Kener ® Mer Sr 'oye 4 cng" AMTA 130 'tricorn investments v ie fermen pyle pane weg Nite mgaey Gol

Kener ® Mer Sr 'oye 4 cng" AMTA 130 'tricorn investments v ie fermen pyle pane weg Nite mgaey Gol - [1947] HCA 10 - HCA 1947 case summary — Zoe

[34]

The next task is to select the past years the profits of which are most appropriate for the purpose of estimating the probable future success of the company. This requires a short examination of the history of the company. The company was incorporated on 17th October 1922 under the name of Star Pictures Ltd. It changed its name to D. Clifford Theatres Ltd. on 10th October 1923. Its nominal capital is £70,000 divided into 70,000 shares of £1 each. On 10th December 1942 its issued capital was 40,000 ordinary shares and 22,408 eight per cent cumulative preference shares all of £1 and fully paid. No dividend had been paid on the ordinary shares since 1927 and the arrears of preference dividends on 30th June 1942 were £15,171. In addition to the 28,150 ordinary shares, the deceased held 535 preference shares in the company. He was also the holder of one share numbered 1, and called " The Life Governor's Share " in an associated company, Clifford's Investments Ltd. The memorandum of association of Clifford's Investments Ltd. provides that : - " The Life Governor's Share shall confer on the said Daniel Clifford or his personal representatives so long as he or they shall be the registered holder or holders thereof the right either in person or by attorney or by proxy at every general meeting or any poll of the Company to three-fourths of the votes in the Company that is to say to three votes as against every one vote conferred on all the other issued shares for the time being in the capital of the Company, provided always that the said special rights attaching to the Life Governor's Share if and when the said personal representatives of the said Daniel Clifford shall be registered as the holders thereof shall only be exercisable by such personal representatives for a period expiring on the 30th day of June 1963 and after such period the said Daniel Clifford being then dead the Life Governor's Share shall become in all respects an ordinary share in the company without any special rights."

[42]

years are those in which the company had surmounted its initial difficulties and had acquired the number of theatres in which it was likely to continue to operate in the future. We think that the five years 1938-1942 inclusive should be chosen. By 1938 the business had reached the extent which it was likely to retain in the future. During this period the gross profits rose from £42,000 in 1938 to £78,000 in 1942, and in the subsequent years remained at about £78,000. The net profits of these five years, after adjusting the accounts by substituting taxes payable for taxes paid, amount to £45,229. These were the net profits after deducting undistributed profits tax under s. 104. But once the company commenced to distribute its net profits by way of dividend this tax would disappear. Further, preference shareholders could not expect to be paid a preference dividend free of tax, and in estimating the dividend of eleven per cent to thirteen per cent as the return which shareholders would require in comparable companies listed on the stock exchange the witnesses have referred to shares in companies in which the shareholders would receive a dividend subject to tax and not a tax- free dividend. Therefore, in order to estimate from the net profits of the five years in question the sums likely to be available for divi- dends in the future, it is necessary to add to the net profits the tax- ation payable by the company under s. 104 on the undistributed profits of the five years. This amounts to £35,616. If this amount. is added to £45,229 the total of net profits available for dividends is, in round figures, £81,000, or approximately £16,200 per annum. This amount is reached after allowing for ordinary company tax, heavy depreciation and setting aside £1,000 in 1938 and £2,000 per annum thereafter as part of a general reserve. This general reserve as at 30th June 1942 was £26,000. After allowing, in round figures, £1,900 to pay the preference dividend, there is left a sum of £14,300 per annum for distribution amongst the ordinary shareholders, or in other words, a sum sufficient to pay a dividend of thirty-six per cent on the ordinary shares. If the return that a prudent investor could reasonably expect to receive on shares in the company is, as. we have said, fixed at fourteen per cent, this would give the shares, when capitalized on a basis of fourteen per cent, a value of £2 11s. 6d. But there was on 30th June 1942 £15,171 arrears on preference shares to be paid off, and for this and other reasons we think that it would be proper to allow some period before the company would be ina position to pay dividends of thirty-six per cent on the ordinary shares. If a period of three years is allowed a prudent purchaser could only be reasonably expected to pay a sum which, with compound interest at ordinary bank overdraft rates, say five per cent, on the:

[54]

anything in respect of the undistributed profits. His Honour thought that both purchaser and vendor would consider that it was useless for a company to make profits unless they matured into dividends, and assumed it was unlikely that the company would commence to pay dividends on the ordinary shares for another ten years. With all respect to his Honour we can find nothing in the condition of the company's finances to justify such an assumption. Nor can we agree that the fact that the company had paid no dividends on its ordinary shares since 1927 would necessarily be a reason for a purchaser placing a low value on the shares or for a vendor desiring to sell them at an undervalue. It all depends on the reason why a company fails to pay dividends. During the depression the company made losses. But after 1933 it made profits but used them to increase its future profit-making capacity. As one expert witness said, " The figures show that from June 1937 to June 1942, the company financed some £90,000 of capital expenditure and wrote off £35,315 deprecia- tion of which only £9,000 came from the increase in liabilities over the increase in other assets." The non-payment of dividends since 1927 would therefore benefit a purchaser once the arrears of preference dividends had been paid. It would not be a reason for the vendor being induced to sell the shares for 17s. 6d. when he knew that as a result of this use of the company's profits his purchase money and his share in a fund of £57,000 of tax-free profits was well secured by tangible assets and that the effect of the non-payment of dividends had been to enhance the company's future prospects. It is true that this sum of £57,000 was buried in the business and it was therefore unlikely that it could be detached to pay a dividend in cash. But it was a fund out of which a bonus dividend could be declared to be satisfied by the issue of fully paid shares. If the company were to decide to sell its assets and wind up it would be a fund which would not be taxable under s. 47 of the Income Tax Assessment Act.

At a glance

Court

Decision date

Before

Source

Judgment (100 paragraphs)

Parties