CMI Services Pty Limited v The Commissioner of Taxation of the Commonwealth of Australia

[1990] HCATrans 215

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A'1t -!)1 AUSTRALIA ,t:

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IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Melbourne No M21 of 1990

B e t w e e n -

CMI SERVICES PTY LIMITED

Applicant

and

THE COMMISSIONER OF TAXATION OF

THE COMMONWEALTH OF AUSTRALIA

Respondent

Application for special leave

to appeal

DAWSON J TOOHEY J McHUGH J

TRANSCRIPT OF PROCEEDINGS

CMI 1 7/9/90

AT MELBOURNE ON FRIDAY, 7 SEPTEMBER 1990, AT 10.37 AM

Copyright in the High Court of Australia

MR A.J. MYERS, OC:  May it please the Court, I appear with

MR J. TSALANIDIS for the applicant. (instructed by

Mallesons Stephen Jaques)

MR D. GRAHAM, QC:  May it please the Court, I appear with my

learned friend, MR C.M. MAXWELL, for the

respondent. (instructed by the Australian

Government Solicitor.

DAWSON J:	Mr Myers.
MR MYERS:	Thank you, Your Honour.  This is an application

for special leave from a decision of the Full Court
of the Federal Court. It concerns the question of

the accessibility of profits derived by an

investment company. The issue is whether those

profits are of an income or of a capital character.

There have been two recent decisions of the

Full Court of the Federal Court dealing with this matter: one is this case, the CMI Services case; the other is the decision in Federal Commissioner

of Taxation v Equitable Life and General Insurance

Co in which, as we will put it to the Court, different principles were applied. In that case,

unlike the present, the Commissioner was

unsuccessful. The taxpayer was successful and the

Commissioner has sought special leave in the

Equitable Life case on much the same basis as the taxpayer does today in this case.

It is necessary to examine to some extent the

facts to understand precisely how this matter

arises.

DAWSON J: Well, we have read the judgments.

MR MYERS:	Yes, Your Honour. There are a few features of the facts that I should like to draw particular
attention to.  In the Full Court it was the
undisputed fact that the taxpayer intended that
each of the properties should be held indefinitely
in the sense that as long as it continued to
provide and to promise for the future a
satisfactory return by way of rent after allowing
for outgoings and did not present any major
problems of management.

It was also the case that the taxpayer's board

received six monthly reviews of the state of the

properties but Mr Justice Woodward said, and it was

accepted in the Full Court, that no decision to

sell was as a result of those six monthly reviews

or the application of any particular policy. The

reasons for sale in each case depended upon the

particular circumstances of each property.

2

The board of the taxpayer did not intend to

resell any property acquired at a profit and it did

not view its business as the acquisition and resale

of properties at a profit. There was no purpose,

in short, as was accepted that the properties would

be acquired for resale at a profit.

TOOHEY J:  Mr Myers, all that has the ring of section 26A

about it?

MR MYERS:  Section 26A did Your Honour say?

TOOHEY J: Yes, which was not the basis on which the case

was fought, was it?

MR MYERS:  No, it was not. Section 26A was raised by the

Commissioner at first instance but eventually, one

could say I think, abandoned. I do not know

whether it was ever formally abandoned.

The issue is whether the mere fact that a

person who purchases property for the purposes of
acquiring a rental from it and who expects that the
property might be resold at some time is to be

taxed upon any profit that arises on the resale as

income according to ordinary concepts.

TOOHEY J: That rather understates it, does it not? It is

not as if it was a case of one property. Your

proposition would have to be reformulated in terms

whether a company which acquires a number of

properties with the intention, perhaps, of renting

them but in the course of that activity sells

properties from time to time, thereby has as an

aspect of its business the sale of properties.

MR MYERS: Certainly, Your Honour, but the size of the

taxpayer's capital asset cannot determine whether

that which it derives the rental from is a capital

asset or a revenue asset.

TOOHEY J:  No, but it throws some light on the nature of the business activity.

MR MYERS:  But in this case the fact was that there was no

purpose of resale at a profit. At the most, there

was an expectation that properties would have to be

sold. If, for example, they had structural defects
as the Belmont properties did or if, for some

reason or another, the rental was not sufficient,

any person - - -

DAWSON J:	Or if the price went high enough.
MR MYERS:	If the price - it is not clear that there was any

case except possibly one where the property was

sold because the price went high enough. There was

CMI 7/9/90

one case where it was suggested that a very large

offer was received and one would be a fool not to

accept it. But that applies in any case in which a

person has a capital asset. If a person has a

house as a private residence and someone comes

along and offers twice the odds for any reason, one

would be a fool not to sell it. It does not turn

the proceeds of sale into income.

The question is what is the criterion or test

to be applied in distinguishing between the capital

receipt and the income receipt where there is a

business which involves investment. It is no doubt

a difficult question but, in our submission, it is

not to be determined as the Full Court did merely

by asking was there an expectation that the

property would or might be sold. There must be an

expectation that any asset might be sold if it no

longer serves the purpose of yielding a sufficient

income. The question of expectation does not help

in determining what is a capital asset and what is

not.

A corporation which has been in a business for

50 years must expect that if that business becomes

unprofitable it will dispose of it. When a new

head office is acquired by a corporation, something

that is indubitably a capital asset, it will have

the expectation that if that building proves
unsuitable or the business for which it is utilized

is no longer profitable it will be sold.

DAWSON J: There is a world of difference between a head

office and a string of properties which you

acquire,.is there not? How many properties were

involved here, I cannot - - -

MR MYERS:  There were 26 properties acquired over a period of 16 years of which - - -

McHUGH J: Sixteen were sold.

MR MYERS:  - - -16 were sold at some time or another.

Indeed, at one particular time quite a few of them

were sold rather close to the present rather than

the past. The question is ultimately whether these

properties were things in which the taxpayer trades

or deals or traffics.

McHUGH J:  Mr Myers, do you challenge the principle which is

expressed at page 78 at line 10?

MR MYERS:	Yes, Your Honour.
McHUGH J:	You challenge that?
CMI	7/9/90

MR MYERS:  Yes, I do. And that is simply a repetition of

what the learned judge at first instance said.

That is the heart of the decision of the

Full Court, and again, at page 75, that proposition

is made clear:

"the expectation and intention at the time of

purchase that the properties in question would

be resold -

and I omit the words in parenthesis because they

state a conclusion - they state a conclusion -

if their prospective yields, in relation to

current market values, made it prudent to do

so."

Now, that is the expectation and intention of every

person who buys a capital asset. It cannot be the

criterion for distinguishing between what is on

capital account and what is on revenue account.

DAWSON J: It is a question of degree, no doubt, but if you

take the head office, you would say that it is the

expectation and intention at the time of purchase

that the property would be resold in the ordinary

course of business, would you?

MR MYERS:  The expectation and intention in relation to the

head office is that it will be sold in the course

of business -

DAWSON J:	Some time.
MR MYERS:	Yes, some time, if it proves not suitable.

DAWSON J: But in the meantime it is being used for a

particular purpose. The primary intention is

really quite different. But when you have a string

of 27 properties and you are going to make the most

out of them which you can either by rental income

or by reselling them then, .surely, that is a

different situation.

MR MYERS:  But in the end, Your Honour, there is no

different test for distinguishing between capital

and income in relation to what might be called an

investment business. What Your Honour is saying to

me, with respect, is this, that if you have an

investment business you cannot have capital. If

you acquire $1 million worth of shares or 10

properties or 27 properties, then - - -

DAWSON J: Well, I am not saying that at all. Take, for

instance, if this business had a head office. It

would be in a very different situation to the other

properties.

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MR MYERS: Certainly, Your Honour, but none the less the

question is whether properties which are purchased
for the purposes of yielding a rental are capital

of the business or are things which - - -

DAWSON J: Well, of course, if it were solely for the

purpose of yielding a rental, then you would be

home and hosed, would you not? But that is not

what was found.

MR MYERS:  No, Your Honour, that is what is found. What was

found is that the properties were purchased for the

purposes of yielding a rental income but with the

expectation and intention that they would be resold

if their yields in relation to current market

values made it prudent to do so. In other words,

these were rental properties which if a prudent

businessman for the purposes of protecting his

capital would sell them, then they would be sold.

McHUGH J:  Does it make any difference to your submission if

you substitute for the words "in the ordinary

course of the taxpayer's business", words such as

"as a matter of practice"?

MR MYERS:	If things are sold as a matter of practice, that will cast a light upon the nature of the business
and hence the purpose of acquisition but in this case the finding was that these properties were sold not because of the application of some principle but each of them was sold because of the
particular circumstances that affected it; either there were bad foundations or structural problems
as in Belmont or the rents were going down because
the rents were tied to the profits of the half-case
warehouse business and so, in the future you would
not expect to get a decent rent from the property
and so forth.

So, if Your Honour pleases, it does because

the expression "in the ordinary course of business"

is really a .conclusion and I take Your Honour's

point that if it was the practice to turn over
properties, that would be a different case.	Then
one would say that the taxpayer is trading in
properties and is not an investor for rental
purposes.

TOOHEY J: Well, the two are not mutually excluded, are

they? You were taken by Justice McHugh to that

passage on page 78 at line 10, but if you take it

in context, Mr Myers, Justice Lockhart is saying:

The taxpayer's activities involved the quite frequent sale of properties, mostly at a substantial profit, for the purpose of

CMI 6

protecting the rental yield of its portfolio

of real estate investment.

Well now, does that not throw light upon the nature

of the business activities of the taxpayer?

MR MYERS:  Yes, it does, Your Honour, and we embrace that

passage. The purpose of the sale was to protect

the rental yield not to derive a detachable profit

by the realization of the property. The purpose of

the sales was to protect the rental yield and that

passage shows, amongst others, how the Full Court

went wrong.

TOOHEY J: Well, it might if you were talking in terms of

section 26A. I am not so sure that it does if you

are talking in terms of section 25.

MR MYERS:	But in the end any investor who buys land or shares or anything else which yields a passive
income must have the expectation that if that which
he buys for the purposes of deriving that yield is
no longer satisfactory for that purpose, he will
sell it.  Now, if he purchases it for the purpose
of trading in it, with it as his purpose that he
will turn it over when the opportunity arises to yield a detachable profit on the sale, that is a
different matter. But here the purpose of the sale
was to protect the rental yield of the portfolio.

It is almost inherent in the idea of a

business of holding properties to derive investment

that properties will be sold from time to time. To

say that that is what the taxpayer expects is to

state no more than the obvious.

McHUGH J:  Mr Myers, how do you go about distinguishing the

London/Australia case?

MR MYERS:  In the London/Australia case there was a policy -

and this is at the bottom of the decision of

Mr Justice Gibbs and Mr Justice Jacobs who formed

the majority. In the London/Australia case the

taxpayer had a policy that when share prices rose

to a certain level thereby causing the yield to

fall to a certain level, the shares would be sold.

So it was inherent in the policy which activated

and governed the carrying on of the business that

when shares rose in price they would be sold and it
was that policy which the two members of the
majority of the Court fastened on to as saying that
the sale of shares at a profit was an inherent part

of the business.

Now, there is a further feature of that case

and it is this: that the London/Australia case was

a case of a public company which distributed its

CMI

detachable profits, however derived, whether from
sale of the shares at a profit or from dividend, to

its shareholders and that is a point of distinction

which Mr Justice Davies who delivered the majority

judgment in the Equitable Life case pointed to.

The task of providing a satisfactory line

between that which is capital and that which is

income in the case of an investment company is no

doubt a difficult one but we say that it does not

depend upon an expectation that things will have to
be sold. Of course, there is an expectation that
things will have to be sold. It is a question of
why the things were purchased and possibly why they

were sold. If they are purchased to provide - and

I use the expression again - "a detachable

profit", which Sir Owen Dixon used in other cases,
by turning over the subject, the shares or the

land, that is a different case from this one.

The Full Court, as did His Honour

Mr Justice Woodward, applied a test that is not the

correct test. It is not to be found truly based in

London/Australia. No doubt Mr Justice Jacobs did

say at a certain point that expectation and

intention in some cases will be rarely

distinguishable from purpose, but if the finding is that the purpose is a purpose of holding and of not

reselling at a profit, the very finding of fact

makes the distinction and so Mr Justice Jacobs

remarks that "expectation and intention will assist

one in discovering purpose" are simply not apposite

in this case.

DAWSON J: Well, it depends on the degree of intensity of

the expectation and intention. To what degree were

they foremost in the mind of those who made

decisions. It is a matter of degree, is it not,

Mr Myers, and what is the real question of law that

arises?

MR MYERS:  The issue of law is what·is the proper test to be

applied in distinguishing between capital receipts

and income receipts in relation to an investment

business. And if the subject which yields the

dividends or the rent is not purchased with the

purpose that it will be sold to yield a detachable

profit then it is part of the capital and not of

the income. That is what the High Court truly

decided in the London/Australia case. The facts

were quite distinct and it is not merely a matter

of asking what was the expectation or intention.
Mr Justice Davies, who delivered the judgment

of the majority - rather, Mr Justice Gummow agreed

with him - in the Equitable Life case said that it

was the purpose of reselling at a profit which was

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critical. In that case His Honour applied what we,

with respect, would say is the correct test and

that it is the correct test is illustrated by the

restatement of the law by this Court in the Myer

Emporium case. Could I hand that to Your Honours?

At pages 209 to 210, about two-thirds of the way

down page 209, the Court states the proposition:

Although it is well settled that a profit

or gain made in the ordinary course of

carrying on a business constitutes income, it

does not follow that a profit or gain made in

a transaction entered into otherwise than in

the ordinary course of carrying on the
taxpayer's business is not income. Because a

business is carried on with a view to profit -

and you have to ask how is the profit to be

derived? Is it to be derived by receiving rents or

by turning over that from which the rents are

received -

a gain made in the ordinary course of carrying

on the business is invested with the

profit-making purpose, thereby stamping the

profit with the character of income.

So, it is purpose, and it is purpose in relation to

the asset.

TOOHEY J: But you continue to treat the notion of

acquisition for the purpose of resale at a profit

and the buying of something for investment purposes

as if they were mutually exclusive but they may not

be.

MR MYERS:  They may not be.

TOOHEY J: That is the point of this case, is it not?

MR MYERS:  Yes it is.

TOOHEY J: That a number of properties were bought, not

profit but in anticipation that if certain events	necessarily with the purpose of their resale at a
happened then they would be sold? And given the number of the transactions of that nature, it seems
to me that all the Full Court is saying is that in
the circumstances of this case the profit realized
answers the description of income according to ordinary concepts.

MR MYERS:  But a number of transactions cannot be the

touchstone, Your Honour.

TOOHEY J:  It may not be but it is an aspect and that is all

the Court is saying.

CMI 9 7/9/90

MR MYERS:	And what the finding was here was that there was no purpose at the time of acquisition of these
properties of reselling them for a profit. It was
expected that some of them would be sold, profit or
loss.  One of them was sold at a loss. There is
discussion of substantial profits. Indeed, if one
took account of inflation, practically everyone of
these properties were sold at a loss. There were
properties that were held for 10 and 12 years that
were sold for 15 or 20 or 30 per cent more than
they were purchased.

In the end, the question is whether these

properties were part of the profit-yielding

structure which will have to be changed from time

to time. Capital is not immutable; it needs to be

husbanded.

McHUGH J: Supposing you have an investment company,

invested in shares for dividend yields but also had

a policy that when the price earnings ratio went

over, say, 10, they would sell. Now, would profits

from the sale of the shares be taxable on ordinary

income concepts in that situation?

MR MYERS: That is really the converse of London/Australia.

MCHUGH J: Yes.

MR MYERS:  I must accept Your Honour's example, but it is a

curious example because it suggests that the
motivation for sale has nothing to do with either

the price of the share or the yield that the share

is producing. Your Honour is saying when the yield

gets higher then one sells it.

McHUGH J: Well, when the yield gets lower on the market.

MR MYERS:  I beg Your Honour's pardon, when the yield gets

lower one sells it. In that case - - -

McHUGH J: Because there may be an underlying rationale if

the prices are then overvalued and the shares are

overvalued.

MR MYERS:  In that case the bare circumstances that

Your Honour puts to me suggest that the shares are

purchased as part of the capital structure because

the purpose is to retain the shares for the

purposes of yielding an income and only sell them

if the income yield becomes too low.

McHUGH J:  Compared with what you can get on a realization

basis.

MR MYERS:  Yes, compared with what you can get on a

realization and a reinvestment. So, the shares are

CMI 10 7/9/90

not being purchased for the purpose of getting

something which will be sold to yield profits but, rather, for the purpose of getting something which will yield an income and, naturally, the husbanding

of that capital will involve making decisions about

whether it is better to reinvest it in something

else.

McHUGH J:  I suppose you say that is like your case, is it?

MR MYERS: Well, it is somewhat akin to this case although

there was no such policy.

MCHUGH J: No, I know.

MR MYERS:  So, this case is a stronger case than the one

Your Honour has put to me. I should say a rather

different case because each property was sold for

ad hoc considerations.

Returning to what Your Honour

Mr Justice Toohey was putting to me, the fact of it

is that it is possible to have capital in an

investment business, that is to say, apart from

owning the chairs in the head office, that which is

used to acquire the property or the shares may be

capital. If the Full Court is right in this case

and Mr Justice Davies is wrong in the Equitable

Life case then that is wrong because anyone who

acquires such an asset must rationally have the

expectation that it might need to be sold. But

unless it is part of the business of deriving

profits by selling, that thing which yields the

income is part of the capital. One has to

distinguish between the capital structure of the

business and the profits that are derived by the

utilization of that capital structure.

If the Full Court is right here, there is no

such thing as capital in what might be described as

an investment business.

DAWSON J: Well, that is not right, of course.

example to you where there was. I put an

MR MYERS:  If Your Honour pleases, the head office would be

capital but that which is - - -

DAWSON J: That which is stock in trade is not and that is

what, of course, was decided against you.

MR MYERS: But, Your Honours, these properties were clearly

not stock in trade, nothing like it. They were not

items to be turned over in the course of the

business. They are not stock in trade and the

Commissioner does not even contend that,

Your Honour. They are not stock in trade, they are

11   7/9/90

the capital of the business; the capital is

invested in properties for the purposes of yielding

an income with the expectation, it must be

acknowledged, that if the capital structure needs

to be manipulated, if the capital needs to be

reinvested in another asset, then it will be.

DAWSON J: we are playing with words,Mr Myers; with the

expectation, with the purpose of turning them over

if it became advantageous to do so.

MR MYERS:  No, Your Honour. Well, advantageous to do so.

The question arises

DAWSON J: Whether it was advantageous is decided by

reference to a number of criteria.

MR MYERS:  Yes, it is. And if it is advantageous for a

businessman to do so, of course he will dispose of

his capital structure. If it is advantageous for the biggest company in the land to dispose of its

steel making business, it will do so, but it does

not make the assets of the steel making business
not part of its capital structure or profits, if

any, derived on its disposal income. The question

is what part does this asset play in the taxpayer's

economy? Is it something purchased for the purpose

of being turned over to yield a profit or is it

something purchased for the purpose of being used

to derive profit by receiving rental and so on?

And the fact in this case was that these properties

were purchased for the purposes of being held

unless circumstances required that they be sold;

such as, for example, if the foundations turned out

to be no good; such as, for example, if the rental

income went down but not for. the purpose of

yielding a profit by selling the property, and that

is the distinction.

TOOHEY J: Well, you are back in the language of section 26A

again, are you not?

MR MYERS: Well, it happens to be the language of

section 26A but it is also the language of

section 25. That is what the Court said in the

Federal Commissioner of Taxation v Myer Emporium.

DAWSON J:  But we go over the same ground, do we not? You

say to us, "These properties were bought for rental

income"?

MR MYERS: That was the fact.

DAWSON J:  "They were not bought for making a profit by

sale."

MR MYERS:  But that was the fact, Your Honour.

CMI 12 7/9/90

DAWSON J:	The purpose of it.
MR MYERS:	Yes, that was the fact, Your Honour.

DAWSON J: But you have the findings of the court below and

there you are. You cannot point to anything in the

judgments below which really posits a wrong test.

It becomes a matter of semantics.

MR MYERS:  Yes, I do, Your Honour.

DAWSON J: Expectation and intention are aspects of purpose.

MR MYERS: But the fact in this case was that it was decided

that the purpose was to retain the properties for

rental. It is not a case where expectation and

intention are indicators of purpose. The purpose

was found to be not a purpose of reselling at a

profit. Always the expectation must be that one's

capital assets will be turned over. The sale was

not part of a business of investing for profit.

The sale was part of a business of investing for

rental and if it was necessary to readjust the

capital assets in order to enhance the return by

way of rental, then the process of readjustment of

the capital structure does not yield a detachable

profit. It is a question of the definition of the

business.

McHUGH J: Would you object to the test: are these sales

made in the ordinary course of business or are they

extraordinary items?

MR MYERS:  It depends how it is understood, Your Honour.

Without wanting to fudge the question: the

expression "ordinary course of business" contains

an ambiguity because in a sense capital

transactions or adjustments of capital take place

in the ordinary course of business or can do. In
the end, I would say that they are extraordinary in
the sense that they are not part of the process of
operating the business. They are part of the

process of husbanding the capital structure.

TOOHEY J: Well, do not worry about terms like "ordinary"

and "extraordinary", what about the test that

Mr Justice Lockhart postulates on page 75 at line 18:

The critical question in this case is

whether the primary Judge correctly held that

the taxpayer, in carrying on the business of

investing in real estate for the purpose of

producing income, bought and sold the real

estate, in particular the Belmont properties,

as part of that business.

CMI	13
MR MYERS:	Yes, Your Honour, and the reason it was said that

they were bought and sold as part of that business

was that there was an expectation and intention at

the time of purchase that they would be resold, and

I omit the conclusory words:

" .... if their prospective yields, in relation

to current market values, made it prudent to

do so."

Capital transactions are part of the business. The

question is whether they are part of the operation

of the business. In this case these transactions

were capital transactions because the property was

not bought for the purpose of being dealt with so

as to yield a profit on the sale of the property.

The expectation and intention is no more than a

statement of fact about the state of mind of any

rational person who acquires a capital asset. "If
it proves to be an unsatisfactory capital asset I

will dispose of it."

The issue in relation to a business is whether

this taxpayer was carrying on a business of deriving rental income or this taxpayer was carrying on a business of buying and selling

properties for a profit or a business that involved

buying and selling properties for a profit. The

finding of fact was that it was no part of the

purpose of the taxpayer in acquiring the properties

to deal with them so as to yield a detachable

profit and that, in the end, is the issue and, in

my submission, the Full Court simply applied an

incorrect test, a test which is inconsistent with

the decision in London/Australia Investment, which

is inconsistent with the decision in the Myer
Emporium case and which is inconsistent with the

test applied by the majority of the Court in the

Equitable Life case in which the Commissioner seeks

special leave to appeal on precisely the same

ground as I do today, namely, that

Mr Justice Davies did not apply the correct test

and the judges in the CMI case did apply the
correct test.	May it please the Court.

DAWSON J: Thank you, Mr Myers. We need not trouble you,

Mr Graham.

MR GRAHAM: If the Court pleases.

DAWSON J:  We do not think that the actual decision in this

case is attended with sufficient doubt to warrant
the grant of special leave. Special leave will be

refused.

MR GRAHAM:  We would seek an order for costs, if the Court

pleases.

CMI 14 7/9/90

DAWSON J:	Mr Myers?
MR MYERS:	We can say nothing, Your Honour.
DAWSON J:	With costs.

AT 11.15 AM THE MATTER WAS ADJOURNED SINE DIE

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