Curran v. Federal Commissioner of Taxation.
Judges: Barwick CJMenzies J
Gibbs J
Stephen J
Court:
High Court of Australia
Stephen J.: Since in this appeal I have found myself obliged to arrive at a conclusion different to that of the other members of the Court, I should state in some detail why I consider that the taxpayer made no loss in his transaction involving shares in Stewart Bacon Holdings Pty. Ltd. but. rather, a modest profit in respect of which the Commissioner has correctly assessed him to tax.
The appearance of a loss situation arises only if the taxpayer is regarded as having outlaid not merely $186,046, the purchase price of his original 200 shares in the Company, but also a further $191,000. representing the par value of the 191,000 bonus shares subsequently issued to him. As against this apparent total outlay of $377,046 his recoupment of only $188,828 on the sale of all of the 191,200 shares reflects a loss of $188,218. It is nothing to the point, so the argument goes, that having entered the transaction with $186,046 and no shares in the Company, he concludes it, once again with no shares in the Company nor with any resultant liabilities but now with $188,828 in his pocket, showing a net gain of $2,782.
Wherein then lies the taxpayer's alleged loss? It arises, it is said, from that part of the
ATC 4306
transaction by which he, as majority shareholder, procured the capitalization of the Company's profits and the issue to himself of 191,000 bonus shares; that process involved two relevant steps, the declaration of a dividend and its application by the company, on behalf of members, in paying up the bonus shares issued to them. Although the first of these two steps results in no assessable income in his hands because of the effect of sec. 44(2)(b)(iii) of the Income Tax Assessment Act it is nevertheless said to involve a receipt of income by him; the second step is, on the other hand, regarded as involving him in an outgoing of $191,000, being the ``cost'' to him of the bonus shares, incurred, apparently, when the Company applies the dividend in paying up these shares. This ``cost'' is to be brought into account as the value of the bonus shares in the taxpayer's trading account, from which the equal amount of the deemed dividend is to be excluded. To take one of these two like sums into account and disregard the other necessarily throws up a loss of $191,000, which then provides the measure of the total alleged loss when there is deducted from it the modest profit of $2,782 earlier referred to.I have, I believe, correctly stated the critical features of the taxpayer's case, although I am conscious of the fact that certain of these features are susceptible of varying emphasis. Thus attention may be focussed upon what is said to be the effect of the Income Tax Assessment Act in deeming the sum of $191,000, used to pay up the bonus shares, to be a dividend (sec. 6(1)) saved only from assessability in the taxpayer's hands by the terms of sec. 44(2)(b)(iii) of the Act. Alternatively the manner in which the acquisition of the bonus shares is shown in the taxpayer's trading account may be stressed, their appearance in that account at an appropriate value, in this instance par, being said to be necessary so that the trading account may reflect the results of the whole transaction.
Whatever may be the precise formulation adopted, the taxpayer's case depends, in essence, upon the view that he should not be regarded, for the purposes of his assessment to tax, as having outlaid only $186,046 and no more, as compared with his admitted receipt of $188,218, instead of a total of $377,046.
There appear to me to be a number of elements of the taxpayer's case which, on examination, stand revealed as erroneous.
I take first what is said to be the effect of sec. 44(2)(b)(iii) of the Act and all that flows from it. It clearly enough excludes from assessable income a dividend paid out of profits such as those here represented by the Company's capital profits reserve account, if it is satisfied by the issue of shares. The taxpayer's case is that, although the dividend declared by the Company does not, because of this effect of sec. 44(2)(b)(iii), form any part of the taxpayer's assessable income, nevertheless he is to be treated as in receipt of that untaxed income, which is then immediately applied in paying-up the bonus shares. This application of the taxpayer's income is, it is said, a real outgoing which he has incurred and which should be reflected in his total taxable situation. Were it not that sec. 44(2)(b)(iii) happened in this instance to operate so as to exclude from assessability the deemed dividend it would, it is said. be very apparent that the application of the dividend in paying up the bonus shares constituted an outgoing and the fact that sec. 44(2)(b)(iii) does here operate in the taxpayer's favour in no way detracts from the reality of his expenditure on his part, incurred in paying up the bonus shares.
The flaw in this argument is, I believe, the erroneous effect assigned to sec. 44(2)(b)(iii), which mistakes the operation of the Act as it relates to dividends. The Act, by its definition of ``dividend'' in sec. 6, includes within the meaning of ``dividend'', wherever occurring in the Act, the paid up value of shares when that value represents a capitalization of profits and then sec. 44(1), read in conjunction with the definition of ``paid'' in sec. 6, operates so as to include such a dividend in assessable income but always ``subject to this section''. When sub-sec (2)(b)(iii) is read it is seen that sec. 44 as a whole in fact has no operation at all in the present case. The consequence is that this extended definition of ``dividend'' is entirely inapplicable and the whole procedure involved in the capitalization of profits and issue of bonus shares never begins to bear the
ATC 4307
appearance of involving the derivation of an assessable dividend. Nor will it otherwise involve the derivation of any assessable income. The Act thus produces no revenue consequences at all so far as concerns the transaction involved in the issue of bonus shares.In
Gibb
v.
F.C. of T.
(1966) 118 C.L.R. 628
, this Court made all this clear when it said, at p. 636, when speaking of the effect of sec. 44
-
``... it is important to observe that, in terms, sub-sec. (1) does not purport to deal with all dividends as defined; it deals, subject to this section , with all such dividends and we find that sub-sec. (2) declares that the assessable income shall not include dividends of the description here in question. Consequently it is, we think, erroneous to say that dividends of that character are, first of all, comprehended by sub-sec (1) and then excluded by sub-sec. (2). On the contrary at no time do dividends of the kind referred to in sub-sec. (2) by force of sub-sec. (1), achieve the character of assessable income. It is, of course, clear that some classes of dividends which by force of sub-sec. (2) are not assessable income would, apart from that sub-section, be income of the taxpayer. But this is because they would be income according to ordinary concepts, not because the provisions of sub-sec. (1) make them assessable income. This, however, is not so in the case of dividends falling within sub-sec. (2)(b)(iii).''
Thus, neither pursuant to any provision of the
Income Tax Assessment Act
nor according to ordinary concepts will the transaction resulting in the issue of these bonus shares be productive of any income for the taxpayer. This Court described the true consequence of such a transaction when it said, in
McRae
v.
F.C. of T.
69 ATC 4066
at p. 4069;
(1969) 121 C.L.R. 266
, at p. 271
-
``... the entire transaction consisting of the declaration of dividend plus the crediting of the bonus shares as fully paid had no other effect than that of a transfer of part of the value of the original shares to the bonus shares. The same property which had been the asset backing for 35,000 shares became the asset backing for 60,000 shares.''
If for ``35,000 shares'' and ``60,000 shares'' there be substituted ``200 shares'' and ``191,200 shares'' this passage precisely describes what here occurred.
In
F.C. of T.
v.
W. E. Fuller Pty. Ltd.
(1959) 101 C.L.R. 403
, Dixon J. said, at pp. 407-8, of bonus shares which had there been paid up out of the revaluation of capital assets
-
``It appears to me that the allotment of shares and the distribution of the share certificates cannot involve a receipt or derivation of income except under some artificial statutory definition of that word and that the appropriation of the aliquot part of the profit fund to the payment up of the shares does not involve the shareholder in a receipt or derivation of income. The objection to considering the allotment of the shares and distribution of the certificates to be income is that it is settled law that they are distributed and received as capital.''
In the absence of any ``artificial statutory definition'' the transaction must be regarded as having no effect beyond what it in fact does, that is, its effect of transferring almost all of the value of the original 200 shares to the bonus shares.
Although in Fuller's case the Chief Justice was in a minority his views were preferred to those of the majority (Fullagar and Menzies JJ.) When the matter was again examined by this Court in Gibb v. F.C. of T . It was there pointed out, at p. 632, that his Honour's view that an issue of bonus shares could not, according to ordinary principles, be regarded as any receipt of income by the shareholder accorded with that of one of the majority, Menzies J., whose views differed from those of the Chief Justice only concerning the effect of the Income Tax Assessment Act upon the character, as income, of the allotment of bonus shares.
If, then, the transaction resulting in the issue of bonus shares involved no receipt of income by the taxpayer but only a transfer of
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values there is no occasion for regarding the payment up of those shares as any payment by him, or as any outgoing or cost incurred by him. No resort to the alleged realities of the situation can be used to support such a view nor does there appear to me to be any other ground upon which it may be maintained. In McRae's case it was said, at p. 4069, that a shareholder who received an issue of bonus shares ``did not put a penny more into the scheme than her original contribution'', so here the taxpayer's only expenditure was his original investment of $186,046.It is convenient, at this point, to note one supporting argument advanced on behalf of the taxpayer. It was said that had not this bonus issue fallen within sec. 44(2)(b)(iii) the taxpayer would have been assessable on a deemed dividend of $191,000 and it would then have been strange indeed not to regard the payment up of the bonus shares as involving an off-setting expenditure by the taxpayer of a like sum of $191,000. This appeal to the alleged equity of the situation assumes, however, that had sec. 44(2)(d)(iii) been inapplicable the remainder of the total transaction would nevertheless have proceeded as it did, an untenable assumption; the taxpayer would not have paid $186,046 for his original 200 shares had the only asset which those shares represented, the Company's capital profits reserve, been liable to carry with it into the hands of shareholders a liability to tax as assessable income. Had that been the case the 200 shares in the Company must necessarily have been worth far less than they were, perhaps rather less than one half what was in fact paid for them, paid in the knowledge that no liability to tax would be incurred on the deemed dividend involved in the issue of the bonus shares. Had the initial purchase price of the 200 shares been reduced in this way so as to take account of the inherent liability of tax possessed by the assets of the Company, and which any purchaser would have to bear if he were to obtain the benefit of these assets, any apparent inequity disappears; there no longer exists any seeming injustice in failing to treat as an outgoing of income on the part of the taxpayer the payment up of his bonus shares.
It may be mentioned in passing that, as
Dixon
C.J. pointed out in
Dickson
v.
F.C. of T.
(1940) 62 C.L.R. 687
at pp. 713-5
and again in
F.C. of T.v.
E.E. Fuller Pty. Ltd. at p. 408
, until the amendment of the legislation in 1924 entirely altered the treatment of bonus shares, they involved the allottee in the derivation of ``income'' for Australian revenue purposes and this despite
Blott's case
, (1921) 2 A.C. 171. But this was because of the then terms of the tax legislation, which specifically included in income ``dividends, interest, profits or bonuses credited or paid...''. Thus in
James
v.
F.C. of T.
(1924) 34 C.L.R. 404
, it was held that although in
Blott's case
, at p. 179, it had been said of a recipient of bonus shares that ``He neither paid nor received any cash'' yet, because the paying up of bonus shares involved a crediting to the shareholder of profits or of a bonus, that sufficed to include the amount paid up on the shares in the taxpayer's income for tax. Ever since 1924 this has no longer been the case and nothing in the present taxing Act produces a like effect. Accordingly
James'case
and the decision on similar State revenue law in
Nicholas
v.
C. of T. (Vic.)
(1940) A.C. 744
, appear now to be of no relevance in a case such as the present.
There remains the contention of the taxpayer that the bonus shares should properly appear in his trading account at a value of $191,000, if not because this was their actual cost to him, then at least they must have some value assigned to them and their paid up value is an appropriate value to select for this purpose.
When shares are acquired as part of a trader's stock in trade in the course of a year's trading it is their cost, not their value, which must initially be shown in a trading account if that account is to fulfil its purpose of disclosing the trader's financial results for the year. Value will be relevant only if, at the close of the year, those shares remain in stock and it is desired, by a departure from original cost, to reflect in the profits or losses of that year the unrealized profit or loss which has resulted from some change in value since date of acquisition. Sections 29 and 31 permit of this, the latter providing for a choice between two bases of valuation as alternatives to adherence to original cost.
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The
Income Tax Assessment Act
contains no prescription concerning the figure at which acquired stock is to be first entered in a trader's account, just as it is silent concerning the correct figure to ascribe sales. In
Ballarat Brewing Co. Ltd.
v.
F.C. of T.
(1951) 82 C.L.R. 364
at p. 368
,
Fullagar
J. referred to this silence saying that the consequence was that
-
``The question does not depend upon any express provision to be found in the Act. It depends upon `the conceptions of business and the principles and practices of commercial accountancy' (per Dixon J. in
C. of T. (S.A.) v. Executor Trustee & Agency Co. of South Australia Ltd. (Carden's case) (1938) 63 C.L.R. 108 at p. 153 ).''
But the matter cannot, I think, be in doubt; what must be done is to adopt that method of accounting which is ``calculated to give a substantially correct reflex of the taxpayer's true income''
-
Dixon
J. in
Carden's case
at p. 154, due regard being had to the principles recognized or followed in business and commerce in the absence of any statutory provision to the contrary
-
and see generally
Arthur Murray (N.S.W.) Pty. Ltd.
v.
F. C. of T.
(1965) 114 C.L.R. 314
. In all but exceptional cases only by entering stock in trade at cost will a reflex of true income emerge from the trading account of the year of acquisition of that stock. Although not expressly adverted to, this approach appears to me to be consistent with the way in which this Court had in the past discussed the proper composition of such accounts
-
Carden's case
at pp. 152, 154
&
156;
J. Rowe
&
Son Pty. Ltd.
v.
F.C. of T.
71 ATC 4001
pp. 4008-9;
(1970) 124 C.L.R. 421
at pp. 434-5
&
448
;
Investment and Merchant Finance Corporation Ltd.
v.
F.C. of T.
71 ATC 4140
pp. 4147
&
4150;
(1971) 125 C.L.R. 249
at 265
&
271
.
An exceptional case will arise should a trader receive stock in trade by way of gift. Such a situation was considered by Lord Greene M.R. in
Craddock
v.
Zero Finance Co. Ltd.
(1944) 27 T.C. 267
at p. 279
. That rather special circumstance will require special treatment, the acquisition will not have formed part of normal trading activities and the stock thus acquired will have to have a value placed upon it, otherwise its value will be reflected in any profit for the year whereas it truly but, rather, the monetary measure of the donor's benevolence. However with this situation we are not here concerned, the present case involves no gift; the taxpayer, when he purchased the 200 shares, paid a price reflecting the value of an aliquot share of the assets of the Company, he gained the opportunity of creating the additional bonus shares which when issued to him still, together with his original share, only reflected the value of that same aliquot share. In a very real sense he paid for the bonus shares when he purchased the original 200 shares. There was no change in the ``wealth'' of the taxpayer before and after the issue of the bonus shares; all that had occurred was ``a transfer of part of the value of the original shares to the bonus shares''
-
McRae's case, supra
.
What entries then should properly appear in the taxpayer's trading account in respect of the Stewart Bacon shares? The original 200 shares cost $186,046 and must initially appears in the trading account for that year at that figure; the 191,000 bonus shares in fact cost the taxpayer nothing more and might initially appear at nil cost. However unless, as was here the case, the whole 191,200 shares were to be disposed of almost immediately and at the one time such an entry for the bonus shares might prove misleading and it would accord better with the true situation if the transfer of values from the original shares to the new shares were reflected in the account at the time of issue of the bonus shares. The 191,000 bonus shares could thus be shown at an amount being 191,000/191,200 of $186,046, the original 200 shares being then correspondingly reduced from their cost of $186,046, at which they had originally been entered in the account, to 200/191,200 of $186,046. Had the whole of the shares not been disposed of during the current accounting year but instead retained into the next accounting year it would be essential, if they were to be carried forward
ATC 4310
at some valuation figure other than cost, to carry out such a spreading of values; the whole 191,200 shares would have to be shown at a total valuation figure and this would, in effect, reflect the transfer of value which had taken place.However, since the whole 191,200 shares were in fact to be sold on the very day of issue of the 191,000 bonus shares none of these procedures is essential; because the cost of the 200 shares is also the cost of the whole 191,200 shares it would suffice to show the 191,000 shares as having no cost attributed to them. When all the shares are then sold the true financial result will be accurately reflected by comparing total proceeds of sale with cost of the 200 shares. By this means ``the truth and reality of the situation'' - Ballarat Brewing case per Fullagar J. at p. 269 - will be revealed. If on the other hand the course contended for by the taxpayer is adopted and some cost or value additional to the cost of the 200 shares is introduced into the accounts in respect of the 191,000 bonus shares error immediately manifests itself and the result will be that the account no longer reflects the true financial position.
It is for the forgoing reasons that I would have answered the questions posed in the stated case, insofar as they relate to the transaction involving the Stewart Bacon shares, on the footing that the taxpayer thereby incurred no loss but rather a profit of $2,782.
ORDER:
that the questions in the case stated by Jacobs J., viz . the following questions -
" 1. Did the Appellant as claimed in paragraph 22 hereof incur a loss in relation to the 200 shares in Stewart Bacon purchased by him on 29 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 6 May 1969, in the sum of $2,368.40, which is an allowable deduction under the provisions of the said Act?
3. In relation to the Appellant's trading in shares in the companies listed in paragraph 24 hereof did he incur:
- a) a loss of $22,573
- b) a loss of some other, and if so, what amount?
- c) a profit of $556, or
- d) a profit of some other, and if so what amount? "
be answered as follows -
1. and 2. The Appellant suffered a deductible loss in relation to all the shares in Stewart Bacon in the sum of $188,217.36.
3. By consent -
- (a) No.
- (b) Yes - $22,513
- (c) Unnecessary to answer
- (d) Unnecessary to answer
The Respondent Commissioner to pay the costs of the case stated.
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