Thiel v. Federal Commissioner of Taxation

Judges: Mason CJ
Brennan J
Dawson J
Gaudron J

McHugh J

Court:
Full High Court

Judgment date: Judgment handed down 22 August 1990.

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McHugh J.

The question in this appeal is whether profits made by a Swiss resident as the result of acquiring two interests in property under a deed of trust, exchanging those interests for shares in a company, and subsequently selling the shares constituted the profits of ``an enterprise carried on by a resident of Switzerland'' within the meaning of Sch. 15 to the Income Tax (International Agreements) Act 1953 (Cth) (``the Agreements Act'').

By majority, the Full Court of the Federal Court ( Sheppard and Lee JJ., Northrop J. dissenting) upheld a decision of Franklyn J. in the Supreme Court of Western Australia which held that the profits were not the profits of an enterprise within the meaning of Sch. 15.

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ATC 4725

The appellant, Gunter Thiel, is a resident of Switzerland. In 1969 he commenced business in Switzerland as a distributor of earthmoving equipment. He continued to conduct that business at all relevant times. In 1983 the appellant feared that he would lose a dealership with one of the major suppliers to his business. He began to seek alternative sources of business. He visited Australia in 1983 and examined investment opportunities in Sydney and in Surfers Paradise. The trial Judge was not satisfied that at that time the appellant was genuinely interested in investment, or was in a position to invest, in Australia. In January 1984, the appellant came to Perth at the suggestion of a Mr Kristensen, whom he had known for many years. Mr Kristensen was an executive of a trust which was involved in high technology research and development. The appellant discussed the activities of the trust with Mr Kristensen and inspected its premises and the prototypes of some of its inventions. He was informed that the trust planned to make a public offer of either units or shares, which would create an opportunity for profit for those who acquired them.

On or about 25 January 1984 the appellant paid $50,000 to acquire an interest, represented by four units, in the trust property established by a deed of trust called the Energy Research Group Unit Trust. On or about 25 May 1984 he paid an additional sum of $100,000 to acquire a further interest, represented by another two units, in the unit trust. Franklyn J. found that about one-quarter of the purchase price of the six units was provided from his business account with a Swiss bank and that the remainder of the price was provided by way of loan, interest free, from his parents. The appellant said that the reason for his purchase of the six units was that it was ``just the kind of venture I had been dreaming of'' and that ``it seemed to me like I had a real winner - a winning position at that moment and I jumped in''.

Energy Research Group Australia Ltd. was incorporated on 22 October 1984. On or about 9 November 1984, the appellant sold his six units in the trust to that company for $300,000 to be satisfied by the allotment to him, or his nominee, of a total of 600,000 fully paid ordinary shares of 50c each in the capital of the company. On 16 January 1985 the appellant's name was entered in the share register of the company as the holder of the shares. As soon as the shares of Energy Research Group Australia Ltd. were listed on the Australian Stock Exchange, the appellant gave instructions to stockbrokers to sell the whole of his shareholding. Between 7 February 1985 and 6 March 1985, he sold 252,000 of his shares. Over 40 sales of shares were made at prices ranging from $2.10 to $2.75 per share. The proceeds of the sale of these shares totalled $566,307.30. The appellant stopped selling the remaining 348,000 shares when the respondent assessed the profits from the sales as assessable income.

The respondent assessed the appellant as having made an assessable profit of $590,307 consisting of two separate gains taxable pursuant to sec. 26AAA of the Income Tax Assessment Act 1936 (Cth). The respondent alleged that the first gain was made when the appellant sold his six units in the trust in consideration of the issue of 600,000 shares to him and that the second gain was made when the appellant sold 252,000 of the shares allotted to him. The appellant does not contest the respondent's calculation of his profit. But he contends that, by reason of the terms of Sch. 15 to the Agreements Act, he was not liable to tax on either of his gains. He contends that his activities constituted ``an enterprise carried on by a resident of Switzerland'' and that the profits which he made are taxable only in Switzerland.

Section 11E and Sch. 15 of the Agreements Act give effect to an agreement made between Australia and Switzerland for the avoidance of double taxation with respect to taxes on income (``the Agreement''). The provisions of the Agreement, in so far as they affect Australian tax, have the force of law in relation to tax in respect of income earned after 1 July 1979.

Article 7 of the Agreement provides:

``Business Profits

(1) The profits of an enterprise of one of the Contracting States shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State, but only so much of them as is attributable to that permanent establishment.''

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ATC 4726

Article 3(1)(f) defines the term ``enterprise of one of the Contracting States'' to mean, unless the context otherwise requires, ``an enterprise carried on by a resident of Australia or an enterprise carried on by a resident of Switzerland, as the context requires''. Article 3(2) provides:

``In the application of this Agreement by one of the Contracting States, any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting State relating to the taxes to which this Agreement applies.''

In giving his reasons for dismissing the appellant's ``appeal'' against the assessment, Franklyn J. said (at p. 4104):

``I am not satisfied on the evidence that the taxpayer entered into the purchase of the shares and units in the expectation of selling the same for a profit as an activity of his existing business or by way of diversification or extension thereof, nor am I satisfied that he did so in the commencement of a new business venture to make profits. I find that the transaction does not carry any of the hallmarks of carrying on business or of business activity other than that of the intention to make a profit.''

His Honour concluded (at pp. 4104-4105):

``I am satisfied that he purchased the units in the private trust with the firm and sole intention that the investment thereby made would enable him, by reason of the carrying into effect by the trust of its plans to make a `public offering', to sell them or whatever it might be that he would have the opportunity to convert them into, and to thereby make a profit; that the decision to acquire the units and in due course the shares was no part of his then business operations, nor the commencement of a new business operation, but was an isolated transaction of a speculative nature, made attractive because of the information gained from and through Kristensen of the products and plans of the trust and the perceived profit to arise therefrom despite the `high risk' which also attached thereto.''

These findings of Franklyn J. were unsuccessfully challenged in the Federal Court. However, Sheppard J. thought that the transactions ``when taken together did amount to a business deal''. His Honour also said that he would have had little difficulty in regarding the transactions in question ``as the carrying out of an enterprise''. But he thought that both the dictionary and judicial meanings of the expression ``carrying on'' compelled the conclusion that it referred to an activity which was of indefinite or indeterminate duration. His Honour said (at p. 4038):

``In my opinion, the enterprise in which he engaged had not that element of continuity which is required to constitute an enterprise carried on by the appellant within the meaning of the relevant articles of the agreement.''

Lee J., the other member of the majority, held that there was no ground for interfering with the finding of Franklyn J. that the transaction did not carry any of the hallmarks of carrying on a business or a business activity other than that of an intention to make a profit. Lee J. concluded that the Agreement made ``no provision for an isolated venture in the nature of trade which stands apart from the conduct or carrying on of the business of an enterprise''. Northrop J., dissenting, held that the word ``enterprise'' as used in the Agreement did not ``connote the existence of an entity or structure attached to the activities entered into by a person in the execution of a plan or scheme''. His Honour held that the activities of the appellant in conceiving and executing his plan to make ``a quick profit in Australia'' constituted an enterprise within the meaning of Art. 7(1).

The Agreement does not define the terms ``enterprise'', ``profits'' and ``business profits''. Nor does it define the compound expressions ``profits of an enterprise'' and ``enterprise carried on''. Moreover, none of these terms or expressions has any settled meaning in Australian income tax law. In sec. 26(a) (now sec. 25A) of the Income Tax Assessment Act , income was defined to include any ``profit arising... from the carrying on or carrying out of any profit-making undertaking or scheme''. In that context, the words ``carrying on'' have been read as covering ``the habitual pursuit of a course of conduct'' and the words ``carrying out'' have been read as ``the carrying into execution of a plan or venture which does not involve repetition or system'':

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ATC 4727

Premier Automatic Ticket Issuers Ltd. v. F.C. of T. (1933) 50 C.L.R. 268 at p. 298 . But the narrow meaning given to the words ``carrying on'' in sec. 26(a) is the product of its juxtaposition with the words ``carrying out'' in the same paragraph. Judicial decisions on the expression ``carrying on'' in the context of sec. 26(a) of the Income Tax Assessment Act , therefore, cannot be regarded as settling the meaning of the expression ``carried on'' in Art. 3(1)(f) or the expression ``carries on'' in Art. 7(1). It follows that, within the meaning of Art. 3(2), none of the relevant terms or expressions in the Agreement has any particular or settled meaning in Australian income tax law. The meaning of those terms and expressions must be ascertained from the Agreement.

The Agreement is a treaty and is to be interpreted in accordance with the rules of interpretation recognised by international lawyers:
Shipping Corporation of India Ltd. v. Gamlen Chemical Co. (A/Asia) Pty. Ltd. (1980) 147 C.L.R. 142 at p. 159 . Those rules have now been codified by the Vienna Convention on the Law of Treaties to which Australia, but not Switzerland, is a party. Nevertheless, because the interpretation provisions of the Vienna Convention reflect the customary rules for the interpretation of treaties, it is proper to have regard to the terms of the Convention in interpreting the Agreement, even though Switzerland is not a party to that Convention:
Fothergill v. Monarch Airlines Ltd. (1981) A.C. 251 at pp. 276, 282, 290 ;
Commonwealth v. Tasmania (the Tasmanian Dam case) (1983) 158 C.L.R. 1 at p. 222 ;
Golder case (1975) 57 I.L.R. 201 at pp. 213-214 . Article 31 of the Convention requires a treaty to be interpreted in accordance with the ordinary meaning to be given to its terms ``in their context and in the light of its object and purpose''. The context includes the preamble and annexes to the treaty: Art. 31(2). Recourse may also be had to ``supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion'' to confirm the meaning resulting from the application of Art. 31 or to determine the meaning of the treaty when interpretation according to Art. 31 leaves its meaning obscure or ambiguous or leads to a result which is manifestly absurd or unreasonable: Art. 32.

The Agreement is one ``for the avoidance of double taxation with respect to taxes on income''. Accordingly, it is necessary to interpret the words of the Agreement with that particular purpose in mind. Moreover, the term ``enterprise'' in Art. 3 and 7 of the Agreement is ambiguous because, on the one hand, it can mean a project or activity undertaken and, on the other hand, it can mean a framework for making and carrying out decisions in respect of activities and projects. Consequently, it is proper to have regard to any ``supplementary means of interpretation'' in interpreting the Agreement. In this case, the ``supplementary means of interpretation'' are the 1977 OECD Model Convention for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital, which was the model for the Agreement, and a commentary issued by the OECD in relation to that model convention. But before referring to those two documents, it is necessary to describe the Agreement in more detail.

The Agreement applies to persons who are residents of Australia or Switzerland or both. The Agreement uses three methods for avoiding double taxation on the income of a resident of a country who has earned income in another country: (a) it eliminates taxation in the source country; (b) it limits taxation in the source country; and (c) it provides relief for tax paid in the source country. However, the Agreement does not contain any general provision dealing with the incomes of residents of Australia and Switzerland. Instead, the Agreement contains specific provisions concerning the taxation of income derived from real property, shipping and air transport, business profits, dividends, interest, royalties, the alienation of property, directors' fees, pensions and annuities, and remuneration in respect of employment and services rendered in the discharge of governmental functions. It also contains specific provisions concerning the taxation of the income of entertainers, students and dual residents.

Thus, although the provisions of the Agreement are far reaching and provide for relief in one form or another from double taxation in respect of most forms of income, the Agreement does not cover the field of taxable income. Indeed, Art. 22 contemplates that some forms of income will be taxable in both Australia and Switzerland. It provides for the granting of credits against Australian tax for Swiss tax paid in respect of income derived by

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ATC 4728

residents of Australia from sources in Switzerland and for the exemption of income from Swiss tax where residents of Switzerland derive income which, in accordance with the provisions of the Agreement, may be taxed in Australia. Moreover, it is significant that the Agreement contains no counterpart of Art. 21 of the model convention which provides:

``1. Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.''

Nevertheless, although the Agreement recognises that some income will be subject to double taxation, its purpose requires that, so far as is reasonably possible, the provisions of the Agreement should be construed so as to avoid double taxation.

The ``supplementary means of interpretation'' are of assistance in interpreting the meaning of the expression ``an enterprise carried on''. The model convention does not seek to attempt to define that expression, but the commentary on Art. 3 states:

``The question whether an activity is performed within the framework of an enterprise or is deemed to constitute in itself an enterprise has always been interpreted according to the provisions of the domestic laws of the Contracting States.''

Thus, the commentary recognises that an isolated activity may be an ``enterprise'' for the purpose of the Agreement.

In the Federal Court, Sheppard J. thought that the word ``enterprise'' should be given a wide meaning. His Honour thought that, on its own, the term ``enterprise'' could consist of one transaction provided that it was entered into for a business or commercial purpose. However, he pointed out that it was part of the composite expression ``enterprise carried on''. He thought that the case law on the meaning of the expression ``carrying on'', as well as its dictionary meaning, required a repetition of acts and excluded the case of a single or isolated activity: see
Kirkwood v. Gadd (1910) A.C. 422 at p. 431 ; Premier Automatic Ticket Issuers Ltd. at p. 298;
Smith v. Capewell (1979) 142 C.L.R. 509 at pp. 517-518 . Consequently, his Honour thought that the appellant's activities lacked the element of continuity which was required to constitute ``an enterprise carried on'' within the meaning of the Agreement. Lee J., the other member of the majority, held that the Agreement makes ``no provision for an isolated venture in the nature of trade which stands apart from the conduct or carrying on of the business of an enterprise''.

I am unable to agree with their Honours' conclusion that the activities of the appellant did not constitute ``an enterprise carried on by a resident of Switzerland''. If, as the commentary acknowledges, an activity may constitute an ``enterprise'' for the purpose of the Agreement, ex hypothesi , the words ``carried on by'' cannot require the term ``enterprise'' to be read as always requiring a repetition of activity. Consequently, the expression ``enterprise carried on by'' in Art. 3(1)(f) does not have any connotation requiring the existence of the enterprise before or after the profit has been earned. Nor does it require that the enterprise exist independently of the activity or activities which earns or earn the profit. The words ``carried on by'' are used in Art. 3(1)(f) to signify the nature of the connection which must exist between the ``enterprise'' and a resident of one of the Contracting States. As counsel for the appellant pointed out, it would make no difference to the meaning of Art. 3(1)(f) if the words ``undertaken by'' were substituted for the words ``carried on by''. Moreover, as the term ``enterprise'' has no technical meaning in Australian law, there is no domestic reason for holding that an activity cannot constitute an ``enterprise carried on'' within the meaning of Art. 3(1)(f). Consequently, the words ``enterprise carried on by'' in Art. 3(1)(f) should be construed as including both an isolated activity and a framework for making and carrying out decisions in relation to activities and projects since that is the construction of that Article which will avoid double taxation to a greater extent than the competing construction which was favoured in the Federal Court.

Cases such as Kirkwood and Smith , to which Sheppard J. referred, deal with the different expression ``carrying on any... business''. Those cases hold that an isolated transaction of a business nature does not constitute ``carrying on... a business''. But that is because the carrying on of a business requires the habitual pursuit of business activities. For the reasons I

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ATC 4729

have already given, cases on sec. 26(a) of the Income Tax Assessment Act , to which his Honour referred, also do not assist in resolving the issue in the present case.

It follows from the foregoing discussion that the Art. 3(1)(f) definition of ``enterprise of one of the Contracting States'' covers an isolated activity as well as a framework for making and carrying out decisions in relation to projects and activities. The definition in Art. 3(1)(f) applies, however, only when the context does not otherwise require. Do the words ``the enterprise carries on business'' which appear twice in Art. 7(1) provide a context sufficient to reject the application of the Art. 3(1)(f) definition to the words ``profits of an enterprise of one of the Contracting States'' which appear in the first line of Art. 7(1)? The concept of carrying on of a business requires repetition of activity. Hence, in the expression ``the enterprise carries on business'', the term ``enterprise'' must refer to a framework for making and carrying out decisions in relation to activities and projects rather than an isolated activity, and the Art. 3(1)(f) definition is inapplicable. If the expression ``profits of an enterprise'' in the first line of Art. 7(1) includes the profits of an isolated activity, then the term ``enterprise'' appears to have two different meanings in that Article.

Nevertheless, I do not think that the context requires the rejection of the application of the Art. 3(1)(f) definition to the phrase ``enterprise of one of the Contracting States'' in the first line of Art. 7(1). If the definition in Art. 3(1)(f) is applied to the first limb of Art. 7(1), Art. 7(1) exempts the profits of an isolated activity as well as the profits of a framework for making and carrying out decisions in relation to activities and projects from taxation in Australia unless the enterprise carries on business in Australia through a permanent establishment based in this country. To interpret the words ``the enterprise'' in the ``unless'' clause and the succeeding sentence of Art. 7(1) as meaning a framework for making and carrying out decisions in relation to activities and projects and not an activity does not, however, contradict the Art. 3(1)(f) meaning of the term ``an enterprise'' in the first limb of Art. 7(1). It simply means that the definition does not apply to the term ``the enterprise'' in Art. 7(1) because, in its context, that term refers only to ``an enterprise'' which has derived its profits by using a framework for making and carrying out decisions in relation to activities or projects.

Accordingly, profits derived from an isolated activity may constitute the profits of ``an enterprise'' within the meaning of Art. 7. Indeed, it would be surprising if this was not the case. It is difficult to see any revenue or commercial reason for distinguishing between a Swiss resident who earns profits by constructing a number of buildings while he is in Australia for a few months and a Swiss resident who earns profits by constructing a single building while he is in Australia for a few months.

To come within Art. 7, however, it is not enough that the carrying on of an enterprise has produced ``profits''. The heading to Art. 7 must be taken into consideration in determining the meaning of that term. Although it is not necessary that the profits referred to in that Article be those of a business, the heading ``Business Profits'' indicates that, to come within Art. 7, the profits of the enterprise must be profits from an adventure in the nature of trade: cf.
Minister of National Revenue v. Tara Exploration and Development Co. Ltd. (1972) 28 D.L.R. 135 .

With some hesitation I have come to the conclusion that the profits earned by the appellant were within the scope of Art. 7. The evidence establishes that the appellant saw his opportunity to invest in the trust as a venture which, although highly speculative, carried with it the prospect of making a large sum of money when an offering was eventually made to the public. To achieve that profit, he had to raise finance from his bank and parents, acquire an interest in the trust property and hold the interest until the public offering. He acquired his first interest in the trust in January 1984. He then acquired a further interest in May 1984. In furtherance of his plan to make a profit, he held those interests until November 1984 when he exchanged them for shares in the recently formed Energy Research Group Australia Ltd. As soon as the shares of that company were listed on the Australian Stock Exchange, he gave instructions to sell them. There were over 40 separate sales between 7 February 1985 and 6 March 1985. No doubt those sales were deliberately staggered so that the price of the shares would not be depressed. If the

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ATC 4730

respondent had not intervened, all the shares would have been sold. Although Franklyn J. found that the acquisition of interests in the trust by the appellant was neither part of nor a diversification of his earthmoving equipment business, the fact that he was a businessman is a matter of considerable importance. It gives colour to the whole venture. The appellant's discussions with Mr Kristensen should be seen as discussions between two businessmen who recognised the chance to make large profits from the public float of the trust. The better conclusion is that the appellant acquired his interests in the trust as a businessman rather than as a private person. To use the words of Sheppard J., what the appellant did amounted to ``a business deal''. Accordingly, the profits which the appellant earned were profits from an adventure in the nature of trade and were the profits of an enterprise carried on by a resident of Switzerland.

The appeal should be allowed.

THE COURT ORDERS THAT:

Appeal allowed with costs.

Set aside the orders of the Full Court of the Federal Court and in lieu thereof order that the appeal to that Court be allowed.

Set aside the orders of Franklyn J. and in lieu thereof order that the appeal to the Supreme Court of Western Australia be allowed.

Remit the assessment to the respondent to be varied in accordance with the judgment of this Court.

Liberty to the appellant to apply within 14 days of this order with respect to the costs of the proceedings in the Supreme Court of Western Australia and the Full Court of the Federal Court.