Case M80
Judges: HP Stevens ChCF Fairleigh QC
JR Harrowell M
Court:
No. 1 Board of Review
J.R. Harrowell (Member)
These three references were heard together as the same basic facts related to each matter. A medical practitioner, a pastoral company and an accountant entered into a partnership for the purpose of buying and selling shares in conjunction with 17 other partners.
2. The partnership in its return of income for the year ended 30 June 1977 showed a loss on ``share trading'' amounting to $999,031.01 which was apportioned between the 20 partners in relation to that portion of the total capital of $20,000 contributed by all partners. The three taxpayers in these references were allotted the following portions of that loss:
Capital Share of
Contributed Loss
$ $
Medical
practitioner 1,200.00 59,941.86
Pastoral
company 1,200.00 59,941.86
Accountant 400.00 19,980.62
3. In brief, the loss returned by the partnership for 1977 was made up as follows -
4. The partnership achieved this result by treating the par value of the bonus issues as exempt income in terms of sec. 44(2) of the Act and the equivalent sum as being deductible as set out above in terms of sec. 51(1). Counsel for the three taxpayers stated at the outset that the partnership had engaged in a
Curran
type scheme
-
Curran
v.
F.C. of T.
74 ATC 4296
;
(1973) 131 C.L.R. 409
.
5. On 30 March 1978 the Commissioner issued an adjustment sheet which converted the partnership loss of $999,031 to an adjusted net income of $469,028 by treating $1,468,059 of the purchase price of the 270 and 50,000 shares in the first and second companies as incurred in relation to the gaining or production of exempt income. The effect of this adjustment was short lived. On 25 May 1978 the Commissioner issued an amended adjustment sheet firstly reducing the previously adjusted net income from $469,028 to ``NIL'' and secondly, treating as assessable income under sec. 26AAA the profits arising from the sale of shares in companies as under -
$
First company 1,750
Second company 2,899
------
$4,649
------
6. These adjustments indicated that at that point the Commissioner had rejected the notion of a Curran type arrangement. By
ATC 602
reducing previous net income adjusted by him to nil he was adopting, to say the least, an unusual short cut to indicate that he did not accept that the partnership was engaged in share trading. Finally in arriving at a final adjusted net income of $4,649 he was applying sec. 26AAA to selected share transactions and apparently not considering the possible application of sec. 26(a). Later in his reg. 35(1) statement he gave the following reasons for disallowing the medical practitioner's claim. The same reasons but with the figures changed where necessary applied to the other two taxpayers.- (1) That the net loss of $999,031 returned by the partnership... for the year ended 30 June 1977 was correctly adjusted to a net income of $4,649 in that
-
- (i) proceeds on sale of shares $1,623,044.54 are not assessable income in terms of sec. 25(1) of the Income Tax Assessment Act ;
- (ii) amounts claimed as purchases and expenses, $2,639,029.50, in relation to share transactions, are not deductible under the provisions of sec. 51(1) of the said Act;
- (iii) the amount of $16,954 brought to account as value of stock on hand at 30 June 1977 has been excluded, not being trading stock for the purposes of Subdiv. B of Div. 2 of Pt. III of the said Act;
- (iv) profit made by the partnership arising from the sale of shares in (the first company) and (the second company) included in net income of the partnership in accordance with the provisions of sec. 26AAA of the said Act.
- (2) That, as a consequence, the loss of $59,941 returned by the taxpayer as his individual interest in the net loss returned by the above partnership for the 1977 year of income was correctly adjusted to an income of $278 being his individual interest in the net income of the partnership for the year of income, pursuant to the provisions of sec. 92(1) of the said Act.
7. The assessments now before this Board take up the adjustments made on this second and final partnership adjustment sheet and which have the following effect:
Share of Share of Increase in
P'ship loss Adjusted Assessable
now reduced Profit Income
to nil $4,649
$ $ $
Medical Practitioner 59,941 278 60,219
Pastoral Company 59,942 278 60,220
Accountant 19,980 92 20,072
8. I have had the opportunity to read the summarised evidence as set out by my colleague Mr. H.P. Stevens, Chairman, whilst I accept his findings of fact there are several matters on which I propose to make observations.
9. The three taxpayers were members of a partnership comprising 20 partners and operating under Articles of Partnership dated 7 June 1977. By 21 June 1977 all capital to be contributed by the partners and totalling $20,000 had been received. Under these Articles each partner agreed:
``to carry on in partnership the business of purchasing or acquiring for the purpose of their sale at a profit the shares debentures or other interests in any company or corporation public or proprietary and whether listed for quotation on any Stock Exchange or not the collection of any dividends, bonuses or other entitlements accruing thereon and the resale of such shares debentures or other interests.''
10. The Articles also provided for the calling of meetings of partners and the keeping of minutes of such meetings. Resolutions dated 8 June 1977 signed by all partners dealt with the appointment of a stockbroker with instructions to purchase
ATC 603
certain listed shares, the granting of a Power of Attorney to four named partners and nominating any two of those four partners to be signatories to a bank account. The power of attorney gave wide powers of purchase and sale as well as the power to mortgage and pledge. As the partners were dispersed over a wide geographical area more than one power of attorney was prepared for signature.11. These references cover a period of time commencing in late May 1977 and ending on 30 June 1977. All that was done during that period was to try and create a Curran type situation so that the 20 partners could benefit from the resulting loss deductions. Counsel for the taxpayers quite correctly made no attempt to obscure this clear purpose behind the gathering of 20 partners. The references proceeded on the basis that if the ultimate facts matched those of Curran the three taxpayers in these references would succeed. However as the hearing proceeded it became clear that whereas Curran was argued on an agreed set of facts the taxpayers here had to establish a set of facts on which there was no agreement. In Curran it was accepted that all relevant steps taken were legally effective. In these references there was no such acceptance.
12. In outline the plan was to gather a group together in partnership formed to carry out share trading. To achieve this purpose a stockbroker was appointed and within the limits of the $20,000 contributed he proceeded to buy and sell certain shares in companies listed on the stock exchange. These transactions took place between 9 and 30 June 1977.
13. Having established the partnership and its pattern of share trading the plan then required the partnership to purchase the issued shares in not one but two companies which had between them at least $1,000,000 in profits arising from the sale of assets not acquired for the purpose of resale at a profit. The first and second companies met these conditions. The first company had $841,391.32 standing to the credit of its capital profits reserve and the second company in a similar account showed a credit of $176,004.02.
14. It was put to the Board that the following events took place -
- (a) On 28 June 1977 branch share registers for the first and second companies were opened in Darwin by a chartered accountant resident there and acting under a power of attorney.
- (b) On 28 June 1977 the directors of the first and second companies approved the transfers from the holders of the issued capital in the first and second companies to the partnership. The details of the transfers approved were as follows
-
First Company Consideration $ 20 Ordinary shares 1,359,900.00 250 Preference shares 500.00 ------------ 1,360,400.00 ------------ Second Company ------------ 50,000 shares 254,500.00 ------------ - (c) On 28 June 1977 the members of the first and second companies at extraordinary general meetings called forthwith passed special resolutions increasing the authorised capital and each declaring a bonus issue to the ordinary shareholders ``on the date of passage of this resolution (namely 28 June 1977)...''. In the case of the first company its authorised capital was increased by 420,000 shares of $2 each and making a bonus issue of 420,600 shares of $2 each fully paid by the application of $841,200 from capital profits reserve. The second company's authorised capital was increased by 80,000 shares of $2 each and it made a bonus issue of 79,400 shares of $2 each fully paid by the application of $158,800 from capital profits reserve.
- (d) On 29 June 1977 the directors approved the transfers from the partnership to a third company of the issued capital in the first and second companies which now included the bonus issues. The details of the shares transferred were as follows
-
First Company Consideration $ 250 Preference shares 500.00 20 Ordinary shares 65.46 420,600 Ordinary shares (Bonus issue) 1,361,585.14 ------------- $1,362,150.60------------- Second Company 50,000 shares 99,459.04 79,400 shares (Bonus issue) 157,940.96 ----------- $257,400.00 -----------
15. The foregoing sets out in summary form what the partnership intended to do and what it believed it did do. However the facts which emerged from the evidence conveyed a somewhat different picture.
16. Quite obviously the accountants in charge of the operation were required to compete against time. By 7 June 1977 they had formed a partnership of 20 members who had to immediately establish themselves as share traders. Between that date and 30 June 1977 they also had to -
- (a) organise the acquisition of two private companies possessing adequate capital profits;
- (b) establish share registries in Darwin for these companies;
- (c) transfer the shares in each to the partnership;
- (d) increase the authorised capital in each company and issue bonus shares to the partnership;
- (e) immediately find a buyer to purchase the shares now held by the partnership in these two companies;
- (f) achieve a ``Curran loss'' of some million dollars on an already fully committed cash capital of $20,000 without resort to any formal borrowing commitment to bridge the large shortfall.
17. As is seen from the evidence most of the action took place on two consecutive days - 28 and 29 June 1977. It is therefore not surprising to find that those in charge were forced into taking short cuts which in my opinion were detrimental to the outcome. I will now deal with this aspect.
18. On 20 June 1977 the firm of advising solicitors wrote to the accountant who had the task of implementation and who is also a taxpayer in these references. This letter is referred to in para. 18 of the Chairman's reasons. The detailed steps to be taken as set down by the solicitors clearly show that at the outset it was intended that the partnership was required to transfer the shares it had yet to acquire in the first and second companies to a nominated third company. This fact is further supported in para. 20 of the Chairman's reasons when on 24 June 1977 the accountant wrote to the Darwin accountant enclosing two sets of unsigned transfers to be signed by the Darwin accountant at the appropriate times under powers of attorney granted to him. The first set of transfers dealt with the partnership's ``purchase'' of the shares in the first and second companies. The second set dealt with the almost immediate ``resale'' of those shares to the third company. The conclusion I draw from this evidence is that the partnership was committed to transfer the shares in the subject companies to the nominated third company before it had acquired the shares. In other words the partnership was never the beneficial owner of those shares. This view is supported by the fact that at no stage did the partnership have the funds or have access to funds, other than by a round robin of cheques, to meet the purchase price ($1,614,900) of these shares. It is quite apparent that in the absence of a formal arrangement with its bankers to lend the money to cover this cost the partnership had to ``sell'' the shares ``purchased'' by the next day to allow the round robin to take place. The round robin operated on the basis that the shareholders of the first and second companies gave the partnership cheques to ``purchase'' their shares. The cheque received by the partnership on the ``sale'' to the third company was offset against cheques drawn by it to repay its loans to the shareholders of the first and second companies. These latter companies then drew cheques in favour of the third company to cover its ``purchase'' of the subject shares from the partnership. When the dust had settled on this fiscal cyclotron the third company owed the shareholders of the two companies for the shares it had ``acquired'' from the partnership. If there had been a break in this chain the partnership could have been in debt to the extent of $1,614,900, a possibility not envisaged by the 20 partners who had committed themselves to a total sum of $20,000 which had been used to purchase listed securities.
19. I now turn to the events which relate to the increase in authorised capital and the issue of bonus shares. On 28 June 1977 the first and second companies passed special
ATC 605
resolutions to increase the authorised capital to allow the implementation of a subsequent resolution passed at the same meeting to authorise the issue and allotment of bonus shares. The special resolution increasing the authorised capital of each company was filed on 8 August 1977. Under sec. 18(1)(c) of the New South Wales Companies Act 1961 (1961 Act) a company must disclose in the Memorandum the amount and details of its authorised capital. A resolution affecting the Memorandum must be filed with the Corporate Affairs Commission within 14 days of the passing of the resolution - sec. 21(2) of the 1961 Act. The Commissioner shall certify the registration of the resolution and on such registration and not before the alteration of the Memorandum shall take effect - sec. 21(3) of the 1961 Act.20. Where the creation, issue and allotment of such shares is invalid by reason of the preceding subsection the Court may upon application and being satisfied deem the relevant shares to have been validly issued and allotted
-
sec. 63 of the 1961 Act
-
see also
In
Re Coolibah Pty. Ltd.
80 ATC 4134
. As no applications to the Court had been made pursuant to sec. 63 the resolution of either company to increase its authorised capital had no effect until some time subsequent to 8 August 1977. I find that the allotment of shares made by the two companies on 28 June 1977 was invalid from the outset and in fact remains invalid until a Court rules otherwise.
21. Naturally counsel for the taxpayer placed great reliance on the decision in Curran (supra) . That appeal before the High Court proceeded by way of a case stated and so the Court was not required to look at the validity of the various things that were done. In that case the taxpayer on 28 April 1969 purchased 200 fully paid shares in Stewart Bacon Holdings Pty. Ltd. (Stewart Bacon) and was registered as a member on that day in respect to those shares. On 6 May 1969 an extraordinary general meeting of shareholders resolved to increase the nominal capital of $100,000 by $150,000 by creating a further 150,000 new ordinary shares of $1 each. The shareholders also resolved to ``capitalise'' the sum of $205,325 forming part of the capital profits reserve account by distributing it to the holders of the ordinary shares as on 29 April 1969 by way of fully paid shares (a bonus issue). In this manner 205,325 fully paid shares were allotted to existing shareholders including the taxpayer who was allotted 191,000 shares. On that same day the taxpayer sold his original holding of 200 shares and the new bonus issue of 191,000 shares. The only issue before the Court was whether those sales of shares resulted in a loss allowable as a deduction under the Act. The Court was not required to consider such issues as whether the Registrar (as the section then read) had registered on 6 May 1969 the special resolution increasing the nominal capital on that same day in terms of sec. 21(3) of the 1961 Act and whether the taxpayer in that case had been committed to sell his 200 and 191,000 shares prior to him being registered as the holder of them.
22. For these reasons I have no difficulty in distinguishing the facts in Curran from the facts in the present references.
23. I am in agreement with the comments of my colleagues regarding certain unsatisfactory aspects regarding the evidence. I was surprised that the senior partner of the advising firm of accountants did not give evidence instead leaving this to be dealt with by the accountant/taxpayer who was at that time his employee. The accountant/taxpayer and another accountant (both now partners in the firm, but at the relevant time employees) each gave evidence which in part contradicted the other. For instance the accountant/taxpayer made the statement that it was his practice at the relevant time to keep minutes of client companies loose in a file. Later when preparing the company's accounts he would ``put them into or affix them into a minute book''. The minutes were certainly not affixed in a minute book following each meeting. The second accountant stated that it was office practice at that time to affix such minutes in a book as soon as practicable after each meeting. The general effect of the foregoing evidence was to cause me to discount the evidentiary value of the minutes tendered to the Board which had been inserted loosely in the book.
24. Before reaching my ultimate conclusions I will take this opportunity to deal with the substance and reality of a bonus issue. I will take by way of illustration the balance sheet of the first company prior to the increase in authorised capital and the issue of the bonus shares.
25. It is quite apparent from these figures that the 20 shares and the 250 preference shares between them are represented by assets totalling $1,364,477.14. Under the articles of the company the preference shareholders except to the extent of any unpaid dividends have no right to surplus capital in a winding up. On the assumption that the loans can be realised in full the 20 shares in this dormant company are worth no more than $1,364,477.14 - $500, in other words $1,363,977.14. On the (purported) issue of 420,600 bonus shares on 28 June 1977 the issued ordinary shares became not 20 but 420,620. However the 420,620 shares were worth no more than the original 20 shares - $1,363,977.14. The only change that has taken place in the company is in the composition of shareholders' funds; capital profits reserve is reduced by $841,200 and issued capital increased by the equivalent amount. The decision of the High Court in Curran (supra) would indicate that if the partnership in this reference was the beneficial holder of the shares in the first company after the bonus issue and it had retained its shares the result would have been -
$
20 shares cost 1,359,900.00
250 shares cost 500.00
420,600 bonus shares
"
cost
"
(as per decision
in Curran) 841,200
-------------
Total Cost $2,201,600.00
-------------
but these shares would still be worth not more than $1,364,477.14. To me this indicates a significant divergence between the legal consequence and the commercial reality of a bonus issue within the context of a taxing statute. For the reasons already stated I have distinguished between
Curran
and these references and so I am not bound to follow this divergent path. What I have tried to illustrate here is summed up in legal terms by Lord
Russell in Hill
v.
Permanent Trustee Co. of N.S.W.
(1930) A.C. 720
at pp. 730-732
and quoted by Mr. Fairleigh in para. 27 of his reasons.
26. I accept that the partnership was engaged in the business of share trading but I do not accept that the partnership beneficially held the shares in the first and second companies. For that reason I find that there was no purchase or sale of those shares by the partnership. However on the evidence I find that in the course of the transfer of those shares to the third company the partnership derived a profit of $4,650 (differs with Commissioner's figure by $1 through rounding off). As a consequence of these decisions I have arrived at a partnership profit of $969 made up as follows -
27. The proportions to be carried into the assessable incomes of the taxpayers in respect to the year ended 30 June 1977 are as follows:
Medical practitioner 1200/20000 x $969 = $58
Pastoral company 1200/20000 x $969 = $58
Accountant 400/20000 x $969 = $19
28. I would hold that in each of the decisions in respect to these three references the Commissioner was in error to the extent set out in the preceding paragraph and I would amend the respective assessments accordingly.
Claims allowed in part
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