Federal Commissioner of Taxation v Comber

Re: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
And: ALBERT HENRY COMBER
No. 238 of 1985
Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Bowen C.J.
Fisher J.
Lockhart J.

CATCHWORDS

Income Tax - Assessable income - Retirement allowance - Lump sum - Portion deemed by s.109 to be a dividend - Whether such portion excluded from assessment under s.26(d) - Whether assessable as a dividend under s.44(1) - Whether capital or income in nature.

Income Tax Assessment Act 1936, ss.25(1), 26(d), 44(1), 78(1), 103A(2), 104(1), 108 and 109.

HEARING

SYDNEY

#DATE 27:3:1986

ORDER

The appeal be allowed.

The order of the Supreme Court of New South Wales be varied by deleting the order that the Commissioner amend the respondent's assessment by including therein 5% of the whole of the sum of $100,000 and substituting therefor an order that there be included in the respondent's assessment 5% of portion of the said sum namely the sum of $41,500.

The assessment be remitted to the Commissioner for amendment in accordance with the terms of this judgment.

The Commissioner of Taxation pay to Albert Henry Comber his costs of this appeal.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the

Federal Court Rules.

JUDGE1

The facts and the relevant statutory provisions are set forth in the reasons for judgment of Fisher J. and Lockhart J.

The first question is whether $58,500, portion of an amount of $100,000 paid to Mr Comber, is assessable as a dividend in his hands by virtue of para. 44(1)(a) of the Income Tax Assessment Act 1936 ("the Act").
The sum of $58,500 being in the opinion of the Commissioner of Taxation in excess of an amount which is reasonable, is by virtue of s. 109 deemed to be a dividend paid by the company on the last day of the year of income in which it was paid or credited. This is of significance for the company, which loses the deduction which it otherwise might have claimed under para. 78(1)(c). However, Mr Comber was not at the relevant time a shareholder in the company. Paragraph 44(1)(a) only reaches shareholders. It does not render the amount assessable income in his hands.
The next question is whether the sum of $58,500 is within para. 26(d) so that it is assessable income in the hands of Mr Comber to the extent of 5%. It is within para. 26(d) unless it is excluded by the terms of para. 26(d)(i). The wording of para. 26(d)(i) raises some difficulties.
Prior to amending Act No. 90 of 1952 the wording of para. 26(d)(i) was appropriate because s. 109 in its then form deemed so much of an allowance, gratuity or compensation as exceeded an amount which in the opinion of the Commissioner was reasonable to be "a dividend paid out of profits derived by it to the recipient and received by him as a shareholder of the company". Clearly the amount of excess determined under old s. 109 was deemed under a provision of the Act to be "a dividend paid to the recipient". When s. 109 was amended in 1952 although the amount of the excess was still deemed to be a dividend it was no longer deemed to be paid out of profits or to be received by the recipient as a shareholder of the company.
The new s. 109 is, of course, dealing with amounts in fact paid to recipients and it deems the excess of the amount so paid to be a dividend. Is this sufficient to answer the words of para. 26(d)(i)? Paragraph 26(d)(i) is clearly dealing with amounts in fact paid to the taxpayer. One such amount paid to the taxpayer which is excluded by the words of para (i) is an amount that under a provision of the Act is deemed to be a dividend paid to the recipient. Can one marry the notional and actual position and say para (i) is satisfied where the amount is "notionally" deemed to be a dividend and "actually" paid to the recipient. Because of the earlier words of para. 26(d)(i) namely "any allowance, gratuity or compensation where that amount is paid in a lump sum", the words "paid to the recipient" would seem to be otiose if they merely refer to the actual position. However, the words are not inconsistent with an interpretation which reads them as referring to the actual position. The draftsman of the amendments of 1952 may well have left the words in para. (i) unaltered when he altered s. 109 on the basis they could still be read appropriately to cover the case of excess under s. 109. Indeed, if this is not so they seem to have become inapplicable to any amount since nowhere else in the Act is the amount of an allowance, gratuity or compensation under any provision of the Act deemed "to be a dividend paid to the recipient".
In my opinion para 26(d)(i) does apply to the amount of $58,500, with the result that it is excluded from the operation of para. 26(d).
The final question which arises is whether the amount is income in accordance with ordinary concepts and in consequence assessable income in the hands of Mr Comber in pursuance of sub-s. 25(1). In the light of the facts found by the learned trial Judge it appears to me that the amount was of a capital nature. It was a gift and it was not in any real sense the product of any income earning activities of Mr Comber. In my opinion it was a capital receipt.
I would order the return of the assessment to the Commissioner for appropriate amendment. The Commissioner of Taxation should pay Mr Comber's costs.

JUDGE2

This is an appeal by the Commissioner of Taxation ("the Commissioner") from the Supreme Court of New South Wales in the Administrative Law Division. There were in fact two appeals heard concurrently by that Court against decisions of Taxation Board of Review No. 3 which had confirmed assessments for the year of income ending 30 June 1980. The respondent Albert Henry Comber ("the taxpayer") and Henry Comber Pty. Limited ("the company") were appellants before the Supreme Court. The learned trial Judge dismissed the appeal by the company and allowed the appeal of the taxpayer. It is from the latter decision that the Commissioner has appealed to this Court, having obtained leave on 12 September 1985.

The facts may be stated reasonably briefly. The taxpayer founded the company and had been its managing director for some 11 years until 30 June 1980 when he retired. It was common ground that the company was a private company, not being a public company in accordance with sub.s. 103A(2) of the Income Tax Assessment 1936 ("the Act"). For some time prior to his retirement the taxpayer had not been a shareholder in the company.
Upon his retirement the company paid to the taxpayer the sum of $100,000. Both of the appeals to the Supreme Court related to the payment of this amount. The company claimed a deduction pursuant to para. 78(1)(c) of the Act and the taxpayer returned 5% of the amount as assessable income pursuant to sub.s. 26(d). The Commissioner however formed the opinion, in accordance with s. 109 that the sum of $100,000 exceeded the amount which in his opinion was reasonable and allowed the company only $41,500 as a deduction under para. 78(1)(c). He assessed the taxpayer under sub.s.26(d) to the extent of 5% of this latter amount and as a dividend under para. 44(1)(a) in respect of the balance, namely $58,500. The Board of Review confirmed each of these assessments but on appeal by the taxpayer his assessment was directed to be amended by the Commissioner to include the whole sum of $100,000 as assessable to the extent of 5% thereof under sub.s.26(d).
It is my opinion that the learned trial Judge was correct in rejecting the Commissioner's assessment of the sum of $58,500 as a dividend pursuant to para. 44(1)(a). My view is however that that sum is excluded from sub. s. 26(d) by para. (i) thereof being an amount deemed under s. 109 "to be a dividend" and, being a capital sum is not assessable to tax under any provision of the Act. In this regard the trial judge's view was that the payment in the taxpayer's hands was capital in nature, although it was not necessary for him to make such a finding.
The particular provisions of the Act to the extent relevant to these proceedings are as follows:

"78. (1) The following shall, subject to. . ., be allowable deductions:

(a) . . .

(aa) . . .

(ab) . . .

(b) . . .

(c) Sums which are not otherwise allowable deductions and are paid by the taxpayer during the year of income as pensions, gratuities or retiring allowances to persons who are or have been employees or dependants of employees, to the extent to which, in the opinion of the Commissioner, those sums are paid in good faith in consideration of the past services of the employees in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income."

"109. So much of a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director, being, or purporting to be -

(a) remuneration for services rendered by that person; or

(b) an allowance, gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and shall, for the purposes of this Act other than the purposes of Division 11A of Part III and Division 4 of Part VI, be deemed to be a dividend paid by the company on the last day of the year of income of the company in which the sum is paid or credited."

The word "relative" is defined in s. 6 to cover a very wide class of persons as follows:

". . . 'relative', in relation to any person, means any of the following, namely:

(a) the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendent or adopted child of that person or of his or her spouse; and

(b) the spouse of that person or of any other person specified in paragraph (a)."

Sub-section 26(d) makes special provision for the inclusion of portion of retiring allowances in assessable income but with exceptions one of which is crucial to the determination of this appeal. It provides -

"26. The assessable income of a taxpayer shall include -

(a) . . .

(b) . . .

(d) 5% of the capital amount of any allowance, gratuity or compensation where that sum is paid (whether voluntarily by agreement or by compulsion of law) in a lump sum in consequence of retirement from, or the termination of, any office or employment, not being -

(i) an amount that, under any provision of this Act, is deemed to be a dividend paid to the recipient; or

(ii) an amount to which section 26AC or 26AD applies;"

I have added the emphasis to the words crucial to this appeal.

The Commissioner contended that the amount in the circumstances deemed to be a dividend was assessable income to the taxpayer pursuant to para. 44(1)(a) which is in the following terms:

44. (1) The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) shall, subject to this section and to section 128D-

(a) if he is a resident - include dividends paid to him by the company out of profits derived by it from any source; and

(b) . . . "

Two other provisions of the Act were prominent in the debate. Section 108 appears, as does s. 109 in Division VII of Part III of the Act, which Division imposes special obligations on private companies. It is as follows:

"108. (1) If amounts are paid or assets distributed by a private company to any of its shareholders by way of advances or loans, or payments are made by the company on behalf of, or for the individual benefit of, any of its shareholders, so much, if any, of the amount or value of those advances, loans or payments, as, in the opinion of the Commissioner, represents distributions of income shall, for the purposes of this Act other than the purposes of Division 11A of Part III and Division 4 or Part VI, be deemed to be dividends paid by the company on the last day of the year of income of the company in which the payment or distribution is made.

(2) Where the amount or value of an advance, loan or payment is deemed, under the last preceding sub-section, to be a dividend paid by a company to a shareholder, and the company subsequently sets off the whole or a part of a dividend distributed by it in satisfaction in whole or in part of that advance, loan or payment, that dividend shall, to the extent to which it is so set off, be deemed not to be a dividend for any purpose of this Act.

Section 109 is in its present form substantially in consequence of significant amendments made in 1952. Prior to those amendments it was as follows with emphasis added to crucial parts thereof:

"109. So much of any sum paid or credited by a private company and being, or purporting to be -

(a) remuneration for services rendered by any person being a shareholder or director of the company or being a relative of any such shareholder or director; or

(b) an allowance, gratuity or compensation in consequence of the retirement of that person from any office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and the excess shall, for all purposes of this Act, be deemed to be a dividend paid out of profits derived by it to the recipient and received by him as a shareholder of the company."

The fact that by the amendments the class of persons affected was expanded to include a person who was or had been a shareholder or director or relative and that the excess was, expressly at best, deemed only to be a dividend are significant matters, in my opinion, when construing s.109 in its present form.
The Commissioner conceded by his assessment that the sum of $100,000 constituted a lump sum paid in consequence of the taxpayer's retirement from the Company. However he pointed to para.26(d)(i) and his exercise of his discretion pursuant to s.109 in answer to the taxpayer's contention that the whole of the sum fell for assessment as to 5% thereof under sub.s.26(d).
The consequences of applying sub-section 26(d) can be unexpected. It has, as the trial Judge said, both a charging and a liberating effect upon the assessment of receipts by way of retiring allowances. If the receipt is capital in nature, 5% of that capital sum is required by the sub-section to be included in the taxpayer's assessable income. If the receipt is income in character, only 5% of the receipt is assessable income and sub.s.25(1) has no application to the balance (Reseck v Commissioner of Taxation (1975) 133 C.L.R. 45 at pp. 49-50 per Gibbs J. and p. 57 per Jacobs J.). However if the allowance is not paid in a lump sum but in two or more separate amounts or by instalments sub.s.26(d) will not apply and each instalment will be assessed, if at all, under the general provisions of the Act (Federal Commissioner of Taxation v Knight (1983) 83 A.T.C. 4789). If, notwithstanding any recurrence in the payments, the instalments are capital in nature, they will not be assessable income in the hands of a taxpayer. If they are income in character they will be assessed under s.25 of the Act.
In this matter, it being conceded that the sum of $100,000 was a lump sum paid in consequence of retirement, the provisions of sub.s.26(d) would apply unless excluded by paras.(i) or (ii) thereof. The trial Judge held that para.(i), the only relevant provision, was not applicable because, although the amount of $58,500 was admittedly a deemed dividend pursuant to s.109, it was not, in the words of that paragraph "deemed to be a dividend paid to the recipient". The emphasis is that of the trial Judge. His view appears to have been that because the amount in question was not by s.109 deemed to be a dividend paid to the recipient as required by sub.s.26(d)(i) and thus not assessable by para.44(1)(a), the amount was not excluded by para 26(d)(i).
It is in this area that I disagree with both the trial Judge and the Commissioner. I disagree with the trial Judge's view that the excess amount is not excluded by para.26(d)(i) and I disagree with the Commissioner's contention that, having been so excluded, the excess amount is assessable to the taxpayer under para.44(1)(a). It follows that it is necessary for me to state what I see as the proper construction to put upon para.26(d)(i) and s.109 in the circumstances of this matter.
As previously mentioned, s.109 appears in Division 7 of Part III of the Act, a Division which applies exclusively to private companies. The purpose of the provisions in the Division is to place additional obligations on private companies. These obligations, and in particular the flat rate of tax imposed by sub.s.104(1), discourage private companies from refraining from distributing income which if received by an individual shareholder would be assessable to tax at his or her personal rate. If such provisions were not included in the Act a taxpayer could transfer his business or his investments to a private company, which company would only be liable to primary tax on its taxable income. The shareholders would be taxable, if at all, only on such of the profits of the company as the directors considered appropriate to distribute by way of dividends. To counter this method of tax minimisation the legislature imposed a flat rate of tax (50c in the dollar) on the undistributed profits of private companies, thereby encouraging if not compelling them to make what was determined to be a sufficient distribution of their profits to their shareholders.
This being the purpose and effect of Division 7 of Part III of the Act, it provides the context in which it is proper to construe s.109.
Both ss.108 and 109 are provisions protective of the purpose and effect of Part III and in each of them the statutory fiction of a deemed dividend is employed to implement that purpose and that effect. Each, in general terms, seeks to ensure that the profits of private companies are not reduced by loans or payments of excessive remuneration or retiring allowances to shareholders, directors or others close to these persons. Section 108 primarily determines that loans which represent distributions of income are deemed to be dividends in the hands of shareholders and s.109 that excessive remuneration or excessive retiring or termination allowances are not allowable deductions to the company. The latter section then provides that the excessive amount which is not deductible is deemed to be a dividend. In each of these sections prior to the amendments in 1952 the legislature provided that the payments (of loans or excessive amounts) were deemed to be "dividends paid to those shareholders out of profits" in the case of s.108 and a "dividend paid out of profits derived by it to the recipient and received by him as a shareholder of the company". The use to this extent of the concept of "deeming" laid in each instance the necessary foundation for the deemed dividends to be assessable to the recipients under para.44(1)(a). In neither instance does such a foundation expressly appear in ss.108 or 109 as they now stand.
It is necessary to construe s.109 to determine for the purposes of this appeal the extent to which it varies or modifies other provisions of the Act. Without doubt, if applicable, the section has the effect of reducing the amount of the deduction to which a company paying a retiring allowance is otherwise entitled under para.78(1)(c). It also expressly deems the amount of the excess, whether it is of remuneration or a retiring allowance, to be for the purposes of the Act a dividend paid on the last day of the year of income. The company as a consequence would be entitled to take the deemed dividend into account for the purpose of determining whether, in accordance with para.105A(1) of the Act, it has made a sufficient distribution and thereby avoided undistributed profits tax. The further question of construction which arises specifically in this appeal is whether by deeming the excess to be a dividend for the purposes of this Act the excess amount is for the purposes of para.26(d)(1) "deemed to be a dividend paid to the recipient". Logically this is the first question for determination, for only if this question is affirmatively answered does the further question arise, namely whether the excess amount, having been excluded from sub.s.26(d) is assessable as a dividend under para.44(1)(a) as the Commissioner contends.

I can accept that the deeming provision does not expressly state that the deemed dividend is deemed to be a dividend paid to the recipient as required by para.26(d)(i). However for a number of reasons I am of opinion that this does not avail the taxpayer. It is my view that the excess is by that paragraph excluded from the provisions of sub.s.26(d). I hold this view notwithstanding the fact that, as later appears in these reasons, I agree with the trial Judge that the taxpayer is not liable to be assessed under para.44(1)(a) in respect of this deemed dividend.
There are two grounds upon which I would find that the excess is excluded from sub.s.26(d). In the first instance there is no need for the legislature to "deem" that the deemed dividend was paid to the taxpayer for the amount thereof was as remuneration or allowance in fact paid to him. Certainly in so far as the company made the payment of the excess, that which was paid was "deemed" to have the character of a dividend. However for the reasons subsequently to be given there is no justification for the view that what was received by the taxpayer was necessarily a dividend assessable to him as such. He had in fact received an amount which by the operation of s.109 was deemed to be a dividend.
The other ground upon which I rely is that if para.26(d)(i) has no application to deemed dividends under s.109 it has no application at all under the Act. The expression "deemed dividend" referred to in that paragraph must refer to an amount of an allowance, gratuity or compensation which under a provision of the Act is deemed to be a dividend. The expression "deemed dividend" appears in a number of provisions of the Act, but apart from s.109, these provisions are in no way referable to an allowance, gratuity or compensation. In these circumstances the uncertainty created by the form of para.26(d)(i) must be resolved by giving it some application and some work to do.
It follows that it is my view that this paragraph excludes the excess amount of $58,500 from the provisions of sub.s.26(d). The Commissioner's consequential contention is that as a deemed dividend it is assessable income primarily under para.44(1)(d) of the Act. I reject this submission. I am of opinion that deeming the excess to be a dividend will not make that amount assessable income nor will it make it even potentially assessable income in the hands of anyone other than a shareholder.
If the contention of the Commissioner were correct, it would mean that by the use of the statutory fiction the section would go beyond the express deeming of the excess to be a dividend. It would in addition imply deeming the person in receipt of the excess to be receiving it as a shareholder and also that the deemed dividend was paid out of the profits of the company. Paragraph 44(1)(a) would not be applicable unless such additional deemings are implied.
I find the Commissioner's construction unacceptable. In my opinion deeming provisions are required by their nature to be construed strictly and only for the purpose for which they are resorted to (Ex parte Walton (1881) 17 ChD 746 per James L.J. at p 756). It is improper in my view to extend by implication the express application of such a statutory fiction. It is even more improper so to do if such an extension is unnecessary, the express provision being capable by itself of sensible and rational application. This is precisely the position in the section in question. The private company, having been denied a deduction in respect of the amount of the excess distribution, should fairly be entitled to have that amount taken into account as an after tax distribution in determining whether it has made a sufficient distribution of its profits.
The fact that the additional deemings which the Commissioner seeks to imply were expressly included in the legislation prior to amendment is also relevant. It would be wrong now to imply that which was previously included but subsequently deleted. Moreover these were deleted at the time when the class of persons referred to in the section was expanded to cover persons who had in the past been shareholders or directors or who had in the past been relatives (as defined) of shareholders and directors.
For these reasons I reject the Commissioner's submission that the amount of the excess is assessable income in the hands of the taxpayer pursuant to para.44(1)(a). As I have said that paragraph requires the dividend to be paid out of profits and to a shareholder. I am not prepared to imply that s.109 deems such to be the case.
Having found that the excess which is excluded from sub.s.26(d) does not fall for assessment under the provisions of para.44(1)(a), the final question for determination is whether it is assessable income under any other provision of the Act. It can be said that if the payment is capital in nature it will not be assessable income, whereas if it is properly to be considered as income it will fall within the provisions of sub.s.25(1).
The trial Judge was not required to make a finding in this regard, though he said that if it was necessary for him "to make that distinction, I would find that payment to be one of a capital nature rather than one of an income nature". He said that he agreed with the findings of Dr. Beck in the Taxation Board of Review, the payment being in his opinion properly characterised in the taxpayer's hands as a voluntary gift in recognition of what the taxpayer had done in founding the company and in building it up. I agree with the reasons of Lockhart J. in this regard.
I also am of opinion that the excess amount of $58,500 is properly characterised as being capital in nature and it follows that it is not assessable under sub.s.25(1) of the Act.
The appeal must be allowed for the purpose of varying the order of the trial Judge. The assessment must be remitted to the Commissioner for amendment to include in the taxpayer's assessable income 5% of the amount of $41,500 being portion only of the amount of $100,000 paid to the taxpayer. The Commissioner must pay the taxpayer's costs of the appeal as provided by the order granting leave to appeal.

JUDGE3

The facts and statutory provisions are mentioned in the reasons for judgment of Fisher J., so I need not repeat them. I would add some observations of my own.

Section 109 of the Income Tax Assessment Act 1936 is in Division 7 of Part III relating to private companies. Prior to the substantial amendments made to the Act in 1952 a company was taxed at what was virtually a flat rate on its profits and its shareholders were taxed on dividends paid out of those profits. Rebates were allowed only to corporate shareholders. Often the combined company tax and tax on the dividends received by the individual shareholder exceeded the average rate of tax which would have been payable by the individual shareholder if he had been a sole trader or a member of a partnership which carried on the business in fact carried on by the company. In other cases, where the company did not distribute any of its profits, the primary company tax was often less than it would have been if the business had been conducted by an individual as a sole trader or member of a partnership and whose average rate of tax exceeded the rate of primary company tax.
The purpose of Division 7 is to prevent the avoidance of tax by accumulating profits. Under Division 7 if a private company makes a sufficient distribution of its income, the dividends received by the shareholders will constitute assessable income in their hands. If a sufficient distribution is not made a heavy rate of tax is imposed on the company. The further tax is imposed on the excess of the private company's retained after tax profits over a permitted retention allowance. This is intended to counter the advantage to which I referred earlier and compel a general distribution of profits by the company. The Legislature recognised however that properly managed companies must retain a proportion of their profits for the further development of their businesses. Effect is given to this by the retention allowances which in short are the profits which private companies may hold without incurring any liability to undistributed profits tax. The general purpose of these provisions was described by Stephen J. (with whose reasons for judgment Barwick C.J., Menzies and Mason JJ. agreed) in Stocks & Holdings (Constructors) Pty. Limited v. Federal Commissioner of Taxation (1973) 129 CLR 617 at 623:

"Together these sections (ie. ss. 103 to 107A) make up a complete legislative scheme for the imposition of additional tax upon private companies making an insufficient distribution. They operate to discourage, by that means, the retention of profits by those companies carried on for profit which, of their nature, would otherwise be likely extensively to retain profits. Because companies are, as to the bulk of their income, taxed at a flat rate of tax which is lower than the upper ranges of the graduated rates of tax payable by individual taxpayers those companies which are closely-held corporations would, but for Division 7, provide a ready means for the accumulation of profits which have borne a relatively light tax burden. It is to those closely-held companies that Division 7 directs its attention and, by means of the threat of additional tax, seeks to deter the undue accumulation of profits which, if it nevertheless occurs, attracts that tax."

In the absence of special statutory provision it may have been possible in some cases for a private company to have reduced its liability to income tax by distributing its income to its shareholders in the form of advances or loans or by making payments on behalf of its shareholders or for the benefit of its shareholders. Section 108 seeks to discourage this practice. It provides:

"108 (1) If amounts are paid or assets distributed by a private company to any of its shareholders by way of advances or loans, or payments are made by the company on behalf of, or for the individual benefit of, any of its shareholders, so much, if any, of the amount or value of those advances, loans or payments, as, in the opinion of the Commissioner, represents distributions of income shall, for the purposes of this Act other than the purposes of Division 11A of Part III and Division 4 of Part VI, be deemed to be dividends paid by the company on the last day of the year of income of the company in which the payment or distribution is made.

(2) Where the amount or value of an advance, loan or payment is deemed, under the last preceding sub-section, to be a dividend paid by a company to a shareholder, and the company subsequently sets off the whole or a part of a dividend distributed by it in satisfaction in whole or in part of that advance, loan or payment, that dividend shall, to the extent to which it is so set off, be deemed not to be a dividend for any purpose of this Act."

A private company may make loans or advances to shareholders or payments on their behalf or for their benefit. If the Commissioner forms the opinion that those loans or payments represent a distribution of the company's income then they will deemed to be dividends paid by the company on the last day of the year of income of the company in which the payment or the distribution is made (sub-s. 108(1)). In the result the amount or value of the loans or payments will be taken into account in determining whether the company has made a sufficient distribution.
The effect from the point of view of the company of deeming loans, advances and payments to or for the benefit of shareholders to be dividends is that the company is denied a deduction to which it might otherwise have been entitled. This is because dividends are not deductible outgoings. To the extent that a deduction is denied the company its taxable income and its liability to primary company tax is increased and the deemed dividend is taken into account in determining whether or not the company has made a sufficient distribution in relation to the year of income for the purpose of avoiding liability to undistributed profits tax.
In the absence of special statutory provision it may have been possible in some cases for private companies to have reduced their liability to income tax by paying persons who are or have been shareholders or directors amounts of remuneration which are disproportionately large having regard to the services rendered by them, or by granting unreasonably high allowances, gratuities or amounts of compensation in consequence of the retirement of such persons or upon the termination of the office or employment held by them. If those excessive amounts were allowed as deductions to the company then the amount of tax payable by the company would be reduced. Section 109 is directed to this problem and it provides as follows:-

"109. So much of a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director, being, or purporting to be -

(a) remuneration for services rendered by that person; or

(b) an allowance, gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and shall, for the purposes of this Act other than the purposes of Division 11A of Part III and Division 4 of Part VI, be deemed to be a dividend paid by the company on the last day of the year of income of the company in which the sum is paid or credited."

Division 11A of Part III and Division 4 of Part VI relate to the assessment and collection of withholding tax on dividends and certain interest paid to non-residents. As the determination of the Commissioner under s. 108 or s. 109 is necessarily made after the assets have been distributed or the payment has been made or credited, it would not be possible for a company to withhold tax at the time the payment or distribution is made. Such outgoings are therefore excluded from withholding tax provisions.
A distribution of the kind referred to in s. 108 or s. 109 is deemed to be a dividend paid by the company. It is true that neither section in terms says that the dividend is deemed to be paid by the company to the shareholder, director or other person although that consequence is necessarily recognised in sub-s. 108(2) in relation to the deemed dividend for which sub-s. 108(1) makes provision. Also, for every payment there must a payer and a payee. In my opinion the deeming provision operates to deem the payment to be a dividend paid by the company and a dividend received by the recipient. Of course, it does not follow that the character of the payment in the hands of the recipient is clothed with the nature of income. All the deeming provision does is to deem a payment to have been made. It says nothing to characterise the receipt in the hands of the recipient. If it is a dividend paid out of profits then it will form part of the assessable income of the taxpayer pursuant to para. 44(1)(a) of the Act assuming he is a shareholder. This is because that provision operates to include in the assessable income of a shareholder in a company dividends paid to him by the company out of profits derived by it from any source. The deeming provisions of ss. 108 and 109 are not expressed to bring the deemed dividend within the word "income" under the Act. Also, the concept of a dividend is not necessarily one of income: Federal Commissioner of Taxation v. W.E. Fuller Pty. Limited (1959) 101 CLR 403 at p 409; Gibb v. Federal Commissioner of Taxation (1966) 118 CLR 628 at 635 and R.W. Rutherford v. Federal Commissioner of Taxation (1976) 76 ATC 4304.
The taxpayer was not a shareholder of Henry Comber Pty. Limited ("the Company") for some time prior to his retirement. Section 44 of the Act could not therefore operate to include the deemed dividend as part of his assessable income even if the dividend could be treated as having been paid out of profits. It would therefore be included in his assessable income only if it was income according to ordinary concepts under s. 25 or under para. 26(d) if it applied; but in the latter case only 5 percent of the capital amount of the lump sum payment would be included.
Paragraph 26(d) provided at the relevant time that the assessable income of a taxpayer included:-

"(d) 5% of the capital amount of any allowance, gratuity or compensation where that amount is paid (whether voluntarily, by agreement or by compulsion of law) in a lump sum in consequence of retirement from, or the termination of, any office or employment, not being -

(i) an amount that, under any provision of this Act, is deemed to be a dividend paid to the recipient; or

(ii) an amount to which section 26AC or 26AD applies;"

Two questions arise with respect to para. 26(d). I agree with Fisher J. that the sum of $58,500, being a deemed dividend under s. 109, answers the description of "an amount that, under any provision of this Act, is deemed to be a dividend paid to the recipient" within the meaning of sub-para. 26(d)(i) and that para. 26(d) cannot therefore apply to it. It is not to the point that s. 109 does not in terms state that the payment that is deemed to be a dividend paid by the company is also deemed to be a dividend paid to the recipient. Section 109 achieves this objective for the reasons already given.
The more troublesome point with respect to para. 26(d) lies in the circumstance that the company paid the amount to the taxpayer as part of a lump sum of $100,000. The words "of the capital amount" do not produce the result that only receipts of a capital nature are included by the paragraph. Those words are used:

"not to describe the nature of the allowance, gratuity or compensation, but to fix the amount that is to be included in the assessable income. The allowance, although it must be paid in a lump sum to come within s. 26(d), may have been fixed at a rate payable in respect of a specified period - for example, at so much for every week worked. The words 'of the capital amount' are in my opinion intended to make it clear that the percentage is to be calculated not according to the rate of the allowance, but according to its capitalized or total value"

per Gibbs J. in Reseck v. Federal Commissioner of Taxation

(1975) 133 CLR 45 at 49.

Paragraph 26(d) applies only where the payment is made in a lump sum. Accordingly, if the payment is made by instalments the provision has no application and the payments may either be assessable in full under other provisions of the Act, in particular s. 25, or not at all. Provided the payment of the amount is made in a lump sum it is of no consequence that the sum itself is made up of various components, for example compensation plus severance pay etc.. Also it is possible for a taxpayer to receive more than one lump sum which would fall within the paragraph. This may occur where, for example a lump sum is paid to a retired employee by his employer and a separate lump sum is paid to him in consequence of his retirement by the parent company of the group in which he was employed; but in each case there is a capital amount of an allowance, gratuity or compensation paid in a lump sum in consequence of his retirement from or the termination of his employment.
Counsel for the taxpayer argued that sub-para. 26(d) (i) did not operate to place the amount of $58,500 beyond the scope of para. 26(d). It was submitted that for sub-para. 26(d) (i) to apply to the sum of $58,500 it would be necessary to read the sub-paragraph as if it said "an amount or so much thereof that, under any provision of this Act is deemed to be a dividend paid to the recipient".

In my opinion para. 26(d) may be read as applying not only to the case where an undivided sum is paid as a lump sum, eg. the sum of $100,000 paid to a retiring employee in consequence of his retirement to which no part of the exclusion relates but, in addition, to the case where, by reason of the operation of s. 109, part of the payment is deemed to be a dividend leaving a balance that is not affected by the deeming provision. This is the only sensible construction to give the paragraph. It then means that the paragraph applies to five percent of whatever amount paid in a lump sum that is not a deemed dividend under s. 109. The amount thus falling within para. 26(d) answers the description of:

". . . the capital amount of any allowance, gratuity or compensation where that amount is paid . . . in a lump sum in consequence of retirement from . . . any office or employment, not being -

(i) an amount that, under any provision of this Act, is deemed to be a dividend paid to the recipient."

It follows in the present case that para. 26(d) does not apply to the $58,500.

There remains the question whether the sum of $58,500 answers the description of income under s. 25. The trial Judge said that he agreed with the findings of Dr. Beck, a member of the Board of Review, that the payment was properly characterised in the taxpayer's hands as a voluntary gift in recognition of what the taxpayer had done in founding the company and in building it up and that in those circumstances it was of a capital rather than of an income nature. This finding by the trial Judge was not however necessary for his decision in view of the way he approached the matter.
The taxpayer was the founder of the company and had been its managing director for some eleven years until he retired on 30 June 1980. He had not for some time been a shareholder himself in the company. Prior to the company's formation the taxpayer had been associated with another company, P.E. Scrivener & Co. Limited. He had introduced to that company and had built up within it a substantial business in the export of meat. When he left Scrivener and formed the company the taxpayer brought the whole of that business with him and no payment was made for goodwill by the company either to the taxpayer or to Scrivener. The taxpayer spent long hours in the service of the company and he had few, if any, breaks on weekends or by way of holidays. Although he took some overseas business trips on behalf of the company the trial Judge found in effect that they were essentially business trips and I see no reason to disagree with his findings. The company gave the taxpayer the use of a motor car, and his travelling, entertainment and telephone expenses were paid by the company. All but a minor portion of his expenses and the use of the car related to the work which he did for the company. The company also provided him with a non-contributory superannuation scheme. The trial Judge concluded that his total salary package was substantially lower than he could have obtained in a similar position elsewhere, a situation which he accepted because he had a high degree of "job satisfaction" with the company which he had built up and of which he was proud. He was not paid director's fees nor was he paid dividends as he was not himself a shareholder. The taxpayer did not solicit the payment of the retiring allowance and played no part in the decision to make the payment or in the calculation of the amount paid. The company's books of accounts show that on 31 July 1980 the taxpayer's loan account was credited with the sum of $100,000 and on the same day it was debited with a payment of just over $90,000. The books were written up by a fellow director, Mr. Cuthbetson. The taxpayer denied lending the company any money after he had received the retiring allowance and he said that he had no recollection of how the loan account had been handled. He was not aware of the credit of $100,000. The trial Judge accepted the taxpayer as a witness of truth and concluded that he did not play any role in whatever Mr. Cuthbetson was doing with his loan account and he accepted the taxpayer's denial of any involvement in the payment of the retiring allowance or its calculation. There is no ground for interfering with these findings of the trial Judge.
His Honour held that both the proposal to pay the retiring allowance to the taxpayer and the calculation of the amount paid originated with Mr. Cuthbetson. He concluded that, although the company's decision to pay the $100,000 to the taxpayer was at least in part because his salary as managing director had been below the level which he deserved, this did not decide the issue against the taxpayer; nor did the fact that part of the payment is deemed by s. 109 to be a dividend because the concept of a dividend is by no means necessarily also one of income.
I agree with these conclusions. The trial Judge regarded as relevant the fact that the taxpayer did not solicit the payment and that he played no part in the decision to make the payment or in any calculation of the amount paid. His Honour said that, had there been any suggestion that the taxpayer had been prepared to accept less than the salary which he deserved in anticipation of being paid a lump sum upon retirement to compensate him for that deficiency, there is little doubt that the lump sum payment would be income in nature. The trial Judge concluded:

"Whilst the payment could not be fairly characterised as compensation for the termination of Mr. Comber's employment (Reseck v. FCT at 48-49), it is, in my view, properly characterised in his hands as a voluntary gift in recognition for what Mr. Comber had done in founding the company and in building it up: Moorhouse v. Dooland

(1955) Ch 284 at 304."

The trial Judge correctly recognised that it is important that the character of a payment should be judged in the hands of the recipient and he relied on Moorhouse v. Dooland (1955) Ch 284 at pp 295, 303-304, and 308; Hayes v. FCT (1956) 96 CLR 47 at p 55 and Scott v. FCT (1966) 40 ALJR 205 at 210.
His Honour noted that the effect of the payment of $100,000 would appear to have been to have reduced what would otherwise have been a profit of $112,517 to one of only $12,517. His Honour stated however, that at the time of the payment no accounts had been taken and the funds from which the $100,000 was paid were not at that stage "profits" and no dividend had been declared out of them. They were payments out of income but not out of profits.
In my opinion the findings made by the trial Judge on this question were reasonably open to him and no ground has been established for interfering with them. It follows that the payment of $58,500 to the taxpayer was of a capital nature and does not constitute assessable income for the purposes of s. 25.
I agree with the orders proposed.

[1986] FCA 92

27 MARCH 1986