Taxation, Commissioner of (Cth) v Ellers Motor Sales Pty Ltd

1. (1957) 100 C.L.R. 66. 2. (1957) 100 C.L.R. 66.

Before the transactions in question took place, profits were held by the companies and they were ultimately concentrated in Harcourt, which then had a large sum available for distribution. At the end of the transaction, Harcourt had distributed that money and its former shareholders had received amounts, proportionate to their respective shareholdings, the total of which corresponded closely to the amount distributed by Harcourt. It seems to me upon the facts that a dominant purpose of the transactions was to arrange matters in such a way that money would be received as capital and not as income. At the same time the tax problems were resolved which would afterwards have confronted Harcourt, or alternatively its shareholders, if nothing had been done and if the money had simply been retained by Harcourt, namely the prospect that it would become liable for Div. 7 tax if it did not make a distribution; and if it did distribute subsequently to its shareholders by way of dividend the money that it held, Mr. and Mrs. Ellers would have been taxable on the dividends received by them and the shareholders who were companies might not have obtained a full rebate.

Subject to certain arguments to the contrary which have yet to be considered, this appears to me to be an arrangement of the kind to which s. 260 should be applied, so as to enable the Commissioner to assess tax on the former shareholders in Harcourt as if they had remained its shareholders, in accordance with the principles as to the operation of s. 260 established in such cases as Bell v. Federal Commissioner of Taxation [1] , Federal Commissioner of Taxation v. Newton [2] , and on appeal to the Privy Council [3] , and Hancock v. Federal Commissioner of Taxation [4] . According to those authorities it is appropriate to look at the end result of the transaction from the point of view of Harcourt and from the point of view of those who were its shareholders before the transfer of the shares to Holdings. The end result was that the profits had gone out from Harcourt and that an equivalent amount had come into the hands of its shareholders. To adopt the phrase used by Fullagar J. in Newton's Case [5] , it may be said in my opinion that "the only real money" which figured in the transactions was Harcourt's money. The loan from the bank to Ellers, the loan from Ellers to Holdings, the use by Holdings of the credit so obtained to pay for the shares, the use of the dividend received by Holdings to pay back the loan obtained from Ellers and the use by him of that money to repay the bank were all steps in the transaction which, although they were "genuine" and although on the face of them they effected transfers of assets (the Harcourt shares) in exchange for a price, did not prevent the end result from being, as it was intended to be, that the Harcourt profits found their way into the hands of those who had been its shareholders. It does not matter that the payment for the shares was made (by means of borrowed money) before the dividend was actually received by Holdings. As was said by Menzies J. in Mayfield v. Federal Commissioner of Taxation [No. 2] [6] , "a substantial identity between what the company distributed and what the assumed members received is sufficient".

1. (1953) 87 C.L.R. 548. 2. (1957) 96 C.L.R. 577. 3. [1958] A.C. 450; (1958) 98 C.L.R. 1. 4. (1961) 108 C.L.R. 258. 5. (1957) 96 C.L.R., at p. 656. 6. (1961) 108 C.L.R. 323, at p. 334.

If the arrangement made between the parties was an arrangement which, so far as it effected the result of transferring the profits held by Harcourt to the hands of its former shareholders, was essentially the same as the arrangements which in the cases cited were held to be affected by s. 260, I am of opinion that the application of that provision is not precluded by the fact that it was part of the arrangement that what has been called a "Keighery company" should be formed. In a practical sense it was a necessary element in the scheme that the recipient of the Harcourt dividend should be one which would enjoy some particular advantage in relation to the impact upon that recipient of taxation. In this case the advantage lay in the circumstance that there was a rebate entitlement under s. 46 and that Holdings was not a private company for the purposes of Div. 7. In Hancock's Case [1] , the recipient of the dividends was in a position of advantage for a different reason, namely, that being a company which traded in shares it expected to set off a loss upon a resale of the shares against what would otherwise have been its taxable income. In my opinion the inclusion in the scheme of the formation of a Keighery company did not operate automatically to make s. 260 inapplicable to the assessment of the former shareholders, in respect of the moneys received by them. Its application in that way would not operate in my opinion "to deny to taxpayers any right of choice between alternatives which the Act itself lays open to them" (see Keighery's Case [2] ).

1. (1961) 108 C.L.R. 258. 2. (1957) 100 C.L.R., at p. 92.

In Hancock's Case [3] , Kitto J. said that the acts done will enable an arrangement to be characterized as a means for the avoidance of tax -

if they have included a transfer of property from the taxpayer in consequence of which income from the property, instead of being received as such by the taxpayer, has followed either of two courses: (i) a course which has carried it through the hands of other persons to the taxpayer, but so as to reach him with the character of capital; or (ii) a course which has amounted in effect to an application of the moneys by the taxpayer, and so has been a practical equivalent of a receipt by him followed by an expenditure by him. If a taxpayer makes a decision to arrange matters so that income from his property follows one of the courses so described and reaches him with the character of capital, in my opinion he is not thereby exercising a "right of choice between alternatives which the Act lays open to him", whether or not the intermediary which he has chosen to interpose between himself and the source of the money happens to be a "Keighery company". At this point it is important, in my opinion, to distinguish between the tax liability of a company which has been formed or reconstructed in such a manner that its character is, for the purposes of the Act, that of a non-private company and the liabilities for tax assessed upon their own incomes of others who have been concerned in that formation or reconstruction. In my opinion it is possible that the circumstances may be such that s. 260 may be used in assessing the latter liabilities, notwithstanding that it cannot be applied in assessing the tax liability of a company so as to treat the company as having a character different from that which it bears according to the terms of the Act as applied to the facts which exist at the relevant date. In Federal Commissioner of Taxation v. Casuarina Pty. Ltd. [1] , in referring to the fact that the taxation liabilities of the Sternberg companies or the Sternbergs were not in question, I recognized that possibility; so also did Gibbs J. [2] . 1. (1961) 108 C.L.R. at p. 283. 2. (1971) 127 C.L.R. 62, at p. 97. 3. (1971) 127 C.L.R., at p. 104.

It is necessary now to refer to some submissions on behalf of the respondents. One was that s. 260 is not applicable, for the reason that the profit did not get out to the pockets of the shareholders, but remained in the company group; and will be liable when distributed by Holdings to taxation as dividends received by the shareholders therein. In relation to that submission, there has been a contest upon the question whether or not it is inevitable that a tax liability of that kind will be incurred in the future. In my opinion, this is not inevitable, but I do not think that the result of these appeals depends in any way upon deciding what tax, if any, will be imposed in the future in consequence of an assumed distribution of profits by Holdings, whether by way of dividends or by way of a distribution in a winding-up. There is no doubt that "the real money" came to the hands of the respondents. It came in such a form that it is not taxable unless s. 260 operates. The question whether s. 260 operates or does not operate to enable the appellant for the purposes of the assessment of tax upon the recipients to treat the money as if it had been received by them as income cannot depend, in my opinion, upon what will ultimately happen to the profits shown in the balance sheet of Holdings as at 30th June 1965 as "unappropriated profits". If the scheme enabled the respondents to avoid or alter or defer liabilities which might otherwise have fallen upon them, the arrangement was in my opinion within the descriptions contained in s. 260, regardless of whether it was effective to solve completely the problems of the group of companies, including any which might subsequently arise in relation to the consequences of the carrying out of the scheme. In this connection it may be observed that the shareholders of Holdings, upon whom if they remained shareholders a tax liability in respect of future dividends declared by it would fall, do not include Sales or Junelle, but are two only of the former shareholders in Harcourt. But even if the shareholders were identical, the question whether they were liable to tax as if they had remained shareholders in Harcourt and had received the money which came from it as income would not depend in my opinion upon determining whether or not they might come under a tax liability at some time in the future, as shareholders in Holdings, as a consequence of its having received the dividend from Harcourt.

Associated with the submission now being considered was an argument that because the profits remained (so it was said) within "the company cell", the transaction could not be described as "a dividend-stripping operation" and therefore such cases as Hancock's Case [1] and Newton's Case [2] had no application. It was said that the principles laid down in those cases as to the operation of s. 260 do not apply unless it is a stranger to the company group that is interposed between a company the profits of which are distributed and the persons to whom in the end result the money comes. In my opinion the judgments in the leading cases concerning s. 260 do not require the placing of such a qualification or gloss upon the principle upon which they were decided. If one finds the principle applied in cases in which in fact the purchaser of shares was a "stranger", as in Hancock's Case [1] and Newton's Case [2] , it is an error to conclude that the principle is limited to cases in which that fact exists, unless it appears from the judgments that this was held to be an essential fact. In my opinion, that does not appear from any of the judgments.

1. (1961) 108 C.L.R. 258. 2. (1957) 96 C.L.R. 577. 3. (1961) 108 C.L.R. 258. 4. (1957) 96 C.L.R. 577.

The circumstances that in this case it was not part of the plan that the shares in Harcourt should revert to their former owners after it had paid a large dividend does not preclude a finding that there was an arrangement to which s. 260 applied. A bargain for a resale of shares may be in some cases a fact to be taken into account in deciding whether an arrangement had a tax-avoidance purpose and was not a mere agreement for the sale of shares by their owners, to which the section could not apply. The absence of an agreement for resale of the shares does not require a finding that the arrangement was nothing more than the ordinary sale of an asset. The operation of s. 260 is not precluded either by the fact that the sale of the shares was a "genuine" sale nor by the fact that there were other purposes, as well as a tax-avoiding purpose, which the arrangement was intended to serve. In my opinion it cannot be said of the respondents that all that they did was to sell their shares cum dividend. It was of the essence of the arrangement that the money which they were to receive upon the sale should come from the profits held by Harcourt and from no other source. In this respect, their position may be contrasted with that of the Lefroys in Hancock's Case [1] .

For the reasons stated I conclude that there was an arrangement to which s. 260 applied, so that in assessing the tax of each of the respondents the transfers of shares in Harcourt to Holdings may be disregarded in so far as the transfers, if treated as valid, would have the effect that the money received by the shareholders was received as capital and not as income. But it is necessary now to consider what is the effect of applying the provision.

It was submitted on behalf of Sales and of Junelle that in considering the tax liability of each company the only transfer that could be regarded as void was its transfer of its own shares. The transfers made by the other shareholders in Harcourt could not be so regarded. It was said that if you examine separately the position of Sales and you treat it as having remained a shareholder in Harcourt, the result is that Holdings became the owner (by transfer from the other shareholders) of 102 shares in Harcourt out of an issued capital of 202 shares. Thus Harcourt became a subsidiary of Holdings. As Junelle was a subsidiary of Harcourt and as Sales was owned by Junelle and Harcourt, the result is said to be that even on the assumption that the transfer by Sales of its shares is treated as void, nevertheless Sales was not for the purposes of Div. 7 a private company and for this reason the assessment of Div. 7 tax cannot be sustained. The same arguments are applicable in the case of Junelle. In my opinion the proposition on which this line of argument depends cannot be accepted. It is not correct to say that in considering the position of Sales the only transfer that can be disregarded is its own transfer. If you find an arrangement which, if valid, would have one of the effects described in s. 260, then (subject to what is stated later in these reasons) any step which has been taken pursuant to that arrangement may be disregarded to the extent to which it would play a part, if valid, in bringing about that effect.

I have stated the conclusion that the appellant was entitled to assess the respondents on the footing that the sums which they received from the sale of the shares in Harcourt were received by them as dividends, by means of which the profits of Harcourt were distributed to them. A question that still remains to be considered is a question as to the manner in which the tax that was properly payable in respect of the income derived respectively by each of the respondents is to be ascertained. As to Mr. and Mrs. Ellers this presents no problem. But as to each of the companies, a problem arises at this point concerning the application, for the purpose of determining its status for tax purposes, of the principles accepted in the cases of Keighery [1] and of Casuarina [2] . For reasons which I have stated, I am of opinion that those principles do not operate to make inapplicable such authorities as Hancock's Case [3] and Newton's Case [4] . Section 260 may be applied to render ineffective the attempt to prevent the receipt by the shareholders in Harcourt of a distribution of its profits from being taxable, by arranging that the money should be received in the form of capital. But it is another question whether s. 260, as interpreted in the cases of Keighery [1] and Casuarina [2] , can be applied so as to treat Sales and Junelle as retaining the character of private companies, doing this by disregarding the effect of the transfers of the shares in Harcourt to Holdings upon the character of those companies. One of the objections raised to the assessments of each of those companies was that in relation to the year of income ended 30th June 1965, it was not a private company for the purposes of Div. 7. On the hearing of these appeals it was submitted that the consequence of the transfer by Sales and by Junelle of the shares in Harcourt to Holdings was that Sales and Junelle became companies which were not private companies as defined by the Act. It was submitted that it was open to them to do the acts which brought about that result and that the resulting change in their character was a change which cannot be disregarded when assessing tax in respect of income received by them in the relevant year. In my opinion, these submissions should be upheld.

1. (1957) 100 C.L.R. 66. 2. (1971) 127 C.L.R. 62. 3. (1961) 108 C.L.R. 258. 4. (1957) 96 C.L.R. 577. 5. (1957) 100 C.L.R. 66. 6. (1971) 127 C.L.R. 62.

The transfers of shares to Holdings were genuine transactions. The result of them was that Holdings, which at the relevant date was not a private company, held all the shares in Harcourt. The Act, in the form in which it continued to be operative up to the relevant date, provided that for the purposes of Div. 7 a company is a private company if "it is not a subsidiary of a public company" (s. 105 (1)) and that "a company is a subsidiary of a public company if, by reason of the beneficial ownership of the shares, the control of the company is in the hands of one or more companies none of which is a private company" (s. 105 (4) (b)). According to these provisions, Harcourt was at the relevant date a subsidiary of a public company, because its control was in the hands of Holdings which was not a private company. Therefore Harcourt was not a private company. For similar reasons, Junelle, in which Harcourt held most of the shares, was not a private company and Sales, in which the shares were held by Harcourt and Junelle, was not a private company.

It does not appear that the advisers who formulated the plan which was adopted gave attention to the consequential changes in the character of Harcourt, of Sales and of Junelle, which the formation of a company which was not a private company and the transfer to it of the Harcourt shares would combine to bring about. Those changes may have been by-products of what was done rather than changes which were directly contemplated and intended. But, in my opinion, that does not preclude the respondent companies from asserting that the appellant was not authorized by the Act to tax them as if they had a character for the purposes of the Act which, in truth, according to its provisions and to the facts, they did not have. It may be urged that the changes in the character of these companies were not effected in the exercise of a "choice" presented to them, because they were changes which were not consciously sought. But, in my opinion, the alteration of the relevant facts which the carrying out of the scheme in fact produced was an alteration that could not be ignored, consistently with Keighery's Case [1] , in determining what was the character at the relevant date of the companies which were being assessed to tax. I am of opinion that the respondent companies are not precluded by the circumstance that they described themselves as private companies in their tax returns or by the fact that Sales at least may have obtained an advantage in relation to the primary tax imposed upon it by being treated as a private company from asserting now that they were not private companies at the relevant date in 1965. On this question I accept with respect the view expressed by Menzies J. in Federal Commissioner of Taxation v. Cappid Pty. Ltd. [2] , which has not been affected by the judgments in the appeal in that case [3] which do not deal with that question.

1. (1957) 100 C.L.R. 66. 2. (1970) 127 C.L.R. 140. 3. (1971) 127 C.L.R. at p. 149.

In my opinion, it is legitimate in the circumstances of this case to hold that s. 260 operates to entitle the appellant to disregard the transfers of the shares, in so far as they would serve the purpose of altering the character of the receipt of money by the former shareholders from an income receipt to a capital receipt and at the same time to hold that s. 260 cannot be applied so as to obliterate the change brought about by the transfers of the shares in the character, for taxation purposes, of the respondent companies. In so far as the transfers effected the latter change they must be treated as having taken effect, in relation to the status for taxation purposes of the respondent companies. That was an effect which, according to the principle of Keighery's Case [1] , lay outside the scope of the operation of s. 260. But in so far as the transfers effected the former change, they were within the scope of that provision and may be disregarded. The application of s. 260 does not require that if a step in an arrangement is treated as void for some purposes it must necessarily be treated as void for all purposes. That is illustrated by the case of Rowdell Pty. Ltd. v. Federal Commissioner of Taxation [2] .

1. (1957) 100 C.L.R. 66. 2. (1963) 111 C.L.R. 106.

In answer to the submissions now being considered, learned counsel for the appellant argued that in so far as a "choice" was available as to what the status of Harcourt should be at the end of the tax year, that was a choice given to Harcourt and not to anyone else. But the question in issue is a question concerning the status of Sales and of Junelle and, in my opinion, it was open to them to bring about a state of facts which, upon the application of the relevant provisions of the Act, would make them non-private companies. It was said also that there is a difficulty in considering the status of Sales and of Junelle, for the reason that Sales was a shareholder in Harcourt and was also a subsidiary of Harcourt and this was in breach of s. 17 (1) of the Companies Act, 1962-1966 SA. But in my opinion, this can have no bearing upon the question of the status which Sales had after it had transferred its shares in Harcourt and was no longer a shareholder in that company.

It is necessary now to apply the foregoing conclusions to the assessments which are in dispute. The assessment of Junelle for Div. 7 tax in respect of income of the year ended 30th June 1965 cannot stand, because it was not at the end of that year a private company. Therefore the order setting aside that assessment was correct and the appeal against that order should fail. In my opinion the assessments of Mr. and Mrs. Ellers should not have been set aside and the appeals against the orders setting them aside should be allowed. As to Sales, the assessment of primary tax has not been shown to have been excessive. Although upon the view that I have taken it was wrong to assess tax on the footing that it was a private company, it does not appear that if it had been assessed on the footing that it was not a private company the amount of primary tax would have been smaller. But the assessment of Div. 7 tax in respect of the year ended 30th June 1965 was not warranted and the appeal against the order setting aside that assessment should fail.

That leaves for consideration the appeal which relates to an assessment against Sales of Div. 7 tax in respect of the year of income which ended on 30th June 1967. In respect of that year Sales made an income tax return in which it described itself as a private company. That was correct. It was a private company on 30th June 1967, under the legislation which was then in force, as it was not a subsidiary of a public company as defined by that legislation. Its return showed a taxable income of $12,528. In arriving at that figure a deduction had been made of losses in previous years amounting to $15,184. The company was assessed for ordinary tax on its taxable income. The tax was $3,698. Later, there was a Div. 7 assessment levied on an undistributed amount of $4,415. It seems plain that that figure was obtained by deducting an allowance (s. 105B) of fifty per cent from the balance remaining after deducting the amount of the primary tax from the taxable income. Very little argument was addressed to the Court in relation to this appeal. From the grounds of objection, it appears that it was there claimed that there was a large sum which ought to be treated as an "excess distribution" and deemed to be a dividend paid during the prescribed period of 1st May 1967 to 30th April 1968, in accordance with the provisions of s. 106 (2) of the Act. The notice of objection set out that objections were being lodged against the assessments in respect of the income of the year ended 30th June 1965 and a copy of those objections was incorporated in the objection to the Div. 7 assessment with respect to the income of the year ended 30th June 1967. Alternative claims were then made. The first was that if the company was a private company in relation to the 1965 year of income and if the amount received on the sale of the Harcourt shares should be excluded from the assessable income and the taxable income of that year, then the company was entitled by s. 106 (2) to have an excess distribution deemed to be a dividend. The second claim was to the effect that if the company was not a private company in relation to the 1965 year and if the amount derived from the sales of the shares should be excluded from the assessable income and the taxable income of that year, then the Commissioner was not empowered to correct what was said to have been a mistake of law made by him in treating the company as a private company in relation to that year and he could not now treat it as a non-private company. The consequence was said to be that the company was entitled under s. 106 (2) to have an excess distribution deemed to be a dividend. It was an essential element in each of those alternative claims that the money received upon the sale of the shares should not have been included in the assessable income or the taxable income of the 1965 year. It follows from my conclusion that that money was properly included in the income of that year, that neither of those claims, as stated in the notice of objection, has been made out. The grounds of objection referred to an appendix setting out the basis upon which was calculated an amount claimed to have been an excess distribution in respect of the year of income ended 30th June 1965. It seems that this appendix was not included in the appeal books but I have seen a copy of it. It is not self-explanatory. It has not been explained or discussed in argument. In my opinion it has not been established that there was, within the meaning of s. 106 of the Act, an excess distribution for the year of income ended 30th June 1965.

In my opinion, the following orders should be made:

(a) that the appeal of Ellers Motor Sales Pty. Ltd. against the disallowance of its objections to the amended assessment No. 936070 issued on 21st February 1969 be dismissed and that that assessment be confirmed.

(b) that that company's appeal against the disallowance of its objections to the assessment issued on 21st February 1969 under Div. 7 of Pt III of the Act be allowed and that assessment be set aside.

(c) no order as to the costs at first instance of those appeals.

(3) Order that the appellant the Commissioner of Taxation pay one-half of the costs of the respondent of the appeal to the Full Court.

(3) In lieu thereof order that the appeal against the disallowance of objections to the amended assessment No. 619738 be dismissed with costs and that assessment be confirmed.

(3) In lieu thereof order that the appeal against the disallowance of objection to the assessment No. 1081113 be dismissed with costs and that assessment be confirmed.

(3) In lieu thereof order that the appeal against the disallowance of objections to the assessment of Div. 7 tax in relation to the year of income ended 30th June 1967 be dismissed with costs and that assessment be confirmed.

I have had the advantage of reading the reasons for judgment prepared by my brother Walsh. I am in agreement with his reasons and further agree with the orders that he proposes.