Oakey Abattoir Pty. Ltd. v. Federal Commissioner of Taxation.

Fox J

Fisher J
Beaumont J

Full Federal Court

Judgment date: Judgment handed down 5 October 1984.

Fox, Fisher and Beaumont JJ.

This is an appeal against a judgment of a single Judge of the Supreme Court of Queensland [reported at 84 ATC 4406] dismissing an appeal by the appellant ("the taxpayer") against an assessment of additional tax under Div. 7 of Pt. III of the Income Tax Assessment Act 1936 (``the Act'') in respect of income derived by the taxpayer during the year of income ended 30 June 1980.

The taxpayer was assessed to additional tax in the sum of $266,691 on the basis that it was not, by virtue of sec. 105 of the Act, deemed to have

ATC 4720

made a sufficient distribution in relation to that year of income and, therefore, was liable to pay additional tax upon the undistributed amount of $533,382. The taxpayer objected to the assessment on the ground that it did not have an undistributed amount in respect of the year of income. It conceded that the amount of sufficient distribution was $533,382 but claimed that, on 22 December 1980, it had paid an amount of $534,534 by way of interest on a convertible note issue, so that, in accordance with sec. 82R(6) of the Act, the interest, being interest paid on a convertible note issue, was to be treated as a dividend for the purpose of calculating the undistributed amount.

Section 82R(6) provides:

``The interest, or payment in the nature of interest, under a convertible note to which this section applies shall, when paid, credited or distributed, be deemed, for the purpose of calculating the undistributed amount, as defined by section 103, in relation to the company, to be a dividend paid by the company.''

(It is common ground that the notes here in question are convertible notes to which sec. 82R applies.)

The objection was disallowed, the taxpayer appealed against the Commissioner's decision to the Supreme Court and, as has been said, the Supreme Court dismissed the appeal and confirmed the assessment.

The taxpayer, a Queensland company, is engaged in the meat industry as the proprietor of an abattoir. It is a family company, owned and controlled by members of the Keong family. As at 30 June 1980, its issued capital consisted of 400 ordinary fully paid shares of one cent each, held as to 266 shares by Mrs. L.J. Keong, and as to 67 shares by John Frederick Keong Pty. Limited (the family company of Mr. J.F. Keong) and as to 67 shares by Shen Enterprises Pty. Limited (the family company of Mr. F.S. Keong). In respect of the income year ended 30 June 1980, for the purposes of Div. 7 of Pt. III of the Act, the taxpayer earned a distributable income of $3,049,515 so that the amount of sufficient distribution for the purposes of Div. 7 was $533,382.

In December 1980, the taxpayer embarked upon a scheme which, it claims, having regard to the provisions of sec. 82R(6) of the Act, had the effect of achieving a sufficient distribution for the purposes of Div. 7. The taxpayer's secretary, and one of its directors, Mr. T.B. Mickelborough, and its accountant, Mr. J.W. Ahern, were jointly responsible for the planning and execution of the scheme. Mr. Ahern was a partner in the firm of Ahern, Betar and Dunn, public accountants. Mr. Ahern arranged for the participation in the scheme of A & B Management (No. 40) Pty. Ltd. (``A & B Management''), a Queensland company controlled by Mr. Ahern and his partner in his accountancy practice, Mr. C.J. Betar. The business of that company was to act as trustee for a trading trust known as the Rocklea Trading Trust. For its services in connection with the planning and execution of the scheme, A & B Management received from the taxpayer a fee of $26,700.

At an extraordinary general meeting of the taxpayer held on 9 December 1980, it was resolved that the authorised capital of the company be increased to $850,000 comprised of 85,000,000 shares of one cent each. It was also resolved that the memorandum of association be altered to add to the powers of the company the power to raise and borrow money and to receive money on deposit or secure the payment of money upon such terms and conditions and in such manner as may be determined with or without security, and particularly by the creation of mortgages, debentures or debenture stock (whether perpetual, terminable, or convertible to shares or stock in the company at the option of either the company or the holder of such debentures or debenture stock) or other securities. The articles of association were also altered to authorise the directors to issue debentures and other securities on such terms, for such term and at such rate of interest as they see fit, whether such interest is payable from time to time or in advance, and to issue such debentures or other securities upon terms which entitle the holders of such debentures or securities to convert these into shares or stock of the company.

A meeting of directors of the taxpayer was held on 18 December 1980. It was resolved that the company raise money by the issue of 763,620 unsecured debentures (the notes) of $1 each, each carrying interest at the rate of 14% per annum payable on 22 December 2010, with power for the company to pay such interest as is payable on the notes in advance. The registered holders of the notes were to have the option to

ATC 4721

convert the notes into shares of the company. A draft of the terms of these convertible notes was submitted to the meeting. It was also resolved that the register on which the convertible notes would be issued be opened at the office of Messrs. Peat Marwick Mitchell & Co. in Darwin. It was further resolved that the company seal be affixed to a power of attorney in favour of Mr. R.R.W. Southwell and/or Mr. G.N. Hocking of Messrs. Peat Marwick Mitchell & Co. authorising them to execute the convertible note issue document in Darwin.

The draft terms of the convertible note included the following clause:

``3. The registered holder hereof may at any time before the principal moneys hereby secured have been paid off direct the company to issue to him fully paid up shares in the capital of the company equal in nominal amount to such principal moneys and in satisfaction and full discharge thereof, the company shall, upon the surrender of this debenture comply with such direction provided that the holder sign and on such surrender deliver to the company an application for allotment of shares comprising such issue in a form approved by the company.''

On the morning of 22 December 1980, a meeting of directors of the taxpayer company was held. The minutes of that meeting record that it was noted that A & B Management had applied for the issue to it of the whole of the issue of 763,620 convertible notes approved at the last meeting of directors of the company and had tendered as payment for the same the sum of $763,620. It was resolved that the application be accepted, and the convertible notes be issued, and that Mr. Southwell and/or Mr. Hocking be authorised to execute the noteholder's certificate on the Darwin Register. It was also resolved that the company pay the interest for the ensuing five years on the note forthwith, such payment amounting to $534,534.

Mr. Mickelborough gave evidence of a discussion with Mr. Ahern prior to the meeting of 22 December 1980 to the effect that A & B Management would apply for the convertible notes. Mr. Mickelborough said that the taxpayer would accept the application and informed Mr. Ahern that it would be exercising the power to prepay the interest for the ensuing five years. Later that day, Mr. Mickelborough had a telephone conversation with a person in the Darwin office of Messrs. Peat Marwick Mitchell & Co. and was told that all the transactions in Darwin had been completed and that the convertible notes had been transferred back to the Queensland Register.

At a meeting of directors of A & B Management in its capacity as trustee for the Rocklea Trading Trust held on the morning of 22 December 1980, it was resolved that the company apply for the issue to it of the whole of the proposed issue of 763,620 convertible notes. Application was then made and the sum of $763,620, being the total moneys payable on application, was tendered. A cheque for that amount was paid into Ahern, Betar and Dunn's Trust Account on account of the taxpayer.

Later in the morning, a further meeting of directors of A & B Management was held at which the directors noted that the taxpayer had exercised the option to pay interest in advance and had paid to A & B Management the sum of $534,534 comprising five years' interest in advance. The minutes record that the directors were informed that the present value of the convertible notes, having regard to the interest payment was now 33.5% of the face value of the notes, that is, a total of $255,786, and were further informed that an offer had been received to acquire the notes as follows:

                           No. of
                           Notes                    Paid
      Mrs. L.J. Keong      507,808                 170,098
      Mr. J.L. Keong       127,906                  42,844
      Mr. F.S. Keong       127,906                  42,844
                           -------                --------
                           763,620                $255,786
                           -------                --------

(It will be noted that, as between the offerors, the proportions in which offers were made for the notes are the same as the proportions in which the offerors or their family companies already held shares in the capital of the taxpayer.)

It was also agreed at that meeting that the company seal be affixed to a power of attorney in favour of Mr. Southwell and/or Mr. Hocking of Messrs. Peat Marwick Mitchell & Co. in Darwin, authorising one of them to execute the transfer of the convertible notes in Darwin.

The power of attorney tendered in evidence was dated 18 December 1980. In fact,

ATC 4722

documents were originally prepared in Brisbane appointing Messrs. Lewis and Morris of Messrs. Peat Marwick Mitchell & Co. in Darwin as attorneys for A & B Management, but it was later discovered that they would not be available for the purpose. New documents were prepared, but, by mistake, the old documents were sent up as well as the new documents at a subsequent date. On 22 December 1980, powers of attorney in the name of Messrs. Southwell and Hocking were not in the possession of Messrs. Peat Marwick Mitchell & Co. but they executed the convertible note and transfers on an assurance that the powers of attorney had been signed by the relevant parties and were in the office of Messrs. Ahern, Betar and Dunn.

Interest was paid on the convertible notes by drawing a cheque on the Ahern, Betar and Dunn Trust Account, on account of the taxpayer. That cheque was banked into the account of A & B Management, as trustee for Rocklea Trading Trust.

The arrangement made for the payment for the notes by A & B Management to the taxpayer was that the funds would be received on the taxpayer's behalf into the Ahern, Betar and Dunn Trust Account. A letter dated 22 December 1980 addressed by the taxpayer to Ahern, Betar and Dunn authorised them to receive into their trust account an amount of $763,620, being an amount subscribed by Rocklea Trading Trust to the taxpayer for an issue of convertible notes on its Darwin Register. The letter continued:

``We also authorise and request you to receive from us a sum of $26,700.00 to the credit of our account.

We hereby request and direct you to pay to Rocklea Trading Trust in your Trust Account an amount of $534,534 being interest paid by our company.

We hereby request and direct you to pay in your Trust Account the following:

      Mrs. L.J. Keong      $170,098
      Mr. J.F. Keong         42,844
      Mr. F.S. Keong         42,844

On 22 December 1980, the taxpayer made loans to Mrs. Keong, Mr. J.F. Keong and Mr. F.S. Keong of moneys to enable them to purchase the notes from A & B Management. The amounts lent were respectively the sums of $170,098, $42,844 and $42,844 referred to above.

A letter dated 22 December 1980 was addressed by Mrs. Keong to Messrs. Ahern, Betar and Dunn requesting them to receive into their trust account an amount of $170,098, being the proceeds of the abovementioned loan and requesting them to pay on her behalf the sum of $170,098 to Rocklea Trading Trust, being the purchase price payable by her for the convertible notes. On the same day, similar letters were written by Messrs. Keong in respect of the advances to and acquisition of notes by them.

The register of convertible notes kept in Darwin disclosed that on 22 December 1980, A & B Management acquired 763,620 notes, and on the same day Mr. Southwell on behalf of A & B Management executed transfers of 507,808 notes to Mrs. Keong and 127,906 notes each to Mr. F.S. Keong and J.F. Keong. Later on that day, the convertible notes were transferred back to the Queensland Register.

The transactions which occurred on 22 December 1980 were thus essentially circular, involving the following six steps:

| Rocklea     |
| Industries  |____________________/_______________________________
| Personal    |                    \                              |
| Account     |          6. fee paid out $26,700                  |
|_____________|                                                  /|\
                                                          | A & B Management  |
                                                          | (Rocklea Trading  |
        ____________________________/_____________________| Trust)            |
        |  1. Purchase of notes     \                     |___________________|
        |     $763,620                                       |    |
       \|/                                                   |    |
        |                                                   /|\   |
|-------------|                                              |    |
| Aher, Betar |                 3. interest $534,534         |    |
| & Dunn Trust|_______________\______________________________|    |
| Account in  |               / (includes $26,700 fee)            |
| trust for   |                                                  /|\
| the taxpayer|                                                   |
|_____________|                                                   |
    |   |                                                         5.
    |  \|/                                                 Purchase of notes
    |   |                                                  $255,786
    |   |           4. Loan $255,786                              |
   /|\  |_____________________________________                    |
    |                                         |                   |
    |                                         |                   |
 2. fee                                       |                  /|\
    $26,700                                   |                   |
    |                                        \|/                  |
    |                                         |                   |
   /|\                                        |                   |
    |                                         |                   |
|--------------|                           |---------------------------------|
| the taxpayer |                           | Ahern Betar & Dunn              |
| personal     |                           | Trust Account in                |
| account      |                           | trust for                       |
|______________|                           |                                 |
                                           | Mrs. L. Keong       $170,098    |
                                           | Mr F.S. Keong       $ 42,844    |
                                           | Mr J.F. Keong       $ 42,844    |

At no stage did the taxpayer attempt to conceal from the Court the obvious fact that the purpose and effect of the transactions, considered as a whole, was to achieve a deemed distribution, in the form of interest paid on the convertible notes, so as to avoid the additional tax which sec. 104 would have otherwise imposed upon the taxpayer. It is plain that, apart from the fee for services paid to A & B Management, the series of transactions had no commercial foundation whatever. The taxpayer was flush with liquid funds and had no need or reason to borrow. If it did decide to borrow, it is impossible to suggest any business or commercial justification, from the taxpayer's point of view, in the prepayment of five years'

ATC 4724

interest at the rate of 14% per annum (cf.
McGain v. F.C. of T. (1966) 116 C.L.R. 172 at p. 175). No discount for premature payment was available and only fiscal reasons could dictate such an extraordinary course.

It is equally impossible to ascribe any commercial advantage to the taxpayer in the grant of the option to convert contained in cl. 3 of the convertible note. The shares in the taxpayer were clearly worth far more than the nominal value at which the shares were offered to the original holder of the notes, A & B Management. On the face of things at least, that company was at arm's length with the taxpayer and its members. Mr. Ahern, who was apparently the principal architect of the plan, was not called to give evidence. Mr. Betar, who was not directly involved in the scheme, was called. Although neither Mr. Betar nor Mr. Mickelborough could give any clear evidence on the point, it would seem that the parties made no specific advertence to the possibility that, by virtue of the grant of the option, A & B Management was put in a position where, if it wished, it could have taken over the taxpayer for a nominal price. The transactions achieved nothing of any commercial benefit or advantage to the taxpayer, even if it be accepted that the avoidance of additional tax under sec. 104 of the Act financially advantaged the taxpayer. The effect of the transactions was to achieve a notional distribution of income in the form of the interest paid on the convertible notes by a circuitous method in which, apart from the payment of the fee for services, the status quo was preserved.

In the Supreme Court, the Commissioner sought to uphold his assessment on four principal grounds. He contended that the transactions were shams and thus of no legal effect; alternatively, he argued that the payment relied on was not interest within the meaning or contemplation of sec. 82R(6) or otherwise; alternatively, he sought to invoke sec. 260 of the Act; finally, he relied on the recent English doctrine of ``fiscal nullity'' (see
W.T. Ramsay Ltd. v. I.R. Commrs. (1982) A.C. 300;
Furniss v. Dawson (1984) 2 W.L.R. 226). The learned Judge rejected all but the last of these contentions. His Honour, however, held that the doctrine of ``fiscal nullity'' was part of the law of this country and further held that the conditions of its application were satisfied in the present case.

We think that the learned Judge was right to hold that no sham was involved here. Although connected, the transactions were genuine and real enough (see
Boydell v. James (1936) 36 S.R. (N.S.W.) 620 per Jordan C.J. at p. 627;
Mullens v. F.C. of T. 76 ATC 4288 per Stephen J. at p. 4302; (1976) 135 C.L.R. 290 at p. 316).

Further, even if prepaid (cf.
F.C. of T. v. Ilbery 81 ATC 4661; (1981) 38 A.L.R. 172), the amounts said to constitute the payment of interest may properly be described as interest in its essential aspects (see
Riches v. Westminister Bank Limited (1947) 1 All E.R. 469 at p. 472). It follows, in our view, that the payments of interest made here fall within the concept of interest of the kind contemplated by sec. 82R(6). We therefore reject the first two grounds of appeal argued on behalf of the Commissioner.

There remains for consideration the Ramsay principle of ``fiscal nullity'', together with the question of the application, if any, of sec. 260.

In Ramsay (supra) the House of Lords dealt with a scheme to avoid capital gains tax. In the accounting period in question, the taxpayer made a ``chargeable gain'' which it desired to counteract, so as to avoid the tax, by establishing an allowable loss. This was sought to be achieved by the purchase of a scheme which involved the creation of two assets, one of which would decrease in value for the benefit of the other. The decreasing asset would be sold, so as to create the desired loss; the increasing asset would be sold, yielding a gain which it was hoped would be exempt from tax. It was held that the scheme should be considered as a whole in the sense that capital gains tax was a tax on gains, or gains less losses, and not on merely arithmetical differences. The scheme was disregarded as ineffective to achieve its fiscal objective, even if no ``sham'' were involved and even if the transactions were effective according to their tenor for the purposes of the general law.

Lord Wilberforce, while accepting the principle of
I.R. Commrs. v. Duke of Westminster (1936) A.C. 1, said (at p. 323) that this principle does not compel the Court to look at a document or transaction ``in blinkers'', isolated from any context to which it properly belongs. If it can be seen that a document or transaction was intended to have effect ``as part of a nexus or series of transactions'', or as ``an

ATC 4725

ingredient of a wider transaction intended as a whole'', there is nothing in the Westminster doctrine to prevent it being so regarded. In his Lordship's view (at p. 326), capital gains tax ``was created to operate in the real world, not that of make-belief''. It is a tax on gains (or gains less losses), it is not a tax on arithmetical differences:

``To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage... at the end of what was bought as, and planned as, a single continuous operation... is not such a loss (or gain) as the legislation is dealing with, is... well and indeed essentially within the judicial function.''

In his Lordship's view, it would be wrong to pick out, and stop at, the one step in the combination which produced the loss, that being entirely dependent upon, and merely, a reflection of the gain: ``(t)he true view, regarding the scheme as a whole, is to find that there was neither gain nor loss...'' (at p. 328).

Lord Fraser of Tullybelton was of the same view for essentially the same reasons. The other members of the House concurred.

Furniss v. Dawson (supra) concerned a scheme to defer liability to capital gains tax. The House of Lords held that the Ramsay principle was not confined to self-cancelling transactions nor to arrangements where the parties were contractually bound to take each step in a series of transactions. The principal speech was delivered by Lord Brightman who described the doctrine in Ramsay in these terms (at p. 242):

``First, there must be a pre-ordained series of transactions; or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (i.e. business) end. The composite transaction does, in the instant case; it achieved a sale of the shares in the operating companies by the Dawsons to Wood Bastow. It did not in Ramsay. Secondly, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax - not `no business effect'. If those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied.''

To import this principle into the realm of the operation of the Australian Income Tax Assessment Act is, as Connolly J. pointed out in
Lau v. F.C. of T. 84 ATC 4618, by no means a self-evident process. It would seem that the decisions in Ramsay and Furniss proceed on the reasoning that, in the capital gains tax area, there is a doctrine of ``economic equivalence''. Yet, the Privy Council and the High Court of Australia have emphatically rejected taxation by ``end result'' or ``economic equivalence'' under the Australian Act (see
Mullens v. F.C. of T. 76 ATC 4288 at p. 4293; (1976) 135 C.L.R. 290 at p. 301).

In any event, even if Ramsay and Furniss decide that certain implications should be read into the United Kingdom Act, impliedly prohibiting tax avoidance or deferment, it does not follow that any such process of implication can simply be translated into very different Australian legislation. In this connection, the remarks of Gibbs J., as he then was, in
F.C. of T. v. Patcorp Investments Limited 76 ATC 4225 at p. 4232; (1976) 140 C.L.R. 247 at p. 292 are pertinent:

``However, the scheme of the English legislation is very different from that of the Australian Act. In particular the English legislation does not contain a provision like sec. 260 of the Act which is aimed generally at tax avoidance. The presence of sec. 260 makes it impossible to place upon other provisions of the Act a qualification which they do not express, for the purpose of inhibiting tax avoidance. In other words, it is not permissible to make an application which does what sec. 260 fails to do in preventing the avoidance of tax. If it is suggested that a taxpayer has engaged in a device to secure a fiscal advantage, and the relevant provisions of the Act do not expressly deal with the matter, the case depends entirely upon sec. 260.''

In our opinion, the Ramsay and Furniss principles should be perceived as no more than rules governing the statutory interpretation of the United Kingdom legislation for the taxation of capital gains. As such, they have no immediate impact upon the Australian Act. Further, given the presence of sec. 260 (a matter adverted to in argument and by Lord Wilberforce in Ramsay (at pp. 320 and 325

ATC 4726

respectively)), and given the doctrine of economic equivalence underlying the approach of the House of Lords, we do not think that this approach affords any useful analogy in the present cast, save to point to the possibility that sec. 260 might well apply here. To this question we now turn.

The Commissioner's contention is that sec. 260 applies in the instant case so as to expose a liability to additional tax under sec. 104 upon the footing that the purported distribution in the form of the prepayment of five years interest is to be treated as void as against the Commissioner. It is not disputed by the taxpayer that the subject transactions were of a non-commercial character; that they were implemented by a ``round-robin'' of cheques; and that they were quite artificial. In this context, the learned Judge [84 ATC 4406 at p. 4412] made the following findings, none of which was challenged by the taxpayer. (The findings were actually made in the context of ``fiscal nullity'', but they are equally apposite to the application of sec. 260):

``There can be no doubt that there was a scheme or arrangement entered into by the taxpayer in this case. Everything was pre-arranged, including the holding of meetings, the resolutions to be adopted, the documents to be executed, the telephone calls to be made, and the times when each step was to be taken. Adapting the language used by Lord Wilberforce in Ramsay's case at p. 328 to the facts of the present case, it can be said of this scheme:

1. The scheme is a pure tax avoidance scheme and has no commercial justification, apart from retaining in the hands of the company funds which would otherwise be payable to the revenue authorities.

2. Every transaction would be genuinely carried through and in fact be exactly what it purported to be.

3. It was reasonable to assume that all steps would, in practice, be carried out, but there was no binding arrangement that they should. The nature of the scheme was such that once set in motion it would proceed through all its stages to completion.

4. The transactions regarded together, and as intended, were from the outset designed to produce a situation where company funds available for distribution to shareholders follow a course where $534,534 is paid to Rocklea Trading Trust, a sum of $763,620 is paid by A & B Management to taxpayer's account, $255,786 is loaned to the shareholders, and a balancing amount of $26,700 is paid to the Ahern, Betar and Dunn Trust Account.

5. The scheme was not designed, as a whole, to produce any result for the appellant or anyone else (apart from the fiscal result), except the payment of $26,200 by way of fees for the scheme. Within a period of a few days, it was designed to and did return the appellant except as above to the position from which it started.''

It is well established that, where the Commissioner seeks to invoke sec. 260, two distinct enquiries are called for. Is the section capable of application? If so, what is its operation, if any, bearing in mind that sec. 260 is not a charging provision in the sense that it merely ``annihilates'' the transactions purportedly entered into? In the present case, if the section is capable of application at all, its application would expose a liability to tax without any need to construct or reconstruct facts so as to expose a liability to tax (see
Clarke v. F.C. of T. (1932) 48 C.L.R. 56 at p. 77). The real contest here centres on whether sec. 260 is capable of application in the first place.

Uninstructed by authority, one would have thought that this was a case where it could properly be said, in the language of sec. 260(1)(c), that the parties had entered into a contract, agreement or arrangement which had or purported to have ``the purpose or effect of in any way, directly or indirectly... avoiding (a) liability imposed on (the taxpayer) by (the) Act''.

Newton v. F.C. of T. (1958) A.C. 450, Lord Denning, in delivering the judgment of the Judicial Committee of the Privy Council said (at p. 466):

``In order to bring the arrangement within the section you must be able to predicate - by looking at the overt acts by which it was implemented - that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not

ATC 4727

come within the section. Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax. Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Div. 7 tax: see W.P. Keighery Pty. Ltd. v. F.C. of T. Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax: see D.F.C. of T. v. Purcell. But when one looks at the way the transactions were effected in Jaques v. F.C. of T., Clarke v. F.C. of T. Bell v. F.C. of T. - the way cheques were exchanged for like amounts and so forth - there can be no doubt at all that the purpose and effect of that way of doing things was to avoid tax.''

More recent authority suggests that these observations of Lord Denning should now be qualified to some extent. The starting point is Mullens (supra) where it was held that the fact that a taxpayer had taken up and acquired shares for the sole purpose of obtaining deductions under sec. 77A(4) of the Act did not attract the operation of sec. 260. Barwick C.J. said (at ATC p. 4294; C.L.R. p. 302):

``Though the section speaks of the purpose in entering into the transaction, it can have no relevance if, being effective, the transaction does not alter the incidence of tax, as that expression has come to be understood. As I have already pointed out, there will be no relevant alteration of the incidence of tax if the transaction, being the actual transaction between the parties, conforms to and satisfies a provision of the Act even if it has taken the form in which it was entered into by the parties in order to obtain the benefit of that provision of the Act. It would be otherwise if there had been some antecedent transaction between the parties, for which the transaction under attack was substituted in order to obtain the benefit of the particular provision of the Act. Section 260 is not directed to tax on income to which the taxpayer is entitled only by reason of the actual transaction into which the parties have entered.''

Stephen J. said (at ATC 4303; C.L.R. p. 318):

``The intent of the section has been described as being `to protect the general provisions of the Act from frustration, and not to deny to taxpayers any right of choice between alternatives which the Act itself lays open to them' (Keighery's case). Their Honours went on to point out that in consequence it was necessary to see whether, in applying sec. 260, what would be rendered ineffectual would be an attempt to defeat etc. a liability imposed by the Act or, rather, an attempt to give a company an advantage which the Act intended that it should be given. Likewise here: if sec. 260 is to be applied its plain effect will be to render ineffectual the attempt to give the Mullens group advantages which the Act does, in my view, manifestly intend them to have. This intent emerges from the terms of sec. 77A, which says quite unequivocally that a beneficial owner of shares who pays money to a company in the circumstances specified shall be allowed a deduction of the amount so paid. This section contains no qualification restricting its operation to those who happen to benefit from it by inadvertence; knowledge of its effect and an intention to take advantage of its provisions are no disqualification.''

Slutzkin v. F.C. of T. 77 ATC 4076; (1977) 140 C.L.R. 314, it was held that sec. 260 did not apply to a sale of shares to a ``dividend-stripper'' notwithstanding that the buyer had stipulated that the company's assets should have been converted to cash by the date of settlement of the transaction and that it should have no liabilities. Barwick C.J. said (at ATC p. 4079; C.L.R. p. 319):

``By no manner of torture of the language of the decided cases would the sale of the shares by the appellants, albeit in unison with the other shareholders in the Company, fall within the operation of sec. 260 of the Act. It was no more than a realisation by them of the benefit of their shareholding in a way which would not attract tax. It may be granted that a purchaser of the shares could not have been found willing to pay the price in cash, which in fact was agreed to be paid, unless the Company had made its assets liquid and itself free of debt: and that all shareholders were willing to sell their shares. It may also be granted that to obtain the benefit of the shareholding by way of dividend or by liquidation would have rendered the shareholders liable to tax in respect of the money thus received. But the choice of the form of transaction by which a

ATC 4728

taxpayer obtains the benefit of his assets is a matter for him: he is quite entitled to choose that form of transaction which will not subject him to tax, or subject him only to less tax than some other form of transaction might do.''

Stephen and Aickin JJ. were of the same view (see at ATC pp. 4080 and 4081; C.L.R. pp. 322 and 325 respectively).

Finally, in
Cridland v. F.C. of T. 77 ATC 4538; (1977) 140 C.L.R. 330, it was held that sec. 260 did not apply to the acquisition by a taxpayer of a unit in a unit trust, the trustee whereof carried on the business of primary production, notwithstanding that the sole purpose of the acquisition was to enable the taxpayer, a university student, to average his income pursuant to Pt. III, Div. 16. Mason J., the other members of the Court concurring, said (at ATC p. 4542; C.L.R. p. 339):

``The decision in the Mullens case and the passages from the judgments to which I have referred show that the principle which underlies the Keighery case is not as narrow as the primary judge supposed it to be. It is not confined to cases in which the Act offers two alternative bases of taxation; it proceeds on the footing that the taxpayer is entitled to create a situation by entry into a transaction which will attract tax consequences for which the Act makes specific provision and that the validity of the transaction is not affected by sec. 260 merely because the tax consequences which it attracts are advantageous to the taxpayer and he enters into the transaction deliberately with a view to gaining that advantage.

The distinction drawn by Lord Denning in Newton v. F.C. of T. (1958) 98 C.L.R. 1 at p. 8, between arrangements implemented in a particular way so as to avoid tax and transactions capable of explanation by reference to ordinary business or family dealing has not been regarded as the expression of a universal or exclusive criterion of operation of sec. 260. Lord Denning's observations were applied neither in the Mullens case nor in the subsequent case of Slutzkin v. F.C. of T.''

Accepting the need to read the observations of Lord Denning in Newton in the light of these remarks, it does not necessarily follow that the three earlier decisions of the High Court mentioned by Lord Denning - Clarke, Jaques and Bell - should be ignored for present purposes. On the contrary, it seems to us that they are very much in point in this case.

In Jaques, in holding a precursor of sec. 260 to be applicable, Isaacs J. (1924) 34 C.L.R. 328 (at p. 360) said that -

``... the combined arrangement entered into by the three companies and the shareholders in the old company - Mr. Campbell acting in various and even conflicting capacities as intermediary - was simply to manufacture a situation to get the better of the Income Tax Act. It in no way altered the income of the taxpayer or changed its ownership. It was in no true sense a business operation. But, by first deliberately preparing the ground for the misuse of legal expedients recognized as equivalents for payment, and then by such misuse, a factitious liability to pay a call and a factitious payment of the call ensued, but throughout, from conception to completion, except for a similar object of escaping stamp duty, with the express and sole purpose of lessening the statutory liability of the taxpayers.''

Starke J., being of the same view, said (at p. 362):

``The form the transactions took, in this case, was admittedly devised for the purpose of securing a deduction of calls. But the transactions did not, in any business sense, alter the position of the shareholders; their income was not diminished nor their property increased.''

In Clarke v. F.C. of T. (1932) 48 C.L.R. 56, in holding that a precursor of sec. 260 applied so as to avoid the interposition of a company as an imputed recipient of a premium payable on the assessment of a lease, Rich, Dixon and Evatt JJ. said at pp. 79-80:

``But to avoid the application of sec. 16(d) which these facts would otherwise require, the taxpayer interposed his Company as a conduit for the assurance of a leasehold interest and as an imputed recipient of the premium. The grant of the lease to the Company, his automaton, and its immediate assignment to the intending lessee, and the subsequent liquidation of the Company, and the entries in the books of the Company narrating the taxpayer's accountability to it for the money and the accountability of

ATC 4729

himself as the Company's liquidator in a like sum, all amount to an arrangement adopted for the sole purpose of intercepting the liability to income tax which would otherwise flow from the payment to him of a consideration actually demanded and actually given in connection with a leasehold. For these reasons the sum of £8,651 formed part of the taxpayer's assessable income.''

Bell v. F.C. of T. (1953) 87 C.L.R. 548, in holding that a scheme was struck down by sec. 260, Dixon C.J., Williams, Webb, Fullagar and Kitto JJ. said (at p. 573):

``Such an arrangement was made, clearly enough, when Bell and his co-shareholders and White and his six clients co-operated, in accordance with the preconcerted plan embodied in the Routine document, in so ordering their affairs that although £77,000 of distributable profit was extracted from the Papuan company and Bell and his associates had their cash resources increased by amounts totalling that very sum, yet the company made no distribution to those persons and what they received they received as the sale price of their capital assets, the shares they held in the company. This arrangement, both in purpose and in effect, represented nothing but a method of impressing upon the moneys which came to the hands of Bell and his colleagues the character of a capital receipt and of depriving it of the character of a distribution by a company out of profits. It was therefore a means for avoiding the income tax which would have become payable had the £77,000 been distributed by the company in the normal way. Section 260(c) postulates a duty or a liability imposed on a person by the Act, but this refers, not to a liability to pay a particular amount of tax (which would be a liability imposed by a taxing Act), but to a liability such as sec. 17 of the Act imposed on Bell, to pay tax in respect of his taxable income ascertained by including in his assessable income his proportion of the Papuan company's profits if and when he should participate in a distribution of them. It must therefore be held that the transactions of 2, 3 and 4 February 1948 constituted an arrangement made by Bell and the others who took part, having the purpose, and (apart from the operation of sec. 260) the effect, of defeating and avoiding a liability imposed on Bell by the Act.''

In our opinion, the present case should be seen as similar, in principle, to the kind of situation which arose in Jaques, Clarke and Bell. In each of those cases, the Court was much influenced by features which were repeated in the present case, in particular, the circular nature of the transactions, the interposition of a co-operative intermediary and the ultimate preservation of the status quo, all planned beforehand and executed according to plan.

At the same time, the more recent trilogy of cases can be distinguished for present purposes. Slutzkin was treated as no more than an instance of a shareholder electing to sell his shares in a way which would not subject him to tax: all that was involved was a sale - at arm's length - of the shares (see at ATC p. 4079; C.L.R. p. 319 in the passage already cited). In Mullens, the matter was approached upon the footing that there is no warrant for importing into sec. 77A of the Act an implication that its provisions are not available to a taxpayer who deliberately seeks to take advantage of its provisions (see at ATC p. 4079; C.L.R. p. 319 in the passage already cited). A similar approach to the construction of sec. 157(3) of the Act was taken in Cridland. But, in the present case, the question is not merely whether the taxpayer can deliberately avail itself of the advantages offered by sec. 82R(6) in the context of Div. 7. The question here is whether, by embarking upon these complex transactions, the taxpayer has thereby purported to avoid liability to tax within the meaning of sec. 260(1)(c), accepting, as Mullens and Cridland decided, that a desire to avoid tax is not itself sufficient to render sec. 260 applicable.

If there were no more to the case than the payment of interest on the notes, we would be disposed to agree with the appellant that, in accordance with the reasoning in Cridland, the motives of the taxpayer are not sufficient to entitle the Commissioner to invoke sec. 260. But we think that the present case should be viewed with the wider perspective that the payment of interest was merely one step in a circuitous series of transactions which bore ``ex facie the stamp of tax avoidance''
(Gulland v. F.C. of T. 84 ATC 4587 per Bowen C.J.). To borrow the language of Bowen C.J. in Gulland (supra) this taxpayer did not merely, as in Cridland, ``create a situation by entry into a

ATC 4730

transaction'' to attract particular tax consequences. Given its complexity, its artificiality, its circular operation and its sole purpose of avoiding liability to tax, the arrangement in this case goes well beyond mere entry into a transaction such as a university student buying units in a trust. In our view, sec. 260(1)(c) is applicable to such an arrangement.

As has been said, if sec. 260 is applicable, no difficulty arises as to the operation of the section. It operates to avoid the whole arrangement including the purported payment of interest. Having avoided that payment, the Commissioner may assess under sec. 104 upon the footing that no sufficient distribution was deemed to be made.

The appeal should be dismissed with costs.

Although the Commissioner cross-appealed on a question of costs below, the cross-appeal was not pursued before us. The cross-appeal should also be dismissed with costs.


1. The appeal be dismissed.

2. The appellant pay the respondent's costs of the appeal.

3. The cross-appeal be dismissed.

4. The cross-appellant pay the cross-respondent's costs of the cross-appeal.

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