Australia and New Zealand Savings Bank Limited v Commissioner of Taxation of the Commonwealth of Australia

[1995] FCA 990

CATCHWORDS

Taxes and Duties - Income tax (Cth) - Ascertainment of assessable income - Exempt income - Includes "the deductible amount" excluded from assessable income by s.27H(1)(a) of the Income Tax Assessment Act 1936 in relation to annuity payments.

Taxes and Duties - Income tax (Cth) - Ascertainment of assessable income - Partners and partnerships - Purchased annuity payment to trustee for partners - Trust deed provided that only so much of the payment as was assessable income in relation to the trust estate should be income of the trust and that the balance should be capital and be paid to the partnership in redemption pro tanto of the units held in the trust - The balance held to be exempt income of the trust estate and received by partnership as exempt income of the partnership.

Income Tax Assessment Act 1936 - s 27H, Divisions 5 and 6 of Part III

AUSTRALIA AND NEW ZEALAND SAVINGS BANK LIMITED v. THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

VG314 of 1989

AUSTRALIA AND NEW ZEALAND SAVINGS BANK LIMITED v. THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

No. VG209 of 1990

Jenkinson J.
Melbourne
5 December, 1995

IN THE FEDERAL COURT OF AUSTRALIA   )
VICTORIA DISTRICT REGISTRY         ) 
GENERAL DIVISION                   )

IN THE MATTER of the Income  Tax Assessment Act 1936

VG No. 314 of 1989

BETWEEN:AUSTRALIA AND NEW ZEALAND SAVINGS BANK LIMITED

Applicant

AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Respondent

VG No. 209 of 1990

BETWEEN:     AUSTRALIA AND NEW ZEALAND             SAVINGS BANK LIMITED

Applicant

AND:THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Respondent

CORAM:     Jenkinson J.

PLACE:     Melbourne

DATE:     5 December, 1995

REASONS FOR JUDGMENT

Further hearing of two appeals against decisions of the respondent on objections against income tax assessments in respect of the years of income ended 30 June 1986 and 1987.

The history of the litigation in this court and in the High Court is disclosed by reports at 92 A.T.C. 4630, 42
F.C.R. 535 and 181 C.L.R. 466. The orders made by the High Court included orders in respect of each of the appeals to this court in accordance with these minutes:

"Orders of the trial Judge be set aside and in lieu thereof:

(i)Order the objection decision of the respondent Commissioner be set aside and the respondent pay the appellant's costs of the appeal.

(ii)Declare that -

A.the assessable income of ANZ-ANZ Savings Bank NSW Treasury Corporation Annuities Partnership No. 17 is to be calculated by reference to s.27H of the Income Tax Assessment Act 1936 (Cth);

B.the net income of the Partnership is to be calculated after determination of the Partnership's allowable deductions.

........ ........ ........ ........ ........ .......

Remit to the Federal Court for consideration in accordance with the reasons of this Court the deductions allowable to the Partnership under s.51(1) of the Income Tax Assessment Act, the appellant to have the costs of the proceedings on remittal unless the Federal Court otherwise orders in whole or in part."

The applicant was at relevant times one of two members of the partnership specified in the order. The deductions the allowance of which is in question are of interest and other charges incurred by the partners during each year of income in respect of money borrowed by them to provide part of the consideration for the purchase by them of investment units in a trust fund. The trustee of the fund made with the New South Wales Treasury Corporation agreements for the purchase by the trustee of what a Full Court of this court has held to be annuities, within the meaning of that word in s.27H of the Income Tax Assessment Act 1936. Amounts of those annuity payments received by the trustee were paid by the trustee to the holders of the investment units, which were held by the partners as assets of the partnership, in accordance with provisions of the deed by which the trust was constituted.

Section 51(1) of the Income Tax Assessment Act 1936 provides:

"All less and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income."

Provisions of s.27H relevant to a consideration of the deductions allowable to the partnership under s.51(1) are:

"The assessable income of a taxpayer of a year of income shall include -

(a)the amount of any annuity derived by the taxpayer during the year of income excluding, in the case of an annuity that has been purchased, any amount that, in accordance with the succeeding provisions of this section, is the deductible amount in relation to the annuity in relation to the year of income;"

The "deductible amount" is directed by "succeeding provisions" of s.27H to be calculated in a way which is designed to identify, in the case of an annuity that has been purchased, so much of the capital component of an annuity payment as has not been, and will not be, an allowable deduction or the subject of a rebate, in accordance with the conception stated by the High Court in Egerton=Warburton v. Deputy Federal Commissioner of Taxation (1934) 51 C.L.R. 568 at 574 that "every annual payment on account of an annuity may be considered to be composed of a proportion of the principal invested in the annuity and an amount of interest borne by the principal".

Mr. Bloom Q.C., who appeared with Mr. B.J. Sullivan for the applicant, submitted that, because s.27H, together with the relevant Income Tax Act, imposed a tax on a proportion of each annuity payment, the whole of the payment is taxed and no part of it is exempt income.  Therefore, in Mr. Bloom's submission, the whole of the interest and other charges incurred by the partners in a year of income are allowable deductions in the calculation of the net income of the partnership because that whole was incurred in gaining the assessable income of the partnership.  Reliance was placed upon the judgment of Fullagar J. in Mutual Life and Citizens' Assurance Co. Ltd. v. Commissioner of Taxation (1959) 100 C.L.R. 537. In that case the taxpayer, a resident of this country, held as part of its life assurance fund investments in certain United Kingdom securities and securities of British
possessions, the income from which was paid and payable in the United Kingdom. In the latter country income tax had been imposed by the law of that country on "[s]uch portion ... of the income ... as bears the same proportion to the total income from those investments as the amount of premiums received in that year from policy holders resident in the United Kingdom ... bears to the total amount of the premiums received by" the taxpayer. Section 23(q) of the Income Tax Assessment Act 1936 then relevantly provided:

"The following income shall be exempt from income tax:- ... (q) income derived by a resident from sources out of Australia, where that income is not exempt from income tax in the country where it is derived ..."

In reasoning to the conclusion that the whole of the income was exempt from income tax by virtue of s.23(q) Fullagar J., in whose judgment Dixon C.J. concurred, made these observations (100 C.L.R. at 550, 553-554, 555):

"If you impose tax on a proportionof x, you are taxing x, and, if x includes y, you are taxing y.  In other words, as my brother Menzies put it during argument, if you impose a tax on 10 per cent of an amount which includes several items, then you are imposing a tax on every item which is included in that amount.

........ ........ ........ ........ ........ .......

The general scheme of the Commonwealth legislation is not to impose tax by reference to specific categories of income.  It contains, of course, many special provisions as to what does and does not constitute income, but its
general plan is to treat as `assessable income' - gross income - whatever is income within the general conception of that term, and to require the `taxable income' to be ascertained by subtracting from assessable income what are called `allowable deductions'.  Consistently with this general plan no income can be regarded as exempt from income tax either if it is required to enter into the calculation directly as itself a part of the assessable income, or even if, though it is excluded from the actual calculation of assessable income, the rate of tax is increased by reference to its existence.

........ ........ ........ ........ ........ .......

It is true, of course, that r.3 of Case III of schedule D does not in terms charge with tax the whole of that interest, but only a specified proportion (2.888 per cent) of that whole. But it does not follow that only that percentage of that whole is to be regarded as `not exempt from income tax' for the purposes of s.23(q). It is not possible to say that any identifiable part of the total sum is taxed, and that an identifiable remainder is `exempt'. It is not possible to attribute or appropriate the United Kingdom tax paid by the company to any specific part or portion of the total interest from the four classes of security in question. The tax was calculated by reference to a percentage of the total sum, but it was not paid on any specific part of that total sum. If it had ever become necessary for any purpose to apportion the amount of tax paid among components of the interest received, the apportionment could only have been made by attributing the tax paid to each pound of that interest rateably."

The expression "exempt income" was then, and still is, defined to mean, unless the contrary intention appears, "income which is exempt from income tax and includes income which is not assessable income".  The final clause of that definition has in my opinion reference only to that which has not the character of assessable income in the contemplation of the Income Tax Assessment Act 1936. The expression "assessable income" was, and is, defined in s.6(1) to mean "all the amounts which under the provisions of this Act are included in the assessable income". That final clause could not therefore influence the construction of the words "is not exempt from income tax in the country where it is derived" in s.23(q). In this case, however, the final clause operates, in my opinion, to require recognition that the amount excluded by s.27H(1)(a) is excluded from the assessable income and is therefore "not assessable income" within the meaning of those words in the definition of exempt income.

But, Mr. Bloom submitted, the amount excluded is capital, not income.  Even in the hands of the trustee under the trust deed, "the deductible amount in relation to the annuity" was in the contemplation of the Income Tax Assessment Act 1936, as it had been in the contemplation of the Income Tax Assessment Act 1922, "that part of the annuity which represents the purchase price". (See Income Tax Assessment Act 1922, s.4; Income Tax Assessment Act 1936, s.26(c) (as originally enacted). Mr. Bloom demonstrated, by reference both to Parliamentary material and judicial exposition, that "every annual payment on account of an annuity may be considered to be composed of a proportion of the principal invested in the annuity and an amount of interest borne by the principal". (See Egerton-Warburton v. Deputy Federal Commissioner of Taxation 1934) 51 C.L.R. 568 at 574.) But that is no more than an explanation of the legislature's reason for excluding that proportion of the principal invested
in the annuity from assessable income, and does not contradict the conclusion, stated by the High Court, in the case cited, and reaffirmed by Hill J., in whose judgment Heerey J. concurred, in Australia and New Zealand Savings Bank Ltd. v. Commissioner of Taxation (1993) 42 F.C.R. 535 at 563, that the whole of the annuity payment is income, in contemplation of law, including the Income Tax Assessment Act 1936.

An alternative submission by Mr. Bloom was that, if the whole of the annuity payment was received by the trustee as income, the whole of that payment was not received by the two partners as income in their hands. The two partners held all the 50,000 investment units issued. The trustee held the capital of the trust fund upon trust for the holders of investment units. (There had first been issued ten "management units" to the manager of the fund in consideration of its payment of $10. Those units conferred no interest in the capital of the trust fund, but such an interest in the income of the fund as was provided in the trust deed.) The capital in relation to the trust fund was defined by the trust deed to mean the fund other than the income of the fund. The income of the fund in relation to a financial year was defined by the trust deed to mean the income in respect of that year as determined in accordance with s.95(1) of the Income Tax Assessment Act 1936. The trust deed provided that the capital of the fund should be held on trust absolutely for the investors in the fund in proportion to the number of investment units in that fund respectively held by them, and should be held on such trust "in accordance with this Deed" : clauses 3.1(b) and clause 10.2 of the trust deed. The trust deed further provided that, "when and to the extent that the Trustee receives cash representing capital" of the trust fund to which an investor is entitled, investment units held by the investor should be redeemed, by payment to the investor of that cash, at what the deed designated as "the Redemption Price" of one dollar per unit. That was also the purchase price of a unit. Section 95(1) of the Income Tax Assessment Act 1936 included a definition, for the purposes of Division 6 of Part III of that Act, of the expression "net income", as follows:

"`net income', in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except the concessional deductions and deductions under Division 16C and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under section 80, 80AAA or 80AA in respect of such of the losses of previous years as are required to be met out of corpus."

Mr. Bloom submitted that the cash received by the partners in respect of the redemption of investment units, although received by the trustee as income, was received by the partners as a return of capital and in extinguishment pro tanto of their capital interest in the trust.  An analogy was drawn between the partners' receipt and the receipt by a shareholder of an amount representing three-fortieths of the value of the net assets of the company upon cancellation of her shares, which were three-fortieth of the issued shares.  In Thornett v. The Federal Commissioner of Taxation (1938) 59 C.L.R. 787 the High Court held the latter receipt to be "in satisfaction of, and by way of replacement for, her share interest", not as to any part income by way of dividend, notwithstanding that what she received exceeded a full return of her share of the paid-up capital of the company. Analogy was also drawn with the redemption of preference shares in a company. These analogies rest on the assumption that what was received by the partners upon redemption of units was a return pro tanto of capital invested by them by purchase of the units. But there was in the eye of the law no capital to return. At the direction of the partners the whole of the capital payment to the trustee for the investment units was expended by the trustee in acquisition of the annuities. That legal situation cannot be affected by the choice which the partners and the other parties to the trust deed made to treat, or to constitute as capital of the trust a part of each annuity payment as and when the payment is received. That contractual arrangement between the parties may be legally effectual. But the analogies sought to be drawn by Mr. Bloom are in my opinion false.

After each receipt by the partners of cash in redemption of investment units the partners remained as they were before that receipt, beneficially entitled to the whole of the trust fund (after provision for the manager's interest and the trustee's right of indemnity).  If there had been another investor, the partners would have been beneficially entitled to the same proportion of the whole of the trust fund after as before any redemption.  (The trust deed provisions contemplated the possibility of other investors.)  As was observed in Charles v. Federal Commissioner of Taxation (1954) 90 C.L.R. 598 at 609, where a unit under a trust deed confers a proprietary interest in all the property which for the time being is subject to the trust, "the question whether moneys distributed to unit holders under the trust form part of their income or of their capital must be answered by considering the character of those moneys in the hands of the trustees before the distribution is made". That character in this case was that of income.

Sub-section 97(1) provided:

"Where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate -

(a)the assessable income of the beneficiary shall include -

(i)so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; and

(ii)so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia; and

(b)the exempt income of the beneficiary shall include -

(i)so much of the individual interest of the beneficiary in the exempt income of the trust estate as is attributable to a period when the beneficiary was a resident; and

(ii)so much of the individual interest of the beneficiary in the exempt income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia,

except to the extent to which the exempt income to which that individual interest relates was taken into account in calculating the net income of the trust estate."

Mr. Bloom submitted that the partners had no "individual interest ... in the exempt income of the trust estate" because what I have held to be exempt income of the trust estate is by virtue of the provisions of the trust deed made capital of the trust fund and as capital is applied in redemption of investment units.  But for the reasons given the partners did in my opinion have an individual interest in the whole of each annuity payment when it was received by the trustee, they being beneficially entitled to the whole trust fund (after making the provisions I have mentioned).  And in my opinion the operation of s.97(1) is not affected by the circumstance that the parties to the trust deed agreed to treat as an accretion to capital part of what the trustee received as income.

In the calculation of the "net income" of the partnership for the purposes of Division 5 of Part III of the Income Tax Assessment Act 1936 the allowable deductions in
respect of the outgoings of interest and other charges will not in my opinion include so much of the outgoings as were incurred in relation to the gaining of the payments on redemption of investment units, because those payments were exempt income of the partnership.  Counsel for both parties invited me, in the event that I reached that conclusion, to afford them an opportunity to see whether the parties could agree on the basis of calculation of those allowable deductions.  Accordingly I will order that further consideration of each appeal be adjourned to a date to be fixed.

I certify that this and the 12 preceding pages are a true copy of the Reasons for Judgment of the Honourable Justice Jenkinson.

Associate

Dated:  5 December, 1995

Counsel for the Applicant     :    Mr. D.H. Bloom Q.C. and Mr. B.J. O'Sullivan instructed by Freehill Hollingdale and Page

Counsel for the Respondent    :    Mr. B.J. Shaw Q.C. and Mr. G.T. Pagone instructed by Australian Government Solicitor

Date of Hearing             :    11 September, 1995

Date of Judgment            :    5 December, 1995