R.W. Rutherford & Anor. v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
To be dealt with are four appeals from a decision of the Board of Review delivered on 14th August, 1975. The decision is reported as Case G56 in
75 ATC 404. There is one appeal by each taxpayer and two appeals by the Commissioner. The facts are generally as stated in the decision of Mr. Dempsey, a member of the Board. It will be necessary for me to supplement them to a degree mainly because of further evidence given in the hearing before me. The company referred to in Mr. Dempsey's decision as R.C. Pty. Limited is Renard Constructions Pty. Limited and that referred to as R.N. Pty. Limited is Renard Constructions (N.S.W.) Pty. Limited; that company was formerly known as B. Munro (Engineering) Pty. Limited (B.M. in Mr. Dempsey's decision). D.J.M. is D J. Mendham Pty. Limited and A.J. Pty. Limited is Arthur J. Pty. Limited.
By its decision the Board of Review decided that a sum of £19,800.0.0 paid to the taxpayers by Renard Constructions (N.S.W.) Pty. Limited on 25th August, 1965, ought properly to be included in their taxable incomes for the year ending 30th June, 1966. They were accordingly each assessed on the basis that their personal income was greater by one half that sum, that is $19,800.00, than was disclosed by them in their returns. The Board also decided that two sums, $20,000.00 and $5,000.00, represented assessable income in the hands of the taxpayers for the year ending 30th June, 1967. They were each assessed in respect of an additional $12,500.00 for that income year. The Board decided that the amounts referred to were part of the assessable income of the taxpayers by reason of the operation of sec. 108 of the Income Tax Assessment Act, 1936 (as amended) (hereinafter called the Act). The Commissioner had relied alternatively upon the provisions of sec. 260 of the Act. The Board found against the Commissioner in relation to that section and the Commissioner did not rely upon it in the proceedings before me. Accordingly it may be left out of account. So may the provisions of sec. 26(a) of the Act which were also at one stage relied upon.
The Commissioner now relies upon no provision other than sec. 108 of the Act except, in a way that I shall presently indicate, indirectly upon sec. 25 of the Act as well.
The Commissioner had assessed each of the taxpayers for one-half of the entirety of the profits made by the companies Renard Constructions (N.S.W.) Pty. Limited, D.J. Mendham Pty. Limited and Arthur J. Pty. Limited. The taxpayers were treated by him as the shareholders of these companies. They acquired them, or at the relevant time were in the process of doing so (they were not then registered as shareholders in Arthur J. Pty. Limited), because the companies each had accumulated tax losses. The taxpayers were also the holders of the shares in Renard Constructions Pty. Limited. It carried on a contract drainage business. About the middle of July, 1965 the taxpayers secured a substantial sub-contract from a joint venture which had contracted to carry out certain work at the Singleton Army Camp. The sub-contract was entered into by Renard Constructions Pty. Limited but the taxpayers decided, according to their evidence and that of their accountant, to have the work done by the first of the tax loss companies, Renard Constructions (N.S.W.) Pty. Limited. Thus the sub-contract with the joint venture was entered into between it and Renard Constructions Pty. Limited which further sub-contracted work to Renard Constructions (N.S.W.) Pty. Limited at rates set out in certain minutes which are in evidence. As that company's accumulated losses were absorbed by the profits which it was thought had been made, so the next company, D.J. Mendham Pty. Limited, would be used, as would eventually the third company, Arthur J. Pty. Limited. As I understand the Commissioner's case presented to the Board of Review it was that there was no real carrying on of any business by any of the tax loss companies with the result that the company carrying on the entirety of the business was Renard Constructions Pty. Limited. This company is in liquidation but before it went into liquidation it was assessed by the Commissioner for the entirety of the profits earned by the three tax loss companies. It appealed against that assessment but the appeal was not prosecuted.
The Commissioner then purported to assess the taxpayers for the amounts determined by him to have been earned by Renard Constructions Pty. Limited on the basis that they could be properly deemed by him to be dividends paid to or for the benefit of the taxpayers by reason of the provisions of sec. 108 of the Act. That case was rejected by the Board. Subject to what I have to say about a fundamental change in the Commissioner's approach, it is against the rejection of his case by the Board that the Commissioner appeals to this Court. He seeks to have restored his original assessments.
The taxpayers appeal against the inclusion in their assessable income of the three amounts to which I have referred. It is their case that no such amounts should have been included in their assessable income and that their returns properly disclosed their taxable income for the income years in question.
I propose to deal with the Commissioner's appeals first. The case made by him before the Board of Review is not the case which he now makes. In order that I might be certain that I understood his case fully I asked his counsel to submit a document in which it was shortly pleaded. In due course counsel for the Commissioner handed up a document which is entitled ``Points of Claim''. I have decided that it is appropriate to append this document to this judgment and accordingly it forms Appendix A hereto. Counsel summarised that case as follows:
- 1. After the acquisition of the first tax loss company and thereafter the loss companies and Renard Constructions Pty. Limited became and acted as the agents of the taxpayers for the purpose of conducting the business of the taxpayers being then the business purported to be carried on by the companies.
- 2. Thereafter the four companies were used as agents for the taxpayers. In the course of being so used the companies, which were legal entities under the control of the taxpayers (although in the case of Arthur J. Pty. Limited the taxpayers were not its shareholders), lent money to each other for the purpose of carrying on the taxpayers' enterprises and paid money to each other for that purpose. Without these payments by way of advances made within the group the four companies could not have carried on their activities in the way the taxpayers said they did. These advances
ATC 4307or loans or payments were made for the individual benefit of the taxpayers as principals in the operation. The value of these advances or loans or payments is represented by the income received by Renard Constructions Pty. Limited as assessed by the Commissioner. That money was never received in fact by the taxpayers but enured in the taxpayers' enterprises for their benefit as being money they were able to use in the enterprises and in various loss companies which they acquired or controlled and in particular would ultimately become available to them, should they have sought it, either by payment direct from the companies to themselves personally or through a tax avoidance arrangement set up by the formation of a company, Pacific Estates Pty. Limited, in Norfolk Island. Those moneys therefore were available at all times to the taxpayers.
- 3. The moneys were made available to them for the further development of the enterprises, they being the whole of the sums which were in fact used as working capital.
What I have set out is my note of the submissions made by counsel for the Commissioner in support of the Commissioner's case.
I do not need to say more about that case than it is impossible, in my opinion, to regard it as a case which can be based at all upon sec. 108 of the Act. The case made before me was that the four companies were all agents for the taxpayers who were to be regarded as principals in the carrying on of the business, each of the companies being an agent. If this view were right the companies themselves could not make payments of their own moneys which could be the subject of a deemed dividend under sec. 108. The moneys, to the extent that they were properly regarded as assessable income, would be the assessable income of the taxpayers by reason only of the provisions of sec. 25 of the Act. That is not the case which the Commissioner makes, nor has he ever made that case. The Commissioner's appeals are therefore dismissed.
The appeals brought by the taxpayers are not so easily dealt with. Section 108(1) is in the following terms:
``If amounts are paid or assets distributed by a private company to any of its shareholders by way of advances or loans, or payments are made by the company on behalf of, or for the individual benefit of, any of its shareholders, so much, if any, of the amount or value of those advances, loans or payments, as, in the opinion of the Commissioner, represents distributions of income shall, for the purposes of this Act other than the purposes of Division 11A of Part III, and Division 4 of Part VI, be deemed to be dividends paid by the company on the last day of the year of income of the company in which the payment or distribution is made.''
It is not material to refer to Div. 11A Pt. III nor Div. 4 of Pt. VI of the Act referred to therein.
For the purposes of dealing with the argument I am prepared to assume that the three sums to which I have referred were either payments made by the companies referred to in the Board's decision or payments made for the benefit of the taxpayers. Despite that assumption I am of opinion that the sum of $20,000.00 earlier referred to was not such a payment in fact. It was a payment made into an accountant's trust account. It is true that an onus is placed upon the taxpayers by sec. 190 of the Act, but, upon the whole of the evidence, it does not appear to me that that payment was to them or for their benefit as distinct from the benefit of one or other of the companies to which I have referred.
The Commissioner's argument, upon the assumption which I have made, is that by reason of the provisions of sec. 25 the payments being deemed to be dividends are properly included in the assessable income of the taxpayers.
The taxpayers by their counsel submitted that that was an erroneous approach because it overlooked the provisions of sec. 44 of the Act. Section 44(1)(a) of the Act is as follows:
``The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) shall, subject to this section, to the next succeeding section and to section one hundred and twenty-eight D of this Act -
- (a) if he is a resident - include dividends paid to him by the company
ATC 4308out of profits derived by it from any source;.''
I should also set out the terms of sec. 44(1B) of the Act and sec. 47(1). Those provisions are as follows: -
``44. - (1B) Where -
- (a) the amount of the moneys or of the value of other property of which a dividend paid by a company consists is debited against an amount standing to the credit of a share premium account of the company; or
- (b) a dividend paid by a company is a repayment by the company of moneys paid upon a share,
the dividend shall, for the purposes of this section, be deemed to have been paid by the company out of profits derived by it.''
``47. - (1) Distributions to shareholders of a company by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid up capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.''
I should also refer to the definition of ``dividend'' in sec. 6 of the Act. I do not set it out but I point out that it is an inclusive and not an exhaustive definition and that there are included within its terms distributions and payments which would not fall within the ordinary meaning of ``dividend''.
It is the taxpayers' submission that although the payments in question here may be deemed by the Commissioner to be dividends pursuant to sec. 108 of the Act, they will not form part of the assessable income of the taxpayers unless they are deemed not only to be dividends but also are deemed to have been paid out of profits. In the taxpayers' submission a dividend does not form part of the assessable income of a shareholder unless, in accordance with the provisions of sec. 44 of the Act, the dividend was paid to the taxpayer by the company declaring it out of profits derived by it. The difficulty in the Commissioner's path, so it was submitted, might be overcome if there were a deeming provision pursuant to which the deemed dividend under sec. 108 was also deemed to have been paid by the company out of profits derived by it; cf. subsec. 44(1B) and 47(1).
As indicated the Commissioner seeks to overcome this problem by ignoring sec. 44 altogether and looking only to sec. 25. Alternatively he submits that it is established that the payments deemed to have been dividends under sec. 108 of the Act were in fact paid out of profits. It is fair to say that the alternative submission was put without substantial enthusiasm.
In his dissenting judgment in
F.C. of T. v. W.E. Fuller Pty. Limited (1959) 101 C.L.R. 403 Dixon C.J. said at p. 409:
``The Act is not expressed to bring the defined conception of dividend within the word `income'. And in my opinion there is nothing in the Act which implies any intention to do so or to affect in any way the meaning simpliciter of the word `income' by the statutory definition of `dividend'. The word `income' is left undefined, that is except perhaps in so far as the definition of the expression `income from personal exertion' may inferentially affect its content, a matter not here relevant. Doubtless the word `income' described the basal conception of the whole Act. It is so to speak the beginning from which the statutory conception of `assessable income' starts. That can be seen from sec. 25(1) which provides that the assessable income of a taxpayer shall include gross income which is not exempt income. (The discrimination between residents and non-residents which forms part of the purpose of the provision I omit as not to the present point). The whole Act is then constructed on the foundation of the `assessable income' to be reduced by allowable deductions to the `taxable income', upon which income tax is imposed. The assessable income is a defined term: it means all the amounts which under the provisions of the Act are included in the assessable income: sec. 6(1). It is a definition which brings out strongly the fact that it is only what the Act makes assessable income that can fall within the conception. Section 25(1) begins so to speak at bedrock with the simple notion of income as a known legal and commercial term. Provision after provision of the Act then
ATC 4309says that this or that shall be part of the assessable income. One such provision is sec. 44 which deals with dividends and says what dividends shall and what shall not be included in the assessable income. From the legal conception of `income' you can work forward, through sec. 25(1), to `assessable income'. But the one thing which to my mind you cannot do is to work backward from what goes by express provision into `assessable income' and use it to control the basal conception of `income'. That appears to me to run counter to the plan on which the Act is constructed. Yet that is what the case for the Commissioner must do.''
Fuller's case was not followed in
Gibb v. F.C. of T. (1966) 118 C.L.R. 628. In that case a company revalued at a value above their book value certain of its assets which had not been acquired for the purpose of resale at a profit, credited all the subsequent profit to its shareholders and then applied it to paying up bonus shares issued to them. It was held that the shares so issued did not constitute income in the ordinary or commercial sense. By a majority the Court also held that the shares did not have the character of income attributed to them by the operation of sec. 6, 44 and 47 of the Act. In the majority judgment of Barwick C.J., Mc Tiernan and Taylor JJ. there is reference to Fuller's case and their Honours expressed themselves to be in agreement with the judgment of Dixon C.J. That being the case it seems to me that it is not a permissible course to by-pass as the Commissioner submits should be done, the provisions of sec. 44. It follows that unless the payments were in fact paid out of profits they ought not to have been included in the taxpayers' assessable income.
Support for this view is, I think, also to be found in the decision of the High Court in
F.C. of T. v. Uther (1965) 112 C.L.R. 630. Taylor J., who agreed with the conclusion reached by Owen J. at first instance (111 C.L.R. 318), thought the case was indistinguishable from
F.C. of T. v. Blakely (1951) 82 C.L.R. 388. Put shortly the case involved the question of whether or not a return of capital which fell within the definition of ``dividend'' is sec. 6 of the Act ought to have been included in the assessable income of the taxpayer. At p. 641 his Honour said:
``On the assumptions which I have made there remains a difficulty in the way of the appellant which I regard as insuperable. This difficulty springs initially from the provisions of sec. 44(1) of the Act which provides that the assessable income of a shareholder, in the case of a resident, includes dividends paid to him by the company out of profits derived by it from any source. In short, to constitute assessable income the amount received by the shareholder must be not only a dividend within the meaning assigned to that term by the Act; it must be a dividend paid out of profits derived by the company.''
His Honour referred to sec. 47 which deemed the distributions there referred to be paid out of profits and contrasted, in the context of the then state of the Act, the situation which prevailed in relation to a sec. 47 payment and payments which were defined as dividends but which were not deemed to have been paid out of profits. It is to be noted that sec. 44(1B) was unquestionably inserted to overcome the effect of the decision in Uther's case.
In a situation such as this, one of course looks for a situation to which sec. 108 could be directed. The provisions of it operate for the purposes of the whole Act other than for the purposes of the two Divisions which are excepted from its purview. I confess to an inability myself to perceive any provision of the Act to which it could apply except the provisions contained in Div. 7 of Pt. III of the Act in which sec. 108 itself appears. The provisions in question are those relating to the payment of additional tax by private companies upon undistributed profits for a particular year - see sec. 104 and 105A. If it had been the intention of the legislature that the section should operate only in respect of undistributed profits tax one would have expected sec. 108 to be limited to the purposes of Div. 7 of Pt. III. However, the same applies to the payments and distributions notionally included in the definition of ``dividend'' in sec. 6. I see no difference in effect in defining payments, which are not in ordinary language to be regarded as dividends, nevertheless to be dividends, and a provision, such as sec. 108, which enables the Commissioner to deem certain payments to be dividends. Both involve legislative devices by means of which payments and distributions which are not, in ordinary language, of a particular kind are, for the purposes of the legislation, turned into
ATC 4310payments or distributions of the kind in question.
It follows from what I have said that the taxpayers are entitled to succeed unless the payments in question were in fact paid out of profits. I am satisfied that they were not. It is to be emphasised that it is not enough that the payments be paid out of income; they must be paid out of profits. At the time that they were paid the profits, if any, of the companies in question had not been determined. It is probable that the sums of $19,800 and $5,000 were paid out of the earnings of the companies but it does not follow that they were paid out of profits. The moneys were paid during an income year and not out of any fund which could be regarded as a profit or dividend fund; see Principles of Company Law - H.A.J. Ford (1974) pp. 186-7, 4 Modern Law Review 273 et seq.
The taxpayers also relied upon F.C. of T. v. Blakely 82 C.L.R. 388 and upon Uther's case for the proposition that one has to look, in determining whether a payment was paid out of profits or not, at the nature or character of the payment in the hands of the payee. There is no question but that the payments of £19,800 and $5,000 are to be regarded in the hands of the taxpayers as advances of capital. In the light of the decision to which I have come on the other matters argued it is not necessary for me to express a view on this submission and I do not.
For the reasons I have given, the payments made were not actually paid, nor can they be deemed to have been paid, out of profits. The taxpayers' appeals ought therefore to be allowed.
There are two further matters which I should mention. Firstly, the argument upon which the taxpayers have succeeded was not advanced to the Board of Review at all.
Secondly, the taxpayers and their accountant were cross-examined strongly to suggest that there was no carrying on of any business by any of the tax loss companies. It is right that I should say that I formed a favourable impression of the taxpayers in the witness box. They were not, and did not claim to be, men of great business acumen. They impressed me as hard working tradesmen who had succeeded in the field of drainage sub-contracting and who had heard that tax loss companies were a good thing. They were naive in the way that they kept their records, and moved money indiscriminately from one company to another or from one or other of the companies into their own bank accounts. But they had no dishonest motive. They did not intend to take any advantage other than that which they believed was lawfully available to them. If they had had a competent accountant in their employ to maintain their records in proper order, or if they themselves had had the ability to do this, a lot of the criticism levelled at them in the witness box would not have been available. For what it is worth - it does not seem to me to have any relevance to any of the appeals - I am satisfied by their evidence that the tax loss companies did carry on business in the way that they described in their evidence more or less at the times mentioned in that evidence. I do not take the view that any of the companies was merely a shell or a sham; nor do I take the view that the business which was attributed to the companies from time to time was not really their business. Counsel for the Commissioner placed reliance on the fact that the appeal by Renard Constructions Pty. Limited against the inclusion in its assessable income of all the profits earned by the loss companies was withdrawn by the taxpayers who were its directors and shareholders. I do not think it appropriate for the Commissioner to place any reliance upon that circumstance. There may have been all sorts of reasons why the appeal was withdrawn.
For the above reasons the Commissioner's appeals are dismissed. The taxpayers' appeals are allowed. The decision of the Board of Review is set aside. The matter is remitted to the Commissioner to issue amended assessments to give effect to this decision. I order the Commissioner to pay the taxpayers' costs of each of the four appeals.
Rutherford v. F.C. of T.
Points of Claim
1. Renard Constructions Pty. Limited a private company in 1965 carried on business as plumbers and drainers.
2. At all times its sole shareholders and directors were the taxpayers.
3. Renard Constructions Pty. Limited entered into a contract to do work for MacNamara Welch Joint Venture Pty. Limited at Singleton and thereafter in 1965, 1966 and 1967 entered into other contracts with other persons to do work.
4. After work on the MacNamara Welch contract by Renard Constructions Pty. Limited commenced and during the performance of that work by that company the taxpayers obtained control of as directors and subsequently shareholders firstly of Renard Constructions (N.S.W.) Pty. Limited then of D.J. Mendham Pty. Limited and later of Arthur J. Pty. Limited all being private companies with accrued losses potentially available to be offset against profits made for the purposes of arriving at the taxable income of these companies.
5. The taxpayers after obtaining control of Renard Constructions (N.S.W.) Pty. Limited as aforesaid and then later after obtaining control of D.J. Mendham Pty. Limited and Arthur J. Pty. Limited and as a result of their ability as directors and shareholders to control the funds and activities of all of the said four companies, purported to cause the contracts entered into by Renard Constructions Pty. Limited to be performed by Renard Constructions (N.S.W.) Pty. Limited, D.J. Mendham Pty. Limited and Arthur J. Pty. Limited and further as a result of their said control of personal funds and bank accounts caused monies being income derived from the said contracts entered into by Renard Constructions Pty. Limited to be distributed by way of loans and advances by Renard Constructions (N.S.W.) Pty. Limited, D.J. Mendham Pty. Limited and Arthur J. Pty. Limited as required for the apparent and purported performance of the said contracts by the said four companies and each of them.
6. The purported performance by Renard Constructions (N.S.W.) Pty. Limited, D.J. Mendham Pty. Limited and Arthur J. Pty. Limited of the work to be done by Renard Constructions Pty. Limited under the said contracts and the purported entry by Renard Constructions (N.S.W.) Pty. Limited, D.J. Mendham Pty. Limited and Arthur J. Pty. Limited into contracts with Renard Constructions Pty. Limited to perform work to be done by Renard Constructions Pty. Limited under the contracts it had entered into were not genuine commercial or business activities or contracts but were caused by the taxpayers to be entered into and were caused by the taxpayers to be done by all the said four companies for the purpose of evading tax ultimately payable by the taxpayers and/or Renard Constructions Pty. Limited on such profits arising or likely to arise from the contracts entered into by Renard Constructions Pty. Limited.
7. After the contract with MacNamara Welch Joint Venture Pty. Limited was entered into by Renard Constructions Pty. Limited and from the time of the obtaining by the taxpayers of the control of Renard Constructions (N.S.W.) Pty. Limited and thereafter throughout 1965, 1966 and 1967 the taxpayers for the purpose of evading tax payable caused, by means of their control of the said four companies and their own funds and bank accounts, the said four companies to act as their agents in or about the performance of all contracts including the MacNamara Welch contract entered into by Renard Constructions Pty. Limited, and in or about the movement of monies being income to Renard Constructions Pty. Limited derived from such contracts within the four companies and to themselves and caused such companies as their agents to make advances and loans between the companies and the taxpayers from the said income. All such advances and loans between the four companies were advances or loans made by the said companies and each of them on behalf of and for the individual benefit of the shareholders of such companies being the taxpayers.
8. The value of such advances and loans is the income of Renard Constructions Pty. Limited as assessed by the Commissioner.
9. Upon the facts alleged as aforesaid the Commissioner was of opinion that the value of such loans and advances as aforesaid represented distribution of income.
It is Claimed
1. That the value of such loans should in the circumstances be deemed to be dividends in the interests of the taxpayers within the meaning of sec. 108 of the Income Tax Assessment Act.
2. Such further order as the Court may see fit.