Condell v Commissioner of Taxation of the Commonwealth of Australia

ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA

AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

REASONS FOR JUDGMENT GYLES J 11 On 2 June 2000 the Hewlett-Packard Company (Hewlett-Packard), a Delaware corporation, issued the appellant, Gregory Condell, with 1327 shares in Agilent Technologies Inc (Agilent). On 28 October 2003 the respondent, the Commissioner of Taxation (the Commissioner), gave notice of amended assessment for the year ended 30 June 2000 adjusting the previous assessment by adding $168,961.00 as assessable foreign income representing the value of those shares. The appellant objected and the Commissioner disallowed that objection. The appellant appealed to the Administrative Appeals Tribunal (the AAT). On 8 June 2005 the AAT set aside the objection decision and allowed the objection of the appellant. The Commissioner appealed to the Court pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) (the AAT Act). On 15 August 2006 the primary Judge ordered that the appeal be allowed, the decision of the AAT was set aside and, in lieu, it was determined that the Commissioner's objection decision be affirmed (Commissioner of Taxation v Condell [2006] FCA 1047; 2006 ATC 4571; (2006) 63 ATR 514). The appellant appeals from that decision. 12 The reasons for the original decision given on behalf of the Commissioner and the contentions advanced on behalf of the Commissioner thereafter depended upon the application of s 44(1)(a) of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) in combination with the definition of 'dividend' in s 6 and with s 21. The Commissioner filed a notice of contention claiming that the judgment appealed from should be affirmed on a ground, in addition to those relied upon in the Court below, the effect of which would be to justify the amended assessment in question under s 6-5 of the Income Tax Assessment Act 1997 (Cth) based upon the recent decision of the High Court in Commissioner of Taxation v McNeil 2007 [2007] HCA 5; 2007 ATC 4223. The appellant submitted that the Commissioner should not be permitted to rely upon that ground. The Court agreed with that submission and ruled accordingly. In order to explain that ruling it is necessary to say something more about the nature of the proceeding before the Court. 13 The jurisdiction of the Court was to hear and determine an appeal instituted in the Court in accordance with s 44(1) of the AAT Act (s 44(3)). An appeal pursuant to s 44(1) can only be on a question or questions of law. It is, thus, essential to identify a question or questions of law in order to enliven the jurisdiction of the Court and the scope of the appeal is limited by that question or those questions of law (Birdseye v Australian Securities and Investments Commission [2003] FCAFC 232; (2003) 76 ALD 321; (2003) 38 AAR 55 at [18] per Branson and Stone JJ with whom Marshall J relevantly agreed; Australian Securities and Investments Commission v Saxby Bridge Financial Planning Pty Ltd (2003) 133 FCR 290 at [42]-[47] per Branson J; Australian Telecommunications Corporation v Lambroglou (1990) 12 AAR 515 at 524 per Ryan J; Comcare v Etheridge (2006) 149 FCR 522 at [19] per Branson J agreed to generally by Spender and Nicholson JJ). 14 Power in the Court to permit amendment to the questions of law arising on an appeal where appropriate can be accepted. However, there was no proper basis upon which the questions in this appeal could have been amended by the primary Judge to permit the issue set out in the notice of contention to be raised. That issue is not a new question of law arising out of the decision of the AAT appealed from - it is a totally new case. Even if there were a full appeal from the AAT to the Court, it would not be appropriate to be raised. To do so would involve the difficulties enunciated in Coulton v Holcombe (1986) 162 CLR 1 and numerous other cases including Dismin Investments Pty Ltd v Federal Commissioner of Taxation (2001) 183 ALR 565; 2001 ATC 4377; (2001) 47 ATR 292 at [26]-[33]. An amendment would certainly not have been appropriate in a case of the limited jurisdiction which was being exercised by the Court. The character of the dividend as income according to ordinary concepts was not the basis of the amended assessment or of the disallowance of the objection. It was not agitated before the AAT and there were no findings of fact and no decision which could throw up a question of law. The attempt to seize on some parts of the AAT's reasons directed to another question was misconceived. An appeal to s 44(7) of the AAT Act would have been of no avail. It cannot alter the jurisdiction of the Court or widen the issues to be decided. It is to facilitate dealing with the issues that are properly before the Court. The position before this Court is even more difficult for the Commissioner as the Full Court sits to correct error on the part of the primary Judge who was not called upon to consider the issue. In the light of those circumstances, the Court rejected the Commissioner's application to rely upon the point raised in the notice of contention.

Findings of fact by the AAT 15 The facts found by the AAT, fleshed out in some respects by documents incorporated in its reasons, were as follows. Hewlett-Packard was originally incorporated in the United States of America in 1947 and by early 1999 decided upon what can be described as a demerger by creating two distinct companies with Hewlett-Packard retaining the computing and imaging businesses and with its test and measurement businesses, semi-conductor products, chemical analysis and health care solutions businesses to be transferred ('spun off') to another company which would then be owned and run as a separate company. Agilent, a subsidiary of Hewlett-Packard, was to be that company. A Master Separation and Distribution Agreement was entered into on 12 August 1999 between Hewlett-Packard and Agilent. The recitals to that Agreement were as follows: 'WHEREAS, the Boards of Directors of HP and Agilent have each determined that it would be appropriate and desirable for HP to contribute and transfer to Agilent, and for Agilent to receive and assume, directly or indirectly, substantially all of the assets and liabilities currently associated with the Agilent Business and the stock, investments or similar interests currently held by HP in subsidiaries and other entities that conduct such business (the "SEPARATION"); WHEREAS, HP has caused Agilent to be incorporated in order to effect the Separation and HP currently owns all of the issued and outstanding common stock of Agilent; WHEREAS, HP and Agilent currently contemplate that, following the contribution and assumption of assets and liabilities, Agilent will make an initial public offering ("IPO") of an amount of its common stock pursuant to a registration statement on Form S-1 pursuant to the Securities Act of 1933, as amended (the "IPO REGISTRATION STATEMENT"), that will reduce HP's ownership of Agilent to not less than 80.1%; WHEREAS, Agilent intends to distribute all of the proceeds of the IPO (including the proceeds from the sale of shares pursuant to the exercise of the Underwriters' over-allotment option (the "IPO OVER-ALLOTMENT OPTION")), net of underwriting discounts and commissions (the "IPO NET PROCEEDS") to HP by means of a dividend declared prior to the IPO, which IPO Net Proceeds HP ultimately intends to use to satisfy obligations to creditors or to repurchase shares of HP common stock within twelve (12) months following the closing of the IPO (the "IPO CLOSING DATE"); WHEREAS, HP currently contemplates that, several months following such initial public offering, HP will distribute to the holders of its common stock, $0.01 par value, by means of a pro rata distribution, all of the shares of Agilent common stock owned by HP (the "DISTRIBUTION"); WHEREAS, HP and Agilent intend that the contribution and assumption of assets and liabilities and the Distribution will qualify as a tax-free reorganization under Sections 368(a)(1)(D) and 355 of the Internal Revenue Code of 1986, as amended (the "CODE"), and that this Agreement is intended to be, and is hereby adopted as, a plan of reorganization under Section 368 of the Code; WHEREAS, the parties intend in this Agreement, including the Exhibits and Schedules hereto, to set forth the principal arrangements between them regarding the separation of the Agilent Business.' The separation date was 1 November 1999. 16 The assets and liabilities of the relevant part of the Hewlett-Packard business were transferred to Agilent which, immediately after the separation date, began operating as a separate company. The assets were transferred at a value of USD3.533 billion. Some surplus assets of the discontinued business were sold by Hewlett-Packard to external parties for approximately USD1 billion. The initial public offering (IPO) of approximately 15.9 per cent of Agilent's common stock was launched on 18 November 1999. Hewlett-Packard retained the balance of the common stock at that time. Following the successful IPO, Agilent distributed proceeds of USD1.335 billion to Hewlett-Packard which was credited as paid in capital. 17 On 7 April 2000 the board of directors of Hewlett-Packard approved the distribution of 380 million shares of Agilent common stock to holders of Hewlett-Packard common stock on 2 June 2000 on the basis of 0.3814 Agilent shares for each Hewlett-Packard share that was held on 2 May 2000. On that date, the appellant held 3483 shares in Hewlett-Packard and, on that basis, was entitled to receive 1327 shares in Agilent. No fractional shares were issued and a cash adjustment was to be made. On 2 June 2000 Hewlett-Packard issued the appellant with 1327 shares in Agilent and then posted a share certificate to him. On that date, the shares had a market value of USD77.0068 each. The Commissioner assessed the value of those shares at market value AUS $168 961.68 by reference to an exchange rate of USD0.68048. The Hewlett-Packard balance sheet account for retained earnings was debited with USD4.239 billion for the total stock dividends. The total market value of the Agilent shares distributed by Hewlett-Packard was approximately USD29.3 billion. 18 No expert evidence was called as to the effect of corporations law, tax law or accounting principles in the United States so far as these transactions were concerned. The AAT did refer to a memorandum from Hewlett-Packard Australia in the following terms: 'Taxation Ruling HP Australia had previously obtained advice from PricewaterhouseCoopers in relation to the Australian taxation treatment of the shares in Agilent Technologies ("Agilent") that the Australian tax residents received on the spin-off of Agilent Technologies. The Australian Taxation Office has confirmed PwC's advice in writing (in the form of an ATO opinion). For Australian taxation purposes, the receipt of the Agilent shares by Australian tax resident shareholders is a taxable dividend. In practical terms, the difference between you receiving the Agilent shares and a usual dividend from Hewlett Packard is that you received the dividend in the form of shares in Agilent Technologies rather than in the form of cash. As stated in HP's quarterly accounts (refer to note 2) filed on 12 September 2000 with the Securities Exchange Commission, the distribution of the Agilent shares was against Hewlett Packard's retained profits. This is the principal reason as to why the receipt of the Agilent shares was regarded by the ATO as a taxable dividend.' No significance attaches to that document. Insofar as the second hand opinion is reported, it is an accountant's opinion as to the question of law for determination in this appeal.

AAT Decision 19 The notice of objection proceeded upon the basis that the stock dividend had a value of USD24 457, being a pro rata amount of the USD4.239 billion by which the retained earnings of Hewlett-Packard were reduced by reason of the transaction. The AAT held that the distribution of the shares was a dividend within the meaning of s 6 of the 1936 Act. However, it held that the distribution of the shares was not wholly paid from profits derived by Hewlett-Packard. Although the retained earnings account of Hewlett-Packard represented profits, the amount debited was much less pro rata than the amount assessed. The AAT went on to refer to the overall nature of the transaction, being a company restructure, and found that a significant component of the distribution of the shares was in the nature of a capital receipt on general principles, rather than wholly from profits. The AAT went on to consider other matters. It is only necessary to mention that the AAT held that there was no 'transaction' within the meaning of s 21 of the 1936 Act. The objection decision was set aside and the objection allowed.

Appeal to the Court 20 The questions of law raised by the Commissioner on the appeal from the AAT to the Court were as follows: (1) Whether the distribution of Agilent shares by Hewlett-Packard to Gregory Condell was a dividend paid out of profits derived by Hewlett-Packard within the terms of s 44(1)(a) of the 1936 Actas applicable for the year ended 30 June 2000; and (2) Whether the distribution of the Agilent shares to Gregory Condell was a transaction for the purposes of s 21 of the 1936 Act. It was accepted that there was a transaction within the meaning of s 21 and there was no need for the second question to be answered. I have reservations as to whether the first question is a question of law within s 44(1) of the AAT Act (see Ergon Energy Corporation Ltd v Commissioner of Taxation (2006) 153 FCR 551 at [84]-[85]). However, no attention was directed to that issue at first instance or on appeal until supplementary submissions on behalf of the appellant touched on it, albeit lightly. Counsel referred to Hope v Bathurst City Council (1980) 144 CLR 1 particularly per Mason J at 144 CLR 7, noting the difficulty of reconciling that with passages in the judgment of Branson J in Comcare v Etheridge 149 FCR at 526-527. Although the issue may be controversial, there is authority to support the view that the question is an appropriate question of law. Neither side has taken the point nor was it raised by the primary Judge. In those circumstances, and in the absence of argument to the contrary, it is not inappropriate to regard the question posed as falling within s 44(1) of the AAT Act. However, that does not convert the appeal into a full appeal or permit findings of mixed fact and law to be made. An appeal on a question of law can only succeed if legal error in the AAT decision is demonstrated. 21 The essence of the reasoning of the primary Judge is found in the following passages ([2006] FCA 1047 at [32]-[33]): 'Whilst profits must be utilised in funding the distribution, there is no limitation upon the source of those profits. They may be unconnected with what gave rise to the need for, or the desirability of, a distribution. In the present case it is sufficient that the source was profits by way of earnings retained by Hewlett-Packard from previous years. It is not necessary that the distribution be paid from profits made on the spin-off transaction before they can be said to be derived for the purposes of s 44(1)(a), as the taxpayer submitted. The term 'profits derived' in the subsection is a compound concept ... It is an amount recorded by a process of proper accounting ... There was no reason in the present case to doubt that profits by way of retained earnings had been utilised to fund the distribution. There was no evidence of other assets or sums involved in the distribution. The Tribunal did not properly address the question posed by s 44(1)(a). It introduced into it the irrelevant consideration of the market value of the shares. This led it incorrectly to seek to identify non-profit sources for the distribution. And it had regard to the nature of the receipt from the taxpayer's point of view, when the question posed by the subsection requires only consideration from the company's viewpoint.' 22 The primary Judge was of the view that the only available outcome of further consideration by the AAT would be favourable to the Commissioner and so, rather than remit the matter to the AAT, affirmed the objection decision.

Full Court Appeal 23 The grounds of appeal from the primary judgment are as follows: (1) The Court erred in ignoring the definition of dividend in s 6(1) of the 1936 Act which includes distributions of property requiring a determination of the market value of the property distributed. (2) The Court erred in ignoring the market value of the shares in Agilent in considering whether, and if so to what extent, the distribution of the shares in Agilent (the 'Agilent Shares') by Hewlett-Packard was a dividend paid from profits derived by Hewlett-Packard. (3) The Court erred in not looking to the difference between the market value of the property distributed by Hewlett Packard, namely the Agilent shares, in this case USD29.3 billion, and the amount that was debited to the retained earnings of Hewlett Packard, in this case USD4.2 billion, in concluding that the whole of the dividend paid by Hewlett-Packard to the appellant was paid from profits of Hewlett-Packard. (4) To the extent that it did, the Court erred in concluding that distributions of property valued at USD29.3 billion with only USD4.2 billion debited to any profits account of Hewlett Packard was a dividend paid wholly from profits of Hewlett-Packard. (5) The Court erred in not finding that the excess of the value of the Agilent shares distributed by Hewlett-Packard (USD29.3 billion) over the amount of profits actually applied by Hewlett-Packard, USD4.2 billion, were not profits ascertained by any process of computation or accounting. (6) The Court erred in setting aside the AAT's finding that the distribution received by the appellant was not wholly paid from the profits derived by Hewlett-Packard. 24 Counsel for the appellant supported the reasoning of the AAT and counsel for the Commissioner supported the reasoning of the primary Judge. Each view is plausible. There is only so much that can be said on either side. The primary Judge and each party referred to, and relied upon, the statement by Rich, Dixon and Evatt JJ in Evans v Deputy Commissioner of Taxation (SA) (1936) 55 CLR 80 at 101 that 'It is enough at least if it is an ascertained profit, ascertained by a proper account' for the purposes of derivation in relation to earlier provisions similar to s 44(1) of the 1936 Act. That statement was referred to, with apparent approval, by the High Court in Commissioner of Taxation (Cth) v Sun Alliance Investments Pty Ltd (in liq) (2005) 222 ALR 286 at 295-299, 300; (2005) 80 ALJR 202 at 213, 214. Each side identified the account described as 'retained earnings' in the accounts of Hewlett-Packard as a 'proper account' for relevant purposes and that account was accepted by each as representing profits for the purposes of derivation. It was also accepted that the stock dividend was only debited against that account by the entry for USD4.239 billion. This was in accordance with the approach of both the AAT and the primary Judge. There were some hints in the submissions for the Commissioner that a wider view could be taken of the 'profits' of Hewlett-Packard based upon authorities such as MacFarlane v Federal Commissioner of Taxation (1986) 13 FCR 356. That should be rejected in this case. It goes beyond the approach of the AAT and the primary Judge. Consideration of it would involve factual and legal issues not explored in the AAT and would probably require expert evidence as to the applicable United States corporations law and accounting principles. 25 It is accepted that the assessable amount must be wholly paid out of profits (per Gibbs CJ in Federal Commissioner of Taxation v Slater Holdings Ltd (1984) 156 CLR 447 at 459). The circumstance that causes the controversy is that the amount debited to retained earnings in the books of Hewlett-Packard was only a fraction of the market value of the Agilent shares at the date of distribution. There is only one possible explanation for the difference - the market value of the assets (including good will) transferred to Agilent by Hewlett-Packard must have been in excess of the amount attributed to them in the books of Hewlett-Packard. The shares in Agilent which were distributed were valued by Hewlett-Packard at a figure not very much greater than the value it attributed to the assets which had been transferred to Agilent. The distribution of shares by way of stock dividend was debited against retained earnings accordingly at Hewlett-Packard's valuation of USD 4.239 billion. 26 Counsel for the Commissioner insisted that as the distribution of the shares was wholly debited against the account for retained earnings the shareholder received the full value of those shares out of profits derived by the company regardless as to whether that value exceeded the pro rata amount debited against the retained earnings account. Whilst that submission has attraction, and found favour with the primary Judge, in my respectful opinion, it does not withstand analysis. So far as the accounts of Hewlett-Packard are concerned, USD4.239 billion of retained earnings, and no more, was the only profit ascertained by a proper account of the company that was distributed by way of the stock dividend. The conclusion is that it is only that amount which can be said to be derived from or paid out of the retained earnings of Hewlett-Packard. The fact that the shares were worth more in the hands of the recipient is beside the point for the purposes of s 44(1)(a). Put another way, USD29.3 billion was not debited to the retained earnings account of Hewlett-Packard. The appellant's objection was soundly based and the AAT committed no error on a question of law in so finding. 27 The primary Judge was correct in finding that the issue of payment out of profits derived by Hewlett-Packard under s 44(1)(a) requires consideration only from Hewlett Packard's point of view. However, in my opinion, the AAT approached that issue in that way. It identified USD4.239 billion as the total amount of ascertained profits that were distributed by the company - which, on a pro rata basis, was well below the amount assessed. Although the stock dividend was distributed and received otherwise than in cash, it is to be treated as if it were cash - that is the consequence of s 21 of the 1936 Act. It was open to the AAT to find as it did. In my respectful opinion, the primary Judge was not correct in finding that the AAT fell into error of law by taking into account the nature of the receipt by the taxpayer. Receipt by the taxpayer of the dividend paid to him was essential to assessment. After all, the taxpayer was assessed for the deemed amount of the dividend at market value. It is that amount that must have been wholly paid out of the company's profits to be assessable. 28 Furthermore, in my opinion, the primary Judge was not correct in finding that the AAT fell into error of law by seeking to identify non-profit sources for the distribution. That topic was not the gravamen of the AAT's decision. It does not strictly matter how the difference in value (pro rata) between USD29.3 billion and USD4.239 billion is categorised. It is not caught by s 44(1)(a). However, it is a feature of the case worthy of comment. The increment in question represented value passed from Hewlett-Packard to Agilent. The appellant was a shareholder of Hewlett-Packard and so suffered the diminution in value consequent upon the transfer of assets out of that company upon demerger and deconsolidation. In a real sense the distribution of the shares restored that value. This was a demerger by split of assets. If the shareholders of Hewlett-Packard were not to be disadvantaged they had to become shareholders in the new company or otherwise be advantaged. The diluting effect of the demerger for those not entitled to Agilent shares such as holders of employee entitlements is noted in the public Hewlett-Packard documents and it is recognised that it had to be adjusted. This is not a case where a company pregnant with excess profits distributed them to shareholders by way of a stratagem. I agree with the AAT in thinking (as a post script) that, in general terms, this was an affair of capital not revenue. 29 In truth, it is the Commissioner's contention which departs from the 'proper account' of Hewlett-Packard in ascertaining whether the amount assessed was wholly paid out of profits derived by Hewlett-Packard. It categorises the difference between the amount assessed and the amount debited in the books of Hewlett-Packard as paid from profits derived by it although not so dealt with by the company in its accounts. 30 The appeal should be allowed. The orders of the Court should be set aside and, in lieu thereof, the appeal to the Court dismissed and the orders of the AAT restored. As the appellant was provided with funding under the Test Case Litigation Program to assist the appellant to meet his costs of the proceedings, there should be no order as to the costs of this appeal or of the primary hearing. I certify that the preceding twenty (20) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gyles.

Associate: Dated: 28 March 2007 Counsel for the Appellant: Mr J.D. Meralls QC with Mr F.D. O'Loughlin

Counsel for the Respondent: Mr G.J. Davies QC with Ms M. Brennan

Solicitor for the Respondent: Australian Government Solicitor