Case B15
Members:JL Burke Ch
RC Smith M
RE O'Neill M
Tribunal:
No. 1 Board of Review
J. L. Burke (Chairman) and R. C. Smith (Member): The present references relate to appeals against two decisions of the Commissioner disallowing objections against his refusal to form an opinion that certain dividends declared by Associates Pty. Ltd. and paid to Associates Pty. Ltd. Provident Fund (hereinafter called ``the fund'') should be exempt from income tax. The first reference relates to the transitional provisions contained in sec. 46 (in particular sub-sec. (3) thereof) of Act No. 110 of 1964 and the second to the provisions of sec. 23F(16) of the Income Tax Assessment Act 1936-1965. No question is raised by the Commissioner as to the proper constitution of the fund at the relevant dates (its constitution was varied on more than one occasion to comply with altered requirements of the Assessment Acts) but he states that the circumstances surrounding the investments made by the fund in Associates Pty. Ltd. are such that he has not formed the opinion required under the above provisions that it would be reasonable to exempt the dividends from tax. We are now asked to review the matter, form an opinion that it would be reasonable to exempt such dividends from tax and substitute that opinion for the one arrived at by the Commissioner.
2. A company, Agency Pty. Ltd., was incorporated on 29 December 1947 and commenced business on 1 January 1948. Associates Pty. Ltd. was incorporated on 17 June 1958 for the purpose of taking over the business activities and assets of Agency Pty. Ltd. and it did this as from close of business on 30 June 1958, paying Agency Pty. Ltd. $23,000 for its goodwill. The original shareholdings in Associates Pty. Ltd. were -
S Pty. Ltd. (the family
company of A - chair-
man of directors)........ 2,550 $2 shares
B (the managing director).. 1,450 '' ''
C (a director) 500 '' ''
D (the secretary) 500 '' ''
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Total.................. 5,000 $2 shares
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3. On 9 April 1955 Agency Pty. Ltd. had established a superannuation fund of the insurance type for its male employees and A, B, C and D, amongst others, were members thereof. On the incorporation of Associates Pty. Ltd. that company by deed took over this fund and continued it for the benefit of those employees who continued in the business and such other employees as might be approved.
4. Not long after the incorporation of Associates Pty. Ltd. its directors came to the conclusion that the benefits provided by the abovementioned superannuation fund were not adequate in respect of its four key senior executives, A, B, C and D, particularly in view of the retiring amounts which would be drawn by relatively junior employees having regard to their expected years of service; one such employee would draw $85,000, another $72,000, if they served the company until the retiring age of 65. Accordingly by letter dated 3 June 1959 to three named trustees (hereinafter referred to as ``the trustees''), the directors constituted the fund and paid to the trustees out of Associates Pty. Ltd.'s profits for the year ended 30 June 1959 the sum of $2,000. This sum was to be held by the trustees for the members of the fund in the following proportions -
for A ...... $1,020
B ...... $580
C ...... $200
D ...... $200
and the letter constituting the fund provided, inter alia -
``The amounts herein contributed, together with any subsequent contributions, shall be credited by you to an account in the name of each employee and/or Director, to which account shall be credited a share of the net income received by you, to be distributed amongst members in the ratio of each member's balance to total balances as at the conclusion of each financial year.''
It will be noted that the respective interests of the members of the fund were in proportion to the original shareholdings in Associates Pty. Ltd.
5. No provision was made by the letter constituting the fund for the admission of any other person as a member of the fund, and in fact membership of the fund has been restricted to the four named executives.
6. On 22 June 1959 the trustees of the fund invested the $2,000 they had received by subscribing for 1,000 $2 ordinary shares in Associates Pty. Ltd., which shares were issued to them at par, no other shares being issued
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at that date. Although the trustees were not required to invest the fund in shares of Associates Pty. Ltd. it must be inferred, we think, that there was an understanding that this was how the fund would be utilised.7. On 10 June 1960 a further $2,000 was paid to the trustees out of the profits of Associates Pty. Ltd. for the year ended 30 June 1960 to be held by them in the same proportions as the earlier sum, and this amount was also invested by subscribing for 1,000 $2 ordinary shares in that company, again no other shares being issued at that date. At this stage the fund had a two-sevenths interest in the assets and profits of the company.
8. During the year ended 30 June 1963 shares were issued to two other employees of Associates Pty. Ltd. and further shares issued to B, C and D. S Pty. Ltd. appears to have sold 250 of its shares to one or more of the other members, reducing its holding to 2,300 $2 shares. At this stage the fund's interest in Associates Pty. Ltd. amounted to 18.5% and this remained the position until after 30 June 1965. It was during the financial year ended 30 June 1965 that the first of the dividends here in question was declared and paid.
9. On 23 September 1965 a further 780 $2 ordinary shares were issued to employees at par and as at 1 November 1965 (the date upon which the second dividend here in question was declared) the fund's interest in Associates Pty. Ltd.'s capital amounted to 17.2%. On 10 November 1966 the share capital was converted from $2 shares to $1 shares.
10. A table was tendered to the Board setting out, inter alia, the years of service, age, salary and expected retiring benefits of A, B, C and D as at 30 June 1966. The details are summarised in Table 1 below.
11. It should be mentioned that, although not written into the terms of the fund, it was tacitly understood that on retirement each member would be paid part of his entitlement in specie by having transferred to him, at face value, shares representing his proportion of the total held by the trustees of the fund, the proportion being in accordance with the amounts contributed for the respective members. It was also agreed that the retiring member would then sell the said shares to existing employees as directed by the board of Associates Pty. Ltd. at a figure to be determined by the company's auditors at their then value. And so when A retired on 31 December 1967 he had distributed to him (in addition to cash $24,725) by the trustees of the fund 2,040 $1 shares in Associates Pty. Ltd. which he then sold to employees for $9,017. The estimated increase in the sale value of the shares held by the fund over their book value has been taken into account in estimating the provident fund entitlement of the members as set out in the above table. The estimate also assumed a continuing dividend rate of 75% and a compounding of interest at 6% on amounts on call advanced to Associates Pty. Ltd. by the fund which at 30 June 1966 totalled $28,852.
12. The dividend income which the Commissioner has subjected to tax amounts to $4,444 for 1965 and $5,872 for 1966, representing
Table 1
Superannuation
Fund Provident Wales
Years of (Insurance) Fund Fund
Employee Service Age Salary (at age 65) (at age 65) (at age 65)
A (chairman,
part-time).... 18 64 $5,720 $16,202 $33,742
B (managing...
director)..... 17 53 12,064 40,668 42,874
C (director).. 11 49 11,440 47,996 18,000
D (secretary). 18 60 6,448 7,796 9,040 $7,900 *
(11 part-time
7 full-time)
* It was stated in evidence that D's expected retiring benefit from the insurance and provident funds was considered inadequate and so Associates Pty. Ltd. contributed, with the Commissioner's approval, to an outside retirement fund on his behalf.
ATC 64
18.5% and 17.27% of the total dividends declared by Associates Pty. Ltd. for those years. (Special A class shares had been issued during 1966 carrying no dividend entitlement.) The average dividend income received by the fund from Associates Pty. Ltd. for the six years ended June 1966 amounted to $5,711.
13. The Commissioner tendered calculations directed towards establishing that the shares in Associates Pty. Ltd. had been acquired by the fund at an undervalue. The calculations may be summarised thus -
Estimated value
Assets basis Earning basis
1,000 $2 shares
acquired June
1959......... $4.80 $15.57
1,000 $2 shares
acquired June
1960 7.65 13.77
Taxpayer's representative, whilst not admitting the correctness of the valuations put forward by the Commissioner, conceded that the shares, when acquired, were worth more than face value.
14. In all the circumstances of this case we are not disposed to find that it would be reasonable to exempt the private company dividends from tax. In forming this view we have taken into account (a) the substantial percentage of total dividends distributed by Associates Pty. Ltd. to which the fund was entitled, (b) that the shares from which the dividend income was derived were acquired at less than their true value, (c) that membership of the fund was restricted to shareholder executives of Associates Pty. Ltd., (d) that entitlement in the fund was in proportion to the shareholding of the members in Associates Pty. Ltd. (for this purpose we regard A (and not his family company) as the shareholder), (e) that the shares issued to the fund were to be transferred at face value to the members on retirement after their work of syphoning off tax free dividends had been done, and (f) that means existed in Associates Pty. Ltd.'s superannuation fund and in outside employees' funds to correct any inadequacy of retiring benefits for senior executives.
15. We would uphold the Commissioner's decisions on the objections and confirm the assessments the subject of review.
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