Curran v. Federal Commissioner of Taxation.
Members: Barwick CJMenzies J
Gibbs J
Stephen J
Tribunal:
High Court of Australia
Gibbs J.:
This case stated raises for our consideration questions in relation to an assessment to income tax based upon income derived by the appellant during the year of income that ended on 30th June 1969. The appellant was a stockbroker and during the year of income he also carried on the business of dealing in stocks and shares on his own account. For the purposes of that business he held, bought and sold stocks and shares in a considerable number of companies. It is common ground that in the circumstances the stocks and shares constituted trading stock for the purposes of the
Income Tax Assessment Act
1936-1969 (``the Act'')
-
see
Investment and Merchant Finance Corporation Ltd.
v.
F.C. of T.
71 ATC 4140
;
(1971) 125 C.L.R. 249
-
and that in determining whether the appellant had a taxable income it is necessary, in accordance with the provisions of sec. 28 of the Act, to compare the value of all stocks and shares held by the appellant at the end of the year with the value of those held at the beginning of the year; an excess of the former value over the latter represents income, whereas an excess of the latter over the former is an allowable deduction. However, sales and purchases made during the year must also be taken into account in arriving at the appellant's taxable income; the proceeds of any sales of stocks and shares must be included in the assessable income and the expenditure incurred in the purchase of stocks and shares
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which by sec. 51(2) is not to be treated as an outgoing of capital or of a capital nature
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is to be deducted. The appellant, with his return of income, submitted an account of his share trading compiled in accordance with these principles. This account showed that the sum of the value of stock on hand at 1st July 1968 (at cost or market value whichever was the lower) and the cost of purchases during the year ended 30th June 1969 exceeded the value of stock on hand at 30th June 1969 (at cost or market value whichever was the lower) plus the proceeds of sale by an amount of $206,019, and the appellant claimed this amount, which he said represented his loss on share trading, as a deduction; in consequence he sustained a considerable net loss for the year. The Commissioner challenged the appellant's accounts in one respect only. The appellant included in the amount representing the cost of stocks and shares purchased during the income year the par value of bonus shares in a number of companies that were issued to him during that period. The Commissioner, however, made his assessment on the footing that the cost of acquiring the bonus shares should be shown in the accounts as nil. The result was to convert the appellant's loss into a profit.
The case as framed raised questions as to bonus issues made by ten public companies and one private company but the parties have reached agreement as to the answer to be given to question 3, which relates to the public companies, and it is unnecessary further to refer to the issues made by those companies. Questions 1 and 2 concern the dealings by the appellant in a private company, Stewart Bacon Holdings Pty. Ltd. (``Stewart Bacon''), which on 6th May 1969 issued 191,000 bonus shares to the appellant. I find it unnecessary to state in full detail the facts surrounding the making of the bonus issue, because although it may be surmised that the issue was made with an eye to its consequences under the taxation law, it was not suggested that what was done attracted the operation of sec. 260 of the Act. The material facts are as follows. At the beginning of the year of income the appellant held no shares in Stewart Bacon. On 28th April 1969 he bought 200 issued shares in that company for $186,046.48. On 6th May 1969 191,000 fully paid shares of one dollar each in Stewart Bacon were allotted to the
ATC 4303
appellant. The allotment was made pursuant to a special resolution by which the company, in the exercise of powers given by its articles, resolved that $205,325, forming part of the undivided profits of the company representing profits arising from the sale of assets not acquired for the purpose of resale at a profit and standing to the credit of the capital profits reserve account, be capitalized and distributed proportionately amongst the members on the footing that they became entitled thereto as capital, and that the capitalized sum be applied in paying up in full 205,325 of the unissued ordinary shares of one dollar each in the capital of the company and that the same be distributed amongst the members as fully paid ordinary shares of a dollar each in satisfaction of the capital sum and in proportion to the number of shares then held by them respectively. Later on the same day the appellant sold for $197.52 the 200 shares which he had bought on 28th April 1969 and also sold for $188,631.60 the 191,000 shares which had been allotted to him. The appellant's accounts made for taxation purposes show that these transactions, which were in truth profitable, resulted in a heavy loss. So far as they relate to these transactions the accounts show as follows - ``To 200 shares at cost $186,046.48
To 191,000 shares issued on
6 May, 1969 $191,000.00
-----------
$377,046.48
-----------
By proceeds of sale of initial
200 shares $ 197.52
By proceeds of sale of the
191,000 shares $188,631.60
Loss $188,217.36
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$377,046.48''
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The Commissioner, on the other hand, contends that in these accounts the cost of the 191,000 shares should be shown as nil; if this is done the result will be that the appellant made a profit of $2,782.64 on these transactions.
The Act does not deal fully with the manner in which a profit and loss account is to be kept by a trader, and in particular does not expressly provide as to the manner in which trading stock acquired during the year of income is to be brought into the account. Where the Act is silent recourse must be had to ``common understanding and commercial principles'' and that method must be adopted which will be ``calculated to give a substantially correct reflex of the taxpayer's true income''
-
cf.
C. of T. (S.A.)
v.
The Executor Trustee and Agency Company of South Australia Ltd.
(1938) 63 C.L.R. 108
, at pp. 154-156
. Speaking generally, common understanding and ordinary commercial principles will require purchases to be brought into the account at their actual cost. The Commissioner submits that where shares have been allotted as a bonus, and not purchased, they have cost nothing, and therefore should be included in the account at a nil value; moreover, he submits that to bring in the bonus shares at par value would lead to a result which would be manifestly unreal and that this supports the view that it would be erroneous to bring them in at par. The appellant, on the other hand, contends that it was not the account, but the Act itself, that led to the result that a real profit was shown for taxation purposes as a loss. The appellant submits that the sum of $191,000 which was applied in paying up the shares was a ``dividend'' for the purposes of the Act, but was not assessable income. By sec. 6(1) of the Act ``dividend'' includes
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``(c) the paid-up value of shares issued by a company to any of its shareholders to the extent to which the paid-up value represents a capitalization of profits.''
Within this definition the sum of $191,000 was clearly a dividend. This ``dividend'' would have been included in the assessable income of the appellant by sec. 44(1) of the Act were it not for sec. 44(2)(b)(iii), which provides that the assessable income of a shareholder shall not include dividends paid wholly and exclusively out of (inter alia) -
``profits arising from the sale or revaluation of assets not acquired for the purpose of resale at a profit... if the dividends paid from such profits are satisfied by the issue of shares (other than redeemable shares) of the company declaring the dividend.''
ATC 4304
According to the appellant, on ordinary principles, if it were not for sec. 44(2)(b)(iii), the amount of $191,000 would have been shown as assessable income immediately on receipt and the bonus shares would then have been brought into the trading account at $191,000 because that sum was in effect applied on behalf of the appellant in paying up the shares. On this submission the only reason why the result of the appellant's accounting seems unreal is because sec. 44(2)(b)(iii) prevents the amount of $191,000 from being taxable, and the error in the Commissioner's approach is demonstrated by the fact that if the bonus issue had, for example, been made out of profits arising from the sale of assets acquired for the purpose of resale at a profit, so that sec. 44(2)(b)(iii) did not apply, the sum of $191,000 would, if the Commissioner's contention is correct, have been taxed twice - once on the issue of the bonus shares and again on their sale.
In fact no dividend, as that word is ordinarily understood, was declared by Stewart Bacon. The appellant was never entitled to receive in cash his proportion of the capitalized profits. Nevertheless, the effect of the special resolution was that capitalized profits to the extent of $191,000 were credited to the appellant and applied on his behalf in paying up the shares:
James
v.
F.C. of T.
(1924) 34 C.L.R. 404
, at p. 416
;
C. of T. (Vic.)
v.
Nicholas
(1938) 59 C.L.R. 230
, at p.244
;
Nicholas
v.
C. of T. (Vic.)
[1940] A.C. 744
, at pp. 757-759
. In a sense, therefore, it may be said that the shares cost the appellant $191,000 and that it was appropriate to treat their acquisition as a purchase for that amount. However, I do not need to base my decision on that ground. In my opinion it was not possible to arrive at the appellant's true income without taking the bonus shares into account as trading stock acquired, whether or not those shares could properly be regarded as having been purchased. The appellant's trading account would not reveal the real situation if it brought in at no value shares which were in fact valuable, because the amount which it would then show as income would include the value which the shares possessed when they were first brought into stock. The case may be compared with that of a trader who takes into his trading stock articles which he received by way of gift or under a bequest. Cases of that kind not falling within sec. 36 of the Act may be rare, but they can be envisaged. In such a case an account will not reveal the true result of the trading unless those articles are brought in at an appropriate value, e.g. market selling value. If the account showed that the articles cost nothing, the result would be to increase the amount of the trader's profit or decrease the amount of his loss by the value of the gift or bequest and in effect to make the trader pay income tax on the gift or bequest. The only practicable way of reaching a true result in a case of that kind would be to bring the articles into the account at an appropriate value as though they had been purchased, and there is no provision in the Act that would require any different approach. To arrive at a true estimate of the appellant's income it seems to me necessary to bring the shares into the trading account at an appropriate value, which in the circumstances of the case must be their par value. However, it may be said that if this were done it would ignore the fact that the shares came to the appellant as the result of a bonus issue made by a company whose shares formed part of the appellant's trading stock and that infact the transactions proved to be profitable. It must, however, be remembered that the transactions had two distinct aspects
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first the acquisition of the shares and then the act of treating them as part of the trading stock and selling them. That which made the transactions profitable was the receipt of the shares as a bonus. If it were not for sec. 44(2)(b)(iii), it would have been necessary to show the value of those shares on the income side of the trading account when they were alloted. It is true that it was held in
Gibb
v.
F.C. of T.
(1966) 118 C.L.R. 628
, that the value of bonus shares issued to a taxpayer does not constitute income in the ordinary sense, but that case was not dealing with the position of a person who traded in shares; if there were no such provision as sec. 44(2)(b)(iii) the account of a share trader who received bonus shares in the circumstances of the present case would be misleading if it did not reflect in the account the benefit received.
ATC 4305
Thereafter the shares, at their par value, would have had to be included in the account together with the purchases, to enable the necessary comparison to be made between stock held at the beginning of the period together with stock acquired, on the one hand, and stock held at the end of the period together with proceeds of sales on the other The ultimate result of accounts prepared in this way would have been to show that a profit of $2,782.64 resulted from the transactions relating to the Stewart Bacon shares considered as a whole. However, sec. 44(2)(b)(iii) has the effect that the value of the bonus shares cannot be included in the assessable income - it is that circumstance that leads to a result which appears to be distorted. That, however, is no reason for falsely showing the shares to have had no value when brought into the account as trading stock, and an account prepared on such a false basis would lead indirectly to the taxation of the ``dividend'' which sec. 44(2)(b)(iii) declares shall not be included in the assessable income.In short, it was, in my opinion, right to bring the bonus shares into the trading account at par value and the reason why this leads to the result, at first sight surprising, that the transactions show a loss of $188,217.36, is that sec. 44(2)(b)(iii) had the effect that the value of the bonus shares never became part of the appellant's assessable income.
It follows that in my opinion the account of the appellant, so far as it related to the Stewart Bacon shares, was correctly prepared for the purposes of the Act.
I would answer the questions asked as follows -
- 1. Did the appellant as claimed in paragraph 22 of the case stated incur a loss in relation to the 200 shares in Stewart Bacon purchased by him on 29th April 1969 in the sum of $185,848.96 which was an allowable deduction under the provisions of the Income Tax Assessment Act 1936-1969?
- 2. Did the appellant incur a loss on the sale of the 191,000 shares in Stewart Bacon issued to him on 6th May 1969 in the sum of $2,368.40 which is an allowable deduction under the provisions of the said Act?
- A. The appellant incurred a deductible loss in relation to all the shares in Stewart Bacon in the sum of $188,217.36.
- 3. In relation to the appellant's trading in shares in the companies listed in paragraph 24 of the case stated did he incur:
- (a) a loss of $22,573?
- A. Answered by consent: No.
- (b) a loss of some other, and if so what, amount?
- A. Answered by consent: Yes, $22,513.
- (c) a profit of $556?
- A. Unnecessary to answer.
- (d) a profit of some other, and if so what, amount?
- A. Unnecessary to answer.
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