The English, Scottish and Australian Bank Limited v. Federal Commissioner of Taxation.

Judges:
Kitto J

Court:
High Court

Judgment date: Judgment handed down 5 June 1969.

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Kitto J.: The appellant, the English, Scottish and Australian Bank Limited, appeals under sec. 187(b) of the Income Tax Assessment Act 1936 (Fed.), as amended, against an assessment of the income tax payable in respect of income which it derived in the year ended 30 June 1966. The question in the appeal is whether the appellant's assessable income includes an amount of $100,000 which in the relevant year it received as a dividend from its wholly-owned subsidiary, the E.S. & A. Savings Bank Limited, which I shall call the Savings Bank.

The appellant is a company incorporated in the United Kingdom. It carries on business in Australia but is a ``non-resident'' for the purposes of the Income Tax Assessment Act by reason of the definitions of that expression and of ``resident'' in sec. 6(1). Accordingly, by force of sec. 44(1)(b) and unless there is some special provision to the contrary, its assessable income includes dividends paid to it by the Savings Bank out of profits derived by the Savings Bank from sources in Australia. In fact the dividend in question was paid wholly out of such profits. The appellant's contention that nevertheless the dividend is not included in its assessable income is based upon a special provision in the Agreement between the Government of the United Kingdom and the Government of the Commonwealth of Australia which is in the First Schedule to the Income Tax (International Agreements) Act 1953-1963. By virtue of that Act the Agreement has the force of law (sec. 5), and its provisions have effect notwithstanding anything inconsistent with it in the Income Tax Assessment Act (sec. 4(2)).

The provision relied upon, which is in clause (2) of Article VI of the Agreement, relates to any dividend paid by a company which is a resident of Australia to a company which (a) is a United Kingdom resident, (b) is subject to United Kingdom tax in respect of it, and (c) beneficially owns all the shares (less directors' qualifying shares) of the former company. The Savings Bank is a resident of Australia: see the definition of ``Australian resident'' in Article II. The appellant is a United Kingdom resident (see the definition). It is subject to United Kingdom tax in respect of the dividend, and it beneficially owns all the shares of the Savings Bank. Clause (2) provides that where these conditions exist the dividend shall be exempt from Australian tax; but it adds two provisos. The first relates to directors' qualifying shares and has no bearing on this appeal. The second is that the exemption shall not apply if ordinarily more than one-half of the taxable income of the company paying the dividend is derived from interest, dividends and rents other than interest, dividends and rents from any wholly-owned subsidiary company the taxable income of which consists wholly or mainly of industrial or commercial profits.

The company paying the dividend in question here, the Savings Bank, carries on a savings bank business of the type that is familiar in this country. It receives deposits from customers and pays interest upon them. The money it receives as deposits it invests, and so derives interest from government, semi-government and local government loans, Reserve Bank deposits, loan to customers, and money at call or deposited with another bank (in fact the appellant). It also derives income of other kinds, e.g. commission, sub-underwriting commissions and rent; but ninety per cent and more of its gross income in any one year consists of interest none of which is derived from any wholly-owned subsidiary of the kind mentioned in the second proviso. The second proviso therefore applies so as to deny the appellant the exemption provided for by clause (2), unless the word ``interest'' in the proviso has a specially limited meaning and the limitation makes the word inapplicable to interest forming at least one-half of the Savings Bank's taxable income.

The appellant contends that in the context of the Agreement ``interest'' has such a limited meaning and refers only to interest on fixed capital. If this is so, the second proviso does not apply in this case, for the interest which the Savings Bank derives is mainly, if not indeed exclusively, interest on moneys which are circulating capital, forming its stock-in-trade and being constantly turned over in the course of the business. To interpret ``interest'' in so restricted a sense as not to include interest of this kind is a large step to take, and requires a very special context to justify it; but the appellant submits that when the Agreement is read as a whole a sufficient context is found.

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ATC 4071

The argument is that the clue to the sense in which ``interest'' is used throughout the Agreement is to be found in the provision in Article II(1) as to the meaning of ``industrial and commercial profits''. It is a provision which is important mainly for Article III, which is concerned with excluding or limiting Australian tax on the industrial or commercial profits of a United Kingdom enterprise engaged in trade or business in Australia and by excluding or limiting United Kingdom tax on the industrial or commercial profits of an Australian enterprise engaged in trade or commerce in the United Kingdom. The expression ``industrial or commercial profits'' is not treated by Article II(1) as requiring an exhaustive definition; but both an extension and a limitation of its meaning are provided. On the one hand, it is to include profits from mining, agricultural or pastoral activities or the business of banking, insurance, life insurance or dealing in investments. On the other hand, the expression is not to include income in the form of dividends, interest, rents, royalties, management charges, or remuneration for personal services.

The appellant offers two submissions upon this provision. One is that an intention to exclude income in the form of interest on circulating capital would virtually nullify the express inclusion of profits from the business of banking, since that class of interest is in the nature of things by far the largest element in banking profits. The other submission is that in the case of a banking business interest on circulating capital, unlike interest on fixed capital, is brought to account in determining profit, and what enters into income is not the interest but is the profit into which the interest has so merged as to lose the character of interest. It is said that when banking profits are included by Article II in industrial or commercial profits the exclusion of ``income in the form of interest'' must refer only to that limited class of interest which enters as such into income.

The second of these submissions may conveniently be dealt with at once. Too much emphasis should not be placed upon the word ``profits'' in Article II, for sec. 3(2) of the Income Tax (International Agreements) Act requires that a reference in the Agreement to profits of a business shall, in relation to Australian tax, be read, where the context so permits, as a reference to taxable income derived from that business. Interest earned by a bank on its circulating capital, no less than interest on its fixed capital, enters directly into the bank's assessable income, not by first swelling profit but in its own right so to speak. The excess of both classes of interest over an appropriate part of allowable deductions is thus to be identified in taxable income with the character of interest still upon it.

The more important submission is the first. Though not without attractiveness, it fails, I think, to take sufficient account of the evident purpose of the simultaneous inclusion and exclusion in the provision as to the meaning of industrial or commercial profits. But for the inclusion there might well be room for argument as to whether the named activities and businesses are truly industrial or commercial. Banking in particular, plainly not industrial, might well be thought not to be commercial either, for the word ``commercial'' might be thought applicable only to businesses connected with trafficking in merchandise. So the inclusion of banking makes it clear that trafficking in money is within the concept. But to include the whole of the profits from the business of banking would be going beyond the basic notion in the word ``commercial''. A bank derives some of its income from dealings in money, in the form, for example, of commissions or charges for transmitting money and discounting bills; and there is no reason why such items of income as these, dwarfed though they may be by income in the form of interest, should not be treated by the Agreement in the same way as income from other kinds of commercial activity. But there is nothing industrial or commercial about income in the form of dividends, interest, rents, royalties, management charges or remuneration for personal services. Unless the concept expressed by ``industrial or commercial'' was to be deserted, one of two courses had to be taken: either profits from mining, agricultural or pastoral activities or from the business of banking, insurance, life insurance or dealing in investments had to be excluded altogether or they had to be restricted by excluding, first, property income, and secondly, income forming the return

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ATC 4072

for personal work not of an industrial or commercial character. Dividends, interest and rents belong to the one category; royalties, management charges and remuneration for personal services belong to the other. And interest is property income whether it be interest on the circulating capital of a business or interest on fixed capital.

Even, indeed, if ``interest'' were found to be used in a limited sense in Article II(1), that would afford insufficient reason, I think, for placing the same limitation upon the word in Article VI(2). It will be noticed that although interest, dividends and rents are there mentioned, though not in the same order as in II(1), royalties, management charges and remuneration for personal services are not mentioned at all. This is, I think, because the purpose is not, as it was in Article II(1), to exclude the named classes of income as being in their nature neither industrial nor commercial, but is only to confine the exemption from Australian tax in respect of a dividend paid to a United Kingdom company by its wholly-owned Australian subsidiary to the case where the taxable income of the subsidiary is not mainly from property. Interest, dividends and rents are in fact the three forms of property income mentioned in the definition of ``income from personal exertion'' in sec. 6(1) of the Income Tax Assessment Act (though interest from such a business as banking is there treated as income from personal exertion). The evident policy behind the second proviso to Article VI(2) is that Australia is not prepared to give the special tax exemption provided for dividends paid by a wholly-owned subsidiary resident in Australia to its principal resident in the United Kingdom, unless the taxable income which is its source is, at least to the extent of one half, the reward of work done as distinguished from the produce of property. (In other cases the applicable provision against double taxation is the general provision in Article XII for the allowance of a credit of United Kingdom tax against Australian tax.) Even this limitation of the exemption provision is subject to a qualification in the concluding words of the second proviso, and the qualification carries out the same policy: if the property income of the subsidiary comes from a subsidiary of its own, and the taxable income of the latter consists wholly or mainly of industrial or commercial profits (so that what is in form property income is in substance income wholly or mainly industrial or commercial) that fact removes the disqualifying effect which otherwise the property nature of the first subsidiary's income would have.

I do not find any sufficient reason for giving a restricted meaning to the word ``interest'' in the second proviso of Article VI(2). In my opinion the dividend here in question is not exempt from Australian tax under Article VI(2), and the appellant's challenge to the assessment fails.

The appeal must be dismissed.

ORDER:

Appeal dismissed with costs.