London Australia Investment Company Limited v. Federal Commissioner of Taxation.

Judges: Barwick CJ

Gibbs J
Jacobs J

Court:
High Court (Full Court)

Judgment date: Judgment handed down 20 September 1977.

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Gibbs J.: The principal question for decision in these three appeals is whether the Commissioner was right in including in the taxpayer's assessable income for the years 1967, 1968 and 1969 the respective amounts of $816,651, $140,166 and $413,263 which represent the difference between the net proceeds of the sale of shares sold by the taxpayer in each of those years and the average cost to the taxpayer of the shares. If the Commissioner was entitled to include in the assessable income the surplus resulting from the sales of the shares, the taxpayer does not challenge the manner in which the amount of the surplus has been determined. The question was whether the surplus was correctly treated as income.

The facts of the case have been fully stated in the judgment of Helsham J. in the Supreme Court and it will be sufficient if I state them shortly. The taxpayer is an investment company whose shareholders were mostly residents of the United Kingdom. Its principal object was to invest mainly or wholly in Australian securities, for the purpose of producing dividend income which it could distribute to its shareholders. The taxpayer in fact held a large portfolio of Australian shares. During the years in question the directors of the taxpayer met each month to decide whether shares should be bought or sold, and during that period, as Helsham J. found, the taxpayer engaged in a continuous large scale activity in the buying and selling of shares. In deciding what shares should be bought, sold or retained the taxpayer was guided by a number of principles, but one important consideration in buying shares was that the shareholding should immediately or within a reasonable time produce a dividend yield of 4 per cent or better. The dividend yield is the return on the shares calculated as a percentage of their market value. In buying shares the taxpayer was influenced by their ``growth potential'', that is, the expectation that they would produce a greater dividend yield. Although a share which is likely to produce an increased dividend is for that very reason likely to increase in value, the taxpayer never bought shares for the purpose of profit-making by sale, or with the intention of selling them, or simply because their market value was likely to increase. It bought shares to hold as an investment to yield dividends, but it foresaw that it was likely that the shares would increase in market value, and of course hoped that this would occur. If the shares did increase in value, but the dividend rate did not correspondingly increase, the dividend yield would fall, and the taxpayer would then be likely to sell the shares. In the years in question there was a steady rise in share prices and in consequence the dividend yield of many shares held by the taxpayer fell and many shares were sold. The shares sold in each of the years in question exceeded a million dollars in value and amounted to at least one-tenth of the total value of the shares held in that year. The moneys realised on the sale of the shares were not under the articles of the taxpayer available for dividend but could be used to buy further shares or to make up a future capital loss.

Helsham J. found that the main or dominant purpose actuating the acquisition of the shares was not profit-making by sale. He further said that he did not believe ``that the profits obtained from a continuity of the business activity of the appellant over three years fall within the concept of profit arising from the carrying on or carrying out of any profit-making undertaking or scheme''. He added that ``the cases relating to the circumstances in which this basis of assessment is to be applied are reviewed by Stephen J. in his reasons for judgment'' in
Williams v. F.C. of T. 72 ATC 4157 ; (1972) 128 C.L.R. 645 . He accordingly held that the surpluses did not fall within sec. 26(a) of the

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Income Tax Assessment Act 1936 (as amended) (Cth). But he held that they were properly treated as income within sec. 25 of the Act.

When a taxpayer sells one of its investments, the question whether the profit on the sales should be treated as capital or income is to be answered by applying the tests stated in
Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 T.C. 159 , at pp. 165-166 , in a passage which has constantly been cited, or repeated, with approval: see, for example,
C. of T. (Victoria) v. Melbourne Trust Ltd. (1914) 18 C.L.R. 413 , at pp. 420-421 ;
Ruhamah Property Co. Ltd. v. F.C. of T. (1928) 41 C.L.R. 148 , at pp. 152, 165 ;
Australasian Catholic Assurance Co. Ltd. v. F. of T. (1959) 100 C.L.R. 502 , at p. 506 and
White v. F.C. of T. (1968), 120 C.L.R. 191 , at p. 222 . The principle was stated as follows in
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1946) 73 C.L.R. 604 , at p. 614 :

``Prima facie the depreciation in or accretion to the capital value of a security between the date of purchase and that of realization is a loss of or accretion to capital and is therefore a capital loss or gain and does not form part of the assessable income... But in the words of the Lord Justice Clerk in Californian Copper Syndicate v. Harris which have been so often quoted, `it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business'.''

Their Honours went on to point out that not all of the proceeds of a business carried on by a taxpayer are income for the purposes of the Act; they will be so only if they are income ``in accordance with the ordinary usages and concepts of mankind, except in so far as the Act states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income'' (see at p. 615). However it is in my opinion established by this and the many other cases in which Californian Copper Syndicate v. Harris has been applied that if the sale in question is a business operation, carried out in the course of the business of profit-making, the profit arising on the sale will be of an income character. To apply this criterion it is necessary ``to make both a wide survey and an exact scrutiny of the taxpayer's activities'':
Western Gold Mines N.L. v. C. of T. (W.A.) (1938) 59 C.L.R. 729 , at p. 740 . Different considerations may apply depending on whether the taxpayer is an individual or a company. In the latter case it is necessary to have regard to the nature of the company, the character of the assets realized, the nature of the business carried on by the company and the particular realization which produced the profit:
Hobart Bridge Co. Ltd. v. F.C. of T. (1951) 82 C.L.R. 372 , at p. 383 , citing Ruhamah Property Co. Ltd. v. F.C. of T., at p. 154.

In the present case the taxpayer naturally placed considerable reliance on the finding that the shares were not bought for the purpose of selling them at a profit. That is indeed an important circumstance. It was then submitted that the shares were acquired on the capital account of the company, for the purpose of adding to its profit-making structure, as the means of producing dividend income, rather than as part of the profit-earning activities within that structure, and amongst other cases
National Bank of Australasia Ltd. v. F.C. of T. 69 ATC 4042 at pp. 4047-4048; (1969) 118 C.L.R. 529 at p. 538 , was cited in support of that view. If that submission were correct, the fact that the shares were realized in a methodical and enterprising way, so as to secure the best results for the taxpayer, would not convert the proceeds of realization into income. But the question whether the shares were acquired on the capital account of the taxpayer can only be answered by applying the tests indicated by Californian Copper Syndicate v. Harris. Helsham J. found that during the three years in question it was an integral part of the taxpayer's business to deal in shares, in the sense that switching of investments was desirable to produce the best dividend returns and was indeed necessary if the taxpayer's policy of investing in shares with growth potential was to be adhered to. In my opinion it is impossible to controvert that finding; it was clearly right. Although the company's business was to invest in shares with the primary purpose of obtaining income by way of dividends, the conduct of the investment business required that the share portfolio should be given regular consideration, and that shares should frequently be sold when the

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dividend yield dropped, which for practical purposes usually meant when the shares went up in value. The taxpayer systematically sold its shares at a profit for the purpose of increasing the dividend yield of its investments. The sale of the shares was a normal operation in the course of carrying on the business of investing for profit. It was not a mere realization or change of investment.

The present case is in my opinion indistinguishable from the decision in Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. The material facts of that case appear in the judgment of Starke J. at first instance. His Honour said, at p. 606:

``The general manager of the Society said, in his evidence, that the general policy of the Society was to hold its securities as investments and not to traffic in or to make a profit from realizing them and that the governing consideration in purchasing stocks or debentures or varying or `switching', as it is called, its investments in such securities was to increase its effective interest yield. I see no reason to doubt the accuracy of this statement.''

Nevertheless it was held that the profits were taxable. On behalf of the taxpayer it was submitted that the decision in Colonial Mutual Life Assurance Society Ltd. v. F.C. of T., and in other cases such as
Punjab Co-operative Bank, Ltd., Amritsar v. Income Tax Commissioner, Lahore , (1940) A.C. 1055 , Australasian Catholic Assurance Co. Ltd. v. F.C. of T., and
C. of T. v. The Commercial Banking Co. of Sydney (1927) 27 S.R. (N.S.W.) 231 , depended on the special nature of the business of banking or insurance which the taxpayer carried on. With all respect I cannot agree. In all those decisions the test suggested in Californian Copper Syndicate v. Harris was applied. That test is applicable to any business, and if the sale of the shares is an act done in what is truly the carrying on of an investment business the profits will be taxable just as they would have been if the business had been that of banking or insurance.

The position of an investment company is materially different from that of an individual managing his own portfolio of shares. It is different also from that of a trustee managing a portfolio of shares in a trust fund. In
Charles v. F.C. of T. (1954) 90 C.L.R. 598 , the moneys said to be taxable were received by the beneficiaries of a unit trust and derived from the realization of investments held by the trustees. Evidence was given that at no time were securities acquired for the express purpose of resale at a profit, and that sales were normally made when the managers anticipated a fall in the value of shares: see at p. 610. The Court held that the case was distinguishable from such cases as Punjab Co-operative Bank, Ltd., Amritsar v. Income Tax Commissioner, Lahore and Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. Their Honours referred to the evidence already mentioned and said, at p. 612:

``According to that evidence, the moneys in question arose, not (as in the cases cited) from transactions forming incidents in the conduct of a business or a profit-making scheme, but from transactions effected in the course of performing a fiduciary duty to preserve for beneficiaries as far as practicable the assets comprising the trust fund and any increments in the value of those assets which might appear from time to time to be in jeopardy. The case therefore differs fundamentally from the cases relied upon by counsel for the Commissioner.''

That passage reveals the distinction between that case and the present.

The finding of Helsham J. that the profits did not fall within the second branch of sec. 26(a) at first sight appeared to create a logical difficulty for the Commissioner because in situations such as the present it is sometimes suggested that sec. 25 and the second branch of sec. 26(a) provide alternative methods by which profits may be brought to tax. However in the case which Helsham J. cited,
Williams v. F.C. of T., Stephen J., at ATC pp. 4166-67; C.L.R. pp. 653-654 , cast doubt on this view, and referred to a number of cases in which it has been said that sec. 26(a) has quite a distinct field of operation from that covered by the conventional method of assessment, and that the latter method applies where the profit is made in the course of the ordinary business of the taxpayer. Although Helsham J. did not elaborate on his finding, it seems to me that he intended to hold that the profits did not fall within the second branch of sec. 26(a) because they were made in the course of the taxpayer's business as a whole, rather than in the course of some special or isolated transaction. It is unnecessary to examine that question further,

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for it is clear that Helsham J. did not intend to hold that the profits were not made in the course of a business. It was common ground that the taxpayer was carrying on the business of investing, for the purpose of producing income, and the question was whether the buying and selling of the shares was done as part of that business; Helsham J. expressly found that it was. The resulting profits were therefore profits of the business and income within ordinary usages and concepts, and fell within sec. 25.

For the reasons I have given, in my opinion Helsham J. was correct in holding the profits made on the sale of the shares to be assessable income and the main argument advanced on behalf of the taxpayer should fail.

The second question raised by the appeal was whether in calculating the amount of the surplus, Helsham J. was wrong in failing to take into account anything in respect of the cost of shares acquired as the result of a bonus issue and later sold. It was conceded on behalf of the Commissioner that in this respect the judgment was not consistent with the decision of this Court in
Curran v. F.C. of T. 74 ATC 4296 ; (1974) 131 C.L.R. 409 (which had not been given at the time Helsham J. delivered judgment) and to that extent the appeals must be allowed.

I would allow the appeals and would order that the assessments be remitted to the Commissioner for amendment. I would allow the appellant one-half of its costs of the appeals to Helsham J. but would order the appellant to pay the costs of the appeals to this Court.