Abrahams v Federal Commissioner of Taxation [1944] HCA 32 - HCA 1944 case summary — Zoe

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Abrahams v Federal Commissioner of Taxation [1944] HCA 32

[1944] HCA 32

High Court of Australia|1944-07-01

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Court

High Court of Australia

Decision date

1944-07-01

Source

Original judgment source is linked above.

Judgment (123 paragraphs)

[1]

ABRAHAMS . . " A 3 5 'i . APPELLANT ; AND THE FEDERAL COMMISSIONER OF TAXA- TION ' RESPONDENT.

[2]

Estate Duty (Cth.) - Assessment - Dutiable estate - Shares in companies - Valuation - Investment companies - Restrictions on transfer of shares - Control of companies vested in one director - Estate Duty Assessment Act 1914-1928 (No. 22 of 1914 - No. 47 of 1928).

[3]

In estimating the future profits of a company for the purpose of determining the amount which would be paid on a hypothetical purchase of shares at the date of death of a deceased, the method of estimating these profits from those past years considered most appropriate is usually a convenient method of approach. In the case of a business where it is necessary to estimate the future volume of the trade, it may well be the only method, but in the case of an investment company, an alternative method is to examine the invest- ments owned by the company and estimate their future earning capacity. Whether assets are owned by a company or an individual, they cannot be expected to produce a higher income than is appropriate to the nature of the particular assets; and, speaking generally, it can be said that the greater the risk that an asset will not produce the estimated income or that the capital invested in an asset will be lost, the higher the income yield that an investor, whether a company or an individual, will expect from that asset. In the case of companies engaged in various kinds of trade, it may be relatively simple to ascertain an appropriate rate of profit or dividend yield which an investor could reasonably require on the price he paid for the shares, but in the case of companies engaged in investment business the profit and therefore the dividend yield must vary considerably according to the nature of the assets in which the shareholders' funds have been invested.

[29]

estate duty shall be levied and paid upon the value, as assessed under the Act, of the estates of persons dying after the commence- ment of the Act. In order to comply with the Act, it is necessary to ascertain the real value as at the date of death of the assets which form part of the dutiable estate. The Act does not, as in s. 7 (5) of the English Finance Act 1894 which has recently been considered by the House of Lords in Inland Revenue Commissioners v. Crossman (1), and in s. 71 of the New Zealand Death Duties Act.1921, which has recently been considered by the Supreme Court of New Zealand in In re Harvey; Public Trustee v. Commissioner of Stamp Duties (2), Tremaine v. Commissioner of Stamp Duties (3), McGregor v. Commissioner of Stamp Duties (4) and In re Crawford; Public Trustee v. Commissioner of Stamp Duties (5), direct that the value of the shares shall be estimated to be the price which such property would fetch if sold in the open market at the time of the death of the deceased. In Crossman's Case (1) it was held by the House of Lords, approving Attorney-General v. Jameson (6) and Salvesen's Trustees v. Inland Revenue Commissioners (7), that this meant that the value of the shares for the purpose of duty was to be estimated at the price which they would fetch if sold in the open market on the terms that the purchaser should be entitled to be registered and to be regarded as the holder of the shares, and should take and hold them subject to the provisions of the articles of association, including those relating to the alienation and transfer of shares in the company. It has been held, however, in the case of other Australian statutes which, like the Estate Duty Assessment Act, do not direct any particular method of estimating the value of the assets, that it is proper to estimate the value of shares held by a deceased in a company, the articles of association of which contain restrictions on transfer, in the same manner, and that the court should endeavour to ascertain (as in the case of pro- perty compulsorily acquired) the price which a willing but not anxious vendor could reasonably expect to obtain and a hypothetical willing but not anxious purchaser could reasonably expect to have to pay for the shares if the vendor and purchaser had got together and agreed on a price in friendly negotiation, the basis of the bargaining being that the purchaser would be entitled to be registered as the owner of the shares but when registered would hold them subject to the provisions of the memorandum and articles of association of

[38]

value to be ascertained is the value to the seller of the property in its actual condition at the relevant time (in the present case at the date of death) with all its existing advantages and all its possibilities : per Lord Romer, when delivering the judgment of the Privy Council in Vyricherla Narayana Gajapatiraju v. Revenue Divisional Officer, Vizagapatam (1) ; per Sir Wilfred Greene M.R. in Horn v. Sunderland Corporation (2). I have italicized the above words because there was a marked tendency on the part of the witnesses for the appellant in this case, as occurred in the two previous appeals which came before me in Perpetual Trustee Co. Ltd. v. Federal Commissioner of Taxation (Murdoch's Case) (3) and in McCathie v. Federal Commis- sioner of Taxation (4), to estimate what a willing purchaser, having an alternative choice of buying shares in public companies, would have been agreeable to pay for the shares, and then to say that this amount was all that a willing vendor could reasonably expect to obtain for them. But in Pastoral Finance Association Ltd. v. The Minister (5) Lord Moulton, in delivering the judgment of the Privy Council, said that: " Probably the most practical form in which the matter can be put is that they " (that is, the owners of the land) " were entitled to that which a prudent man in their position " (that is the purchasers) " would have been willing to give for the land sooner than fail to obtain it." A practical example of the price that a hypothetical purchaser must reasonably expect to pay is given by Lord Romer in Vyricherla's Case (6) where he says : - "Take as an example the case of an owner of vacant land that adjoins his factory. The land possessed the potentiality of being profitably used for an extension of the factory. But the owner is the only person who can turn that potentiality to account. In valuing the land, however, as between him and a willing purchaser, the value to him of the potentiality would necessarily have to be included " (7).

[44]

Generally it may be said that the possibility of a distribution of accumulated profits by way of dividend or a capitalization of such profits by the issue of bonus shares does not enter largely into the calculation of the prices that investors will pay for shares in com- panies, but this possibility is important in the present case because of the large outstanding debts to the three companies already mentioned ; the large amounts standing to the credit of the profit and loss accounts of all the companies except Avrom and in particular of these three companies; and the complex position of Alfred as the holder of half the shares in and a large debtor to each of these three companies, as the director in control of their business and affairs, and as the sole executor of and residuary beneficiary under the will of Emanuel, whose estate is the owner of the other half of the shares and which is similarly indebted to each of these companies. In the case of the Opera House and the Small Arms companies, it is clear that their future as going concerns would not be prejudiced by the declaration of dividends out of the undistributed profits of sufficient amounts completely to discharge the debts owing to them, and in the case of Mia Mia that a dividend of a sufficient amount could be declared without prejudice to its future stability so as to discharge a large part of the indebtedness to this company. It is also clear that Alfred, as executor of and the residuary beneficiary under the will of Emanuel, should press himself as the director in control of these three companies to declare these dividends, unless it could reasonably be anticipated that, if the debts were repaid, the amounts could be put to such profitable use by the companies con- cerned that it would be an advantage to the estate for this to be done. The Court is dealing on this appeal with the valuation of shares in five companies as going concerns, but in order to estimate the value of these shares to the seller, it must pay considerable attention to this aspect of the matter; because it would be highly improper for Alfred as executor, and against his interest as residuary beneficiary, to sell the shares owned by the estate in these three companies to a stranger without obtaining a satisfactory quid pro quo for the loss of the right to press for the debts to be discharged in

[89]

capitalized at 64 per cent equals £305,400. If this sum is divided - by 329,000 shares it gives a capital value of 18s. 6d. per share. 4 A subsidiary but useful check can, I think, be made on the values - of the shares in the Opera House, Small Arms and Mia Mia companies by assuming that dividends are declared to discharge the brothers' debts owing to them wholly or in part, and then taking and capitaliz- ing Mr. Philip's adjusted profits for these companies, which, as I have said, were reached without allowing for any notional interest on these debts, and adding these capitalized values to these dividends, In the case of the Opera House company, it would require the declara- tion of a dividend (in round figures) of £6 10s. per share to discharge the indebtedness to this company ; in the case of the Small Arms - company the dividend would be £1 5s., while in the case of Mia Mia - it would be safe to declare a dividend of 15s. per share, which would amount to £93,750, and leave £72,903 of the debt to be repaid, or even to declare a dividend equal to the total amounts to the credit - of the profit and loss accounts of 19s. per share which would leave £48,000 of the debt to be repaid. These are possibilities which, as I have said, must, in the special circumstances of this case, be taken - into account in any valuation of the shares. Accepting for the moment the rates of capitalization which he applied, namely Opera _ House 7} per cent and Small Arms 9 per cent, and adding the amounts. per share at which he arrived, namely Opera House £2 7s. and Small - Arms 15s., to these amounts of £6 10s. and £1 5s., the capital value - of the shares in these companies would be Opera House £8 17s. and Small Arms £2. But, having regard to the nature of the busi- nesses which the Opera House and the Small Arms companies were - carrying on, even after leaving the advances out of account, the highest rates at which their profits could be capitalized would be, in my opinion, Opera House 7 per cent and Small Arms 8 per cent. On this basis the result would be as follows : - Opera House profit £4,944 capitalized at 7 per cent would be £70,600 which divided by 28,000 shares would give each share a capital value of £2 10s., so that the value of the Opera House shares would be £9. Small Arms profit £3,068 capitalized at 8 per cent would be £38,350, which divided by 45,000 shares would give a value of 17s. per share, so that the value of the Small Arms shares would be £2 2s. per share. In the case of Mia Mia Mr. Philip capitalized at 15 per cent, but the extra security afforded by leaving the balance of the debt with the company is sufficient ground, I think, to reduce the rate of capitaliza- tion to 10 percent. Mr. Philip's adjusted net profit for this company is £1,598 per annum. This sum capitalized at 10 per cent gives £15,980, which, divided by 125,000 shares, gives a capital value of

[100]

The question whether any deduction should be made from these values on account of (1) the restrictions on transfer, and (2) the so- called lack of control of the companies by the shareholders during the rest of Alfred's life, now arises for consideration. It is convenient to deal with the companies other than Avrom in the first instance. In the case of these companies, the restriction on transfer is that the board of directors may refuse to register a transferee whom they consider would be an undesirable member of the company. This restriction, with some embellishments, is the ordinary article which is recommended in Palmer's Company Precedents for a proprietary company. It confers a fiduciary power which must be exercised by the board of directors bona fide for the benefit of the company. If it is not used for this purpose, the transferee is entitled to apply to the court to have the register rectified and his name inserted on the register of members (In re Coalport China Co. (1); In re Bede Steam Shipping Co. Ltd. (2); In re Smith and. Fawcett Ltd. (3) ; Manning River Co-operative Dairy Co. Ltd. v. Shoesmith (4); Aus- tralian Metropolitan Life Assurance Co. Ltd. v. Ure (5)). It is not an appropriate article in the case of a public company where the restriction should be confined to shares which are not fully paid, but it is entirely appropriate to proprietary companies which bear many analogies to partnerships and in which the shareholders, as in the case of partnerships, usually desire to exercise some control (which is almost invariably confided to the directors) over the introduction of new shareholders into the company (Re Royal British Bank; Re Joint Stock Companies Winding-up Acts 1848 and 1849 (Nicol's Case) (6) ). The articles of association of such companies almost invariably also contain restrictions requiring shareholders to offer shares which they wish to sell to the existing shareholders either at par or at some fair value fixed by the articles in the first instance, and it is usually these latter restrictions which are relied upon as depreciating the value of the shares. The present restriction would, no doubt, as some witnesses said, often make the shares unacceptable to banks as a security for an overdraft, and they would not be readily realizable like shares in companies registered on the stock exchange. A share in a partnership would have the same disadvantages, but it has

[102]

never been suggested that such a share should be discounted on this account. Such a restriction undoubtedly limits the market and makes the shares unattractive to many investors. But since Vyricherla's Case (1), applied by this Court in Geita Sebea v. Territory of Papua (2), it is clear that the full value to the seller must be ascertained, however limited the market may be, even where there is only one possible hypothetical purchaser. To a prudent purchaser willing to give full value for the shares sooner than fail to obtain them, this restriction should not, to my mind, have many terrors. It is also said that a further discount should be made because of Alfred's control of the companies' affairs to the exclusion of the shareholders. It is true that the articles give very complete control to Alfred during his life. But these powers are also fiduciary powers to be exercised bona fide for the benefit of the companies. The past history of the companies shows that he is an extremely capable business man, and the appeal has proceeded on the footing that, whatever liberties were taken with the companies' affairs whilst they were thoroughly solvent and the two brothers were the only shareholders, Alfred would recognize that as soon as strangers became shareholders it would become his duty to conduct the business of the companies on sound and profitable commercial lines. The argument that the shares should be discounted on this ground is really a two-edged sword, as it can just as reasonably be suggested that he is such an able business man that people would be induced to put their money into these companies just because he was in control of their affairs. Thus in two of the New Zealand cases already cited the appellants, seeking naturally to place the lowest possible value on the shares for the purposes of death duty, contended (I will add unsuccessfully) that the future prospects of the companies there in question judged from previous results should be discounted because their past successes had been caused by the outstanding business ability of the managing directors who had died, so that the prob- abilities were that the companies would not be so successful in the future. After all, judging from past results, the risks inherent in Alfred having sole control would appear to be that he might continue to overpay himself as a director and allow these large cash balances to lie idle, but these contingencies, however remote, have already been allowed for in the profits used for the purposes of capitalization. Taking the following considerations into account, I am of opinion that no further deduction should be made from the values already mentioned on either of these grounds. In the first place, I have capitalized on the basis that the income yields which I have mentioned

[104]

his money in similar assets as an individual or to buy shares in public companies owning such assets to produce such yields subject to taxa- tion, he could reasonably be expected to invest his money in com- panies possessing such assets, even with restrictions on transfer of the shares, on the basis that they were net profit yields when he would obtain the benefit of a rebate of the taxes paid by the com- panies on any dividends which he received ; in the second place, the adjusted net profits calculated by Mr. Outhwaite and Mr. Philip, even allowing for notional interest on the outstanding debts, are on the low side compared with what they would have been if the com- panies' assets had been used to their full capacity during the years on which they relied instead of large cash balances lying idle, and I have made no adjustments for this except in the case of Interstate Investments; and, in the third place, the expenses, particularly those for salaries and wages, which include the directors' fees, in some of the accounts are distinctly on the high side, having regard to the small amount of time that it would require to manage invest- ment businesses such as the companies were carrying on. Mr. Outhwaite said that the amounts in the case of the Small Arms company were too high. The respondent did not challenge the amounts in the accounts of the Opera House company, but I agree with Mr. Mirams that they would also appear to be on the high side. No doubt the two brothers, as is so often the case in proprietary companies where the only shareholders are also directors, were dis- tributing some part of the profits as directors' fees, which in public companies would have to be paid as dividends. The right of the court to adjust such distribution in valuing the shares for the pur- poses of death duties has been asserted in Smyth v. Revenue Commissioners (1), In re Crawford (2), and McCathie's Case (3). And cf. Aspro Ltd. v. Commissioner of Taxes (4). I am not able on the evidence to attribute any definite increase to the profits arrived at by Mr. Outhwaite or Mr. Philip on these grounds, but I have no doubt that they should be increased to some considerable extent. The restrictions on transfer in the case of Avrom are more severe than those contained in the articles of association of the other companies. The restriction which confers upon the governing directors the power to prevent shareholders disposing of their shares without their consent is, like the restriction upon transfer contained in the memoranda of association of the other companies, a fiduciary power which must be exercised bona fide for the benefit of the

[106]

company (In re Copal Varnish Co. Ltd. (1) )- These restrictions should not be sufficient to discount the shares below the values already mentioned. The more serious article is that which enables the governing directors at any time to acquire the shares of any shareholder at their par or asset value, whichever is the lower. The asset value of the shares calculated in accordance with this article was as at 30th June 1938 above par. In Salvesen's Trustees v. Inland Revenue Commissioners (2), approved by the House of Lords in Crossman's Case (3), the articles of association contained a provision that the company might at any time, by extraordinary resolution, resolve that any shareholder, other than a director or a person holding more than 10 per cent of the shares of the company do transfer his shares, and, to put it shortly, that upon such a transfer the vendor would only be entitled to their nominal value if fully paid. In Crossman's Case (4), there was no article which compelled a shareholder to sell his shares involuntarily, but there was an article which provided that upon a voluntary sale he had to sell at a fair value calculated as therein mentioned and this value was well below the market value calculated upon the dividend return. Neverthe- less, the court in Salvesen's Case (5) fixed the value of fully paid £1 shares for the purposes of duty at £3, and in Crossman's Case (6) shares for which the fair value was £221 and £209, at £351 and £355 respectively. In the Court of Appeal, Lord Hanworth, in referring to this provision, said : - ' It is not easy to affirm that some private and exceptional method of confiding the possession of certain pro- perty to members of a family, or the special devices for ascertaining the amount to be paid by one member of that family to another, or another's estate upon his death, ought to be allowed to depreciate the quota to be paid upon that property, which in the hands of the members of the family provides them with an income and wealth that if measured by the ordinary standards would reach a figure at least half as high again as that which the family estimate of the the sum to be paid allows " (7).

[111]

It appears to me that this part of the headnote is too widely stated, and that the reason why the trust company could not be taken into consideration as a competitor was, as Finlay J. pointed out, because the directors would have refused to register such a company. In the present case, Alfred was in a very favourable position as a purchaser of the shares, and he could hardly have objected to have registered himself on the ground that he was an undesirable person to admit asa member. He could not alter the nature of the restric- tions on transfer which are contained in the memoranda of associa- tion of four of the companies, but he could sell and transfer the shares as he liked through his control of the Board. He was the tesiduary beneficiary under the will so that, subject to the payment of funeral and testamentary expenses, death duties and debts, and subject to paying the legacies and setting aside a fund to secure the annuities during the lifetime of the annuitants, he was entitled to the estate. If he had paid or provided for the liabilities other than the debts owed by the estate to three of the companies he could, whilst he owned the whole of the shares, have arranged to leave these debts outstanding. The shares had, therefore, a special value to him. Mr. Outhwaite capitalized at the following rates for the three companies to which these debts were owed : Opera House 7 per cent ; Small Arms and Mia Mia each 8 per cent ; which means in effect that, while the appellant for the purposes of duty is claiming the benefit of a deduction of the full amount of these debts as a liability of the estate, he is at the same time seeking to bring in the same amounts as assets (although the two entries might be expected approximately to cancel one another) on the basis that, if they were repaid to the companies, they would only have about half that value when reflected in the price which a prudent purchaser might reason- ably be expected to pay for the shares. Such a price would not be likely to attract Alfred as residuary beneficiary, however reasonable it might appear to be when valuing the estate for the purpose of estate duty.

[116]

Mr. Nixon, instead of basing his valuations principally on the income yield, preferred to rest his opinion upon the amounts the - shareholders would have received upon an immediate liquidation of the companies, or alternatively upon the basis that a large part of the accumulated profits of the companies other than Avrom would be immediately distributed to the shareholders. In the case of Mia Mia, his alternative method involved a reduction of the capital of the company, and would have left the company seriously depleted of cash resources to restock after a drought. But the financial position of each of the companies was extremely strong, so that the possibility of a liquidation upon a creditor's petition could be dis- missed, and, as there was no indication that Alfred desired to wind up the companies, the only ground upon which they could have been wound up against his will at the date of death would have been that it was just and equitable to do so. This ground gives the court a wide discretion, and, in the case of companies like the present, it would not hesitate to exercise the power if one of the shareholders had control of the company and was misusing his powers for his own benefit and to the detriment of the other share- holders, but, as there is no evidence that Alfred would not conduct the companies on sound and profitable lines and pay reasonable dividends if strangers were introduced as shareholders, I can see no justification for valuing the assets on the basis that the companies would be immediately wound up. Further, there is not sufficient evidence to ascertain what the assets would have realized upon a winding up, and, a purchaser buying the shares, on this basis would surely require some profit on the realization. In the same way, Alfred would not be under any legal compulsion to discharge the debts by making any distribution of the accumulated profits of the three creditor companies, or to make any distribution of the accumulated profits of Interstate Investments or of the balance of the accumulated profits of the Small Arms company, so that what Mr. Nixon has done is by the first method to elevate a remote pos- sibility, and by the second method a strong possibility, into a basis

[119]

Mr. Miram's method was to take the assets which existed at the date of death, estimate the amount of income they were likely to produce in the future, taking into account the income which they had produced in the past, and to value them by comparing their capacity to earn income with the income which assets of that nature should reasonably be expected to produce. His general approach to the problem was sound, but he spoilt his evidence by analyzing the assets in too much detail. There were also several aspects of his evidence with which I could not agree. In particular, he con- sidered that the purchaser of the shares would take over the debts, but this appears to me to be impracticable ; and his view that the option to purchase the shares from the other shareholders in Avrom was a right attached to the 4,000 shares held by the brothers which would pass to the purchaser was clearly erroneous. Also I do not think it is right to leave income tax out of account in estimating net profits, although the fact that a shareholder would get a rebate on his dividends of the tax paid by a company would be a matter that a purchaser would take into account. Further, I could not find sufficient justification in the evidence for his crediting the Mia Mia accounts with the item of £4,870 as being the difference between the cost of 12,000 sheep purchased for £9,070 13s. 7d. and the amount of £4,200 obtained by applying to them the standard valua- tion of 7s. per head adopted for the purposes of the annual accounts, and I think that five years was too short a period to estimate the future profits of a business of that nature. Also I could not agree that it was reasonable to treat the trading business of Small Arms as though it would be liquidated at the date of death just because losses had been made in the two previous years. His first values of £10 3s. for Opera House, £2 6s. 3d. for Interstate Invest- ments, £3 2s. 2d. for Small Arms, £1 12s. 10d. for Mia Mia and £1 4s. 8d. for Avrom were, in my opinion, too high. But I entirely agree with him that 20 per cent was an ample percentage by which to discount the values of the shares because they were held in pro- prietary companies; and during the addresses Mr. Tait handed in corrected figures to show what his values would be if adjusted to the values of the assets and if 20 per cent was deducted from the values he placed upon the debts. These figures would require some further adjustment because they were based on Mr. O'Brien's and not