Case K43

Judges:
AM Donovan Ch
RK Todd M
LC Voumard M

Court:
No. 2 Board of Review

Judgment date: 31 July 1978.

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A.M. Donovan (Chairman); R.K. Todd and L.C. Voumard (Members): The company requesting these references is a private company which in a period of some five years ended 30th June, 1969, had traded unprofitably, incurring losses of the kind contemplated by sec. 80 of the Income Tax Assessment Act. The company's financial problems led, in 1966, to a firm of accountants recommending that the company enter into a scheme of arrangement with its creditors; a purely moratorium scheme was entered into and approved by the Supreme Court in December 1966. No provision was made for the transfer of any of the issued capital. It was hoped that the company would be able to ``trade its way'' out of its difficulties; if it were unable to do so, provision existed for the termination of the scheme, and for the debts of the scheme creditors to be compounded. This was set out in cl. 20 of the scheme, which read:

``If it is resolved by a special Resolution of Scheme creditors... that all the assets of the company have been realised... and that it does not appear to be in the interests of the Scheme creditors for the company to continue to carry on its business, then the committee (of

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creditors) may determine that this Scheme has been wholly effectuated and the Trustees shall declare a final dividend... If the Trustees shall declare such a dividend they shall certify thereto... and the debts of the Scheme creditors shall be deemed to be finally and fully compounded at such declared rate of dividend.''

2. Efforts to have the company ``trade its way'' out of its difficulties were unsuccessful, but by 30th June, 1969, it had incurred a respectable sum of ``tax losses''. With all other assets realised, and the creditors still substantially unsatisfied, the scheme trustees entered into negotiations that led to the company being ``sold for its tax losses'', to use an inaccurate but descriptive phrase. More precisely, by contract dated 19th June, 1970, the only three shareholders sold part of their holdings. Of an issued capital consisting of 100 fully paid ``A'' class shares and 50 fully paid ``B'' class shares, 56 ``A'' class shares and 30 ``B'' class shares were sold, and 44 ``A'' class shares and 20 ``B'' class shares were retained by the vendors. The purchase consideration was payable to the scheme trustees for application by them in accordance with the terms of the scheme of arrangement, and thereafter cl. 20 of the scheme operated. No part of the purchase consideration passed to the vendors of the shares, although this was not occasioned by any provision contained in the scheme. At all material times the issued shares, each with a nominal value of $2, were fully paid up.

3. An initial difficulty arises in connection with the rights attaching to the different classes of shares, and with the date on which the class ``B'' shares were allotted. A copy of a minute of a meeting of directors of the company held on 19th April, 1965 (Exhibit M) resolved ``that the capital of the company be divided into two share classes, namely 4900 `A' class shares and 100 `B' class shares''. The directors ``further resolved that there be no difference as to rights privileges or conditions between either class excepting this only that 4900 shares should be known as `A' class shares and that 100 only should be known as `B' class shares''. It would seem, therefore, that the two classes of shares should perhaps be regarded as belonging to the same class, for there was certainly no difference in the rights attaching to them. This conclusion is not, we think, affected by the fact that at the same meeting the directors resolved to allot 50 ``B'' class shares to Mrs. J, and to declare a dividend in respect of those shares only. More troublesome is the fact that this minute, which purported to be signed by the chairman and was therefore to be taken as evidence of the proceedings to the extent provided by sec. 148 of the Companies Act of the State concerned, resolved to allot the 50 ``B'' class shares to Mrs. J on 19th April, 1965. Yet the company's Register of Members (Exhibit Q) which by sec. 151(4) of the relevant Companies Act is ``prima facie evidence of any matters inserted therein as required or authorised by'' that Act, records that the 50 ``B'' class shares were allotted to Mrs. J on 29th April, 1970. This discrepancy was not the subject of comment at the hearing. Perhaps in the end nothing turns on it as it seems that, whichever date is taken as correct, sufficient shares were retained by the vendors, hereinafter called the continuing shareholders, to bring the matter within sec. 80A. At all relevant times, subsec. (1) of that section provided:

``(1) Notwithstanding sections eighty and eighty AA of this Act, but subject to the next succeeding sub-section and the next four succeeding sections, a loss incurred by a taxpayer, being a company, in a year before the year of income shall not be taken into account for the purposes of section eighty or section eighty AA of this Act unless -

• (a) the company satisfies the Commissioner; or
• (b) in the case of a company that is not a private company in relation to the year of income, the Commissioner is satisfied that it is reasonable to assume,

that, at all times during the year of income, shares in the company carrying between them -

• (c) the right to exercise not less than two-fifths of the voting power in the company;
• (d) the right to receive not less than two-fifths of any dividends that may be paid by the company; and

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• (e) the right to receive not less than two-fifths of any distribution of capital of the company in the event of the winding up, or of a reduction in the capital, of the company,

were beneficially owned by persons who, at all times during the year in which the loss was incurred, beneficially owned shares in the company carrying rights of those kinds.''

4. After the change in shareholding the company derived income, but in respect of income derived in the years ended 30th June, 1970 and 1971, the Commissioner declined to allow deductions in respect of the unrecouped losses of prior years. The consequence was that for each of those years there issued primary assessments and, because on the basis of the taxable income disclosed in those assessments the company failed to make a sufficient distribution, Div. 7 assessments as well. Objections against all four assessments were disallowed by the Commissioner, and the matters are now before the Board.

5. Mr. Dowling, who appeared for the Commissioner, did not put any separate contentions with respect to the beneficial ownership of the necessary 40 per cent or more continuity of shareholding referred to in sec. 80A. But he did contend that sec. 80B(5) authorised the Commissioner to treat the shares retained by the continuing shareholders as not having been beneficially owned by them at the relevant time, with the consequence that the company was unable, in terms of sec. 80A, to satisfy him of the matters described in para. (c), (d) and (e) of sec. 80A(1). As it stood at the time material to these references, sec. 80B(5) provided:

``80B(5). Where -

• (a) a person who beneficially owned any shares in the company at all times during the year in which the loss was incurred also beneficially owned shares in the company at any time (in this sub-section referred to as `the relevant time') during the year of income;
• (b) before or during the year of income, that person entered into a contract, agreement or arrangement, or granted or was granted a right, power or option (including a contingent right, power or option) that, in any way, directly or indirectly, related to, affected, or depended for its operation on -
  • (i) the beneficial interest of that person in the last-mentioned shares, or the value of that interest;
  • (ii) the right of that person to sell, or otherwise dispose of, that interest, or any such sale or other disposition;
  • (iii) any rights carried by those shares, or the exercise of any such rights; or
  • (iv) any dividends that might be paid, or any distribution of capital that might be made, in respect of those shares, or the payment of any such dividends or the making of any such distribution of capital; and
• (c) the contract, agreement or arrangement was entered into, or the right, power or option was granted, for the purpose, or for purposes that included the purpose, of enabling the company to take into account for the purposes of section eighty AA of this Act a loss that the company had incurred in a year before the year in which the contract, agreement or arrangement was entered into or the right, power or option was granted or a loss that the company might incur in that last-mentioned year,

the Commissioner may, subject to the succeeding provisions of this section, treat those shares as not having been beneficially owned by that person at the relevant time.''

6. The questions before the Board may be stated thus:

• (a) Was there an arrangement, etc. (meaning by this expression a contract, agreement, arrangement or option of the kind proscribed by sec. 80B(5)(b)) for purposes of sec. 80B(5)? If not, then the taxpayer's objections must be upheld, the primary assessments amended accordingly and the Div. 7 assessments reduced to nil.

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• (b) If there were such an arrangement, etc., did the purpose of the continuing shareholders (see
  F.C. of T. v. Students World (Australia) Pty. Ltd. 78 ATC 4040, per Mason J. at pp. 4048-9, and per Aickin J. at p. 4053) answer the description contained in sec. 80B(5)(c)? If not, that again would require decisions in favour of the taxpayer.
• (c) If there were an arrangement entered into for a sec. 80B(5)(c) purpose, should the Commissioner's (and now the Board's) discretion be exercised in favour of or against the taxpayer? If the latter, then a subsidiary question concerning sec. 105AA will arise in relation to the year ended 30th June, 1971.

7. Among those who gave evidence was one W who, prior to 1968 had been an employee of, and who subsequently became a partner in, the accounting firm that had been administering the scheme of arrangement. He referred to discussions he had had with the representative of the proposed purchasers of the shares, and (separately) with the continuing shareholders; he agreed with the former that the shares not transferred were to continue to be held by the continuing shareholders ``completely unfettered and unencumbered with all the rights that had previously been with them, that there wasn't any change to that and shouldn't be''. In discussions with the continuing shareholders he stressed that they could do as they wished with the shares they were to retain. In cross-examination, his recollection was that he may have told the continuing shareholders that if the shares should improve in value then they would have the benefit of that; he did not think that he had told them that the shares retained would be of no value. W also referred to a file memorandum dated 22nd June, 1970 - a date that appeared to be a mistake, as the sale of the shares mentioned in para. 2 of these reasons had taken place three days earlier - written by a then employee of the accounting firm administering the scheme of arrangement, and reading:

``Phoned Mr. (J) (one of the continuing shareholders)... concerning the sale of the structure of the... company. I informed him of the proposal and of the necessity for him and Mrs. (J) to sign certain documents required to effect the sale. He agreed to co-operate in any way possible and would be available to attend the office in the afternoon of June 19 but it would be difficult for him to attend earlier in the week. I suggested that if he could be in attendance on the Friday all of the details could be attended to and finalised. We are to confirm our requirements concerning his attendance at this office.''

We have set out this memorandum in full because, as will be seen, the Commissioner attached some significance to the statement in it concerning J's agreement ``to co-operate in any way possible''.

8. The accountant who at the time was acting for the purchasers also gave evidence that there was no arrangement whereby his clients would be enabled to get in the shares held by the continuing shareholders after the tax losses had been recouped. Further, as secretary of the company, he sent notices of the annual general meetings held in 1970, 1971 and 1972 to the continuing shareholders, including proxy forms relating to the 1970 meeting. Two of the continuing shareholders completed these forms in favour of the accountant and returned them to him. Cheques were also sent to the continuing shareholders for dividends declared in 1972.

9. Mr. J. also gave evidence. He had no precise recollection of what took place; he was ``told'' by the scheme administrators that ``they had sold the shares'', and could not recall much more about the matter, although he recalled that he received nothing for the shares sold in 1970. His recollection of his reason for signing the proxy form (para. 8), which contained no solicitation, was that he was not very interested in going to the meeting. In cross-examination he conceded that he knew that the sale of the shares took place because ``somebody was interested in buying the losses, buying the company for a tax loss''. He added, ``I didn't understand what it was about. It didn't make sense to me...'' There was some confusion as to whether he had or had not been told by the scheme administrators that he had to retain his shares, though they would be of no value to him, but in re-examination he affirmed that no-one had

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ever told him that he had to retain his shares, and we accept this. He did not think he had met any of the purchasers at any time, despite the fact that minutes of a meeting held on 19th June, 1970, showed them both as present.

10. To complete the story, in 1976, some years after the losses had been recouped, the continuing shareholders sold the balance of their holdings to other parties. They originally declined offers to sell at par, but accepted $70 per share.

11. Counsel for the taxpayer submitted that in the light of the evidence summarised above, apart from the giving of the proxies (see para. 8), sec. 80B(5) could not operate. There was nothing to suggest that the continuing shareholders had entered into an arrangement, etc. which depended on the fact that they were the owners of the shares, and which had the purpose of enabling the company to gain the benefit of the tax losses. Consequently, he said, the Commissioner was not entitled to treat the continuing shareholders as not being the beneficial owners of their shares at all times during the two years ended 30th June, 1971. The proxies given by Mr. and Mrs. J, it was conceded, probably satisfied the requirements of sec. 80B(5)(a) and (b), being powers granted by those two continuing shareholders and dependent for their operation upon their ownership of the shares, and related to the exercise of one of their rights as shareholders, namely the right to vote. But, counsel said, the circumstances in which the proxies came to be given precluded a finding that they were granted for the purpose of enabling the company to take the tax losses into account within sec. 80B(5)(c). The forms had not been specially prepared for these two continuing shareholders; they were sent out by the company secretary as part of the general, routine practice that he followed in summoning general meetings, and it was, as counsel expressed it, ``adventitious that they happened to fill (them) out.'' Counsel for the Commissioner did not place any reliance at all upon the matter and, with respect, we agree with Mr. Forsyth that the giving of the proxies in these circumstances is not a relevant factor for purposes of sec. 80B(5)(c).

12. The case put by Mr. Dowling for the Commissioner really came down to this. In the first place, the continuing shareholders, or at any rate J, when he sold part of his holdings in June 1970 knew that the purchasers hoped the company would be able to make use of the tax losses. Next, it was said, he went ahead with the transaction having been told that the shares he retained were of no value, and knowing that the only reason he was retaining them lay in the desire of the purchasers to preserve the benefit of the tax losses. In the light of the other evidence, this involves taking a step that we are not disposed to take. We do not read as much into the file memorandum set out in para. 7 as counsel suggested should be done. The statement that J ``would co-operate in any way possible'' can be explained on a number of hypotheses; it is not necessary to relate it only to a sec. 80B(5) arrangement, etc.

13. Nor does the fact that the continuing shareholders could, simply by selling their remaining shares to an outsider, have brought to nought the plan to make use of the tax losses, provide any basis for concluding that there must therefore have been some arrangement of the proscribed kind.

14. In our opinion, the matter of the proxies apart, there was no arrangement entered into by the continuing shareholders such as authorises the Commissioner, pursuant to sec. 80B(5), to treat them as not being the beneficial owners, during the years ended 30th June, 1970 and 1971, of the shares not sold by them in June 1970. Nor, as we have said, can the proxies be treated as given for the purpose, or a purpose, such as is described in sec. 80B(5)(c). It follows therefore that we would allow the taxpayer's objections in full. The primary assessments issued in respect of the years ended 30th June, 1970, and 30th June, 1971, should be amended accordingly, and the Div. 7 assessments in respect of each of those years should be reduced to nil.

Claims allowed