FFWX and Commissioner of Taxation
[2009] AATA 657
•1 September 2009
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2009] AATA 657
ADMINISTRATIVE APPEALS TRIBUNAL )
) No NT2006/0413 to 0416
TAXATION APPEALS DIVISION ) Re FFWX Applicant
And
COMMISSIONER OF TAXATION
Respondent
DIRECTION
TRIBUNAL: Mr J Block, Deputy President
Mr S E Frost, MemberDATE: 2 September 2009
PLACE: Sydney
The Tribunal directs the Registrar, pursuant to subsection 43AA(1) of the Administrative Appeals Tribunal Act 1975, to alter the text of the reasons for decision in these applications NT2006/0413, NT2006/0414, NT2006/0415 NT2006/0416 in the following manner:
1.Within clause 3 of the reasons for decision, delete “Australian Government Solicitor” and substitute with “Legal Services Branch of the Australian Taxation Office”;
2.At the conclusion of the reasons, delete “Solicitor for the Respondent” and substitute with “Appearance for the Respondent”; and
3.At the conclusion of the reasons, delete “Australian Government Solicitor” and substitute with “Legal Services Branch of the Australian Taxation Office”.
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Mr J Block, Deputy President
DECISION
Tribunal Mr J Block, Deputy President and Mr S E Frost, Member Date1 September 2009
PlaceSydney
Decision The objection decision under review is affirmed.
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Mr J Block, Deputy President
CATCHWORDS
TAXATION LAW – Special income under section 273 of the Income Tax Assessment Act 1936 –consideration of the factors in section 273(2) – whether the correct focus is on the years in which the dividends are paid without regard to the transaction which gave rise to those dividends – interpretation of the paragraphs contained in section 273(2) and in particular paragraph (a) – consideration of the case law and in particular a number of Board of Review cases – the transaction which gave rise to the dividends is a relevant factor and must be taken into consideration – objection decision under review affirmed
RELEVANT ACT/S:
Income Tax Assessment Act 1936
Income Tax Assessment Act 1997
Income Tax and Social Services Contribution Assessment Act (No. 3) 1964
Income Tax Assessment Act 1965
Taxation Laws Amendment Act (No. 2) 1989
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CITATIONS
Hancock v Federal Commission of Taxation (1961) 108 CLR 258
Rowdell v FCT (1963) 111 CLR 106
Case A38 69 ATC 225
Case A39 69 ATC 227
Case A40 69 ATC 229
Case B40 70 ATC 202
Ord Forrest Pty Ltd v FCT (1973) 130 CLR 124
Case E56 73 ATC 442
Case M63 80 ATC 440
CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384
Carr v State of Western Australia (2007) 232 CLR 138
Harris v Commissioner of Taxation (2002) 125 FCR 46
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OTHER AUTHORITIES
Taxation Ruling TR 2006/7
Report of the Ligertwood Committee
Various Explanatory Memoranda and Second Reading Speeches
REASONS FOR DECISION
1 September 2009
Mr J Block, Deputy President
Mr S E Frost, Member
PART A - Preliminary and Background
1. The objection decision which is under review in this matter is the disallowance dated 1 December 2006 of an objection (dated 4 August 2006) by the Applicant against notices of assessment and amended assessment (collectively “the assessments”) in respect of the years ending 30 June 2000, 30 June 2001, 30 June 2002, and 30 June 2003 (collectively “the relevant years”). The assessments relate to dividends distributed in the relevant years by V Pty Ltd (which is sometimes referred to in these reasons as “the private company”) to the Applicant, those dividends having been derived by the private company by way of dividends from A Limited, a listed public company (and which is sometimes referred to in these reasons as “the public company”).
2. This matter (in respect of which confidentiality was sought and granted) was heard on three days in 2008 and also on one day in February 2009; it was then adjourned because Mr C, a director of the public company was not available for further cross-examination. During the hearing days referred to in this clause 2, evidence had been taken from Mr C, Mrs C and also Mr H who is a director of the Applicant.
3. The Applicant was originally represented by Mr B. Sullivan SC and Mr M. Richmond of counsel instructed by Ernst & Young Law while the Respondent was represented by Mr D. B. McGovern SC and Mr I. Young of counsel instructed by the Australian Government Solicitor. After the hearings in February 2009, Dr Mark Robertson of counsel instructed by Ernst and Young Legal represented the Applicant.
4. The evidence taken up to and including the hearings in February 2009 was designed, put in broad terms, to establish that an amount of $51,218 paid in October 1995 by the Applicant to Mrs C for four shares in the private company (referred to henceforth as "the relevant shareholding") was a price established on arm’s-length terms and that it was in fact the market value of the relevant shareholding. The private company was a holding company which held a large majority interest in the public company. The public company engaged in a large project which proved to be very successful. If the relevant shareholding acquired by the Applicant were valued at any relevant time (and in particular at the date of acquisition but also if relevant at any time thereafter) by reference to the value of the (underlying) listed holding the amount so resulting would have been considerably in excess of $51,218. The listed market value of each listed public company share on 10 October 1995 was 0.58c per share; the private company held 25,609,320 shares in the public company The relevant acquisition had the effect that the Applicant obtained an indirect interest in 1,024,373 shares in the public company, the market value of which on date of acquisition was $594,136. This amount is of course the amount found without applying any discount arising from the fact that the relevant shareholding was a minority shareholding. The private company held apart from its shareholding in the private company a minority interest in W Pty Limited. We refer to the question of discount later in these reasons but one thing is clear and that is that the price paid for the relevant shareholding was much less than its market value. The Applicant conceded in June 2009 that this was so.
5. It was arranged when the hearings in February 2009 were adjourned that on its resumption, further cross-examination of Mr C would take place followed by expert evidence from valuers consulted by each of the parties. Both valuers furnished lengthy and detailed valuation statements and which indicated that there was a significant issue between them as to the appropriate discount to be applied in respect of a minority holding in a private company. The value determined by the Applicant's valuer would, having regard to his witness statement, have been to the effect that the appropriate discount is greatly in excess of that advocated by the valuer consulted by the Respondent, and as set out in Exhibits R1 and R2.
6. The issued share capital of the private company consisted of 100 ordinary shares which were issued at one dollar per share. The relevant shareholding therefore constitutes 4% of the issued capital of the private company. It is relevant in passing to note that Mr H personally owns another and separate holding of 6 shares in the private company and for which he paid $6 in 1988.
7. During the hearings in 2008 (and in the case of exhibits thereafter), the Tribunal accepted the tender of the T documents lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 and in addition admitted into evidence a number of exhibits, including statements by the persons who gave oral evidence. Having regard to the turn which this matter took in June 2009, it is unnecessary for the Tribunal to refer in specific terms to those exhibits or to the evidence which had been taken. It is sufficient to note that much of the evidence furnished to the Tribunal as to the circumstances in which the Applicant acquired its shareholding (and being the relevant shareholding) in the private company from Mrs C was open to doubt.
8. The term “AS” as used in these reasons refers to the Applicant's written submissions dated 22 June 2009; it is convenient at this juncture to include a portion of Part C, entitled “The relevant facts". Clauses 49 to 52, edited and amended where necessary to ensure that confidentiality is maintained, read as follows:
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49.For the above reasons, the Tribunal is concerned only with the circumstances surrounding the payment of the dividends in the 2000 to 2003 years.
50.It is to consider whether there is any derivation of dividends beyond what could be expected from the mere holding of shares as a true investment.
51.Regrettably, much of the evidence adduced to date has been directed at what it submits are irrelevant issues:
(a)The Applicant had originally intended to rely on evidence of the market value of the private company shares, and cavilled at whether they should be valued in 1994 or 1995. It did not read that evidence, and accepts the Respondent’s case that the shares were acquired on 10 October 1995 and the Respondent’s valuation evidence (subject to its legal relevance) of the market value on that date.
(b)The Applicant admits that the trustee of the H. Superannuation Fund was brought the opportunity to acquire the private company shares by Mr H (that Mr H had been offered) and did not negotiate in any way for that opportunity or for the acquisition itself.
52.Based on matters subject to agreement and the evidence of the Applicant’s witnesses, the Tribunal should find the following facts, which the Applicant submits are the only relevant facts surrounding the payment of dividends in each of the 2000 to 2003 years of income:
(a)The Applicant was trustee of the H superannuation fund established for the benefit of Mr and Mrs H.
(b)The V company was a private company with issued capital of 100 ordinary shares with an issue price of $1 per share.
(c)Mr H owned 6 ordinary shares in the V company, for which he paid $6 in 1988.
(d)On 10 October 1995 the then trustee of the H. superannuation fund, (name omitted) had acquired 4 ordinary shares in the V company, for which it paid $51,218.
(e)In November 1997 the Applicant took over as trustee of the H superannuation fund, including the shareholdings in the V company.
(f)the Applicant’s V company shares carried the same rights as all other issued shares in the V company.
(g)Mr H was not a director of, nor did he control, the V company.
(h)the V company shares were a substantial and valuable holding of the H superannuation fund, providing property income in their own right in 2000 to 2003 without the exertion of Mr H. Specifically,
(1) the V company owned a majority shareholding in a public company, the A company
(2) the V company acted solely as a conduit for dividends received from the A company
(i)in 2000 to 2003 the dividends from the V company were not derived as part of any dividend stripping operations, nor any manipulation or discrimination in each of the payments of these dividends. In particular, the Commissioner does not suggest that in 1995 the 2000 to 2003 dividends were planned to be paid in order to reimburse the Applicant its cost to acquire its shares.
(j)in 2000 to 2003 the A company paid dividends to the V company along with all its other shareholders on the same basis.
(k)in 2000 to 2003 the V company in turn passed on those dividends by way of the payment of dividends on a pari passu basis to its shareholders, including the Applicant. That is, all dividends were paid at the same rate to all shareholders.
The Table below sets out for the years of income 30 June 2000 to 2003 the amount of the dividends paid by the V company to all its shareholders including the Applicant and by the A company up to the Applicant:
Year Ended 30 June Dividends received by the V company from the A company Total Dividends Paid by the V company to its Shareholders Dividends Paid by the V company to the Applicant 2000 $3,594,804 $3,593,000 $143,720 2001 $3,592,253 $3,593,000 $86,320 2002 $2,155,396 $2,158,000 $86,320 2003 $1,915,920 $1,916,000 $76,640 …
9. The documentation before the Tribunal is quite extraordinarily large. Apart from the transcripts in respect of all of the hearing days, the Tribunal had before it the T documents, the exhibits and lengthy submissions by both parties. The term “RS"” refers to the Respondent’s written submissions dated 30 July 2009; the Applicant filed submissions in reply dated 12 August 2009 but it is not necessary for us to refer to them specifically.
PART B - The Developments in June 2009
10. In a directions hearing in March 2009, this matter was listed to resume on 22 June 2009 and for the whole of the week commencing with 22 June 2009. Earlier in June 2009, the Applicant gave notice that it intended to apply in accordance with section 45 of the Administrative Appeals Tribunal Act 1975 for the referral of four questions to the Federal Court. It was not possible to arrange a hearing date convenient to counsel and the Tribunal prior to 22 June 2009 and the referral application was accordingly argued on that date. On the following day, i.e. 23 June 2009, the Tribunal determined that it would not grant the referral application. A decision in this regard as to the refusal of the referral application was subsequently published: see [2009] AATA 476
11. The Applicant conceded (as set out previously) that the price at which it acquired the relevant shareholding in October 1995 was not an arm’s-length price. The Applicant notified the Tribunal that it would not present evidence as to the market value of the relevant shareholding and moreover would not cross-examine the Respondent’s valuer as to the content of his valuation statements. It follows then that the Respondent’s valuation statement must be accepted and in consequence of which the discount for which he contended should prevail. The result is that the market value of the relevant shareholding, both when it was acquired and thereafter (and during the relevant years), was far in excess of the amount paid for it by the Applicant.
12. There is one other factual matter which is deserving of mention at this early stage. The Applicant is the trustee of the H Superannuation fund; it is the superannuation fund which acquired the relevant shareholding. Mr H gave evidence (and which was not disputed) that in respect of that acquisition the relevant funds were obtained from moneys paid out by the public company’s superannuation scheme and of which he was a member.
13. It is sufficient for the purposes of this decision to make it clear that the market value of the relevant shareholding at the date of its acquisition was far higher than the price paid. During the course of the hearings there were references on an approximate basis to $500,000, and so that the price paid, again on an approximate basis, was about 10% of its market value.
14. It will be noted that during the relevant years the public company paid large dividends to the private company, which in turn distributed those dividends to its shareholders and including the Applicant, and pro rata to their shareholdings in the private company. It is common cause that the private company treated all of its shareholders equally in the sense that their dividends were calculated according to the number of shares held by them respectively in the private company. It is equally clear that the private company did not retain any part of the dividends derived by it from the public company and indeed there was no need for it to do so. In the result the dividends derived by the Applicant during the relevant years were in all cases considerably in excess of the price paid by the Applicant for the relevant shareholding in 1995. In fact, dividends were paid in respect of the relevant shareholding from the time of acquisition; we refer in this context to clauses 120 and 121 of RS as follows:
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120.On the facts here, dividends flowed on the four V company shares within weeks of their acquisition. In fact, a dividend was declared on 22 September 1995, though not yet paid, at the time of acquisition of the shares in October 1995. Thereafter dividends have continued to flow in each of the succeeding years as follows:
(a)year ending 30 June 1996 – the amount of $26,400;
(b)year ending 30 June 1997 – the amount of $208,136;
(c)year ending 30 June 1998 – the amount of $140,000;
(d)year ending 30 June 1999 – the amount of $125,200
(e)year ending 30 June 2000 – the amount of $143,720;
(f)year ending 30 June 2001 – the amount of $143,720;
(g)year ending 30 June 2002 – the amount of $86,320;
(h)year ending 30 June 2003 – the amount of $76,640.
121.Under self assessment the dividends declared for the 1996 to 1999 years were not assessed as special income and amended assessments have not been issued. It is however correct to say that dividends have flowed continuously and without interruption immediately following the acquisition of the shares by the Applicant in October 1995.
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15. Because of these developments the matter was heard on two hearing days in June 2009; it was then arranged that there would be a period allowed for final submissions with one final hearing day for oral submissions on 21 August 2009.
PART C - Section 273 of the 1936 Act
16. Section 273 of the Income Tax Assessment Act 1936 (“the 1936 Act”) during the relevant years, read as follows:
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(1)This section applies to income derived in a year of income by a fund or unit trust (in the section called the entity) that is a complying superannuation fund, a complying ADF or a PST in relation to the year of income.
(2)A dividend paid to the entity by a company that is a private company in relation to the year of income of the company in which the dividend was paid is special income of the Entity unless the Commissioner is of the opinion that it would be reasonable not to treat the dividend as special income of the Entity, having regard to:
(a)the value of the shares in that company that are assets of the entity;
(b)the cost to the entity of the shares on which the dividend was paid by the company;
(c)the rate of the dividend paid to the entity by the company on the shares in the company that are assets of the entity;
(d)whether the company has paid a dividend on other shares in the company and, if so, the rate of that dividend;
(e)whether any shares have been issued by the company to the entity in satisfaction of, or of a part of, a dividend paid by the company and, if so, the circumstances of the issue of those shares; and
(f)any other matters that the Commissioner considers relevant.
(3)For the purposes of subsection (2), income that, in the opinion of the Commissioner, was derived by the entity indirectly from a dividend paid by a company, being a private company in relation to the year of income of the company in which the dividend was paid, shall be deemed to have been a dividend paid to the entity by the company.
(4)Income (other than a dividend to which subsection (2) applies or income derived by the entity in the capacity of beneficiary of a trust estate) derived by the entity from a transaction is special income of the entity if the parties to the transaction were not dealing with each other at arm's length in relation to the transaction and that income is greater than the income that might have been expected to have been derived by the entity from the transaction if those parties had been dealing with each other at arm's length in relation to the transaction.
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17. The effect of section 273 of the 1936 Act is that a dividend received by the Applicant from a private company is treated as special income unless the Respondent determines that it would be reasonable not to treat that dividend as special income having regard to the factors listed in paragraphs (a) to (f) of subsection 273(2). Put in other words, the starting point is that a private company dividend is treated as special income unless the Applicant can persuade the Commissioner (or the Tribunal standing in his shoes) that it is reasonable not to treat the private company dividends as special income.
18. Section 273 of the 1936 Act was removed from the 1936 Act and re-enacted in the Income Tax Assessment Act 1997, but after the relevant years. A consideration of subsection (2) indicates that the relevant paragraphs are (a), (b), (c), (d) and (f); paragraph (e) is not relevant on the facts. The section does not furnish any guidance as to how precisely the relevant paragraphs are to be considered and more particularly as to the weighting to be attributed to each of them. In particular and as regards paragraph (a), there is no specific guidance as to what is meant by value and more particularly whether it was intended that that reference should be construed by reference to market value or to any other value. Paragraph (a) is difficult to interpret for another reason; assuming that “value” means market value, does it mean market value at the date when the relevant shareholding was acquired or, by contrast, the market value on the dates when the relevant dividends were distributed? The questions in respect of which the Applicant sought referral to the Federal Court related inter alia to this question.
19. Paragraph (b) of section 273(2) draws attention to the cost of the shares but does not specify its relevance. It could (although this is not clear) be intended to draw attention to the difference between cost and value (and in the case of value, market value or some other value) but if so, it is not clear as to whether the value is that which applies at the date of the acquisition or the values which were relevant on the dates on which the dividends were distributed. Nor is it clear, having regard to paragraph (c), what part the rate of dividend has to play in a consideration of the other relevant factors. Paragraph (d) must be read in conjunction with and compared with paragraph (c) although its relevance in this matter is limited given that it is common cause that all shareholders in the private company received dividends at the same rate and in proportion to their shareholdings in the private company. Paragraph (f) is a general provision which is common in legislation of this nature.
20. It is relevant in this particular context to note that the Respondent does not contend that the manner in which the Applicant ran its case prior to June 2009 is a relevant factor either for the purposes of paragraph (f) or otherwise. That concession on the part of the Respondent is important; the manner in which the Applicant ran its case prior to June 2009 involved the presentation of evidence which, as has been noted, was in important respects incomplete and unsatisfactory.
21. Taxation Ruling TR 2006/7 (“the Ruling”) was referred to at some length during the hearing. The Ruling provides inter alia that the term “value” as used in paragraph (a) of subsection 273(2) means market value. The Applicant contends that the Ruling is in this regard incorrect. The Ruling proper is relevant in relation to this decision and accordingly its terms (set out in clauses 8 to 28) are reproduced in this decision as follows:
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8.Section 273 sets out four different types of special income. These are:
·dividends paid by a private company, including income derived indirectly from a dividend and non-share dividends;
·income from a transaction where the parties are not dealing at arm's length;
·income received from a trust in the capacity of a beneficiary other than by virtue of holding a fixed entitlement; and
·non-arm's length income received from a trust in the capacity of a beneficiary holding a fixed entitlement.
9.In order for any amount to be special income, it must be income derived in a year of income by a complying superannuation fund, a complying ADF or a PST in relation to a year of income.
10.The word 'income' in section 273 is to be interpreted widely. It can include both income according to ordinary concepts and amounts included in assessable income under a statutory provision. This means that franking credits and capital gains could be special income if they satisfy the other requirements set out below.
11.The 'income' referred to in subsections 273(6) and 273(7), which deal with trust distributions, is the amount included within assessable income under Division 6 of Part III.
12.An amount of income either has the character of being special income or it does not. When an amount of income is special income, the whole amount is special income. An amount of income that is characterised as special income cannot be divided between an amount that is special income and an amount that is not special income. The amount of income that is special income is not only the amount by which an amount of income is greater than the amount that might have been derived if the parties had been dealing at arm's length; it is the whole amount of income derived.
Dividends paid by a private company
13.Subsection 273(2) provides that a dividend that is paid by a private company to a complying superannuation fund, a complying ADF or a PST is special income of the entity unless the Commissioner is of the opinion that it would be reasonable not to treat the dividend as special income, having regard to the matters listed in subsection 273(2).
Self-assessment
14.This Ruling sets out the way in which the discretion in subsection 273(2) will be exercised by the Commissioner. A trustee may self-assess as to whether or not to treat a dividend as special income by applying this Ruling to their particular circumstances. If the trustee is uncertain as to whether or not the Commissioner will exercise the discretion, the trustee should seek clarification by requesting a private ruling.
Income derived indirectly from a dividend
15.The application of subsection 273(2) is extended by subsection 273(3). Subsection 273(3) deems income that is derived by the entity indirectly from a dividend paid by a private company to be a dividend paid to the entity by the company. This means that private company dividends that are derived indirectly may also be special income under subsection 273(2). A private company dividend that is derived by a superannuation entity from an interposed entity is indirectly derived from a dividend and will be special income unless the Commissioner exercises the discretion in subsection 273(2). The Commissioner's view is that the test in subsection 273(3) can include private company dividends received indirectly by a superannuation fund through a publicly listed company. In these situations, the Commissioner would always exercise the discretion in subsection 273(2) so that the dividends were not special income.
Non-share dividends
16.Subsection 273(9) also extends the scope of subsection 273(2). It ensures that subsection 273(2) applies to distributions that are paid by a private company that are not dividends, but are non-share dividends as that term is defined in section 974-120 of the Income Tax Assessment Act 1997 (ITAA 1997). Non-share dividends are distributions to holders of equity that are not dividends paid to shareholders.
Matters to be considered by the Commissioner
17.In order to decide whether the Commissioner will form the opinion that it would be reasonable not to treat a dividend as special income, the Commissioner will have regard to all of the matters in paragraphs 273(2)(a) to (e) and any other matters that the Commissioner considers relevant in accordance with paragraph 273(2)(f). No one matter is determinative. The importance attached to any particular matter may vary depending on the facts of the case. While some matters may be unfavourable to the Commissioner exercising the discretion, others may be favourable.
18.The Commissioner will form the opinion that it would be reasonable not to treat the dividend as special income when the dividends are derived on an arm's length basis. The Commissioner will consider paragraphs 273(2)(a) to (e) as matters that indicate whether or not the dividends are derived on an arm's length basis. The Commissioner will consider a matter to be relevant under paragraph 273(2)(f) if it indicates whether or not the dividends are derived on an arm's length basis.
19.Dividends are only derived on an arm's length basis when the shares are acquired, the investment is maintained, and the dividends are paid on an arm's length basis. If the shares are acquired at market value, the private company is not involved in non-arm's length dealings and the rate of dividend is the same as the rate of dividend paid on other shares in the company or is reasonable having regard to investment risk, and there are no other matters that the Commissioner will consider relevant, the Commissioner will form the opinion that it would be reasonable not to treat the dividend as special income.
20.The Commissioner will consider the matters listed in paragraph 273(2) to paragraph 273(2)d in comparison with each other. In cases where the dividend paid relates to a share which has a par value, the Commissioner will compare this value with the partly paid value under paragraph (a). The cost of the shares considered under paragraph (b) will be compared with the market value of the shares at the time of acquisition, which is considered under paragraph (a). The rate of dividend considered under paragraph (c) will be compared to the cost of the shares under paragraph (b) and the market value of the shares under paragraph (a). The rate of dividend will also be compared to the rate of dividend paid on any other shares in the company, which is considered under paragraph (d).
Value of the shares
21.The Commissioner will, as required by paragraph 273(2)(a), have regard to the value of the shares.
22.The market value of the shares at the time the superannuation fund, ADF or PST acquires them will be compared to the cost of the shares, which is considered under paragraph 273(2)(b) (see paragraphs 26 to 28 of this Ruling).
23.The market value of the shares will also be compared to the rate of dividend to determine whether the rate of the dividend is consistent with an arm's length outcome. This matter is considered under paragraph 273(2)(c) (see paragraphs 36 to 40 of this Ruling).
24.Where the shares of a company have a par value, the Commissioner will compare this value with the partly paid value of the shares under paragraph 273(2)(a). The paid-up value of the shares will also be compared with the paid-up value of shares held by other shareholders of the private company. This will be a relevant matter considered under paragraph 273(2)(f) in determining whether the payment of the dividend is consistent with an arm's length outcome.
25.If the shares in the private company are paid-up to different extents, and there are no other matters that the Commissioner considers adequately explain the difference, the Commissioner will treat the dividend as special income.
Cost of the shares
26.The Commissioner will, as required by paragraph 273(2)(b), have regard to the cost to the superannuation fund, ADF or PST of the shares.
27.The cost of the shares will have particular relevance in comparison to the market value of the shares at the time of acquisition.
28.If a superannuation fund, ADF or PST acquires shares in a company for an amount less than the market value of those shares, this will be a significant factor in determining whether the payment of the dividend is consistent with an arm's length outcome. This will especially be the case where other shareholders in the company paid market value for their shares.
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22. It would appear, having regard to the written submissions by the parties, that they agree that some parts of the Ruling are correct; however, in regard to paragraph 273(2)(a), the Ruling provides that value means “market value”. The Respondent contends that the Ruling is in this regard correct; moreover, the Ruling provides in clause 22 that market value is relevant by way of comparison with cost for the purposes of paragraph (b). The Applicant, by contrast, contends that the Ruling is in this regard incorrect.
PART D - Principles of Construction in respect of Section 273 of the 1936 Act
23. We note that we have drawn on AS in respect of the content of this part.
24. In 1997, the High Court in CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384 at 408 said:
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It is well settled that at common law, apart from any reliance upon s 15AB of the Acts Interpretation Act 1901 (Cth), the court may have regard to reports of law reform bodies to ascertain the mischief which a statute is intended to cure. Moreover, the modern approach to statutory interpretation (a) insists that the context be considered in the first instance, not merely at some later stage when ambiguity might be thought to arise, and (b) uses "context" in its widest sense to include such things as the existing state of the law and the mischief which, by legitimate means such as those just mentioned, one may discern the statute was intended to remedy. Instances of general words in a statute being so constrained by their context are numerous. In particular, as McHugh JA pointed out in Isherwood v Butler Pollnow Pty Ltd, if the apparently plain words of a provision are read in the light of the mischief which the statute was designed to overcome and of the objects of the legislation, they may wear a very different appearance. Further, inconvenience or improbability of result may assist the court in preferring to the literal meaning an alternative construction which, by the steps identified above, is reasonably open and more closely conforms to the legislative intent.
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25. That this remains the proper approach to construction was confirmed recently by Gleeson CJ in Carr v State of Western Australia (2007) 232 CLR 138 at [6]:
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Interpretation of income tax legislation commonly raises questions as to how far the legislation goes in pursuit of the purpose of raising revenue. In some cases, there may be found in the text, or in relevant extrinsic materials, an indication of a more specific purpose which helps to answer the question. In other cases, there may be no available indication of a more specific purpose. Ultimately, it is the text, construed according to such principles of interpretation as provide rational assistance in the circumstances of the particular case, that is controlling.
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26. The Full Federal Court, in the context of superannuation, applied this approach in Harris v Commissioner of Taxation (2002) 125 FCR 46 to consider the meaning of section 82AAA of the 1936 Act. The Full Court reviewed the history of the section’s predecessors and the Ligertwood Committee report of 1961 (see paragraphs [29]-[46] below).
27. The Respondent referred the Tribunal to other case authority all of which is relevant and apposite but the Tribunal does not consider it necessary to refer to the other cases specifically.
PART E - The History in respect of Section 273 of the 1936 Act
28. It was always clear that in order to interpret section 273, and in particular to determine whether “value” in section 273(2)(a) means market value, it would be necessary to consider the history of and the background surrounding the enactment of section 273 and also the amendments made after its enactment.
29. In 1961, superannuation funds were wholly exempt from taxation: refer to section 23(j) of the 1936 Act; taxpayers who made gifts to superannuation funds received deductions.
30. The Ligertwood Committee (referred to henceforth as “the Committee”) was set up to report on superannuation and it reported in particular on the widespread abuse of tax concessions through the diversion of income into exempt superannuation funds and in particular through the use of private companies. Private companies at that time were also subject to undistributed profits tax. At that time also, it was evident that dividend stripping schemes were being used and contested; see by way of example Hancock v Federal Commission of Taxation (1961) 108 CLR 258; Rowdell v FCT (1963) 111 CLR 106.
31. The Committee identified other illustrations of abuse; the Tribunal refers to clauses 739 to 742 of its report as follows:
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739.... it has come to our notice that Section 23 (j) is being extensively exploited in a manner which was never contemplated when the legislation was introduced for encouragement of employers in establishing bona fide funds on behalf of employees. In fact, the section has been widely abused.
740.The following illustrates cases where the Revenue has been adversely affected:
(1)A superannuation fund set up mainly for the benefit of the directors of a private company and controlled by them, purchases at par one or more shares in the company carrying special rights. The company’s Articles of Association give to the directors a complete power as to the dividends to be declared on the special shares and, in fact, they distribute the bulk of the company’s profits as dividends to the trustees of the superannuation fund holding such shares. Payment of these dividends relieves the company from liability to undistributed income tax. In addition, the dividends being income of the superannuation fund are exempt from tax, and the amount received by way of such dividends may be lent back to the company with or without interest. On retirement, the directors obtain the bulk of the fund, but are taxed on no more than 5 per cent of the amounts received.
(2)A director-controlled superannuation fund is set up by a private company, primarily for the benefit of those employees who are also shareholders and directors. The directors then cause the company to make interest-free loans to the fund, which invests the proceeds. The income derived by the fund from its investments is exempt under Section 23 (j) and when this income is eventually paid to the directors in a lump sum on their retirement, only 5 per cent thereof will be taxed in the hands of the beneficiaries or alternatively the amount may be wholly free from tax.
741.Under the present law, there are numerous other ways by which it is possible for a taxpayer so to constitute a superannuation fund and income, which would have accrued to him in the ordinary course of events, shall be received in virtually a tax free form. The anomaly is considered more serious if the terms relating to the fund, or other circumstances, enable the taxpayer to withdraw his benefits from the fund before reaching the normal retiring age, for example, by retiring from one company and immediately commencing employment with another company under the same ownership.
742.Remedial action, whilst necessary, should not prejudice the operation of bona fide superannuation funds. However, the remedy to be adopted must be sufficiently strong so as to prevent existing abusive practices and to overcome possible future exploitation of the Revenue.
32. This is a convenient point at which to deal with an aspect referred to on several occasions during the hearings. Section 273 of the 1936 Act is not confined to dividend stripping schemes. It is an anti-avoidance provision, which has been in force for many years and in much the same form, and is not so confined. The Tribunal refers in this context to the Committee report a part of which is included in the preceding clause.
33. The Committee in the result recommended the inclusion of anti-avoidance provisions designed to combat arrangements which inflated income. Because of the fact that private companies were used so widely in a manner which was considered improper, it also recommended a blanket proscription for private company dividends.
34. In 1964, Parliament adopted the first recommendation, but considered the second too harsh. In the Second Reading Speech for the Income Tax and Social Services Contribution Assessment Bill (No. 3) 1964, the then Treasurer, Mr Holt, said:
…
The Ligertwood Committee also recommended that the exemption of income of any superannuation fund should not extend to dividends and, in certain circumstances, other income derived by the fund from any private company. As to private company dividends, the Government considers a blanket withdrawal of the exemption too severe. It is proposed, instead, that each individual case should be examined on its merits by the Commissioner of Taxation to determine whether such dividends should be taxed in full in the hands of a trustee of a superannuation fund, irrespective of any exemption that would otherwise be available to the fund.
…
35. The Respondent considers it appropriate in this context in referring to the relevant extrinsic material to include the following extract from the Minister’s Second Reading Speech in the Senate as follows:
…
A further proposal of the Ligertwood Committee was that no superannuation fund should be exempt from tax on dividends from private companies and, in certain circumstances, other income derived from a private company. The Government considers, however, that a full and unconditional withdrawal of the exemption on private company dividends would not be warranted in all cases. Accordingly, it proposes that the Commissioner of Taxation will examine each case on its individual merits to determine whether such dividends should be taxed in full, without regard to any exemption otherwise available to a fund. To be treated in a corresponding way is income from a transaction by a superannuation fund with a person not dealing with the fund at arm's length. This income is to be taxed in full if it exceeds the amount that might have been expected to be received by the fund from the same transaction with a person dealing with the fund at arm's length, for example, a person completely independent of, and unassociated with, the fund.
…
36. Specifically, by Act No. 110 of 1964, paragraph 23(j)(i) was repealed and replaced with s 23F. Subsection 23F(7) conferred an exemption from tax on the income of superannuation funds with a general exception in subsection 23F(10) for non-arm’s length income which corresponds precisely with subsection 273(4). Subsection 23F(8) also contained a particular exception to that exemption in relation to private company dividends, which corresponds precisely with subsection 273(2) except in one respect. Paragraph 23F(8)(a) directed the Commissioner to consider as one matter the “paid-up value” of the shares whereas paragraph 273(2)(a) as it existed in the relevant years refers only to the “value”.
37. That a reference to paid-up value was intended and deliberate is demonstrated by the following extract from page 627 of the relevant Explanatory Memorandum as follows:
…
Sub-section (8.) provides that the exemption authorised by sub-section (7.) will not apply in relation to dividends paid to a superannuation fund by a private company. The Commissioner is, however, granted a discretion to exempt such dividends if he is of the opinion that it would be reasonable to do so.
In exercising his discretion the Commissioner is directed to have regard to certain matters listed in the sub-section. These matters relate to the paid-up value of shares held by the fund, the cost of the shares, the rate of dividend on the shares and on other shares in the company, the circumstances in which bonus shares have been issued to the fund and other matters that the Commissioner regards as relevant.
…
38. The Applicant contends that the kernel of a dividend stripping scheme involves the acquisition by a fund of shares at par as a formal mechanism for the diversion of income, or the fund acquiring shares for more than their paid-up value by way of capital premium and then receiving reimbursement of that additional cost by way of dividend. But, and as set out previously, the section is not confined in its operation to dividend stripping schemes.
39. In 1965, section 23F was re-enacted, with the same exceptions but renumbered, by the Income Tax Assessment Act1965. In 1987, other provisions mirroring section 23F were enacted. Subsection 23FC(2) and subsection 23FD(2) were enacted by Taxation Laws Amendment Act (No. 4) 1987. The Explanatory Memorandum to Taxation Laws Amendment Bill (No. 4) 1987 describe those provisions in the following way:
…
The proposed provisions [i.e. section 23FC and FD] are similar to those which have applied for many years in relation to non arm’s length income derived by certain superannuation funds that are otherwise exempt from tax.
…
40. Here too the Respondent contends that it is appropriate to quote in full context from the relevant Explanatory Memorandum as follows:
…
The proposed provisions are similar to those which have applied for many years in relation to non-arm's length income derived by certain superannuation funds that are otherwise exempt from tax. Under the amendment, private company dividends derived by an approved deposit fund after 12 January 1987 will not be exempt from tax unless the Commissioner of Taxation considers that it would be reasonable to exempt the dividends. In making his decision the Commissioner will have regard to the manner in which the relevant company shares are acquired by the approved deposit fund and the circumstances surrounding payment of the dividends as well as any other matters considered to be relevant.
…
41. The “provisions” which have “applied for many years” included subsections 23F(18) and 23FB(2), which the Explanatory Memorandum to the 1987 Bill goes on to describe later as being concerned with “certain non arm’s length income”. We refer in this context to page 21 of the relevant Explanatory Memorandum as follows:
…
The exemption under Subsection (1) will not extend to income to which proposed subsections (2) to (5) apply. These provisions are intended to act as a safeguard against abuse of the exempt status of approved deposit funds through private company investments or other non-arm's length dealings.
Under subsection 23FD(2), a private company dividend paid after 12 January 1987 to an approved deposit fund to which subsection (1) applies will not qualify for exemption under subsection (1) unless the Commissioner is of the opinion that it would be reasonable to exempt the dividend having regard to certain matters set out in paragraphs (a) to (f) of the subsection. These matters, which are directed at establishing whether the circumstances surrounding the payment of the dividends constitute exploitation of the fund's exempt status, are:
§the paid-up value of the fund's shares in the company (paragraph (a));
-this could be relevant, for example, when related to the paid-up value of other shares in the company and the dividends paid on the different shares;
§the cost to the fund of those shares (paragraph (b));
-it would be relevant, for example, to compare this cost with the value of the shares at the time of purchase;
§a comparison of the rate of the dividend paid on those shares with the rate of the dividend (if any) paid on other shares issued by the company (paragraphs (c) and (d));
§whether, and in what circumstances, shares in the company were issued to the fund in satisfaction of a dividend (paragraph (e)); and
§any other relevant matters (paragraph (f).
…
42. The Explanatory Memorandum to the 1987 Bill is also relevant because it confirms (at page 21) and as to subsection 23FD(2) that the matters listed:
… are directed at establishing whether the circumstances surrounding the payment of the dividends constitute exploitation of the fund’s exempt status.
…
43. Section 273 was introduced in 1989 by Taxation Laws Amendment Act (No. 2)1989. At that time, the exceptions mirrored the exceptions in section 23F referred to earlier, with paragraph 273(2)(a) also referring to “paid up value”.
44. In 1998, and in point of time after the events upon which the Respondent relies, paragraph 273(2)(a) was amended by Taxation Laws Amendment (Company Law Review) Act1998 to replace the words “paid-up value” with the word “value”. An examination of the amendments in 1998 suggests (and so the Applicant contends) that Parliament did not intend to alter the meaning of paragraph 273(2)(a), and that Parliament was concerned only to align the provision, and other similar provisions, with Corporations Law provisions which removed the concept of par value for companies.
45. These amendments were expressed in the relevant Explanatory Memorandum as being inserted to:
… ensure that existing provisions within the tax laws that are dependent on the concept of par value operate consistently with the policy underlying their operation under the current Corporations Law.
…
46. The relevant amendment was moreover expressed to be only a definitional amendment, not a substantive amendment – see paragraph 1.114 of the relevant Explanatory Memorandum. It is relevant in this context to note that in the Taxation Laws Amendment (Company Law Review) Act 1998, clause 63 which related in its terms to paragraph 273(2)(a) provided “omit paid up value; substitute value” whereas clause 30, in contrast, and in relation to paragraph 128, provided “omit nominal; substitute market”. Had Parliament wished to amend paragraph 273(2)(a) so as to ensure that “value” meant “market value”, it would have been easy enough to do so.
47. The Applicant contends that by force of sections 254C and 1444 of the Corporations Act 2001, the private company was deemed to be a company with shares with no par value. The Applicant contends further that the amount necessary to obtain a fully-paid share in the private company remained $1. Accordingly, $1 was the “paid up value” of each private company share within paragraph 273(2)(a) when they were acquired by the Applicant in 1995, and it remained the “value” under paragraph 273(2)(a) in the years that the dividends were paid.
48. Put in summary form and in relation to paragraph (a), the Applicant contends that the legislative amendment whereby “value” replaced “paid up value” was in fact no more nor less than a reference to the paid up value and being the expression which appeared in the section prior to the amendments designed to bring the legislation into line with amendments to company law.
49. The Respondent contends that the Applicant’s interpretation is not correct and that in fact the legislative amendments did go beyond a mere alignment between company and tax law. The Respondent’s argument in this context is encapsulated in clauses 92 to 98 of RS as follows:
92.Further, there exists a powerful textual consideration to the contrary of value meaning the issue price. If the legislature had intended to merely substitute “the amount necessary to acquire fully paid shares” instead of the existing “paid-up value of the shares” it could have used the expression and concept underlying sec 254X(1)(c) of the Corporations Act 2001, enacted at the same time as the amendments to sec 273(2)(a). By that provision the company must report to ASIC:
the amount (if any) paid, or agreed to be considered as paid, on each of those shares.
93.Even more compelling, at the same time and by the same Bill and subsequent Act, as the legislature amended sec 273(2)(a), it inserted in sec 6(1) of the ITAA 1936, a definition of the defined term “amount paid-up”. By Item 1, of Schedule 5 of Taxation Laws Amendment (Company Law Review) Act 1998 the following definition was inserted:
“amount paid-up” on a share means the amount (if any), including any premium, paid on that share.
94.In so far as shares might be issued partly paid, there was inserted a commensurate definition of any “amount unpaid” on a share.
95.Apropos the words of the learned Deputy President, if the legislative intention was merely to continue “the old concept … in order to see whether there are shares being issued at a hefty premium”, then the legislature could have used its newly defined term of “amount paid-up”. That defined term does the very work, as envisaged by the learned Deputy President, specifically picking up the issue at “a hefty premium”.
96.The failure to use the defined term, the “amount paid-up” on a share, introduced as it is, by the very same amending Act as had substituted “value” for “paid-up value” is, in the Commissioner’s view compelling.
97.The Applicant then says, “… if Parliament wanted to turn “value” or that word into “market value,” it would have done so”. The Commissioner says, if the Parliament wanted to turn “the paid-up value” into “the amount necessary to acquire fully paid shares” it would have used the defined term “amount paid-up” on a share.
98.Further, the contention of the Applicant is contrary to the established proposition that the word “value”, appearing on its own, means “market value”. Frequently an adjective is used with a view to achieving a more precise definition, for example, “actual value”, “assessed value” and “fair value”: see White & Co. Ltd v The City of Toronto [1955] 5 DLR 602-3 per Laidlaw JA (Ontario Court of Appeal).
…
50. The Tribunal is of the view that the term “amount paid up “and “paid up value” are not necessarily synonymous. The term “paid up value” in historical terms would generally have referred to the amount paid up on the relevant shares; the term “amount paid up” by contrast adds a reference to the premium element which would not, again in historic terms, have formed part of paid up value.
51. It must be remembered that the Committee was concerned inter alia with avoidance schemes which related in many cases to the issue of shares at par but which were designed to furnish access to substantial profits. It is thus not surprising that the reference to “paid up value” was inserted and remained for many years.
52. In summary then, the Tribunal has formed the view that the reference in paragraph (a) to value is not a reference to market value and that the Ruling is in this particular regard incorrect. However, the matter does not end there, in that market value may be relevant for the purposes of paragraph (b) and in accordance with the case law (and as to which we refer in the next succeeding Part) is relevant in respect of a consideration of paragraph (f)
PART F - The Case Law and in particular the Board of Review Cases
53. Part I of RS (clauses 46 to 70) contains a complete and admirable review of the Board of Review decisions which are relevant in this context. We have checked all aspects and are satisfied with the accuracy of all of its provisions. It is for this reason that we have drawn to some considerable extent on Part I of RS, but amplified and amended it in certain respects for the purpose of this Part F.
54. Following on from the enactment of subsection 23F(8) and its replacement provision in subsection 23F(16), a number of cases, generally concerning the 1966 year of income, came before each of the three Boards of Review.
55. In Case A38 69 ATC 225 at 226, a superannuation fund was established in April 1959. A year later, by April 1960, it had received contributions of $1,600, from which, the fund acquired “500 “A” shares of $2 each allotted at par” in a private company. In April 1960, the “net tangible asset backing” for the shares was $6.40 per each $2 share. Thus, the cost was less than 1/3rd of the value of the shares. In April 1966, some six (6) years later, the private company declared a dividend equally on all its issued shares. The No. 1 Board (Messrs Burke, Smith and O’Neill) said at [6] as follows:
…
Having regard to the matters specified in para. (a) to (e) of sec. 23F(16), it is against the claim for exemption of the dividend received from X Pty. Ltd. that the Fund obtained its shares for less than their fair value
…
56. Clause 6 of the decision in Case A38 then goes on to deal with other aspects not material to this decision and its reasoning is perhaps, and with respect, somewhat sparse. The reference in the part quoted to “fair value” is plainly a reference to market value.
57. In Case A39 69 ATC 227 at 228 the superannuation fund was established in October 1959. In April 1961, shares in the employer were allotted at par of $2 each. On that day, the net asset backing for the shares was $7, some 350% greater: the shares were acquired “for an outlay of $1,000 although the real worth of such interest was then in the vicinity of at least $7,000”. Dividends were declared in the 1966 tax year, that is, some five years later. At 228, paragraph [11], the No.1 Board said that:
…
In forming our opinion, the way in which we are influenced having regard to the matters specified in sub-sec. (16) is as follows: under paras. (a) and (b) we are influenced against an opinion favourable to the Fund because it got too great an interest in the company for too little an outlay …
58. Thus, the Board has considered the value of the interest acquired against both the “paid-up value” in paragraph 23F(16)(a) and its cost within paragraph 23F(16)(b).
59. In Case A40 69 ATC 229, the superannuation fund was established in June 1957. One year later in June 1958, the Fund acquired 5,500 shares of $2 each at par. At that time, “the net tangible assets backing for the 5,590 issued shares (which were all of the same class) was $5.56 per $2 share”. In the 1966 year of income, that is, eight years later, the private company declared a dividend equally across all shares. Submissions and calculations as to the yield per share were made and the No. 1 Board stated as follows:
…
However, to do that [yield on cost calculation] seems to us to do no more than emphasize that the shares allotted to the Fund at par had a net asset backing in excess of par with the consequence that the Fund got its shares cheaply, which is a circumstance to which regard may be had pursuant to para. (b) of the sub-sec. (16).
…
60. Thus, in the opinion of the No. 1 Board, the value of the shares is a relevant consideration regarded against the cost of the shares under sec 23F(16).
61. In Case B40 70 ATC 202, the superannuation fund was established in June 1960 and in July 1960 was issued with 200 “C” class shares in a private company at $2 each, being their par value. At the time of the establishment of the fund, the private company had acquired other shares “worth approximately £28,400”. Thus, for an outlay of $400, the fund had acquired a majority interest (200 out of 202 issued shares) in a company which held assets valued at $56,800.
62. In the 1966 year of income, that is, six years after the shares were acquired by the fund, a dividend was declared by the private company. At issue was whether it was reasonable in terms of subsection 23F(16) to exempt that dividend in the 1966 year in the hands of the fund.
63. The decision in Case B40 is important for a number of reasons. Firstly, it is a decision of a different Board of Review – in this case, the No. 3 Board. Secondly, the fund was represented by experienced counsel, namely, Mr I V Gzell, now Mr Justice Gzell of the Supreme Court of New South Wales. Thirdly, counsel for the fund, in substance and effect, presented an identical argument to that of the present Applicant (that is, it did not matter “a hoot” what the market value was). Thus, Mr Thompson, at 204, paragraph [4], recorded counsel’s argument as follows:
…
Counsel stressed the ordinary meaning of the paid-up value of shares in (a) as being its meaning in company practice, for instance, the paid-up value of a £1 share is £1, and does not mean the market value of the share. He further submitted that Board of Review No. 1 was in error in construing factors (a) and (b) together, with the result that it took into account the market value of the paid-up shares.
…
64. Mr Dempsey at 204, paragraph [22], (with whom Mr Thompson agreed) recorded that he was “unable to accept that argument” and that:
…
These paragraphs [sec 23F(16)(a) and (b)] have been included for a specific reason and if one adopts the view submitted by Counsel then they would be largely meaningless.
…
65. The Chairman, Mr Dubout, commenced by agreeing with counsel for the fund, that value and paid-up value in paragraph 23F(16)(a) has “no connotations of market value or real value or of value in any related sense”. But in the opinion of the Chairman at 203, paragraph [3], whatever was the meaning of the expression “paid-up value” in paragraph 23F(16)(a):
… it merely states a fact, and to make this paragraph effective, it must be read, in my opinion, as importing an idea of comparison.
…
66. According to the Chairman “paid-up value” in paragraph (a) permitted “a comparison with shares in that company held by persons other than the fund”. If that interpretation were not available under paragraph (a), “then undoubtedly the necessary comparison could be achieved by reliance upon para. (f)”. The matters in paragraphs (c), (d), and (e) were not raised in the case. But it was otherwise with paragraph (b) and “the cost to the fund of the shares”. Mr Dubout stated at 203-4, paragraph [4]:
…
Like the words “paid-up value” in para. (a), the word ``cost'' in para. (b) relates simply to a matter of fact. In isolation, the cost to the fund of the shares would seem to me to be an entirely neutral consideration. Again, as with para. (a), it seems that there is this implied notion of a comparison to be made, and one obvious comparison that suggests itself is a comparison between cost and value. If the language of para. (b) itself does not authorise such a comparison to be made, I have no doubt that the value of the shares would be a relevant matter within the meaning of para. (f) and that a comparison could be obtained by a reading together of the two paragraphs.
…
67. On the actual facts of the case the fund obtained the shares at a cost of “something less than one-fifth of their value”. That disparity between cost and value was a factor regarded by the No. 1 Board as “militating against the formation of an opinion favourable to a fund, and I agree that it should be so regarded”. The Chairman concluded at 204, paragraph [5]:
…
It is sufficient to say that in the circumstances of this case, the excess of the value of the shares over their cost to the fund was so great, and the fund thereby obtained so great an advantage, that I am not of the opinion that it would be reasonable to exempt the dividend from tax.
…
68. Mr Thompson referred to the decisions of the No. 1 Board and noted their view of considering paragraphs (a) and (b) together with the consequence “it was thought that the Fund got too great an interest in the company concerned by the allotment of shares for too small an outlay”. Mr Thompson described that disparity in value as “this important factor” and he concluded as follows at 205, paragraphs [6]-[7]:
…
In any event, whether or not this important factor comes within the language of factors (a) and (b) read together of sec. 23F(16) of the Act, I am clearly of opinion that it is relevant and should be considered under para. (f) above, which is cumulative to paras. (a) and (b) above, and speaks of any other matters that the Commissioner, and on reference, this Board, considers relevant. … It seems to me, therefore, that para. (f) casts a wide net, and catches all relevant matters. I have set out my view on this particular matter in more detail, out of respect for the detailed argument of Counsel for the taxpayer. Otherwise I agree with the reasons expounded by Mr. Dempsey, which I think accord in principle with the decisions of Board of Review No. 1 abovementioned.
I accordingly think that this important factor that the Fund acquired valuable shares at low cost must influence the Board to uphold the Commissioner's action in forming the opinion that the dividends received by the Fund should not be exempt from income tax.
…
69. Mr Dempsey, as the third member of the No. 3 Board, after setting out in detail the relevant facts of the case concluded at 206-7, paragraphs [22] and [24], that:
…
I consider it very relevant that for the purposes of having regard to paras. (a) and (b) one must look at these paragraphs together and when this is done then one sees what amount has been actually invested in the shares and what is the true value of this investment …
The fund was allowed to contribute £200 for 200 fully paid shares, thus giving it an equity on a valuation basis of over £24,000 for its investment of £200. Surely this is to be had regard to, as Board of Review No. 1 has consistently held. In any case, if it is to be ignored for the purpose of paras. (a) and (b) then I consider that under para. (f) it is a very relevant matter.
70. It will be noted in particular that Board was of the view that regardless of how value was to be interpreted for the purposes of paragraph (a) market value would always be relevant under paragraph (f).
71. So it was that the No. 3 Board of Review, when pressed with the argument by counsel that the “paid-up value” meant the company law concept of par value and that the market value of the shares was irrelevant, followed the view taken by the No. 1 Board. The disparity between cost and market value was an “important” and “very relevant factor”.
72. The Respondent contends (and the Tribunal agrees) that the reasoning of Mr Dubout is supported, by analogy, by the decision of Stephen J in Ord Forrest Pty Ltd v FCT (1973) 130 CLR 124. That case concerned two issues. Firstly, whether an allotment of shares was a “disposition of property” for gift duty purposes. Secondly, if so, was there any inadequacy of consideration for that allotment at par. On the second issue the taxpayer contended that “the allotment of a share at par or at any premium above par is inherently incapable of constituting a transaction for other than fully adequate consideration”. Stephen J, after referring to two English decisions, said at 129 that there was:
… no "lawyers' mystery" which requires that the par value of shares should be taken to be their actual value … [and] the rejection of par value as indicative of actual value is noteworthy.
…
73. As to whether there was adequacy of consideration, his Honour said the test was “a comparison of the value of what was promised or paid with the value of what was given”.
74. The comparison postulated by Stephen J as to any inadequacy of consideration mirrors the approach of the Board in comparing “cost” under paragraph 273(2)(a) and earlier provisions with the value of what was given.
75. In substance and effect, the argument advanced by counsel in Case B40 and the Applicant, was again pressed in Case E56 73 ATC 442. On this occasion it was to the No. 2 Board of Review. There the taxpayer contended that paragraphs 23F(16)(a) through to (e) were concerned exclusively with the terms of the terms on which the particular investment in private company shares was made. The No. 2 Board recorded at 446, paragraph [17], that:
…
We have given very careful consideration to the first submission and must confess that initially we were much attracted by it. There is a great deal of merit in the view that, since cl. (a) to (e) of sec. 23F(16) relate to matters of investment, cl. (f) should be restricted to similar matters. The reasons supporting such a view are obvious. Dividends from private companies may frequently represent more than a proper reward for capital invested. The flexibility provided by suitably drawn articles of association of a private company allows for the declaration of dividends by directors, rather than shareholders, for dividends to be attached to some only of the issued shares or for them to be paid in relation to issued, rather than paid-up, capital. These are but some of the matters which would permit an undue amount of company profits to be diverted to a superannuation fund. Such a practice is one which the Legislature could be expected to discourage even though it was prepared to exempt the other income of the fund. There are thus grounds for thinking that sec. 23F(16) in its entirety was intended to achieve this end and no other. If this were the first case of its kind to come up for consideration we would therefore be very inclined to adopt the submission made by the trustees' representative. However, the ambit of cl. (f) has been considered by Boards other than this on previous occasions [citations omitted] and a wide interpretation of the provisions has been consistently adopted. It is far too late now for a more restrictive view to be adopted. Accordingly, we are of the opinion that we should follow the interpretation of the provision adopted by the other Boards.”
76. The concepts underlying the decisions of each of the three Boards of Review, is in turn, picked up and repeated in the Explanatory Memorandum for the introduction of subsection 23FD(2).
77. In oral argument, the Applicant relied upon one Board of Review decision, namely, the decision of the No. 1 Board in Case M63 80 ATC 440. Properly understood, that case does not assist the Applicant’s argument and is, in fact, consistent with all of the earlier decisions and the Commissioner’s contentions herein. In that case, the taxpayer through its counsel, Mr D G Hill (later Mr Justice Hill), submitted that, as a fact, market value was paid for the shares and there was no acquisition on non-arm’s length terms. Counsel’s argument was recorded at 445, paragraph [16], of the Chairman’s reasons as follows:
…
For the Fund it was argued that sec. 23F(16)(a) was satisfied because all shares were fully paid, (b) was also satisfied because a proper “cost” was paid (see para. 14-15 above) and (e) was met since no shares had been issued in satisfaction of a dividend or part thereof.
…
78. The reference by the Chairman to “para 14-15 above” was a reference to the attempt by the Fund to adduce evidence of what the market value actually was. The opening sentence to [14] provides as follows:
…
In view of the fact sec. 23F(16) directs the Commissioner to have regard to, inter alia, the cost to the Fund of the shares on which dividends are paid evidence was led from a chartered accountant as to what would have been a proper arm's length valuation of the shares in the company as at each of the dates shares were allotted to the Fund.
…
79. That evidence was unsatisfactory because the valuation was done the day before the hearing, by the taxpayer’s accountant, who was unable to place before the Board “details of his calculations”. At 445, paragraph [15], the Chairman stated that he was “prepared to accept that shares allotted to the Fund were not allotted at any under value in relation to those allotted to other shareholders”. That is, in effect, he accepted there was no undervalue. Of course, that problem does not arise here because the Applicant does not now challenge the Respondent’s expert valuation and accepts that the shares were acquired at between 1/10th and 1/6th of their true value.
80. Within Case M63, the observations of Mr Fairleigh at 447, in paragraph [11] of his reasons, are important because he stresses the importance of the totality of the circumstances of acquisition as follows:
…
It will be noted that in sec. 23F(16) the circumstances of the issue of shares occur expressly in para. (e) thereof, and by implication in para. (b). The present significance of para. (f) thereof is that the relevance of the circumstances of acquisition of the shares is not confined to those set out in para. (b) and (e) of sec. 23F(16).
…
81. A consideration of the Board of Review decisions indicates that although in some instances the decision might perhaps have been more closely reasoned (and arguably Case A38 is an example), this was by no means so in respect of all of them. The Board of Review cases do establish that where the relevant shares were acquired for an amount which was much below market value, the decisions went against the taxpayer. In Case B40 an argument as to market value in relation to paragraph (a) was raised but without success. We refer also in this context to Case M63 and the argument raised by Mr Hill and the manner in which and the reasons why the decision went against the taxpayer.
82. We accept of course that Board of Review decisions are not binding on this Tribunal and that it would be open for us to hold that they were incorrectly decided. Leaving aside the truism that consistency in decision making is always desirable, we do not consider that the Board of Review cases were incorrectly decided and that the Boards concerned wrongly refused to exercise their discretionary powers in favour of the taxpayers. Moreover, the Ruling was issued in the context of those decisions and we note also that legislative amendments were made subsequently to those decisions and inferentially on the basis that their correctness was not disputed. Although we have come to the conclusion that value in paragraph (a) does not mean market value, we agree with the Boards of Review that market value was relevant for the purposes of paragraph (f).
83.
Dr Robertson sought to distinguish the Board of Review cases on the basis that they all involved a “controller” who had the power to do as he pleased and so that he could issue shares at par without reference to true value whereas in this case the Applicant or perhaps Mr H was not a controller in the same sense. We do not consider that this is a relevant distinguishing factor. The relevant shareholding was and is a shareholding in a company controlled by Mr C. Mr C was quite clearly a party to the arrangement whereby the relevant shareholding was sold by Mrs C to the Applicant for roughly 10% of its market value. There was plainly at that time a relationship between them which allied Mr H with Mr C. and which resulted in the sale of the relevant shareholding to the Applicant for so low a value and apparently without objection (and whether in accordance with rights of pre-emption if such rights existed) by the other shareholders in the private company; it is also possible that
Mr C, as controller of the private company, had the power to compel registration of the relevant transfer despite objections by other shareholders. Having regard to the fact that the evidence in 2008 was not satisfactory and in any event was to the effect that the price was equivalent to market value, the Tribunal cannot know what in fact occurred. There are references in the Applicant’s Statement of Facts and Contentions which might be thought to bear on this subject but to refer to them would not be apposite in light of the change in direction which the Applicant’s case took in June 2009.
PART G - Analysis of Section 273 and Related Matters
84. The thrust of Dr Robertson’s argument was that section 273 must be construed by focussing on the dividends paid during the relevant years and thus the circumstances obtaining in the relevant years on the basis that the acquisition of the relevant shareholding was at those times irrelevant. His contention was that it would not have mattered if the price had been even less or if the relevant shareholding was a gift. His argument in effect was that when one focuses on the dividends themselves one must accept that each dividend was paid to all shareholders on a pari passu basis and that there was no reference to any preference to any of them. Put another way and at the time when the dividends were distributed, there was no avoidance of any kind.
85. Mr McGovern contended that the acquisition of the relevant shareholding was material and important because it was the origin of dividends which, in relation to the relevant shareholding, were in all cases in excess of cost and by a significant margin. Mr McGovern drew an analogy with a dam from which water is obtained and where the Applicant obtained 10 hoses for the price of 1 and thus obtained 10 times as much water as he would have obtained had it paid a true market price.
86. We have previously noted that we consider that the value for paragraph (a) is not market value and that it means paid up value or par. That is so for historical reasons. At the time when the Committee reported, the avoidance schemes with which it was concerned involved in broad terms and in the main issues of shares at par which by one means or another allowed access to large profits.
87. As to paragraph (b), we consider that the reference to cost means that it must be taken into account as a relevant factor and as part of the overall deliberation. That consideration will probably and inevitably require a consideration by way of comparison with other values. It is possible that the other values will require consideration of the paid up value but market value will inevitably figure in the equation.
88. As to paragraph (c), we agree that the rate of dividend was such that all shareholders in the private company were treated on a pari passu basis. However, the term “rate” can refer to the rate of return to the Applicant and it was unquestionably enormous and in all the relevant years in excess of 100% of cost. As previously noted, the relevance of paragraph (d) is limited, even though it must be compared with paragraph (c) given that all shareholders in the private company received dividends at the same rate.
89. We have previously noted that paragraph (e) is not apposite. In relation to paragraph (f) we consider that the Board of Review cases were correctly decided and even though there was in some instances a lack of detailed reasoning.
90. Dr Robertson argued that if this decision is against the Applicant, the “tainting effect” arising from the acquisition of the relevant shareholding for much less than market value must have the effect that that tainting effect endures indefinitely, and that this consequence could not have been intended. On the basis that a consideration of section 273 may arise in respect of years subsequent to the relevant years the effect which is feared by the Applicant may be realistic but that is the effect of the section as drawn. It is worthy of note that it does not include words such as “to the extent that” or words of similar effect and thus permitting an apportionment, and so that the result will always be one which is “all or nothing”.
91. The starting point, as we have noted, is that private company dividends will be treated as special income unless the Commissioner (or the Tribunal standing in his shoes) considers that the discretion should be exercised in favour of the Applicant. It is incumbent on the Applicant to persuade the Commissioner or Tribunal and, to the extent that there is an onus, it has not been discharged.
92. The Tribunal agrees in relation to the Board of Review decisions that paragraph (f) does compel a consideration of market value and more particularly that market value is not, as Dr Robertson contended, irrelevant. Put in other words, the underlying transaction and which gave rise to the relevant dividends cannot be divorced from the dividends themselves in the manner for which the Applicant contends and must form part of the factual matrix to be considered in relation to the question of whether the discretion can or should be exercised.
93. For the reasons set out in this decision, the Tribunal does not consider that this is a case in which the discretion set out in section 273 of the 1936 Act can or should be exercised in favour of the Applicant and, in all the circumstances, the objection decision under review must be affirmed.
I certify that the ninety-three (93) preceding paragraphs are a true copy of the reasons for the decision herein of Mr J Block, Deputy President and Mr S E Frost, Member.
Signed: ..................................[sgd].......................................
AssociateDate/s of Hearing: 11-13 August 2008
11 February 2009
22-23 June 200921 August 2009
Date of Decision: 1 September 2009
Counsel for the Applicant: Dr M Robertson in succession to Mr B Sullivan SC and Mr M Richmond
Solicitor for the Applicant: Ernst & Young Law
Counsel for the Respondent: Mr D B McGovern SC and Mr I Young
Solicitor for the Respondent: Australian Government Solicitor
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