Discussion of the cases bearing upon s 47(1) of the Act
14 As is well known s 47(1) had its origin in the differences that exist in a system of taxation of income between the liability for tax of a person in receipt of dividends and the liability for tax of a person in receipt of a liquidator's distribution.
15 As the joint judgment of Rich, Dixon and McTiernan JJ in Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80 at 97-100 points out, in a system directed at the taxation of income it could be possible to treat what is received by a shareholder, other than an original shareholder, as, at least in part, a return to the shareholder of a part of the amount paid for the shares. However, such an approach is not adopted. Rather the law distinguishes between income and capital by reference to "the source of the receipt". Distributions by a company out of profits, or at least those earned during the period in respect of which a distribution is made, "clearly fall", as their Honours say, within the concept of income. However, it has not proven possible to distinguish between shareholders in accordance with the relation to which a particular individual may stand to the particular profit distributed and so no attention is paid to the fact that, as their Honours say, to one shareholder the distribution may be but a return of the amount the shareholder paid for the share.
16 In terms of company law and the law of income tax the distribution by a company of profits, be they profits accumulated or current year profits, is seen as the "detachment", "release" or "liberation" of the profits. The share itself remains in existence and is held by the shareholder. So, as the Privy Council said in Hill v Permanent Trustee Co of New South Wales Ltd [1930] AC 720, a case concerned with the meaning of "income" for trust law purposes, it was said at 734 that:
"If payment to the shareholders is made out of profits it is income of the shares, and no statement of the company or its directors can change it from income into corpus."
17 It may be noted that the influence on Australian income tax law so far as it distinguishes between income and capital, rather than the analysis made by economists in distinguishing between the two concepts, has been the subject of criticism by some commentators and forms the basis for the drive towards the fresh approach to the calculation of taxable income proposed in what is presently referred to as "Option 2": cf Krever "Simplicity and Complexity in Australian Income Tax" in Peterson & Gallagher (eds) Tax and Transfer Reform in Australia and Germany (Berliner Debatte Wissenschaftsverlag 2000) at 67-69.
18 But, whether for trust law purposes or for the purposes of a tax based upon concepts of income and capital (absent a special provision such as s 47), where a company goes into liquidation and the mass of assets of the company, representing as it might accumulated profits or profits earned up to the date of liquidation is distributed to the shareholder on liquidation the rule adopted is different. In such a case shareholders are returned the ultimate capital value of the intangible property constituted by their shares which no longer exist. Profits are not detached, released or liberated leaving the share intact. There is, as their Honours said in Stevenson at 99, "no dividend" and
"no distribution of profits because they are profits. The shareholder simply receives his proper proportion of a total net fund without distinction in respect of the source of its components and he receives it in replacement for his shares."
19 What the shareholder receives is not income, it is capital. And this is so, whether the context is trust law (see Hill at 729) or the taxation of income: see Inland Revenue Commissioners v George & Burrell [1924] 2 KB 52.
20 These cases and the many cases which have since applied them explain the structure of ss 47 and 44 and the language which the legislature employed.
21 First it must be said that the legislature determined to reverse, for the purposes of the Australian income tax law, decisions such as George & Burrell. Thus s 47 was enacted to ensure that a distribution made by a liquidator (to the extent that the distribution had been made out of income) should be taxable to a shareholder who received it. To achieve this it was not sufficient to deem the distribution to be a dividend, for that word could contemplate and was used in the Act to cover acts or transactions not necessarily of a revenue nature. So, for example, s 6(1) of the Act now defines "dividend" as "any distribution made by a company to its shareholders". A distribution on capital account could thus be a dividend as defined. It will be noted that the definition, of itself, would thus be incomplete to determine the character of the distribution to be either income or capital. The source from which the distribution is to be made is not revealed. The present definition of "dividend" may be compared with the definition of "dividend" first introduced in 1934 which qualified the definition by requiring that the distribution be out of profits. The qualification was dropped in the 1936 Act, no doubt because s 44(1) of the Act, introduced at the same time, required a dividend to be paid out of profits before it was comprehended within s 44(1) and thus became, albeit depending upon the geographic source of profit, assessable income: cf Federal Commissioner of Taxation v Uther (1965) 112 CLR 630 at 636 per Kitto J. The fact that his Honour dissented in the result does not affect the historical analysis which his Honour there sets out. See too per Taylor J at 642 and per Menzies J at 643. The judgment of Fullagar J in Federal Commissioner of Taxation v Blakely (1951) 82 CLR 388 at 406 repeats the history.
22 Section 47 itself contained no territorial limitation. Since the basal concept of the Act was to levy tax on residents of Australia deriving income wherever sourced, but to contain the impact of the tax on non-residents to Australian sourced income, s 44(1) not only explained what dividends were to be brought into assessable income, but also supplied a territorial limitation, consistent with s 25(1). Hence while taxpayers resident in Australia would pay tax on all dividends out of profits wherever sourced, non-resident taxpayers would only pay tax on dividends to the extent that the profits out of which the dividends were directly or indirectly paid were from an Australian source.
23 The first High Court decision to address some of the issues relevant to the present case was Blakely where shareholders obtained the assets of a company in the course of what may be described as an informal liquidation. It was held that no amount was to be included in assessable income. In the course of his judgment, Latham CJ at 397 accepted a submission of the Commissioner that the criterion of assessability under s 44(1) was not whether what was received by a shareholder was detached from the capital asset, namely the shares, but whether what the shareholder received came from the profits of the company. His Honour was of the view that there had on the facts of the case been no distribution, although at least in part what was received by the shareholder represented profits derived by the company. Fullagar J, with whom Dixon J agreed, was of the view that there had been no distribution of profits because they were profits. Rather the shareholders had received a proportion of a net fund without distinction as to the source of the components: at 404. Because all that happened was that the shareholders received but a proportion of the net fund without distinction as to the source of its components, there was nothing in the Act which gave the receipt the character of an income receipt, the character that it would otherwise have being capital.
24 The second case (historically) dealt with by the High Court was Archer Bros Pty Ltd (in liq) v Federal Commissioner of Taxation (1953) 90 CLR 140. The question which arose in that case was whether a private company which in the year of income went into liquidation should be treated as making a sufficient distribution for the purposes of the then Division 7 of the Act, which imposed a tax upon private companies which had not distributed at least as much as the Act prescribed to be a sufficient distribution. It was held that a distribution to shareholders made by the liquidator, to the extent that that distribution was made out of income, was to be treated by force of s 47 of the Act as a dividend and that this was for the purposes of Division 7 as well as the other purposes of the Act. Perhaps the only significance the case has in the present discussion is to illustrate some of the work which the words "for the purpose of the Act" have to perform. For this, it provides the foundation of the Commissioner's third summary submission. It is, however, important to note that in the joint judgment of Williams ACJ, Kitto and Taylor JJ their Honours refer to s 47 as assimilating for the purpose of the Act a distribution by a liquidator in the course of winding up for the purpose of the Act to dividends paid to shareholders by a company out of profits. On the other hand this may be seen as no more than a paraphrase of the language of s 47(1). However, their Honours did, at 155, emphasise that s 47(1) was not to be seen as "merely" ancillary to s 44(1).
25 Next in time was Federal Commissioner of Taxation v W E Fuller Pty Ltd (1959) 101 CLR 403. In that case a company made a bonus share issue to its shareholders. The taxpayer, who had made a loss in the year of the issue, claimed to be entitled to carry forward that loss, notwithstanding the bonus issue. It was held by majority (Fullagar and Menzies JJ, Dixon CJ dissenting) that the bonus shares were exempt income within s 80(1) of the then Act, the section governing the carry forward of losses, with the result that the amount of the loss carried forward was reduced by the amount of the value of the bonus share. The majority reached this conclusion because s 6(1) defined dividend as including the paid-up value of shares distributed by a company to its shareholders. Being a dividend, the bonus share issue was thus, it was held, income.
26 The judgment of the majority need not now be explored. It has subsequently been disapproved and the minority judgment of Dixon CJ has been said to be correct: cf Gibb v Federal Commissioner of Taxation (1966)118 CLR 628 at 632.
27 It was the Chief Justice who held that, in the ordinary sense, a bonus share issue resulted in the shareholder receiving capital: Inland Revenue Commissioners v Blott [1920] 2 KB 657. The fact that a bonus share was included in the definition of "dividend" for the purposes of the Act did not produce the result that the issue was income. More was required where the share issue had the nature of capital.
28 Parke Davis & Co v Commissioner of Taxation (1959) 101 CLR 521 was decided in the same year. In that case a subsidiary company of the taxpayer, incorporated in Colorado and a non-resident, was liquidated and its assets distributed on liquidation to its parent which was also not a resident of Australia. The assets distributed included profits derived from sources in Australia as well as profits sourced outside Australia. It was held that s 47(1) was to be treated as having an application independent of considerations of locality. This is the Commissioner's summary submission 2. It was concerned only with a kind of transaction which comes within the ambit of s 44(1) relating to the assessability of dividends. Section 44(1) provided the territorial criteria for including dividends in assessable income. Section 44(1), so far as it concerned source was expegetical to s 23(r) which was the general provision providing the nexus between residence and source and thus confining the assessability of non-residents to income from an Australian source. Accordingly, to the extent that there was an Australian source, s 44(1) applied to include an amount in the assessable income of the non-resident.
29 Of s 47(1) their Honours said at 530-1 (and it is from this passage that the Commissioner's submission 1 is derived):
"Section 47(1) is a provision dealing with a transaction according to its character. Its purpose is obvious enough. The section was first enacted in an earlier form to meet the situation, made clear enough by Inland Revenue Commissioners v Burrell which decided in effect that a distribution of a mass of assets, although in a colloquial sense they represented or contained profits, was a distribution of capital. There is no ground, we think, for adding territorial restrictions to s 47. That does not mean, of course, that in the description of the transactions s 47 gives, in reference to winding up and to a liquidator, and so on, grounds may not be found for saying that some particular procedure or process prescribed by a foreign law will be outside the terms of the section. But it is, we think, of general application, quite independently of questions of locality. It is when a transaction comes within the terms of s 47 that you go back to the provisions relating to locality if the case be one of a non-resident. It is at that stage that you consider the source of imputed dividend."
30 An argument based upon lack of territorial connection with Australia likewise failed.
31 Glenville Pastoral Co Pty Ltd (in liq) v Federal Commissioner of Taxation (1963) 109 CLR 199 is more to the point. In that case the appellant company, which had received a liquidation distribution from its subsidiary, then went into liquidation and a distribution was made by its liquidator to its shareholders. The question in issue was whether there had been a "sufficient distribution" by the appellant for the purposes of Division 7 of the Act as it then stood. The appellant took the distribution it received from the liquidator of its subsidiary into its books as capital, as indeed it was (other than by force of s 47 with or without s 44(1)). It was argued by the Commissioner that the only part of the distribution made by the appellant which qualified as a deemed dividend by the appellant for the purposes of s 47 was the amount by which the appellant's funds exceeded the amount of its paid up capital which represented profit in the company law sense. The argument was rejected. Kitto, Taylor and Owen JJ said at 206-7:
"In no sense, apart from the provisions of this section, did any part of the distributions which the appellant received from the liquidator of Killens constitute income of the appellant. But since, to the extent of £243,402, they represented income derived by Killens they were to that extent to be deemed, for the purposes of the Act, to be dividends paid to the appellant by Killens out of the profits derived by it. As already mentioned, one result was that to that extent what the appellant received from Killens constituted by force of s 44(1)(a) the appellant's assessable income for the year in question. But the purposes of the Act are not limited to the purposes of s 44(1)(a); they include the purposes of every provision of the Act: see Archer Brothers Pty. Ltd. v. Federal Commissioner of Taxation. Accordingly, in applying s 47(1) itself in relation to distributions by the appellant to its shareholders, it is necessary to treat the amount the appellant received from Killens as constituting, to the extent of £243,402, dividends paid out of Killens' profits and therefore as being income derived by the appellant. That being so, the whole amount of the distribution made by the appellant's liquidator on 29th October 1957, namely £241,669, must be deemed to have represented income derived by the appellant, and therefore to be deemed dividends paid by the appellant out of its profits except as regards any part of it which had been 'properly applied to replace a loss of paid-up capital'."
32 One "significance", at least, of Glenville for present purposes is that it demonstrates, if demonstration be necessary, that s 47(1) can have a multiple operation, at least where the companies in the chain of companies liquidated are all resident in Australia. The real argument in the case was actually whether, since the appellant had lost its capital, a distribution which represented income had to be treated as excluded from the operation of s 47 on the ground that to the extent of the lost capital, it had necessarily been applied to make good that loss. That argument, which has no resonance in the present case, was rejected.
33 Next in terms of reported cases was Federal Commissioner of Taxation v Uther (1965) 112 CLR 630, a case dealing with a distribution to shareholders by way of reduction in capital. In that case Taylor and Menzies JJ (Kitto J dissenting) found that the distribution was neither a distribution of profits or out of profits, but that what the shareholders received was capital. The majority took the view that the decision in Blakely, to which reference has already been made, governed the case. While an ordinary dividend necessarily had to be paid out of profits, that was not the case with a reduction of capital. As Taylor J said, the fact that the distribution came within the definition of "dividend" told nothing. His Honour, however, distinguished s 47, where the dividend as defined was deemed to have been paid out of profits. Likewise, Menzies J commented at 645:
"To deal with the same sort of problem as here confronts us when there is the liquidation of a company rather than a reduction of its capital, a special provision was found to be necessary, viz s 47"
34 Gibb v Federal Commissioner of Taxation (1966) 118 CLR 628 again concerned the making of a bonus issue. The bonus shares were sold and the company subsequently placed into voluntary liquidation. The issue for decision was whether the proceeds of the bonus shares were to be treated as income. Were Fuller to be accepted as correct, the bonus shares were income by force of the fact that they constituted a "dividend" under s 6(1) and the subsequent liquidation was to that extent thus made from "income". However the High Court by majority, Barwick CJ, McTiernan, Taylor and Windeyer JJ (Owen J dissenting), refused to follow the majority view in Fuller but rather approved the dissenting view of Sir Owen Dixon. The bonus shares had, the Court said, the character of capital and were not, by force of s 6, made income. All the definition of s 6 did was give a meaning to the word "dividend" as it was used in the Act. Their Honours continued at p 635:
"Consequently, any distribution of the character mentioned in the definition is for the purposes of the Act a 'dividend' whether it constitutes an income or a capital receipt to the shareholders. The line of reasoning employed to support the respondent's contention does not, of course, suggest that the effect of the definition is to convert every distribution of the nature described in the definition into dividends in the ordinary sense of that term. It asserts that, since dividends, in the ordinary and natural sense of that term, are income it follows that when the Act defines the term in a different and artificial sense - that is, to include distributions which are not dividends or income in the ordinary sense - it operates to invest dividends as so defined with the character of income. In our view, and with respect to those who think otherwise, this line of reasoning is fallacious. The function of a definition clause in a statute is merely to indicate that when particular words or expressions the subject of definition, are found in the substantive part of the statute under consideration, they are to be understood in the defined sense - or are to be taken to include certain things which, but for the definition, they would not include…
We agree with Dixon CJ when he said:
'the conception of 'dividend' does not affect the meaning or application of the word 'income'; at all events so it appears to me. The Act is not expressed to bring the defined conception of dividend within the word 'income'."
35 In a passage which, while not directly relevant to the facts in issue in Gibb, has great persuasion since it represented the refutation by Barwick CJ, McTiernan and Taylor JJ of the view of the majority in Fuller, which their Honours did not follow, their Honours commented at 637:
"One further matter may be mentioned which, it seems to us, operates to confirm the views which we have expressed. By force of s 47 of the Act, distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company other than income which has been properly applied to replace a loss of paid-up capital, are deemed to be 'dividends' paid to the shareholders by the company out of profits derived by it. But although in the language of the Act they may to this extent be properly described as 'dividends' they do not, by force of their character as such, further assume the character of assessable income, or, for that matter, of income. This we think, is clear enough from the observations in Glenville Pastoral Co Pty Ltd v Commissioner of Taxation of the Commonwealth and Commissioner of Taxation of the Commonwealth v Uther. The 'statutory fiction' (see Muller v Dalgety & Co Ltd) introduced by s 47 merely provides a basis for the operation of s 44 which is concerned exclusively with what dividends shall or shall not form part of a taxpayer's assessable income. It would, in our view, be anomalous to hold that distributions which constitute 'dividends' because they are comprehended by the definition of that term thereby, necessarily, achieve the character of income whilst distributions of a character which are not comprehended by the definition but which are deemed by s 47 to be 'dividends', do not by force of that provision achieve that character."
36 It is this passage which is relied upon by BIL in refutation of the Commissioner's third proposition. Indeed, it is submitted that this passage is part of the ratio of Gibb and provides a complete answer to the Commissioner's submissions, it being conceded that the Commissioner's argument must fail if the third summary submission is incorrect. I shall return to this question later.
37 Windeyer J expressed the view that the word "income" where appearing in s 47(1) of the Act included both that which was income by ordinary concepts as well as that which was assessable income. However, the bonus dividend was neither income in ordinary concepts, nor was it made assessable income under s 44. In consequence s 47(1) did not operate to include any amount in the assessable income of the taxpayer. His Honour labelled as "fallacious" an argument that might be expressed in the following terms: any dividend paid out of profits has the character of income in ordinary concepts; therefore anything which is comprehended within the definition of "dividend" is given the character of income by the Act. By this argument, the word "income" as used in the Act comprehends anything which is a "dividend" in the defined sense. I should say in anticipation of the later discussion that it would not be fallacious, however, to say that because any dividend paid out of profits has the character of income in the ordinary sense, anything which the Act deems to be a dividend paid out of profits is given the character of income for the purposes of the Act so that when the Act uses the word "income" in s 47 it is capable of comprehending anything which the Act deems to be a dividend paid out of profits.
38 Gibb was shortly afterwards followed by Harrowell v Commissioner of Taxation (1967) 116 CLR 607. That case concerned successive distributions, the first the distribution to a parent company on the winding up of its subsidiary and the second the distribution to the parent company's shareholders of its assets on liquidation. The argument for the taxpayer was that what the parent received on liquidation of its subsidiary, while deemed by s 47 to be a dividend paid out of profits, was actually of a capital and not an income nature. Accordingly the liquidation distribution by the liquidator of the parent was made out of capital, not out of income, and so did not enliven s 47. In arriving at this conclusion the Court expressed the view that Gibb did not require a contrary view. It had been submitted that the deeming of the distribution, to which s 47 referred, to be a dividend paid out of profits did not enable the Commissioner to treat any part of the amount of the distribution as income, just as the deeming of the bonus shares to be a dividend by force of s 6 did not have the effect of making the proceeds of the bonus shares income. The judgment is brief and significant to the present appeal. That part of it (at 611-2) which addresses the submission made may usefully be repeated:
"The argument, however, is fallacious and the reasoning applied in Gibb's Case has no application to the circumstances of this case. Distributions by a liquidator to the shareholders of a company can be made only after the debts of the company have been paid or provided for and this must be borne in mind when we come to consider s 47(1). Accordingly, when the sub-section expresses the initial condition for its operation - 'Distributions … to the extent to which they represent income derived by the company' - it proceeds on the basis that if a distribution is made to shareholders in the course of a winding up out of a fund which, either in whole or in part, represents income derived by the company, such distribution, or such part thereof, is to be regarded as a revenue profit and it is in that context that the distribution 'is deemed to be dividends paid to the shareholders by the company out of profits derived by it'. Within this framework there is, therefore, no room for the view that a deemed dividend under s 47 may in some circumstances consist of or include a capital profit and the reasoning in Gibb's Case can have no application. It seems to us that the concluding words of the sub-section were introduced to accommodate its provisions to the language of s 44. But it is clear enough that when the legislature used these words it was speaking of a profit derived by a company on its revenue account and not otherwise. Accordingly the sub-section, for the purposes of the Act, deems the distribution, to the extent to which the distribution is made out of income derived by the company, as dividends paid to the shareholders out of such profits. The distribution by the liquidator of Killens, representing, as it did, income derive by Killens, the conclusion is inescapable that the effect of the sub-section was to invest the distribution with the character of a dividend paid to Glenville out of, and only out of, profits derived by Killens on revenue account and, therefore, income in Glenville's hands. That being so the appellant's contention must be rejected ..." [original emphasis]