Loxton v. Federal Commissioner of Taxation.

Judges: Before

Gibbs J

High Court

Judgment date: Judgment handed down 26 January 1973.

Gibbs J.: This is an appeal from a decision of a Board of Review upholding the decision of the Commissioner of Taxation on an objection made by the appellant against an assessment to tax in respect of income derived during the year ended 30 June 1968. The question for decision is whether the Commissioner was correct in treating as assessable income the profit realised by the appellant during that income year on the sale of shares in Planet Metals Ltd. (``Metals'') and Planet Gold Ltd. (``Gold'') and the sale of share options in the latter company.

The appellant is a solicitor. He does not trade in shares. The transactions which gave rise to the profit - stated, for the moment, without explanation - were as follows. On or about 24 July 1967 the appellant applied for and was allotted 2,000 shares in Metals at 55c

ATC 4003

per share (including a premium of 5c) and 1,100 shares in Gold at 50c per share (being 2c money payable on application and 48c payable as an immediate call). The total amount paid by the appellant for these shares was $1,650. Each of the shares carried two options each of which entitled the holder to take up an additional share at par; in other words, the appellant obtained at no extra cost 4,000 Metals options and 2,200 Gold options. Between 28 July 1967 and 9 August 1967 the appellant sold the 2,000 Metals shares for $857.46, the 1,100 Gold shares for $223.87 and the 2,200 Gold options for $117.20 - a total of $1,198.53. He still held the 4,000 Metals options and on or about 13 September 1967 he instructed his brokers to exercise those options and to sell the shares at 69c. On the exercise of the options he paid the application money due, namely $2,000. Of the Metals shares acquired by the exercise of these options, 1,700 were sold on 13 September 1967 and 2,300 on 5 October 1967; all sales were at 69c and the sum yielded was $2,699.20. The result of these transactions was that the appellant made a profit of $456.66 on the sale of the Metals shares and a loss of $208.93 on the sale of the Gold shares and options - a net profit of $247.73.

On 7 December 1967 the appellant bought on the Stock Exchange 4,000 Metals options for a price of $1,339. He exercised these options and paid the application money of $2,000, and thus acquired 4,000 Metals shares. He sold these shares between 7 and 9 February 1968 and received $4,380.22 for them. His profit on this transaction was $1,041.22.

The Commissioner assessed the appellant to tax on the basis that the profit made in these transactions formed part of the appellant's assessable income, either because it was profit arising from the sale by the appellant of property acquired by him for the purpose of profit-making by sale or from the carrying on or carrying out of a profit-making undertaking or scheme within sec. 26(a) of the Income Tax Assessment Act 1936-1968 (``the Act'') or because it was income according to normal concepts and thus within sec. 25(1) of the Act. However, although in fact the appellant's total net profit amounted to $1,289, the Commissioner assessed the amount of the profit at $5,498. That figure was reached by applying the provisions of sec. 82 of the Act. The Commissioner allowed the appellant a deduction, calculated in accordance with sec. 77AA of the Act, in respect of the moneys (other than the amount of the premium) paid to Metals on the shares in that company and a deduction under sec. 78(1)(c) of one-third of the amount of the calls paid on the Gold shares. The application of sec. 82(2) and (4) of the Act had the result that the greater part of the moneys paid by the appellant in respect of these shares was excluded from the calculation of the profit or loss arising on their sale. It is not necessary to refer to the details of the calculations by which the Commissioner arrived at his assessment, for it was common ground that if the profit was rightly included in the appellant's assessable income the assessment of the amount of the profit was justified by sec. 82 and was correct. The matter for decision, therefore, is whether the Commissioner was entitled to treat the profit as assessable income.

It now becomes necessary to give a fuller account and explanation of the transactions to which I have referred. The appellant's firm of solicitors had acted for the Planet group of companies. The member of the firm who was engaged in the legal work involved in the flotation of the Metals and Gold, Mr. Harper, became aware some time in 1967 that there remained a considerable number of shares in those companies that had not been subscribed. At the same time he and his partners had become concerned at the high incidence of tax on their professional incomes. It occurred to him that a useful tax deduction might be obtained under sec. 77AA by taking up shares in Metals. He then asked the chairman of the Planet companies whether shares could be made available to the members of the firm and on 25 June 1967 he was told by Mr. Legge of Ralph King & Yuill, the brokers handling the flotation, that about 50,000 shares could be made available. It was a condition of the offer that for every two Metal shares accepted one Gold share should be taken - Gold shares were apparently less attractive than Metals shares - for one thing they offered a smaller taxation advantage - and this conditional offer was a means adopted to have the Gold shares taken up. On

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26 June 1967 Mr. Harper sent to some of his partners, including the appellant a memorandum telling them of the availability of the Metals shares, which were described as ``fully deductible'', and of the obligation to take one Gold share - said to be ``1/3 deductible'' - for every Metals share. The memorandum stated that for the cost of one dollar shares and options having a market value of $1.07 might be obtained (this was an erroneous understatement) and that the shares were to be taken up as a group with other investors and sold ``in an orderly manner''. At that stage the appellant took no action to acquire any of these shares. In the following month Mr. Legge offered Mr. Harper about 25,000 more Metals shares, and on 21 July 1967 Mr. Harper circulated another memorandum informing his partners of that fact. This memorandum stated that 25 Gold shares had to be taken for every 47 Metals shares, that the price of the Metals shares would be 55c, ``5 cents thus being a premium which is stated not to be deductible for tax purposes'', and that the price of the Gold shares would be par. On this occasion the appellant was interested, and discussed the matter with Mr. Harper, who told him that if he took up the shares he should obtain a tax deduction but that the shares could only be resold through Ralph King & Yuill, who would determine the time of sale. Mr. Harper explained that if the shares were all sold together it would be likely that the market would fall and that there would be a loss on resale and that the arrangements were designed to prevent this, if possible. In the course of this discussion, the appellant asked Mr. Harper if there was likely to be any market profit in the proposed transaction and Mr. Harper replied that there was more likely to be a loss because the market might fall. At about the time of this discussion the appellant made some calculations which, in the Board of Review, were taken to indicate that he did not intend to effect an immediate resale of the shares and options which he proposed to acquire. The calculations (Exhibits F and G) show that the appellant was considering the taxation advantage to be gained and the cost of the shares, but I am quite unable to agree that they reveal any intention, one way or the other, as to the resale of the shares. After this discussion the appellant asked Mr. Harper to apply on his behalf for 2,000 Metals shares at 55c each and 1,100 Gold shares at 50c. The appellant gave evidence that when he decided to acquire the shares he had made up his mind that he would sell the Metals shares and the Gold shares and the Gold options as soon as possible but that he would not exercise the Metals options until the Metals and Gold shares and Gold options had been sold. He was at the time overdrawn at his bank and expected to have to meet a substantial tax liability early in the following year and did not wish to outlay the further moneys that had to be paid on the exercise of the options until the amounts already expended in the transaction had been returned to him as a result of the sales. On 27 July 1967 he instructed Mr. Legge to sell the Metals shares and the Gold shares and Gold options, at the best price procurable, and they were sold accordingly between that date and 9 August 1967.

On 24 August 1967 the appellant banked the amount of $1,198.53 paid to him in respect of the sales of the Metals shares and the Gold shares and Gold options. On 13 September 1967 he wrote to Ralph King & Yuill stating that he desired to exercise the 4,000 Metals options and enclosed a cheque for $2,000. In the same letter he stated that he confirmed his instructions (which it appears had been given by telephone) to sell the shares at 69c, which was the price at which the last sale of Metals shares had been made on 12 September. The brokers sold 1,700 of the shares immediately but the appellant heard nothing about the balance; later he got in touch with the brokers again and on 5 October 1967 the remaining shares were then sold. All the sales were made at 69c as instructed. However, on 14 September the shares had fallen in the market below 69c and they did not rise again to that figure until 5 October. It is therefore probable that the brokers had refrained from selling the balance of 2,300 shares not because of inadvertence but because they were waiting to get the stipulated price.

The appellant was encouraged by the apparent success of this venture, and decided to engage in another similar transaction while options in Metals shares were still available for exercise. On 7 or 8 December he instructed Ralph King & Yuill to buy 4,000 Metals

ATC 4005

options on the market and these options were bought for him at a total price of $1,339. On 11 December 1967 he exercised the options and paid $2,000 for that purpose. He said that it was his intention when he acquired the options to sell the shares as soon as he properly could but he believed that he could not sell until the share scrip had been issued by the brokers and he was in a position to make delivery to the purchaser. He did not in fact give instructions to his brokers to sell the shares until about 7 February 1968. He explained his delay by saying that he was very busy before he went on leave on about 19 December and again when he returned and that while he was away on leave it was inconvenient to get in touch with his brokers. In fact on 7 February 1968 he had not received the scrip from his brokers but he assumed it was available. The price of the shares had with some fluctuations risen throughout January and it continued to rise during the first week of February, reaching something of a peak on 6 February.

The appellant swore that the possibility of a commercial profit played no part at all in his acquisition of any of the shares or options. He said that he bought to obtain a tax deduction and thus to improve his financial position. I accept that evidence; indeed, I regard both the appellant and Mr. Harper as witnesses of truth and accept their evidence generally.

I am satisfied that the appellant acquired the shares and the options, both in July and in December, for the purpose of obtaining taxation deductions. When he made these acquisitions it was his intention that he should resell the shares after he had made the payments in respect of them that would give rise to the deductions under sec. 77AA and sec. 78(1)(b). Of course it is right to say, as was submitted on behalf of the Commissioner, that the appellant was not indifferent to the question whether the resales would be at a profit or a loss. If he made a profit on resale, that would be an added benefit, whereas a loss would reduce or, if large enough, nullify the advantage to be gained from the taxation deductions. However, although he hoped for a profit, it was not his object to make a profit. In the case of the first transaction, when he made the purchases in July 1967 he was by no means optimistic that there would be a profit on the resale of the shares; on the contrary, he contemplated the possibility of a loss, although the proposed orderly resale of the shares at times to be chosen by the brokers was designed to prevent a loss. It is true that the price at which the shares were made available by the companies in July 1967 was lower than the current market values of the shares and options then obtained, so that if it had been possible to resell immediately some profit would have been made. However, it was essential to the whole transaction that the Metals options should be exercised before they were sold and it was feared that the market might fall before the resales could be effected. By the time the second transaction was commenced, in December 1967, the market had shown a disposition to rise and the appellant had more grounds for optimism that he would make a profit but, as I have said, that was not the object of the transaction, which was to obtain a taxation deduction. I find further that the appellant did not delay in reselling the shares, on either occasion, in the hope that the market would rise or with the intention that he would thereby make a profit. In the case of the first transaction, I accept that his reason for refraining from exercising the Metals options immediately was his reluctance to increase his overdraft and his consequent wish to wait until the initial payment had been recouped before he made the further payment necessary to exercise the options. In the case of the second transaction, I accept the explanation that he allowed some time to elapse before he instructed the brokers to resell, first because of his belief that he ought to wait until the scrip had become available and then because he was busy and the holidays intervened.

It now becomes necessary to consider whether on these findings of fact the appellant has succeeded in showing that the assessment was erroneous. The profit made by the appellant will be taxable under the first limb of sec. 26(a) if the shares and options whose sale yielded the profit were acquired by the appellant for the purpose of profit-making by sale. For that limb of the section to apply, the purpose must have been the main or dominant purpose actuating the acquisition - see the cases cited in
Jacob v. F.C. of T. 71 ATC 4192 at p. 4194; 45 A.L.J.R. 568 at p. 569.

ATC 4006

On behalf of the Commissioner it was submitted that the purpose of which the section speaks is the use to which the assets are to be put - see
Buckland v. F.C. of T. (1960) 34 A.L.J.R. 60 at p. 62, and
Evans v. D.F.C. of T. for S.A. (1936) 55 C.L.R. 80 at p. 99 - and that assets which are not acquired for personal use or enjoyment should be regarded as having been acquired either with a view to deriving income from them or with a view to selling them sooner or later at a profit - see Buckland v. Commissioner of Taxation, supra, at p. 62, and
Pascoe v. Commissioner of Taxation (1956) 30 A.L.J. 402 at p. 404. The second proposition contained in that submission is true as a generalisation but the present case is exceptional. The shares and options were not acquired to produce income for the appellant, but that does not mean that they were acquired for the purpose of resale at a profit. They were acquired with a view to allowing the appellant to claim tax deductions in respect of moneys paid on them. To attain that benefit without suffering a loss that would outweigh it, it was necessary for the appellant to recover the money he outlaid, or at least enough of it to make the deductions worthwhile notwithstanding some loss on resale. It was an essential part of the purpose with which the shares and options were acquired that they should be resold. It may therefore be right to say that the property was acquired for the purpose of sale but it is unnecessary to determine that question or to consider the effect of
Commr. of I.R. v. Hunter, (1970) N.Z.L.R. 116, which was decided on a New Zealand section which, although similar in some respects to sec. 26(a), speaks of property ``acquired for the purpose of selling or otherwise disposing of it''. Under sec. 26(a) it is not enough that the property was acquired for the purpose of selling it; it must have been acquired for the purpose of making a profit by selling it. To achieve the purpose of the appellant in the present case it was not necessary that the shares and options should be resold at a profit; it was enough that they should be resold without too great a loss. It was not part of his object in acquiring them to make a profit, although he had some hope of making a profit. It would be contrary to the evidence which I accept to find that the property was acquired for the purpose of profit-making by sale.

In the course of the Commissioner's submissions reference was made to a passage in my judgment in
XCO Pty. Limited v. F.C. of T. 71 ATC 4152 at p. 4156; 45 A.L.J.R. 461 at p. 464, where I said: ``The purpose of the scheme was to make a profit, even though the motive for making the profit was to lay the foundation for a test case. It hardly needs saying that the motive with which a profit is made is irrelevant to the question whether the scheme which yielded the profit was a profit-making scheme''. Those remarks, to which I adhere, were made in relation to the second limb of sec. 26(a) but under the first limb also if the acquisition was actuated by the dominant purpose of profit-making by sale it is immaterial what motive the taxpayer had to seek to make the profit. However, in the present case the desire to obtain a taxation deduction was not merely the motive which impelled the appellant to acquire the shares and the options; it was the object which he had in view in acquiring them. Of course, the question to be finally decided is not whether the appellant had some other purpose in acquiring the property but whether or not he acquired it for the purpose of profit-making by sale. For the reasons I have given, that question must be answered in the negative.

Counsel for the Commissioner very properly did not seek to espouse the view taken by one of the members of the Board of Review that a mere saving of tax can be regarded as a profit within sec. 26(a). That view is untenable.

I hold, therefore, that the case does not fall within the first limb of sec. 26(a). It follows from what I have said that the second limb of that section is equally inapplicable. In my opinion, as I said in XCO Pty. Limited v. Commissioner of Taxation, supra at p. 4155, ``a scheme is not a `profit-making scheme' simply because it yields a profit when none was intended; in the ordinary sense of the words a `profit-making scheme' is a plan devised in order to obtain a profit, and a scheme only answers that description if the taxpayer carries it out with the purpose of making a profit''. If it be assumed that in the

ATC 4007

present case the appellant carried out a scheme in the course of which he bought and sold shares and options, the scheme was not carried out for the purpose of making a profit.

The final question is whether the profit made by the appellant can be regarded as income within ordinary usages and concepts. The profit represented a capital gain resulting from the realisation by the appellant of assets which had appreciated in value. It is impossible to say that the profit was made in the course of carrying on a business, and the profit could only be regarded as income if it could rightly be said that in entering into the transactions the appellant engaged in an adventure in the nature of trade. Shares may of course be the subject of trade, and an isolated transaction may in some circumstances amount to an adventure in the nature of trade, but the finding of fact that I have made that the appellant did not buy the shares and options in question for the purpose of making a profit on their resale appears to me in the circumstances of this case to be fatal to the contention that the appellant carried on an adventure in the nature of trade. The fact that in the first transaction the shares were to be sold only at a time selected by the brokers, whose object was to maintain their price, only means that the proposed realisations were intended to be as advantageous as possible. The question whether the appellant engaged in an adventure in the nature of trade is one of fact and I answer it in the negative. In my opinion the profit gained by the appellant cannot be described as income within the ordinary understanding of that term and is not taxable within sec. 25(1) of the Act.

For the reasons I have given, the appeal must be allowed and the assessment must be remitted to the Commissioner to be amended in accordance with my judgment.


Appeal allowed with costs. Matter remitted to the Commissioner to reassess in accordance with the reasons for judgment.

Usual order as to exhibits.

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