Practitioners advising on reductions of capital should note that payments to shareholders upon cancellation of shares remain capital receipts and are not assessable as dividends under s 44(1)(a), even where the payments exceed the amounts originally paid up on the shares.
Later decisions that cite Uther v Federal Commissioner of Taxation
Decisions cited by Uther v Federal Commissioner of Taxation
UTHER v. FEDERAL COMMISSIONER OF TAXATION [1964] HCA 80; (1964) 111 CLR 318
Income Tax (Cth)
High Court of Australia
Owen J.(1)
CATCHWORDS
Income Tax (Cth) - Assessable income - Dividends - Reduction of capital in company - Payments to shareholders - Excess of payments received over amounts originally paid up on shares - Whether excess included in assessable income - Income Tax and Social Services Contribution Assessment Act 1936-1962 (Cth), ss. 6 (1) "dividend", 44 (1) (a).
HEARING
Sydney, 1964, December 7, 18. 18:12:1964DECISION
December 18.2. The facts are that the taxpayer was a shareholder in and the Chairman of Directors of a company, incorporated in Victoria, named Best & Gee Pty. Ltd. to which I shall refer as "the Company". Until 1961 the nominal capital of the Company was 60,000 pounds divided into 20,000 preference shares of 1 pound each, 38,500 ordinary shares of 1 pound each and 30,000 deferred shares of 1s. each. The issued capital amounted to 49,526 pounds consisting of 17,026 fully paid preference shares, 31,000 fully paid ordinary shares and 30,000 fully paid deferred shares. Of these the appellant held 848 preference shares and 3,640 ordinary shares. He was also a beneficiary in the estate of one George L'Estrange Gee, deceased, and 13,280 ordinary shares in the Company were held by the trustees of that estate. In March 1960 the assets of the Company included shares in a number of subsidiary companies, valued at cost at 163,821 pounds. These included 851 fully paid preference and 2,066 fully paid ordinary shares of 1 pound sterling each in an English company, Lantigen (England) Ltd., valued at cost at 107,704 pounds. In June 1960, the Company agreed to sell to Norcros Ltd., a company incorporated in England, the shares held by it in Lantigen (England) Ltd. The purchase price agreed to be paid for each of the 851 preference shares was 3 pounds payable in cash and the total price agreed to be paid for the 2,066 ordinary shares was 497,447 pounds, payable as to 194,947 pounds in cash, the balance of 302,500 pounds to be satisfied by the allotment to the Company of 220,000 fully paid ordinary shares of 5s. each in Norcros Ltd. The agreement was carried out, the Company receiving 197,500 pounds in cash and the 220,000 shares being allotted to it. In August 1960, it sold 100,000 of these shares for 250,778 pounds 15s. 0d., which was duly paid, and the surplus arising on the sale was credited to an account in the Company's books styled "Capital Profit or Loss on Sale of Assets Account". Later in August 1960 a company named Southcros Ltd. was incorporated in England. It offered 1,177,666 of its ordinary shares each of 5s. sterling to holders of ordinary shares in Norcros Ltd. at a price of 5s. 6d. sterling per share in the proportion of one ordinary share in Southcros Ltd. for every nine shares in Norcros Ltd. The Company, as one of the holders of ordinary shares in Norcros Ltd., was offered and accepted 13,333 shares in Southcros Ltd., for which it paid 4,607 pounds 10s. 1d. In December 1960 the Company sold a further 100,000 of its shares in Norcros Ltd. for 268,747 pounds 10s. 0d. and the surplus arising from the sale was carried to the "Capital Profit or Loss on Sale of Assets Account" in its books. It also sold 10,000 of its shares in Southcros Ltd. for 39,060 pounds and the surplus arising on that sale was carried to the same account. (at p320)
3. The only relevance of the transactions outlined above seems to me to be that they show how it came about that early in 1961 the Company was in a position to take the action which it then proceeded to take. Its directors decided to recommend to its shareholders that it had assets in excess of its requirements and that the sum of 499,663 pounds 10s. 0d. then held by it in cash was not required for any of its purposes and could safely be paid to shareholders. In these circumstances they recommended that the Company's capital be reduced by extinguishing the unissued shares and cancelling one half of the issued shares of each class in the capital of the Company and that the amount of 499,663 pounds 10s. 0d. should be paid to the shareholders upon the cancellation of their shares. They recommended that 2 pounds per share should be paid in respect of each cancelled preference share and that the amounts to be paid in respect of each of the cancelled ordinary and deferred shares should be 17 pounds 5s. 6d. and 14 pounds 6s. 6d. respectively. All necessary resolutions to enable these steps to be taken were passed at meetings of the shareholders and in April 1962 an order was made by the Supreme Court of Victoria under s. 53 of the Companies Act 1958 (Vict.) confirming the reduction of capital proposed to be effected and the method of effecting it. Under that section and subject to confirmation by the Court, a company may, if so authorized by its Articles - as was the case here - reduce its share capital in any way and inter alia may pay off any paid-up share capital which is in excess of its wants. The reduction of capital was carried out and 424 of the preference shares and 1,820 of the ordinary shares held by the appellant were cancelled. He was paid 2 pounds in respect of each cancelled preference share and 17 pounds 5s. 6d. in respect of each cancelled ordinary share, the total amount received by him being 32,288 pounds 10s. 0d. One half of the ordinary shares held by the trustees of the estate of George L'Estrange Gee were also cancelled and they were paid 114,706 pounds, representing 17 pounds 5s. 6d. in respect of each cancelled ordinary share. Of the moneys thus received by the trustees the appellant, as a beneficiary, was presently entitled to be paid and was paid by them the sum of 3,782 pounds. This represented the proportion payable to the appellant of the difference between the sum of 114,706 pounds received by the trustees upon the cancellation of one half of the ordinary shares previously held by them in the Company and the sum of 6,640 pounds, being the amount originally paid up on those shares. (at p321)
4. In his income tax return for the year ended 30th June 1962, the appellant showed a taxable income of 16,930 pounds. He disclosed the fact that he had received from the Company the sum of 32,288 pounds 10s. 0d. but claimed that it was not part of his assessable income. The Commissioner, however, assessed the appellant to tax upon a taxable income of 50,756 pounds. The adjustment sheet accompanying the notice of assessment showed that this figure had been determined by adding to the taxable income as returned at 16,930 pounds , the sum of 3,782 pounds received by the appellant from the trustees of the estate of George L'Estrange Gee and the sum of 30,044 pounds , being the difference between the amount received by the appellant from the Company upon the cancellation of one half of his shareholding and the sum of 2,244 pounds, being the amount which had originally been paid up on those shares. (at p321)
5. For the Commissioner it was contended that both these amounts formed part of the appellant's taxable income. It was not disputed that, apart from any statutory provision bearing on the question, the amount received by the appellant from the Company was on general principles a capital receipt. It was a payment received by him in replacement or extinguishment of his shares which had been cancelled. So too the amount received by the trustees was received by them in replacement of the shares held by them which had been cancelled. It was submitted, however, that the effect of s. 44 (1) of the Income Tax and Social Services Contribution Assessment Act 1936-1962, when read with the definition of "dividend" in s. 6 (1), was to make what would otherwise have been capital receipts in the hands of the appellant receipts of income for the purpose of the Act. (at p321)
6. Section 44 (1) (a) provides that "the assessable income of a shareholder in a company shall . . . if he is a resident - include dividends paid to him by the company out of profits derived by it from any source" and s. 6 (1) defines "dividend" to include "any distribution made by a company to the shareholders . . . but does not include a return of paid-up capital . . .". The amount paid by the Company to the appellant was, so it was said, a "distribution" made by the Company to him as one of its shareholders ; portion only of the amount so paid was a "return of paid-up capital" ; and the balance was by force of the Act assessable income. In the same way the moneys received by the trustees of the estate of George L'Estrange Gee in respect of the cancelled shares which they had held less the amount which had been paid up on those shares were, for taxation purposes, assessable income and the appellant being presently entitled to his proportion of that difference the amount received by him formed part of his assessable income. (at p322)
7. Three cases have been decided by this Court which throw light on the question thus raised. The first is Commissioner of Taxation (N.S.W.) v. Stevenson [1937] HCA 72; (1937) 59 CLR 80 , a case arising under the Income Tax (Management) Act, 1928 of New South Wales. There a company owned an hotel and held also an amount of undistributed profits. It sold the hotel and after discharging its liabilities its assets were distributed amongst the shareholders in proportion to their shareholdings. No steps had been taken to put the company into liquidation and what was done amounted to what Evatt J. described as a de facto liquidation. One of the shareholders was assessed to tax under s. 11 (b) of the New South Wales Act in respect of so much of the amount received by her as could be traced back to the company's undistributed profits. Section 11 (b) of the New South Wales Act provided that the assessable income of a member or shareholder of a company should include all dividends credited, paid or distributed to the member or shareholder from any profit derived from any source by the company, and "dividend" was defined, unless the context required another meaning, as "profit and bonus and bonus share, whether declared or dealt with by the company issuing the bonus share as capital or not, except to the extent to which a bonus share represents a writing-up or revaluation of assets without disposal thereof, or the capitalization of profits derived from the sale of capital assets, if such profits were not liable to income tax". It was held by Rich, Dixon, Evatt and McTiernan JJ. that s. 11 (b) did not bring into the category of assessable income distributions traceable to accumulated trading profits but paid to retire or extinguish shares. In their joint judgment Rich, Dixon and McTiernan JJ., after referring to the fact that the payment made to the taxpayer was received by her in replacement of her shares, went on : "No part of it was a detachment of the profit from the funds of the company paid as the income earned by the share. None of it was a dividend, profit or bonus, paid by the company as a going concern in respect of the shares as continuing, although intangible, pieces of property" (1937) 59 CLR, at p 104 . For those reasons their Honours considered that the amount distributed represented the full capital value of the taxpayer's shares and the payment was made in extinguishment of her share interest. The receipt was a receipt of capital and no part of it was brought to tax by the Act. (at p323)
8. The next case is Thornett v. Federal Commissioner of Taxation [1938] HCA 32; (1938) 59 CLR 787 . There the taxpayer held 3/40ths of the issued shares in a company. They were fully paid 1 pound shares and she held 26,250 of them. The company reduced its capital by paying off and cancelling a number of its issued shares, including those held by the taxpayer. In return for the cancellation of her shares, the company transferred to her assets to the value of 41,823 pounds, representing 3/40ths of the whole of its assets. The Commissioner treated 26,250 pounds, the face value of the shares, as being a return of capital and sought to tax the balance as assessable income under s. 16 (b) (i) of the Income Tax Assessment Act 1922-1929. That provision was in terms almost identical with those of s. 11 (b) of the New South Wales Act which had been considered in Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 . It was held, following that case, that the amount paid to her, although derived from profits earned by the company, was not a dividend, bonus or profit credited, paid or distributed to her as a shareholder. Latham C. J. said: "The section contemplates a shareholder who receives a dividend, bonus or profit in respect of a share which remains in existence as representing an interest in the capital of the company. In the present case, the shareholder received the payment as a step in a transaction directed towards the abolition or extinction of her interest in the capital of the company. There was no payment by the company which can be said to represent income upon the interest in the capital of the company represented by the shares which a shareholder continued to hold as a capital interest. The transaction really amounted to a surrender by a shareholder of all capital interest in the company in return for a lump sum payment" (1938) 59 CLR, at p 796 . Dixon J. (as he then was) said: "The appellant received an entire and indivisible sum representing the value of her shares, that is, her interest in the company. It was paid and received in satisfaction of, and by way of replacement for, her share interest. It terminated her interest and extinguished the property or choses in action which it replaced. In my opinion none of the sixty per cent excess over the paid-up capital held by her in the company forms part of her assessable income" (1938) 59 CLR, at pp 802, 803 . I should add that in the course of his judgment his Honour referred to the fact that in 1928 s. 16B had been added to the Act (1938) 59 CLR, at p 802 . It dealt with distributions made to shareholders by a liquidator in the course of the winding up of a company and provided that such distributions were assessable income in the hands of the shareholders to the extent that they represented profits which, if distributed by a company not in liquidation, would be deemed to be assessable income of the shareholders. The successor to that section in the present Act is s. 47. Speaking of s. 16B, his Honour said: "To my mind the tendency of the introduction of this provision into the statute is to confirm, and not to negative, the view that s. 16 (b) (i) would not carry the same consequence" (1938) 59 CLR, at p 802 . (at p324)
9. The third case is Federal Commissioner of Taxation v. Blakely [1951] HCA 17; (1951) 82 CLR 388 . As in Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 there was a de facto liquidation of a company with a paid-up capital of 5,000 pounds. There were only two shareholders, who were also the directors. These two persons appropriated the company's assets, discharged its liabilities and later sold the assets and divided the proceeds. The Commissioner treated 5,000 pounds of the amount received on the sale of the assets as being a return of paid-up capital. The balance he treated as representing the company's profits and assessed the taxpayer in respect of his share of that balance in reliance upon ss. 44 (1) and 47 of the present Act. One or other of these provisions, it was said, made the amount in question assessable income in the hands of the taxpayer. All three members of the Court (Latham C. J., Dixon and Fullagar J. J.) rejected the contention that s. 47 was applicable. It applied only to distributions by a liquidator in the course of a winding up. There was in fact no liquidator and in the relevant sense no winding up. As to the contention that s. 44, when read with the definition of "dividend" in s. 6, made the amount in question part of the assessable income of the taxpayer, Latham C. J. was of opinion that, in the circumstances of the case, there had been no distribution by the company. The shareholders had appropriated the assets by their own acts, the company had done nothing and no part of the assets that the taxpayer had appropriated to himself could be regarded as a distribution by the company. Fullagar J., with whose judgment Dixon J. agreed, reached the same conclusion but for different reasons. Notwithstanding the fact that in 1936 the words "out of its profits" had been omitted from the definition of "dividend" and the words "but does not include a return of paid-up capital" had been added to that definition, his Honour took the view that the case was governed by Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 and Thornett's Case [1938] HCA 32; (1938) 59 CLR 787 . He said: "Now it is possible that, when the Commonwealth legislation assumed in 1936 the form which it has since retained, it was intended to cover, and was believed to cover, such cases as Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 and Thornett's Case (1938) [1938] HCA 32; 59 CLR 787 . I should seriously doubt this myself. One would have expected such a result to be sought rather through the medium of s. 47 than through the medium of s. 44, and s. 47 would seem to be unnecessary if s. 44 has the meaning contended for. But, if this was the intention behind the new form which the legislation took, I think that the draftsman missed, as I think the argument for the Commissioner in this case misses, the whole point of the decisions in Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 and Thornett's Case [1938] HCA 32; (1938) 59 CLR 787 - and, for that matter, in Burrell's Case (1924) 2 KB 52 . And I do not think that the Act of 1936-1942 brings into charge any part of what the taxpayer received in this case. I would not be prepared to deny that there was a 'distribution' in this case. There was clearly a 'distribution' in Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 . But the point in this case is, as it was in Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 , as to the nature of the receipt. There was not a distribution of profits, or a distribution out of profits. What was received was capital. There was no detachment or severance from the funds of the company of money or other assets as representing a profit made by the company. There was simply a realization of a share investment (per Starke J. in Thornett's Case (1938) 59 CLR, at p 799 ). 'The shareholders . . . receive nothing but the ultimate capital value of the intangible property constituted by the shares . . . The shareholder simply receives his proper proportion of a total net fund without distinction in respect of the source of its components, and he receives it in replacement for his share' (per Rich, Dixon and McTiernan JJ. in Stevenson's Case (1937) 59 CLR, at p 99 ). There is, in my opinion, nothing in the Act which gives the character of income to this receipt, which was according to general principles a capital receipt" (1951) 82 CLR, at pp 406, 407 . Whether Fullager J. was right or wrong in doubting whether the alterations made to the wording of the definition of "dividend" in 1936 were intended to cover cases such as Stevenson's Case [1937] HCA 72; (1937) 59 CLR 80 and Thornett's Case [1938] HCA 32; (1938) 59 CLR 787 is not to the point. If that was the draftsman's intention, it is plain that, in his Honour's opinion and that of Dixon J., he had failed to effect that purpose. (at p325)
10. For these reasons I am of opinion that the appeal should be allowed with costs, the assessment set aside and the matter remitted to the Commissioner to issue an amended assessment to give effect to this decision. (at p326)
ORDER
Appeal allowed. Assessment set aside and matter remitted to the Commissioner to issue an amended assessment to give effect to this decision. Respondent to pay appellant's costs of the appeal.