Federal Commissioner of Taxation v Slater Holdings Ltd

[1984] HCA 78

HIGH COURT OF AUSTRALIA

Gibbs C.J., Mason, Brennan, Deane and Dawson JJ.

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA v. SLATER HOLDINGS LIMITED

(1984) 156 CLR 447

29 November 1984

Income Tax

Income Tax (Cth)—Assessable income—Dividends—Company limited by guarantee—Payments to member—Payments from moneys derived from gift—Payments from moneys derived from capital profits—Whether assessable income of member—Income Tax Assessment Act 1936 (Cth), ss. 6(1) "dividend", 44(1)(a).

Decisions

GIBBS C.J. The question for decision on this appeal is whether two amounts, of $12,000 and $12,330.32 respectively, which form part of a sum of $26,900, described as a dividend, and paid to the respondent, Slater Holdings Limited ("the taxpayer") by Ogg Holdings Limited, form part of the taxable income of the taxpayer for the year ended 30 June 1970. It is not in contest that $2,569.68, the balance of the total sum, was taxable.

2. Ogg Holdings Limited was a company limited by guarantee and it had no share capital. Its membership included ordinary members and non-participating members. Immediately before 8 December 1969 there were three ordinary members of the company, William Ogg, Douglas Ogg and Enid Isabella Slater, the three children of William Ogg, Senior, deceased, who had previously been a governing director of the company. The three members decided that the assets of the company should be distributed between them in equal one-third shares. The method adopted to achieve this result was to arrange that Mr Douglas Ogg and Mrs Slater would cease to be ordinary members of Ogg Holdings Limited, that two companies which they respectively controlled, Ogg Investments Limited and the taxpayer, should become ordinary members in their place, that one-third of the assets of Ogg Holdings Limited should be distributed to each of those companies, that those companies should then cease to be members, and that Mr William Ogg should remain an ordinary member of Ogg Holdings Limited. At a meeting of directors on 8 December 1969 a number of resolutions were passed to bring about this change of membership in the company and it was also resolved:

"That the Company declare the following dividends out of its capital:-

To Ogg Investments Limited $26,900.00 To Slater Holdings Limited $26,900.00"

On 15 December 1969 a general meeting of the company was held and it was resolved "that the dividend of $26,900 to Ogg Investments Limited and $26,900 to Slater Holdings Limited as recommended by the Directors to be paid out of the Capital of the Company be hereby adopted and the said dividends paid forthwith."

There were two articles of the company pursuant to which

the dividends might have been declared. Article 8 provided, inter alia:

"Upon a person ceasing to be a member for any

reason whatsoever the Company may make such payment to him ... as the Board of Directors shall think fit."

Article 42 provided:

"Subject to the rights of the members of any

class and subject to such provisions as may from time to time be made as to reserves the profits of the Company which shall from time to time be determined to divide in respect of any year or other period may be distributed by way of dividend amongst the members according to their respective rights thereto and in the proportions affecting the same."

Since it is safe to assume that Mr William Ogg had equal rights with his brother and sister, and since no dividend was declared to Mr William Ogg, it can be inferred that if the declaration of the dividend was authorized by any of the articles, it was made under art.8 and not under art.42.

3. Although the evidence is not clear, it seems that thereafter both the taxpayer and Ogg Investments Limited resigned as members of Ogg Holdings Limited. Mr William Ogg remained an ordinary member and his wife and children became ordinary members also. Mr Douglas Ogg, Mrs Slater and Mr McDonald (the solicitor of the company) became non-participating members of the company.

4. According to the affidavit of Mr McDonald, the dividend of $26,900 was declared in favour of the taxpayer from the capital funds of Ogg Holdings Limited as follows:

"1/3rd of capital reserves $12,330.32

1/3rd of capital reserves represented by gifts to the Company 12,000.00

1/3rd of divisible revenue profits 2,569.68"

The taxpayer in its return of income for the year ending 30 June 1970 showed the receipt under the heading "DIVIDENDS AND DISTRIBUTIONS RECEIVED" as follows:

"Ogg Holdings Limited :- Taxable - From accumulated 2,569.68 Appropriation Account. Non-taxable :- Return of Members Funds 12000.00 Dividend ex Capital Profits 12330.32 Reserve"

The Commissioner, in his original assessment, treated the amount of $2,569.68 as income but did not so treat the further sums of $12,330.32 and $12,000. However, by an amended assessment, he did include those two amounts in the taxable income of the taxpayer. An objection by the taxpayer was disallowed and an appeal to the Supreme Court of New South Wales was dismissed. However a further appeal to the Full Court of the Federal Court was successful. One member of that Court, McGregor J., would have upheld the appeal as to the sum of $12,000, but would have dismissed it as to the sum of $12,330.32, but the majority (Lockhart and Fitzgerald JJ.) allowed the appeal as to the whole amount in dispute. From that decision an appeal has been brought to this Court.

5. There is no dispute as to the source of the moneys that went to make up the dividend. The amount of $12,330.32 represented one-third of net capital gains totalling $36,990.96 which had resulted mainly from the sale of a shopping centre built and later sold by Ogg Holdings Limited. The amount of $12,000 was one-third of a gift of $36,000 made to Ogg Holdings Limited by Mr William Ogg, Senior, on or about 2 June 1960. The balance of $2,569.68 represented one-third of revenue profits made by the company.

6. The contention on behalf of the Commissioner is that the amounts in question were rightly brought to tax pursuant to s.44(1)(a) of the Income Tax Assessment Act 1936 (Cth), as amended ("the Act"), which, as in force at the material time, provided as follows:

"(1) The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) shall, subject to this section, to the next succeeding section and to section one hundred and twenty-eight D of this Act -

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

The other provisions of s.44, and those of ss.44A and 128D, are immaterial for present purposes. By s.6(1) of the Act, "dividend" is defined to include:

"(a) any distribution made by a company to any of its shareholders, whether in money or other property;

(b) any amount credited by a company to any of its shareholders as shareholders; and

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

The concluding words of the definition, which provide that "dividend" does not include certain moneys paid or credited or property distributed, have no present relevance. By s.6(1), "shareholder" includes "member or stockholder". Section 47(1) provides that distributions to shareholders by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up capital, shall, for the purposes of the Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it. Section 47(2) provides that those distributions shall, to the extent to which they are made out of any profits or income, be deemed to have been paid wholly and exclusively out of those profits or that income. Subsections (2A) and (2B) of s.47 deal with distributions in the course of what might be described as the de facto liquidation of a company whose business has been, or is in the course of being, discontinued and deems such distributions in certain circumstances to be distributions to the shareholders by a liquidator in the course of winding-up the company. It is common ground that the provisions of s.47 do not apply to the present case, because there was no liquidation and the business of the company was not discontinued.

7. If the provisions of the Act are applied directly to the facts of the case, it is difficult to resist the conclusion that the dividends became part of the assessable income of the recipients, at least to the extent that they were paid out of the capital profits reserve which represented the capital gains made on the sale of the shopping centre. Whether or not the so-called dividends were dividends in the ordinary sense of the word, each was a distribution made by a company to a member of the company and (at least to the extent of $14,900.00 in each case) it was paid out of profits.

8. Before us, counsel for the taxpayer abandoned the argument that the word "profits" in s.44(1)(a) of the Act refers only to profits of a revenue or income nature. As at present advised I can see no reason to doubt that the word includes capital profits.

9. However, in the Federal Court, Lockhart and Fitzgerald JJ. felt constrained by the decisions of this Court in Federal Commissioner of Taxation v. Blakely (1951) 82 CLR 388 and Federal Commissioner of Taxation v. Uther (1965) 112 CLR 630 to reach the conclusion that the distributions in the present case did not fall within s.44(1)(a) of the Act. Their Honours said:

"The true nature of the payment made by Ogg Holdings to the taxpayer is of capital not income. The taxpayer simply received its proper proportion of the total available surplus of assets over liabilities without distinction as to the source of its components. There was no detachment or severance from the funds of the company as representing a profit made by it. The taxpayer received an entire and indivisible sum representing the value of its interest in Ogg Holdings. It was paid and received in satisfaction of and by way of replacement for its interest as a participating member. It terminated or severed the taxpayer's interest and extinguished the chose in action which it replaced. The taxpayer received its aliquot proportion of the net fund without distinction as to the source of its components."

10. Before I turn to the two cases on which their Honours principally relied it is necessary to mention two earlier cases. In Commissioner of Taxation (N.S.W.) v. Stevenson (1937) 59 CLR 80 the Court held, by a majority, that no part of the money received by a shareholder under an unauthorized distribution described by Evatt J. as a "de facto liquidation" was a dividend, profit or bonus credited, paid or distributed by the company within the meaning of s.11(b) (when read with the definition of "dividend" contained in s.4) of the Income Tax (Management) Act 1928 (N.S.W.). By s.11(b) of that Act the assessable income included dividends credited, paid or distributed to the shareholder from any profit derived from any source by the company. By s.4, "dividend" included "profit and bonus and bonus share". The amount distributed to the shareholder in that case included a proportion of trading profits. Rich, Dixon and McTiernan JJ., who, with Evatt J., constituted the majority, said, at p.103, that the taxpayer's liability would have been clear if s.11(b), interpreted by means of the definition of "dividend", were construed to cover all distributions in a liquidation, but that the position would be otherwise if the section referred only to distributions or detachments of profit by a company as a going concern. Then, after saying that the prima facie liability of the shareholders to account for the assets of the company received in an unauthorized distribution tended against their taxability as income, their Honours said that the liability to tax depended upon an examination of the true nature or character of the receipt. Their Honours continued, at pp.103-104:

"Such an examination shows, we think, that the amount distributed to each shareholder represented the full capital value of the share. Considered apart from the liability of the shareholder to replace the amount received, the payment to her was made in extinguishment of her share interest. No part of it was a detachment of the profit from the funds of the company paid as the income earned by the share. None of it was a dividend, profit or bonus, paid by the company as a going concern in respect of the shares as continuing, although intangible, pieces of property."

That case was followed in Thornett v. Federal Commissioner of Taxation (1938) 59 CLR 787. In that case the capital of a company was reduced by paying off and cancelling certain issued shares, including those of the taxpayer. It was held that the sum received by the taxpayer was paid and received in satisfaction of, and by way of replacement for, her share investment and no part thereof was a dividend, bonus or profit credited, paid or distributed to a shareholder within the meaning of s.16(b)(i) of the Income Tax Assessment Act 1922 (Cth), as amended. That Act contained no definition of "dividend", and it was again held that the statutory provision did not extend to all distributions by the company to its members: see at pp.797, 801-802.

11. Federal Commissioner of Taxation v. Blakely was decided under the Income Tax Assessment Act 1936-1942 (Cth). The definition of "dividend" in s.6 of the Act, although not identical with the present definition, did include any distribution made by a company to its shareholders, but did not include a return of paid-up capital. The two shareholders of the company in that case, who were husband and wife, had appropriated the assets of the company and discharged its liabilities, and the company ceased to carry on business but no liquidator was appointed. It was held that no part of the amount received by a shareholder could be regarded as a dividend. Latham C.J. held that the appropriation of the assets by the shareholders was not a distribution by the company; that view, of course, has no application to the present case. Fullagar J. (with whom Dixon J. agreed) accepted that there was a distribution (see at p.406) but continued, at p.407:

"But the point in this case is, as it was in Stevenson's Case, as to the nature of the receipt. There was not a distribution of profits, or a distribution out of profits. What was received was capital. There was no detachment or severance from the funds of the company of money or other assets as representing a profit made by the company. There was simply a realization of a share investment (per Starke J. in Thornett's Case (at p.799)). 'The shareholders ... receive nothing but the ultimate capital value of the intangible property constituted by the shares ... The shareholder simply receives his proper proportion of a total net fund without distinction in respect of the source of its components, and he receives it in replacement for his share'. ... There is, in my opinion, nothing in the Act which gives the character of income to this receipt, which was according to general principles a capital receipt."

Latham C.J. expressly disagreed with this view of the effect of the Act. He said, at p.397:

"I agree with the argument for the commissioner that the criterion of assessability under s. 44 is not whether what is received by a shareholder is income to him in the sense of something detached from his capital asset consisting in his shares: the relevant question to ask is whether what is received comes from the profits of the company."

12. In Federal Commissioner of Taxation v. Uther, Kitto J., in his dissenting judgment at pp 638-640, advanced a criticism of the judgment of Fullagar J., which, with all respect, I find compelling. Fullagar J. was right in saying that the distribution made to the shareholders in Federal Commissioner of Taxation v. Blakely was a capital receipt according to general principles, but he gave insufficient weight to the change that had been effected to the law by defining "dividend" so as to include a distribution made by a company to any of its shareholders. As Kitto J. pointed out at p.639, the effect of the amendments to the law, first made by the Income Tax Assessment Act 1934 and repeated when the Act was passed in 1936, was to make shareholders in a company which is a going concern assessable to tax on a principle fundamentally different from that of the previous legislation. Kitto J. continued:

"The criterion for the inclusion of a shareholder's receipts from the company is no longer the "dividend" character of the receipts, that is to say their income character when considered from the shareholder's point of view; it is the profit character - from the company's point of view - of the source from which distributions should be made."

However the majority of the Court in that case (Taylor and Menzies JJ.) approved the decision of Owen J. who, sitting at first instance, had followed Federal Commissioner of Taxation v. Blakely: see (1964) 111 CLR 318. The case was one in which a shareholder had on a reduction of capital received in respect of his shares more than he had paid up on them. The majority held that the difference was not taxable. Taylor J. declined to reconsider the decision in Federal Commissioner of Taxation v. Blakely, saying, at p 640:

"It was the subject of decision some fourteen years ago, since then the Act has been amended on numerous occasions but without any attempt to amend it in any particular relevant to the present problem and, presumably, assessments in the meantime have issued on the assumption that the judgment of Fullagar J. was correct. Further, as recently as 1959 it seems to have been accepted as

a correct statement of the law (Parke Davis &Co.

v. Commissioner of Taxation ((1959) 101 CLR 521, at p 530))."

He went on to say that an amount to be taxable under s.44(1) must not only be a dividend - it must also be a dividend paid out of profits - and that although s.6 deemed a distribution to be a dividend, it did not deem it to have been paid out of profits. He concluded, at p.642:

"... it is impossible to say that this amount was paid out of profits derived by the company. It was ... received in partial distribution of a mass of assets which, although in a colloquial sense they contained profits, was a distribution of capital. The point which Blakely's Case made was that, although, in the case of distribution by a liquidator, s. 47 carried the matter as far as deeming such distributions to a limited extent to be dividends paid out of profits derived by the company, in the case of distributions of the character now under consideration, no provision of the Act takes this final and essential step."

The third member of the Court, Menzies J., primarily based his judgment on the fact that in his opinion there had been "a return of paid-up capital" within the exempting words of the definition of dividend. On this question, which of course does not arise in the present case, Kitto J. expressed a contrary opinion and Taylor J. left the question open. However, Menzies J. added, at p.645:

"Furthermore, I consider that the judgment of

Fullagar J., with which Dixon J. agreed, in Federal Commissioner of Taxation v. Blakely requires the conclusion that the distribution here made was not a distribution of profits or a distribution out of profits. In this case, as was held in that, what was received by the shareholders was capital."

13. There were two possible grounds for holding that the distributions in Federal Commissioner of Taxation v. Blakely and Federal Commissioner of Taxation v. Uther were not assessable income. The first, which appears to have been accepted by Fullagar J. in the earlier case, is that the receipt in the hands of the shareholder was capital in nature, representing as it did, the value of the shareholder's interest in the company. However, as I have already said, Kitto J. pointed out in Federal Commissioner of Taxation v. Uther that to take that view would be to disregard the words of the Act. The second possible ground was that the distribution was not made out of profits. The fact that a distribution is itself of a capital nature does not mean that it did not have its source in profits; that proposition was recognized as correct by Lord Reid in Brogan v. Staffordshire Coal and Iron Co. Ltd. (1963) 1 WLR 905, at p 910, and is consistent with the language of Dixon C.J. in Parke Davis &Co. v. Commissioner of Taxation, at p 530, but in any case is not novel. However, what appears to be implicit in the judgment of Taylor J. in Federal Commissioner of Taxation v. Uther is the suggestion that to come within s.44(1)(a) the distribution must have been made wholly out of profits; it is not enough that there is a distribution of a mass of assets which contains profits. This view may be supported by the fact that the section does not refer to "dividends to the extent to which they were paid to him by the company out of profits", since, in the light of the construction given to s.51 of the Act, the inclusion of the phrase "to the extent to which" would no doubt have allowed a dissection or apportionment to be made of the distribution: cf., Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 CLR 47, at p 55.

14. By the Income Tax Assessment Act (No. 4) 1967, the Parliament amended the definition of dividend in s.6 and inserted a new sub-s.(1B) in s.44 and new sub-ss.(2A) and (2B) in s.47. No doubt the intention of these amendments was to nullify the effect of Federal Commissioner of Taxation v. Blakely and Federal Commissioner of Taxation v. Uther. However the amendments do not expressly deal with the situation which arises in the present case, where there was no return of moneys paid up on a share, and where the business of the company was not discontinued.

15. It is unnecessary finally to decide whether the reasons given by the majority in Federal Commissioner of Taxation v. Blakely and Federal Commissioner of Taxation v. Uther were in all respects correct. On any view, those decisions do not assist the respondent in the present case, which is plainly distinguishable from them.

16. The fact that the company in the present case was a company limited by guarantee makes the case an exceptional one, for it has not hitherto been regarded as usual for companies of that kind to engage in the conduct of undertakings intended to return a profit to their members. With all respect to the majority of the Federal Court, it was not correct to say that the taxpayer "simply received its proper proportion of the total available surplus of assets over liabilities without distinction as to the source of its components." In the first place, of course, since the taxpayer had no share in the company, it is inappropriate to say that it received nothing but the ultimate capital value of its interest in the company. If the company had been wound up, the taxpayer would have been entitled to share in the distribution of the assets (see art.53 of the articles of the company) but the only entitlement of a person ceasing to be a member was to receive such payments as the directors might think fit to make under art.8. The power given by that article is purely discretionary, and a payment made under it does not necessarily represent any particular proportion of the value of the company's assets; in particular it does not represent the value of an interest to which a retiring member is entitled. Secondly, the evidence in the present case shows that the components of the payment were identified - the sources of the payment are revealed. So much of the payment as represented one-third of capital profits reserve and one-third of the divisible revenue profits was clearly made out of profits. The remainder of the sum, whose source was the gift to the company, was also, in my opinion, paid out of profits. It is not always easy to determine what are profits out of which dividends ought to be paid. Although profit, in its ordinary sense, often means the excess of returns over the outlay of capital, Farwell J. said in Bond v. Barrow Haematite Steel Company (1902) 1 Ch 353, at pp 365-366, that the question whether there are profits available for distribution "is to be answered according to the circumstances of each particular case, the nature of the company, and the evidence of competent witnesses." In answering the question, a starting point is provided by the well known definition of Fletcher Moulton L.J. in In re Spanish Prospecting Company, Limited (1911) 1 Ch 92, at p 98:

"'Profits' implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates."

I agree with the statements in In re Income Tax Acts (No. 2) (1930) VLR 233, at pp 245 and 250, that this dictum of Fletcher Moulton L.J. is not of universal application, and that each case must depend on its own circumstances. However, if the definition of Fletcher Moulton L.J. is taken as a guide, the amount of the gift in the present case contributed to an increase in assets and represented a profit. The other evidence in the present case reinforces that view. The amount paid was declared to be a dividend and that implies that it was paid out of profits. Moreover, there was expert evidence that the amount was to be regarded as a profit. Mr Cameron, a chartered accountant, deposed as follows:

"In my opinion a gift received by a company increases the net tangible asset worth of the company, is not paid in capital and is therefore properly to be regarded as profit. It is not a gain of a revenue nature and is therefore a profit of a capital nature."

He was not cross-examined on that statement and there was no expert evidence to the contrary.

17. It was argued on behalf of the respondent that a gift is not ordinarily regarded as a profit and reliance was placed on Federal Commissioner of Taxation v. Williams (1972) 127 CLR 226, particularly on a statement of Barwick C.J. who said, at p.241, "that the realization of a gift, however elaborately made, can neither yield a profit nor in itself be a profit-making scheme." The question in that case was whether any part of the proceeds of the sale of land which had been received by the taxpayer as a gift was "profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme" within s.26(a) of the Act. The question was answered in the negative. The case however is not authority for the proposition that moneys received as a gift cannot properly be treated by a company as a profit out of which a dividend may be declared. Although a gift may be regarded as a windfall, and not in itself income, it seems hardly open to doubt that a company which had received a gift of money could distribute the amount by way of dividend to its shareholders.

18. For the reasons I have given I consider that the amount received by the taxpayer was, as it purported to be, a dividend; it was a distribution of money paid by the company to a member and was paid wholly out of profits derived by the company. It was accordingly assessable under s.44(1)(a) of the Act.

19. I would allow the appeal and restore the judgment of the Supreme Court.

MASON J. I would allow the appeal for the reasons given by the Chief Justice.

BRENNAN J. I would allow the appeal for the reasons stated by the Chief Justice.

DEANE J. I agree with the judgment of the Chief Justice.

DAWSON J. I agree with the judgment of the Chief Justice. I would only add a few words to emphasize that the character of Ogg Holdings Limited as a company limited by guarantee and not having a share capital was such as to preclude the application of the principle laid down in Federal Commissioner of Taxation v. Blakely (1951) 82 CLR 388.

2. Membership of the company was not an incident of any shareholding in its capital. Upon a winding up, ordinary members would be entitled under the articles of association to share in the assets available for distribution and no doubt the surplus assets would, apart from s.47 of the Income Tax Assessment Act 1936 (Cth), be capital in the hands of the liquidator as would any amount received by a member be capital in his hands. See Stafford Cole &Iron Co., Ltd. v. Brogan (Inspector of Taxes) (1963) 3 All ER 277. Under s.47, of course, a distribution by the liquidator in the course of a winding up would be deemed to be a dividend paid to the member by the company out of profits derived by it. But the payment of an amount by the company when the company was clearly not being wound up could not represent a payment for property in the sense that payment to a shareholder of his proportion of the surplus assets of a company might be regarded as payment for his shareholding and the replacement of one capital asset in his hands with another. No res ceased to exist by reason of payment by the company to the taxpayer in this case.

3. The most that can be said is that it is a fair inference that Mrs Slater and, if such were the case, Slater Holdings Limited, resigned their membership of the company as ordinary members pursuant to some arrangement which involved the payment of an amount equal to about one-third of the surplus assets of the company to Slater Holdings Limited. But the payment and the resignations were separate steps and not merely different sides of the same coin. The payment did not operate to extinguish Mrs Slater's or Slater Holdings Limited's membership of the company or their right to participate in a winding up of the company. That only occurred in the performance of the separate arrangement made, presumably, between the ordinary members of the company and not by operation of law. Federal Commissioner of Taxation v. Blakely has no application.

Orders

Appeal allowed with costs.

Order of the Full Court of the Federal Court set aside and in lieu thereof order that the appeal to that Court be dismissed with costs.