Federal Commissioner of Taxation v Newton

[1957] HCA 99

96 CLR 577

FEDERAL COMMISSIONER OF TAXATION L. J. NEWTON

RESPONDENT.

FEDERAL COMMISSIONER OF TAXATION L. NEWTON

RESPONDENT.

FEDERAL COMMISSIONER OF TAXATION H. J. LANE

RESPONDENT.

FEDERAL COMMISSIONER OF TAXATION FENTON

RESPONDENT.

FEDERAL COMMISSIONER OF TAXATION S. M. A. LANE

RESPONDENT.

FEDERAL COMMISSIONER OF TAXATION CHRISTIAN

RESPONDENT.

96 CLR 578

FEDERAL COMMISSIONER OF TAXATION

NEWTON AND OTHERS (EXECUTORS

OF THE ESTATE OF R. NATHAN,

RESPONDENTS. DECEASED) Income Tax (Cth.)-Assessable income-Arrangements etc. to avoid tax-Companies

liable to Div. 7 tax unless sufficient distribution-Conversion of existing shares into two classes-Attachment of special dividend rights to one class for limited 1956,

period-Sale by shareholders of that class to share trading company-Receipt by latter company of dividends-Purchase by share trading company of new issue in May 29, 30,

private company and sale by it of shares comprising at purchase price to share- 31;

holders who had sold to it shares having special rights-Simultaneous presentation June 1, 5, 6,

of all cheques involved in transactions at same branch of bank-Whether money 7, 8, 11, 12,

and shares coming as result of transactions into hands of original shareholders SYDNEY,

Act 1936-1950 (No. 27 of 1936-No. 48 of 1950) S. 260. Aug. 8.

At the beginning of December 1949 the respondents were the holders of the 237,321 ordinary shares of £1 each which had been issued by a company L. MELBOURNE,

T. was the holder of the 5,000 five per cent cumulative preference shares which Oct. 11, 12,

constituted the remaining issued capital of the company. At that time the 15, 16, 17,

company had available for distribution profits in excess of £400,000 consisting 18, 19

as to part of profits derived during the year ended 30th June 1949, as to part 1957,

of profits made during the then current income year and as to £8,569 of profits May 31.

on which additional tax under Div. 7 had been paid. Early in December the existing 237,321 shares were converted into two classes. One third of each shareholder's holding, 79,107 shares in all, became A ordinary shares and two thirds became B ordinary shares. The unissued shares, 445,000 in number became B preference shares. Thereafter, subject to the rights of the holder of the existing 5,000 preference shares, special dividend rights were attached to the A ordinary shares. Pursuant to an amendment of the articles of association made on 14th December 1949 the holders of these shares became entitled to receive the whole of the dividends declared by the company on or after that date until such dividends should reach a total of not less than £5 15s. 10d. in respect of each share and to a fixed cumulative preferential dividend of five per cent per annum as from 1st January 1950. On 15th December 1949 the respondents gave to P., a company engaged in share- trading, options to purchase their A ordinary shares at £5 16s. Od. per share and on 19th December 1949 P. exercised these options and delivered to the respondents in payments cheques totalling £458,820. Transfers of the A ordinary shares to P. were registered on the same day. Meanwhile, on 16th December 1949, L. resolved to make available for issue at par 402,679 B preference shares of £1 each and specified that such shares should be offered to the person or persons entitled to the dividends upon the A ordinary shares on or after 19th December 1949. On this date P. applied to L. for the issue

96 CLR 579

to it of the 402,679 B preference shares and lodged with L. its cheque for £402,679. On 20th December 1949 L. resolved to pay dividends on the A ordinary shares amounting to £446,295 (i.e. £5 12s. 10d. per share) and there- after to issue to P. the 402,679 B preference shares. On the same day L.'s cheque for £446,295 was handed to P. and the B preference shares were issued to it. On the same day P. sold the B preference shares to the respondents for £1 per share and received their cheques for a total sum of £402,679. All of the cheques which had passed between the parties were deposited in the same branch of the E. S. &A. Bank on 21st December 1949, where each of the parties concerned had a current account. On 22nd March 1950 L. resolved upon the payment of a further dividend of 3s. per share in respect of the A ordinary shares out of the profits of the then current year. This dividend was paid to P. on the same day and completed the payments necessary to satisfy the special dividend rights attached to the A ordinary shares. Subse- quently P. sold the 79,107 A ordinary shares to another company for £1 per share. The Commissioner of Taxation conceded that the various dealings had full legal force and effect according to their tenor.

Held by Dixon C.J., McTiernan, Williams and Fullagar JJ., Taylor J. dissent- ing, that S. 260 of the Income Tax and Social Services Contribution Assessment Act applied SO as to leave the respondents taxable in respect of the distribution made by L. including the cash and shares which, when all the transactions were completed, were left in the hands of P., but not including the sum on which additional tax had been paid under Div. 7.

Deputy Federal Commissioner of Taxation v. Purcell (1921) 29 C.L.R. 464; Jaques v. Federal Commissioner of Taxation (1924) 34 C.L.R. 328 Clarke V. Federal Commissioner of Taxation (1932) 48 C.L.R. 56 Bell v. Federal Commissioner of Taxation (1953) 87 C.L.R. 548 and War Assets Pty. Ltd. V. Federal Commissioner of Taxation (1954) 91 C.L.R. 53, discussed.

Decision of Kitto J., reversed.

APPEAL from Kitto J.

Lauri Joseph Newton, Lionel Newton, Henry James Lane, Leonard Alfred Fenton, Stella Maud Adeline Lane, Francie Una Christian and the executors of the estate of Robert Nathan, deceased, namely Lauri Joseph Newton, Lionel Newton and Frederic Ernest Bunny each appealed to the High Court of Australia against two amended assessments to income tax, one for the year ended 30th June 1950 and the other for the year ended 30th June 1951.

The appeals were heard together before Kitto J. in whose judg- ment hereunder the material facts appear.

R. M. Eggleston Q.C., B. P. Macfarlan Q.C., A. B. Kerrigan Q.C. and J. A. Nimmo, for the appellant in each appeal.

J. B. Tait Q.C., D. I. Menzies Q.C. and K. A. Aickin, for the respondent in each appeal.

Cur. adv. vult.

96 CLR 580

The following written judgment was delivered by

KITTO J. Fourteen appeals under S. 197 of the Income Tax and Social Services Contribution Assessment Act 1936-1950 (Cth.) against assessments amended in exercise of the power given to the commissioner by S. 170 (2) of that Act have been heard together. The appellants are Lauri Joseph Newton, Lionel Newton, Henry James Lane, Leonard Alfred Fenton, Stella Maud Adeline Lane, Francie Una Christian, and the trustees of the estate of Robert Nathan deceased. Each appellant (counting the trustees as one) appeals against two amended assessments, one being in respect of income derived in the year ended 30th June 1950 and the other in respect of income derived in the year ended 30th June 1951.

In each case the amendment increased the liability of the tax- payer by including in assessable income, as income derived from property, certain amounts which were described, in an alteration sheet accompanying the notice of amended assessment, as the tax- payer's proportion of distributions made by three companies, Lane's Motors Proprietary Limited, Neal's Motors Proprietary Limited and Melford Motors Proprietary Limited. (In this judgment these companies will be referred to as Lane's, Neal's and Melford respectively, and together they will be referred to as the motor companies.) In some cases income from estates which were treated as having participated in such distributions was also included. In each case the amendment also assessed the taxpayer to additional tax under S. 226 (2), on the footing that the taxpayer had omitted these amounts from his return. Objections upon a number of grounds were duly lodged, and, having been disallowed by the commissioner, they were forwarded at the taxpayers' request to this Court as appeals.

The grounds of objection in each case in effect denied that the amounts included in assessable income by the amendment to the assessment had been derived by the taxpayer in fact, and denied that on any other ground those amounts were to be treated as forming part of the taxpayer's assessable income. Other grounds also were taken, but they have not been pressed. The facts con- cerning the distributions referred to in the alteration sheets were not disclosed to the commissioner before he made the original assessments. If the commissioner is right in his view that the appellants derived, or must be considered to have derived, assessable income in respect of those distributions, it is clear that in each original assessment there was an avoidance of tax, and that accordingly the commissioner had power under S. 170 (2) to amend the assessment. It is also clear that on the same hypothesis the commissioner was

96 CLR 581

justified by S. 226 (2) in assessing the taxpayer to additional tax. The arithmetical correctness of the amended assessment is not disputed. The only issue is whether the hypothesis is correct.

The distributions were made as dividends upon shares which were held, at the respective dates on which the dividends were declared, by a company called Pactolus Pty. Ltd. (which will be referred to as Pactolus), and it was to that company that the divi- dends were paid by the motor companies. The nature of the case may be indicated broadly by saying that the shares had been acquired by Pactolus from the appellants (or the shareholders whom they represent), and that according to the commissioner's view the facts surrounding the transfers of the shares to Pactolus entitle him by virtue of S. 260 to treat the appellants as having received the dividends.

The history of the matter is complicated and a detailed investi- gation of it has been necessary. It will make for clarity if, when referring to the persons whose shares Pactolus purchased, I speak generally of " the original shareholders " in relation to each of the three motor companies, though the members of those companies at relevant times were not identical. In Lane's, at the earliest material date, 30th June 1949, the largest shareholder was Robert Nathan. The next largest was the estate of Robert Lane deceased, of which the appellants Henry J. Lane and Stella M. A. Lane were the trustees. Then there were the respective estates of Joseph Nathan deceased and Catherine M. Nathan deceased, the trustees of both these estates being the appellants Lauri J. Newton, Lionel Newton and Francie U. Christian. In addition, shares were held in his or her own right by each of the appellants Lauri J. Newton, Lionel Newton, Francie U. Christian, Stella M. A. Lane and Henry J. Lane. All the shares held by these persons were ordinary shares and the only other issued capital consisted of 5,000 preference shares held by one W. B. Thomas who was the manager and secretary of the company. In Neal's, Robert Nathan held at that date a large number of ordinary shares and the rest were held by the trustees (already mentioned) of the respective estates of Robert T. Lane deceased, Joseph Nathan deceased and Catherine M. Nathan deceased, and the appellants Lauri J. Newton, Lionel Newton, Francie U. Christian and Henry J. Lane. There were 5,000 pref- erence shares, held by one Cedric Broomhall, the manager of the company. In Melford, Henry J. Lane and Stella M. A. Lane held shares as trustees of the estate of Robert T. Lane deceased, the appellants Stella M. A. Lane and Leonard A. Fenton (the manager of the company) each held shares beneficially, and one Lionel B.

96 CLR 582

Wallace held the balance in trust for the respective estates of Robert Nathan and Joseph Nathan. There were no preference shares in Melford.

With the exception of the three managers, and of Mr. Wallace who had no beneficial interest of his own, the persons who had been named belonged to two family groups, for Lauri J. Newton, Lionel Newton and Francie Una Christian were children of Joseph and Catherine Nathan and nephews and niece respectively of Robert Nathan, while Henry J. Lane was a brother, and Stella M. A. Lane was the widow, of Robert T. Lane deceased. The businesses of Lane's and Melford had been started by Robert T. Lane, and the business of Neal's by Henry J. Lane. By the time with which we are concerned in this case, the oversight of the affairs of all three companies had devolved mainly upon Henry J. Lane. On the side of the Nathan family, Lauri Newton was the only one who was taking much active interest, and he was more closely concerned with a furniture business carried on by a firm known as Maples. Robert Nathan was taking little part in the motor businesses-he died in June 1950-and Lionel Newton was abroad.

The three motor companies carried on business in Melbourne as distributors and sellers of motor cars, and similar businesses were carried on there by subsidiaries including British Service Pty. Ltd., which was a subsidiary of Lane's, Allcars Pty. Ltd. and Overland (Victoria) Pty. Ltd. which were subsidiaries of Neal's, and Devon Motors Pty. Ltd. which was a subsidiary of Overland. The motor car selling business had been severely affected by con- ditions existing in the community during and immediately after the war; but in the year ended 30th June 1949 the three principal companies were able to pay large dividends on their ordinary shares. Although some of the profits they distributed were tax- free by virtue of Div. 7 to which reference will be made later, a large proportion was taxable as income in the hands of the recipient shareholders. This placed the shareholders under a heavy tax liability, for they were all persons whose incomes attracted income tax at the highest rate, at that time 15s. Od. in the pound, and under the provisional tax system in force, any increase in one year's income over the income of the preceding year meant that the amount of the increase attracted not only ordinary income tax in excess of that which was covered by the provisional tax paid in the previous year but also provisional tax assessed on the assumption that the income of the next year would be maintained at the same level. Consequently the distribution of fully taxable dividends amongst the shareholders in the year ended 30th June 1949 involved them

96 CLR 583

in finding amounts equal to 30s. Od. in the pound on their respective proportions. It would seem that this result had not been brought home to them by the tax advisers whom they were consulting when the dividends were declared, but the unwisdom of making the distri- butions was to be emphasised to them later by a new consultant.

Business in the motor trade was markedly improving as the year ended 30th June 1949 advanced. The number of cars delivered by Lane's, for example, was to reach 4,519 by the end of that year and 6,479 by the end of the year next following. The total in the preceding year had been only 2,714, and only 1,008 in the year before that. Taxation difficulties due to rising private incomes were being felt acutely. This may be seen in cables which passed in April 1949 between Mr. Lauri Newton and his brother Lionel, who, as I have said, was abroad. Mr. Lauri Newton referred to difficulty he was having in getting bank accommodation for them both to meet their taxes. He indicated that he was being asked for an under- taking to float public companies within the next few months, and he mentioned the possibility of having to realise assets on behalf of Lionel. The latter replied stating a preference for floating the motor companies, presumably because SO long as they remained private companies, in the sense that they were not listed on the stock exchange, realisation of shares at anything like their value was not likely to be easy. But by no means was the desire for public flotations unanimously supported. Mr. Harry Lane, in particular, had sentimental objections, and no doubt practical objections also, to an abandonment of the family character of the companies. But he was weakening in his opposition to the idea, and it provided a reason, in addition to others that existed, for considering whether the capital structure of the companies, including their dependence upon accumulated profits and loans for adequate working capital, ought to be substantially reformed. In any such consideration problems concerning taxation must necessarily have loomed large. In this situation, in June of 1949 there came a move on the part of Lauri Newton and Harry Lane which culminated in the transactions upon an examination of which the fate of these appeals must depend.

By those transactions, profits of the three principal companies, were dealt with, and, in most though not all instances, the paid-up capital of the companies was increased. The first step towards understanding what was done must be to consider the financial situation of each company as at the close of the year ended 30th June 1949, and see what were the difficulties inherent in it.

Lane's. The volume of business being done by this company as the post-war boom in motor car sales got under way may be seen

96 CLR 584

from its gross sales figure of £3,442,565, which gave it a net operating profit for the year of £376,121. For a company doing SO large a business, Lane's had a small paid-up capital: only £242,321 divided into 237,321 ordinary shares of £1 each and the 5,000 preference £1 shares held by W. B. Thomas. But its shareholder's funds of other kinds were large: in addition to a tax-paid profit reserve of £250,000, there were undistributed profits amounting to £387,125 (including £302,799 being the profit of the year just ended after deducting income tax), and loans (including dividend moneys undrawn or redeposited by shareholders) amounting to £164,009. The total shareholders' funds in the company therefore amounted to nearly £800,000. Its assets included Commonwealth bonds and money in the bank, but if these be treated as set off against sundry creditors it will be found that the whole of the shareholders' funds were represented by assets which, though almost all tangible and conservatively valued, were in use in the company's business.

Neal's. This company also was in a large way of business. Its gross sales figure for the year amounted to £2,197,227, and its net profit to £195,241. Yet its paid-up share capital was only £114,332, including the £5,000 paid up on the preference shares held by Broomhall. The credit balance in its profit and loss appropriation account was £268,438 (including the net profit of the year); it had a tax-paid profits reserve of £26,103, and its loan account stood at £239,749. The total of its shareholders' funds was £648,622 and this amount was represented by assets consisting of cash in the bank which may be taken (after deducting sundry creditors) at £86,000, Commonwealth bonds £54,565, and other assets, mainly tangible and all conservatively valued, but in use in the company's business.

Melford. This company also had large sales, the gross figure for the year being £1,586,731. Its paid-up capital was only £16,506, represented by 16,506 ordinary shares of £1 each. Other share- holders' funds consisted of a taxed-profits reserve of £192,449, shareholders' undrawn dividends £51,800, and the credit balance in the profit and loss appropriation account £134,629. The external liabilities, which (including income tax reserve) amounted to £74,342, were greater than the total of the cash in the bank and on hand plus Commonwealth loans: and the rest of the assets, though almost all tangible and conservatively valued, were employed in the business.

It will be seen from this that each of the three companies, facing a period of evidently increasing activity in the motor trade, could

96 CLR 585

hardly do with much less money in its business than it had as share- holders' funds of one sort and another. It certainly could not pay out to shareholders the whole of its distributable profits without serious embarrassment, unless it replaced the whole or a substantial part with other moneys. In more primitive times a sensible course would have been to capitalise a sufficient part of the profits by means of dividends satisfied by an issue of paid-up shares; but that would have involved the shareholders individually in liability for income tax on the amount capitalised: cf. Nicholas v. Commissioner of Taxes, Victoria 1, a liability similar in kind to that to which the distribution of untaxed profits in the year before had exposed them, but considerably greater in amount. What in fact was done is said by counsel for the commissioner to have produced exactly this result, except for the interposition of certain steps which should be treated as void by virtue of S. 260 of the Income Tax and Social Services Contribution Assessment Act. It is important, in view of this contention, to make clear what was the tax position which called for the attention of anyone considering, say in the second half of 1949, what course it was expedient for the companies and their share- holders to pursue.

By annual taxing Acts there had been imposed, and was likely to continue to be imposed, what may be called ordinary company tax at the rate of 5s. Od. in the pound on the first £5,000 of taxable income derived during the preceding year and 6s. Od. in the pound on the excess: see Act No. 2 of 1949, S. 4 (7) and cl. 1 of the seventh schedule, and Act No. 49 of 1950, S. 9 and cl. 1 of the sixth schedule. This was subject to a rebate, under S. 46 of the Assessment Act (the Income Tax and Social Services Contribution Assessment Act 1936-1949), of (roughly) the amount of tax assessed on SO much of the taxable income as consisted of dividends from other companies. In addition, taxes were annually imposed which differed according as a company was or was not a "private company as defined in S. 103 of the Assessment Act. A company not being a "private company was subject to a super-tax and an undistributed profits tax. The super-tax was at the rate of 1s. Od. in the pound on the excess of its taxable income over £5,000: Act No. 2 of 1949, S. 5; Act No. 49 of 1950, S. 10. The undistributed profits tax, provided for by Pt. IIIA of the Assessment Act, was at the rate of 2s. Od. in the pound on that portion of the taxable income which had not been distributed as dividends, ascertained by making from taxable income the deductions provided for in S. 160c of the Assessment Act: see Act No. 2 of 1949, S. 4 (7) and cl. 4 of the sixth schedule, and Act

1(1940) A.C. 744. 96 CLR 586

No. 49 of 1950, S. 9 and cl. 4 of the sixth schedule. On the other hand, a company which was a "private company (and Lane's, Neal's and Melford were such), though not subject to either the super-tax or the undistributed profits tax imposed upon other companies, was subject to a tax which will be referred to as Div. 7 tax, being the tax provided for by Div. 7 of Pt. III of the Assessment Act. Section 104 in that Division, as it applied to the three motor companies, provided in effect that where a private company had not made a sufficient distribution of its income of the year of income by the ensuing 31st December, the commissioner might assess the aggregate additional amount of tax which would have been payable by its shareholders if the company had, on the last day of the year of income, paid the undistributed amount as a dividend to the share- holders who would have been entitled to receive it, and that the company should be liable to pay the tax SO assessed. What was

a sufficient distribution of its income of the year of income" was defined in S. 103 (2) (e) as a payment in dividends, out of the taxable income of that year, of an amount not less than the aggregate of certain stated percentages of defined portions of the distributable income. This left an amount (a comparatively small amount in the case of the three motor companies) which could be left undistrib- uted without attracting Div. 7 tax, and this amount will be referred to as the retention amount. As has been mentioned already, the shareholders of the motor companies all had incomes of such a level that the tax payable by them on any amounts distributed to them by those companies would be at the rate of 15s. in the pound. Consequently, when the operations of the year ended 30th June 1949 produced, as they did, a large distributable profit, the tax liability of each company consisted of a liability to pay ordinary company tax and, in addition, 15s. Od. in the pound on SO much of a sufficient distribution as it failed to distribute in dividends by 31st December. Dividends subsequently paid wholly and exclus- lively out of the amount SO left undistributed were tax-paid, in the sense that the recipients were entitled in respect of them to a rebate of tax as provided in S. 107. It is accurate enough for present purposes to say that the rebate was of the amount by which the proceeds of the dividends increased the income tax of a person who derived them, either directly or through any interposed company, trustee or partnership, by virtue of shares in respect of which a distribution was supposed to have been made for the purposes of the assessment of the Div. 7 tax on the company.

It will be seen that the end of a profitable year of income presented a "private company with a choice broadly speaking, in SO far

96 CLR 587

as it refrained from distributing to its members, by the following 31st December, dividends absorbing its taxable income of the year of income (except the retention amount)-a course which would involve its members in liability to pay tax on the amounts received by them individually-it would be liable itself to pay Div. 7 tax equal in amount to the aggregate tax which the members would have paid if the distribution had been made. The present appeals relate to five transactions, each of which, according to the commis- sioner's contention, was an arrangement entered into in view of this taxation position and for the purpose of avoiding both Scylla and Charybdis, that is to say the purpose of enabling a company to avoid incurring Div. 7 tax (by making in time a sufficient distri- bution of its income of the year ended 30th June 1949 and also of the year ended 30th June 1950), and yet of enabling those who were the shareholders at the beginning of the arrangement to say that they received from the distribution no income involving them in liability to pay income tax. Three of the transactions, one with respect to each of the three motor companies, took place in December 1949. A second transaction concerning Melford took place in December 1950, and a second concerning Neal's in June 1951. All five transactions were proposed by Mr. J. v. Ratcliffe, a consulting accountant of wide experience in financial and taxation problems, who had been called into consultation by Mr. Harry Lane and Mr. Lauri Newton in circumstances to which I shall later refer. It will be convenient to describe at once the main steps comprised in these transactions and to indicate the results which they achieved, assuming them for the moment to be unaffected by S. 260. Lane's Transaction.

On 14th December 1949, special resolutions were passed which increased the capital of Lane's from £250,000 divided into £1 shares to £750,000 similarly divided. They created four classes of shares. The 5,000 preference shares held by Thomas were made A preference shares; the 237,321 issued ordinary shares were made as to one- third (79,107) A ordinary shares and as to two-thirds (158,214) B ordinary shares; 62,679 unissued shares were made B ordinary shares; and 445,000 unissued shares were made B preference shares. (The sub-division of the issued ordinary shares into the A and B classes was effected rateably, SO that Lauri Newton (for example), who had held in his own right 15,072 ordinary shares, now held 5,024 A ordinary shares and 10,048 B ordinary shares). The rights attached to Thomas' 5,000 preference shares remained unaffected when they became A preference shares. Subject to

96 CLR 588

these rights, the A ordinary shares were made to entitle the holders to the whole of the dividends thereafter to be declared by the company until they should amount in the aggregate to £5 15s. 10d per A ordinary share (i.e. £458,1 7s. 6d. in all), including 2s. 2d. per share tax-paid under Div. 7. Beyond this, the A ordinary shareholders were given no right to participation in the company's profits except to the extent of a fixed cumulative preferential dividend of five per cent. They were given the same voting rights as the B ordinary shares until the dividends aggregating £5 15s. 10d. (which I shall call the special dividends) should be paid, but there- after only voting rights of the kind ordinarily found in the case of preference shares, viz. to vote when their five per cent dividends should be in arrear for six months or on any proposal for reduction of capital, winding up, or sanctioning a sale of the undertaking, or directly affecting their rights. The B preference shares were made to confer a right (subject to the rights of the A preference and the A ordinary shareholders) to receive a five per cent fixed cumulative preference dividend, and other rights typical of preference shares. Thus the B ordinary shares were left as the only ordinary shares in the usual sense of the term.

On the next day, 15th December 1949, each of the ordinary shareholders gave to a company called Pactolus Pty. Ltd. an option in writing to purchase his or her A ordinary shares in Lane's at the price of £5 16s. Od. per share. Pactolus Pty. Ltd. was a com- pany which had been formed by Mr. Ratcliffe in the preceding March. He was the only substantial shareholder in it. This com- pany, it is important to note, appears to have been carrying on business as a dealer in shares, though until then in a small way only.

On 16th December 1949, the directors of Lane's resolved that 402,679 of the B preference shares be made available for issue at par and be offered to the person or persons entitled to the dividends from the A ordinary shares on or after 19th December 1949. By letter of the same date, Pactolus was informed that this had been done.

On 19th December 1949, Pactolus exercised the options to purchase the A ordinary shares, and handed cheques for the appropriate amounts of purchase money (totalling £458,820 12s. Od.) to the authorised agent of the vendors, a Mr. Ross, in exchange for completed transfers and the relevant share certificates. The transfers were immediately registered, and new share certificates were issued to Pactolus. On the same day Pactolus applied to Lane's for the 402,679 B preference shares which had been made

96 CLR 589

available to be taken up, and gave Lane's a cheque for the amount payable therefor (£402,679).

Next day, 20th December 1949, the directors of Lane's declared three dividends on the A ordinary shares: £8,569 18s. 6d. (or 2s. 2d. per share) out of profits tax-paid under Div. 7, £262,232 out of the profits of the year ended 30th June 1949, and £175,493 8s. Od. out of profits of the year ended 30th June 1950. The total was £446,295 6s. 6d., which was at the rate of £5 12s. 10d. per A ordinary share. This was only 3s. Od. per share short of the amount of the special dividend rights which had to be satisfied before the A ordinary shares would become, in effect, five per cent preference shares. A cheque in favour of Pactolus for the amount of the dividends thus declared was handed to Ross on behalf of Pactolus. Later on the same day, the directors of Lane's allotted to Pactolus the B preference shares for which it had applied, and Pactolus gave Lane's a cheque for the full amount of these shares, £402,679. On the same day, Pactolus sold the whole of the newly-issued B prefer- ence shares at £1 per share to the original shareholders (now the holders of the B ordinary shares) in the proportions in which they held B ordinary shares and transfers thereof were on that day exchanged for cheques drawn by the transferees, totalling £402,679.

On 21st December 1949, all the cheques that have been mentioned were banked simultaneously at the South Melbourne Branch of the English Scottish and Australian Bank Ltd. Lane's and the share- holders had all had accounts there for some time, and an account had been opened there for Pactolus a few days before, with a deposit of £19,000.

Three months later, on 22nd March 1950, the directors of Lane's declared out of the profit of the year ended 30th June 1950 a further dividend of £11,866 1s. Od. on the A ordinary shares. This was 3s. Od. per share. It brought the total dividends to £5 15s. 10d. per share or £458,161 7s. 6d. in all, and the special rights attached to the A ordinary shares thus became exhausted. The amount of the new dividend was paid to the credit of Pactolus's bank account at the South Melbourne branch of the E. S. &A. Bank Ltd.

On 12th May 1950, Pactolus sold the whole of the A ordinary shares in Lane's to a company called Pactolus Investments Pty. Ltd., which will be referred to as Pactolus Investments and in which Mr. Ratcliffe and members of his family were the only share- holders. This sale was at £1 per share, which was the full value of the A ordinary shares as they then stood, that is to say as virtually five per cent preference shares.

96 CLR 590

These steps had the following results: (1) in Lane's accounts, £402,679 of profits went out and was replaced by paid-up capital of the same amount represented by B preference shares in the hands of the original shareholders; (2) the difference between that figure and the total of the special dividends paid (£458,161) viz. £55,482, was contained in the sum of £56,141 which, as will be mentioned in a moment, was kept by the original shareholders in cash (the remaining £659 of the latter sum being put in by Pactolus); (3) the original shareholders, although they receive nothing directly from the distribution of Lane's profits, received between them £458,820 as the price of their A ordinary shares, keeping £56,141 of that amount in cash and applying the balance in the purchase of

B preference shares from Pactolus; and (4) although Pactolus had to put in £659 in cash, being the amount by which the special dividends fell short of the price paid for the A ordinary shares, it sold those shares for £79,107 and thus made an over-all profit of £78,448. To put Pactolus's result in another way, it lost on the resale of the A ordinary shares £379,713, but the dividends it received amounted to £458,161, SO that on the whole it made a profit of £78,448. On the footing, which has been assumed to be correct for the purposes of the argument, that Pactolus was a trader in shares, its taxable income would include, in respect of the Lane's transaction, only the last-mentioned amount and not the full amount of the dividends which Pactolus derived from the A ordinary shares. First Neal's Transaction.

This transaction followed the same pattern as the Lane's trans- action and was carried through contemporaneously with it. Of the ordinary shares in Neal's, 36,444 became A ordinary shares carrying a right to all dividends declared until they should reach not less than £13 7s. Od. per share (i.e. £486,527) of which not less than £1 was to be out of profits tax-paid under Div. 7. Thereafter they were to become in effect five per cent preference shares. On 15th Decem- ber 1949, options were given to Pactolus to purchase all the A ordinary shares at £12 8s. 4d. per share (or £452,513 in all). On 16th December 1949, 403,314 B preference shares were made avail- able for issue, to be offered to the person or persons entitled to the dividends from the A ordinary shares on or after 19th December 1949 and Pactolus was SO informed. On the latter date, Pactolus exercised the options to purchase the A ordinary shares, and handed over cheques for the purchase money in exchange for transfers which were thereupon registered. On the same day Pactolus

96 CLR 591

applied for the new issue of B preference shares and handed its cheque to Neal's for the amount thereof. On 20th December 1949 dividends were declared by Neal's £36,444 (or £1 per share) tax- paid under Div. 7, £137,086 out of profits of the year ended 30th June 1949, £121,556 out of profits of the year ended 30th June 1950, and £154,997 8s. Od. out of dividends declared by the sub- sidiary Overland (Victoria) Pty. Ltd. (which included dividends from the sub-subsidiary Devon Motors Pty. Ltd.). These four dividends totalled £450,083 8s. Od., which is £12 7s. Od. per share. Later on the same day, the 403,314 B preference shares were allotted to Pactolus at par, and Pactolus thereupon sold them to the original ordinary shareholders for £1 per share. On 21st December 1949, the cheques were all banked simultaneously at the South Melbourne Branch of the E. S. &A. Bank: Pactolus's cheques in favour of the original shareholders for the price of the A ordinary shares (totalling £452,513), Pactolus's cheque in favour of Neal's for the amount to be paid up on the B preference shares (£403,314), Neal's cheque in favour of Pactolus for the amount of the dividends declared on the

A ordinary shares (£450,083 8s. Od.), and the shareholders' cheques in favour of Pactolus for the price of the B preference shares (£403,314). Then, on 22nd March 1950, a further dividend of £1 per share (£36,444) was declared and paid on the A ordinary shares to Pactolus out of Neal's profits for the year ended 30th June 1950, the special dividend rights being thereby exhausted. On 12th May 1950, Pactolus sold the A ordinary shares to Pactolus Investments for £1 per share.

The results achieved by these steps were: (1) £403,314 of Neal's profits were replaced in its accounts by paid-up capital of the same amount represented by B preference shares in the hands of the original ordinary shareholders; (2) the difference between that figure and the total of the special dividends paid (£486,517) viz. £83,203, was represented by £49,199 kept by the original share- holders in cash and £34,004 kept by Pactolus in cash (3) the original shareholders, although they received nothing directly from the distribution of Neal's profits, received between them £452,513 as the price of their A ordinary shares, keeping £49,199 of that amount in cash and applying the balance in the purchase of B preference shares from Pactolus and (4) Pactolus kept for itself the difference between the amount of the special dividends (£486,517) and the price it had paid for the A ordinary shares (£452,513), viz. £34,004, as well as the price it got on reselling those shares (£36,444), a total profit of £70,448. To put Pactolus's result in another way, it lost on the resale of the A ordinary shares £416,069, but the

96 CLR 592

dividends it received were £486,517, SO that on the whole it made a profit of £70,448. First Melford Transaction.

The first Melford transaction occurred, as I have said, simul- taneously with the Lane's transaction and the first Neal's trans- action, and it followed the same general pattern, though with differences in detail. The 16,506 issued ordinary shares were divided into A ordinary and B ordinary shares in equal proportions, and 200,000 preference shares (unissued) were created. (There were no preference shares in this company previously.) The amount of the special dividends to be declared on the 8,253 A ordinary shares was in this instance £26 11s. Od. per share, of which not less than £3 was to be out of profits tax-paid under Div. 7. On 15th December 1949, Pactolus was given options to purchase all the A ordinary shares at £24 per share (or £198,072 in all). On 16th December 1949, 189,819 preference shares were made available for issue, and were offered to the person or persons entitled to the dividends from the A ordinary shares on or after 19th December 1949. On the latter date, Pactolus exercised the options to purchase the A ordinary shares, and handed over cheques for the purchase money in exchange for transfers which were thereupon registered. On the same day, Pactolus applied for the new issue of preference shares and gave Melford its cheque for the requisite amount. On 20th December 1949, dividends were declared by Melford: £3 per share (totalling £24,759) out of tax-paid profits, £97,200 out of profits of the year ended 30th June 1949, and £72,399 out of profits of the year ended 30th June 1950. These totalled £23 11s. Od. per A ordinary share, or £194,358. Later on the same day, the 189,819 preference shares were allotted to Pactolus at par, and Pactolus thereupon sold them to the original ordinary shareholders for £1 per share. On 21st December 1949, the cheques were all banked simultaneously at the South Melbourne Branch of the E. S. &A. Bank: Pactolus's cheque in favour of the original shareholders for the price of the A ordinary shares (totalling £198,072), Pactolus's cheque in favour of Melford for the amount to be paid up on the preference shares (£189,819), Melford's cheque in favour of Pactolus for the amount of the dividends declared on the A ordinary shares (£194,358), and the shareholders' cheques in favour of Pactolus for the price of the preference shares (£189,819). Then, on 22nd March 1950, a further dividend of £3 per share (£24,759) was declared and paid on the A ordinary shares to Pactolus out of Melford's profits of the year ended 30th June 1950. This brought the total special dividends

96 CLR 593

paid to £219,117, which exhausted the special dividend rights. On 12th May 1950, Pactolus sold the A ordinary shares to Pactolus Investments for £1 per share.

The results achieved by these steps were: (1) £189,819 of Melford's profits were replaced in its accounts by a corresponding amount of paid-up capital represented by preference shares in the hands of the original shareholders; (2) the difference between that figure and the total of the special dividends (£219,117), viz. £29,298, was repre- sented by £8,253 kept by the original shareholders in cash and £21,045 kept by Pactolus in cash; (3) the original shareholders, although they received nothing directly from the distribution of Melford's profits, received between them £198,072 as the price of their A ordinary shares, keeping £8,253 of that amount in cash and applying the balance in the purchase of the preference shares from Pactolus and (4) Pactolus got for itself the difference between the amount of the special dividends (£219,117) and the price it had paid for the A ordinary shares (£198,072), viz. £21,045, as well as the price it got on reselling those shares (£8,253): a total profit of £29,298. Second Melford Transaction.

On 29th November 1950, after £80,000 of tax-paid profits had been distributed to the original shareholders as dividends on the B ordinary shares, the capital structure of Melford was altered again. The 8,253 issued B ordinary shares were made C ordinary shares; and the 200,000 preference shares (of which 189,819 had been issued) became B ordinary shares, making (with the previously existing unissued B ordinary shares) a total of 383,494. The new

C ordinary shares were given rights similar to those which in the preceding year had been given to the A ordinary shares, the amount of the special dividends being fixed on this occasion at £26 11s. Od. per share, of which not less than £3 per share was to be out of income tax-paid under Div. 7. On 30th November 1950, the C shareholders gave Pactolus options to purchase the C ordinary shares at £24 per share, totalling £198,072. On 4th December 1950, dividends of £19 per share out of profits of the year ended 30th June 1950 and £3 per share out of tax-paid profits were declared by Melford on the C ordinary shares. These dividends totalled £181,566. On the same day the directors of Melford resolved to allot 189,819 of the unissued B ordinary shares at par to the holders of the B ordinary shares already issued, thus doubling their holdings of such shares: and the shareholders' cheques for the amounts required to pay in full for the new issue were handed to

96 CLR 594

Melford on that day. On 6th December 1950 the various cheques were banked simultaneously at the South Melbourne Branch of the E. S. &A. Bank Ltd.: Pactolus's cheques in favour of the share- holders for the price of the C ordinary shares (£198,072); the shareholders' cheques in favour of Melford for the amount to be paid up on the new issue of B ordinary shares (totalling £198,819) and Melford's cheque in favour of Pactolus for the dividends on the C ordinary shares (£181,566). On 30th January 1951, Melford declared and paid a further dividend of £37,551 (at £4 11s. Od. per share) on the C ordinary shares, bringing the total dividends on those shares to £219,117 (or £26 11s. Od. per share) and thereby exhausting the special dividend rights. Pactolus did not sell the

C ordinary shares to Pactolus Investments.

The results achieved by these steps were as follows: (1) £189,819 of Melford's profits were replaced in its accounts by paid-up capital of the same amount represented by newly-issued B ordinary shares in the hands of the original shareholders; (2) the difference between that figure and the total special dividends (£219,117), viz. £29,298, was represented by £8,253 kept by the old shareholders in cash and £21,045 kept by Pactolus in cash; (3) the original shareholders, although they received nothing directly from the distribution of Melford's profits, received between them £198,072 as the price of their C ordinary shares, keeping £8,253 of that amount in cash and applying the remainder in taking up the new B ordinary shares; and (4) Pactolus got for itself the difference between what it paid for the C ordinary shares (£198,072) and the amount of the special dividends (£219,117) viz. £21,045, and it retained in addition the C ordinary shares then worth £8,253. It will be noticed that in this second Melford transaction the new shares were taken up by the old shareholders directly; they were not taken up by Pactolus and sold by it to the old shareholders. The significance of this point of difference will be referred to later. Second Neal's Transaction.

On 12th June 1951 the capital structure of Neal's was altered for the second time, 29,156 of the issued B ordinary shares being made

C ordinary shares. This left 43,732 issued B ordinary shares. The C ordinary shares were given rights similar to those which in 1949 had been attached to the A ordinary shares, the amount of the special dividends being fixed on this occasion at £13 1s. 6d. per share, of which not less than 12s. 11d. was to be out of income tax-paid under Div. 7. On 21st June the C shareholders gave Pactolus options to purchase the C ordinary shares at £12 8s. Od.

96 CLR 595

per share. On 25th June 1950, Pactolus exercised the options, the C ordinary shares were transferred to it in exchange for cheques, and dividends of 14s. 6d. out of tax-paid profits and £12 7s. Od. out of profits of the year ended 30th June 1951 were declared on those shares. These dividends (at £13 1s. 6d. per share) totalled £381,214. On 27th June 1951 the cheques were banked simul- taneously Pactolus's chéques in favour of the shareholders for the price of the C ordinary shares (£354,245 8s. Od.), and Neal's cheque in favour of Pactolus for the amount of the dividends (£381,214). Pactolus sold the C ordinary shares to Pactolus Investments for £1 share. It will be seen that this time there was no increase in the paid-up capital of Neal's. That company distributed £381,214 of its profits but it was Pactolus which received them. If there be set off against that sum the loss which Pactolus made on the resale of the C ordinary shares, viz. £325,089, Pactolus will be seen to have made an over-all profit of £56,125. The original holders of the C ordinary shares received £354,245 in cash, and this amount came to them as a capital receipt and not as income.

Such were the five transactions which took place. It is plain that, apart from S. 260, the original shareholders cannot be said to have derived from the dividends which were declared and paid in the course of these transactions anything that can be treated as assessable income in the assessment of their respective taxes. Every step taken was genuinely intended to have full effect; there was nothing in the nature of a sham or pretence. The original shareholders really and effectually divested themselves of all legal and beneficial interest in the A ordinary shares and the C ordinary shares, in consideration of the respective prices for which they stipulated in the options granted to Pactolus. So much the commis- sioner concedes. His case depends entirely upon an application of S. 260, which is in the following terms 260. Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall SO far as it has or purports to have the purpose or effect of in any way, directly or indirectly--(a) altering the incidence of any income tax (b) relieving any person from liability to pay any income tax or make any return (c) defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or (d) preventing the operation of this Act in any respect, be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose."

96 CLR 596

For the commissioner it is contended that each of the five trans- actions was, within the meaning of the section, an arrangement which, to the extent of the change in ownership of the A and C ordinary shares, had both the purpose and, the effect of altering the incidence of income tax on the special dividends, of relieving the original shareholders from liability to pay income tax thereon, or of avoiding a liability imposed by the Assessment Act on the original shareholders to pay tax on taxable incomes assessed by including in their assessable incomes the amounts of the special dividends. This being SO (the contention proceeds), the transfers of the A and C ordinary shares to Pactolus must be treated as void for the purposes of these proceedings, and the amended assessments should be sustained on the footing that the special dividends were derived in their entirety by the original shareholders, a portion of each such dividend having been actually received by them, and the remainder having been paid to Pactolus at their instance and retained by Pactolus with their consent and for its own benefit as something in the nature of a remuneration or a reward for its co-operation in the transactions.

Section 260 is a difficult provision, inherited from earlier legis- lation, and long overdue for reform by someone who will take the trouble to analyse his ideas and define his intentions with precision before putting pen to paper. There have not been many cases in which the meaning of the section has been considered, but some points must now be taken as settled. One is that, although the word arrangement does not include a conveyance or transfer of property as such, it does include any kind of concerted action by which persons may arrange their affairs for the stated purpose or SO as to produce the stated effect; and that a conveyance or transfer may be void as against the commissioner as forming part of a course of action which constitutes an arrangement in this sense: Bell V. Federal Commissioner of Taxation 1. It is also settled that since

' this Act" (i.e. the Assessment Act as distinguished from the Acts which impose taxation at rates which they prescribe) imposes by S. 17 a general liability to pay tax at the rates declared by the Parliament upon the taxable income derived during the year of income by any person (subject to an exception), an arrangement having the purpose or effect of avoiding that liability in the case of any particular person is within the operation of S. 260 (c): 2.

A third point which is settled is that the section is an annihilating provision only, SO that it avails the commissioner where, and only where, the result of its rendering an arrangement void to the extent

1(1953) 87 C.L.R. 548, at p. 573. 2(1953) 87 C.L.R., at p. 574. 96 CLR 597

which it mentions is to leave standing a state of affairs in which a challenged assessment is justified 1.

On this third point there seemed in the course of the argument in the present case to be what I regard as a misunderstanding, for some of the submissions that were made appeared to assume that the operation of the section upon any particular arrangement is to eliminate from consideration, as if it had never occurred, either everything that was done, or some severable part of the things that were done, in the course of the arrangement. Perhaps this comes from attributing to the word 'annihilate", as used in the earlier cases, the sense of blotting out and deeming never to have existed. The word has been used, however, only to emphasise the fact that the section has merely a destructive, and never a construc- tive, operation; that it renders a contract, agreement or arrange- ment void to the stated extent, but never supplies any element which is absent and is necessary for a valid assessment. It must not be overlooked that what is meant by "void" is simply devoid of legal effect or significance. (Hence the courts have been con- strained to reject, as inapplicable in the construction of S. 260, the meaning which "arrangement" has in some contexts, namely a consensus, generally of a more or less unformulated character, lacking in legally operative effect.) The section leaves all the facts of a case exactly as it finds them, requiring neither that anything which was not done shall be deemed to have been done nor that anything which was done shall be deemed not to have been done. As applied to a transfer of shares, for example, it leaves standing the fact that the transfer was executed and was registered, and merely requires that the title to the shares be considered as remaining never- theless unchanged.

Then, too, it must be observed that the section is drawn on the footing that where the stated purpose or effect exists, it may be only to a limited extent that the arrangement is to be described as having or purporting to have that purpose or effect. In one sense, of course, if an arrangement has that purpose. or effect to any extent, it is true to say that the whole arrangement has that purpose or effect: but the section looks at the matter differently. It recognizes that the arrangement considered as a whole may have other purposes and effects as well; and it requires that out of the legal consequences of everything that constitutes the arrangement those legal conse- quences be selected and treated as void which have the purpose or effect of themselves producing any of the results described in pars. (a), (b), (c) and (d) of the section, that is to say those consequences

1(1953) 87 C.L.R., at pp. 572, 573. 96 CLR 598

which are intended to form or in fact form the decisive or operative factors in bringing about such a result. And even such legal consequences are to be treated as void to the extent only that they have that purpose or effect. So, if it is the operation of a convey- ance that is void (under par. (c) for example), it is void only in relation to the particular liability which it has the purpose or effect of defeating, evading or avoiding: it is not void, for example, in relation to all the future income of the property, but is void in relation to that income only which, but for its efficacy, would be assessable income of the conveyor.

The expression " the purpose or effect " is not without its diffi- culty. Only the actual legal effect of a thing can be made void, not an effect which, though aimed at, is not achieved even if the section does not apply. The meaning seems to be that if you find that an arrangement has such a purpose as the section describes, you must treat it as void as against the commissioner and you need not stay to inquire into its general validity; but that if you find that it is effectual apart from the section, then you must treat it as void as against the commissioner whether it had such a purpose or not. The expression "has or purports to have' " seems to carry out the same idea. In other words, the meaning which I should place upon the expression SO far as it has or purports to have the purpose or effect of altering" (etc.) may be expressed by some such paraphrase as: "so far as its validity would have the conse- quence of altering (etc.), whether that was the purpose of the parties in entering into it or is only its de facto result, and whether such a purpose or result is or is not to be found acknowledged in the course of the transaction".

Now, it is clear that in each of the five transactions with which the present appeals are concerned a company made a distribution of its profits. It is also clear that none of the taxpayers concerned participated directly in any of the distributions, for every penny went directly to Pactolus. It is equally clear that each of the taxpayers received money or both money and fully-paid preference shares from Pactolus, and that neither the money they received nor that which had been used to pay for the preference shares can be treated as their assessable income unless it has that character for income tax purposes in consequence of the operation of S. 260.

I must now examine the history of the transactions-not SO much to find whether they had one or more of the purposes mentioned in S. 260, but in order to discover whether, if the sales and transfers of the A and C shares be treated as void in law, a consideration of all that remains should lead to the conclusion that the moneys

96 CLR 599

and shares received by the original shareholders, either alone or together with the moneys retained by Pactolus for itself, were derived by those shareholders as income.

The first step was taken in June 1949, when Mr. Ratcliffe was consulted. It had become apparent to those in charge of the motor companies' affairs that business was increasing, and that, as soon as restrictions such as petrol rationing were lifted and goods were in better supply, there would be (as Mr. Lane put it in evidence) " a lot of difficulty for us with our capital" The difficulties referred to included, of course, the need to keep sufficient working funds in the businesses, bearing in mind that, as Mr. Lane said: " in the motor business everything you touch is a thousand pounds and a million pounds goes nowhere In addition, there was the fact that bank accommodation, if it should be required at any time, would be harder to get with balance sheets which showed SO much of the working capital in the form of withdrawable funds, and the further fact that it would be difficult, with those balance sheets, to float public companies, and thereby to move out of the area of liability to Div. 7 tax and at the same time to place shareholders who might need cash in a position to sell shares readily. That these considerations were seen as difficulties, however, was due to the fact that the companies' profits could neither be retained as profits nor converted into paid-up share capital without taxes being incurred which would absorb a large part of them (or amounts equal to a large part of them). It is easy, therefore, to understand that, when Mr. Harry Lane was asked in cross-examination whether he was not concerned at the time that something should be done SO that the tax liability which loomed should never arrive, he replied:

That is one of the reasons that we consulted Mr. Ratcliffe in regard to the formation of a public company, SO we could remove from the private company tax And he went on to say that that was made clear to Mr. Rateliffe. Mr. Ratcliffe was well known to Mr. Lane and Mr. Newton, for at an earlier date he had given advice concerning the Melbourne furniture firm of Maples, in which the Newtons and Mr. Harry Lane were interested. He was also associ- ated with Mr. Lauri Newton, Mr. Harry Lane and Mr. Fenton on the board of a Sydney furniture company, Bebarfalds Ltd. It was at the close of a meeting of that board that Mr. Newton asked Mr. Ratcliffe to discuss the motor companies with Mr. Harry Lane. This he did, and they talked in general terms of the difficulties likely to confront the motor companies in relation to their capital, and of the question of forming them into public companies. Mr. Ratcliffe asked to be supplied with the accounts. When he had

96 CLR 600

received and examined them, he saw that each company was seriously under-capitalised, and in August 1949 he had a discussion, confined to Lane's and Neal's, with Mr. Harry Lane and Mr. Newton. Mr. Rateliffe suggested that the capital of Lane's should be increased to £800,000, and the capital of Neal's to £750,000. Mr. Lane did not favour a higher figure than £600,000 for Lane's, and in any case he made evident his personal feeling against converting the companies into public companies. Mr. Ratcliffe then put forward a preliminary outline of another plan. This, as he described it in his evidence, was that "they could divide their shares into two classes, giving one class special dividend rights and thereby deferring the second class, that they could sell the class I first referred to and that they could use that money to take up a large number of shares at par, and that would raise their capital." Being asked where they could sell the shares, he said he had a company which would be prepared to make an offer.

The matter was carried a stage further at a meeting in Melbourne in September, at which Mr. Ratcliffe developed his proposal in the presence of Mr. Robert Nathan, Mr. Harry Lane, Mr. Lauri Newton, the accountant of Maples named Atcheson, a public accountant named Wallace (a trustee shareholder in Melford), and Mr. F. E. Bunny a solicitor who was acting for the motor companies and their shareholders. It is evident that at this discussion the problem of private company tax draining away undistributed profits was very much wrapped up with the question of the companies' capital situation, for Mr. Ratcliffe, realising that the idea of listing the companies on the stock exchange was too controversial to be worth pursuing, mentioned, as an alternative to that, the possible course of bringing in a few new shareholders and SO arranging the voting power that the companies could be made to be no longer private companies within the meaning of the Income Tax and Social Services Contribution Assessment Act. This would mean that they would have to pay (in addition to ordinary company tax) super-tax and Pt. IIIA tax on undistributed profits, amounting together to about fourteen and one-half per cent, instead of Div. 7 tax amounting to seventy-five per cent. In this suggestion he found that they were " really not interested", because it had nothing to do with their capital but was directly on the question of tax saving only" (It was too late to do this SO as to take effect with respect to the profits of the year ended 1949, but even as to those profits there was a course which would be effective, namely to form holding companies and let each motor company distribute its profits before 31st December 1949 to its holding company, the latter being, or

96 CLR 601

becoming before the ensuing 30th June, a non-private company.) The main elements in the problem as they saw it were the need of each company for an increased share capital, the desirability of getting the increase from the company's own resources and without bringing in new money, and the apparent impossibility of getting it out of profits because income tax would in effect absorb the greater part of each year's profits either in the companies' hands or in the hands of the shareholders. The possibility of writing up assets and issuing shares for the amount of the increase was discussed, and SO was the possibility of satisfying the existing loans by an issue of shares but these courses together would not have provided the capital which Mr. Ratcliffe thought necessary and they were rejected. Most of the discussion seems accordingly to have been devoted to the plan Mr. Ratcliffe had propounded for a sale of shares with special dividend rights and two questions about it assumed importance: whether the price obtained on the sale would be taxable in the hands of the vendors, and how the amount of the price would be determined. Mr. Ratcliffe, and apparently Mr. Bunny and the accountants, having ascertained that none of the shareholders had acquired his shares for resale at a profit, expressed the opinion that the price paid to them would be a capital receipt and not taxable, and that (to use words of Mr. Lane's) "such taxation as applied was Pactolus's, the obligation of Pactolus as the recipient of the dividends." The method suggested for arriving at the price was based on the view that probably no buyer could be found except a public company, that such a company would have to pay (in addition to the ordinary company tax which was a liability of private and non-private companies alike) approx- imately fourteen and one-half per cent tax on the dividends it received (taking super-tax at 1s. in the pound and Pt. IIIA tax at 2s. in the pound on the balance), and that such a company would be likely (according to an experience Mr. Ratcliffe had had) to want to keep the price low enough to allow both for these taxes and for a considerable margin above it, perhaps as much again, by way of profit on the deal. Mr. Ratcliffe said in effect, as I understand his evidence, that his company (Pactolus), being a trader in shares and able to resell the shares purchased under the plan and set off a loss SO incurred against dividends received, could afford to offer a price equal to the amount of the dividends less only the fourteen and one-half per cent for taxes and a profit margin of £5,000. One other matter was mentioned in the discussion, namely the necessity which existed at that time to get official consent under the Capital Issues Regulations to the issue of the new shares. Mr.

96 CLR 602

Rateliffe told the meeting, in effect, that in order to get the consent granted with expedition as a formal matter the application should make it clear that the new shares would be paid for, not by new money, but out of "current resources ". At this stage, however, it seems not to have been contemplated that Pactolus would take up the new shares, for Mr. Bunny's evidence satisfies me it was proposed that the purchase money for the shares with special dividend rights should be used by the vendors to take up the new shares.

Mr. Ratcliffe was asked to put his proposal in writing. He did not do exactly that, but he wrote to Mr. Wallace a letter dated 30th September 1949 for consideration by all concerned. It dealt with the three motor companies, and also with a fourth company in which the same people were interested, Ajax Insurance Co. Ltd., as to which the proposal was eventually dropped. It enclosed three memoranda. The first dealt with the alterations required in the articles of association of the several companies, particularly for the purpose of creating the special dividend rights for a segregated class of shares to be called A shares. The second memorandum dealt with the matters to be covered in a proposed contract for the sale of the A shares to Pactolus, and it included a provision (ultimately not the subject of any written agreement but neverthe- less quite distinctly agreed between all parties) that Pactolus would take up new preference shares and that immediately these shares are fully paid " (without stipulating how they should be fully paid) Pactolus would sell them to the original shareholders in proportion to their holdings.

The third memorandum set out Mr. Ratcliffe's method of calcu- lating the prices to be paid by Pactolus for the A shares and of the number of new shares to be issued and taken up by Pactolus. This memorandum used figures which were the actual figures for the year ended 30th June 1949, but were necessarily only rough estimates for the year ended 30th June 1950. I shall take the portion dealing with Lane's, as sufficient to show the nature of the document. It showed Mr. Ratcliffe's workings and was not in narrative form; but what it conveyed to those for whom it was intended may be described briefly as follows. First, there was a calculation of the amounts which the company would need to distribute out of the profits of each of the two years in order not to be liable for Div. 7 tax. These (together with amounts similarly calculated in relation to a subsidiary company) came to £410,000. It followed that if Pactolus were to purchase from the shareholders a proportion of their shares carrying special dividends amounting to that sum, and

96 CLR 603

that sum were thereafter distributed to Pactolus, Lane's would save Div. 7 tax amounting (at 15s. in the pound) to £307,500. That amount of tax might have been saved in another way, namely by the company ceasing to be a "private company", either by becoming listed on a stock exchange or by SO altering its member- ship and control as to get outside the definition of " private com- pany "; but this could only have been done at the cost of becoming liable to pay super-tax and Pt. IIIA tax, which would have amounted in all to £72,524. The net saving to the company by the distri- bution to Pactolus might be taken as the difference between these two figures, namely £235,000. Suppose, then, that the A shares bought by Pactolus were one-third of the issued ordinary shares, viz. 79,107 (enough to protect Pactolus's interest from interference by a special resolution but not enough to affect the general control of the company). Suppose, too, that the special dividends to which these shares entitled Pactolus were made to include a small amount of tax-paid profits (taken for convenience at £2,684), and that they would be worth £1 per share when the special dividends had been paid in full and the only rights remaining attached to them were a right to a five per cent cumulative preferential dividend and pro- tective voting rights. On these hypotheses the A shares would be worth to Pactolus a gross amount of £491,791, made up of taxable dividends (£410,000) tax-paid dividends (£2,684) and capital value (£79,107). That would enable Pactolus to pay £419,267, or £5 6s. Od. per share, and get as its profit an amount equal to the £72,524 which, as mentioned above, Lane's would have had to pay in super-tax and Pt. IIIA tax if it had been a public company and had made no distribution. The figure of £419,267 was described as

' net price ", the £5,000 margin for which Mr. Ratcliffe was stip- ulating being omitted from this memorandum because (as he explained in evidence) he wanted to show only the approximate equivalence between the three possible methods, namely listing on the stock exchange, ceasing by other means to be a "private company", and adopting his Pactolus plan. The document went on to show that in order to pay the dividends, taxable and tax-paid, which would thus be required, amounting to £412,684, Lane's would need to find only £10,005 in cash, assuming that enough of the dividends were turned into capital paid up on the new shares to bring the total paid-up ordinary capital to £640,000, viz. £402,679. This cash amount of £10,005 would go to the shareholders, together with a cash amount of £6,583 to be supplied by Pactolus, making £16,588 in all, to make the difference between the amount of new

96 CLR 604

share capital in the company (£402,679) and the price Pactolus would be paying for the A shares (£419,267).

As I have said, the figures used in this memorandum were hypo- thetical, but the course indicated was in substance that which was pursued in the three transactions of December 1949 and a study of the memorandum shows what the practical effect of those trans- actions was to be. It was to enable the motor companies, (a) while parting with comparatively little cash, to replace the greater part of their 1949 and 1950 profits by paid-up share capital, (b) to make the distributions required in order to exonerate themselves from Div. 7 tax, and (c) at the same time to avoid involving the original shareholders, though they became the holders of the new share capital, in an income tax liability on the footing that they had participated in a distribution of profits. What those in charge of the motor companies' affairs had to consider in September, with Mr. Ratcliffe's memorandum before them, was whether it was good enough business to achieve this desirable result at the cost of letting Pactolus reap a profit broadly equal to the sum of the amount which would have gone to the Taxation Department if the companies had been public companies and had retained their profits undistributed, plus £5,000 of which some part at least would have been expended in the process of converting the com- panies to public companies.

By the end of that month it had become apparent to Mr. Ratcliffe, from communications which had passed, that the proposition he had submitted would probably be agreed to. He therefore set about providing Pactolus with sufficient funds to purchase the shares carrying special dividend rights. Pactolus had, or could raise from its shareholders, little more than £20,000, and another £125,000 seemed likely to be needed to tide over the interval between the purchase of the A ordinary shares and the receipt of the full amount of the special dividends. To obtain this amount, Mr. Ratcliffe applied in writing to his bank, the Commercial Banking Company of Sydney Ltd., for an overdraft. The figure was arrived at on the assumption that the Ajax proposal as well as the others would proceed; and as regards the motor companies it was based on more recent figures than had been available when the letter of 12th September was written. In calculating the amount Mr. Ratcliffe worked on an anticipation that the special dividends on the A shares would probably be declared as follows Lane's, £373,130 immediately after sale and £39,554 in March 1950 Neal's, £358,366 immediately after sale and £81,999 in March 1950; Melford, £177,854 immediately after sale and £41,265 in March 1950.

96 CLR 605

The purchase prices for the A shares were taken at £419,267 for Lane's, £412,425 for Neal's and £198,072 for Melford. Although the amount of cash accommodation required was worked out by setting off the immediate dividends from the price to be paid for the A shares, the document said that the special dividends would be used to take up the new shares, totalling Lane's 402,679 Neal's 405,668 and Melford 189,819. All these new shares, it was shown, would be sold at par to the vendors of the A shares for cash as soon as taken up. The application was not proceeded with, for two reasons. One was that the Ajax proposal fell through. The other was that the motor companies' profits exceeded Mr. Ratcliffe's expectations to such an extent that it proved possible, simultaneously with the purchase of the A shares by Pactolus, to pay dividends sufficient in amount to enable Pactolus to take up and pay for all the new shares without having to find more cash than it had available from its own resources. The written appli- cation was admitted in evidence without objection. It does not purport to state anything as having been agreed. The expectations it reflects are not shown by it to have been the expectations of anyone but Mr. Ratcliffe and the use of the dividends to the necessary extent, as and when declared, to take up the new shares, is shown as intended (by him) but not as obligatory.

On 12th and 13th October 1949, the motor companies sent to the Capital Issues Board applications (with covering letters) for consent to the issue of cumulative preference shares 402,679 in Lane's 405,668 in Neal's and 200,000 in Melford. Each covering letter said that it was proposed that these shares should be 'taken up by the shareholders and paid for by them out of funds obtained through the declaration by the Company of tax-free and taxable dividends", Lane's and Neal's letters adding or in part by the use of dividends previously declared and still owing". The letters added: "The Company does not wish to directly capitalise any profits but prefers to declare dividends and allow the shareholders to make application for the shares and use the funds from the divi- dends to pay for them." The application form in each case con- tained a statement that the proposed issue was for the Company's business as the present paid-up capital is inadequate"; and it added: " It is not intended to capitalise any account but is intended to distribute tax-paid and taxable dividends at least equal to the amount paid on the new shares On 14th November in the case of Melford, and on 17th November in the cases of Lane's and Neal's, the consent applied for was given and in each instance a note was added, stating that the approval had been given on the

96 CLR 606

undertaking that all the conditions pertaining to the issue of capital as set out on the application would be observed.

Correspondence ensued between Mr. Ratcliffe and the companies legal advisors, Messrs. Corr &Corr, solicitors, of Melbourne. The topics dealt with included the amendments to be made in the respective articles of association, the application of the National Security (Capital Issues) Regulations, and the establishment of branch share registers in the Australian Capital Territory-a refinement introduced into the proposal to avoid difficulties of valuation and consequential delays which were thought likely to occur if the stamp duty laws of the States were encountered. One outcome of this was that, instead of having a contract executed by all parties for the sale and purchase of the A shares as Mr. Ratcliffe's letter of 12th September had proposed, it was decided to have options given by the shareholders to Pactolus, to be exercised in Canberra by a notice to Mr. Ross, as agent for the shareholders, and that Mr. Ross should be authorised both to accept the purchase money for the A shares and to pay Pactolus the purchase money for the new shares taken up by it. Only one other point discussed in the letters need be mentioned. Mr. Bunny, of Corr &Corr, showed that he understood the transactions to be preliminary to the ultimate conversion of the companies into listed public com- panies, for he proposed to make it a term of the transactions that if that should not happen within a stipulated period the vendors of the A ordinary shares should repurchase them at £1 each. Mr. Ratcliffe strongly opposed anything in the nature of a string to the purchase, mainly on the ground that it would enable the Com- missioner of Taxation to contend that the vendors were engaged in a profit-making scheme. In a letter to Mr. Harry Lane he said that the adoption of Mr. Bunny's suggestion might 'result in the loss of the advantage sought to be obtained "; and he added:

If the sale includes a 'string' to the shares, opinion both official and public would be against us and the Commissioner might seek an amendment of the law to tax the transaction. If there is no 'string' there is then only a sale of an investment which would be very difficult to legislate for, either retrospectively or otherwise." Plainly enough, the "advantage" referred to was the immunity of the profits from a drain of 15s. in the pound in favour of the Commissioner of Taxation; and, equally plainly, the transactions which were being evolved were regarded as ensuring that immunity by reason of their being sales of investments and nothing more. With his letter of 18th October 1949, Mr. Bunny submitted to Mr. Ratcliffe a draft option agreement for the sale of the A ordinary

96 CLR 607

shares. This included a covenant by the purchaser to apply for a number of new shares, to pay for them in full (without saying with what moneys), and to sell them to the original shareholder at £1 per share. It also contained an authority to Ross as the original shareholder's agent (inter alia) to receive the purchase money for the A shares and to pay out of it any amount payable by the original shareholder on his purchase of the new shares. The option agree- ments ultimately executed did not contain the second part of this authorisation.

The details of the proposed transaction were dealt with in a number of letters, and in the meantime Mr. Ratcliffe was being given the monthly figures of the motor companies. He was asked in November to draft the dividend resolutions and the drafts he prepared were ultimately varied in the light of the latest figures and the conclusions drawn from those figures as to the amounts that could be distributed. Mr. Ross prepared what he called a check sheet, setting out in detail all that had to be done to carry through the transactions. This was not agreed between the parties in the sense of becoming any part of the bargain, though Mr. Ratcliffe did see it and make the comment that it seemed to cover everything. On 8th December 1949, Mr. Ratcliffe wrote to Mr. Ross, referring to the account he had arranged to open for Pactolus with the South Melbourne branch of the E. S. &A. Bank Ltd., and saying (inter alia): "I have calculated that Pactolus Pty. Limited will need something less than £19,000 to meet the cheques which it will give on this new account, and I am, therefore, paying this amount into the Sydney Office of the I.A.C. to-day and would be glad if you would arrange with your (i.e. I.A.C.'s) Melbourne Office to draw a cheque for the same amount and pay it into the Bank when you open the Account." The calculation which Mr. Ratcliffe had made he checked against a statement supplied by Mr. Ross, which set out in schedule form exactly how each shareholder in the three motor companies would fare in consequence of the trans- actions and for what amounts each of them would have to provide cheques to be used in the carrying out of the transactions. The receipt of this statement, embodying final figures as it did, made it clear to Mr. Ratcliffe that the shareholders had finally decided to go on with his proposal but there was never anything more specific by way of assent to it. Everyone concerned proceeded to carry out the transactions which I have described at an earlier stage of this judgment, all the details being attended to as worked out in Mr. Ross's check sheet.

In Clarke's Case (2) the facts showed that the appellant was the owner of licensed premises which he proposed to lease to a tenant. Part of the contemplated consideration for the granting of a lease was the payment by the tenant of a substantial premium which, if it had been paid to the appellant pursuant to an agreement between them, would have constituted assessable income in the appellant's hands. But instead of granting a lease directly to the tenant he agreed that he would grant a lease in the proposed terms to a company of which he was the governing director and sole bene- ficial shareholder, and that, in consideration, inter alia, of the pay- ment to the company of the specified premium, the company

1(1953) 87 C.L.R. 548. 2(1932) 48 C.L.R. 56. 96 CLR 668

would transfer the whole of its interest in the lease to the tenant. Thereafter the lease was granted to the company, the specified premium was paid and the company thereupon assigned the lease to the tenant. In fact the premium was received from the tenant by the appellant and was paid by him into his personal banking account but this is of little consequence for, in law, the tenant thereby discharged his liability to the company and the payment was treated by the company in its books as a payment to it. The only reason for mentioning this particular circumstance is to explain why when, shortly after, the appellant decided that the company should go into liquidation and that its assets should be distributed this amount was not paid by the company to him. It was however the subject of an adjustment and reconciliation in the course of the liquidation.

It was not suggested in Clarke's Case 1 that the dealings between the appellant and his company were mere shams. Indeed in the stated case it was expressly stated that none of them were shams or fictitious transactions and that "they were intended by the company to be operative and effective". "But they were it was said, " entered into by the company solely because their operation and effect would or might prove advantageous to the appellant, both generally, and from the point of view of State and federal income tax legislation." It is, however, obvious from what has been said that, although a lease was granted to the company, the interest which it SO acquired was not of the slightest use or benefit to it. Nor, indeed, was the premium which it received from the tenant and it may well be said that, although the various dealings were legally effective according to their tenor, they had no significance whatever other than the avoidance of income tax. As was said in the course of the Court's reasons: "The grant of the lease to the Company, his" (the appellant's) "automaton, and its immediate assignment to the intending lessee, and the subsequent liquidation of the Company, and the entries in the books of the Company narrating the taxpayer's accountability to it for the money and the accountability of himself as the Company's liquidator in a like sum, all amount to an arrangement adopted for the sole purpose of intercepting the liability to income tax which would otherwise flow from the payment to him of a consideration actually demanded and actually given in connection with a leasehold " 2. The italics are mine and emphasise that the dealings were dispositions of property in favour of the company in name only and that the sole purpose and significance of the arrangement of which they formed part was as a facade to defeat the provisions of the Act.

1(1932) 48 C.L.R. 56. 2(1932) 48 C.L.R., at pp. 79, 80. 96 CLR 669

It was possible to characterise the arrangement disclosed by the evidence in Bell's Case 1 in precisely the same way. In that case a company had been formed for the purpose of selling surplus military equipment which had been acquired by the appellant and the other six beneficial owners of the seven £1 shares which repre- sented the issued capital of the company. The circumstances in which the appellant and the other beneficial owners secured transfers of these shares and, thereafter, resold them for £11,000 each are fully set out in the reasons delivered in that case and it is unnecessary to reiterate them. It is sufficient to say that the profits which, at the relevant time, became available for distribution to the ultimate shareholders amounted to approximately, £78,500, that the payment by the company to those shareholders of dividends of £11,000 per share almost entirely stripped it of its resources and that it was established that there was not the slightest intention on the part of anyone that the company should continue to function after the arrangement had been carried out. It was said that at the material time The Papuan company had been paid £78,520 for the goods it had sold to Torokina Disposals Pty. Ltd., and this sum consisted almost entirely of distributable profits since the Papuan company had no external liabilities and its paid-up capital was only £7. It had disposed of £77,000 of these profits, and the old shareholders between them had received £77,000. The old shareholders had parted with their shares. The new shareholders held all the issued shares in a company whose assets consisted of a little over 100, being the surplus which remained after providing for directors' travelling expenses and other small outgoings. It may be added, in order to complete the history of the company, that Mr. White " (the solicitor engaged by the appellant and his colleagues) " on 6th February 1948 was paid his costs and obtained £1,000 from the company's funds as a loan. He later bought in for £20 each the shares which his six clients had purchased. The company had then only about £30 left in its bank account and no one seems to have troubled about it since" 2. The only difference between Clarke's Case 3 and Bell's Case (1) is that the company which was interposed between the appellant in the former case and the tenant to whom the lease was assigned received no benefit whatever from the carrying out of the arrangement, whilst, in the latter case, it appears that each of the six persons who had acted virtually as ciphers in the matter received a small reward for their co-operation and that the solicitor for the parties succeeded to practically the whole of the residual profits of the company, no

1(1953) 87 C.L.R. 548. 2(1953) 87 C.L.R., at p. 571. 3(1932) 48 C.L.R. 56. 96 CLR 670

doubt, as remuneration for his services. In these circumstances was said that: "This arrangement, both in purpose and in effect, represented nothing but a method of impressing upon the moneys which came to the hands of Bell and his colleagues the character of a capital receipt and of depriving it of the character of a distribution by a company out of profits. It was therefore a means for avoiding the income tax which would have become payable had the £77,000 been distributed by the company in the normal way 1. I take these observations to mean that the Court saw nothing in the fact that the company retained a comparatively insignificant portion of its profits to defeat the otherwise inevitable conclusion that the sole purpose and effect of the arrangement was to avoid a liability to income tax and, accordingly, Clarke's Case 2 was directly in point. It was no doubt necessary to make provision for the remuneration of those who had co-operated in the carrying out of the scheme and, since it was not intended that the company should engage in any future business, it was convenient to arrange for their remuneration in the manner indicated.

The broad conclusion to which the above observations lead is that, although the operation of S. 260 is not invoked by every "arrangement" which has the effect of avoiding income tax in the general sense already indicated it will be invoked where the arrange- ment has no significance or purpose but the avoidance of tax in that sense. Indeed, as will appear the section would seem to be of little use except in such cases.

In the present case there can be no doubt whatever that consider- ation of the incidence of income tax determined the selection of the transactions which the parties subsequently carried out. Unless sufficient distribution of the profits made by the several companies during the year ended 30th June 1949 was made before 31st December of that year additional tax under Div. 7 of the Act would have become payable. On the other hand the making of such a distribution to the existing shareholders would have resulted in the dividends paid becoming part of their assessable income and subject to income tax at a high rate. And the latter result would, of course, have ensued, if instead of declaring and paying dividends to the shareholders in cash, the company had issued bonus shares to them. But as appears from the evidence it was essential for the companies concerned to maintain their working capital intact, or substantially intact, and this could not be done if a large proportion of its profits was to be used in the payment of additional tax under Div. 7 or in the payment of dividends to the shareholders and sub- jected to taxation in their hands. One solution of the problem

1(1953) 87 C.L.R., at p. 573. 2(1932) 48 C.L.R. 56. 96 CLR 671

was, of course, to convert the companies into public companies and seek additional capital from the public. But although a great deal of tax would have been saved by this method it did not find favour; none of the interested parties were prepared to enlist public support to the extent of the capital required. Accordingly this method was rejected and the course ultimately pursued was decided upon. That is to say the parties determined that the companies should remain private companies and that, instead of proceeding to capitalise their profits, steps should be taken to secure the necessary capital in such a way that, whilst the companies would continue to remain under the control of the existing shareholders, no tax liability would arise.

In all, Kitto J. was required to consider five separate sets of transactions or arrangements" Three of these arrangements were made in December 1949 and the remaining two in November 1950 and June 1951 respectively. The earlier arrangements presented identical features whilst in the remaining two there were slight variations which it is unnecessary to notice. The manner in which it was sought to achieve the desired object may therefore be illustrated by stating as briefly as possible what occurred in December 1949 in relation to the shares and profits of Lane's Motors Pty. Ltd. (hereinafter referred to as Lane's), one of the three companies concerned. In the earlier part of that month the respondents (or persons whom they represented) were the holders of the 237,321 ordinary shares of £1 each which at that time had been issued by the company. One, Thomas, was the holder of the 5,000 five per cent cumulative preference shares which constituted the remaining issued capital of the company. At that time the company had available for distribution profits in excess of £400,000 and a sub- stantial part of these profits had been derived during the year ended 30th June 1949. A further substantial part consisted of profits actually made during the then current income year whilst the residual sum, £8,569, represented profits upon which additional tax under Div. 7 of the Act had been paid. It is apparent, therefore, that the value of the ordinary shares was well in excess of their nominal value. It is equally apparent that had the shareholders, or any of them, been minded to sell their holdings the purchase price would have been received by them as capital and the purchaser would have become accountable for income tax purposes in respect of dividends subsequently declared and, thereafter, received by him. But the amount which any purchaser would have been prepared to pay to obtain any of these shares would have been greatly affected by two factors. Firstly, failure on the part of

96 CLR 672

Lane's to make a sufficient distribution before 31st December 1949 of the profits earned during the year which had ended on 30th June previously would have resulted in the absorption of a considerable part of those profits in additional tax under Div. 7, with a resultant depreciation in the value of the shares and, secondly, the extent of the purchaser's liability to tax in respect of dividends received by him was a material factor. Assuming the certainty of a distribution before the critical date it is, of course, apparent that a public company might well have been prepared to pay a larger sum for the shares than an individual taxpayer and, in turn, that a charitable institution, the income of which was exempt from tax by virtue of the provisions of S. 23, could profitably have paid more for them than a public company. If the shareholders in Lane's had merely sold their shares to a purchaser answering either of these descriptions there could be no doubt that the subsequent receipt of dividends by the purchaser could not have involved the original shareholders in any liability to income tax. And this conclusion would follow whether the sale was induced by contem- plation of a prospective liability to income tax and whether or not the dividends subsequently paid would, in the hands of the purchaser, attract a liability to income tax at the same or a lower rate or not at all. But the respondents had no wish to part with substantial control of their company and they had no intention of parting entirely with their existing holdings. Accordingly, the first step in the arrangement was to convert the existing 237,321 ordinary shares into shares of two classes. One-third of each shareholder's holding -79,107 shares in all-became A ordinary shares and two-thirds became B ordinary shares. The unissued shares, 445,000 in number, became B preference shares. Thereafter, subject to the rights of the holder of the existing 5,000 preference shares, special dividend rights were attached to the A ordinary shares. Pursuant to an amendment to the articles of association made on 14th December 1949 the holders of these shares became entitled to receive the whole of the dividends declared by the company on or after that date until the dividends should reach a total of not less than £5 15s. 10d. in respect of each share and to a fixed cumulative preferential dividend of five per cent per annum as from 1st January 1950. Save as provided in the articles as amended, the holders of these shares had, thereafter, no other right to participate in the profits of the company. On the following day, 15th December 1949, the shareholders in Lane's gave to Pactolus Pty. Ltd. options to purchase their A ordinary shares at £5 16s. Od. per share and, on 19th December 1949, Pactolus Pty. Ltd. exercised

96 CLR 673

these options and delivered to the respondents in payment cheques totalling £458,820. Transfers of the A ordinary shares to Pactolus Pty. Ltd. were registered on the same day. Meanwhile, on 16th December 1949, Lane's resolved to make available for issue at par 402,679 B preference shares of £1 each and by the same resolution it was specified that such shares should be offered to the person or persons entitled to the dividends upon the A ordinary shares on or after 19th December 1949. On the last-mentioned date Pactolus Pty. Ltd., as the holder of the A ordinary shares, applied to Lane's for the issue to it of the 402,679 B preference shares and lodged with Lane's its cheque for £402,679. On the following day Lane's resolved to pay dividends on the A ordinary shares amounting to £446,295 (i.e. £5 12s. 10d. per share) and, thereafter, to issue to Pactolus Pty. Ltd. the 409,679 B preference shares. On the same day Lane's cheque for £446,295 in respect of the dividends then pay- able was handed to Pactolus Pty. Ltd. and the B preference shares were issued to the latter company. Again, on the same day, Pactolus Pty. Ltd. sold the B preference shares to the respondents for £1 per share and received their cheques for a total sum of £402,679. All of the cheques which had passed between the parties were deposited in the same branch of the English Scottish and Australian Bank on 21st December 1949 where each of the parties concerned had a current account.

At a later stage, on 22nd March 1950, Lane's resolved upon the payment of a further dividend in respect of the A ordinary shares out of the profits of the then current year. The dividend

SO declared was 3s. per share and the amount involved, £11,866, was paid to Pactolus Pty. Ltd. on the same day. This payment completed the payments necessary to satisfy the special dividend rights attached to the A ordinary shares. Thereafter Pactolus Pty. Ltd., which has been formed for the purpose of trading in shares, sold the A ordinary shares to another company, Pactolus Invest- ments Ltd., for £79,107 (i.e. £1 per share).

The effect of these transactions is compendiously stated by Kitto J. in the following passage "These steps had the following results: (1) in Lane's accounts, £402,679 of profits went out and was replaced by paid-up capital of the same amount represented by B preference shares in the hands of the original shareholders; (2) the difference between that figure and the total of the special dividends paid (£458,161) viz. £55,482, was contained in the sum of £56,141 which, as will be mentioned in a moment, was kept by the original shareholders in cash, (the remaining £659 of the latter sum being put in by Pactolus); (3) the original shareholders,

96 CLR 674

although they received nothing directly from the distribution of Lane's profits, received between them £458,820 as the price of their

A ordinary shares, keeping £56,141 of that amount in cash and applying the balance in the purchase of B preference shares from Pactolus and (4) although Pactolus had to put in £659 in cash, being the amount by which the special dividends fell short of the price paid for the A ordinary shares, it sold those shares for £79, 107 and thus made an over-all profit of £78,448. To put Pactolus's result in another way, it lost on the resale of the A ordinary shares £379,713, but the dividends it received amounted to £458,161, SO that on the whole it made a profit of £78,448. On the footing, which has been assumed to be correct for the purposes of the argu- ment, that Pactolus was a trader in shares, its taxable income would include, in respect of the Lane's transaction, only the last- mentioned amount and not the full amount of the dividends which Pactolus derived from the A ordinary shares."

In the transactions which concern the other companies Pactolus Pty. Ltd. received more than sufficient by way of dividends to enable it to purchase the holdings of the respondents and, although it is unnecessary to state the details of those transactions, it is of importance to notice that the respondents did in each case part with substantial numbers of shares and that, on the whole, those shares were sold for less than the special dividends available. That Pactolus Pty. Ltd. was able to pay SO much for the shares resulted from the fact that the special dividend rights were of a temporary character and that it was a company engaged in share trading. Hereunder is appended a table showing the amounts paid by that company for the shares which it acquired in each company, the number of shares acquired, the amounts received by way of dividend and the difference between the two sets of amounts referred to :- Lane's Motors Pty. Ltd. Neal's Motors Pty. Ltd.

(1st Transaction) Melford Motors Pty. Ltd.

(1st Transaction) Melford Motors Pty. Ltd.

(2nd Transaction) Neal's Motors Pty. Ltd.

(2nd Transaction)

96 CLR 675

In the course of the same transactions the respondents acquired 1,185,621 new shares in the same three companies. These shares were made up as follows: 402,679 shares in Lane's; 403,314 shares in Neal's Motors Pty. Ltd.; and 379,638 shares in Melford Motors Pty. Ltd. For these shares the respondents paid in all the sum of £1,185,621.

It will be seen that Pactolus Pty. Ltd. paid for the shares which it purchased sums which, in the aggregate, fell short of the dividends which it received by £102,414 and that, for the amounts paid to the respondents, they parted with shares totalling in number 161,213. For these shares Pactolus Pty. Ltd. had paid £1,661,722 but when the special dividend rights had been fully satisfied they resold the shares for £161,213 making, it was contended, an over-all loss on the various sales of £1,500,509.

It should again be stated that the various dealings were not attacked as shams. Nor was it suggested that they did not have full legal force and effect according to their tenor. In these circum- stances it is not open to doubt that the appellants sold their shares- 161,213 in number-for £1,661,722 and that Pactolus Investments Limited is now the owner of these income-producing assets. Nor can it be asserted that the parties did not intend to produce this result. That the form of the transactions was induced by consider- ation of the incidence of income tax is, however, unquestionable and the submissions made on behalf of the commissioner focus attention on a number of features. The creation of special dividend rights, the use by Pactolus Pty. Ltd. of moneys received by way of dividend to finance its purchase of the respondents' shares and the reinvestment of the bulk of the purchase money in each of the three companies concerned were, it is said, all steps in an arrangement designed to defeat a liability to tax on the part of the respondents. But if a liability to tax was avoided by these transactions it was, in the loose sense already referred to, avoided because, when the dividends in question became payable, Pactolus Pty. Ltd., and not the respondents, were the owners of the shares and because that company was a company which traded in shares and its operations left room for the contention that comparatively little or no tax could be collected from it in respect of its income receipts for the relevant year.

To my mind the case is vastly different from Clarke's Case 1 and Bell's Case 2. As already appears the arrangements disclosed by the evidence in those cases had no purpose other than the avoidance of a liability to tax and had no significance beyond the achievement of this result. It is true that the dealings which were

1(1932) 48 C.L.R. 56. 2(1953) 87 C.L.R. 548. 96 CLR 676

held to be avoided as against the commissioner by the operation S. 260 were legally effective dispositions of property but it was inevitable that they should be regarded as having no commercial significance and as serving no other purpose than, prospectively, to transmute income into capital. On this basis S. 260 applied and its effect on the relevant dealings was such as to enable the commissioner to deny any such transmutation and to assert that the particular receipts were receipts of income. But in the present case no such simple solution is possible. It may be urged that when the arrangements are considered in their entirety it is clear that it was intended that the bulk of the money paid as dividends by the companies concerned should find its way into the hands of the respondents as capital and that, in the circumstances, the amounts received by them should be regarded as income. But this brief statement presents a picture which is quite inadequate for the arrangements reached much further. The fact is that each respondent sold and intended to sell shares which were and still remain of considerable value and, as consideration, for the various transfers the purchaser intended to pay and each respondent intended to receive the purchase price. Indeed the respondents parted with and intended to part with shares which constituted practically one-third of the issued capital of the companies con- cerned and which, notwithstanding the new issue which was sub- sequently made, remained a substantial holding in those companies. That it was profitable for Pactolus Pty. Ltd. to pay SO much for the shares resulted from the circumstances that it was a company, that its operations were of a particular character and that it was intended that the special dividend rights attached to the shares would be discharged within a short space of time. But although these circumstances may have produced features which appear to be artificial their presence is by no means fatal to the respondents' contentions. As was conceded on behalf of the commissioner the dealings were within the capacity of the companies concerned and were genuine and effective and, in these circumstances, it cannot be said that the arrangements had no purpose or significance other than the avoidance of income tax. Whilst the various dealings were designed to ensure that no tax liability should arise as far as the respondents were concerned their purpose and object was to divest the respondents of a substantial part of their existing holdings and to ensure that at no time in the future would they derive income from them. They were at liberty to sell their shares and when they sold them they did SO by dealings which were genuine and effective sales. Pactolus Pty. Ltd., having purchased them, became entitled to valuable income-earning assets and nothing

96 CLR 677

emerges upon a consideration of the arrangements in their entirety to strip any of the relevant dealings of its commercial significance. It was, of course, otherwise in Clarke's Case 1 and Bell's Case 2. In these circumstances it is impossible to say that the sole purpose of the arrangements was, in the language of S. 260, to avoid any duty or liability imposed by the Act and, accordingly, the condition precedent to the operation of S. 260 has not been established.

But even if I thought otherwise I would agree with Kitto J. that S. 260 would not entitle the commissioner to treat the amounts actually received by the respondents as income. In Clarke's Case (1) and Bell's Case (2) the problem was comparatively simple. The only practical effect produced by the transactions which the com- missioner was entitled to treat as void was to transmute prospective income into capital for the facts showed that, in neither case, did the taxpayer, in a commercial sense, really part with anything. In those circumstances the annihilation of the arrangements left each taxpayer in statu quo. But in the present case the respondents parted with assets of considerable value and it is impossible simply by ignoring one part of the relevant transaction, i.e. the transfer of the shares, to characterise the actual receipt of the price of the shares as the receipt of assessable income. The appellant approaches the problem by asserting that the transfers of the shares are to be regarded as void. That is to say, the respondents must be regarded as the shareholders at all material times. Then, the argument proceeds, what happened was, merely, that Pactolus Pty. Ltd. received dividends to which it was not entitled and passed them, or some part of them, on to the respondents as the shareholders. This final conclusion, however, does not depend merely upon the notional avoidance, as against the commissioner, of the several transfers: it can be reached only by taking a further notional step for the purpose of giving a new colour or character to the payments, that is, by attributing to Pactolus Pty. Ltd. an intention to account to the respondents for the dividends received by it. But it is abundantly clear that nothing was further from the minds of the parties. The amounts paid by Pactolus Pty. Ltd. were paid in respect of a price legally payable and, although the notional annihilation of the transfers may, again notionally, leave those amounts without a character it cannot operate to invest them with a new character. Again it should be stressed that the problem in Clarke's Case (1) and Bell's Case (2) was quite different. In each of those cases the dealings between the respective parties were, as already appears, set up as a facade and upon its removal a state of affairs which involved the taxpayer in a tax liability was

1(1932) 48 C.L.R. 56. 2(1953) 87 C.L.R. 548. 96 CLR 678

A. left exposed. But, even if the section may be invoked where

dealings which have no real commercial significance have taken place, the same observation is not open in those circumstances. In a case such as the present the section may, notionally annihilate the transfer of the shares in question and it may operate to divest the purchase price of its true character but this is far from saying that it can operate to invest the payments with a completely new character and one which is completely foreign to the circumstances in which they were made.

The challenged assessments include as the assessable income of each respondent, not only the amounts actually received by them, but, in the aggregate, the whole of the moneys paid as dividends by the three companies concerned and received by Pactolus Pty. Ltd. Nevertheless the more restricted view was put on behalf of the appel- lant as an alternative and since, as it seems to me, that view involves consideration of matters which are relevant in determining whether S. 260 may be invoked at all, it has been convenient to consider the alternative view first. But in reaching the conclusion that this view should be rejected enough has been said to indicate why it is impossible to maintain that the payments to Pactolus Pty. Ltd. when made by the companies concerned could, in any way, be regarded as income derived by the respondents. They were paid to and received by Pactolus Pty. Ltd. as moneys to which that company was entitled and the notional annihilation even of every one of the steps in the arrangements under consideration cannot enable the commissioner to treat those payments as having been received on account of or for the benefit of the respondents.

The extent to which the annihilation of an offending arrangement will assist the commissioner is well illustrated by the decision in War Assets Pty. Ltd. v. Federal Commissioner of Taxation 1 and it is not out of place to quote again the two passages from Clarke's Case 2 which were cited in that case. Speaking of S. 260 it was said 3: "In its application perhaps it can do no more than destroy a contract, agreement, or arrangement in the absence of which a duty or liability would subsist. Where circumstances are such that a choice is presented to a prospective taxpayer between two courses of which one will, and the other will not, expose him to liability to taxation, his deliberate choice of the second course cannot readily be made a ground of the application of the pro- vision. In such a case it cannot be said that, but for the contract, agreement or arrangement impeached, a liability under the Act would exist. To invalidate the transaction into which the prospec-

1(1954) 91 C.L.R. 53. 2(1932) 48 C.L.R. 56. 3(1954) 91 C.L.R., at pp. 96, 97. 96 CLR 679

tive taxpayer in fact entered is not enough to impose upon him a liability which could only arise out of another transaction into which he might have entered but in fact did not enter. Where, however, the annihilation of an agreement or arrangement SO far as it has the purpose or effect of avoiding liability to income tax leaves exposed a set of actual facts from which that liability does arise, the provision effectively operates to remove the obstacle from the path of the commissioner and to enable him to enforce the liability " 1; and that 2: "The section is, of course, an annihilating provision only. It has no further or other operation than to eliminate from consideration for tax purposes such con- tracts, agreements and arrangements as fall within the descriptions it contains. It assists the commissioner, in a case like the present, only if, when all contracts, agreements and arrangements having such a purpose or effect as the section mentions are obliterated, the facts which remain justify the commissioner's assessment 3.

For the reasons given I am of the opinion that S. 260 has no appli- cation to these appeals and that, even if it has, it does not assist the appellant in upholding the assessments either wholly or in part.

In conclusion I desire to reiterate that the decision in this case depends essentially upon the meaning to be attributed to the wide and uncertain words of S. 260 and to add that, in attempting to give some reasonably precise and practical meaning to the section for the purpose of reaching a decision, I have failed to derive any assistance from current aphorisms which tend to obscure rather than reveal the solution. Nor have I found helpful observations such as those made by Viscount Simon in Latilla v. Inland Revenue Commissioners 4 concerning which I find myself in full agreement with the remarks of Jordan C.J. In the Estate of William Vicars (dec'd.) 5.

Appeals allowed with costs. Orders under appeal set

aside. In lieu of each such order, order that the appeal from the amended assessment to which it refers be dismissed with costs. Liberty to apply. Solicitor for the appellant in each appeal, H. E. Renfree, Crown Solicitor for the Commonwealth of Australia.

Solicitors for the respondent in each appeal, Corr &Corr.

1(1932) 48 C.L.R., at p. 77. 2(1954) 91 C.L.R., at p. 97. 3(1953) 87 C.L.R., at pp. 572, 573. p. 93; 62 W.N. 28. 4(1943) A.C. 377, at p. 381. 5(1944) 45 S.R. (N.S.W.) 85