Business Operation or Commercial Transaction
226 Both sides accepted that the loss incurred here would be deductible if the shares sold had been held by the taxpayer on revenue account.
227 The proposition that a gain will constitute income if the property generating that gain was acquired in a "business operation or commercial transaction" for the purpose of profit-making by the means giving rise to the profit is well established: Myer Emporium at 209-210. Previous authorities, however, have tended to focus on the existence of the required profit-making purpose rather than upon the need for there to be a "business operation or commercial transaction".
228 The "commercial dealing" requirement, it would appear, is a test derived from English revenue law. According to Parsons' Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (The Law Book Company Limited, 1985), it was introduced into domestic law by the Privy Council in McClelland v Federal Commissioner of Taxation (1970) 120 CLR 487 in the context of former s 26(a) of the Income Tax and Social Services Contribution Assessment Act 1936-1963 (Cth) (the "1936 Act"). In that case, the appellant had inherited land with her brother. She wished to keep the land, but the brother did not. He wanted to sell his half as soon as possible. She needed to sell off part of the land to buy the brother out. She did this and made a profit. The profit was assessed by the Commissioner pursuant to former s 26(a) of the 1936 Act which at the time provided as follows:
26. The assessable income of a taxpayer shall include -
(a) profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme.
229 In advice delivered by Lord Donovan, Viscount Dilhorne and Lord Wilberforce (constituting the majority), their Lordships observed that the relevant test in the United Kingdom at that time would have been whether the transaction was an "adventure in the nature of trade" (at 491). There was, it was observed, no similar test in the 1936 Act. However, for the purposes of s 26(a), their Lordships advised that a gain made from a profit-making scheme, in order to be assessable, must "exhibit features which give it the character of a business deal". They explained why at 494-495 as follows:
It is clear in the first place that not all such undertakings or schemes are caught by the section. Otherwise every successful wager would be within it. So also would the purchase of investments bought by a private investor as a hedge against inflation and sold - perhaps long afterwards - at more than the purchase price. The participator in a lottery would also be liable if he drew the winning ticket. The undertaking or scheme, if it is to fall within s. 26(a), must be a scheme producing assessable income, not a capital gain. What criterion is to be applied to determine whether a single transaction produces assessable income rather than a capital accretion? It seems to their Lordships that an "undertaking or scheme" to produce this result must - at any rate where the transaction is one of acquisition and resale - exhibit features which give it the character of a business deal. It is true that the word "business" does not appear in the section; but given the premise that the profit produced has to be income in its character their Lordships think the notion of business is implicit in the words "undertaking or scheme".
The foregoing passage supports the proposition that the purpose of the "business deal" test was to prevent s 26(a) from taxing gains made from waging, from a lottery and from an investment by a "private investor" made as a hedge against inflation. It was not at that time concerned with the notion of income according to ordinary concepts.
230 In this appeal, Senior Counsel for the Commissioner submitted that the acquisition and sale of the Nexus shares did not take place on revenue account because what happened was not an adventure in the nature of trade. This was said to be an expression of the test that the transaction must constitute a "business operation or commercial transaction". That proposition suffers, with respect, from an immediate difficulty. In Federal Commissioner of Taxation v Visy Industries USA Pty Ltd (2012) 205 FCR 317, Edmonds, Greenwood and Robertson JJ. observed that an important element of the reasoning of the primary judge in that case (Gordon J.) was her Honour's rejection of the Commissioner's contention that the transaction in question "was not a commercial transaction or was not an adventure in the nature of trade". The expression "adventure in the nature of trade" was found by the Court not to be relevant to the concept in Australia of income according to ordinary concepts. Their Honours said at 332-333 [52]:
Finally, by way of general observation, we have to say that we do not find terms such as "profit-making undertaking", "profit-making scheme" or "adventure in the nature of trade" to be helpful in a case such as this where the taxpayer is carrying on a business and the transaction is entered into in the course of that business albeit not in the ordinary course. As the High Court has warned in a different context, the statute is to be construed and applied according to its terms, not under the influence of "muffled echoes of old arguments" concerning other legislation: Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at 414 in the plurality judgment. Terms such as "profit-making undertaking", "profit-making scheme" and "adventure in the nature of trade" have an historical nexus with provisions no longer to be found in the statute. They certainly find no expression in the pivotal passage from the High Court's judgment in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 at 209, 210 which lies at the heart of this case:
Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a 'one-off' transaction preclude it from being properly characterized as income: Federal Commissioner of Taxation v. Whitfords Beach Pty. Ltd. The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.
(Emphasis added and emphasis in original quote.)
231 It follows that the outcome of this appeal does not turn upon a characterisation of the share trading as an "adventure in the nature of trade".
232 It is noteworthy that prior to the decision of the House of Lords in Jones v Leeming [1930] AC 415, which led to the introduction of an earlier version of s 26(a) (now s 25A of the Income Tax Assessment Act 1936 (Cth) and s 15-15 of the 1997 Act), gains made from trades entered into for short-term profit-making were considered in Australia to be on revenue account. To preserve that position and to reverse what was perceived to be the effect of Jones v Leeming, in 1930, the definition of "income" in the Income Tax Assessment Act 1922 (Cth) was amended through the insertion of words which were later to be repeated in s 26(a): Montgomery at 674 [107]. Sections 25A and 15-15 are now expressly and relevantly limited to profits made from property acquired prior to 20 September 1985. Those provisions do not apply here.
233 A good example of a pre-Jones v Leeming authority is the decision of the High Court in Blockey v Federal Commissioner of Taxation (1923) 31 CLR 503. In that case, two individuals entered into an agreement to buy wheat scrip using brokers for the sale of such scrip at a profit. Their intention was not to hold the scrip as an investment. The purchasing of sufficient scrip took two months to complete and the selling of that scrip, a few months later, took place over about a month. The High Court held that the profits were on revenue account because they were the product of a discrete business. Isaacs J. (as his Honour then was) also found that even absent the presence of a business, the profits were still on revenue account. His Honour said at 508-509:
But nothing I have said must be taken as indicating that, if the adventure had not been a "business" and the Commissioner had assessed the profits as income from property, he would have failed. Whatever is "income" is income from property, unless it falls within the statutory definition of "income from personal exertion." A mere realization of property though producing profit does not, as I have said, produce income. It is a mere enlargement of capital. But if a man, even in a single instance, risks capital in a commercial venture - say, in the purchase of a cargo of sugar or a flock of sheep - for the purpose of profit making by resale and makes profit accordingly, I do not for a moment mean to say he has not received "income" which is taxable. I intimated during the argument that this was possible; and I leave it open.
234 After McClelland, the High Court considered on a number of occasions the need for a transaction to be a business dealing for the purposes of former s 26(a) of the 1936 Act (as amended from time to time). That need, it would appear, was to prevent s 26(a) from being used to tax the mere realisation of a capital asset. For example in Steinberg v Federal Commissioner of Taxation (1975) 134 CLR 640, Gibbs J. (as his Honour then was) contrasted the features of a business deal as against "[t]he mere realization of a capital asset" (at 699). Subsequently, in Federal Commissioner of Taxation v Bidencope (1978) 140 CLR 533, his Honour explained the need for the test at 552:
The second proposition which their Lordships asserted in McClelland's Case - that to come within the second limb of s. 26(a) the scheme should exhibit features giving it the character of a business deal, at least where the transaction is one of acquisition and sale - has been accepted and applied in this Court. The reason for construing the section in that way is no doubt that if some such limitation were not placed on its generality it would include profits which were apparently not intended to come within its scope; for example, a mere realization of capital, carried out in an enterprising way, might then fall within the section. It is unnecessary for present purposes to consider whether there is an exception to the generality of the proposition so stated.
(Emphasis added.)
The perceived role of the "business deal" test in this passage again appears to be to prevent mere realisations of capital from being taxed by s 26(a).
235 In Whitfords Beach, Mason J. (as his Honour then was) again considered the "business deal" test from McClelland. He had "some difficulty" with the conclusion in that case. His Honour said at 378-379:
Unfortunately there is an element of ambiguity in the expressions "business deal" and "operation of business" as there is in the adjectives "business", "commercial" and "trading" which have about them a chameleon-like hue, readily adapting themselves to their surroundings, different though they may be. In some contexts "business deal" and "operation of business" may signify a transaction entered into by a person in the course of carrying on a business; in other contexts they denote a transaction which is business or commercial in character. Although the majority in McClelland thought that s. 26(a) was mainly, if not wholly declaratory, of the existing concept of income, they did not by the references to "business deal" and "operation of business", necessarily mean a transaction entered into in the course of carrying on a business.
It is of importance to note their Lordship's statement [(1970) 120 CLR 487 at 494-495] that not only are wagers and lottery tickets excluded from profit-making undertakings or schemes, but "also … the purchase of investments bought by a private investor as a hedge against inflation and sold - perhaps long afterwards - at more than the purchase price", and the further statement [(1970) 120 CLR 487 at 495] that "The undertaking or scheme, if it is to fall within s. 26(a), must be a scheme producing assessable income, not a capital gain." There are two separate strands of thought embedded in these observations: (1) that the transaction must have about it some business or commercial flavour - the purchase of an investment by a private investor is not enough; and (2) the profit in view must be an income, not a capital, gain, according to ordinary concepts.
Not all that was said in McClelland can now be accepted. The majority judgment fails to differentiate between the United Kingdom and the Australian systems of arriving at taxable incomes and employs expressions derived from the United Kingdom income tax legislation which have no place in our legislation. And there is the possibility that it insufficiently acknowledges that the operation of the second limb of s. 26(a) may extend to some gains of a capital nature according to general revenue law.
I do not doubt that the majority was right to exclude from the second limb of s. 26(a) successful wagers and lottery windfalls. Perhaps the exclusion of private investments originally made as a hedge against inflation was more open to question but there is now a strong body of authority to support its exclusion.
The last sentence in the passage quoted above is perhaps an indication that the requirement that a transaction be a "business deal" or "commercial transaction" involves only a low threshold. It certainly works to exclude gains made from wagers and lotteries from being taxed by s 26(a), however Mason J. doubted whether it also excluded the type of private investment referred to in McClelland. In that respect, the authorities appear to contrast a profit-making scheme from an investment. An investment connotes something to be held over time, which might then be sold "long afterwards", to use the language of McClelland.
236 An earlier decision of Stephen J. in Williams v Federal Commissioner of Taxation (1972) 128 CLR 645 should also be noted. In that case, Williams was a managing director and shareholder in a certain company which paid him fees and dividends. His Honour characterised the taxpayer as someone who had, until the mineral boom in Australia, been a "very modest and infrequent" trader in shares. However, with the coming of the boom, the taxpayer became a "speculator in mining and oil exploration shares" who, using a broker, indulged in "quite considerable share market speculation" (at 656). The speculation was considered to be "individual forays in particular stocks which [the taxpayer] bought with a view to resale" (at 656). At 657, Stephen J. said:
The taxpayer's evidence of how he undertook his stock exchange transactions indicated nothing in the nature of a system or method or the carrying on of a business; he simply relied upon his own knowledge of the prospects of particular companies, gained very largely from his contacts with their managements in the course of the export and import business which he managed and which brought him into contact with a number of mining companies.
237 Stephen J. decided that the taxpayer was assessable under s 26(a) (and therefore entitled to a deduction pursuant to former s 77A of the Income Tax Assessment Act 1936-1969 (Cth), thus engaging, for the purposes of that case, s 82(2) and (3)(c) of the Act).
238 There is an evident analogy between the facts here and those in Williams. Stephen J. had to decide whether the taxpayer's trades in shares were subject to former s 26(a). His Honour decided that s 26(a) applied because the forays into particular stocks were carried out with a view to resale. The need for any feature or attribute which might have given the share trading the character of a "business deal" was not addressed, presumably because it was self-evident that the trading was of such a nature.
239 The applicable principle to be derived from the subsequent decision of the High Court in Myer Emporium is reproduced in the quotation from Visy Industries USA above. In Myer Emporium the Court decided, amongst other things, that the "business deal" test was not just relevant for the purposes of applying s 26(a); it applied equally to gains derived from profit-making undertakings which constituted income according to ordinary concepts for the purposes of former s 25 of the Income Tax Assessment Act 1936 (Cth). The need for it was explained at 211-212 as follows:
Several different strands of thought have combined to deter courts so far from accepting the simple proposition that the existence of an intention or purpose of making a profit or gain is enough in itself to stamp the receipt with the character of income. The first was the notion that the realization of an asset was a matter of capital, not income. The second was the apprehension that windfall gains and gains from games of chance would constitute income unless the concept of income, apart from income from personal exertion and investments, was confined to profits and gains arising from business transactions. And the third notion, itself associated with the idea that the carrying on of a business involves a systematic series of recurrent acts or activities, was that a gain generated by recurrent transactions is income, whereas a gain generated by an isolated transaction is capital.
In the United Kingdom, Schedule D of the Income Tax Act 1918 (U.K.) reinforced these notions. The Schedule seemingly confined the concept of income to (a) profits or gains from any trade, profession, employment or vocation, and (b) annual profits and gains from investments, though "trade" is defined so as to include every "manufacture, adventure or concern in the nature of trade". These provisions naturally provoked the question: Was a profit made on an isolated transaction of purchase and sale income, if the purchase was made with the intention, or for the purpose, of making the profit, even though the transaction was not one entered into in the course of carrying on a business?
In Jones v. Leeming [[1930] AC 415], the House of Lords answered this question in the negative. There was a finding that the taxpayer never meant to hold the land bought as an investment. Nevertheless it was found that the transaction "was not a concern in the nature of trade". This led to the conclusion that a profit on an isolated sale, not being an adventure in the nature of trade, was a capital accretion [at 430]. Central to the reasoning was the view that in order to constitute a trading or business transaction, an element of recurrence or repetition is needed and that the intention or purpose of making a profit or gain, is not enough. Viscount Dunedin said [at 423]:
"The fact that a man does not mean to hold an investment may be an item of evidence tending to show whether he is carrying on a trade or concern in the nature of trade in respect of his investments, but per se it leads to no conclusion whatever."
And Lord Buckmaster [at 420] discounted the suggestion that a profit made on the sale of an asset acquired in the expectation that it would rise in value (and presumably result in a realized gain) is income. To him all that was involved in such a case was the realization of a capital asset.
On the other hand in Edwards (Inspector of Taxes) v. Bairstow [[1956] AC 14] joint venturers who engaged in an isolated transaction of buying and selling a complete spinning plant, with a view to making a profit, having no intention of using the plant or deriving income from it, were held liable to income tax on the profit made on resale. Lord Radcliffe concluded [at 36-37] that it was a profit from an adventure in the nature of a trade because the joint venturers had no intention of using the machinery and therefore did not buy it to hold as an income-producing asset or to consume it or for the pleasure of enjoyment; and, instead of having any intention of holding the plant, they planned to sell it even before they bought it. This they did, making a net profit, as they hoped and expected to do. In his Lordship's opinion this was "inescapably, a commercial deal in second-hand plant".
In rejecting the argument that the profit was not income because it arose from an isolated transaction, Lord Radcliffe observed [at 38]:
"... that circumstance does not prevent a transaction which bears the badges of trade from being in truth an adventure in the nature of trade. The true question in such cases is whether the operations constitute an adventure of that kind, not whether they by themselves or they in conjunction with other operations, constitute the operator a person who carries on a trade. Dealing is, I think, essentially a trading adventure, and the respondents' operations were nothing but a deal or deals in plant and machinery."
240 More recently, the majority in Montgomery, reaffirmed the expression of the test from Myer Emporium at 673 [104] and said the following about singular transactions at 676 [113] which should be noted:
The singularity of a transaction may very well invite close attention to whether it is in business. The singularity of a transaction may suggest that there is a mere realisation of a capital asset or change of investment rather than a transaction on revenue account. The purpose of profit-making may be an important consideration in deciding these questions. But, as Myer demonstrates, a singular transaction, in business, even if unusual or extraordinary when judged by reference to the transactions in which the taxpayer usually engages, can generate a revenue receipt. And that is why, in Federal Commissioner of Taxation v Cooling, the Full Court of the Federal Court rightly emphasised the fact that, in that case, the receipt was an ordinary incident of part (albeit an extraordinary and unusual part) of the firm's business activity.
(Footnotes omitted.)
241 Finally, I observe that Parsons thought that the test of "business deal" might only require that the transaction be the sort of thing a business person, or person in trade, might do. In his seminal book at [2.498]-[2.500], Parsons wrote the following:
2.498 But the features which are necessary to give a transaction the character of a business deal or of a trade of dealing on a single occasion, include an elusive factor that is more than purpose to profit. This elusive factor may not be capable of any more precise defining than to say that the transaction must be the sort of thing a business man or man in trade does. In this context "business man" or "man in trade" brings in received ideas in the community about how such people behave.
2.499 A taxpayer may acquire and sell land and not engage in trade, provided there is a decent interval between acquisition and disposition so that he does not appear too concerned about his profit, or, if circumstances have required him to sell soon after acquisition, he did not contemplate quick sale when he acquired (Turner v. Last (1965) 42 T.C. 517, Eames v. Stepnell Properties Ltd [1967] 1 W.L.R. 593). A taxpayer may acquire shares and not engage in trade. Indeed as a director of a company he may be required to own some shares. A taxpayer may sell shares and not engage in trade, provided he is not too hasty about it. But a taxpayer does engage in trade if he buys "a large quantity of a commodity like whisky, greatly in excess of what could be used by himself, his family and friends, a commodity which yields no pride of possession, which cannot be turned to account except by a process or realisation". The words quoted are from the judgment of Lord Normand, in I.R.C. v. Fraser (1942) 24 T.C. 498 at 502-503. Lord Normand added that he could not consider a person who did this as "other than an adventurer in a transaction in the nature of a trade". A taxpayer does engage in trade if he buys one million rolls of toilet paper (Rutledge v. I.R.C. (1929) 14 T.C. 490), or if he buys the Government's surplus stock of aeroplane linen and embarks on its sale to more than one thousand purchasers: Martin v. Lowry [1927] A.C. 312. A taxpayer may engage in trade if he sets up an elaborate selling organisation to effect the sales. He may engage in trade if he carries out some manufacturing process and sells the manufactured goods (I.R.C. v. Livingston (1926) 11 T.C. 538 at 543-544, per Lord Sands).
2.500 The cases may suggest that it is less likely that a conclusion that there is a trade will be reached if the transaction is in shares or land rather than in some other kind of property. Shares and land are traditional subjects of investment activity - activity that is not directed to profit-making in the turning over of the property acquired. An isolated transaction in land or shares does not necessarily yield an objective inference of profit purpose, when the same transaction in another kind of property may yield such an inference. A subjective purpose of profit-making, of which there may be evidence, will not in itself give the character of trade: Jones v. Leeming [1930] A.C. 415.
(Emphasis added.)
242 Six propositions may next be stated:
(1) first, I doubt whether the taxpayer's loss arose out of an isolated trade, even though all his shares were disposed of at one time. The Nexus shares were acquired on 64 occasions over approximately a two-year period, and only disposed of following a protracted legal battle in which the taxpayer was a party. Meanwhile, as already mentioned, the taxpayer purchased over 200 parcels of shares in other companies and sold approximately 180 of these. The overwhelming majority of shares were held for only short periods of time;
(2) secondly, the Commissioner submitted that prima facie shares are held on capital account. That proposition is, with respect, mistaken. Whether shares are held by a taxpayer on capital account or on revenue account will depend on each occasion on the applicable facts. There is no prima facie position; there are no different or special rules for individuals or particular classes of assets;
(3) thirdly, the way a taxpayer personally characterises transactions as being either on revenue account or on capital account is probably irrelevant to the determination of his or her liability to pay primary tax. That treatment is either right or wrong. It certainly cannot control the objective conclusion which this Court must reach about the issue of characterisation. Such evidence might, nonetheless, be relevant to an attack on credit or be relevant to the issue of penalty for the purposes of Sch 1 to the Taxation Administration Act 1953 (Cth);
(4) fourthly, expressing, as Parsons did, the applicable test as being that the transaction must be the sort of thing a business person or person in trade does, effectively ensures that windfall gains, and gains from lotteries and hobbies, are not caught by the ordinary concept of income. In my view, this is an adequate expression of the content of the test;
(5) fifthly, the Court here was urged to accept that a "private" transaction is not one which has the characteristics of a "business deal". There was a debate about what is and is not "private". The proposition is rejected. Many truly private transactions may not be capable of being a "business deal" because they are not business-like. The usual example might be a gain encountered in the pursuit of a hobby. However, just because a transaction has been undertaken "privately", it does not follow that any gain thereby made is necessarily an affair of capital: c.f. Federal Commissioner of Taxation v Anstis (2010) 241 CLR 443 at 458-459 [38] per French CJ, Gummow, Kiefel and Bell JJ. The concept of a "private" transaction, referred to briefly in Whitfords Beach and in McClelland in the context of an "investment", is not referred to in Myer Emporium or Montgomery. Parsons also does not relevantly refer to it; it does not form part of his eight propositions concerning what is income. Nor is there an equivalent exclusion in s 6-5 of the 1997 Act akin to that found in s 8-1(2)(b) concerning a loss or outgoing of a "private or domestic nature". In that respect, I observe that s 8-1(2) would appear to assume that expenditure of a capital nature (addressed in s 8-1(2)(a)) is distinct from expenditure of a private nature (s 8-1(2)(b)). Private expenditure, it would appear, is not subsumed within expenditure of a capital nature for the purposes of s 8-1. The Commissioner here otherwise made no attempt to rely upon s 8-1(2)(b); and
(6) sixthly, where shares are acquired by an individual for the purposes of obtaining a dividend yield and for long-term growth, any gain made on a subsequent to sale of those shares is likely to be an affair of capital, if the sale is a mere realisation or change of investment. No doubt a great many individuals hold shares privately in Australia on this basis. But the gain so made is not ordinary income by reason of the transaction being "private", rather, it is because the gain is on capital account.