Investment & Merchant Finance Corporation Ltd v Commissioner of Taxation

Investment & Merchant Finance Corporation Ltd v Commissioner of Taxation - [1971] HCA 35 - HCA 1971 case summary — Zoe

[21]

"trading stock" includes anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock. In Australian Machinery and Investment Co. Ltd. v. Deputy Federal Commissioner of Taxation, Dixon J. (as he then was), with whom I concurred, said [1] : As at present advised I am not prepared to hold that the shares were "trading stock" within the meaning of Div. 2, Sub-div. B, ss. 28-31, though this does not necessarily mean that the principles of accounting embodied in those provisions are themselves altogether inapplicable. In my opinion, whatever may be the general position with regard to shares held by a company trading in shares, these particular shares could not be considered as trading stock. This transaction was certainly not part of the taxpayer's normal trading business. In fact it was the only dealing of this type engaged in by the taxpayer during the period 1961-1968. I think it appropriate to quote the words of Lord Morris of Borth-y-Gest in Bishop (Inspector of Taxes) v. Finsbury Securities Ltd. [2] , where a dividend-stripping operation, similar in nature, if not in detail, to that in this case, had occurred. His Lordship said [3] : A consideration of the transactions now under review leads me to the opinion that they were in no way characteristic of, nor did they possess, the ordinary features of the trade of share dealing. The various shares which were acquired ought not to be regarded as having become part of the stock-in-trade of the company. They were not acquired for the purpose of dealing with them. In no ordinary sense were they current assets. and later at the same page: It was a wholly artificial device remote from trade to secure a tax advantage. [1] It must also be remembered that the taxpayer did not treat the shares in question as trading stock in either of the returns lodged for the years of income ended 30th June 1964 and 30th June 1965. 1. (1946) 8 A.T.D. 81, at p. 107. 2. [1966] 1 W.L.R. 1402; [1966] 3 All E.R. 105; (1966) 43 T.C. 591. 3. [1966] 1 W.L.R., at p. 1417; [1966] 3 All E.R., at p. 112; (1966) 43 T.C., at p. 627. 4. [1966] 1 W.L.R., at p. 1418; [1966] 3 All E.R., at p. 112; (1966) 43 T.C., at p. 627.

[34]

In that case there was a purchase of the shares in a company called Bendit Ltd. (afterwards called Claiborne Ltd.). The vendors of the shares had no interest in the shares thereafter. They had no prospect of receiving any benefit from any tax recovery. After the Harrison company owned the shares in Claiborne Ltd. there was a declaration of dividend on the shares. After that the shares were sold. It was my view in that case that the transaction was demonstrably a share-dealing transaction. Shares were bought; a dividend on them was received; later the shares were sold. There may be occasions when it is helpful to consider the object of a transaction when deciding as to its nature. In the Harrison Case, [1] , my view was that there could be no room for doubt as to the real and genuine nature of the transaction. The fact that the reason why it was entered into was that the provisions of the revenue law gave good ground for thinking that welcome fiscal benefit could follow did not in any way change the character of the transaction. It was not capable of being made better or worse or being altered or made different by the circumstance that the motive that inspired it was plain for all to see. In Harrison's Case Viscount Simonds [2] had said: Here was a company whose object it was to deal in shares. It entered into a commercial transaction which, though it might be given an invidious name, contained no element of impropriety, much less of illegality. I can find nothing that enables me to say that it is not a trading transaction, and echo the question asked by the majority in the Court of Appeal: "If it is not that, what is it?" No doubt, many observations that have been made alio intuitu will be found to the effect that trade is carried on with a view to a profit. This proposition, however, is not universally true, nor can it be tested merely by ascertaining the difference between the purchase price (or, it may be, the manufacturing cost) of an article and the selling price of that article. For a dealer may seek his profit, if a profit is essential, otherwise than by an enhanced price on a re-sale, as by a declaration of dividend, a repayment on a reduction of capital or on a liquidation of the company whose shares he has bought. It appears to me to be wholly immaterial, so long as the transaction is not a sham (as was the case in Johnson v. J. S. Jewitt (Inspector of Taxes) [3] ), what may be the fiscal result, or the ulterior fiscal object of the transaction 1. [1963] A.C. 1; [1962] 1 All E.R. 909; (1962) 40 T.C. 281. 2. [1966] 1 W.L.R. 1402, at pp. 1416-1417; [1966] 3 All E.R. 105, at p. 111; (1966) 43 T.C. 591, at p. 626-627. 3. [1963] A.C. 1; [1962] 1 All E.R. 909; (1962) 40 T.C. 281. 4. [1963] A.C. 1; [1962] 1 All E.R. 909; (1962) 40 T.C. 281. 5. [1963] A.C., at pp. 11-12; [1962] 1 All E.R., at p. 912; (1962) 40 T.C., at pp. 293-294. 6. (1961) 40 T.C. 231.

[36]

I come now to the learned Solicitor-General's second submission. I would not dispute that what the taxpayer did, in buying the shares, reaping the dividend and selling the shares, was to carry out a profit-making scheme. It did so, however, in the course of its business as a share dealer. I do not think that every business that involves the buying and selling of stock in trade is to be fragmented into a large number of separate transactions and the dealer taxed on the aggregate of the profits derived from each transaction considered separately. The taxable income of a business is to be ascertained by deducting allowable deductions from assessable income, and in the calculation of assessable income regard must be had to many considerations to be found specified in the Income Tax Assessment Act, such as all the appropriate items set out in s. 26; the requirement that trading stock on hand at the beginning of the year of income and at the end of the year of income must be brought into account; to the allowance of depreciation; to the deduction of bad debts; to past losses. It is the assessable income of the business as a whole to which regard must be had and from which deductions are to be made to arrive at taxable income. It is significant that s. 26 (a) defines but one item to be included in assessable income, and, in my opinion, the whole of the carrying on of a business of buying and selling is not to be comprehended within s. 26 (a), nor does that provision aptly apply to the particular dealings constituting, in total, the carrying on of a business. Section 26 (a) deals with particular transactions which might otherwise escape from the tax net and it brings into assessable income profits, after outgoings attributable to the particular transaction have been taken into account. Outgoings made in earning a profit which is assessable income by virtue of s. 26 (a) are not outgoings for the purposes of s. 51. There is no profit from a scheme to be included in assessable income until such outgoings have been taken into account. In most cases items of assessable income are gross receipts; a profit which is assessable income by virtue of s. 26 (a) is a net receipt. In my opinion, therefore, the income derived from the transaction with which we are here concerned is not to be brought into account as a profit pursuant to s. 26 (a). The transaction in question was part of the business of the taxpayer and it is the proceeds of that business that constitute the income of the taxpayer. I have re-read my observations about s. 26 (a) in Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation [1] , and further consideration of the problem has confirmed me in what I there said.

[39]

The first of the outstanding matters to which I want to refer is concerned with the application of s. 31 of the Income Tax Assessment Act. As I have already set out, the taxpayer, upon receipt of the dividend upon the Macgrenor shares, wrote down their value by approximately the amount of the dividend. The result of this was, in effect, that the shares were then in the taxpayer's accounts at or near market selling value, although they were eventually sold for less, no doubt to give the buyers some advantage. Thus, at the end of the year in which the shares were bought they were brought into account at £3,250, and, in the course of that year, they were sold for £21. However, in the taxpayer's income tax return they were, in effect, brought into account at £86,503.17s.0d. by virtue of the adding back of what had been written off. There was no argument whether or not this sort of double-dealing - I use the word inoffensively - is permissible. Presumably it is, for when the Act provides a method for the ascertainment of the value of stock in trade for the purposes of determining assessable and taxable income (ss. 28 and 31) it does not go further and require that the taxpayer's profits should be determined in the same way for commercial purposes, or require the taxpayer's taxation return to accord with its commercial accounts. However, I do not pursue this matter further beyond noting that, had the taxpayer's return to the Commissioner been made up on the same basis as that upon which the taxpayer's books of account were kept, it would seem that the taxpayer would have made a substantial loss in the year ended 30th June 1964, for in that year it would have had the additional advantage of stock values at the end of the year reduced by the amount written off. In other words, the Macgrenor shares would, at 30th June 1964, have been valued at market selling value rather than at cost price. The course actually taken did give the taxpayer considerable taxation benefits in the year ended 30th June 1965 as well as in the year ended 30th June 1964. However, as no attention was devoted to what may be a problem that it is immaterial to solve, I refer to it simply to leave the matter open.

[47]

In the case of a company the business of which includes dealing in shares, it could scarcely be doubted that shares which it buys and which it intends to resell would generally be regarded as part of its trading stock according to the meaning in which, apart from any statutory definition, that expression would be understood. This was taken for granted in all the Courts, including the House of Lords, that considered the case of Craddock v. Zevo Finance Co. Ltd. [1] . I cannot think that it ought to be denied that this is so in relation to particular shares, merely for the reason that the company expects or intends that the resale of those shares will be at a lower price than the cost price. In s. 6 of the Act it is provided that "trading stock" includes "anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock". I need not decide whether in this provision the word "includes" should be read as "means". If it should not, it seems clear to me that the Macgrenor shares were trading stock of the appellant. But if it should be so read, I do not think that a different conclusion should be reached. In Modern Permanent Building and Investment Society (in liquidation) v. Federal Commissioner of Taxation [2] , Williams J. expressed the opinion that in ss. 28, 29 and 31 of the Act "trading stock" did not include choses in action. But, with respect, the reasons which his Honour went on to give for that opinion, although they may have been valid reasons for holding that the particular choses in action with which the case was concerned were not trading stock, did not warrant in my opinion the generalization which his Honour made. I find no difficulty in thinking of shares as being "on hand" at a specified time (s. 28) or in supposing that their value at a particular date may be ascertained for the purposes of ss. 29 and 31. In Australian Machinery and Investment Co. Ltd. v. Deputy Federal Commissioner of Taxation [1] , Rich J. made a declaration, at first instance, that certain shares and options held by the taxpayer company formed trading stock within the meaning of ss. 28 and 31. The case was a complicated one. There was an appeal and a cross-appeal and many questions were raised in them. According to Latham C.J. [2] , the company did not appeal against that declaration and in the cross-appeal the ground that that declaration was in error was abandoned at the hearing. But Dixon J. (with whom McTiernan J. concurred) said [3] that "as at present advised" he was not prepared to hold that the shares were trading stock within the meaning of ss. 28-31. Starke J. [4] stated more positively the opinion that the shares and options did not form trading stock. Williams J. [5] expressed the contrary opinion. There is nothing in that case, in my opinion, which is authority for the proposition that shares can never be trading stock within the meaning of the Act; and nothing in the reasoning in the judgments in the case requires the conclusion that in the present case the Macgrenor shares were not trading stock of the appellant. In my opinion, the evidence shows that they were purchased "for purposes of sale", although it is clear that the appellant wanted also to get the benefit of the dividend and to get the advantage of selling the shares at a loss, to be offset against profits made on other dealings. I do not assert, of course, that shares are always trading stock in the hands of their owner; and even where the owner is a dealer in shares the circumstances may show that particular shares are not trading stock. But when shares are bought by a dealer in shares and it is intended that they are to be resold and that this will probably occur in the not distant future, I do not think they are to be denied the description of trading stock, either because the trader expects or intends that they will be sold at less than their cost price or because he seeks to obtain a commercial advantage from the transaction otherwise than from a profit on the resale, that is, an advantage from an expected dividend and from an expected taxation benefit.

[52]

The learned Solicitor-General has contended that if the transaction of the purchase and sale of the Macgrenor shares ought not to be held to be of a capital nature but should be regarded as bearing a trading aspect, then the appropriate way of dealing with it is to treat it as a profit-making undertaking or scheme, within the meaning of s. 26 (a) and of s. 52 of the Act, and in working out the profit or the loss made or incurred, the dividend received on the shares must be taken into account. According to the argument, it would have been proper to treat the dividend as not being as such an item in the assessable income in the year in which it was received, but as being simply a factor in the calculation to be made for the purposes of s. 26 (a) or of s. 52. That was not what the respondent did, but it was submitted that in the light of the facts disclosed by the evidence it may now be seen that that was the appropriate way of dealing with the transaction. Thus would be avoided the consequence, which would otherwise be involved in taking into account the dividend in the computation of a profit or loss for the purposes of s. 26 (a) or of s. 52, that the amount of the dividend would be included twice (in this case once in each of two tax years) as an addition to the amount which but for the receipt of the dividend would have been the amount of the appellant's assessable income. But, in my opinion, this argument cannot be accepted. The amount of the dividend had to be included in the assessable income in the year in which it was paid, in accordance with s. 44. In my opinion the provisions of the Act do not permit the exclusion of the dividend from the assessable income of a taxpayer, who is assumed to be engaged in a profit-making undertaking or scheme, upon the ground that not until the undertaking or scheme has been brought to completion can the overall profit or loss be ascertained. Section 44 required that the dividend be included as such in the assessable income and this is equally so whether tax will be payable upon so much of the income as represents the dividend or the taxpayer will be entitled to a rebate in accordance with s. 46.

[53]

The learned Solicitor-General submitted that even if the dividend ought not to have been excluded from the assessable income in the first of the two tax years covered by the transaction, it is nevertheless right to treat the transaction as one to which s. 26 (a) or s. 52 applies and to bring into account at the appropriate time any ultimate overall profit or loss from the undertaking or scheme, taking the dividend into account in calculating the profit or loss. If that is what the Act provides, effect must of course be given to it. But the consequences of that construction of the relevant provisions of the Act are such as to cast doubt upon its correctness. I do not doubt that the appellant may properly be regarded as not having really suffered a loss of more than £80,000 from the transaction concerning the Macgrenor shares. In calculating the commercial result achieved by the whole enterprise the dividend must be counted. But it is to be counted once only. The direct financial result of the whole transaction was, as the Commissioner concedes, a loss of some £4,000. But according to the argument now under consideration, the result for income tax purposes was an increase of over £81,000 in the assessable income of the year ended 30th June 1964 and a decrease of about £4,000 in the assessable income of the year which ended 30th June 1965. It should be added that it would not be consistent with this argument to say that the appellant could have claimed as a deductible outgoing in the former year the amount which it paid for the shares, because (except for the dividend which on this branch of the argument is treated as coming into income under s. 44) it is only upon the ultimate profit or loss of the whole undertaking or scheme that the provisions of the Act operate. In my opinion the arguments on behalf of the respondent as to the application of s. 52 and as to the manner in which for its purposes a loss should be computed ought not to be accepted in the circumstances of this case. In my opinion, the claim of the appellant to deduct a loss in the sale of the shares should not have been dealt with by applying s. 52 but should have been dealt with in the manner which I have stated earlier.

At a glance

Court

Decision date

Before

Source

Judgment (53 paragraphs)

Parties

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