Sachs and Sachs v. Federal Commissioner of Taxation.

Judges:
Hanger CJ

Court:
Supreme Court of Queensland

Judgment date: Judgment handed down 8 December 1976.

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Hanger C.J.: This is an appeal by the taxpayer, Roger Norman Sachs, against an assessment to income tax, dated 9th August 1974, in respect of income derived during the year ended 30th June 1969. The taxpayer lodged an objection to the assessment; this was disallowed by the Commissioner; and the objection has been forwarded to this Court to be dealt with as an appeal.

The adjustment sheet which accompanied the assessment showed the income returned by

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the taxpayer as $8,130.00; and to this the Commissioner had added: "Income derived by you being your proportion of the distribution by Panjarra Pty. Ltd. as follows -

                Amount of
                Distribution
                 $170,000

                Date of
                Distribution
                 21/4/1969

                Your taxable
                proportion
                 $148,750"
      

It also contained a statement that a concessional deduction of $312 claimed for the wife of the taxpayer was disallowed.

In the result, the Commissioner assessed on a taxable income of $157,192.00

The question arising in the appeal is whether the circumstances which I shall set out, gave rise to the application of sec. 260 of the Income Tax Assessment Act.

Six companies may be mentioned at once. Of each of these, the taxpayer was a director. Abbotsford Pty. Ltd. was a holding company of National Springs Pty. Ltd., National Beds Pty. Ltd., National Manufacturing Pty. Ltd., National Nail Pty. Ltd. and Tarcoola Pty. Ltd. The five last-mentioned companies were described as operating companies. In early June 1968, National Springs, National Manufacturing and National Nail were directly owned by Abbotsford; National Beds was directly owned by National Springs: and Tarcoola was directly owned by National Nail.

From an affidavit by the taxpayer, it appears that in June 1968 it became obvious to him that the shareholders in Abbotsford would have difficulty in meeting their income tax commitments as a result of dividends which Abbotsford would have to declare to avoid additional tax under Div. 7 of the Act. He received a letter dated 31st May 1968 from a bank manager, which enclosed a circular dated 17th May 1968 from Quester Pty. Ltd. Having read this circular, he thought it possible that the income tax problem might be solved.

The circular is headed: ``Proposal for companies making big money so to minimise their tax bill.'' I shall not set out the contents in full; but the opening paragraph states that the company, the author of the circular, Quester Pty. Ltd., was able to provide, before 30th June 1968, public company status for tax purposes to select private companies whose income exceeded, say, $25,000 per year. The circular goes on to mention advantages of public company status as including (a) no necessity to pay dividends, with a consequent tax saving for the share-holders and a higher plough-back of profits into the business; (b) the ability to create an excess distribution prior to 30th June 1968 in the company already operating; (c) loans and advantages can be made to shareholders from a public company without any tax complications; (d) where dividends are received by public companies, the Commissioner must allow the full sec. 46 rebate whereas with private companies, the Commissioner may allow the full sec. 46 rebates on dividends from other private companies.

The concluding paragraph of the circular was:

``If immediate advantage is to be gained, public company status must be achieved before 30th June 1968. This requires prompt action as time is running out.''

About 18th June, the taxpayer discussed his problem with Mr. G. Offner, a member of the firm of accountants of the group of companies mentioned, and Mr. Butler, the Manager of National Nail. The scheme seemed complicated; time was short and he decided not to proceed with the scheme proposed in the circular. On 20th June, he talked further with Mr. Offner on the matter; and on 21st June, the problem was discussed by him with Mr. Offner and Mr. J. Baker, an accountant employed by Fadden & O'Shea, who had an interest in Quester. He was given then a brochure by Quester entitled ``Public Company Status''. This document was exhibited to the taxpayer's affidavit. The affidavit of the taxpayer states that, subject to the approval of the other directors of Abbotsford, he decided that that company should proceed with the offer made by Quester.

As a result of the discussions he had had, the directors - the taxpayer, his wife and Mr. C.G. Marjason - on 26th June agreed to proceed and the shareholdings of the group

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were rearranged. The shares held by National Springs in National Beds were transferred to Abbotsford and the shares held by National Nail in Tarcoola were transferred to Abbotsford. In the result, Abbotsford became the owner of the five operating companies.

On 27th June, the taxpayer and his wife became the only ordinary shareholders in Panjara Pty. Ltd., a company brought into existence by Quester or Fadden & O'Shea; and on the same day that company allotted redeemable preference shares to Fondulac Pty. Ltd. This company was a company listed in the Stock Exchange and therefore a public company. The issued and paid up capital of Panjara was then $100.00 held as follows: -

• Fondulac Pty. Ltd. - 60 redeemable preference shares of $1.00
• Taxpayer - 35 ordinary shares of $1.00
• Wife of Taxpayer - 5 ordinary shares of $1.00

The result of this share-holding was that Fondulac being a public company and Fondulac having control of Panjara by virtue of its shareholding, Panjara was a subsidiary of Fondulac and therefore a public company.

Abbotsford remained a private company. It was therefore subject to Div. 7 tax unless it made the necessary distribution of profits; the five operating companies were in the same situation.

On 28th June, Abbotsford allotted to Panjara ten non-voting redeemable preference shares. The Articles of Association of Abbotsford were not put in evidence, but a copy of a special resolution passed on 21st June 1968 was tendered; and from this it appears that non-cumulative participating preference shares conferred on the holders the right to a preferential dividend at the rate of 7% per annum and the right to such further preferential dividend in priority to all other shares as might be declared by the company. The holders had no voting rights. The shares might be redeemed on a resolution of the Board of Directors on seven days notice in writing of the intention to redeem.

On the same day, each of the five operating companies declared dividends to Abbotsford as follows: -

      National Springs              $31,242.00
      National Beds                 $25,102.00
      National Manufacturing        $44,882.00
      National Nail                 $44,288.00
      Tarcoola                       $4,278.00
                                   ------------
                                   $149,792.00
      

On the same day, Abbotsford declared an interim dividend to Panjara on the ten preference shares, of $170,200.00. The dividends declared by the operating companies and the dividend declared by Abbotsford were paid by journal entries in the books of the companies, crediting the relevant amounts to a loan account in the name of the shareholder; on 28th June, Panjara had agreed to lend Abbotsford $170,200.00 repayable on demand. Appropriate journal entries were made in the books of each of the companies.

In the result, it appears that the purpose of the taxpayer had been achieved; the funds of the companies were retained by them for their use. The taxpayer states that income tax returns for the year ended 30th June 1968 were lodged by all the companies and by the taxpayer and his wife on the basis of the transactions which had taken place and that assessments were issued in conformity with the returns.

On 10th April 1969, a Mr. D.P. O'Shea spoke to the taxpayer on the telephone. As a result of this conversation, the taxpayer says that he believed that the Deputy Commissioner of Taxation in New South Wales was disallowing, under sec. 46 of the Income Tax Assessment Act, rebates on dividends received by companies like Panjara; that Mr. O'Shea offered to purchase his shares and those of his wife in Panjara - in substance the whole of the shares - ``at a discount of $2,000 from their asset backing values''. He says he did not wish to become involved in litigation with the Commissioner if he should choose to disallow the rebate and decided to sell his shares to O'Shea and to advise his wife (who, he knew, would accept his advice), to do likewise.

He subsequently received a letter dated 15th April 1969 from Stratford Holdings Pty. Ltd. I do not understand why this letter was sent; Mr. Offner obviously had all the information it contained already.

The situation in which the taxpayer found himself was this. Panjara had been brought

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into existence because the taxpayer wished to retain for use by his operating companies the profits which were coming to Abbotsford. Matters were so arranged that Panjara was not a private company for income tax purposes and its funds could be loaned to shareholders. In accordance with this policy, the dividends declared by the five operating companies on 28th June 1968 in favour of Abbotsford amounting in all to $149,720.00 were retained by the operating companies; and the dividend declared by Abbotsford on the same day in favour of Panjara was paid by journal entries crediting the amount to a loan account in the name of the shareholders.

Paragraph 17 of the affidavit of the taxpayer is this:

``When I acquired the said shares in Panjara Pty. Ltd., I had no intention of selling them. It was my intention to hold the shares to maintain control of Panjara Pty. Ltd. which I believed to be a public company for income tax purposes being a subsidiary of the public company Fondulac Pty. Ltd. I intended that the operating companies should each year make excess distributions to Abbotsford Pty. Ltd. that it should issue shares to Panjara Ltd. and itself make excess distributions to Panjara Pty. Ltd. by dividends declared on those shares. I believed that a public company Panjara Pty. Ltd. did not have to declare a dividend to its shareholders to avoid Div. 7 tax and that it was not circumscribed in its ability to make loans to its shareholders. It was my intention that moneys paid to Panjara Pty. Ltd. by way of dividend should be loaned by that company to me or my wife or to the operating companies in the group. In order to prevent these loans being called in it was necessary for me to maintain my shareholding in Panjara Pty. Ltd.''

However, circumstances had changed to the extent that the taxpayer's belief in the security of the tax position was shaken. In fact, his position appeared to him to be: Panjara is faced with tax if no distribution is made; if distribution is made, the shareholders are faced with tax. What is the way out of this situation? The only way out is to sell the shares held in Panjara. It was this solution which was offered by O'Shea.

That the feared liability in Panjara to pay tax if it failed to make a distribution was not soundly based does not seem to me of importance in this case. To avoid this apprehended liability was one purpose of the course of action taken; it was this apprehension which gave rise to the course actually taken. The purpose or effect of the action taken was also to avoid the liability to tax on any dividends declared by Panjara in the hands of the taxpayer and his wife unless sec. 260 could be made use of.

The precise order of events thereafter is not entirely clear. Produced to me are minutes of a meeting of directors of Abbotsford dated 8th April 1969 at which it was resolved to redeem the 10 non-voting preference shares which it had issued to Panjara; and also a copy of a letter dated 9th April 1969 from Abbotsford to Panjara informing that company that redemption of the shares would be effected on 17th April. Mr. Offner said that the dates of the meeting and of the letter were incorrect. The wrong dates were used so as to make it appear that the necessary seven days notice of intention to redeem the preference shares had been given. From the material before me, it appears as if the meeting was held on 16th April: Mr. Offner agreed that putting a false date to the minutes of a meeting and on a letter would be done to deceive someone but he was not able to explain whom. The Commissioner of Taxation comes to mind. But, so far as I have been able to ascertain, the only importance of the false entries is that they reflect on the credit of the persons responsible. It does appear that the proceedings subsequent to the approach of Mr. O'Shea were intended to proceed with haste. An assessment had not been issued in respect of Panjara and it appears that O'Shea was anxious to have his scheme carried through before the assessment issued.

The taxpayer says that his motive in agreeing to the course which events took was to avoid litigation with the Commissioner and to avoid the Div. 7 tax which would have to be paid if the new attitude of the Commissioner to companies like Panjara should prove to be well founded in law. At my suggestion, Mr. Offner, as a statement of his approach to the scheme, said that the purpose was to avoid a potential liability to tax. This, no doubt, he would have explained as a reference to a Div. 7 tax.

There can be no doubt that the taxpayer and Mr. Offner knew that dividends declared to

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the taxpayer would be taxable. It was to avoid the necessity of paying these dividends that the scheme was adopted in 1968. There can also be no doubt that each of them knew the significance of the distinction between a receipt of capital and a receipt of income. The reiteration by the taxpayer and Mr. Offner that the purpose of the course of action taken in 1969 was to avoid possible Div. 7 tax and litigation with the Commissioner cannot obscure the fact that that course of action was expected and intended to have the effect of getting the assets of the companies into the hands of the shareholders as a capital receipt free of tax and therefore available to the companies for use in their businesses.

On 14th April, Art. 79A was deleted from the Articles. This dealt with notice of 21 days required for the appointment of a director.

On 16th April 1969, the taxpayer discussed with Mr. O'Shea by telephone the offer which had been made to purchase the shares in Panjara for the asset backed value less $2,000; and got Mr. Offner to prepare a ``Profit and Loss Appropriation Account'' and ``Balance Sheet'' of Panjara up to 30th June 1968 and a balance sheet of the company as at 17th April 1969. These were made available to O'Shea. The latter shows loans due to Panjara by Abbotsford, of $170,200, by P.D. Sachs, of $17,314 and by R.N. Sachs, of $68,634. It also shows a loan by National Nail to Panjara of $85,948 - a figure which coincides with the loans by Panjara to P.D. Sachs and R.N. Sachs. The taxpayer and his wife agreed to sell their shares in Panjara to Stratford Holdings Pty. Ltd. for $168,240 representing the net asset backing of the shares less $2,000. It was arranged that the completion of the transfer take place in Canberra to avoid stamp duty. The taxpayer was to receive $147,240 and his wife $21,030. O'Shea had asked that the loan accounts in Panjara be paid out before completion. I should add here that while the assets of the company are shown in the balance sheet as $170,300, the sale price of the shares, $168,240, is explained as excluding the nominal value of the 60 redeemable preference shares of Fondulac which were not being sold and the $2,000 commission to O'Shea.

A Mr. Steele, from Mr. Offner's firm, acted for the taxpayer and his wife for completion of the business. The 18th April 1969, the day of completion, was a Friday and the 21st April was the following Monday.

Steele took with him to Canberra a cheque for $20 made out by Abbotsford in favour of Panjara to redeem the ten preference shares; he took also a cheque for $68,633.64 made out by National Nail in favour of Panjara; this was to discharge the taxpayer's liability to Panjara; he took a cheque for $17,314.55 made out by National Nail to Panjara to discharge Mrs. Sach's liability to Panjara, and he took a National Nail cheque for $84,251.81 in favour of Panjara. By novations, the result would be that Panjara was paid all that was owed to it and had paid its debt to National Nail because the cheque for $84,251.81 represents the difference between the $170,200 owed by Abbotsford and the $85,948.19 owed by Panjara to National Nail; and the taxpayer and his wife would owe National $85,948.19.

On 16th April 1969, the directors of Panjara resolved that the company open a bank account at the Bank of New South Wales, Canberra, that necessary documents be provided for this purpose "and that the undermentioned persons be authorised to sign individually or jointly to operate the account (Five to operate). The undermentioned persons consisted of Mr. and Mrs. Sachs, Mr. C.G. Marjason (a director), Mr. J.A. Butler, and Mr. N.R. Meredith. Mr. Meredith went to Canberra to complete the transaction as the representative of the purchaser. On 16th April 1969, there was also held a meeting of directors of Panjara at which the Chairman (the taxpayer) advised that all shareholders were prepared to sell their shares at the sum of approximately $4,206.00 per share; that each shareholder was aware that the other shareholders were offering their shares to Stratford Holdings Pty. Ltd. also; and it was resolved that the directors advise Stratford Holdings Pty. Ltd. forthwith that all the issued ordinary shares were offered for sale for the sum of $168,240 but not including the 60 fully paid non-voting redeemable preference shares. At a meeting of the directors of Panjara on Thursday 17th April 1969 it was resolved that Mr. D.P. O'Shea, Mr. N.K. Meredith, and Mr. E.E. O'Shea be appointed directors of the company, the appointments to take effect immediately upon the completion of the purchase by Stratford Holdings Pty. Ltd. of the whole of the company's issued ordinary shares but not including the 60 fully paid non-voting redeemable preference shares.

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A copy of a minute of a meeting of directors of Panjara held at Canberra on 21st April 1969 shows an acceptance of resignations of R.N. Sachs and P.D. Sachs as directors; and a resolution for payment of a dividend of $170,000 to the holders of the undermentioned shares -

      40 ordinary shares              $68,000
      60 redeemable preference
      shares                         $102,000
                                    ----------
                                     $170,000
                                    ----------
      

In Canberra, on Friday 18th April, a bank account was opened in Canberra with the Bank of New South Wales there and into the account were paid Abbotsford's cheque for $20, and the three National Nail cheques for $68,633.64, $84,251.81 and $17,314.55 - a total deposit of $170,220.00. So far as appears, Stratford had no funds with which to pay for the shares being transferred to it in Panjara. This situation was remedied very quickly. On the same day, Friday 18th April, Panjara drew a cheque for $170,220.00 in favour of Stratford (Meredith being the signatory), and this cheque was paid on that day into an account opened by Stratford in Canberra on that day. The authority for this step does not appear clear to me. Panjara had not then declared any dividend; but a letter from Stratford to Panjara signed by E.E. O'Shea dated 21st April - the Monday following Friday 18th April - is in these terms:

``With respect to the proposed dividend to be declared on 21st April 1969, please note that it is our wish that this dividend shall be credited to our account with your company and so hold until we direct otherwise. In the meantime the loan so created shall be used to repay our loan and the balance, if any, shall be repayable on demand''

That Panjara in fact lent the money to Stratford appears from the evidence of D.P. O'Shea.

Stratford having now - Friday 18th April - $170,200.00 available to spend, drew cheques as follows:

•Cheque 624225 for $147,210.00 in favour of National Nail for credit to the account of Roger Norman Sachs;

•Cheque 624226 for $21,030.00 in favour of National Nail for credit to the account of Pamela Dorothy Sachs;

•and cheque 624227 for $2,000 in favour of Stratford.

The last cheque was debited to the account on 18th April; the other two on 22nd April. Clearly, these two were to discharge Stratford's liability to Mr. and Mrs. Sachs for the shares which Stratford had purchased in Panjara. Clearly also, it was money which came from Panjara to Stratford that provided Stratford with the means to make these payments.

The cheques for $147,210.00 and $21,030.00 were received by Mr. Offner and sent to the taxpayer so that they were received by him on 21st April. They were banked with the Bank of New South Wales to the credit of National Nail on the same day. It does appear that until these cheques were banked, National Nail did not have sufficient funds to meet the three cheques which it had drawn in favour of Panjara.

Neither Mr. Offner nor the taxpayer made any inquiries as to the financial standing of Stratford. I am satisfied that it was contemplated by the taxpayer and those in control of Stratford that the moneys of Panjara would be transferred to Stratford (as was in fact effected by Meredith) to be used for the purchase of the shares of the taxpayer and his wife; and I do not accept that the taxpayer or Offner was ignorant of the means by which the money to be used to pay for the shares was to be provided. Nor do I accept that there was no intention to declare a dividend in Panjara until after 18th April.

In the result, I am satisfied that there was an arrangement to which the taxpayer was a party which had the purpose and effect of relieving the taxpayer from a liability to pay tax - or would have had but for the operation of sec. 260. That the motivating factor was to avoid the apprehended threat that the Commissioner's axe would fall upon Panjara does not assist the taxpayer;

``the stubborn fact remains that, for whatever else the arrangement was a means, it was a means for the avoidance of tax''

(per Kitto J. in
Hancock v. F.C. of T. (1961) 108 C.L.R. 258 at p. 292.)

Once the share transfer is avoided as against the Commissioner, the conclusion necessarily follows that the assessment of the Commissioner must stand except for one small qualification. It appears that on my findings the assessment is excessive because it is based upon the amount distributed by

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Panjara to Stratford - an amount in fact larger than that which found its way to the taxpayer.

For the reasons given, the appeal by Mrs. Sachs must suffer the same fate as the appeal by her husband.