Burnside v. Federal Commissioner of Taxation.
Judges: Barwick CJMason J
Stephen J
Jacobs J
Aickin J
Court:
Full High Court
Mason J.: This is an appeal by the appellant against orders of the Supreme Court of South Australia ( Hogarth J) dismissing his appeals against assessments to income tax for the years ended 30th June 1970 and 1971 by which the Commissioner included in his assessable income profits made by the appellant on the sale between February and August 1970 of 6,400 shares in Samin Ltd. (``Samin''). The appellant acquired by way of allotment 14,800 shares in Samin early in January 1970 in circumstances to which I shall refer. Of these shares 3,900 were sold between 26th February and 30th April 1970 yielding a profit of $23,143. By an amended assessment the Commissioner included this amount in the appellant's assessable income for the first of the two years in question. The appellant sold a further 2,500 shares in Samin between 30th July and 3rd August 1970 at a profit of $24,312 which the Commissioner included in his assessable income for the second year. In each instance the Commissioner relied on the provisions of sec. 25 and 26(a) of the Income Tax Assessment Act 1936 (as amended) to support the assessments. The primary judge, after a comprehensive review of the circumstances in which the shares were acquired, held that they had been acquired in the course of a profit-making undertaking or scheme and that the profits fell within sec. 26(a). Whether the profits fell within the first or second limbs of sec. 26(a) are the only issues for determination.
In 1948 the appellant, who was a Canadian, entered the employment of McPhar Geophysics Ltd., a Canadian company, as a field technician. By 1954 when he had become a geophysicist he entered the employment of an associated exploration company. In 1961 he returned to McPhar Geophysics Ltd. and became a shareholder in that company. At present his shareholding represents about 8% of the paid-up capital of the company.
In 1961 the company joined a consortium with three Australian companies. It was arranged that McPhar Geophysics Proprietary Ltd. (``McPhar'') would provide technical assistance for the consortium. This company opened an office in Melbourne and conducted its activities from there. McPhar provided its services at cost but on the understanding that in the event of mining activity being undertaken it would be entitled to participate in that activity on a 10% basis. The appellant came to Australia in 1961 as the Vice-President and General Manager of McPhar, taking up residence in Melbourne. Although he returned to Canada in 1964 he came back to Australia in 1965 when a renewal of the consortium agreement for a further three years was agreed upon. At first he continued to live in Melbourne but later in that year he and his family moved to Adelaide. He was promoted to President and Managing Director of McPhar.
In 1969, after the Australian members of the consortium decided that they would not participate in the development of certain copper deposits at Burra in the State of South Australia which the consortium had investigated, Basil Lewis a geoligist, who had formerly been employed at Broken Hill South Ltd., a member of the consortium, took steps to incorporate Samin with a view to mining the deposits at Burra. It was arranged that McPhar would take a 10% interest in the capital of Samin. Subsequently the arrangement was varied to enable employees of McPhar to take up a proportion of the capital in Samin to which McPhar would otherwise be entitled. It was initially thought that Samin would require a paid-up capital of between half a million and one million dollars to engage in mining operations.
Samin was incorporated on 6th October 1969. On 29th September, immediately before Samin's incorporation, a company known as Poseidon N.L. announced that it had discovered a valuable nickel deposit in Western Australia. On the evening of that day Mr. Lewis had a conference with Mr. Shierlaw of Poseidon, in which it was agreed that Samin would apply for and be allotted 200,000 fully paid 20c shares in Poseidon at the closing market price of the shares on 30th September less $2 per share. The
ATC 4592
consideration for the discount was that Samin would provide mining and exploration services for Poseidon. The closing price of Poseidon shares on the following day was $6.90 and this led to Mr. Lewis agreeing on behalf of Samin (which was yet to be incorporated) to pay $5 per share for the 200,000 shares. In consequence of this arrangement the proposed capital of Samin was increased, with the result that shortly after its incorporation it had a paid-up capital of $1,750,000 of which $1,000,000 was applied in paying-off a loan raised to pay for the Poseidon shares. By the date of Samin's incorporation the market price for Poseidon fully paid shares had risen to $20.As a result of discussions between the President of the Canadian company, the appellant and Mr. Lewis agreement was reached as to the number of shares to be allotted to McPhar employees and to Samin employees. The appellant was allocated 20,000 shares of which he applied for 14,800 in his own name, the balance being applied for by his wife and children except as to 400 shares which were made available to his bank manager, Mr. Byrnes.
The closing price for Poseidon fully paid shares on 18th December was $115, on 19th December (which was a Friday) $128 and on 22nd December $170. Applications for Samin shares closed on the following day when the closing price for Poseidon fully paid shares was $175. As the primary judge observed, it must have been obvious that the allotment of a 50c shares in Samin would give an interest in a company with an asset backing far in excess of its paid-up capital.
In August 1969 the appellant and his wife who were then living in a house in Panorama, a suburb of Adelaide, of which they were the owners subject to a mortgage, were looking for a home in a different area. They were attracted to a house in the suburb of Hawthorn which was for sale by auction. They attended the auction with their bank manager. The house was sold but they were not the successful bidders. Fortuitously the house came on the market again in December 1969 and the bank manager informed them that it was available for purchase. On 19th December 1969, the day on which they signed their applications for shares in Samin, they entered into a contract to purchase the Hawthorn house for $46,700, the bank manager having agreed to provide short term finance. Arrangements were made on 22nd December between the appellant and the bank manager for more specific financial assistance by the bank. The then financial position of the appellant and his wife and the arrangements made for the provision of finance by the bank were summarized by the primary judge in this way:
``At that time the general account of the appellant and his wife was in overdraft to the extent of $5,461. The No. 2 account was $1,515 in debit.
On the 18th of December 1969, therefore, the appellant and his wife needed funds to finance, first, the purchase of the Hawthorn house; and secondly, the shares in Samin. They therefore applied for an increase in the approved overdraft limit of the general account to $56,000. This meant that the total accommodation sought by the appellant and his wife was $57,515. The purpose stated by the appellant, as recorded by Mr. Byrnes, was:
Assist purchase of house property $46,700 less 1st mtge. E.S. & A. Savings 10,000 ------ $36,700 Purchase 20,000 shares Samin N/L for self and family 10,000 Present debt, say 6,000 Personal needs, car etc. 3,300 ------- $56,000' Under the heading `Repayment' appears: `Sale of present house property expected to provide equity of $10,000 Sale of sufficient Poseidon and/or Samin shares $50,000'
ATC 4593
The expiry date for the proposed overdraft was given as the 8th of March 1970.
In February 1970 the bank approved an overdraft limit of $57,000 to be reduced to $25,000 by the 8th of March 1970; and to be discharged in full by the 31st of July 1970. The No. 2 account was to continue to be repaid by monthly payments until the sale of the Panorama house, when it was to be paid off; and the whole indebtedness was to be paid off in any event by the 31st of July 1970. In fact the Panorama house, although put up for sale, was not sold until after 1970. In the result, therefore, the whole of the debt to the bank had to be paid from other sources.''
The appellant and his wife were at this time confronted with the necessity of selling part of their assets, in addition to the Panorama house, in order to discharge the debt to the bank or, alternatively, of obtaining long term finance by way of mortgage. Apart from the shares in Samin the appellant and his wife held 1,000 shares in Poseidon which had been acquired on 30th September 1969 for $6,695. He and his wife had previously on 15th September 1969 bought 1,000 contributing shares in that company for $896 and sold them on 29th September for $3,240. They also held shares in other Australian companies which were sold in February and March for $10,288.18. In addition the appellant had the shares in McPhar Geophysics Ltd. to which I have already referred. The proceeds of sale of the shares in Australian companies were credited to the joint account with the bank and almost all the proceeds of sale of the Samin shares sold between February and April 1970 were also credited to the joint account, reducing the overdraft to $8,223.55 on 30th April 1970. The proceeds of sale of the 2,500 shares in Samin sold between 30th July and 3rd August 1970, amounting to $25,562.03, were also paid into the joint account, thereby creating a credit balance of $5,165.60.
The appellant claimed in his returns that the purchase of the Samin shares was an investment rather than a speculation and in evidence he stated that he wished to purchase and hold as an investment the Samin shares as they were attributable to him as an employee of that company. His evidence in this respect was accepted by the primary judge who drew a distinction between the acquisition of the Samin shares and other share transactions into which the appellant and his wife entered some of which the appellant conceded to have been speculative transactions in the shares of mining and oil exploration companies.
His Honour found that when the appellant applied for the Samin shares he knew that he would have to raise a substantial part of the necessary funds by selling some of his shares in Poseidon or in Samin, or in both of those companies, and that this sale would be at a profit, but that, subject to this sale, it was the appellant's intention to retain the shares in both companies as a long term investment - an intention which the appellant carried out, and to his cost, because the shares ultimately became of little value. His Honour also found that at the time of acquisition of the Samin shares the appellant had no definite intention of selling the exact numer, or indeed any, of the shares in that company which were in fact sold in 1970.
The gist of his Honour's conclusion in relation to the first limb of sec. 26(a) was that it was not satisfied because the appellant at the relevant time did not have a definite purpose or intention of selling the Samin shares, it being possible that he would sell the Poseidon shares.
However, the primary judge went on to find that the arrangements made by the appellant in December 1969 with the bank manager for a temporary loan to finance the purchase of the house and the applications for the Samin shares, to use the Poseidon and Samin shares as security for the loan and to raise funds to pay off the loan within the times mentioned, in part by the sale of the Poseidon or Samin shares, or shares in both companies, amounted to a profit-making undertaking or scheme with the second limb of sec. 26(a) with the consequences that the profits formed part of his assessable income.
I am in agreement with his Honour's conclusion that the profit made by the appellant on the sale of the 6,400 Samin shares did not fall within the first limb of sec. 26(a). It speaks of profits arising from the sale of property ``acquired... for the purpose of profit-making by sale'', not profits arising from the sale of property acquired for the purpose of sale. The remarks made in connection with sec. 16(b)(i)(1) of the
Income Tax Assessment Act
1922-1932 by
Rich, Dixon
and
Evatt
JJ. in
Evans
v.
D.F.C. of T. (S.A.)
(1936), 55 C.L.R. 80,
at p. 99
,
ATC 4594
apply with equal force to the first limb of sec. 26(a). Their Honours said:``No doubt to transfer the assets to another company for shares is a sale. To that extent the purpose of sale was not absent. But the proviso defines the purpose which it excludes, not as one of resale simply, but as resale at a profit. It is concerned with the well known difference between enlargement of capital by sale of capital assets and obtaining detachable profit by buying and selling assets. The purpose of which it speaks is the dominant purpose actuating the acquisition of the assets - the use to which they are to be put.''
Under the first limb of sec. 26(a) the issue in this case may be expressed thus: Has the appellant established that the dominant purpose actuating the acquisition of the shares was not that of profit-making by sale? On the findings of fact made by his Honour it is my opinion that this question must be answered in favour of the appellant. It was in August 1969 that it was arranged that the appellant and his family would be allocated 20,000 shares (approximately) in Samin and it was at this time that the appellant formed the intention that he would take up shares in that company as a long term investment. There was then no question of selling any part of the shares in order to meet the cost of acquiring the Hawthorn house because the negotiations for the purchase of that house did not take place until December when it came on the market for a second time. Had it not been for the purchase of the house in December the appellant may well have been able to finance the purchase of the shares without resorting to selling them in 1970. The moneys borrowed to take up the Samin shares could have been repaid out of the proceeds of sale of the shares held in other Australian companies. These shares were in fact sold in February and March 1970 for over $10,000 which exceeded the amount of $10,000 payable on the 20,000 50c shares in Samin.
It is to be inferred that the notion that either some Samin or Poseidon shares, or both, should be sold to repay the indebtedness of the bank was first entertained by the appellant when the bank manager announced in December 1969 the terms on which the bank was prepared to provide temporary finance for the purchase of the Hawthorn house and insisted on repayment by 8th March 1970, the terms being subsequently modified so as to require a repayment of $25,000 on that date. It may then be said that from the beginning the purpose of acquiring the Samin shares was that of long term investment, as the judge found, and that subsequently, by the time the application for the shares was made and they were later allotted, that purpose was qualified by the appellant's recognition that there was a possibility that he would need to sell portion of the Samin shares to reduce or extinguish his debt to the bank. There is not enough in this circumstance to justify the conclusion that the acquisition of the shares in Samin which were sold in 1970 was actuated by the dominant purpose of profit-making by sale. The other possibility considered by the appellant at the time of acquisition of the Samin shares was that the debt to the bank would be repaid out of the proceeds of Poseidon shares the sale of which, as we shall see, would not have produced, and did not produce, assessable income in the hands of the appellant. The Samin shares were acquired in circumstances in which the appellant had no dominant purpose of making a profit by selling them. In these circumstances the profit does not fall within the first limb of sec. 26(a).
This conclusion does not necessarily dispose of the case because, like
Gibbs
J. in
F.C. of T.
v.
Williams
72 ATC 4188
at p. 4195;
(1972) 127 C.L.R. 226
at p. 250
, I do not understand their Lordships in
McClelland
v.
F.C. of T.
70 ATC 4115
at p. 4120;
(1970) 120 C.L.R. 487
at p. 495
, to be saying that the second limb of sec. 26(a) is otiose
-
see also
Steinberg
v.
F.C. of T.
75 ATC 4221
;
(1975) 50 A.L.J.R. 43
. But once attention is given to the findings of fact made by the primary judge and to the conclusion that the first limb of sec. 26(a) has no application, it is impossible to avoid the further conclusion in the circumstances of this case that the profit did not arise from a profit-making undertaking or scheme.
In the first place, where the profit in question arises from the purchase and subsequent sale of an asset and it is found that the asset was not acquired for the purpose of profit-making by sale it is very difficult to see how the profit can be said to arise from a profit-making undertaking or scheme (see
McGuiness
v.
F.C. of T.
72 ATC 4023
;
(1972) 46 A.L.J.R. 279
). In this case the difficulty becomes insurmountable because the finding in connection with the first limb of sec. 26(a) denies the existence of the relevant profit-
ATC 4595
making undertaking or scheme which is alleged to bring the profit within the second limb. For the Commissioner's claim is that the essence of the profit-making scheme lies in the purpose of acquiring the Samin shares and selling them at a profit. According to the Commissioner it is that purpose and that purpose alone which stamps the scheme with a profit-making character.The Poseidon shares, the other possible source of funds from which the bank's debt might be repaid, were acquired by the appellant and his wife in September 1969 some months before the formation of the alleged profit-making undertaking or scheme in December of that year. It is conceded by Mr. Rice, Q.C. for the Commissioner that the Poseidon shares were not acquired for the purpose of profit-making by sale and that any profit made by the appellant on their sale was not assessable income in the hands of the appellant and his wife. On the assumption that the appellant's application for shares in Samin, his arrangement to repay the bank and his intention to sell either enough Poseidon or Samin shares, or both, to repay the bank deserved to be labelled as an undertaking or scheme, that undertaking or scheme was not in my opinion a profit-making undertaking or scheme within the meaning of sec. 26(a) because the acquisition of the Samin shares which represented a critical element in the alleged plan, like the earlier acquisition of the Poseidon shares, was not actuated by the dominant purpose of profit-making by sale.
I would therefore allow the appeal against the orders made by the Supreme Court dismissing the appellant's appeals against assessments to income tax for the years ended 30th June 1970 and 1971.
This information is provided by CCH Australia Limited Link opens in new window. View the disclaimer and notice of copyright.