McRae v Commissioner of Taxation

The Court delivered the following written judgment: -

Dr. F. G. N. Stephens owned in 1958 a parcel of land upon which was erected a building comprising twenty-three flats, three shops and a basement garage, all let to tenants. The value of the property was considered by the Valuer-General, after some negotiation, to be only £35,000. It would have been substantially greater, however, had the property not been subject to certain controlling provisions in landlord and tenant legislation; and consequently, if the property had been owned by a company the articles of association of which had divided the shares into groups and attached to each group a right to occupy a particular portion of the building as a "home unit", the shares would almost certainly have had a much higher aggregate value, indeed a value of at least £60,000.

Dr. Stephens did not want to form such a company and get in so large an amount. He was well on in years and was concerned about the duties that might become payable on his death. He would be content to have £35,000 and to let his six children share the excess over that amount; but of course a gift would attract a liability of gift duty. So he got his accountants to prepare a plan of action, with a view to avoiding these pitfalls, and his children, of whom the appellant was one, joined with him in carrying it out. A company called Kurrajong Pty. Ltd. was formed with an authorized capital of £60,000 divided into 60,000 shares of £1 each. The children took up 35,002 of the shares: each of two children held one signatory share and took 5,833 additional shares; each of two others took 5,833 shares, and each of the other two took 5,834 shares. Each child obtained the money with which to pay for his or her non-signatory shares by borrowing it from Dr. Stephens. The company, being thus equipped with £35,000 in cash, used it to buy the property from Dr. Stephens for that amount. Dr. Stephens's cheques for the loan moneys and the company's cheque for the price of the property were paid over on the one day. Then, within a year, the company, having taken the property into its books at cost, wrote up its value in the books to £61,000, put the increase of £26,000 to the credit of an assets revaluation reserve account, and capitalized £24,998 of it by declaring thereout a dividend of that amount to be satisfied by paying in full for 24,998 unissued shares to be distributed to the shareholders in proportion to their existing holdings. The distribution resulted in the six children holding 10,000 fully paid shares each. The articles of association were forthwith altered so as (inter alia) to divide the 60,000 shares in the company's capital into twenty-seven groups, each group entitling the holder to the exclusive right, subject to the articles, to use and occupy a unit consisting of a particular flat or shop or the basement garage. Since the groups would naturally command different prices, and as equality as between the children was of the essence of the plan, a deed of trust the terms of which had been agreed upon from the beginning was executed between the children as trustees and the children as beneficiaries, under which each of them declared that he or she held his or her 10,000 shares in the company upon trust for all the beneficiaries in equal shares as tenants in common. Thereafter a number of the groups of shares were sold for prices payable by instalments, and in each of the years ended 30th June, 1960 and 1961 certain instalments of purchase money were received by the trustees.

In assessing the appellant's income tax in respect of income derived in those two years the Commissioner treated her as having derived as assessable income in each year one-sixth of what he described as the distributable income of the "partnership" consisting of the six children of Dr. Stephens. This distributable income was the proportion attributable to the instalments received in each year of the "profit" contained in the aggregate sale prices of the shares sold, the "profit" being arrived at by deducting from those aggregate sale prices (less commission and legal costs) the proportion attributable to the shares sold of what the 60,000 shares had cost the six children. That cost was taken to be the £35,000 which the children had paid for the shares and which the company in turn had paid for the property, plus a small amount of legal and other expenses.

These facts having been established in an appeal from a decision of a board of review which had upheld the assessments, the judge has stated a case in which the substantial question is, in effect, whether his Honour is at liberty to find that the appellant's proportion of the net proceeds arising in each of the relevant years from the sale of shares in the company included any profit arising from the sale by her of any property acquired by her for the purpose of profit making by sale or from the carrying on or carrying out of any profit-making undertaking or scheme. The appellant does not deny that if any excess of the ultimate total proceeds of sale of the whole 60,000 shares over the £35,000 will have the character of profit it is proper, for the purposes of the assessments under appeal, to regard the proceeds of sale received in each of the relevant years as having included an element of profit; nor, subject to the second and third questions, does she quarrel with the Commissioner's method of ascertaining for present purposes the amount to be treated in each year as profit. Her counsel has rightly refrained from pressing a contention which seems to have been advanced before the board of review, that the Commissioner's view of the case involves some inconsistency with the provisions of s. 44 (2) (b) (iii): plainly it does not. Her contention on the main question is that by selling the property to the company for the £35,000, which was all it is proved to have been worth as a single piece of real estate, when everyone must have known that a larger sum could be obtained by the simple expedient of vesting the property in a company and selling shares having rights of occupancy attached to them, Dr. Stephens was in a practical sense making a gift to the children of the excess over £35,000, and they, by taking the steps necessary to realize the larger amount, were merely converting into cash a capital asset which he had partly sold to them and partly given to them.

The fallacy in the contention is apparent. Dr. Stephens did not make any gift to the children. First, he lent his children £35,000 between them. The reality of the transaction as creating a debt owing by each child to him is not disputed. Consequently the £35,000 that the children put into the company was theirs. Secondly, Dr. Stephens sold the property to the company for the full amount of its value as assessed by the Valuer-General. No basis exists for a contention that he made a gift of anything. The result, it is true, was that the opportunity of getting a sum greater than £35,000, by adopting a particular course of action relating to the property, passed from him to the children. If he had availed himself of it the excess over £35,000 that he might have got by selling shares carrying rights of occupation might well have been a profit, and a profit arising from the carrying out of a profit-making scheme: cf. Federal Commissioner of Taxation v. McClelland [1] ; but certainly when his children took up the plan which the accountants had devised for the purpose of turning their £35,000 into a larger sum they were engaging in a profit-making scheme. That conclusion is not only permissible but inevitable on the facts before us. To adopt it is not, as the appellant's argument suggests, to make the mistake of deserting the practical business concept of profit through attending to form rather than substance: it is to insist that the facts be looked in the face. The children really did embark £35,000 of their own money, but no more, in a scheme the whole object of which was to yield them a larger sum in place of it. The profit-making character of the scheme and the profit character of the excess as and when realized are quite plain. It cannot make any difference that the scheme was in the nature of a family arrangement. One of the members of the board of review thought that it did, but we do not find it possible to accept his interpretation of the facts.

The first question must therefore be answered that upon the facts appearing in the stated case the judge is at liberty to find that the appellant's proportion of any profit included in the proceeds received in the relevant years of income from sales of shares in the company was profit arising to her from the carrying out of a profit-making scheme, and that as such it forms part of her assessable income of those years.

The remaining questions may be considered together. They reflect the only grounds upon which the appellant attacks the method by which the Commissioner has reached the conclusion that the proceeds of the sales of shares included an element of profit. The second question comes to this: in ascertaining whether the scheme has yielded a profit, is it right to include in the amount from which the cost of the scheme is to be deducted the proceeds of sale of the bonus shares, that is to say the shares that were issued as fully paid by the application of the dividend declared out of the amount standing to the credit of the assets revaluation reserve account? And the third question is: if so, ought the amount of the dividend so applied to be taken into account as part of the cost of the scheme?

The appellant contends that the application of the dividend to make the bonus shares fully paid amounted to a payment by the shareholders (cf. Spargo's Case [1] ; Joseph v. Campbell [2] ) and that therefore the proceeds of sale of the bonus shares cannot properly be treated as part of the amount from which cost is to be subtracted in order to ascertain profit unless the cost to be subtracted includes the amount of the dividend. The answer is obvious. In the first place it is beyond dispute that the proceeds of sale of all the shares sold, both original and bonus shares, must be brought to account in order to find the gross amount which the carrying out of the scheme produced. And in the second place the notion that the dividend formed a part of what the children put into the scheme in order to get the gross proceeds out of it overlooks the fact that the declaration of the dividend had the effect of subtracting an equal amount from the value of the original shares, so that the entire transaction consisting of the declaration of dividend plus the crediting of the bonus shares as fully paid had no other effect than that of a transfer of part of the value of the original shares to the bonus shares. The same property which had been the asset backing for 35,000 shares became the asset backing for 60,000 shares. The appellant did not put a penny more into the scheme than her original contribution of one-sixth of £35,000 plus £1 for her subscriber's share; and therefore her profit when the scheme has been carried to completion must necessarily be the amount by which her proportion of the gross proceeds has exceeded £5,834. The answer to Question 2 must be Yes, and to Question 3 No.

1. (1873) L.R. 8 Ch. 407. 2. (1933) 50 C.L.R. 317.