimately transferred by the nominees to the North, South, and Central companies. But no evidence was given of the date or circumstances, and the fact itself was not the subject of distinct proof. It does appear, however, that none of the three companies gave any consideration for the transfer. On the evidence, the position appears to be that the original grantees of the leases were trustees for Guinea Gold No Liability, that by its direction they transferred them to its subsidiary companies which gave no consideration for them either in the form of share capital or otherwise, and that then Guinea Gold No Liability sold the leases, and obtained and distributed the consideration which in no way passed through the subsidiary companies, although, presumably, the latter executed formal transfers of the leases. It is true that the burden of proof is upon the taxpayer. But, on these bare facts, the inference is that the equitable property in the leases of Guinea Gold No Liability was not extinguished by the transfer of the legal interest to the three subsidiary companies.
No question is raised as to the legality of the trust in favour of the parent company upon which the nominees held the leases. The result is that, in so far as the proviso may be considered to require that the moneys shall arise from the resale by a company of property beneficially owned by it, that requirement is satisfied.
The next question is whether the leases were originally acquired not for the purposes of resale at a profit. The learned Chief Justice was of opinion that it had not been established that they were acquired not for such a purpose. His view was much influenced by the fact that the company's capital was quite insufficient for it to hope to work the lower leases, that it never increased its capital to an amount suggesting that it expected to work them, and that the reports of the directors spoke of exploitation by other companies. There can be no doubt that from the beginning the possibility, perhaps probability, of the company promoting another company to take over the leases and work them was kept in view by the directors. For a time they looked to the three subsidiary companies as the probable instruments for the purpose of raising capital and working them. But at the time when the leases were applied for and up to the time when they were granted to the nominees, the directors did not propose that the profit which the company was seeking should be gained upon a transaction by way of sale.
No doubt to transfer the assets to another company for shares is a sale. To that extent the purpose of sale was not absent. But the proviso defines the purpose which it excludes, not as one of resale simply, but as resale at a profit. It is concerned with the well known difference between enlargement of capital by sale of capital assets and obtaining detachable profit by buying and selling assets. The purpose of which it speaks is the dominant purpose actuating the acquisition of the assets-the use to which they are to be put. The object which actuated Guinea Gold No Liability in taking up the leases was not the making of a profit by turning them over at an increased value, whether expressed in money, or in shares, or in securities. Its object was to make money for its shareholders by the working or exploitation of the mining leases. The exploitation might require the formation of a larger company, including many additional shareholders who would, perhaps, subscribe more capital than Guinea Gold No Liability or its shareholders could. But the transaction contemplated as possible at the beginning was no more than a transformation of the leases into shares which, either in its hands or those of its shareholders, would obtain their value through the actual or anticipated recovery of gold from the leases and consequent payment of dividends. From this view it follows that, prima facie, the distribution of 10s. a share on 14th August 1930 obtained the protection of the proviso and did not form part of the assessable income of the shareholder.
The only outstanding question possibly affecting its prima facie immunity is whether it should be treated as composed in part of some other element than the profit made upon the resale of the lower leases. That profit was quite sufficient to cover the amount distributed, and the suggestion that the 10s. a share should be treated as including some extraneous element arises from a mistaken attempt to proportion the profit shown upon an erroneous account made up by the company. The account is sufficiently discussed in the succeeding part of this judgment in dealing with the shares in New Guinea Goldfields Ltd and in Guinea Airways Ltd distributed on 16th September 1929, and the matter is not worth pursuing in relation to the dividend of 10s.
The question whether the shares in New Guinea Goldfields Ltd and in Guinea Airways Ltd should be included in the shareholder's assessable income depends upon the extent to which those shares represent profits arising from the sale, in the one case, of the upper leases, and, in the other case, of the air service. In an account made up by the company after the event, the shares were shown as of their face value. Upon this basis the profit from the resale of the leases was shown as PD41,500 Os. 2d., the difference between PD90,000 and PD48,499 19s. 10d., the amount expended in connection with the leases. As the whole PD90,000 was shown in the account as distributed in shares, it was made to appear that a distribution had been made, not only of the apparent profit of the transaction, but also of something which must, unless the distribution was made in violation of the company's articles, represent profit from some other source. The account showed a profit much more than enough for the purpose, but a great part of it was attributable to the inclusion in the account of a large surplus arising from the writing up of the value of the lower leases, the sale of which, although not concluded, was confidently expected. Problems thus arose, the account being adopted as the basis of assessment, as to the manner of ascertaining how much of the amount contained in the shares distributed represented profit attributable to the sale of the leases. The same problem affected the Guinea Airways Ltd shares which were put down in the account at a revaluation of PD2 a share. The Commissioner's solution was to proportion the total profit disclosed by the account and allow only 25.22 per cent of the value as exempt.
It is unnecessary to enter into the details of these questions, because they do not really arise. The company's account is clearly wrong in putting down the shares in New Guinea Goldfields Ltd at their face value, and they ought not to be treated as of that value for the purpose of applying the proviso to s. 16 (b) (i). There is an evident incongruity in treating the same asset as equivalent to 5s. 6d. in the hands of the shareholder to whom it is distributed and PD1 in the hands of the company which distributes it. The distribution closely followed the receipt by the company of the shares, and there is no reason to suppose that there was any marked drop in values. It may safely be inferred that the money's worth of the 90,000 shares did not equal PD48,499 19s. 10d., the amount expended by the company in connection with the leases. That amount represents nearly double the value (5s. 6d.) assigned to the shares at the time of distribution. It follows that there was no net profit on the resale of the leases. It was contended for the taxpayer that the proviso was satisfied if profits arose, that is, were realized by the company, out of the sale of an asset not acquired for resale, although the profits were earned otherwise than by the acquisition and resale of the asset itself. This is not the true meaning of the proviso, which is concerned with capital net profits of a particular description. Accordingly, the distribution of the shares in New Guinea Goldfields Ltd is not exempt under the proviso.
The contention of the appellant that, upon such a footing as this, the distribution would not come within the charging portion of s. 16 (b) (i) (1) is erroneous. In the first place, the fact that the shares contain no profit on the sale of the leases does not mean that they represent capital and not profit of the company. Actually they represented surplus assets, that is, assets not required to make good issued share capital. This appears from the last preceding balance-sheet. In the second place, s. 16 (b) (i) (1) brings into charge all dividends and distributions out of profit, whatever be the nature of the profit. The word "derived" does not connote that the profit must be a realized profit. It is enough at least if it is an ascertained profit, ascertained by a proper account. Under the articles, the 5s. 6d. contained in the share could not lawfully be distributed, except as a dividend satisfied by specific assets, and the dividend must be out of profits. The meaning of profits in s. 16 (b) (i) (1) is no narrower, and the state of the company's affairs, as disclosed by its balance-sheet, permitted such a dividend. It follows that the whole amount of the 5s. 6d. per share should be included in the appellant's assessable income.
The question whether any profit arose from the sale of the air service for 10,000 paid up shares of PD1 each is more difficult. The face value of the shares represented the capital expenditure of the company in relation to the service and, unless the value contained in the shares exceeded their face value, the transaction produced no profit. When, nearly two years later, the shares were distributed, they admittedly possessed a face value of PD2 each. Probably much of this value existed in the shares at the time of acquisition. But it does not appear upon the evidence whether any part arose from appreciation in the interval. Profit, consisting in such an appreciation, would, for the reasons already given, fall within the charging part of s. 16 (b) (i) (1) and would not be protected by the proviso. The parties, however, do not seem to have directed any evidence to the matter, no doubt because the Commissioner had adopted the account made up by the company as the basis of the assessment, and it thus became the focus of the controversy between the parties. But apparently it is conceded that, in a proper account of the net profit gained upon the disposal of the air service, the expenditure would be about equal to the face value of the shares forming the consideration. It follows that to whatever extent the actual value contained in the shares at that time exceeded their face value, the shares represented profit upon the sale of the air undertaking.
It appears from the previous balance-sheet of Guinea Gold No Liability that it was in a position, apart from the revaluation of the lower leases, to make the distribution of 16th September 1929 out of surplus assets, leaving more than enough to answer its issued capital. Thus it was open to the company to distribute the net profit upon the transaction, consisting of the establishment and the subsequent sale of the air undertaking. This profit was actually contained in the shares distributed. By handing over in specie the assets containing the profit, the source of the distribution is identified. Thus, to whatever extent the actual value of the shares in Guinea Airways Ltd exceeded their face value at the time of their allotment or so soon thereafter as their face value was established, to that extent their value should not be included in the shareholder's assessable income. But, because on the evidence it is impossible to ascertain the amount of the excess value, there is no course open except to set aside the assessment so that it may be made afresh.
The appeals should be allowed with costs.
The amended assessment for the financial year ending 30th June 1931 should be set aside.
The amended assessment for the financial year ending 30th June 1932 should be reduced by excluding from the assessable income the sum of PD222, being the dividend of PD300, less PD78 thereof already allowed by the amendment of the assessment. The assessment should be remitted to the Commissioner to give effect to the reduction.
In the result the taxpayer's appeal from the assessment has succeeded in part and failed in part. But the success of his appeal has been so great that he should have his costs of the proceedings. It does not appear that any substantial costs are exclusively referable to issues upon which the taxpayer failed.
The Commissioner should pay the costs of the appeals to the Supreme Court.