Investment and Merchant Finance Corporation Ltd v FCT

(1971) 125 CLR 249
(1971) 45 ALJR 432
(1971) 71 ATC 4140
(1971) 2 ATR 361
BC7100340

---

(Judgment by: Menzies J)

Investment and Merchant Finance Corporation Ltd
v FCT

Court:

Judges: Barwick CJ
McTiernan J

Menzies JWalsh J

Hearing date: 12 and 13 May 1971
Judgment date: 18 August 1971

---

Judgment by:
Menzies J

The appellant taxpayer, which has at all times material been inter alia a dealer in shares, bought, in October 1963, twenty-one shares in Macgrenor Investment Pty Ltd for approximately £4000 a share. There were out-of-pockets in connexion with the purchase and the taxpayer's total outlay for the shares was £86,503 17s0d. Macgrenor had large profits available for immediate distribution among shareholders and in November 1963 it declared and paid a dividend, of which the taxpayer received £81,900. In December 1964 the taxpayer sold its twenty-one shares in Macgrenor for £1 a share each. The effect of the foregoing, according to the taxpayer, was that in the year ended 30 June 1964 the outlay of £86,503 17s0d was a taxation deduction; the dividend of £81,900 was rebatable under s 46 of the Income Tax and Social Services Contribution Assessment Act 1936-1964 (Cth), and, in the year ended 30 June 1965, the difference between the purchase price of the shares, £86,503 17s0d and their selling price, £21, was a taxation deduction.

Until the dividend had been received the shares, which had by virtue of the purchase become part of the taxpayer's stock in trade, were worth what had been paid for them. After the receipt of the dividend they were not. They were worth approximately the difference between the price paid and the dividend received, ie £4607 17s0d. In its taxation return for the year ended 30 June 1964 the taxpayer showed the dividend of £81,900 and it showed the twenty-one Macgrenor shares which, in one place, were wrongly stated to have cost £3250. Had the Macgrenor shares been shown in the taxpayer's commercial accounts for the year ended 30 June 1964 as worth what had been paid for them, the accounts would, of course, have been grossly misleading. To avoid this, what the taxpayer did was to write down their value by £82,931. In its income tax return, however, it added back the amount written off so that, for the purposes of the calculation of tax for the year ended 30 June 1964 (the Macgrenor shares having been shown in the commercial account as worth £3250, arrived at as follows: Cost Price (less £323 stamp duty): £86,180 17s0d. Less Written Down: £82,930 17s0d. Written Down Book Value: £3250 0s0d.) there was added to the item net profit before taxation -- as shown in the commercial accounts -- the amount written off, ie £82,931. The consequence of this was that, for taxation purposes, the shares were treated as having cost £86,180 17s0d and as valued at that sum as part of the taxpayer's stock in trade on 30 June 1964, although then their true value was about £3250. No doubt the justification for what was done was found in s 31 of the Income Tax and Social Services Contribution Assessment Act 1936-1964 (Cth). Each share was presumably taken into account at the end of the year of income at its cost price, although in its own accounts the taxpayer took it into account at what was really market selling value. To this aspect of the matter I will return later. The point for present purposes is that the Macgrenor shares were bought for £86,503 17s0d and were, for taxation purposes, taken in stock on 30 June 1964 as valued at that amount. Accordingly, when they were sold for £21 in December 1964 there was, so the taxpayer claimed, a loss of £86,682 17s0d The Commissioner, however, took a different view. He allowed as a deductible loss the sum of £4583, being the calculated difference between the purchase price which the taxpayer had paid for the shares and the sum of the dividend received upon the shares, £81,900, and the price at which they were sold, £21. This assessment Windeyer J upheld, and the appeal is from that decision.

The learned Solicitor-General sought to uphold the assessment and the judgment in two ways. First, on the footing that the whole transaction was of a capital nature, so that the difference, between what was paid for the shares when purchased, and what was received for the shares when sold, was a capital loss and therefore not deductible. Alternatively, on the footing that the transaction, as a whole, was the carrying out of a profit-making scheme for the purposes of s 26(a) of the Act, and that, in determining the profit derived from the scheme, the dividend received should be brought into account rather than being treated as itself assessable income in accordance with s 44 of the Act.

In advancing the first proposition the learned Solicitor-General did not deny that the taxpayer was a share dealer; his contention was rather that this particular transaction was outside its business as a share dealer and was of a capital nature. Of course, a dealer may enter into a transaction that does fall outside his income-producing business. Thus a company, which buys and sells land, might buy a building to occupy as its principal office so that the purchase price paid for it would be an outgoing of a capital nature. I have, however, found no basis here for excluding this transaction from the taxpayer's share dealing transactions. The learned trial judge clearly regarded it as falling within that business. In doing so he was, I think, correct. The taxpayer bought the shares intending to take the dividend and to sell the shares at their then market price. It was undoubtedly true that the attraction of the transaction lay in the concurrence of three features, namely, that the purchase price would be deductible from assessable income; that the dividend to be received would be rebatable and that the sale of the shares would result in a loss which would, it was expected, be deductible from other income of the year in which the loss was made. It seems to me, however, that this transaction was a transaction of a trading character. The decision of the House of Lords in Griffiths (Inspector of Taxes) v J P Harrison (Watford) Ltd (1963) AC 1; (1962) 1 All ER 909; (1962) 40 TC 281 supports this conclusion. In the later case of Bishop (Inspector of Taxes) v Finsbury Securities Ltd (1966) 1 WLR 1402, at pp 1416-1417; (1966) 3 All ER 105, at p 111; (1966) 43 TC 591, at p 626-627, Lord Morris spoke of Harrison's Case (1963) AC 1; (1962) 1 All ER 909; (1962) 40 TC 281 in these terms: "In that case there was a purchase of the shares in a company called Bendit Ltd (afterwards called Claiborne Ltd). The vendors of the shares had no interest in the shares thereafter. They had no prospect of receiving any benefit from any tax recovery. After the Harrison company owned the shares in Claiborne Ltd there was a declaration of dividend on the shares. After that the shares were sold. It was my view in that case that the transaction was demonstrably a share-dealing transaction. Shares were bought; a dividend on them was received; later the shares were sold. There may action when deciding as to its nature. In the Harrison Case, (1963) AC1; (1962) 1 All ER 909; (1962) 40 TC 281, my view was that there could be no room for doubt as to the real and genuine nature of the transaction. The fact that the reason why it was entered into was that the provisions of the revenue law gave good ground for thinking that welcome fiscal benefit could follow did not in any way change the character of the transaction. It was not capable of being made better or worse or being altered or made different by the circumstance that the motive that inspired it was plain for all to see." In Harrison's Case Viscount Simonds (1963) AC, at pp 11-12; (1962) 1 All ER, at p 912; (1962) 40 TC, at pp 293-294 had said: "Here was a company whose object it was to deal in shares. It entered into a commercial transaction which, though it might be given an invidious name, contained no element of impropriety, much less of illegality. I can find nothing that enables me to say that it is not a trading transaction, and echo the question asked by the majority in the Court of Appeal: 'If it is not that, what is it?' No doubt, many observations that have been made alio intuitu will be found to the effect that trade is carried on with a view to a profit. This proposition, however, is not universally true, nor can it be tested merely by ascertaining the difference between the purchase price (or, it may be, the manufacturing cost) of an article and the selling price of that article. For a dealer may seek his profit, if a profit is essential, otherwise than by an enhanced price on a re-sale, as by a declaration of dividend, a repayment on a reduction of capital or on a liquidation of the company whose shares he has bought. It appears to me to be wholly immaterial, so long as the transaction is not a sham (as was the case in Johnson v J S Jewitt (Inspector of Taxes) (1961) 40 TC 231), what may be the fiscal result, or the ulterior fiscal object of the transaction . . ." The expenditure incurred in buying the shares was, I have no doubt, in a sense a capital expenditure, but being, as I see it, "expenditure incurred . . . in the purchase of stock used by the taxpayer as trading stock" it is not to be deemed an outgoing of capital: Income Tax Assessment Act 1936-1965 (Cth), s 51(2). Accordingly, in my opinion, the judgment is not to be upheld upon the learned Solicitor-General's first submission.

I come now to the learned Solicitor-General's second submission. I would not dispute that what the taxpayer did, in buying the I would not dispute that what the taxpayer did, in buying the shares, reaping the dividend and selling the shares, was to carry out a profit-making scheme. It did so, however, in the course of its business as a share dealer. I do not think that every business that involves the buying and selling of stock in trade is to be fragmented into a large number of separate transactions and the dealer taxed on the aggregate of the profits derived from each transaction considered separately. The taxable income of a business is to be ascertained by deducting allowable deductions from assesable income, and in the calculation of assessable income regard must be had to many considerations to be found specified in the Income Tax Assessment Act, such as all the appropriate items set out in s 26; the requirement that trading stock on hand at the beginning of the year of income and at the end of the year of income must be brought into account; to the allowance of depreciation; to the deduction of bad debts; to past losses. It is the assessable income of the business as a whole to which regard must be had and from which deductions are to be made to arrive at taxable income. It is significant that s 26(a) defines but one item to be included in assessable income, and, in my opinion, the whole of the carrying on of a business of buying and selling is not to be comprehended within s 26(a), nor does that provision aptly apply to the particular dealings constituting, in total, the carrying on of a business. S 26(a) deals with particular transactions which might otherwise escape from the tax net and it brings into assessable income profits, after outgoings attributable to the particular transaction have been taken into account. Outgoings made in earning a profit which is assessable income by virtue of s 26(a) are not outgoings for the purposes of s 51. There is no profit from a scheme to be included in assessable income until such outgoings have been taken into account. In most cases items of assessable income are gross receipts; a profit which is assessable income by virtue of s 26(a) is a net receipt. In my opinion, therefore, the income derived from the transaction with which we are here concerned is not to be brought into account as a profit pursuant to s 26(a). The transaction in question was part of the business of the taxpayer and it is the proceeds of that business that constitute the income of the taxpayer. I have re-read my observations about s 26(a) in Australasian Catholic Assurance Co Ltd v Federal Commissioner of Taxation (1959) 100 CLR 502, at p 509, and further consideration of the problem has confirmed me in what I there said.

There is, however, another reason for rejecting the learned Solicitor-General's second argument. That argument involves disregarding as assessable income the dividend which was declared and paid notwithstanding that it was received before there was any completed scheme that could yield a profit to be included as assessable income by virtue of s 26(a). I consider that dividend was assessable income simply by virtue of the provisions of s 44 of the Income Tax Assessment Act. Had this transaction been carried out by an individual, rather than by a company, there could, I think, have been no question but that the dividend which was received would be part of the individual's assessable income, although, of course, it would not be rebatable under s 46. It makes no difference to the nature of the transaction that the taxpayer is a company. It is, of course, true that it is because company dividends are rebatable under s 46 that dividend-stripping is so attractive, and, if it be thought that this is a practice which should be checked, it is to that section that Parliament may choose to direct some of its attention. It is not for the courts, however, to depart from Parliament's clear statement in s 44 that assessable income of shareholders, including companies, shall include dividends, and to do so in order to bring the dividends into account as part of the profits of transactions of buying and selling outside the operation of s 46 which makes certain dividends paid to companies rebateable.

This alternative argument of the learned Solicitor-General is the argument which found favour with the learned trial judge. I regret that I cannot accept it. Subject to two matters which I shall have to mention, it seems to me that the taxpayer has done no more than taken advantage of the provisions of the Act to reduce its income in the year of the purchase of the shares by an outgoing of the purchase price paid for them; to increase its income in that year by the receipt of a rebatable dividend almost equal to the purchase price paid; and in the year of sale to have incurred a loss being the difference between the purchase price of the shares -- which was also their value as stock in trade for taxation purposes -- and their sale price.

The first of the outstanding matters to which I want to refer is concerned with the application of s 31 of the Income Tax Assessment Act. As I have already set out, the taxpayer, upon receipt of the dividend upon the Macgrenor shares, wrote down their value by approximately the amount of the dividend. The result of this was, in effect, that the shares were then in the taxpayer's accounts at or near market selling value, although they were eventually sold for less, no doubt to give the buyers some advantage. Thus, at the end of the year in which the shares were bought they were brought into account at £3250, and in the course of that year they were sold for £21. However, in the taxpayer's income tax return they were, in effect, brought into account at £86,503 17 s Od. by virtue of the adding back of what had been written off. There was no argument whether or not this sort of double-dealing -- I use the word inoffensively -- is permissible. Presumably it is, for when the Act provides a method for the ascertainment of the value of stock in trade for the purposes of determining assessable and taxable income (ss 28 and 31) it does not go further and require that the taxpayer's profits should be determined in the same way for commercial purposes, or require the taxpayer's taxation return to accord with its commercial accounts. However, I do not pursue this matter further beyond noting that, had the taxpayer's return to the Commissioner been made up on the same basis as that upon which the taxpayer's books of account were kept, it would seem that the taxpayer would have made a substantial loss in the year ended 30 June 1964, for in that year it would have had the additional advantage of stock values at the end of the year reduced by the amount written off. In other words, the Macgrenor shares would, at 30 June 1964, have been valued at market selling value rather than at cost price. The course actually taken did give the taxpayer considerable taxation benefits in the year ended 30 June 1965 as well as in the year ended 30 June 1964. However, as no attention was devoted to what may be a problem that it is immaterial to solve, I refer to it simply to leave the matter open.

The final problem relates to the proviso to s 52. The loss said to have been incurred upon the sale of the shares is deductible by virtue of s 51. What bearing then has s 52 upon the matter? We were informed by counsel for the appellant that the case was conducted, at first instance, upon the footing that the Commissioner had been duly notified that the Macgrenor shares had been acquired by the taxpayer for the purpose of profit making by sale or for carrying on or carrying out of any profit-making undertaking or scheme. The notice was given, no doubt, to attract s 52. There is, however, no such notice among the papers, nor was it possible to inform us of its terms. This might have been an insurmountable difficulty for the taxpayer if it had to rely upon s 52 for the deduction which it claims. Consistently, however, with the view which I have expressed about s 26(a) and its inapplicability to this transaction, I have come to the conclusion that s 52 does not apply here. It is a companion section to s 26(a) and it applies only when that provision would apply to a profit, which, if made, would have to have been included in assessable income. It seems to me the proper way to regard the loss here in question is simply that, in the course of its business as a dealer in shares, the Macgrenor shares were bought for £86,503 17s 0d, and, having been stripped of their dividend, were sold for £21. The difference was a loss incurred in carrying on the business of share-dealing. It is as if an aged stud cow in calf were to be bought by a breeder and dealer for $500 and after the birth of the calf the cow was sold to a butcher for $100. An outgoing of $500 and a receipt of $100 would, in that case, produce a loss of $400. The only difference in principle between such a transaction and that which is under consideration here is that, whereas a dividend is rebatable, the value of the calf would not be rebatable.

Accordingly, I think this appeal should be allowed and the assessment reduced by allowing as a deduction from the assessable income of the taxpayer for the year ended 30 June 1965 the sum of £86,503 17s0d, instead of the sum of £4583 which the Commissioner has allowed.