Hill J

Federal Court

Judgment date: Judgment handed down 22 February 1991

Hill J: The present case raises, once again, the familiar problem whether the profits of a taxpayer, in this case the applicant, AGC (Investments) Limited, are income in accordance with the ordinary concepts of mankind and thus assessable income under s. 25 of the Income Tax Assessment Act 1936 (Cth) (``the Act''), as contended for by the respondent Commissioner of Taxation or gains of a capital nature and thus not brought to tax, as contended for by the applicant.

The problem may be a familiar one, but the resolution of it turns upon a detailed analysis of

ATC 4182

the affairs of the applicant. Hence, it is necessary to go back in time, away from the year in which the sales occurred which gave rise to the profits (the year ended 30 September 1987, a substituted accounting period for the year of income ended 30 June 1987) and to consider the circumstances which gave rise to the purchases of the public company shares the subject of the sales.

The applicant commenced its corporate existence as a wholly owned subsidiary of Transport & General Insurance Co. Limited on 17 May 1965. It was then called TGI (Investments) Pty Limited. It subsequently changed its name to AGC (Investments) Limited. Its immediate holding company then was called AGC (Insurances) Limited (``Insurances''). In turn, that company was a wholly owned subsidiary of Australian Guarantee Corporation Limited.

The evidence is that the applicant was incorporated as a vehicle for the investment of funds provided to it by its parent company which at all times was carrying on the business of a general insurance company. The criterion for investment (at least so far as that investment was in listed public company shares) was the ensuring of long term dividend investment income and the maximisation of potential asset growth. Public company shares did not represent the entirety of the portfolio of the applicant. In addition, there was investment in fixed interest securities and preference shares. These other assets were not directly the subject of the application, as any disposal of them did not give rise to profits.

It is an essential part of the business of a general insurer (particularly one, such as AGC (Insurances) Ltd, which until 1988 operated, inter alia, in the area of Workers Compensation insurance which is ``long tailed'' insurance, that is to say insurance where claims may be received and continue many years later than the premium income to which the claims relate) that an insurer have an adequate reserve fund. This fund is not necessarily required to meet day to day claims; such claims may often be paid out of current premium income on new insurance and renewals effected. But there is a necessity that the fund be available if day to day cash receipts are insufficient to meet claims, or if claims are received in respect of insurance which is no longer written so as to generate premiums (as was the case when Insurances discontinued writing Workers Compensation insurance) or, no doubt if the level of claims, for whatever reason, exceeded the short term fund available.

Such a reserve would ordinarily consist of short term investments (liquids), but would not necessarily be confined to that. And, indeed, the cases show that insurers typically invest in public company shares as well as fixed interest securities and liquids.

Insurances invested in its own name in short term securities. It invested in mortgages through another wholly owned subsidiary, AGC (Securities) Limited, and it invested in public company shares by providing funds to the applicant to invest in those shares. All of these investments were viewed by the Board of Insurances as part of the reserve fund of the insurance company, albeit held in the name of a separate legal entity, which was a wholly owned subsidiary. Indeed the portfolio was established and the Board of Insurances wished to preserve it against the possibility of claims being made in excess of immediately available liquid funds. This is not to say that they viewed the assets of the applicant as there to be drawn upon at will for the needs of the insurance business. In the words of Mr Robson, one of the directors of Insurances and of the applicant (the boards of the two companies were common except for the period from 1984/5 onwards when there was an additional director on the Board of Investments),

``it was... that excess of reserves which one maintains prudently.''

From an organisational point of view in the AGC group of companies, the affairs of Insurances, the applicant and AGC (Securities) Limited (``Securities''), were run as one Division, separate from the affairs of the other companies that formed part of the AGC Group of Companies. The applicant had neither premises nor staff. Regular reports of this insurance division were prepared which in effect consolidated the position of the three companies that formed the division. The reports showed in consolidated form, the income from the underwriting business and the income from investments, without distinguishing that income which was derived from the investments in liquids, from interest from other investments,

ATC 4183

such as mortgages, and from dividends which came from Insurances, the applicant or Securities. For the purposes of these reports, and indeed for all purposes of accounting, the profits on the sale of shares made were treated as extraordinary profits.

By way of example, a profit report for the month of September, 1986, which also showed the results for the twelve months to the end of September, 1986, showed that the Insurance group had made an underwriting loss of $17,024,000, but had derived investment income of $33,219,000, leaving a net profit before tax of $16,195,000. Of that amount of $33,219,000, $19,696,000 was income from short term deposits etc (the liquids), and $7,547,000 was dividends from shares. The figures shown in the profit report were unaudited; the audited accounts of the applicant for the same year reveal that dividends derived by the applicant for the year amounted to $7,325,865, and interest on deposits (which presumably includes discounted bills and other money market transactions excluding interest on deposits with AGC Limited of $146,859) amounted to $308,565.

It may be noted that the audited accounts for the same year disclose capital profits on the sale or redemption of shares and rights at $9,889,457, of which $669,300 represented profits on the sale of assets within twelve months of purchase and thus assessable income under s. 26AAA of the Act. These profits were described as ``capital'' profits and $9,550,457 appeared in the applicant's profit and loss account as ``extraordinary items'', the discrepancy being almost entirely the income tax liability upon the s. 26AAA profit.

The applicant was also of significance to Insurances in assisting that company to comply with requirements of the Insurance Commissioner, for the purposes of the Insurance Act 1973 (Cth). Section 29 of that Act provides, inter alia, that the authority of a company to carry on insurance business is subject to compliance with certain ratios of assets to liabilities. However, in calculating these ratios no regard is to be had to loans to or shares in related companies, unless and to the extent that the Insurance Commissioner so approves. There was correspondence with the Commissioner on this issue in 1977, and it would seem that thereafter, and until 1984, the Insurance Commissioner accepted the assets of the applicant as included in the assets of Insurances for the purpose of calculating the relevant ratios, and, at least so far as the evidence discloses, did not formally approve the inclusion of related assets year by year.

Thus, the return to the Insurance Commissioner lodged in respect of the 1982 year disclosed a deficiency of assets over liabilities of Insurances of $62,414,042, but disclosed also that there were investments by way of shares, loans etc in related companies to be approved of $134,581,466.

The applicant's return to the Insurance Commissioner lodged on 28 December 1984, after the accounts for the year to 30 September 1984 had been prepared showed assets of Insurances (without regard to the investments of Securities and the applicant) as $114,701,607, leaving that company with a deficiency of assets over liabilities of $27,248,708, taking out of consideration insignificant overseas assets and liabilities. By contrast, its investments in related companies in the form of shares or loans, the substantial amount of which represented its investments in the applicant, totalled $141,849,708. Hence, in that year, too, it was necessary to obtain the approval in writing of the Insurance Commissioner pursuant to s. 30(2) of the Insurance Act, to the whole or part of the investments in related companies being taken into account in calculating the solvency ratio.

Following discussions with the Insurance Commissioner, on 11 January 1985 the Commissioner approved the taking into account for the purposes of s. 29 of the Insurance Act, the share capital of the applicant (10,000 $2 ordinary shares) and the loans to the applicant to the extent of $40,000,000, that being the figure appearing in the balance sheet of the company as at 30 September 1984. It is unclear whether the amount taken into account for the shareholding in the applicant was to be taken to be valued at book value, or at market value. Perhaps it was this lack of clarity which caused the applicant to consider an appeal against the Insurance Commissioner's determination. Ultimately, however, an appeal as instituted was not proceeded with. The problem

ATC 4184

apparently did not arise thereafter as the applicant rearranged its affairs to ensure that there was more liquidity in Insurances without the need for reference being made to the applicant's assets to satisfy the solvency ratio. According to Mr Crisp, the applicant's Managing Director at the time, this was achieved by not investing as much in Securities as theretofore, rather than by recalling moneys invested in Investments. I shall return to that matter later, in the light of other evidence that emerged at the hearing, which threw doubt upon Mr Crisp's evidence in chief.

Initially, it would seem, the applicant was funded with loan funds to be invested on a monthly basis. By 1 December 1966, the portfolio of the applicant had a value of $1,800,000. Because dividend yields were attractive, having regard to the provisions of the then s. 46 of the Act, providing for a full rebate of tax on public company dividends, the then General Manager recommended that the applicant invest in January and February 1967 upwards of $1,000,000, being approximately the cash flow of the current year's operations. In fact, the Board approved an increase in the share portfolio to $3,000,000 in the four months from December 1966, provided liquidity warranted such an outlay.

By 1 March 1983 the amount of the loan account of Insurances with the applicant stood at $23,250,000. Thereafter amounts were transferred from time to time from Insurances to the applicant on a regular basis, but in amounts which fluctuated, no doubt as the available funds in Insurances fluctuated. There were only occasional months when no funds were transferred. As at September 1987 the loan account stood (after certain repayments) at $91,683,103.55. Between March 1983 and December 1985 it seems the loan account was reduced by a repayment only once, in an amount of $250,000, being a repayment of a temporary advance made earlier in the same month. The situation was somewhat different in the calendar year 1986.

As at the beginning of that year, the loan account stood, after the declaration of a dividend by the applicant to Insurances of $4,661,350.27, at $71,661,350.27. During the year the following credit entries were made by the applicant in favour of Insurances:

      January 1986        $2,000,000
      March 1986          $2,661,350.27
      April 1986          $1,000,000
      September 1986      $9,000,000

The first two entries reflect the payment out of the dividend declared, and are of little concern. It is the next two entries which are curious. The first, was described in an affidavit of the Managing Director, Mr Crisp, as follows:

``After reviewing the balance of the loan account on 31/3/86, a decision to reduce it was taken. The funds were with AGC Ltd on deposit until 10/4/86 when Bank bills were purchased.''

Mr Crisp, commenting in his affidavit on the September transaction said:

``Reduction of balance to the level existing at September, 1985.

These funds were used by Insurances to buy bank bills on 22/9/86 and 26/9/86.''

Not surprisingly, these somewhat cryptic comments were the subject of cross-examination. This was especially so as Mr Robson, a director of the applicant, deposed in an affidavit that it was never necessary for Insurances to call upon the applicant to repay monies to supplement liquidity or to assist in the meeting of the obligations of Insurances. The answers in cross-examination given by Mr Crisp were not wholly satisfactory. Initially, he suggested that the explanation may lie in part in steps taken to improve the liquidity of Insurances as part of the problem of complying with the liquidity ratios of the Insurance Act. He also believed that it might have been related to the fact that the company was aware at the time that it would lose its Workers Compensation Act business, and be related to decisions being then taken as to whether to run off its portfolio of workers compensation business. He could recall no conscious policy, but could give no explanation other than those stated above.

In re-examination, Mr Crisp was shown a document which reminded him that in September 1986 the applicant had sold a parcel of shares which had realised an extraordinary profit of $3,450,000. This, Mr Crisp said, reinforced his view that the $9,000,000 was ``surplus'' in the appellant's hands and was paid back to Insurances in part repayment of

ATC 4185

the loan. The document shown also referred to an additional gain arising as a result of a change in accounting standards whereby on a share exchange a capital profit had to be taken up, so that the cost of the new shares was taken into the books at market price at the time of sale. As a result, the document spoke of an extraordinary profit of $9.6m being achieved.

With respect to Mr Crisp, it is difficult to see how the difference in accounting treatment of a share exchange, realising a book profit, but with no cash proceeds, could account for a payment of cash from the applicant to Advances. He was given an opportunity to explore the files relating to the share exchanges, but no further evidence was forthcoming. Nor, even if $3,459,000 of the $9m cash could be explained by the sale of a particular parcel of shares, did that explain why the cash amount was returned to Insurances as being ``surplus'', rather than being reinvested in the name of the applicant. Indeed, it is hard to conceive of a company whose business activity is investing, ever having funds that are ``surplus''.

I find that it is more probable than not that the payments in April and September 1986 from the applicant to Insurances were made for the business ends of Insurances, and that they related, as Mr Crisp initially deposed in cross-examination, either to matters connected with the solvency ratios of Insurances or to providing a source of liquidity for that company having regard to the run off of workers compensation business. The evidence would suggest that no further amounts were repaid in reduction of the loan account (other than in respect of dividends declared but not paid) until September 1987, after the sales the subject of the present application when $7,500,000 was repaid by the applicant to Insurances.

Critical to the resolution of the issues between the parties is the investment policy of the applicant. It would seem that the initial portfolio was built up and managed from within the AGC Group from 1964 to 1967, during which time Wales Management Pty Limited acted in an advisory role. From approximately 1967 that company, later called Westpac Investment Management Pty Limited (``Westpac Management''), managed the portfolio. Apparently, so far as Westpac Management could discern, no firm investment policy was initially formulated. Certainly there was no evidence adduced as to the policy applicable in the initial years, save that as at 1 December 1966, it is clear that an attraction of a share portfolio lay in the receipt of dividends which were subject to a full tax rebate.

An undated internal memorandum of Westpac Management, prepared some time after 30 September 1975, referred to the ``aims'' of the applicant as being ``Capital growth with approximate income return of 5% as cost''. The same document indicated that:

``Sales over $100,000 to be referred to General Manager AGC Insurances or General Manager AGC Group - in their absence we can proceed using our own discretion.''

On 26 January 1978, the General Manager of Insurances wrote to Westpac Management confirming the continuity of that company in the management of the investment portfolio. At that time the investments in the portfolio, valued at cost, amounted to $10,741,276. The letter was written shortly after the decision of the High Court in
London Australia Investment Company Limited v FC of T 77 ATC 4398; (1976-7) 138 CLR 106 was delivered (September 20, 1977). Insurances had requested its tax advisers to report on the effect, if any, which they believed that decision would have on the portfolio of the applicant. The letter continued:

``If we are to be taxed on the principles set out in the judgment we may as well face these issues and exploit all forms of gain from our equity operation. We shall inform you their advice and the policy we should like to follow.

Notwithstanding the above we feel it is important that you should fully exploit the cyclical fluctuations in the share market by capitalising on market highs for sales and repurchasing at the bottom of any depressed period.

The point we make is that if we sell any stock the reinvestment does not have to be made immediately unless the decision to sell was made with the intention of replacing the stock sold. The main recommendations in your submission with which we agree are:

  • 1. Consolidation of the share portfolio with a view to reducing the number of

    ATC 4186

    stocks to approximately 50, each to have a minimum holding of.5%.
  • 2. Investments be directed to preference and ordinary shares rather than fixed interest securities.
  • 3. Special submissions to be made from time to time in regard to special opportunities which may be presented for investment in Government or semi-Government securities.
  • 4. The equity portfolio be compounded by reinvestment of earnings.
  • 5. Additional funds be provided to take up any rights entitlement and if rights be sold the proceeds will be available for reinvestment.
  • 6. Proceeds from sales be available for reinvestment: (funds from such sales and the sale of rights will be held by us pending reinvestment).
  • 7. The Bank only refer purchases of stock within the authorised total investment allocation in excess of $100,000.

In addition to the above we should like you to refer to us for approval any proposed sales which will create a capital loan (sic) in excess of $10,000 for approval.''

Subsequently, the General Manager of Insurances advised Westpac Management on 24 July 1978, speaking of London Australia that:

``Our taxation advisers have now informed us that they consider that this judgment would not be applicable to our operations and we would like you to plan our investment portfolio accordingly.''

Mr Gates, a portfolio manager with Westpac Management, commenced employment with that company in 1981 and thereafter was responsible for the management of the applicant's share portfolio. He was not responsible for the investment of the applicant in short term securities. Shortly after he commenced that employment the General Manager of Insurances wrote a letter, addressed to his attention confirming a discussion that had apparently taken place on 18 September 1981. That letter, so far as is presently material, read:

``We confirm our discussion of 18th September when it was agreed that in principle the guidelines set out in letters of 26th January and 24th July 1978 should continue subject to the following:

  • 1. The Bank only refer purchase of stock within the authorised total investment allocation in excess of $200,000.
  • 2. Sales transactions involving a capital loss need not be reported.

It is estimated that the funds currently available for reinvestment amount to $5m.

We also agree that you will provide a half-yearly report at 30th September and 31st March each year... giving an appreciation of the performance of the fund within that period.''

Mr Gates had no recollection of the discussion to which that letter referred. Initially, he said that he could not remember whether he had seen the letters of 26th January or 24th July 1978. He speculated that the letters may have been in the bank's archives and could not be located. He could not recall the contents of the letters being discussed with him. Later he categorically denied having seen the letters. He said that it was always clear in his mind what he was to do with the portfolio.

In his affidavit evidence Mr Gates referred to a conversation that he had had with Mr Woods, the General Manager of Insurances in 1981 when he assumed responsibility for the management of the portfolio. It is likely, despite the oral evidence to the contrary, that this was the conversation to which reference was made in the letter of 25th September, 1981. Mr Gates deposed that Mr Woods, in this conversation, had said:

``AGC Investments is not a trader in shares. Shares should be purchased only with a view to long term dividend growth.''

Mr Gates referred to ``guidelines'' contained in a letter of 10 May 1983 from Mr Crisp to him as typical of the instructions he received throughout the period from 1981 to the end of the year of income. In that letter Mr Crisp had written:

``Guidelines previously issued indicated that funds available to you for reinvestment were made up of dividends received and capital profits during the year. We advise you that on the criteria set out the investment portfolio can be increased to a total of

ATC 4187

$24m. The amount invested by you up to the 31st March, 1983 is $20.5m therefore you have funds available for investment of $3.5m up to and including the 30th September, 1983 at which time you will be advised of funds available for investment to 30th September, 1984.

The provisos to the above investment allocation are as follows:

  • 1. The bank is to refer purchase of stock on individual investments for amounts in excess of $200,000.
  • 2. Sales Transactions involving a small capital loss need not be reported.
  • 3. The investment allocation of $3.5m for the next six months is of course only a guideline. The investment of these funds is subject to your judgment (sic) on market conditions applying from time to time and reference to us as outlined in (1) above.''

The report of Mr Gates of 24 October 1983 relating to the twelve months to 30 September 1983 was in evidence. It showed that as at 30 September 1983 the cost of investments in the portfolio was $20,184,160, and that there had been an appreciation in market value of the portfolio over cost of $15,843,150. The report after detailing the shares added in the year to the portfolio and the sales in that year of shares in three companies continued:

``In our management of the portfolio, we are very conscious of AGC Investments being a long term investor. We therefore continue to seek shares in companies that provide a reasonable yield together with medium and long term growth potential. We will continue to purchase ordinary shares under this criteria and maintain close contact with the Company's executives.''

Mr Gates' affidavit evidence made no specific reference to any instructions he was given concerning sale of shares in the portfolio. Indeed, he deposed that as manager of the portfolio he was authorised to decide on changes to the portfolio. According to his evidence he notified the General Manager of Insurances of proposals for changing the portfolio within approximately 36 hours of a transaction taking place. Correspondence produced in support of this evidence was sometimes couched in terms of recommendations. On other occasions, it recorded, without previous correspondence, that a transaction of sale had taken place. The evidence of Mr Crisp was that some transactions were referred to him, but fell short of supporting the proposition that all transactions of sale were carried out only after approval had been granted. Yet, in cross-examination, Mr Gates deposed that he was instructed that before any shares were sold by him he should refer the transaction to AGC for instructions. I have considerable difficulty in accepting this part of Mr Gates' evidence. Clearly, a restriction on sale was an important matter to the applicant's case. Yet, on Mr Gates' evidence he overlooked this significant matter when preparing his affidavit. Further, the existence of such a restriction is inconsistent with the written instructions to which I have already made reference. It is also inconsistent with the correspondence which Mr Gates tendered and with the evidence of Mr Crisp. I find that it is more probable than not that Mr Gates did have authority to sell without reference to Insurances or the applicant, but subject to a monetary limit, which at some stage was increased from $100,000 to $500,000 and that he did in fact do so on occasions, although it is obvious that Mr Gates from time to time sought instructions from Mr Crisp or other officers of Insurances or the applicant on sales.

Mr Gates also gave evidence that in considering investment of funds he regarded the present and prospective future yield on the investment as of dominant importance. He sought to invest in shares where the dividend income would increase over time matching or exceeding the inflation rate. He said that he did not take account as part of the prospective yield on the investment the capital gain which might be realised by disposing of the investment.

Finally, reference should be made to the evidence of Mr Crisp on the matter of the investment policy of the applicant. Mr Crisp became General Manager of Insurances in 1983. His understanding of the applicant's investment policy was derived from a conversation with his predecessor, Mr Wood, in which Mr Wood said:

``AGC Investments is not a trader in shares. It was set-up to invest funds provided by Insurances in securities which ensure long

ATC 4188

term dividend investment income and maximise potential asset growth.''

As is apparent from the evidence so far discussed, the share portfolio of the applicant grew considerably under the management of Westpac Management. Some idea of the way it grew can be seen by considering the number of shares acquired each year. In the years ended 30 September 1982 and 1983, purchases were made in 35 five different companies; in 1984, there were purchases in 31 companies; in 1985 in 33 companies and in 1986 in 27 companies. As at 30 September 1986 the portfolio included shares in 51 companies and had a value of $85,909,940. There were relatively few sales in comparison with acquisitions. Generally, the occasion of the sales was a takeover offer, although it did not follow that the offer was accepted. The shares the subject of the offer were often sold on the market either because a higher price was thus realised or because the proceeds of sale were thus received faster than would have been the case if the takeover offer were accepted. Rights issues were often sold on the market, presumably where it was not regarded as desirable to take up the shares the subject of the rights issue.

The parties each prepared analyses of the purchases and sales over various periods of time. The analyses differed, but nothing turns upon the minor differences between the parties. If regard be had only to the transactions in public company shares, as the applicant suggested, there were, accepting the applicant's calculations, total sales in the years 1982-1986 as follows:

      1982      $ 2,492,174
      1983      $   720,459
      1984      $ 2,384,011
      1985      $ 2,160,058
      1986      $16,715,555

It is obvious that these sales were but a small percentage of the value of the portfolio in the years in question. Thus, by way of example, the total value of the portfolio as at 30 September 1982 was $30,392,412, and the total sales expressed as a percentage of this were 2.36%. As at 30 September 1986, the total value of the portfolio was, as already indicated, $85,909,940 and the total sales expressed as a percentage of this were 16.29%. The percentages are considerably smaller if there are eliminated from the figures of sales, as the applicant would seek to do, the sales that were attributed to takeovers. I do not think that it is appropriate, however, to disregard these sales, as they were nevertheless sales, and generally were on the market, the takeover offer presenting the occasion of the sale, rather than the means of sale.

The decision to realise a substantial part of the portfolio in the year of income was prompted by Mr Robson. He foresaw, what others to their detriment failed to see, that the share market was overvalued. Accordingly, after consultations with others he instructed Westpac Management to commence selling parcels of shares and moving the funds out of equities into fixed interest securities. The instructions were given in mid September 1987; the stock market slump occurred in October of the same year. In the result the applicant in the twelve months to 30 September 1987 sold in circumstances other than the existence of a takeover offer, its holdings in 33 companies, realising in total $79,413,638. Shares sold on the occasion of takeovers in that year realised $5,286,692. In relation to the total value of the portfolio as at the end of that year the total sales amounted to just slightly over 50% of the portfolio.

It is in these circumstances that the applicant submits that the sales made by it in the year of income were on capital account. The applicant submitted:

  • • The shares were clearly on the facts not trading stock of the applicant, nor were they acquired for the dominant purpose of resale at a profit.
  • • The fact that the applicant was a subsidiary of an insurance company was irrelevant to determining its assessability to tax. The corporate veil could or should not be lifted.
  • • The decision of the High Court in the London Australia case was inapplicable to the applicant which was not carrying on a business of investment, such that the proceeds of its sales were income in ordinary concepts.
  • • The evidence merely established that the applicant had purchased the shares over a long period of time to obtain the dividends from them and had no purpose of resale at a profit.

    ATC 4189

  • • The respondent had been made aware of the activities of the applicant for many years and had never assessed the profits of the applicant to tax. Accordingly he was as a matter of ``equitable estoppel'' no longer able to assess the applicant.

The respondent, on the other hand, submitted:

  • • The applicant's transactions should be characterised on the basis that it was an insurance company, and the cases applicable to the taxation of insurance companies provided a useful guide to the resolution of the applicant's appeal.
  • • Alternatively, the company was carrying on a business of investment in the London Australia sense, so that its profits were assessable income.

The respondent refused to concede that the shares in the present case were not trading stock, albeit that no submission was made on his behalf that they were. The evident difficulty about the concession was the decision of the full court of this Court in
FC of T v Equitable Life and General Insurance Co. Ltd 90 ATC 4438, upon which the applicant strongly relied. The taxpayer in that case had carried on business as an insurance company for some years, until it ceased to carry on that business. It retained an investment portfolio consisting largely of shares from which it derived dividends. From time to time shares were purchased and sold. It was held that the profits on the sales of shares were not income, and this notwithstanding that the taxpayer was a subsidiary of a company which carried on insurance business.

At first instance it had been held that the portfolio was unrelated to the insurance business of the parent company, with the consequence that the insurance cases were of no assistance to the Commissioner. Particularly on the facts of that case the share portfolio was not maintained and managed as part of the insurance business of the parent company. The Commissioner conceded in that case that the shares in question were not trading stock, a concession described by Davies J (at 4444) as having been correctly made. However, it followed in that case, as Davies J said (at 4447):

``As the taxpayer in the present case... was not a trader in shares and did not carry on a business of or involving dealing or trading in shares, it follows from the principles I have outlined that the profits made from its investment activities did not form part of its assessable income. Its profits were capital profits derived from an activity of investment that was not a business.''

Notwithstanding the absence of such a concession in the present case, it is clear that the evidence does not support a finding that the applicant was conducting a business of trading in shares of which the shares could be trading stock. Does it follow therefore, as the applicant submits, that the principles applied by the majority of the court in Equitable Life require the result that the applicant must succeed?

There is no doubt that the applicant is a separate legal entity from its parent company and that to attribute the business of the parent to its subsidiary would involve the impermissible lifting of the corporate veil. The circumstances in which the corporate veil may be lifted are greatly circumscribed:
Dennis Willcox Pty Ltd v FC of T 88 ATC 4292 at 4295-6; (1988) 79 ALR 267 at 272,
Sharrment Pty Ltd & Ors v Official Trustee in Bankruptcy (1988) 82 ALR 530 at 552-3. It would also involve ascribing a fictional business to the subsidiary. But it does not follow, as the applicants submit, that it is irrelevant that the applicant in the present case is a subsidiary of an insurance company. The issue in the present case is the characterisation of the profits of the applicant in the applicant's hands. Those profits do not necessarily have the same character as they would have in the hands of the parent insurance company:
Federal Coke Co. Pty Ltd v FC of T 77 ATC 4255; (1978) 34 FLR 375.

I should say here that, notwithstanding a submission of the applicant to the contrary, had the portfolio investment been in the name of Insurances, but otherwise there were no difference as to the facts, I would have had little difficulty in concluding that the profits were income, as representing profits from a reserve fund:
Colonial Mutual Life Assurance Society Ltd v FC of T (1946) 73 CLR 604,
Chamber of Manufactures Insurance Ltd v FC of T 84 ATC 4315; (1984) 2 FCR 455,
FC of T v Employers' Mutual Indemnity Association Ltd 90 ATC 4787 and cases discussed therein.

However, the fact, not only that the applicant is a subsidiary of an insurance company, but

ATC 4190

also that its assets are treated by the parent insurer as its own assets for the purpose of creating and maintaining a reserve fund, and that those assets are not surplus to the requirements of the insurance business of the parent, but indeed are relevant to be taken into account for the purposes of calculating solvency ratios, is of considerable relevance. That fact alone, clearly distinguishes the present facts from those considered by the full court in Equitable Life.

The fact that the applicant is a subsidiary of an insurance company and is administered as part of that company, and that its assets are regarded by the parent as part of a reserve fund, to be available to meet liabilities in the event that that be necessary (even perhaps where the occasions of necessity may be rare indeed) assists in the characterisation of the activities of the applicant as a business. It also enables an inference more readily to be drawn as to the profit making purpose of the applicant in undertaking its investment activities. That is not to say that it should thereby be taken as being an insurance company. It is not receiving premiums which require reinvestment to provide for claims, nor is it investing, as the Commissioner submitted, the funds of the insurance company. It is investing its own funds, albeit that those funds are provided by way of interest free loans, repayable on demand from the insurance company. Those funds represent the capital of the applicant, not the circulating capital of its parent insurance company.

The generally accepted starting point for the resolution of problems such as the present is the oft quoted passage from the decision of the Lord Justice Clerk, in
Californian Copper Syndicate v Harris (1904) 5 TC 159 at 165-6:

``It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business.''

Later in the judgment his Lordship posed the question for decision as being (at 166):

``Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?''

As Gibbs J observed in London Australia (at ATC 4404; CLR 118), the test in Californian Copper is applicable in any business, be it a business of banking, a business of insurance or a business of investment. In applying it, it will be necessary:

``to make both a wide survey and an exact scrutiny of the taxpayer's activities.''

Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740.) Further:

``Different considerations may apply depending on whether the taxpayer is an individual or a company. In the latter case it is necessary to have regard to the nature of the company, the character of the assets realized, the nature of the business carried on by the company and the particular realization which produced the profit.''

(London Australia at ATC 4403; CLR 116.)

The facts in London Australia may be thought more clearly to favour the Commissioner than the present. It was found in that case that it was an integral part of the taxpayer's business to deal in shares, in the sense that switching of investments was desirable to produce the best dividend returns, and to this end the taxpayer pursued a systematic and vigorous policy of purchasing and selling shares, notwithstanding that the dominant purpose of resale at a profit was not present, nor were the shares trading stock of the taxpayer. The resultant profits were profits of the business of investment and thus income in ordinary concepts.

The judgment of Jacobs J in the same case is also of considerable assistance. First his Honour in discussing the insurance cases makes the point (at ATC 4410; CLR 129) that it is of the nature of an insurance or banking company that it invests its circulating capital, rather than

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its original capital structure or that structure as enhanced by accumulated net profits. Prima facie, at least, the funds invested by the applicant, while circulating capital of Insurances, are not circulating capital of the applicant. Second, his Honour spoke of the ``scale of activity coupled with the source of funds'' in the case of banks or insurance companies as leading to an inference that ``a purpose or intention of the acquisition is eventual resale at a profit'' (at ATC 4410; CLR 130). Although the applicant here is not an insurer, the circumstances in which the applicant is provided with funds and the commercial integration of the affairs of the applicant into the insurance activities of Insurances, coupled with the scale of its activities leads to a similar inference.

As the judgment of Jacobs J further points out, mere scale of activities will not of itself lead to the conclusion that the activities involve a business with a purpose of profit making. However, as his Honour observed (at ATC 4411; CLR 130):

``... but it is very important evidence tending to show a business of acquiring and disposing of shares and it was some evidence from which a purpose of thereby making a profit might be inferred. It was for the appellant to rebut the latter inference.''

London Australia, and more recently
FC of T v Myer Emporium Ltd 87 ATC 4363 at 4366-7; (1987) 163 CLR 199 at 209-10, make it clear that profits made on the realisation of investments will be income where the investments are acquired as a part of a business and where in addition there was at the time of acquisition an intention or purpose that they be realised subsequently at a profit. There seems little doubt that the activities of the applicant can be characterised as a business: indeed counsel for the applicant conceded this. However, he emphasised, properly, that it is necessary to determine the nature of the business and that there was a distinction between a business of investing, that being the description he preferred to use for the applicant, and an investment business, as was the case in London Australia. If there be substance in the distinction just drawn, and I think there is, it lies in the absence of an intention to resell at a profit in the first situation and its presence in the second. The proceeds of shares acquired, even in the course of carrying on a business, which were acquired with no purpose of resale at a profit at all will, at least usually, not be income in ordinary concepts. The insurance and banking cases may perhaps be an exception to this general principle.

In particular, there is no general principle of taxation that the mere management of a share portfolio, conducted in a systematic and concerted way brings about the result that all the surpluses of that activity are income in ordinary concepts:
Trent Investments Pty Limited v FC of T 76 ATC 4105 at 4108, Equitable Life (supra) at 4445. As Mahoney J observed in the former case, in a passage approved by Davies J in the latter:

``Investment, in the sense to which I have referred, does not cease to be such merely because it is done systematically and skilfully. It may do so if, as a matter of fact, the activities of a taxpayer are such that he is carrying on a trade... But, upon the present facts, I do not think that it was so.''

The respondent Commissioner relied upon the decision of the full court of this court in
CMI Services Pty Limited v FC of T 90 ATC 4428 in support of a submission that it was unnecessary that there be any purpose of resale at a profit in the case where a taxpayer carries on a business of investing funds, but rather it was sufficient if there was a business of investing where realisation of assets was an integral part of that business.

There are some evident similarities although some differences which, if anything, favour the respondent, between the facts of the present case and those of the CMI case. CMI Services Pty Limited (``CMI'') was a wholly owned subsidiary of a general insurer and was incorporated to serve as a property investment company through which surplus funds of the insurer could be invested. It had been found as a fact that the funds advanced by the parent to CMI (at interest) were surplus to the needs of the insurance business. Each property purchased was to be held indefinitely so long as a satisfactory rental return was achieved. The taxpayer was never called upon to repay any loan to its parent to meet any actual or anticipated insurance claim. The loans were repaid from accumulated rental and resales. Over a number of years, 27 properties were purchased by the taxpayer of which 16 were

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sold, one was in the process of being sold and ten were still held. Sales were made either because rental returns had not achieved expected levels or were likely to decrease or because of structural problems affecting the property.

At first instance it was found that the taxpayer was engaged in a business of purchasing property for long term investment purposes but was not in the business of buying and selling real estate for the purpose of profit making by sale, resale at a profit forming no part of the reasons for acquisition. However, there was an expectation or intention that the properties in question would be resold in the ordinary course of business if it were prudent so to do. These findings of fact were not challenged.

The judgment of the court in favour of the Commissioner was delivered by Lockhart J with whose judgment Jenkinson and Gummow JJ agreed. His Honour expressed the view, based upon California Copper and the judgment of Gibbs J in London Australia, that there was no requirement that a taxpayer who carries on a business must necessarily have a purpose of resale at a profit when assets are acquired in the course of carrying on a business. Some comments in the judgment clearly cast doubt upon the views of Jacobs J in London Australia as to the extent that his Honour was expressing a general principle. The conclusions of Lockhart J are expressed in the following passage from the judgment (at 4437):

``The fact that the taxpayer did not buy real estate for the purpose of selling it at a profit is an important consideration. But, as the primary Judge found, there was a pattern discernible in the policy of the taxpayer in investing in real estate which involved it being resold if its prospective returns from rental fell below acceptable levels. Although the taxpayer's business was to invest in real estate for the primary purpose of obtaining income by way of rental, the conduct of that investment business required that the real estate portfolio should be considered and monitored on a fairly regular basis and that real estate should be sold when its rental yield, measured in relation to market value, dropped to an unacceptable level. The purchase of the Belmont properties is the directly relevant example of the application of that policy.

The taxpayer was carrying on the business of investing for the purpose of producing income; but the facts disclose that the buying and selling of real estate was done as part of that business of the taxpayer of investing for the purpose of producing income. The profits which were realised on the sale of the Belmont properties were profits of the business and income within ordinary usages and concepts and so fell within sec. 25.''

There may be thought to be some difficulty in reconciling what was said in CMI with what was held in Equitable Life. Most investors who purchase assets for investment make their investment decisions with an eye to the possibility of resale if the investment income does not live up to expectation. That was accepted by Lockhart J in CMI. A company carrying on a business of, say, steel making may invest funds surplus to that business and may be said to do so in a general sense as part of its overall business yet, to say that profits made in such a case are necessarily income because the desire of the taxpayer is to achieve income (by way of dividends) would totally blur the distinction between capital and income. As Lockhart J observed in CMI (at 4437):

``The answer depends on the facts of the particular case.''

Critical to the CMI case was the factual finding that there was a pattern of buying and selling in the activities of the taxpayer. Given a finding that the activities of the taxpayer were properly characterised as a business, a characterisation that involves the making of profit, it is hard to resist the conclusion that the proceeds of sale were more than a mere realisation of a capital asset; but it is equally difficult to resist the conclusion (contrary to the admissions made by the Commissioner) that there was no purpose or intention that realisations as and when made would be at a profit.

If CMI stands for a general principle that a taxpayer who as part of an activity properly characterised as a business derives income in ordinary concepts when it realises investments made by it at a profit notwithstanding that it had no purpose at all of so doing when it acquired the investment, the respondent must succeed in the present case. But if it does, it is only capable of reconciliation with Equitable Life,

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on the basis that the latter case is to be seen as a case where the activities of the taxpayer involved no business at all. However, all that was said on that matter by Davies J is that the taxpayer was not carrying on a business of dealing or trading in shares.

For the purposes of the present case, however, it is unnecessary to attempt to resolve the differences, if any, between the two cases, depending as they perhaps do, on the different factual matrices in each. I am prepared to resolve the present case on the basis that for the applicant to succeed it must show, despite the scale of its activities and the relationship which its activities had to the insurance business of its parent, that on the balance of probabilities, in acquiring its portfolio of shares, it had no purpose of ultimate resale at a profit and conversely that it will fail if it does not satisfy the burden of proof of showing that resale of the portfolio at a profit was not one of its purposes.

As I have already indicated, the integration of the business activities of the applicant with the affairs of Insurances, the place which the assets of the applicant occupied as part of a reserve fund for the insurance business of Insurances and perhaps also the scale of its activities, raise an inference that the necessary profit purpose existed. No evidence was adduced of any resolution of the board of the applicant, or for that matter Insurances, which would rebut such an inference. The present is not a case where the policy of a company can be ascertained by reference to the mind of a particular dominant director, cf
Tesco Supermarkets Ltd v Nattrass [1972] AC 153 at 170-171 (per Lord Reid) and at 187 (per Viscount Dilhorne);
Smorgon & Ors v FC of T 76 ATC 4364 at 4368; (1976) 134 CLR 475 at 482-3, Allied Pastoral Holdings Pty Limited v FC of T 83 ATC 4015; the applicant was operated as a public company, as was not inappropriate, having regard to the size of its activities and its status as a subsidiary of a public company.

The letter of 26 January 1978, with its reference to the desire to ``fully exploit the cyclical fluctuations in the share market'' makes it clear that at least as at that date, the applicant did have a purpose of profit making in acquiring its portfolio, and confirms the inference which would arise from its insurance association.

The question then remains whether the evidence shows in respect of the applicant's activities after 26 January 1978 that it changed direction from being a company carrying on an investment business after that date, so that at least in respect of so much of its portfolio as was thereafter acquired it became a mere investor? The evidence does not satisfy me that it did.

The witnesses called for the applicant were all concerned to say that the policy of the applicant throughout its life, so far as they were able to glean it in the early days from conversations with others no longer with the applicant, remained constant. This is not surprising having regard to the assertion made, contrary to the only documentary evidence extant, that this policy involved no element of profit making by resale. I prefer to rely upon the contemporaneous documentary evidence rather than on the recollection of witnesses of conversations long past, particularly when that evidence is in any event hearsay.

Certainly it can be said that the significance of the affairs of the applicant to Insurances continued unabated throughout the whole of the period until the year of income. The events of the calendar year 1986 when considerable funds were repaid by the applicant to Insurances for purposes connected with the business of Insurances amply demonstrates that. It is true that Westpac Management did not generally seek to take advantage of the cyclical trends of the market, and that, having regard to the size of the portfolio the value of sales was relatively small, but capital growth remained at all times of significance. The applicant seems to have been concerned at all times to ensure that it was not a share trader and went to some pains to communicate this to Mr Gates. I accept that the applicant was concerned to obtain increasing dividend yields. Indeed this was particularly so when its parent company was incurring substantial underwriting losses. But, the desire for dividend yield does not exclude a purpose of profit making by sale, where the investment is made with the knowledge that the sale may be required to provide funds (albeit not on a day to day basis, but only perhaps in the event of a catastrophe or a running down of particular insurance business) for the purposes of the insurance business of its parent. This is particularly so when the applicant's funds were

ATC 4194

all provided on a short term basis of loans repayable on demand.

In determining whether the applicant changed the policy which it had espoused, at least until 1978, I find the evidence of Mr Gates of little assistance. His purpose in selecting shares for investment tells one little about the purposes of the applicant. In any event, his instructions were merely to refer sales in excess of a particular figure to officers of Insurances. At the most, his evidence could only be useful in so far as it went to the instructions he was given by the applicant, and thus as a means of establishing the purposes of the applicant. But it is precisely in this area that his evidence seems to be in conflict with the contemporaneous documentary evidence. I do not accept his evidence on this matter. The evidence of Messrs Robson and Crisp makes it clear that the applicant was not intended to be a share trader, but it stops short of denying the profit making purpose of the applicant. The fact that the shares were not to be traded in the short or medium term, and were to be treated as long term investments is not inconsistent with the conclusion that the shares were acquired with a profit making purpose. Indeed, as Mr Crisp acknowledged, asset growth was always an aim of the applicant. No doubt increasing dividends over the medium to long term almost invariably bring asset growth, but in the circumstances of the present case one may ask rhetorically whether asset growth was an end in itself, or merely a means to ensuring that realisations would, if made, be at a profit.

It follows, that the applicant has not satisfied the burden of showing that its original profit making purpose was displaced. In my view the applicant was carrying on a business, that business being integral to the insurance business of its parent, and in the course of this business it acquired a portfolio of shares having at the time of acquisition a profit making purpose in so doing. It realised a large part of that portfolio to preserve the gain which had accrued to it, and the profits it made in so doing were income in ordinary concepts.

There remains but one submission for the applicant, that based upon the incontestable fact that until the present assessment was issued, returns had been lodged by the applicant and been assessed by the Commissioner on the basis that the proceeds of sales which generated profits were not income in ordinary concepts. The submission received little elaboration, save that it was said to be based upon ``equitable estoppel'', rather than common law estoppel. The suggestion, presumably, was that the Commissioner was, as a result, precluded from assessing the applicant to tax in the year of income upon a basis that the profits in question were income in ordinary concepts.

Even if it be assumed that the doctrine of estoppel could have any application to the Income Tax Assessment Act, it is difficult to see how the elements necessary to equitable estoppel have been made out. Equitable estoppel precludes a person who by a promise has induced another party to rely on the promise and thereby to act to the other party's detriment from resiling from the promise without avoiding the detriment:
Waltons Stores (Interstate) Ltd v Maher & Anor (1987-8) 164 CLR 387 at 427. Estoppel, by representation, existed both at common law and at equity. It required a representation of existing fact to have been made, and was intended to provide:

``protection against the detriment which would flow from a party's change of position if the assumption (or expectation) that led to it were deserted.''

(See Waltons Stores at 404 and 419,
Commonwealth v Verwayen (1990) 64 ALJR 540 at 544.)

As the judgments of Mason CJ, Brennan and Deane JJ in Verwayen all point out, the modern decisions show the emergence of a single principle of estoppel, rather than a series of discrete rules. Deane J (at 560), described the central features of the doctrine as follows:

``2. The central principle of the doctrine is that the law will not permit an unconscionable - or, more accurately, unconscientious - departure by one party from the subject matter of an assumption which has been adopted by the other party as the basis of some relationship, course of conduct, act or omission which would operate to that other party's detriment if the assumption be not adhered to for the purposes of the litigation.

3. Since an estoppel will not arise unless the party claiming the benefit of it has adopted the assumption as the basis of action or inaction and thereby placed himself in a

ATC 4195

position of significant disadvantage if departure from the assumption be permitted, the resolution of an issue of estoppel by conduct will involve an examination of the relevant belief, actions and position of that party.

4. The question whether such a departure would be unconscionable relates to the conduct of the allegedly estopped party in all the circumstances. That party must have played such a part in the adoption of, or persistence in, the assumption that he would be guilty of unjust and oppressive conduct if he were now to depart from it...''

What is the representation, whether of existing or future fact, or indeed of law, that is said to have been made by the Commissioner? Presumably, the applicant would have it that the Commissioner by assessing on a basis which is wrong in law, represented that the correct view in law of the facts stated in the applicant's returns was that the gains were of a capital nature. What was the basis of action or inaction that the representation by the Commissioner or the adoption of the assumption by the applicant induced? There is no evidence of any at all. There is no evidence which suggests that the applicant would have acted in any way differently from the way it did, had no such representation been induced. It is difficult to see what detriment the applicant is said to have sustained, particularly when its assets have been increased by the tax properly exigible, which it has not had to outlay. Why is it either unconscionable or unconscientious for the Commissioner, having assessed upon a wrong basis, to depart from that course and assess on a correct basis? To me, the question is unanswerable, other than to say it is not.

The last question merely reflects the reasons why there is no room for the doctrine of estoppel operating to preclude the Commissioner of Taxation from pursuing his statutory duty to assess tax in accordance with law. The Income Tax Assessment Act imposes obligations upon the Commissioner and creates public rights and duties, which the application of the doctrine of estoppel would thwart. In my view the doctrine of estoppel cannot be invoked by a taxpayer so as to prevent the Commissioner assessing pursuant to his duty so to do. The cases certainly support that view:
FC of T Wade (1951) 84 CLR 105 at 117;
Inland Revenue Commissioners v Brooks [1915] AC 478 at 493;
Maritime Electric Co. Ltd v General Dairies Ltd [1937] AC 610 at 620-624;
North West County District Council v JI Case (Australia) Pty Limited [1974] 2 NSWLR 511 at 523-524;
Commissioner of Inland Revenue v Lemmington Holdings Ltd [1982] 1 NZLR 517 at 523;
David Jones Finance and Investment Pty Ltd & Anor v FC of T 90 ATC 4730 at 4733. In my opinion this submission is of no substance.

I would accordingly dismiss the application and order that applicant to pay the respondent's costs of it.


1. The application be dismissed.

2. The applicant pay the respondent's costs of the application.

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