Brookton Co-operative Society Limited v. Federal Commissioner of Taxation.

Judges: Brennan J
Deane J

Fisher J

Court:
Federal Court of Australia

Judgment date: Judgment handed down 1 May 1979.

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Fisher J.: These are four appeals brought by Brookton Co-operative Society Ltd. (``the Society'') against a decision of the Supreme Court of New South Wales in its Administrative Law Division. That court confirmed the decision of Board of Review No. 1 which by a majority upheld income tax assessments issued against the Society by the Commissioner of Taxation (``the Commissioner'') in respect of the years of income ended 30 June 1972, 1973 and 1974.

The Society lodged its returns for each of the said years of income contending that at all material times it was a ``co-operative company'' within the provisions of sec. 117 of the Income Tax Assessment Act 1936 (``the Act''), and thus a ``public company'' pursuant to sec. 103A(2)(b) of the Act. The Commissioner did not concede that the Society was a ``co-operative company'' and his notices of assessment were issued on the basis that, not being a co-operative company (and thus not a public company), the Society was a private company. Notices of Assessment for income tax and for additional tax pursuant to Div. 7 of the Act were issued by the Commissioner on this footing. Objections lodged by the Society were disallowed by the Commissioner and by a majority of the Board such disallowances were upheld and the assessments confirmed. The Society appealed to the Supreme Court from the decision of the Board which court on 24 June 1977 dismissed the appeal. There is an additional dispute arising out of an amended return lodged by the Society in respect of the year ended 30 June 1973. This amended return was lodged because, the Society contended, it was necessary to delete a dividend shown in the original return as having been received during that year in the circumstances that the dividend had been reversed. This matter is dealt with later in these reasons in some detail, but is mentioned at this stage as it is the only area in which there is any dispute as to amount of income or amount of tax. In these circumstances there is no point in referring in greater detail to the assessments or objections thereto.

The principal issue which fell for consideration by the Board of Review and the Supreme Court was whether the Society qualified as a co-operative company in accordance with sec. 117 of the Act during the relevant years. It is only if it did so qualify that what I will call subsidiary questions are necessary to be determined. Section 117 as relevant is as follows:

``(1) In this Division `co-operative company' means a company the rules of which limit the number of shares which may be held by, or by and on behalf of, any one shareholder, and prohibit the quotation of the shares for sale or purchase at any stock exchange or in any other public manner whatever, and includes a company which has no share capital, and which in either case is established for the purpose of carrying on any business having as its primary object or objects one or more of the following: -

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ATC 4228

(a)...

(b)...

(c)...

(d) the rendering of services to its shareholders;

(e)...''

It is common ground that the Society has complied with the limitation on the number of shares and the prohibition on quotation of shares, and that the issue at this stage is whether it is established for the purpose of carrying on any business having as its primary object or objects the rendering of services to its shareholders. The trial judge found that it was encumbent on the applicant to satisfy him that it was so established, and he held that the appellant failed to do so. Counsel for the appellant conceded, in my view correctly, in the course of the hearing before us that this finding was a finding of fact. It was in my opinion a finding which was without doubt open on the evidence. In my view the trial judge was both justified and correct in making the finding that he was not satisfied that the Society was established for the relevant purpose.

The trial judge was assisted in arriving at his conclusion by his finding that the Society used its public company status to acquire profits from share dealing activities and that this constituted a business activity of the Society even though implemented through subsidiaries. This may well be so but I would prefer to found my decision on a consideration of the purpose of establishment of the Society rather than on a finding that the Society was conducting such a business activity. I will deal with this aspect of the matter and the facts relevant to its determination before turning to the subsidiary questions. As the trial judge has set these facts out carefully and they are undisputed except as to the inferences to be drawn therefrom, I need not deal with them in detail.

The formation of the Society was the consequence of the ingenuity of three Sydney professional men. Mr. Bainton Q.C., the only one of them to give evidence in the hearing, acknowledged that they could fairly be called the promoters of the Society. Mr. Bainton gave evidence that the Society had its origin in discussions between a number of professional men relating to their inability to find time to care for their personal affairs. There arose out of these discussions the idea of forming a service company. Mr. Bainton acknowledged that the promoters were aware of the benefits of a co-operative company under the Act in that rebates were allowable deductions. Subsequently the evidence discloses that they ascertained that a co-operative company had, under the Act, the status of a public company, which status followed through and attached to its wholly owned subsidiaries. The promoters were likewise aware of the existence of profitable business that was available in the nature of dividend stripping, share dealing and acquisition of excess distribution companies. It was readily apparent to them that this type of business could very appropriately be developed by subsidiaries of a co-operative company. In considering the manner in which such a company could render a service to its members, they came up with the concept of a ``wine buying society''. However the trial judge found as a fact that although the promoters and their friends may have had in mind this activity, it was not the reason for its incorporation. In fact the society never at any stage engaged in buying wine, but limited its service activities to assisting with the acquisition of wine by its members from suppliers.

The preliminary inaugural meeting of the members of the proposed society which is required to be held prior to incorporation was held on 24 June 1971 and the Society was incorporated on 28 July 1971 on which day its first meeting of directors was held. The three promoters were amongst the first directors of the Society. At this inaugural meeting the objects of the Society were discussed, model rules were adopted and the Initial Statement required by sec. 39(3)(a) of the Co-operation Act 1923 (N.S.W.) was signed at the meeting by the Chairman and the Secretary. There is in the evidence no indication that anywhere in the discussions or relevant documents was any reference made to the anticipated wine buying activities of the Society, and there is no such reference in the minutes of either of the meetings. The objects of the Society set out in cl. 5 of the Rules are however appropriate for a Society the business of which was to be the rendering of services to its members.

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ATC 4229

However, prior to the incorporation of the Society and in fact the day upon which it was incorporated, its first meeting of directors was held, and much occurred which is of relevance to the subsequent activities of the Society. It is significant that none of these occurrences had any relevance to the service or wine buying activities proposed for the Society. I will deal with these happenings in chronological order.

On 9 October 1970 a company September 6 Pty. Ltd. (``September 6'') was incorporated, and its shares were held equally by companies owned by the two promoters other than Mr. Bainton. September 6 arranged for the incorporation on 29 April 1971 of three shelf companies R.H.D. Investments Pty. Ltd. (``R.H.D.''), Boongil Investments Pty. Ltd. (``Boongil'') and Wyomee Investments Pty. Ltd. (``Wyomee'').

The preliminary inaugural meeting of the members of the Society was, as already stated, held on 24 June 1971, on which day and the succeeding day a number of members of the proposed Society executed options over the majority of the shares which it was intended the proposed Society would allot to each of them. These options were in favour of September 6 and were granted in respect of the purchase of forty five of the fifty shares each member contemplated being allotted. The price payable upon exercise of the option was two dollars, being the par value for each share. The option was initially only capable of being exercised between 1 July 1974 and 30 June 1975. It was conceded in evidence that the taking of the options had nothing to do with the wine buying or wine service activities of the Society but that they were taken because it was feared members might desire to terminate the Society and distribute its assets. Certainly the holding of the options gave to September 6 the capacity ultimately to control the Society and prevent its premature dissolution. But additionally, to the extent that the asset backing of the issued shares in the Society exceeded at any time their par value, September 6 had, by virtue of its right to purchase the shares at par, acquired a beneficial interest in 90% of such excess.

On 9 July 1971 another company Yorta Pty. Ltd. (``Yorta'') was incorporated at the behest of September 6 as a shelf company. On 16 July 1971 Boongil entered into agreements to buy shares in three companies, which shares it ultimately acquired for $1,132,146.08. Further options were executed by prospective members of the Society on 27 July 1971.

The Society was, as already stated, incorporated on 28 July 1971 on which day was held the first meeting of its directors. September 6 held on the same day a meeting of its directors and its shareholders. R.H.D. also held a meeting of its directors on the same day. At the meeting of directors of September 6 Mr. Bainton was allotted a share and appointed a director. The three original promoters of the Society were now the sole directors of September 6 and as well directors of the Society and the sole directors of R.H.D. September 6 applied for three shares in R.H.D. (which shares were allotted by that company on that day) and September 6 resolved to make a gift to the Society of its shares in R.H.D., the two issued shares which it already held and the three allotted that day. Additionally September 6 resolved to make a gift of $50 to trustees to enable the trustees to acquire shares for the Society. The decision to make the gift was recorded as having been made on this day and thereafter shares were subscribed or acquired on behalf of the Society in companies which in consequence became its subsidiaries. However it would appear probable that the deed of gift was not executed until 11 December 1972.

On 3 August 1971 the Society accepted the gift of shares in R.H.D. from September 6. On the same day the former company was allotted 100 shares in each of them, Boongil, Wyomee and Yorta.

Thus within six days of its incorporation the Society had acquired in consequence of the gifts the ownership of four subsidiary companies, all of which had originally been shelf companies incorporated by September 6. Moreover the latter company had the potential capacity to control the Society by virtue of its holding of the options, and its directors were directors of the subsidiaries. To complete the picture at this stage, it is noteworthy that by 11 August 1971 Boongil had received dividends totalling $1,297,640 declared on the shares which it agreed to buy on 16 July 1971 for $1,132,146.08.

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ATC 4230

At a meeting of directors of the Society held on 12 August 1971 the wine service activity of the Society was raised for the first time at any meeting of the Society. Before dealing with the part that this played in the activities of the Society it is appropriate to carry the story of the acquisition of subsidiaries by the Society to the end of its first financial year.

On 14 March 1972 Tunwin Pty. Ltd. (``Tunwin'') was incorporated and its directors, the three promoters, held their first meeting on 17 March 1972. It appears that the subscribers' shares were held in trust for the Society, the directors of which accepted the gift at a meeting held on the same day. Two further companies Sans Holdings Pty. Ltd. (``Sans'') and Tovella Traders Pty. Ltd. (``Tovella'') were incorporated on 20 April 1972. In each instance it appears that funds for the subscribers' shares were provided out of the $50 settled by September 6 on 28 July 1971. These shares were accepted by the Society at a meeting of directors held on 8 May 1972. At that meeting the directors declared a rebate of $3,000 in respect of wine purchases to be made during the next succeeding financial year. It is accepted that virtually its only funds on hand at this time were members' subscribed capital but the necessary money to pay this rebate fortuituously became available the following day when the directors of Tunwin (the three promoters) declared a dividend of $3,000.

On 26 June 1972 the directors of R.H.D. caused their company to make a gift of the shares their company held in Boongil, Wyomee and Yorta to the Society, in consequence of which the three latter companies became direct subsidiaries of the Society. Prior thereto they had been subsidiaries of a subsidiary.

The position at 30 June 1972, reported by the Society, was that it had acquired seven subsidiaries, all of which other than Yorta had traded in shares or entered into profitable ventures during the past year. Tunwin had paid a dividend of $3,000 and Boongil had received dividends (in respect of its dividend stripping transactions) totalling $1,297,740. Tovella, Sans and Wyomee had made gross profits during their initial two and a half months of trading totalling $20,049.00, $25,489.67 and $19,505.00 respectively. Tunwin's gross profit for the three and a half months it traded was $105,927.00.

Dividends received by the Society increased from $3,000 received from one subsidiary in the year ended 30 June 1972 to at least $130,000 received from four subsidiaries in the succeeding year.

The pattern was the same during the year ended 30 June 1973 in that the Society acquired by way of gift shares in three new companies incorporated by September 6, each of which became a wholly owned subsidiary of the Society and it was hoped a public company for tax purposes. Likewise during the year ended 30 June 1974 three further subsidiaries were acquired by the Society each of which achieving in consequence it was hoped public company status. In each instance the promoters or at least two of them were the directors or comprised the majority of the directors of each subsidiary. I will hereafter refer to the activities of the Society in this regard, namely the acquisition of subsidiaries in consequence of gifts of shares, the achieving of public company status for these subsidiaries and the receipt of dividends from these subsidiaries, as ``the commercial activities'' of the Society. It is unnecessary for me to form a concluded view as to whether these activities can be properly characterised as the carrying on of a business.

I turn now to the wine services rendered by the Society to its members. These were the only services rendered by the Society at least during the years in question. The objects of the Society, I repeat, appropriately provided for the rendering of services to the members (but without indicating the nature of the services) and the activity of providing wine services was first discussed at a meeting of directors held on 12 August 1971 when a manager for that purpose was appointed. It was a part time position for which he was to be paid $650 per annum. The Society appreciated that it was not permitted to buy wine and re-sell it to its members, and thus the manager arranged for supplies to be delivered to members and they paid the suppliers. The Society received commissions from the suppliers which ranged from 7 ½ %-10%. Members were circulated with monthly bulletins whereby they were informed of the availability of wines and other related

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ATC 4231

matters of interest. It appears that the bulletins first appeared in October 1971 about which time members received their first supplies. During the year ended 30 June 1972 18 of the 34 members took advantage of this service, buying wines totalling $4,245.93. The Society earned that year $408.40 by way of commission. In the succeeding year commissions received totalled $1,178 and in the year ended 30 June 1974, $1,443.

In addition to the dividends and these commissions the Society received interest on funds deposited. The funds comprised not only members' subscribed capital but other funds representing dividends received by the Society etc. Interest for the first year totalled $75, and for the years ended 30 June 1973 and 30 June 1974, $378 and $6,623 respectively.

Expenses of the Society for the year ended 30 June 1972 totalled $930, of which $558 was shown as wages doubtless paid to the manager. In the year ended 30 June 1973 these expenses were $1,313, $791 being wages and in the year ended 30 June 1974, $1,372 of which $153 was described as wages. Expenses thus in each year exceeded the commission earned by the Society except in the third year when commission exceeded expenses by some $70.

At the meeting of directors held on 8 May 1972 the directors of the Society resolved that a rebate of $3,000 be given to members during the succeeding financial year. The rebate was stated to be in respect of purchases to be made during that succeeding year. However it was to be calculated on a pro rata basis to purchases made during the earlier year, but was not to exceed in respect of any member 50% of his aggregate purchases during the succeeding year. The explanation for the complexity of the calculation may well be that the directors desired to encourage members to use the Society's wine facilities, and in a circular put out the following day the manager referred to the directors' disappointment in this regard. The manager also drew attention to the fact that commissions earned had not covered operating costs, but that dividends totalling $5,000 were expected during the current year. This expectation was not disappointed in that Tunwin declared its dividend of $3,000 on the following day.

The rebate was subsequently paid during the succeeding year but as ``available profits'' were less than anticipated the amount paid was reduced to $2,500. It is apparent that this rebate, as with the rebate paid in the next year, was not a rebate based on purchases made by the members from the Society (cf. sec. 120(2)) as the members purchased from the suppliers and not the Society. Moreover the rebate was neither paid out of nor bore any relationship to the commissions earned on wine activities. The only link the rebates had with these activities was that the amount of rebate which each member received was calculated in proportion to the value of orders which he had placed through the Society with suppliers.

It is in these circumstances and against this background that the Society's claim to come within the terms of sec. 117 of the Act falls for determination. I have already said that the trial judge was not satisfied that the Society qualified as a co-operative company and that I agree with his decision.

The crucial question is whether the Society ``is established for the purpose of carrying on any business having as its primary object or objects one or more of'' the objects specified in (a) to (e) of the section. A number of comments may be made on the component parts of this definition.

In the first instance it should be noted that the present tense, ``is established'', has been used. Thus consideration must be given not only to the purpose for which the Society was established i.e. the purpose of its incorporation but also the purpose for which it is currently conducted. It was argued in
Farmers & Graziers Co-operative Grain Insurance and Agency Ltd. v. F.C. of T. (1959) 12 A.T.D. 29 that to determine whether a company was a co-operative as defined it was necessary to go back to the establishment of the company to determine whether it then complied with the definition. However in the circumstances before it the court did not have to rule on the argument. Later in
Renmark Fruitgrowers Co-operative Ltd. v. F.C. of T. 69 ATC 4135 Menzies J. was faced with the situation where the company, whilst at the time of its incorporation not carrying on an appropriate business as its primary object, was however

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ATC 4232

in the relevant years pursuing that business as a primary object. At p. 4137 his Honour made these comments:

``It appears to me, however, that sec. 117 requires attention to be directed to the company's business, and its primary objects, at the time when the question whether or not it is to be treated as a co-operative company has to be determined. In my opinion a company which, in accordance with its constitution, is carrying on a business, having as a primary object one or more of those set out in the lettered paragraphs of sec. 117, must be regarded as a company `which... is established for the purpose of carrying on' that business, whether that business was carried on from the inception of the company or was developed at some later time.''

Again in
A. & S. Ruffy Pty. Ltd. v. F.C. of T. (1957-1958) 98 C.L.R. 637 at p. 656 Fullagar J. stated that in determining the question whether a company is a co-operative regard must inter alia be paid to the activities of the company. This supports the conclusion that consideration is not restricted to the time when the company was incorporated. The purpose for which the Society was incorporated may well be relevant but is certainly not the determining factor. It follows that the purpose for which it is being conducted may be a different purpose from that for which it was incorporated. A company may change its purpose to or from one of the qualifying purposes, and in consequence of the change gain or lose, as the case may be, status as a co-operative.

The section requires that the company is ``established'' for the requisite purpose. It is relevant to compare this part of the definition namely the purpose of establishment and the succeeding requirement that the company's business have ``as its primary object or objects one or more of the following...'' It is only necessary for the business to have the requisite activity as one of its primary objects, whereas what must be determined is the purpose of establishment. It seems to me proper to see ``the purpose'' as the sole or dominant purpose, and to construe in this way is consistent with authority.

We have then the task of determining the dominant purpose of the establishment of the Society and the primary object or objects of the company's business. The purpose for which a company is established is not necessarily synonymous with its objects - see In
re Governments Stock Investment Company (1891) 1 Ch. 649 at p. 655 .

Here the enquiry in the court below seems to have been directed towards the ascertainment of the primary object of the business of the Society, on the basis that this, having been ascertained, would disclose the purpose of the establishment of the Society. Counsel for the appellant put it to us that the relevant enquiry was ``what was the business which the company was established to carry on, and what was the principal object of that business''. But an enquiry posed in those words assumed that the dominant purpose of the establishment of the Society was the carrying on of a business activity. It presupposes that the business activity that the Society was at the relevant time pursuing, was the purpose of its incorporation or its conduct. In Ruffy's case (supra) 98 C.L.R. at p. 656 Fullagar J. differentiates between ``the purpose of its establishment and the primary object of its business''. To do otherwise would be to assume that the primary object of its business is the purpose of its establishment.

The trial judge in the present case also focused attention on the business activity of the Society and having found that the commercial activities (as defined above) comprised the carrying on of a business, held that the carrying on of this business was the purpose of the Society's establishment.

However such an approach in my opinion does not attach sufficient significance to all of the words of the definition. If the only enquiry is as to what business activity the company was formed to pursue or was pursuing, the words ``established for the purpose of'' are surplus and otiose. If so the definition could be restricted to the requirement ``which is carrying on a business having as its primary object or objects''. In that case the only enquiry would be as to the primary object or objects of the business which the Society was currently engaged upon. However, properly considered, there are here two enquiries, for what purpose is

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ATC 4233

the company established, and if the company is established for the purpose of carrying on a business, does the company have one of the specified activities as the primary object or one of the primary objects of this business? It is, in my opinion, only after it has been accepted that the dominant purpose of the establishment of the Society is the carrying on of a business that it becomes necessary to determine the primary object or objects of such business.

The dominant purpose for the incorporation of a company and the conduct of its activities need not be a business purpose. As Fullagar J. said in Ruffy's case (supra) 98 C.L.R. at p. 657:

``The sole purpose of... the establishment of the new company was to seek the benefit of sec. 120 of the Assessment Act. This was perfectly legitimate, but it is not a purpose mentioned in sec. 117.''

Similarly, it seems to me in the present case that the purpose of the formation of a company may be to make available to each of its subsidiaries the status of a public company for tax purposes. Stated in the terminology of Fullagar J. as applied to the facts of this matter, the sole purpose of the establishment of the Society was to seek the benefit of sec. 103A(2)(b) of the Assessment Act. But so stated is to go further than necessary and further than is appropriate if it is the purpose of and not the motive for establishment which is required to be determined. The availability of tax advantages for subsidiaries of a co-operative society who were engaged in profitable business motivated the society to pursue what I see as the purpose of its establishment namely, the acquiring of subsidiaries and the bestowing upon them of public company status. In Ruffy's case (supra) in their joint judgment Dixon C.J. Williams and Webb JJ. agree at p. 651, that ``Motive, of course, is not purpose, that is to say it is not necessarily purpose or object''. In the present case the advantages and benefits which might be attained may well have motivated the attempt to acquire co-operative status, but the gaining of these advantages may also be the purpose of the establishment of the alleged co-operative company.

Should it be said however that if the company conducts a business it is necessary to give consideration to the object of that business so as to arrive at the purpose of establishment, the enquiry would be whether the conduct of the business is an end in itself, or merely the means to an end, which latter end is the dominant purpose for the company's existence. In Ruffy's case (supra) the court looked to ascertain the purpose of the conduct of the business. I refer in particular to the following passage in the joint reasons at p. 651, a sentence of which I pointed to above.

``Neither in the hands of the old company nor in the hands of the new company was the business conducted for the primary object of serving the purposes of the wholesale butchers as shareholders by acquiring the runners forming a by-product of their trade. The dominating motive so it would seem was to earn profits for the holders of A and B class shares. The motive of allotting shares to the suppliers of runners was subordinate even if powerful. No one can doubt that one motive was to obtain the advantage of the allowance or allowances given by sec. 120(1)(a) and (b). Motive, of course, is not purpose, that is to say is not necessarily purpose or object. But it seems clear enough that it was not the primary object of the business to acquire the runners from the shareholders of the company or to process their commodities. But for the tax allowance, the runners of anyone else would have done as well. Shares were allotted to the suppliers, one may well suppose, because of the benefit to the appellant, if the allowance could thus be obtained. The company's business has not been carried on with the object of serving the shareholders who were wholesale butchers, that is, with the object of acquiring their runners for disposal or processing them.''

Likewise Fullagar J. at p. 657:

``The business carried on by the company had no primary object in any relevant sense except to make profits for its `A' and `B' shareholders.''

It seems proper therefore to consider whether the dominant purpose of the establishment of the Society in the years of income was not some purpose other than the conduct of the wine activities. It would appear to be open to conclude that the

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ATC 4234

purpose of its establishment was the acquisition of subsidiaries and bestowal of public company status. Alternatively, in so far as the conduct of the wine business was the object of the Society, was it the primary object or was it not merely a means to an end? The end being of course the obtaining and maintaining of its status as a co-operative company. A further possible line of enquiry is whether, as the trial judge conceived the position, the company had two businesses and whether in truth the wine activity was not subsidiary, although essential, to the commercial activities.

In Ruffy's case (supra) Fullagar J. not only differentiated between the purpose of establishment and the primary object of the company's business, but also in the following passages, again at p. 656, 98 C.L.R. indicated the matters upon which the purpose and objects were to be determined. After drawing attention to the danger of commencing ``with an a priori conception of the differentia between a co-operative company and companies generally'', he went on as follows:

``The first thing to be noted is that the section speaks of the primary object of the business for the purpose of carrying on which the company is established. We may, of course - and indeed, I think, must - look at the company's memorandum of association, but this can not be conclusive either way. We must in addition look at the activities actually carried on by the company, and at its history, constitution and control, for all or any of these things may throw light on the purpose of its establishment and the primary object of its business.''

Dixon C.J., Williams and Webb JJ. in their joint judgment agreed that they could not look ``exclusively or even initially'' at the objects clause and examined the structure and the conduct of the company to determine the primary object of its business. See Ruffy's case (supra) at pp. 649-651.

In my opinion all the matters to which I am directed to pay regard in considering the purpose of establishment of the Society point irresistibly to the conclusion that the Society was not established for the purpose of rendering wine services to its members. Doubtless these were an important part of the Society's operations but only as a means to an end. The Society's establishment was part of a grander design. It was established for the purpose of obtaining for an overall scheme of profit making the benefits of public company status. It was a scheme that encompassed the activities of a number of companies, each playing a separate but crucial role in the scheme. The aim of the scheme as visualized by the promoters was to participate in the profitable business of dividend stripping and share dealing etc., but to operate in such a way as to minimise the extent to which these profits would be subject to tax.

The essence of this perfectly proper scheme was to secure public company status for the operators. If these operators, being the profit makers, were private companies they were obliged to distribute their profits to pay undistributed profits tax. If distributed the profits would be subject to tax at the rates applicable to the ultimate recipients. It is, of course, quite permissible and legitimate to avoid such consequences by taking advantage of options available under the Act. The crucial feature here is that the taking of advantage of an option may not have the desired result because such could be the purpose of establishment of the Society and as such is not a purpose within sec. 117 of the Act.

The companies that made up the parties to the arrangements were September 6, which was to play what I would call a controlling role in the arrangement, the subsidiaries of the Society which were the operating profit earners and the Society which it was contemplated would give these subsidiaries public company status. The chronological statement of events which I have detailed, indicates how each party performed its role, September 6, with the promoters of the scheme as its directors and shareholders, by donating shares and by taking the options, the Society by qualifying itself, it was hoped, as a co-operative company and accepting the donations of shares, and the subsidiaries by undertaking profitable transactions. It was an ingenious and elaborate arrangement in an attempt to avoid distributing profits, but to state it is to disclose the true purpose of the establishment of the Society, in which case the attempt fails.

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ATC 4235

In order however that the Society could effectively make its contribution it was essential that it acquire and retain the status of a co-operative company under sec. 117 and 118 of the Act. This necessitated it carrying out its conceived role, namely the carrying on of the business of providing services to its members. If it failed in this it failed to make its contribution to the scheme. But the performing of this business activity, albeit essential, was not the primary purpose of the Society's establishment but was subsidiary to that purpose.

It follows that I see the purpose of the establishment of the Society as the acquisition of public company status so as to pass such status to its subsidiaries. If the commercial activities as above described comprise business activities, then the Society performed two business activities, wine services and commercial activities. The commercial activities in my opinion comprised the primary object of the Society's business.

In my opinion therefore the Society has failed to establish that it has the status of a co-operative company and thus that of a public company pursuant to the provisions of the Act.

In the light of this finding there is no necessity for me to consider the alternative contentions of the Commissioner, namely that, assuming the Society is a co-operative company, it lost its public company status by reason of its failure to qualify generally under sec. 103A(3)(a) or under sec. 103A(3)(c) in respect of the year 1973 year of income or under sec. 103A(3)(d) in respect of the 1972 year of income.

The final matter for consideration is the liability of the Society to additional tax pursuant to Div. 7 of the Act in consequence of the receipt by the Society of a dividend of $47,915 allegedly paid by Tunwin Pty. Ltd. on 29 April 1973. The trial judge upheld the assessment rejecting two arguments tendered by the Society to the effect that the dividend was effectively rescinded. The arguments were firstly that the resolution to pay the dividend did not create the relationship of creditor and debtor between the Society and Tunwin and thus the dividend could be rescinded; secondly that no profits being available to Tunwin out of which a dividend could validly be declared, there was no valid resolution to pay a dividend.

As previously related Tunwin was incorporated on 14 March 1972, and the subscribers' shares were held in trust for the Society of which it thus was a wholly owned subsidiary. Tunwin appears to have engaged immediately in profitable share trading activities and on 9 May 1972 it declared a dividend of $3,000 which was received by the Society on 10 May 1972. Its accounts disclosed a gross profit on share trading account for the period 14 March 1972 to 30 June 1972 of $105,927, and a net profit of $50,914.97. Of this figure of $50,914.97, $3,000 had been appropriated to the abovementioned dividend of $3,000 and thus the unappropriated profits carried to the balance sheet was $47,914.97. The accounts were audited and in this form annexed to the income tax return lodged by Tunwin for the period ended 30 June 1972. On 29 April 1973 a directors' meeting of Tunwin was held at which Messrs. Bainton, Grant and Smith were present. The minutes disclose that the accounts of the company were produced to the meeting which showed unappropriated profits of $47,914.97. The directors passed the following resolution:

``Resolved that an interim dividend of $47,914.97 be declared and credited to the accounts of Brookton Co-operative Society Limited and be available to that company on demand.''

The minutes were signed by Mr. Bainton as confirmed but they are undated.

At a meeting of the directors of the Society (at this time the abovementioned three directors of Tunwin were also directors of the Society) held on 15 May 1973 the following is recorded:

``The meeting was advised that the following dividends had been declared and were due to the Society:

      Tovella Traders Pty. Ltd.       $16,608.10

      Sans Holdings Pty. Ltd.         $23,448.97

      Tunwin Pty. Ltd.                $47,914.97

      Wyomee Investments Pty. Ltd.     $7,629.39

      R.H.D. Investments Pty. Ltd.    $70,866.92
          

It was resolved that upon receipt of these dividends the money be invested on fixed deposit with the Commercial Banking Company of Sydney Limited.''

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ATC 4236

The income tax return for the Society in the year ended 30 June 1973 was dated 28 February 1974, and it disclosed receipt of the dividend of $47,915 from Tunwin.

However a resolution signed by the abovementioned three directors as directors of Tunwin and dated 10 December 1973 is as follows:

``RESOLVED that it now being apparent from an examination of certain share sales agreements from which the company had anticipated deriving of profits in respect of the year ended 30/6/72 that there were not profits of $47,914.97 derived during that period, the declaration of a dividend of $47,917.97 on 29 April 1973 be rescinded, the credit of Brookton Co-operative Society Limited be reversed and that Brookton Co-operative Society Limited be requested to acknowledge and accept the reversal of this credit.''

In the minute book of the Society a resolution of the same date which is signed by the above three directors and three others purports to accept the rescission.

On 17 March 1975 the Commissioner issued against the Society in respect of the year of income ended 30 June 1973 a Notice of Assessment of additional tax under Div. 7 in respect of an undistributed amount of $125,994 to which the Society objected by Notice of Objection dated 13 May 1975.

On 2 June 1975 the Society by one of its directors wrote to the Commissioner enclosing an amended tax return for the year ended 30 June 1973 which sought to exclude the dividend of $47,914.97 previously returned as received from Tunwin.

On 7 July 1975 the Commissioner disallowed the objection dated 13 May 1975 and the Society requested that that decision be referred to a Board of Review for review.

On the matter of payment of the dividend it is relevant to note that the dividend was shown as having been paid in the audited profit and loss account of Tunwin and also in its tax return. The Society for its part brought the dividend to account as having been received in both its journal and ledger. However it is accepted that the Society did not ever receive actual payment but that the amount of the dividend was credited to its account in the books of Tunwin.

The trial judge was of the opinion that the dividend had been paid by Tunwin and received by the Society, and that its payment could not be rescinded or reversed by the directors of Tunwin and the Society. He therefore dismissed the appeal against the Board's decision disallowing the Society's objection. In my opinion he was right and I agree substantially with the reasons which he gave.

Before us counsel for the Society again contended that the dividend had been invalidly declared in that it had not been declared out of profits nor had it been declared in accordance with the provisions of the Articles of Association. Not having been validly declared and not having been paid it was, he submitted, open to the company to rescind the dividend. I would, generally for the reasons given by the trial judge, reject each of these submissions.

A recent decision of the New South Wales Court of Appeal
Marra Developments Ltd. v. B.W. Rofe Pty. Ltd. (unreported except in (1977) CCH Company Law Cases ¶ 40-375 and noted in (1978) 52 A.L.J. 701 ) reached the conclusion that profits are required to be available at the time when the dividend is declared but that it is irrelevant that profits were not available at the time the dividend was paid.

Profits in the present case had been made by Tunwin in the period ending 30 June 1972, a fact determined by the directors in preparation of the balance sheet and profit and loss account as at that date and confirmed by the auditors. As to whether or not there are in fact profits is a matter left to the discretion of the directors as ``men of business'' (see Marra Developments (supra) per Mahoney J. at p. 29,690 adopting the approach of Lindley L.J. in
Lee v. Neuchatel (1889) 41 Ch. D. 1 at p. 21 ). Both directors and auditors agreed that at 30 June 1972 there were profits in Tunwin to the extent of $47,915, available for distribution. Admittedly, with the benefit of hindsight the directors and auditors, had they appreciated the contingent liability of the company to reimburse at least a portion of the price paid by the purchaser of the shares in Hughes Investments Pty. Ltd. would have raised a provision to cover this liability. At the time the directors resolved to pay the dividend however, the liability was still contingent and

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ATC 4237

the profits were available. It would appear that the liability did not crystallize until later in the year upon the enactment of retrospective legislation affecting the matter.

In any event there were profits available and the directors were entitled to resolve to pay an interim dividend in accordance with their powers under the Articles. It was not the payment of the dividend (which I subsequently shall indicate in my opinion occurred at the time of the resolution) which lost the company's capital but the subsequent crystallization of a pre-existing contingent liability, for which no provision had been made.

The taxpayer's alternative submission was that the dividend was liable to be rescinded in that it had neither been validly declared nor been paid to the Society. There is no doubt that to resolve to declare, as opposed to pay, an interim dividend was beyond the powers of the directors. Only the company in general meeting could declare a dividend (art. 99), but the directors were empowered to pay an interim dividend, i.e. a dividend between general meetings. Admittedly here the directors purported to ``declare'' an interim dividend, as did the directors in
Potel v. I.R. Commrs. (1971) 2 All E.R. 504 and in
Commr. of I.R. (N.Z.) v. Taylor (1964) 13 A.T.D. 389 . In each instance the directors had the same powers as the directors of Tunwin, and in each instance the resolution was construed as a resolution to pay rather than to declare a dividend.

Thus in this matter I would agree with the trial judge that the directors had validly exercised their power to pay an interim dividend.

Ultimately the directors resolved to rescind this resolution which action was open to them at any time prior to payment. ``Where the directors are authorised to pay interim dividends, a mere resolution to pay does not create a debt as between the company and the member so as to prevent the directors from subsequently rescinding the resolution.'': Potel's case (supra) per Brightman J. (1971) 2 All E.R. at p. 513 approving a passage in Buckley on the Companies Act 13th ed., p. 897.

The resolution here however went beyond authorising payment of an interim dividend, it resolved that the dividend be ``credited to the accounts of Brookton Co-operative Society Limited and available to that Society on demand''.

Counsel for the Society contended, in reliance upon Taylor's case (supra) that the directors had no authority to declare a dividend and vote to pay it at some later date, albeit when demanded and that the significance of their purporting to do so was not to create a debt in favour of the Society. As I have already said, on similar articles the directors of the company in Taylor's case (supra) purported to ``declare'' an interim dividend which was construed as a resolution to ``pay'' the same. By way of contrast however the shareholders in Taylor's case (supra) were not entitled to the dividend until ``cash becomes available and at the sole discretion of the directors'' - see Taylor's case (supra) 13 A.T.D. 389 at p. 393. It was held that in these circumstances the interim dividend would be payable only in the future event of cash becoming available and then at the directors' discretion. At the date of the declaration of interim dividend the entry in the company's books ``acknowledged no present indebtedness and made nothing available to the shareholder and placed nothing at his disposal or for his immediate benefit''. - Taylor's case (supra) 13 A.T.D. 389 at p. 397.

Such a situation is in sharp contrast to that in the present case, where the dividend was to be credited to the Society's account and available on demand. That such a situation is quite different from that in Taylor's case (supra) is acknowledged in the reasons of Henry J. who decided that case and gave examples similar to the present situation to illustrate his point. He cited the case of
I.R. Commrs. v. Doncaster (1924) 8 T.C. 623 , which he said, indicates that ``a decisive step, divesting the directors of control of the fund must be taken before the fund becomes income''. In Doncaster's case (supra) the final step in the payment of an interim dividend was to carry the money to what was called a loan account which was really a current account of the shareholders with the company. Rowlatt J. at p. 631 of the latter case commented on the payment of a dividend in circumstances where he held that the final act of crediting it to the shareholder's loan account with the company amounted to distribution or payment of the

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ATC 4238

dividend: ``I can conceive nothing more complete in the way of payment. It was simply putting it to the credit of what is equivalent to a banking account. Those loans were money in the hands of the company belonging to the shareholder as an individual.'' This passage is quoted in Taylor's case (supra) 13 A.T.D. 389 at p. 396.

In my opinion that is exactly the position here. The directors of Tunwin resolved that the amount of the dividend be credited to the Society's account with Tunwin and this was done. Moreover the directors had no further control over the moneys which were, they agreed, payable to the Society on demand. A debt was thus created between the Society and Tunwin and a debtor-creditor relationship established in consequence of the dividend having been paid.

For their part the directors of the Society (three of whom being the directors of Tunwin who ``declared'' the dividend) acknowledged at their meeting on 15 May 1973 their awareness that the dividend had been ``declared'' and was ``due'' to the Society and resolved that when received the monies would be placed on fixed deposit. Moreover the Society disclosed ``receipt'' of the dividend in its profit and loss account and in its tax return, and in its balance sheet disclosed the fact that the amount thereof was owing by its associated company. It seems to me that the Society would be hard put to contend (and in fact it did not contend) that it was not aware of and did not consent to the crediting of the dividend to its account. Moreover it was the amount of this credit which was available to the Society upon demand, the dividend in my opinion having been paid when it was credited in accordance with the decision of Tunwin's directors.

In the circumstances the directors of Tunwin were prevented from subsequently rescinding the resolution for payment of the dividend.

In my opinion the appeal should be dismissed with costs.

ORDER:

(Appeal Nos. G48, 49, 51 of 1977)

1. The appeal be dismissed.

2. The appellant pay the respondent his costs of the appeal to be taxed.

(Appeal No. G50 of 1977)

1. The order of the Supreme Court be set aside and in lieu thereof IT IS ORDERED that the assessment of the appellant to Div. 7 tax for the income year ended 30 June 1973 be amended by reducing by $47,915 the appellant's taxable income for that income year and by consequentially reducing the assessment of the undistributed amount and the Div. 7 tax and IT IS FURTHER ORDERED that otherwise the appeal to the Supreme Court be dismissed and that the appellant pay to the respondent his taxed costs of the appeal to the Supreme Court less the taxed costs (if any) of the issue as to the reduction by $47,915 of its taxable income for the purposes of Div. 7.

2. The appellant pay to the respondent his costs of the appeal to this Court to be taxed less the taxed costs (if any) of the issue as to the reduction by $47,915 of the appellant's taxable income for the purposes of Div. 7 for the 1973 year.