Clayton Utz

Counsel and Solicitors I.V. Gzell QC with

The Court orders:

1. Appeal allowed, with costs.

2. The orders of Hill J. be set aside; in lieu thereof order (a) that the

decision of the respondent disallowing the objection by the appellant to an assessment to income tax in respect of the year of income ended 30 September 1987 be set aside and that there be substituted a decision allowing the objection, so as to exclude from the amount of the taxable income assessed by the respondent the sum of $45,068,073 which was described in the adjustment sheet accompanying the notice of assessment as "profit from sale of investments"; and (b) that the respondent pay the appellant's costs of the application at first instance.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

AGC (Investments) Limited appeals from the dismissal by Hill J. of its application to review a decision of the Commissioner of Taxation disallowing an objection by the appellant against an assessment of income tax for the year of income ended 30 September 1987 (see 9l ATC 4180). The appellant claims that the amount of the taxable income assessed by the Commissioner should be reduced by excluding the sum of $45,068,073 which was described as "profit from sale of investments" in an adjustment sheet accompanying the notice of assessment. The basis of the assessment was that in the year ended 30 September 1987 (a substituted accounting period for the year of income ended 30 June 1987) the appellant sold, at a profit, several parcels of shares in listed public companies and thereby derived income, as understood in ordinary usage, which income was thus said to be assessable by virtue of the provisions of s.25(1) of the Income Tax Assessment Act 1936.

2. The appellant was incorporated in 1965. At all material times, it was a wholly owned subsidiary of AGC (Insurances) Limited ("AGC (Insurances)"), itself a wholly owned subsidiary of Australian Guarantee Corporation Limited ("AGC"). The affairs of AGC (Insurances), the appellant and AGC (Securities) Limited (another subsidiary of AGC (Insurances)) were administered as a single unit, known as the "AGC Insurance Division" of the AGC group of companies. The appellant had no separate staff or premises and its operations were administered by staff employed by AGC (Insurances).

3. Over a considerable period AGC (Insurances) advanced substantial amounts to the appellant with a view to their investment by the appellant in, inter alia, the acquisition of a portfolio of shares in listed public companies. An advance account was established for this purpose. By March 1983, the amount owed by the appellant to AGC (Insurances) on this account was $23,250,000. By September 1987, the account stood at $91,683,103.55.

4. The appellant's share portfolio was managed by Westpac Investment Management Pty. Limited ("Westpac Management"). As at 30 September 1986, the portfolio included shares in some 51 companies. The shares had a market value of $85,909,940. In mid September 1987 (shortly before the stock market slump which occurred in the following October) the appellant decided to commence selling the portfolio and to reinvest the proceeds of sale in fixed interest securities. In the 12 months to 30 September 1987, the appellant sold its holdings in 33 companies, realising the sum of $79,413,638. (This figure does not include sales made as a consequence of a take-over offer.) The sales represented approximately one-half of the value of the portfolio. The surplus achieved on realisation being the "profit from sale of investments" mentioned in the adjustment sheet accompanying the notice of assessment, was $45,068,043 in total.

The evidence with respect to the appellant's investment activities

5. Evidence of the appellant's investment activities was given by William Russell Gates, at material times an employee of Westpac Management; and by Robert Alick Robson and Donald Duncan Crisp, both formerly employed by the AGC Group. Mr Gates, who was employed by Westpac Management from 1981, managed the appellant's share portfolio between 1981 and 1987. Mr Robson was Chief Executive Officer and Group General Manager of AGC from 1983 to June 1987, when he was appointed Managing Director of AGC. Mr Crisp was employed by AGC (Insurances) from 1966 in several capacities. From 1983, he was its General Manager. Documentary evidence, mainly in the form of the business records of the AGC Group, (which was the principal evidence available with respect to the period prior to 1981) was also relied on.

6. The evidence revealed that the history of the appellant's investment activities was as follows.

7. (1) In a memorandum dated 1 December 1966 on the subject of "Investments" written by the appellant's then General Manager to its Chairman of Directors, it was stated that the appellant held a portfolio of equity shares to the value of $1.8 million. The General Manager went on to say:

"Anticipating a cash flow of approximately $1 million during the current

year's operations and having in mind that funds on deposit with A.G.C.

are now over $8.2 million, or 54% of our total funds, I have been

discussing with the Investment Management Department of the Bank of New

South Wales the question of the further investment of our funds in

equity shares.

Their recommendation is that the market at the present time is

particularly attractive for long term investments in the equity market

and they recommend that we take further advantage of this opportunity.

With dividend yields averaging 4.75% on a diversified equity portfolio

the return is equivalent to an earning of over 8.26% taking into

consideration the tax relief on this investment.

In our discussions it was at first thought that we would invest our cash

flow on a monthly basis but, subject to the availability of funds, the

Bank recommend that consideration be given to the investment of the

whole of our cash flow of upwards

of $1 million during the next two months to take advantage of the

present market conditions."

(Emphasis added)

8. (2) In an internal memorandum concerning the affairs of the appellant written on behalf of Westpac Management which is undated, but apparently written after 30 September 1975, it was stated under the sub-heading "Aims":

"Capital growth with approximate income return of 5% as

(sic) cost." (Emphasis added)

9. Under the subject "Restrictions", it was stated, inter alia:

"Sales over $100,000 to be referred to General Manager AGC

Insurances or General Manager AGC Group - in their absence

we can proceed using our own discretion."

"Contributions:

If equity market becomes particularly attractive at any time company

will consider making additional funds available for investment.

Apart from this no new money is available, purchasers are financed by

proceeds of sales. Company is agreeable to approximately $20,000 being

made available to allow for special situations from time to time.

Method of Operation:

Portfolio was originally formed within A.G.C. and we acted in an

advisory capacity from 17/3/64 until approximately June 1967 when we

assumed management. In May 1965 portfolio was transferred into name

T.G.I. (Investments) Pty. Ltd. Later changed to A.G.C. (Investments)

Limited.

No firm policy was ever effected and difficulty was obtained in finding

out just where the portfolio and available funds stand. However, since

assuming complete management in 1967 we have had a clearer

picture, and contributions are supplied usually at

our request if and when funds are available.

Sub-underwriting is referred to us for decision.

We must advise company what action to take regarding sales, new issues

and other entitlements.

Company handles its own book-keeping and settlements, and securities are

held in their own name. Our action is to place orders on their behalf."

11. (3) The regulatory framework created by the enactment of the Insurance Act 1973 required AGC (Insurances) to have an authority to carry on the business of an insurer. In February 1977, discussions took place between Mr H.E. Wood, then its General Manager, and the Insurance Commissioner. The discussions included consideration of the relationship between the parent company and the subsidiaries. In a letter dated 2 March 1977 the Insurance Commissioner wrote to Mr Wood confirming his agreement under sub-s.30(2) of the Insurance Act that for the purposes of liquidity and spread of assets of AGC (Insurances), he would be prepared to accept the three subsidiaries, including the appellant, "as if they were an integral part of" AGC (Insurances). In later years the Insurance Commissioner gave approvals under s.30(2) of the Insurance Act allowing loans from AGC (Insurances) to the appellant to be treated as part of the assets of AGC (Insurances) for the purposes of the Insurance Act.

12. (4) In a letter to Westpac Management dated 26 January 1978, Mr Wood confirmed the "continuity of (Westpac's) management of our investment portfolio" and went on to say:

"We have requested our tax advisers to report on the effect that the

decision in the London/Australian investment case may have on our

investments. If we are to be taxed on the principles set out in the

judgment we may as well face these issues and exploit all forms of gain

from our equity operation. We shall inform you their advice and the

policy we should like to follow.

Notwithstanding the above we feel it is important that you should fully

exploit the cyclical fluctuations in the share market by capitalising on

market highs for sales and repurchasing at the bottom of any depressed

period.

The point we make is that if we sell any stock the reinvestment does not

have to be made immediately unless the decision to sell was made with

the intention of replacing the stock sold.

(Emphasis added)

The main recommendations in your submission with which we agree are:

1. Consolidation of the share portfolio with a view to reducing

the number of stocks to approximately 50, each to have a

minimum holding of .5%.

2. Investments be directed to preference and ordinary shares

rather than fixed interest securities.

3. Special submissions to be made from time to time in regard

to special opportunities which may be presented for

investment in Government or semi-Government securities.

4. The equity portfolio be compounded by reinvestment of

earnings.

5. Additional funds be provided to take up any rights

entitlement and if rights be sold the proceeds will be

available for reinvestment.

6. Proceeds from sales be available for reinvestment: (funds

from such sales and the sale of rights will be held by us

pending reinvestment).

7. The Bank only refer purchases of stock within the authorised

total investment allocation in excess of $100,000.

In addition to the above we should like you to refer to us for approval

any proposed sales which will create a capital loan in excess of $10,000

for approval.

Purchases of preference shares or Government and semi-Government

security be referred before purchase."

13. (In London Australia Investment Company Limited [1977] HCA 50; (1977) 138 CLR 106, a decision of the High Court in September 1977, a company invested in shares with a view to the production of income from dividends. During the years 1967, 1968 and 1969, the company engaged in a continuous large scale activity in the buying and selling of shares and had substantial surpluses in those years representing the difference between the net proceeds of the sale of the shares and the average cost of the shares sold. The Commissioner included those amounts in the company's assessable income for those years. At first instance, Helsham J. had held that the profits were properly treated as income within s.25. An appeal to the High Court was dismissed by a majority (Gibbs and Jacobs JJ., Barwick C.J. dissenting). Gibbs J. said (at 117):

"Helsham J. found that during the three years in question it

was an integral part of the taxpayer's business to deal in

shares, in the sense that switching of investments was

desirable to produce the best dividend returns and was

indeed necessary if the taxspayer's policy of investing in

shares with growth potential was to be adhered to. In my

opinion it is impossible to controvert that finding; it was

clearly right. Although the company's business was to

invest in shares with the primary purpose of obtaining

income by way of dividends, the conduct of the investment

business required that the

share portfolio should be given regular consideration, and

that shares should frequently be sold when the dividend

yield dropped, which for practical purposes usually meant

when the shares went up in value. The taxpayer

systematically sold its shares at a profit for the purpose

of increasing the dividend yield of its investments. The

sale of the shares was a normal operation in the course of

carrying on the business of investing for profit. It was

not a mere realization or change of investment."

"I do not think that a conclusion on scale by itself

provides the answer; but it is very important evidence

tending to show a business of acquiring and disposing of

shares and it was some evidence from which a purpose of

thereby making a profit might be inferred. It was for the

appellant to rebut the latter inference. In my opinion it

has not done so. It has in its favour the very important

circumstance that the source of the funds was the subscribed

capital of the company. But this is only part of the

evidence. The evidence taken as a whole strongly supports a

conclusion that a purpose or intention or expectation

implicit in the carrying into effect of its investment

policy was that shares acquired would be resold if and when

an occasion arose which would make it desirable so to do and

an element of desirability was that there would be greater

financial benefit in disposing of the shares at an enhanced

value than in retaining them. The fact that enlargement of

dividend income was the dominant purpose does not gainsay

the existence of a concurrent purpose of resale if and when

that resale would throw up a profit which could be used to

enlarge the dividend income. The massive scale of the

activities in the years in question practically compels the

inference that the investment policy was one which in its

inception and throughout the course of carrying it into

effect would in the expected state of the rising market

require frequent and regular realizations of shares whenever

they rose in market price before dividends from them were

increased.")

15. (5) By letter dated 24 July 1978, Mr Wood wrote again to Westpac Management saying that AGC's taxation advisers had advised that the decision in London Australia "would not be applicable to our operations and we would like you to plan our investment portfolio accordingly."

16. (6) By letter dated 25 September 1981, Mr Wood wrote to Mr Gates at Westpac Management, confirming that it had been agreed "in principle" that the "guidelines" in the letter dated 26 January and 24 July 1978 should continue, subject to two qualifications: (1) Westpac need only refer purchase of stock "within the authorised total investment allocation" in excess of $200,000; (2) Sales transactions "involving a capital loss" need not be reported.

17. (7) In his affidavit evidence, Mr Gates said that in 1981 he had a conversation with Mr Wood in which Mr Wood said that the appellant was not a trader in shares and that shares should be purchased only with a view to long term dividend growth. In his affidavit, Mr Gates said:

"In considering an investment the matter which I regarded as being of

dominant importance was the present and prospective future yield on the

investment. I regarded as desirable investments those where I thought

that the dividend income would increase over time, matching or exceeding

the rate of inflation. While I was concerned not to invest in

securities which were likely to diminish in market value, I did not at

any time take into account as part of the prospective yield on an

investment the capital gain which might be realised by disposing of the

investment. My instructions in connection with the management of the

portfolio were expressly, and were always understood by me to be, that

the investments were long term investments, not to be realised except in

the event of some catastrophe affecting the company in which the

investment was held or by reason of any event such as a takeover."

(Emphasis added)

(Mr Gates was not cross-examined on either of these passages in his affidavit.)

18. (8) In his affidavit, Mr Robson gave evidence that in 1983, Mr Wood stated to him:

"We have placed our funds for investment with Westpac Investment

Management. It is important to us that we are continuing investors and

that we are not seen as traders in shares. All shares purchased should

be treated as long term investments and not traded in the short or

medium term. As a rule we only sell when we have to, for instance

for instance during takeovers."

(Emphasis added)

"(T)he view given to me at my induction into the company by

Mr Wood was that we were virtually constrained in the

investments - in AGC Investments to being long term holders,

that the most frequent event of disposal was in response to

a takeover offer. That both the requirement of the

insurance commissioner and workers compensation Licence - as

well as taxation advice received, was that we should not

confuse this activity with anything that could be, in any

sense, considered to be trading and, for that reason,

disposal would be a very rare and exceptional event so that

there was no regular pattern in any way of discussion of

disposal of shares."

20. (9) In his evidence, Mr Crisp said that in 1983 Mr Wood informed him of the following:

"AGC Investments is not a trader in shares. It was set-up to invest

funds provided by Insurances in securities which ensure long term

dividend investment income and maximise potential asset growth."

(Emphasis added)

(Mr Crisp was not cross-examined upon this passage in his affidavit.)

21. (10) By letter dated 10 May 1983 to Westpac Management, Mr Crisp wrote as follows:

"INVESTMENT PORTFOLIO

We refer to recent discussions with the Administration Manager

concerning guidelines for the investment portfolio handled by you.

Guidelines previously issued indicated that funds available to you for

reinvestment were made up of dividends received and capital profits

during the year. We advise you that on the criteria set out

the investment portfolio can be increased to a total of $24m. The

amount invested by you up to the 31st March, 1983 is $20.5m therefore

you have funds available for investment of $3.5m up to and including the

30th September, 1983 at which time you will be advised of funds

available for investment to 30th September 1984.

(Emphasis added)

The provisos to the above investment allocation are as follows:

1. The Bank is to refer purchase of stock on individual investments

for amounts in excess of $200,000.

2. Sales Transactions involving a small capital loss need not be

reported.

3. The investment allocation of $3.5m for the next six months is of

course only a guideline. The investment of these funds is subject

to your judgment on market conditions applying from time to time

and reference to us as outlined in (1) above.

All contact with the Company involving our investment portfolio is to be

made through the Administration Manager, Mr R. Culbert. Please do not

hesitate to contact either Mr Culbert or myself should you have any

queries on these guidelines."

22. (11) In his oral evidence, Mr Crisp said that these standing instructions remained in force until the end of 1987 save that, in 1986, the limit of $200,000 was increased to $500,000.

23. (12) The records of the appellant's share sales do not go back earlier than 31 December 1970, although there were transactions prior to that date. A schedule of those investments prepared by Mr Gates indicated that the turnover in publicly listed shares acquired by the appellant was low. Of 81 acquisitions, 26 were held for a period exceeding 15 years, 20 for between 10 and 15 years, and a further 14 for between 5 and 10 years. It was his practice not to sell ordinary shares which he had purchased in the portfolio except in consequence of a takeover offer or by occasional divestment. New equities were acquired from time to time and existing equities extended by additional acquisitions, bonus issues or the taking up of rights. In some cases rights attached to existing shareholdings were disposed of by sale rather than being taken up.

24. (13) In his affidavit, Mr Crisp gave evidence of the history of the advance account between 1 March 1983 and 30 September 1987 as follows:

EXTRACT OF AGC (INSURANCES LIMITED ADVANCE ACCOUNT

WITH AGC (INVESTMENTS) LIMITED FOR THE PERIOD

1ST MARCH 1983, TO 30TH SEPTEMBER, 1987

25. (14) The following details of the loan account repayments by the appellant were given:

26. (15) From time to time Mr Gates advised the appellant with respect to offers of new issues of shares by companies in which the appellant already held shares. On several occasions, the advice referred to the particular shareholding in question as "a sound long term investment and as such, well fits the investment criteria of (the appellant)." Reference was also made from time to time by Mr Gates, in his correspondence with the appellant, to his concern to obtain an increasing dividend yield on investments if possible.

27. (16) In May 1984, Mr Robson asked Mr Crisp to review the investment strategies of the AGC Insurance Division. In a memorandum on the subject dated 29 May 1984, Mr Crisp referred, by way of background, to the "constraints...placed upon our ability to invest funds/assets by the licensing/ authorisation provisions imposed by the Federal Insurance Commissioner and by the Workers' Compensation Commission of New South Wales." It was said, in respect of "current strategies" that to "comply with licensing/authorisation requirements and a prudent investment strategy we have a spread of investments." It was stated that the Insurance Group's equity investment was carried by the appellant; that these investments were principally managed by Westpac Investment Management; and that after consultation with Westpac it was agreed that the Investment Managers were free to sell and purchase securities on behalf of the Group. Additionally any profits produced from these operations could be reinvested.

"We seek long term dividend producing shares.

The overriding instruction to Westpac is that they must

conduct the portfolio in a manner to ensure AGC

(Investments) cannot be classed as a trader."

(Emphasis added)

29. (17) By letter to Mr Crisp dated 25 November 1986, Mr Gates wrote of the appellant's investment policy as follows:

Further to our conversation this morning, I wish to confirm my

recommendation that the portfolio continue to place overwhelming

emphasis on first class industrial shares rather than seek a higher

immediate yield and buy shares of a lesser quality.

I have strictly adhered to high quality shares since I took over

management of the portfolio five and a half years ago and believe the

results have amply justified this stance.

As you are aware, share prices generally have advanced quite strongly

over the past few years, in fact at a faster rate than earnings and

dividend growth per share.

The affect (sic) of this has been that dividend yields have fallen such

that the average dividend yield on industrial shares at the moment is

3.7% compared with 4.4% a year ago and 4.9% two years ago.

I am recommending that we continue to buy basically the same type of

shares but point out that we will have to accept a lower immediate

running yield. I remain confident that the quality industrial shares

will continue to show above-average earnings and dividend growth per

share and believe the long term interests of the portfolio remain best

served by staying in the quality area.

(Emphasis added)

As a result of the portfolio accepting a number of takeover offers last

year, $3.5 million more was realised from sale of shares than was spent

on purchases. Added to this, I assume, was approximately $3 million of

dividend income which was available for investment but which was not

spent by us.

It would be appreciated if you could confirm that the amount available

for investment in l986/87 is approximately $10.5 million, which is the

total of the above two amounts plus expected dividend income of around

$4 million this year."

30. (18) By letter dated 26 June 1987, Mr Crisp wrote to Mr Gates as follows:

"I have been requested by our Managing Director, Mr R.A. Robson, to

discuss with you the most appropriate way of securing the unrealised

capital gain now held within the share portfolio.

The Board consider that such action is appropriate as the share market

now has reached a high level and it is possible that share values could

fall following the election.

(Emphasis added)

In consultation with you I would seek to determine:

1. A strategy to successfully dispose of the existing share

portfolio prior to 30/9/87 and

2. a plan to reinvest a significant proportion of the funds

received from the sell off operation.

I am aware that you will be unavailable until 7th July and propose to

telephone you to confirm the contents of this letter."

31. (19) Mr Gates and Mr Crisp met on 22 July 1987 and on 23 July 1987 Mr Crisp wrote to Mr Gates confirming that -

"(t)wo distinct scenarios are to be considered:

1. A complete disposal of the share portfolio, and

2. a disposal of selected lower performing or lower quality

equity holdings."

32. (20) Mr Gates replied to Mr Crisp by letter dated 24 July 1987 advising on practical aspects of the two "scenarios". In the course of his analysis, Mr Gates expressed the view that "with a few exceptions the portfolio is comprised of companies that will demonstrate long term earnings and 'franked' dividend growth".

33. At the trial, there was no substantial dispute about the primary facts. The dispute between the parties centred on what inferences should properly be drawn from the primary facts. His Honour said (at 4193):

"...the integration of the business activities of the applicant with the

affairs of Insurances, the place which the assets of the applicant

occupied as part of a reserve fund for the insurance business of

Insurances and perhaps also the scale of its activities, raise an

inference that the necessary profit purpose existed. No evidence was

adduced of any resolution of the board of the applicant, or for that

matter Insurances, which would rebut such an inference...

The letter of 26 January 1978, with its reference to the desire to

'fully exploit the cyclical fluctuations in the share market' makes it

clear that at least as at that date, the applicant did have a purpose of

profit making in acquiring its portfolio, and confirms the inference

which would arise from its insurance association.

The question then remains whether the evidence shows in respect of the

applicant's activities after 26 January 1978 that it changed direction

from being a company carrying on an investment business after that date,

so that at least in respect of so much of its portfolio as was

thereafter acquired it became a mere investor? The evidence does not

satisfy me that it did."

"It is true that Westpac Management did not generally seek to take

advantage of the cyclical trends of the market, and that, having regard

to the size of the portfolio the value of sales was relatively small,

but capital growth remained at all times of significance. The applicant

seems to have been concerned at all times to ensure that it was not a

share trader and went to some pains to communicate this to Mr Gates. I

accept that the applicant was concerned to obtain increasing dividend

yields. Indeed this was particularly so when its parent company was

incurring substantial underwriting losses. But, the desire for dividend

yield does not exclude a purpose of profit making by sale, where the

investment is made with the knowledge that the sale may be required to

provide funds (albeit not on a day to day basis, but only perhaps in the

event of a catastrophe or a running down of particular insurance

business) for the purposes of the insurance business of its parent.

This is particularly so when the applicant's funds were all provided on

a short term basis of loans repayable on demand."

35. His Honour was of the view that, for present purposes, the evidence of Messrs Robson and Crisp was more significant than that of Mr Gates. Hill J. said (at 4194):

"The evidence of Messrs Robson and Crisp makes it clear that the

applicant was not intended to be a share trader, but it stops short of

denying the profit making purpose of the applicant. The fact that the

shares were not to be traded in the short or medium term, and were to be

treated as long term investments is not inconsistent with the conclusion

that the shares were acquired with a profit making purpose. Indeed, as

Mr Crisp acknowledged asset growth was always an aim of the applicant.

No doubt increasing dividends over the medium to long term almost

invariably bring asset growth, but in the circumstances of the present

case one may ask rhetorically whether asset growth was an end in itself,

or merely a means to ensuring that realisations would, if made, be at a

profit."

"It follows, that the applicant has not satisfied the burden of showing

that its original profit making purpose was displaced. In my view the

applicant was carrying on a business, that business being integral to

the insurance business of its parent, and in the course of this business

it acquired a portfolio of shares having at the time of acquisition a

profit making purpose in so doing. It realised a large part of that

portfolio to preserve the gain which had accrued to it, and the profits

it made in so doing were income in ordinary concepts."

37. Hill J. referred to the decisions of the High Court in the London Australia case and in Federal Commissioner of Taxation v Myer Emporium Ltd. [1987] HCA 18; (1987) 163 CLR 199 at 209-10, for the proposition that "profits made on the realisation of investments will be income where the investments are acquired as part of a business and where in addition there was at the time of acquisition an intention or purpose that they be realised subsequently at a profit" (at 4191).

"The fact that the applicant is a subsidiary of an insurance company and

is administered as part of that company, and that its assets are

regarded by the parent as part of a reserve fund, to be available to

meet liabilities in the event that that be necessary (even perhaps where

the occasions of necessity may be rare indeed) assists in the

characterisation of the activities of the applicant as a business. It

also enables an inference more readily to be drawn as to the profit

making purpose of the applicant in undertaking its investment

activities. That is not to say that it should thereby be taken as being

an insurance company. It is not receiving premiums which require

reinvestment to provide for claims, nor is it investing, as the

Commissioner submitted, the funds of the insurance company. It is

investing its own funds, albeit that those funds are provided by way of

interest free loans, repayable on demand from the insurance company.

Those funds represent the capital of the applicant, not the circulating

capital of its parent insurance company."

39. Hill J. distinguished, on its facts, the decision of the Full Court of this Court in Federal Commissioner of Taxation v Equitable Life and General Insurance Co. Ltd. 90 ATC 4438 where it was held that the profits made by the subsidiary of an insurance company on the sales of shares were not income.

40. In GRE Insurance Limited v Commissioner of Taxation of the Commonwealth of Australia 92 ATC 4089, in which judgment was given after Hill J. decided the present matter, it was held that the profits made on the sale of equities by a subsidiary ("Unitraders") of an insurance company ("GRE") were income. Northrop, Davies and Jenkinson JJ. said (at 4093):

"...the activities of Unitraders were an integral part of the insurance

business conducted by GRE. Although the equities were held by the

wholly owned subsidiary rather than by GRE directly, the equities

indirectly formed part of the funds representing the insurance reserves

and part of the circulating capital of the business. Just as the

prudent management of the investment portfolio of an insurance company

ordinarily requires that some proportion of equities be held as well as

government securities, mortgages and debentures, so in this present

case, it was always an element of the investment strategy that a

proportion of equities be held. And that strategy continued, the

proportion varying whenever it seemed prudent from an investment point

of view to vary the mix.

As the reason for holding the equities in Unitraders rather than GRE was

to enhance the profits, the after tax profits, of the insurance

business, we are unable to regard the activities of Unitraders as being

other than an integral part of the insurance business, whose profits

were by this technique increased."

"That is not to say that Unitraders should not be considered as a

taxpayer in its own right. It was such a taxpayer and its activities

should be so considered. Nevertheless, the part which a subsidiary

plays in affairs which concern its holding company, or in the group in

which both companies form a part, may throw light upon the character of

the activities of the subsidiary. Thus, in Radnor, it was considered

relevant that the taxpayer company was an instrument through which the

holding company performed its obligations as a trustee. See the remarks

of Hill J. in AGC (Investments) Ltd. v. Federal Commissioner of Taxation

(1991) 91 ATC 4180 at 4190. In the present case, Unitraders was

introduced into the affairs of GRE solely to ensure that the benefit of

the s.46 rebate would not be lost in the event that underwriting losses

brought GRE to the position that it had no taxable income. Unitraders

was a separate entity from GRE but its activities reflected, indeed

formed part of, the overall business in which GRE was engaged."

42. His Honour's conclusions may be summarised thus:

(A) The fact that the shares were not to be traded in the short or

medium term, but were to be treated as long term investments, was not

inconsistent with the conclusion that the shares were acquired with a

profit making purpose. Asset growth was always an aim of the appellant.

The appellant had not satisfied the burden of showing that its original

profit making purpose was displaced.

(B) The appellant was carrying on a business and that business was

integral to the insurance business of its parent, AGC (Insurances); in

the course of that business, the appellant acquired a portfolio of

shares having, at the time of acquisition, a profit making purpose; the

appellant realised a large part of that portfolio to preserve the gain

which had accrued to it; and the profits thus earned were income in

accordance with ordinary concepts.

43. His Honour's reasons for these conclusions were, in essence, as follows:

(1) The appellant was used as a vehicle for the investment of funds

provided to it by its parent company, which carried on business as a

general insurer. The criterion for investment, in the case of shares in

listed public companies, was long term dividend investment income and

the maximisation of potential asset growth.

(2) It was essential that a general insurer have an adequate reserve

fund, particularly where, as in the case of AGC (Insurances), workers'

compensation insurance was undertaken so that claims might continue

after the period in respect of which premiums were payable ("long tail"

insurance); such a reserve would ordinarily consist of short term or

liquid investments, but might also consist of listed shares.

(3) AGC (Insurances) invested in public company shares by providing

funds to the appellant to invest in those shares. All of those

investments were viewed by AGC (Insurances) as part of the reserve fund

of the insurance company, although they were held in the name of a

separate legal entity, which was a wholly owned subsidiary. The share

portfolio was established and maintained by AGC (Insurances) so as to

provide for the possibility of claims being made against it in excess of

its immediately available liquid funds. The Insurance Commissioner, at

least until 1984, accepted that the assets of the appellant, including

the shares, should be treated as part of the assets of AGC (Insurances)

for the purposes of the Insurance Act 1973.

(4) The investment policy of the appellant was that of a long term

investor seeking shares in companies that provided a reasonable yield

together with medium and long term growth potential. Although the

appellant was not conducting the business of trading in the shares, the

facts that the appellant was a subsidiary of an insurance company, and

that its affairs were administered as part of that company and that the

appellant's assets were regarded as reserves available to meet the

liabilities of the insurance company, justified the inference of a

profit-making purpose in undertaking the investment activities.

(For the sake of completeness, it should be noted that, at the trial, the Commissioner put an alternative submission that the profits were assessable under the second limb of s.25A(1). Hill J. did not deal with this argument, possibly because it involved, as an essential ingredient, a conclusion that there was a profit-making purpose, so that his Honour's consideration of the possible operation here of s.25(1) could also be applied to s.25A(1). For the same reason, we do not need to consider the alternative argument.)

44. The appellant now challenges these conclusions in three main ways:

(i) It disputes the finding by his Honour that it was carrying on a

business which was "integral" to the insurance business of its parent

and attacks the conclusion that, in the course of this business, the

appellant acquired the shares having a profit-making purpose at that

time.

(ii) The appellant says that his Honour should have held that it was

engaged in a business of investment, in which the realisation of

surpluses on disposal was no more than a known possibility, rather than

its object.

(iii) It maintains that its purpose was to produce a steady and growing

dividend income; and that as a consequence, the profits were on

capital, and not on revenue, account.

45. There is little, if any, difference in the submissions put by the parties with respect to the legal principles applicable here. The central issue in the litigation at first instance, and before us, was the true characterisation of the appellant's purpose in acquiring its share portfolio. This is a question of fact, albeit of secondary fact. There is no real dispute about the primary facts, and little appears to turn on the credit of the individual witnesses called on behalf of the appellant. But the proper inferences to be drawn from the primary facts are contentious. On behalf of the appellant, it is said that the oral evidence of those concerned with the management of the portfolio demonstrates that the investments were acquired on a long term footing and were realised, as a general rule, only in exceptional circumstances. The appellant says that this version of the events is fully supported by the contemporary documentation. On the other hand, the Commissioner contends, in accordance with the conclusion of Hill J., that in the particular circumstances of this case, especially when regard is had of the relationship between the appellant and AGC (Insurances) and in the light of the correspondence in 1978 concerning the possible impact on the appellant of the decision of the High Court in the London Australia case, the appellant failed to discharge the onus of establishing the absence of a profit-making purpose in acquiring the portfolio.

46. Although the resolution of this central issue will, in the end, depend upon an examination of all of the circumstances disclosed in the evidence, it is convenient to approach the matter by reference to the two main matters raised in argument before us. We will consider them in turn.

The relationship between the appellant and AGC (Insurances)

47. As has been noted, Hill J. placed considerable emphasis on the role of the appellant as the investment vehicle of the Insurance Division and it is clear from the banking and insurance cases that the need to maintain liquidity continuously in order to conduct this kind of business is the reason why profits generated by the purchase and sale of securities by banks and insurance companies are usually treated as income. For instance, in the Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation [1946] HCA 60; (1946) 73 CLR 604 at 620, Latham C.J., Dixon and Williams JJ. referred, with approval, to a statement in the English text Konstam as follows:

"...the buying and selling of investments is a necessity of

insurance business; and where an insurance company in the

course of its trade realizes an investment of a larger price

than was paid for it, the difference is to be reckoned among

its profits; conversely any loss is to be deducted." (Our

emphasis)

48. Their Honours went on to say that, in this respect, there was no substantial distinction between the business of an insurance company and that of bank. They said (at 620):

"The acquisition (by a bank or an insurance company) of an

investment with a view to producing the most effective

interest yield is an acquisition with a view to producing a

yield of a composite character, the effective yield

comprising the actual interest less any diminution or plus

any increase in the capital value of the securities. Such

an acquisition and subsequent realisation is a normal step

in carrying on the insurance business, or in other words an

act done in what is truly the carrying on of the business of

the society."

(Our emphasis)

49. But, in our opinion, the facts of the present case may be distinguished from the usual circumstances of an insurance company or a bank, where the need to buy and sell securities on a regular basis, in order to maintain liquidity, justifies the conclusion that this is a normal step in carrying on a banking or insurance business, with the consequence that the profits so earned are regarded as income. The evidence here indicates that there was no necessity for the appellant to buy the securities now in question in order to maintain the liquidity of AGC (Insurances).

50. The role actually played by the appellant in the Insurances Division was, we think, accurately stated in Mr Crisp's memorandum dated 29 May 1984 which we have already mentioned. As this was an internal memorandum, there is no reason to suppose that it was not a correct statement of the general position and it is illuminating for present purposes. It will be recalled that the memorandum was addressed by Mr Crisp, as General Manager of the Insurances Division, to Mr Robson as General Manager of the AGC Group. Its subject was "Insurances - Investment Strategies". The purpose of the paper was stated to be "to review the investment strategies now in place". The first section of the paper dealt with background matters. Reference was made to the constraints imposed by the Federal Insurance Commissioner and by the Workers' Compensation Commission of New South Wales. This meant, inter alia, that "unrestricted asset/funds investment by AGC (Insurances)" was not permitted. The second section of the paper dealt with "Current Strategies" as follows:

"2. CURRENT STRATEGIES:

To comply with licensing/authorisation requirements and a

prudent investment strategy we have a spread of investments.

(a) A.G.C. (Securities) Limited:

This company is placed in funds by A.G.C. (Insurances)

Limited: the funds are advanced

as first and second mortgages by Property Finance.

On the Investment Control Report only the 10% interest

being paid on the funds is reported. A specific

profit contribution from AGC (Securities) is taken

into AGC (Insurances) Group account only at March and

September.

(b) A.G.C. (Investments) Limited:

The Insurance Group's equity investment is carried by

this company.

These investments are principally managed by Westpac

Investment Management Pty. Limited. After

consultation with Westpac we have agreed the

Investment Managers are free to sell and purchase

securities on our behalf. Additionally any profits

produced from their operations can be reinvested.

We seek long term dividend producing shares.

The overriding instruction to Westpac is that they

must conduct the portfolio in a manner to ensure AGC

(Investments) cannot be classed as a trader.

Within the Investment Control Report we only show the

dividends being received through AGC (Investments).

An appreciation on capital gain value is not taken

into account.

Liquidities trading is undertaken through AGC Money

Market operations in consultation with Mr David Hobbs.

Preference share details are referred to us through a

variety of brokers and via Westpac."

(Emphasis added)

51. The third section of the paper gave selected statistics on the current investment programme.

52. The final section of the paper gave some recommended strategies. It was suggested that the investment portfolio should be balanced as follows:

"(a) Investment in Category l assets as set 10%

the Workers' Compensation Commission

comprising bank bills and Government

bonds

(b) Investment in Category ll assets as set 15%

by the Workers' Compensation Commission -

letters of credit

(c) Mortgages - Securities 45%

Domestic lending about 7O%

commercial lending about 30%

with a maximum of $500,000

any one mortgage or group.

Commercial lending to be

limited to Sydney and

Brisbane PF offices.

(d) Investments in ordinary and 15-20%

preference shares

(Emphasis added)

(e) Debentures and notes (AGC) 15%"

53. It was stated that the recommended strategies were in essence a continuation of the current mixture of investments.

"Our existing strategy is returning a reasonable investment

yield while still enabling us to operate within the terms of

the license authorisations to which we are subject."

(Emphasis added)

55. As we have said, we are of the view that there is no reason to doubt that this statement of the role of the appellant in the Insurances Division was an accurate one. It must follow, we think, that it was not part of the corporate scheme that the appellant buy equities in order to maintain liquidity for the insurance operations of the AGC Group. The memorandum and the other evidence, documentary and oral, to which we have earlier referred, demonstrate that it was at all times intended that the appellant invest long term. Its subsequent conduct was consistent with this intention. As we have noted, 26 of the equities acquired were held for a period exceeding 15 years, 20 for between 10 and 15 years and a further 14 for between 5 and 10 years. This pattern of activity is inconsistent with an objective or purpose of acquiring the shares in order to provide liquid funds for the Insurance Division.

56. It may be accepted, as Hill J. found, that the appellant was the investment vehicle for the Insurances Division. But it does not necessarily follow that the investments made by the appellant were not made on a long term basis. The evidence demonstrates that, in fact, the securities now in question were acquired with a view to their long term capital growth.

57. The evidence also indicates that, insofar as liquid funds were required for the purposes of the insurance operations, they were found in sources other than the appellant's share portfolio. Reliance was placed, on behalf of the Commissioner, upon the circumstance that when, in April and September 1986, the appellant repaid AGC (Insurances) the sums of $1,000,000 and $9,000,000 respectively, the latter used these funds to acquire bank bills. Even if it be accepted, without finding, that these circumstances indicated a desire by AGC (Insurances) to obtain substantial funds in a liquid form at that time, it does not follow that the appellant's investment policy was not oriented towards long term capital growth. With the possible exception of the correspondence in 1978 concerning the London Australia case, to which we now turn, the documentary and other evidence, taken as a whole, indicates that Westpac Management was instructed to achieve, and did achieve, the objective of long term capital growth in the appellant's share portfolio.

The correspondence in 1978 concerning the London Australia decision

58. It will be recalled that, by its letter dated 26 January 1978, the appellant informed Westpac Management that the appellant was seeking advice as to the effect of the London Australia decision; and that, if the appellant were to be taxed accordingly, the appellant should "exploit all forms of gain from our equity operation". The letter added that, notwithstanding this, Westpac Management -

"should fully exploit the cyclical fluctuations in the share

market by capitalising on market highs for sales and

repurchasing at the bottom of any depressed period."

59. On behalf of the Commissioner, much reliance is placed upon this passage to justify the inference, at the time of acquisition, of a purpose or intention on the part of the appellant, of profit-making by subsequent sale.

60. We have difficulty in accepting this submission. For one thing, the existence of such a purpose would be inconsistent with the well documented instructions to Westpac Management, before and after this letter and confirmed by the oral evidence, to acquire stocks with a view to long term investment. For another, it will be recalled that the letter went on to explain the above passage as follows:

"The point we make is that if we sell any stock the

reinvestment does not have to be made immediately unless the

decision to sell was made with the intention of replacing

the stock sold."

61. When the letter is read as a whole, it appears that the appellant was not instructing Westpac Management to become a trader in shares; nor was it giving instructions that a system of "switching" securities in a regular organised and large scale fashion, as was done in London Australia, be embarked upon. Rather, against the background of the standing instructions to aim for capital growth in the long term, the appellant was making the point that if stocks were sold, it was not necessary to go into the market immediately to replace those stocks for their own sake; rather, regard should be had to "cyclical fluctuations" in deciding on what action to take and when to take it. These instructions are consistent with an objective of long term capital growth.

62. In our opinion, when regard is had to the whole of the material in evidence, it should be concluded that the appellant has discharged the statutory onus of demonstrating, as a matter of proper inference from the facts, that at the the time of acquisition, the shares in its portfolio were not acquired with an intention that they be realised subsequently at a profit. It must follow, in our view, that the surpluses realised in 1987 were on capital account.