Federal Commissioner of Taxation v Miller Anderson Ltd

73 CLR 341
1946 - 0404A - HCA

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(Judgment by: LATHAM CJ)

Between: Federal Commissioner of Taxation
And: Miller Anderson Ltd

Court:

Judges:
Latham CJStarke J
Dixon J

Subject References:
Taxation and revenue
War-time company tax
Accumulated profits
Averaging of accumulated profits over accounting period

Legislative References:
War-time (Company) Tax Assessment Act 1940 No 90 - s 24

Hearing date: ADELAIDE 20 September 1945; 21 September 1945; 24 September 1945
Judgment date: 4 April 1946

SYDNEY

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Judgment by:
LATHAM CJ

These are two cases stated in appeals by the Federal Commissioner of Taxation against decisions of a Board of Review in relation to assessments of the respondent company under the War-time (Company) Tax Assessment Act. One assessment relates to an accounting period ended 31st January 1941, the relevant Acts in the case of this assessment being the War-time (Company) Tax Act 1940 and the War-time (Company) Tax Assessment Act 1940. The other assessment relates to an accounting period ended 31st January 1942, and in this case the relevant Acts are the War-time (Company) Tax Act 1940-1941 and the War-time (Company) Tax Assessment Act 1940-1941. The questions which arise upon the cases stated depend upon the interpretation and application of s. 24 of the Assessment Act, which has not been amended since its original enactment.

The procedure of appeal from an assessment to a Board of Review and from a Board of Review to the High Court is introduced by s. 34 of the Assessment Act, which applies the provisions of the Income Tax Assessment Act 1936-1941 relating to these matters.

War-time (company) tax is imposed upon the amount by which the taxable profit derived by any company during the relevant accounting period exceeds the percentage standard (s. 13). "Taxable profit" is defined in s. 3 of the Act. The percentage standard where the accounting period is a period of twelve months (as in the present case) is an amount equal to the statutory percentage of the capital employed or deemed to be employed during the accounting period (s. 19). The statutory percentage under the 1940 Act was 8 per cent, but was reduced to 5 per cent by the amending Assessment Act of 1941.

The greater the amount of the capital employed in any accounting period the higher the percentage standard, and the higher the percentage standard the smaller the amount of difference between the percentage standard and the taxable profit, and, therefore, the lower the tax. The company contends that in each assessment the Commissioner has wrongly calculated the capital employed during each accounting period, because he has deducted from the amount which the company claims to be correct an amount of loss incurred prior to 1st February 1935. The same question arises upon each case stated, and, following the course of argument, I propose to examine it in relation to the second assessment, i.e., for the accounting period ending 31st January 1942.

Section 24 of the Assessment Act contains the following provisions:

"(1)

Subject to section twenty-five of this Act, the capital employed in any accounting period shall, for the purposes of this Act, be ascertained by adding the following amounts, namely:

(a)

the capital paid up in money or by other valuable consideration, averaged over the accounting period;

(b)

accumulated profits, averaged over the accounting period, including amounts standing to the credit of the Profit and Loss Account at the commencement of the accounting period but not including any profit of the accounting period. ..."

The amount to be included in the capital under par. (a) of s. 24 (1) is not in dispute. It is the amount of the paid up capital less an amount of PD1,243, representing depreciated value of assets deducted under par. (i) of s. 24 (1). Thus it is agreed that under (a) the amount to be included in the capital employed in the accounting period is PD183,757.

Certain profits were placed by the company to the credit of reserve accounts. There are three reserve accounts-income tax, stock, and bad debts, amounting to PD17,792, which amount it is also agreed should be included in the capital employed. Deductions were made by the Commissioner in respect of a proportion of dividends declared during the accounting period and not paid until after the commencement of the period. As to this matter there is also no dispute.

Controversy arises with respect to the meaning and application of the following words appearing in par. (b) of s. 24 (1)-"accumulated profits ... including amounts standing to the credit of the Profit and Loss Account at the commencement of the accounting period."

The company's year ended on 31st January. The company made profits for the years 1928, 1929 and 1930 (that is, the years ending on 31st January in each case) and, after provision had been made for taxation, depreciation, bad debts and payment of dividends, there was PD820 to the credit of profit and loss account at the end of the accounting period ending 31st January 1930. In the five following years the results of trading were as follows:

As at 31st January 1935 the debit balance in what was called the "Profit and Loss Appropriation Account" was PD13,107.

At this time there were arrears of dividends on preference shares amounting to PD28,800, and ordinary shares had not received a dividend since 1929.

On 15th May 1935 an agreement was made and duly confirmed by which the rights of the preference shareholders were altered. Arrears of dividend were reduced in amount and payment on account of arrears was postponed until after 1st February 1938. The preference dividend rate was reduced and it was agreed that profits should be applied in the first place to satisfying preference shareholders upon the reduced basis of the agreement.

Another agreement varying the rights of shareholders was made on 7th September 1938. It provided for the distribution of future profits as between preference and ordinary shareholders, and, as to profits not distributed, for their retention, use or application, at the absolute discretion of the directors in "reducing the amount standing to the debit of `Profit and Loss Account on 31st January 1935,' in making further payments on account of the arrears of preference dividend on that day or in writing off depreciation" or such profits "might be retained and carried forward in the profit and loss account." In fact the power of applying profits to the reduction of the standing debit has not been exercised and the "Profit and Loss Appropriation Account on 31st January 1935" still shows the same debit of PD13,107.

After 31st January 1935 the company made profits, and these were "carried to a separate profit and loss appropriation account in the `liabilities' column of the company's balance sheets." This account was entitled "Profit and Loss Appropriation Account from 1st February 1935" (par. 11 of case). Thereafter the company had two sets of entries in its accounts, each described as "Profit and Loss Appropriation Account." The older account was called "Profit and Loss Appropriation Account to 31st January 1935" and at all times (with one exception) it has since shown merely a debit of PD13,107 1s. 10d.

The exception appears in the company's private ledger in a balance sheet as at 31st January 1936. In that ledger the following entries appear:

"Profit and Loss Appropriation-

Balance as at 31st January 1935	13,107 1 10
Less net profit for the year	5,579 0 10
	PD7,528 1 0"

But the published balance sheet issued to shareholders with the notice of the annual meeting held on 20th March 1936 contained the following entries:

Under "assets":

"'Profit and loss appropriation'-

Balance as at 31st January 1935

PD13,107 1 10."

Under "liabilities":

"'Profit and loss appropriation'-

from 1st February 1935

Net profit for year ended 31st January 1936

5,579 0 10."

The new account is called "Profit and Loss Appropriation Account from 1st February 1935." This account, made up from the liabilities column of the balance sheet (where alone the relevant entries appear), shows a credit balance in each year up to the latest accounting period, an application of part of the profit in paying dividends, and a credit balance as at 31st January 1941 of PD20,548.

The company claims that this amount of PD20,548 represents accumulated profits which should be included in the "capital employed" by virtue of the words "accumulated profits" in s. 24 (1) (b), and that no deduction should be made on account of the outstanding debit of PD13,107 recorded in the older account. That debit balance, it is contended, should be regarded as a loss of capital. The statements of account show that there was nothing to meet the loss except capital assets. Section 24 (1) (a) entitles the company to have all the capital which has been paid up in money included in the calculation of "capital employed," even though the capital has been lost. Similarly, it is argued, no attention should be paid to the debit of PD13,107.

Alternatively, the company contends that the amount of PD20,548 is an amount standing to the credit of the profit and loss account at the commencement of the accounting period, namely on 31st January 1941, and that therefore it should be included in the "capital employed" by virtue of the express words of s. 24 (1) (b).

The Commissioner contends, on the other hand, that the amount of PD20,548 does not represent accumulated profits because there has been no accumulation of this amount, inasmuch as it has not been set aside in any way from the general assets of the company. Further, it is contended for the Commissioner that the true amount standing to the credit of the profit and loss account is not PD20,548, but that sum less PD13,107. The section, it is said, refers to a true statement of accounts, and a true statement of the profit and loss account would show a credit balance, not of PD20,548, but of PD7,441.

The Board of Review by a majority decided in favour of the view submitted on behalf of the company.

Some guidance in interpreting the provisions of s. 24 (1) can be obtained from decisions of this Court upon somewhat similar provisions in other statutes. In Meares v Acting Federal Commissioner of Taxation ^[F1] , the Court held that a true profit and loss account, strictly so called, was limited to the dealings of a stated period. It was also said, however, that companies frequently transferred balances from the profit and loss account for one year to the same account for the following year, and that if that were done such action might well be thought to be "inconsistent with an intention to treat the amount so dealt with as an accumulated fund." Thus this decision suggests that an amount carried forward in a profit and loss account should be regarded as not "accumulated."

But other views have been expressed in the Court as to the meaning of "accumulated profits." In Forrest v Federal Commissioner of Taxation ^[F2] , the Court considered a provision in the Income Tax Assessment Act 1915-1916 referring to "undistributed income accumulated prior to 1st July 1914," with a proviso that amounts "carried forward by a company to the credit of the profit and loss account shall not be deemed to be accumulated income." The company in question revalued its assets, with the result that the value of assets was increased over their previously shown book values by an amount of PD100,000. The company, treating this sum as representing a profit the existence of which had not previously been recognized, applied the amount for the purpose of enabling shareholders to pay for debenture stock issued by the company. The question was whether a shareholder was liable to income tax in respect of the debenture stock issued to him, or whether, on the other hand, he escaped tax because the debenture stock represented profits accumulated before 1st July 1914. It was held that the increase in value was undistributed income so accumulated. In the judgment of the Court this was said: "Considering the object of the proviso that is, to exempt a shareholder from certain tax liability, we see no reason for attributing to the expression `undistributed income accumulated' any meaning other than income which had not been in fact distributed and had in fact accrued to the Company before 1st July 1914" ^[F3] . It will be observed that the "income" in question had not been separated from the other assets of the company by being placed in a reserve fund or otherwise. It had been received, and still existed. Those facts were regarded as sufficient to show that it had been "accumulated." It may further be noted that it was thought necessary by the legislature to make a provision expressly excluding from "accumulated income" amounts "carried forward" by a company to the credit of profit and loss account.

In Hooper & Harrison Ltd (in Liquidation) v Federal Commissioner of Taxation ^[F4] , one of the sections under consideration was s. 17 (1) of the War-time (Profits) Tax Assessment Act 1917-1918, which provided that:"The amount of the capital of a business shall be taken to be the amount of its capital paid up by the owner in money or in kind, together with all accumulated trading profits invested in the business, with the addition or subtraction of balances brought forward from previous years to the credit or debit respectively of profit and loss account." This section, providing for the ascertainment of "the amount of the capital of a business," performs in relation to the Act in which it appeared the same function as s. 24 in the present Act. Knox C.J., Higgins and Gavan Duffy JJ. decided the case upon the meaning of the word "invested" (See ^[F5] ), and not upon the meaning of the word "accumulated." (The word "invested" is not used in s. 24 (1) of the present Act.) Isaacs and Rich JJ., however, did examine the meaning of the word "accumulated" and were of opinion ^[F6] that the true import of the term, "accumulated profits" was "that they are profits which the Company has appropriated to some reserve account, whether that account be of a capital nature or not. `Accumulation' in that connection does not mean the mere existence of profits, even over a lengthened period, however they are employed; but it connotes the affirmative gathering of these profits, or such as may be selected, into a measured or measurable heap and allocated to a named reserve fund, whatever its nature may be." This view of the meaning of "accumulation" (differing from that expressed in the decision in Forrest's Case ^[F7] ) would exclude from accumulated profits a sum which existed only as a credit balance carried forward from one year to another in a profit and loss account, and not placed to any reserve. It is, I think, clear that the legislature had this possible view of the nature of accumulated profits in mind when it expressly provided in the present Act that an amount standing to the credit of a profit and loss account at the commencement of an accounting period should be included in the capital of the company. The words "accumulated profits" appearing at the beginning of par. (b) of s. 24 (1) might not have been effective to bring in such amounts.

In Stodart v Deputy Federal Commissioner of Taxation ^[F8] , the Court had to deal with a section in the Income Tax Assessment Act 1922-1927. This section corresponded to the section which was the subject of decision in Forrest's Case ^[F9] . It excluded from income sums received by a shareholder out of "undistributed income accumulated prior to 1st July 1914," but varied the terms of the earlier section by including the following provision:"For the purpose of this proviso, amounts carried forward by a company in its profit and loss account, appropriation account, revenue and expenses account, or any other account similar to any of the foregoing accounts shall not be deemed to be accumulated income." The company in which the taxpayer was a shareholder showed in its public accounts only the actual profit in respect of a yearly period, not bringing forward any balances from preceding years. (In so doing it presented a profit and loss account in the sense held to be strictly proper and accurate in Meares' Case ^[F10] .) The company had in its ledger a profit and loss account in which balances were carried forward from year to year. It was unanimously held by the court that the amount so brought forward was accumulated income. Knox C.J. simply said: "The sum ... represented trading profits earned by the Company in two preceding years and not distributed or otherwise dealt with, and, in my opinion, is properly described as accumulated income of the Company" ^[F11] . Isaacs J. in this case held that he was bound by Forrest's Case ^[F12] to come to the same conclusion. In so doing he adopted and applied the view which he had rejected in Hooper's Case ^[F13] . There was an equal division of opinion in the Court as to whether the words "carried forward by a company in its profit and loss account" referred to the public accounts of the company, or to its books of account, which were not public.

Another case which was mentioned in argument was Sharp, Stevenson & Hare Pty Ltd v Federal Commissioner of Taxation ^[F14] . But this case is an authority with respect to the meaning of the word "invested" and not with respect to the meaning of either "accumulated" or "carried forward."

The result of the decisions mentioned is that profits may be "accumulated," even if they are not placed to a reserve fund, but that no definite guidance has been afforded by the Court as to the meaning of the words "carried forward in a profit and loss account."

A profit and loss account strictly so called relates only to receipts and expenditure during a definite period; a profit and loss appropriation account is an account showing disposition of profit or method of dealing with a loss: Meares Case ^[F15] . Section 24 refers to a profit and loss account. But it has not been contended on behalf of the company that the "Profit and Loss Appropriation Account from 1st February 1935" is not a profit and loss account within the meaning of s. 24. Such a contention would prevent the company from relying upon the words "amounts standing to the credit of the Profit and Loss Account at the commencement of the accounting period," and would make it necessary for the company to rely only upon the words "accumulated profits." The cases cited show that a balance of profits may be held to be "accumulated" though they merely exist and have not been placed to a reserve fund. But "accumulation" plainly refers to the past and not to a current period. Thus accumulated profits must refer to a continuous account, and the words of the section show that the account is a loss as well as a profit account. Thus, if the matter is to be decided on the words "accumulated profits," it should be held that the loss of PD13,107 must be deducted from the amount of PD20,548. It is only this balance of PD7,441 which can be regarded as accumulated profits.

The company contends, however, that the amount of PD20,548 should be taken into account in full as an amount standing to the credit of its profit and loss account at the commencement of the accounting period, i.e., at 1st February 1941, without deduction of the amount of PD13,107.

In s. 24 (1) of the Assessment Act the legislature, in addition to including "accumulated profits," has expressly included money standing to the credit of a profit and loss account at the commencement of an accounting period. This provision excludes any argument that such an amount is not to be calculated in capital employed for the reason that it is not "accumulated." Further, this provision also seeks to avoid the difficulties which arose from the use of the words "carried forward" by substituting the words "standing to the credit." The words "carried forward" almost inevitably raise an argument as to whether the reference is not merely to the bookkeeping of the company; the words "standing to the credit" are perhaps stronger to exclude this argument and to require an ascertainment of the amount which actually stands to the credit of the account, whatever may be the form in which the books of the company are kept.

The company has elected to draw a line across its accounts at 1st February 1935, and, by separating its life into two periods, has shown a loss of PD13,107 in the first period, and what is called an accumulated profit of PD20,548 in the second period. There were quite good reasons for doing this arising out of the necessity for making some arrangement with the preferential shareholders. That arrangement involved special provisions as to the application of profits earned during a period after the making of the arrangement. But though such an arrangement limited the power of the company in respect of the disposition of its profits, it did not affect the amount of profits nor could it, in my opinion, affect the application of taxation legislation. If the company, for purposes of its business, could separate its accounts at 1st February 1935 and thus affect its liability to tax, it could equally well separate them at any other time and so could, without any real change in its true financial position, radically affect its tax liability. It could put all the profits into one account and all the losses into another account, and then claim that the profits so shown were amounts standing to the credit of a profit and loss account within the meaning of s. 24, so that they should be added to the capital employed by the company.

I am of opinion that it is not open to the company to do this, not because such a course would disappoint the revenue authorities, but because the terms of s. 24 (1) (b) show that the legislature intended that the profit and loss account referred to in the section should be a continuous account, and not a series of separate accounts relating to separate years or to selected groups of years. The words "standing to the credit of the profit and loss account at the commencement of the accounting period" show that the profit and loss account referred to is not an account of the strict character referred to in Meares' Case ^[F16] , that is, an account limited to the transactions of a single period, with no balance brought forward from preceding years. A profit and loss account of such a character cannot have any amount standing to its credit at the commencement of an accounting period. Thus the profit and loss account which the section contemplates is a profit and loss account which does bring forward balances at the beginning of each year. The account, therefore, must be continuous and, being an account of losses as well as of profits, must bring forward debit balances as well as credit balances. The difficulties revealed in the cases as to the meaning of "carried forward" are avoided by the use of the words "standing to credit at the commencement of the accounting period." The only question to be asked is whether the amount in question really stands to the credit of the profit and loss account at the relevant time. I use the word "really" because the section does not say "shown as standing to the credit" etc The words which are used mean "actually standing to credit upon a true statement in a continuous account."

The result is that, in my opinion, the two profit and loss accounts of the company must be regarded as a single account. The company cannot at will divide its profit and loss account into two or more profit and loss (or profit or loss) accounts and elect to ignore one or more for the purpose of s. 24. Thus, in my opinion, the debit balance of PD13,107 must be carried forward, with the result that the credit balance of PD20,548 is reduced to PD7,441.

Argument was addressed to the Court as to whether the company was entitled to declare dividends before replacing the loss of PD13,107 (Lee v Neuchatel Asphalte Co ^[F17] ; Ammonia Soda Co Ltd v Chamberlain ^[F18] ). But this question does not appear to me to have any relevance to the first question in the cases before the Court.

Question No. 1 in the case relating to the accounting period ending on 31st January 1942 is:

"Whether upon the true construction of s. 24 of the War-time (Company) Tax Assessment Act 1940-1942 the sum of PD13,107 1s. 10d. standing to the debit of `Profit and Loss Appropriation Account to 31st January 1935' in the books of the respondent company on 1st February 1941 should have been taken into account in computing the capital of the company employed in the accounting period which ended on 31st January 1942 for the purposes of such section."

In my opinion this question should be answered: Yes.

The amount standing to the credit of the profit and loss account should therefore be stated as PD7,441, and not as PD20,548, and the amount of accumulated profits at the commencement of the accounting period is therefore PD25,233, the total of the reserve fund (PD17,792) and PD7,441.

A further question arises, however, as to the application of the provision in s. 24 (1) (b) that "accumulated profits" are to be "averaged over the accounting period." In my opinion this provision for averaging applies to all the accumulated profits to which the provision relates, that is to say, in the present case it includes not only the reserve funds mentioned, but also the amount of PD7,441 standing to the credit of the profit and loss account at the commencement of the accounting period.

On 31st March 1941, that is, after 59 days of the accounting period had elapsed, the company declared a dividend of PD10,075. The company did not draw upon the reserve funds, and the dividend was in fact paid out of other moneys, namely out of the whole or part of the amount of PD20,548, which represented profits earned since 1935. The company was entitled to do this without replacing the accrued loss of PD13,107: See Lee v Neuchatel Asphalte Co ^[F19] . The question is as to the proper method of averaging the accumulated profits under the section. If the whole of the PD7,441 is regarded as having been absorbed by the payment of the dividend, the company would be regarded as having the use of PD7,441 (part of PD25,233) for only 59 days of the year, and the proper addition to make to the reserve fund (PD17,792) under the section would be 59/365 of PD7,441, that is, PD1,203.

This was the view taken by the chairman of the Board and it was in effect accepted on both sides upon the hearing of the appeal. Subsequently, upon the invitation of the Court, counsel made submissions with respect to another possible method of applying the averaging provision of the section. The parties also agreed upon a further fact as to the declaration of the dividend which they desired the Court to take into consideration. This fact is that the company resolved in general meeting to adopt a recommendation of the directors that the dividend be paid out of a sum of PD14,528, being the profits of the preceding year. According to the other possible method of applying the averaging provision the dividend would be regarded as paid either out of the whole credit balance of PD20,548, or alternatively out of the amount of PD14,528, and only a ratable proportion of the dividend would be treated as paid out of the amount of PD7,441. There is, I think, much to be said in support of this view. But, though not without doubt, I have come to the conclusion that the former view is to be preferred. Section 24 adopts a special artificial method of determining the "capital employed" for the purposes of the Act. It is the part of that capital, determined in accordance with par. (b) of the section, that is to be averaged. The reference to averaging supposes that that part of such capital may be increased or diminished during an accounting period. Increases during the year are to be added to that capital and on the same principle decreases during the year should be charged against that capital, in each case in respect of the period during which the increase or decrease was effective in relation to the amount of that capital available for use by the company. The object of s. 24 is to ascertain how much capital is to be taken for the purposes of the Act as being used in the business of the company. Only the amount calculated in accordance with this section is regarded by the Act as being available for disposition by the company. Where, as in this case, part of the capital is made up of accumulated profits as ascertained under par. (b) of the section, expenditure chargeable against accumulated profits should, I think, be regarded as chargeable against the accumulated profits which are recognized by the Act as part of the statutory artificial "capital employed," and not against another fund which the section excludes from recognition as accumulated profits within the meaning of the Act. Thus the proper addition to make to the reserve fund (PD17,792) is, in my opinion, the above-mentioned sum of PD1,203.

The second question in the case, which suggests various methods of averaging, should be answered by stating that the method set out in par. 2 (c) of the question is correct.

A corresponding order should be made in the other case-No. 9 of 1943. The costs of the cases should be costs in the appeal and the cases should be remitted to Dixon J.