New Zealand Flax Investments Ltd v Federal Commissioner of Taxation

61 CLR 179

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(Judgment by: Starke J)

New Zealand Flax Investments Ltd
v Federal Commissioner of Taxation

Court:

Judges: Rich J

Starke JDixon J
McTiernan J

Subject References:
Taxation and revenue
Income tax
Assessable income
Deductions claimed for future interest
Payment of bonds by instalments

Legislative References:
Income Tax Assessment Act 1922 No 37 - ss 23(1); s 25

Hearing date: SYDNEY 26 August 1938; 29 August 1938; 22 November 1938;
Judgment date: 22 November 1938

Sydney

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Judgment by:
Starke J

Appeal from the decisions of a board of review upon assessments to income tax for the trading period from 8th October 1928 to 30th June 1929, and for the next trading period ended 30th September 1930, referred into this court pursuant to s. 18 of the Judiciary Act.

The appellant, New Zealand Flax Investments Ltd , was a company incorporated under the Companies Act in New South Wales. and it carried on business there and in New Zealand. The objects of the company were, amongst others, to acquire lands suitable for growing New Zealand flax and clearing and cultivating the lands so acquired for the purpose of flax cultivation and to sell, issue and grant bonds, securities, certificates and the like giving such rights and privileges over the assets and property of the company as the company should decide and, upon such sale or issue of any such bonds, to transfer, assign and set over the same to such person or body as the company might decide.

The company during the period relevant to these appeals issued bonds of two series, called the first and second series, of the face value of PD30 and PD20 respectively. The issues were made under the terms and conditions of trust deeds. Each issue was, as I understand the facts, a separate and independent transaction from any other issue of bonds, though the various issues were together said to constitute the business of the company. But I shall only deal with the trust deed relating to the first issue. It recited that the company had entered into contracts for the purchase of 731 acres of freehold lands in the Bay of Plenty in New Zealand. It also recited that for the purpose of providing funds for the cultivation of such lands and the milling and marketing of flax produced therefrom the company proposed to issue and sell to the public a series of bonds upon the terms and conditions thereinafter appearing of a nominal value of PD30 for each one-half acre of the said land. And it also recited that the company had requested the Public Trustee, which was a corporation sole under the Public Trustee Act, to act as trustee for the purpose of securing the due performance by the company of the terms and conditions by it to be performed as therein stated.

The trust deed is attached to the reference, but I confine myself to a summary of the provisions I consider necessary for the consideration of these appeals. 1. The company covenanted to complete the purchase of the 731 acres of freehold land and to transfer the land to the trustee upon trust for the bondholders. 2. The company agreed that it should endeavour to sell the bonds, which should have a face value of PD30 each for each half acre of the said 731 acres, and that the bonds should be subject to the following terms and conditions: (a) that the company would not issue first series bonds representing an area greater in the aggregate than 731 acres; (b) that the bonds might be issued in respect of the aforesaid area of 731 acres; (c) each bond for PD30 might be paid for on application or in monthly instalments; (d) when the face value of the bond was fully paid in manner stipulated then the company would pay interest to the bondholder at the rate of 7 per cent per annum.

The deed then made provisions for the company cultivating the lands, erecting a mill and necessary plant for the efficient milling of the flax, and gathering and selling the flax. The company was to provide sufficient working capital for the cutting, milling and marketing of the flax, whereupon the company's obligation to bondholders ceased, subject to obligations to manage and administer the property. The company was to keep proper accounts and furnish the bondholders with a copy of the accounts of the company in so far as they related to the bondholders' interest. A true account of the expenditure in working the property was to be kept and an addition thereto might be made of an amount representing 5 per cent of the gross return from sales as the company's charge for administration. Rates and taxes and other incidental expenses and outgoings accruing against the land were to be paid by the company until such time as the first dividend was paid and then they were deductible from the moneys realized from the sale of the products so far as the same would extend. The net profits of the undertaking when ascertained were to be divided amongst the bondholders in proportion to their respective bond interests. The company also covenanted that in the event of its going into liquidation (except for the purpose of reconstruction) and there being any of the trust funds in the hands of the Public Trustee in the terms of the deed, then he should be at liberty upon such liquidation to return to the applicants for bonds the money in his hands in proportion to their interests.

The deed also enabled the Public Trustee to take over the operations agreed to be carried out by the company and to apply any moneys held by the company in trust for the bondholders or due and payable to it from the sale of the bonds in the manner in which they should have been applied by the company. "Bonds are now recognized," stated the prospectus for the first series of bonds, "as an important vehicle of investment and flax investment bonds representing a co-operative interest in the profitable New Zealand flax industry are regarded as sound securities backed up by productive farm lands increasing in value year by year. The well-known New Zealand financial critic, `Cambist,' writes:The flax industry is exempt from income tax and in that case there is nothing to whittle down the large profits to be earned from this form of enterprise. A sound endowment principle which will return an income for small investors better than anything else hitherto available. Investors in this company first of all secure an immediate return of 7 per cent interest on fully paid bonds which covers the development period of the plantations," and there follows a table giving the estimated returns thereafter to the bondholders. The scheme is well enough devised for the profit of the company and its promoters if the "best endeavours" of the company to dispose of the bonds resulted in subscriptions well above the cost of the land and the contemplated operations. But it can hardly be described as offering a sound security for bondholders: indeed it was a hazardous adventure put forward in a form likely to mislead unwary investors. It is not surprising that the company according to statements made at the bar has ceased operation. But this reference is only concerned with the assessment of the company to income tax imposed by the Commonwealth.

It appears that the 731 acres were purchased for PD4,473. Bonds of the No. 1 series sold to 30th June 1929 amounted to PD4,375, and in the next trading period I gather that 1,259 additional bonds of the No. 1 series were also sold. Pursuant to the income-tax Acts the company returned its gross profit or income for the trading period 8th October 1928 to 30th June 1929 as PD1,599 13s. 11d., and its net profit as PD154 16s. 3d. The trading account of the company thus shows the gross profit:

The item reserves PD1,762 11s. 6d. covered various items such as deferred commission, which represented the balance of commission due to salesmen in respect of bonds sold by them in the trading period but which were not fully paid in that period, and obligations to bondholders under the deed such as interest, and for clearing, cultivating and drainage of the land.

The sum of PD2,314, part of the sum of PD4,375, was not actually received during the trading period. But the reserves so far as they related to amounts set aside to meet obligations to bondholders were estimates based on experience, though they were reasonable and proper estimates and amounts.

The taxable income of the company was assessed at PD1,271 7s. 9d. on the following basis:

Profit disclosed in return PD154 16 3

Add (a) reserve for deferred commission PD264 10 0

(b) obligations to bondholders 1,479 12 6

1,762 11 6

PD1,917 7 9

Less expense charged to establishments etc 646 0 0

PD1,271 7 9

The board of review allowed a further reduction for interest and directed the assessment to be reduced for the period ended 30th June 1929 to PD969 18s. The argument before this court had not proceeded far when the court inquired whether the sum of PD4,375 received from the sale of bonds was income of the company for the purposes of the income-tax Acts, or a receipt of a capital nature, or moneys to which the bondholders were entitled. The bondholders were not parties to the proceedings and were necessarily unrepresented. The only answer the court received was that the Act taxes the gross income of the taxpayer-all that comes in-subject to certain statutory deductions and, in any case, that the matter was not raised by the objections to the assessments and the court was thus precluded from investigating it (Act, s. 51 (2)). The former answer overlooks the fact that the Income Tax Assessment Act imposes a tax upon income. It is not a tax upon everything that comes in whether an income receipt or a capital receipt (Ruhamah Property Co Ltd v Federal Commissioner of Taxation ^[F1] ; Premier Automatic Ticket Issuers Ltd v Federal Commissioner of Taxation ^[F2] ). The case of Webster v Deputy Federal Commissioner of Taxation (W.A.) ^[F3] and some cases in which it has been mentioned were also referred to. The provisions of s. 23 of the Act 1922-1934 prescribe that in calculating the taxable income of a taxpayer the total assessable income, that is, the gross income derived by the taxpayer, shall be taken as a basis and from it there shall be deducted certain items.

It is asserted that these and any other deductions elsewhere found in the Act are the only deductions that can be made, and that Webster's Case ^[F4] so decided. But the judgment of Knox C.J., in which Rich J. joined, merely asserts, so far as I understand it, that the deduction there claimed was an outgoing of a capital nature prohibited by s. 23 (1) of the Act. I should have thought that s. 23 did no more than enumerate various deductions to which the taxpayer was entitled but did not exclusively define those deductions. The prohibited deductions are to be found in other sections of the Act, such, for example, as ss. 25 and 23 (1). I do not know whether the matter is of any importance under the Act of 1936, but if it is I hope the question is not finally closed, for the rule will not give the income of a person in the ordinary signification of that term. Usher's Wiltshire Brewery Ltd v Bruce ^[F5] , on the English Acts, is worth attention. The latter answer is, I think, well founded, but it seems strange that the sum of PD2,314, part of the sum of PD4,375 which had not "come in" in the trading period in question, should be treated as income of that period.

The argument that the appellant relied upon in these proceedings was that the deduction of PD1,762 11s. 6d. claimed by it was wrongly disallowed. But the commissioner contends that the deductions are prohibited by the Act (ss. 23 (1) and 25). The former section allows a deduction for all losses or outgoings actually incurred in gaining or producing the assessable income. The latter section prescribes that a deduction shall not in any case be made in respect of money not wholly and exclusively laid out or expended for the production of assessable income. A good deal of argument was expended upon the meaning of these words. But I should like to refer to some observations of Lord Sumner in Usher's Case ^[F6] upon the question whether a disbursement was "wholly or exclusively" laid out for the purpose of the trade or concern. It had been said that the question was one of law and not of fact. But the noble and learned Lord observed:"With this I am not able to agree. Though the answer to the question may itself be an inference from a wide area of facts, it is an answer of fact.

There is no suggestion here that the commissioners found the facts under any mistake in law, including in that term the view, conscious or unconscious, that a fact may be found which there is no relevant evidence to support." It is difficult in the face of s. 25 to say that the board of review was in error in disallowing various items claimed as deductions. But it is open to doubt whether there is any evidence which justifies the precise sums arrived at by the board in respect of deferred commission and interest. The assessment has proceeded on a wrong basis from first to last and it is advisable in my judgment to set aside the assessments and remit them to the commissioner for reassessment. The assessment for the trading period 1st July 1929 to 30th September 1930 stands in the same position. The commissioner will doubtless give consideration to the suggestions made by this court: his duty is to see that the taxpayer is assessed according to law and not according to some mistake or want of understanding on the part of the taxpayer. But it is also necessary if the taxpayer desires to rely upon any such suggestions that it take them clearly and precisely in its notice of objections.

In my judgment the assessments for the trading periods should be set aside and the matters remitted to the commissioner for reassessment and the parties should abide their own costs of the proceedings throughout.