'4.2 The amendment will prevent a controller of a company or an associate of a controller from being able to generate a capital loss on the disposal of shares in the company in circumstances where the controller or associate does not suffer an economic loss to the extent of that capital loss.
4.3 Under the current law, a capital loss could be generated in relation to the disposal of shares in a company where there is no equivalent economic loss. This could arise where the shares are sold after the pre-acquisition profits of the company have been distributed in the form of rebatable dividends. Pre-acquisition profits, in relation to a shareholding in a company, are profits retained in the company at the time the shareholding was acquired.'
Thereafter the Explanatory Memorandum set out paragraphs already extracted above. The appellant contended that the primary judge failed to observe or apply that extrinsic material, which was said by the appellant to be inherently referable to pre-acquisition profits that had been derived, and that were identifiable.
60 The appellant next addressed the legislative context of Division 3 of Part IIIA of the Tax Act. It was submitted by the appellant that account should be taken of the circumstance that s 160ZLA, formerly part of Division 3 and contemporaneously enacted with s 160ZK but subsequently repealed by s 32 of Act No 170 of 1995, addressed the subject of payment of rebatable dividends from revaluation reserves. It was pointed out that not only was specific provision made by s 160ZLA in relation to rebatable dividends from revaluation reserves, but that the same used distinctly different language, in that it specifically addressed profits arising from the revaluation of the asset, and any profit that would have arisen on the disposal of an asset. Thus it was submitted that the Legislature had previously drawn a distinction in language by the previous provisions of ss 160ZK and 160ZLA when read together, between the expressions profits arising or that would have arisen contained in s 160ZLA, and the expression profits that were derived contained in s 160ZK, and therefore that those respective expressions could not have been previously intended to have the same meaning. It could not be said rationally, so the submission continued, that the removal of s 160ZLA was intended to change the meaning of s 160ZK, the latter continuing to address a revaluation reserve (or part thereof) representing profits on the revaluation of an asset where, if the company had disposed of the asset after the revaluation, any profit arising on the disposal of the asset would have been included in the company's assessable income or given rise to a taxable capital gain. It was further submitted by the appellant that the former s 160ZLA had been concerned with profits that were unrealised, and not therefore derived. By way of contrast, it was submitted by the appellant that s 160ZK has always been concerned only with realised or retained profits.
61 Section 160ZLA was replaced by an amending statute containing s 46H(1)(d) of the Tax Act. Consistently with the approach previously adopted in s 160ZLA, so it was submitted by the appellant, s 46H(1)(d) applies to profits from the revaluation of assets of the company that have not been disposed of by the company, and is not directed to derived profits. In fact, so the appellant's submissions continued, if profits have been derived, it is apparent that s 46H does not apply to prevent a dividend being rebatable under ss 46 or 46A. It was further submitted that s 46H(1)(d), when read with s 46G, makes it apparent that whereas s 160ZLA had adopted a proportional approach in determining whether there was to be a rebatable dividend adjustment, s 46G adopts a different approach, and looks to the accounts against which the taxpayer corporation has chosen to debit the dividend distribution. That approach was said to reflect the principle that a company is entitled to choose from where, and when, it declares dividends. In the present case of course, the dividends which SAIL and Phoenix did ultimately declare were so declared from retained and operating profits, and not from an unrealised profits reserve.
62 The appellant further submitted that the former s 160ZLA addressed the circumstance of a revaluation reserve wholly or partly representing profits on the revaluation of an asset where, if a company had disposed of the asset immediately after revaluation, any profit arising on the disposal of that asset would have been included in the company's assessable income, or given rise to a capital gain. It was therefore concerned, so the appellant's submission further emphasised, with 'profits that were by their nature unrealised', and thus profits not derived in the normal sense. By way of contrast, s 160ZK remains concerned with profits that have been derived.
63 The dictum of the primary judge that the 'purpose of the provisions is to preclude a taxpayer from claiming a capital loss where there is no economic loss to the taxpayer' was contended by the appellant to'take a few words' from the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 2) 1994, which introduced s 160ZK(5), out of context, and in any event to ignore the words of the statute. The appellant emphasised that the Explanatory Memorandum cannot of course replace the words of the section as enacted, which do not provide that a capital loss cannot be claimed where there is no economic loss to the taxpayer. On the contrary, so the appellant's submission continued, s 160ZK(5) provides that the cost base of a share is to be reduced if an amount (being the whole or part of a distribution) could reasonably be taken to be attributable to profits that were derived by the company before the company acquired the RDA share, and contemplates, consistently with commercial reality, that there may be amounts later recovered by a shareholder that may have the effect of reducing the economic loss of the taxpayer for the time being, yet would not satisfy s 160ZK(5), because at the time of the acquisition of the share, the conditions for the application of s 160ZK had not been satisfied.
64 The appellant further submitted that the illustration in the Explanatory Memorandum referred to above provides the context in which the statement concerning no economic loss was made, together with an indication of the kind of situation intended to be caught by s 160ZK(5). In that example, at the date of acquisition (or deemed acquisition), there were profits that were derived in the form of so-called retained profits. In the present case, it was emphasised moreover that the companies continued business operations over the ensuing four years and distributed current earnings as well as retained profits. That those distributions over that period were attributable, in part, to retained profits, was duly acknowledged by the appellant. It was submitted that the view that the phrase 'profits that were derived' in s 160ZK refers only to retained profits is confirmed by the fact that the Explanatory Memorandum defines pre-acquisition profits as retained profits, a matter said to have been overlooked by the primary judge.
65 The appellant next submitted that the alleged misunderstanding on the part of the primary judge of the concept of economic loss, in the context of s 160ZK(5)(b) of the Tax Act, was illustrated by her Honour's view that a profit was derived simply if the market value of investments had increased after the date of acquisition, being an approach which necessarily involved the proposition that a loss is suffered if the value of investments declines after acquisition. If it be the case that a loss is suffered when the market value of investments decline, so the appellant's submissions continued, there would have been an economic loss sustained by the Holding Company which the primary judge has implicitly ignored in the course of her reasoning. The asserted fallacy in that approach was said to be illustrated by the following examples, formulated by the appellant:
'Example 1: if shares were acquired in year 1 which included an unrealised gain arising on the revaluation of certain assets, her Honour would have concluded that a profit was derived before acquisition. However, if immediately after the acquisition, the assets lost 50% of their value, stayed at that value for the next 20 years, and then subsequently the value of the assets returned to the value at acquisition, the primary judge would have held that the taxpayer had suffered no economic loss.
Example 2: if shares were acquired in year 1 at a price which included an unrealised gain arising on the revaluation of certain assets, her Honour would have concluded that a profit was derived before acquisition. However if immediately after acquisition, the assets lost 50% of their value, and the position of the company was restored by way of gift, her Honour would have determined that the taxpayer had suffered no economic loss.'
66 It was contended by the appellant that in each of the two examples, the conclusion reached as a result of the application of the construction of the Tax Act, as found by the primary judge, demonstrates the error in her Honour's approach. In each of the two examples, the taxpayer did obviously suffer economic loss. The errors exemplified were said to arise from the fact that her Honour took the phrase 'no economic loss to the taxpayer' out of context and ignored the literal words of the statute; the cost base of an asset was not subjected to reduction, according to an implicit outcome of the reasons of the primary judge, when a taxpayer suffered no economic loss over the period during which the taxpayer held the asset. The appellant emphasised that the legislation requires that there be 'profits that were derived by the company before the holder acquired the RDA share'. The appellant's submission was of course that there were no such profits actually derived in the events which happened.
67 The word derived in relation to profits, where used in s 160ZK(5)(b), is not of course an expression defined by the Tax Act. Interpretations in different curial contexts have been as follows:
(i) obtained, got in or acquired: Federal Commissioner of Taxation v Clarke (1927) 40 CLR 246 at 261 (Isaacs ACJ);
(ii) arising or accruing or coming in by way of income, not necessarily actually received but ordinarily that is the mode of derivation: Tindal v Federal Commissioner of Taxation (1946) 72 CLR 608 at 624 (Starke J);
(iii) to draw, fetch, get, gain, obtain: Brent v Federal Commissioner of Taxation (1971) 125 CLR 418 at 428 (Gibbs J citing from the Oxford English Dictionary);
(iv) gains that have, during the relevant period, come home to the taxpayer in a realised or immediately realisable form: Commissioner of Taxes (SA) v Executor Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108 at 155 (Dixon J).
68 The appellant thus submitted that the critical word derived in s 160ZK(5)(b) should take its meaning from and subject to the proper interpretation therein of profits, and for that purpose, should be construed in the context of the other provisions of the Tax Act simultaneously enacted, and in particular the subsequently repealed s 160ZLA. It was submitted by the appellant by way of conclusion that s 160ZK(5) could only apply to profits already realised and retained in a company at the time of acquisition by the holder of the RDA share referred to in the subsection. Furthermore it was submitted by the appellant that in construing the s 160ZK(5) phrase profits that were derived by the company, and in particular the word derived, the distinctions drawn by the primary judge 'between the profits from which the dividend is to be derived and the profits from which it must be paid' and 'between the source from which the dividend is paid and the derivation of that source' are not relevant, since s 160ZK(5) is directed at determining whether there were profits that were derived, and if so, to then determining whether there is a connection between a particular distribution made, and what have been identified as the particular profits that were derived.
69 The issues here arising are concerned with unrealised accretions in the value of particular assets as at 8 October 1992, in the case of SAIL the Bridge Street properties, and in the case of Phoenix, the value of the share portfolio as at the same date. The appellant submitted that neither could be said to have come home in a realised or immediately realisable form. Moreover neither was treated by the Royal & Sun Alliance Group as available for distribution as dividends. On that footing, the appellant submitted that upon no view could the unrealised accretions in value be described as profits that were derived by the company within s 160ZK(5).
70 Accordingly the appellant submitted that the proposition that profits were derived at the time of the merger was contradicted by the objective circumstances that profits were not in reality derived until the Bridge Street properties, or the shares held by Phoenix, were sold. The appellant's case was that the sums in dispute could not reasonably be taken to be attributable to profits derived within s 160ZK(5), that is to say, derived before the Holding Company was deemed to have acquired the shares in SAIL and Phoenix. There is a distinction between deriving assessable income and deriving profits, in that the latter normally or generally requires that profits will crystallise in quantification only when sums required to be deducted therefrom have been ascertained.
71 The appellant submitted alternatively that if the unrealised accretions in the values of the investments prior to the merger were profits that were derived, it was not reasonable to attribute the source of each dividend in question to those profits for the following reasons:
(i) the distributions that were made by each company were not attributable to those movements in book value;
(ii) each distribution was wholly attributable to later realised profits;
(iii) post December 1992 operating profits were sufficient themselves to fund the dividends declared post December 1992;
(iv) in relation to SAIL:
(a) although the merger completion accounts accounted for SAIL's assets at purported market value, the Bridge Street properties declined substantially in value after the merger; and
(b) events after the deemed acquisition of the shares were the source of the profit distributed in the dividend paid on 6 September 1996.
(v) in relation to Phoenix:
(a) the unrealised accretions in the value of the total portfolio was a figure subject to constant variation (including reduction) until fixed by realisation; and
(b) the unrealised accretion in the value of an individual shareholding within the portfolio was a figure subject to constant variation, including reduction, until fixed by realisation.
The submissions of the Commissioner
72 Counsel for the Commissioner framed the issues which the Commissioner perceived to arise on the appeal as follows:
(i) whether upon the true construction of s 160ZK(5) of the Tax Act, the dividends received by the Holding Company from its subsidiaries SAIL and Phoenix could reasonably be taken to be attributable to profits that were derived by SAIL and Phoenix before the holder, being the Holding Company, was deemed to have acquired the shares in SAIL and Phoenix;
(ii) whether in the context of s 160ZK(5), the expression profits that were derived by the company before the deemed acquisition date included unrealised profits accrued as at that date;
(iii) whether the dividends received could reasonably be taken to be attributable to the unrealised profits accrued as at the deemed acquisition date.
The issues so framed coincide essentially with the structure, as well as the order, of the appellant's submissions. The words in italics reproduced above pick up of course part of the text of s 160ZK(5). The first and second issues involve essentially the task of statutory construction. The third is more of a factual one to resolve. The threshold rejoinder of the appellant was that those questions posed by the Commissioner ignored the fact that a pre-requisite to the application of the section is that profits be derived; furthermore those issues, so framed by the Commissioner, assumed, contrary to the Tax Act and what Parliament was said to have clearly intended, that unrealised profits, as at the date the Holding Company is deemed to have acquired the shares in SAIL and Phoenix, constituted profits that were derived by the company before the holder acquired the RDA share.
73 Senior counsel for the Commissioner prefaced his response to the appellant's submissions upon the meaning and operation of s 160ZK(5), and in particular the expression could reasonably be taken to be attributable to profits that were derived, by reference to principles of statutory construction, and submitted that the mischief which s 160ZK was intended by the Parliament to address was initially to be distilled from the objects clause of the relevant subdivision of the Taxation Laws Amendment Act (No 2) of 1994 (Act 82 of 1994), reading as follows:
'The object of this Subdivision is to remove the capital gains tax advantages of dividend rebate arrangements.'
Reference was made to dictum of Hill J in MLC Ltd v Deputy Commissioner of Taxation (2003) 1996 ALR 502 that '…the English language is seldom so clear and unambiguous that only one construction is open', and his Honour proceeded to emphasise that in recent times, great importance has been attached to context and the process of construction. His Honour cited extensively in that regard from the High Court's decision in CIC Insurance Ltd v Bankstown Football Club Limited (1997) 187 CLR 384 per Brennan CJ, Dawson Toohey and Gummow JJ at 408.
74 The Commissioner submitted that the primary judge had correctly identified the mischief addressed by s 160ZK, as illustrated by the example in the Explanatory Memorandum and by her Honour's reference to the 'general rule' concerning 'no economic loss'. Upon that footing, the Commissioner submitted that it would defeat the legislative intent, and thus not give effect thereto, to construe the legislation as not applying to a rebatable dividend paid out of profits reflected in the purchase price, and cost base, of the shareholding involved in the present context, unless the s 160ZK(5)(b) use of the word derived admitted of no other meaning than that of realised. To read the legislation otherwise, the submission continued, would produce so 'absurd', 'extraordinary', 'capricious' or 'irrational' a result as to lead to the conclusion that 'the legislature could not have intended such an operation and that an alternative interpretation must be preferred'. (see Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation (1981) 147 CLR 297 per Mason CJ and Wilson J at 320-1.)
75 The Commissioner's submission continued that it was unnecessary to resort to such reasoning in the present case, because as the primary judge was said to have correctly observed, the reference to profits in s 160ZK(5)(b) is unqualified, and would seem to include, as a matter of plain English, both realised and unrealised profits. However, it is to be kept in mind that the mischief addressed by s 160ZK(5) is not to remove the capital gains tax advantages of all dividend rebates, but only those where the dividend could reasonably be taken to be attributable to profits that were derived by the company before the holder acquired the RDA share.
76 The Commissioner pointed out that the word derived is encountered in the Tax Act in three principal differing contexts, first in relation to the source from which income arises (s 23(p) or the former 23(g)), secondly in relation to the time at which assessable income is derived for the purposes of ss 25 or 26(a), and thirdly in relation to the nature of the fund from which dividends are paid for the purposes of s 44. Upon that footing, the Commissioner submitted that in terms of principle, a word may not necessarily have the same meaning in the various statutory contexts in which it appears, particularly in revenue statutes (Clyne v Deputy Commissioner of Taxation (1981) 150 CLR 1 per Mason J at 15.)
77 Senior counsel for the Commissioner next emphasised that the words could reasonably be taken to be attributable to profits that were derived by the company before… werereferable to circumstances prior to the acquisition date of the RDA share, thereby requiring an identification of the existence of a fund of profits derivedby the company to which the dividend subsequently paid may reasonably be attributed. The Commissioner further submitted in that regard that the word derived in s 160ZK(5)(b) served the functionof identifying the fund of profitsto which the post acquisition dividend is reasonably attributable, being profits, whether realised or unrealised, accrued to, or obtained by the company before that acquisition date. It may be observed that s 160ZK(5) contains no explicit reference to notions of profits which are yet to crystallise. Cited in that context of the Commissioner's submissions was the dictum in Evans referred to earlier, namely that '[t]he word derived does not connote that the profit must be a realised profit'. However it is to be further observed that further dicta in Evans also emphasised that although a profit need not be, in the income tax context thereby involved, a realised profit, it must be at least an 'ascertained profit'. The statutory phrase addressed in Evans was that part of the Income Tax Assessment Act 1922-1930 comprising s 16(b)(i)(1), which brought to charge all dividends and distributions out of profits, whatever be the nature of the profit (see the passage in the reasons of the majority at 101).
78 The Commissioner referred next to the authorities of Lachberg and Dimbula, to which reference has been made above. Those cases were cited by the Full Court of the Supreme Court of Western Australia in Hancock Family Memorial Foundation Ltd v Porteous (2000) 156 FLR 249 at 277, for the propositions that the term profits appearing in corporation law statutes has a 'broad meaning, and requires a comparison to be made of the entire accounts of a company at the beginning and end of a period to assess the amount of the gain during that period [and] includes capital profits, both realised and, in some circumstances, unrealised'. The Commissioner submitted in that context that Read was correctly distinguished by the primary judge as being of little assistance in construing s 160ZK(5), since it was a decision referable to the policy of the Social Security Act to the effectthat gains which had come home and represented disposable income should be taken into account in determining the level of pension provided to a pensioner, but that unrealised gains which had not yet and might not come home should not be similarly taken into account. The principle in Read as to a gain not being realised until it is earned derived or received was implicitly adopted by Davies J in Clarke v Federal Commissioner of Taxation (1992) 92 ATC 4136 at 4140. The judgment of Davies J in Clarke was upheld on appeal (92 ATC 4562), though Read was not mentioned by the Full Court in its reasons.
79 The Commissioner accepted the appellant's contention that unrealised profits by way of an accretion in value of capital assets may only be distributed as dividends in circumstances where 'the accretion is of a permanent character', but dismissed the relevance of the contention. The issue arising on the present appeal, so the Commissioner contended, was not whether at the merger date, SAIL and Phoenix could have paid a dividend out of recognised but unrealised profits derived prior to that date, but whether the dividends actually paid by the companies after the unrealised profits had crystallised by realisation could reasonably be taken to be attributable to unrealised profits that had accrued at the merger date.
80 It was emphasised by the Commissioner that the example in the Explanatory Memorandum referred to earlier merely illustrates the nature of the mischief which the legislation was intended to remedy, and did not purport to confine the operation of the statute to that example, nor define the s 160ZK(5)(b) expression profits that were derived as profits realised. Moreover the Commissioner emphasised that the primary judge was not concerned simply with whether a profit was derived, or an economic loss suffered, but with the issue whether a dividend actually paid was reasonably attributable to a profit derived before the merger date. Thus if the subject assets depreciated in value after the deemed acquisition date, so that the unrealised profits were lost, so the Commissioner hypothesised, it would not be reasonable to attribute a subsequent dividend to the profits accrued at acquisition, and s 160ZK(5) would not apply.
81 The Commissioner's submissions then addressed the controversy concerning the operation of the now repealed s 160ZLA, and submitted that no assistance could be obtained from the wording thereof in construing s 160ZK(5), nor could any limitation on the meaning thereof be imputed. As has already been indicated, s 160ZK(5) defines a rebatable dividend adjustment for the purposes of s 160ZK(1B), as the language of s 160ZK(1B) was said to make plain, and thereby for the purpose of ascertaining the reduced cost base of shares in a relevant company. The Commissioner further submitted that the provisions of s 160ZK(5) apply only for the purpose of reducing capital losses which are recouped by rebatable (and thus tax-free) dividends, and by virtue of par (d) thereof, only then to receipts by a controller of the company.
82 The Commissioner next pointed out in relation to s 160ZLA that the section provided a different definition of the same term for the purposes only of two different provisions, in order to prevent conversion of capital gainsinto rebatable (ie tax-free) receipts, those two different provisions being:
(i) Sub-section 160ZA(4A), enacted in 1994, which excluded 'rebatable dividend adjustment' amounts from otherwise assessable income, in respect of which relief was afforded by s 160ZA(4), by way of reducing a capital gain to the extent of the overlap; and
(ii) Sub-section 160ZL(5), which treated a 'rebatable dividend adjustment', as defined in s 160ZLA, as a return of capital for the purpose of that section.
83 The Commissioner thereafter submitted that the definition in s 160ZLA, for the purposes of the reduction of amounts for calculation of a reduced cost base, was confined to distributions carrying an entitlement to a dividend rebate made by a company in respect of a disposal of its shares or a reduction of capital or a winding up, or under an arrangement:
(i) under which the same or other shares were issued at a premium, to the extent that the premium recouped the dividend; or
(ii) which included the revaluation of assets, the sale of which would have generated an assessable profit, whether or not the distribution was made out of the revaluation reserve.
A different but similarly limited definition of rebatable dividend adjustment was included for the purpose of the share buy-back provisions of the Tax Act, by the insertion of s 159GZZZMA.