Curran v Federal Commissioner of Taxation

[1974] HCA 46

HIGH COURT OF AUSTRALIA

Barwick C.J., Menzies, Gibbs and Stephen JJ.

CURRAN v. FEDERAL COMMISSIONER OF TAXATION.

(1974) 131 CLR 409

4 November 1974

Income Tax

Income Tax—Allowable deductions—Bonus shares issued to taxpayer through payment of par value by declaration of dividends—Whether costs of bonus shares to taxpayer is nil or their paid-up amount—Trading stock—Whether bonus shares to be brought in at cost price or market value—Income Tax Assessment Act 1936-1969 (Cth), ss. 6, 44(2)(b)(iii), 51.

Decisions

Nov. 4.
The following written judgments were delivered:-
BARWICK C.J. The appellant, a stockbroker, during the tax year ending on 30th June 1969, was dealing in shares on his own account. In keeping his financial accounts in connexion with that business he treated the shares which he bought as his stock in trade, bringing to account as the opening entry for the financial year all the shares he then had on hand at their market value or cost whichever was the lower, entering to his debit the cost of all the shares which he acquired during the year and to his credit the amounts received for shares of which he disposed during the year, and bringing to account at market value or cost whichever was the lower as a closing entry the shares of which he remained possessed at the end of the financial year. The difference between the total of the first two items and the total of the second two represented his gain or loss in his share dealing for the year. He had also an income account to which he carried the amount of dividends which he received during the year. (at p411)

2. He purchased in the tax year shares in various companies which, after he had become a shareholder, resolved to issue bonus shares either out of the proceeds of the realization of assets not acquired for the purpose of resale at a profit, or out of the amount of the revaluation of assets not acquired for the purpose of resale at a profit, or out of a share premium account, or out of a combination of these elements. The appellant debited his share dealing account to which I have referred with the amount of capital credited as paid up in respect of such bonus shares as the price paid for them as well as the cost of the shares in the company originally acquired by him. Later, when he sold the shares originally acquired and the bonus shares, he credited the account with the amount received on the sales. Over the period of the year, these entries, along with all other entries of shares purchased and sold and with the value or cost as the case may be of opening and closing lists of shares on hand, resulted in what was claimed to be a trading loss of $206,019. (at p411)

3. In his return of income for the tax year, the appellant entered his dividend and other income so far as its receipt constituted assessable income and claimed to deduct the above-mentioned sum of $206,019 as a loss under s. 51 of the Income Tax Assessment Act, 1936-1969 (the Act). (at p411)

4. The Commissioner disallowed this deduction and assessed the appellant on the footing that the appellant had made a much smaller loss from his share dealing in the companies which had issued bonus shares in the year. An objection to this course of assessment by the appellant was disallowed by the Commissioner. Pursuant to the appellant's request his objection was treated as an appeal to this Court where a single Justice stated a case for the opinion of a Full Court. (at p411)

5. The questions asked by the case are as follows:
1. Did the appellant as claimed in par. 22 hereof incur a loss in relation to the 200 shares in Stewart Bacon purchased by him on 29th April, 1969 in the sum of $185,848.96 which was an allowable deduction under the provisions of the Income Tax Assessment Act, 1936-1969?
2. Did the appellant incur a loss on the sale of the 191,000 shares in Stewart Bacon issued to him on 6th May, 1969 in the sum of $2,368.40 which is an allowable deduction under the provisions of the said Act?
3. In relation to the appellant's trading in shares in the companies listed in par. 24 hereof, did he incur: (a) a loss of $22,573; (b) a loss of some other, and if so what, amount; (c) a profit of $556; or (d) a profit of some other, and if so what, amount? (at p412)

6. The parties resolved their disagreement as to the amount to be deducted in respect of dealings in the shares listed in par. 24 and consequently have agreed on the answer to the third question. (at p412)

7. In the agreed facts set out in the stated case there are eleven instances of the purchase of shares in companies, with details as to the various steps by which the bonus shares in such companies were issued. But the parties agreed on the answer to the third question asked in the stated case with a slight variation in the amount of the loss claimed by the appellant. Consequently, it is only necessary to deal with one instance, this as it happens being the instance which involved by far the largest sum claimed as a loss. Accordingly, I set out the basic facts of this instance. (at p412)

8. On 28th April 1969, the appellant purchased 200 fully paid shares in Stewart Bacon Holdings Pty. Ltd. (Stewart Bacon) for the sum of $186,046.48 which was at the rate of $930.23 per share. The issued capital of that company at that date was $215. Its assets consisted of $206.619.78 at bank on current account. Its liabilities were $162.02. It had a capital profits reserve account ($206,242.76) which represented the proceeds of the realization of assets not acquired for the purpose of resale at a profit. The articles of association of the company were in the form of the regulations in Table A to the 4th Sch. of the Companies Act, 1961 (N.S.W.) with some modifications not presently relevant. Its nominal capital on that date was $100,000 divided into 100,000 ordinary shares of $1 each. (at p412)

9. The appellant was registered as a member of the company on 28th April 1969 in respect of the 200 ordinary fully paid shares in the capital of the company which he had that day purchased. (at p412)

10. At an extraordinary general meeting of shareholders held on 6th May 1969 it was resolved that:
1. The nominal capital of the company be increased to $250,000 by the creation of 150,000 new ordinary shares of $1.00 each;
2. An additional article be adopted:

"96A. Any General meeting declaring a dividend may on the recommendation of the Board resolve that such dividend be paid wholly or in part by the distribution of specific assets and in particular of paid-up shares debentures or debenture stock of the company or paid-up shares debentures or debenture stock of any other company or in any one or more of such ways; any general meeting may on the recommendation aforesaid resolve that any moneys investments or other assets forming part of the undivided profits of the Company standing to the credit of a reserve account or in the hands of the company and available for dividend or representing premiums received on the issue of shares and standing to the credit of the share premium account be capitalised and distributed amongst the members in accordance with their rights on the footing that they become entitled thereto as capital and that all or any part of such capitalised fund be applied on behalf of the members in paying up in full any unissued shares of the company and that such unissued shares so fully paid be distributed accordingly amongst the members in the proportion in which they are entitled to receive dividends and be accepted by them in full satisfaction of their interests in the said capitalised sum. For the purpose of giving effect to any resolution under this Article the Board may settle any difficulty which may arise in regard to the distribution as they think expedient and in particular may issue fractional certificates and may fix the value for distribution of any specific assets and may determine that cash payments shall be made to any members upon the footing of the value so fixed or that fractions of less value than one dollar may be disregarded in order to adjust the rights of all parties and may vest any such cash or specific assets in trustees upon such trusts for the persons entitled to the dividend or capitalised fund as may seem expedient to the Board. Where requisite a proper contract and/or proper particulars thereof shall be filed in accordance with the Act and the Board may appoint any person to sign on behalf of the persons entitled to the dividend any contract required under such Act or any contract agreeing to accept fully paid shares in satisfaction of any dividend.";

3. The sum of $205,325 forming part of the capital profits reserve account be "capitalized" and distributed amongst those who were members in respect of ordinary shares on 29th April 1969 "on the footing that they become entitled thereto as capital in pursuance of Article 96A" and in proportion to their ordinary shareholding; 4. The capitalized sum of $205,325 be applied in paying up in full 205,325 of the unissued ordinary shares of $1.00 each in the capital of the company and that the same be distributed amongst the members aforesaid in fully paid ordinary shares of $1.00 each in satisfaction of the said capital sum and in proportion to the number of shares then held by them respectively;
5. The said 205,325 shares rank in all respects equally with existing ordinary shares of $1.00 as from 6th May 1969. (at p414)

11. Later the same day, the board of directors of the company allotted to t he appellant 191,000 fully paid $1.00 shares, being his entitlement under the abovementioned resolutions. Later still on the same day the appellant sold for the sum of $197.52 the 200 shares initially purchased by him and for the sum of $188,631.60 the 191,000 bonus shares. (at p414)

12. In his shareholding account, the appellant entered the sum of $191,000 as the purchase price of the 191,000 bonus shares and the proceeds of their sale in the record of shares sold. Taking this accounting of the transaction in the shares of Stewart Bacon, there was a loss of $188,217.36, which sum was included in the total of $206,019 claimed to be deducted in the appellant's return of income. (at p414)

13. The Commissioner's submission is that the correct way to account for the result of the appellant's transactions in the shares of Stewart Bacon is to compare the price paid for the 200 shares initially acquired ($186,046.48) with the total price received for these and the bonus shares ($188,829.12). Such a comparison shows a surplus on realization of $2,782.64 which the Commissioner claims was the profit made upon the transaction as a whole. Put another way, the Commissioner submits that the purchase price of the bonus shares was nil and that whilst their acquisition should be reflected in the account amongst the purchases, no sum should be entered against them as a purchase price. (at p414)

14. The appellant supports the method of accounting which I have described and submits that it properly reflects the financial result of his transactions in the shares of Stewart Bacon. (at p414)

15. The appellant begins with the proposition that a company cannot issue shares as wholly or partly paid except against payment of the amount for which they are to be credited as paid up, or without creating a liability in the shareholder who accepts them to pay that amount. Where a company has profits available for distribution it may issue paid-up bonus shares to the extent of the amount of such profits, assuming its articles of association allow that course. Whether the company does so expressly or not, the effect of a decision to issue bonus shares paid up to some amount is to declare a dividend of the amount requisite to balance the amount for which the bonus shares are to be treated as paid up; such dividend not being payable in cash but to be credited to the shareholder against the liability to pay the amount for which the bonus shares are to be credited as paid up, a liability which arises from the issue and acceptance of such shares. In general, bonus shares are issued as fully paid up, but I have expressed these propositions so as to cover the issue of partly paid-up shares as well as fully paid-up shares. (at p414)

16. Thus, in more than a formal sense, the shareholder who has been credited actually or notionally with an amount of distributable profits pursuant to a resolution to capitalize them and to issue bonus shares to a total paid-up value equal to or less than the amount of such profits, by accepting the bonus shares in terms of the resolution to issue them has paid for the shares. By accepting them he has agreed to the application to the capital of the company of the amount of the distributable profits so credited to him, thus effecting payment for the shares. (at p415)

17. For the purposes of income tax under the Act, the amount of the distributable profits thus credited to the shareholder constitutes income. This is so whether or not the company first purports to capitalize such profits before effecting any distribution of them. Having regard to Blott's Case (1921) AC 171 , it may properly be said that the receipt of the bonus share, representing an interest in the capital of the company, is not income: but the crediting of the sum of profits used to effect payment for that share is income. See James v. Federal Commissioner of Taxation (1924) 34 CLR 404 ; Commissioner of Taxes (Vict.) v. Nicholas (1938) 59 CLR 230 , particularly the judgment of Sir George Rich (1938) 59 CLR at pp 240-245 ; and Nicholas v. Commissioner of Taxes (Vict.) (1940) AC 744, at p 759; (1940) 63 CLR 191, at p 199 , per Lord Thankerton. (at p415)

18. Thus, where a company having distributable profits impliedly effects their distribution by the issue against them of bonus shares fully or partly paid up, the recipient of the shares, having regard to the definition of "dividend" in s. 6 of the Act, must treat himself as having received income to the amount of the profits of the company applied to pay for the bonus shares and, in my opinion, will be entitled to regard those shares as having cost him that amount of money, even though the resolutions of the company do not provide for payment to him of that sum of money. Whether or not the recipient of the bonus shares must pay income tax in respect of the amount credited to him by the company in connexion with the issue of the bonus shares depends on the provisions of the Act. But, in my opinion, whether or not he pays income tax on the amount so credited can have no relevance to the question whether he is entitled to treat himself as having paid the amount credited to him by the company as the cost of the bonus shares. (at p415)

19. In the present case, s. 44(2)(b)(iii) of the Act in the circumstances of the issue of the bonus shares by Stewart Bacon exempts from income tax the amount credited to the appellant in respect of the issue of the shares. But that does not mean, in my opinion, that the appellant is not to be regarded as having paid for those shares the amount of their paid-up value. The appellant is bound to treat the amount of $191,000 credited by the company as income received by him, though by reason of s. 44(2)(b)(iii) it is not assessable income. In my opinion, he is also entitled to treat himself as having paid for the bonus shares the amount credited to him by the company in connexion with the issue of those shares. He paid for them by means of the credit given him by the company of his aliquot share of the distributable profits of the company derived from the realization of assets not acquired for resale at a profit. The resolutions of the extraordinary general meeting of Stewart Bacon went to unnecessary lengths in purporting to allot aliquot portions of the capitalized profits of the company to the shareholders before resolving to issue the bonus shares. But it was the resolution described in the sidenote as a "Special Resolution Effecting Bonus Issue of Shares from Capital Profits Reserve", which included the resolution to apply a capitalized sum in paying in full the bonus shares, which was effective to warrant the appellant in treating the amount credited to him as his share of the capitalised profits as having been paid by him for the bonus shares issued to him. Consequently, I would regard the appellant's account of his share dealings in the year of income as accurately reflecting the result of his transactions in the shares of Stewart Bacon. In my opinion, for the purposes of determining his assessable income, the appellant rightly claimed to have suffered a loss of $188,217.36 on his transactions in the shares of Stewart Bacon in the tax year ending 30th June 1969. (at p416)

20. In my opinion, the questions posed by the stated case should be answered as follows: 1 &2. The appellant suffered a deductible loss in the sum of $188,217.36. 3. By consent - (a) No. (b) Yes - $22,513. (c) Unnecessary to answer. (d) Unnecessary to answer. (at p416)

MENZIES J. The Commissioner, for the purpose of taxing the appellant, who is a share dealer, seeks to follow a simple course to determine his profit or loss upon the buying and selling of shares in certain companies. It is to compare the price at which the appellant sold X plus Y shares in a company with the price which the appellant paid for the X shares only, attributing no cost to the Y shares because they were a bonus issue received by the appellant as the owner of the X shares. Accordingly the Commissioner looks only to the appellant's initial outlay and final receipt. (at p416)

2. The appellant on the other hand contends that, although a bonus issue, he paid for the Y shares by the application of a dividend upon the X shares declared by the company so that the amount of the dividend so applied is the cost of the bonus shares and is deductible. (at p416)

3. Had the dividend been assessable income of the appellant the Commissioner would have included it in the assessment to arrive at taxable income and would, no doubt, have been content to allow the appellant the deduction claimed as the expenditure of assessable income to acquire shares. The dividend, however, was by virtue of s. 44(2)(b)(iii) of the Act, not assessable income. Hence the dispute. (at p417)

4. In my opinion although the resolutions of the company relating to the bonus issue disclose some confusion resulting in some inconsistency, it ought to be concluded that they did result in the declaration of a dividend and its application to pay up in full shares to be issued as bonus shares. By reason of this, and the appellant's acceptance of the bonus shares, a payment was made for those shares out of a credit created in favour of the appellant by the declaration of the dividend. It matters not that the dividend had to be so applied and was not payable in cash. The significance of this is simply that the dividend was one within s. 44(2)(b)(iii) of the Act. (at p417)

5. I do not think it correct to ignore the part played by the company leading to the allotment of the bonus shares and to treat them as but part of the appellant's original purchase notwithstanding that the purchase was made with an eye to what was, in due course, done. The appellant is, therefore, entitled to a deduction for what was so paid for the shares allotted to him. (at p417)

6. I would accordingly answer the first and second questions in the case stated as follows: The appellant incurred a deductible loss in relation to all the shares in Stewart Bacon in the sum of $188,217.36. It has been agreed that the third question should be answered as follows: 3. (a) No. (b) Yes. $22,513. (at p417)

GIBBS J. This case stated raises for our consideration questions in relation to an assessment to income tax based upon income derived by the appellant during the year of income that ended on 30th June 1969. The appellant was a stockbroker and during the year of income he also carried on the business of dealing in stocks and shares on his own account. For the purposes of that business he held, bought and sold stocks and shares in a considerable number of companies. It is common ground that in the circumstances the stocks and shares constituted trading stock for the purposes of the Income Tax Assessment Act 1936-1969 ("the Act") - see Investment and Merchant Finance Corporation Ltd. v. Federal Commissioner of Taxation (1971) 125 CLR 249 - and that in determining whether the appellant had a taxable income it is necessary, in accordance with the provisions of s. 28 of the Act, to compare the value of all stocks and shares held by the appellant at the end of the year with the value of those held at the beginning of the year; an excess of the former value over the latter represents income, whereas an excess of the latter over the former is an allowable deduction. However, sales and purchases made during the year must also be taken into account in arriving at the appellant's taxable income; the proceeds of any sales of stocks and shares must be included in the assessable income and the expenditure incurred in the purchase of stocks and shares - which by s. 51(2) is not to be treated as an outgoing of capital or of a capital nature - is to be deducted. The appellant, with his return of income, submitted an account of his share trading compiled in accordance with these principles. This account showed that the sum of the value of stock on hand at 1st July 1968 (at cost or market value whichever was the lower) and the cost of purchases during the year ended 30th June 1969 exceeded the value of stock on hand at 30th June 1969 (at cost or market value whichever was the lower) plus the proceeds of sale by an amount of $206,019, and the appellant claimed this amount, which he said represented his loss on share trading, as a deduction; in consequence he sustained a considerable net loss for the year. The Commissioner challenged the appellant's accounts in one respect only. The appellant included in the amount representing the cost of stocks and shares purchased during the income year the par-value of bonus shares in a number of companies that were issued to him during that period. The Commissioner, however, made his assessment on the footing that the cost of acquiring the bonus shares should be shown in the accounts as nil. The result was to convert the appellant's loss into a profit. (at p418)

2. The case as framed raised questions as to bonus issues made by ten public companies and one private company but the parties have reached agreement as to the answer to be given to question 3, which relates to the public companies, and it is unnecessary further to refer to the issues made by those companies. Questions 1 and 2 concern the dealings by the appellant in a private company, Stewart Bacon Holdings Pty. Ltd. ("Stewart Bacon"), which on 6th May 1969 issued 191, 000 bonus shares to the appellant. I find it unnecessary to state in full detail the facts surrounding the making of the bonus issue, because although it may be surmised that the issue was made with an eye to its consequences under the taxation law, it was not suggested that what was done attracted the operation of s. 260 of the Act. The material facts are as follows. At the beginning of the year of income the appellant held no shares in Stewart Bacon. On 28th April 1969 he bought 200 issued shares in that company for $186,046.48. On 6th May 1969 191,000 fully paid shares of one dollar each in Stewart Bacon were allotted to the appellant. The allotment was made pursuant to a special resolution by which the company, in the exercise of powers given by its articles, resolved the $205,325, forming part of the undivided profits of the company representing profits arising from the sale of assets not acquired for the purpose of resale at a profit and standing to the credit of the capital profits reserve account, be capitalized and distributed proportionately amongst the members on the footing that they became entitled thereto as captial, and that the capitalized sum be applied in paying up in full 205,325 of the unissued ordinary shares of one dollar each in the capital of the company and that the same be distributed amongst the members as fully paid ordinary shares of one dollar each in satisfaction of the captial sum and in proportion to the number of shares then held by them respectively. Later on the same day the appellant sold for $197.52 the 200 shares which he had brought on 28th April 1969 and also sold for $188,631.60 the 191,000 shares which had been allotted to him. The appellant's accounts made for taxation purposes show that these transactions, which were in truth profitable, resulted in a heavy loss. So far as they relate to these transactions the accounts show as follows:

"To 200 shares at cost $186,046.48 To 191,000 shares issued on 6 May, 1969 $191,000.00 $377,046.48

By proceeds of sale of initial 200 shares $ 197.52 By proceeds of sale of the 191,000 shares $188,631.60 Loss $188,217.36 $377,046.48"

The Commissioner, on the other hand, contends that in these accounts the cost of the 191,000 shares should be shown as nil; if this is done the result will be that the appellant made a profit of $2,782.64 on these transactions. (at p419)

3. The Act does not deal fully with the manner in which a profit and loss account is to be kept by a trader, and in particular does not expressly provide as to the manner in which trading stock acquired during the year of income is to be brought into the account. Where the Act is silent recourse must be had to "common understanding and commercial principles" and that method must be adopted which will be "calculated to give a substantially correct reflex of the taxpayer's true income" - cf. Commissioner of Taxes (S.A. v. Executor Trustee &Agency Co. of South Australia Ltd. (1938) 63 CLR 108, at pp 154-156 . Speaking generally, common understanding and ordinary commercial principles will require purchases to be brought into the account at their actual cost. The Commissioner submits that where shares have been allotted as a bonus, and not purchased, they have cost nothing, and therefore should be included in the account at a nil value; moreover, he submits that to bring in the bonus shares at per value would lead to a result which would be manifestly unreal and that this supports the view that it would be erroneous to bring them in at par. The appellant, on the other hand, contends that it was not the account, but the Act itself, that led to the result that a real profit was shown for taxation purposes as a loss. The appellant submits that the sum of $191,000 which was applied in paying up the shares was a "dividend" for the purpose of the Act, but was not assessable income. By s. 6(1) of the Act "dividend" includes.

"(c) the paid-up value of shares issued by a company to any of its shareholders to the extent to which the paid-up value represents a capitalization of profits."

Within this definition the sum of $191,000 was clearly a dividend. This "dividend" would have been included in the assessable income of the appellant by s. 44(1) of the Act were it not for s. 44(2)(b)(iii), which provides that the assessable income of a shareholder shall not include dividends paid wholly and exclusively out of (inter alia)

"profits arising from the sale or re-valuation of assets not acquired for the purpose of resale at a profit . . . if the dividends paid from such profits are satisfied by the issue of shares (other than redeemable shares) of the company declaring the dividend".

According to the appellant, on ordinary principles, if it were not for s. 44(2)(b)(iii), the amount of $191,000 would have been shown as assessable income immediately on receipt and the bonus shares would then have been brought into the trading account at $191,000 because the sum was in effect applied on behalf of the appellant in paying up the shares. On this submission the only reason why the result of the appellant's accounting seems unreal is because s. 44(2)(b)(iii) prevents the amount of $191,000 from being taxable, and the error in the Commissioner's approach is demonstrated by the fact that if the bonus issue had, for example, been made out of profits arising from the sale of assets acquired for the purpose of resale at a profit, so that s. 44(2)(b)(iii) did not apply, the sum of $191,000 would, if the Commissioner's contention is correct, have been taxed twice-once on the issue of the bonus shares and again on their sale. (at p420)

4. In fact no dividend, as that word is ordinarily understood, was declared by Stewart Bacon. The appellant was never entitled to receive in cash his proportion of the capitalized profits. Nevertheless, the effect of the special resolution was that capitalized profits to the extent of $191,000 was credited to the appellant and applied on his behalf in paying up the shares: James v. Federal Commissioner of Taxation (1924) 34 CLR 404, at p 416 ; Commissioner of Taxes (Vict.) v. Nicholas (1938) 59 CLR 230, at 244 ; Nicholas v. Commissioner of Taxes (Vict.) (1940) AC, at pp 757-759; (1940) 63 CLR, at pp 198-199 . In a sense, therefore, it may be said that the shares cost the appellant $191,000 and that it was appropriate to treat their acquisition as a purchase for that amount. However, I do not need to base my decision on that ground. In my opinion it was not possible to arrive at the appellant's true income without taking the bonus shares into account as trading stock acquired, whether or not those shares could properly be regarded as having been purchases. The appellant's trading account would not reveal the real situation if it brought in at no value shares which were in fact valuable, because the amount which it would then show as income would include the value which the shares possessed when they were first brought into stock. The case may be compared with that of a trader who takes into his trading stock articles which he received by way of gift or under a bequest. Cases of that kind not falling within s. 36 of the Act may be rare, but they can be envisaged. In such a case an account will not reveal the true result of the trading unless those articles are brought in at an appropriate value, e.g., market selling value. If the account showed that the articles cost nothing, the result would be to increase the amount of the trader's profit or decrease the amount of his loss by the value of the gift or bequest and in effect to make the trader pay income tax on the gift or bequest. The only practicable way of reaching a true result in a case of that kind would be to bring the articles into the account at an appropriate value as though they had been purchased, and there is no provision in the Act that would require any different approach. To arrive at a true estimate of the appellant's income it seems to me necessary to being the shares into the trading account at an appropriate value, which in the circumstances of the case must be their par value. However, it may be said that if this were done it would ignore the fact that the shares came to the appellant as the result of a bonus issue made by a company whose shares formed part of the appellant's trading stock and that in fact the transactions proved to be profitable. It must, however, be remembered that the transactions had two distinct aspects - first the acquisition of the shares and then the act of treating them as part of the trading stock and selling them. That which made the transactions profitable was the receipt of the shares as a bonus. If it were not for s. 44(2)(b)(iii), it would have been necessary to show the value of those shares on the income side of the trading account when they were allotted. It is true that it was held in Gibb v. Federal Commissioner of Taxation (1966) 118 CLR 628 that the value of bonus shares issued to a taxpayer does not constitute income in the ordinary sense, but that case was not dealing with the position of a person who traded in shares; if there were no such provision as s. 44(2)(b)(iii) the account of a share trader who received bonus shares in the circumstances of the present case would be misleading if it did not reflect in the account the benefit received. Thereafter the shares, at their par value, would have had to be included in the account together with the purchases, to enable the necessary comparison to be made between stock held at the begining of the period together with stock acquired, on the one hand, and stock held at the end of the period together with proceeds of sales, on the other. The ultimate result of accounts prepared in this way would have been to show that a profit of $2,782.64 resulted from the transactions relating to the Stewart Bacon shares considered as a whole. However, s. 44(2)(b)(iii) has the effect that the value of the bonus shares cannot be included in the assessable income-it is that circumstances that leads to a result which appears to be distorted. That, however, is no reason for falsely showing the shares to have had no value when brought into the account as trading stock, and an account prepared on such a false basis would lead indirectly to the taxation of the "dividend" which s. 44(2)(b)(iii) declares shall not be included in the assessable income. (at p422)

5. In short, it was, in my opinion, right to bring the bonus shares into the trading account at par value and the reason why this leads to the result, at first sight surprising, that the transactions show a loss of $188,217.36, is that s. 44(2)(b)(iii) had the effect that the value of the bonus shares never became part of the appellant's assessable income. (at p422)

6. It follows that in my opinion the account of the appellant, so far as it related to the Stewart Bacon shares, was correctly prepared for the purpose of the Act. (at p422)

7. I would answer the questions asked as follows:
1. Did the appellant as claimed in par. 22 of the case stated incur a loss in relation to the 200 shares in Stewart Bacon purchased by him on 29th April 1969 in the sum of $185,848.96 which was an allowable deduction under the provisions of the Income Tax Assessment Act 1936-1969?
2. Did the appellant incur a loss on the sale of the 191,000 shares in Stewart Bacon issued to him on 6th May 1969 in the sum of $2,368.40 which is an allowable deduction under the provisions of the said Act?
A. The appellant incurred a deductible loss in relation to all the shares in Stewart Bacon in the sum of $188,217.36.
3. In relation to the appellant's trading in shares in the companies listed in par. 24 of the case stated did he incur:
(a) a loss of $22,573?
A. Answered by consent: No.
(b) a loss of some other, and if so what, amount?
A. Answered by consent: Yes, $22,513.
(c) a profit of $556?
A. Unnecessary to answer.
(d) a profit of some other, and if so what, amount?
A. Unnecessary to answer. (at p423)

STEPHEN J. Since in this appeal I have found myself obliged to arrive at a conclusion different to that of the other members of the Court, I should state in some detail why I consider that the taxpayer made no loss in his transaction involving shares in Stewart Bacon Holdings Pty. Ltd. but, rather, a modest profit in respect of which the Commissioner has correctly assessed him to tax. (at p423)

2. The appearance of a loss situation arises only if the taxpayer is regarded as having outlayed not merely $186,046, the purchase price of his original 200 shares in the company, but also a further $191,000, representing the par value of the 191,000 bonus shares subsequently issued to him. As against this apparent total outlay of $377,046 his recoupment of only $188,828 on the sale of all of the 191,200 shares reflects a loss of $188,218. It is nothing to the point, so the argument goes, that having entered the transaction with $186,046 and no shares in the company, he concludes it, once again with no shares in the company nor with any resultant liabilities but now with $188,828 in his pocket, showing a net gain of $2,782. (at p423)

3. Wherein then lies the taxpayer's alleged loss? It arises, it is said, from that part of the transaction by which he, as majority shareholder, procured the capitalisation of the company's profits and the issue to himself of 191,000 bonus shares; that process involved two relevant steps, the declaration of a dividend and its applicaton by the company, on behalf of members, in paying up the bonus shares issued to them. Although the first of these two steps results in no assessable income in his hands because of the effect of s. 44(2)(b)(iii) of the Income Tax Assessment Act it is nevertheless said to involve a receipt of income by him; the second step is, on the other hand, regarded as involving him in an outgoing of $191,000, being the "cost" to him of the bonus shares, incurred, apparently, when the company applies the dividend in paying up these shares. This "cost" is to be brought into account as the value of the bonus shares in the taxpayer's trading account, from which the equal amount of the deemed dividend is to be excluded. To take one of these two like sums into account and disregard the other necessarily throws up a loss of $191,000, which then provides the measure of the total alleged loss when there is deducted from it the modest profit of $2,782 earlier referred to. (at p424)

4. I have, I believe, correctly stated the critical features of the taxpayer's case, although I am conscious of the fact that certain of these features are susceptible of varying emphasis. Thus attention may be focussed upon what is said to be the effect of the Income Tax Assessment Act in deeming the sum of $191,000, used to pay up the bonus shares, to be a dividend (s. 6(1)) saved only from assessability in the taxpayer's hands by the terms of s. 44(2)(b)(iii) of the Act. Alternatively, the manner in which the acquisition of the bonus shares is shown in the taxpayer's trading account may be stressed, their appearance in that account at an appropriate value, in this instance par, being said to be necessary so that the trading account may reflect the results of the whole transaction. (at p424)

5. Whatever may be the precise formulation adopted, the taxpayer's case depends, in essence, upon the view that he should not be regarded, for the purposes of his assessment to tax, as having outlayed only $186,046 and no more, as compared with his admitted receipt of $188,218, instead of a total of $377,046. (at p424)

6. There appear to me to be a number of elements of the taxpayer's case which, on examination, stand revealed as erroneous. (at p424)

7. I take first what is said to be the effect of s. 44(2)(b)(iii) of the Act and all that flows from it. It clearly enough excludes from assessable income a dividend paid out of profits such as those here represented by the company's capital profits reserve account, if it is satisfied by the issue of shares. The taxpayer's case is that, although the dividend declared by the company does not, because of this effect of s. 44(2)(b)(iii), form any part of the taxpayer's assessable income, nevertheless he is to be treated as in receipt of that untaxed income, which is then immediately applied in paying up the bonus shares. This application of the taxpayer's income is, it is said, a real outgoing which he has incurred and which should be reflected in his total taxable situation. Were it not that s. 44(2)(b)(iii) happened in this instance to operate so as to exclude from assessability the deemed dividend it would, it is said, be very apparent that the application of the dividend in paying up the bonus shares constituted an outgoing and the fact that s. 44(2)(b)(iii) does here operate in the taxpayer's favour in no way detracts from the reality of his expenditure on his part, incurred in paying up the bonus shares. (at p424)

8. The flaw in this argument is, I believe, the erroneous effect assigned to s. 44(2)(b)(iii), which mistakes the operation of the Act as it relates to dividends. The Act, by its definition of "dividend" in s. 6, includes within the meaning of "dividend", wherever occurring in the Act, the paid-up value of shares when that value represents a capitalization of profits and then s. 44(1), read in conjunction with the definition of "paid" in s. 6, operates so as to include such a dividend in assessable income but always "subject to this section". When sub-s. (2)(b)(iii) is read it is seen that s. 44 as a whole in fact has no operation at all in the present case. The consequence is that this extended definition of "dividend" is entirely inapplicable and the whole procedure involved in the capitalization of profits and issue of bonus shares never begins to bear the appearance of involving the derivation of an assessable dividend. Nor will it otherwise involve the derivation of any assessable income. The Act thus produces no revenue consequences at all so far as concerns the transaction involved in the issue of bonus shares. (at p425)

9. In Gibb v. Federal Commissioner of Taxation (1966) 118 CLR 628 , this Court made all this clear when it said, when speaking of the effect of s. 44 (1966) 118 CLR, at p 636 :
". . . it is important to observe that, in terms, sub-s. (1) does not purport to deal with all dividends as defined; it deals, subject to this section, with all such dividends and we find that sub-s. (2) declares that the assessable income shall not include dividends of the description here in question. Consequently it is, we think, erroneous to say that dividends of that character are, first of all, comprehended by sub-s. (1) and then excluded by sub-s. (2). On the contrary at no time do dividends of the kind referred to in sub-s. (2), by force of sub-s. (1), achieve the character of assessable income. It is, of course, clear that some classes of dividends which by force or sub-s. (2) are not assessable income would, apart from that sub-section, be income of the taxpayer. But this is because they would be income according to ordinary concepts, not because the provisions of sub-s. (1) make them assessable income. This, however, is not so in the case of dividends falling within sub-s. (2)(b)(iii)." (at p425)

10. Thus neither pursuant to any provision of the Income Tax Assessment Act nor according to ordinary concepts will the transaction resulting in the issue of these bonus shares be productive of any income for the taxpayer. This Court described the true consequence of such a transaction when it said, in McRae v. Federal Commissioner of Taxation (1969) 121 CLR 266, at p 271 :

". . . the entire transaction consisting of the declaration of dividend plus the crediting of the bonus shares as fully paid had no other effect than that of a transfer of part of the value of the original shares to the bonus shares. The same property which had been the asset backing for 35,000 shares became the asset backing for 60,000 shares."

If for "35,000 shares" and "60,000 shares" there be substituted "200 shares" and "191,200 shares" this passage precisely describes what here occurred. (at p426)

11. In Federal Commissioner of Taxation v. W. E. Fuller Pty. Ltd. (1959) 101 CLR 403, at pp 407-408 , Dixon J. said of bonus shares which had there been paid up out of the revaluation of capital assets:

"It appears to me that the allotment of shares and the distribution of the share certificates cannot involve a receipt or derivation of income except under some artificial statutory definition of that word and the appropriation of the aliquot part of the profit fund to the payment up of the shares does not involve the shareholder in a receipt or derivation of income. The objection to considering the allotment of the shares and distribution of the certificates to be income is that it is settled law that they are distributed and received as capital."

In the absence of any "artificial statutory definition" the transaction must be regarded as having no effect beyond what it in fact does, that is, its effect of transferring almost all of the value of the original 200 shares to the bonus shares. (at p426)

12. Although in Fuller's Case (1959) 101 CLR 403 the Chief Justice was in a minority his views were preferred to those of the majority (Fullagar and Menzies JJ.) when the matter was again examined by this Court in Gibb v. Federal Commissioner of Taxation (1966) 118 CLR 628 . It was there pointed out (1966) 118 CLR, at p 632 , that his Honour's view that an issue of bonus shares could not, according to ordinary principles, be regarded as any receipt of income by the shareholder accorded with that of one of the majority, Menzies J., whose view differed from those of the Chief Justice only concerning the effect of the Income Tax Assessment Act upon the character, as income, of the allotment of bonus shares. (at p426)

13. If, then, the transaction resulting in the issue of bonus shares involved no receipt of income by the taxpayer but only a transfer of values there is no occasion for regarding the payment up of those shares as any payment by him, or as any outgoing or cost incurred by him. No resort to the alleged realities of the situation can be used to support such a view nor does there appear to me to be any other ground upon which it may be maintained. In McRae's Case (1969) 121 CLR, at p 271 it was said that a shareholder who received an issue of bonus shares "did not put a penny more into the scheme than her original contribution", so here the taxpayer's only expenditure was his original investment of $186,046. (at p426)

14. It is convenient, at this point, to not one supporting argument advanced on behalf of the taxpayer. It was said that had not this bonus issue fallen within s. 44(2)(b)(iii) the taxpayer would have been assessable on a deemed dividend of $191,000 and it would then have been strange indeed not to regard the payment up of the bonus shares as involving an off-setting expenditure by the taxpayer of a like sum of $191,000. This appeal to the alleged equity of the situation assumes, however, that had s. 44(2)(b)(iii) been inapplicable the remainder of the total transaction would nevertheless have proceeded as it did, an untenable assumption; the taxpayer would not have paid $186,046 for his original 200 shares had the only asset which those shares represented, the company's capital profits reserve, been liable to carry with it into the hands of shareholders a liability to tax as assessable income. Had that been the case the 200 shares in the company must necessarily have been worth far less than they were, perhaps rather less than one half what was in fact paid for them, paid in the knowledge that no liability to tax would be incurred on the deemed dividend involved in the issue of the bonus shares. Had the initial purchase price of the 200 shares been reduced in this way so as to take account of the inherent liability of tax possessed by the assets of the company, and which any purchaser would have to bear if he were to obtain the benefit of these assets, any apparent inequity disappears; there no longer exists any seeming injustice in failing to treat as an outgoing of income on the part of the taxpayer the payment of his bonus shares. (at p427)

15. It may be mentioned in passing that, as Dixon C.J. pointed out in Dickson v. Federal Commissioner of Taxation (1940) 62 CLR 687, at pp 713-715 and again in Federal Commissioner of Taxation v. W. E. Fuller Pty. Ltd. (1959) 101 CLR, at p 408 , until the amendment of the legislation in 1924 entirely altered the treatment of bonus shares, they involved the allottee in the derivation of "income" for Australian revenue purposes and this despite Blott's Case (1921) 2 AC 171 . But this was because of the then terms of the tax legislation, which specifically included in income "dividends, interest, profits or bonuses credited or paid . . ." Thus in James v. Federal Commissioner of Taxation (1924) 34 CLR 404 it was held that although in Blott's Case (1921) 2 AC, at p 179 , it had been said of a recipient of bonus shares that "He neither paid nor received any cash" yet, because the paying up of bonus shares involved a crediting to the shareholder of profits or of a bonus, that sufficed to include the amount paid up on the shares in the taxpayer's income for tax. Ever since 1924 this has no longer been the case and nothing in the present taxing Act produces a like effect. Accordingly James' Case (1924) 34 CLR 404 and the decision on similar State revenue law in Nicholas v. Commissioner of Taxes (Vict.) (1940) AC 744; (1940) 63 CLR 191 appear now to be of no relevance in a case such as the present. (at p427)

16. There remains the contention of the taxpayer that the bonus shares should properly appear in his trading account at a value of $191,000, if not because this was their actual cost to him, then at least because they must have some value assigned to them and their paid-up value is an appropriate value to select for this purpose. (at p428)

17. When shares are acquired as part of a trader's stock in trade in the course of a year's trading it is their cost, not their value, which must initially be shown in a trading account if that account is to fulfil its purpose of disclosing the trader's financial results for the year. Value will be relevant only if, at the close of the year, those shares remain in stock and it is desired, by a departure from original cost, to reflect in the profits or losses of that year the unrealized profit or loss which has resulted from some change in value since date of acquisition. Sections 29 and 31 permit of this, the latter providing for a choice between two bases of valuation as alternatives to adherence to original cost. (at p428)

18. The Income Tax Assessment Act contains no prescription concerning the figure at which acquired stock is to be first entered in a trader's account, just as it is silent concerning the correct figure to ascribe to sales. In Ballarat Brewing Co. Ltd. v. Federal Commissioner of Taxation (1951) 82 CLR 364, at p 368 , Fullagar J. referred to this silence saying that the consequence was that:
"The question does not depend upon any express provision to be found in the Act. It depends upon 'the conceptions of business and the principles and practices of commercial accountancy' (per Dixon J. in Commissioner of Taxes (S.A.) v. Executor Trustee &Agency Co. of South Australia Ltd. (Carden's Case) (1938) 63 CLR 108, at p 153 ."
But the matter cannot, I think, be in doubt; what must be done is to adopt that method of accounting which is "calculated to give a substantially correct reflex of the taxpayer's true income" - per Dixon J. in Carden's Case (1938) 63 CLR, at p 154 , due regard being had to the principles recognized or followed in business and commerce in the absence of any statutory provision to the contrary - and see generally Arthur Murray (N.S.W.) Pty. Ltd. v. Federal Commissioner of Taxation (1965) 114 CLR 314 . In all but exceptional cases only by entering stock in trade at cost will a correct reflex of true income emerge from the trading account of the year of acquisition of that stock. Although not expressly adverted to, this approach appears to me to be consistent with the way in which this Court has in the past discussed the proper composition of such accounts - Carden's Case (1938) 63 CLR, at pp 152, 154, 156 ; J. Rowe &Son Pty. Ltd. v. Federal Commissioner of Taxation (1970) 124 CLR 421, at pp 434-435, 448 ; Investment and Merchant Finance Corporation Ltd. v. Federal Commissioner of Taxation (1971) 125 CLR 249, at pp 265, 271 . (at p429)

19. An exceptional case will arise should a trader receive stock in trade by way of gift. Such a situation was considered by Lord Greene M.R. in Craddock v. Zevo Finance Co. Ltd. (1944) 27 TC 267, at p 279 . That rather special circumstance will require special treatment, the acquisition will not have formed part of normal trading activities and the stock thus acquired will have to have a value placed upon it, otherwise its value will be reflected in any profit for the year whereas it truly represents not any profit from trading but, rather, the monetary measure of the donor's benevolence. However with this situation we are not here concerned, the present case involves no gift; the taxpayer, when he purchased the 200 shares, paid a price reflecting the value of an aliquot share of the assets of the company, he gained the opportunity of creating the additional bonus shares which when issued to him still, together with his original share, only reflected the value of that same aliquot share. In a very real sense he paid for the bonus shares when he purchased the original 200 shares. There was no change in the "wealth" of the taxpayer before and after the issue of the bonus shares; all that had occurred was "a transfer of part of the value of the original shares to the bonus shares" - McRae's Case (1969) 121 CLR, at p 271 . (at p429)

20. What entries then should properly appear in the taxpayer's trading account in respect of Stewart Bacon shares? The original 200 shares cost $186,046 and must initially appear in the trading account for that year at that figure; the 191,000 bonus shares in fact cost the taxpayer nothing more and might initally appear at nil cost. However unless, as was here the case, the whole 191,200 shares were to be disposed of almost immediately and at the one time such an entry for the bonus shares might prove misleading and it would accord better with the true situation if the transfer of values from the original shares to the new shares were reflected in the account at the time of issue of the bonus shares. The 191,000 bonus shares could thus be shown at an amount being 191,000/191,200 of $186,046, the original 200 shares being then correspondingly reduced from their cost of $186,046, at which they had originally been entered in the account, to 200/191,200 of $186,046. Had the whole of the shares not been disposed of during the current accounting year but instead retained into the next accounting year it would be essential, if they were to be carried forward at some valuation figure other than cost, the carry out such a spreading of values, the whole 191,200 shares would have to be shown at a total valuation figure and this would, in effect, reflect the transfer of value which had taken place. (at p430)

21. However, since the whole of 191,200 shares were in fact to be sold on the very day of issue of the 191,000 bonus shares none of these procedures is essential; because the cost of the 200 shares is also the cost of the whole 191,200 shares it would suffice to show the 191,000 shares as having no cost attributed to them. When all the shares are then sold the true financial result will be accurately reflected by comparing total proceeds of sale with cost of the 200 shares. By this means "the truth and reality of the situation" (Ballarat Brewing Case (1951) 82 CLR, at p 369 per Fullagar J.) will be revealed. If on the other hand the course contended for by the taxpayer is adopted and some cost or value additional to the cost of the 200 shares is introduced into the accounts in respect of the 191,000 bonus shares error immediately manifests itself and the result will be that the account no longer reflects the true financial position. (at p430)

22. It is for the foregoing reasons that I would have answered the questions posed in the stated case, in so far as they relate to the transaction involving the Stewart Bacon shares, on the footing that the taxpayer thereby incurred no loss but rather a profit of $2,782. (at p430)

Orders

Order that the questions in the case stated by Jacobs J., viz. the following questions:
"1. Did the appellant as claimed in par. 22 hereof incur a loss in relation to the 200 shares in Stewart Bacon purchased by him on 29th April 1969, in the sum of $185,848.96, which was an allowable deduction under the provisions of the Income Tax Assessment Act, 1936-1969?
2. Did the appellant incur a loss on the sale of the 191,000 shares in Stewart Bacon issued to him on 6th May 1969, in the sum of $2,368.40, which is an allowable deduction under the provisions of the said Act?
3. In relation to the appellant's trading in shares in the companies listed in par. 24 hereof did he incur:
(a) a loss of $22,573
(b) a loss of some other, and if so, what amount?
(c) a profit of $556, or (d) a profit of some other, and if so, what amount?" be answered as follows:
1. and 2. The appellant suffered deductible loss in relation to all the shares in Stewart Bacon in the sum of $188,217.36. 3. By consent - (a) No. (b) Yes - $22,513. (c) Unnecessary to answer. (d) Unnecessary to answer. The respondent Commissioner to pay the costs of the case stated.