Federal Commissioner of Taxation v Radnor Pty Ltd
[1991] FCA 499
•22 AUGUST 1991
Re: COMMISSIONER OF TAXATION
And: RADNOR PTY LIMITED
Nos. G446-454 of 1990
FED No. 499
Income Tax
91 ATC 4689/22 ATR 344
102 ALR 187
COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Sheppard(1), Gummow(2) and Hill(3) JJ.
CATCHWORDS
Income Tax - Taxpayer investment vehicle for trusts - investments in shares in public companies - assets sold in event of takeover, poor performance or if required for trust purposes - professional investment advisers retained to manage portfolio - whether profit realised on sale of shares income in ordinary concepts - whether business of dealing or trading in shares - significance of trust relationship - relevance of professional investment adviser
Income Tax Assessment Act 1936 (Cth): s.25
HEARING
SYDNEY
#DATE 22:8:1991
Counsel and Solicitors I.V. Gzell QC and N.R. Burns
for Applicant: instructed by the Australian
Government Solicitor
Counsel and Solicitors J.W. Durack instructed by
for Respondent: Minter Ellison
ORDER
(1) The appeal be dismissed.
(2) The appellant pay the respondent's costs of the appeal.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
JUDGE1
In these matters I have had the advantage of reading the judgments to be delivered by Gummow and Hill JJ. I am in agreement with their reasons and conclusions. The appeal should be dismissed with costs.
JUDGE2
The facts have been set out and analysed in the judgment of Hill J. and what follows should be read with that analysis.
I agree, particularly having regard to what is revealed as the true level of the volume and frequency of transactions in stocks, and to the nature of the trusts of which the shareholder of the taxpayer was a trustee, that the activities of the taxpayer are to be characterised as those of investment in shares to obtain dividends for use in enabling the performance of the trusts for the benefit of David Minter.
Two points only call for further comment in this judgment.
As has been explained, in the years of income in question, Mahana was trustee of the three trusts and held as trustee the shares in the taxpayer, Radnor. Radnor held a portfolio of shares in public companies and other assets. The terms of one of the trusts, the Pacific Trust, do not fully appear, but the settlements constituting the other two trusts each contained power of investment in shares of any company carrying on business in any State, together with a power to switch investments. The learned primary Judge (Davies J.) expressed the view that when a taxpayer is a trustee:
". . . it is less likely that a finding will be made that the sale of shares was an operation in the course of carrying on a business of investing for profit and more likely that the finding will be made that the sale was a mere realisation or change of investment."
In stating that proposition, his Honour referred to the obligation of a trustee to take such care as an ordinary prudent man would take.
No doubt, in the context of a family settlement, particularly that of the kind under consideration here, with the making of provision for a handicapped person over the remainder of his lifetime, it was, with respect, quite appropriate for Davies J. to regard the use of Radnor as the vehicle holding the share portfolios of the trusts as a factor tending against the conclusion that Radnor was conducting a business of dealing in shares.
But it would be quite wrong to conclude, and in the end it was not submitted by the appellant that the learned primary Judge did conclude, that a trustee of an express trust is never to be treated as conducting such a business, on the footing that were the trustee to be so treated, the trustee would be acting in breach of the fiduciary duties owed to beneficiaries. Much depends upon the nature of the trust in question. Express trusts take many forms and serve a variety of purposes. The content of the duties of the trustee will vary according to the nature and terms of the powers vested in the trustee. There has been a long history of the conduct of trading activities by the medium of trustees, of which the recent use (and abuse) of the trading trust has been an echo. The history, before the rise of the limited liability corporation, of the use of trusts for the conduct of significant trading ventures is discussed elsewhere; see, generally, Elders Trustee and Executor Co Ltd v E.G. Reeves Pty Ltd (1987) 78 ALR 193 at 228-231. If such trustees are authorised or directed by the constituent documents, or, in a given case, by the beneficiaries, to conduct speculative activities or otherwise to engage in a business, then the content of their duties is to be ascertained with that in mind.
The second point concerns the uses to which the decision in London Australia Investment Company Limited v The Federal Commissioner of Taxation of the Commonwealth of Australia (1977) 138 CLR 106 has been put in this Court. In the present case, we were invited by counsel to descend upon the judgments of Gibbs J. and Jacobs J. in that case, and upon subsequent decisions in this Court, with what would resemble the pedantic zeal of glossators. We even had pressed upon us the transcripts of arguments in three unsuccessful applications to the High Court for special leave to appeal from decisions of this Court. This cannot be right. It should not be repeated.
I should refer in particular to two decisions of the Full Court delivered in June 1990, CMI Services Pty. Ltd. v Federal Commissioner of Taxation (1990) 90 ATC 4,428 and Federal Commissioner of Taxation v Equitable Life and General Insurance Co. Ltd. (1990) 90 ATC 4,438. It has been suggested that the bench in these cases acted each in ignorance of the judgments about to be delivered by the other: Unitraders Investments v Federal Commissioner of Taxation (1991) 91 ATC 4,454 at 4,472. That is not so. Nor are the two decisions at odds.
In Equitable Life (supra at 4,456), in the course of what in the result was a dissenting judgment, Pincus J. said it might be deduced from the majority judgments in London Australia that a profit on a sale of shares may fall within s. 25 in the case of a company carrying on business, either as profit earned in the course of the business or because of its connection with the taxpayer's business; his Honour referred to various authorities describing the connection between the profit and the business which is sufficient, or insufficient, to make the former assessable. As his Honour said, the questions involved are ones of degree and therefore different minds may reasonably reach different conclusions. The division in the Court deciding Equitable Life is an illustration.
The majority in Equitable Life agreed with the primary Judge (Wilcox J.) that the connection between the profits in question and the insurance business of the taxpayer was not such as to render them assessable. Further, it was not contended that the taxpayer, having regard to the number, repetition and regularity of its dealings, was to be characterised as carrying on a business of trading in shares, in addition to its insurance business. What was unsuccessfully submitted was that there was another available category attracting liability, that of a business of investment "in the London Australia sense". That proposition was rejected in a passage in the judgment of Davies J. (supra at 4,447) which emphasised the elements common to the reasoning of Gibbs J. and Jacobs J. in the earlier case. Likewise, in CMI, Lockhart J., with whose judgment the other members of the Full Court agreed, described (supra at 4,436) London Australia as a case where the large volume of share transactions was a normal operation in the course of carrying on a business of the taxpayer of investing for profit.
The taxpayer in CMI had been incorporated to serve as the property investment company through which surplus funds of its parent, Chamber of Manufactures Insurance Limited, might be invested. A proposition was put in CMI which was not put in Equitable Life. The taxpayer contended that London Australia established that the profit on the realisation of investments is assessable under s. 25 only if the investments had been acquired for the purpose of profit-making by sale. Lockhart J. had regard to the dealings by the taxpayer in real estate, in substantial sums and not inconsiderable in volume. His Honour concluded (supra at 4,437) that whilst the taxpayer was carrying on the business of investing for the purpose of producing income, the buying and selling of real estate in the manner I have described was done as part of that business. His Honour also held (supra at 4,435) that London Australia, particularly the judgment of Jacobs J., did not require that a taxpayer who carries on a business must, in order for s. 25 to be attracted, necessarily have a purpose of resale at a profit, when assets are acquired in the course of carrying on that business; the lack of such a purpose was an important but not, on the facts of CMI, the decisive factor.
I would dismiss the appeals with costs.
JUDGE3
The appellant, Commissioner of Taxation, appeals against the judgment of a judge of this court (Davies J) allowing the appeal of the respondent, Radnor Pty Limited ("Radnor") against objection decisions of the Commissioner in respect of assessment of income tax for the years of income ended 30 June 1980 - 1986 inclusive and under the provisions of Division 7 of Part III of the Income Tax Assessment Act (1936) ("the Act") for the 1980 and 1981 years of income.
At issue in the appeal is the assessability of profits made by the respondent in the respective years of income from the sales of public company shares. The Commissioner submits that the profits are income in ordinary concepts and thus fall to be included in assessable income under s.25 of the Act; the respondent submits that the profits are capital profits. It is not suggested that the provisions of s.26(a) or s.25A of the Act are applicable, it being conceded that the shares were not purchased for the dominant purpose of resale at a profit.
Between 1929 and 1949 three trusts were settled known as the Pacific Trust, the David Minter Settlement Trust and the David Minter Trust. Two of these trusts were established specifically to provide for David Minter the income being payable to him or for his benefit during his life with the capital passing on his death to other members of the Minter family. The third, the Pacific Trust, empowered the trustees to apply income for the benefit of four members of the Minter family including David. Since 1949 the income of the Pacific Trust was paid to Mr Clifford Minter, David's father and until his death in 1977 a well known Sydney solicitor, for use solely for the maintenance and care of David.
David, now 61 years of age, was born with serious intellectual and physical handicaps and is unable to care adequately for himself. Upon the death of Mr Clifford Minter, the Pacific Trust vested in the surviving members of the Minter family, John, Robert and David Minter. David's share was advanced to Radnor and dealt with by it as part of its assets.
The trustees of the three trusts were originally Clifford Minter, Ethel Minter (until her death), Robert and later also John Minter. In 1956 Mahana Pty Limited ("Mahana"), a company controlled by members of the Minter family, purchased the assets of the then three trust estates. It would seem that the whole, or at least a substantial part of the purchase price, remained outstanding as a loan. Mahana also acquired the shares in two family companies which owned rural properties in Moss Vale. As part of a further reorganisation, Radnor was incorporated in 1959 and in that year acquired from Mahana the majority of its assets being shares in public companies and the shares in the private companies owning the Moss Vale land. As part of this reorganisation, Mahana was thereafter appointed as trustee of each of three trust estates. It held thereafter, in its trustee capacity for the benefit of the three trust estates, all the shares in Radnor and Radnor in turn held a portfolio of public company shares as well as the shares in the two companies owning rural land. Dividends declared by Radnor in each year were declared in favour of Mahana as trustee of the three trust estates. Some interim dividends were declared to meet David's requirements as they arose. In turn Mahana distributed so much of the income as was needed for David's requirements and the surplus was reinvested with Radnor.
From time to time, family members, particularly Mr Clifford Minter, lent sums to Radnor for investment; at times Radnor lent funds to family members usually at interest. Loans made by Radnor interest free were made on the basis that the recipient would in some way contribute to David's maintenance, welfare or general enjoyment of life.
His Honour described David's lifestyle in the following terms:
"David lived with his parents until his mother's death and thereafter with his father until May 1966 when Radnor acquired a house at 23 Clairvaux Road, Vaucluse, as a home for him. He has since lived there, except for visits to the family's farming property at Moss Vale and other short trips. He is assisted by and is accompanied on his trips by a live-in housekeeper who attends to his needs and manages purchases of food, household supplies, cooking and cleaning. As David does not read books or newspapers and now tires easily from physical exertion, he spends much of his time watching television."
The Moss Vale properties were sold between 1980 and 1985 when David no longer had much enjoyment of them following the death of his parents and of the wife of the manager of the properties with whom David had liked to stay on the properties.
Until 1976 the investments of Radnor were managed by members of the Minter family. The investment policy which was pursued in respect of the public company shares from the time when those shares were held directly by the trustees of the family trust throughout the periods when they were held by Mahana and Radnor was explained by Mr Robert Minter, whose evidence was not contested, in the following words:
"We bought shares primarily to obtain an income for David but also with a view to securing the growth of capital as a means of providing against inflation. It was obvious to me then and I believe also to the other trustees, as it remains obvious to me now, that moneys placed on deposit to earn interest income only will eventually lose their value as a consequence of inflation. We therefore bought shares in public and private companies with a view, from time to time expressed by all of us, to combating the influence of inflation by obtaining either bonus issues in the securities acquired or issues at less than the market price then prevailing with the object of continually raising the level of capital upon which dividends were calculated. Occasionally we would invest in securities with such a high yield or anticipated yield that the absence of capital growth did not concern us although this was unusual, and from time to time we made interest bearing deposits of funds not immediately required for David or investment elsewhere. We sold shares representing such investments only in the following circumstances which were from time to time discussed between us:-
(i) If there was a need for funds for some specific purpose associated with David's or the family's welfare;
(ii) If the relevant shares had become the subject of a takeover offer - either because we did not wish to be the subject of a compulsory acquisition or we did not wish to be left in the position of one of a group of shareholders who did not have control of the company; or
(iii) If the shares were performing poorly - this could occur either because the dividend yield was too low and there were no bonus issues or signs of growth or if the management was apparently performing poorly. I was also interested, although not unduly so, in the market value of shares in our portfolios from time to time. The other trustees expressed similar interest. Had the value of the portfolios entrusted to us been declining we would have been concerned about the consequences of inflation and each of us had in mind, and expressed as much to each other, that if we ever had to commit David to an institution or to substantially increase the level of care for him then it might be necessary to have resort to capital of the trusts and, failing the availability of sufficient capital, to our own resources in order to support David. We therefore regarded substantially declining market values as an indication of poor performance which did not meet our criteria for investment."
In 1976 Radnor appointed a firm of professional investment advisers, John D.G. Robinson and Associates, to manage the investment portfolio. That firm merged with Wardley Australia Limited and became Wardley Investment Management Limited ("Wardley"). A portfolio management agreement was executed in 1984 with that company.
Initially a Mr McKinnon was the adviser responsible for the management of the portfolio. Upon Mr McKinnon ceasing to be employed by Wardley in 1987 it was managed by Mr Williams. At the commencement of the engagement of the adviser, Mr Minter instructed Mr McKinnon that the portfolio should be managed on the basis that the purchase of stocks was to be made with a view to obtaining a good yield with growth prospects and also with a view to investing in shares the value of which would at least keep pace with inflation. By yield, Mr McKinnon understood "income yield or dividend yields". At the time these instructions were given Mr Minter explained to Mr McKinnon David's circumstances and instructed Mr McKinnon that he had to provide a certain amount of income for David. Mr McKinnon was to provide a level of income to cover David's expenses and as those expenses would increase with inflation Mr McKinnon understood that he was to look at investing in stocks with growth in earnings and therefore growth in dividends.
Upon Mr Williams taking over the management of the portfolio from Mr McKinnon, Mr Minter gave Mr Williams instructions to the like effect. Mr Minter explained to Mr Williams that the Minter family was interested in investment in shares that would pay high dividends or have long term growth potential that would be a protection against inflation. Shares were only to be sold to raise funds to meet David's expenses or if the stock should, in Mr Williams opinion, be sold because of a takeover or because the particular stock was performing badly.
Thereafter shares were acquired from time to time in accordance with this policy. Shares were sold only where takeover offers raised the prospect of compulsory acquisition or Radnor remaining a minority holder, where shares were performing poorly e.g. if the dividend yield was low, there were no bonus issues, or if the management was performing poorly or where there was a need for funds for some specific purpose associated with the welfare of David or that of the family. Shares were also sold for the purpose of disposing of stocks or rights where there was an absence of available funds to take up the issue or because the percentage investment by Radnor was disproportionate having regard to weightings of stocks in the portfolio by reference to the Stock Exchange All Ordinaries Index.
During the time the portfolio was managed by Wardley an attempt was made to ensure that the portfolio did not hold percentages of stocks in particular areas of the market which were substantially different from the proportion of those holdings in the Stock Exchange All Ordinaries Index, or as determined by overall investment policy. His Honour found that weighting was not used as a strict or inflexible rule but was a factor which was taken into account. The basis of such an investment policy was that the performance of the All Ordinaries Index was often a more reliable guide to performance of shares than an individual assessment of the merits or demerits of particular stocks. On occasions stocks were also sold because their prices were not justified by their likely future performance.
Except when a specific need for funds arose, the Minter family accepted the adviser's advice as to purchase and sale of shares. However, Mr Minter stressed that the advisers did not have carte blanche. They were required to invest within the policy which Mr Minter had communicated to them. Mr Minter, when asked as to his state of mind at the time of purchase replied:
"We did not buy shares for possible sale, but any state of mind I would have had would have been that if we did sell the shares or had to sell the shares, as we did on occasions, we would not want to do it at a loss. The primary thing was to keep the fund going, not to make a loss."
Evidence was given below of all transactions which had occurred from the year ended 30 June 1960 to the year ended 30 June 1988 and, so far as could be recalled, the reason for each purchase and sale. In the 1980 income tax year shares were sold in ten companies for a total sale price of $132,347. Four of those sales, totalling approximately $65,000 of the gross proceeds were as a result of takeovers. In the year ended 30 June 1981 shares were sold in seventeen companies for a gross sale price of $167,325. Of the shares sold, eight of the sales were as a result of takeovers which accounted for approximately $60,000 of the sale proceeds. Four of the sales arose to finance funds to be advanced to R.H. and S.J. Minter. In the year ended 30 June 1982 sales of shares or rights in twenty four companies occurred for a gross sale price of $190,459. Of the shares sold, six were the result of takeovers accounting for some $50,000 of the sale proceeds, five of the parcels of shares were sold to raise funds needed for a family reorganisation and a number of the sales were of small parcels of rights. In the 1983 year twelve parcels of shares were sold for a total consideration of $69,135. Of these sales, two for a total of approximately $12,000 were attributable to takeovers and one arose as a result of a voluntary liquidation of a company. In the year ended 30 June 1984 shares were sold in twelve companies for a gross selling price $151,283. Of the sales, two occurred as a result of takeovers amounting to approximately $53,000, one parcel of shares realising $29,676 was sold to meet part of the tax on amended assessments, and one transaction realising $19,500 arose as a result of the winding up of a trust. In the 1985 year there were sales of four parcels of shares for a total of $12,465. One of these transactions, realising $4,644, was as a result of a takeover. In the 1986 year there were sales of five parcels of shares and one parcel of convertible notes for a total sale price of $252,681. Of those transactions, four, accounting for approximately $83,000, were as a result of takeover offers.
The profits derived from the sales:
"Year ending 30 June 1980 $93,706 Year ending 30 June 1981 $84,981 Year ending 30 June 1982 $79,367 Year ending 30 June 1983 $25,282 Year ending 30 June 1984 $5,891 Year ending 30 June 1985 $10,048 Year ending 30 June 1986 $171,387."
Against this it might be noted that the market value of shares held by Radnor as at 30 June in each year was as follows:
1979 year $608,784 1980 year $928,904 1981 year $981,390 1982 year $579,075 1983 year $659,946 1984 year $760,136 1985 year $981,076 1986 year $1,238,622
His Honour found that dispositions resulting from takeover offers amounted to 46% in value of the total dispositions made by Radnor. When takeover offers are disregarded, dispositions in each year ranged from 1.03% to 16% of the value of the shares held at the beginning of the year.
His Honour was of the view that in these circumstances the share transactions involved in the years of income did not constitute a business of dealing or trading in shares. In reaching this conclusion he gave weight to the fact that Radnor was in substance a trustee with a duty to invest the trust funds, to derive income therefrom and to preserve the capital. He said:
"Thus, when a taxpayer is a trustee, it is less likely that a finding will be made that the sale of shares was an operation in the course of carrying on a business of investing for profit and more likely that the finding will be made that the sale was a mere realisation or change of investment;"
Reference was made by his Honour to Charles v Federal Commissioner of Taxation (1954) 90 CLR 598, and the comments on that case by Gibbs J in London Australia Investment Company Limited v Federal Commissioner of Taxation (1977) 138 CLR 106 at 118 and by Jacobs J at 132. His Honour continued:
"Like considerations apply in the present case for Radnor, though it is not the trustee of the trusts, (it) is the instrument of the trustee for the purpose of investment of the trusts' funds. Being the investment arm of the trustee, Radnor must manage its investments having regard solely to the interests of the beneficiaries. Radnor was aware of and involved with the trusts, and, if Radnor or its directors had acted in a manner inconsistent with the trust obligations or otherwise than in the interests of the beneficiaries, they would have been liable for the consequences. See Bacon V.C. in Lee v Sankey (1873) LR 15 Eq 204 at p 211. In this circumstance, I am of the view that it would be wrong to characterize Radnor's activities as a business of dealing or trading in shares. Radnor's function was not to trade but to invest. Radnor had the ongoing duty to see to both the derivation of income and the protection of the capital.
I incline to think that, absent this factor, I would conclude that the frequency of acquisition and sale, the engagement of professional managers and the resort to a system, if I might call it that, whereby shares were bought and sold by reference to the proportions of various classes of shares in the All Ordinaries Index, tended to characterize Radnor's activities as a business of dealing in shares. But Radnor was not an investment company carrying on a business for the profit of shareholders Radnor was the investment arm of a trustee and was under a duty to invest funds to the benefit of beneficiaries. As such Radnor had a duty regularly to review its investments so as to maintain an adequate level of current income and to maintain the value of the fund. If it did so in a businesslike way, it did not cease to be carrying out its function to care for the funds in the interests of beneficiaries.:"
The Submissions:
For the Commissioner it was submitted that his Honour had, in the passage cited above, found that Radnor was, on the evidence trading, or carrying on a business, but that because it was under a duty to invest, rather than to trade, his Honour had erroneously found that no trade was conducted and accordingly the profits on realisation of shares were capital profits. Alternatively, the Commissioner submitted that the only conclusion open on the evidence was that Radnor was trading in investments. Finally, it was submitted that if Radnor was not trading in shares it was conducting a business and a purpose of acquisition of the shares that were realised was resale at a profit.
For the respondent, it was submitted that Radnor had not dealt in shares, but rather that it had acquired and held shares for their dividend income. Alternatively, if Radnor carried on any business at all, it was not a business in the course of which profits were made in the realisation of investments. Finally, it was submitted, that in reaching a conclusion whether a business of trading or dealing in shares was carried on, the circumstances of the ownership of the shares by trustees, under a duty to provide income for David, was a matter appropriate to be taken into account, and that his Honour had not erred in so doing.
The applicable principlesThe starting point for determining whether profits on the realisation of assets is income in ordinary concepts is the well known statement of the Lord Justice Clerk in Californian Copper Syndicate v Harris (1904) 5 TC 159 at 165-166, where his Lordship said:
"It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business... ...Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?"
That test for distinguishing income from capital profits has been applied in numerous cases, both in the High Court and in this court, see eg: London Australia (supra) at 115-6, and cases there referred to, Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199; Commissioner of Taxation v Equitable Life and General Insurance Co. Ltd (1990) 93 ALR 609 at 617 per Davies J; CMI Services Pty Limited v Federal Commissioner of Taxation (1990) 94 ALR 153 at 155 ff, AGC (Investments) Limited v Commissioner of Taxation (1991) 91 ATC 4180. It may perhaps be thought that the test is more useful in stating the issue, than in resolving it.
There has never been any doubt that if a company is carrying on a business of buying and selling shares, those shares will form its trading stock and the gross profits it makes in realising those shares will be income in ordinary concepts. The concept of trading stock connotes, as its ordinary meaning suggests, that the stock is purchased in the course of a business activity and is held for resale: Federal Commissioner of Taxation v St Hubert's Island Pty Ltd (1977-8) 138 CLR 210, per Mason J at 226. It will, of course, in an appropriate context extend to raw materials and components and partly finished goods. The concept of resale, inherent in the ordinary meaning of trading stock, is to be found in the inclusive definition of trading stock in s.6(1) of the Act. On the evidence the shares in question were not purchased for a purpose of resale and would not be seen to be trading stock of a trader in the ordinary meaning of that term. Although the Commissioner did not concede that the shares were not trading stock, no submission was made that they were, nor could such a submission have been made on the facts.
London Australia made clear that there were cases where, notwithstanding that a taxpayer was not carrying on a business of trading in shares, such that the shares were his trading stock, his net profits, not gross sales proceeds, could be income in ordinary concepts. Previously it had been recognised in the cases of banks and insurance companies whose business required as an incident that funds surplus to the day to day requirements of banking or insurance, be invested, that net profits were income in ordinary concepts: Commissioner of Taxation v Commercial Banking Co of Sydney (1927) 27 SR (NSW) 231 at 233-4; Punjab Co-operative Bank Ltd, Amritsar v Commissioner of Income Tax, Lahore (1940) AC 1055; Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1946) 73 CLR 604. In such cases, the making of profits on investments was an ordinary incident of the banking or insurance business. It was, however, perceived that the banking and insurance cases were anomalous exceptions to the general rule.
In London Australia, Gibbs J made it clear that the banking and insurance cases were but a reflection of the general principle enunciated in Californian Copper. In that case, upon which the Commissioner relied heavily in the present case, the taxpayer had a consistent policy of buying or selling depending upon market movements, and did so on a large scale. Nevertheless the taxpayer had not purchased the shares for the dominant purpose of resale at a profit nor were the shares trading stock of a business of trading in shares. It was, however, common ground in the High Court that the taxpayer was carrying on the business of investing, for the purpose of producing income (supra at 119). Hence, in the view of Gibbs J, the issue was whether the buying and selling of the shares was done as part of that business. His Honour was of the view that the conclusion at first instance in the affirmative was correct. In so doing his Honour referred (at 117) with approval, to the characterisation of the activities of the taxpayer by Helsham J at first instance as involving a business of dealing in shares "in the sense that switching of investments was desirable to produce the best dividend returns and was indeed necessary if the taxpayer's policy of investing in shares with growth potential was to be adhered to."
Jacobs J was also of the view that the profits were income in ordinary concepts. In so doing his Honour expressed the view that the activity of the taxpayer constituted a business. In a discussion that some have thought to diverge from the position taken by Gibbs J, his Honour said, in the context of discussing the difference between the first limb of s.26(a) and income in ordinary concepts (at 128):
"If the acquisition and disposal of property is part of a business of so doing, the position is significantly different. There must still be a purpose of resale because resale is part of the description of the relevant business, and, since business has in it the notion of profit-making rather than loss-making, there must no doubt be a purpose of resale at a profit. But the significant difference is that the purpose of resale need not be the sole purpose or the primary or dominant purpose, as is the case under the first limb of s.26(a). It need only be one of the purposes..."
Later in the judgment, his Honour observed (at 130-1), in the context of a discussion of whether the taxpayer was carrying on a business:
"I do not think that a conclusion on scale by itself provides the answer; but it is very important evidence tending to show a business of acquiring and disposing of shares and it was some evidence from which a purpose of thereby making a profit might be inferred. It was for the appellant to rebut the latter inference. In my opinion it has not done so. It has in its favour the very important circumstance that the source of the funds was the subscribed capital of the company. But this is only part of the evidence. The evidence taken as a whole strongly supports a conclusion that a purpose or intention or expectation implicit in the carrying into effect of its investment policy was that shares acquired would be resold if and when an occasion arose which would make it desirable so to do and an element of desirability was that there would be greater financial benefit in disposing of the shares at an enhanced value than in retaining them... The massive scale of the activities in the years in question practically compels the inference that the investment policy was one which in its inception and throughout the course of carrying it into effect would in the expected state of the rising market require frequent and regular realizations of shares whenever they rose in market price before dividends from them were increased."
It is not necessary for the purpose of the present case to determine whether anything turns upon the difference in emphasis between the judgment of Gibbs J, and that of Jacobs J, cf CMI Services Pty Limited v Federal Commissioner of Taxation (supra) at 160 ff in the judgment of Lockhart J, with whom Jenkinson and Gummow JJ. agreed, and AGC (Investments) Limited v Commissioner of Taxation (1991) 91 ATC 4180 at 4192-3. On either view it is necessary to determine whether the activities of Radnor were such as to constitute a business, and to characterise that business. If the shares were purchased by Radnor as part of a business, so that the gains on realisation were made in the ordinary course of that business the gains will be income. If, the gains made were made otherwise than in the ordinary course of business, then the gains could not be income unless the acquisitions were made with the intention or purpose of making a profit, cf Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 at 209-210. Since on the evidence they were not, the respondent must in such case succeed. Likewise, if no business was carried on by Radnor, then the gains, not having been made for the purpose of profit-making by sale, would be on capital account.
The relevance of Radnor's position as a vehicle for the investment of trust funds.It must be said at the outset that his Honour did not, despite the submissions of counsel for the Commissioner to the contrary, find that but for the ownership of Radnor by the trusts and the duties of the trustees to ensure that funds were invested for the benefit of David, or other members of the Minter family, Radnor was carrying on a business of dealing or trading in shares. In the passage criticised by counsel his Honour expressed a view that was, at the most, tentative. He expressed himself in terms of inclination. He referred to the evidence as only "tending" to characterise the activities of Radnor as a business of dealing in shares. What his Honour did was take into consideration, in weighing up the facts upon which his conclusion that Radnor carried on no such business was based, the factual circumstance that Radnor was a vehicle for the investment by the three trusts of the funds which the trustees were under a duty to invest. I do not read his Honour's judgment as suggesting that he was constrained by Charles Case, as a matter of law, to find that Radnor was not carrying on a business.
In Charles, the taxpayer was also a trustee. The trust deed provided that, except for the purposes of the deed, the trustees should not sell any investments until the determination of the trust. Nevertheless, the deed did give the trustees a wide power to vary investments. The court, on the evidence before it which included the provisions of the trust deed, saw the case as one where the transactions were effected in the course of the trustee's fiduciary obligations to the beneficiaries to preserve for them the trust assets and increments thereto, rather than as a case where the trustees were carrying on a business of "stock jobbing". Nevertheless, Dixon CJ, Kitto and Taylor JJ. said (at 610):
"...if the proper conclusion from the evidence were that the managers and the trustees co-operated in pursuing a systematic course of buying and selling securities for the purpose of producing profits and thereby swelling the half-yearly amounts of `cash produce' available for distribution to certificate holders, the commissioner's opinion that such profits should be treated as assessable income of the certificate holders when paid over to them would be clearly correct."
It could never be conclusive of the question whether a business is carried on by a taxpayer that the taxpayer is a trustee. The taxpayer in Official Receiver in Bankruptcy (Fox's Estate) v Federal Commissioner of Taxation (1956) 96 CLR 370, for example, was a trustee, but on the facts of that case was engaged in a business or profit-making scheme. But that is not to say that the fact that a taxpayer is a trustee with fiduciary duties to his beneficiaries is irrelevant to the process of characterisation involved in determining whether his activities involve a business.
In London Australia Gibbs J observed (at 118), citing Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740, that in determining whether a sale was a business operation carried out in the course of the business of profit making, rather than a mere realisation of a capital asset, it was necessary:
"to make both a wide survey and an exact scrutiny of the taxpayer's activities"
It was in this context that his Honour noted that different considerations might apply, depending on whether the taxpayer were an individual or a company. Later in the judgment his Honour said (at 118):
"The position of an investment company is materially different from that of an individual managing his own portfolio of shares. It is different also from that of a trustee managing a portfolio of shares in a trust fund. In Charles v Federal Commissioner of Taxation (1954) 90 CLR 598 the moneys said to be taxable were received by the beneficiaries of a unit trust and derived from the realization of investments held by the trustees. Evidence was given that at no time were securities acquired for the express purpose of resale at a profit, and that sales were normally made when the managers anticipated a fall in the value of shares. The Court held that the case was distinguishable from such cases as Punjab Co-operative Bank Ltd., Amritsar v Income Tax Commissioner, Lahore (1940) AC 1055 and Colonial Mutual Life Assurance Society Ltd. v Federal Commissioner of Taxation (1946) 73 CLR 604."
Jacobs J (at 131-2) referred to Charles Case and commented:
"However, there were differences in the facts which explain the decision. There was evidence that sales were normally made when the managers anticipated a fall in the value of shares. The purpose was to preserve for the fund any increase in value which had occurred and which it seemed likely would otherwise be lost."
His Honour, after referring to the passage in Charles (at 611-2), in which the court had made reference to the fiduciary duty of the trustee in that case, said:
"Thus it could be concluded that there was no business but merely an activity of investment which was explicable by reference to the specific duties of trustees and therefore did not lead to an inference adverse to the taxpayer. In my opinion the same cannot be said of the course of activity and the reasons given therefor which are present in the instant cases."
It may very well be that since Charles it has become more normal than it was in the 1950's for trustees, often for taxation reasons, to undertake business activity. Waters, in his work Law of Trusts in Canada (2nd ed) Carswell Company Limited, Toronto, 1984, referring to the rule that a trustee was obliged to invest, but not speculate, observes (at 781) that:
"Today because of inflation the distinction between investment and speculation cannot be stated with anywhere near the same clarity. All capital is now at risk, and the task of the trustee is to keep his portfolio reasonably balanced between investments so as to maintain and, if possible, expand the capital value of the trust funds."
If in so doing, the trustee's activities amount, when viewed objectively, to the carrying on of a business, then the realisation by the trustee of his investments will be acts truly carried out in the course of his business activity and the profits or losses made will be on revenue account. Nevertheless, it remains true today that in determining whether an activity is properly to be characterised as a business activity, it will be relevant that the activity is one undertaken by a taxpayer in the position of a trustee who is obliged, in accordance with his obligation of prudence, to ensure that the assets under his control are preserved for the benefit of the beneficiaries. In such a case the fact of realisation will not enable an inference to be drawn so readily, that his acquisition of the security was undertaken for a purpose of profit-making.
It is not necessary, for the purpose of this case, to pursue the question whether Radnor owed a duty to the beneficiaries of the trusts directly, or whether, it owning its own assets beneficially, his Honour's reference to Lee v Sankey (1873) LR 15 Eq 204 was apposite. It was ultimately conceded, and in my view correctly, by counsel for the Commissioner, that in the circumstances of the present case it was not an irrelevant factor in the process of characterisation of Radnor's activities that Radnor was the vehicle for the investment of the funds of the three trusts. The necessity to ensure the availability of funds for David, for the foreseeable future, was a factor which underlay the entire investment philosophy of the company and those who managed its investments. It was a powerful factor to take into account. It was, however, only one factor and it is necessary to examine in more depth the activities which Radnor undertook, to determine whether those activities, in the light of the investment philosophy adopted, constituted a business.
Was Radnor carrying on a business of dealing in shares?There is no single factor that can be isolated as determinative of the question whether a taxpayer is carrying on a business. Rather, as Jessel MR said in Erichsen v Last (1881) 8 QBD 414 at 416:
"There are a multitude of things which together make up the carrying on of trade."
Two specific factors assist, however, in marking out activities as a business: repetition and the existence of a purpose of making a profit; Hope v Bathurst City Council (1980) 144 CLR 1 at 8-9. The significance of these factors was pointed out in the joint judgment of Bowen C.J. and Franki J in Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310 at 314, where their Honours said:
"There are many elements to be considered. The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on business notwithstanding his profit is small or even where he is making a loss. Repetition and regularity of the activities is also important. However, every business has to begin and even isolated activities may in the circumstances be held to be the commencement of carrying on business. Again, organisation of activities in a business-like manner, the keeping of books, records and the use of system may all serve to indicate that a business is being carried on..."
Volume and scale of the activity may be significant, as the passage quoted earlier from the judgment of Jacobs J in London Australia suggests, as may the amount of capital employed. While an intention to carry on a business must exist, this does not mean that the question is subjective. As Lord Buckmaster said in J. and R. O'Kane v Inland Revenue Commissioners (1919-20) 12 TC 303 at 347:
"...the intention of a man cannot be considered as determining what it is that his acts amount to."
Conversely, a man will be held to intend the natural and probable consequences of his acts, so that, albeit that he does not intend to carry on a business, if his acts amount to a business in fact, he will ordinarily be held to be carrying on a business.
However, intention may, nevertheless, be relevant, particularly in a case where the determination of business or no business is to be made at the time of commencement of a business, or in a time of business quietude, cf Goodman Fielder Wattie Ltd v Commissioner of Taxation (1991) 91 ATC 4438 at 4446-7) and cases there cited.
The Commissioner pointed to the existence of system, represented by the weighting of the portfolio in accordance with the All Ordinaries Index as of immense importance in the present case. However, where the issue is whether a taxpayer is carrying on a business of trading or dealing in shares, the mere fact that an investment adviser is employed who brings to bear professional portfolio management principles will not, of itself, require the conclusion that a business is carried on if the activities themselves do not amount to a business. So much was decided in Trent Investments Pty Limited v Federal Commissioner of Taxation (1976) 10 ALR 58.
In Trent the Commissioner argued that the profits from share sales there under consideration should be treated as business profits, where the taxpayer's activities were dictated by what was referred to as "portfolio management principles". Commenting on this submission, Mahoney J, (at 62-3) in a passage approved by the full court of this court in Federal Commissioner of Taxation v Equitable Life and General Insurance (supra) at 616 said:
"In my opinion, this general principle should not be accepted. The term `portfolio management' covers a number of different kinds of business activities and I do not think that the activities, systematic and concerted though they may be, have the income tax results which the Commissioner claims. The term, as perhaps it would more usually be understood, denotes merely the systematic investment of assets. I do not think that ... such investment activities have the tax consequences he suggests because they are systematic or are directed to matters other than the derivation of income. Those who have large sums of money have normally not held such money in globo but have turned it to account. Where this has been done not by way of trading or in the making of profits by ventures in the nature of trade, but by the purchase of assets to be held, it has generally been accepted than an increase in the value of the assets, whether realised or unrealised, is not of the nature of income. The distinction between investment, in this sense, on the one hand, and the use of capital in trade is well established. ...
Investment in the sense to which I have referred, does not cease to be such merely because it is done systematically and skilfully. It may do so if, as a matter of fact, the activities of a taxpayer are such that he is carrying on a trade."
The facts in Trent were greatly different from those in London Australia. The taxpayer in Trent was a private company, the taxpayer in London Australia was a publicly listed company. The taxpayer in Trent, as the taxpayer in the present case, had acquired a portfolio of shares before the years of income in question in circumstances admittedly not amounting to a business. That was not the case in London Australia. In each of the three years of income in question in Trent, shares were sold as follows:
No. of Sale Price Profit Shares on parcels sold hand at commencement of year - cost 9 $ 81,703 $ 35,854 $142,162 16 $201,194 $112,174 $119,208 7 $116,344 $ 67,729 $109,350
By contrast, in London Australia, shareholder's funds invested in the late 1960's amounted to over ten million dollars, there were purchases and sales in virtually each month and sales ranged from a total of $2,062,610 to $1,114,472. It was in these circumstances that it was found to be integral to the appellant's business that it dealt in shares. Helsham J at first instance in London Australia (1974) 74 ATC 4213 found that the appellant as part of its business regularly and systematically bought and sold shares and used any favourable yield in its business. Such a finding could not be made in the present case where sales made other than to provide funds for David or members of the Minter family or as a result of takeovers were relatively few having regard to the capital investment and the size of the portfolio.
Counsel for the Commissioner submitted that Trent, decided as it was before the High Court decision in London Australia, was now to be seen to be wrongly decided. I do not agree. With respect, Mahoney J was conscious of the decision of Helsham J, which was affirmed on appeal, and for substantially the same reasons as given by Gibbs J, but said that he found it distinguishable. Of course, one must be careful not to elevate issues which are in the final analysis merely questions of fact, into questions of principle. However, I am of the view that the decision in Trent provides some analogies to the present case, save that if anything the present case is more favourable to the taxpayer than were the facts in Trent for two reasons. First, the amounts involved and the volume of transactions was greater in Trent after inflation is taken into account than in the present case. Second, as Jacobs J points out in London Australia in the discussion on Charles Case cited earlier, the fact that trust relationships are involved, helps the taxpayer more easily to rebut the presumption of a profit motive that arises from a number of sales. This is particularly the case when the activities of Radnor were substantially devoted to the maintenance and care of a handicapped person, who could at any stage have needed full time institutional care, and who in any event was in need of home care.
The present is not a case where, having regard to the size of the portfolio when John D.G. Robinson and Associates were appointed to manage it, there was a large volume of transactions, particularly when takeovers are taken into account.
It was pointed out during the hearing by the court that even if the Commissioner's submission were accepted the assessment could not be correct as the profits from the sale of shares acquired at a time when Radnor was admittedly not carrying on a business were brought to tax in it. Although this matter was not the subject of argument below, or perhaps even open to be argued having regard to Radnor's objection, we were ultimately informed that the Commissioner had undertaken, in the event that the appeal was upheld, to amend the assessments for the relevant years to value the portfolio at the time the business was said to commence and bring to tax only profits made thereafter in accordance with the principles implicit in the decision of the High Court in Federal Commissioner of Taxation v Whitford's Beach Pty Ltd (1982) 150 CLR 355.
Counsel for the Commissioner submitted that the evidence of transactions in particular stocks suggested a pattern of buying and selling. At the invitation of the bench a schedule was prepared of each stock the subject of sales. What that schedule revealed was, accepting that at the time of appointment of John D.G. Robinson and Associates the respondent would have held shares in some at least of the companies, that thereafter further shares were bought from time to time. Ultimately, after the passing of a number of years, some or all of the total holdings were sold. There were isolated instances of sales and purchases in close proximity. An example, not atypical of such a case is the following history of acquisition and sales in Comalco Ltd, the opening holding is unknown:
Bought Sold 1977 674 - 1979 411 - 1980 1000 - 1983 1037 2000 1985 519 -
The sale in question, referred to as having been one made by the manager, hardly seems to be an act of trading. The stock itself was not speculative, nor can one see a pattern of buying and selling as suggested.
Ultimately, the question whether the respondent was carrying on a business of dealing in shares is a question of fact and degree, a question of impression. In my view the present case falls on that side of the line where the activity of the taxpayer can be seen, not as involving the carrying on of a business of dealing in shares, but rather of investing in shares to obtain dividends having an eye to the funds that were needed on a day to day basis and potentially could be needed if David were institutionalised in the future. The profits made and losses incurred were of a capital and not a revenue nature.
I would accordingly dismiss the appeal with costs.
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