London Australia Investment Company Limited v. Federal Commissioner of Taxation.Judges:
High Court (Full Court)
Barwick C.J.: The appellant is an investment company incorporated in New South Wales with a shareholding predominantly held by residents of the United Kingdom. It did not carry on any business in Australia other than investment in Australian companies with a view to the production of an income from dividends. A full description of its manner of operating its investment policy is to be found in the carefully expressed judgment of Helsham J. from which these appeals are brought. It suffices for my present purpose to say that the appellant, with the advice and recommendation of an Australian
ATC 4400management company which managed its affairs in Australia, pursued a policy of endeavouring to maintain a consistent yield on its capital invested in shareholding in Australian companies. It did not purchase or otherwise acquire shares in order to make a profit by their resale. But, in order to maintain the desired yield, it was advisable if not indeed necessary from time to time to realise shares which, by reason of changes in market value or dividend paid, ceased to provide that yield. A share of which the market value substantially increased would have a diminished yield unless in the unlikely event its dividend rate commensurately increased. Upon realisation of such a share in order to maintain a consistent yield, an excess over the cost of the share could result. But, as the learned primary judge found, this was not a result sought by the appellant or its advisers for its own sake. Indeed, the appellant's articles of association precluded the use of any such excess for the payment of dividends to shareholders. Sums so obtained must be held in an equalisation account designed to protect the invested capital. From this account amounts could be carried in the discretion of the Board to a capital reserve. An excess in recovery or a deficiency in recovery were similarly treated. Dividends were payable only out of the income derived from dividends received on shares held by the appellant.
Also in pursuance of its investment policy, occasions arose for the appellant to increase its liquidity. For this purpose, realisations of shareholdings were effected. The difference between recovery on disposal and cost on such operations was placed in the equalisation fund to provide for diminution in value of capital assets.
In consequence of the pursuit of its investment policy, the appellant bought and sold shares on a considerable scale from the time of its commencement in 1957. But in the tax years 1967, 1968 and 1969, there was a large surplus in recovery because of very substantial realisations, principally because of dramatic increases in market values in those years of shares in which the appellant had invested. The consequential fall in yield had caused the appellant to sell, a course which resulted, in the years in question, in an excess in recovery in each of the years as follows: 1967, $816,651; 1968, $140,166; and 1969, $413,263. The respondent Commissioner included these sums as assessable income in making his assessment for each of those years. The appellant's objections to the assessments were disallowed and the subsequent appeals to the Supreme Court of New South Wales rejected.
The Supreme Court (Helsham J.), having heard oral evidence, expressly found that the appellant had not acquired any of the shares realised in those years for the purpose of profit making by sale. He also found that none of the sums I have mentioned constituted a profit from the carrying on or carrying out of a profit making undertaking or scheme. He thereupon held that the several sums did not constitute assessable income by dint of sec. 26(a) of the Income Tax Assessment Act, 1936 as amended (the Act). This conclusion, well reasoned and expressed, is, in my opinion, acceptable and beyond challenge.
But the Court found that, none the less, the several sums were properly included in the appellant's assessable income by virtue of sec. 25 of the Act; that they formed part of the income of a business carried on by the appellant. He held that, in the years in question, it was ``an integral part of the appellant's business to deal in shares, in the sense that switching of investments was desirable to produce the best dividend returns, indeed was necessary if the appellant's policy of investing in shares with growth potential was to be adhered to''. I might here interpolate that his Honour had accepted as fact that the appellant's interest in growth potential was an interest in increase in dividend and not in an increase in market value. His Honour approximated the business of the appellant to that of a bank or insurance company in relevant respects.
I begin my consideration of these appeals on the footing that none of the individual transactions which produced the sums in question fell within either branch of sec. 26(a). It was part of the reasoning which resulted in that finding that the sales were effected in pursuance of an investment policy wedded to securing a particular yield by dividend. Indeed, the Supreme Court was given the detailed reasons for the realisation of the particular shares and the relationship of those reasons to the settled investment policy of the appellant and, as I read his Honour's reasons, those reasons were accepted by him.
It must appear, certainly at first sight, extremely odd that an accretion to capital
ATC 4401derived from the sale of an asset, not forming part of circulating capital and not purchased or held as a trading asset, should be accounted income. But the question is whether, none the less, the decisions and settled doctrine in the law of income tax require such a conclusion. Discussion of the subject usually begins with a citation of the remarks of Lord Justice Clerk in
Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 T.C. 159 at p. 166. The oft citation of the truism there expressed has given it a delphic significance. But, in truth, what was there said furnishes no criterion for determining such a question as is now before this Court in this case. Of course, what is produced by a business will in general be income. But whether it is or not must depend on the nature of the business, precisely defined, and the relationship of the source of the profit or gain to that business. Everything received by a taxpayer who conducts a business will not necessarily be income. As I have said, it must depend on the essential nature of his business and the relationship of the gain to that business and its conduct.
In holding that gains upon the realisation of securities by banking and insurance companies constitute income by the banking or insurance business, the Court relied upon the particular nature of those businesses and the relationship which investment realisation bore to that nature: see
C. of T. v. The Commercial Banking Co. of Sydney (1927) 27 S.R. (N.S.W.) 231,
Colonial Mutual Life Assurance Society Limited v. F.C. of T. (1946) 73 C.L.R. 604; see the group of cases referred to by Menzies J. in
Australasian Catholic Assurance Company Limited v. F.C. of T. (1959) 100 C.L.R. 502. In high contrast, the Court in
Charles v. F.C. of T. (1954) 90 C.L.R. 598, held that such realisation did not form part of the income of the unit trust business conducted by the taxpayer. The Court accepted that the switching or realisation of investments was not part of the particular investment business conducted by the unit trust company. No doubt the switching or realisation was incidental to that business and occurred because of the exigencies of that business. But as trafficking in shares did not form part of that business, the gains or losses were not income gains or losses. Having regard to the findings of the primary judge in this case, it is worth noting that a decisive factor in arriving at the Court's conclusion was the fact that the realised shares were not bought for profit-making by resale: see particularly at p. 610 of the report.
That the appellant carried on investment in Australian shares as a business or business activity cannot be doubted. The essence of that business was the receipt of dividends in order to service the dividend to be paid by the appellant to its U.K. shareholders. Quite clearly, it was no part of that business to traffic in shares. Accordingly, no shares were acquired with the purpose of making profit by their resale. But, as the maintenance of the subscribed capital and of a consistent yield upon it was also of the essence of the company's business, realisation of shares from time to time became necessary or advisable. Market conditions and the fortunes of companies in which shares were held determined whether or not realisation should occur. Those realisations could be said, in my opinion, to be a result of the nature of the company's business but not part of that nature. It would indeed be surprising, in my opinion, if the company could successfully claim as deductions from its dividend income losses incurred by it on realisation of unwanted investments. The facts in C. of T. v. The Commercial Banking Co. of Sydney are in contrast to those in this case. The Court in that case could properly say that ``the money used was part of the'' bank's ``stock in trade, it was used in an operation of business, and it was used in carrying out the'' bank's ``scheme of profit making as a banker''. Here, quite clearly, the realised shares did not form part of the appellant's stock in trade or of any circulating capital. The money invested in them formed part of the capital of the appellant, capital derived from the subscription of shareholders except to the extent that possibly some part of the equalisation account had at some stage been carried to capital reserve. But, in that event, the augmentation was contingent and problematical. Subsequent losses on realisation may reduce that accretion: indeed may fully absorb it.
In my opinion, nothing in the banking and insurance cases included in the references I have made requires the conclusion that the gains or losses on realisation of shares by this company formed part of, or in the case of a loss, a reduction of, its assessable income. I have included in the references I have made the decision in Australasian Catholic Assurance
ATC 4402Company Limited v. F.C. of T. For present purposes I am prepared to treat that decision as explicable on the footing that the investment in the real estate by the taxpayer was part of the nature of its particular business of insurance. There may be good reasons, in my opinion, for doubting that conclusion but it is unnecessary for me in the decision of this case to pursue that matter. On the other hand, the reasoning of the Court in Charles v. F.C. of T. supports the view that such a conclusion should not be drawn in this case. If analogy is of any assistance to decision in this kind of case, the investment policy outlined in the reasons for judgment in Charles v. F.C. of T. bears a striking similarity to the investment policy evidenced and accepted in this case.
In my opinion, the gains or losses in realisation of shares by the company accumulated by pursuit of its investment policy cannot properly be brought to account in determining the assessable income of the company. The appeals should be allowed.