Burnside v. Federal Commissioner of Taxation.

Judges: Barwick CJ
Mason J
Stephen J
Jacobs J

Aickin J

Court:
Full High Court

Judgment date: Judgment handed down 22 December 1977.

Aichin J: This is an appeal from a decision of Hogarth J. of the Supreme Court of South Australia in two appeals by the taxpayer against the disallowance of objections to the Commissioner's assessment of income tax in respect of the years ended 30th June 1970 and 1971. The Commissioner disallowed the objections and the taxpayer appealed to the High Court of Australia pursuant to the provisions of the Income Tax Assessment Act 1936 (as amended) but the appeals were remitted to the Supreme Court of South Australia for hearing in that Court.

The judgment of Hogarth J. contains a careful review of the history of the matter and of all relevant facts and it is not necessary to repeat the whole of that account here. The Commissioner included in the assessable income of the taxpayer in each of the two years an amount representing the profit made by the taxpayer on the sale of shares in a mining company, Samin Ltd. The taxpayer had acquired 14,8000 shares in that company for which he had applied on 18th December 1969 on the occasion of a public floatation. The shares were allotted to him in early January 1970. He sold 6,400 of those shares between February and August 1970. The origin of the transaction and the association out of which it arose as accepted by the learned trial judge went back prior to 1969. The appellant is a geophysicist of Canadian origin and in 1948 he entered the employment of a Canadian company, McPhar Geophysics Ltd. (``McPhar Canada'') and remained in its employment or that of associated companies at all relevant times. At some stage he became a shareholder in McPhar Canada and in 1969 held about 8 per cent of its paid-up capital. In 1961 McPhar Canada entered into a consortium with three Australian companies interested in exploration for minerals and the development of mines. Broken Hill South Ltd. was the major participant and it arranged for McPhar Canada to provide technical assistance for a period of three years. This was effected by a subsidiary, McPhar Geophysics Pty. Ltd. (``McPhar Australia'') incorporated in Australia. McPhar Australia entered into the consortium on the basis that its services would be supplied at cost, but that in the event of any mining activity being undertaken it would have the right to enter the venture on a 10 percent basis. The appellant came to Australia in 1961 as the Vice-President and General Manager of McPhar Canada for a three year term. He returned to Canada in 1964 but made two further trips to Australia in that year and in the following year. During this time negotiations were under way for a further three year contract with the other members of the consortium. In the result the agreement was renewed and the appellant returned to Australia to live in 1965 and settled in Adelaide. The appellant was during the second three year term promoted to being President and Managing Director of McPhar Australia. During the second term the consortium explored a number of copper prospects in South Australia and the appellant was

ATC 4598

connected with those activities. During that period he was closely associated with Mr. Lewis, a geologist employed by Broken Hill South Ltd.

During the latter part of the second three year term Lewis learned that the Australian members of the consortium were not likely to be interested in one of the two copper deposits which had been investigated, namely, that at a place called Burra. He left the employment of Broken Hill South Ltd. on 30th June 1969 after discussions with the Chairman of Directors of that company. With other employees of that company he formed a syndicate with the object of forming a company to take over the interest of the consortium at Burra and to mine the deposits there. The appellant was not a member of that syndicate. However the prospect of forming such a syndicate had been discussed by Lewis with the appellant and Dr. Hallof, the President of McPhar Canada, over a period prior to 30th June 1969. Lewis' evidence was that about two or three months prior to 30th June Dr. Hallof and the appellant had indicated that McPhar Australia would participate and would like to increase its interest above the 10 per cent to which it was entitled in the original consortium and a figure of 25 per cent was mentioned. It was not at any time contemplated that it would take less than 10 per cent. Lewis also said that at the same time it was informally agreed that a proportion of McPhar Australia's entitlement would go to its staff on a percentage basis to be determined later. In September 1969 Lewis received formal confirmation that the other two Australian members of the original consortium were not interested in pursuing the Burra project and he then approached the Director of Mines in South Australia. On 30th September he was informed that the Minister would approve the transfer of the mining tenements to the proposed company. On 6th October 1969 Samin Ltd. (``Samin'') was incorporated on Lewis' instructions. The appellant and McPhar Australia were kept informed of these developments. Prior to that, further discussions took place in August between the appellant, Lewis and Dr. Hallof who was in Australia at that time. It was then agreed that McPhar Australia's proportion should be a 10 per cent interest in the new company and that a stated proportion of that would be made available to be taken up by the appellant and other employees of McPhar Australia and by Dr. Hallof himself. These discussions took place on the basis of the percentage of the capital of the new company to be attributed to McPhar Australia, because at that stage the amount of capital required was not definitely known. At that time it was contemplated by Lewis that it would require between half a million and a million dollars to set up the mining operations.

On 29th September 1969 another mining company, Poseidon N.L. (``Poseidon''), reported the discovery of a rich deposit of nickel on a mining tenement in Western Australia and its shares rose rapidly on the stock exchanges. There was prior to that no connexion between Samin and Poseidon, but later on that day Lewis made an arrangement with those concerned with Poseidon that Samin would apply for and be allotted 200,000 fully paid 20 ¢ shares in Poseidon at the closing market price on 30th September, less $2 per share. This discount was to represent services in the mining and exploration field to be performed by Samin's experts for the benefit of Poseidon. At the same time it was agreed that Poseidon would take up 200,000 shares in Samin at par, which it did shortly after that company was incorporated. The actual price for Samin's shares in Poseidon was subsequently fixed at $5 per share for the 200,000 shares, thus requiring the payment of $1,000,000. This arrangement required changes in the proposed capital structure of Samin. The necessary funds to enable it to take up the Poseidon shares were borrowed on a short-term basis, but ultimately an issue of approximately 2,000,000 shares of 50 ¢ each was made over and above what would otherwise have been required for the Burra operation alone.

Samin was incorporated with an authorized capital of $5,000,000 divided into 10,000,000 shares of 50 ¢ each. By then the market price of Poseidon shares had risen to $20 so that Samin's shares in Poseidon would on that basis be valued at $4,000,000, compared with Samin's then issued capital of approximately $100,250. Shortly after Samin was incorporated it was decided to issue 3,000,000 shares so as to bring the total paid-up capital to $1,600,250. Of this $1,000,000 was required to pay off the loan which had been raised to take up the Poseidon shares. A list was prepared setting out the persons and companies who were to be invited to apply for these shares and the number which would be

ATC 4599

reserved for allotment to them. Firm arrangements were made between Dr. Hallof, the appellant and Lewis as to the allocation of shares from the McPhar Australia interest to its employees. It was then agreed that Dr. Hallof himself might apply for and be allotted 20,000 shares and that the appellant would be entitled to the same number. Other employees of McPhar Australia were to be entitled to allotments of other numbers of shares which were also agreed upon at the time. The issue of shares by Samin was delayed by the formalities required for the issue of a prospectus. The prospectus was issued on 10th December 1969. On 18th December the appellant applied for 14,600 shares in his own name and his wife and children applied for the balance of the 20,000 shares except for 400 shares which were applied for by his bank manager, who acted generally for him in all his financial arrangements and as his financial adviser. The subscription moneys were payable on application. By the time applications for Samin shares closed on 23rd December, the price of Poseidon shares on the Stock Exchange was $175. The Samin shares were allotted in early January 1970 and the 20,000 shares available to the appellant were in fact allotted in accordance with the applications.

Hogarth J. sets out in detail the financial arrangements made by the appellant from the time that he came to live in South Australia in 1965 and thereafter. For present purposes it is sufficient to say that he bought a house in which he and his family resided until 1969. It was in the joint names of his wife and himself and its purchase was substantially financed by mortgage arranged by the bank. He and his wife also bought and sold certain parcels of shares, which transactions were managed for them by the bank's nominee company. In August 1969 the appellant and his wife were looking for a house in a different area and located one in Hawthorn which they wished to purchase. They spoke to the bank manager who agreed to make finance available for the purchase if the taxpayer and his wife were successful in purchasing the property at the contemplated auction. The appellant was not in Adelaide on the day of the auction but the bank manager attended the auction on his behalf. He was not successful at the auction but in December 1969 he heard that the same house was again on the market and notified the appellant. In the result on 18th December the appellant and his wife entered into a contract to purchase that house for some $46,000, having previously arranged with the bank manager in general terms that short-term finance would be provided to enable the purchase to be made at that price.

The appellant's evidence was that he had previously informed the bank manager of the Samin proposal as it developed, and that he was in communication with him regularly, and depended on him for advice.

In the result on 18th December the appellant and his wife needed funds to finance both the purchase of the house and the taking up of the shares in Samin. They applied for an increase in the approved overdraft limit to a figure of some $56,000. The bank manager recorded the details of this as follows: 

      ``Assist purchase of house property                   $46,700

      less 1st mtge. E.S. 
&
 A. Savings                     10,000

                                                          -------

                                                          $36,700

      Purchase 20,000 shares Samin N/L for self and

      family                                               10,000



      Present debt, say                                     6,000

      Personal needs, car etc.                              3,300

                                                           -------

                                                          $56,000.''

Under the heading ``Repayment'' in bank manager's memorandum there appeared the following notations: 

      ``Sale of present house property

      expected to provide equity of

                                             $10,000



      Sale of sufficient Poseidon

      and/or Samin shares                    $50,000.''

The date stated for the expiration of the new overdraft arrangements was 8th March 1970 but this date was later extended to 31st July 1970. In fact the other house was not sold until after 1970 and the proceeds were therefore not available to contribute to the discharge of the overdraft in accordance with the arrangements.

ATC 4600

There were several possible sources from which the appellant could raise funds to discharge the debt to the bank, namely:

The shares in other Australian companies were sold in February/March 1970 for a total of some $10,000 and this was used to reduce the overdraft. The appellant repaid the balance due to the bank out of the proceeds of sale of Samin shares in accordance with advice given by the bank manager as follows:

``(1) On 26th February 1970 he sold 390 shares for $11,451.10. This amount was paid into the joint account at the bank, and had the effect of reducing the overdraft to $45,163.78.

(2) On the 14th and 15th April 1970 he sold 1,510 shares for $15,131.72. Of this amount $15,107.47 nett was paid into the joint bank account and reduced the overdraft to $26,068.89.

(3) On the 30th of April 1970 he sold 2,000 shares for $19,527.84. Of this amount $19,427.84 nett was paid into the joint bank account, and reduced the overdraft to $8,223.55.

(4) Between the 30th July and the 3rd August 1970 he sold a further 2,500 shares for $25,562.03. This amount was paid into the joint bank account and had the effect of discharging the overdraft in full, and creating a credit balance of $5,165.60.''

It is the surplus arising upon those sales of Samin shares over the amount paid on application for them that the Commissioner included in the assessable income of the taxpayer.

The learned trial judge made a number of findings of fact which are of critical importance to the determination of this appeal. They are as follows:

  • ``But the mere fact that he hopes that his investments will increase in value may make the transaction speculative, but does not necessarily bring the profits made on the investment to tax when he disposes of it, unless it can be shown that the time he made the investment he had the purpose of selling the shares at a profit or that the project was otherwise part of a profit-making undertaking or scheme.;''
  • ``... it seems to me that the purchases and sales of shares though E.S. & A. Nominees and through the bank itself, in the joint names of the appellant and his wife, stand on a completely different footing from his acquisition of the Samin shares. As I have pointed out, he had a close professional interest in the development of the Burra mine, for which purpose Samin was incorporated. Similar considerations did not apply to any of the other shares. He took up the shareholding in Samin as the result of negotiations between his employer, McPhar, the president of the parent corporation in Canada, Dr. Hallof, and Mr. Lewis as the spokesman for the syndicate which incorporated Samin. No other shares were acquired in this manner, but were merely shares bought on the market. Although, therefore, as I have said, I think that many, if not all, of the shares purchased through E.S. & A. Nominess and subsequently resold (and I am thereby excluding the parcel of 1,000 Poseidon shares bought on the 30th of September 1969), would be brought to tax under the first limb of sec. 26(a), I do not think that the considerations which lead to that result apply in respect of the profit made on the sale of the Samin shares.''

The trial judge then reviewed the appellant's resources, the circumstances of his dealings with the bank, and the origin of his interest in Samin and said:

``For practical purposes, this means that when the appellant applied for the Samin shares he must have intended to raise a substantial part of the necessary funds by selling some of his shares in Poseidon or in Samin, or in both those companies; and the memorandum made by Mr. Byrnes of the interview of the 22nd of December 1969 with the appellant confirms this.

I am satisfied that when the appellant acquired the Samin shares he did not have a definite intention of selling the exact number, or indeed any, of the shares in that company which in fact were sold in 1970 and whose sale gives rise to these proceedings.''

After considering other factors including a parcel of Poseidon shares which the appellant and his wife had acquired on 30th September 1969 and the circumstances surrounding that purchase he then said:

``It follows, in my opinion, that it is impossible to attribute to the appellant an intention or purpose of selling any of the Poseidon shares, on the date of his acquisition of them, in order to finance his subsequent purchase of the Hawthorn house or his application for the allotment of shares in Samin some two and a half months later out of the profits he would make by the sale. And so if he had chosen to pay off his indebtedness to the bank by the sale of Poseidon shares, I do not see how his profit on such sale could be brought to tax. The case is, therefore, not of an election to sell shares in one of two companies where profits on the sale of either would be taxable.

The appellant said that when eventually he raised the necessary funds by selling shares in Samin as opposed to Poseidon shares, he did so on the recommendation of his bank manager, Mr. Byrnes. Whatever Mr. Byrnes may have said to influence the appellant, the decision in the end was his own; and I have no doubt that when the shares were sold he made his decision in the light of his consideration of which shares it would be better for him to retain in the long run.''

The learned trial judge summarized his conclusions as follows:

``I am satisfied, and find, that when the appellant applied for and was allotted his holding of 14,800 shares in Samin he confidently expected that he would be able

ATC 4602

to sell them at a profit as soon as they came on the market; that he knew that he would have to sell some shares either in Samin or in Poseidon, or both, in order to discharge his short-term indebtedness to the bank; that he wished to keep both the Poseidon and the Samin shares as long-term investments; but that he realised that he would be unable to keep all of them and that he would have to sell some. Is this attitude of mind sufficient justification for concluding that he acquired the Samin shares under review with the purpose of profit-making by their sale? I do not think that it is.

I have found no authority on the topic, nor were counsel able to refer me to any. But bearing in mind the possibility that the appellant could use his alternative means of raising finance by selling shares in Poseidon, and that when he acquired the Samin shares he had an open mind as to whether or not he would do so, in my opinion he has satisfied the onus of establishing that at that time he did not have purpose of selling them at a profit. He acquired them in the realisation that he might do so, and I would go so far as to say that he had the purpose of putting himself in a position where he would be able to do so; but at that time he had not formed the intention, or the definite purpose, of selling them or any of them.''

He therefore concluded that the appellant had not had the requisite intention for the transactions to fall within the first limb of sec. 26(a) and went on to deal with the second limb. As to that he said:

``I do not suggest for one moment that the mere application by the appellant for shares in Samin, in the knowledge that those allotted to him would have an immediate value far in excess of the amount paid by him for the allotment, would constitute the carrying on or carrying out of a profit-making undertaking or scheme. But there was more to it than that. I refer to the arrangements made with the bank for the provision of finance for the acquisition of the shares, as well as for the purchase of the Hawthorn house, on the security inter alia of those very shares; and the express intention of the appellant to pay off the debt in part by the 8th of March 1970, and in full by the 31st of July 1970, by the sale to the extent necessary of shares either in Poseidon or in Samin or in both those companies.''

After referring to a number of authorities he described the situation as follows:

``The arrangements made by the appellant in December 1969 were to raise a temporary loan from the bank in order to finance the purchase of the Hawthorn house and the applications for Samin shares by himself and his wife and for his children; to use the Poseidon shares and the Samin shares as security for the loan; and to raise funds to pay off the loan within the times I have mentioned, in part by the sale of Poseidon or Samin shares, or shares in both companies. In my opinion the combined effect of these arrangements amounted to an undertaking or scheme within the meaning of the section. By carrying out the scheme he did indeed make a profit of which the amounts included by the Commissioner in the appellant's taxable income formed a part. I think that when he embarked upon the undertaking or scheme he did so with the intention of raising whatever funds were still to be found, after he had obtained what he could from other sources, by the sale of either Poseidon or Samin shares, or shares in both companies, to his best advantage. When he embarked upon the undertaking or scheme he believed that he would be able to sell shares in either of those companies at a very substantial profit. Even though he had not decided finally either how much money he would need to raise from those sources, nor exactly what shares he would sell, he nevertheless embarked upon the undertaking or scheme with that general intention; he carried out that intention; and he thereby made a profit of the sort which he had had in general contemplation at the outset.''

Accordingly, the learned trial judge dismissed the appellant's appeal on the ground that the amount which the Commissioner had included as part of his assessable income was in fact assessable income by reason of the second limb of sec. 26(a). The appellant appealed to this Court from that decision.

In my opinion no basis has been made out for departing from the trial judge's conclusions as to the first limb of sec. 26(a). It is not merely that he had the advantage of seeing the witnesses and assessing their

ATC 4603

reliability. Although he looked at the intention as at 18th December 1969 he rightly took into account the earlier events as relevant to ascertaining that intention. The undisputed history of the arrangement leads in my opinion clearly to the conclusion that neither in August 1969, when the arrangement fixing his proportion of McPhar Australia's entitlement was made, nor in December when he signed the application form and paid the application moneys did the appellant have as his purpose or dominant purpose profit-making by their sale.

As to the second limb of sec. 26(a) the principal difficulty lies in formulating the scheme as found by the trial judge and as submitted by counsel for the Commissioner in a manner which does not contradict the primary finding that the shares which were sold were not acquired for the purpose of profit-making by sale, and which reveals what source of profit was involved in the scheme itself. No formulation advanced succeeded in showing any profit, or any profit-making capacity, other than that arising from the difference between the amount paid on the application for the shares and the amount obtained on their sale.

The situation was one in which on 18th and 22nd December the appellant found himself overcommitted on capital account. By coincidence two unrelated projects had come to fruition at the same time. One was the purchase of the house at Hawthorn which he had been seeking to purchase for some months and for which his bank had throughout been prepared to provide finance. The other was the taking up of his entitlement in respect of shares in Samin. That had been under way since prior to 30th June 1969 and had been in substance finalized in August, subject only to the company being incorporated and its promoters fixing the amount of capital to be raised on its floatation. His proportion was agreed and he intended to take it up, even though the amount of money required was not known. He retained that intention throughout.

When December came his liquid assets in Australia were not adequate to finance these two projects without substantial bank support. He had however two other capital assets which would provide both security and a source of funds for repayment of the bank advance in whole or in part. They were his existing house which throughout he had intended to sell if and when he obtained the new house, and the Poseidon shares which by that time had greatly increased in value. The trial judge found that those shares had not been acquired for the purpose of resale at a profit, and in this Court counsel for the Commissioner conceded that if the appellant had sold the Poseidon shares any profit derived would not have been assessable. The details recorded by the bank manager on 22nd December required the bank's advance to be repaid by 8th March 1970. It was assumed that the proceeds of sale of the first house would contribute to the reduction of the overdraft but in fact it took longer to sell than was expected. The remaining source listed under ``Repayment'' was ``Sale of sufficient Poseidon and/or Samin shares.'' Thus the major source of repayment was to be the sale of shares of one or other or both kinds, each of which were found not to have been acquired for the purposes of profit-making by sale. This may no doubt properly be regarded as an ``arrangement'' but one may properly ask, where is the profitmaking undertaking or scheme. In argument it was conceded by counsel for the Commissioner that the only profit which arose from carrying out the arrangement was the profit on the sale of the Samin shares, but that was not a profit of an income character, and a capital profit is outside the scope of the second limb of sec. 26(a). The realisation of a capital asset is not a profit-making undertaking or scheme, however enterprising or simple the mode of realisation may be - see
Scottish Australian Mining Co. Ltd. v. F.C. of T. (1950) 81 C.L.R. 188 ,
White v. F.C. of T. (1968) 120 C.L.R. 191 ,
F.C. of T. v. Williams 72 ATC 4188 ; (1972) 127 C.L.R. 226 . There was here no scheme of profit-making to which this asset, or these assets, were committed in any relevant sense, nor was there any business activity.

The trial judge took the view that the combined effect of the arrangements made in December 1969 was an undertaking or scheme which he described in the passage which I have quoted above. That reasoning however overlooks the significance of his Honour's own findings that neither the Poseidon nor the Samin shares had been acquired for the purpose of profit-making by sale, though the profit to which he referred arose solely out of the sale and not out of the arrangement.

In my opinion there was here no profit-

ATC 4604

making undertaking or scheme at all, and no ``profit'' within the meaning of sec. 26(a) because, as is established by the decision of the Privy Council in
McClelland v. F.C. of T. 70 ATC 4115 ; (1970) 120 C.L.R. 487 , the second limb of sec. 26(a) is concerned only with profits on income account, and not with capital gains.

Accordingly I would allow the appeals and order that in lieu of the trial judge's orders it be ordered that the appellant's appeals against the amended assessments issued by the Commissioner in respect of each of the years ended 30th June 1970 and 30th June 1971 be allowed with costs and the amended assessments set aside.

ORDER:

Appeal allowed with costs.

Orders of the Supreme Court of South Australia set aside and in lieu thereof order that the appeals to the Court be allowed with costs.

Remit matters to the Commissioner to reassess in accordance with the reasons for judgment of the Court.

 

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