Commissioner of Taxation of the Commonwealth of Australia v Sun Alliance Investments Pty Limited (In liq)

[2005] HCATrans 140

[2005] HCATrans 140

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
  Sydney  No S128 of 2004

B e t w e e n -

COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Applicant

and

SUN ALLIANCE INVESTMENTS PTY LIMITED (IN LIQUIDATION)

Respondent

Application for special leave to appeal

GLEESON CJ
GUMMOW J
CALLINAN J

TRANSCRIPT OF PROCEEDINGS

AT SYDNEY ON FRIDAY, 11 MARCH 2005, AT 9.34 AM

Copyright in the High Court of Australia

MR G.J. DAVIES, QC:   If the Court pleases I appear with my learned friends, MR R.L. HAMILTON and MR S.H. STEWARD, for the applicant.  (instructed by Australian Government Solicitor)

MR B.J. SHAW, QC:   If the Court pleases I appear with my learned friend, MS M.M. GORDON, SC, for the respondent.  (instructed by Maddocks)

GLEESON CJ:   Yes, Mr Davies.

MR DAVIES:   Your Honours, I wish to mention three matters.  The first is that the issue before the Federal Court was one of statutory construction.  In our submission, the court erred in determining the issue of statutory construction without reference to context and, in particular, without reference to the legislative purpose of the provision which the learned primary judge had reference to and based her result upon.

Can I take your Honours to page 31 of the application book.  It is the start of the reasons for judgment of the Full Court.  At the foot of the page between lines 45 to 55, the Full Court notes:

The issues in the appeal involve the construction of s 160ZK(5) –

and then at line 50:

The central issue of statutory construction concerns the words “could reasonably be taken to be attributable to profits that were derived by the company” as they appear in s 160ZK(5).  The findings of fact made by the primary judge are not contested.

The Full Court sets out in length the manner in which the primary judge came to her decision.  That passage commences in the Full Court’s decision at page 43 at line 45.  At the foot of page 43 the Full Court observes at line 55:

The primary judge acknowledged that the legislative purpose of s 160ZK was ‘highly relevant’ to the enquiry –

and then had reference to the explanatory memorandum.

Can I now take your Honours to page 51, where the Full Court, still dealing with the learned primary judge’s reasons, refers at the top of page 51 to the High Court’s decision in Read.  Then at line 10 there is a quotation from Read.  Then at line 19 the Full Court notes:

The primary judge characterised that dicta in Read as ‘fundamentally and relevantly different from the context in which the issues in this case must be decided’, for the following reasons –

this is a passage taken out of her Honour’s judgment –

‘In a case where the issue was whether there should be a reduction in the appellant’s pension if she had acquired additional income it is not surprising that the Court should have focused on actual financial gain to the appellant. 

Now, that was the case in Read:

The position here is the opposite.  The purpose of the statutory provisions under consideration here is discussed above . . . As that discussion indicates the purpose of the provisions is to preclude a taxpayer from claiming a capital loss where there is no economic loss to the taxpayer.  The issue is whether at the Merger Date there existed profits to which subsequent dividends ‘could reasonably be taken to be attributable’ and by recourse to which the purchase price could be recouped.  In relation to this issue the decision in Read does not assist.  The legislative purpose would, in my view, be defeated by applying the analysis in Read.’

Her Honour then comes back to legislative purpose as a ground for supporting her decision in relation to the Phoenix shares.

GLEESON CJ:   How did she deal with the legislative text?  What did she say the word “derived” means?

MR DAVIES:   Your Honour, she said that the word “derived” meant obtained – if I can ‑ ‑ ‑

GUMMOW J:   About page 18, paragraph 50.

MR DAVIES:   Thank you, your Honour.  Yes, her Honour refers to Evans, which is a case that stated that a profit could be derived even though it was an unrealised profit.  After quoting that passage of the High Court in Evans at line 42, she notes:

The above passage is relevant to the present enquiry not only for its observations on the nature of profits but also in relation to the meaning of ‘derived’.  The applicant submits that the phrase ‘profits that were derived’ should be construed as referring to ‘gains that have come home and are available for distribution.’  The respondent submits that the term should is much broader and refers to profits both realised and unrealised.

Her Honour then goes on to say that it is not a technical ‑ ‑ ‑

GUMMOW J:   It is the sentence at about line 28:

There is, to my mind, a distinction between the source from which the dividend is paid and the derivation of that source.

Does that encapsulate what she was saying?

MR DAVIES:   Yes, your Honour.

GUMMOW J:   She seems to come back to it at the bottom of page 20 too.

MR DAVIES:   Yes.  And she relies upon that by reference to context, by which we take to be, your Honours, the fact that the words “profits that were derived”, that expression is found within a composite expression where what is asked of the legislation is ‑ ‑ ‑

GLEESON CJ:   The legislation here was dealing with a very familiar problem, was it not?  It is like the problem that arose in Curran’s Case.  If I buy a cow for $100 in calf and the cow has a calf and I sell the cow for $80, the financial or the fiscal consequences of that are going to depend upon the way I account for the calf.  It is a well-known problem.

MR DAVIES:   Yes, your Honour.

GLEESON CJ:   And the legislature addressed the problem by using the language with which we are confronted.

MR DAVIES:   Yes, your Honour.  In our submission, the learned primary judge’s finding as to legislative purpose is correct, and the critical thing about the manner in which the Full Court deals with the matter is that it makes no reference to legislative purpose and adopts a construction…..result which the learned primary judge has found would defeat the legislative purpose.

Your Honours will find that finding repeated by the Full Court at the foot of page 52 and over the page to page 53.  The Full Court sets out the concluding paragraph of her Honour.  The last sentence on page 53 of the passage quoted is:

‘This result is consistent with the policy of the legislation.  Any other result would allow [the Holding Company] (and consequently the [appellant]) to claim a capital loss in circumstances where it had not suffered a financial loss.’

Now, your Honours will see the Full Court’s treatment of the issue of statutory construction on pages 71 to 72; it consists of four paragraphs.  In none of those paragraphs does the Full Court address (a) what is the legislative purpose; and (b) why is it that the Full Court is reaching a decision which the learned primary judge has found is contrary to the legislative purpose.

GUMMOW J:   They quote the trial judge’s reference to the explanatory memorandum at page 45, paragraph 37.

MR DAVIES:   They do.  At page 45, your Honour, at paragraph 37, yes, and to the general rule.  Her Honour looked at the explanatory memorandum.  The Full Court repeats her Honour’s observations about the explanatory memorandum.

GLEESON CJ:   But the object is to construe the text.  How do you relate the purpose explained in the explanatory memorandum to the language of the text, which is “profits are derived”?

MR DAVIES:   Your Honour, in our submission, if one goes back to the text, which is set out in its short form on page 31, “could reasonably be taken to be attributable to profits that were derived by the company”.  In our submission, the question is one of attributing subsequent dividends, the payment of subsequent dividends, to profits that had been derived at an earlier date.  In our submission ‑ ‑ ‑

CALLINAN J:   Were any of the profits derived from other than the sale of listed shares? 

MR DAVIES:   There were other profits in the company and there were distributions that were attributable to the other profits, and they are not in issue.

CALLINAN J:   No.  So relevantly we are only concerned with profits derived from gains on the sale of shares.

MR DAVIES:   Well, the issue is whether – a few years later the shares have been sold, and the proceeds distributed by way of dividend.  The question was whether the dividend distribution could reasonably be taken to be attributable.

CALLINAN J:   Yes, the point being that the value of the shares would fluctuate on a day-to-day basis.

MR DAVIES:   That was the evidence, your Honour.  But can I say this about the facts.  The facts are that the question is, “What were the profits derived by Phoenix at the merger date?”  At the merger date the value of the share portfolio held by Phoenix was revalued and recorded in an asset revaluation account in accordance with accounting standards.  So that the books referable to Phoenix’s asset position showed an asset that recognised a gain on the relevant shares, albeit an unrealised gain.  That is the first matter.

The second matter, your Honours, is that the purpose for the revaluation was to enable two arms length parties, two large arms length parties, the Royal Group and the Sun Alliance Group, to enter into a merger.  Sun Alliance contributed 60 per cent of the contribution to the merger and Royal Group contributed 40 per cent contribution to the merger.  The 60 and the 40 per cent contributions were based on the valuations of the groups’ assets at that date.  So, in other words, the two arms length parties entered into the commercial transaction in recognition of and accepting the gain made on the share portfolio by Phoenix, amongst other things.

GLEESON CJ:   In your approach to the construction of the section, how would it operate in the following case?  At the date of the merger between company X and company Y, company X has a share portfolio, the current market value of which is $100 million.  The following year the market value of the same share portfolio, which remains unrealised, has fallen to $90 million.  The year after that the market value of the share portfolio, which is still unrealised, has risen to $105 million.  The following year, though shares are sold, for $107 million, and the gains are distributed by way of rebatable dividend.

MR DAVIES:   Your Honour, in our submission, in those circumstances the profit would be the $90,000.  One takes into account subsequent market fluctuations when one is looking at the words “could reasonably be attributable to” and in your Honour’s example, because of subsequent market valuations, the profit that was in the portfolio at merger date has been reduced by reason of a subsequent event.  If there is then an increase in the profit again, that is by reference to yet another subsequent event.  In this case the evidence was that the value of the share portfolio, whilst it fluctuated after merger date, never fluctuated below the date recorded in the accounts at merger date.

Your Honours, I go back to pages 71 to 72.  The first matter that I wish to make in oral submissions is that section 15AA of the Acts Interpretation Act requires the court to prefer a construction of the Act that gives effect to the statutory purpose, and the Full Court, in our submission, erred by disposing of the issue of statutory construction without reference to the statutory purpose in circumstances in which the learned trial judge has found that the result reached by the Full Court would defeat the statutory purpose.

Now, the second matter, your Honours, that I wish to raise is that paragraph 94 is the conclusionary paragraph of the Full Court.  Having mentioned the cases about profits, the court says in the first sentence:

No such ascertainment can occur or determination be made on the basis of the evidence relating to the loss on the Phoenix shares.

Then in the second-last sentence at line 35:

The evidence does not appear to travel beyond circumstances of the ‘mere process(es) of valuation’.

In our submission, that statement is incorrect, having regard to the uncontested facts.  The uncontested facts that we rely upon, your Honours, can be found at page 39, where at line 27 their Honours note:

As at the merger date, Phoenix held shares in a number of companies listed on the Australian Stock Exchange (‘ASX’).  These were valued at cost at $8,900,000 and were revalued at the time of the merger to a market value of $20,700,000.  The revaluation reflected an unrealised gain of $11,800,000.

If I can then take your Honours to line 41:

Rather, the increases and decreases in the value of Phoenix’s shares were recorded as increments and decrements in its asset revaluation reserve in accordance with ASSB 1010.

So the revaluation is done, it is done in accordance with accounting standards and it records an unrealised gain of $11.8 million.

Then, your Honours, can I go to the finding on page 32 at line 23, talking about the merger that occurred on the merger date:

Contributions to the capital of the merged undertaking were made by the Royal Group as to 40%, and by the Sun Alliance Group as to 60%, based on valuations of their respective assets as at the merger date.

So as a matter of fact, your Honours, the two arms length parties recognise the gain and act upon it at merger date.  Her Honour at page 22, in a very short sentence, appears to agree with that observation.  At page 22, line 6:

As with the Bridge Street Building –

which is the other matter –

there was an unrealised profit that was recognised and adopted at the time of the merger.

Now, that is the finding of fact.  In our submission, the observation and conclusion then by the Full Court that the evidence does not appear to travel beyond circumstances of mere processes of valuation is just incorrect, with respect.  Can I take your Honours to ‑ ‑ ‑

CALLINAN J:   You do not realise a profit merely by making a valuation.

MR DAVIES:   No, you do not, your Honour.

CALLINAN J:   And if you have to make a valuation for a particular purpose, why does that mean you have made a profit?

MR DAVIES:   Well, the valuation, your Honour, may simply recognise that there is a problem.  Of course one has ‑ ‑ ‑

CALLINAN J:   Or it may identify the valuation for a particular purpose on a particular date, and that is what the valuation did here.  The purpose was the merger and the date was the date of the merger.

MR DAVIES:   That is true, your Honour, but the parties contributed money to the merger on the basis that there had been a gain.

CALLINAN J:   Money and assets.

MR DAVIES:   Well, contributed money on the basis of the revalued assets, 40/60 per cent.  So that in agreeing to pay money, they accept and act upon the fact that Phoenix has made a profit.

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

MR SHAW:   If the Court pleases, my learned friend complains that the Full Court did not pay sufficient attention to the statutory purpose, as he says.  The fact of the matter is that in describing what the trial judge did, they set out in extenso what she had said about the statutory purpose.  When they came to their conclusion they said this at page 71, paragraph 92:

it is appropriate to pay regard to the Explanatory Memorandum . . . which exemplifies a simple accounting calculation containing reference to ‘Retained Profits’.

Then they say that you can rely in effect on the explanatory memorandum, and they say:

The very notion of retained profits implies an outcome calculated from all reasonably available criteria.

So, in our submission, what the Full Court was doing was having set out in great detail what had been said about the explanatory memorandum, they referred to a part of it, indicating they had taken into account all of it, and said that the example was a relevant factor to take into account, as it must surely be.

The second thing we would say is this.  In describing the Commissioner’s submissions, the Full Court says at page 68 in paragraph 86:

In the course of the Commissioner’s contentions, certain evidentiary issues arose in the course of the presentation thereof, which the appellant sought to correct.

The first contention related to . . . SAIL –

that is the other matter.  Then going over to page 69 in paragraph 89, it is said:

It was said that the statement that when SAIL –

so that relates to SAIL too.  Then in paragraph 90 on page 70 they say:

The further corrections sought to be made by the appellant related to Phoenix, and were as follows –

first of all, there was a statement about the profits of Phoenix being on revenue account, and the correction sought was to say that they were on capital account.  The second correction was that:

(ii)      contrary to the Commissioner’s assertion, Phoenix did not produce audited accounts for each calendar years from 1991 to 1996; instead for the financial years ended 31 December 1992 and following, Phoenix produced a so-called special purpose financial report; nor did Phoenix produce unaudited accounts for the period ended 30 September 1992; moreover in relation to the balance sheet of Phoenix as at 8 October 1992, the same was prepared by the appellant –

for the Tax Commissioner in effect.

GLEESON CJ:   Mr Shaw, you and your opponent each had, as it were, one win and one loss in the Full Court.

MR SHAW:   We did.

GLEESON CJ:   What is the essence of the difference that the Full Court saw between the SAIL matter and the matter with which we are concerned?

MR SHAW:   The essence of the difference is this.  In relation to the SAIL matter the merger agreement provided that if the Bridge Street buildings were sold at a price less than their then value, the other party to the merger would contribute the amount of the difference between the sale price and the price that was fixed, which was $58 million.

GLEESON CJ:   So that the merger agreement in effect fixed or crystallised in a sense the gain ‑ ‑ ‑

MR SHAW:   Yes.  I mean, we say that they were wrong about that because you have to find that the profit emerged before the merger and you have to see that the profit was derived, and you cannot see it derived because part of the profit that was ultimately made arose from the purchaser paying an increased amount.  In any case, we would say that the profit arose from the merger agreement, so that it did not arise before the merger, but the difference is that what the Full Court said was the agreement crystallised the amount.  In the case of Phoenix of course, there was not anything to crystallise an amount in that way at all.  It is simply a question of whether or not what the Full Court regarded as the process of revaluation meant that the profits were derived, although they were not crystallised in the same sense.

GLEESON CJ:   Is that argument against you, looking at page 36 where we find the text on line 30 ‑ ‑ ‑

MR SHAW:   I am sorry, your Honour?

GLEESON CJ:   If you look at page 36, line 30, that is the text, is it not?

MR SHAW:   Yes.

GLEESON CJ:   Is the argument against you in relation to paragraph (b), that we are concerned not only with the words “profits” and “derive” but also with the concept of something “being reasonably to be taken to be attributable”?

MR SHAW:   Yes.

GLEESON CJ:   Your argument, as I understand it, is that on the facts, no matter how politically reasonable it might appear, you could not reasonably take these things to be attributable because there were no profits derived.

MR SHAW:   Yes.

GLEESON CJ:   You cannot reasonably attribute an occurrence to something that did not happen.

MR SHAW:   Exactly.  My learned friend asserted what I do not believe to be the fact, and in fact the value of the Phoenix shares never fell below the market value as at the merger date.  The evidence is that they went up and down.  The result that the trial judge arrived at was one which did not take into account the fluctuations between the merger date and the time when the shares were sold.  We would submit that when one looks at what was said by the Full Court in relation to our submissions at page 70, there is a problem in that they never say in relation to the corrections whether they accept them or not in express terms, but they do say that there was not any sufficient ascertainment and they do say at page 72 in paragraph 94 that:

the evidence does not yield a conclusion in favour of the Commissioner as to accretions of value . . . of a permanent character –

my learned friend did not criticise that –

or of gains having come home . . . in a realised or realisable form –

that reference to Executor Trustee and Agency is a reference to…..Case.  The Court will recall that in that case Justice Dixon spoke as the object of income tax legislation is to determine what gains have come home to the relevant taxpayer in the realised or realisable form.  But what my learned friend does quarrel with is the next sentence:

The evidence does not appear to travel beyond circumstance of the ‘mere process(es) of valuation’.

In our submission, that is absolutely accurate, because what was simply happening was, as your Honour Justice Callinan said, things were being marked to market just to show what the market price was at whatever the time was, but that does not mean that at that point of time anything has been

derived or any profit made in any real sense at all.  The fact is that the section uses “profits derived”.  “Derived” is a term which can have varying meanings, it is true, but has an accepted meaning in relation to the Income Tax Assessment Act.  Their Honours set out the various meanings of “profits” in paragraph 93, and then they say that there has not been a sufficient ascertainment to mean that any profit has been derived.

GLEESON CJ:   The argument against you appears to translate the purpose into a reading of the text that would have it as “could reasonably be taken to be attributable to business that was conducted by the company before the holder acquired the RDA share”.

MR SHAW:   Well, I think it goes even further than that, your Honour.  It seems to seek to treat what happens to be at the market value at a particular time as containing, for the purpose of this part of the Act, a profit, whether or not there was any prospect of the thing being sold at that particular time or not.

GLEESON CJ:   Well, it seems to be part of the argument against you that these profits are derived day by day.

MR SHAW:   Yes, and then presumably losses are derived day by day if the price goes down.  His explanation of how it works when they go down, in our submission, just will not fit the section.  So our submission is that my learned friend has only put before the Court part of the relevant facts.  The relevant facts involve the corrections we sought to make below.  Secondly, what the Full Court says about “profits” and “derived” and “attributable” are all undeniable good sense.  The words compel the answer.  If the Court pleases.

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

MR DAVIES:   Your Honours, briefly in relation to the last matter, the facts I did take the Court to were accepted; that is, at merger date there was a revaluation, it was recorded in the accounts and the parties entered into a commercial transaction recognising the gain and contributed money on the basis of the gain, amongst other things.

The second point, your Honours, is that there is nothing in the Full Court’s decision that indicates that when construing the words “profits that were derived” the Full Court took into account the context in which those words appear, and that is that they are found in a legislative context where the inquiry is whether subsequent dividends could be said to be reasonably attributable to something that had occurred earlier in time.  When one takes legislative purpose into account, in our submission, that twofold inquiry – context and purpose – indicates that the reference to “profits derived” in the section can include unrealised gains in circumstances such as this case; that is, where a gain has been recognised in the accounts and accepted at least by the taxpayer as at the relevant date.

Your Honours, that construction is not unexceptional.  It is the very construction which the High Court adopted in Evans.  We have mentioned Evans in our written submissions, but in Evans the Court there was dealing with a situation of whether dividends were paid out of profits that were derived.  In that case the facts demonstrated, according to the balance sheet, that the company’s assets exceeded its liabilities.  The company’s assets included shares that were revalued and the subsequent distributions were of those very shares.

The Full Court accepted that in calculating the profits derived in accordance with the balance sheet, it was appropriate to take into account the revalued market value.  If I could take your Honours to page 101, behind tab 1 of our hand-up.  At page 101 at the second half of the page the majority is there dealing with one of the distributions of shares.  There was a question about whether or not a proviso operated in relation to section 16(b)(i)(1), and their Honours were directing their attention to that proviso, but their Honours do in that sense refer to the concept of “profit derived”.  In the third line their Honours state:

In the first place, the fact that the shares contain no profit on the sale of the leases does not mean that they represent capital and not profit of the company ‑

that is directed at the proviso –

Actually they represented surplus assets, that is, assets not required to make good issued share capital.  This appears from the last preceding balance-sheet.  In the second place, sec 16(b)(i)(1) brings into charge all dividends and distributions out of profit, whatever be the nature of the profit.  The word “derived” does not connote that the profit must be a realized profit.  It is enough at least if it is an ascertained profit, ascertained by a proper account.  Under the articles, the 5s. 6d. contained in the share could not lawfully be distributed, except as a dividend satisfied by specific assets, and the dividend must be out of profits.  The meaning of profits in sec 16(b)(i)(1) is no narrower, and the state of the company’s affairs, as disclosed by its balance-sheet, permitted such a dividend.

If I could stop there, your Honours.  There is no suggestion in this case that at the relevant date, the merger date, the assets of Phoenix in accordance with the accounts recognised an unrealised gain on the share portfolio that was vastly in excess of liabilities of the company.  The total assets of the

company were $28 million and the liabilities were $1,500.  It was a company pregnant with valuable assets. 

I go over the page, your Honours.  Their Honours then go on to the next parcel of shares – I will not go into the facts of it.  It is enough to observe at the top of the page their Honours there observed that from the time the shares were originally acquired by the company making the distribution to the time that the company made the distribution, the shares appreciated in value.  Their Honours state at line 10:

Profit, consisting in such an appreciation -

it is a simple appreciation in value –

would, for the reasons already given, fall within the charging part of sec 16(b)(i)(1) and would not be protected by the proviso.

GLEESON CJ:   Thank you, Mr Davies.  We will adjourn for a short time to consider the course we will take in the matter.

AT 10.14 AM SHORT ADJOURNMENT

UPON RESUMING AT 10.21 AM:

GLEESON CJ:   We are of the view, Mr Davies and Mr Shaw, that in this case there should be a grant of special leave to appeal, but that leaves Mr Shaw’s proposed cross-appeal.  Obviously there should be a grant of special leave in that case too, should there not?

MR DAVIES:   Yes, your Honour.

GLEESON CJ:   We will, as it were, anticipate that.  In this matter and in the matter of the cross-appeal which the respondent proposes to make, there will be a grant of special leave to appeal.

MR SHAW:   If the Court pleases.

GLEESON CJ:   We will adjourn to reconstitute.

AT 10.22 AM THE MATTER WAS CONCLUDED