Cheung and Commissioner of Taxation (Taxation and business)
[2024] ARTA 152
•4 December 2024
Cheung and Commissioner of Taxation (Taxation and business) [2024] ARTA 152 (4 December 2024)
Applicant:Allen Sing Kai Cheung
Respondent: Commissioner of Taxation
Tribunal Number: 2023/9547
Tribunal:General Member R Smith
Place:Adelaide
Date:4 December 2024
Decision:The Tribunal affirms the decision under review.
.......................[SGND].................................................
General Member R Smith
Catchwords
TAXATION – whether assessment excessive – distribution paid to shareholder following sale of main asset – whether the distribution is a “dividend” for the purposes of section 44 of the Income Tax Assessment Act 1936 (Cth) – whether the distribution is a capital payment for shares to which CGT event G1 applies for the purposes of section 104-135(1) of the Income Tax Assessment Act 1997 (Cth) - decision under review confirmed.
Legislation
Administrative Review Act 2024
Income Tax Assessment Act 1936 (Cth)
Income Tax Assessment Act 1997 (Cth)
Taxation Administration Act 1953 (Cth)Cases
Federal Commissioner of Taxation v Slater Holdings Limited (1984) 156 CLR 447
Re Spanish Prospecting Limited (1911) 1 CH 92
Statement of Reasons
The Applicant seeks a review of the Respondent’s objection decision dated 29 June 2023 (Objection Decision).[1]
[1] T Documents, T1.
The Objection Decision disallowed the Applicant’s objection to the income tax assessment for the income year ended 30 June 2021.[2] In doing so, the Respondent determined that a distribution received by the Applicant in his capacity as a shareholder of a company was a dividend and therefore assessable as ordinary income. The Applicant asserts that the distribution was the return of capital and therefore assessable as statutory income pursuant to the capital gains tax (CGT) provisions.
[2] Ibid, T2.
MATERIAL BEFORE THE TRIBUNAL
The parties consented to the matter being determined on the papers.[3] The Tribunal has the following material before it:
[3] Administrative Review Tribunal Act 2024 (Cth) s 106.
Tribunal Documents
T Documents dated 2 February 2024
Supplementary T-documents dated 16 May 2024
Applicant’s material
Statement of Issues, Facts and Contentions prepared by the Applicant (ASFIC) dated 12 April 2024 and including the following annexures:
Annexure A – Notice of Assessment and Refunds of Tax for 2020-21
Annexure B – Deed of Assignment
Annexure C – Notice of Termination
Addendum to the ASFIC prepared by the Applicant dated 12 April 2024
Amended ASFIC prepared by the Applicant dated 22 July 2024 (Amended ASFIC)
Letter from Applicant to the Tribunal dated 31 December 2023
Letter from Mr Lee to the Tribunal dated 22 January 2024
Bundle of documents provided by the Applicant to the Tribunal which were obtained by the Applicant from the Respondent through a Freedom of Information request
Letter from Mr Cheung dated 20 July 2024 in relation to the distribution made on 14 October 2020
Letter from Mr Lee to the Tribunal dated 27 August 2024 (Lee Letter)
Respondent’s Material
Statement of Facts, Issues and Contentions prepared by the Respondent dated 16 May 2024 (RSFIC)
The Applicant declined to provide any witness statements. As the matter proceeded on the papers, the Applicant did not give any evidence and was not subject to cross examination.
BACKGROUND
The following facts are taken primarily from the Notice of Decision for Private Ruling which are repeated in the Objection Decision and SFICs[4] filed by each party. There are also references to the audited Reports and Financial Statements for the year ended 31 March 2021 of Wu Tung Steel Fabrics Co Ltd (the Financial Statements). The facts are uncontroversial and not disputed by the Applicant.
[4] Including the Amended ASFIC and the Addendum to the ASFIC.
The Applicant is Dr Allen Sing Kai Cheung. He moved to Australia at a young age. He has been an Australian resident for tax purposes at all material times.
Wu Tung Steel Fabrics Co Ltd (the Company) was incorporated on 16 October 1979.[5] The Company operated a steel fabrics factory in Hong Kong. The business was run by the Applicant’s late grandfather with the assistance of other family members.
[5] T documents, T4 at page 24.
The Applicant has never been a director or otherwise involved in the operations of the Company.
From 1 November 2006, the Applicant has held 165 ordinary shares in the Company. This represents 16.5% of the 1000 ordinary shares issued.[6]
[6] Ibid, T9 at page 60.
The Applicant has received dividends from the Company in previous income years and declared those dividends as ordinary income in his income tax returns and paid Australian tax accordingly.
The dividends paid to the Applicant in the earlier financial years were recorded in the financial statements of the Company as “dividends”.
In early 2020, the Applicant’s late grandfather became seriously ill and decided to retire from the business.
A decision was made by the directors of the Company to sell the factory premises (the Premises). The Premises had been purchased on 11 October 1982 for HKD $1.9 million and was sold on 30 September 2020 for HKD $188 million.
The profit on the sale of the Premises was HKD $150 million. The Company was not required to pay tax on the capital gain on the sale in Hong Kong.
The proceeds from the sale of the Premises were recorded in the Financial Statements in:
(a)“Other Revenue”, “Profit Before Taxation” and “Profit for the Year” in the Income Statement;[7]
(b)“Accumulated Profits” in the Statement of Changes in Equity;[8]
(c)“Gain on Disposals of Property, Plant and Equipment” under “Other Revenue” in the notes section of the Statement of Changes in Equity;[9]
(d)“Gain on Disposals of Property, Plant and Equipment”, “Profit Before taxation” and “Profit for the Year” in the Detailed Income Statement.[10]
[7] Ibid, T9 at page 62.
[8] Ibid, T9 at page 66.
[9] Ibid.
[10] Ibid, T9 at page 70.
After the sale of the Premises, the Company retained some assets, including land and equipment. It also retained some employees.
On or around 12 October 2020, the Company issued to the Applicant a Notice of Dividend notifying him that a “dividend” of HKD $24.75 million would be payable to him on 14 October 2020.[11]
[11] Ibid, T9 at page 53.
The “dividend” was subject to a condition that all the shareholders had to pay a 5% gratuity out of the distribution to the founder of the Company.
The Applicant received a net amount of HKD $23,512,500 (the Distribution) on or about 15 October 2020.
The shares held by the Applicant were not cancelled following payment of the Distribution.
The Distribution was recorded in the Financial Statements:
(a)in the Report of the Directors;[12]
(b)in “Final dividend paid” in the Statement in Changes in Equity;[13] and
(c)in the notes section of the Statement of Changes in Equity under the heading “7. Dividend”.[14]
[12] Ibid, T9 at page 56 under the heading “Results and Appropriation”. The distribution is referred to as “… the payment of a final dividend at HK 150 000(2020 HK $3000) per share…)”.
[13] Ibid, T9 at page 62.
[14] Ibid, T9 at page 66.
The Financial Statements record no change in the share capital account between the 2020 and 2021 financial year.[15]
[15] Ibid, T9 at pages 61, 62 and 68.
On 16 May 2022, the Applicant lodged his income tax return for the financial year ending 30 June 2021, and included under the label “other net foreign sourced income – other” the Distribution received from the Company in the amount of AUD $4,059.408.[16]
[16] Supplementary T documents, ST1 at page 200.
In December 2023, the Company sold its remaining assets. The employees were terminated on 16 December 2023.
The Company has not been wound up.
Procedural history
On 17 March 2023, the Applicant made an application for a private ruling.[17] In the application, the Applicant asserted that the Distribution received from the Company was either not subject to Australian tax, or alternatively only subject to Australian CGT.
[17] T documents, T4.
On 29 June 2023, the Respondent issued a Notice of Private Ruling accompanied by reasons for the decision.[18] The Respondent concluded the Distribution was a dividend and therefore assessable as ordinary income.
[18] Ibid, T12.
On 11 July 2023, the Applicant lodged an objection to the assessment for the 2021 income tax year.[19]
[19] Ibid, T14.
On 30 October 2023, the Respondent issued the Objection Decision.[20]
[20] Ibid, T2.
On 18 December 2023, the Applicant filed an application to the Administrative Appeals Tribunal for review of the Objection Decision.[21]
[21] Ibid, T1.
ISSUES FOR DETERMINATION
The issue for determination by the Tribunal is whether the assessment for the financial year ending 30 June 2021 is excessive or otherwise incorrect and what the assessment should have been.
In the circumstances of this case, this involves determining whether the Distribution:
(a)is a dividend for the purposes of section 6(1) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) and is therefore included as ordinary assessable income under section 6-5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). Relevant to this determination is whether the Distribution was a dividend paid by a foreign resident company out of profits derived from any source within the meaning of section 44(1) of the ITAA 1936; or
(b)a capital payment for shares to which CGT event G1 under subsections 104-135(1) of the ITAA 1997 applies.
Should the Tribunal determine the Distribution is a dividend within the meaning of sections 6 and 44 of the ITAA 1936, the Applicant will fail to establish the assessment is excessive or otherwise incorrect and the review will be unsuccessful.
Additionally, the Applicant has asserted that in disallowing the objection the Respondent breached the Fairness in Law doctrine by:
(a) analysing the revenue effect of the Distribution first;[22]
(b) unnecessarily relying on the form of the transaction rather than the substance of the Distribution;[23] and
(c) failing to apply the law consistently between taxpayers.[24]
As a consequence of these matters, the Applicant asserts the Respondent’s decision-making process was not impartial or free from external influence.
THE STATUTORY FRAMEWORK
[22] Amended ASFIC at paragraph 9 of the contentions; Lee Letter at page 2.
[23] Amended ASFIC at paragraph 10 of the contentions; Lee Letter at page 2.
[24] The Applicant says that another shareholder in the Company was advised by the Respondent that the distribution was subject to CGT provisions; T1 at page 7; Addendum to the ASFIC; Lee Letter at page 2.
The Burden of Proof
Section 14ZZK(b)(i) of the Taxation Administration Act 1953 (Cth) provides that the Applicant has the burden of proving that the assessment is excessive or otherwise incorrect and what the assessment should have been. The standard of proof to be adopted is the balance of probabilities.
Dividends
A “dividend” is defined in section 6(1) of the ITAA 1936 as follows:
dividend includes:
(a)any distribution made by a company to any of its shareholders, whether in money or other property; and
(b)any amount credited by a company to any of its shareholders as shareholders;
The definition in section 6(1) of the ITAA 1936 is limited by a number of exclusions. Section 6(1)(d) ITAA 1936 reduces the amount of a distribution that is considered to be a dividend by the amount paid or credited to an amount standing to the credit of the share capital account of the company.
Section 44 of the ITAA 1936 states the assessable income of a shareholder of a company includes for a resident - dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source.
Section 47(1) of the ITAA 1936 deems distributions by a liquidator in the course of a winding up of a company to be dividends out of profits to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid -up share capital.
Share Capital Account
Section 995-1 of the ITAA 1997 provides the term ‘share capital account’ has the meaning given by section 975-300 of the ITAA 1997, which is relevantly:
A company's share capital account is:
(a) an account that the company keeps of its share capital; or
(b) any other account (whether or not called a share capital account) that satisfies the following conditions:
(i) the account was created on or after 1 July 1998;
(ii) the first amount credited to the account was an amount of share capital.
CGT event G1
Section 104-135 of the ITAA 1997 provides that a CGT event G1 happens if a company makes a payment in respect of a share,[25] and some or all of the payment is not a dividend,[26] and the payment is not included as assessable income.
THE PARTIES’ CONTENTIONS
[25] Except for a CGT event A1 or C2 happening in relation to the share.
[26] Including deemed dividends.
The Applicant
The Applicant contends the Distribution is not ordinary income by way of a dividend, but rather the return of capital subject to the CGT regime. This is because:
(a)the Distribution was funded from the capital proceeds of the sale of the Premises and not trading profits of the Company;[27]
(b)the distributions from the Company in previous income years were included in the Applicant’s income tax returns as assessable dividends. The process adopted by the Company in relation to those prior distributions was different (primarily because those distributions were funded by trading profit) to the process adopted for the Distribution. This is consistent with the Distribution being the return of capital to the shareholders;[28]
(c)the Applicant’s late grandfather became ill in early 2020 and the decision to sell the Premises was the first step toward winding up the Company. The Company did not trade after the sale of the Premises, no further dividends were declared and the Company address was a small office space for administrative purposes only. The director was in substance acting as the administrator of the Company and the Distribution was the first payment as part of a return of capital to the shareholders.[29]
[27] Amended ASFIC, at paragraph 5 and 7 of the contentions.
[28] Ibid, at paragraph 3 and 5 of the contentions.
[29] Ibid, at paragraphs 1, 2 and 3.
The Respondent
The Respondent contends that the Distribution is dividend and assessable as ordinary income because:
(a) the Distribution was a distribution from the Company to the Applicant in proportion to his shareholding;[30]
(b) the Distribution was not debited against the share capital account of the Company and therefore the exclusionary provisions do not apply;[31]
(c) the Distribution was paid out of profits derived by the Company. Accordingly, the profits can be from any source, and it is immaterial whether the profits are derived from ordinary business activities or capital;[32]
(d) the Distribution was from the Company. The provisions in section 47 of the ITAA 1997, which deal with distributions by a liquidator, do not apply;[33] and
(e) the Distribution meets the statutory definition of a dividend and therefore the CGT provisions in the ITAA 1997 do not apply.[34]
CONSIDERATION
[30] RSFIC, at paragraph 35.
[31] Ibid, at paragraphs 37 and 38.
[32] Ibid, at paragraphs 34, 39 and 40.
[33] Ibid, at paragraph 46.
[34] Ibid, at paragraph 47.
Was the Distribution a “dividend”?
The Distribution was a monetary distribution by the Company to the Applicant. The distribution was reflected in the Notice of Dividend issued by the Company to the Applicant.
Subsection 6(1)(d) of the ITAA 1936 limits the definition contained in section 6(1) to reduce the amount of a distribution that is considered to be a dividend by an amount debited against an amount standing to the credit of the share capital account of the company.
The Applicant says that the Distribution should be taken to have been debited against the share capital of the Company in circumstances where there is a reduction in the Revaluation Reserve account from HKD $4,795,245 to HKD $2,771,585 in the Financial Statements after distribution to the shareholders.[35]
[35] Lee Letter at page 2.
Although there was a reduction in the Revaluation Reserve account, the Financial Statements show that the Distribution was actually from the Accumulated Profits account.[36] Moreover, the share capital account of the Company did not change between the 2020 and 2021 financial years. The balance of the share capital account remained at HKD $5,000,000.[37]
[36] T documents, T14 at pages 127 and 128. I also note that at the objection stage this was conceded by the Applicant who argued that the Accumulated Profits account should be considered a share capital account as it forms part of the Company’s equity.
[37]Ibid, T14 at pages 127, 128 and 134.
The Applicant contends that one should “… look pass (sic) the form to determine the substance of a transaction in order to find out what was done in fact rather than what the papers look (sic).[38] The Applicant considers that the term “share capital account” should be interpreted broadly to include any account relating to the Company’s equity, and that the Financial Statements should not be interpreted literally.[39]
[38] ASFIC, at paragraph 10
[39] ASFIC at paragraph 10; Lee Letter at page 2.
The term “share capital account” is defined by the ITAA 1997. It is limited to an account that a company keeps of its share capital or any other account created after 1 July 1998 where the first amount credited was an amount of share capital. It clearly does not extend to any account relating to a company’s equity.
The accuracy and reliability of the Financial Statements have not been challenged, and I accept their contents correctly reflect the financial position and performance of the Company. The Financial Statements show that the distribution was not credited to the share capital account of the Company.
The Distribution was therefore not debited against an amount standing to the credit of the share capital account of the Company and so the exclusion in subsection 6(1)(d) of the ITAA 1936 does not apply.
The Distribution therefore meets the definition of “dividend” in section 6(1)(a) of the ITAA 1936.
Section 44 of the ITAA 1936
An Australian resident shareholder is assessable on all dividends paid by foreign resident company out of profits derived from any source. Was the Distribution, as determined by this Tribunal to be a dividend, paid out of Company profits?
It is common ground between the parties that the Distribution was not sourced out of the normal trading activities of the Company but rather from gains realised by the Company upon the sale of the Premises.
The Applicant argues that this distinction is material and that “profits” refer to trading or revenue profits of the Company and do not include capital profits.
The starting point in determining whether there has been a profit can be found in the decision of Fletcher Moulton L.J in Re Spanish Prospecting Limited (1911) 1 CH 92 as follows:
The word “profits” has in my opinion a well-defined legal meaning, and this meaning coincides with the fundamental conception of profits in general parlance, although in mercantile phraseology the word may at times bear meanings indicated by the special context which deviate in some respects from this fundamental signification. “Profits” implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates.[40]
[40] Re Spanish Prospecting Limited (1911) 1 CH 92 at 98.
The sale of the Premises resulted in a gain to the Company between the 2020 and 2021 years. The Company therefore made a profit in the 2021 income year. This is consistent with the Financial Statements which include the sale proceeds in the Company’s “profit”.[41]
[41] T documents, T9 at pages 60, 62 and 70.
Subsection 44(1) of the ITAA 1936 specifically refers to dividends paid to a shareholder “…out of profits derived by it from any source”. There is nothing inherent from a plain reading of the legislation to suggest its application is limited to profits derived only from revenue or income sources.
This is consistent with the decision of the High Court in Federal Commissioner of Taxation v Slater Holdings Limited (1984) 156 CLR 447. In that case, the Court considered that the term “profits” in the context of section 44(1)(a) included capital profits.[42]
[42] Federal Commissioner of Taxation v Slater Holdings Limited (1984) 156 CLR 447 at 310.
The Distribution was therefore a dividend paid to the Applicant out of profits derived by the Company. The Distribution is assessable to the Applicant as ordinary income.
Section 47 of the ITAA 1936
The Applicant has argued that the sale of the Premises was the first step toward winding up the Company and that in this context the:
(a)the Company director was, as a matter of substance, undertaking the role of an “Administrator”; and
(b)the Distribution was not from the income of the Company but rather the return of capital as part of the winding up process.
Section 47(1) of the ITAA 1936 deems certain distributions to shareholders by a liquidator in the course of winding up a company to be dividends which are then included in the shareholders assessable income. The appropriation of a distribution from a particular fund determines the character of the distribution. The character is maintained which may be different than if the payment had been distributed prior to liquidation.
A liquidator in this context is a person required by law to carry out the winding up of a company.[43] A winding up is a legal process in which the assets of a company are liquidated, creditors are paid in full, and any assets are distributed to the shareholders before dissolving the company.
[43] Income Tax Assessment Act 1936 (Cth) s 6.
Although I accept that the ill-health of the Applicant’s late grandfather set in chain the events leading to the sale of the Premises and a significant scaling back of Company operations, the Company had not commenced a legal process of winding up the Company at the time of the Distribution.[44] Furthermore, the Distribution was made directly from the Company and not a person required by law to carry out the winding up of a company.
[44] As at the date of the Lee letter (27 August 2024) the Company still had not commenced a winding up.
Even if the sale of the Premises was the first step taken by the Company director toward discontinuing the business of the Company otherwise than in the course of winding up, Section 47(2A) is not engaged as the Distribution was made directly by the Company.[45]
[45] Section 47(2A)(b) of the ITAA 1936 applies to money distributed “otherwise than by the company”.
The Applicant has urged the Tribunal to focus on the “substance” on the conduct, namely that the Distribution should be treated as though it was made as part of the winding up of the Company in circumstances where it was the intention of the Company director to eventually dissolve the business after the Applicant’s late grandfather became unwell.[46]
[46] Amended ASFIC, at paragraphs 1 - 3 of the contentions.
Putting to one side that there is no evidence as to the subjective intention of the Company director, section 47 of the ITAA 1936 is specifically intended to capture distributions to shareholders made otherwise than by a company. The source of the distribution is critical to the application of the legislation. It is not disputed that the Distribution was made by the Company to the Applicant and on this basis section 47 of the ITAA 1936 has no application on the facts of this case.
CGT event G1
Section 104-35 of the ITAA 1997 provides that the CGT event G1 happens when a company makes a payment in respect of a share that a taxpayer owns in the company, and that some of all of the payment is not a dividend for the purposes of the ITAA 1997, and the payment is not included in the taxpayer’s assessable income.
For the reasons outlined in paragraphs 44 to 60 of this decision, I have concluded that the Distribution is a dividend and the entire amount is to be included as assessable income. Section 104-35 of the ITAA 1997 has no application.
Procedural Fairness
In the Amended ASFIC, the Applicant expressed a concern that the Respondent, in making the Objection Decision, analysed the “revenue effect first” of the Distribution and that this process was both biased and partial.[47] The Applicant has consistently highlighted that the sale proceeds from the Premises were capital profits in the hands of the Company. Although not expressly stated, I infer the Applicant contends that in this context, the CGT consequences of the Distribution should have been considered first.
[47] Ibid, at paragraph 9.
Section 104-35 only applies if the payment is not a dividend which requires consideration of this issue from the outset in any event. As the Distribution meets the legislative requirements of a dividend (for the reasons explained earlier in this decision), the same conclusion would have been reached even if the analysis commenced with consideration of the CGT provisions.
I note the Applicant also expressed a concern that the Respondent advised a different taxpayer that the distribution they received in the same circumstances was a gain for CGT purposes. The Applicant is concerned the Objection Decision on this basis has breached the “Fairness in Law” doctrine.
The objective of the Tribunal is to provide an independent mechanism of review of decisions based on their merits according to law. I have considered the material referred to at paragraph 3 of this decision and concluded having regard to the facts and the law in this case, the Distribution is dividend and assessable as ordinary income.
DECISION
The Tribunal affirms the decision under review.
I certify that the preceding seventy-four (74) paragraphs are a true copy of the reasons for the decision herein of General Member R Smith
……[SGND]………………………..
Associate
Dated: 4 December 2024
Date of hearing: 7 November 2024 Date final submissions received: N/A Representative for the Applicant: Stephen Lee Solicitors for the Respondent: Nalisha Hnein, Australian Taxation Office
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