J. Hammond Investments Pty. Limited v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
Sheppard J.: This appeal raises questions concerning the construction of sec. 106D of the Income Tax Assessment Act 1936, which section forms part of Div. 7 of Pt. III of the Act. The provisions of sec. 106D and other provisions of Div. 7 (sec. 106, 106A, 106B and 106C) have been repealed (Act No. 205 of 1976) but the repeal does not affect the matters which are to be determined in this case.
The taxpayer was incorporated on 1st September, 1954. At about the same time another company, A. Scheinberg Holdings Pty. Limited was also incorporated. The subscribers to the memorandum of association of each company were two brothers, Messrs. Hammond and Scheinberg.
The nature of the business carried on by the taxpayer since its incorporation is stated generally in para. 3 of Mr. Scheinberg's affidavit of 19th July, 1977, as follows:
``In general terms the taxpayer's course of business has been to enter into business ventures with people who have management and executive skills in a particular commercial field. When the taxpayer decided to join in a business venture with a particular person that person carried on and managed the business activity. The taxpayer provided the capital and gave assistance on financial matters. Essentially the taxpayer's method was to become associated with someone
ATC 4313who was energetic and capable in his own field, and who had little or no capital; the taxpayer would provide him with funds and some supervision and assistance on the financial side of his activities and give him a free hand to build up a business in the field in which his talents lay. Usually proprietary companies were used as the owners of the particular business and to give effect to the arrangements between the taxpayer and the other person. The object was to build up the businesses conducted by the companies in which the taxpayer and the other person were shareholders into profitable and commercial operations, a result which in many cases was achieved.''
Mr. Scheinberg, in his affidavit, then enters upon some detail of the ventures in which the taxpayer invested in the years following its incorporation. It is unnecessary for me to refer to the detail of this evidence. I should say, however, that I accept it and I should give two examples of how it was that the company operated.
I shall refer hereafter to the taxpayer as ``JHI'' or ``the taxpayer'' and to A. Scheinberg Holdings Pty. Limited as ``ASH''.
In 1955-56 JHI and ASH invested in a company in which a Mr. Kriesler was interested. After the investment Mr. Kriesler or his interests had a fifty per cent interest and JHI and ASH each had a twenty-five per cent interest in the company which successfully carried on a bakery business for five to six years. It was then decided to sell the bakery business but to continue ``in partnership'' in real estate and development. The company, Kritzler Holdings Pty. Limited was formed. Associated companies of that company are Leo Pty. Limited and Lesley Corporation Pty. Limited. Thus the taxpayer and ASH, having first invested in a company carrying on a bakery business, have, for many years past, been investors in companies dealing in real estate and development.
A Mr. Gemes and companies of his were associated with JHI and ASH in a number of business activities. After being associated in a company known as Berryman & Company Pty. Limited there was an expansion into the field of retail shops. These included two groups of retail shops known as Bonds and Kirby. The two groups were eventually merged and the businesses conducted under the names Bonds & Kirby Furniture Pty. Limited. Later on other companies became part of the group. I do not name them but there were seven in all. Additionally, a company, Avant Garde Pty. Limited was formed in association with Mr. Gemes for the purpose of retailing furniture and furnishings of a more exclusive type.
Thus, in addition to investing in shares in companies carrying on a bakery business and dealing in real estate and land development the taxpayer had a substantial interest in companies carrying on the business of retailing furniture and furnishings.
It ought not to be thought that in the way that the taxpayer operated it acted as an investor who took no part whatever in the management of the various companies in which it had interests and merely looked to results as disclosed in financial accounts from time to time. The way in which the taxpayer and ASH operated is described in Mr. Scheinberg's oral evidence. Amongst other things he said that he kept up contact with ``all the different partners'' and if they had financial problems he would try to solve them. Likewise if they had manufacturing problems he would try to solve them. He said that he was always available for discussion and advice. He was a director of each of the companies. He said that he did not take part in the day to day management of any of the companies but continued, ``I am quite good in manufacturing problems and I seem to sort it out very quickly so if they have a problem I am active but if they have no problems then I let them go on. Once there is a problem I might spend weeks in one place and then go away for half a year.''
In January 1968 Mr. Hammond and Mr. Scheinberg were joined in business by one Andrew Barry. There was a partnership agreement entered into on 12th January, 1968, by three companies, Pressglass Pty. Limited, Krinkel Pty. Limited and Marbltone Cultured Marble Pty. Limited. Without going into detail the partnership was an equal one between interests controlled by Mr. Barry on the one hand and those controlled either by JHI or ASH or Mr. Hammond and Mr. Scheinberg on the other. Subsequently two other companies, Vanitone Pty. Limited and Red Gables Pty. Limited were added. The taxpayer and ASH joined Mr. Barry in this venture because they formed the view that he had the managerial capacity and experience to
ATC 4314carry on and develop the business of manufacturing and selling fibreglass sheeting and artificial marble. JHI and ASH were in a position to contribute capital and advice mainly in relation to financial matters.
On 1st September, 1971, a new partnership agreement was entered into. The partnership was known as Marbltone Group Australia. This comprised eleven companies of which JHI and ASH were two. Previously they had not been partners in the venture. Notwithstanding statements to the contrary in Mr. Scheinberg's evidence, the Marbltone Group partnership was the first partnership into which JHI and ASH had entered directly. Previously their investment in the types of activity that I have mentioned was all done by taking up shares in other companies.
Mr. Scheinberg referred to some of the earlier arrangements as partnerships because that is how he understood them, but in fact no partnerships had been entered into directly by the taxpayer or ASH. What I have last said must be read subject to one matter relied upon by counsel for the taxpayer to which I shall in due course refer.
The problem in the present case arises in relation to the income year ended 30th June, 1972. In its return the company stated that it had not paid, and would not pay, a dividend during the period commencing at the beginning of the year of income and ending at the expiration of ten months after the year of income. The period mentioned was part of the prescribed period (defined for present purposes in sec. 103 of the Act as the period of one year ending on 30th April, 1972) for the purposes, inter alia, of sec. 104, 105A and 106 of the Act, that being the prescribed period in relation to the year of income ending 30th June, 1972.
The Commissioner thereupon assessed the taxpayer in the sum of $27,805.50 for additional or Div. 7 tax pursuant to the provisions of sec. 104 of the Act. The reason that the Commissioner took this course was because there had been a change in the ownership of the shares in JHI which, by reason of the provisions of sec. 106B of the Act, the Commissioner contended disqualified the company from having taken into account in its favour excess distributions of income made in earlier years.
Until 1970 the shares in the taxpayer were owned and controlled by Messrs. Hammond and Scheinberg equally. The position was the same in ASH. In 1970 there were transactions which brought about a situation in which Mr. Hammond and members of his family owned and controlled the whole of the shares in JHI and Mr. Scheinberg and members of his family owned and controlled the whole of the shares in ASH. This was the change in ownership which was relied upon by the Commissioner. It is agreed by the taxpayer that it was a disqualifying one with the result that unless the taxpayer can rely upon the provisions of sec. 106D of the Act, the Commissioner's assessment is not open to challenge. The provisions of sec. 106D(1) are as follows:
``106D(1) Subject to subsec. (2) where -
(a) An amount paid in a dividend by a private company during the period that is the prescribed period in relation to a year of income would not, but for this section, by reason of a change that has taken place in the beneficial ownership of shares in the company or in any other company, be included, in whole or in part, in a notional dividend that is deemed to have been paid by the company in the period that is the prescribed period in relation to a later year of income;
(b) the first-mentioned company carried on at all times during the period that is the prescribed period in relation to the later year of income the same business as it carried on immediately before the change referred to in para. (a) took place; and
(c) the first-mentioned company did not, at any time during that last-mentioned prescribed period, derive income from a business of a kind that it did not carry on, or from a transaction of a kind that it had not entered into in the course of its business operations before the change took place,
sec. 106B and 106C do not prevent the amount being included.''
Subsection (2) is not here in question.
Paragraph (a) of the subsection of course applies. The question is whether the taxpayer can bring itself within the provisions of para. (b) and (c). Unless it can it must fail in this appeal.
The reason why the Commissioner submits, in relation to para. (b), that the taxpayer did not at all times during the period there specified carry on the same business as it carried on immediately before the change took place is because of the entry by it into the partnership known as Marbltone Group Australia. In short the Commissioner submits that whatever was the nature of the business carried on by the taxpayer prior to entering into that partnership, it began, upon the entry into the partnership agreement, on 1st September, 1971, then, for the first time, to carry on business as a manufacturer of and dealer in fibreglass and artificial marble. It followed also, according to the Commissioner's submission, that the carrying on by the taxpayer of this business meant that it was thereafter deriving income from a business of a kind that it did not carry on before the change of ownership took place within the meaning of para. (c), and further meant that it was deriving income from transactions of a kind that it had not previously entered into in the course of its business operations within the meaning of the same paragraph.
On behalf of the taxpayer it was submitted that it was, in effect, at all material times a financial entrepreneur whose business activities had consisted of investment in a great variety of other business ventures, albeit up to the time that the partnership was entered into, in the form of investments in shares in other companies. Counsel for the taxpayer described its business as being that of establishing and investing with a third party in businesses by means of suitable legal arrangements or structures. Counsel for the Commissioner submitted that this was not the description of a business but the modus operandi by which the taxpayer carried on its activities. He contended that its business up to the time of the entry into the partnership was investing in private and public company shares, ``or share structures''. But it is to be observed, notwithstanding the Commissioner's submission, that the essential difference between the two submissions is that one refers to the business as an investment in other businesses by appropriate legal arrangements whereas the other confines the business to investment in shares in companies.
In my opinion it is unhelpful to characterise the description attributed to the business by counsel for the taxpayer as a modus operandi by which the business was carried on, and not as a description of the business itself. I say this notwithstanding what was said by Simonds J. (as he then was) in In re Rhagg (1938) 1 Ch. 828 at p. 835, namely, ``the word `business' in such a context as this bears much the same meaning as when it is said that a man has sold his business. It means the undertaking or enterprise itself, not the process of carrying it on''. But in the present case, as I have pointed out, the essential difference in the competing descriptions of the business which were used by counsel was that one referred to the business as that of investing in other businesses or undertakings whilst the other restricted it to the business of investing in shares in companies. The taxpayer's description of its business may indicate the method by which the business was carried on; but if the Commissioner be right, his description has the same vice, although indicating a narrower field within which the taxpayer operated.
Counsel for the Commissioner sought support in his more general submission for the proposition that the business, after the change in ownership, was not the same as that carried on prior thereto, from the decision of the High Court in
Rose v. F.C. of T. (1951) 84 C.L.R. 118, where, at p. 124, reference is made to the fact that the members of a partnership do not form a collective whole distinct from the individuals composing it, ``nor are they collectively endowed with any capacity of acquiring rights or incurring obligations''. Thus it was contended by counsel for the Commissioner that, after entry into the partnership agreement in 1971, the business of the taxpayer was twofold, investing in shares in public or private companies and manufacture and sale of fibreglass and marble.
The answer to the question of whether the business was the same after the entry into the partnership agreement as it was before involves a factual inquiry,
Avondale Motors (Parts) Pty. Ltd. v. F.C. of T. 71 ATC 4101; (1971) 124 C.L.R. 97. It is a different inquiry from that which is posed by the first limb of para. (c), although that too involves a factual investigation. The distinction between the two concepts is, with respect, clearly brought out in the judgment of Gibbs J. in the Avondale case. Despite the fact that the two inquiries are different it would seem to me that an answer to that posed by para. (b) favourable to the taxpayer must also result in an answer
ATC 4316favourable to it in relation to the inquiry posed by the first limb of para. (c).
I think the question is whether it is right to say, as the taxpayer does, that the business prior to the change was that of investing in businesses or whether it was right to say, in accordance with the Commissioner's contention, that the business was that of investing only in shares with the consequence that when the partnership was entered into there was either an investment in a partnership or the actual carrying on by the taxpayer of the partnership business itself.
Counsel for the taxpayer placed reliance upon two provisions of the partnership agreement, cl. 17 and 18. The first of these provisions was to the effect that neither JHI nor ASH should be called upon to provide its own personnel nor to provide any labour for the partnership. The second provision provided that the two companies should, if called upon by the other partner, contribute a sum by way of loan to the partnership up to a limit of $50,000 for terms up to twelve months. It was said that this indicated an investment by the two companies rather than any intention on their part to become involved in the day to day running of the business which it carried on.
These provisions do, to my mind, indicate an intention on the part of the two companies, notwithstanding their involvement as partners, to remain aloof and away from the daily management of the partnership business in much the same way as had been the case in relation to the interests which they had in the other companies to which I have referred, notwithstanding the presence on the boards of directors of the various companies of the mainsprings of JHI and ASH, Messrs. Hammond and Scheinberg, and Mr. Scheinberg's active participation from time to time.
I think it relevant when considering the answer which should be given to the question to look at the conduct of the taxpayer as described in the evidence of Mr. Scheinberg. It is plain that he was not concerned with legal structures but merely with the investing of money in sound business ventures managed by persons who had capacities in particular fields. Furthermore, and this is the matter relied upon by counsel for the taxpayer to which I said I would later refer, it is clear from the evidence of Mr. Scheinberg that very often investments would be made in advance of the formation of companies and the carrying out of other steps thought by the taxpayer's legal advisers to be necessary to give effect to the intended arrangements. This only goes to show that Mr. Scheinberg, on behalf of the taxpayer, was looking to the substance of each of the transactions into which it entered and left the documentation and the formalities to be carried out by solicitors and accountants in due course. It is not a matter that has weighed very much with me but it serves to underline, in my opinion, what the substance of the matter really was.
A further factor is that the businesses in which money had already been invested up to the time that the partnership came into existence were in very diverse fields, but the taxpayer and ASH had already invested in a business of the kind eventually to be conducted by the partnership. This was because of their interest in the companies who were partners pursuant to the earlier partnership agreement entered into on 12th January, 1968.
In my opinion the totality of the evidence points to the fact that the real nature of the taxpayer's business was investment in businesses, ventures and enterprises of various kinds. The form of the investment, although, down to the date when the partnership agreement was entered into, it had always been by the taking up of shares, was an inconsequential matter. It was only chance that had led to a situation where there was no partnership in which the taxpayer was directly involved until 1st September, 1971. The agreement evidencing that partnership contained provisions to which I have referred making it clear that the taxpayer and ASH were in a rather special position and left them, practically speaking, in a similar situation to that in which they found themselves in relation to the other ventures in respect of which they had taken up shares in other companies.
For the reasons I have given I have reached the conclusion that the taxpayer was, at all material times, carrying on the same business as it had carried on immediately before the change took place and furthermore, that it did not derive income from a business of a kind that it had not carried on before the change in question.
It follows that I have answered the questions so far posed favourably to the taxpayer, but
ATC 4317there remains the question of whether it is correct to say, within the meaning of para. (c) of the subsection, that the taxpayer did not derive income from a transaction of a kind that it had not entered into in the course of its business operations before the change took place. I confess to having had substantial difficulty in resolving this question, the difficulty stemming from the use in the provision of the words, ``in the course of its business operations''.
Upon reflection I think it is correct, as both counsel concluded, that the word ``transaction'' means ``dealing''. Upon that basis one would think that what is being referred to is a transaction distinct or isolated from transactions which would arise from day to day in the conduct of the taxpayer's business. That is how I first read the provision but it seems to me that such a reading of it may not give full effect to the words earlier referred to, ``in the course of its business operations''.
It is hardly likely, however, that the legislature intended to catch in the second limb of para. (c) that which the first limb was designed to catch. This is because the first limb refers to income derived from a business. It is likely that that income would be derived from a series of completed dealings or transactions, for instance, as counsel for the Commissioner contended, the sale from time to time of products manufactured by the partnership. One could well have a situation in which a taxpayer, notwithstanding changes in the ownership of its shares, continued to carry on the same business as was carried on immediately before the change, but amalgamated with that business a business of a similar kind. It would still be carrying on the same business within the meaning of para. (b) and also a business of a similar kind within the meaning of the first limb of para. (c). Ought one to infer that the legislature, by reason of the provisions of the second limb of para. (c), intended that the taxpayer should be disqualified from obtaining the benefit of the section simply because it was involved, by reason of the carrying on of the additional business, in transactions into which it had not previously entered in the course of its business operations prior to the change in ownership coming about. If this were the intention, one would think that there would have been no need to enact the first limb of para. (c). The legislative intention would have been entirely achieved by the operation of the second limb of that paragraph.
In my opinion it is not without significance that the provisions of sec. 80E of the Act dealing with tax losses are in similar terms. One could imagine a situation where a company was taken over for the purpose of its tax losses in order to gain the benefit thereof, not for the purpose of offsetting income derived from the business against the losses of previous years, but for the purpose of offsetting against those losses an isolated or chance profit which might have been foreseen, perhaps a profit taxable by reason of the provisions of sec. 26(a) of the Act or some other income resulting in a chance or isolated profit or gain to the company.
The provisions of sec. 80E were first inserted into the Act in 1965 (Act No. 103 of 1965) but those of sec. 106D which are in similar form were not inserted until 1973 (Act No. 51 of 1973). That latter Act also amended sec. 80E, but not materially for present purposes. The provisions of sec. 106D(1)(c) ought not to be construed differently from those of sec. 80E(1)(c) with the result that if the considerations I have mentioned tend to account for the presence of the words in question in sec. 80E then they ought also to account for their presence in sec. 106D even if it be likely that there could be little or no occasion for the words to have any practical operation.
The matters I have so far mentioned do not, however, in my opinion, take the matter sufficiently far to explain the presence in both provisions of the words, ``in the course of its business operations''. But I have come to the conclusion that there is a different type of transaction which probably does explain their presence. There are of course many receipts which are not properly described as being income from a business. There is an example of such a receipt in the present case. The partnership acquired a new building with a tenant in it, who remained in occupation for a short time after the acquisition. The sum of $160 was received by way of rental. It does not seem to me that that was income derived from the business being carried on by the partnership but it was certainly income derived from a transaction entered into in the course of the partnership's business operations. Many other transactions of this general type can be imagined.
Whilst, therefore, I do not regard the matter as free from difficulty, I have reached the conclusion that the second limb of the paragraph is not intended to refer to the daily transactions involved in carrying on a business but to transactions of an isolated and independent kind, which transactions have nevertheless arisen in the course of the taxpayer's business operations.
During the argument there was discussion concerning a number of examples thought of by counsel. One of these related to the business of a motor dealer which, until a disqualifying change in shareholding, had, amongst other things, financed the acquisition of motor vehicles by providing hire purchase and leasing facilities. It was contended by counsel for the Commissioner that if, after the disqualifying change, the dealer had additionally financed the purchase of motor cars by advancing moneys by way of loan and derived income from these transactions, there would plainly be a derivation of income from transactions of a kind not entered into previously in the course of the dealer's business operations. Counsel for the taxpayer sought to answer this submission by saying that everything depended upon the nature of the dealer's business prior to the change. If it were the business of financing the acquisition of motor vehicles, it would not be to the point to say that previously the only methods of financing had been by way of hire purchase and lease. If, on the other hand, it was correct to say that the dealer carried on the business of financing the acquisition of motor vehicles by hire purchase and lease facilities, then, the answer to the question might be different. It might very well be different in the example postulated because the dealer might not previously have wished to provide money lending facilities due to the need to comply with the provisions of money lending legislation. But the fact that the taxpayer would then be denied the benefit of the provisions of the section would be brought about because it could not bring itself within the provisions of the first, not the second, limb of para. (c).
In the present case there is not, in my opinion, any special isolated or separate transaction to which the provisions of the second limb could attach.
At one stage of the argument it was submitted by the Commissioner that the receipt of the rent to which I have referred was such a transaction. I think it is appropriate to regard that receipt as de minimis, but if that be not a correct view, there is evidence in the testimony of Mr. Scheinberg that the same sort of thing had happened on previous occasions, albeit in relation to real estate acquired by companies.
I have therefore reached the conclusion that the taxpayer's argument in relation to the second limb of para. (c) is also sound.
I am thus of opinion that the taxpayer is entitled to succeed.
My conclusion in this regard makes it unnecessary for me to decide the outcome of an alternative submission made by counsel for the taxpayer based on the provisions of sec. 105AA of the Act and a letter received from the Commissioner dated 5th November, 1974, after the taxpayer's objection had been disallowed.
Accordingly the appeal is upheld. The assessment objected to is set aside. The Commissioner is ordered to pay the taxpayer's costs of the appeal.