Totledge Pty. Limited v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
Preventicare Pty. Limited (``Preventicare'') carried on business providing pathology testing services. It encountered financial problems and on 1 July 1971, by the order of this Court in its Equity Division, Mr. J.E. Walker was appointed provisional liquidator. Mr. Walker carried on the business as provisional liquidator until 12 December 1972.
Pursuant to the provisions of sec. 181 of the Companies Act, 1961, a Scheme of Arrangement (``the Scheme'') between Preventicare and its creditors was approved by the Chief Judge in Equity on 11 December 1972. Before turning to the Scheme, I should mention that at that time there was in existence a dormant company called Morlea Pathology Services Pty. Limited (``Morlea''), the directors of which were Mr. Walker and his partner and all the shares in which were beneficially owned by Mr. Walker.
In essence, the Scheme provided for the transfer of the business of Preventicare (referred to in the Scheme as ``the Company'') to Morlea ``which Company shall hold and carry on the said business upon the trusts and with the powers set out in Clause 7'' (Recital F). The Scheme provided for the dismissal of the winding-up petition which had been presented against Preventicare.
With this background it is necessary to consider the provisions of the Scheme in a little detail. I am afraid I am bound to say the Scheme did not maintain any great consistency either in concept or in language and this has made resolution of the present appeals more complex than it required to be. Clause 1 defined a ``creditor of the Company'' as including all persons having unsecured claims of any kind whatsoever against Preventicare. Clause 2 provided that every creditor of Preventicare, the Trustee, Morlea and Preventicare should be bound by the Scheme. Certain powers with respect to the Scheme Fund, including all the powers of the Directors of the Company, were then conferred upon Mr. Walker who was appointed Trustee of the Scheme and is referred to in the Scheme as ``the Trustee'' (cl. 3). Clause 6, so far as relevant, provided:
``That as soon as practicable after the date upon which this Scheme takes effect Morlea shall carry on manage and conduct the said business upon the trusts hereinafter set forth and for that purpose the Company shall sell and transfer to Morlea as trustee upon such trusts ALL the fixed assets of the said business at a price equal to the depreciated value of the said fixed assets as at the date of the said sale and transfer thereof to Morlea''
Somewhat oddly in the light of cl. 3, cl. 7 provided that Morlea shall for the purpose of performing the trusts have all the powers conferred by its Memorandum and Articles of Association upon its directors and "shall in particular have in addition the following powers privileges and obligations:
- `(a) to carry on manage and conduct the said business as Trustee for the creditors of the company and as and when the same become available to account to and pay the Trustee for application in accordance with the provisions of this Scheme all surplus income and other moneys, derived by Morlea from the carrying on of the said business until such time as each creditor of the company has been paid:'
- One hundred cents in the dollar in respect of his Claim against Preventicare together with interest." (my emphasis).
After all creditors of Preventicare had been paid in this fashion and upon completion of the administration of the Scheme, the Trustee was required to assign and transfer for nominal consideration the whole of the business, assets and undertaking to the previous shareholders of Preventicare for their own use and benefit absolutely. This provision was however subject to cl. 7(c) which gave Morlea the power to sell the business or any part thereof subject only to the prior approval of the creditors. By reason of cl. 5, the proceeds of such sale became part of the Scheme Fund. Against the possibility that the business might not prosper and thus not be able to be carried on, cl. 7(d) gave power to a Creditors' Committee of Management to resolve to wind up and liquidate the business and to distribute the proceeds of realisation of the assets in accordance with the order of priority prescribed by the subclause.
Clause 8 provided for the order in which the Trustee was to distribute the moneys from the Scheme Fund coming to his hands including payments to former creditors of the Company. Thus, it will be appreciated that either by reason of the exercise of power under cl. 7(c) or 7(d), former creditors of Preventicare might be paid not just out of income earned by the conduct of the business, but also from the proceeds of sale of the business or any of its assets.
It is fair to say that for the rest, the Scheme contained provisions commonly encountered in Schemes of Arrangement including cl. 10 which provided that forthwith upon the taking effect of the Scheme all the debts of and claims by each creditor of the Company should be extinguished and discharged and ``such creditor of the Company shall have in lieu thereof the right to participate in the distribution of the Scheme Fund in respect of the amounts of such debts and claims to which he may be entitled''.
Effect was given to cl. 6 of the Scheme by selling the assets of Preventicare to Morlea and leaving the purchase price as a loan from Preventicare. Preventicare also supplied some necessary operating capital by way of further loan.
After the coming into effect of the Scheme, the financial fortunes of the business underwent dramatic transformation and the business of Morlea prospered so as to enable the payment of the creditors in full at an early date. On 26 June 1973 it was resolved by the directors of Morlea that the full taxable profit for the period 12 December 1972 to 30 June 1973, of the pathology business conducted by it as Trustee be paid ``to the creditors/beneficiaries in accordance with their respective entitlement pursuant to Scheme of Arrangement''. After the accounts were taken out for that period, a further resolution was passed on 4 December 1973 to the effect that the ``full taxable profit'' for the period in question being an amount of $76,900.33 be paid to the creditors/beneficiaries at the rate of 10.08 cents in the dollar. The same procedure was followed in respect of the profit made for the year ended 30 June 1974, when the sum of $76,089.74 at the rate of 10 cents in the dollar (Minute of 5 August 1974) or the sum $89,413.90 at the rate of 11.75 cents (Minute 9 December 1974) was resolved to be distributed. Again resolutions passed on 2 October 1975 and 14 November 1975 for further distributions resulted in payment of 100 cents in the dollar whilst on 10 December 1975 a resolution to pay creditors/beneficiaries interest in accordance with the Scheme satisfied that outstanding requirement. Finally, in accordance with the provisions of the Scheme, on 25 June 1976 the directors resolved to make the necessary transfers of shares in Morlea to achieve a transfer of the business at the direction of the former shareholders of Preventicare. Thereafter the name of Morlea was changed to Totledge Pty. Limited.
In respect of the period 12 December 1972 to 30 June 1973 Morlea disclosed in its income tax return a profit of $76,900 and showed payment of this sum to the Scheme Fund creditors. Accordingly, it claimed not to be liable to payment of income tax. However the respondent issued a Notice of Assessment to ``the Trustee for Morlea Trust'' in respect of an alleged taxable income of $76,900 and in the Adjustment Sheet accompanying the Assessment, stated that the Assessment issued because it was considered that ``no person is presently
ATC 4435entitled to the income of the trust and that the net income is assessable to the Trustee in terms of sec. 99 of the Income Tax Assessment Act''. A similar procedure was followed in respect of the amounts earnt and distributed in the taxation years ended 30 June 1974, 1975 and 1976 and upon objection being made to each of the assessments and these objections being disallowed, appeals were brought to this Court in respect of each of the assessments. By consent, all the appeals were heard together.
Mr. Gleeson Q.C., who with Mr. Hill, appeared for that appellant, submitted that the profit obtained by Morlea from its activities in each of the taxation years in question was derived by it as a trustee and distributed to the person or persons who were presently entitled within the meaning of the relevant provisions of the Act and that therefore sec. 99 of the Act, on the basis of which the assessments were levied, had no application. That section, so far as relevant, provides by subsec. (2) as follows:
- (a) There is no part of the net income of a trust estate that is included in the assessable income of a beneficiary in pursuance of sec. 97 or in respect of which the trustee is assessed and liable to pay tax in pursuance of the last preceding section;
the trustee shall be assessed and is liable to pay tax on that net income as if it were the income of an individual and were not subject to any deduction.''
The ``net income of a trust estate'' is defined in sec. 95 as ``the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income...''.
Section 97 referred to in sec. 99 provides in subsec. (1):
``Where any beneficiary is presently entitled to a share of the income of a trust estate and is not under any legal disability, his assessable income shall include that share of the net income of the trust estate.''
Mr. Gleeson identified Mr. Walker as the beneficiary presently entitled but alternatively pointed to the creditors under the Scheme or as yet another alternative, all the entities including the creditors entitled to payment in the priority provided for by cl. 8 of the Scheme. It was submitted that the beneficiary or beneficiaries were presently entitled under the terms of the Scheme itself or alternatively by virtue of the resolutions passed by the Directors of Morlea in the various years of income.
Mr. Beaumont Q.C., who with Mr. Bloom, appeared for the respondent, contested the very foundation of the argument for the appellant. He accepted that the Scheme created some fiduciary obligations. From this, it followed that there was a ``trustee'' within the definition of that term provided by sec. 6 of the Act, which includes within the term every person ``acting in any fiduciary capacity''. He parted company with Mr. Gleeson in submitting that Morlea was not a ``trustee'' of the income distributed and in submitting that there were no beneficiaries ``presently entitled''. I pause to observe that the expression ``beneficiary'' enjoys no extended statutory meaning. In the respondent's submission, the Scheme merely provided an informal method of winding up Preventicare. In the same way that the creditors had a contractual entitlement to be paid the amount of their debt by Preventicare, they acquired a contractual entitlement to be paid by Morlea the amount declared annually to be payable as a dividend to the creditors. Until the passing of a resolution their only entitlement was to have the business carried on in accordance with the Scheme and to have Mr. Walker make a determination of what was surplus income. If Morlea chose to appropriate all the profit of a given year to reserves say (as it was entitled to do by the combined effect of Art. 101 of the Articles of Association of Morlea and cl. 7 of the Scheme), then there was no ``surplus'' income within the meaning of cl. 7(a) and therefore nothing in respect of which they could sue in debt.
The basic point in issue between the parties may best be examined by reference to the decision of the High Court in
Stewart Dawson Holdings Pty. Limited v. F.C. of T. 10 A.I.T.R. 113; (1965) 39 A.L.J.R. 300, on which Mr. Gleeson placed great reliance. Norman Stewart Dawson was a bankrupt and shares in a number of private companies
ATC 4436which had ``Stewart Dawson'' as part of their corporate names were included in his bankrupt estate. In order to resolve the administration of the bankrupt estate, a scheme was evolved which included the incorporation of the appellant by two subscribers to the Memorandum of Association who took the only issued shares. They were an accountant and a managing law clerk. The appellant borrowed £1500 from a Stuart Stewart Dawson and with that money it purchased the assets of the bankrupt's estate from the Trustee. As part of the transaction various creditors entered into agreements with the appellant whereby each of such creditors was to receive a stated fraction of all moneys received by the appellant after deduction of the costs, charges and expenses of obtaining the same. These receipts were not restricted either in point of time or by reference to the pre-existing indebtedness of the bankrupt. The whole of the appellant's income was from dividends in the private companies. The opposing contentions were on the part of the appellant that its only role was that of a trustee to hold the relevant shares for the sole purpose of deriving moneys therefrom and that it received all moneys coming to its hands either as capital or income simply as Trustee of a trust estate for distribution to the other parties to the agreements in the stated fractions. The Commissioner contended that the appellant merely had a contractual obligation to apply its income in payment to the various persons and companies with whom it had entered into agreements. The Full Court of the High Court was required to answer a question posed by a Stated Case as to whether it was open to the trial Judge to find that the appellant was a Trustee of the dividends received. By a majority, Justices Kitto and Taylor, with Mr. Justice Menzies dissenting, their Honours answered this question in the affirmative. As a matter of historical fact, Mr. Justice Taylor subsequently as the trial Judge, found as a matter of fact, that the appellant had received the dividends as Trustee.
It will be obvious from what I have said that the appellant's task in the case before the High Court was much more complex than the present case in the absence of any Declaration of Trust. It was necessary for the Court to spell out from the matrix constituted by the agreements and surrounding circumstances, a state of affairs constituting a trust existing at the time of receipt of the dividends. Mr. Justice Kitto emphasised the opposing contentions in saying at 10 A.I.T.R. 114:
``But it is necessary to attend to the difference between a person's deriving income as trustee of a trust estate and his deriving from his own property, or by means of his own exertion, income with respect to which a trust arises at the moment of derivation; for it is only to a trustee of a trust estate that Division 6 refers.''
Again, a little later, he described the Commissioner's contention as being that even if, by reason of the agreements, on receipt of a dividend, the appellant became a trustee of the money, the obligation was a disposition by the appellant of moneys which otherwise would have been its own. Because his Honour was of the view expressed at 10 A.I.T.R. 118 that it was the common intention of all concerned as regards the property bought from the trustee in bankruptcy that the appellant should have no beneficial interest in it but should be a bare trustee, that his Honour came to his conclusion. As he said:
``It is hard to conceive that anyone dreamt of the appellant ever becoming entitled to distribute to its two shareholders, the accountant and the law clerk, any of the moneys to come in from the assets purchased from the bankrupt's estate. The alternative is that under the arrangement which the agreements partially reflect, the appellant agreed to accept the position of a trustee of a trust estate.''
Similarly Mr. Justice Taylor said that the transaction was one out of which the appellant was to get nothing at all at any stage beyond the costs, charges and expenses of obtaining its receipts. Conversely, Mr. Justice Menzies took the view that the appellant was not a trustee of the assets because it bought those with its own moneys, moneys which it had borrowed and was liable to repay and there was an absence of any Declaration of Trust. His Honour took the view that the transaction was cast in the language of contract and not that of trust.
Here, as cl. 6 of the Scheme makes clear, the assets are not the beneficially owned assets of Morlea. There was no possibility of Mr. Walker ever being beneficially entitled to any of the moneys which were collected whether by way of income or from the proceeds of sale of assets. The assets which were acquired by Morlea were acquired pursuant to cl. 6 ``for that purpose'', that is to manage and conduct the business upon the trusts set out in the Scheme. Here the nature of the trust was not left to inference but was spelt out.
It was submitted that there were significant differences between the facts in the present case and those in Stewart Dawson which ought to bring a different result.
First, it was said that in Stewart Dawson there was a family arrangement of a special kind. So much may be conceded. However, that fact played an important role only in permitting the Court to draw the inference that the appellant had no interest in the assets at all. Here it is unnecessary to look to inference in the light of the terms of the Scheme.
Next it was pointed out that payment was to continue to be made under the agreements in Stewart Dawson even after the whole of the pre-existing debt had been repaid. Emphasis was placed on what fell from Taylor J. in this regard at p. 118. However, this again was said in aid of the general proposition that the ``transaction was one out of which the appellant was to get nothing at all''. The same description may be given to the transaction here, the only difference being that once the creditors had been paid in full the assets were to be held for others.
Lastly it was said that in Stewart Dawson the appellant was merely a passive recipient of dividends, whereas here Morlea carried on business. Once again, the distinction in fact may be acknowledged but if in fact the trust estate is a business which requires the employment of persons in throwing up an annual profit, that does not disqualify the receipt from being the ``net income of the trust estate'' within the meaning of sec. 95.
F.C. of T. v. Everett 80 ATC 4076, the partners in the firm of solicitors and their employees were all engaged in the partnership business to produce the partnership income, a portion of which was in issue in the litigation. The subject of the assignment there was a chose in action being a share of the respondent's interest in the partnership which carried with it a right to future income. Here, as there, what was created was an immediate trust. There it was an interest in partnership, here it was a business. Both required to be carried on in order to throw up an income but when derived the income was that of a trust estate.
It is simply inaccurate to say that in the present case that there was a divorce between corpus and income. As I have pointed out, the Scheme Fund, which in the appropriate order of priority was available to satisfy inter alia those who had previously been creditors of Preventicare, included the proceeds, if realised, of the whole of the business. Once those who had been Preventicare creditors were satisfied, the beneficiaries of the trust changed, but it is incorrect to say that they never had any rights in respect of the corpus.
A further submission which was advanced for the respondent founded on the word ``surplus'' in cl. 7(a). It was submitted that persons could not be said to be ``presently entitled'': to income within the call of sec. 97 where the Company could appropriate some or all of the income to reserves. True it is that the precise amount of the income to which the beneficiaries may be entitled may not be ascertained until a determination is made by the Company as to what amount is to be appropriated to reserves but that does not preclude a present entitlement. Thus A, B and C may be presently entitled to the income of Blackacre when their interest is described as being one third each of the income after payment of all levies and a levy is not quantified until the close of the tax year. So long as the criteria for ascertainment of quantum are prescribed, it is not necessary that quantification should have taken place.
I should make it clear that in what I have said I was addressing myself to a trust of the kind here under consideration. Different questions arise in relation to partially administered estates (
F.C. of T. v. Whiting (1943) 68 C.L.R. 199) and bankrupt estates (Official Receiver in
Bankruptcy v. F.C. of T. (1956) 96 C.L.R. 370).
I consider that pursuant to cl. 7(a) of the Scheme, the profit in the several tax years derived by Morlea was the net income of a
ATC 4438trust estate which was payable to the Trustee, Mr. Walker, as the person presently entitled, to be dealt with by him pursuant to the directions of the Scheme.
Accordingly these appeals are allowed. The assessments are set aside. The respondent is ordered to pay the appellant's costs. Exhibits to be retained for 28 days and unless a Notice of Appeal is filed in the meantime they may be handed out.