Clowes v Commissioner of Taxation

Clowes v Commissioner of Taxation - [1954] HCA 10 - HCA 1954 case summary — Zoe

[5]

The taxpayer himself is described as a draper and it is obvious that he paid the sum of £75 to Pine Plantations Pty Ltd by way of investment. He passively awaited whatever return he might receive from that company. Pine Plantations Pty Ltd appears to have been incorporated in Victoria and to have held land near Mt. Gambier, South Australia, where it carried out a project of planting and cultivating pine trees which upon maturity it would cut and market. There were separate areas of land which the company dealt with as distinct enterprises. The first of the two contracts made by the taxpayer with the company is concerned with an area of 450 acres called South Australian Plantation Number One: the second with an area of 500 acres called South Australian Plantation Number Three. The agreements with the company into which the taxpayer entered are in common form and are numbered serially. The form begins by giving the name and occupation of the taxpayer and describing him as the lot-holder. There is then a recital that the lot-holder is desirous of becoming possessed of a beneficial interest in the produce in the first case of one acre and in the second case of two acres of timber land afterwards referred to as a lot or lots forming portion of 450 and 500 acres respectively of the company's land, described in the company's register as South Australian Plantation Number One or Number Three. The agreement which is under seal contains a number of provisions of which the following are material to the present question. An obligation is imposed on the lot-holder to pay to the company £3 per lot on the signing of the contract on account of the purchase money which amounted to £50 in the one case and £25 in the other. The balance of the purchase money is to be paid in instalments. The lot-holder was to pay every month in the one case an amount of £1 a lot and in the other of 10s. a lot, that is to say until the balance of the purchase money was paid off. The company engaged, as soon as the whole of the lots in the plantation had been sold and the purchase money paid by the lot-holders, to transfer the title to the land into the name of a trustee company to be held upon trust to compel the company fairly and faithfully to carry out all the obligations entered into by it with respect to planting and maintaining the land with pine trees and upon trust to hold the whole of the land as security for the performance by the company of its obligations under the trust deed and afterwards in trust for the company and to hold the produce of the land and the net proceeds thereof as to nine-tenths for the lot-holders and as to one-tenth for the company. The company agreed that within two years or at the next planting season thereafter it would plant all the land in respect of which lots had been taken up with pine trees and would continue to plant the remainder of the land as the remaining lots were taken up and paid for. Although this clause might seem to refer to the lots taken up as if each was a separate and specific acre of land it is obvious that the reference is rather numerical than specific; the plantation is dealt with as a whole and the lot-holders take only a distributable share of the total net proceeds. The duty of the company to sell the timber and distribute among the lot-holders their share of the proceeds is the subject of another clause of the agreement. This clause provides that as soon as the forest or growing timber on the land or any part of it has reached maturity or has otherwise become marketable the company will make such arrangement as it considers necessary or advisable for marketing the produce thereof either standing or cut and, after deducting all costs and expenses and the company's one-tenth of a share of the net proceeds, will distribute the remaining nine-tenths amongst the lot-holders in proportion (in the case of the first contract) of one-four hundred and fiftieth part and (in the case of the second contract) of one-five hundredth part for every fully paid up lot, in full and final settlement of the claims of such lot-holders under the contract.

[8]

The part of this clause upon which the board relied is of course that referring to a profit-making undertaking or scheme. It is not a case of "profit arising from the sale by the taxpayer of any property acquired by him". The board took the view that there was "one profit-making undertaking or scheme, to which those who entered into contracts with the company were parties. They adventured their money in the scheme in the hope and expectation that the ultimate proceeds of the timber, to be shared between themselves and the company, would return to them a profit on their outlay". After some consideration I have come to the conclusion that this view of the matter, simple and attractive as it may at first seem, is fallacious. When s. 26 (a) speaks of the carrying on or carrying out of a profit-making undertaking or scheme it means the carrying on or out by the taxpayer or on his behalf. The words "by the taxpayer" occur only after the word "sale" but they give the sense of the whole clause. It was aimed at bringing what might otherwise have been thought possibly to be capital profits within the conception of income. It was not concerned with the somewhat different matter of treating as the assessable income of a given taxpayer a receipt by him derived from someone else because that someone else had obtained it by a scheme of profit-making or by some other means that would justly give it in the latter's hands the character of income. It is therefore necessary to find an undertaking or scheme carried on or carried out by or on behalf of the taxpayer. No doubt, so much is inferentially conceded when it is said that the lot-holders were parties to the one profit-making scheme. But the operation giving rise to the profit so described was the planting of pine trees, the cultivation of the plantation and the logging and disposal of timber. These appear to me to have been both in fact and in law the operations of the company conducted on its own behalf and not on behalf of the lot-holders. True it is that the company had contracted with the lot-holders to plant the trees, market the timber and pay over the stipulated portion of the proceeds. But these were contractual terms on which the money was raised by the company. From the taxpayer's standpoint the only profit in contemplation was an increase in the amount he invested with the company when the money became repayable as a result of the operations of the company, operations which as part of the terms of the investment the company became bound to carry out. To enter into a contract to provide a specified sum on such terms, to pay it and then to await results cannot in my opinion be properly described as "carrying on or carrying out a scheme or undertaking". If the case is considered apart from s. 26 (a), then I think the taxpayer's gain should be held to be a mere enlargement of capital. In the case of each of the two contracts, a single sum was paid in the expectation or hope of the return of a single sum, an increased sum. From the taxpayer's point of view it was nothing but a casual investment of capital in hope of enlargement at the end of many years. It was not done in the course of the taxpayer's business. There is no suggestion that it formed part of any system or practice. It is likely enough that it was nothing but the result of yielding to a canvasser.

[17]

The agreement of 1926 recited that the appellant (who was called the lot-holder) was desirous of becoming possessed of a beneficial interest in the produce of one acre of timber lands (referred to as a lot or lots) forming portion of a specifically described area of land known in the company's register as South Australian Plantation Number One. The agreement of 1929 contained a similar recital with respect to a beneficial interest in the produce of two acres of timber lands forming portion of an area known in the company's register as South Australian Plantation Number Three. The operative portions of the two agreements were substantially identical. The first two clauses obliged the lot-holder to pay the appropriate sum (£25 or £50) by instalments, the whole being described as the purchase money. Of the remaining clauses, those which have any present materiality prescribed the obligations of the company, which were as follows. As soon as all the lots in the plantation had been sold and the purchase money paid by the lot-holders, the company was to transfer the title to the land into the name of a trustee company, to be held upon two trusts. The first trust was to compel the company to carry out certain obligations, with respect to planting and maintaining the land with pine trees, to be set out in a trust deed. The second trust was to hold the land as security for the performance by the company of its obligations under the trust deed and under cl. 8 of the agreement (which will be mentioned in a moment), and afterwards in trust for the company, and to hold the produce of the land and the net proceeds thereof in trust for the company and the lot-holders, as to nine-tenths thereof for the lot-holders according to their respective lot-holdings, and as to one-tenth thereof for the company. The company also promised to deposit £2,500 with the trustee company as security for the performance of the company's obligations to the lot-holders as prescribed in the trust deed.

[24]

There remains the question whether the profit which the £105 contained, though of a capital nature, should be treated as included in the appellant's assessable income by virtue of s. 26 (a) of the Act, as being profit arising from the carrying on or carrying out of any profit-making undertaking or scheme. The board of review thought that s. 26 (a) applied to the facts of the case, and decided against the appellant for that reason. In effect, the answer has been given already. There was, undoubtedly, a profit-making scheme, and it produced a profit. But the scheme was the company's scheme, and the profit it produced arose to the company and not to the lot-holders. Omitting to observe the significance of this, the board of review treated passages in the judgments delivered in this Court in New Zealand Flax Investments Ltd. v Federal Commissioner of Taxation [1] as applicable by analogy to the present case. In truth there is nothing in that case which throws any light upon the problem here. Moreover, it cannot be said that the company and the lot-holders were co-adventurers, each putting capital into a joint enterprise and deriving together the profit arising from the carrying of that enterprise to fruition. If the case were one of that description, not the £30 alone, but the whole £105 would be assessable income of the appellant. This result, however, is not contended for by the commissioner; and indeed it could not be supported, for the expression "profit arising" in s. 26 (a) must necessarily mean profit arising to the taxpayer, and the £105 was not profit arising to the appellant. But it is insisted that the £30 was profit arising to the appellant, and that it arose from the carrying out of a profit-making scheme. The scheme is said, according to one form of the argument, to have consisted of the investment of £75, upon the terms of the agreements of 1926 and 1929, for the purpose of deriving a profit from the carrying out by the company of the profit-making scheme which it had evolved. This contention must be rejected because a profit to which s. 26 (a) applies, since it must be a profit arising to the taxpayer, must be a profit arising from the carrying on or carrying out by him or on his behalf of an undertaking or scheme, that is to say by him or on his behalf either alone or with others. The appellant's profit cannot be said to have arisen to him from the carrying out by the company of its scheme. The entire net proceeds of marketing the timber constituted a profit which arose therefrom, but it arose to the company; and the payment of the £105 by the company to the appellant was simply the agreed application by the company of a proportionate part of that profit, so that the £30 profit arose to the appellant from his investment and not from the carrying out of the company's scheme. If it be said, as the alternative form of the argument asserted, that this investment was itself a profit-making scheme, the answer must be given that paying a sum of money in consideration of a promise of a possibly larger payment upon the happening of a future event cannot be described as carrying out a scheme, according to any ordinary use of language. If it could, every bet would be a profit-making scheme, as would every contract of life assurance. The word "scheme" is not satisfied unless there is some programme, or plan of action; and clearly there was nothing of that sort which the appellant can be said to have carried out.

[27]

The amount of £30 represented portion of three amounts received by the appellant from Pine Plantations Pty Ltd, a company which entered into contractual engagements with the appellant first of all in 1926 and again in 1929. The first of these contracts recited that the appellant (thereinafter called the "lot-holder") was desirous of becoming possessed of a beneficial interest in the produce of one acre of timber lands forming portion of 450 acres of certain specified land situated in the State of South Australia known as South Australian Plantation Number One, and witnessed that the lot-holder should pay to the company or its authorized agent, in all, the sum of £25 for his lot. By cl. 3 of the contract the company bound itself, as soon as the whole of the lots in the said plantation had been sold and the purchase money paid by the lot-holders, to transfer the title to the said land into the name of a trustee company to be formed for the purpose. It was further agreed that such trustee company should hold the land upon trust "to compel the company to fairly and faithfully carry out all the obligations entered into by it with respect to planting and maintaining the said land with pine trees" and "to hold the whole of the said lands as security for the performance by the company" of its obligations under a certain trust deed and "to hold the produce of the said land and net proceeds thereof in trust for the company and the lot-holders as to nine-tenths thereof, for the lot-holders who have made all payments in respect of their lots according to their respective lot-holdings and, as to one-tenth, thereof in trust for the said company". The company further agreed (cl. 5) that it should within two years from the date of the contract, or at the first available and usual planting season after the expiration of two years from the date thereof "plant all the said land in respect of which lots have been taken up with pine trees in a proper and husband-like manner" and (cl. 8) that it would as soon as the forest or growing timber on the land or any part of it should reach maturity or otherwise become marketable make such arrangements as it should consider necessary or advisable for marketing the produce thereof either standing or cut and after deducting all costs and expenses and the company's one-tenth share of the net proceeds that it would distribute the remaining nine-tenths among the shareholders in the proportion of one-four hundred and fiftieth part for every fully paid up lot in full and final settlement of the claims of "such lot-holders under this contract".

[34]

Burrell's Case [1] is classic authority for the proposition that upon a distribution to shareholders by a liquidator in the winding-up of a company the amounts received by the shareholders are, apart from any statutory transformation of their nature for a particular purpose, receipts of a capital nature, and this conclusion is not affected by the circumstance that some portion of the company's assets at the commencement of the winding up represents undistributed or accumulated income. The alternate argument advanced by the appellant in that case was that portion of the fund in the hands of the liquidator represented profits, that that portion of the fund did not, in his hands, cease to have that character and that its distribution constituted a distribution of profits to the shareholders. The contention was unanimously rejected. Pollock M.R. pointed out that the liquidation had deprived the directors of the power of declaring a dividend and that the rights of the parties must be governed by "what is and not what might have been". Thereupon he proceeded: "Further it is a misapprehension, after the liquidator has assumed his duties, to continue the distinction between surplus profits and capital. Lord Macnaghten in Birch v Cropper [2] , the case which finally determined the rights inter se of the preference and ordinary shareholders in the Bridgewater Canal, said: "I think it rather leads to confusion to speak of the assets which are the subject of this application as "surplus assets" as if they were an accretion or addition to the capital of the company capable of being distinguished from it and open to different considerations. They are part and parcel of the property of the company - part and parcel of the joint stock or common fund - which at the date of the winding-up represented the capital of the company". As Lindley L.J. said in In re Armitage [3] "The moment the company got into liquidation there was an end of all power of declaring dividends and of equalizing dividends, and the only thing that the liquidator had to do was to turn the assets into money, and divide the money among the shareholders in proportion to their shares". It is not right to split up the sums received by the shareholders into capital and income, by examining the accounts of the company when it carried on business, and disintegrating the sum received by the shareholders subsequently into component parts, based on an estimate of what might possibly have been done, but was not done The quota returned to the shareholder is returned to him as that part of the property of the company to which he is entitled, by the officer whose duty it is to distribute the "property of the company" in accordance with s. 186 of the Companies (Consolidation) Act, 1908. That officer does not carry on the company as the directors did; and he has no longer the power that they had, to divide the profits as dividend upon the shares - profits, to which, in that character, the shareholder had no right to lay a demand" [1] .

[36]

The reasons of Atkin and Sargant L.JJ. proceeded on the same lines the former remarking that neither branch of the appellant's argument took into account sufficiently the legal results of the winding-up. After referring to the statutory duties of the liquidator he said: "The liquidator's duty is to realize it", (the property of the company) "to pay off the liabilities and distribute the remaining assets amongst the shareholders subject to the rights given under the articles. The liquidator cannot declare a dividend or distribute a dividend. He deals with assets. He need not trouble himself with the question whether the assets in the company's books represent capital or uncapitalized profits. He can realize the assets in the most beneficial way and can pay capital liabilities out of the assets that represented profits, or liabilities on revenue account of the assets that represented capital. Having paid the liabilities and having a lump sum in his hand there appears to me to be no liability in him to reconstruct his capital account or other accounts; and no power in the shareholders either to insist on the liquidator doing so, or themselves so to adventure. Of course, the property that comes to his hands, as it always remains the property of the company, is bound by the engagements of the company whether created by the articles or otherwise. Thus if the profits in the hands of the company are charged to a third person, the charge is operative against the liquidator. This, I think, is the case In re Spanish Prospecting Co. [2] . If the articles have given any particular body of shareholders the right to profits whether distributed or not, this (subject to the claims of the creditors) must be recognized in distribution by the liquidator, In re Bridgewater Navigation Co. [3] which turned upon a special article. But though the liquidator must honour such obligations he himself has no power to capitalize or decapitalize, to distinguish in his distribution between capital or income: his duty is simply to distribute assets. He may, while carrying on the business of a company, with a view to a beneficial realization, earn profits. In such a case the company will be assessable to income tax on such profits. But the shareholder will not receive them as profits; for him they are but an accretion to the assets; and if they become surplus assets, it is in that form that the shareholder will receive them" [1] .

[43]

On the facts it is clear that the appellant did not carry on any profit-making undertaking. What he did was merely to pay his money on the terms of the contracts referred to in expectation that at some future and more or less remote point of time he would receive a return exceeding the amount outlaid by him. To "carry on business" has been said to "import a series or repetition of acts" (Kirkwood v Gadd [1] and Blockey v Federal Commissioner of Taxation [2] ) and I have no doubt that the expression in s. 26 (a), whatever it may mean in other contexts, must be understood in this sense in its application to profit-making undertakings. But the sub-section is not limited to profits arising from activities from this nature; it extends expressly to profits arising from the carrying out of a profit-making scheme. This conception, standing alone, would, I think, be quite wide enough to cover the activities embraced by the first limb of the sub-section and also to embrace activities which constitute the carrying on of a profit-making undertaking. But it extends further and is, in my opinion, wide enough to cover the circumstances of this case. The only difficulty which I have felt in the matter is occasioned by the fact that the expression, if understood without restriction of any kind might, on occasions, tend to impress with the character of assessable income profits which, on general principles ought fairly to be regarded as capital profits. An attempt to restrict the meaning of the expression - "the carrying out of any profit-making scheme" - is to be found in the appellant's contentions that the carrying out of a scheme also implies a series or repetition of acts and that the scheme must be one which the taxpayer himself carries out. I should have thought however, that whether the second contention be sound or not there is no valid ground for accepting the first for I can see no warrant for concluding that every profit-making scheme or plan which may be decided upon by a taxpayer must require for carrying it into effect a series or repetition of acts. In my view such a conclusion would be erroneous and I respectfully adopt the observations of Dixon J. in Premier Automatic Ticket Issuers Ltd. v Federal Commissioner of Taxation [3] where, referring to the second limb of the predecessor of s. 26 (a) he said: "It is not easy to say whether the expression "profit-making by sale" refers to a sole purpose, or a dominant or main purpose, or includes any one of a number of purposes. The alternative "carrying on or carrying out" appears to cover, on the one hand, the habitual pursuit of a course of conduct, and, on the other, the carrying into execution of a plan or venture which does not involve repetition or system" [4] .

At a glance

Court

Decision date

Before

Source

Judgment (45 paragraphs)

Parties