Cecil Bros Pty Ltd v Federal Commissioner of Taxation

[1964] HCA 82

HIGH COURT OF AUSTRALIA

Owen J. Dixon C.J., Kitto, Taylor, Menzies and Windeyer JJ.

CECIL BROS. PTY. LTD. v. FEDERAL COMMISSIONER OF TAXATION

(1964) 111 CLR 430

16 July 1962

Income Tax (Cth)

Income Tax (Cth)—Avoidance of arrangement having purpose or effect of avoiding any liability imposed by Act—Outgoings incurred in gaining or producing assessable income—Purchases by retailer from associated family company—Prices paid higher than those at &hich retailer able to purchase those goods from usual trade suppliers—Family company thereby enabled to make profit—Income Tax and Social Services Contribution Assessment Act 1936-1960 (Cth), ss. 51 (1), 260.

Decisions

1962, July 16.
OWEN J. delivered the following written judgment:-
This appeal relates to an assessment for income tax for the year ended 30th June 1960. In its return for that year the taxpayer company, which was a retailer of footwear, showed its taxable income at 52,371 pounds and in its trading and profit and loss account, a copy of which was annexed to the return, the amount of its purchases of footwear for the year was shown as 804,400 pounds. Of this last amount the Commissioner disallowed the sum of 19,777 pounds, thus increasing the taxpayer's taxable income to 72,148 pounds, and it is against the disallowance of this item that the taxpayer has appealed. The facts are as follows: For some years prior to June 1955 a partnership, consisting of a Mr. Alec Breckler and his wife Hannah, his brother Cecil Breckler and the latter's wife Pearl, and Vera Rosenwax and Minnie Freedman, sisters of Alec and Cecil Breckler, carried on business in Perth as retailers of footwear. The partnership operated two stores, one under the name of Cecil Bros. and the other under the name of Betts &Betts. In June 1955 the taxpayer company Cecil Bros. Pty. Ltd. was formed and took over the business of the partnership and thereafter carried it on. The six members of the partnership were the original shareholders. By 30th June 1960 the number of shareholders had increased. They then comprised the six members of the Breckler family who were the original shareholders, the estate of their deceased mother, a company called Breckler Pty. Ltd., and a number of descendants of the original shareholders. The managing directors of the taxpayer were at all times Alec Breckler and his brother Cecil. Breckler Pty. Ltd., which became a shareholder in the taxpayer in October 1959, had been formed in 1951 while the partnership was carrying on the business and at all times its directors were Alec and Cecil Breckler and their brother-in law Nathan Rosenwax, the husband of Vera Rosenwax. The original shareholders in Breckler Pty. Ltd. consisted of the children, grandchildren, a daughter-in-law and two nieces of the various members of the partnership. As at 30th June 1960 the number of shareholders in Breckler Pty. Ltd. had increased by the addition of further children and grandchildren. Most of these shareholders in Breckler Pty. Ltd. were also shareholders in the taxpayer but none of the original shareholders in the latter company has ever held shares in Breckler Pty. Ltd. One of the objects for which Breckler Pty. Ltd. was formed was to carry on business as dealers in footwear. Mr. Cecil Breckler said in evidence that "the idea in forming Breckler Pty. Ltd. was to provide for married members of the next generation and their children" rather than take the course of expanding the membership of the partnership. Breckler Pty. Ltd. had its registered office at the same address as the partnership and later the taxpayer company. It employed no staff and such clerical work as was required was done by Mr. Rosenwax. For this he received a small annual remuneration but no director's fees were ever paid. From the time of its formation a considerable proportion of the income of Breckler Pty. Ltd. was derived from business put through it first by the partnership and later by the taxpayer company. Instead of buying all its footwear requirements direct from the manufacturer or wholesaler the partnership and later the taxpayer placed a proportion of its orders with Breckler Pty. Ltd. which in turn purchased from the manufacturer or wholesaler the goods required to fill those orders and resold them to the taxpayer. The course of business was for the goods to be invoiced by the manufacturer or wholesaler to Breckler Pty. Ltd. which paid for them and also paid the freight charges involved. Breckler Pty. Ltd. then reinvoiced the goods to the taxpayer and was paid by it. The price at which the goods were invoiced to the taxpayer showed Breckler Pty. Ltd. a profit. Had the taxpayer bought the goods supplied by Breckler Pty. Ltd. direct from the manufacturer or wholesaler, it would have been able to do so on the same terms as those on which Breckler Pty. Ltd. bought and in fact a large proportion of its total purchases was so bought. The effect of the transactions was therefore to enable Breckler Pty. Ltd. to make a profit which would have been made by the taxpayer if it had dealt direct with the suppliers of footwear. (at p433)

2. In the year with which this appeal is concerned the purchases made by the taxpayer from Breckler Pty. Ltd. amounted to about 230,000 pounds out of total purchases of 804,400 pounds, the balance of the taxpayer's purchases amounting to 574,400 pounds being obtained direct from manufacturers or wholesalers. The amounts paid during the year by Breckler Pty. Ltd. to the manufacturers or wholesalers and for freight totalled 215,120 pounds and discounts amounting to 4,787 pounds were allowed. Resales to the taxpayer totalled 230,000 pounds and, taking into account the discounts, the transactions showed Breckler Pty. Ltd. a profit of 19,777 pounds. From what I have said it follows that had the taxpayer done all its buying direct from the manufacturer or wholesaler, its total purchases for the year would have been less by 19,777 pounds than the figure actually paid by it and its profits and the tax payable by it would have been correspondingly increased. In these circumstances, the Commissioner disallowed the full amount of 804,400 pounds shown as the total of the taxpayer's purchases and reduced that figure by 19,777 pounds. (at p433)

3. The first submission made in support of the Commissioner's assessment was based upon s. 51 (1) of the Income Tax and Social Services Contribution Assessment Act. It was contended that, of the total payments of 230,000 pounds made by the taxpayer to Breckler Pty. Ltd., the amount of 19,777 pounds should not be regarded as an outgoing incurred in gaining or producing the taxpayer's assessable income. That amount was paid, so it was argued, not as part of the purchase price of goods supplied but to provide Breckler Pty. Ltd. with income. I do not agree with this submission. The fact that the taxpayer paid more for its purchases than it would have paid had it dealt direct with the manufacturers or wholesalers in order that Breckler Pty. Ltd. might make a profit out of the transactions does not, in my opinion, prevent the amount which it in fact paid from being regarded, for the purposes of s. 51 (1), as an outgoing incurred in gaining its assessable income. It seems to me that the contention really is that the taxpayer paid more for its goods than it should have. But "it is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent". (Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 CLR 47, at p 60 and the cases therein cited). (at p434)

4. Next it was submitted that the dealings between the taxpayer and Breckler Pty. Ltd. were sham transactions. The short answer is that they were genuine transactions for the sale and purchase of goods and in no way fictitious or unreal. (at p434)

5. Finally reliance was placed by the Commissioner upon s. 260 and I have felt considerable difficulty about this aspect of the case. The arrangement by which the taxpayer bought part of its requirements from Breckler Pty. Ltd. and the acts done in pursuance of that arrangement undoubtedly had the effect of increasing the taxpayer's outgoings and thereby reducing its profits with the result that its liability to tax was less than it would have been had it made all its purchases from the manufacturers or wholesalers. The fact, as I think it was, that the taxpayer was moved to transact a proportion of its business with Breckler Pty. Ltd. by a desire to benefit the younger generations of the Breckler family appears to be irrelevant in considering the application of s. 260. Lord Denning, speaking for the Privy Council, said in Newton's Case (1958) AC 450 ; (1958) 98 CLR 1 the section "is not concerned with the motives of individuals. It is not concerned with their desire to avoid tax, but only with the means which they employ to do it." (1958) AC, at p 465 ; (1958) 98 CLR, at p 8 His Lordship went on to say (1958) AC, at p 466 ; (1958) 98 CLR, at pp 8, 9: "In order to bring the arrangement within the section you must be able to predicate - by looking at the overt acts by which it was implemented - that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section. Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax. Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Division 7 tax: see W. P. Keighery Pty. Ltd. v. Commissioner of Taxation (1957) 100 CLR 66 Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax: see Deputy Federal Commissioner of Taxation v. Purcell (1921) 29 CLR 464 " I take these passages to mean that it is irrelevant to enquire whether, in doing what he did, the taxpayer was actuated by a desire to avoid tax. The material matter to be considered is the arrangement into which he enters and the steps taken to implement it. If, looking at that arrangement and the acts done to carry it out, it can be said that the transaction falls within the description of an ordinary business or family dealing, the section has no application even if in the result tax is avoided. If, however, what is done does not fall within that description and tax is in the result avoided, the section operates. In applying those tests to the present case, I think regard must be had to not only the actual transactions between the taxpayer and Breckler Pty. Ltd. but also to the relationship between the two companies and their directorates and shareholders, and to the fact that the taxpayer could, to the knowledge of its directors, at all times have bought all its requirements from the manufacturers or wholesalers on the same terms as those on which Breckler Pty. Ltd. bought. (at p435)

6. In the light of all these circumstances I think the arrangement between the companies and the acts done to implement that arrangement cannot reasonably be explained by what Lord Denning called "ordinary business or family dealing". The case is therefore one on which s. 260 will operate provided, of course, the other requisites for its operation exist. If, therefore, the arrangement between the two companies and the acts done in pursuance of that arrangement had the effect of, in any way, directly or indirectly altering the incidence of tax, or relieving the taxpayer from liability to pay tax, or avoiding any liability to pay tax, or preventing the operation of the Act, the Commissioner is entitled to ignore so much of them as had that effect. What he has done is to treat as having no legal efficacy so much of the arrangement between the two companies as required the taxpayer to pay Breckler Pty. Ltd. amounts in excess of the price which it would have paid if it had made the purchases direct from the manufacturer or wholesaler and to regard those excess payments as though they had not been made. In my opinion he was entitled to do so in the circumstances of this case. The effect of the transactions was to relieve the taxpayer from a liability to tax which it would otherwise have incurred and the Commissioner was entitled to proceed upon the footing that the steps taken to produce this result had not been taken. It is true that in most, if not all, the cases in which s. 260 has been held to apply, the fact has been that moneys have come into the hands of the taxpayer which the section has enabled the Commissioner to treat as an income receipt. This is the converse case. Section 260 is being called in aid to reduce the amount of the taxpayer's outgoings and thus increase its taxable income, but I can see no reason why it should not be invoked for that purpose. In my opinion the appeal fails and should be dismissed with costs. (at p436)

7. From this decision the taxpayer company appealed to the Full Court. (at p436)

8. N. H. Bowen Q.C. (with him H. V. Reilly), for the appellant. This was not a complicated scheme for avoiding tax. It was a channelling of business. The result from the tax point of view is that each company bears its tax. The real question is whether the money should be treated as not paid for stock at all. The appellant did not pay an excessive price. It paid a competitive price, but did not take advantage of the specially low price it could have obtained. The purchases were made in this way for the purpose of benefiting the family - the sort of think that a man might do in order to provide for his family not being minded to affect tax in any way. The purpose sworn to is that of benefiting the remoter members of the family whom it was not desired to bring into the partnership. (He referred to Hancock v. Federal Commissioner of Taxation (1961) 108 CLR 258 .) His Honour nowhere identifies the arrangement. There is no arrangement in the sense of an actual thing resolved or agreed upon. There is only a concerted course of action implemented by particular transactions. When one comes to the annihilating process, the question is what does one annihilate ? The suggestion is that so much of the arrangement is annihilated as requires the taxpayer to pay amounts in excess of the price which it would have paid, had it purchased direct from the manufacturer. It is not possible to substitute a different arrangement by the application of s. 260. It is very difficult logically to see how s. 260 can apply to a deduction expressly conferred by the Act. (at p437)

9. M. H. Byers Q.C. (with him J. R. Gibson), for the respondent. The proper deduction under s. 51 (1) is the amount which the company expended for the shoes, less 19,777 pounds. (He referred to Jaques v. Federal Commissioner of Taxation (1924) 34 CLR 328) Section 51 requires that for a thing to be deductible it should be incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. The situation was that the payment was as to part a sum to go to Breckler Pty. Ltd. as a profit and as to part for the price. Section 51 permits the apportionment of a lump sum. The true test is what amount was necessarily incurred in carrying on the business. (He referred to Ronpibon Tin N. L. and Tongkah Compound N. L. v. Federal Commissioner of Taxation (1949) 78 CLR 47) One cannot say of the 19,777 pounds that it was a payment necessarily incurred in the production of assessable income. (He referred to Robert G. Nall Ltd. v. Federal Commissioner of Taxation (1937) 57 CLR 695 and to Commissioner of Taxation v Finn (1961) 106 CLR 60) The next way in which the assessment may be supported is by reference to s. 260. The transaction in question was an arrangement between the two companies that Breckler Pty. Ltd. should buy goods needed for the taxpayer's business at a price at which the taxpayer could buy them and that it should pay Breckler Pty. Ltd. for those goods at a price in excess of that price. If s. 260 works upon that transaction the result is that the transaction is void to the extent to which the excess payments reduced the taxpayer's assessable income. It is not normal for a company without cause to pay more than it needs to. It was not an ordinary family dealing. (at p437)

10. (DIXON C.J. You are here seeking to use s. 260 not to annihilate a transaction but to say that it cannot bear the character which it does in fact bear.) (at p437)

11. That is so. The object of the arrangement was to get a particular sum allowable under s. 51. If the arrangement is struck down, there is no deduction of that sum under s. 51. The basis of the assessment was s. 51. (He referred to Millard v. Commissioner of Taxation (1962) 108 CLR 336.) The whole purpose of doing it in this way must be to inflate the deduction. (He referred to Newton v. Federal Commissioner of Taxation (1958) AC 450; (1958) 98 CLR 1; J. P. Sennitt &Son Pty. Ltd. v. Federal Commissioner of Taxation (1932) 1 ATD 387; Aspro Ltd. v. Commissioner of Taxes (1932) AC 683 and Peate v. Federal Commissioner of Taxation (1962) 36 ALJR 258) (at p438)

12. N. H. Bowen Q.C., in reply. The motives with which a person incurs an expense in gaining or producing an assessable income are irrelevant to the application of s. 51.

Cur. adv. vult. (at p438)

1964, February 25. The following written judgments were delivered:-
DIXON C.J. This is an appeal by a taxpayer, pursuant to s. 260 of the Income Tax and Social Services Contribution Assessment Act 1936-1960 (Cth) from an order of a Judge of this Court, made on appeal from an assessment of the Commissioner, referred to the Court pursuant to s. 187 (b). The learned judge, Owen J., dismissed the appeal from the assessment. (at p438)

2. The facts of the case are sufficiently set out in the judgment of Menzies J. which I have had the advantage of reading and I shall not repeat them. Upon those facts, once it was held that the payment of the amount received by Breckler Pty. Ltd. from the taxpayer company was paid for boots and shoes as stock in trade, there could, I think, be no ground for excluding any part of it from the allowable deductions from assessable income. In my opinion, s. 260 of the Act can have no application to such a case as the present. Indeed, in spite of the views expressed by Owen J. and by Menzies J., I have great difficulty in seeing how it could apply to defeat or reduce any deduction otherwise truly allowable under s. 51. Moreover, I do not think that on the facts of this case there was any contract, agreement or arrangement to which the taxpayer was a party, falling within s. 260. But subject to the foregoing, I agree with the reasons given by Menzies J. for allowing the appeal. I think that the appeal should be allowed and the assessment set aside and remitted to the Commissioner for reassessment. (at p438)

KITTO J. I am of the same opinion and I have nothing to add. (at p438)

TAYLOR J. I share the difficulty felt by the Chief Justice in seeing how s. 260 of the Income Tax and Social Services Contribution Assessment Act can operate to extinguish a deduction otherwise properly allowable under s. 51. Further, I find great difficulty in identifying what, on the facts of the case, is said to constitute the contract, agreement or arrangement falling within s. 260. But assuming, as it was put in argument, that the contract, agreement or arrangement was constituted by an arrangement between the appellant and Breckler Pty. Ltd. pursuant to which the latter company was to buy goods needed for the appellant's business at a price at which those goods were available to the appellant and that the appellant should pay Breckler Pty. Ltd. for those goods at a price in excess of the price at which Breckler bought them, I fail to see how its annihilation could, on the proved facts, be said to result in any increase in the taxable income of the appellant. Subject to these observations I agree that the appeal should be allowed for the reasons given by my brother Menzies. (at p439)

MENZIES J. Here we are concerned, not with the usual application of s. 260 of the Income Tax and Social Services Contribution Assessment Act (Cth) to increase a taxpayer's assessable income by bringing into that income what the arrangement, unless avoided, would exclude, but to increase a taxpaying company's taxable income by denying to it an outgoing from assessable income to which it is entitled unless the tax-avoiding arrangement is avoided. In the course of the judgment under appeal, Owen J. said: "Section 260 is being called in aid to reduce the amount of the taxpayer's outgoings and thus increase its taxable income, but I can see no reason why it should not be invoked for that purpose" (1962) 111 CLR, at p 436 With this general statement I agree - vide Jaques v. Federal Commissioner of Taxation (1924) 34 CLR 328 The point of this case, however, as it seems to me, is whether the application of s. 260 does show that in truth the taxpayer's actual outgoings were smaller than any arrangement which was avoided had made them to appear. (at p439)

2. The appellant company is a retailer of boots and shoes, so that what it pays for its stock is an outgoing which s. 51 makes an allowable deduction. Normally, in the sort of business carried on by the taxpayer company, the retailer buys at the best price available, but the taxpayer here chose not to do so. It preferred to buy some of its stock from Breckler Pty. Ltd. interposed between it and its usual suppliers at prices higher than those that would have been charged to it by those suppliers. The shareholders in Breckler Pty. Ltd. were the children, grandchildren and other relatives of the shareholders in the taxpayer company and what happened was that Breckler Pty. Ltd. made profits by buying the taxpayer company's requirements as ordered at the prices the taxpayer would itself have had to pay the suppliers and reselling what it bought to the taxpayer company at higher prices. When I say that Breckler Pty. Ltd. was "interposed" in this way, I am not suggesting that it was formed to be the intermediary between the taxpayer company and its suppliers. In fact, it was formed before the taxpayer company and at a time when that company's business was carried on by a partnership for which it had bought and to which it had sold in the same fashion. I use the term, however, to emphasize that it was at all material times open to the taxpayer company to buy directly from its usual suppliers at lower prices or to order its requirements from Breckler Pty. Ltd. at higher prices so that the latter could make profits. When it bought from Breckler Pty. Ltd., therefore, it chose to pay more than was necessary for the purpose of allowing that company to make a profit. (at p440)

3. The Commissioner applied s. 260 of the Act in the assessment of the taxpayer's taxable income and tax for the year ended 30th June 1960, disallowing 19,777 pounds of its deductions and increasing its taxable income to 72,148 pounds. The 19,777 pounds disallowed was the difference between what the taxpayer company paid Breckler Pty. Ltd. for boots and shoes and what Breckler Pty. Ltd. paid for those boots and shoes. From that assessment the taxpayer company appealed to this Court and Owen J. dismissed its appeal and confirmed the assessment. The appeal to the Full Court from that decision was upon the grounds that the learned trial judge was wrong in holding (a) that the appellant was party to an arrangement within the meaning of s. 260 of the above Act and (b) that the application of the said s. 260 to that arrangement justified the assessment. (at p440)

4. I propose to decide this appeal upon the second ground of appeal for, assuming without deciding that the arrangement which did exist between the taxpayer and Breckler Pty. Ltd. fell within s. 260, I have come to the conclusion that application of the section in the circumstances stated does not show that the taxpayer company's real outgoings for stock were 19,777 pounds less than it had paid to its suppliers, including Breckler Pty. Ltd. The application of s. 260 here could not be regarded as invalidating the contracts between Breckler Pty. Ltd. and the taxpayer or as substituting the taxpayer for Breckler Pty. Ltd. in the contracts which that company made with the suppliers. The contracts, as made, stand, as his Honour recognized. His critical findings were expressed as follows: "What he" (i.e. the Commissioner) "has done is to treat as having no legal efficacy so much of the arrangement between the two companies as required the taxpayer to pay Breckler Pty. Ltd. amounts in excess of the price which it would have paid if it had made the purchases direct from the manufacturer or wholesaler and to regard those excess payments as though they had not been made. In my opinion he was entitled to do so in the circumstances of this case. The effect of the transactions was to relieve the taxpayer from a liability to tax which it would otherwise have incurred and the Commissioner was entitled to proceed upon the footing that the steps taken to produce this result had not been taken" (1962) 111 CLR, at p 436 This means that s. 260 has been regarded as a warrant for disregarding part of the price actually paid for goods pursuant to contracts, the validity of which remains unaffected. I do not think that section authorizes the Commissioner to substitute a different price for that actually paid in accordance with those contracts. Indeed, s. 260 does not authorize the Commissioner to do anything; it avoids as against the Commissioner arrangements, etc. as specified and so leaves him to assess taxable income and tax on the facts as they appear when the avoided arrangements, etc. are disregarded. Here, it is not revealed that the taxpayer company's real outgoings for its supplies were 19,777 pounds less than the price it paid or that the additional 19,777 pounds was not paid or was a gift to Breckler Pty. Ltd. To arrive at any such conclusion would, I think, be an unauthorized reconstruction of what occurred and, moreover, would not be in accordance with the true facts. All that does appear is that the taxpayer company could have bought its requirements for 19,777 pounds less than it did, but the disregard of what his Honour regarded as the tax-avoiding arrangement does not seem to me to warrant reducing whatever deduction is permitted by s. 51. The Commissioner did argue unsuccessfully before Owen J. that, independently of s. 260, the amount of 19,777 pounds should not be regarded as an outgoing necessarily incurred in gaining or producing the taxpayer's assessable income. His Honour rejected this submission, relying upon Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 CLR 47. With this I agree. Moreover, if the application of s. 260 could have any effect in this case, it is at this point that one would expect to find that effect in revealing that what had been made to appear as a necessary outgoing was really something different. As I have said, however, I have not found any basis for such a conclusion. Accordingly, it seems to me that his Honour's decision that the purchase money paid by the taxpayer to Breckler Pty. Ltd. could not be apportioned really disposed of this appeal because any possible application of s. 260 did not expose any new situation affecting that conclusion. Although not so expressed, his Honour's decision really amounted, as between the Commissioner and the taxpayer, to avoiding the contracts between the taxpayer and Breckler Pty. Ltd. and to substituting the taxpayer for Breckler Pty. Ltd. in the contracts made by that company with the taxpayer's suppliers. If the result is looked at in this way, it again illustrates that s. 260 has been treated as giving the Commissioner some power to modify when its sole function is to destroy. (at p442)

5. His Honour also rejected the Commissioner's contention that the dealings between the taxpayer and Breckler Pty. Ltd. were sham transactions. Again I agree with his Honour. (at p442)

6. For the foregoing reasons I consider this appeal should be allowed and that the assessment should be amended by allowing as a deduction from assessable income an additional sum of 19,777 pounds. (at p442)

WINDEYER J. I agree in the judgment of the Chief Justice. (at p442)

Orders

Appeal allowed with costs. Order appealed from discharged and in lieu thereof order that the appeal be allowed with costs and that the assessment be remitted to the Commissioner to be amended by allowing as a deduction from assessable income the additional sum of 19,777 pounds.