Federal Commissioner of Taxation v. Westraders Pty. Limited.
Judges: Barwick CJMason J
Murphy J
Aickin J
Wilson J
Court:
Full High Court
Mason J.
This is an appeal by the Commissioner from the judgment of the Federal Court of Australia which by majority dismissed an appeal from the decision of the Supreme Court of New South Wales, Administrative Law Division ( Rath J.) which had allowed the respondent taxpayer's objection to the assessment of income tax made by the Commissioner upon income derived by the taxpayer during the year ended 30 June 1975 (``the 1975 year'').
For the 1975 year the respondent taxpayer claimed a deduction of $248,844.00 as ``Tax Loss in Share Trading Partnership Jenspart Trading Co.''. The members of this partnership (``Jenspart'') were the taxpayer, Jensen Mining & Investments Limited (``Jensen'') and seventeen others. Section 92 of the Income Tax Assessment Act 1936 (as amended) (``the Act'') provides that a partner's individual interest in a partnership
ATC 4362
loss incurred in the year of income shall be an allowable deduction. The deduction claimed was disallowed by the Commissioner.Jenspart showed a loss of $6,463,484.00 in its return for the 1975 year. In this return 3.85% of the loss, amounting to $248,844.00, was assigned to the taxpayer. By its return the partnership claimed that it was a share trading partnership and that it had sustained, for taxation purposes, a very substantial loss on the sale of shares which it had acquired from Jensen in circumstances shortly to be described. After taking into account the actual cost of the shares which it sold, together with the actual cost of closing stock at 30 June 1975 and the price of the shares sold as well as stamp duty, brokerage and other expenses, Jenspart made a small ``book profit''. However, Jenspart and the taxpayer claimed that the profit was converted into a loss for tax purposes of $6,463,484.00 by reason of Jensen and the other members of the partnership having made an election under sec. 36A(2) of the Act. The effect of this election, if validly made, was that the cost of the shares transferred by Jensen to Jenspart was deemed to be the price paid by Jensen for those shares. It was common ground that the price paid by Jensen for the shares which it transferred to Jenspart was $6,584,513.00.
In this Court, as in the Federal Court and the Supreme Court, the broad issue for determination is whether, in the circumstances disclosed in evidence, the election on which the taxpayer relies was validly made under sec. 36A(2). The resolution of this issue depends on the interpretation of sec. 36 and 36A of the Act and upon the outcome of certain issues of fact to be discussed, in particular -
- (a) Whether Jensen was carrying on business as a share trader; and
- (b) Whether the shares transferred by Jensen to Jenspart formed part of the trading stock of Jensen in its business as a share trader.
For the taxpayer to succeed in bringing into play the provisions of sec. 36 and 36A it is necessary that these two issues of fact be determined in its favour.
Section 36(1) provides that where a taxpayer disposes of trading stock otherwise than in the ordinary course of business, the value of the trading stock shall be included in the assessable income of the taxpayer, and the person acquiring the trading stock shall be deemed to have purchased it at a price equal to that value. For this purpose ``value'' is the market value at the date of the disposal; or, if in the opinion of the Commissioner, there is insufficient evidence of market value on that day - the value which in his opinion is fair and reasonable (subsec. (8)).
Section 36A(1) provides that where, for any reason including the formation of a partnership, a change has occurred in the ownership of trading stock, and the person who owned the trading stock before the change has an interest in the trading stock after the change, sec. 36 applies as if the person who owned the trading stock before the change had, on the day on which the change occurred, disposed of the whole of the trading stock to the persons by whom the trading stock is owned after the change. Section 36A(2) provides that in certain circumstances the parties referred to in sec. 36A(1) may elect that the value shall be cost, not market value, and the taxpayer contends that those circumstances exist in this case.
Jensen was at all material times a public company. It had commenced business in 1958 as a merchant banker, but in the financial years ending 30 June 1971 and 1972 (``the 1971 and 1972 years'') it changed its business. The new business was described as that of a mining and investment company.
In these two years it actively subscribed for, bought and sold shares in public and private companies. These activities were so regular, so continuous and of such magnitude that Rath J. held that Jensen carried on the business of a share trader. He also found that Jensen continued its share trading and dealing activities in the years ended 30 June 1973 to 1975 inclusive, notwithstanding that in the latter years Jensen's activity in buying and selling shares was apparently confined to the carrying out of schemes known in taxation circles as ``Division 7 schemes''. In essence these schemes involved the acquisition by Jensen of a substantial proportion of the share capital of private companies having large amounts of undistributed profits, the
ATC 4363
declaration and payment of substantial dividends out of those profits by the companies and the subsequent sale of the share capital in the companies at a lower price than that paid on acquisition.In May 1975 Jensen made plans for the promotion of partnerships which were designed to take advantage of the deemed price provisions contained in sec. 36 and 36A. Jenspart was such a partnership. It was formed in May 1975. The Partnership Deed dated 28 May 1975 provided that the initial capital of the partnership was to consist of -
- (a) $345,000.00 in cash to be contributed by the partners other than Jensen; and
- (b) $115,000.00 being the agreed market value of certain shares beneficially owned by Jensen which Jensen, from the commencement of the partnership, held on trust for the partnership until the shares were transferred to the partnership and registered in the names of the partners.
On 27 June 1975 Jensen executed transfers to Jenspart of the shares it had held in trust for the partnership, being parcels of shares in nineteen companies. On the same day Jenspart transferred all the shares contributed by Jensen, except a parcel of shares in a company known as Beneficial Finance Corp. Ltd., to four other companies.
As I have said, the original cost to Jensen of the shares transferred to Jenspart was $6,584,513.00. This price reflected the fact that the companies in which the shares were held had large amounts of undistributed profits available for distribution by way of dividend. After causing the profits to be distributed in the form of dividends, Jensen sold the shares to Jenspart for the greatly reduced figure of $111,284.20. In most instances Jensen had carried out what is known as a ``dividend stripping'' operation.
If, by virtue of sec. 36A(1), sec. 36(1) applied to the transaction between Jensen and Jenspart, then the value of the shares transferred in the hands of Jenspart was the reduced value. If, however, sec. 36A(2) applied to the transaction, then the value of the shares in the hands of Jenspart for the purposes of sec. 36 was the cost of the shares to Jensen, viz. $6,584,513.00.
It is convenient in the first instance to consider the Commissioner's contentions that Jensen was not carrying on business as a share trader in the 1975 year and that even if it was, the shares which it transferred to Jenspart on 27 May 1975 did not form part of the trading stock of Jensen. After a detailed examination of the activities of Jensen, Rath J. concluded that Jensen was a share trader and that the relevant shares were part of Jensen's trading stock. I see no reason to disagree with these findings. However, in order to deal with the arguments advanced for the Commissioner it is necessary to canvass the facts in some detail.
The Commissioner does not contest Rath J.'s finding that Jensen carried on business as a share trader in the 1971 and 1972 years, conceding that it bought and sold shares in listed companies through brokers on an extensive scale in those years. However, he draws attention to Rath J.'s comments that the operations were not profitable, that the operations in the 1972 year were on a smaller scale and that the management might well have turned its mind ``to the wisdom of continuing share trading operations in their then present form''. In fact there was no direct evidence that the management gave consideration to this question.
The Commissioner then says that stock on hand at the end of the 1972 year, valued at $3,860.00 only, was disposed of in the 1973 year, with the exception of a parcel of shares in Arcadia Minerals N.L. which were of negligible value. To this observation he adds the comment that there were no new acquisitions after 30 June 1972 before the 1975 year. This comment ignores the acquisition of shares in seven companies in the 1973 year at a total cost of $3,293,026.00 which were purchased, according to the evidence, in the course of Jensen's share dealing operations. The comment also ignores the acquisition of shares in nine other companies in the 1974 year at a total cost of over $1,000,000.00 again, according to the evidence, in the course of the same business.
It is true that in its first return of income for the 1973 year Jensen did not claim that it was a share trader. But Rath J. expressly accepted the evidence given by Mr. Fox, the chairman of Jensen, that the return was lodged without his knowledge due to his
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absence overseas and that steps were subsequently taken to submit an amended return stating that the company was a share trader.It is also true that Jensen's annual returns for the years up to 30 June 1974 (``the 1974 year'') contain no express reference to share trading and that the 1974 report describes the principal activities of the company as ``the financing and operation of mining and exploration ventures, the operation of Wine Bars and country Bistro Restaurants and a wide range of general investments similar to those undertaken in previous years''. However, the accounts of Jensen lodged with its 1974 taxation return give these particulars of its profits and losses from share trading:
``Profit (Loss) from Share Trading as Per Accounts
$ Metropolitan Tenpin Bowling Limited ........................ 94,659 J. & J. Finance Pty. Limited ........................ ( 995,000) Norpe Investments Pty. Limited ........................ ( 995,000) Meik Pty. Limited .............. ( 995,000) ----------- (2,890,341) Add amount provided in accounts in previous years ..... 2,985,000 ---------- Total Profit ................... 94,659 ----------Profit (Loss) from Share Trading for Taxation
$ Metropolitan Tenpin Bowling Limited ........................ 94,659 J. & J. Finance Pty. Limited ................... ( 995,000) Norpe Investments Pty. Limited ................... ( 995,000) Meik Pty. Limited .............. ( 995,000) ----------- (2,890,341) -----------''
The four companies referred to were companies in which shares were acquired in the 1973 year.
In its 1974 return Jensen gave these further particulars of its share dealing operations:
``Share Dealing Operations
As part of its business in share dealing, the company held at the end of the year of income the following shares:
Company Cost $ Austral Pacific Mining Corp. Limited ............................ 10,235 Renmore Pty. Limited ............... 99,250 Toomar Investments Pty. Limited ............................ 153,552 N. & K. Properties Limited ......... 454,080 Saxonvale Vineyards Limited ........ 36,432 George Hudson Holdings Limited ............................ 761 Arcadia Minerals ................... 1,612 Geear Pty. Limited ................. 100 Colmar No. 1 Pty. Limited .......... 105,500 Scarf Bros. Corp. Pty. Limited ....................... 600,930 Hero Scarf Bros. Pty. Limited ....................... 283,140 Demos Pty. Limited ................. 74,250 Clabeaux Pty. Limited .............. 27,720 --------- 1,847,562 ---------By virtue of sec. 31 of the Income Tax Assessment Act, the taxpayer elects the value of the above trading stock to be its cost price.''
Three of the companies mentioned were companies in which shares were acquired in the 1973 year.
The Commissioner attaches importance to the circumstance that most of the shares acquired by Jensen after the 1972 year and that all the shares in eighteen of the nineteen companies acquired by Jenspart were private company shares, the exception being the shares in Beneficial Finance Corp. Ltd. It is said that shares in private companies are not normally the subject of trading transactions, unlike, for instance, manufactured articles or commodities. No doubt it is true to say that shares in public companies are much more frequently dealt with by traders than shares in private companies, but I can see no reason why private company shares should lie outside the realm of share dealing. In recent years it seems that there has been a strong demand for various classes of private company shares, e.g. shares in loss companies and excess distribution companies. The fact that there are restrictions on the transfer of private company shares does not prevent a person from dealing in them.
The Commissioner then advances a number of reasons with a view to supporting
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the conclusion that Jensen, in acquiring shares after the 1972 year, was not motivated by a desire to make a profit on the resale of shares and that it was ``on the take-over trail'', bent on acquiring cheaply the assets of other companies. Thus it is said that shares in Toomar Investments Pty. Ltd. and Renmore Pty. Ltd. were acquired so that Jensen might purchase inexpensively land which was an asset of these companies. In some instances, such as J. & J. Finance Pty. Ltd., the dividends received exceeded the price paid for acquisition of the shares and in other cases Jensen derived special advantages from the acquisition of shares, e.g. the acquisition of shares in Metropolitan Ten Pin Bowling Ltd. resulted in the ownership by Jensen of its operating subsidiary.However, neither the circumstance that Jensen was ``on the take-over trail'', whatever that colourful expression may mean, nor the fact that it derived special advantages from its acquisitions, not being the making of a profit on resale, nor the fact that the acquisitions took place in the course of carrying out ``Division 7 schemes'', is enough to justify the conclusion that Jensen was not, or had ceased to be, a share trader in the 1975 year.
The point is that Jensen engaged in diverse share trading activities and that the character of those activities changed over the years. The cases of
Investment and Merchant Finance Corporation Ltd.
v.
F.C. of T.
71 ATC 4140 (F.C.)
;
(1971) 125 C.L.R. 249
, and
F.C. of T.
v.
Patcorp Investments Ltd.
76 ATC 4225
;
(1976) 51 A.L.J.R. 40
, clearly establish that the purchase of shares in companies having large amounts of undistributed profits, the payment by way of dividends from those profits and then the sale of the shares at a reduced price are transactions of a trading nature and may therefore form part of the activities of a share trader. The two cases also establish that shares so acquired may be considered trading stock. As
Walsh
J. put it in
Investment and Merchant Finance Corporation Ltd.
v. F.C. of T. 71 ATC at p. 4150; 125 C.L.R. pp. 270-271):
``But when shares are bought by a dealer in shares and it is intended that they are to be resold and that this will probably occur in the not distant future, I do not think they are to be denied the description of trading stock, either because the trader expects or intends that they will be sold at less than their cost price or because he seeks to obtain a commercial advantage from the transaction otherwise than from a profit on the resale, that is, an advantage from an expected dividend and from an expected taxation benefit.''
See also
Patcorp
(76 ATC at pp. 4232-33; 51 A.L.J.R. pp. 44-45), per
Gibbs
J. I agree with these observations. They accord with the notion expressed in the statutory definition of ``trading stock'' in sec. 6
-
``anything... purchased for purposes of... sale''. See also
F.C. of T.
v.
St. Hubert's Island Pty. Ltd.
78 ATC 4104
.
I acknowledge that in the present case Jensen was not in 1975 buying and selling shares through brokers as an orthodox share trader would. Indeed, Jensen's transactions in the later years were limited to Div. 7 schemes and the promotion of sec. 36A partnerships. Nonetheless I regard its activities in buying and selling shares, connected though they were with the carrying out of Div. 7 schemes, as constituting the business of share trading. Jensen's earlier activities as an orthodox share trader assist in arriving at this conclusion. But I do not regard them as essential to the conclusion.
The Commissioner's third submission is that even if Jensen was considered a share trader in the relevant period and the shares were considered part of Jensen's trading stock prior to 27 May 1975, the shares ceased to be trading stock at the time of their transfer to Jenspart. This was the view taken by
Brennan
J., who dissented in the Federal Court. In support of his submission the Commissioner cited the cases of
Danmark Pty. Ltd.
v.
F.C. of T.
(1944) 7 A.T.D. 333
and
Watson Bros.
v.
Hornby (H.M. Inspector of Taxes)
(1942) 24 T.C. 506
as examples of situations in which assets cease to be trading stock and are converted into capital assets. The two cases demonstrate that assets initially acquired as trading stock in a business may in some circumstances be changed into investments or capital assets.
Although it is clear that a company may change the nature of its activities, there must be sufficient evidence to support such an alteration. Here, as Rath J. found, all the
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evidence supported the view that Jensen was a share trader and that the shares which it purchased were trading stock. Rath J. saw the promotion of ``sec. 36A partnerships'' as ``another business activity'' of Jensen's. The relevant shares which were transferred to Jenspart were ``trading stock in a business carried on by Jensen''.Watson Bros. v. Hornby (H.M. Inspector of Taxes) (which was approved by Sharkey v. Wernher (1956) A.C. 58) establishes that a trading asset may in some circumstances subsequently be treated as a capital asset. But it has no relevance to a situation, as here, where a trading company is engaged in diverse trading activities, using in a new trading venture or trading phase assets which were clearly trading stock of its business activities prior to the new venture.
The next argument of the Commissioner was that Jenspart was not a share trader and the shares which were transferred on 27 May 1975 were not trading stock of Jenspart. This is said to be an essential condition of the application of sec. 36A. The argument is that because sec. 36 states that the value of the property (shares) shall be included in the assessable income of the transferor and because it also states that the purchaser of the property shall be deemed to have purchased it at a price equal to that value, it is to be inferred that both transferor and transferee are traders and that the property is trading stock in the business of each of them. The Commissioner also argues that as sec. 36A(1) provides for the notional application of sec. 36 in the circumstances postulated in sec. 36A(1), it is necessary that the relevant property constitute trading stock in the hands of transferor and transferee if the latter is to have the option under sec. 36A(2).
In my opinion there are two distinct reasons for rejecting this submission. First, as Toohey J. stated in the Federal Court:
``In contrast with the opening words of sec. 36A(1) the requirement [in sec. 36A(2)] is that the property becomes an asset of a business carried on by a person or persons by whom the property is owned after the change; the additional requirement of being trading stock does not exist. There is nothing in the language of the section that requires the property to be received as trading stock. What is necessary is that it becomes upon the change in ownership an asset of a business carried on.''
Secondly, Rath J. accepted that:
``Jenspart was in business as a sharetrader from the day after its formation. The shares transferred to it from Jensen were sold as part of its sharetrading activities, and were an asset of the business carried on by it within the meaning of sec. 36A(2)(a).''
I see no reason to disagree with this finding, despite the Commissioner's challenge to it.
The fifth and final submission of the Commissioner is that sec. 36 and sec. 36A should be read together so that the requirement in sec. 36(1)(c) that ``the disposal was not in the ordinary course of carrying on that business'' is imported into sec. 36A so that a ``change'' referred to in sec. 36A(1) is one that occurs otherwise than in the ordinary course of business. It is further submitted that this transfer of shares from Jensen to Jenspart was in the ordinary course of Jensen's partnership promotion business and therefore that sec. 36A had no application to the transaction in question.
In his reasons for judgment Rath J. rejected this submission, as did Toohey J. in the Federal Court, with whom Deane J. agreed. I am in agreement with their Honours' conclusion.
The terms of sec. 36A are quite clear. The section provides its own criteria for a change in the ownership of property coming within its scope. To come within sec. 36A(1), there must be (a) a change in the ownership of, or in the interests of persons in, property, (b) the property must constitute the whole or part of the assets of a business and must be trading stock or standing or growing crops, crop-stools or trees planted and tended for the purpose of sale, and (c) the person, or one or more of the persons who owned the property before the change must have an interest in the property after the change. Once these three conditions are satisfied the legal consequences of sec. 36 attach to the change in ownership, i.e.:
``The value of that property shall be included in the assessable income of the taxpayer, and the person acquiring that property shall be deemed to have
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purchased it at a price equal to that value.''
The ``value'' mentioned is then ascertained by reference to sec. 36(8), unless an election is made under sec. 36A(2).
The Commissioner relies strongly on
Rose
v.
F.C. of T.
(1951) 84 C.L.R. 118
, in consequence of which sec. 36A was introduced, as demonstrating that sec. 36A was designed merely to overcome the shortcomings in sec. 36 which the decision disclosed. There the Court held that property in the assets of a business moving under a partnership deed from the sole ownership of one person to the co-ownership of that person and two other persons as partners in equal shares was not ``disposed of'' within the meaning of sec. 36(1). The inference to be drawn, the Commissioner suggests, is that sec. 36 was given an operation in relation to the disposition of undivided fractional interests in property in the circumstances set out in para. (a), (b) and (c) of sec. 36(1) and not otherwise.
Mr. Priestly Q.C. for the Commissioner seeks to give additional force to this argument by pointing to the different provisions made by the Act with respect to (a) sales of trading stock made by a taxpayer in the ordinary course of carrying on a business (sec. 25 and 51) and the taking into account of trading stock of a taxpayer carrying on a business in ascertaining his taxable income (sec. 28 and 31); and (b) the taxation of disposals of trading stock made by a taxpayer otherwise than in the ordinary course of carrying on his business - see sec. 36(1). This argument would have great force if the provisions referred to in (a) above were capable of applying to undivided fractional interests in property and to transactions relating to such interests. Then there would be a compelling reason for regarding sec. 36A as a provision aimed directly and exclusively at the gap in sec. 36 revealed by the decision in Rose .
Of necessity the answer to this argument is not without some complication. First, I am unable to conclude that sec. 28 and 31, unlike sec. 36, apply to undivided fractional interests in property forming part of trading stock. The definition of ``trading stock'' in sec. 6 which ``includes anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes livestock'' and the reference in sec. 31 to ``each article of trading stock'' suggest that sec. 28 and 31, like sec. 36, are not speaking with reference to undivided fractional interests in assets, but to the entirety of the ownership in assets. Even if the judgment of
Latham
C.J. and the decision in
Farnsworth
v.
F.C. of T.
(1949) 78 C.L.R. 504
, at pp. 512-513
, did not deal with this precise topic, they at least raised a very serious question as to the application of sec. 28 and 31 to undivided fractional interests in assets said to constitute trading stock. The application of sec. 25 to the proceeds of sale of an undivided fractional interest in property hitherto forming part of the vendor's trading stock would raise another problem.
The construction and effect of sec. 36A(1) should accordingly be approached on the footing that there was a problem in 1952 relating to disposals of undivided fractional interests in property said to constitute trading stock, whether made in the ordinary course of carrying on a business or not, and that the problem was not one which was confined to sec. 36. Moreover, I note that when in 1952 sec. 36A was introduced into the Act, sec. 36(1) was amended so as to include the present para. (c). Despite the earlier absence of the provision which is now contained in this paragraph, the Court had concluded that sec. 36(1) ``had no application to the regular disposal of trading stock in the ordinary course of carrying on a business'' (
F.C. of T.
v.
Wade
(1951) 84 C.L.R. 105
at p. 111
;
Farnsworth
at p. 514). The purpose of this amendment, so it seems to me, was to ensure that sec. 36 itself would of its own force continue to have the operation which the Court had conceded to it, notwithstanding that the new sec. 36A gave it an independent and additional operation.
It is against this background of judicial interpretation and legislative amendment that sec. 36A has to be considered. The first point to be made is that the very general words of sec. 36A(1) travel beyond the situation which the Commissioner's argument postulates. Secondly, it is of great significance that, whereas the relevant elements of para. (a) and (b) of sec. 36(1) are expressly reiterated in sec. 36A(1), para. (c)
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of sec. 36(1) is not reflected in any way in the later subsection, notwithstanding its contemporaneous introduction into the earlier subsection. The legislative intention, as I read it, was that sec. 36 was to have the operation which had been conceded to it by judicial interpretation, para. (c) being inserted to ensure this result, and sec. 36A was to have a comprehensive application to disposals of undivided fractional interests in trading stock whether made in the ordinary course of carrying on a business or not, this application being ensured by the absence of any counterpart to para. (c) of sec. 36(1). By giving sec. 36A this comprehensive operation the Parliament not merely cured the defect in sec. 36 revealed by Rose, it also took action to resolve the doubts which were engendered in relation to sec. 28 and 31 by Farnsworth.For these reasons I would dismiss the appeal.
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