Investment & Merchant Finance Corporation Ltd v Federal Commissioner of Taxation [1970] HCA 1; (1970) 120 CLR 177 (2 February 1970)

HIGH COURT OF AUSTRALIA

INVESTMENT & MERCHANT FINANCE CORPORATION LTD. v. FEDERAL COMMISSIONER OF TAXATION [1970] HCA 1; (1970) 120 CLR 177

Income Tax (Cth)

High Court of Australia

Windeyer J.(1)

CATCHWORDS

Income Tax (Cth) - Deductions - Losses and outgoings incurred in gaining assessable income - Loss incurred by carrying out scheme the profit (if any) from &which would have been assessable income - Purchase by taxpayer of shares in private company having accumulated profits and resale after stripping of dividend - Dividend rebatable in hands of taxpayer - Whether dividend to be brought into account in calculating loss - Income Tax Assessment Act 1936-1965 (Cth), ss. 26 (a), 46, 51, 52.

HEARING

Adelaide, 1969, September 25, 26;

Sydney, 1970, February 2. 2:2:1970

APPEAL pursuant to s. 187 of the Income Tax Assessment Act 1936-1965 (Cth).

DECISION

1970, February 2.

WINDEYER J. delivered the following written judgment:-

This is a taxpayer's appeal against an assessment of income tax in respect

2. The case arises out of what was called in the evidence a "dividend stripping operation". That term has become well known in English revenue law. I quote from Halsbury's Laws of England, 3rd ed., vol. 20, p. 201:

"Dividend stripping is a term applied to a device by which a

financial concern obtained control of a company having accumulated

profits by purchase of the company's shares, arranged for these

profits to be distributed to the concern by way of dividend, showed

a loss on the subsequent sale of shares of the company, and obtained

repayment of the tax deemed to have been deducted in arriving at the

figure of profits distributed as dividend."

So well known has the term become that the second edition of Fowler's Modern English Usage (1965) has a brief explanation, under the heading "Bond washing and dividend stripping", introduced by -

"Most of us are familiar with these terms, but few know much more

about them than that they are devices for the legal avoidance of

taxation. In the course of the duel provoked by them between the tax

avoider and the legislature they have developed a protean variety of

detail, but their essence remains the same."

The duel has, in the United Kingdom, been a running fight in which taxpayers have adopted one ingenious and complicated tactic after another. These Parliament sought successively to counter in 1955, 1958 and 1960, and more recently, in the Finance Acts of 1965 (s. 65) and 1967 (par. 4 of Sched. XI). The course of the struggle is explained in Simon's Income Tax Law, vol. 2, p. 192 et seq. and vol. 2A, p. 679. In the result Lord Denning M.R. said last year: "The legislature has recently killed dividendstripping but this is one of its death struggles": Lupton (Inspector of Taxes) v. F.A. & A.B. Ltd. (1969) 1 WLR 1627, at p 1632; (1969) 3 All ER 1034, at p 1037 The Australian Parliament has not retaliated in the same way. It has not so far found it necessary to do so. Here a way of escape is not available to taxpayers by exactly the same route as in England. The statutory provisions in the two countries are different. The provisions of s. 341 of the Income Tax Act, 1952 (U.K.), are not precisely matched here. However, the taxpayer claims that it can in this case get the benefit of a dividend-stripping operation in much the same way as used to be possible in the United Kingdom. It relies upon the operation of ss. 46, 51 and 52 of the Income Tax Assessment Act 1936-1965 (Cth). (at p180)

3. Differences between the statutes here and in England mean that English revenue cases which turn on dividend-stripping are not directly relevant here. I was, however, referred to some of these cases, and I have read others, including Thomson (Inspector of Taxes) v. Gurneville Securities Ltd. (1969) 2 All ER 1195 and other recent cases to be mentioned later. (at p180)

4. In the case that I have mentioned, heard last year in the Court of Appeal, leave to appeal to the House of Lords was granted. Their Lordships' views of that case are not yet known. There are, however, discussions of the effect of the English legislation in the judgments of the House of Lords in Griffiths (Inspector of Taxes) v. J. P. Harrison (Watford) Ltd. (1963) AC1 ; Inland Revenue Commissioners v. F. S. Securities Ltd. (1965) AC 631 ; Bishop (Inspector of Taxes) v. Finsbury Securities Ltd. (1966) 1 WLR 1402; (1966) 3 All ER 105 , reversing the decision of the majority in the Court of Appeal (1965) 1 WLR 1206; (1965) 3 All ER 337 I acknowledge that I have gained from these and other cases an illumination which I hope has enabled me to see this case the more clearly; but I do not think it necessary in this judgment to go through the English cases and discuss them. I repeat that the case now before me must depend upon its own facts and on the provisions of the Australian statute. There is no suggestion that the taxpayer's dealings were a sham, or that they were void against the Commissioner. The only question is what fiscal consequences flow from a transaction that was open, honest and taking effect in law. If it had fiscal consequences advantageous to the taxpayer, it matters not that this was one of the things in the mind of the taxpayer when it engaged in the transaction. Subject always, of course, to s. 260, that proposition accords with general principle. It is sustained too by the decision of the House of Lords in Griffiths (Inspector of Taxes) v. J. P. Harrison (Watford) Ltd. (1963) AC1 , especially by the remarks of Lord Morris which have often been quoted since then. His Lordship himself was later to say:

"It was my view in that case that the transaction was demonstrably

a share-dealing transaction. Shares were bought: a dividend on them

was received: later the shares were sold. There may be occasions

when it is helpful to consider the object of a transaction when

deciding as to its nature. In the Harrison Case (1963) AC1 my

view was that there could be no room for doubt as to the real and

genuine nature of the transaction. The fact that the reason why it

was entered into was that the provisions of the revenue law gave

good ground for thinking that welcome fiscal benefit could follow

did not in any way change the character of the transaction. It was

not capable of being made better or worse or being altered or made

different by the circumstance that the motive that inspired it was

plain for all to see": Bishop (Inspector of Taxes) v. Finsbury

Securities Ltd. (1966) 1 WLR, at pp 1416, 1417; (1966) 3 All

E.R., at p. 111.

So too here. The question is not: Did the taxpayer act as it did in the hope that the transaction would yield it some relief from taxation? It is: Is that hope realized? (at p181)

5. The documentary evidence tendered, statements of account, minutes and other writings, is voluminous. It was supplemented and explained by the oral testimony of Mr. R. J. Lipman who has been a director of the taxpayer company since 1957 and is now a managing director. His evidence was clear, frank, helpful and not disputed. Although the material put before me was massive, with numerous figures and complicated calculations, I was aided by the analysis of counsel to an understanding of it; and I can extract and state fairly briefly what seem to me to be for present purposes the salient facts. I shall speak of money in terms of pounds, not dollars. The Commissioner's assessment is in dollars, but pounds were the currency when the transaction began. Some events bestride the transition to dollar currency, but for convenience I shall refer throughout to pounds. (at p181)

6. The taxpayer is a company that was incorporated in South Australia in 1949. It is resident in Australia carrying on business in Adelaide. It was incorporated in the name Devon Credits Limited. This name was changed to its present name in 1967. The business that, at all relevant times, the company has carried on, and which it has power to carry on, is described by it in its income tax return as that of a financier. It has engaged in money-lending, in underwriting, and in dealing in shares. It has held shares as investments. It has also dealt extensively in buying and selling shares with a view to profit. Share dealings have been throughout a substantial part of its activities. This case arises from an unusual transaction it carried out in 1963 and 1964 in relation to a private company incorporated in Victoria called Macgrenor Investments Pty. Limited. That company had an excess of assets (consisting mainly of moneys lent and shares in other companies) over liabilities of approximately 138,000 pounds. Of this amount about 122,000 pounds represented accumulated profits available for distribution to ordinary shareholders by way of dividends. Only thirty ordinary shares in Macgrenor had been issued. As a result of negotiations, in which Mr. Lipman took a leading part on behalf of the taxpayer, it was arranged that the taxpayer should buy twenty-one of these shares for approximately 4,000 pounds each, and that another company, The Investment Company of South Australia Limited, which was referred to as "Tiscal", should buy the remaining nine shares at the same price. "Tiscal" was a company whose undertaking was separate from that of the taxpayer, although they had some association and a connexion through Lipman who was a director of each. The price for each of the thirty Macgrenor shares was arrived at as representing one-thirtieth of the value of the Macgrenor assets available for distribution after allowing an amount for stamp duty and expenses attributable to the transaction. The amount which the taxpayer actually paid for its twenty-one Macgrenor shares was 86,180 pounds.17.0. It also paid the duty on the transfers. Its total outlay to get the shares was thus 86,504 pounds. In the result the shareholders in Macgrenor got about 120,000 pounds in all for the thirty shares sold. (at p182)

7. The taxpayer and "Ticsal" having thus become the owners of all the Macgrenor shares, that company then declared a dividend which absorbed the whole of the accumulated profits. The taxpayer received by way of dividend 81,900 pounds. "Ticsal" got approximately 40,000 pounds. Macgrenor later issued twenty new shares; but they did not rank for dividend until after the abovementioned distribution of the accumulated profits. Nine were allotted to "Ticsal", and eleven to a company called Happy Venture Pty. Limited. It was a small private concern having only ten shareholders, five of them being directors of the taxpayer. It traded in shares. It seems to have come into existence as an offshoot of the taxpayer. The taxpayer managed its affairs. It has a part as one of the dramatis personae, but only a small part. Nothing, for present purposes, turns on the allotment of the twenty new shares in Macgrenor. (at p183)

8. The result of the events so far narrated was that the holders of the original thirty shares in Macgrenor had received an amount approximately equal to their rights to the accumulated profits of their company. They had not received it by way of dividends taxable as income in their hands, but upon the sale of a capital asset, their shares. This was no doubt thought advantageous by them. The taxpayer by its expenditure of 86,000 pounds had become possessed of twenty-one Macgrenor shares and in respect of them it had in the year ended 30th June 1964 received a dividend of 81,900 pounds. This dividend it got in effect tax free, as it was rebatable by virtue of s. 46 of the Income Tax Assessment Act. Then in December 1964, that is the next financial year, it sold its twenty-one Macgrenor shares for the sum of 1 pound each. This low price, it was said, could be explained because the only assets of Macgrenor remaining after the distribution of the accumulated profits had by the end of 1964 become of little value. (at p183)

9. Of the twenty-one shares the taxpayer sold, seventeen were sold to Happy Venture : the remaining four were sold to an employee, who apparently bought them on her own account. The taxpayer, having thus sold for 21 pound shares which had cost it 86,504 pounds to buy, claimed that it had made a loss which should be taken into account as a deduction in arriving at its taxable income. This loss it claimed was 82,931 pounds, that being the amount that had been written off in its books upon a revaluation of the shares before they were actually realized for 21 pound. I need not consider the correctness of this written down figure. The question in the case is more fundamental. (at p183)

10. The Commissioner refused to accept the taxpayer's proposition that its purchase of the Macgrenor shares had resulted in a stupendous loss as claimed. It had brought the taxpayer a share of Macgrenor's profits amounting to 81,900 pounds. This the Commissioner considered was not to be ignored when the total profit or loss of the undertaking had to be ascertained. Taking this view the Commissioner, in arriving at the taxpayer's taxable income, computed the loss as only 4,583 pounds. This figure is the difference between on the one hand what the purchaser paid for the shares, 86,504 pounds, and on the other what it got by stripping the dividend, 81,900 pounds, and selling the shares thereafter for 21 pound. The Commissioner assessed tax for the year ended 30th June 1965 accordingly. The taxpayer now appeals contending that its claim to have made a deductible loss of 82,931 pounds ought to be hpheld. (at p184)

11. Counsel for the Commissioner put some stress upon the purpose and intention of the taxpayer in entering into the transaction with Macgrenor. As this matter may go further, I should state my findings on that. I accept unreservedly what Lipman said of it. He was the managing director of the taxpayer. There were two persons called managing directors ; but he was the one who was especially concerned with financial aspects of the taxpayer's business. He initiated, conducted and carried through the negotiations with Macgrenor. The other directors of the taxpayer approved and ratified his actions. In the circumstances his statements as to the intention and purpose of the taxpayer can be accepted. It was in fact the intention and purpose with which he acted on its behalf with the knowledge and approval of the other directors. He said, under cross examination by counsel for the Commissioner, that it was definitely the taxpayer's intention to receive an immediate dividend to be declared out of the accumulated profits of Macgrenor, which it knew would be virtually tax free. He was pressed to say that this was the taxpayer's sole purpose in buying the shares. He would not agree. He said it was always also intended that when the dividend had been taken the shares would be sold. Macgrenor would then, as he put it, be "a shell" and he said "any company which is a shell is not difficult to sell". He explained the plan:

"The directors acquired the Macgrenor shares for the purpose of

purchasing for a given sum the shares to make available to the

taxpayer, a corporate shareholder, the tax advantage of the

dividend, and to dispose of the shares when the dividend had been

stripped from them. That was the purpose, and the inherent

advantages that go to a share trader who performs that exercise,

which is not limited to the receiving of a dividend. - - - What

other advantage did you see for your company at the time you

acquired the shares ? - - - The advantages that exist for a share

trader in any form of trading in shares to offset the profits he

makes in some shares against the losses he makes in the sale of

other shares, which was done by our company a lot with gold shares

and other shares." (at p184)

12. Counsel reverted to this later and the witness repeated his explanation.

"I asked you yesterday afternoon about the purpose for which the

company, your company, entered into this Macgrenor transaction. Do

you agree that the primary purpose of the company was to obtain the

dividend out of the accumulated profits, which dividend you

recognized would be virtually tax free ? - - - I could not agree

that it was the primary purpose. I would call it a composite

purpose, your Honour. - - - And what other purpose would the

company have? - - - The actual operation which I would describe as a

dividendstripping operation is a two-phase operation of removing the

dividend and disposing of the share. One by itself as such does not

create the desired result from a dividend-stripping operation."

I then intervened:

"HIS HONOUR : I do not quite follow that. Would you just explain

it to me ? You say one by itself does not create the desired result,

but one by itself created the desired result of obtaining certain

moneys tax free, or virtually tax free, but what does the retaining

of the company - - - ? - - - No, it is the selling of the shares. -

- - The selling of the shares ? The retaining of the shares and - I

see, the selling of the shares. Well, what desired result is that ?

- - - If one has a series of transactions and one is buying some

shares for a given price and selling some for more, one is taxed on

the profit that one makes on the selling of those shares. If one can

marry that off with a loss from the sale of other shares, then the

overall situation is contra to a greater or lesser extent, and I

therefore link the obtaining of the dividend and the removal of the

shares as a contra to the other transaction as being the operation.

- - - I see. The advantage of the sale of the shares is that you

sell them at a loss ? - - - Yes. - - - And you offset that loss

against the profits which you have made in other share deals ? - - -

Yes." (at p185)

13. This clearly stated the basic practice of a dividend-stripping operation. Somewhat similar operations, on a much smaller scale and in relation to shares in public companies listed on stock exchanges, had been earlier incidents in the taxpayer's business. They were distinguishable in several respects from the Macgrenor transaction ; and they and their consequences are not in question. A taxpayer who trades in shares may, in the ordinary course of his business, sell shares in a public company ex-dividend, or after he has received a regular periodic dividend. That, as I understand the matter, does not, merely because the shares were sold for a less price than was paid for them, amount to dividendstripping having questionable consequences for the Revenue. But this taxpayer's transaction in respect of the Macgrenor shares was very different from that. (at p185)

14. I have failed to appreciate why counsel for the Commissioner was so eager to obtain from Lipman an admission that the taking of the dividend was the sole, or primary, purpose for which the taxpayer bought the Macgrenor shares. It has never been disputed that the dividend was income of the taxpayer. It was received on revenue account ; and if it had not been for the operation of s. 46 it would have been taxable. Similarly the taxpayer does not dispute that the sum of 21 pounds, the proceeds of the sale of its twenty-one Macgrenor shares, is to be taken into account in arriving at its income from share dealings. The question is whether the 81,900 pounds is to be left out of account in calculating the loss upon the whole transaction, which Lipman described as a "two-phase opertion" with a "composite purpose". I accept Lipman's evidence that each main phase of the operation was planned from the outset and intended to be carried out. He did not suggest, in fact he denied, that it was part of the original plan that the shares should be sold for 21 pound or for any particular price to any particular person : it was planned to sell them. The price and the buyer were details for later on. The price would, he said, depend upon whether Macgrenor had become virtually devoid of assets or still had some assets after the dividend had been paid : that is to say, would it transpire that it was then a quite empty shell or merely a very much emptied shell ? And who the buyer would be was not at the outset envisaged : but, as the plan developed, Happy Venture was on the spot, a ready buyer. The question for the Court is whether the sale of the shares for 21 pound really represented a loss of over 80,000 pounds which the taxpayer could offset against its profits in other fields. (at p186)

15. The case put for the taxpayer was based, it seems to me, on a formal rather than a commercially realistic notion of the nature of a share in a company. A share can be compendiously called the interest of a shareholder in the company : see Archibald Howie Pty. Ltd. v. Commissioner of Stamp Duties (N.S.W.) [1948] HCA 28; (1948) 77 CLR 143, at p 156 Of course, a shareholder has no property, legal or equitable, in the assets of the company : Commissioner of Stamp Duties (N.S.W.) v. Millar [1932] HCA 63; (1932) 48 CLR 618, at p 632 Nevertheless, the value of a share at any particular time must depend upon the assets the company then has and the then state of its affairs : see generally as to the legal nature of a share, Gower, Modern Company Law, 2nd ed. (1957), pp. 319-323. When the taxpayer bought shares in Macgrenor those shares represented an interest in a company teeming with undistributed profits, ripe to be taken - and easily taken by anyone who got control of the company. When the taxpayer sold the shares those assets had all been taken by it. It bought an interest in a company that was full of wealth. It sold an interest in a company that had been impoverished, which answered the description of a shell. (at p187)

16. I do not doubt that a profit or loss made by buying and selling a thing can ordinarily be measured by simply setting the price realized against the price paid. But it seems to me that this simple method of calculation will not suffice when the thing that is sold differs radically and in its economic character from the thing that was bought, and when the difference, whether for better or for worse, has been produced by the one person, the person who has brought and sold. If he has improved the thing he bought so that he gets a better price for it than he paid for it, as for example if he has built upon vacant land, then the measure of his profit is reduced by the cost to him of improvements. If, on the other hand, he has taken something from it to diminish its value, so that he gets a less price for it than the price he paid, then, in measuring the result of the transaction in terms of profit and loss, the value to him of what he took away must be taken into account. If a man bought land with a crop ripe for harvest, and after harvesting the crop, sold the land bare for less than he paid for it under crop, the value of the crop to him must, in any rational economic calculation, be brought to account in arriving at his profit or loss of the whole enterprise of buying, harvesting and selling. Similarly if he brought a mine, extracted some of the mineral from it, and then sold the mine. Whether or not in cases of that sort the profit or loss would be a capital profit or loss or a profit or loss on revenue account depends upon further factors. But whether a profit or loss bears upon income or capital does not affect the basic question of what is to be taken into account in computing profit or loss. It may be thought a naive point of view : but I am unable to regard the purchase of a controlling interest in a company with large profits ready for distribution as different, in economic character, from the purchase of land with a crop ready for harvest, or of a mine with minerals that can be taken. (at p187)

17. The taxpayer when it entered upon the Macgrenor transaction intended to take that part of the accumulated profits referable to the interest in Macgrenor which it acquired by buying twenty-one shares : and it intended too that having taken the dividend it would sell its shares. I think that in measuring the profit and loss of the taxpayer from the whole enterprise in which it thus engaged, the financial results to it of both parts of its plan must be brought to measure together. That is, I consider, the first step. It was the step the Commissioner took, and in my opinion rightly took, in measuring the loss the taxpayer made when it sold the twenty-one shares. The question which then presents itself is whether the provisions of the Act enable the taxpayer to escape the consequences of this in the assessment of its taxable income. The ordinary business of the taxpayer included share dealings. These were no doubt all designed by it to be advantageous to it, some profitable in an ordinary economic sense, some as also affecting its ultimate liability to tax. I think that the Macgrenor transaction is properly to be regarded as an incident in the business of the taxpayer. That is enough to distinguish this case from the decision of Buckley J. in Fundfarms Developments Ltd. v. Parsons (Inspector of Taxes) (1969) 1 WLR 1735 ; (1969) 3 All ER 1161 , even if that case had otherwise any direct bearing on this. (at p188)

18. The notice of objection puts the taxpayer's claim to displace the Commissioner's assessment on several grounds. They were not all pressed by counsel for the taxpayer. His main argument centered upon s. 52 of the Act. That section reflects, in an obverse way, the provisions of par. (a) of s. 26. Section 26 and s. 52 are in a sense counterparts. So far as relevant, s. 52 is as follows:

"Any loss incurred by the taxpayer in the year of income upon the

sale of any property or from the carrying on or carrying out of any

undertaking or scheme, the profit (if any) from which sale,

undertaking or scheme would have been included in his assessable

income, shall be an allowable deduction."

It will be seen that the deductible loss to which the section refers is a loss incurred in the year of income. When s. 52 is read with s. 26 this means a loss arising either (a) from the sale by the taxpayer of any property acquired for the purpose of profit-making by sale, or (b) from the carrying on or carrying out of any profitmaking undertaking or scheme. (at p188)

19. If the first limb of par. (a) of s. 26 be invoked, it is not necessary that the property sold at a loss should have been acquired in the year of income in which it was sold. The essential condition is the purpose of the acquisition, not the time of the acquisition. (at p188)

20. If the second limb of the paragraph be relied upon, it is not necessary that the profit-making undertaking or scheme should have had its inception in the year of income in which a profit arose, or loss was incurred, from carrying it on or carrying it out. The paragraph postulates a profit-making undertaking or scheme. It assumes that carrying on the undertaking or carrying out the scheme will extend over a period of time. A scheme presupposes some programme of action, a series of steps all directed to an end result. Similarly an undertaking is an enterprise directed to an end result. Each word connotes activities that are co-ordinated by plan and purpose - that whatever is done under the scheme or pursuant to the undertaking is done as a means to an end. There may, in one sense, be several transactions, but they are related because all directed to the attainment of the one end, profit. The phrases "carrying on" or "carrying out" are not technical expressions, as Buckley J. had occasion to remark very recently: Greenberg v. Inland Revenue Commissioners (1969) 3 WLR 883, at p 900 But they are aptly related to undertakings and schemes. (at p189)

21. It is impossible to say in this case that the shares said to have been sold at a loss were bought for the purpose of profit-making by sale within the meaning of the first limb of par. (a) of s. 26. They were bought as part of the two-phase transaction. The taxpayer contemplated that they would be sold for less than the price paid for them. The lower the sum for which they could be sold, the more pleased the taxpayer would be, the better would its purpose in buying them be satisfied. That cannot be said to be a purpose of making a profit by their sale. (at p189)

22. Looked at from the other angle, that the second limb of par. (a) applies and that they were bought as part of a profit-making undertaking or scheme - the loss incurred must then be measured by the result of carrying out the scheme as a whole. It was a single scheme having two phases - taking the dividend and then selling the shares. The loss incurred from carrying on the undertaking or carrying out the scheme must be measured by "a yield of a composite character", to use the expression this Court used in Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation [1946] HCA 60; (1946) 73 CLR 604, at p 620 (at p189)

23. An alternative argument for the taxpayer was founded upon s. 51. The taxpayer paid 86,000 pounds for the Macgrenor shares it bought. That, having regard to the purpose for which they were bought, was I do not doubt an outgoing in the year it was paid incurred in gaining assessable income, for it produced the dividend received. That this part of the taxpayer's income was in effect tax free by virtue of s. 46 is immaterial. The outgoing was incurred to gain it. It was an allowable deduction under s. 51. But the question in this case is not whether 86,000 pounds was an allowable deduction in the year in which it was spent. It is whether the receipt of 81,900 pounds is to be ignored in measuring the loss next year upon the sale of the shares which had produced the 81,900 pounds. It was said for the taxpayer that this followed from the observations of Dixon C.J. in Rowdell Pty. Ltd. v. Commissioner of Taxation [1963] HCA 61; (1963) 111 CLR 106, at p 118 I am not persuaded that this passage or the decision in that case concludes this case. The issue there was as to the computation of an amount rebatable by virtue of s. 46. When the facts of that case are borne in mind, the decision does not I think provide any firm support for the taxpayer's contention that it suffered a loss as claimed and to the extent it claims. (at p190)

24. In my opinion the taxpayer has failed to shew that the Commissioner's assessment is erroneous. I must therefore dismiss its appeal with costs and confirm the assessment. (at p190)

ORDER

Appeal dismissed with costs. Assessment confirmed. Usual order as to exhibits. By consent this order to bear date 9th February 1970.