Commissioner of Taxation v McNeil - [2005] FCAFC 147

FEDERAL COURT OF AUSTRALIA
Commissioner of Taxation v McNeil [2005] FCAFC 147
INCOME TAX – income according to ordinary concepts – capital gain – CGT event H2 – act, transaction or event occurring in relation to a CGT asset – ‘in relation to’ – nature of relationship – requirement for asset existing at time of event – taxpayer’s asset – announcement by listed public company of 5% of issued share capital – Sell Back Rights issued on 1 for 20 basis – taxpayer shareholder in company – taxpayer giving no direction to acquire or exercise the Sell Back Rights to which she was entitled – Sell back Rights traded on Australian Stock Exchange – absent direction taxpayer entitled to proceeds of sale of Sell Back Rights at conclusion of limited period of trading according to pre-existing formula – whether entitlement created in respect of Sell Back Rights and share of proceeds of sale thereof was income according to ordinary concepts – whether stock market value of taxpayer’s unrealised Sell Back Rights subject to capital gains tax – whether proceeds represented a capital gain
Corporations Act 2001 (Cth) ss 256A, 256B
Income Tax Assessment Act 1915 (Cth) ss 3, 10, 14
Income Tax Assessment Act 1936 (Cth) ss 6(1), 44, 44(1), 47, 108, 108(1)
Income Tax Assessment Act 1997 (Cth) ss 3-1, 6-5, 102-5, 102-20, 104-5, 104-10, 104-155, 104-155(1), 104-155(2), 104-155(3), 106-50, 108-5, 112-25, 116-20, 116-20(2), 116-125, 116-20, 118-20
Abbott v Philbin [1961] AC 352 considered
Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143 considered
Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 cited
Callow v Federal Commissioner of Taxation (1997) 73 FCR 421 cited
Commissioner for Internal Revenue v Blott [1921] 1 AC 171 cited
Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80 cited
Commissioner of Taxation v Brewing Investments Ltd (2000) 100 FCR 437 cited
Commissioner of Taxation v Scully (2000) 201 CLR 148 considered
Commissioner of Taxation v Slater Holdings Ltd (1984) 156 CLR 447 considered
Commissioners of Inland Revenue v Fisher’s Executors [1926] AC 395 cited
Commissioners of Inland Revenue v Paget (1938) 2 KB 25 followed
Dickenson v Federal Commissioner of Taxation (1958) 98 CLR 460 considered
Donaldson v Federal Commissioner of Taxation (1974) 3 ALR 516 considered
Eisner v Macomber (1920) 252 US 189 cited
Federal Commissioner of Taxation v Blakely (1951) 82 CLR 388 referred to
Federal Commissioner of Taxation v Comber (1985) 64 ALR 451 cited
Federal Commissioner of Taxation v Cook and Sherden (1979) 29 ALR 202 cited
Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42 cited
Federal Commissioner of Taxation v Miranda (1976) 11 ALR 85 cited
Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 cited
Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 approved
Federal Commissioner of Taxation v Uther (1965) 112 CLR 630 referred to
Federal Commissioner of Taxation v WE Fuller Pty Ltd (1959) 101 CLR 403 cited
Gibb v Federal Commissioner of Taxation (1966) 118 CLR 628 cited
Hayes v Federal Commissioner of Taxation (1956) 96 CLR 47 cited
Hepples v Federal Commissioner of Taxation (1991) 173 CLR 492 cited
Macmine Pty Ltd v Federal Commissioner of Taxation (1979) 24 ALR 217 cited
Ord Forrest Pty Ltd v Federal Commissioner of Taxation (1973) 130 CLR 124 cited
PMT Partners Pty Ltd (In Liquidation) v Australian National Parks & Wildlife Service (1995) 184 CLR 301 considered
Read v The Commonwealth (1988) 167 CLR 57 referred to
Scott v Commissioner of Taxation (NSW) (1935) 35 SR(NSW) 215 cited
Thomson v Federal Commissioner of Taxation (1929) 43 CLR 360 considered
Webb v Federal Commissioner of Taxation (1922) 30 CLR 450 cited
Stone J, Legal System and Lawyers’ Reasonings (Maitland 1968)
Parsons RW, Income Taxation in Australia (1985)
COMMISSIONER OF TAXATION v HELEN MARY McNEIL
N671 OF 2004
FRENCH, EMMETT AND DOWSETT JJ
8 AUGUST 2005
SYDNEY

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

N671 OF 2004

On Appeal from a Single Judge of the Federal Court of Australia

BETWEEN:

COMMISSIONER OF TAXATION
APPELLANT

AND:

HELEN MARY McNEIL
RESPONDENT

JUDGES:

FRENCH, EMMETT AND DOWSETT JJ

DATE OF ORDER:

8 AUGUST 2005

WHERE MADE:

SYDNEY

THE COURT:
1.        Orders that the appeal be dismissed.
2.        Notes the parties’ agreement that there be no order as to costs.
Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

N671 OF 2004

On Appeal from a Single Judge of the Federal Court of Australia

BETWEEN:

COMMISSIONER OF TAXATION
APPELLANT

AND:

HELEN MARY McNEIL
RESPONDENT

JUDGES:

FRENCH, EMMETT AND DOWSETT JJ

DATE:

8 AUGUST 2005

PLACE:

SYDNEY

REASONS FOR JUDGMENT
FRENCH J:
Introduction

This appeal by the Commissioner of Taxation (the Commissioner) involves a contest with a 90 year old widow (the Taxpayer) who is a small shareholder in St George Bank Ltd (SGL). She received $576.64 from SGL in 2001 in connection with a capital reduction which it undertook in that year. Although there is a certain incongruity about the protagonists in this appeal, it is a test case which raises issues about the correct taxation treatment of the issue of Sell Back Rights by SGL to its existing shareholders in 2001. The Sell Back Rights, which were issued on a 1 for 20 basis were in effect ‘put options’ under which each shareholder could require SGL to buy back 5% of his or her shares at a premium price of $16.50. However no shareholder was required to actually acquire a legal or beneficial interest in the Sell Back Rights or to exercise them. They were traded on the Australian Stock Exchange (ASX) and shareholders who gave no directions in respect of their entitlements were paid the proceeds of trading activities in relation to the Rights which were conducted for their benefit by a merchant bank.
The question which falls for determination in this appeal is whether the creation of the entitlement to the Sell Back Rights and the payment of the proceeds in relation to it constituted income or a capital gain in the hands of the shareholder. Conti J held at first instance that they were neither.
For the reasons which follow, I am of the opinion that the entitlement and the payment of the proceeds were neither income according to ordinary concepts nor a capital gain and that the Commissioner’s appeal must be dismissed. The appellant should pay the respondent’s costs of the appeal.
Factual background
The Taxpayer has been a widow since 1975. She lives in Sydney. Since 1987 her main source of income has been dividends from shares, interest from term deposits and debentures and an annuity. At the commencement of 2001 she held 5,450 shares in SGL which had been a publicly listed company since 1992. She acquired the shares between 1987 and 1997. Some were acquired through rights issues. On 12 January 2001 SGL announced its intention to carry out an off-market buy-back of ordinary shares from its shareholders to the extent of about 5% of its then issued capital. That is it intended to buy back one ordinary share for every 20 ordinary shares held as at 23 January 2001. The buy back price was fixed at $16.50 per ordinary share. That represented a premium of 18.9% over the price of the shares on the ASX as at 10 January 2001, which was $13.88. It represented a 17% premium on historically high share price of $14.10. The $16.50 paid in respect of each ordinary share was to be debited by SGL to its share capital account. The total number of shares involved was 22,788,461.
Each person who was a shareholder as at 23 January 2001, known as the Record Date, was to be entitled to a 1 for 20 issue of Sell Back Rights, ie the right to sell back one ordinary share in SGL at $16.50 for every 20 shares held at 23 January 2001. The Sell Back Rights themselves were listed on the ASX and were traded from 19 February 2001. Shareholders who wanted to exercise or dispose of any of the Sell Back Rights were required to complete a direction form and return it to SGL by 5pm on 16 February 2001. The directions that could be given were:
(i)a direction to SGL that the shareholder wished to exercise all of his or her entitlements to Sell Back Rights;
(ii)a direction that some or all of the Sell Back Rights be transferred to the shareholder.
Shareholders who gave no direction would still benefit from the Sell Back Rights. There was also a category of Excluded Shareholders who were foreign shareholders and persons who held their shares under SGL employee share schemes. They were in effect treated in the same way as shareholders who gave no direction. The Rights relevant to shareholders who gave no direction would be sold to a merchant bank, Credit Suisse First Boston Australia Equities Ltd (CSFB). The non-directing shareholders would receive the net proceeds of that sale calculated according to a formula, set out later in these reasons, called the Sale Mechanism Price.
The Taxpayer was one of those who gave no direction in relation to the Sell Back Rights. She received $2.12 for each Sell Back Right allotted to her. That sum was calculated according to the Sale Mechanism Price formula. She had a total of 272 Sell Back Rights allocated to her in respect of her 5,450 shares in SGL. That represented one Sell Back Right for every 20 shares she held. The total sum remitted to her in respect of her Sell Back Rights was $576.64 The market value of the Sell Back Rights at the date of issue was $1.89.
In her income tax return for the year ended 30 June 2001 the Taxpayer included $576 by way of receipts made up of:
. $514 as ordinary income under s 6-5 of the Tax Act
.$62 as a capital gain representing the difference between the sell price received from the Sell Back Rights ($576) and their cost base calculated by reference to their market value ($514).
She was assessed by the Commissioner on the basis that she had derived assessable income, according to ordinary concepts of income, in the sum of $514 or $576.64. She was assessed in the alternative on the basis that she had received a capital gain of $514.
The Taxpayer objected to the assessment contending that the sum of $514 was not assessable as ordinary income under s 6-5 of the Income Tax Assessment Act 1977 (Cth) (the ITAA 1977) or as a capital gain. She took no objection to the inclusion of $62 as a capital gain. The Commissioner disallowed her objection. His stated reasons were:
‘Mrs McNeil was granted 272 Sell Back Rights on 19 February 2001. The grant of the Sell Back Rights is assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). The amount to be included in assessable income for each Right granted is its market value at the time of the grant. The market value of each Right is $1.89, and accordingly Mrs McNeil is assessable on an amount of $514.00.
Alternatively, the grant of the Rights is a CGT event H2, and a capital gain of $514.00 arises under subsection 104-155(3) of the ITAA 1997.
This decision is in accordance with Class Ruling CR 2001/75.’
The Taxpayer appealed against the disallowance of her objection. On 14 April 2004 Conti J allowed the appeal, set aside the Commissioner’s objection decision of 31 October 2002 and allowed the Taxpayer’s objection of 19 June 2002. His Honour remitted the matter to the Commissioner for reassessment according to law. The Commissioner appeals against that judgment. Before turning to the judgment at first instance, it is helpful to set out in summary the relevant documentation.
The transaction documents
The transaction documents under which the buy back was implemented were entered into on 12 January 2001. They were:
1.A Sell Back Rights Deed Poll made by SGL in favour of Participants defined as Record Date Shareholders, Sell Back Right Holders, CSFB and St George Custodial Pty Ltd (Custodial).
2.A Deed Poll (Shareholders) made between SGL and Custodial.
3.A Deed Poll (Excluded Shareholders) made between SGL and Custodial.
4.A CSFB Deed Poll made by CSFB in favour of Sale Mechanism Participants, SGL and Custodial.
The Sale Mechanism Participants, defined in the Sell Back Rights Deed Poll referred to shareholders who did not give directions as to the exercise or transfer of their Sell Back Rights and also to Excluded Shareholders.
The general operation of the transaction documents was conveniently set out in overview in the Taxpayer’s written submissions and it is convenient to follow that overview. In so doing some reference to Excluded Shareholders has been omitted. The transaction documents broadly operated as follows:
(a)SGL covenanted to grant to Custodial on or before the listing date, for the absolute benefit of each Record Date Shareholder, not being an Excluded Shareholder (ie being a Participating Shareholder) one put option ‘a Sell Back Right’ in respect of each 20 ordinary shares held at 5pm on the Record Date: cl 2(a) of the Sell Back Right Deed Poll.
(b)SGL’s covenant referred to in subparagraph (a) was subject to:
(i)a right of revocation by SGL at any time prior to the listing date; and
(iii)the ASX agreeing to list the Sell Back Rights on or before the listing date – cl 2(a) and cl 3 of the Sell Back Right Deed Poll.
(c)an Information Memorandum which was dispatched to Participating Shareholders on or around 29 January 2001 contained a form of direction (a ‘Direction Form’) – cl 1.1 of the Sell Back Right Deed Poll;
(d)Direction Forms sent to Participating Shareholders varied depending on whether the Participating Shareholders were:
(i)Participating Shareholders being Issuer Sponsored Holders – these Participating Shareholders were sent a Direction Form entitled ‘Direction Form for Issuer Sponsored Holders Only’;
(ii)Participating Shareholders not being Issuer Sponsored Holders, but being CHESS Holders (Clearing House Electronic Subregister System) - these Participating Shareholders were sent a Direction Form entitled ‘Direction Form for CHESS Holders Only’.
The Taxpayer was a Participating Shareholder, being an Issuer Sponsored Holder and was forwarded a Direction Form entitled ‘Direction Form for Issuer Sponsored Holders Only’. The remainder of this overview applies only to Participating Shareholders who were Issuer Sponsored Holders.
(e)Subject to subparagraph (g) the Direction Form made provision for Participating Shareholders:
(i)to exercise their respective (prospective) entitlements to Sell Back Rights against SGL (and thus to participate in the buy back at $16.50 per ordinary share in SGL);
(ii)to have all of their respective (prospective) entitlements to Sell Back Rights transferred to them; or
(iii)to have some of their respective (prospective) entitlements to Sell Back Rights transferred to them
by ticking the appropriate box on the Direction Form and returning the Direction Form to SGL by 5pm on the Election Date. A Participating Shareholder who completed and returned the Direction Form to SGL by that time and date was taken to have given a ‘direction’ – cls 2 and 3 of the Deed Poll (Shareholders).
(f)Given that the covenant of SGL referred to in subparagraph (a) was subject to the conditions referred to in subparagraph (b) the ‘entitlement’ of a Participating Shareholder who gave a direction remained a prospective entitlement as at 5pm on the Election Date. If a Participating Shareholder gave a direction an interest in a Sell Back Right would vest in the Participating Shareholder on the listing date: cl 2 of the Sell Back Right Deed Poll and cl 2 of the Deed Poll (Shareholders).
(g)Upon the grant of the Sell Back Rights by SGL on the Listing Date, Custodial was to hold the Sell Back Rights, to which each Participating Shareholder who gave a direction was entitled, on a separate trust for each such Participating Shareholder: cl 2.1 of the Deed Poll (Shareholders).
(h)The Direction Form contained in the Information Memorandum despatched to Participating Shareholders provided, inter alia:
‘If you choose to do nothing and wish to receive proceeds (if any) equal to the Sale Mechanism Price for your Sell Back Rights, do not return this Direction Form. (emphasis as in Direction Form)
(i)A Participating Shareholder who did not give a direction became a ‘Remaining Shareholder’ (also known as a ‘non-acceptance shareholder’): cl 1.1 of the Sell Back Right Deed Poll and cl 1.1 of the Deed Poll (Shareholders).
(j)A Remaining Shareholder did not obtain an interest in a Sell Back Right: cl 2(c) of the Sell Back Right Deed Poll, cl 3.2 of the Deed Poll (Shareholders) and cl 3 of the CSFB Deed Poll. They had vested initially in Custodial on trust and were then sold back to CSFB.
(k)Each Remaining Shareholder obtained a chose in action, namely the right to compel the due administration of a trust. The trust property included the Sell Back Rights that were not the subject of a direction by a Participating Shareholder. These Sell Back Rights were granted upon terms that they would be transferred by Custodial to CSFB. CSFB was required to sell them or acquire ordinary shares in SGL and to exercise the Sell Back Rights which it held. The net proceeds of the sale or exercise were to be divided among the Remaining Shareholders and Excluded Shareholders: cl 3.2 of the Deed Poll (Shareholder), cl 3 of the Deed Poll (Excluded Shareholder) and cl 3 of the CSFB Deed Poll.
(l)The amount ultimately payable to each Remaining Shareholder and each Excluded Shareholder was calculated in accordance with the ‘Sale Mechanism Price’ as defined in cl 1.1 of the CSFB Deed Poll.
(m)      The Sale Mechanism Price was calculated in accordance with the following formula:
SMP    =        A + B
     C
The variables in the formula were defined as follows:
A=        The aggregate of the amounts received by CSFB from the sale on the ASX of Sell Back Rights which were not the subject of direction by a participating shareholder and Sell Back Rights relating to excluded shareholders.
NB the definition of the latter category is not relevant for present purposes.
B=         The amount paid by SGL (in buying back shares) minus (the cost of acquiring those shares on the ASX).
C=         The aggregate of the Sell Back Rights referred to in A.
(n)In the case of a Participating Shareholder who did give a direction and so had the legal title to a Sell Back Right transferred to him or her but who did not exercise the Sell Back Right or dispose of the Sell Back Right to a third party by 5pm on the Cut-off Date (20 March 2001), the Sell Back Right was deemed to have been transferred by Custodial to CSFB and the Net Proceeds of Sale (as defined) accounted for to the shareholder. The Net Proceeds of Sale was determined pursuant to a formula: cl 2(c) and cl 8 of Schedule 1 of the Sell Back Right Deed Poll and cl 9 of the CSFB Deed Poll.
The rights comprised in Sell Back Rights were identified in the Sell Back Right Deed Poll which provided in cl 6:
(a)St George acknowledges and agrees that each Sell Back Right constitutes a separate and distinct binding obligation on St George in favour of a Sell Back Right Holder on and subject to the Terms.
(b)For the avoidance of doubt, Sell Back Rights shall not confer on the Sell Back Right Holder any right to dividends or other accretions or rights which are declared, paid, made or issued by St George in respect of Shares.’
The word ‘Terms’ was defined in cl 1.1 as meaning ‘the terms and conditions of the Sell Back Rights set out in Schedule 1’. Clause 1 of Schedule 1 of the Sell Back Right Deed Poll provided that:
‘Rights Conferred
(a)Each Sell Back Right confers on the Sell Back Right Holder a put option to require St George to purchase one Share at the Buy Back Price. The Sell Back Right Holder is not obliged to exercise this option.
(b)On the exercise of a Sell Back Right in accordance with these Terms, St George must acquire from the Sell Back Right Holder one Share at the Buy Back Price subject to satisfaction of the Sell Back Right Conditions by the Sell Back Right Holder.
(c)Sell Back Rights automatically lapse if they have not been exercised by 5pm on the fourth Business Day after the Cut-off Date.
(d)Exercise of a Sell Back Right must be made in accordance with clause 4 of these Terms.’

The sale and purchase of Sell Back Rights could only be done during the ‘Trading Period’ (Schedule 1 cl 2(a)). The ‘Trading Period’ was defined in the transaction documents as the period commencing at the opening of trading on the Listing Date, which was Monday 19 February 2001, and ending at the close of trading on Tuesday 13 March 2001.
The exercise of a Sell Back Right required the Holder to complete and sign an Exercise Notice to be returned to SGL before either the Election Date or the Cut-off Date which were respectively 16 February 2001 and 20 March 2001 (Schedule 1 cl 4). The circumstances under which either of those dates applied are not material for present purposes. Upon the exercise of a Sell Back Right the Holder would have agreed to SGL buying back the Buy Back Shares (Schedule 1 cl 5(ii)) and would be taken to have given SGL necessary ancillary authorities and appointments to effect the buy back. For each Sell Back Right validly exercised, SGL was to pay to the Holder the Buy Back Price on the final payment date which was 2 April 2001.
In relation to unexercised Sell Back Rights cl 8 provided:
‘Unexercised Sell Back Rights
(a)In relation to each Unexercised Sell Back Right each Unexercised Sell Back Right Participant is taken to have:
(i)transferred to CSFB its Unexercised Sell Back Rights in accordance with clause 9 of the CSFB Deed Poll;
(ii)agreed to receive the Net Payment in consideration for this transfer; and
(iii)automatically and irrevocably appointed each officer of St George that Unexercised Sell Back Right Participant’s attorney to execute any documents or do any thing necessary to transfer to CSFB the Unexercised Sell Back Rights.
(b)Notwithstanding any other provisions in this Deed Poll, CSFB shall exercise any Unexercised Sell Back Right in accordance with clause 4(a) or (b) of these Terms (as the case may be) at any time up to 5pm on the fourth Business Day after the Cut-off Date for the purposes of clause 9(c) of the CSFB Deed Poll and to the extent provided therein.’
Statutory Framework
The relevant provisions of the ITAA 1997 are set out below. In relation to assessable income the relevant provision is s 6-5:
‘Income according to ordinary concepts (ordinary income)
(1)Your assessable income includes income according to ordinary concepts, which is called ordinary income.
(2)If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
(3)If you are not an Australian resident, your assessable income includes:
(a)the ordinary income you derived directly or indirectly from all Australian sources during the income year; and
(b)other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source.
(4)In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.’
Provisions relevant to the application of capital gains tax are as follows:
‘104-10 Disposal of a CGT asset: CGT event A1
(1)CGT event A1 happens if you dispose of a CGT asset.
(2)You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur:
(a)if you stop being the legal owner of the asset but continue to be its beneficial owner; or
(b)merely because of a change of trustee.
(3)The time of the event is:
(a)when you enter into the contract for the disposal; or
(b)if there is no contract – when the change of ownership occurs.
(4)You make a capital gain if the capital proceeds from the disposal are more than the asset’s cost base. You make a capital loss if those capital proceeds are less than the asset’s reduced cost base.
...
104-155Receipt for event relating to a CGT asset: CGT event H2
(1)CGT event H2 happens if:
(a)an act, transaction or event occurs in relation to a CGT asset that you own; and
(b)the act, transaction or event does not result in an adjustment being made to the asset’s cost base or reduced cost base.
(2)The time of the event is when the act, transaction or event occurs.
(3)You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred that relate to the event. You make a capital loss if those capital proceeds are less.
...
(5)CGT event H2 does not happen if:
...
(b)the act, transaction or event requires you to do something that is another CGT event that happens to you.
...
116-20General rules about capital proceeds
(1)The capital proceeds from a CGT event are the total of:
(a)the money you have received, or are entitled to receive, in respect of the event happening; and
(b)the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).
Subsection (2) of s 116-20 sets out the ‘capital proceeds’ from classes of CGT events including CGT event H2. In respect of H2 the capital proceeds are:
‘The money or other consideration you received, or are entitle to receive, because of the act, transaction or event.’
The judgment at first instance – the income point
Conti J found the Taxpayer had a history of long term retention of listed public company shares for the dominant purpose of deriving dividend income from them. Had she sold any of the shares prior to the commencement of the buy back scheme the proceeds of such sale could not have been income according to ordinary concepts.
The Commissioner contended that the sum of $514 representing the market value of the Taxpayer’s Sell Back Rights as at 19 February 2001 when they began trading on the ASX, was income. His alternative argument was that the sum of $576.64 received by the Taxpayer on 2 April 2001 was income. He argued that the grant of Sell Back Rights was a gain by way of a benefit entitling the Taxpayer to money proceeding from her existing shareholding in SGL and only because she held shares in SGL. It was not a distribution of capital. It did not provide the Taxpayer with any advantage of an enduring nature nor with any profit making structure but merely with items to be traded, that is bought or sold or realised for profit.
The Taxpayer argued that receipt of moneys by a shareholder sourced from the funds of the company would not constitute income unless it were a dividend or the product of the employment of, or other services rendered by, that shareholder. She maintained that the benefit received under the Sell Back Rights was not in the nature of a dividend. There had been no dividend declaration by SGL nor was there any other form of detachment of profits of SGL in relation to the payment made to her.
His Honour set out the factors which he regarded as governing the characterisation of the proceeds of the Sell Back Rights. They were:
1.The absence of any distribution to the Taxpayer of any profits of SGL or of any funds emanating from or derived out of or representing profits of SGL.
2.The absence of any income severed or detached from the capital or derived from the underlying property of SGL for the purpose of effecting that distribution.
3.The amount of $576 comprised an addition to and formed part of the purchase price paid for the buy back of 5% of the Taxpayer’s shareholding in SGL. The earlier emerging but unrealised amount of $514 was prospectively of the same character. Its character was assessed by reference to what might be described as the basic sale price the Taxpayer was entitled to receive from SGL for the disposition in favour of SGL of that percentage of her shareholding calculated at the rate of $16.50 per share.
No judicial precedent bore directly upon the characterisation of the respective sums of $514 and $576.64 for income tax purposes in relation to the taxpayer. His Honour said (at [48]):
‘Once it is seen that the derivation by the [Taxpayer] of either sum is referrable entirely to her existing shareholding in SGL, the [Taxpayer’s] submission to the effect that the absence of a fund or source of profits within SGL, out of which the alleged earlier accrual and the later payment originated, bears decisively in her favour upon the exclusion of either amount from the scope of operation of section 6-5.’
He also found much to be said in favour of the further view (at [49]) :
‘... that the proceeds of disposal of the sell back rights in the [Taxpayer’s] hands should bear no different fiscal character to that of the principal sum of $16.50 per share, proffered by SGL to the [Taxpayer] for the sell back of 5% of her shareholding in SGL, by reason of the reasonably (though of course not precisely) analogous nature of the payment of $576.64 to a put option fee paid in the context of a prospective purchase of a capital asset (in contrast of course to a revenue asset), albeit that the payment was calculated and actually paid by SGL to the [Taxpayer] subsequent to the sell back rights trading period ...’
His Honour concluded that the proceeds of sale of the Taxpayer’s Sell Back Rights were not assessable to income tax pursuant to s 6-5 of the ITAA 1997. It may be taken also that the entitlement valued at $514 was not assessable to income tax on his Honour’s findings.
The judgment at first instance – the capital point
The Commissioner submitted that the grant of the Sell Back Rights attracted capital gains tax as an act, transaction or event which happened in relation to the SGL shares owned by the Taxpayer. That is to say, it was a CGT event H2 within the meaning of s 104-155(1)(a) of the ITAA 1997. It was an act which did not result in an adjustment of the cost base of the Taxpayer’s SGL shares so satisfying s 104-155(1)(b). The exception set out in s 104-155(5)(b) did not apply because the grant of the Sell Back Rights did not require the Taxpayer to do anything that was another CGT event.
The amount of the capital proceeds were said by the Commissioner to be the amount which the Taxpayer was to receive pursuant to her entitlement to Sell Back Rights which entitlement crystallised upon their issue. The amount was to be the Sale Mechanism Price multiplied by the number of Sell Back Rights attributable to the Taxpayer, that is not less than $514. There were no incidental costs to the Taxpayer and so a capital gain of not less than $514 accrued to her on the Listing Date, 19 February 2001.
His Honour set out the Commissioner’s contentions and those advanced by the Taxpayer. He rejected the Commissioner’s contentions upon the basis of a fairly broad brush approach to the construction of s 104-155. His Honour said (at [63]):
‘The complexity of the sell back arrangements put in place by SGL compounds the difficulty presented by a taxing provision as imponderable in scope of expression as section 104-155 of the 1997 Act. I would venture to suggest that the Legislature would not have reasonably contemplated the operation adversely to a taxpayer of circumstances in which a passive investor, such as the applicant, would become exposed to capital gains tax, merely by reason of having decided not to take up, or having omitted to take up, the opportunity of trading in sell back rights by way of sale on the ASX. The only example proffered by the Legislature of an operation of section 104-155 ..., as I have already suggested, would surely be at best an unusual occurrence, and is in any event far removed from circumstances of the kind here arising for consideration. Moreover there is commercial unreality involved in the description of the imputed figure of $514 as ‘capital proceeds’ within subsection 104-155, in relation to the circumstances of the applicant as an investor and not a share trader, that sum reflecting nothing more than the initial day’s average trading transactions on the ASX in the sell back rights. Her status relevantly was that of a so-called ‘non-directing or remaining shareholder’ .... In those circumstances, it is I think unrealistic and unjustified to postulate that trading in sell back rights on the ASX during the first listing day could have constituted an act, transaction or event occurring in relation to sell back rights the subject of the applicant’s ownership, within the scope of para (a) of subsection (1).’
His Honour therefore concluded that it was not within what he called ‘the objective intention of the Legislature’ that the issue of the subject Sell Back Rights, in the circumstances of the Taxpayer’s shareholding should qualify for capital gains exposure.
His Honour concluded that the relief sought by the Taxpayer should be allowed and the assessment set aside to the extent evident in the conclusions to his reasons. There was no order as to the costs of the proceedings as the parties had agreed in advance that each would bear their own costs irrespective of the outcome.
Grounds of appeal
There were 18 grounds of appeal and there could have been considerably fewer. In substance the judgment was attacked upon the bases:
1.The Sell Back Rights granted by SGL to Custodial for the benefit of the Taxpayer were assessable income of the Taxpayer quantified at $514.
2.Alternatively, the sum of $576.64 received by the Taxpayer was assessable income.
3.Alternatively, the taxpayer had made a capital gain of $514, the grant of the Sell Back Rights being a CGT event H2 within the meaning of the ITAA 1997.
The submissions on the income point
The Commissioner relied upon and sought to apply the majority judgment of the United States Supreme Court in Eisner v Macomber (1920) 252 US 189 which was said by the High Court in Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 661-662 to have identified the core of the meaning of income where the character of a gain derived from property is being considered. In Eisner the Supreme Court had referred to the familiar metaphors illustrating the distinction between income and capital: fruit and trees, crops and land, outlet stream and reservoir. Nevertheless it found little to add to the succinct statement that:
‘Income may be defined as the gain derived from capital, labor, (sic) or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets ...’.
That definition indicated the characteristic and distinguishing attribute of income. The Supreme Court referred to what it called ‘the essential matter’ as:
‘Not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being ‘derived’ that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal;- that is income derived from property. Nothing else answers the description.’
The Commissioner identified what he described as critical factors going to the nature of the grant of the Sell Back Rights and the proceeds of their sale:
1.The receipt arose from the Taxpayer’s shareholding in SGL which she held for the purposes of income.
2.The receipt was severed from her shares which remained in tact and unchanged by the process. SGL did not buy back any of her shares and she did not dispose of any of them. The money was not received by her in consideration for or as an incident of the disposal or alteration of any capital asset that she held.
3.The receipt did not represent a distribution of capital by SGL.
4.The receipt of money was sourced from the trading activities of CSFB.
Using the language of Eisner the Commissioner said that the benefit of the Sell Back Rights or the money that was received by the Taxpayer was ‘a gain, a profit, something of exchangeable value proceeding from the property [her shares in SGL], severed from the capital [her shares] ... and coming in, being derived, that is, received, or drawn by the recipient (the taxpayer) for her separate use, benefit and disposal’.
The payment made to the Taxpayer and other non-directing shareholders did not involve any distribution of the funds of SGL. The funds used to make the payment represented the net proceeds of CSFB from the sale of Sell Back Rights and their exercise in respect of SGL shares which it acquired. It followed that cases which might support the proposition that a distribution by a company to its shareholders as income in the hands of the shareholders only if the distribution is out of the profits of the company, were not applicable. Here, there was no distribution by the company.
The Commissioner identified what he said were two errors by the learned trial judge:
1.He characterised the sum received by the Taxpayer by reference to the character of a hypothetical receipt if, contrary to the fact, she had sold shares back to the company.
2.He characterised the sum received by the Taxpayer by reference to the fact that there was no distribution of the profits of the company.
As to the first point his Honour did say that the character of the $576.64 actually received and the $514 quantified entitlement was ‘derived by reference to what might be described as the basic sale price the applicant was entitled to receive from SGL for the disposition in favour of SGL of that percentage of her shareholding, calculated, of course, at the rate of $16.50 per share. On the second point, his Honour said (at [48]):
‘... the absence of a fund or source of profits within SGL out of which the alleged earlier accrual and the later payment originated, bears decisively in her favour upon the exclusion of either amount from the scope of operation of s 6-5.’
The Commissioner accepted that the question whether a payment was made out of profits is relevant where there is a distribution of funds of the company. In such a case the source of the dividend bears upon the characterisation of the receipts – Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80 at 97-100; Commissioner of Taxation v Brewing Investments Ltd (2000) 100 FCR 437 at 442-443. However the fact that there is not a distribution out of profits does not require the conclusion that the receipt is not income. The payments made to the Non-directing Shareholders were made in discharge of CSFB’s obligations under the CSFB Deed Poll from funds representing the net proceeds of CSFB from trading activities carried out by it pursuant to that Deed.
The Taxpayer’s submissions began with the observation that her shares were held for the purposes of deriving dividends. The legislature had traditionally brought receipts by shareholders within the scope of assessable income by the device of expanding the definition of ‘dividend’ in the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). But even dividends falling within the deeming provision of the Act could not be assessable income of a shareholder unless, and to the extent to which, they were paid out of the profits of the company – s 4 ITAA 1936; Federal Commissioner of Taxationv Comber (1985) 64 ALR 451. The exclusion of a ‘return of paid up capital’ is common to both the original and expanded definitions of dividend.
It was also submitted that unless there is a detachment by the company of its profits and a distribution of those to the shareholder the receipt to the shareholder is not income according to the ordinary concepts. That principle applies where, as in the present case, the payment is not a dividend. Reference was made to Webb v Federal Commissioner of Taxation (1922) 30 CLR 450, Commissioner of Taxation (NSW) v Stevenson and Federal Commissioner of Taxation v Blakely (1951) 82 CLR 388.

The Taxpayer also argued that bonus shares issued by a company to its shareholders are capital not income and cited Commissioner for Internal Revenue v Blott [1921] 2 AC 171; Federal Commissioner of Taxation v WE Fuller Pty Ltd (1959) 101 CLR 403 and Gibb v Federal Commissioner of Taxation (1966) 118 CLR 628. Nor does the concept of income extend to other bonuses given by companies to shareholders which include rights offered in proportion to their shareholding – Federal Commissioner of Taxation v Miranda (1976) 11 ALR 85; Macmine Pty Ltd v Federal Commissioner of Taxation (1979) 24 ALR 217 and Commissioners of Inland Revenue v Fisher’s Executors [1926] AC 395 – the latter relating to bonus debentures.
The receipt to the Taxpayer was unsolicited. It was voluntary in character but not a gift – Ord Forrest Pty Ltd v Federal Commissioner of Taxation (1973) 130 CLR 124 and Hayes v Federal Commissioner of Taxation (1956) 96 CLR 47. It was submitted that if the receipt were not a deduction within ITAA 1936 it would only be income if it were ‘... the product of an income-earning activity on the part of the [taxpayer], and therefore to be regarded as income from [the taxpayer’s] personal exertion’ – Hayes at 54 (Fullagar J).
The Taxpayer submitted there was no derivation of income at some antecedent point. She was not entitled to sell that right or any interest in them. Her only right as a Remaining Shareholder was to a prospective share of the net proceeds of the sale and/or exercise of the Sell Back Rights transferred to CSFB. What the Taxpayer had on 19 February 2001 was said to be a chose in action which was the right to compel the due administration of a trust. Even if assignable it was not at that point ‘readily convertible into cash’. At that point there would be no income according to ordinary concepts – Federal Commissioner of Taxation v Cook and Sherden (1979) 29 ALR 202 at 212-214.
Whether the entitlement to the Sell Back Rights and the moneys paid to the Taxpayer under the scheme were income
The word ‘income’ is not defined in the ITAA 1997. The use of the words ‘income according to ordinary concepts’ in s 6-5 imports the jurisprudence about its meaning that preceded the enactment of that provision. The Explanatory Memorandum to the Income Tax Assessment Bill 1996 which became the ITAA 1997 stated (at 38):
‘Ordinary income is a succinct label for income according to ordinary concepts which is a major concept in the present law. The courts have developed principles for determining what is ordinary income. However there is no complete set of rules for determining that question.’
The courts have not developed any clear general test for the characterisation of receipts as income. The term ‘income’ not being a term of art the inquirer about its meaning and application in particular circumstances is left to ‘the ordinary concepts and usages of mankind’ – Scott v Commissioner of Taxation (NSW) (1935) 35 SR(NSW) 215 at 219 (Jordan CJ) or ‘... the sense which it has in the vocabulary of business affairs’ – Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 at 320.
In this case the Taxpayer had acquired an entitlement to benefits flowing from the creation and trading of Sell Back Rights in respect of which she never acquired either legal or beneficial title. Other than being a holder of shares in SGL she took no step and none was necessary to establish that entitlement or the subsequent payment based upon it. Neither entitlement nor payment was an incident of her rights as a shareholder at the time that she purchased or otherwise acquired her shares. In this respect the entitlement and payment differed from her entitlement as a shareholder to receive dividends declared by SGL out of profits from time to time. The creation of the Sell Back Rights was a step taken by the company in order to change its capital structure. The entitlements and the payment flowing from it had something of the character of voluntary benefits conferred upon the Taxpayer albeit they accrued to her because of her shareholding as at the Record Date. In these circumstances invocation of the ‘ordinary concepts and usages of mankind’ or ‘the vocabulary of business affairs’ is of little or no assistance. A poll of literate business men and women would probably yield a result covered by the Latin phrase ‘quot homines tot sententiae’.
The Court when called upon to make judgments on circumstances well removed from the core meaning of ‘income’ as most people would understand it is called upon to apply what Professor Stone designated a ‘category of meaningless reference’. In his book, Legal System and Lawyers’ Reasonings (Maitland,1968) at 340, Professor Stone listed as one of a number of ‘apparently meaningless categories’ what he called ‘the distinction over an unusually penumbral area between capital and income’. The distinction between capital and income, like that between fact and law, he treated as having become meaningless ‘only because applied in so many different fields that an accumulation of decisions at the borderline often banishes real difference between cases assigned to different sides of the line’. Nevertheless, the Court must do its best to make the characterisation as the law requires.
The process of characterisation can begin by the exclusion of various forms of receipt conventionally described as income and easily recognisable as such. The entitlement created and the payment made in this case were not the results of any personal exertion on the part of the Taxpayer. They did not have any element of periodicity, recurrence or regularity about them. Nor were they profits derived from an investment or trading activity on the part of the Taxpayer. Although there was a voluntary character about the creation of the entitlement and the making of the payment they did not attach to any employment or office held by the Taxpayer. These attributes are not necessary features of income but do attach to categories of receipt conventionally accepted as such.
The payment was not in the nature of a dividend distributed out of the profits of SGL which would fall within ordinary usage notions of a dividend as income. As Professor Parsons pointed out in – Parsons, Income Taxation in Australia (1985) (at 93):
‘One aspect of the notion requires that the distribution received should be produce of a taxpayer’s shares or his membership of the company.
...
If the form of the distribution is not a payment for the surrender or extinguishment of rights which makes up a share or membership it will be held to be produce of the share or membership.’
The present case is not one which the entitlement conferred upon the Taxpayer by reference to the creation of Sell Back Rights could be regarded in any relevant sense as produce of her shares. It was not an entitlement derived from profits earned by the company. It arose out of the decision by the company to reduce its issued capital through a buy back process.
There may be an analogy to be drawn between the creation of the Sell Back Rights and the issue of bonus shares to an existing shareholder save that in this case no Sell Back Rights were legally or beneficially held by the Taxpayer. Professor Parsons observed that the issue of bonus shares might be thought to suggest a detachment received by the shareholder which remains the produce of the shares held even though transformed into additional shares. However bonus shares have been treated ‘merely as a reframing of the shareholder’s interest in the company’ and therefore as not constituting income according to general usage.
Eisner held that a stock dividend issued to stockholders in proportion to their previous holdings, for profits capitalised, without any distribution of profits, is not income. The Supreme Court asserted its power to look through the form of the corporation and determine the nature of the shareholder’s rights in order to ascertain whether he had received income taxable without apportionment. Pitney J, delivering the judgment of the majority in that case, said (at 214):
‘... we cannot disregard the essential truth disclosed; ignore the substantial difference between corporation and stockholder; treat the entire organization as unreal; look upon stockholders as partners, when they are not such; treat them as having in equity a right to a partition of the corporate assets, when they have none, and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized.’
In Blott, the House of Lords held that, for the purpose of liability to super-tax under the Finance (1909-1910) Act (UK), bonus shares allotted could not be treated as income as they were an addition to the capital of the shareholder. Viscount Haldane pointed to the discretion which a company has to pay dividends out of profits or to capitalise the profits and to pay up capital sums which shareholders, electing to take up unissued shares, would otherwise have to contribute. When the latter course is chosen (at 184):
‘... the money so applied is capital and never becomes profits in the hands of the shareholder at all.’
In Gibb bonus shares issued by a company upon a revaluation, above their book value, of assets not acquired for resale for profit, were held not to constitute income. That an issue of bonus shares made in such circumstances was not income was treated as a matter of settled law – (at 632, Barwick CJ, McTiernan and Taylor JJ). See also Federal Commissioner of Taxation v WE Fuller Pty Ltd, which was discussed in Gibb.
The entitlements created and the payment made to the Taxpayer in the present case were in furtherance of SGL’s decision to reduce its capital through a buy back of shares. That global objective does not support a classification of the entitlement or the moneys paid to the Taxpayer as income. If anything it tends to support their broad characterisation as a return of capital. Upon closer examination of the precise arrangements, the pay out cannot accurately be described for present purposes by reference to its global objective. There is no suggestion that the Taxpayer relinquished any of her shares. She did not hold or ever exercise the ‘put options’ constituted by the Sell Back Rights. No doubt the Sell Back Rights notionally attributed to her were ultimately applied to secure a buy back of shares from some other party following the trading of the Rights on the ASX. The payment made was calculated by reference to a Sale Mechanism Price which was in turn based upon the amount realised by CSFB for the sale of the Sell Back Rights on the ASX. This was not a profit making activity. Nor was it undertaken using any property of the Taxpayer to realise the proceeds. The entitlement itself was a product of the capital restructuring process. It was never a property in the hands of the Taxpayer albeit she might be thought to have acquired a chose in action arising out of the transaction documents. Certainly she benefited from the obligations assumed by Custodial to hold the entitlement and from CSFB to market the Sell Back Rights and remit the proceeds. In my opinion neither the core meaning of the term ‘income’ nor its penumbral applications allow the entitlement created in favour of the taxpayer or the proceeds of that entitlement ultimately received by her to be treated as income according to ordinary concepts. In this respect the Commissioner’s appeal fails.
The submissions on the capital point
The Commissioner submitted, by way of alternative to his argument on the income point, that the grant of the Sell Back Rights for the benefit of the Taxpayer involved the creation of a taxable capital gain in her hands. He submitted that the grant constituted a CGT event H2. It was an ‘act, transaction or event’. It occurred ‘in relation to’ a CGT asset owned by the Taxpayer, namely her SGL shares. But for those shares, the Sell Back Rights would not have been granted for her benefit. Section 104-155(1)(b) was satisfied because the act, transaction or event did not result in an adjustment to the cost base of her shares.
The capital proceeds from a CGT event H2 are set out in the table in s 116-20(2). The Sell Back Rights were granted to Custodial for the Taxpayer’s benefit. She was entitled to receive money because of that grant. Either the value of the benefit or the money she received constituted the ‘capital proceeds’ of the grant. On that basis the Commissioner argued that the grant of the Sell Back Rights constituted a CGT event H2 within s 104-155 of the Act for which the capital proceeds were $576.64.
The Taxpayer submitted that the ‘asset’ referred to in the definition of CGT event H2 in s 104-155(1)(a) must be an asset of the taxpayer. She referred to a division of views in the High Court on this question in relation to s 160M(7) of the ITAA 1936 in Hepples v Federal Commissioner of Taxation (1991) 173 CLR 492. Section 160M(7) was the predecessor, in ITAA 1936, of s 104-155. It was amended after Hepples by the Taxation Laws Amendment Act (No 4) 1992 (Cth). The Explanatory Memorandum for the Bill for that Act said:
‘The amendment will therefore provide for subsection 160M(7) in its future operation to be limited to situations where the act, transaction or event takes place in relation to an asset owned by the taxpayer.’
On the basis that s 104-155 was intended to do no more than s 160M(7) of the ITAA 1936 it was submitted that it must be concerned with assets of the taxpayer only and not assets owned by somebody else.
The Taxpayer also referred to Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42 in which Hill J, referring to the pre-amendment form of s 160M(7), said (at 67):
‘... it is clear that the consideration received or to be received by the taxpayer must be derived by reason of the relevant act, transaction or event. There must be a causal connection between them. The use of the word “consideration” suggests that there will be some contractual relationship between the recipient and some other person giving rise to a receipt or entitlement to receive that consideration, be it a monetary consideration or otherwise.’ (emphasis in judgment)
It was submitted for the Taxpayer that the act, transaction or event relied upon in the CGT event H2 cannot itself be the ‘consideration’ received ‘because of’ that act, transaction or event within the meaning of the definition of capital proceeds in s 116-20(2).
The relationship between the act, transaction or event and the asset of the taxpayer must be ‘real’ – Callow v Federal Commissioner of Taxation (1997) 73 FCR 421 at 427 (Kiefel J). The Taxpayer submitted that as a Remaining Shareholder she had been entitled on 2 April 2001 to an aliquot portion of the net proceeds realised by CSFB by reference to her being on the SGL Register at the Record Date which was 23 January 2001. She could have disposed of her shares at any time after the Record Date and still had been entitled to the benefit of the Sell Back Rights under the Transaction Documents. On this basis it was said that neither the grant of the entitlement nor the receipt of the proceeds was an act ‘in relation to’ an asset of the Taxpayer which was in existence at the time of each of those occurrences.
Whether the grant of the Sell Back Rights or the receipt of the proceeds of their sale involved a capital gain
The definition of CGT event H2 in s 104-155(1) reflects the language of the former s 160M(7) of the ITAA 1936. That subsection, shown in both its pre-amendment and post 1992 amendment form, was as follows:
‘160M(7) [Entitlement to receive money or other consideration] Without limiting the generality of subsection (2) but subject to the other provisions of this part, where –
~~(a)an act or transaction has taken place in relation to an asset or an event affecting an asset has occurred; and~~
(a)either:
(i)an act or transaction has taken place in relation to an asset, whether or not affecting the asset; or
(ii)an event affecting an asset has occurred;
where, in a subparagraph (i) case in which the asset was affected or in any subparagraph (ii) case, it does not matter whether the asset was affected adversely or beneficially, or neither adversely nor beneficially; and
(b)~~a person~~ the person who owned the asset at the time of the act, transaction or event has received, or is entitled to receive, an amount of money or other consideration by reason of the act, transaction or event (whether or not any asset was or will be acquired by the person paying the money or giving the other consideration) including, but not limited to, an amount of money or other consideration –
(i)in the case of an asset being a right – in return ~~for forfeiture or surrender of the right or~~ for refraining from exercising the right; or
(ii)the use or exploitation of the asset,
the act, transaction or event constitutes a disposal by the person who received, or is entitled to receive, the money or other consideration of an asset created by the disposal and, for the purposes of the application of this Part in relation to that disposal –
(c)the money or other consideration constitutes the consideration in respect of the disposal; and
(d)the person shall be deemed not to have paid or given any consideration, or incurred any costs or expenditure, referred to in paragraph 160ZH(1)(a), (b), (c) or (d), (2)(a), (b), (c) or (d) or (3)(a), (b), (c) or (d) in respect of the asset,;
and
(e)the person is taken to have acquired and owned the asset immediately before the disposal.’
In Hepples’ case, decided before the amendments to s 160M(7), a taxpayer agreed with his employer, for a sum of $40,000, that he would not, for two years after the termination of his employment, disclose to third parties or himself use certain trade secrets or special processes or compete with the employer. He also agreed to assign to the employer any patent protection and any invention made by him resulting from the use of the special processes. The sum paid in consideration of these promises was held not to be part of his assessable income by reason of s 170M(7).
Brennan J said (at 508):
‘... the asset referred to in par (a) is necessarily an existing asset when the act or transaction in relation to it takes place or the event affecting it occurs.’
Mason CJ agreed with that proposition at 498. Deane J said (at 516-517):
‘... the provisions of s 160M(7) should be construed as confined to a case where the person who has received the money or other consideration was, immediately before the deemed disposal, the owner of the pre-existing asset referred to in the sub-section.’
Upon that construction of s 160M(7) his Honour held it to be inapplicable to the case where the suggested existing ‘asset’ for the purposes of the subsection was the goodwill and trade secrets which were owned by the employer and not by the appellant. See also Dawson J at 519-520, Toohey J at 522, Gaudron J at 528 and McHugh J at 540-541. McHugh J, in language applicable to the present case said (at 540):
‘The starting point in any analysis of an action, transaction or event alleged to be within s 160M(7) is to identify whether the act, transaction or event is one by reason of which “an amount of money or other consideration” has been paid. The phrase “by reason of” requires that the act, transaction or event upon which the Commissioner relies be the cause of the receipt of or entitlement to the amount of money or other consideration. This means that the act, transaction or event must be precisely identified. Further, while it is not appropriate to substitute another verbal formula for the causal phrase “by reason of”, a causal connexion between two events is not established in a statutory context merely because one event is a causa sine qua non of the other or because, in the widest sense, one event has contributed to the occurrence of the other, unless the language of the statute clearly indicates that it is established.’
His Honour went on to say (at 541) that although the words ‘in relation to’ can be of wide import in the statutory context of s 160M(7) a coincidental or mere connexion was not enough. It was necessary that there be a direct connexion between the act or transaction which had taken place and the asset. This was reflected in the observations of Hill J in Cooling already cited at 67. In Callow Kiefel J (at 427) said, in similar vein:
‘The words “in relation to”, used to connect the relevant transaction with an asset, would appear to be very broad. But, in the context of a subsection which concerns some dealing which gives rise to payment, such that it is to be deemed a disposal of the asset or rights associated with it, a closer connection must be required.’
Her Honour referred to what Toohey J and McHugh J said in Hepples and what was said by Hill J in Cooling and added (at 427):
‘The need for there to be a real or direct connection with the asset to which the agreement, or the covenants contained within it, refers, is reinforced, in my view, by the following reference to an “event affecting an asset” in par (a) having occurred.’

In my opinion neither the creation of the entitlement in respect of the Sell Back Rights nor the payment of proceeds derived from that entitlement could be said, at the respective dates of their creation and payment, to have occurred in relation to a CGT asset then owned by the Taxpayer. That is because the Taxpayer’s ownership of the SGL shares at the time of those events was irrelevant to their occurrence. They were not acts, transactions or events which happened in relation to her ownership of the SGL shares in the real or direct sense that the section requires.
I accept also that the act, transaction or event cannot be the money or consideration received for the purposes of identifying capital proceeds from CGT events H2. The Commissioner’s submissions appear to involve that contention.
Conclusion
For the preceding reasons the Commissioner’s appeal fails on both the primary and alternative basis and the appeal should be dismissed.

I certify that the preceding sixty (60) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice French.
Associate:
Dated: 8 August 2005

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

N671 OF 2004

ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

COMMISSIONER OF TAXATION
APPELLANT

AND:

HELEN MARY MCNEIL
RESPONDENT

JUDGES:

FRENCH, EMMETT & DOWSETT JJ

DATE:

8 AUGUST 2005

PLACE:

SYDNEY

REASONS FOR JUDGMENT
EMMETT J:

At all relevant times, ordinary shares in the capital of St George Bank Limited (‘the Company’) have been listed for quotation on Australian Stock Exchange Limited (‘ASX’). This appeal concerns certain income tax consequences of an off market buy back by the Company of approximately one-twentieth of those shares.
As at 5 pm on 23 January 2001, the respondent, Helen Mary McNeil (‘the Taxpayer’), held 5,450 ordinary shares in the capital of the Company. On 2 April 2001, the Taxpayer received a payment of the sum of $576.64 in connection with the buy back.
On 14 November 2001, the appellant, the Commissioner of Taxation (‘the Commissioner’), issued to the Taxpayer a notice of assessment under the Income Tax Assessment Act 1997 (Cth) (‘the 1997 Act’) for the year ended 30 June 2001. The Notice of Assessment was for an amount calculated on the basis that the whole of the sum of $576.64 was assessable income of the Taxpayer. On 19 June 2002, the Taxpayer lodged notice of objection against the assessment. On 31 October 2002, the Commissioner made an appealable objection decision, disallowing the objection.
On 8 November 2002, the Taxpayer commenced a proceeding in this Court by way of appeal from the appealable objection decision. On 14 April 2004 a judge of this Court upheld the appeal and made the following orders:
‘1. The application be allowed.
2.The objection decision dated 31 October 2002 be set aside and the objection of the [Taxpayer] dated 19 June 2002 be allowed.
3.The matter be remitted to the [Commissioner] for reassessment according to law.’
On 5 May 2004 the Commissioner filed Notice of Appeal to the Full Court from those orders.
THE TAXPAYER AND THE BUY BACK
The Taxpayer is an Australian resident, who retired from her last working position in 1976. From 1987, the Taxpayer’s principal income has been from share dividends, interest on term deposits and debentures and an annuity/pension. She acquired her 5,450 shares in the capital of the Company in several parcels prior to 2001. The first parcel was acquired in 1992 when St George Building Society Limited converted from a building society into a company limited by shares. That entity is the Company and it subsequently changed its name to its present name.
On 12 January 2001, the Company announced that it proposed to buy back 22,786,937 of the ordinary shares in its capital, representing 5 per cent of its issued capital. The buy back was to be achieved by granting to every person who was a Shareholder as at 5 pm on 23 January 2001 the right to require the Company to purchase 1 share for every 20 shares held at that time, for $16.50 per share. On 10 January 2001, shares in the Company were traded at $13.88. The highest price at which shares in the Company had previously been traded was $14.10. Thus, the right to require the Company to purchase a share for $16.50 had some value, equal to the amount by which $16.50 exceeded the market value of shares in the Company.
A series of instruments (‘the Scheme Instruments’) was entered into by the Company and others in order to give effect to the proposed buy back (‘the Buy Back’). The Scheme Instruments, each of which is stated to be a deed poll, were as follows:
- Deed Poll (Shareholders), expressed to be made on 12 January 2001 by the Company and St George Custodial Pty Ltd (‘Custodial’);
- Sell Back Right Deed Poll, expressed to be made on 12 January 2001 by the Company;
- Deed Poll (Excluded Shareholder), expressed to be made on 12 January by the Company and Custodial;
- CSFB Deed Poll, expressed to be made on 12 January 2001 by Credit Suisse First Boston Australia Equities Limited (‘CSFB’).
The pertinent provisions of the Scheme Instruments are summarised in the Schedule to these reasons. Terms used in these reasons are used in the same way as in the Scheme Instruments.
On 29 January 2001, the Company sent to all Shareholders of the Company a copy of a booklet (‘the Buy Back Booklet’) by which the Company offered the opportunity of participating in the Buy Back. In the Buy Back Booklet, the Company said it was issuing one Sell Back Right for every 20 shares held at 5 pm on Tuesday, 23 January 2001. Each Sell Back Right conferred a put option on the holder, being an option to require the Company to purchase one share in its capital for $16.50. The Buy Back Booklet explained that each Shareholder had three choices in relation to Sell Back Rights as follows:
(1)exercise Sell Back Rights.
(2) deal with the Shareholder’s entitlement to Sell Back Rights;
(3) do nothing.
The Buy Back Booklet set out a timetable for the implementation of the Buy Back as follows:

Event Date

Determination of how many Sell Back Rights you have [Record Date] 5.00pm on Tuesday, 23 January 2001

Buy-Back booklet sent to you Monday, 29 January 2001

Final date for you to lodge your Direction Form [Election Date] 5.00pm on Friday, 16 February 2001

Trading of Sell Back Rights starts on a deferred settlement basis [Listing Date] Monday, 19 February 2001

Despatch of Sell Back Rights holding statements/advice and exercise form Tuesday, 20 February 2001

Trading of Sell Back Rights on a T+3 basis starts on ASX Tuesday, 27 February 2001

Last day to have your broker buy or sell Sell Back Rights lend of Trading Period] Tuesday, 13 March 2001

Final date for exercise of Sell Back Rights [Cut-off Date] 5.00pm on Tuesday, 20 March 2001

Completion of the Buy-Back and [the Company] announces the number of Shares it has bought back 5.00pm on Wednesday, 28 March 2001

Proceeds to be despatched to participants in the Buy-Back Monday, 2 April 2001

The Buy Back was intended to give flexibility to Shareholders, such that, if they did not wish to sell their shares in the Company, they would nevertheless be entitled to participate in certain benefits of the Buy Back. Thus, persons who were Shareholders at the Record Date could either sell one in twenty shares to the Company for $16.50 or retain all of their shares and participate in any benefit that might arise by reason of the fact that the Buy Back Price was expected to be in excess of the market value of the shares.
The Scheme Instruments provided a mechanism whereby the Sell Back Rights of those Shareholders who did not elect either to deal with their entitlements or to exercise the Sell Back Rights, were to be sold by Custodial and the proceeds distributed to such Shareholders. Each Buy Back Booklet was accompanied by a Direction Form that specified the name and address of the Shareholder, the number of shares in the Company held by the Shareholder at the Record Date and the number of Sell Back Rights that the Shareholder was to be granted. If the Shareholder wished to deal with Sell Back Rights or to exercise Sell Back Rights, the Shareholder was required to complete the Direction Form and return it to the Company no later than 16 February 2001, the Election Date.
In late January or early February 2001, the Taxpayer received a copy of the Buy Back Booklet, which informed her that she had been granted 272 Sell Back Rights. The Taxpayer read only part of the Buy Back Booklet. She understood that she could, at her option, sell up to 272 of her shares for $16.50 per share. She did not realise that, if she did not accept the offer to require the Company to buy 272 of her shares, she could nonetheless sell her Sell Back Rights. Nor did she realise that, if she did not respond to the offer made by the Buy Back Booklet, those Sell Back Rights would be sold and she might receive money for them. She decided not to sell any of her shares in the Company and took no further action.
On 19 February 2001, the Company granted Sell Back Rights in performance of its obligations under clause 2(a) of the Sell Back Rights Deed Poll. In particular, 272 Sell Back Rights were granted to Custodial for the absolute benefit of the Taxpayer. The Taxpayer could not obtain legal title to her Sell Back Rights since the Election Date had passed and she had not given a Direction to the Company, by completing a Direction Form.
Trading in Sell Back Rights on ASX commenced on 19 February 2001 and ceased on 13 March 2001. On listing, the Sell Back Rights were first quoted at $1.89 each, the buy back price of $16.50 being above the market price of shares in the Company at that time. On that basis, the Taxpayer’s 272 Sell Back Rights had a realisable value of $514. However, there was no evidence that the value of shares in the Company decreased as a result of the grant of the Sell Back Rights.
In fact, the Taxpayer’s 272 Sell Back Rights were sold by Custodial to CSFB pursuant to clause 2(c) of the Sell Back Rights Deed Poll. The Taxpayer’s Sell Back Rights were then sold by CSFB on ASX and, in due course, the proceeds were paid to Custodial. The Taxpayer’s Sell Back Rights realised the sum of $576.64. The Taxpayer did not receive any further correspondence about the Buy Back until she was informed, on or about 2 April 2001, that she was entitled to $576.64, being the proceeds of the sale by Custodial to CSFB of her Sell Back Rights. On that date, the amount of $576.64 was deposited directly into her bank account with the Company.
The Taxpayer concedes that the sum of $62.64, being the difference between $514 (the realisable value of her Sell Back Rights at the date of grant) and $576.64 (the proceeds of realisation of her Sell Back Rights) was assessable income as a capital gain. However, the Commissioner contends that the whole of the sum of $576.64 was income according to ordinary concepts and was therefore assessable income. Alternatively, the Commissioner contends that the whole of the sum of $576.64 was a capital gain. The Taxpayer contends, as the primary judge held, that the value of the Buy Back Rights was not assessable income in her hands according to ordinary concepts. She also contends, as the primary judge held, that there was no capital gain, except to the extent of the sum of $62.64 just mentioned.
INCOME ACCORDING TO ORDINARY CONCEPTS
The question of whether the value of the Sell Back Rights granted to the Taxpayer constituted income according to ordinary concepts, is not without difficulty. For reasons that are very persuasive, the Primary judge concluded that neither the value of the Sell Back Rights nor the proceeds of their realisation was income. Ordinarily, one would be slow to reach a conclusion different from that reached by a judge so experienced in tax matters as is the primary judge. However, I have reached a contrary conclusion.
Income can be considered as the gain derived from capital, from labour or from both combined; it should also be understood to include profit gained through the sale or conversion of capital assets. The essence of income derived from property is not that it is a gain accruing to capital, nor a growth or increment of value in the investment; rather, it is a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital, however invested or employed, and coming in, being derived, that is, received or drawn by the recipient/taxpayer for the separate use, benefit and disposal of the recipient taxpayer– see Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at [65].
The Sell Back Rights that were granted to the Taxpayer on 19 February 2001 would not have been granted to her if she had not been the holder of 5,450 ordinary shares in the capital of the Company as at 5.00 pm on the Record Date. Thus, because she was the holder of such shares, the Taxpayer was afforded an opportunity to acquire from the Company put options in relation to 272 shares in the Company. That opportunity was afforded when she received the Buy Back Booklet. The Taxpayer did not avail herself of the opportunity. Nevertheless, by the operation of the Scheme Instruments, the opportunity afforded to her was availed of on her behalf. The proceeds of doing so, namely the sum of $576.64, were paid to the Taxpayer in accordance with the Scheme Instruments.
The Taxpayer could have availed herself of the opportunity to require the Company to buy up to 272 shares from her for $16.50 in respect of each share. She would then have been required to sell such shares to the Company. Further, the Taxpayer could have disposed of 272 of her shares in the Company at any time after receipt of the Buy Back Booklet by selling them on ASX. Rather, she preferred to retain all of the shares she held in the Company.
Had the Taxpayer availed herself of the opportunity afforded to her by the Company to require the Company to buy up to 272 of her shares or if she had sold her shares on ASX, she would have received proceeds of sale. Had she availed herself of the Sell Back Rights granted by the Company and exercised the put options, she would have received proceeds equal to $16.50 per share. If she sold her shares on ASX, the proceeds would have been the quoted price less the costs of sale. The proceeds generated by the former course would have been greater than the proceeds generated by the latter course. To the extent that the proceeds exceeded the cost of her shares, the Taxpayer may have derived a profit, which may have been income.
In either of those circumstances, the Taxpayer would have had fewer shares than she now has. However, after 2 April 2001, the Taxpayer still held the 5,450 shares in the Company that she had held at the Record date. Those shares had a value as at 2 April 2001, which may have been more or less than the value that they had as at the Record date. There does not appear to have been evidence on that question.
The sum of $576.64 that the Taxpayer received from the realisation of her Sell Back Rights was clearly not a gain derived from her labour or services. It was in no sense derived from any effort on her part. Rather, the sum represented the proceeds of the realisation of a benefit conferred upon the Taxpayer by the Company. The primary question is whether the proceeds of the realisation of the benefit conferred by the Company on the Taxpayer, by the grant of Sell Back Rights on 19 February 2001, was income according to ordinary concepts.
The Company could have asked its Shareholders to agree to a reduction of its capital, by cancelling one share for every 20 shares held and returning $16.50 for each share cancelled. Such a return of capital would not have been income in the hands of a Shareholder according to ordinary concepts. It would have represented the proceeds of realisation of that share. If such a course had been adopted by the requisite majority of Shareholders, there would have been no option for individual Shareholders. The shareholding of each Shareholder would have been reduced by 5 per cent. On the other hand, the Company would still have conferred some benefit on each of its Shareholders, because the return made by the Company to its Shareholders in respect of each cancelled share would have been in excess of the market value of that share. Nevertheless, as explained below (at [33]), if the amount returned was debited to a share capital account, the amount would not have been assessable income.
The Company did not part with any of its property by reason only of the grant of Sell Back Rights. Further, the sum of $576.64 received by the Taxpayer was not paid by the Company. Nor was it paid from any property of the Company. Rather, the Company undertook an obligation to each Shareholder, for which it received no specific consideration from the Shareholder, to pay a sum for an asset or property of the Shareholder greater than its market value.
In one sense, it might be said that the Company made a gift to its Shareholders by undertaking to buy back shares in its capital at a future time for a price greater than the market value of the shares. On the other hand, the holder of a share in a company has a right to have the assets of the company used and applied in the various ways in which the Company’s constitution expressly or implicitly requires or authorises. The distribution of money of a company to its members is one of the ways usually authorised by the constitution of a company. Such a return of capital by a company to its members is an effectuation or realisation of the rights obtained by the acquisition of the share in the same way as the distribution of a dividend by the company. The consideration given by the member is the payment up of the share capital in satisfaction of the liability of the amount of the share incurred on allotment. A share is a chose in action such that, upon its transfer, those rights are transferred to the new member. Thus, as a matter of company law, there was no gift by the Company to its Shareholders by agreeing to buy back its own shares (see Archibald Howie Pty Ltd v Commissioner of Stamp Duties (1948) 77 CLR 143 at 152).
By granting Sell Back Rights to its Shareholders, the Company conferred on those Shareholders the capacity to obtain a benefit without disposing of, or parting with, any of their shares in the Company. Of course, the Company could do that only if a sufficient number of Shareholders were prepared to part with a sufficient number of shares to enable CSFB and others to acquire a sufficient number of shares to be in a position to exercise Sell Back Rights granted for the benefit of Shareholders who did not elect to exercise Sell Back Rights.
It was completely irrelevant whether or not any Shareholder held shares in the Company on the Listing date, being the date of grant of Sell Back Rights on the Election Date. A Shareholder who sold all of that Shareholder’s shares on the day after the Record Date was still given the right to require the Company to buy a fixed number of shares. If a Shareholder who had sold all shares wished to exercise the Shareholder’s Sell Back Rights, the Shareholder could have done so by buying more shares on the ASX in order to be in a position to satisfy its obligations, upon exercising Sell Back Rights, to transfer shares in exchange for $16.50 per share.
The Company did not grant to Shareholders the right to sell particular shares. More specifically, the Company did not grant to Shareholders the right to sell the shares held by them as at the Record Date. Rather, the Company simply stipulated, in one sense arbitrarily, that it would grant Sell Back Rights to a finite class of persons. That class was those persons who happened to be Shareholders of the Company at 5 pm on the Record Date. Putting aside the extent of the power conferred on the Company by the Corporations Act 2001 (Cth) to grant a put option in respect of its own shares, the Company could, in theory, have granted a put option to any person, whether or not a Shareholder. However, there would be a real question as to the propriety of a grant of put options that had intrinsic value, such as the Sell Back Rights had, to any persons, other than Shareholders in their capacity as members of the Company. To do so would have been to make a gift to such persons. However, for the reasons indicated above, there was no gift by the Company, in granting such rights to Shareholders.

In other words, Kitto J accepted that the excess of the amount received over the amount paid up on each share was not income according to ordinary concepts. Another aspect of his Honour’s reasons is of assistance in understanding the development of the law in this area. At 638- 639, his Honour considered the earlier decision of Fullagar J in Federal Commissioner of Taxation v Blakely (1951) 82 CLR 388, a decision which was relied upon to some extent in argument in the present case. The importance of this passage is that it highlights a change which had taken place in the legislative treatment of dividends for income tax purposes. Kitto J considered that Fullagar J had, in Blakely, failed to recognize the change, observing:
‘The amending Act had repealed s 16B, and replaced it with a new s 16AA in terms similar to those of the present s 44(1), a new s 16AB which need not be discussed, and a new s 16B in terms similar to those of the present s 47. It is important to see what this means. The need to enact the original s 16B (in 1928) had been made clear by Burrell’s Case …, which had shown that a distribution to shareholders by a liquidator in a winding up is, in the hands of the shareholders, necessarily of a capital nature, whether the moneys or other assets distributed represented, from the company’s point of view, capital or income. What s 16B did was to include in the shareholder’s assessable income any amount received by him in such a distribution to the extent to which it represented income of the company (with an exception). Capital though it was in the hands of the shareholder, its inclusion in his assessable income was made a consequence of the income character (from the company’s point of view) of the source from which it was taken by the liquidator. The 1934 Act carried a similar notion into the field of distributions made by a company while still a going concern. This it did by enacting simultaneously the definition of “dividend” and the new s 16AA. The section brought into a shareholder’s assessable income “dividends” to the extent to which they were paid out of the profits of the company, while the definition, as I have said, removed from the word “dividend” the prima facie restriction to income which is normally inherent in it, and gave the word a comprehensive meaning to include “any distribution” by a company out of its profits. The expression “out of its profits” was omitted in the 1936 consolidation, as I have already said, but its presence or absence is immaterial to the point which it is important here to notice. The point is that the enactment of section 16AA together with the definition had the effect of making shareholders in a company which is a going concern assessable to tax on a principle fundamentally different from that of previous legislation. The criterion for the inclusion of a shareholder’s receipts from the company is no longer the “dividend” character of the receipts, that is to say their income character when considered from the shareholder’s point of view; it is the profit character – from the company’s point of view – of the source from which distribution should be made.’
Although Kitto J was in dissent in Uther, his Honour’s reasons were, as I have said, expressly approved by Gibbs CJ (Mason, Brennan, Deane and Dawson JJ concurring) in Slater at 457. Thus it can be seen that an amount received by way of dividend may be liable to taxation by virtue of the statutory treatment of dividends but not income according to ordinary concepts.
In my view, three cases offer guidance in resolving the present question. The first is the decision of the Court of Appeal in Commissioners of Inland Revenue v Paget (1938) 2 KB 25. The facts of that case bore some similarity to those of the present case. Ms Paget held bearer bonds issued by the City of Budapest and by the Kingdom of Yugoslavia. The former bonds yielded interest which was payable in pounds sterling in London and in certain other countries in their respective currencies. In 1931, the Royal Hungarian government forbade the payment of interest in accordance with the terms of the Budapest bonds. The Municipality was directed to deposit with the Hungarian National Bank the local currency equivalent of all amounts due. Access to this fund was controlled by the Bank. It issued bond holders with coupons in Hungarian currency but such funds could be used only for specified purposes within Hungary. In the case of the Yugoslav bonds, interest was payable half-yearly in American dollars in New York. In 1933 the government of Yugoslavia revealed that it was unable to pay interest on the bonds in full and proposed to meet part of the interest by issuing coupons in Yugoslav currency payable in Belgrade, the use of such funds being governed by local regulations. There was a market in London for the sale of both the Budapest and Yugoslav coupons. Ms Paget sold her coupons at considerably less than their face value. The Commissioners sought to assess the proceeds to income tax as income according to ordinary concepts. Sir Wilfred Greene MR said at 35:
‘The [Inland Revenue Commissioners] … claimed in the alternative that the purchase price of the coupons was “income arising from securities out of the “United Kingdom” and was charged with income tax … . There are two sub-divisions of this argument. … The second is that Miss Paget was directly assessable in respect of the purchase price. The latter of these two contentions can be disposed of quite shortly. The purchase price received by Miss Paget was not income arising from the bonds at all. It arose from contracts of sale and purchase whereby Miss Paget sold whatever right she had to receive such income in the future as well as her right to take what was offered by the defaulting debtors. It is, in my opinion, quite impossible to treat this as equivalent in any sense to “income arising from” the bonds.’
At 44-45, Lord Romer said:
‘In these circumstances, the only question to be decided is whether the proceeds of sale of a right to receive income in the future can be treated as income for the purpose of the Income Tax Acts. The question thus broadly stated plainly admits of but one answer; and that answer must be in the negative. The proceeds of the sale for a lump sum of an annuity, for instance are capital in the hands of the vendor and not income. And this is true even when the subject of the sale is not the annuity for its whole duration but the right to be paid the annuity for a number of years or even for one year. Nor is it any less true because the purchaser will pay less for an annuity that will be subject to a deduction of income tax in his hands than he would be for a tax free annuity. Nor is it any the less true because in many cases the net income when paid to the purchaser is not income in his hands. In the case, for instance, of a man carrying on the business of dealing with coupons, the sum collected by him on cashing a coupon will be merely a trade receipt and not income. … [T]he interest represented by the coupon cannot be regarded as forming part of the total income of anybody. …’
At 46 his Lordship continued:
‘The transactions appear to have been bona fide transactions of sale and purchase. The moneys received from them by Miss Paget were held by Finlay J to be simply the purchase price of the coupons and in no sense income from foreign securities. In my judgment he was right in so holding, and the appeal should be dismissed with costs.’
Similarly at 48, MacKinnon LJ observed:
‘What Ms Paget sold was the possibility of making some money abroad upon the acceptance of these offers. The money she so received is said to be “income from securities”. If Budapest had offered, in lieu of paying interest due on the bonds, to hand over so many quarters of wheat for each coupon, Miss Paget might have realized some money by selling her coupons to a corn dealer with foreign trade connections. The Attorney-General did not shrink from the proposition that the money she received from the corn dealer would be “income from a security outside the United Kingdom”. This was logical, but in my opinion, irrational.
The fundamental fact is that no interest or dividends have been paid on these securities out of the United Kingdom. The debtors have defaulted.’
The High Court (Mason ACJ, Wilson, Brennan, Deane and Dawson JJ) effectively approved the decision in Paget in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 at 219, where the Court observed, concerning that decision:
‘The purchase price of the coupons was not interest nor were the benefits which purchase of the coupons conferred on the dealers. What Miss Paget sold was, as MacKinnon LJ described it …, “the possibility of making some money abroad” by accepting in lieu of the promised interest certain payment in local currency or a mixture of US dollars and funding bonds. The coupons were the sole source of the possibility of making some money abroad; they were the sole source of the expectation of substitutionary payment. The substitutionary payment offered by the defaulting borrowers (or the expectation of obtaining that payment) on production of the coupons was not regarded as interest and the sale of the coupons was not by way of assignment of a right to interest by way of transfer of the instruments of title to the substitutionary payment. The coupons had come to represent, like a contract to pay an annuity, the sole source of the expected payment. Lord Romer … drew that analogy, treating the sale for a lump sum of an annuity as an instance of a sale of a right to receive income in the future, the proceeds of which are not treated as income.’
The Court then continued:
‘Unlike the sale of the coupons in Paget, the sale of a right to interest severed from the debt is not a sale of a tree of which the future payments are the fruit.’
The significance of this passage will be more obvious after a consideration of the decision in Myer. In that case, the holding company of the well-known retailing group lent a substantial amount of money to another company in the group for a period of seven years at 12.5 per cent per annum interest. Three days after making the loan, the holding company assigned to an unassociated financier, pursuant to arrangements entered into before the loan was made, ‘the moneys due or to become due as the interest payments’ under the loan agreement and interest thereon. The consideration for the assignment was the immediate payment of $45.37 million, calculated as the value at the date of assignment of the right to interest over the period of the loan. The group carried on business mainly in the areas of retail trading and property development. The borrower was to operate as a finance company within the group. The loan had been derived largely from funds representing the proceeds of sale by the holding company of another subsidiary newly formed for the purpose of holding the group’s real assets.
The question was whether or not the consideration paid for the assignment formed part of the holding company’s assessable income for the relevant year, either as income according to ordinary concepts, or as profit arising from the carrying on or carrying out of a profit-making undertaking or scheme. Only the first aspect of the case is presently relevant. Further, much of the judgment concerns or reflects the fact that the transaction took place in the context of the clearly commercial activities being carried on by the group, a circumstance which is not presently relevant.
At pp 217-218, the Court considered the nature of interest, pointing out that the right to receive interest on money is not itself an asset, at least for tax purposes. Thus disposition of such a right is not the disposition of a capital asset. In Paget the subject matter of the assignment was not the right to receive interest, but the right to receive something quite different. Their Honours observed at 218:
‘The source of interest is never the mere covenant to pay. Interest is not like an annuity. Annuity payments are not derived from the money paid for the annuity; they are derived solely from the annuity contract. And so, when a contract right to be paid an annuity is sold for a price, the proceeds of sale are ordinarily capital in the hands of the vendor ….’
When the High Court observed that: ‘Unlike the sale of the coupons in Paget, the sale of a right to interest severed from the debt is not a sale of a tree of which the future payments are the fruit’, it was highlighting the fact that the sale in Paget was of the substituted rights which had not proceeded from the bonds. On the other hand, in Myer, the assignment was of interest which was ‘referable to’ the loan.
In Montgomery, the High Court considered the receipt by a partnership of solicitors of a payment designed to induce them to enter into a lease of commercial premises from which to conduct the business of the partnership. The majority of the Court (Gaudron, Gummow, Kirby & Hayne JJ) at [117] concluded that such inducement constituted ‘not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being ‘derived’, that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal … .’
Their Honours observed at [118]:
‘To put the matter another way, the firm used or exploited its capital (whether its capital is treated for this purpose as being the agreement to take premises or its goodwill) to obtain the inducement amounts.’
Before setting out the extract from Eisner which I have previously quoted, the majority observed as follows at [63] – [64]:
‘[63]Nearly a century ago Lord Macnaghten begged pardon for reminding his listeners that “[i]ncome tax … is a tax on income. It is not meant to be a tax on anything else” … . But, as Jordan CJ said in Scott v Federal Commissioner of Taxation … :
“The word ‘income’ is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.” …
[64]Because the distinction between income and capital has so often been considered by the courts, attempts to classify a particular receipt often proceed by seeking to draw analogies with decided cases. … That approach is often helpful, but resort to analogies should not be permitted to obscure the essential nature of the inquiry which is to determine whether “in ordinary parlance” the receipt in question is to be treated as income. As Jordan CJ made plain, the references to “ordinary parlance” and to the “ordinary concepts and usages of mankind” are no mere matters of ritual incantation; they identify the essential nature of the inquiry.’
In Paget, the subject of the assignment was not interest, but the proceeds of sale of something substituted for the right to receive interest. It seems to me that in the present case, the Sell Back Rights and the moneys received from their sale were not derived from the Taxpayer’s shares but from the Scheme which varied the entitlements attached to those shares. In Myer, the High Court explained why, in Paget, the proceeds of sale were not income according to ordinary concepts. In my view, the same reasoning leads to the same result in the present case. Nothing in Montgomery suggests a different outcome.
Without overlooking the warning concerning arguments by analogy to which I have referred above, my conclusion is, at least in part, supported by analogy to three other situations. The first is that described in Montgomery as concerning ‘payments received by a taxpayer on its agreeing to give up part of its profit-earning structure’. At [100], the Court referred to Dickenson v Federal Commissioner of Taxation (1958) 98 CLR 460 where the High Court treated such payments as being of a capital nature. The second analogy is with the treatment of moneys received from the creation of profits à prendre or similar rights. See Thomson v Federal Commissioner of Taxation (1929) 43 CLR 360. A third analogous situation is that in which a person receives compensation for the compulsory acquisition of part of his or her interest in an asset, particularly land.
THE SCHEME AND CAPITAL GAINS TAX
Subsection 102-5(1) of the 1997 Act provides:
‘Your assessable income includes your net capital gain (if any) for the income year. … ’
The net capital gain for an income year is to be calculated by deducting from capital gains made during that year, capital losses made during that year or previous years. Section 102-20 provides:
‘You can make a capital gain or capital loss if and only if a CGT event happens. The gain or loss is made at the time of the event.’
The various CGT events are described in Div 104. The Commissioner presently relies upon event H2. In effect, a CGT event H2 occurs if:
۰an act, transaction or event occurs in relation to a CGT asset that the Taxpayer owns; and
۰the act, transaction or event does not result in an adjustment being made to the assets cost base or reduced cost base.
The Taxpayer accepts that her shares constituted a CGT asset and has not suggested that any relevant act, transaction or event resulted in adjustment to their cost base or reduced cost base. I will return to this aspect at a later stage. Pursuant to subs 104-155(3), there will be a capital gain if the capital proceeds because of the CGT event are more than the incidental costs incurred relating to that event. Pursuant to subs 116-20(2), the capital proceeds from a CGT event H2 are:
‘The money or other consideration you received, or are entitled to receive, because of the act, transaction or event.’
In the present case the matter has proceeded upon the basis that no relevant incidental costs were incurred by the taxpayer.
Obviously, the first step is to identify any CGT event H2. Such an event must be ‘in relation to a CGT asset’, in this case the Taxpayer’s shares. It follows from what I have said previously that the decision by SGL to enter into the Scheme was itself an event occurring in relation to the Taxpayer’s shares. However the Commissioner has not suggested that such decision, of itself, produced a capital gain. I need not consider whether, in those circumstances, the decision was a CGT event H2 which yielded no capital gain or simply not such an event. The next event which occurred in relation to the shares was the failure by the Taxpayer to notify any election to SGL. Again, the Commissioner does not suggest that this, of itself, yielded any capital gain. The third event was the grant to Custodial of the Sell Back Rights to be held on behalf of the Taxpayer. This is the event upon which the Commissioner relies. However the Taxpayer submits that her entitlement to such grant arose pursuant to the terms of the Scheme as a result of her having held shares on 23 January 2001. The Sell Back Rights were not granted until 19 February 2001. Thus it is submitted that the grant did not occur “in relation to” the shares. There is much to be said for that argument.
The expression “in relation to” is capable of very wide import, describing even quite tenuous relationships between different concepts or entities. As the majority of the High Court (Brennan CJ, Gaudron and McHugh JJ) observed in PMT Partners Pty Ltd (In Liquidation) v Australian National Parks & Wildlife Service (1995) 184 CLR 301 at 313:
‘Inevitably, the closeness of the relationship required by the expression “in or in relation to” in s 48 of the Act – indeed, in any instrument – must be ascertained by reference to the nature and purpose of the provision in question and the context in which it appears.’

In Commissioner of Taxation v Scully (2000) 201 CLR 148 at [40], the majority (Gaudron ACJ, McHugh, Gummow and Callinan JJ) took a similar approach to the expression “in respect of”.
Section 104-155 appears in legislation designed to impose tax upon benefits which have traditionally been described as ‘capital gains’. It might be thought that at its highest, the expression ‘an act, transaction or event … in relation to a CGT asset’ describes any event capable of affecting the capital value of the particular asset. Such an approach is indicated by par 104-155(1)(b) and subs 104-155(3). The issue of the Sell Back Rights to Custodial was not capable of affecting the value of the Taxpayer’s shares simply because any such effect had already occurred, being caused by SGL’s decision to enter into the Scheme and the failure of the Taxpayer to make any election pursuant thereto. The issue of the Sell Back Rights merely gave effect to a legal obligation which had already arisen under the Memorandum and Articles of Association of the company and pursuant to the decision of the Board, taken in conjunction with the other circumstances to which I have referred. However it is not necessary finally to determine whether or not that broad approach to the meaning of the expression “in relation to” in s 104-155 accurately reflects its meaning.
Pursuant to subs 104-155(3) a capital gain is to be measured by reference to the amount of the capital proceeds ‘because of the CGT event’. As I have observed “capital proceeds” means:
‘The money or other consideration you received, or are entitled to receive, because of the Act, transaction or event.’
If, as the Commissioner submits, the act, transaction or event was the issue of the Sell Back Rights, then that event did not, of itself, result in the Taxpayer receiving any money or any entitlement to receive money. The question, then, is whether the Taxpayer received or was entitled to receive the Rights as “consideration” because of the relevant event, namely the grant of the Rights to Custodial. It may be possible to distinguish between the grant of the Rights and the Rights themselves so that the Rights could be described as “consideration” received “because of” the CGT event H2. However such a usage would be inconsistent with the approach to the term “consideration” adopted by the High Court in Scully at [25] – [26]. The Court considered that the term usually involved some element of exchange. In any event, the real point is that no benefit flowed to the Taxpayer from the grant of the Rights. The Taxpayer was already entitled to participate in the Scheme. The grant was merely a mechanism designed to facilitate realization of that entitlement. Whatever the precise meaning of the word “consideration” it cannot, in this context, describe something which is of no value.
I have previously observed that the Taxpayer did not submit that there had been any adjustment to the cost base or reduced cost base of the shares at any relevant time. The absence of such adjustment is a necessary element of a CGT event H2. On my view of the facts, it may be that at some stage, the Taxpayer’s assets, namely the shares, were split into two, the shares (with attenuated entitlements) and the Sell Back Rights. If so, then s 112-25 may have applied, leading to adjustment of the cost base and/or reduced cost base. It is not necessary that I consider this matter.
CONCLUSION
In my view the primary Judge was correct in concluding that the Taxpayer did not derive income according to ordinary concepts as a result of her participation in the Scheme, and that receipt of the Sell Back Rights did not result in a capital gain arising from a CGT event H2. The appeal should be dismissed with costs.

I certify that the preceding ninety-eight (98) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Dowsett.

Associate:
Dated: 8 August 2005

Counsel for the Appellant:

Mr G Davies QC

Mr M Moshinsky

Solicitor for the Appellant:

Australian Government Solicitor

Counsel for the Respondent:

Mr D H Bloom QC

Mr J H Morrison

Solicitor for the Respondent:

Mallesons Stephen Jaques

Date of Hearing:

12 November 2004

Date of Judgment:

8 August 2005

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY	N671 OF 2004

BETWEEN:	COMMISSIONER OF TAXATION APPELLANT
AND:	HELEN MARY McNEIL RESPONDENT
JUDGES:	FRENCH, EMMETT AND DOWSETT JJ
DATE OF ORDER:	8 AUGUST 2005
WHERE MADE:	SYDNEY

JUDGES:	FRENCH, EMMETT AND DOWSETT JJ
DATE:	8 AUGUST 2005
PLACE:	SYDNEY

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY	N671 OF 2004

Event	Date
Determination of how many Sell Back Rights you have [Record Date]	5.00pm on Tuesday, 23 January 2001
Buy-Back booklet sent to you	Monday, 29 January 2001
Final date for you to lodge your Direction Form [Election Date]	5.00pm on Friday, 16 February 2001
Trading of Sell Back Rights starts on a deferred settlement basis [Listing Date]	Monday, 19 February 2001
Despatch of Sell Back Rights holding statements/advice and exercise form	Tuesday, 20 February 2001
Trading of Sell Back Rights on a T+3 basis starts on ASX	Tuesday, 27 February 2001
Last day to have your broker buy or sell Sell Back Rights lend of Trading Period]	Tuesday, 13 March 2001
Final date for exercise of Sell Back Rights [Cut-off Date]	5.00pm on Tuesday, 20 March 2001
Completion of the Buy-Back and [the Company] announces the number of Shares it has bought back	5.00pm on Wednesday, 28 March 2001
Proceeds to be despatched to participants in the Buy-Back	Monday, 2 April 2001

Counsel for the Appellant:	Mr G Davies QC Mr M Moshinsky
Solicitor for the Appellant:	Australian Government Solicitor
Counsel for the Respondent:	Mr D H Bloom QC Mr J H Morrison
Solicitor for the Respondent:	Mallesons Stephen Jaques
Date of Hearing:	12 November 2004
Date of Judgment:	8 August 2005