Com of Taxation v ANZ Bank

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
Melbourne Nos M108 and M109 of 1997

B e t w e e n -
THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Appellant
and
AUSTRALIA AND NEW ZEALAND SAVINGS BANK LIMITED

Respondent

GLEESON CJ
McHUGH J
GUMMOW J
KIRBY J
CALLINAN J

TRANSCRIPT OF PROCEEDINGS

AT CANBERRA ON THURSDAY, 18 JUNE 1998, AT 10.28 AM

MR B.J. SHAW, QC: If the Court pleases, I appear with my learned friends, MR G.T. PAGONE, QC, and MR G.P. HARRIS, for the appellant in each matter. (instructed by the Australian Government Solicitor)

MR D.H. BLOOM, QC: May it please the Court, I appear with my learned friend, MR B.J. SULLIVAN, for the respondent. (instructed by Freehill Hollingdale & Page)

GLEESON CJ: Mr Shaw, I am a shareholder in the ANZ Bank. I do not understand the outcome of this case is likely to affect the market value of the shares but I thought I should mention that.

MR SHAW: If your Honour pleases.

CALLINAN J: Yes, I am too, Mr Shaw, but I think that was communicated to the parties, who said they had no objection to my sitting.

MR SHAW: That is so, your Honour, I think.

GLEESON CJ: Yes, Mr Shaw.

MR SHAW: If the Court pleases, there is a convenient short description of the facts in this case in the Federal Court Reports in volume 42 at pages 542 and following. That is in the course of a judgment of Justice Hill in the Full Court of the Federal Court in what I might call the first stage of this matter. It is not the judgment which is under appeal but the stage at which the question was whether or not the annuity agreements which were entered into were indeed annuity agreements or loans and whether or not the Commissioner was entitled, if they turned out truly to be annuity agreements, to raise the question which is now being agitated. But there is a convenient short description there.

What happened was, at the end of April and the beginning of May 1986, a number of transactions were entered into which were all intended to be entered into or none of which were intended to be entered into. The first to - not in time but for the purposes of description - is a partnership agreement of 30 April between the present taxpayer, the ANZ Savings Bank, and another member of that group, the ANZ Banking Group Limited. The partnership deed is in volume 2 of the appeal books at page 262. I need not go to that, but the purpose of the partnership was to subscribe for investment units in a trust which had been established on the previous day, 29 April, and to enter into the other transactions which were contemplated by documents which were described as the transaction documents which, speaking loosely, were the whole bundle of agreements which were entered into.

The trust deed is in volume 1 of the appeal books at page 73 and if I might take the Court to that. The Court will see that there were, in the definition sections, two classes of investment funds, the “A Class Fund” and the “B Class Fund”. It is the B Class Fund that is presently relevant, and there is a definition at page 75 of “Capital”, at line 35, and it would be seen that “Capital” is the whole of the Fund:

other than the income of the Fund.

and “Income” is defined on the next page, page 76, as:

in relation to a Fund and a financial year means the net income of that Fund in respect of the relevant financial year as determined in accordance with section 95(1) of the Tax Act.

The purpose of the Fund is amongst other things - and this appears at clause 10 on page 86 - I am sorry, I have the wrong number there - it is at page 88 in paragraph 12.1, is a power to invest in annuities with the consent of the investors. Going back to clause 3 at page 79, there is provision in clause 3.1(b) that:

The Trustee shall hold the capital of the B Class Fund UPON TRUST for the B Class Investors.

A similar provision in relation to income in clause (d) on page 80. The power to issue units is - and the interest which they give is set out in clause 5 which is at page 81 at the bottom and going over to 82 at the top, and in clause 5.2(a) it is seen that:

Every Investment Unit shall confer such an interest in a Fund as is provided in this Deed but shall not confer any interest in any particular part of that Fund.

There is a provision for application for units in clause 6, and in clause 9 there is a provision in relation to income. It is provided in clause 9.1 - this is at page 85, at line 33:

Except as elsewhere herein provided the Trustee shall receive all moneys rights and property which are paid or receivable in respect of a Fund.

There is a provision for the payment of what amounts to a manager’s fee in clause 9.2(a) in respect of management units and in clause 9.2(b), at the top of page 86, a provision that is subject to the rights of the manager:

The income of each Fund in respect of each financial year shall be held by the Trustee on trust absolutely for the Investors.....in proportion to the number of Investment Units in that Fund respectively held by them.

Then there is a provision in clause 10.1 that:

The Trustee shall retain all moneys being capital of a Fund pending the investment or redemption of Units or other dealing with the same in accordance with this Deed.

GLEESON CJ: Just before you go to clause 10, does the “income” referred to in clause 9.2(b) include the deductible amount of an instalment of annuity?

MR SHAW: No.

GLEESON CJ: Thank you.

MR SHAW: That is because, your Honour, of the definition of “income” as net income and that, as I will come to in section 95, is defined as the assessable income of the trust treating it as if ‑ ‑ ‑

GUMMOW J: But that is picked up in the definition at 76, the definition of “income”, which in turn picks up 95.

MR SHAW: Yes, your Honour.

GLEESON CJ: Then for whom is that held on trust?

MR SHAW: That was what I was coming to, your Honour. Your Honour will remember that everything that is not income is capital. What is provided in clause 10.2 is that:

The capital of each Fund shall be held on trust absolutely for the Investors in that Fund in proportion to the number of Investment Units in that Fund respectively held by them.

In clause 10.3 the investment units are redeemed on receipt of capital to the extent that the capital is available. So that, looking at the annuity and ignoring any expenses or management fees or whatever and just looking at the annuity, that part of it which forms part of the assessable income of the trust is the income for trust purposes as well as for income tax purposes and that is distributed as income. The deductible amount is for trust purposes regarded as capital because it includes everything that is not income and is applied in redeeming the units to the extent that the deductible amount permits as the years go by. So that one has a progressive redemption of units.

GLEESON CJ: And that is an amount to which the unit holders are presently entitled?

MR SHAW: Yes, your Honour, that is so. If one looks at the whole of the annuity which in accordance with ordinary principles is all income, all of it is something to which the holders of the units are presently entitled under the name of income as to part and under the name of capital as to the rest.

The partnership then borrowed funds at interest from a company called Fazen, which is a subsidiary of a bank. It borrowed slightly over $42 million from the bank. It put in slightly over, or quite a lot over $7 million but under $8 million of its own funds to produce a total of $50 million and invested the $50 million in B class units. The trustee agreed to use the $50 million to apply for and acquire the annuities. The partnership subscribed for the units. I should say that the loan agreement with Fazen is in volume 2 of the appeal book at page 300. The subscription for the units which was made on 1 May appears in volume 3 of the appeal book at page 588.

The trustee then acquired the annuities pursuant to three annuity agreements. They are in volume 1 of the appeal book at pages 112, 162 and 212 with the consent of the partners and the consent is at volume 3 at page 590. If I might just go briefly to one of the annuity agreements, that in volume 1 at page 112. At page 119 in clause 2 at line 30, there is a provision for acquisition of the annuity and in clause 5 at page 123 there are a number of assumptions set out on the basis of which the annuity is provided and if it were to turn out that any of the assumptions was incorrect then, provided the agreement was not brought to an end, a recalculation could be made of the payments, the payments being directed to ensure that the annuities, in the event of the assumptions turning out to be wrong, still providing what is called the “required return” to the partnership.

GLEESON CJ: Does the result of this case challenge any of these assumptions?

MR SHAW: Yes, it does, because one of the assumptions is that the interest is wholly deductible to the partnership.

GLEESON CJ: So the burden of your success would fall on the New South Wales Treasury?

MR SHAW: Yes.

GLEESON CJ: I am not suggesting I mind that.

MR SHAW: No, one would have to think about whether one did or not, your Honour. Without going to the full detail of the assumptions, it can be seen that in 5.1(a) it is that the annuity payments are treated as income of the trust except to the extent of the deductible amount and in (d) on page 124 a provision that “the redemption of the Units”is to be treated as resulting in the receipt of capital by the unit holders and at page 125 in paragraph (f) the assumption about all the interest being deductible appears in (f)(i).

The required return is set out in what is called the investor’s letter. That is in volume 2 of the appeal book at page 361 and the Court will see that the required return appears right at the top of page 362. It is 12.661 per cent and the investor’s letter contains as annexures, documents fixing the amount of the manager’s remuneration by way of income under the management units and it has attached a number of tables which set out how the various returns are calculated.

What happened was that the Commissioner, as I indicated earlier, originally took the view that the annuity agreements were not annuity agreements, they were loan agreements and that tax should be calculated on the basis that that was so and under Division 16E on an accruals basis but the Federal Court held after Justice Jenkinson had agreed with that submission that that was not so, they were, in truth, annuity agreements, and on that basis the Commissioner said if that is so then only part of the interest is deductible because the interest which was borrowed to acquire the units results, it is true, partly in the derivation of income which is assessable but partly in what is, in effect, the derivation of the deductible amount. For that reason, the whole of the amount is not deductible.

That turns as a first step in the reasoning on the nature of an annuity, and we have referred to a number of cases in our outline and, in particular, if we refer to Egerton-Warburton 51 CLR 568 at 573 to 574, and if I could just take the Court to that for a moment in order to remind it of something of which it is no doubt very well aware but because of its present significance it seems worthwhile reminding the Court about it:

A transaction by which an owner of capital assets disposes of them for a consideration which includes annual payments may serve the double purpose of converting a capital asset into money and converting the money, which otherwise would be capital, into income. In other words, the annual payments are not necessarily deferred payments of principal, they may be income the right to which has been purchased by an outlay of capital. In the ordinary case of the purchase of a life annuity for cash, the annuity is income into which the capital laid out has been transformed. “An annuity means where an income is purchased with a sum of money, and the capital has gone and ceased to exist, the principal having been converted into an annuity” (per Watson B, Foley v Fletcher). “An annuity means generally the purchase of an income and usually involves a change of capital into income, payable annually over a number of years”.

So that the annuity is, it is submitted, clearly all income, subject, of course, to what the Act may say about it, but starting off as a matter of general principle the annuities, although they might have been purchased with a capital sum, were all income and that would have had the effect that, unless the Act otherwise provided, the whole of the amount of the annuities would have been assessable but, of course, the Act does provide differently and it provides differently in section 27H. It will be seen in 27H(1) ‑ ‑ ‑

GUMMOW J: Now, this is part of this Subdivision AA which came in by Act 47 of 1984.

MR SHAW: Yes, your Honour, but there is a whole previous history in relation to annuities and there is a difference between us and our learned friends as to the effect of these provisions, but it will be seen that what it provides, for relevant purposes, is that:

The assessable income of a taxpayer of a year of income shall include:
(a) the amount of any annuity derived.....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;

and that how you work out the deductible amount is set out in section 27H(2). It will be seen that it is calculated by reference to the purchase price.

GLEESON CJ: There is a question as to whether, when you perform that act or process of exclusion, you are taking the deductible amount into account for the purpose of calculating the net income.

MR SHAW: There is such a question under section 97. If I could, in that connection, remind the Court of the provisions of section 25 ‑ ‑ ‑

GUMMOW J: They were changed to refer to subdivision AA.

MR SHAW: They were, your Honour, but for present purposes that does not matter. The point of the reference is that it includes gross income, which is the part one generally thinks about when one thinks about this section, from all sources or from sources in Australia, depending on whether the taxpayer is resident or not. The next words are:

which is not exempt income -

so that even in section 25 there is a separation out from gross income of exempt income. The question that your Honour the Chief Justice mentioned does arise, namely, what is the proper description of the act of exclusion and that depends, partly, on the definition of net income in section 95, and I will come to that in a moment. But I should, before doing that, remind the Court also that exempt income was defined in the old Act as:

income which is exempt from income tax and includes income which is not assessable income.

So it has a wider meaning than one might have prima facie expected. It is submitted that, having regard to the provisions of section 27H, they leave the deductible amount as income, not assessable income but income. The Full Court - that is to say the Full Court from whom this appeal is presently brought - accepted that submission. The consequence of that is, it is submitted, that if one goes to section 51(1) the interest outgoing in this case, if the borrowed funds had been directly invested in the purchase of annuities instead of in the purchase of units in the trust, the interest outgoings would only have been partly deductible because the first part of section 51(1) commences with the words:

All losses 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 -

and it is submitted that, had the partnership invested directly in annuities - it would not have been a very sensible thing to do, perhaps - but had it done so, the interest expense would have been deductible only to the extent to which it was directed to obtaining that part of the annuity which did not constitute a deductible amount because the deductible amount is income but is not assessable income.

GLEESON CJ: Does not the concluding portion of section 51(1) seem to assume that an outgoing can be:

necessarily incurred in carrying on a business for the purpose of gaining or producing -

assessable income, even though part of it is:

incurred in relation to the gaining or production of exempt income.

If it were otherwise, you would not need the exception.

MR SHAW: Your Honour, the answer to that turns on whether or not, what is expressed as an “exception”, is truly an exception or not.

GLEESON CJ: You say it is merely a repetition?

MR SHAW: It was described, I think, by Justice Dixon, in relation - the position is not necessarily the same, in respect of all the bits of the exception, but in respect of exempt income it has been said not to be a true exception to be unnecessary and to be put in merely by way of expressing a contrast and I am going to come to that, your Honour, but in Ronpibon that is expressed and nobody has really doubted, but that, in relation to exempt income, at any rate, it is unnecessary and not a true exception and, your Honour will have noticed that, although the first parts of the exception are expressed to except:

losses of outgoing of capital, or of a capital or private and domestic nature -

when one comes to the bit that deals with “exempt income” it is expressed in the same kind of terms as the first part is, because, leaving out the references to capital, and so on, it reads:

all losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income -

and I will leave out the next part, because it is easier to understand the similarity of the term if it is -

incurred in gaining or producing the accessible income.....shall be allowable deductions except to the extent to which they.....are incurred in relation to the gaining or producing of exempt income.

So it is the same kind of reference to “exempt income” as there is in relation to “assessable income”.

The question is, whether the outcome is different because of the structure, which has been adopted in this particular case and that depends, in part, on the terms of the Act relating to the taxation of trusts and, in part, on the way in which the operation of those provisions has been held to operate in relation to the interest they give to beneficiaries in the income of a trust.

If I might go to section 95. In the course of the application for special leave, Justice Gaudron, who I think was presiding on that occasion, asked that we prepare some history ‑ ‑ ‑

GUMMOW J: We wanted to be sure we had the actual text.

MR SHAW: And, what her Honour was asking for was not only the actual text, as it was, but some indication of the various changes which had happened, and we have tried to do what we were asked to do; whether we have achieved it or not, I do not know, but having done it, may we offer it. The first bundle is a bundle which relates to sections 95 and 97, and the second bundle is a bundle which relates to the carry forward loss provisions.

KIRBY J: Mr Bloom says that when we peer into these entrails we will come to the view that this problem has no longer - that the legislation has changed and that we revoke special need.

MR SHAW: Your Honour, will not, it is submitted, come to that conclusion. Section 51(1) has been substituted by a provision in the rewrite which, although it is not expressed in precisely the same terms, is, for all material purposes, in the same terms. There is still a reference to exempt income in the same kind of way. There is a new definition of “exempt income” but for present purposes it is not materially different. The provisions of section 25 have been substantially repeated. The trust provisions have not been altered at all and whether they will be and when they will be, is in the lap of the gods. The carry forward loss provisions have been altered but, for present purposes, those alterations do not really make any difference.

So, it is a matter of continuing importance and, indeed, one might say of special importance since, were it to happen that the trust provisions were to be rewritten, since the overall intention is, subject to minor changes, to reproduce the existing law in a form which is easier to understand, it will be important to know what the existing law is.

GLEESON CJ: However, what Mr Bloom did point out in his written submissions, as I understand it, is that when the words that were decisive in the Full Court of the Federal Court were originally enacted, there was no definition of “exempt income” in the legislation. I am referring to pages 9 and 10 of the respondent’s written submissions.

MR SHAW: Your Honour, in Belford’s Case, which was decided in 1952, was decided when section 97 was in a much simpler form but it had a proviso in substantially the same form, and what his Honour Justice Dixon said was that the provisions of section 97(2), which he was then dealing with, were directed to the carry forward loss provisions of the Act so far as trusts were concerned and it is submitted that that can be clearly seen when one looks at the provisions relating to trusts and compare them with the provisions relating to partnerships. If I could just, first of all, take your Honours to Belford 88 CLR 589.

The terms in which section 97 then was appears in the bundle relating to the trust divisions which I handed up behind the tab which is marked section 97 - I am sorry, it is not there. It appears, I think, in my learned friend’s submissions actually.

GLEESON CJ: Yes, at page 9 of his written submissions.

MR SHAW: Page 9 of his written submissions. For present purposes, it is in substantially the same form. In Belford’s Case at page 599 towards the bottom of the page, starting about point six on the page, his Honour says:

Do ss. 25 and 26 in each of these cases make it taxable in the trustee’s hands and also in the beneficiaries’ hands? If so, where is the provision to be found against double tax? No express provision applies to either case. It is not easy to imply one.

And then his Honour goes on and deals with section 97(1) and about point eight on the page says:

That is a case under s. 97(1). Still more difficult is a case under section 98. It must be remembered too that the tax is graduated. The difficulties of making an implication for the avoidance of double taxation are not lessened by s. 97(2), which is directed to dealing with a case where losses of a previous year are taken into account in calculating the income of the trust estate.

So, his Honour is regarding these provisions as directed to the carry forward loss provisions. In fact it is in the bundle I handed up behind the tab 97 in the small print below section 97(1).

If I could then remind the Court of the structure of the Act so far as trusts are concerned.

GUMMOW J: Was that particular passage in Sir Owen Dixon’s judgment about 97(2) adverted to in the Full Federal Court in this case?

MR SHAW: No, it was not, your Honour.

GUMMOW J: That is what I wonder because it looks rather significant.

MR SHAW: The way in which the case was argued developed, your Honour, the way it was argued before Justice Jenkinson was at all dependent on whether or not the income was exempt income or not, and there was not any reference to the question of the effect of the proviso and that only came up in the Full Court. Your Honour will have observed that his Honour Justice Sundberg said that some of the submissions that were put on behalf of the Commissioner were not developed and that was because in the circumstances which has occurred there was not much time to think of a development and it is just that the way it happened rather took us unawares.

KIRBY J: I do not quite understand that. If it is relevant, you might make it clearer. If it is not - - -

MR SHAW: Sorry.

KIRBY J: I do not quite understand those comments. If they are relevant, you might make it clear.

MR SHAW: His Honour Justice Gummow - - -

KIRBY J: I followed what his Honour asked you and what you said, but I do not understand the observations about the way in which matters developed in the Full Court. Are you suggesting that you were not given an opportunity to put argument forward?

MR SHAW: No, I am not suggesting that at all.

KIRBY J: Well, what is the suggestion?

MR SHAW: The suggestion, your Honour, is that, not having been aware of the desirability, we had not discovered the passage that I have just referred to at the time it was argued in the Full Court, and for that reason it was not referred to, that is all. It is just one of those events which is not perhaps as happy as it might be and one’s ‑ ‑ ‑

GUMMOW J: And now it has been unearthed in time.

MR SHAW: Yes, one’s omissions have come back to haunt one. That is all I am saying, your Honour. What I am trying to say is it is an omission but we hope not too serious.

KIRBY J: As long as it is criticism of yourself, Mr Shaw, and not of the Federal Court.

MR SHAW: The Court will see, if one goes to section 95, that the “net income” of a trust estate is defined and it is defined to mean:

the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer.....less all allowable deductions -

and at the relevant time it was “except carry forward losses”. It then referred to the carry forward loss provisions. The reason for that was that, so far as trusts were concerned, it was not possible to attribute the losses of a trust to the beneficiaries, and that will be found in section 97 where it will be seen that in section 97(1):

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.....as is attributable.....
(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 -

and then there is the exception:

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.

That is to be contrasted with the provisions relating to partnership because, if one goes to section 90, one sees that there is a definition of “net income” without the exclusion of the carry forward losses. There is a definition of “partnership loss” and in section 92 there is a provision that:

The assessable income of a partner in a partnership shall include -

in the same sort of terms -

the individual interest of the partner in the net income of the partnership -

a provision which one does not find in the trust provisions relating to partnership loss, so the partnership losses are allowable to partners differently from the position in relation to trusts. Then there is a provision in the same sort of terms in section 92(3) in relation to exempt income as is found in section 97(1)(b) except for the fact that there is no proviso or exception.

The explanation for that lies, it is submitted, in the different way in which losses are treated so far as partnerships are concerned and trusts are concerned. One needs to ask oneself, of course, why it was necessary to have a provision at all about exempt income and it is submitted that the answer is probably to be found in section 24. Section 24 at the time provided that:

Where any income is exempt from income tax, the exemption shall be limited to the specified or original recipient of the income and shall not extend to persons receiving payments from that recipient, although the payments may be made wholly or in part out of that income.

GUMMOW J: I am sorry, I am just not sure I understand that. What mischief is that directed to or what reassurance was it giving?

MR SHAW: I think the general idea was, your Honour, that if you were, say, a goldminer, the exemption from tax stopped with the goldminer, that sort of idea, but, while it might not have been strictly necessary as a matter of logic in respect of partnerships, it was necessary in relation to trusts if one wanted to ensure that the beneficiary took the income which the trustee had received as exempt income in the same character, and that is even despite Charles’ Case because of the presence of section 24. If you wanted that provision there, namely, that the beneficiary was to receive the income as exempt income, you actually had to say so because otherwise he would not.

GUMMOW J: Thank you.

MR SHAW: The point of that seems to lie wholly in the way in which losses are treated for the purposes of the trust provisions of the Act and the purpose of the proviso is, we would submit - and I will come to this later - to prevent the exempt income from affecting the position of the beneficiary, if it has already affected his position, by its effect on the net income of the trust estate, but only in those circumstances. So that it is submitted, your Honours, that the position in relation to trusts is really unaffected by what my learned friend has put in his written submissions because one can see, it is submitted, with reasonable clarity that the presence of the definition does not matter for present purposes. The whole point of these provisions lies in the different treatment of losses for partnerships and trusts and the way in which it affects the beneficiary in relation to the calculation of his carry forward losses.

I should retrace my steps and remind the Court that despite what I have just said about exempt income, the position generally is, apart from statutory provision, that income in the hands of a beneficiary does have the same character as it had in the hands of the trustee and that is explained in Charles’ Case 90 CLR 598 at 604 to 605. At the bottom of the page the Court said:

The appeal concerns an amount of £390, portion of a sum of £830 which the appellant received in the relevant year as a certificate holder in what is known as the Second Provident Unit Trust. £440 of that sum consisted of the appellant’s share of dividends and interest received on capital investments of the Trust, and it was treated both by the appellant and by the commissioner as retaining in the hands of the appellant its original character of income from property. The balance, the £390 now in question, came partly from profits which had been made on realizations of capital investments of the Trust, and partly from the proceeds of sale of “rights” in respect of new share issues which had arisen in respect of shares held as capital investments of the Trust.

The question was, first of all, was it capital in the hands of the Trust. That was a matter which was considered and decided it was and if it was, was it capital in the hands of the beneficiary, and at page 606 at the bottom of the page, the last two lines and going over to the top of the next page, the terms of the trust deed are explained and it is said at the top of page 607 at line 3:

The fund to be distributed on each occasion was called “the cash produce” which should have arisen in respect of the trust fund during the preceding half year. This expression was defined to include, first, all cash received or to be received by the trustees by way of dividend -

and so on and -

secondly, all cash received in respect of any sale of, inter alia, any rights.....and thirdly.....any profits realized, less any losses sustained, on the sale of any of the securities.

Then going down to the bottom of that page, the bottom five lines:

In the relevant year, the appellant participated in half‑yearly distributions of “cash produce”. The amounts distributed included moneys belonging to each of the three classes comprised in the definition: dividends, proceeds of sale of rights, and profits realized on sales of securities. The question presents itself at once whether the case is distinguishable in any material respect from a case in which moneys of the same descriptions are distributed amongst beneficiaries by the trustees of a will or settlement -

and so on.

GLEESON CJ: What happens now if you have a trust under which X is entitled to capital and Y is entitled to income and there is a capital gain which is liable to tax? Who bears the tax?

MR SHAW: Am I allowed to say it is a difficult question? I cannot answer. There have been a number of difficulties about not only capital gains tax but also about what happens when depreciation has been referred to and also about what happens when there is a difference between trust income, if you like, and assessable income of the trust. Going back to page 608, at about point 8, the Court said:

At first sight it may seem that a person who invests in units under a trust deed such as that which is here in question does so with a view to obtaining the half-yearly distributions for which the deed provides, just as he might have bought shares in an investment company with a view to deriving half-yearly dividends from them; and that the periodical distributions received should be regarded as income in the one case just as they would be in the other. Some such view, indeed, would appear to be suggested by the brochure which the managers issued, for the amount to be received by a unit holder in a half-yearly distribution is spoken of throughout that document as income of the unit. But the view is untenable, for a unit held under this trust deed is fundamentally different from a share in a company. A share confers upon the holder no legal or equitable interest in the assets of the company; it is a separate piece of property; and if a portion of the company’s assets is distributed among the shareholders the question whether it comes to them as income or as capital depends upon whether the corpus of their property (their shares) remains intact despite the distribution. But a unit under the trust deed before us confers a proprietary interest in all the property which for the time being is subject to the trust to the deed so that 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.

So that one has, it is submitted, a clear decision there that the annuities, if they were income in the hands of the trustees, were income in the hands of the beneficiaries, if they were entitled to them, and they were. As your Honour the Chief Justice asked, they were entitled to them, partly as income, because of the provision about net income of the trust, and partly on a redemption of their units, because when the deductible sum was received it was to be applied immediately in redemption of the units to the extent that the moneys allowed. So it is submitted that when one looks at section 51(1) one can say that the moneys which were borrowed by the partnership to invest in the units were borrowed partly, it is true, to acquire assessable income but partly to obtain the other part of the annuities, that is to say, the deductible amount. It is submitted that section 51(1), the first part of it - by that I mean - and it is difficult to speak about 51(1) because it is customary to refer to the first limb and the second limb, and the first limb and the second limb mean:

in gaining or producing the assessable income -

is the first limb or:

in carrying on a business for the purpose of gaining or producing such income -

is the second limb. But for present purposes, the division is between the first part, including both those limbs, and the second part, which deals with the exception.

In Ronpibon Tin 78 CLR 47 the way in which the section should be approached was dealt with by the Court. At the top of page 55, about point 2, the Court refers to the difference between section 51(1) of the 1936 Act and the old provisions of section 23 and 25 of the earlier Acts. At about point 5 on the page, in about the middle of that middle paragraph, the Court says:

Instead of imposing a condition that the expenditure shall be wholly and exclusively be for the production of assessable income the present section 51(1) adopts a principle that will allow of the dissection and even apportionment of losses and outgoings.

And then it explains how it does that. It says:

It does this by providing for the deduction of losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income. In the second place it introduces an alternative ground or head of deduction. It allows the deduction of all losses and outgoings to the extent to which they are necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

Then it refers to contentions which had previously been made by the Commissioner and, on the next page, the definition of “business”. At about point 6 on the page the Court says:

The third matter to be mentioned is the express exception with which s. 51(1) concludes. To except losses and outgoings of capital is both necessary and logical. But to except losses and outgoings to the extent to which they are incurred in relation to the gaining or production of exempt income seems to except something from the primary description which could not fall within it. For exempt income can never be assessable income. They are mutually exclusive categories. The explanation doubtless is the desire to declare expressly that so much of the losses and outgoings as might be referable to exempt income should not be deductible from the assessable income. Although it may not be strictly logical to express the declaration in the form of an exception, the declaration serves the not unimportant purpose of making an express contrast.

So, what the court is saying is that, strictly speaking, it is not an exception but one can understand why it is expressed that way. Then the court goes on to say:

The present case, however, can be decided by reference to the earlier or positive part of the subsection, that which makes the deduction of losses and outgoings allowable.

What that is emphasising, it is submitted, is the independent force of the first part of section 51(1) which is not, it is submitted, to be diminished or read down by reference to the so-called exception in the second part. For that reason, we would submit that it does not follow, as the Full Court of the Federal Court said, that if it was not exempt income then section 51(1) could have no application. Because one has to ask a separate question about the operation of what I have called the first part of section 51(1), that is the part before the exceptions.

Now, passing from that might I then go to the provisions of section 97? In our submission the Full Court was wrong to say that the exception at the end of section 97(1)(b) applied, and that turns on the question of whether or not they were correct in taking the view that the - assuming that the income was exempt income, it had been taken into account in calculating the net income of the trust estate. The reason it had been taken into account in calculating the net income of the trust estate according to the Full Court was because it had been taken into account in the calculation of the assessable income because of the effect of section 27H. But it is submitted that that is not so because if one looks at section 27H one finds that there is no assessable income until the deductible amount has been separated out from the gross amount of the annuity. It says:

The amount of any annuity derived by the taxpayer during the year of income excluding.....the deductible amount.

It is submitted that, in those circumstances, the exclusion of the deductible amount had simply not affected the amount of the assessable income of the trust estate or the net income of the trust estate. It will be recalled that the net income means total assessable income, so you have to start off with the total assessable income calculated in a particular way, less all allowable deductions.

GUMMOW J: Involved in that is some view of the relationship between 27H and 25. That is to say if one only had 25, this law would have got in.

MR SHAW: Yes, it would.

GUMMOW J: But one is reading 27 as a Code in some way, is one not?

MR SHAW: Yes, one is.

GUMMOW J: It is against that background that one then applies these words “taken into account”.

MR SHAW: Yes. If one goes to the carry forward loss provisions in section 80, one finds that the exempt income is relevant for the purpose of both sections 80(1) and 80(2). I should perhaps have said to your Honour Justice Gummow that that section 27H was a Code was ‑ ‑ ‑

GUMMOW J: It has been decided, has it not?

MR SHAW: Yes. In fact, in the ‑ ‑ ‑

GUMMOW J: In this litigation?

MR SHAW: In this litigation, and in fact in the report that I referred to earlier in 42 FCR. In section 80(1) it is provided that:

a loss shall be deemed to be incurred in any year when the allowable deductions -

and then there are some exceptions -

from the assessable income of that year exceed the sum of that income and the net exempt income of that year, and the amount of the loss shall be deemed to be the amount of such excess.

In subsection (2):

Subject to -

a number of subsections -

so much of the losses incurred by a taxpayer in any of the 7 years next preceding the year of income as has not been allowed as a deduction from his income of any of those years shall be allowable as a deduction in accordance with the following provisions -

If there is no exempt income, the deduction is made from the assessable income. If he has derived exempt income, the deduction is to be:

made successively from the net exempt income and from the assessable income -

and there is a definition of “net exempt income” in section 80(3). It is true that both in sections 97 and 92 what is referred to is not the net exempt income but the exempt income, but it is submitted that that is simply the consequence of the policy of the Act in providing for exempt income to be used as something to absorb losses which otherwise might be carried forward. That policy is modified - perhaps I should say not modified but given effect to - in the exception to section 97(1)(b) by excepting the inclusion in the exempt income of a beneficiary of the exempt income of the trust, exempt income:

to the extent to which the exempt income.....was taken into account in calculating the net income of the trust estate.

And the object of that, it is submitted, is to prevent the exempt income being used twice to reduce losses. Now, it is true that the expression of the exception is not an expression which refers in terms to carried forward losses. By that I mean it does not say except to the extent to which the exempt income has already been taken into account in determining the amount of carried forward losses for the trust or whatever it might be, but it is submitted that that is the only way in which under the Act the exempt income can affect the amount of the net income of the trust.

It is clear, it is submitted, that the view which was taken by his Honour Justice Dixon in Belford’s Case about the purpose of the exception expressed the understanding of its operation at the time and there has been no alteration in the terms of the Act which would make one think any different and, accordingly, it is submitted that when one looks at these provisions the Full Court was wrong in saying it had been taken into account simply because it is the basis, I suppose, from which one starts under section 27H.

If that were sufficient, one would, it is submitted, never find exempt income being included in the exempt income of a beneficiary of a trust because always one has to look at section 25 and in order to determine gross income which is not exempt income one has to do precisely in relation to all income that which one has to do under section 27H for the purpose of calculating the deductible amount. It is submitted that for those reasons the court below was in error and it ought not to have embraced the conclusion that the exception in section 97(1)(b) applied and one can, it is submitted, confirm that conclusion by looking at the matter in a more general way.

I know that it is not necessarily a very useful thing to say about some conclusion or other in relation to the application of the provisions of the Income Tax Assessment Act that the conclusion is not very sensible or it is very sensible, but one can sensibly ask oneself, it is submitted, when the whole object of this transaction was to invest in annuities and to receive back via the trust the whole of the amount of the annuities, leaving out the management fees for the moment since that they seem to be irrelevant, to receive it back, here you have a partnership, or if one regards it as two

beneficiaries, who are receiving the whole amount of annuities and part of that amount having passed through the trust is not assessable.

If it is not assessable, one would have thought that the deduction which is provided by section 51(1) ought to be available only to the extent to which it is assessable, and to say that the provisions of section 97(1)(b) do achieve that result, means, it is submitted, they are being applied in circumstances in which they do not achieve any policy result in avoiding double taxation or double deductions, or double whatever it might be. It is providing, what it is submitted, must be thought to be unexpected generosity on the part of the levier of tax.

GLEESON CJ: You may be right when you say that your first line of argument may be more helpful than that last one. When an anomaly operates in favour of the Commissioner, the Commissioner never offers the money back.

MR SHAW: That is true, your Honour.

GLEESON CJ: Mr Shaw, if you were to succeed in this appeal, what would be the precise orders you would seek? I read somewhere, and I forget whether it was in the papers in this case or in one of the other reports, that after the proceedings before Justice Jenkinson concluded, the parties agreed upon a formula.

MR SHAW: They did, your Honour. There was an agreement, your Honour, in relation to the way that the amount should be calculated but I do not think that the actual amount, as opposed to the way in which it was to be calculated, was ever actually agreed.

GLEESON CJ: So, page 697 of the appeal book sets out a form of order. Is that still the order that you would seek?

MR SHAW: Your Honour, the answer is yes. We seem to think that if we were successful that would be an appropriate order.

GLEESON CJ: Right. Thank you, Mr Shaw. Yes, Mr Bloom.

MR BLOOM: Your Honours, we might deal first with the first limb of section 51(1) or the first part, the positive part of 51(1). It has, notwithstanding my learned friend’s submission, two parts and those two parts are, as the High Court said in Ronpibon and thereafter, alternatives. The best exposition of this is probably to be found in the judgment of Justice Brennan, then on the Federal Court, in Magna Alloys and Research Pty Limited v Federal Commissioner of Taxation 33 ALR 213. Firstly, at page 216, at the top of the page, his Honour said:

The statutory criteria are expressed in the two limbs of s 51: “incurred in gaining or producing the assessable income”, and “necessarily incurred in carrying on a business for the purpose of gaining or producing such income”. The purpose mentioned in the second limb is not a purpose imported by the phrase “incurred in carrying on”, but the purpose of the business in the carrying on of which the deductible expenditure is incurred.

Now, that is why, this being a second limb case, one goes automatically to the exception and not to the words in the first positive limb of section 51(1). We have given your Honours a reference to a passage in Coles Myer about the business of finance companies and, a fortiori, of course, applies to the business of banks. Actually the page number we have given your Honours is wrong, it should be 663 to 664, that in paragraph 5 of our submissions, but I will not take your Honours to it.

Your Honours, the first submission that we make is, excepting certainly in the context of Division 16E and section 25 that 27H operates as a code, it taxes, however, in our submission, the entire payment, and by taxing the entire payment leads to the result that none of it is exempt income, because the whole is taxed. Your Honours, we have prepared a short calculation, together with a copy of 27A and 27H, which your Honours might use as a working copy, that is as they stood at the relevant time. I think we have prepared nine, your Honours, but one can have some spares.

GUMMOW J: They are not spares. We will need them for the Court file and for Court Reporting.

MR BLOOM: Yes. I thought it was nine, though, when the Court sat seven, your Honour. I may be wrong. In any case, hopefully it is enough. If one looks, firstly, at the calculation that is by reference to the first B class annuity, the relevant figures for which appear at volume 2 of the appeal book at page 368 ‑ ‑ ‑

GUMMOW J: What is all this designed to show?

MR BLOOM: It is designed to show that tax is imposed on the whole, initially, and also to show, for our final point, the taking into account of the deductible amount. If one goes to volume 2, at page 368, and sees the figures for the first of the annuities ‑ ‑ ‑

GUMMOW J: What is the construction you offer that differs from Mr Shaw’s construction before we get into this cloud of algebra?

MR BLOOM: Of calculation, if your Honour pleases.

GUMMOW J: What is the mode of construction of the Act? What different meaning do you place on the words?

MR BLOOM: “Taken into account”?

GUMMOW J: Yes.

MR BLOOM: We say that if it is taken into account in calculating assessable income - and we say it most clearly is - then it is taken into account ‑ ‑ ‑

GUMMOW J: You say it is “most clearly”, that is just assertion.

MR BLOOM: But this demonstrates it, with respect, your Honour. This shows how it is taken into account.

GUMMOW J: All right.

MR BLOOM: So one sees the figures for the first annuity payment at page 368, and in fact section 27H operates on an annual basis, not on an each annuity payment basis but on an annual basis, so one needs to aggregate the two payments to get the total first shown on the sheet that we have handed up of “$7,279,804”. That is the amount of the annuity derived during the year of income ending 30 June in each case. The deductable amount is calculated by reference to that formula:

A(B-C)
D

the figures for which, coming from sections 27A and 27H, are those figures that we have put there, 1 into what turns out to be the purchase price less zero over the number of years, which is four, and that gives a deductable mount of “$5,587,000” for that year. In order to calculate the amount which is included in the assessable income, one must take 2 away from 1, and one then gets the amount included in the assessable income. That does two things, in our submission: first of all, it shows that you take what you deduct into account in calculating the assessable income figure, but, secondly, that when you express it as a proportion, “23.25%”, that in fact the Act is really taxing 23.25 per cent of the whole - or 23.25 cents in the dollar.

GLEESON CJ: That is just your expression; it is not the Act’s expression.

MR BLOOM: No, it is not.

GLEESON CJ: The Act says it taxes that part of the annuity instalment which does not include the deductible amount.

MR BLOOM: The Act, your Honour, does not use the word “taxes”. It says the portion - the proportion that shall be included in the assessable income is worked out as follows. That is effectively what it does. It does not use the word “proportion” or the word “portion” but it says:

The assessable income.....shall include
(a) the amount of any annuity.....excluding -

so A minus B. It should say X minus Y, because A an B appear in the next subsection. It is not dissimilar, in our submission, to the decision to which we have made reference in paragraph 13 of our submissions, which is the Mutual Life and Citizen’s Assurance Co Case 100 CLR 537. There, and the headnote is accurate, it was a question of whether the whole of an amount of income which had been derived by the insurance company was exempt or not exempt from income tax in England for the purposes of section 23Q.

The insurance company derived income in the United Kingdom which was exempted by certain rules under the Income Tax Act 1918 but was required to pay income tax:

on that “portion” of the total income of the investments of the life assurance fund which bore the same proportion to that total income as the amount of premiums received from the policy holders resident in the United Kingdom and certain other policy holders bore to the total amount of premiums received by the company.

And the Court held that the whole was taxed because a proportion was, therefore, the whole was not exempt from income tax in England.

GLEESON CJ: Is not the question on the issue that was decisive in the Federal Court - and I realise you have other arguments as well - whether or not giving effect to the exclusion required by section 27H is taking the excluded income into account in calculating the net income of the trust estate for the purpose of section 97?

MR BLOOM: Yes, your Honour. That is really the decision in our favour that the Full Court made and we say, leaving aside the point I am presently addressing on, that if you get to the figure of assessable income only by saying A minus B, then you take B into account in normal parlance, in the grammatical and ordinary meaning of the words, by taking B away from A to get to the result. That algebraical mathematical exercise of necessity involves taking it into account by excluding it. It is not as if the two sums identify themselves.

GUMMOW J: But why otherwise is it included?

MR BLOOM: Why is it included?

GUMMOW J: You say excluded. That assumes that otherwise it is in.

MR BLOOM: Well, but for the way that the Act has approached annuities from the word go, the whole of the annuity would be as my learned friend, Mr Shaw, submits, income.

GUMMOW J: Yes, we realise that.

MR BLOOM: The Act says no, that the only portion that shall be included in income or the assessable income is the portion arrived at by taking away from the total an amount calculated to be this excluded amount and that it is thus, in our submission, clearly taken into account. If you subtract something in making the calculation to get at your resultant figure, you must take it into account in calculating that item of assessable income to fall into the net income of the trust estate.

GUMMOW J: What does “account” mean?

MR BLOOM: “Account”?

GUMMOW J: Yes.

MR BLOOM: “Taking into account”?

GUMMOW J: I understand the work it does when one is in section 80(2).

MR BLOOM: Yes. Well, that would be taken into account actually in looking at a composite idea also of net exempt income. It is not just exempt income. Before you get to section 80(2), you then have to take it into account in making the calculation of what is the net exempt income, just as you would here.

GUMMOW J: It does not say “having regard to”. It says “taking into account”.

MR BLOOM: “Taking into account”. Well, in coming to net exempt income one would start with exempt income and take away the deductions incurred in gaining or producing that exempt income. Now, surely those deductions would be taken into account in calculating the composite phrase “net exempt income” simply because it is necessary to subtract them to get to that concept and it is net exempt income with which section 80(2) is concerned, not just exempt income.

CALLINAN J: You would say including in the accounting exercise?

MR BLOOM: Yes, including in the calculation, because the phrase is not just “taken into account”; it is “taken into account in calculating”. The calculation exercise of necessity starts - assuming, as was the case with this trust, that there is no other income but the annuity, it starts with the exercise of working out what portion of that annuity is going to be assessable and what is not. That, we say, involves the subtracted item being taken into account in the calculation of that assessable income just on its ordinary words. It is only a strained construction, with respect to our learned friends, that one could say otherwise.

GUMMOW J: No, he says you read the section as a whole and you read the plus tax provisions as a whole and it then makes sense.

MR BLOOM: What he says is - and really there is far more in his final point than he may have allowed - it would produce an anomaly because it does something in favour of a taxpayer, and that is not the idea of the Tax Act. No doubt if the draftsman was always the Commissioner and the Commissioner was asked his intention, he would say, “That’s always my intention”, but who knows?

GUMMOW J: It is not a question of an anomaly favouring X or Y. It is a question of is it an anomaly? If you could achieve a result that appears to give a sensible effect to the obvious structures, as explained in Belford, why do you not do so?

MR BLOOM: If you have the ordinary and grammatical meaning of the words ‑ ‑ ‑

GUMMOW J: But it is the words in the whole of the section, the whole of the structure.

MR BLOOM: Well, yes, but ‑ ‑ ‑

GUMMOW J: We got away from that sort of interpretation a long time ago, Mr Bloom.

MR BLOOM: Your Honour, I am not for a moment suggesting we do not have a contextual interpretation but, when you go to the words which we are now working out the meaning of, the ordinary and grammatical meaning of them achieves the purpose which is alleged to be the purpose. If that is the case, then there is no reason for departing from those ordinary and grammatical words. If the result is that something else is also brought within those ordinary and grammatical words, that is not a basis for departing from them unless it is some Liversidge v Anderson approach which says that we do a Humpty Dumpty exercise and have the words having one meaning in one situation and one in another.

What we say is that if in truth the purpose is the purpose which our learned friends have identified, that purpose is given effect to by the literal or grammatical meaning of the words in question. If that is the case, one does not depart from them by reference to the facts of this case if the facts of this case also fall within that literal or grammatical interpretation. I have gone away from Mr Justice Fullagar in Mutual Life and Citizens and I might return if I may in due course, your Honours, to that other very important question.

At page 550 in Mutual Life and Citizens, in the middle of the page there is a passage in his Honour’s judgment where he says:

If you impose tax on a proportion a

over -

b of 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.

Then over at page 555, the top of the page:

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”.

Pausing there, of course in one sense it was. You could say that by applying the figure of 2.888 per cent to the whole, you could come up with an identifiable figure that was taxed and, by applying 97.12 per cent to the balance, you could come up with an identifiable figure that was not taxed. But his Honour is saying really that is not the way you do it. If in truth it is taxation of a proportion of a whole, the whole is taxed. His Honour continues:

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. There are many purposes of the law for which it may be necessary to make an apportionment in respect of a payment, and, unless a special appropriation can be made and is made, the rule of the common law is that a payment is attributed rateably to each pound of a debt or fund. In Ellis v Emmanuel Blackburn J said:- “It was said that the dividends are by law applied to each part of the debt rateably, which is unquestionably true”.

His Honour referred to a number of cases including taxation cases.

In the present case it may be said that essentially it is not a matter of distributing a payment but of distributing a burden. But the position is entirely analogous. The burden cannot be distributed in any way which will leave it resting not on the whole, but exclusively on some severable part, of the interest received. The whole, therefore, is “not exempt”.

So our first submission is that the whole, based on that calculation sheet that we have handed to your Honours, is not exempt because tax is effectively imposed on 23.25 per cent or 23.25 cents in every dollar of what is received, not on a certain amount of the dollars flowing in - first in, first out, sort of thing - not on some identifiable amount. One bears in mind that the amount of the annuity for the year comes in in two amounts. It is just that rateably one would apply that proportion of 23.25 cents in the dollar to every dollar of the annuity that comes in, and therefore the whole is taxed and therefore the whole is not exempt.

Your Honours, our second point is sufficiently set out, with respect, in our submissions. It is that, in any case, when annuities were first dealt with by the Act, they were dealt with in such a way that the undeducted purchase price, or now deductible amount calculation, was recognised as, in truth, capital. The Act treated it as capital from the first Income Tax Assessment Act. When the change was made from income to assessable income, that was not a change intended, in our submission, to change the way in which the Act approached the taxation of annuities. So that the Act treated as income, and still treats as income, only that portion of the annuity which does not represent the undeducted purchase price.

GLEESON CJ: Presumably, it is the periodicity of payments which would make an annuity income.

MR BLOOM: Yes, your Honour, according to all my concepts, yes. It was spoken about in those old cases to which my learned friend, Mr Shaw, referred, as the purchase of an income. Then, your Honours, we submit that the beneficiaries did not derive exempt income. This depends upon the meaning to be given to the words in section 97(1)(b) “the individual interest of”. We accept that the beneficiaries are entitled to at least a share of the income, trust law income of the trust estate, but the question is, did they have, in the way in which this trust deed worked, an individual interest in the exempt income? Now, this accepts, of course, for the purposes of this argument, that what came in was assessable income and exempt income.

But if one goes to the trust deed, which is in volume 1, it commences at page 73, and if I could take your Honours to some only of the clauses, firstly, 3.3, and I will take your Honours to some that my learned friend did not take you to and a couple that he did. Clause 3.3 on page 80:

A Registered Holder -

and that includes the beneficiaries -

shall be entitled as herein provided to a beneficial interest in a Fund but such interest shall not entitle the Registered Holder other than as herein provided:-
(a) to require the transfer to him of any of the investments of any Fund.

Then, clause 4.3 on page 81:

Upon termination of the trusts.....the investments.....shall, subject to Clause 4.4, be realised.....and the proceeds of realisation and other ‑ ‑ ‑

GUMMOW J: Sorry, where are you reading now, Mr Bloom?

MR BLOOM: Clause 4.3, page 81, your Honour:

and the proceeds of realisation and other available cash shall be distributed as follows -

and 4.4:

The Trustee may retain in its hands or under its control for as long as it thinks fit such part of the relevant Fund (other than cash representing any income.....) as in its opinion may be required to meet any outgoings or liabilities.

GUMMOW J: So, you have to construe the phrase in the Act “individual interest in”, is that the idea?

MR BLOOM: Yes.

GLEESON CJ: Who else might have had any interest in these amounts?

MR BLOOM: Well, if ‑ ‑ ‑

GUMMOW J: I mean, they are vested in interest, they may not be vested in possession, but they are certainly vested.

MR BLOOM: What section 97 does, with regard to both assessable and exempt income, is to advance the point of derivation in an appropriate case. So, if there is a present entitlement to income, to a share of trust law income, the assessable income will include that share of the tax law income.

If, on the other hand, there is an individual interest in exempt income, that will be the point of derivation. What we say distinguishes this case is that the beneficiary is not entitled unconditionally to the exempt income. He does not have that sort of interest in it which would enable him to say, “Give it to me so that I may do with it what I will,” or, “so that I may have it applied in any way that I may choose.”

GUMMOW J: He cannot call for payment.

MR BLOOM: No.

GUMMOW J: Well, so what?

MR BLOOM: Apart from the fact that that has been said by this Court to be an essential aspect of present entitlement to it ‑ ‑ ‑

GUMMOW J: Yes, but we are not construing that phrase.

MR BLOOM: We have to to get into individual interests because - well, your Honour, we say that at least there has to be a vested interest in it, but that a person who has a vested interest, even if he has not got the right to demand immediate payment, has the right to have it dealt with as and when he wants for his benefit. Now, when the trustee receives the so‑called capital under this deed, it can only be dealt with by redeeming and in discharge of, pro tanto, part of the capital interest of the beneficiary in the trust. So it is an interest that is somehow conditional and, therefore, we say not relevantly an interest in the exempt income.

GLEESON CJ: I would like to just understand a little bit of what the process of redemption involves.

MR BLOOM: Yes, your Honour, I am coming through to those clauses, if I may. If I could just keep going in the way I was. Firstly, at page 82 clause 5.2(a):

Every Investment Unit shall confer such an interest in a Fund as is provided in this Deed but shall not confer any interest in any particular part of that Fund or of any investment but only such interest in that Fund as is conferred under this Deed.

And 5.3(b) the beneficial interest in the B class fund originally went to the management units, which went to the relevant beneficiaries. Clause 8 permits transfer of units. That is on page 84. Clause 9 deals with income and the position of that income can be compared to the position as regards capital. 9.1 says:

Except as elsewhere herein provided the Trustee shall receive all moneys rights and property which are paid or receivable in respect of a Fund.
9.2 (a) The income of each Fund in respect of each financial year of the Trust shall be held on trust absolutely for the Manager to such extent ‑

and otherwise “absolutely for the Investors” over on page 86 in (b) and, if you read (b) together with 9.3, you get the contrast when we come to clause 10:

(b) Subject only to Clause 9.2(a) the income of each Fund in respect of each financial year shall be held by the Trustee on trust absolutely for the Investors in that Fund in proportion to the number of Investment Units in that Fund respectively held by them.
9.3 The Trustee shall promptly distribute cash representing the income of each Fund in respect of each financial year, in accordance with the entitlements of the Registered Holders thereto as and when such cash is received by the Trustee.

Now, there is no condition attached to that, but when we get to 10, 10.2:

The capital of each Fund shall be held on trust absolutely for the Investors in that Fund in proportion to the number of Investment Units ‑

so that is the same, but 10.3(a):

Subject to subclause (c) and Clause 19.3 the Investment Units held by an Investor shall be redeemed in accordance with this Clause 10 as and when and to the extent that the Trustee receives cash representing capital of a Fund to which such Investor is entitled ‑ ‑ ‑

GLEESON CJ: How do you go about redeeming them?

MR BLOOM: It continues on in clause 10.3, if your Honour please:

(b) The number of Investment Units held by an Investor which shall be redeemed in accordance with Clause 10 shall be equal to the amount of that proportion of the cash available for distribution representing capital.....
(c) In order to effect any such redemption as aforesaid the Trustee shall pay to the relevant Investor the Redemption Price of the relevant Investment Units ‑

and they are defined terms, of course ‑

and thereupon the relevant Investment Units shall be redeemed.

If one, for instance, purported to make a gift to a charity of $100 upon condition that that charity would give $90 of that to one’s wife, one would not have a gift of the whole $100.

GUMMOW J: Well, you would have sort of an exam question for law students, I suppose.

MR BLOOM: No, the Federal Court has already dealt with it, your Honour, and has said that that is not a gift of the whole, and only by way of analogy. Here, one is not entitled to this so-called capital in any way other than by having one’s interest in the Fund, in the capital of the Fund, discharged pro tanto by payment, and that focuses away, in our submission, from the question of advancing to the point of ascertaining an interest in exempt income, for the purpose of section 97 to the point of actual receipt, and it is in the hands, therefore, of the Banks, the partners, that this amount must be determined as assessable or not. I mean, Charles’ Case was not concerned with this sort of a situation; it was concerned with distributions on units which continued. There was no question of any distribution of something which was trust or income, but which had to be received by the capital beneficiary in discharge, pro tanto, of its capital rights.

Now there is a passage in the judgment of Sir Gerard Brennan in Federal Coke. I can give your Honours a reference.

GUMMOW J: What happens if a holder dies, is there any provision in here?

MR BLOOM: No, I do not know if that was ‑ ‑ ‑

GUMMOW J: Or becomes bankrupt?

MR BLOOM: I do not know if that was contemplated, I have not looked.

GUMMOW J: They must die or become bankrupt owning something.

MR BLOOM: Well, insolvency is a possibility, your Honour, given at least for those that are - not my clients, of course, your Honour - at least for companies. If your Honour will give me a moment, I will see if there is a ‑ ‑ ‑

GUMMOW J: The answer, unless there is something special, is that the ordinary general law is to transmission on death or insolvency would imply. It would be odd if the general law said that there was nothing that was transmitted. I am sure it would say that it was.

MR BLOOM: Well, as soon as an amount representing capital is received, it must be paid out in redemption. It is not to be held and invested and, apart from perhaps the instant when it goes into the bank immediately preceding the drawing of the cheques, and if one leads that aside, it is intended to be dealt with upon receipt, so that the entitlement of the beneficiary to it is not in discharge of his interest in it as income, but in discharge of his capital rights in the trust, and that is the distinction that this trustee seems to bring to bear.

We do have copies of Federal Coke 15 ALR 472, if your Honours please. At 472, at the bottom of the page, in Justice Brennan’s judgment:

When a recipient of moneys provides consideration for the payment, the consideration will ordinarily supply the touchstone for ascertaining whether the receipt is on revenue account or not. The character of an asset which is sold for a price, or the character of a cause of action discharged by a payment will ordinarily determine, unless it be a sham transaction, the character of the receipt of the price or payment. The consideration establishes the matter in respect of which the moneys are received. The character of the receipt may then be determined by the character, in the recipient’s hands, of the matter in respect of which the moneys are received. Thus, when moneys are received in consideration of surrendering a benefit to which the recipient is entitled under a contract, it is relevant to enquire whether or not that benefit was a capital asset in his hands.

Now, these moneys are not received for the giving up or discharge of a right to the income, per se, an interest in it which entitles the beneficiary to have it paid to him or applied for his benefit in the ordinary sense. This is in discharge of part of his capital interest in the Fund, and that is intended to be the situation brought about by the trustee and, for those reasons, we say, when you look at there was no individual interest, as that expression has been said to be understood, particularly in Whiting’s ‑ ‑ ‑

GUMMOW J: What does the word “interest” mean in this section? You have got to get down to it.

MR BLOOM: An interest vested in an interest or possession, in our submission, your Honour. We have given your Honours an extract from Jowitt’s Dictionary as to both of those terms. It was said by Justice Rich in Whiting’s Case 68 CLR 199 ‑ ‑ ‑

GUMMOW J: Exactly. He says, “in the course of due administration there is no present entitlement.” One understands that. And in the course of due administration you have got an asset all right. That is what Livingston Case decides; they levied death duty on it.

MR BLOOM: Yes.

GUMMOW J: When the person having the interest in the unadministered estate herself died, so I do not see how this helps you.

MR BLOOM: At page 204, at about point 7 of the page, he simply says that:

By individual interest is here meant the interest to which a partner is solely entitled, as contrasted with his joint interest in the whole.

But it is an interest in, which can only be an interest vested in interest or possession. I mean, in Harmer’s Case, 173 CLR 264, the question arose as to the meaning of the phrase “presently entitled” and the Court said, at page 271 in the joint judgment, just under the reference to the names of the Judges who comprised the Court for that joint judgment:

The appellants claim that, during the tax years, one or other of the claimants was “presently entitled” to the interest earned, either within the primary meaning of that phrase or by reason of the deeming provision of section 95A(2) which provides that, for the purposes of the Act, the beneficiary shall be deemed to be presently entitled to income of a trust estate in which he or she “has a vested and indefeasible interest ... but [to which the beneficiary] is not presently entitled”.

So you could apparently have a vested and indefeasible interest but not be presently entitled, at least as far as the draftsman is concerned.

The parties are agreed that the cases establish that a beneficiary is “presently entitled” to a share of the income of a trust estate if, but only if: (a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of the income -

as income, we say -

whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

It would be a strange result if, for present entitlement, one required at least that first limb of an interest which is “both vested in interest and vested in possession” and yet the interest spoken about in 97(1)(b) was some different sort of interest. It must be the same interest, namely it must be one “both vested in interest and vested in possession.”

We say that, having regard to the manner in which the monies representing the capital, or exempt income as our friends would have it, were to be here applied, there was not an interest in it as income. Hence, one does not look at 97(1)(b) in determining its assessability or its nature as income or capital, but rather goes to the ordinary concepts in the way in which Sir Gerard Brennan expressed them in Federal Coke.

Now, your Honours, that brings us to the point upon which we succeeded in the Full Court of the Federal Court. If we fail on the first points that we have put to your Honours, then it is necessary for us to succeed again on this point. Now, if one looks at that calculation sheet that I handed to your Honours, there can be no doubt, in our respectful submission, that if item No 2 is taken away from item No 1, item No 2 has been taken into account in calculating item No 3, as is item No 1. Both 1 and 2 are taken into account in calculating item No 3, and item No 3 is the assessable income item. Now, we have annexed two examples. The Commissioner says, well, the first definitely involves a taking into account for the purposes of section 95 because it is taken into account in calculating the allowable deductions integer of net income, although he resists that proposition when it is taken into account in calculating assessable income integer of the same thing.

So, in annexure “B” to our submissions, and the Commissioner says here that the exception applies, so net income is assessable income minus allowable deductions, and he says, “Well, in calculating the allowable deductions, you look at your loss carried forward”, and here we have used a figure equal to one of the first B class annuity payments, and then we have assumed an exempt income figure equal to the exempt income figure alleged here, in relation to the annuity payment. So, your permissible loss deduction becomes little 1 minus little 2. Now, that is the way that exempt income is taken into account in calculating the allowable deductions integer, in exactly the same way. The loss carry forward is that figure of $3 million, you take away or subtract the exempt income figure to get to the permissible allowable deduction and it is that end figure that then comes into the allowable deductions to calculate net income of the trust estate.

If we go to the next annexure, in which we do the same with regard to assessable income, using exactly the same figures, again net income equals assessable income less allowable deductions. In calculating this time the assessable or positive integer, same annuity payment or same amount of, in this case, an annuity payment of $3 million‑odd, less the deductible amount gives you the amount included in the assessable income. Now, in each case there is a subtraction of the figure that is said to be the exempt income in order to get an integer in the net income calculation.

In each case it is equally taken into account. In the Commissioner’s argument, it is only taken into account if it is taken into account in calculating the allowable deductions but that, he says, comes about because of the purpose, not because of the words. The words are apt to cover each. The subtraction in each case is exactly the same exercise except one is calculating the allowable deductions integer and one is calculating the assessable income integer. One performs no different task in either case and yet the Commissioner says, “Well, I accept that the words of the section are, given their grammatical or literal meaning, perfectly apt to cover the second of those situations”, and he must accept on their ordinary and literal meaning they are apt to cover the first, but he says you some how, in application to the facts of the first, read them down.

Your Honours, no purposive canon of construction leads, in our respectful submission, to that result. We have pointed out, your Honours, that one must construe the Act as it was when the exception first appeared in the Act, and that was without any reference in section 95, or indeed in Division 6, to a difference between exempt income and assessable income by way of definitions and we have shown your Honours - and I do not need to take your Honours to it - the reason why the definitions came in, simply to overcome the effect of the Court’s decision in Union‑Fidelity where it was held that foreign source income was not brought into the trust provisions either exempt or assessable.

There is also a canon of construction that an exception such as this, if its construction is seriously in doubt, should favour the taxpayer. The latest case in which that was referred to is a decision of Justice Beazley when on the Federal Court in Bons v Federal Commission of Taxation 94 ATC 4,372. At 4,375 her Honour says in the right‑hand column:

The task of the Court in interpreting statutory provisions, including taxing provisions, is to ascertain what the legislature means by the words it has used.

There is a reference to a passage in the joint judgment of Justices Mason and Wilson in Cooper Brookes.

It has long been held that the situations in which tax will be imposed should be clear. As Lord Ellenborough said in Warrington v Furbor -

and that is actually reported in the English Reports, your Honours, in (1807) 103 ER 334:

“I think that when the subject is to be charged with a duty, the cases in which it is to attach ought to be fairly marked out; and we should give a liberal construction to the words of exception, confining the operation of the duty.”
See also Armytage v Wilkinson -

That was a decision of the Privy Council.

In Burt v Commissioner of Taxation (1912) 15 CLR 469 Barton J said at 482, 483/4:
“Where the construction of such exceptions [to tax] is seriously in doubt, the interpretation should favour those whose claims are based upon the exceptions.”

KIRBY J: But you would be more aware than we are, Mr Bloom, that there has been an awful lot of discussion about this, and many of those 19th century - almost 18th century - observations were written in times when legislatures were unrepresentative.

MR BLOOM: Yes, your Honour.

KIRBY J: Some of the old principles really, I think, have to be reconsidered in the light of the modern state, the role of Parliaments, the representative nature of Parliaments, their democratic accountability and the importance of taxation for sustaining the role of the community. So that I just think it is rather - I thought that that had all gone out the window, that we just construe the Tax Act as another statute looking for its purpose but not with any bias.

MR BLOOM: Well, your Honour, as to that I can only say that Mr Pearce, in his current edition, still allows for this sort of approach to the construction of tax legislation ‑ ‑ ‑

KIRBY J: Be sure you have underlined that.

McHUGH J: And Justice Deane ‑ ‑ ‑

MR BLOOM: Justice Deane in Hepples, yes, your Honour. Justice Deane in Hepples also said that a case such as this - I leave aside cases involving specific tax avoidance legislation and the like - one would require clear and unambiguous words. Of course, it is hard to say with anything in the Tax Act these days that clarity and ambiguity is a prerequisite, but at least in the sense of application, what we have here is a situation of words which, if given their ordinary meaning, fulfil the purpose which is alleged against us and those words also cover our situation. What is the court to do? To depart from the grammatical meaning in the second instance, but not in the first? In our submission, that is not right.

All one can say about what Justice Dixon in Belford’s Case said, is that that certainly was what occurred to him to be the purpose. Now, one does not know if one had asked the draftsman in 1936 about the idea that a beneficiary under a trust, receiving a return of capital, would be treated as if he had received exempt income and be denied a deduction for a proportion of the interest he had laid out to acquire the money to acquire his annuities. One does not know what approach might have been taken by the legislature at that time. So it is all conjecture.

All that could have been done, one presumes, is to add some words to it; some words by way of, exception to the exception, and that is not really part of the court’s function, as we understand purposive construction, where the normal and grammatical meaning of the words gives effect to what the purpose is, once that purpose has been ascertained.

GLEESON CJ: This is of the most marginal relevance, but at the time when the Commissioner was assessing your client in respect of this transaction to tax on the basis that this was a loan, how did the assessment proceed?

MR BLOOM: Well, he applied Division 16E and he did not disallow any part of the deduction at all. Indeed, the question of whether ‑ ‑ ‑

GLEESON CJ: What did he bring to tax?

MR BLOOM: He brought to tax what was worked out to be the interest proportion of the annuity payment.

GLEESON CJ: In effect, excluding the principal amount.

MR BLOOM: Yes, but it is done under Division 16E by a formulaic approach which is not that simple, your Honour. But he then came to this Court which held that he could, notwithstanding that he had not assessed on that basis, rely upon section 51(1) to defend an assessment that had been made upon the basis of assessable income, so that he could rely on the other side of the coin. That case is, of course, reported in the Commonwealth Law Reports and I will obtain for your Honour the reference. But this only occurred to him once his argument concerning assessability was defeated. That argument being based purely upon the substance of the transactions rather than upon any argument based on Part IVA.

But there is a passage in the judgment of Justice Mahoney in a decision of the Court of Appeal, and your Honour Justice McHugh was on that court - I am sorry, Mr Sullivan tells me that the report of the earlier decision is in 181 CLR 466.

GLEESON CJ: Thank you.

MR BLOOM: Now, that case is Tokyo Mart Pty Ltd (1988) 15 NSWLR 275, if I might hand that to the Court. At page 283 his Honour, with your Honour Justice McHugh and Justice Clarke agreeing, said at the top of the page, about the reference to Wentworth Securities v Jones:

Legislative inadvertence may consist, inter alia, of either of two things. The draftsman may have failed to consider what should be provided in respect of a particular matter and so fail to provide for it. In such a case, though it may be possible to conjecture what, had he adverted to it, he would have provided, the court may not, in my opinion, supply the deficiency. In the other case, the legislative inadvertence consists, not in a failure to address the problem and determine what should be done, but in the failure to provide in the instrument express words appropriate to give effect to it. In the second case, it may be possible for the court, in the process of construction, to remedy the omission.

We fall, in our respectful submission, within the first of that dichotomy. A case where the purpose has been achieved by the express words chosen, so to achieve the purpose one need make no change at all, but that it is said well, he has failed to consider another situation and to have provided for it. That is a situation which, according to the Court of Appeal, is not one where the Court may enter into remedying the deficiency by adding in words, or changing the words. Your Honours, is that a convenient time?

GLEESON CJ: Very well, we will adjourn until 2.15.

AT 12.42 PM LUNCHEON ADJOURNMENT

UPON RESUMING AT 2.19 PM:

GLEESON CJ: Yes, Mr Bloom.

MR BLOOM: Thank you, your Honour. Now, before lunch I was essentially submitting to the Court that something is taken into account in calculating an amount if the figure that represents that thing is included in the mathematical calculation for the result and the focus is really on that process of mathematical calculation. If the Commissioner is right in his construction of the words “taking into account” where he applies them to assessable income, then the exempt income would not only not be taken into account on the assessable income side, but on that construction, nor would it be taken into account on the allowable deductions side, thus completely missing the purpose that he alleges is the purpose behind the provision. The truth is it is taken into account in each of examples B and C which we have annexed.

GLEESON CJ: Could you just explain that last proposition again?

MR BLOOM: Well, effectively what he says is the assessable income only enters in after you have done the calculation, so it is not taken into account in calculating the assessable income, but so it is with the allowable deductions side. If one goes to section 80(2) the carry forward losses are allowable as a deduction:

(b) where he has in that year derived exempt income.....from -

initially -

net exempt income ‑

and “net exempt income” is defined as “exempt income less expenses in earning exempt income”. So when one goes to the example in annexure B to our submissions, when calculating the allowable deductions of the trust estate applying section 80 as it was, it is necessary to first start with the loss carried forward then subtract from it the exempt income, in fact, the net exempt income that section 80 defines, before one gets the allowable deduction that comes into the calculation of the net income.

So, it is exactly the same process as happens in annexure C in relation to section 27H. In order that the exempt income being taken into account in calculating the assessable income - one starts with the full amount of the annuity, one takes from that the deductible amount or exempt income and one ends up with the amount that goes into the assessable income as a result. It is exactly the same process. Now, the Commissioner cannot argue that one is a correct process because it applies to allowable deductions because that is what was intended, but the other identical process in so far as it applies to assessable income is not doing exactly the same thing.

GLEESON CJ: Mr Shaw put a submission to the effect that if you look at section 92(3) concerning partnerships, you will find nothing there corresponding to the exception in section 97(1)(b).

MR BLOOM: Yes, your Honour.

GLEESON CJ: What is the reason for that?

MR BLOOM: It is that losses of the partnership are worked out specifically as if the partnership was a taxpayer having a partnership loss. That concept does not exist with trusts so one does not work out in relation to trusts losses and then give them, in effect, to the beneficiaries. One does, however, with a partnership work out the partnership loss and the individual interest of the partner in that loss is, itself, an allowable deduction.

GLEESON CJ: So it is the subject matter of carry forward losses that explains why you have the exception in section 97(1)(b) and not in section 92(3)?

MR BLOOM: Section 92(3)(b)? Yes, your Honour.

GLEESON CJ: Well then, if that is the explanation of the exception, it throws some light on its meaning, does it not?

MR BLOOM: It throws some light on its purpose and it allows us to accept that what the Commissioner says is probably correct when he says that the purpose was to deal with that situation. But what it does not do is to assist us when the same language applies to the assessable income integer. It is simply the case that in order to do the work of achieving the purpose for which for the moment one accepts it is there, the words must be given a meaning, and only one meaning, which gives them the same effect with regard to the facts before the Court.

I cannot point to anything, your Honours, which says that the purpose was to deal with the facts of this case and the Commissioner can point to statements such as that by Sir Owen Dixon in Belford’s Case that suggests that the purpose was to deal with the allowable deductions integer. But in order for it to do that work on its ordinary and grammatical meaning, it must apply also to the facts of this case. We simply say there is no basis for adopting the grammatical and ordinary meaning with respect to one integer but not for the other. In either case, the amount is taken into account in calculating the net income which is the result of assessable income less allowable deductions.

GLEESON CJ: It comes down to this then: we know what the purpose of the exception was, the question is whether its effect goes beyond that.

MR BLOOM: Yes. Your Honours, my learned friend, Mr Shaw, was a little coy about something that your Honour the Chief Justice put to him about how section 97(1)(a) operates in relation to a capital gain. No doubt, on obtaining instructions, he would have told you that it applies in exactly the way that we have put it in our written submissions in paragraph 35.

It was dealt with by Justice Hill in Davis 86 ALR 196. At page 230 his Honour refers to Union Fidelity and sets out section 97 as it was before Union Fidelity, and then says:

Under the “proportionate view” the opening words of s 97(1) require a calculation of the share or proportion of the trust law income to which each beneficiary of a trust estate is presently entitled. Once that share or proportion is calculated then the second half of the subsection operates to include in assessable income that same share or proportion of the “net income”. Under this view, provided that there is a beneficiary or there are beneficiaries who are alone or together presently entitled to the whole of the trust law income of a trust estate, the net income for tax purposes will be distributed among those same beneficiaries proportionately and there will be no amount upon which the trustee will be liable to pay tax under the provisions of s 99 or 99A of the Act.
The alternative view, while accepting as it must that present entitlement can relate only to trust law income and not to tax law income (for the simple reason that the composition of “net income” is merely a matter of computation and may include amounts which have no correlation with assets at all.....would construe s 97 as directing specific attention to a taxpayer’s share of trust law income and requiring the inclusion in assessable income only of that part of the net income of the trust estate as is represented by the proportionate part of trust law income. Thus if one assumes that trust law income is to be divided equally between two beneficiaries A and B and the trust law income is $100, where the net income is $200, of which only $100 is represented by the trust law income, only that $100 is distributed equally between A and B under s 97, leaving there to be a balance undistributed in respect of which the trustee is to be assessed and liable to pay tax under s 99 or 99A.
It is quite clear that neither interpretation of s97 produces a desirable result as a matter of tax policy and the scheme of Div 6 calls out for legislative clarification, especially since the insertion into the Act of provisions taxing capital gains as assessable income. On the proportionate view, a taxpayer may be assessed on amounts he neither did nor could receive; on the alternative view a taxpayer could be taxed on less than he received if the share of trust law income exceeded that part of the net income as is represented by trust law income, and the maximum rate of the tax under s 99A would be applicable to the balance.

Now, different judges have taken different views as to which method should be adopted. Certainly Justice Hill preferred the proportionate method as did the Asprey Review Committee in its report. Recently, Justice Merkel in a case called Richardson in 150 ALR 167 has taken a contrary view. But the point has been re-argued in a case called Zeta Force Pty Ltd v The Commissioner on 21 May in Melbourne before Justice Sundberg. Judgment is reserved, and ‑ ‑ ‑

GUMMOW J: What is the name of Justice Merkel’s decision?

MR BLOOM: Richardson150 ALR 167, your Honour, and the relevant passages are at 181 to 184. The argument strongly put for the Commissioner in the Zeta Force Case, was again for the proportionate method, notwithstanding it was accepted that it produced this anomalous result in relation to capital gains. So, it is no answer, with respect to our learned friends, to say in relation to Division 6 that one interpretation or the other, of a provision of it, produces an anomaly. This will always be a difficulty in the endeavour to access the income of trusts in the hands of either the trustee or the beneficiaries, and it has been proved clear, for many many years, in terms of the argument about the proportionate method of taxation.

GLEESON CJ: So that in the example that I gave, if X is entitled to the caucus of a trust estate and Y is entitled to the income, and a capital gain arises which attracts tax, that is borne by Y.

MR BLOOM: That is correct, your Honour, on the proportionate method, and that is obviously an anomaly and it is obviously an unfairness, but it is one which has not stopped the Commissioner from contending that it is the correct approach to section 97. In terms of the rewrite of Division 6, there is little doubt that Division 6 and the taxation of trusts is to be very

substantially changed. The only decision that the government is making at the moment is how. It is not a question of a simple rewrite, like might be the case, for instance, with the old section 51(1) and present section 8-1 of the 1997 Act. This is to be a complete recasting of the trust provisions in a new statute.

In relation to our flagging of the issue as to whether special leave should be revoked - and we do it only because there are other bits of legislation which do have some impact on what the Court will be deciding - your Honours will see from annexure E to the submissions that there is a new category of income introduced into section 6(1) which replaces section 25 of the 1936 Act. It is a category called non‑assessable and non‑exempt. Under the replacement for section 51(1) there is no denying of a deduction to the extent to which it is incurred in gaining or producing non‑assessable, non‑exempt income. So, really, a question arises in terms of the future relevance of this point before your Honours as to whether the section 27H deductible amount is non‑assessable, non‑exempt income, for instance.

There are also, as we have pointed out, in the form of an Act which has been enacted, substantial provisions relating to trust losses, and yet the Commissioner’s case is put upon the basis of losses applicable to trusts and the purpose to be served in relation to those. We do still maintain for your Honours the point as a point for consideration as to whether or not special leave should be revoked, given the fact that one must really look into the future and see whether what your Honours are about to say will have some relevance to the provisions that have been and are being enacted.

GUMMOW J: It will be about ten years before they get here, judging by this case anyway.

MR BLOOM: To this Court, yes - on the basis of this case certainly, your Honour, but this case has had a few yoyo appearances in this Court and the Full Federal Court. Those are our submissions, if your Honours please.

GLEESON CJ: Thank you, Mr Bloom. Yes, Mr Shaw.

MR SHAW: I have asked my learned friend Mr Pagone to make the reply, your Honour.

GLEESON CJ: Yes, Mr Pagone.

MR PAGONE: Your Honours, may I just deal with that last point first and very quickly. All my learned friend says about the amendments in the rewrite simply is not right and, without going through the provisions, may I simply refer the Court, just for the purposes of record, as it were, that, although there is no such concept as non‑assessable, non‑exempt income, it is not correct to say that the new provisions in section 51(1) and the other provisions together do not produce the same effect as is in issue here.

May I just mention the provisions, your Honours, the new provisions in the rewrite, the new 51(1) is now section 8-1. The matching provision, for present purposes, is 8-1(2)(c), which excludes a deduction if it is incurred in relation to gaining, producing or exempt income. Exempt income is defined, strictly speaking, in section 995 but in fact it refers the reader back to section 2-20 and also is relevant to section 6-1(3), exempt income is not assessable income. Section 6-20 provides a definition of exempt income, materially identical to the one with which the Court is presently concerned. As the Court can be aware from the materials in the special leave application this, of course, is a test case and lots of other cases will depend upon the outcome in this case, for parties who had entered into similar transactions.

My learned friend referred to Mr Shaw as being coy in his response to the question about the consequences for the capital gains tax purposes. The question for capital gains tax purposes is somewhat difficult, but difficult because the peculiarities of other provisions in the Act, which have the effect of creating as a class of assessable income the capital gain. The question then becomes, what do you do with the income created by the Act, pursuant to a capital gain, where the net income of the trust estate, as defined, is directed to particular people. It is a very, very different problem from the one with which we are presently concerned and, as it happens, not one that the Court needs to be troubled with for present purposes.

GLEESON CJ: Except that it does have a relevance to Charles’ Case, does it not?

MR PAGONE: Not for present purposes, your Honour, because for present purposes the question in Charles’ Case is whether the character remains the same in the hands of the beneficiary and the answer would be the same for a receipt of a capital gain. What you do with it for trust law purposes is one thing; what you do with it for assessability purposes is another. Even if one could make the liability fall upon the corpus beneficiaries one would have the difficulty, I suppose, that the corpus beneficiaries might not actually have received the benefit of the gain in a form that would enable them to pay the tax. My learned friend Mr Shaw was perhaps not being coy but putting his hands up saying it is a difficult problem that, as Mr Bloom has indicated, is being dealt with as a serious and difficult problem.

GUMMOW J: But it is one that the capital gains tax provisions do not specifically direct attention to.

MR PAGONE: No, your Honour. It arises because of the funny definition of - I should not say funny - but particular definition about the net income of the trust estate. By way of reply to the points made by our opponents in respect of the construction of the words “taken into account”, what we say really is simply this: the examples that they have given in the annexures, whilst in a sense attractive, can be somewhat distracting because when - I do not invite the Court to do this but when one looks at annexure B what one finds is that the inquiry that annexure B is concerned with is: what are the allowable deductions at a particular time?

In that process the exempt income is relevant and is relevant in a way that actually changes the allowable deduction, so that the character of the thing being affected by the calculation, by the bringing into account of that integer, is different from the integer that is being brought in. Annexure C is a very different inquiry completely. There the inquiry is what is the exempt income, and what you have in 27H is a mechanism that tells you what from amounts received is to be treated as one thing, exempt income, or as assessable income for the other. It is at the point of separation, as it were, those sheep that go into one paddock and those that go into another.

GLEESON CJ: The phrase that has to be construed is not “taken into account”. It is “taken into account in calculating the net income of the trust estate” and a question arises as to where the relevant calculation begins and ends. If you look at the definition of net income it tells you that is assessable income less allowable deductions. Now, there was a preceding calculation by which you ascertained the assessable income, but in calculating the net income of the trust estate what you did was to subtract allowable deductions from assessable income.

MR PAGONE: Yes, your Honour, but what one has in respect of these calculations - I suppose what one could say as a complete answer to our learned friend’s case here is that on these facts there has never been any actual taking into account of the exempt income because on the facts here until the separation of the 27H amounts have occurred as either assessable income or exempt income there has been nothing to take into account.

GLEESON CJ: But the taking into account of the deductible amount occurred, if it occurred at all, in the course of a calculation of the assessable income.

MR PAGONE: If it occurred at all, your Honour?

GLEESON CJ: Yes. A possible point of view is that the calculation with which this exception is concerned is the calculation of the net income which is a later calculation than the one that took into account the deductible amount.

MR PAGONE: Yes, your Honour. So that on that view also - - -

GLEESON CJ: Well that, some people might think, would be a very literal interpretation of the Act.

MR PAGONE: Indeed, your Honour. But one does not stop with a literal interpretation of the Act, from our point of view. We say that, as it happens, it produces good sense because when one looks at the object, the policy if you like, to be achieved by the provision, it is to ensure that there be no double concession or, for that matter, double taxation. So that if it has had its effect in the process of the liability or the reduction of the liability, then it should not have that effect twice, and our construction, and your Honour’s construction, produces that result. Our learned friend’s construction would not.

GUMMOW J: Now, he seeks to say you approbate the reprobate effect because he points to section 80(2). What do you say as to that?

MR PAGONE: Your Honour, our construction does not achieve that object, and perhaps badly, but I did try to indicate that by referring back to the annexures that because the bringing into account of the integer, the exempt income to work out the allowable deduction, there you can see that the exempt income is having an impact, an effect, in the calculation of the allowable deduction so that that being the allowable deduction, it is taken into account in the sense that it has an impact and effect upon the, as it were, bottom line for the taxpayer.

That is not the case in respect of the calculation of exempt income with which we are concerned because what happens with 27H is that there is simply a segregation - some of it is this and some of it is that -and it is only until you have got the end result that you know what is what. And what is striking about that is how very very different that is from what was being considered by the court in Mutual Life. There you could not say there had been a segregation and indeed, the words that my learned friend read out ‑ ‑ ‑

GUMMOW J: That was construing the old 23(q).

MR PAGONE: Yes, your Honour, of course, and indeed not absolutely directly on point, but it is useful to see the kind of underlying logic, because in the passage that my learned friend referred to at page 555, admittedly not strictly on point, but useful to see the way the court was thinking, Justice Fullagar said:

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 -

Well, how different can you get; that is exactly what happens here. You get this separation, the segregation, not a tax upon the whole, it is not a proportion of the whole; it is a segregation and once you have worked out what is assessable and what is not assessable, exempt, you then tax the bit that is assessable.

Our learned friends said something, and in their outline it appears that they seek to get some comfort from the second limb, as usually referred to, in section 51(1), the business limb of section 51(1). They say, well, here the Bank has business and these annuities were a part of its business. Well, they cannot get much comfort from that analysis because, here, the fact is, that this part of the activity is business directed to the production of non‑assessable income, and what section 51 requires you to do is to apportion. I mean, otherwise one could have a business where some portion of it, large perhaps, were devoted to the derivation of exempt income, and all the deduction would be allowable, all the costs, as it were, would be allowable as deductions, if my learned friend’s construction was right, and that is not the way the second limb has ever been construed. That would be a very curious result if it were.

Your Honours, may we say something also about the question which I think the Chief Justice asked about, whether the reason that the annuity is assessable is because of the periodicity. That is certainly a factor, if the Court pleases, but perhaps the overwhelming factor is that with annuities, what occurs is that the capital is gone. With strict annuity, you pay $1000, or whatever you pay, and you do not get it back. It is true, you convert it - that is to say, you replace it with regular payments over a period of time but, ordinarily, one does not get the capital back; it is simply gone. So that if you a life annuity and you have calculated it by reference to life expectancies and you have the misfortune of dying after six months and it cost you $10,000 to buy it, you end up with only six months’ worth, which may be very small. It does rather emphasise the fact that ‑ ‑ ‑

McHUGH J: Is the result of the formula in 27H(2) that the deductible amount would be income in the common law sense?

MR PAGONE: Yes, your Honour.

McHUGH J: It is. That is the result of it, is it?

MR PAGONE: I do not know whether it is the result of the calculation of formula, your Honour, the ‑ ‑ ‑

McHUGH J: The parties accept - and obviously on fairly solid grounds - that the deducible amount is exempt income, notwithstanding that this part is taken out of the old 23, where it was specifically stated to be exempt income. But I have been wondering for some time as to whether or not the deductible amount, having regard to the formula, was, all of it, strictly income.

MR PAGONE: It would have been but for the treatment in section 27H.

McHUGH J: Yes.

MR PAGONE: It would have been income. Indeed, that is what the arrangements depended upon, it being ‑ ‑ ‑

McHUGH J: Yes. I was just wondering whether the result of the formula - that was the consequence of the formula: the deductible amount only took what would have been income for the ‑ ‑ ‑

MR PAGONE: Income, and made it non-income.

McHUGH J: Yes.

MR PAGONE: And what follows follows.

McHUGH J: Yes.

MR PAGONE: Yes, your Honour. If your Honours please.

GUMMOW J: What do you say about Mr Bloom’s notice of contention point, 97(1)(b)(i) “individual interest” et cetera?

MR PAGONE: Your Honour, yes, I had meant to say something about that. We say it is perfectly plain that the beneficiaries did have an interest in the amounts returned to them upon the redemption of the units and the trust deed in clause 10 makes it abundantly clear that they did and that was the end of the matter.

GUMMOW J: But Mr Bloom works back into the notion of present entitlement, does he not, in the sense of right to call for payment?

MR PAGONE: At that point, your Honour, they did have a right to call for payment.

GUMMOW J: But he says they have to in order to satisfy the criterion of individual interest. That is as I understand it. Why is that wrong?

MR PAGONE: I had better look at exactly what he said, your Honour.

GUMMOW J: In other words, he reads “individual interest” there in a Whiting’s Case-type sense.

MR PAGONE: Your Honour, I suppose all one can say about that is that the provisions of section 80 make it perfectly plain that what is given to the trustees is an amount to which they are presently entitled and the provisions of the trust deed do make it clear that so far as the deductible amount is concerned, they are presently entitled and to that extent we say they are. They do have an individual interest in it. If your Honours please.

GLEESON CJ: Thank you. We will reserve our decision in this matter and the Court will adjourn until 9.30 am in Sydney and 10.30 am in Canberra.

AT 2.53 PM THE MATTER WAS ADJOURNED

[1998] HCATrans 216

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