Between: Federal Commissioner of Taxation
And: Miller Anderson Ltd

Judges: Latham CJ
Starke J

Dixon J

Subject References:
Taxation and revenue
War-time company tax
Accumulated profits
Averaging of accumulated profits over accounting period

Legislative References:
War-time (Company) Tax Assessment Act 1940 No 90 - s 24

SYDNEY

Judgment by:
DIXON J

The facts and issues in this rather complicated case are explained with great clearness and completeness in the valuable opinion given in the Board of Review by the chairman (Mr. Gibson), with whose conclusions I find myself in substantial agreement. In view of his explanation, it is enough to state the chief question we have to decide in general terms. It concerns the method of ascertaining, for the purpose of s. 24 (1) (b) of the War-time (Company) Tax Assessment Act 1940-1941, a company's accumulated profits including amounts standing to the credit of the profit and loss account at the commencement of the accounting period. The question is whether a company may exclude a past accrued loss which it has carried to, or carries in, a distinct account and bring into the computation of what, for the moment, I may call its undistributed profits, only the gains and losses of subsequent accounting periods. The contrary view is that it must bring into account the consecutive results of its trading over its history, that is, except in so far as it has effectually written off or otherwise disposed of any specific accrued loss, as for instance by reduction of capital.

The respondent company incurred losses which, taking into account a possibly unjustifiable distribution of dividend, amounted as at 31st January 1935 to PD13,107. This, in consequence of arrangements between the company and its preference and ordinary shareholders, was segregated and placed to an account called "Profit and Loss Appropriation Account to 31st January 1935." As at the end of the next accounting period a new account was opened and called "Profit and Loss Appropriation Account from 1st February 1935." After the deduction of dividends, the relevant result of the company's operations from that date to 31st January 1941, the commencement of the second of the two accounting periods with which we are concerned, as appearing from the balance sheet, has been a credit to the last-mentioned account of PD20,548 and the making of provisions which we may call reserves amounting to PD17,792. In the balance sheet on the debit side was shown "Profit and Loss Appropriation Account from 1st February 1935 PD20,548," and, on the credit side, "Profit and Loss Appropriation Account to 31st January 1935 PD13,107." If the two profit and loss appropriation accounts had not been separated as at 31st January 1935 and instead there had been a continuous account, the amount at its credit would have been PD7,441. No one denies that the reserves, amounting to PD17,792, constitute accumulated profits within the meaning of par. (b) of s. 24. But the important issue is whether, for the purposes of the paragraph, what I may call its undistributed profits should, as the company claims, be considered as PD20,548 or as PD7,441. The claim of the company is maintained both by general reasoning and upon the precise structure of the paragraph. As to the latter, it will be noticed that the general words "accumulated profits" are followed, after the direction for averaging the amount over the accounting period, by the specific inclusion of amounts standing to the credit of the profit and loss account at the opening of the relevant accounting period. Can the respondent bring the balance at credit of the "Profit and Loss Appropriation Account from 1st February 1935" within the latter words? That is to say, can the company say that balance is specially provided for and falls outside the operation of the general descriptive expression "accumulated profits"? Or to state the question more generally, are unreserved or floating profits accruing before the opening of the accounting period governed by the words "accumulated profits" or by the special inclusion of amounts standing to the credit of the profit and loss account at the commencement of the period? These questions arise because, as is obvious, the descriptive character of the general words "accumulated profits" provides a justification for going behind the form of the accounts adopted by the company and independently ascertaining what, so to speak, is the net result of the company's profits, losses and distributions, and such a justification would not exist if the question depended exclusively on what was found standing to the credit of the profit and loss account. Like expressions, such as "income accumulated," "accumulated trading profits invested in the business," "amounts carried forward to the credit of profit and loss account," have been used in pari materia in prior legislation and they have been considered and discussed in this Court in Meares v Acting Federal Commissioner of Taxation ^[F24] ; Forrest v Federal Commissioner of Taxation ^[F25] ; Hooper & Harrison Ltd (in Liquidation) v Federal Commissioner of Taxation ^[F26] ; Sharp, Stevenson & Hare Pty Ltd v Federal Commissioner of Taxation ^[F27] ; Stodart v Deputy Federal Commissioner of Taxation ^[F28] , decisions which, as the chairman's analysis and comparison have shown, do not provide a consistent guidance in the meaning and application of the phrases. Indeed, I repeat what I said in Resch v Federal Commissioner of Taxation ^[F29] , at p. 231 concerning Forrest's Case ^[F30] , namely, that how far that case is consistent with Hooper & Harrison Ltd (in Liquidation) v Federal Commissioner of Taxation ^[F31] , at pp. 480-482 and Sharp, Stevenson & Hare Pty Ltd v Federal Commissioner of Taxation ^[F32] , at p. 172 may be doubted.

I think that, perhaps, there has been a tendency to give both too much fixity of meaning and too much precision to expressions of the kind in question and that the purpose of the provision in which they occur and the principle upon which it proceeds will throw more light on their exact application. Broadly speaking, the legislature may be taken to be alive to the distinction between the two courses that a company may follow with reference to profits which have accrued but which it does not desire immediately to distribute or withdraw from its business. The directors may in some way earmark the profit or part of it as a reserve or provision for a special purpose and thus distinguish it by placing it in an accounting category so that to withdraw it and make it available for distribution would require a new and affirmative decision. On the other hand, they may carry it forward in the company's accounts in such a way that, subject to the increment or diminution the trading of the next period or later periods may bring, it still awaits the decision of the directors to distribute it, to earmark it as a reserve, or otherwise to dispose of it. If the latter course is followed the profit will, according to the usual practice, stand as a credit to an appropriation account. But, although a profit and loss account should be confined to the transactions of a single accounting period, sometimes the profit of the previous period is carried to the actual profit and loss account itself of the subsequent period. But in either case it may be said to be carried forward on account of profit and loss. It may sometimes be uncertain whether and how far it is the intention of a legislative provision dealing with the profits retained in a business to demand some decision or indication on the part of a company to segregate or earmark the profits. It may be a question of interpretation whether it demands so formal a course or regards it as enough for the company to ascertain the profits and in its accounts to identify them as belonging to an accounting period. When expressions like "accumulation" and "amounts carried forward to the credit of profit and loss" are used in such a legislative provision, it may be important to extract from the expressions an intention precisely to distinguish reservation or earmarking for a purpose or separation, on the one hand, from, on the other hand, carrying forward an account of profit and loss. Further, under the latter head, it may be found that a second distinction is made, namely, between crediting profits to an appropriation account and the less usual and unorthodox course of carrying them down to the next profit and loss account.

In Meares' Case ^[F33] and Stodart's Case ^[F34] , the second distinction was drawn and the fact that it was credited to the appropriate account was considered enough to satisfy the purpose of that legislation in preserving the separate identity and chronological source of the profit. In Forrest's Case ^[F35] and Stodart's Case ^[F36] , it was thought that none of these things was demanded by the particular provision and that, if a profit existed before the requisite time and remained, it was to be considered to have been accumulated; whereas, in Hooper & Harrison's Case ^[F37] , Isaacs and Rich JJ. regarded "reservation" in some form as necessary and, I think, it may be said that the judgments in Sharp, Stevenson & Hare Pty Ltd ^[F38] tend in the same direction, more particularly those of the minority.

Now the object of the provision contained in par. (b) of s. 24 (1) appears to me to be to authorize the inclusion in the capital amount on which the percentage standard is calculated of all shareholders funds employed in the business at or over the relevant time, that is to say, funds put to employment in the business and not withdrawn. This view is borne out by the general plan of the section and the nature of the other paragraphs as well as by the care shown to see that the funds mentioned in pars. (b) and (c) are averaged over the accounting period. When the legislature expressly included amounts standing to the credit of the profit and loss account at the commencement of the accounting period, I think that it meant exactly what it said and was referring to the distinction already drawn by this Court in the cases mentioned between the two ways in which profit is carried forward on account of profit and loss; viz., the orthodox crediting of an appropriation account and the loose practice of carrying down a profit into the next profit and loss account or showing it in connection therewith. It means that the line is not to be drawn at a profit and loss appropriation account so as to include nothing which had not at least gone into such an account and that there was to be no exclusion of an ascertained profit on the ground that it had been transmitted into the account of the next period to share with the net receipts of that period the burdens and chances to which the further transactions would expose it. I agree with the chairman-"that the inclusive words were inserted in order that companies should not be penalized for dealing" in this manner "with the unappropriated balances of their profit and loss account." More than that is not covered, I think, by the reference to amounts standing to the credit of the profit and loss account. The expression "accumulated profits" comprises all else down to and including balances to the credit of the profit and loss appropriation account.

I am, therefore, of opinion that the question whether the amount to be taken into account under par. (b) is PD20,548 or PD7,441 depends upon the meaning of those words and not upon the application of the words-"standing to the credit of the Profit and Loss account at the commencement of the accounting period," which are material only as part of the context in which the expression "accumulated profits" is to be interpreted. The argument that, under that expression, the accrued losses of the period up to 31st January 1935 should be excluded from consideration depends in some aspects upon the general purpose and policy disclosed by s. 24 and, in others, upon the principles governing the dealings of companies with their profits, principles which s. 24 may be taken to presuppose. In some degree, too, it claims support from the word "accumulated" on the footing that the word connotes or suggests some decision or course of action or of accounting on the part of the company. It is pointed out that, though s. 24 (1) speaks of "capital employed," it is clear from par. (a) that the chief element is the capital which the shareholders have in the past contributed to the company, not what at the opening of the accounting period may be found still to be represented by the assets. The same policy is discernible in par. (c). It follows that, although share capital is not represented by assets, it forms part of the capital fund on which the percentage standard is calculated, and that, it is said, is because the purpose is to allow a standard of war-time profit commensurate with what shareholders have committed to the enterprise, whether it has been lost or not. In the same way, it is contended, par. (b) ought to be understood with respect to profits which the shareholders might have had but which it was decided to leave at risk in the enterprise. It is not, according to the argument, a question of what on a balance of gains and losses over an extended period of time, over a period, perhaps, from the establishment of the company, ought to be treated as the net accretion to its funds over and above share capital. The question, it is claimed, is rather what sums, annually ascertained as detachable profits which the shareholders might have taken out by way of dividend but preferred to leave at risk in the business, are shown by the accounts to remain. Are they not, it is asked, notionally as much contributions by the shareholders to the funds employed as premiums on the issue of shares or as paid up capital itself? When the loss of PD13,107 was ascertained, what else could it mean but a loss of money subscribed as share capital? On what are now established principles of company law, why, it is asked, should subsequent profits be treated as replacing this loss? So far from appropriating subsequent profits to the purpose, a line was drawn, the loss was carried or suspended, and subsequent profits were treated as available for provisions in the nature of reserves and for dividend. The case is represented as one in which past losses are left unreplaced deliberately by a definite decision, while the company, in accordance with law, dealt with the net proceeds of subsequent trading by distributing profits, reserving them, or carrying them over on account of profit and loss as the wisdom of its directors and members might dictate. In other words, the law allowed the company to appropriate the profits as it thought fit and instead of dividing them or wiping out the loss with them, it decided to retain them as profits and that, it is said, amounts to "accumulating" them. Notwithstanding the closely reasoned argument of counsel for the respondent company, I think that the foregoing contention should not be accepted. In the first place, I reject the view that by "accumulated profits" par. (b) means to establish a test depending in any way on accountancy, or on the positive course the company may take in appropriating the profits it retains. For whatever purpose the like expressions may be used elsewhere, I think that those contained in par. (b) were intended to cover the profit actually ascertained and retained for employment in the business. They are intended as a descriptive category implying, no doubt, the ascertainment and retention of profit, but not otherwise depending on the accounting or on the volition of the company.

In the next place, it must be true that as part of the working capital of the company's business the subsequent profits did in fact replace the past losses. There was no reduction of share capital. The subsequent profits necessarily made up once more the fund which would answer share capital. Perhaps it is true that they were never placed beyond the power of the directors to divide them and, in that sense, they never came fully to "represent" share capital. But, except for the arrangement with shareholders which justified the division of the appropriation accounts as at 31st January 1935, there was nothing in the dealings with the profits or the assets of the company to segregate out, or to provide for, the loss, except by the actual use of the subsequent profits. When the placing of the respective balances of the two appropriation accounts, the debit of the one and the credit of the other, on opposite sides of the balance sheet is considered, it will be seen as an express acknowledgment of their necessary relation and as falling just short of an amalgamation of the two accounts by using the later to answer the earlier.

In my opinion the reality is that up to 31st January 1941 the company never accumulated more than PD7,441 of profits and that sum, together with the addition of the reserves of PD17,792, is the amount upon which the calculation under s. 24 (1) (b) should be based.

There is, however, a question arising under the words "averaged over the accounting period" contained in par. (b). For, on 31st March 1941, that is, within the accounting period, the company declared dividends amounting to PD10,075. In addition, an interim dividend amounting to PD2,400 was paid on preference shares on 10th October 1941. It does not appear, however, from what source it was paid or to what profits the payment has been attributed. It may amount to a distribution of the profits of the then current accounting period, that ending on 31st January 1942. If so, the distribution would not affect the period under consideration. I think, therefore, that we should ignore it and confine ourselves to the dividends amounting to PD10,075 declared as on 31st March 1941.

The declaration of these dividends involved a reduction or diminution by PD10,075 of the accumulated profits fifty-nine days after the opening of the accounting period. The question is how should this diminution of accumulated profits be averaged over the accounting period?

In the first place, it is clear that none of it was in fact or in law paid out of reserves. The reserves as such were continued without increase or diminution throughout the accounting period. If it be proper to regard them separately, they require no "averaging." The chairman of the Board so regarded them and put them out of consideration in applying the averaging provision, on the ground that it was not necessary to average the reserves as their amount remained unchanged throughout the year. This position the Commissioner accepted on the hearing of the appeals before us and we need not consider its correctness.

The sum of PD20,548, which the company's accounts showed as its balance of unreserved accumulated profits as at 31st January 1941, included a sum of PD14,528, the profits of the year ending upon that date. It appears that, in proposing to the shareholders the declaration of the dividends amounting to PD10,075, the directors recommended that they should be payable out of the profits of the year just closed, viz., out of the PD14,528, and, as the shareholders resolved that the dividends as recommended by the directors be declared, we may assume that the source of the distribution of PD10,075 was the PD14,528 parcel of the PD20,548. These sums of profit are recognized by company law as existing, notwithstanding that prior losses have not been recouped, and as being available as a source of dividend. But, for the purpose of the War-time (Company) Tax Assessment Act upon the foregoing interpretation of that Act, the only accumulation of profit recognized is PD7,441. That sum may be considered to be contained within the PD20,548 recognized under company law and perhaps it may be treated as altogether comprised within the PD14,528, the profits last to be earned, forming part of the PD20,548. It is clear that, after 31st March 1941, the amount declared as dividends ceased to be profits held by the company. In applying the direction to average the accumulated profits over the accounting period, should we throw the whole of the dividends so declared against the PD7,441 with the consequence that we must treat no part of that sum as in the possession of the company for more than fifty-nine days of the accounting period and must then regard it as having been exhausted by contributing to the payment of PD10,075? Or, on the other hand, should we treat the dividend as payable ratably out of each and every PD1 of the PD14,528, so that only so much in the PD1 of the dividend should be considered attributable to the PD7,441, treating the latter sum of course as forming part of the PD14,528? Before the Board this question does not appear to have been raised and the chairman regarded the whole of the sum of PD7,441 as distributed, or appropriated for distribution, as at the end of fifty-nine days in part payment of the dividends amounting to PD10,075. He, therefore, considered that the sum of PD7,441 should be averaged as follows, viz. 59/365 X PD7,441 = PD1,203.

The opposing view is based on an application of the rule that where sums such as dividends are paid out of an aggregate sum without differentiation, they must be taken to have been paid ratably out of every part of it (Resch v Federal Commissioner of Taxation ^[F39] , at pp. 230, 231). If this principle be applied the dividends amounting to PD10,075 would be taken as paid out of a total sum of PD14,528 without differentiation and, of every PD1 of the latter sum, the dividends must be considered to have taken PD10,075/PD14,528. On the footing that the accumulated profits recognized by s. 24 (1) (b), viz. PD7,441, form a part of the PD14,528, the dividends would be taken to have been paid out of the PD7,441 only to the extent of PD10,075/PD14,528, that is PD5,160.

On the whole I have come to the conclusion that the principle of ratable attribution ought not to be applied, and that the chairman's method is the correct one. My reason for this conclusion, which I have not reached without some doubt, lies in s. 24 (1) (b) itself. In that section the words "averaged over the accounting period" are attached to the words "accumulated profits." I do not mean by this to exclude the possibility of them governing also the words "standing to the credit of the Profit and Loss Account." That is a question that can be put on one side. But I do mean that the conception of "accumulated profits" seems, by the juxtaposition of the words, to be one that ought to be carried into the process of averaging. If it is right, as for the reasons given, I think it is, to go to the actual accumulation of profits as ascertained from a consideration of the profits made, the losses made and the dividends distributed, I think it is also right to carry the same principle into averaging. This means, in effect, that we ought not to go to company law to find out what sum was consumed in distributing the dividends during the accounting period or, in other words, to determine the source of the dividends. We should continue, in averaging, just as in ascertaining the accumulated profits at the beginning of the accounting period to look to the actual balance of accumulated profits available. This means that we should treat the sum of PD7,441 as the accumulated profits at the beginning of the accounting period against which the dividends paid during the accounting period should be primarily thrown. We are averaging the sum of PD7,441 in the sense of ascertaining over what period of time that amount was retained as part of the funds of the company, and making an apportionment in accordance with time over the accounting period. I, therefore, think that the view of the chairman is correct, namely, that since 31st March 1941, the amount declared as dividends ceased to be profits held by the company, the accumulated profits not distributed or otherwise dealt with at the beginning of the accounting period amounted to PD7,441 and, having been distributed at the end of fifty-nine days, this amount should be averaged as follows:

59 / 365 = PD1,203.


I, therefore, answer the first question in the case stated in respect of the accounting period ending 31st January 1942, Yes, and the second question, that it should be taken into account to the extent and in the manner described in par. (c) of the question.

In the case stated for the accounting period ending 31st January 1941 the facts are the same, though, of course, the figures differ. The questions are in the same form and the answers should be the same.